asian journal of economics and empirical research issn: 2409-2622 vol. 2, no. 1, 47-51, 2015 http://asianonlinejournals.com/index.php/ajeer 47 a methodological note on the construction of high frequency macroeconomic series: evidence from tunisia hathroubi salem 1 1 al-imam mohammad ibn saud islamic university, college of economics and administrative sciences, department of economics, riyadh, kingdom of saudi arabia abstract this work is licensed under a creative commons attribution 3.0 license asian online journal publishing group contents 1. introduction ............................................................................................................................................................................... 48 2. the combined qlf and blue method ................................................................................................................................. 48 3. proprieties of tunisian data .................................................................................................................................................... 49 4. generating high frequency series for tunisia ...................................................................................................................... 50 4. conclusion .................................................................................................................................................................................. 50 references ...................................................................................................................................................................................... 50 this note aims to formulate and to apply a combined method of the loss quadratic function of denton and the best linear unbiased estimator of chow-lin to construct quarterly data for tunisia. high frequency series for gdp and total investment are obtained from related series which exist in high (quarterly) and low (annual) frequencies for the period 1970-2013. tunisia began publishing quarterly gdp only since 2001q1. we use these series to compare our estimates to those published by the tunisian national institute of statistic (ins). results show that the combined method generates high quality quarterly series. key words: high frequency data, loss quadratic function, tunisian data. jel classification: c82. http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2015, 2(1):47-51 48 1. introduction applied macroeconomics, especially time series econometrics, are eager in data (data intensive method). the quality of estimation depends crucially on the series length because modern econometric techniques, such as vector auto-regression, consume many degrees of freedom in the estimation process. in developing countries, macroeconomic high frequency series are very scarce and usually unavailable. credible high frequency data are often required for econometric modeling and forecasting. this kind of data is useful to establish classical business turning points, assess the impacts of various government policies and external shocks. for example, ilzetzki and vègh (2008) noted that in order to study rigorously the cyclicality of fiscal policy, it’s highly recommended to use high frequency data (quarterly). in general, disaggregation methods, combine mathematical and statistical approaches. mathematical approach which has been developed by denton (1971) differs from statistical approach in that simulated data are not assumed to follow a specified statistical time series model. statistical modeling approach encompasses arima model based methods proposed by hillmer and trabelsi (1987) and state space models proposed by durbin and quenneville (1997). the choice of a particular method depends to a large extend on the information available for estimation and subjective preference or operational criteria. depending on the availability and the quality of benchmarking indicators, we usually distinguish three categories of temporal disaggregation methods: methods without indicators, methods with benchmarking indicators, extrapolation methods. in this article we are interested in the second category of methods. these methods lie on the hypothesis that the information contained in the quarterly benchmarking indicator is conform to that contained in the annual series. in developing countries and particularly in tunisia, most of the macroeconomic series are in annual frequency. the construction of high frequency series has been taken in the literature by chow and lin (1971), denton (1971) and fernandez (1981), and has been used by many economic institutions such as insee (france) bournay and laroque (1979), banque de france (1986) the oecd. to construct a quarterly data set for tunisia we use a combined approach of the quadratic loss function (qlf) of denton and the best linear unbiased estimator (blue) of chowlin. this approach can be summarized as follows: the construction of high frequency macroeconomic series (x) can be obtained from related series (z) on which data are available in both high and low frequencies. the procedure is to estimate regression coefficients, using annual totals of the dependent (y) and independent variables (z), and then apply these coefficients to the high frequency series to obtain preliminary higher frequency estimates of the dependent variable. as these estimates would not add up to the observed annual totals of the dependent variables, they are adjusted following the approach of denton (1971). the rest of the paper proceeds as follows. in section 2 we describe the combined qlf and blue method. in section 3 we study the proprieties of the series used. we set the unit root tests and the cointegration relationships. section 4 applies the qlf-blue method to a set of macroeconomic variables in tunisia. section 5 concludes. 2. the combined qlf and blue method assume that the low frequency series to be distributed =[ ] is annual series with k intraannual time period (k=4 in the case of quarters). let the observed high frequency series cover m years and consist of n = m k values. these series are represented in matrix form by [ ]. where [ ] i=1, 2……q are column vectors. the problem is to construct a new vector [ ] that: makes use of the information available from the zi’s , and satisfies the condition that the k values of the new series within each year sum to the observed annual totals for that year. assume that series to be estimated x, satisfies the relationship: (1) [ ]’ is a vector of unknown coefficients and is a random vector such that ( ) and ( ) = v. v is unknown and can’t be estimated directly. in order to estimate v one has to specify the process followed by the disturbances different forms have been taken in the literature. chow and lin assume that the quarterly errors follow an ar(1): with ( ) ( ) and| | . fernandez (1981) supposed that is a random walk and litterman (1983) formulated a markov-random walk which is an arima(1,1,0), and . more recently wei and stram (1990) have adopted the general case arima (p,q,d) but in practice they use one of the above three methods. then, the observed low frequency series, y, satisfies the relationship: z + (2) s = [ ] is an n m block matrix and where j is column vector in which each element is unity and 0 is a kdimensional null column vector. =[ ] if we look to construct quarterly data. asian journal of economics and empirical research, 2015, 2(1):47-51 49 fernandez (1981) formulated the qlf method of denton and the blue method of chow-lin as follows: we minimize a quadratic loss function in the difference between the series to be created x and a linear combination of high frequency series z. subject to the constraint . the program can be written { [( ) ( )] (3) a is a symmetric n n non singular matrix such that: where ( ) [ ] is a square matrix which converts the values of x and z to first differences. the solution for x and of the program (3) are: { ̂ [ ( ( ) ) ] ( ( ) ) ̂ ̂ ( ) ( ( ) ) [ ̂] (4) ̂is the general least square (gls) estimator by regressing the annual values of high frequency series on the low frequency series y. ̂is the estimator of the high frequency for the dependent variable (y) and consists of two components. the first, z ̂ applies the estimated regressing coefficients ̂ to the observed high frequency series of explanatory variables. the second is an estimate of the vector ( ) of residuals obtained by distributing the annual residuals [ ̂] with the matrix ( ) s( ( ) ) . this method of generating data avoids the introduction of artificial discontinuity between the last period of one year and the first period of the next. the step problem occurs when benchmark to indicator ratio changes dramatically from year, given that the indicator that is used in the distribution process grows at different rate from the benchmark. 3. proprieties of tunisian data 3.1. unit roots test in order to avoid spurious regressions, we first study the proprieties of the series. in tunisia, most of the macroeconomic series are integrated of order one. in particular, using the adf test, we verify that gdp, total investment and all the related series are integrated of order one. in order to have stationary and serially uncorrelated series we transform the series considered by the study to first differences. unit roots tests for annual data are presented in table 1and table two presents the same tests for quarterly related data. table-1. unit root tests of annual series 1970-2013. variable adf level 1 st differences gdp -2.283 -4.523 ipi -2.541 -4.416 i -2.073 -5.092 ce -1.984 -3.873 ice -2.352 -4.625 table-2. unit root tests of quarterly series 1970-2013. variable adf level 1 st differences ipi -2.731 -5.503 ce -2.014 -4.356 ice -2.276 -4.082 results of table 1 and table 2 show that all the variables have a unit root. adf test shows that they are first difference stationary. we can then look for stationary combination between variables in level through co-integration relationships. to generate quarterly data for nominal gdp 1 we use the industrial production index (ipi) as a related series for which annual and quarterly frequencies data are available. this is judicious because industrial production is an important share of the tunisian domestic product and because there exist a co-integration relationship between the two variables. the quarterly series of total investment (i) is constructed using two related series which are total credit to the economy (ce) and the importation of capital equipment (ice). this relationship could hold in tunisia where financial market is still not well developed. most of the firms’ activity is still financed by the banking system through short and long term credit. also, tunisia is not an industrialized economy and the totality of capital goods is imported. in order to corroborate this idea we verify that the three series are co-integrated using the lambda max and the trace tests of johansen (1988). 1 we use nominal series for two objectives. first, to allow the user of the generated series, to choose the adequate deflator according to his goals. second, using nominal series gives the possibility to compare generated series to the quarterlynominal series published by the ins since 2000. asian journal of economics and empirical research, 2015, 2(1):47-51 50 3.2. cointegration relationships in order to generate suitable quarterly data we verify that there exist co-integration relationships between the dependent variables and the related series at low frequency. in this objective we use the trace statistic and the maximum eigenvalue statistic. the trace statistic for the null hypothesis of r cointegrating relations is computed as: ( | ) ∑ ( ) where k is the number of endogenous variables and is the largest i th eigenvalue. the maximum eigenvalue statistic which tests the null hypothesis of cointegrating relations against the alternative of no-cointegrating relations is computed as: ( | ) ( ) results are reported in table 3. they indicate that the gdp and the industrial production index (ipi) are cointegrated and there exist a long relationship between investment (i) and the two related series, credit to the economy (ce) and the importation of capital equipment (ice). table-3. johansen cointegration tests cointegration relationship lrtr lrmax gdp, ipi 32.65 12.65 32.65 11.87 i, ce, ice 40.35 10.13 40.35 10.04 critical value 5% 29.68 15.41 29.68 14.07 lr test indicates one cointegration equation for each relationship. the null hypothesis of no-cointegration is rejected at 5% critical value. these cointegration relationships allow to use related series to generate high frequency series of the dependent variables, namely gross domestic product and investment. 4. generating high frequency series for tunisia the procedure has been implemented using r© cran software package. in order to compare our quarterly generated series for gdp 2 to those published by the tunisian national institute of statistic (gdp true) beginning at 2001, we use the mape criterion as follows: ∑ | | . the calculation gives a value of mape= 1.4%. this means that the method adopted generates high frequency data with an error equal to 1.4%. we can see also through the plot that the two series are almost similar. little differences are certainly due to the lack of information contained in the related series. figure-1. true gdp (pibins) and generated gdp (pibtri) 4. conclusion in this paper we have generated quarterly tunisian data using a combined method of the loss quadratic function of denton and the best linear unbiased estimator of chow-lin. the generated series are useful for macroeconomic studies especially those which are interested with fluctuation and cyclicality. for example, most of the researchers agree nowadays that the study of the cyclicality of fiscal policy needs high frequency data. references banque de france, 1986. méthode de trimestrialisation. cahier economiques et monétaires, 23: 39 42. bournay, j. and g. laroque, 1979. réflexions sur la méthode d’élaboration des comptes trimestriels. annales de l’insee, 36: 3-30. chow, g. and a.l. lin, 1971. best linear unbiased interpolation distribution and extrapolation of time series by related series. review of economic and statistics, 53(4): 372-375. denton, f., 1971. adjustment of monthly or quarterly series to annual totals: an approach based on quadratic minimization. jasa, 66(1971): 99-102. durbin, j. and b. quenneville, 1997. benchmarking by state space models. international statistical review, 65(1): 23–48. fernandez, r., 1981. a methodological note on the estimation of time series. review of economics and statistics, 63: 471-476. 2 the generated quarterly series for nominal gdp and total investment (i) in millions of tunisian dinars on the period 1970-2013 are available from the authors upon request. asian journal of economics and empirical research, 2015, 2(1):47-51 51 hillmer, s. and a. trabelsi, 1987. benchmarking of economic time series. journal of the american statistical association, 82(december): 1064-1071. ilzetzki, e. and c.a. vègh, 2008. procyclical fiscal policy in developing countries: truth or fiction. nber working paper wp no. 10780, september. johansen, s., 1988. statistical analysis of cointegration vector. journal of economic dynamic and control, 12(2-3): 231-254. litterman, r.b., 1983. a random walk-markow model for the distribution of time series. journal of business and economics statistics, 1(2): 169-173. wei, w.w.s. and d.o. stram, 1990. disaggregation of time series models. journal of the royal statistical society. series b, 52(3): 453-467. views and opinions expressed in this article are the views and opinions of the authors, asian journal of economics and empirical research shall not be responsible or answerable for any loss, damage or liability etc. caused in relation to/arising out of the use of the content. asian journal of economics and empirical research issn: 2409-2622 vol. 1, no. 1, 24-28, 2014 http://asianonlinejournals.com/index.php/ajeer 24 an exploration of trend in internet usage and perception of information credibility among indian post graduate students sandhya rai accurate institute of management & technology, greater noida, india abstract this work is licensed under a creative commons attribution 3.0 license asian online journal publishing group 1. introduction the internet services were launched in the year 1995. the state owned videsh sanchar nigam limited (vsnl) was the first one to launch it and was the only player for the first four year. according to internet service provider association of india (ispai) in the first year the broadband usage shows a growth of 20% per month. in november 1998, the entry of private service operators was allowed by the government. since then the internet usage is increasing rapidly day by day. internet has impact in each and every area including higher education and research. the table given below (table 1) shows the growth in the internet usage throughout the world. table-1. worldwide internet users 2005 2010 2013 world population 6.5 billion 6.9 billion 7.1 billion not using the internet 84% 70% 61% using the internet 16% 30% 39% users in the developing world 8% 21% 31% users in the developed world 51% 67% 77% estimate. source: international telecommunications union. (source http://www.internetworldstats.com/asia/in.htm) there has been a gradual increase in the internet user and india is not far behind. it is the third topmost country with respect to internet users and is expected to leave usa behind by the end of 2014. the internet mainly offers two benefits to its users, communication and information. according to asemi (2005) the source of information available on the internet is increasing day by day. this growth of information in quantity and variety via the internet has implication for how it is used in education. it would be inappropriate to talk about the internet growth without the taking its use in education. we all are aware that students in all the different countries are using the internet for information and communication. however we yet do not know how the indian post -graduate students are using the internet. this paper is an effort to find out the usage pattern among the post graduate students in the indian institutes. 2. literature review internet has become a way of life for the college going students. for most of them it not just is a tool that helps them to share their views and be in contact with their fellow students and mentors but they also use interne to get internet services have become very popular worldwide and india is not different. since its launch in the year 1995, india is the third largest country in the world in terms of number of internet users. there are lot many studies about the use of internet among the student community worldwide but not much had been studied about the internet usage and perception of information credibility among the indian students. this study had been conducted to study it. also the popular sources used by the indian post graduate students for the search were studied. the research also tries to find out if there is any difference between the usage pattern of the internet in term of gender. the perception of the students towards the credibility of the information available on the internet had also been studied. keywords: internet, postgraduate students, surf, e mail, information, random search, wi-fi, brad band. http://creativecommons.org/licenses/by/3.0/ http://en.wikipedia.org/wiki/list_of_countries_by_number_of_internet_users http://www.internetworldstats.com/asia/in.htm asian journal of economics and empirical research, 2014, 1(1): 24-28 25 information about their studies and complete a wide range of projects. according to asan and koca (2006), usun (2003) the internet is popular among the students for a number of reasons, it reduces time lag between the production and utilization of the knowledge. it also promotes international cooperation and exchange and promotes multidisciplinary research. laurillard (1992) in his studies has found that computer based learning can increase the understanding of the theoretical and technical concepts. this concept was also supported by dryli and kinnaman (1996) who found that internet do enable the students to find out information and expert. he also found that the internet helps the students in developing critical thinking. schleyer et al. (1998) in their study found that the internet users in dentistry used the internet for discussion of clinical cases and for obtaining diagnostic and therapeutic information. they also use it for procuring dental products and communicating with patients. bao (1998) studied the seton hall university students and found that 40.27% of the students were using internet on daily basis. it was also found that both the faculty and the students uses the internet for the academic and non-academic purpose charp (2000) who found from his studies that internet has brought about a positive change in the teachers and the instructors. there are many surveys on the use of internet world wide. hoffman et al. (2000) found that internet usage is most prevalent among the youngsters. odell et al. (2000) in their study about the use of internet among the college students found that male and female students uses the internet in different ways. there was a gap between the use of internet among the male and the female students. the study by korgen et al. (2001) about the difference in the internet usage among different race and ethnicity students found that the internet use is affected by the presence of absence of computer in the country of origin. jagboro (2003) studied the use of internet in africa and found that majority of the postgraduate students are using the internet. it was the fourth most important source used by the students to search the material. george et al. (2006) in their research have found that in usa most of the information search at the university was basically through the internet. most of the students were found to be using google for their search. mishra (2009) in his study about the use of internet at the university of maiduguri, nigeria found that for close to 61% of the respondents internet was very important, 75% were using it for research and google was the most popular search engine. there are many more studies like that of john lubans (1998), rena et al. (2007) that show the use of internet among the students. in india studies were conducted on the use of internet among the students. a study conducted by kaur and manhas (2008), on the use of internet service and resources in the engineering colleges of punjab and haryana found that all the respondents makes frequent use of internet as they have access to it either in the college or at homes. in the research it was found that more than 75% of the students were using the internet services for the educational and research process and google and yahoo were the most popularly used search engines. another study conducted by malik and mahmood (2010) about the web search behavior of students of the university of punjab found that 59.9% of the students used the internet to search the material of their interest, google was the most popular search engine followed by yahoo. the major constrain that these students’ faces with respect to then use of internet was slow speed and information overload loading to more of poor and irrelevant information. though lots of studies about the use of internet among the students in different countries have been found, there is no research about the use of internet among the indian postgraduate students, especially the management students. the present study is an effort the find out the usage of internet among the management students. 3. scope of study the scope of this study is limited to the students studying in the delhi ncr region. this region consists of students from all the different nook and corner of the country. all the students surveyed were the student of the post graduate program in management (post graduate diplomas in management or master of business administration). the survey was conducted in the summer of 2014 4. objective of study the research was conducted with the following objectives in hand i. to study the pattern of use of internet among the post graduate students. ii. to find out the purpose for which the internet is used most of the time. iii. to find out the device used for the internet connectivity most frequently. iv. to find out if there is any gender difference in the average use of internet. v. what is the opinion of the students toward the credibility of the information available on the internet? 5. hypothesis h10= there is no significant association between the gender and the frequency of use of internet. h1a= there is a significant association between the gender and the frequency of use of internet. h 20 = there is no significant association between the gender and average time spent per day on internet. h 2a = there is a significant association between the gender and average time spent per day on internet. h 30 = there is no significant association between the gender and the purpose for which the internet is used. h 3a = there is a significant association between the gender and the purpose for which the internet is used. h 40 = there is no significant association between the gender and the kind of information preferred on the internet. h 4a = there is a significant association between the gender and the kind of information preferred on the internet. 6. research methodology in this study a questionnaire was used to conduct the study. before administering the questionnaire the validity of questionnaire was tested with a focus group interview. the questionnaire’s reliability was tested by test re-test method on 50 students. for this a pilot study was conducted. after this the final questionnaire was constructed which asian journal of economics and empirical research, 2014, 1(1): 24-28 26 was administered to 500 students. but of these questionnaires only 469 were returned and 18 questionnaires were found to be unsuitable due to incomplete information only 451 questionnaires were found suitable and the study is based on the analysis of these 451 questionnaires. 7. data analysis and findings 7.1. demographic profile of the respondents a total of 451 respondents were surveyed, of these 385 were male and 66 were females. most of the students surveyed were in the age group of 20-25 years, 92% students were in this age group also 91.8% students were found the be using the internet on their own laptops or desktops and 4.7% were using it on their mobiles. only 3.5% students were using other sources like cyber café or friends laptops for it (table 2) table-2. variables particular frequency percentage gender male 385 85.4 female 66 14.6 age 20-25 years 415 92 25 years and above 36 8 usage instrument own computer/ laptop 414 91.8 mobile 21 4.7 others (café/ friends computer) 16 3.5 internet skill very high 118 26.2 high 212 47.0 fair 121 26.8 source of internet broad band 104 23.1 data card/ 3g 311 69 wi-fi of campus 29 6.4 cyber cafe 7 1.6 it was also found from the study that 26.2% students consider themselves as having very high internet using skills and 47% consider it to be only high at the same time 26.8% consider themselves to be having fair internet skills. 7.2. the pattern of usage of internet when the students were asked how frequently they access internet, 90.5% says that on daily basis whereas only 1.8% students use the net once a week. it is a routine task for the students to use it. the study also indicate that the students are spending a considerable amount of time on internet, most of them were spending more than 3 hours per day on internet (39%) whereas only 6.2% were spending less than an hour on daily basis. all the 100% students were found using google as the search engine. (table 3). table-3. variables particular frequency percentage usage frequency daily 408 90.5 twice a week 35 7.8 once a week 8 1.8 others 0 0 time spent less than an hour 28 6.2 1-2 hour 123 27.3 2-3 hour 117 25.9 more than 3 hours 176 39.0 other ( as required) 7 1.6 search engine used google 451 100.0 7.3. the purpose for which the internet is used most of the time when the students were asked about the purpose of using internet, most of the time it was emails (31) followed by random search (29.5), 14.4% students were found using it for chatting and only 11.8% use it for research projects. the percentage of students using it for music or videos is far more than the percentage of students using it for e books. 11.5% students were found to be using internet for music or videos whereas only 1.8% uses it for ebooks. most of the students preferred the material in the form of soft copy only. (table 4) table-4. variables particular frequency percentage purpose e mail 140 31.0 random search 133 29.5 chatting 65 14.4 research projects 53 11.8 ebook 8 1.8 music / videos 52 11.5 form of information preferred soft copy 392 86.9 printed 59 13.1 7.4. device used for the internet connectivity most frequently most of the students (69%) were found to be using data card or 3g services for internet connectivity followed by broad band connection (23.1%). there were 6.4 percent students who use wi-fi of the college/ institute/ university campus to surf the net.( table 5) asian journal of economics and empirical research, 2014, 1(1): 24-28 27 table-5. variables particular frequency percentage source of internet broad band 104 23.1 data card/ 3g 311 69 wi-fi of campus 29 6.4 cyber cafe 7 1.6 7.5. to find out if there is any gender difference in the average use of internet for achieving this objectives four hypothesis were made. these hypotheses were tested using the chi square test. the result of the chi square test was as follows: for hypothesis 1 h10= there is no significant association between the gender and the frequency of use of internet. h1a= there is a significant association between the gender and the frequency of use of internet. table-6. test statistics gender how frequently do you use internet chi-square 2.256e2a 664.874b df 1 2 asymp. sig. .000 .000 a. 0 cells (.0%) have expected frequencies less than 5. the minimum expected cell frequency is 225.5. b. 0 cells (.0%) have expected frequencies less than 5. the minimum expected cell frequency is 150.3. the test statistics results shows that null hypothesis is not rejected, thus there is no significant association between the gender and the frequency of use of internet. thus each of different gender people are using the internet in there own way, the usage frequency of internet is independent of gender of the student. (table 6) h 20 = there is no significant association between the gender and average time spent per day on internet. h 2a = there is a significant association between the gender and average time spent per day on internet. table-7. test statistics gender how much time do you spend everyday chi-square 2.256e2a 221.140b df 1 4 asymp. sig. .000 .000 a. 0 cells (.0%) have expected frequencies less than 5. the minimum expected cell frequency is 225.5. b. 0 cells (.0%) have expected frequencies less than 5. the minimum expected cell frequency is 90.2. for this hypothesis also since the test statistics shows p value less than 0.05, the null hypothesis is not rejected, thus we can conclude that there is no significant association between the gender and average time spent per day on internet. (table 7) h 30 = there is no significant association between the gender and the purpose for which the internet is used. h 3a = there is a significant association between the gender and the purpose for which the internet is used. table-8.test statistics gender for what purpose do you use internet most frequently chi-square 2.256e2a 175.488b df 1 5 asymp. sig. .000 .000 a. 0 cells (.0%) have expected frequencies less than 5. the minimum expected cell frequency is 225.5. b. 0 cells (.0%) have expected frequencies less than 5. the minimum expected cell frequency is 75.2. the test statistics for this hypothesis shows that the pvalue is less than 0.05, hence null hypothesis is not rejected, and therefore there is no significant association between the gender and the purpose for which the internet is used. any gender person can use the internet for any purpose. h 40 = there is no significant association between the gender and the kind of information preferred on the internet. h 4a = there is a significant association between the gender and the kind of information preferred on the internet. table-9. test statistics gender what kind of information do you prefer chi-square 2.256e2a 245.874a df 1 1 asymp. sig. .000 .000 a. 0 cells (.0%) have expected frequencies less than 5. the minimum expected cell frequency is 225.5. the result indicated that there is no significant association between the gender and the kind of information preferred on the internet. people of all the different gender prefer a mix of information.(table 9) asian journal of economics and empirical research, 2014, 1(1): 24-28 28 7.6. perception of students towards the information credibility on internet when students were asked about their perception towards the authenticity of the information available on the internet, 36% says that they have occasionally faced the problem of data authenticity. that mean they have not received the authentic data. only 8.4%students says that they frequently faced the problem of data authenticity. (table 10) table-10. data authenticity frequency percent valid percent cumulative percent valid very rarely 15 3.3 3.3 3.3 rarely 88 19.5 19.5 22.8 occasionally 163 36.1 36.1 59.0 frequently 147 32.6 32.6 91.6 very frequently 38 8.4 8.4 100.0 total 451 100.0 100.0 8. findings and conclusions the research indicated that most of the students were using laptops for surfing the internet followed by using it on mobile. hence we can conclude that the laptops are more popular among the students fort he surfing, mobile phones are used only in emergencies. also they all do not have internet connectivity on their mobiles. google was found to be the popular search engine all the 100% students surveyed were using google for the search. more than half of the students were having data card, which they use for surfing the internet, hence they do not depends upon their college/ hostel/ accommodation place for the internet connectivity, they want to have freedom of surf. email and random serach wre the main reason for the students to use internet. this concludes that many times they are hooked to internet without any purpose and are busy for the random search looking for the information. also the study do not find any significant difference in the average time spent by male and the female students, this indicates that all the students are spending on an average more than three hours per day on the internet checking mails and doing random search. also no significant difference was found between the male and the female students on the frequency of use of internet and the information searched , thus they all were using the internet daily and were also using it to search information research projects, e-mails, random searches. most of the students were facing the problem of not getting authentic or accurate data, this may be because most of them are not having a very high internet usage skill. references asan, a. and n. koca, 2006. an analysis of students attitude towards internet, 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http://www.sociology.org/content/vol005.003/korgen.html http://www.lubans.org/docs/1styear/firstyear.html http://www.webology.org/2009/v6n2/a70.htm http://firstmonday.org/htbin/cgiwrap/bin/ojs/index.php/fm/article/viewarticle/2301/2118 http://www.ncbi.nlm.gov/enterz/query.fcgi?cmd=retrieve&db=pubmed&list_uids=9854927&dopt=abstract asian journal of economics and empirical research vol. 4, no. 2, 68-74, 2017 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2017.42.68.74 68 assessment of the enterprise risk management (erm) in the nigerian banking industry chris o udoka1  akaninyene billy orok2 ( corresponding author) 1,2department of banking and finance faculty of management sciences university of calabar, nigeria abstract this study aimed at evaluating enterprise risk management practice by deposit money banks in nigeria. evolving from the research were three specific objectives which were reconstructed into research hypotheses. the hypotheses investigated the relationship between objections and challenges faced by nigerian banks, government policy, risk and acceptance of enterprise risk management by nigerian banks. the study utilized an ex-post facto design. a sample of 374 respondents extracted across six geopolitical zones in nigeria responded to a re-validated 5 points likert scale questionnaire. data extracted from the collection was evaluated using ordinary least square ols regression analysis. the study revealed that various challenges of practicing banks significantly influences the level of acceptance and implementation of erm in nigeria, the government policies on erm has a direct and significant relationship on the practice of erm by players in the industry and that the practice of erm has positively influenced the performance of the nigerian banks that have accepted and implemented erm. the study recommended that apex institution should devise a strategic plan and framework to help banks in the implementation of enterprise risk management since it has been adjudged to be the industry best practice in line with basel iii accord. keywords: enterprise risk management, government policy, challenges faced by banks adoption of enterprise risk management. citation | chris o udoka; akaninyene billy orok (2017). assessment of the enterprise risk management (erm) in the nigerian banking industry. asian journal of economics and empirical research, 4(2): 68-74. history: received: 8 december 2015 revised: 10 january 2017 accepted: 20 september 2017 published: 21 october 2017 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 69 2. literature review ............................................................................................................................................................................ 69 3. research methodology ................................................................................................................................................................... 71 4. data presentation and data analysis .......................................................................................................................................... 71 5. summary of finding, conclusion and recommendations ....................................................................................................... 73 references .............................................................................................................................................................................................. 73 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://orcid.org/orcid-search/quick-search?searchquery=chris o udoka https://orcid.org/orcid-search/quick-search?searchquery=akaninyene billy orok https://orcid.org/orcid-search/quick-search?searchquery=chris o udoka https://orcid.org/orcid-search/quick-search?searchquery=akaninyene billy orok https://orcid.org/orcid-search/quick-search?searchquery=chris o udoka https://orcid.org/orcid-search/quick-search?searchquery=akaninyene billy orok asian journal of economics and empirical research, 2017, 4(2): 68-74 69 1. introduction managing risk is important function for business organisations dealing with money, which includes banks and insurance firms. the complications arises from the evaluation of the future outcome of monetary investments and underwriting of such investments over time. these variations must be managed purposely in order to minimize or completely eliminate losses. theories relating to management of risk in corporate firm advocates value addition to firms, through risk management practices (klimczak, 2007). again, devastating economic and financial crises in the world has demonstrated the importance of risk management to corporations and financial regulators globally. this can be inferred from the 1772 credit crises triggered from scotland, spreading across europe to america resulting in boston tea party protest and a revolution in america. also devastating was the wall street crash of 1929 that ignited the great depression peaking in 1933. of course, the most recent is the financial crises of 2007 2008 that culminated in the collapse of major financial institutions. recently, risk governance is seen as pivotal to bank management evidently with more emphasis being placed on senior executives and management. it is however, still farfetched with banks as new structures are envisaged and processes evaluated in this direction. again new tools of risk management is advanced and problematic areas is still evident. with the trend of renewed focus, it could have been expected that considerable investments in risk management will yield advanced results. this is not so with the perceived challenges of information gathering and technological advancement. some professionals in the discipline of risk management surmise that financial crisis emanated from the failure of the corporate world to embrace erm globally, suggesting that the acceptance and implementation of erm may forestall reoccurrence (senior supervisors group, 2009). recent years has witnessed increasing organizations accepting the concept of erm as an avenue to strengthen risk management. while risk management is seen as the process which an organization is able to analyses risk inherent in their operations and develop measures to reduce or completely avoid occurrence of such risk (pyle, 1997); (nocco and stulz, 2006) viewed erm “as a process that identifies, assesses and manages individual risks (e.g. currency risk, interest rate risk, reputational risk, legal risk, etc.) within a coordinated and strategic framework”. erm symbolizes a profound movement from the conventional approach of evaluating risks individually to managing risk holistically. accordingly, erm stresses looking at risks collectively and not individually. banks are complex financial institutions involve in intermediation process with risk such as credit risk, interest rate risk, market risk, systemic risk, performance risk, operational risk as well as liquidity risk. the need to institutionalize erm in the banking industry translates to the fact that each components of risk must be treated collectively. again, the standard measure of portfolio risk (markowitz, 1952) under portfolio theory evaluates the standard deviation of the different risk components in order to establish risk-return trade off that is acceptable to the organization with their set objectives. erm proposes that risk management decision cannot be centralized but will entail an integrated framework that incorporate branches. this scientific measure requires business managers in banks to balance their risk appetite and the capital investments as well as anticipate the value of anticipated losses and balance it with the available liquidity at their disposal from customers, investors and regulators. it is this framework or holistic approach to management of banks’ risk that forms the premise of this paper. the article is arranged into four sections. first, the theoretical background and review of relevant literature of erm has been reviewed. a brief of several banking industry events including their impact have been added. the lack of literature in valuing the performance of erm is described. the hypotheses of the study are explained. second, the data evaluated in the study is scrutinized including their scope and the methodology of analysing data is proposed. third, the analysis of data is recapitulated and the findings discussed succinctly. the fourth section captures the concusion drawn from the study. 1.1. statement of the problem the recent banking reforms in nigeria that culminated in the increased capitalization equipped them with strong positions to play a vital role in supporting the rapid economic growth. however, there is a great concern as to the level of their readiness in meeting new business and regulatory requirements. banks still need a readjustment of their internal processes to accommodate the requirement for erm assessment (beasley et al., 2010). this involves making adequate provision for training of staff and risk officers which could translate to huge cost for the organization. again, a good erm framework requires robust it structure, and this requires guidance and banks are still struggling with implementation. the complexity of banking transactions is also a critical problem confronting effective implementation of risk management in an enterprise wide approach. kerstin et al. (2014) describe this complexity in terms of dynamic changes or volatility, ambiguity of cause and effects of risks, uncertainty and disarrays surrounding banking institutions. hence, it is envisaged that it will take longer for nigerian banks completely integrate with the current international trend in risk management. 1.2. research hypothesis in the investigation, the following hypothesis will be tested; h1: challenges of erm has no significant impact on the adoption of erm in nigerian banking industry h2: government policy has no significant relationship with the adoption of erm by nigerian banks h3: the impact of erm on nigerian banks has no relationship with banks adoption of erm 2. literature review 2.1. concept of enterprise risk management (erm) neo-classical theory of finance (ncft) opines that an organization’s specific risk has no impact on the firm and that only the firm’s asset returns co-varies with the combination of assets. under the capital asset pricing model (capm), this covariance measured by beta is said to be important. this suggests that adoption of erm adds no value to firms and stakeholders. however, this perception contradicts the increased acceptance of erm in the banking industry. nevertheless, impact of erm on the value of banking firms and shareholders has rarely been empirically evaluated (lai et al., 2011). asian journal of economics and empirical research, 2017, 4(2): 68-74 70 in the perfect and complete market condition, the neo-classicalist holds that there is full disclosure of facts regarding risks that investors are exposed to with regards to the operations of the firm. this means that corporate and individual investors can mitigate the organization specific risk just like individual organizations with their asset combinations. as a result, management of risks by the firm will not differ in terms of value creation with respect to what investors are able to do for themselves. again, this assertion is clearly opposed to the concept of corporate risk management (lai et al., 2011). to disprove this proposition of ncft, researchers in corporate risk management delve into compartmental cost that is associated with mitigation of corporate risk structure. for example (doherty, 2000) while evaluating integrated risk revealed that risk gravitate towards increase taxes and of course could be potential costs of financial distress. moreover, considering evaluating an organization with a risky cash flows, creditors and shareholders have divest interest and seems to be in contention. lai et al. (2011) considers what constitute determinants for organizations engaging in risk management, adding that such determinants are in line with the firm’s value maximization hypothesis. this we could therefore consider as fundamental of value maximization hypothesis supporting application of erm in corporate organizations globally. few financial propositions supporting the implementation of erm in an organization includes financial distress cost hypothesis, lower tax burden hypothesis, costly external financing hypothesis and agency problem hypothesis. 2.1.1. financial distress cost hypothesis in as much as there are many justification for risk management, one key motive is to hedge against financial distress cost. while there exist evidences to support the proposition that organizations engage in evaluation and control of risk in their likelihood of suffering some kind of losses in distress, [cummins, phillips and smith] insisted that the corroboration is not convincing for firms other than financial institutions. again, a study by [wall and jpringle] supported evidence that organizations with low leverage would rather consider derivative options as alternative risk management swap than organizations with higher credit rating. opler and titman (1994) using debt ratio of organizations established also that a companies’ financial leverage is related to possibility of financial distress. [andrade and kaplan] supported the work of opler and titman (1994); jensen (1989); wruck (1990) and ofek (1993) reported that financial leverage can be utilized to advantage of distress cost. 2.1.2. lower tax burdens hypothesis empirical research by nance et al. (1993) revealed that non-financial firms recording investment tax that were considerable high contracted derivative transactions – a form of risk evaluation and control. the study by [cummins, phillips and smith] presented another convincing argument in support of the tax hypothesis. they maintained that taxes burdens was a factor that determine the organizations decision to utilize derivative options as a measure of risk management. 2.1.3. costly external financing hypothesis studies reveals that firms involves in risk management by adopting derivatives as a means of achieving stability of internal financing mechanism in order to reduce differences in the firm’s income. myers (1984) and hubbard (1998) in the study of capital market imperfection and capital structure, stressed that financial models relating to capital market analysis shows that financing an organization from external sources is more expensive than internal financing options. this ensures adequate availability of internal funds within the organisation for more attractive and comparatively high yielding transactions. internal financing, therefore stands out as a more veritable option over the external sources because of its relative pricing. the investigation as in [gay and nam] showed evidences that firms other than financial institutions with low liquidity rating and relatively high expansion propositions, expressed by the ratio of the market value and replacement value adopts derivatives options hedging. in their study, nance et al. (1993) found that these institutions are highly disposed to use derivative to forestall unwarranted events of giving up transactions with high returns because of lack of internal funding. 2.1.4. agency problem hypothesis reference [cummins, phillips and smith] argued that managers had an economic incentive to ensure the firm continued to do well in that they had disproportionately large investments in the forms of their skills or human capital in the firm. it would be costly to transfer these skills should they need to seek other work. as such, managers were concerned about any negative shocks to profits which might result in putting the firm into financial distress or the edge of bankruptcy. bankruptcy and times of financial distress often led to the replacement of current management. this posed a huge personal risk that could not be easily diversified away like what shareholders could. 2.2. review of related literature the risk prevalent in business organization portents that the organization face business losses or events that are injurious to their performance (udoka et al., 2014). these risks are endemic to the achievement of the business overall objectives and furthermore the existence of organization. while operational risk covers the internal strength and weakness of the organization, strategic risks evaluates and mitigates the opportunities and threat confronting the organization, in this case nigerian banks considering the level of completion. “enterprise risk management (erm) is the process of planning, organizing, leading and controlling the activities of an organization in order to minimize the effects of risk on an organisation’s capital and performance” (stulz, 2004). erm is a means of ensuring the efficient itemization, analysis and evaluation of all meaningful risks of an organization. it takes into consideration all the conventional areas of risk, and also strategic and operational risk (head, 1978). asian journal of economics and empirical research, 2017, 4(2): 68-74 71 erm and internal control system (ics) works hand-in-hand in organizations since ics is integral structure of controls in an organization put in place by the board to ensure that transactions are conducted in line with established policy to forestall loss of assets, integrity and completeness of documentations (ozor, 2010). again, ics is established within the framework of management policies to ensure that manipulations and errors are easily and quickly detected from the system (barnes, 2004). erm implements systematic and organized means of managing the totality of risks in an organization (koontz and bradspies, 2002). risk management therefore can be seen as an integral and important framework that will help in increased revenue and profit. this is so because every undetected avenue of revenue losses are prevented with implementation of holistic risk evaluating system in the organization. it also connects operations conforming with operational policies that invariably translates to better performance and performance leads to sustainable profitability and growth. the advocacy of erm in banks centers on managing the objectives of the banking business. these include firstly achievement of the level of capital that will sustain the current businesses as well as future expansion opportunities, secondly maximization of the returns for investors given the risk inherent in every transactions; and finally, sustaining capital adequacy and statutory risk governance as established by authorities and rating agencies (acharyya, 2009). few literature on risk management relates to characteristic of erm (liebenberg and hoyt, 2003; beasley et al., 2005). there is however, very narrow empirical evidence to substantiate the impact of implementation of erm in banking. lai et al. (2011) proposed erm framework consists of fourteen implementation elements deemed to be relevant and important to define the intensity, maturity, and penetration level of erm practices. the fourteen elements cover seven aspects of the very essence of erm implementation namely, (i) erm definition, (ii) effective communication of risk and responsibilities, (iii) philosophy of erm, (iv) risk identification and response, (v) compliance, (vi) risk quantification, and (vii) performance measurement. empirical evidence also shows that risk management enhances shareholder value (allayannis and weston (2001)); carter (mayers and smith (1982); smith and stulz (1985) and froot et al. (1993); hoyt and liebenberg (2011); and phillips et al. (1998). ernst and young (2010) undertook an evaluation of risk management internationally using key senior executives of about 40 banks. in their findings, just fourteen percent respondents confirmed that their organizations have fully adopted the proposition of erm across their departments and similar components. they maintained that most of the banks have not completely implemented bank-wide risk management. dabari and saidin (2015) evaluated the present position of erm by nigerian banks utilizing a data from 722 respondents, found that risk components threatening banks impacted significantly on present disposition of banks to erm practice, and few banks in nigeria abided incompletely with erm framework established by central bank of nigeria. other studies include (donwa and garuba, 2011; owojori et al., 2011; kolapo et al., 2012; njogo, 2012; fadun, 2013; ajibo, 2015). 3. research methodology the research design to be adopted for this study is ex-post facto approach or causal comparative design. according to kerlinger (1973) ex-post facto is a systematic empirical enquiry in which the scientist does not have direct control of independent variables because they are inherently not manipulable. in effect, there will be no manipulation of the independent variables used in this study. the population of this study consisted of credit risk managers and operational risk managers in commercial banks in nigeria. information from the central bank of nigerian reviewed that there are a total of 20 commercial banks with a total of 5692 branches. stratified random sampling technique was used to select the required sample of the study. firstly, nigeria was stratified into six geopolitical zones. three of the six geopolitical zones were randomly selected and used for the study. 3.1. model specification the model specification involves the determination of the dependent and explanatory variables based on a specific theoretical expectation of the sign and the size of the parameters. the functional relationship between the variables can be expressed thus: ad = f(ch) ad = f(gp) imp = f(ad) transforming into mathematical equation we have ad = a0 + a1 ch + u, ad = b0 + b1 gp + u imp = c0 + c1 ad + u where ad= adoption ch= challenges gp= government policies imp= impact 4. data presentation and data analysis this section is concern with the presentation of data gathered for the study as well as analysis and discussion of 4.1. data analysis in this section each hypothesis will be restated in the null form and the variables identified asian journal of economics and empirical research, 2017, 4(2): 68-74 72 hypothesis one challenges of erm has no significant impact on the adoption of erm in nigerian banking industry the dependent variable in this hypothesis is adoption of enterprise risk management while the independent variable is the challenges faced by the banks. linear regression was used to evaluate the hypothesis and result presented in table 1. the result in table 1 shows an r2 value of 0.91 which implies that about 91 percent changes in adoption of enterprises risk management could be caused by challenges faced by banks. the adjusted r2 value of .0876 means that the model is 87 per cent goodness fit. the f-value of 64.8 which is greater than the critical f-value of 3.14 at 1 and 371 degrees of freedom indicates that relationship between challenges faced by banks and the adoption of enterprise risk management by banks is significant. again, the estimated coefficient for challenges is positive, and can be interpreted that there exist a direct relationship between challenges face by banks and the adoption of enterprise risk management by banks. this result is in order with economic a priori condition. the result is statistically significant at both 5 and 10 percent level of significant. table-1. regression results of the relationship between challenges face by banks and adoption of enterprise risk management dependent variable: adoption of enterprise risk management (erm) variable estimated coefficients standard error t-statistic pvalue constant 22.118 .798 27.732 .000 ch .018 .004 4.50 .072 r = 0.964 r-square = 0.911 adjusted r-square = 0.876 f – statistic = 64.828 durbin watson statistic = 2.781 source: author computations hypothesis two government policy has no significant relationship with the adoption of erm by nigerian banks the dependent variable in this hypothesis is adoption of enterprise risk management while the independent variable is government policy. linear regression statistical technique was used to test the hypothesis. the result is as presented in table 2. table 2 shows an r2 value of 0.813 which indicates that about 81 percent changes in the adoption of enterprise risk management could be caused by government policy. this means that the remaining 19 percent changes in the dependent variable adoption of enterprise risk management could be caused by other variables not found in the equation represented by the error term. the adjusted r2 value of .79 means that the model is 78 per cent well fitted. the f-value of 16.8 which is greater than the critical f-value of 3.14 at 1 and 371 degrees of freedom confirms that the three exist a significant relationship between government policies and the adoption of enterprise risk management by banks. the estimated coefficient for gp is positive, meaning that there exist a direct relationship between government policies and the adoption of enterprise risk management by banks. this result is in order with economic a priori condition. the result is statistical significant at 10 percent level of significant. table-2. regression results of the relationship between government policy and the adoption of enterprise risk management by banks dependent variable: adoption of enterprise risk management variable estimated coefficients standard error t-statistic pvalue constant 20.016 .937 21.357 .000 mral .152 .059 2.598 .042 r = 0.867 r-square = 0.813 adjusted r-square = 0.794 f – statistic = 16.89 durbin watson statistic = 1.681 source: author computations hypothesis three the impact of erm on nigerian banks has no relationship with banks adoption of erm. the dependent variable in this hypothesis is the impact on bank performance while the independent variable is adoption of enterprise risk management. linear regression statistical technique was used to test the hypothesis. the result is as presented in table 4. table 3 shows an r2 value of 0.783 which indicates that about 78 percent changes in bank performance could be caused by adoption of enterprise risk management. this means that the remaining 22 percent changes in the dependent variable bank performance could be caused by other variables not found in the equation represented by the error term. the adjusted r2 value of .76 means that the model is 76 per cent well fitted. the f-value of 12.56 which is greater than the critical f-value of 3.14 at 1 and 371 degrees of freedom confirms that the three exist a significant relationship between adoption of enterprise risk management and the performance of banks. the estimated coefficient for ad is positive, meaning that there exist a direct relationship between adoption and bank performance. this result is in order with economic a priori condition. the result is statistical significant at 5 percent level of significant. asian journal of economics and empirical research, 2017, 4(2): 68-74 73 table-3. regression results of the relationship between adoption of enterprise risk management and its impact on bank performance dependent variable: bank performance variable estimated coefficients standard error t-statistic pvalue constant 20.246 .500 40.521 .000 ad .138 .031 4.446 .000 r = 0.817 r-square = 0.783 adjusted r-square = 0.764 f – statistic = 12.56 durbin watson statistic = 1.262 source: author computations 5. summary of finding, conclusion and recommendations 5.1. summary of the study this study investigated enterprise risk management in nigerian banking industry. three research objectives were formulated and transformed into hypotheses. the hypotheses investigated the relationship between challenges faced by banks, government policy, risk and adoption of enterprise risk management by nigerian banks. ex-post fact research design was adopted for this study. a sample of 374 respondents were selected and used for the study. a well validated structured questionnaire was used for data collection. data collected was analyzed using ordinary least square regression. result of the findings revealed that. 1. that various challenges faced by practicing banks significantly influences the level of adoption of erm in nigeria. 2. the government policies on enterprise wide risk management has a direct relationship on the adoption of erm by players the industry 3. that the adoption of enterprise wide risk management practice has positively impacted with the performance of the nigerian banks that have adopted erm. 5.2. conclusion and recommendations we can conclude from the discussion on enterprise wide risk management (erm) which centred on proposition of the modern financial theory (neo-classical finance theory) on the efficiency of erm. while ncft repudiates the proposition of strategy theory, their argument equally differs from the classical theory (i.e. markowitz) in this respect. nevertheless, as bettis (1983) put it approproately: “to alter either result is to disrupt significantly the logical structure of the underlying discipline”. but then, how can an absolute interpretation be made to justify the difference and possible to show a point of convergence? it is important therefore to seek theoretical association among the schools of thoughts, viz the classical finance theory, neo-classical finance theory, and strategy theory. our erm framework, hence, endeavours to provide such linkage having shown the positive influence of erm on the performance of banking in support of the ncft. the research shows that such impact results from the government effort in policy formulation that supports erm. again the challenges experienced by industry participants validates the position of the classical theory. in view of the above assertion, the study recommended that: 1. apex institution should come up with a strategic plan for banks to help banks in the implementation of enterprise risk management since enterprise risk management framework has been adjudged to be the industry best practice in line with basel iii accord. 2. supervisory framework should be involved in the building of enterprise wide risk management implementation by banks in order to reduce the attendant cost and encourage banks as a measure to forestall future financial crisis. 3. finally, the directors of banks and policy makers should be on the forefront of the adoption or erm in order to strengthen the enforcement framework and strengthen individual banks. references acharyya, m., 2009. 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https://scholar.google.com/scholar?hl=en&q=financial%20distress,%20reorganization,%20and%20organizational%20efficiency https://scholar.google.com/scholar?hl=en&q=financial%20distress,%20reorganization,%20and%20organizational%20efficiency http://dx.doi.org/10.1016/0304-405x(90)90063-6 asian journal of economics and empirical research issn: 2409-2622 vol. 3, no. 1, 25-31, 2016 http://asianonlinejournals.com/index.php/ajeer 25 an exploration of sustainable customer value and the procedure of the intelligent digital content analysis platform for big data using dynamic decision making shen-tsu wang1 1 department of commerce automation and management, national pingtung university taiwan, province of china abstract the dynamic parasuraman, zeithaml and berry (pzb) service quality model is applied in the analysis of different customer clusters of sustainable customer value, while considering enterprise sustainability, customer relationship management (crm), and customer equity of customer satisfaction and customer value. based on intelligent digital content analysis and the recommendation platform of the different customer clusters of sustainable customer value, the dynamic six-sigma method is applied to the leisure agriculture of sustainable key resources and procedures solutions, as well as the impact of environmental and social costs and benefits. based on the leisure agriculture of sustainable key resources and procedures solutions, the sustainable contradictions of leisure ecotourism agriculture are considered using dynamic multi-criteria decision making (dynamic gray multi-attribute decision making and dynamic multi-objective planning) to analyze the optimal plan for balancing the leisure agriculture of ecotourism and sustainable contradictions. first, sustainable and local identification plans are developed by the dynamic grey multi-attribute decision making method. next, dynamic multi-objective planning is developed, as based on the priority factors sorted by gray multi-attribute decision making, in order to carry out the decision-making analysis of different objectives under different situations; thereby, helping the development of featured sustainable customer value of local leisure agriculture. keywords: intelligent digital content analysis and recommendation platform, dynamic decision making, sustainable customer value, local leisure agriculture contents 1. introduction ......................................................................................................................................................................... 26 2. research method ................................................................................................................................................................. 26 3. conclusion and future studies ........................................................................................................................................... 29 references ................................................................................................................................................................................ 29 citation | shen-tsu wang (2016). an exploration of sustainable customer value and the procedure of the intelligent digital content analysis platform for big data using dynamic decision making. asian journal of economics and empirical research, 3(1): 25-31. doi: 10.20448/journal.501/2016.3.1/501.1.25.31 issn (e): issn (p): 2409-2622 2518-010x licensed: this work is licensed under a creative commons attribution 3.0 license funding: this study received no specific financial support competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained ethical: history: this study follows all ethical practices during writing. received: 28 november 2015/ revised: 31 december 2015 accepted: 4 january 2016/ published: 8 january 2016 publisher: asian online journal publishing group http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.25.31 http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.25.31 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.25.31 http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.25.31 asian journal of economics and empirical research, 2016, 3(1): 25-31 26 1. introduction the value proposition (schaltegger et al., 2012) which refers to the value transmitted to customers through the work flow of different industries providing products or services, must be distinguished from competitors. the value proposition is the dialogue between providers and receivers, which includes the value provided by products, as well as balancing social, environmental, and economic needs (boons and lüdeke-freund, 2013). the value proposition can drive the buying motive (jam and jam, 2011) and highlighting the value proposition is a sort of market strategy, where the work flow and ability to provide must be considered. tangible and intangible ecological, social, and economic values are highlighted and measured by the value proposition (hlava and camlek, 2010; boons and lüdeke-freund, 2013). the value proposition of sustainable enterprises must mediate public and personal interests in order to avoid conflicts. the important concept of sharing value creation is to respect the customers' needs, rights, and interests, to increase product and service values through a management model, and to create value for customers, enterprises, societies, or environments (chiang, 2010; yen et al., 2011; liu et al., 2012; yu et al., 2012; chiu and lin, 2013; yen and chen, 2013; lee et al., 2014). as taiwan will be confronted with contradictory decisions regarding economic growth and environmental protection in the key processes of technology development and innovative design, this study constructs a dynamic decision model for building an environment with sustainable development, which considers sustainable and locally identified pingtung leisure agricultural ecology. the new market management model, which competitors cannot imitate, is integrated with the perpetual customer value perspective (cvp) in order to develop a sustainable optimization scheme of dynamic decisions for success, where sustainable key resources and sustainable key work flows are analyzed by dynamic six-sigma to create an innovative dynamic process for analyzing business models. this study uses the dynamic pzb service quality model to analyze the sustainable customer values of different customer groups, including customer clustering according to tourism motives and the favorite leisure agriculture type of customer groups, and considers enterprise sustainability, crm, customer equity of customer satisfaction, and customer value. the sustainable key resources and sustainable key work flow of leisure agriculture will be analyzed by the dynamic six-sigma method, as based on sustainable customer values of different customer groups, in order to select the leisure farm scheme, which includes the four major systematic leisure agriculture schemes in pingtung district, according to the leisure agricultural resources classification scheme and knowledge scheme with local culture characteristics, and the effects on environmental and social costs and interests are analyzed. finally, the sustainable contradiction content of leisure agricultural ecological tourism is considered based on sustainable key resources and sustainable key work flow of leisure agriculture, where the optimal schema of leisure agricultural ecological tourism and sustainable contradiction are analyzed by dynamic multi-criteria decision making (dynamic gray multi-attribute decision making and dynamic multi-objective planning), which consider the sustainable contradiction content of leisure agricultural ecological tourism. the sustainable and local identification optimal service plans are developed using dynamic gray multi-attribute decision making; dynamic multi-objective planning is developed using the priority factors sorted by dynamic gray multi-attribute decision making; the decision analysis of different objectives is implemented in different situations; and the leisure agriculture strategy is analyzed according to the dynamic view, in order to provide local leisure agriculture providers with decision references, as described in figure 1 (johnson, 2010; asif et al., 2011; gimenez et al., 2012; liu and kuo, 2012; robinson and boulle, 2012; cheshmehgaz et al., 2013; rahardjo et al., 2013; chang, 2013a; 2013b; ji et al., 2014; oztaysi, 2014; steyn and niemann, 2014; thai et al., 2014; wolf, 2014). sustainable customer value crm (customer group classification), customer equity (customer satisfaction and customer value). sustainable key resources low-carbon tourism criteria, leisure motive, leisure benefits. sustainable key work flow scenario, result, action. decision making: select leisure agriculture plan. sustainable optimization plan sustainable contradictions of leisure agricultural ecological tourism (environmental aspect, economic aspect, social aspect). digital content analysis and recommendation dynamic six sigma method environmental and social costs/benefits dynamic gray multi-attribute decision making dynamic multi-objective planning dynamic pzb service quality model figure-1. this research structure source: (wang et al., 2011; cheng et al., 2012) 2. research method this project uses the dynamic pzb service quality gap model to analyze the sustainable customer value of different customer groups, including customer clustering according to the tourism motive and favorite leisure agriculture type of customer groups, considers enterprise sustainability, crm, and customer equity of customer satisfaction and customer value, crm and customer equity, and the developing leisure agriculture, such as a flourishing enterprise. this study uses the dynamic pzb service quality model to analyze sustainable cvp, including tourism planning goods or leisure combinations, which can assist customers to attain their goals in an environmental, reliable, rapid, and economical manner. in addition, it describes how leisure agriculture uses specific resources to asian journal of economics and empirical research, 2016, 3(1): 25-31 27 create sustainable value for different customer groups (carrasco et al., 2012; chen and mo, 2012; kuo and chou, 2012; lin and lin, 2012; liou et al., 2012; lo et al., 2013; shih and yang, 2013; su et al., 2013). afterwards, based on the sustainable customer value of different customer groups, the sustainable key resources and sustainable key work flows of leisure agriculture are analyzed using the dynamic six-sigma method in order to select leisure agriculture plans, including four major systematic leisure agriculture plans in pingtung district, a knowledge plan with local culture characteristics according to the leisure agricultural resources classification plan, and their effects on environmental and social costs and benefits are analyzed. the sustainable key resources and sustainable key work flows are analyzed by the dynamic six-sigma method, which emphasizes that, at the dynamic six-sigma quality level, customer requirements set specific specification limits and the key index for measuring project performance. while the processes of leisure agriculture are fixed, customer requirements and markets are dynamic and uncertain, which is a condition that degrades service quality level. the dynamic six-sigma method does end when a project is completed, but continuously makes goods and services meet the leisure agriculture service flow of sustainable customer value. leisure agriculture provides value for customers and itself through key assets, technologies, activities, routine business practices, and repeated use and dynamic adjustments of leisure agriculture, in order to satisfy the work flow of sustainable cvp, thus, becoming the competitive advantage of leisure agriculture to fulfill the customer's actual key job to be completed. the key management model tells a story, including origin, story line, participant motive, special transition, windfall, and subsequent extension. all new stories are derived from local historical allusions, and the differences and attractions, as found by human resources of leisure agriculture and fisheries, are used as important resources, which are integrated into moving and exciting stories in order that different customer groups are moved by emotional marketing and experiential marketing (magretta, 2002; magretta and stone, 2002). these resources are integrated through the reliable, rapid, and economical method of johnson (2010) to complete the business personally conducted by customers, attract customers to leisure agriculture in order to experience particular environments different from hotels or home stay facilities, and continuously and steadily provide profit, to guarantee the optimum and sustainable operating conditions of leisure agriculture (wang et al., 2011; wu, 2011; cheng et al., 2012; cheng, 2012a; cheng, 2012b; lin and tsui, 2013). 2.1. intelligent digital content analysis and recommendation platform for big data with the coming of the digital age, the digital content possessed by various blog websites is duplicated, and how website operators provide intelligent and customized help for busy modern people to find the desired articles out of numerous blog articles becomes an important subject. this paper proposes a complete personal digital content recommendation technology architecture, as based on content correlation analysis, with three user quantitative indices, which are preference, community closeness, and article freshness, in order that the digital content service platform can improve the users’ digital reading experience. the overall recommendation architecture is as shown in figure 2 which shows the basic structure of personal digital content recommendations of a travel blog website. the "digital content database" is the data of blog articles in the backend of blog websites, the "user behavior record" is the browsing history of the user on the blog website, and the "intelligent analysis and recommendation platform" comprises the following modules (cheng and wu, 2013; lim and zhu, 2016): (1) "content correlation analysis module": to analyze the correlation of data in the "digital content database" of a blog website. (2) "user preference analysis module": to analyze user's preference according to the "user behavior record" of a blog website. (3) "community closeness analysis module": to analyze the community closeness between users according to the "user behavior record" of a blog website. (4) "article freshness analysis module": to analyze the freshness of each article according to the article publication time and the number of clicks from the "digital content database" of a blog website. (5) dea calculated overall performance: the overall performance of three analysis modules is calculated by dea. figure-2. intelligent digital content analysis and recommendation platform for big data source: (manzardo et al., 2012; lee et al., 2014) asian journal of economics and empirical research, 2016, 3(1): 25-31 28 the personal digital content recommendation technology platform, as proposed in this paper, can generate the analytical data of a multi-user quantitative index, in order that the blog website can create an intelligent personalized recommendation service centered on users. this service not only approaches the user's personalized requirements, but also helps the website increase the user's stay time and visiting frequency to the blog website. finally, a leisure agriculture plan is selected according to the sustainable key resources and sustainable key work flow, where the sustainable contradiction content of leisure agricultural ecological tourism is considered, the sustainable optimization plan is analyzed by multi-criteria decision making, and the sustainable and local identification optimal service plan is developed, in order to assist pingtung district to develop local leisure agriculture. leisure agriculture and type of operation with sustainable customer value are analyzed by multi-criteria decision making (gray multi-attribute decision making and multi-objective planning). this study uses gray multiattribute decision making to select the optimal implementation plan, and then uses the priority factors, as sorted by the optimal implementation plan, to analyze the most important profit objectives of multi-objective planning according to different situations: the revenue model, cost structure, target unit profit, and developing the constraints (hsu, 2011; tai et al., 2011; wei, 2011a; wei, 2011b; golmohammadi and mellat-parast, 2012; luo and wang, 2012; manzardo et al., 2012; zhu and hipel, 2012; zhang et al., 2013; wang et al., 2013a; chang, 2013a; 2013b; wang et al., 2013b; oztaysi, 2014). leisure agriculture is usually commerce and interest oriented, where the cultural aspect of sustainable operation takes cultural protection and popularization as the main implementation objectives; therefore, there are constant conflicts, meaning it is urgent to integrate the leisure agriculture of sustainable customer value with culture. it involves the actual application of culture and natural resources, ethics of the tourism industry, local capacity construction, and exact maintenance of community spirit. only a combination of the leisure agriculture of sustainable customer value and culture can guarantee effective implementation of policies, where culture shall be redefined as the key to a developmental strategy, in order to merge justice and respect into local society and maintain cultural diversity and locality. therefore, sustainable leisure agriculture requires a holistic method to promote high cooperation, coordination, and integration of all participants at various levels. in many ways, sustainable leisure agriculture is the competition for and allocation of limited resources, thus, it requires a political solution to break the balance point between tourism and existing and future processes. just as some professionals' query the feasibility of sustainable development, there are three views on the practical application of sustainable development to leisure agriculture, including completely believing that sustainable development is applicable to leisure agriculture, believing that sustainable leisure agriculture with environmental, social, and economic objectives can be jointly executed; secondly, specific thoughts denying the common development of sightseeing and social environments, where the former is perfect. finally, facing existing challenges, the negative significant impact of sightseeing development is accepted, determines the full necessity of sustainable development, and is devoted to an overall integrated coordination strategy of sightseeing development and environmental protection (hsu, 2011; tai et al., 2011; wei, 2011a; wei, 2011b; golmohammadi and mellat-parast, 2012; luo and wang, 2012; manzardo et al., 2012; zhu and hipel, 2012; zhang et al., 2013; wang et al., 2013a; chang, 2013a; 2013b; wang et al., 2013b; oztaysi, 2014). 2.2. loss function the end product of decision making under risk is determined by the adopted plan and the state of uncertain factors. therefore, before uncertain factors are determined, the expected loss or revenue is estimated only according to probability. in bayesian decision analysis, each combination of a plan and a natural state  ,i jg  has a corresponding reward or loss, called the loss function. the loss function  ,i jl g  represents the loss in actual state j after action ig is taken according to the decision making rule   ix g  when the decision maker observes sample x . the probability  j  corresponding to each state j is the weighted average of weights, where the expected loss of plan ig is expressed as eq. (1) (chien, 2007; alessi and detken, 2014; zinodiny et al., 2014).      , ,i i j j jel g l g         (1) whether or not to adopt plan is determined according to decision rule, where the sample value meeting condition must be observed before plan is implemented. therefore, the actual loss function of plan and state is, where all meeting the decision rule and the probability of being from state shall be considered, thus, can be changed to the function of, as expressed by eq. (2).         , , , ji j i j i x l g l x g p x x x x g           (2) where   j p x is the likelihood function of x under j  , the decision rule   ix g  is given, and eq. (1) is substituted in eq. (2) to obtain the expected loss of plan ig , as expressed by eq. (3).        , ji j i j x el g l x g p x                  (3) when natural function j and sample x are continuous values, the expected loss is deduced integrally, as expressed by eq. (4).        ,i i x el g l x g p x dx d               (4) the decision maker can determine the expected loss of each plan according to eq. (3) or (4), and the minimum asian journal of economics and empirical research, 2016, 3(1): 25-31 29 expected loss is the optimal plan. 2.3. dynamic multi-objective planning the multi-objective planning vector optimization, i.e.  1 2max , ,..., pz z z z , is usually a set of points instead of a single point, as expressed by eq. (5). therefore, the general multi-objective planning normal formula is n variables, m constraints, and p objectives (wang, 2005; tzeng et al., 2007; arturo et al., 2010; tsai et al., 2010; cheshmehgaz et al., 2013).      1 2 1 1 2 2 1 2 1 2max , ,..., , ,..., , , ,..., ,..., ( , ,..., )n n n p nz x x x z x x x z x x x z x x x    (5) 1 . . , 1,2,..., 0, 1,2,..., n ij j i j j s t a x b i m x j n       where  1 2, ,..., nz x x x is the objective function, and 1 2, ,..., pz z z are p single objective functions. one or multiple solutions are calculated under max z optimal vector. dynamic multi-objective planning can select different multi-objective planning decision-making styles according to the environment and the decision maker’s preference of dynamic conditions. the real non-inferior solution set to be deduced by multi-objective planning without preference has infinite solutions, and the solutions will not end in practice. therefore, the analyzer uses parametric programming to estimate several representative non-inferior solutions, and uses these non-inferior solutions as alternative schemes of decisions, in order to provide the decision maker with related suggestions. in terms of multi-objective planning with preference, when the decision maker's preference is known beforehand, the solving process is simpler than multi-objective planning without a preference; however, as the decision maker's preference shall be obtained in advance, its use is limited, and because it is difficult to obtain a decision making preference, the range of application is greatly reduced. when interactive multi-objective planning is used, the decision maker must be aware of reducing some target values in exchange for another target value in order to reach the optimal solution, thus, as the objective function of the interactive tchebycheff method is not limited to linear functions, it can be applied to nonlinear integer programming (wang, 2005; tzeng et al., 2007; arturo et al., 2010; tsai et al., 2010; cheshmehgaz et al., 2013). according to the ek analysis of dea, the maxz analysis of el(gi), and the multi-objective before and after the introduction of this method in figure 3 there is apparent improvement after the introduction of this method. figure-3. before and after introduction of this method source: this study 3. conclusion and future studies this study develops dynamic multi-objective planning and digital content recommendation and analysis, and implements decision analysis for leisure agriculture according to different scenarios, in order to assist leisure agriculture to develop local leisure agriculture with sustainable customer value. it is intended that this method can be used in different types of sustainable development plans for the service industry. references alessi, l. and c. detken, 2014. on policymakers loss functions and the evaluation of early warning systems: comment. economics letters, 124(3): 338-340. arturo, a.r., a. 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estimation of the multivariate normal mean vector under balanced loss function. statistics & probability letters, 93: 96-101. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 165 asian journal of economics and empirical research vol. 5, no. 2, 165-172, 2018 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2018.52.165.172 the relationship among economic growth, trade, unemployment, and inflation in south asia: a vector autoregressive model approach anh tru nguyen1 1the university of newcastle level 6, new space, 409 hunter street, newcastle nsw 2300, australia abstract the article aims to investigate the causal relationship among economic growth, exports, imports, unemployment, and inflation in five developing countries in south asia for the last two decades (1997-2016) using a var model. we found that gdp has a negative relationship with inflation, while imports positively affect inflation in south asian countries. results demonstrated that there are no directional causalities between gdp, exports, imports, and unemployment rate and other variables in the short run. in contrast, there is a directional causality between inflation rate and other variables in the short run. we also found that there is a long-term relationship among economic growth, exports, imports, unemployment, and inflation in south asia. lastly, policies are recommended in order to ensure economic growth and a sustainable development in the south asia. keywords: economic growth, trade, unemployment, inflation. jel classification: e02, o11, o47. citation | anh tru nguyen (2018). the relationship among economic growth, trade, unemployment, and inflation in south asia: a vector autoregressive model approach. asian journal of economics and empirical research, 5(2): 165-172. history: received: 18 june 2018 revised: 22 august 2018 accepted: 25 september 2018 published: 19 october 2018 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 166 2. empirical literature ...................................................................................................................................................................... 166 3. research methodology ................................................................................................................................................................. 166 4. results and discussion ................................................................................................................................................................. 167 5. conclusions ..................................................................................................................................................................................... 171 references ............................................................................................................................................................................................ 171 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2018.52.165.172&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/256 https://orcid.org/0000-0002-3345-2009 http://asianonlinejournals.com/index.php/ajeer/article/view/256 https://orcid.org/0000-0002-3345-2009 http://asianonlinejournals.com/index.php/ajeer/article/view/256 https://orcid.org/0000-0002-3345-2009 asian journal of economics and empirical research, 2018, 5(2): 165-172 166 1. introduction south asia has been seen as the fastest growing region in the world. inflation of this region has increased because of vibrant economic activities and higher oil prices. although economic growth in destination markets, exports present a low performance, while imports are growing sharply (world bank, 2018). this region has to deal with macroeconomic vulnerabilities. for example, fiscal deficits and public debt are higher than those of other regions. despite capitalization levels of the region’s banking systems appear generally adequate, underlying financial vulnerabilities are a matter of concern (imf, 2018). most of south asian countries export textile, readymade garments, leather, and agricultural products, while the majority of petroleum and capital-intensive goods are imported. consequently, trade between south asian economies is likely to be more competitive rather than complementary. further, the region faces serious troubles insecurity due to civil violence, intrastate separation, and religious conflicts (kher, 2012). there are some previous studies examining the relationship among macroeconomic indicators in south asia (rizavi et al., 2010; sarwar et al., 2013; behera, 2014; bibi et al., 2014). however, none of these uses the vector autoregressive (var) model in order to investigate the relationship among economic growth, trade, unemployment, and inflation in south asia. this research, therefore, expects to narrow down existing gaps of previous studies and more importantly, based on findings, affordable policies are recommended to the governments of south asian countries to enhance economic growth and achieve the target in sustainable development. the var model is employed in this study because it interprets the endogenous variables solely by their own history, apart from deterministic regressors and therefore this method incorporates non-statistical a priori information (pfaff, 2008). in addition, the var model is a consistent approach since it can examine the dynamic relationship between economic growth and other macroeconomic indicators (gudeta et al., 2017). the rest of this paper is organized as follows. section 2 presents empirical literature. research methods are presented in section 3. section 4 presents results and discussion. finally, conclusions are summarized in section 5. 2. empirical literature the theme in the relationship among macroeconomic indicators is still debated by scholars in recent years. a study by ramanayake and lee (2015) assessed the relationship between export growth, trade openness, export diversification, and foreign direct investment (fdi) and economic growth in developing countries. they concluded that simply opening an economy for international integration does not guarantee sustained economic growth unless these actions lead to export growth. likewise, enejoh and tsauni (2017) examined influences of inflation on economic growth in nigeria over the period 1970-2016. they found that inflation and foreign exchange have positive relationships with economic growth in both the short run and long run. however, inflation and foreign exchange rates do not granger cause economic growth. there are a number of studies assessing the causal relationship among macroeconomic determinants in south asia in recent years. rizavi et al. (2010) estimated the relationship between openness and growth in south asia for the period 1980-2008. results addressed that openness of the economy is an important component to accelerate economic growth in south asia. likewise, a research by behera (2014) examined the effects of inflation on economic growth in six south asian countries from 1980 to 2012. results showed that there is a positive relationship between inflation and economic growth for all the countries. bibi et al. (2014) evaluated the impacts of trade openness, inflation, imports, exports, real exchange rate and foreign direct investment on economic growth in pakistan over the period 1980-2011. they found that there is a long run relationship among variables. however, negative impacts of trade openness can be reduced by producing import substitutes and creating conditions for trade surplus. in addition, fdi and trade are essential elements to foster economic growth. furthermore, mallick (2002) investigated influences of factors on economic growth in india from 1950 to 1995 using a var model. the study found that economic output depends upon private investment, human capital, real interest rate, and public investment. private investment is determined by public investment, domestic credit, real interest rate, and human capital. the long-run of economic growth of this country has not been driven by exports. similarly, ali et al. (2016) assessed contributions of exports and other determinants on economic growth in pakistan over the period 1972-2015 using the auto-regressive distributed lag (ardl) model. they concluded that exports and other trade policy variables have played vital contributions to economic growth of this country. lastly, a research by akram (2017) examined the impacts of public debt on economic growth in sri lanka from1975 to 2014 by employing the ardl model. results demonstrated that public debt has a positive effect on economic growth, but debt servicing presents a negative influence on gdp per capita and investment. 3. research methodology 3.1. data and sources a panel dataset for the relationship among economic growth, trade, unemployment, and inflation in south asia is gathered from the database released by the world bank (wb). due to constraints in human and financial resources, five developing countries in south asia, including bangladesh, india, nepal, pakistan, and sri lanka, are chosen for the study. a panel dataset is collected for the last two decades (1997-2016). thus, a total of 100 observations are entered for data analysis. the panel data is used for this research because of the following advantages: (1) it benefits in terms of obtaining a large sample, giving more degree of freedom, more information, and less multi-collinearity among variables; and (2) it may overcome constraints related to control individual or time heterogeneity faced by the cross-sectional data (hsiao, 2014). 3.2. the vector autoregressive (var) model the var model is used to examine the causality among gross domestic product (gdp), exports, imports, unemployment, and inflation in five developing countries in south asia for the last two decades (1997-2016). the var model is chosen for this study because it interprets the endogenous variables solely by their history, apart from deterministic regressors and therefore this method incorporates non-statistical a priori information (pfaff, asian journal of economics and empirical research, 2018, 5(2): 165-172 167 2008). furthermore, the var model is a popular method in economics and other sciences since it is a simple and flexible model for multivariate time series data (suharsono et al., 2017). the specification of a var model can be defined as follows (pfaff, 2008): (3.1) where: yt denotes a set of k endogenous variables (gdp, exports, imports, unemployment rate, and inflation rate); ai represents (k x k) coefficient matrices for i = 1,…, p; and ɛt is a k-dimensional process with e(ɛt) = 0. an important characteristic of the var model is stability and therefore it generates a stationary time series with time-invariant means, variances and covariance structure, given sufficient starting values. the stability of an empirical var model can be analyzed by considering the companion form and computing the eigenvalues of the coefficient matrix. a var model may be specified as follows (pfaff, 2008). (3.2) where: ɛt denotes the dimension of the stacked vector; a is the dimension of the matrix (kp x kp); and vt represents (kp x 1). table-3.1. description of covariates in the var model variable definitions label unit gdp y1 us$ export value y2 us$ import value y3 us$ unemployment rate y4 % inflation rate y5 % note: us$ means united states dollar in this research, the procedure of a var model comprises six steps, consisting of (1) performing the unit root test; (2) determining lag length; (3) estimating the var model; (4) testing the granger causality; (5) checking the stability of eigenvalues; and (6) implementing the johansen test for co-integration. the var model is estimated by the stata mp 14.2 software. 4. results and discussion 4.1. characteristics of economic growth, trade, unemployment, and inflation of selected countries in south asia due to the slowdown of india, the growth in south asia slightly declined by 0.2 percent from 6.7 percent in 2016 to 6.5 percent in 2017. growth is projected to reach 7.1 percent in 2018 because of stability in all countries, except nepal. growth in the region is determined by domestic demand along with support from favorable financial conditions and improvement of external demand (imf, 2018). table-4.1. characteristics of macroeconomic indicators in south asia variable mean sd min max gdp 2.90e+11 5.24e+11 4.86e+09 2.27e+12 export value 3.90e+10 7.58e+10 4.06e+08 3.23e+11 import value 5.88e+10 1.14e+11 1.25e+09 4.90e+11 unemployment rate 4.33 2.06 0.6 10.6 inflation rate 7.34 3.65 2 22.6 source: author’s calculation note: sd denotes standard deviation the average value of gdp of five countries accounts for us$290 billion. the average values of export and import account for us$39 billion and us$58.8 billion, respectively. unemployment and inflation rates account for 4.3 percent and 7.3 percent, respectively, on average (table 4.1). 4.2. the relationship among economic growth, exports, imports, unemployment, and inflation in south asia 4.2.1. implementation of the unit root test the unit root test is performed to check the stationarity of the time series variables (adeola and ikpesu, 2016). in this research, the augmented dickey-fuller (adf) test is employed to examine the stationarity of gdp, exports, imports, unemployment rate, and inflation rate with the hypothesis as follows: null hypothesis (h0): the variables contain a unit root alternative hypothesis (ha): the variables do not contain a unit root asian journal of economics and empirical research, 2018, 5(2): 165-172 168 table-4.2. the adf test for the unit root variables level 1st difference 2nd difference lngdp t-statistic: -2.18 p-value: 0.21 critical values: 1% level: -3.51 5% level: -2.89 10% level: -2.58 t-statistic: -2.23 p-value: 0.19 critical values: 1% level: -3.51 5% level: -2.89 10% level: -2.58 t-statistic: -2.27 p-value: 0.17 critical values: 1% level: -3.51 5% level: -2.89 10% level: -2.58 lnexports t-statistic: -2.16 p-value: 0.21 critical values: 1% level: -3.51 5% level: -2.89 10% level: -2.58 t-statistic: -2.17 p-value: 0.21 critical values: 1% level: -3.51 5% level: -2.89 10% level: -2.58 t-statistic: -2.19 p-value: 0.20 critical values: 1% level: -3.51 5% level: -2.89 10% level: -2.58 lnimports t-statistic: -2.13 p-value: 0.23 critical values: 1% level: -3.51 5% level: -2.89 10% level: -2.58 t-statistic: -2.33 p-value: 0.16 critical values: 1% level: -3.51 5% level: -2.89 10% level: -2.58 t-statistic: -2.41 p-value: 0.13 critical values: 1% level: -3.51 5% level: -2.89 10% level: -2.58 lnunemployment rate t-statistic: -2.99 p-value: 0.03 critical values: 1% level: -3.51 5% level: -2.89 10% level: -2.58 t-statistic: -2.88 p-value: 0.04 critical values: 1% level: -3.51 5% level: -2.89 10% level: -2.58 t-statistic: -2.67 p-value: 0.07 critical values: 1% level: -3.51 5% level: -2.89 10% level: -2.58 lninflation rate t-statistic: -5.19 p-value: 0.00 critical values: 1% level: -3.51 5% level: -2.89 10% level: -2.58 t-statistic: -5.04 p-value: 0.00 critical values: 1% level: -3.51 5% level: -2.89 10% level: -2.58 t-statistic: -3.71 p-value: 0.00 critical values: 1% level: -3.51 5% level: -2.89 10% level: -2.58 source: author’s calculation, 2018 results show that we cannot reject the null hypothesis because p-values of all variables are greater than critical values at 1%, 5%, and 10%, respectively and these imply that variables exhibit a unit root (table 4.2). 4.2.2. determination of the lag length the purpose of this step is to identify the optimal lag for the var model. if the lag is used too little, then the residual of the regression will not show the white noise process and as the result, the actual error could not be accurately estimated by the model (suharsono et al., 2017). table-4.3. selection of the lag length lag ll lr df p fpe aic hqic sbic 0 -358.59 0.001 7.904 7.959 8.041 1 -107.06 503.08 25 0.000 0.000* 2.979* 3.311* 3.801* 2 -92.11 29.89 25 0.228 0.000 3.198 3.806 4.705 3 -76.30 31.61 25 0.170 0.000 3.397 4.283 5.590 4 -61.90 28.80 25 0.272 0.000 3.628 4.789 6.506 5 -44.28 35.24 25 0.084 0.000 3.788 5.226 7.352 6 -25.8 36.96 25 0.058 0.000 3.930 5.645 8.179 7 -10.16 31.26 25 0.181 0.000 4.134 6.125 9.068 8 14.27 48.89* 25 0.003 0.000 4.146 6.414 9.765 endogenous: lngdp lnexports lnimports lnunemployment rate lninflation rate exogenous: constant number of observations = 92 source: author’s calculation, 2018 notes: * denotes lag order selected by the criterion; ll means log likelihood values; lr represents sequential modified lr test statistics; fpe denotes final prediction error; aic means akaike information criterion; sc denotes schwarz information criterion; hqic represents hannanquinn information criterion; and sbic means schwarz’s bayesian information criterion. as seen in table 4.3, results suggest that the optimal lag length in this case is one lag because this value is recommended by fpe, aic, hqic, and sbic indicators. therefore, one lag (the number of lag is equal to 1) is chosen to run the var model in the next step. asian journal of economics and empirical research, 2018, 5(2): 165-172 169 4.2.3. estimation of the var model table-4.4. estimation of the var model variables coefficient standard error t p-value lngdp lngdp (l1) 0.931*** 0.27 3.39 0.001 lnexports (l1) 0.059 0.19 0.31 0.758 lnimports (l1) -0.100 0.29 -0.34 0.735 lnunemployment rate (l1) 0.029 0.15 0.19 0.853 lninflation rate (l1) 0.186 0.16 1.15 0.254 constant 2.347* 1.31 1.79 0.077 lnexports lngdp (l1) 0.103 0.28 0.36 0.716 lnexports (l1) 0.836*** 0.19 4.19 0.000 lnimports (l1) -0.045 0.30 -0.15 0.883 lnunemployment rate (l1) 0.146 0.16 0.90 0.371 lninflation rate (l1) 0.166 0.16 0.99 0.324 constant 1.740 1.35 1.28 0.203 lnimports lngdp (l1) 0.093 0.23 0.39 0.694 lnexports (l1) 0.055 0.16 0.34 0.738 lnimports (l1) 0.739*** 0.25 2.90 0.005 lnunemployment rate (l1) 0.040 0.13 0.30 0.766 lninflation rate (l1) 0.154 0.13 1.11 0.269 constant 2.206* 1.12 1.96 0.053 lnunemployment rate lngdp (l1) -0.067 0.11 -0.58 0.564 lnexports (l1) -0.019 0.08 -0.23 0.816 lnimports (l1) 0.118 0.12 0.94 0.350 lnunemployment rate (l1) 0.828*** 0.06 12.32 0.000 lninflation rate (l1) -0.077 0.06 -1.13 0.263 constant -0.282 0.55 -0.51 0.615 lninflation rate lngdp (l1) -0.280* 0.16 -1.74 0.085 lnexports (l1) -0.178 0.11 -1.59 0.116 lnimports (l1) 0.512*** 0.17 2.95 0.004 lnunemployment rate (l1) 0.113 0.09 1.23 0.224 lninflation rate (l1) 0.433*** 0.09 4.56 0.000 constant -0.039 0.76 -0.05 0.960 source: author’s calculation, 2018 notes: l1 means lag 1; *** and * denote statistical significance at 1% and 10%, respectively we found that gdp negative affects inflation and this implies that an increase of gdp leads to a decrease in inflation. in contrast, imports had a positive relationship with inflation and this reflects that if imports rise, then inflation also increases (table 4.4). 4.2.4. testing the granger causality the goal of the granger causality is to evaluate the predictive capacity of a single variable on other variables (musunuru, 2017). in this research, five hypotheses need to be tested as follows: testing the relationship between gdp and other variables (h1): null hypothesis (h0): gdp does not cause exports, imports, unemployment rate, and inflation rate alternative hypothesis (ha): gdp causes exports, imports, unemployment rate, and inflation rate testing the relationship between exports and other variables (h2): null hypothesis (h0): exports does not cause gdp, imports, unemployment rate, and inflation rate alternative hypothesis (ha): exports causes gdp, imports, unemployment rate, and inflation rate testing the relationship between imports and other variables (h3): null hypothesis (h0): imports does not cause gdp, exports, unemployment rate, and inflation rate alternative hypothesis (ha): imports causes gdp, exports, unemployment rate, and inflation rate testing the relationship between unemployment rate and other variables (h4): null hypothesis (h0): unemployment rate does not cause gdp, exports, imports, and inflation rate alternative hypothesis (ha): unemployment rate causes gdp, exports, imports, and inflation rate testing the relationship between inflation rate and other variables (h5): null hypothesis (h0): inflation does not cause gdp, exports, imports, and unemployment rate alternative hypothesis (ha): inflation causes gdp, exports, imports, and unemployment rate table-4.5. results of the granger causality wald test hypotheses f-statistic probability h1 0.412 0.799 h2 0.461 0.764 h3 0.388 0.816 h4 0.565 0.688 h5 2.470 0.050 source: author’s calculation, 2018 asian journal of economics and empirical research, 2018, 5(2): 165-172 170 for the first four hypotheses (h1, h2, h3, and h4), we cannot reject the null hypothesis since the probabilities are greater than the critical value (0.05) and these imply that gdp, exports, imports, and unemployment rate do not cause other variables. in terms of h5, we can reject the null hypothesis because the probability is equal to the critical value (0.05) and this implies that inflation rate causes gdp, exports, imports, and unemployment rate (table 4.5). we can conclude that there are no directional causalities between gdp, exports, imports, and unemployment rate and other variables. by contrast, there is a directional causality between inflation rate and other variables. 4.2.5. examination of eigenvalue stability the purpose of this assignment is to check stability of the eigenvalues in the var model. all the eigenvalues lie inside the unit circle and we can conclude that the var model satisfies stability condition (table 4.6 and figure 4.1). table-4.6. eigenvalue stability condition eigenvalue modulus 0.921 0.921 0.831 0.831 0.812 0.812 0.720 0.720 0.481 0.481 source: author’s calculation, 2018 figure-4.1. checking eigenvalue stability source: author’s calculation, 2018 4.2.6. performance of the johansen co-integration test the johansen co-integration test is carried out in order to examine the long-run relationship among variables. if variables are co-integrated, it suggests that there is a long term relationship among variables (musunuru, 2017). the hypothesis to be tested can be identified as follows: null hypothesis (h0): there is no co-integration among variables alternative hypothesis (ha): there is co-integration among variables in this study, the johansen co-integration test is carried out by both trace and max statistic tests. both trace and max tests are all likelihood-ratio-type tests, which operate under different assumptions in the deterministic part of the data generation process. in some situations, the trace tests tend to have more distorted sizes compared to that of the maximum eigenvalue tests (lüutkepohl et al., 2001). table-4.7. results of trace statistic in the johansen co-integration test maximum rank ll eigenvalue trace statistic 5% critical value 1% critical value 0 -129.39 84.03 68.52 76.07 1 -107.86 0.355 40.97*1*5 47.21 54.46 2 -99.15 0.162 23.55 29.68 35.65 3 -93.63 0.106 12.51 15.41 20.04 4 -89.64 0.078 4.53 3.76 6.65 5 -87.37 0.045 source: author’s calculation, 2018 notes: *1 and *5 denote the number of co-integrations (ranks) chosen to accept the null hypothesis at 1% and 5% critical values, respectively asian journal of economics and empirical research, 2018, 5(2): 165-172 171 table-4.8. results of max statistic in the johansen co-integration test maximum rank ll eigenvalue max statistic 5% critical value 1% critical value 0 -129.39 43.06 33.46 38.77 1 -107.86 0.355 17.42 27.07 32.24 2 -99.15 0.162 11.03 20.97 25.52 3 -93.63 0.106 7.98 14.07 18.63 4 -89.64 0.078 4.53 3.76 6.65 5 -87.37 0.045 source: author’s calculation, 2018 as seen in table 4.7, we cannot reject the null hypothesis in the rank one (one co-integration) because trace statistic is less than the 5% and 1% critical values (40.97 < 47.21 and 40.97 < 54.46) and this implies that there is a co-integration among variables. 4.3. discussion we found that gdp has a negative impact on inflation, while imports positively affect inflation in south asian countries. results indicated that there are no directional causalities between gdp, exports, imports, and unemployment rate and other variables in the short run. in contrast, there is a directional causality between inflation rate and other variables in the short run. we also found that there is a long term relationship among economic growth, exports, imports, unemployment, and inflation in south asia. our results in a long run relationship among economic growth, exports, imports, and inflation are consistent with conclusions of bibi et al. (2014). however, we found that there is no causality between trade and economic growth in the short term, while (rizavi et al., 2010) claimed that trade openness positively influences on economic growth in south asia. further, we stated that economic growth has a negative effect on inflation and this result is contrast to arguments of behera (2014). lastly, our results addressed that there is the relationship among economic growth, trade, unemployment, and inflation in the long term, while (mallick, 2002) concluded that there is no correlation between exports and economic growth in the long run. differences in research outcomes can be interpreted by differences in scopes and research methods. for example, rizavi et al. (2010) used the ordinary least square (ols) and random effect models to estimate the relationship between trade openness and economic growth in south asia, while we employ the var model. bibi et al. (2014) employed a dynamic ols to examine the longterm relationship among trade, inflation, and economic growth in pakistan for the period 1980-2011, and mallick (2002) investigated the relationship between exports and economic growth in india from 1950 to 1995. 5. conclusions the article aims to investigate the causal relationship among economic growth, exports, imports, unemployment, and inflation in five developing countries in south asia for the last two decades (1997-2016) using a var model. we found that gdp has a negative relationship with inflation, while imports positively affect inflation in south asian countries. results demonstrated that there are no directional causalities between gdp, exports, imports, and unemployment rate and other variables in the short run. in contrast, there is a directional causality between inflation rate and other variables in the short run. we also found that there is a long-term relationship among economic growth, exports, imports, unemployment, and inflation in south asia. there is a great potential for growth of south asia. however, this region needs to overcome vulnerabilities such as religious conflicts and natural disasters. stability and growth of south asia have played a crucial role in the stability and growth of asia (jica., 2017). in order to accelerate economic growth in south asian countries, inflation should be controlled by imposing consistent fiscal and monetary policies. moreover, domestic productions should be facilitated to substitute imported commodities which currently is contributing to an increase of inflation. finally, the program in job creation should be urgently implemented because recently india, pakistan, and bangladesh would have to create nearly 13 million jobs, 2 million jobs, and 1.6 million jobs annually (wb, 2018). references adeola, o. and f. ikpesu, 2016. an empirical investigation of the impact of bank lending on agricultural output in nigeria: a vector autoregressive (var) approach. the 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process. the econometrics journal, 4(2): 287-310. available at: https://doi.org/10.1111/1368-423x.00068. asian journal of economics and empirical research, 2018, 5(2): 165-172 172 mallick, s.k., 2002. determinants of long-term growth in india: a keynesian approach. progress in development studies, 2(4): 306-324. available at: https://doi.org/10.1191/1464993402ps043ra. musunuru, n., 2017. causal relationships between grain, meat prices and exchange rates. international journal of food and agricultural economics, 5(4): 1-10. pfaff, b., 2008. var, svar and svec models: implementation within r package vars. journal of statistical software, 27(4): 1-32. available at: https://doi.org/10.18637/jss.v027.i04. ramanayake, s.s. and k. lee, 2015. does openness lead to sustained economic growth? export growth versus other variables as determinants of economic growth. journal of the asia pacific economy, 20(3): 345-368. available at: https://doi.org/10.1080/13547860.2015.1054164. rizavi, s.s., m.k. khan and s.h. mustafa, 2010. openness and growth in south asia. south asian studies, 25(2): 419-428. sarwar, k., m. afzal, m. shafiq and h. rehman, 2013. institutions and economic growth in south asia. journal of quality and technology management, 9(2): 01-23. suharsono, a., a. aziza and w. pramesti, 2017. comparison of vector autoregressive (var) and vector error correction models (vecm) for index of asean stock price, in aip conference proceedings 1913, 1, pp. 020032-1-020032-9. aip publishing. doi: 10.1063/1.5016666. international conference and workshop on mathematical analysis and its applications (icwomaa 2017). world bank, 2018. jobless growth. south asia economic focus spring. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. asian journal of economics and empirical research vol. 4, no. 1, 1-7, 2017 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2017.41.1.7 1 east asian trade cooperation versus us and eu protectionist trends and their association to chinese steel exports tanoos, james j1 1purdue university, indiana, usa abstract the asia-pacific region has recently witnessed unprecedented trade cooperation, prompted especially by china. successfully negotiated chinese bilateral and regional free trade agreements are now common, leading to greater rates of economic success for all involved parties, particularly chinese exporters. fta’s are not limited to this region, though. the success of the chinese pursuit of new fta’s has inspired economic rivals to pursue their own new fta’s. many of these are developed countries which have a history of filing anti-dumping grievances with the world trade organization, many of which have been directed at china. this has led to heightened international trade tensions between china and non-chinese fta partners. for example, the us trans-pacific partnership, a proposed fta between the us and east asian countries, intentionally did not include china. many attribute the exclusion of china to the influence of us labor groups that have spearheaded anti-dumping grievances along with similar groups in other developed countries in an attempt to thwart china’s efforts to increase their exports to these regions. the past few years have seen sharp increases in chinese steel exports in particular, leading to heightened protectionist practices within the us and the eu. this study will assess the merits of these anxieties by analyzing the direction of chinese steel to determine if chinese steel is flowing more to their fta partners or to developed countries without fta’s in place. keywords: trade cooperation, free trade agreement, chinese steel, tpp, manufacturing. citation | tanoos, james j (2017). east asian trade cooperation versus us and eu protectionist trends and their association to chinese steel exports. asian journal of economics and empirical research, 4(1): 1-7. history: received: 16 january 2017 revised: 16 february 2017 accepted: 24 february 2017 published: 9 march 2017 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ......................................................................................................................................................................................... 2 2. literature review and background................................................................................................................................................. 2 3. data and methodology ...................................................................................................................................................................... 4 4. results ................................................................................................................................................................................................... 4 5. reactions/future studies ................................................................................................................................................................. 5 references ................................................................................................................................................................................................. 6 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2017.41.1.7 https://orcid.org/orcid-search/quick-search?searchquery=tanoos, james j http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2017.41.1.7 https://orcid.org/orcid-search/quick-search?searchquery=tanoos, james j asian journal of economics and empirical research, 2017, 4(1): 1-7 2 1. introduction due to its record of economic success, asia-pacific trade cooperation continues to spread. however, with the increases in industrial exports originating from that region, tensions have escalated in developed countries, prompting increased anti-dumping grievances with the world trade organization (wto). one focus of these complaints has been the steel industry, where chinese exports have seen especially sharp increases in recent years. with the increased salience of free trade agreements (fta’s), especially new chinese-prompted fta’s concentrated in the asia-pacific region, one might inquire whether these successfully negotiated chinese fta’s are responsible for much of this steel export increase or if the increase is directed towards industrialized countries without chinese fta’s in place. the anti-dumping claims may be misdirected if china’s steel export increases are a result of selling more to their fta partners. as such, this study will examine if these increases in chinese steel production are being exported to their successfully negotiated fta partners in order to assess whether there may be better means of complaining, such as negotiating better, more, or more favorable fta’s rather than filing antidumping disputes. 2. literature review and background the vast majority of economists point to overall economic gains as a result of decreasing international trade barriers and increasing trade cooperation (krugman, 1997; irwin, 2013; kellenberg and levinson, 2014). prem (2015) called the elimination of trade barriers a “central” component of worldwide and domestic gdp growth. geopolitical scholars point to the importance of access to markets as a result of decreased trade barriers for overall economic development, especially for underdeveloped countries (akyüz, 2003; mountjoy, 2007; autor et al., 2013). the accelerated trade cooperation concentrated in the asia-pacific region is a recent phenomenon (zhang et al., 2007). and china in particular has taken the lead in prompting many of these trade negotiations and collaborations (cass et al., 2004). it has been noted that this trend is the result of numerous successful fta negotiations in the region and has led to a “chain-reaction” of unprecedented economic cooperation whereby countries are now trying to keep up with their neighboring countries in economic development (ervine and fridel, 2015). this was not always the case. the early 1990’s were characterized by a regional economic rivalry between china and the association of southeast asian nations (asean) trade group for industrial-based asia-pacific trade, an era characterized by limited trade cooperation and economic integration (herschede, 1991; chen, 2009). as recently as 2007, hoadley and yang (2007) described china’s political leaders as “relative newcomers” in working toward free trade agreements (fta’s). the prestigious group of nations governing global trade, the world trade organization (wto), was formerly an association composed of industrialized countries, but more recently, membership in this organization has been coveted by underdeveloped countries wishing to utilize the group’s association to gain access to more markets, particularly for their manufactured goods. numerous studies of china’s wto 2001 accession process uniformly noted the unprecedented increase in manufacturing-based trade, particularly after china was admitted as an official wto member (brandt et al., 2012; cook, 2015). no other country’s manufacturing trade has been examined in literature as closely as china’s in recent decades (chen, 2009). for instance, there have been numerous studies discussing aspects of chinese export increases (zhang et al., 2007; amiti et al., 2014; taylor, 2015). brandt et al. (2012) commented that “china’s import tariffs differed tremendously across industry in the earlier years, but converged to an almost uniform low level after wto entry,” and allee and scalera (2012) confirmed that “those who engage in the greatest amount of accession-driven liberalization experience the greatest trade increases from wto membership, particularly in the years right after joining.” this has been especially true of china. china’s intentional shift toward trade liberalization has not been limited to joining the wto. in addition to successful transition to wto membership, china has had success in negotiating regional asia-pacific fta’s (baldwin, 2009). recently, china has accelerated these fta negotiations and has been a leader in the recent east asian economic regionalism phenomenon of local trade cooperation (cook, 2015). according to the chinese ministry of commerce, china perceives fta’s as important components of not only integrating into the global economy but also furthering domestic reforms (feng, 2012; chinese ministry of commerce, 2015). hoadley and yang (2007) surmised that china utilizes “ftas to open new markets.” while trade cooperation has historically focused on regional fta’s and wto membership, an even more recent trend has been to negotiate fta’s with individual countries, which are often labeled “bilateral” or “extraregional” fta’s. baldwin (2009) confirmed that industrialized nations “increasingly rely on bilateralism to open up foreign markets.” it is becoming more common in east asia, including china, for governments to formulate these bilateral fta’s (zhang et al., 2007; cook, 2015). these arrangements tend to go beyond the more historical crossregional fta’s such as asean (hoadley, 2007; fora, 2014) and have increased between countries with mutual economic and/or political interests. for example, new zealand and chile have been economically profitable bilateral fta partners with east asian countries (hoadley, 2007). these bilateral fta’s have been an up and coming strategy of east asian governments (hoadley, 2007; zhang et al., 2007; tosevska, 2010) in part because they take less time to negotiate. as the chinese negotiate new fta’s, there has been a coinciding rivalry in this pursuit. in the united states, the obama administration in 2015 sought the trans-pacific partnership (tpp), an fta connecting the nafta trade partners to pacific rim countries (not including china) because of its potential to provide benefits beyond trade such as acting as a means of diplomacy and even as a counterweight to asean (wang, 2015). the obama administration perceives fta’s as a means of expanding us exports and even diplomatic influence in the region (cooper, 2011). this has not been a smooth process, though, as the united states congress bitterly debated the tpp fta during the first half of 2015. this fta has been labeled “the most ambitious trade deal“ since the signing of nafta (granville, 2012) and is seen as a deal that boosts the japanese influence in the region at the expense of china (schlesinger et al., 2015). as a response, china has pursued and accelerated negotiations of its own new trade partnerships. manufacturing and industrial production tend to be the sectors in which developing countries can best gain economic development through fta’s (akyüz, 2003; mountjoy, 2007; serfati, 2015). the development of heavy asian journal of economics and empirical research, 2017, 4(1): 1-7 3 manufacturing industries for export has been a strategy of china since their wto accession and has been called the “engine” of their economic growth (zhao et al., 2012). brandt et al. (2012) found positive domestic productivity benefits for chinese manufacturers due to trade liberalization via wto membership and fta’s. one economic sector which china has historically focused on as an important component of trade and global influence is the steel industry. steel has always been a strategic economic sector for china and has provided the impetus for its fastgrowing industries in the 1990s (hogan, 1999; zhao et al., 2012). china has also historically seen steel production as a symbolic means of establishing itself in the global marketplace (hogan, 1999; song and liu, 2013). garnaut (2013) commented that “steel has been a central part of china's rapid growth story”, and added that “developments in the steel industry…are central” to chinese integration into the world economy. chinese steel exports have seen increases in total tons of steel exported. china’s total crude steel production rose from just 39% in the region in 2000 to 72% in 2014 (international steel statistics bureau, 2015). from 20132014, china saw an increase in steel exports of over 50% (translating to 93.78 million tons), while global steel output increased by only 1% (issb, 2015) and domestic chinese steel consumption actually shrank by 3.4% (davis, 2015). these numbers continue to skyrocket, as wilson (2015) reported that in january 2015, china’s steel exports increased by “a whopping 63% from just last year’s numbers.” many believe that china is exhibiting an economic model called new trade theory (fujita et al., 2015) an international trade strategy whereby a government uses economic tactics to build industrial bases in certain industries. caliendo and rossi-hansberg (2012) found that liberalizing trade provides the exporter with more productivity than revenue. as such, china’s increase in steel exporting might be attributed more to the goal of dominating world markets than the desire to make short-term financial gain. often, when countries experience such high rates of exporting in strategic sectors, importing countries retaliate with protectionist measures, which are international trade economic strategies by which a country restrains trade by various means, usually prompted by the fear of losing domestic output in manufacturing due to cheaper imports from underdeveloped areas (singh, 2014). recently protectionism has been on the rise, and there have been more signs of protectionist feelings in international trade during recent years (blustein, 2009; zhao et al., 2012; roehrkasten, 2015). in both developing and developed countries, trade protection tends to be concentrated in politically sensitive areas such as labor-intensive manufacturing including steel (wu et al., 2007; chen, 2009; prem, 2015). wilson (2015) warned that in the current global marketplace, “china’s excess sales create a very real threat” in the steel trade industry and noted the heavy focus on steel trade protectionism: “the global steel industry suffers from overcapacity in part because many countries make it a point of national pride to support a domestic steel industry.” since steel is also seen as a key industry for politically sensitive sectors such as the military, these sharp increases in chinese steel exports have been particularly worrisome to developing countries (mankiw, 2008; sawyer and sprinkle, 2015). partially prompted by the chinese steel industry, protectionist feelings have accelerated, which in the past have translated into wto-directed anti-dumping complaints. dumping is a type of predatory pricing tactic affiliated with new trade theory in which a product (usually from an underdeveloped country) is sold at below the cost of production in another market in an effort to gain market share at the expense of profits (raslan, 2009; huertagoldman, 2010; cook, 2015). trade protection demands by governments such as anti-dumping grievances in the steel industry have been common in history; in yeager (1980) noted that “governments have become increasingly involved in steel production” for some time. in more recent decades, developed countries have been able to successfully negotiate these anti-dumping trade protection measures on chinese goods. anti-dumping grievances first gained momentum after china’s wto accession in 2001, when developed countries negotiated anti-dumping measures after china realized so much success in exporting steel (wu et al., 2007; chen, 2009; zhao et al., 2012; neumayer, 2013; liu, 2014; cook, 2015). in addition to prompting anti-dumping complaints, in 2001 the us requested the international trade commission to research the negative effects of steel imports on the domestic industry, resulting in three-year steel import tariffs levied in 2002 to protect the american steel industry, followed by requests to establish dispute panels in the wto (cook, 2015). the eu followed suit and placed tariffs on select imported steel products (huerta-goldman, 2010; wilson, 2015). zhao et al. (2012) surmised that the wto has been in “defensive positions” recently with anti-dumping steel industry complaints from industrialized countries. as such, while an overriding goal of wto membership is to limit trade disputes, it appears as if the opposite is happening. as a result of these increases in chinese steel exports since 2014, fresh outcries for trade protection have ensued. serfati (2015) characterized the current state of global trade, including steel trade, as having “internal tensions among … government actors”. mukherji et al. (2015) noted that “flooding the world with exports, spurring steel producers around the globe to seek government protection” prompted renewed calls in the eu and us for new trade protection measures. the european steel association prompted anti-dumping complaints with the eu in march of 2015 (yap, 2015) and subsequently imposed anti-dumping duties on certain chinese steel (lian and stanway, 2015). as such, with the recent sharp increase in exports originating from east asian heavy-industry sectors, most notably chinese steel, an array of coinciding negative reactions in international trade will predictably continue based on the massive increases in chinese steel exports (akyüz, 2003; neumayer, 2013; cook, 2015). these reactions may be exacerbated by the obama administration’s negotiation of the tpp fta that strategically did not include china and could serve to heighten tensions even further between the us and china, particularly in the steel industry. while these protectionist reactions might be predictable, the question remains about whether they are misdirected. often protectionist outcries are not the result of an attempt by a developing country to dominate global markets, potentially even at the expense of profits as new trade theory would outline, but may simply be the byproduct of a developing country’s exporting without a broad fta in place (irwin, 2013). if a fta was in effect, the massive increases in imports coming into a developed country may be offset by an equal amount of exports. there have been some studies detailing the relationship between fta’s and protectionism. one such study asserts that the existence of fta’s increases the likelihood of trade protectionism and even trade “discrimination” whereby asian journal of economics and empirical research, 2017, 4(1): 1-7 4 antidumping actions are eliminated between fta partners, leading to heightened tensions with non-fta members (prusa and teh, 2010). one might inquire if these protectionist outcries in the form of anti-dumping complaints by governments are simply a caving-in to pressure from powerful anti fta factions. an assessment of the direction of increased chinese steel exports would shed some light on whether the anti-dumping grievances directed at steel have merit, or whether these sharp increases can be attributed to the recent record of successfully negotiated new chinese fta’s. perhaps governments should be pursuing more favorable negotiations with new fta’s to allow for better access to new markets rather than launching new rounds of anti-dumping grievances and tariff increases. an assessment of the directions of the sharp increases in chinese steel exports would enlighten that inquiry. 3. data and methodology a cross-sectional analysis of historical trends in recent chinese steel imports related to new chinese fta’s was the overall design for this study. data related to chinese steel exports were requested from the issb (2015) in the united kingdom, which features data related to total tons of steel exported by china as well as importing countries from 2007-2014. next, the study determined which of the steel importing countries constituted official chinese fta partners using information from the chinese government’s ministry of commerce. china has nineteen total trade partners from their fta’s as of august 2015 (cmc, 2015). these partners are displayed in table 1 below. the countries labeled with an “a” belong to the regional chinese fta of asean. the table also depicts the year of the fta, which was determined to be when the ministry of commerce claimed that the fta “went into force” (cmc, 2015). table-1. official chinese fta partners brunei (a-2005) burma (myanmar) (a-2005) chile (2006) costa rica (2008) hong kong (2003) iceland (2014) indonesia (a-2005) laos (a-2005) macao (2003) malaysia (a-2005) new zealand (2008) pakistan (2007) peru (2009) philippines (a-2005) singapore (a-2005) south korea (2006) switzerland (2014) thailand (a-2005) vietnam (a-2005) source: china’s ministry of commerce the next step consisted of discovering percentage changes in chinese steel exports from year to year for both chinese fta partners and non-fta partners. between 2007 and 2014, four countries successfully negotiated and concluded a fta with china: pakistan, peru, costa rica, and new zealand. switzerland and iceland were also granted free trade status via a concluded fta in 2014 and were excluded from this tabulation. the years in which the fta “went into effect” for pakistan, peru, costa rica, and new zealand were calculated as the first year of the fta, and the years before were used in the non-fta partners group. 4. results of the top 10 destinations for chinese steel in 2014, seven were fta partners (south korea, vietnam, philippines, thailand, indonesia, singapore, and hong kong). figure-1. year-to-year percentage change in chinese steel exports: fta countries and non-fta countries asian journal of economics and empirical research, 2017, 4(1): 1-7 5 figure 1 above displays the year to year percentage change in chinese steel exports with both chinese fta countries and non-fta countries. in five of the seven years, year-to-year changes in chinese steel exports to fta countries were higher than those to non-fta countries. overall, steel exports to fta partners increased more than steel exports to fta partners at a 115.21% increase per year versus a yearly 113.41% steel export increase to non-fta partners. however, the total tons of steel for fta partners by 2014 was still 213,428,180, versus 451,217,534 to non-fta partners. figure 2 below displays this chinese steel export difference between fta partners and non-fta partners since 2007. figure-2. difference between steel exports: average percentage of chinese steel export change since 2007 between fta partners and nonfta partners next, the study analyzed bilateral fta’s versus regional ftas. it appears as if chinese steel exporting to asean fta partners increased at a higher rate per year (119.52%) than the bilateral fta per year rate (112.45%). table 2 below displays the yearly percentage of chinese steel export change since 2007 between regional and bilateral fta partners. table-2. yearly percentage of chinese steel export change since 2007 between regional and bilateral fta partners. 2008 2009 2010 2011 2012 2013 2014 avg. asean trade partners, change from prior 70.38% 49.44% 179.09% 114.37% 149.46% 122.63% 151.24% 119.52% bilateral trade partners, change from prior 103.48% 39.53% 173.29% 114.30% 114.06% 104.25% 138.25% 112.45% the “new” fta partners during this timeframe (i.e., countries successfully completing a fta with china from 2007-2014) included pakistan, peru, costa rica, and new zealand. the years before were used in the non-trade partners group. between these times, the year-to-year changes after the fta went into effect for these countries was 139.22%. of course, this is higher than the year-to-year changes from non-fta partners at a 115.21% increase versus a 113.41% change from non-fta partners. figure-3. average percentage of chinese steel export change since 2007 between regional, bilateral, and “new” fta partners. 5. reactions/future studies there is a relative similarity in recent chinese steel export increases between 2007-2014 attributed to both fta partners and non-fta partners. since the anti-fta factions in developed countries still claim that china is dumping steel into their markets, the tpp, which does not include china, could escalate tensions even further if chinese steel exports continue such steep increases. the serfati (2015) study characterized the current state of global trade as having anxieties between actors that are bound to intensify further. asian journal of economics and empirical research, 2017, 4(1): 1-7 6 in the analysis of regional versus bilateral fta’s, it does appear that the regional chinese trade partners have seen more steel exports than their bilateral partners. and perhaps more notably, with chinese exports of steel increasing sharply to new fta partners, a case may be made for the need to successfully negotiate fta’s with china. there may be some intentionality in china’s pursuing recent fta’s, since there were such sharp increases in steel exports to these trade partners in the years immediately after the fta was successfully negotiated. as such, there could be an economic rationale for china’s non-fta partners to negotiate new, mutually beneficial fta’s, especially if provisions in the recent fta’s contributed to the rise in steel trade. another inquiry might be whether there is an equal increase in goods flowing from these new fta partners to china. future studies might assess whether newly negotiated fta’s continue to be destinations for chinese steel and whether these trade partners are increasing their exports to china. while many factions point to fta’s as having a net negative effect on developed countries, an 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publisher zhao, c., s. lin and s. bao, 2012. the chinese economy after wto accession. farnham, surrey, united kingdom: ashgate publishing company. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://scholar.google.com/scholar?hl=en&q=recommendations%20for%20further%20reading https://scholar.google.com/scholar?hl=en&q=local%20firm’s%20knowledge%20acquisition%20in%20the%20global%20manufacturing%20network:%20evidence%20from%20chinese%20samples http://dx.doi.org/10.1142/s0219877007001119 https://scholar.google.com/scholar?hl=en&q=trade%20protection%20as%20an%20international%20commodity:%20the%20case%20of%20steel https://scholar.google.com/scholar?hl=en&q=trade%20protection%20as%20an%20international%20commodity:%20the%20case%20of%20steel http://dx.doi.org/10.1017/s0022050700104498 https://scholar.google.com/scholar?hl=en&q=the%20prospects%20for%20china's%20free%20trade%20agreements https://scholar.google.com/scholar?hl=en&q=the%20prospects%20for%20china's%20free%20trade%20agreements http://dx.doi.org/10.2753/ces1097-1475400201 asian journal of economics and empirical research issn: 2409-2622 vol. 2, no. 2, 62-73, 2015 http://asianonlinejournals.com/index.php/ajeer 62 inequality and unemployment management kwangsik jung 1 1 instructor, sisa sls foreign language academy, south korea abstract this work is licensed under a creative commons attribution 3.0 license asian online journal publishing group contents 1. introduction ............................................................................................................................................................................... 63 2. inequality and unemployment ................................................................................................................................................. 63 3. definition of the middle class .................................................................................................................................................. 64 4. malmquist index ....................................................................................................................................................................... 66 5. data ............................................................................................................................................................................................ 67 6. results ........................................................................................................................................................................................ 68 7. conclusion .................................................................................................................................................................................. 71 references ...................................................................................................................................................................................... 71 many studies have claimed that inequality and unemployment should be reduced. they also assert that the middle class should be increased for economic development. these strategies sound like similar outcome strategies. however, what would happen if they were not? in other words, if reducing inequality and unemployment risks aggravating the middle class, how should we manage inequality and unemployment? in this paper, we will examine this. keywords: inequality, unemployment, middle class, malmquist index. productivity index, data envelopment analysis http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2015, 2(2):62-73 63 1. introduction inequality and unemployment are key topics for the social stability and economic growth of a country. but what do inequality and unemployment management mean? which countries manage them well? most people may answer based on value of the gini coefficient and the unemployment rate. for example, if a country’s gini coefficient and unemployment rate are low, people may say that inequality and unemployment are managed well. however, this is only partly correct. the gini coefficient and the unemployment rate do not consider societal structure. in other words, various social structures can exist under the same inequality and unemployment levels. therefore, inequality, unemployment, and social structure should be considered comprehensively. for this study, we think of inequality and unemployment as resources. through this approach, their relationship with social structure is explained, and the definition of ideal inequality and unemployment management is redefined. the paper is organized as follows. in the following section, the concept of this paper is explained, and ideal inequality and unemployment management are theoretically reviewed. in the second half of the paper, the management of inequality and unemployment of 49 countries during, before, and after the financial crisis is analyzed. 2. inequality and unemployment in this paper, we handle the inequality and unemployment as the resource, and use the terms “inequality resource” and “unemployment resource”. according to the oecd, “income inequality has a negative impact on subsequent growth”. federico (2014) from the okun’s law, we know that there is a negative relationship between gdp growth and unemployment. therefore, these resources have a negative impact on society. while it is better not to use them, this is impossible. each country uses these resources to a certain degree. to estimate the consumption of inequality resources and unemployment resources, the gini coefficient and unemployment rate are used here. ideal stratification: when inequality and unemployment resources are allocated to society, people’s income level is seen to be diversified, and unemployment occurs. this means that the society is divided into three groups (upper, middle, and lower class). in other words, each country produces stratification by spending inequality and unemployment resources. the outcome of consuming inequality and unemployment resources is stratification. therefore, we need to consider the structure of stratification because consuming the same amount of resources does not guarantee the same structure of stratification. from the same gini coefficient and unemployment rates, various lorenz curves can be generated. therefore, we pursue ideal stratification. what is ideal stratification? it differs depending on the goal of each country. if each country’s goal is economic development and social stability, then ideal stratification means that there is a relatively large middle class because the middle class is strongly related to economic development and social stability. kristin forbes (2000); william (2001) claimed that a “higher share of income for the middle class is associated with higher income and higher growth.” landes and david (1998) also noted that the “ideal growth and development of society” is related to “a relatively large middle class.” in africa, strong economic growth has been accompanied by the emergence of a sizeable middle class over the past two decades. mthuli et al. (2011) castellani francesca and gwenn (2011) and parent also argue a robust middle class is related to economic and social stability and to better development prospects. in conclusion, the size of the middle class is important. from now on, we will focus on the middle class and use the term “middle class production.” efficiency: to explore the consumption of inequality and unemployment resources, and middle class production, the concept of efficiency is used. the term efficiency is often used in the input-to-output ratio. abraham et al. (1978) there are two types of efficiency (absolute or relative efficiency). however, in the case of absolute efficiency, it is almost impossible to know the theoretical levels of efficiency. therefore, relative efficiency is often used and is used in this paper. inequality and unemployment resources correspond to the input variable, and the output variable is middle class production. therefore, the management ability of the inequality and unemployment resources is represented as ( ) ( ) there are two types of efficiency (input-oriented and output-oriented efficiency). william cooper et al. (2007) among them, input-oriented efficiency is defined as that the ability to use a minimal amount of input to generate a given level of output. in this paper, the input-oriented efficiency is used to estimate the ability to manage inequality and unemployment resources. therefore, the goal of ideal inequality and unemployment management is to achieve the lowest inequality and unemployment with a given middle class size. theoretical review: for simple explanation, we will use only the inequality resource in this section. let us consider two lorenz curves described in figure 1. middle class refers to households whose income falls between a% and b% of income distribution. at this time, the middle class on lorenz curve (1) is bigger than that on lorenz curve (2) 1 . however, the gini coefficient of lorenz curve (1) is bigger. therefore, a little inequality does not necessarily guarantee a larger middle class. in other words, the risk of weakening the middle class exist in polices intended to reduce inequality. 1 d%-a% > c%-b% asian journal of economics and empirical research, 2015, 2(2):62-73 64 figure-1. paradox example in inequality and middle class which lorenz curve is better? we can answer is found in the terms “consumption of inequality resource” and “middle class production.” they can be illustrated as efficiency; the greater the value the better. ( ) ( ) figure-2. concept of ideal inequality management in this paper, ideal inequality management means achieving a minimum consumption of inequality resources with a given middle class size. in figure2 the middle class of the two lorenz curve are same in a% b% in terms of income distribution. however, the gini coefficient of lorenz curve (2) is smaller than lorenz curve (1). when lorenz curve (1) is closer to lorenz curve (2), the efficiency of lorenz curve (1) increases. by definition of relative efficiency, the maximum attainable efficiency of lorenz curve (1) is achieved when it matches lorenz curve (2). in conclusion, inequality should be managed to achieve lorenz curve (2). 3. definition of the middle class there is no consensus on a definition of the middle class. craig elwell (2014) there are two main approaches (income or consumption based), and each includes a number of sub-definitions. in this paper, we adopt the incomebased approach has been used to cope with the gini coefficient representing income distribution. the income-based definition is also divided into four sub-approaches (ppp-based, distribution-based, median income-based, and poverty-line based). in this study, we will use the distribution-based and median income-based definitions have been used. the former is a relative approach and assumes the relative position with regard to national income distribution. the latter is an absolute approach and considers fixed income ranges. in this study, the two definitions are presented as follows. the distribution-based middle class refers to households whose income falls between the 20th and 80th percentile of income distribution. in addition, a median income-based middle class refers to households whose income ranged within 50 200% of the median income. although a distribution-based middle class can be estimated by a simple calculation, and estimating the median income-based middle class needs additional calculations, as described in the following section. asian journal of economics and empirical research, 2015, 2(2):62-73 65 3.1. estimating the median income-based middle class general quadratic lorenz curve: to estimate the median income-based middle class, we should estimate the lorenz curve by year for each country. there are two types of lorenz curves: the general quadratic lorenz curve (gq lorenz curve) and the beta lorenz curve (jose and barry arnold, 1984; gaurav, 1998); both are accurate. as the gq lorenz curve is more convenient to calculate, we will use it in this study. the equation of the gq lorenz curve is below. ( ) [ ( ) ] where, ( ) ( ) ( ) ( )⁄ ( ) ( )⁄ all parameters are estimated from the percentile income distribution data. in the actual calculations, the world bank’s povcal software is used. head-count index (h): after estimating the gq lorenz curve, the headcount index [ ( ⁄ )*( ⁄ ) + ⁄ ] is used and the middle class size is estimated. it is a method to calculate the ratio of people under a certain income level. table 1 shows the median income in each year of the three groups according to income level. in addition, figure 3 shows the median income difference between each group. during 2005-2012, the average median income of high-income countries is about five times larger than that of the middle-income countries. in addition, the average median income of middle-income countries is about two times greater than that the low-income countries. table-1. median incomes (us$ per household, at current prices) high income country middle income country low income country 2005 81718.3 10859.9 6600.2 2006 86520.1 12086 6789.7 2007 74736.7 14517.7 7651.5 2008 80019.4 17651.4 8960.1 2009 79804 16504.2 8629 2010 96811 19254.7 9128.2 2011 11562.1 22646.8 10011.3 2012 119550.1 24137.8 10247.5 average 91847.5875 17207.3125 8502.1875 the middle class estimated range is 50-200% of each median income. in the case of highand middle-income countries, they are rounded to the nearest hundredth, and in the case of low-income countries, they are rounded to the nearest tenth. the difference between high-income countries and the other two groups is greater than the difference between middleand low-income countries. the median income difference between high-income countries and the other two groups decreased before and after the financial crisis. however, since 2009, it has sharply increased. on the other hand, between the middleand low-income countries, it gradually increased, but the difference is not large. in conclusion, the financial crisis created a significant income gap between high-income countries and other countries. figure-3. median income difference (us$ per household, at current prices) asian journal of economics and empirical research, 2015, 2(2):62-73 66 4. malmquist index the malmquist index shows the change in efficiency over the two periods. the malmquist index can be decomposed into two components: the catch-up effect and the frontier-shift effect.(michael james, 1957) catch-up effect (cu) shows the change in distance from the efficient frontier, namely the technical efficiency change (rolf et al., 1985); (rolf et al., 1990); (rolf et al., 1992); (rolf et al., 1994). in this paper, efficiency is defined as a country’s ability to manage inequality and unemployment resources under a certain sized middle class. cu refers to changes in this management ability. therefore, an increase in cu means an improvement in management ability. the country can produce the same middle class size from lower resource consumption. figure-4. concept of cu in this paper in figure 4 the middle class of a and b are same. over the two periods (t, t+1), b is constant. although the middle class of a has not changed, inequality is reduced. in all periods, b is more efficient than a. when it is compared to b, although a is inefficient, the efficiency of a improves between period t and t+1. at this time, cu of a is bigger than 1, and we say it is relatively efficient. the frontier-shift effect (fs) shows the shift of the efficient frontier, namely the technical change. this refers to a change in the attainable minimum level of input with a given level of output. fs can be interpreted as the external influence. in this paper, fs mainly refers to the impact of the financial crisis. figure-5. concept of fs in this paper in figure 5 over the two periods, although a is constant, the inequality of b decreased. b is always more efficient than a. a should reduce inequality to improve efficiency. by definition of relative efficiency, a can improve efficiency to the point where it matches b. in period t, the maximum efficiency of a can be attained when it matches the lorenz curve of b (t). using the same logic, the attainable maximum efficiency of a is the efficiency of the lorenz curve of b (t+1) in period t+1. this means a has a greater possibility to reduce inequality and improve efficiency in period t+1 than t. therefore, period t+1 is more favorable to a than period t. at this time, we say the efficient frontier is shifted upward, and the value of fs is bigger than 1. productivity considers the cu and fs. the whole period is divided into several sub-periods. in this paper, the whole period (2005-2012) is divided by three-year sub-period, and there are five sub-periods. cu, fs and productivity are calculated for each period. the average productivity of all sub-periods is mi. we explained the concept of cu, fs, and productivity in this paper by using the lorenz curve. it is necessary to review the malmquist index more deeply because the concept of unemployment is added and all variables are changed. figure 6 below illustrates the construction of the malmquist index, which uses the inputs, x and x+1 in periods, t and t+1 to produce the output y and y+1, respectively. the efficient frontier of the first and second periods is, the cf and be. is the position of the first period, and is the position of the second period. asian journal of economics and empirical research, 2015, 2(2):62-73 67 figure-6. a malmquist index the catch-up effect from the first period to the second period is represented below: ⁄ ( ) if cu > 1, it means it is relatively efficient. oppositely, cu < 1 means it is relatively inefficient. in figure 6 the reference point of moves from c to b from the first period to the second. therefore, the frontier-shift effect of is expressed as following. ( ) this can be rewritten as the following equation. ⁄ ( ) similarly, the frontier-shift effect of is represented as following. ⁄ ( ) according to rolf et al. (1994) the frontier-shift effect is defined as the geometric mean of and , namely √ ( ) if fs > 1, it means the efficient frontier is shifted upward. as a result, mi is the product of the cu and fs. if mi > 1, it means productivity growth, and mi < 1 means a productivity decline. √ ( ) 5. data for a time series analysis, data sets from 2005 to 2012 are used. all data are taken from euromonitor 2 . however, the middle class size of each country is calculated by the present author, using the household income distribution data. in total, 49 countries are analyzed in this study. 3 to increase the accuracy of the analysis, they are divided into three groups depending on the income level. although we followed the classification of euromonitor, taiwan has been regarded as exceptional. according to euromonitor, taiwan belongs to the high-income countries. however, when emerging and developed countries are analyzed together, the emerging countries tend to be overestimated. therefore, taiwan is analyzed in the group of middle-income countries in this study. 5.1. input and output for the analysis, two input variables (inequality and unemployment resources) are used. table 4 in appendix shows the statistics of the input variables. on the other hand, the middle class size is the output variable. statistics of output variable are illustrated in table 5. 2 world consumer income and expenditure patterns 2014 3 it is ideal to handle all of the world’s major countries. however, in the case of oil-producing countries, due to the peculiarities of their economic structures, the result has been distorted. for this reason, they are excluded from this study. it is desirable to study separately the case of the middle east. asian journal of economics and empirical research, 2015, 2(2):62-73 68 two types of middle classes (distribution-based and median income-based) are used for the analysis. a distribution-based middle class (db middle class) is defined as households not including the poorest 20% and the richest 20%. in addition, a median income-based middle class (mb middle class) means households whose income is within 50-200% of the median income. table 2 shows the correlations of two types of middle classes. there is a high positive correlation between the db middle class and mb middle class in high-income countries. however, the lower the income levels, the smaller the correlation coefficient. in the case of low-income countries, the correlation coefficient is less than two. this means the results are greatly varied depending on the middle class definition when studying the middle classes of low-income countries. table-2. correlation of the middle class sizes high income country middle income country low income country 2005 0.891349315 0.558145854 0.081098545 2006 0.852985495 0.570599265 0.125025219 2007 0.81352883 0.607218803 0.225812519 2008 0.864168942 0.687132048 0.162813883 2009 0.845014362 0.68883036 0.061711886 2010 0.845800916 0.583921509 0.251772797 2011 0.757251884 0.578693627 0.300136708 2012 0.715479671 0.531436074 0.293427904 average 0.823197421 0.600747193 0.187724933 6. results three groups are analyzed two times in accordance with the output items. for each analysis, a 2-input (unemployment rate and gini coefficient) 1-output (db middle class or mb middle class) model are used. in the actual calculations, the dea-solver-pro(professional version 10.0) software is used. 6.1. the correlation coefficient between the results the correlation coefficient between the productivity results is also large in the case of highand middle-income countries, as it is greater than 0.9, see table 3. on the other hand, in the case of low-income countries, it is only 0.49. this can be thought of in connection with table 2. in the case of low-income countries, the middle class size is different according to the definition. as well, it affects the productivity results, the details of which will be mentioned in section 6.6. table-3. the correlation coefficient between the results high income country middle income country low income country 0.937341 0.921121 0.498141 6.2. standard deviation the standard deviation of the analysis results shows a remarkable fact (see table 6 in appendix). first of all, the fs in most countries is less than 1. this means the attainable minimum level of resource consumption has decreased. in other words, there is an unfavorable change in the situation. in all analyses, a standard deviation of the fs is very small compared to that of the cu. it means, the mi of each country is determined greatly by the cu. in conclusion, although negative influences existed during the financial crisis period, they had little effect on productivity. therefore, if a country’s productivity decreased, the main reason was poor management of inequality and unemployment. 6.3. u-curve most countries show a u-curve over five sub-periods of analyzing mi. figures 7 and 8 show the average productivity change of each group. figure-7. the productivity change (db middle class output) asian journal of economics and empirical research, 2015, 2(2):62-73 69 figure-8. the productivity change (mb middle class output) overall, except for the low-income countries in the case of the mb middle class output, all are shown in the form of a u-curve. this means productivity was reduced until the financial crisis, but it recovered after the financial crisis. high and middle-income countries have shown the typical u-curve form in the two analysis results. in both results although middle-income countries have recovered productivity at greater than 1, high-income countries have not reached 1. figure-9. productivity change of greece and netherlands in particular, although most highand middle-income countries appear in u-curve form, greece and the netherlands have declined their productivity continuously. figure 9 shows the productivity changes between the two countries. in both analyses, low-income countries are quite remarkable. in most of the sub-periods, the average values of low-income countries are greater than 1. in particular, when the output is the mb middle class, they are greater than 1 in all sub-periods. furthermore, they sharply increased after the financial crisis. this was possible thanks to remarkable economic growth in china, about which we will mention later. 6.4. high-income countries figure 10 shows that high-income countries show generally low mi. the mi of only three countries among high-income countries is greater than 1 in two analyses at the same time. however, in the case of austria and finland, it is hard to say “growth,” because their values are almost 1. therefore, germany is the only country we can say exhibited “growth” among high-income countries. figure-10. mi (high-income countries) asian journal of economics and empirical research, 2015, 2(2):62-73 70 on the other hand, five low mi countries demonstrated the relationship between input and mi. four countries except the usa among the five countries consumed unemployment resource excessively. figure 11 shows the trend of unemployment rates in four countries. figure-11. unemployment rate (denmark, greece, ireland, spain) on the other hand, the usa consumed inequality resource excessively, rather than unemployment resource. the gini coefficient of the usa is higher than 0.46. although the usa is the richest country in the world, it is also the most unequal country among high-income countries. it is the reason of low mi of usa. 6.5. middle-income countries in middle-income countries, it is necessary to look at argentina and lithuania. in the case of argentina, the results are different depending on the middle class definition. when an mb middle class is the output, its mi is high (1.3), see figure 12. figure-12. mi (middle-income countries) however, when the db middle class is the output, the mi dropped significantly. this means argentina was not significantly effective in its distribution of wealth. furthermore, argentina defaulted on its debt again in 2014, as well as faced a national crisis. on the other hand, even though, lithuania’s results are the worst in both analyses, since lithuania joined the euro in 2015, it is worth watching for changes in the future. 6.6. low-income countries the performance of china is prominent among low-income countries. when the mb middle class is the output, the mi is 1.52, see figure 13. in addition, it has the highest mi among 14 low-income countries. however, when the db middle class is the output, the mi declines to 1.05, and its ranking dropped to 4th. this difference means economic fluctuations and distributions are moving apart. in other words, even though the economy is growing, distribution is not done well. countries, such as ukraine and indonesia, have the same problem. in the case of low-income countries, the mi of more than half the country is greater than 1 in both analyses. alternatively, in the case of high-income countries, the mis of just three countries are greater than 1. however, the important thing is we should not conclude that low-income countries are better than high-income countries from the results. this is because all results are based on the relative value comparison of their group. thus, even if one country’s mi is very high in its group, it does not mean one country is better than another country of other group. asian journal of economics and empirical research, 2015, 2(2):62-73 71 figure-13. mi (low-income countries) 7. conclusion we redefined the definition of ideal inequality and unemployment management, and evaluated the management ability of 49 countries during, before, and after of the financial crisis. this paper has shown that reducing inequality and unemployment is not always same as improving the middle class. therefore, social structure should be taken into account. second, during the financial crisis period, in the case of the high-income countries that account for a large share of the world economy, although most countries had the option to manage inequality and unemployment more efficiently, they failed (except for austria, finland and germany). third, in the case of low income-countries, the reliability of the results is low. the main reason is they are very sensitive to the definition of middle class. additional problems should be resolved. first, it is necessary to properly define inequality and unemployment management because these concepts are too general. second, we need to review their relationship with economic fluctuations. although we saw a productivity decrease during the financial crisis, the specific functional relationship between them should be reviewed. third, examining the ambiguous definition of the middle class is required. finally, an analysis method, which can compare different income-level countries, should be developed to make more efficient inequality and unemployment management possible. this will help to achieve sustainable economic 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growth, technical progress, and efficiency change in industrialized countries. american economic review, 84(1): 66–83. rolf, f., g. shawna, y. suthathip, k. sung li and w. zhaoping, 1990. productivity growth in illinois electric utilities. resources and energy, 12(4): 383–398. william cooper, w., m. lawrence seiford and t. kaoru, 2007. data envelopment analysis: a comprehensive text with models, applications, references and dea-solver software. us: springer. william, e., 2001. the middle class consensus and economic development. journal of economic growth, 6(4): 317–335. asian journal of economics and empirical research, 2015, 2(2):62-73 72 table-4. statistics of input variables high income country 2005 2006 2007 2008 2009 2010 2011 2012 unemployment rate average 6.77777777 78 6.31055 5556 5.8038 88889 5.91944 4444 7.9833 33333 8.533333 333 8.6088888 89 9.3188888 89 max 11.28 10.28 8.66 11.33 18.03 20.08 21.64 25.05 min 4.38 3.91 3.56 3.08 3.73 4.4 4.04 4.19 sd 2.22192432 6 2.08127 0744 1.8063 74786 2.05855 0239 3.2872 10511 3.894533 122 4.7915254 71 6.1793849 77 gini coefficient average 0.34577777 8 0.35027 7778 0.3526 11111 0.34983 3333 0.3520 55556 0.352555 556 0.3456111 11 0.3555555 56 max 0.469 0.47 0.463 0.466 0.468 0.47 0.477 0.478 min 0.267 0.273 0.28 0.268 0.259 0.266 0.269 0.271 sd 0.04643091 7 0.44471 809 0.4160 195 0.44333 296 0.4484 8073 0.044579 37 0.4511311 1 0.0450231 6 middle income country 2005 2006 2007 2008 2009 2010 2011 2012 unemployment rate average 8.10647058 8 7.19176 4706 6.4247 05882 6.40117 6471 9.1223 52941 9.936470 588 9.3141176 47 9.2858823 53 max 17.93 13.97 13.1 12.65 18.23 19.83 16.2 15.85 min 3.53 3.3 3.23 3.18 3.62 3.22 3.09 3.04 sd & 3.93105733 4 3.28784 1684 2.9800 12831 2.71867 5878 4.1390 05813 4.903756 138 4.1322528 04 4.1744326 84 gini coefficient average 0.37588235 3 0.37370 5882 0.3703 52941 0.37252 9412 0.3721 76471 0.372235 294 0.3733529 41 0.3744705 88 max 0.506 0.5 0.492 0.485 0.48 0.475 0.472 0.471 min 0.26 0.264 0.261 0.254 0.251 0.252 0.256 0.257 sd 0.06666228 5 0.06387 0733 0.0622 13284 0.06216 1199 0.0610 76013 0.059788 721 0.0591459 44 0.0589068 31 low income country 2005 2006 2007 2008 2009 2010 2011 2012 unemployment rate average 9.47642857 1 9.05214 2857 8.3728 57143 7.75428 5714 8.3471 42857 8.239285 714 8.1078571 43 7.8657142 86 max 15.26 12.27 13.79 11.33 12.03 11.79 12 12.68 min 4.19 4.1 4.02 4.19 4.29 4.1 3.83 3.74 sd 2.68704472 2 2.20906 2379 2.4367 70967 2.08369 3888 1.7835 11785 1.869827 077 2.3421757 75 2.7138610 43 gini coefficient average 0.42364285 7 0.42378 5714 0.4292 85714 0.428 0.429 0.429071 429 0.4284285 71 0.4291428 57 max 0.595 0.594 0.593 0.593 0.592 0.592 2.592 0.591 min 0.31 0.33 0.343 0.343 0.342 0.333 0.326 0.328 sd 0.08927968 8 0.08891 4115 0.0832 82123 0.08474 2143 0.0830 54199 0.084137 675 0.0830817 15 0.0820992 43 table-5. statistics of output variables high income country 2005 2006 2007 2008 2009 2010 2011 2012 db middle class average 52.371666 67 52.087222 22 51.854444 44 52.17833 333 52.15666 667 52.05333 333 51.907222 22 51.867222 22 max 54.94 54.76 54.58 54.95 55.51 55.37 55.23 55.15 min 46.41 46.34 46.68 46.73 46.38 46.39 45.79 45.72 sd 2.1383562 96 2.1440226 23 2.2581122 77 2.081691 196 2.132397 16 2.145479 516 2.2444462 32 2.2509496 18 mb middle class average 67.922222 22 67.705555 56 68.027777 78 67.63333 333 67.36111 111 65.62777 778 65.711111 11 64.238888 89 max 75.5 74.9 75.5 78 80.4 77.3 78 76.7 min 52.5 52.5 54.5 53.4 53.7 52.3 52.9 48.3 sd 5.5697244 16 5.3611315 99 5.0855973 74 5.264755 176 5.555086 582 5.668779 883 6.4435000 43 7.4956566 94 middle income country 2005 2006 2007 2008 2009 2010 2011 2012 db middle class average 50.541764 71 50.825882 35 50.806470 59 50.73 50.67764 706 50.78117 647 50.768235 29 50.708823 53 max 55.42 55.21 55.22 54.84 54.69 54.82 54.94 54.8 min 42.04 42.82 43.16 43.47 43.83 44.01 44.19 44.26 sd & 3.5666041 89 3.2785554 34 3.2378085 7 3.217067 764 3.132677 627 3.147447 145 3.1275554 26 3.1027384 73 mb middle class average 58.552941 18 58.552941 18 59.452941 18 62.51176 471 59.69411 765 61.04705 882 61.682352 94 60.635294 12 max 77 77.1 77.7 85.4 84.8 85.2 84.2 78.8 min 34.9 36.7 36.7 41.3 41.2 46.7 45.1 45.3 continue asian journal of economics and empirical research, 2015, 2(2):62-73 73 sd 12.481141 66 10.802726 37 11.871453 03 11.79776 898 11.21413 564 10.81827 838 10.527656 15 9.9303160 31 low income country 2005 2006 2007 2008 2009 2010 2011 2012 db middle class average 45.664285 71 45.335714 29 44.942857 14 45.4 45.27857 143 45.17857 143 45.107142 86 45.092857 14 max 52.1 53 51.9 51.9 51.9 51.8 51.8 51.7 min sd 6.0326811 42 6.2976927 57 6.1967378 87 5.973273 809 5.799360 518 2.774769 868 5.5610547 26 5.5399894 87 mb middle class average 58.085714 29 48.821428 57 56.957142 86 54.22857 143 52.72142 857 58.02857 143 55.042857 14 56.864285 71 max 89.5 81.2 82.6 79.8 82 85.5 83.8 82.7 min 34.6 23 31.3 34.2 27.3 41.8 39.8 37.9 sd 16.237509 15 15.805217 18 13.497162 91 12.78739 936 14.98666 699 12.37804 686 11.958049 38 10.819114 65 table-6. standard deviation of cu and fs high income countries db middle class output mb middle class output cu fs cu fs 2005→2008 0.095436267 0.037089688 0.108190434 0.035407862 2006→2009 0.12069557 0.020808809 0.129922961 0.08518847 2007→2010 0.116588756 0.026162906 0.133956861 0.033139944 2008→2011 0.102556379 0.015777084 0.140820412 0.010348775 2009 →2012 0.100155306 0.008259692 0.15963529 0.010348775 average 0.107086456 0.021619636 0.134505192 0.024676021 middle income countries db middle class output mb middle class output cu fs cu fs 2005→2008 0.105347548 0.063119159 0.181023277 0.075170224 2006→2009 0.141520478 0.04469597 0.171126902 0.06139061 2007→2010 0.184350774 0.25327634 0.255543253 0.21240582 2008→2011 0.128440321 0.043864624 0.223649275 0.032986299 2009 →2012 0.117962361 0.051703667 0.180505365 0.067636202 average 0.135524296 0.04574221 0.202369614 0.051684783 low income countries db middle class output mb middle class output cu fs cu fs 2005→2008 0.119996807 0.024365075 0.197829426 0.057696919 2006→2009 0.09426296 0.022783937 0.219483715 0.025571054 2007→2010 0.126240602 0.031737642 0.1817485 0.036689347 2008→2011 0.150401295 0.029173167 0.319145649 0.067701349 2009 →2012 0.1678201 0.018151432 0.365622042 0.017532905 average 0.13174436 0.025242251 0.256765866 0.041038315 views and opinions expressed in this article are the views and opinions of the authors, asian journal of economics and empirical research shall not be responsible or answerable for any loss, damage or liability etc. caused in relation to/arising out of the use of the content. asian journal of economics and empirical research issn(e) : 2409-2622 issn(p) : 2518-010x vol. 3, no. 2, 156-162, 2016 http://asianonlinejournals.com/index.php/ajeer 156 futures trading: informational content of open interest and trading volume on futures price shylaja p1  anver sadath c2 ( corresponding author) 1 research scholar, department of economics, central university of kerala, thejaswini hills, periye, kasargod 2 assistant professor, department of economics, central university of kerala, thejaswini hills, periye, kasargod abstract in an agriculture dominated country, like india, farmers face not only yield risk but price risk as well. commodity futures market play major role in the price risk management process, especially in agriculture. this study empirically analyses the informational content of open interest and trading volume on futures price determination on the basis of selected agricultural commodities. breuschgodfrey serial correlation lm test is used for analyzing the role of informational content of open interest and trading volume on futures price. empirical result shown that open interest playing a major role in futures price determination on commodity futures trading. in case of trading volume, the results show that a significant negative impact on futures price. the study strongly argues that the stockholders will be benefited through informational content of open interest and volume there by reducing the risk involved in the futures market. by monitoring the price trend, volume and open interest the technician is better able to measure the buying or selling pressure behind market moves. this will provide traders with valuable information to develop a suitable pricing strategy and an appropriate production and marketing plan for producers farming. keywords: futures price, open interest, trading volume, regression, breusch-godfrey serial correlation lm test, informational content. contents 1. introduction ....................................................................................................................................................................... 157 2. relationship between futures price, open interest and volume .................................................................................... 157 3. literature review .............................................................................................................................................................. 157 4. data and methodology....................................................................................................................................................... 158 5. regressions ......................................................................................................................................................................... 158 6. conclusions ........................................................................................................................................................................ 161 references .............................................................................................................................................................................. 161 citation | shylaja p; anver sadath c (2016). futures trading: informational content of open interest and trading volume on futures price. asian journal of economics and empirical research, 3(2): 156-162. doi: 10.20448/journal.501/2016.3.2/501.2.156.162 issn(e) : 2409-2622 issn(p) : 2518-010x licensed: contribution/acknowledgement: this work is licensed under a creative commons attribution 3.0 license all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. history: received: 12 august 2015/ revised: 30 december 2015/ accepted: 24 november 2016/ published: 23 january 2017 ethical: this study follows all ethical practices during writing. publisher: asian online journal publishing group http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.2/501.2.156.162 https://orcid.org/orcid-search/quick-search?searchquery=shylaja p https://orcid.org/orcid-search/quick-search?searchquery=anver sadath c http://search.crossref.org/?q=10.20448/journal.501/2016.3.2/501.2.156.162 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.2/501.2.156.162 https://orcid.org/orcid-search/quick-search?searchquery=shylaja p https://orcid.org/orcid-search/quick-search?searchquery=anver sadath c http://search.crossref.org/?q=10.20448/journal.501/2016.3.2/501.2.156.162 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.2/501.2.156.162 https://orcid.org/orcid-search/quick-search?searchquery=shylaja p https://orcid.org/orcid-search/quick-search?searchquery=anver sadath c http://search.crossref.org/?q=10.20448/journal.501/2016.3.2/501.2.156.162 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.2/501.2.156.162 https://orcid.org/orcid-search/quick-search?searchquery=shylaja p https://orcid.org/orcid-search/quick-search?searchquery=anver sadath c http://search.crossref.org/?q=10.20448/journal.501/2016.3.2/501.2.156.162 asian journal of economics and empirical research, 2016, 3(2): 156-162 157 1. introduction country like india where agricultural production is heavily dependent on monsoon and agricultural output is prone to vary depending upon weather conditions. hence, price variability is one of the most important problems faced by agricultural farmers in india. along with price variability, producers of agricultural commodities are expected to face high price risk. this unwanted risk again accelerated by the new economic reforms under world trade organization (wto) policy regime. consequently the government intervention is significantly declined in agricultural commodities market. as a result price of agricultural commodities are determined by market forces. in order to reduce these unwanted price risks, it requires a well-developed commodity derivatives market which will expect to function for over all benefit of the farmer as well as consumer. in order to manage price risk and discovering better price for commodities, derivatives entered into commodity markets. since then, the commodity futures trading including agricultural futures have witnessed tremendous growth in terms of trading volume. the growth in trading volumes and with increasing integration of indian economy with the rest of the world there was huge rise in prices of agricultural commodities. the rise in prices does not directly benefit to the farmers since there are a chain of intermediaries between the farmer and the ultimate consumer. the government has therefore been strengthening its approach towards futures trading of agricultural commodities at times suspending or totally banning it (the futures trade) and at other times permitting it. after the removal of banning during 2008 there is a sharp decline in the trading volume of agricultural commodities. it is therefore necessary to conduct a study to find out whether the trading volume or open interest determines the price behavior of the futures contract. by using the informational content of open interest and trading volume of pepper and rubber in the futures contract, this study empirically analyzing these nonprice variables has any relationship in the futures price determination. 2. relationship between futures price, open interest and volume the concept of open interest represents all contracts outstanding given for a particular commodity (hull, 2002). outstanding refers to contracts which are not yet offset by a transaction (reversed out), by delivery, by exercise, etc. (cftc, 2012).open interest is defined as the number of contracts existing in a futures market that have not yet been closed out (geman, 2005). open interest is the total number of futures contracts that are not closed or delivered on a particular day. open interest is a calculation of the number of active trades for a particular market. it is often used to confirm trends and reverse trend for futures contracts. the open interest situation is stated each day and represents the increase or decrease in the number of contracts for that day. open interest increases when new market entrant (buyers and sellers) coming to the markets in greater number than current position holder going away the market. open interest declines when current position holder exits their position in a greater number than new market entrants changed their position. it is remain unchanged when current position holder trades are balance by new market entrant traders. open interest is an important indicator for hedging (kamara, 1993) and market depth (bessenbinder and segain, 1993).open interest collective with price provides understanding about the leading market. the volume offers information about market liquidity (the higher the volume, the higher its liquidity). it is possible for the volume traded to exceed the open interests at the end of the day (hull, 2002).volume measures the forces or strength behind a price trend. volume describes the total amount of trading goings on or contracts that have changed hands in a given commodity market for a single trading day. the greater is the amount of trading, the higher will be the trading volume (geman, 2005). thus, volume represents a measure of strength or pressure behind a price trend. the greater is the volume, the more likely will the existing trend continue. volume and open interest help investors find evidences to market movement and strengthen the chances of improving their financial position. 3. literature review studies regarding to the information content of open interest and volume for futures price in commodity futures market is limited. franken and parcell (2003) examined the relationship between closing price and open interest in indian stock index futures market. the results show that the information of open interest can be used to predict future prices in the long run. moreover, the long-run information role of open interest is a good indicator for the usefulness of technical analysis in markets. bhuyan and chaudhury (2005) investigated whether options open interest contains information that can be used for trading purposes. regression results indicate that the prediction of stock price movement based on the distribution of options open interest to have reasonably good accuracy. the open interest based active trading strategies generate better returns compared to the passive benchmarks. srivastava (2003) used data from november2002 to february 2003 on 15 most liquid stocks of nse and options on them and analysed, using the methodology developed by bhuyan and chaudhury (2005) the power of open-interest and volume to predict the underlying spot price. he found both the variables to have significant explanatory power, while openinterest being more significant. pathak and rajesh (2010) study shows that both net open interest and trading volume are relevant for the futures return. brieden and lunn (2009) investigated the effects of open interest and trading volume on the future stock price for the spx index derivative market and found that the open interest variables were significant and the trading volume variables were not. gulati (2012) examined the relationship between closing price and open interest in indian stock index futures market. the evidence of granger causality shows that the information of open interest can be used to predict future prices in the long run. moreover, the long-run information role of open interest is a good indicator for the usefulness of a technical analysis in future markets. suhashini and chandrasekar (2013) empirically tested the price, volume and open interest for futures currency pairs. they tested the relationship between change in future return on change in volume, change in volume on change in open interest, change in future price on change in spot price by granger causality test. the results show that most of the variables have bidirectional causality at all lags and some have unidirectional causality. asian journal of economics and empirical research, 2016, 3(2): 156-162 158 4. data and methodology the present study empirically examines the importance of open interest and trading volume on futures price determination. open interest, trading volume and futures price data of rubber and pepper collected from historical data set of nmce (national multi commodity exchange) kochi and ncdex (national commodity & derivatives exchange limited). period taken for the study for rubber is from january 1, 2008 – 14 september 2013 and for pepper january 2008 to december 2013. the present study makes use of ols (ordinary least square) methods to carry out the empirical analysis. we use the following methodology for our empirical analysis: first we calculate the descriptive statistics for all the variables. in order to examine the informational content of open interest and trading volume on futures price ols method is used. before going to use ols technique one should test the stationary properties of the variable in the case of time series data. as our data is time series in nature, the study needs to test stationarity property of the variables using unit root test, namely dickey and fuller (1979) unit root test to avoid the spurious regression results. time series stationarity is a statistical characteristic of a series’ mean and variance over time. if both are constant over time, then the series is said to be a stationary process (i.e. is not a random walk/has no unit root), otherwise, the series is described as being a non-stationary process (i.e. a random walk/has unit root). differencing techniques are normally used to transform a time series from a non-stationary to stationary by subtracting each datum in a series from its predecessor. for our purpose here, since we will difference our series once, there is one unit root, so it is i (1) series. the commonly used methods to test for the presence of unit roots are the augmented dickey-fuller (adf) tests (dickey and fuller, 1979). the test is as follows: ∆yt= β1+ β2t+ yt-1+ αi∑ yt−i + ut (1) where ∆ is difference operator, β1 the intercept, t is time or trend value (t=1, 2, 3, . . .,t ) that yt contain. this we added to the equation as a variable with coefficient.yt−1 is lag of dependent variable which included in the equation to avoid the problem of serial correlation. here ut is error term and is coefficients of dependent variable. the null hypothesis is that yt contain a unit root (non-stationary) and the alternative hypothesis is that yt is stationary. the decision rule of dickey fuller test is based on the estimate of . if the estimated is statistically less than zero then we reject null hypothesis of non-stationarity. if the estimated is not significantly less than zero, then we can’t reject null hypothesis of non-stationarity. the criterion of selection for unit test is that the absolute value of the test statistics should be higher than the critical absolute value (dickey and fuller, 1979) and p-value of the test is less than 5 per cent significance level. the model hypotheses are: ho: =1(nonstationary) h1: < 1(stationary) 5. regressions the following equation is used as the basic model to show the informational content of open interest and trading volume on futures price. futures price = f (open interest, trading volume) the following model is specified to measure the informational content of both variables on futures price. we estimate this by ordinary least squares (ols) techniques which can be written as: fpt= + oit+ volt vt(2) where, fpt dependent variable of futures price of pepper and rubber , oit explanatory variables of open interest of pepper and rubber, volt explanatory variables as trading volume of pepper and rubber, vt is error term, t the subscript will denote the t th observation, β1 the intercept, β2, β3 coefficients of variables. equation (2) gives the effect of explanatory variables such as open interest and trading volume of pepper and rubber on futures prices of pepper and rubber. 5.1. empirical results this section presents the analysis of the empirical results and its discussion. the result is based on ols regression analysis. before going to use the regression technique, the present study used to examine the descriptive statistics of the variables. after that the stationary property of the time series data has been calculated. summary statistics of the data used for analysis is given in table1. table-1. descriptive statistics fprubber oirubber volrubber fppepper oipepper volpepper mean 16411.82 1233.521 1090.671 1533.773 2609.127 23720.33 maximum 26162.00 5412.000 11574.00 19421.00 12172.00 44660.00 minimum 6210.000 0.000000 2.000000 0.000000 0.000000 9842.000 std.dev. 4647.192 1136.549 1304.852 2568.224 3062.906 10696.99 skewness -0.344062 1.242208 2.044990 2.843740 1.237546 0.421089 kurtosis 2.258570 4.421453 8.861189 12.86004 3.385242 1.632109 probability 0.000000 0.000000 0.000000 0.000000 0.000000 0.000000 observation 1535 1535 1535 1650 1650 1650 source: author calculation based on ncdex and nmce price data the summary statistics shows that mean values of the fprubber, oirubber, volrubber, and fppepper are similar to some extent but oipepper and volpepper found larger. the variability of the variables is measured by standard deviation. here the variability among the variables are quite differs from each other. the maximum and the minimum values show the range in between which the values of the variables are lying. the value of skewness and kurtosis for trading volume, open interest and futures price of rubber and pepper asian journal of economics and empirical research, 2016, 3(2): 156-162 159 displayed some interesting characteristics. skewness helps us to determine the nature and extent of the concentration of the observations towards the highest or the lowest values of the variables. the negative skewness implies that the fupepper have a heavier tail of large values which indicates that the frequency curve of the distributions is little bit symmetric bell shaped curve. here the skewness values of all other variables are positive. if they are stretched more to the right side or have a longer tail towards the right side which show all are positively skewed. kurtosis is concentrated with the flatness or peakedness of the frequency curve. here the value of kurtosis exceeds 3, for oipepper, oirubber, fupepper, volrubber which is indicates that variable has platy kurtic while variables fprubber and volrubber is less than 3 which indicate that variable is leptokurtic (more peaked than normal curve). table-2. adf unit root test result augmented dickey fuller unit root test exogenous: constant, linear trend, lag length: 2 (automatic based on sic, maxlag=2) variables statistics p value dfprubber 38.77130 0.0000 dfppepper 38.89092 0.0000 doirubber 14.87354 0.0000 doipepper 40.89435 0.0000 dvolrubber 35.18521 0.0000 dvolpepper 34.94995 0.0000 note: 1.dfprubber and dfppepper represents differentiated futures price of rubber and pepper 2. doirubber and doipepper represent differentiated open interest of rubber and pepper 3. dvolrubber and dvolpepper represent differentiated trading volume of rubber and pepper each series are stationary after differentiating. the p-values are statistically significant and we can conclude that each of the price series is i (1), hence reject the null hypotheses and accept the alternative hypotheses data is stationary and proceeded to the next step of regression analysis. empirical result obtained from ordinary least square method is not considered as good one because of low value of the r 2 (0.099925) and adjusted r 2 (0.098750) means that model is not fit. durbin-watson d-statistics is low (enders, 2004) which shows that existence of auto-correlation problem in the model. the result which is drawn from the simple ols technique can’t be considered as good one. the overall goodness of fit of the regression model is measured by the coefficient of determination, r 2 . it tells what proportion of the variation in the dependent variable is explained by the explanatory variable. if r 2 lies between 0 and 1; the closer it is to 1, the better is the fit of model but here it is too low (0.099925 and 0.098750) and the tested regression is statistically not significant. table-3. informational content of open interest and trading volume on futures price of rubber dependent variable: dfprubber, included observations: 1535 variables coefficient std. error prob. c 15417.09 166.3964 0.0000 doirubber -0.381573 0.144078 0.0082 dvolrubber 1.343589 0.125495 0.0000 r-squared 0.099925, adjusted r-squared 0.098750, f-statistic 85.04041, prob(f-statistic 0.000000, durbin-watson stat 0.066250, akaike info criterion 19.62389, schwarz criterion 19.63432 for p value: at 1 per cent level is 0.01; 5 per cent level is 0.05 the standard error in this model is relatively large which indicates that presence of multicolinearity. but here cannot detect the problem of multicolinearity because only two independent variables are exists. hence check the problem of autocorrelation affecting the model or not. to assess serial correlation breusch-godfrey lm test is used. 5.2. breusch-godfrey serial correlation lm test statisticians breusch and godfrey (bg) have developed a test of autocorrelation it allows the lagged values of the regressand; higher-order autoregressive schemes i.e., ar (1), ar (2) etc., and simple or higher-order moving averages of error terms, such as ut. lagrange multiplier (lm) test of autocorrelation analyzing how well the lagged residual explain the residual of the original equation. if lagged residuals are significant in explaining this times residuals on the basis of chi-square then we can say there is no serial correlation. if sample size is large, breusch godfrey lm test based on n*r 2 follow a chi-square. n*r 2 exceeds the critical value at the chosen level of significance, and then it indicates there is serial correlation exist.in serial correlation the value of error terms in one time period depends on some systematic way on the value of the error term in other time periods. in regressions involving time series data, successive observations are likely to be interdependent. we experience autocorrelation when e(uiuj) ≠ 0, no autocorrelation between the error term if given any two x values, xi and x j (i =j), the correlation between any two error term ui and uj(i =j) =0. the regression model to illustrate for the test is as follows: fpt = β1 + β₂oit+ β3volt+ ut (3) ut= α1ut-1+α2ut-2+………..+αput-3+ εt (4) where, fpt is futures price of pepper and rubber, oit open interest of pepper and rubber volt trading volume of pepper and rubber ut error term, β1 intercept β2, β3 is coefficients of independent variables,ut-1, ut-2, ut-3 = lagged values of error termα1, α2, α3, αpare coefficient of error term and εt is residuals of error term. the model (4) assumes if α1, α2, asian journal of economics and empirical research, 2016, 3(2): 156-162 160 α3, ….αp =0 indicate that the error terms between two the series are equal to zero or there is no serial correlation exist between series. table-4. breusch-godfrey serial correlation lm (bg) test dependent variable dfprubber ,included observations: 1535 obs*r-squared 1469.415 prob. chi-square(2) 0.0000 variable coefficient std. error prob. c 6.270884 34.41754 0.8554 doirubber 0.553206 0.030115 0.0000 dvolrubber -0.631578 0.026400 0.0000 r-squared 0.957274, adjusted r-squared 0.957162, f-statistic 8569.879, prob(f-statistic) 0.000000, akaike info criterion16.47355, schwarz criterion16.49094, durbin-watson stat1.440659 for p value: at 1 per cent level is 0.01; 5 per cent level is 0.05 the result which is drawn from the bg lm test is considered as good one in comparison to the simple ols method. the serial correlation causes ols to produced incorrect standard error, and r 2 value. in this model observed r square and corresponding probability chi-square values are statistically significant specify that there is no serial correlation in the model. r square (0.957274) and adjusted r 2 (0.957162) are nearer to 1 which shows the goodness of fit of the model. the r 2 or coefficient of determination is included to represent how much variation in the dependent fpt variable is captured by the regression. both akaike info criterion (aic) and schwarz info criterion (sic) which are used for the selections of better model, (penalize for introducing more regressors in the model). suggest that this model is better, the lower the value of sic and aic, the better the model (gulati, 2012) as aic and sic have values 16.473 and 16.490 for the bg model as compared to 19.623 and 19.634 for the simple ols model. therefore, we consider the regression results of table 4 for our analysis, as the estimated regression results satisfy all the criteria for a good model. the estimated regression test result value helps in examining the informational content of open interest and volume for discovering price. from the above bg lm test both variables have mutual impact on the futures price. the coefficient value (0.553206) of open interest is statistically significant at 1 per cent(0.0000) level, which indicates information content of open interest is significant impact on futures price while trading volume has insignificant or negative (-0.631578) impact on futures price of rubber. next, we estimated the equation with ordinary least square (ols) method to find out the informational content of open interest and trading volume for futures price of pepper during the period of study. here, dfupepper is considered as dependent variable. but the result is not quite good because of low value of r 2 and adjusted r 2 and low value of the durbin-watson statistics which shows the existence of auto-correlation problem. table-5. informational content of open interest and volume for futures price of pepper dependent variable: dfupepper, included observations: 1650 variables coefficient std. error prob. c 26143.39 333.2566 0.0000 doipepper -1.275191 0.125509 0.0000 dvolpepper 0.589442 0.149684 0.0001 r-squared0.075637, adjusted r-squared 0.0745f-statistic67.38341, prob(f-statistic)0.000000, akaikeinfocriterion21.31769, schwarz criterion 21.32753, durbin-watson stat 0.015140 for p value: at 1 per cent level is 0.01; 5 per cent level is 0.05, the simple ols technique can’t be considered as good one. here p-values of open interest and trading volume are statistically significant. though the values of both r 2 and adjusted r 2 is very low which show our model is not fit, at the same time the durbin-watson (dw) statistic is very low i.e. 0.015140 which indicate the presence of autocorrelations. to solve the problem of auto-correlation of error term, we have allowed a bruesch godfrey model of test. the result of the ols technique with bg test is presented in table 6. table-6. breusch-godfrey serial correlation of pepper dependent variable: dfupepper: included observations: 1650 obs*r-squared 1628.743 prob. chi-square(2) 0.0000 variable coefficient std. error prob. c -123.9748 37.89798 0.0011 doipepper 0.192413 0.014319 0.0000 dvolpepper -0.242177 0.017033 0.0000 r-squared 0.987117,adjusted r-squared0.987085,f-statistic31509.97,prob(fstatistic)0.000000,akaike info criterion16.96829, schwarz criterion16.98468, durbin-watson stat1.634313 for p value: at 1 per cent level is 0.01; 5 per cent level is 0.05 breusch godfrey lm test for serial correlation on the basis of lagged values of error terms. it is tested on the basis of observed r square and p values of the chi-square. here the observed r square and chi square values are significant at 1 per cent and we can say that there is no auto correlation among variables. the values of both r 2 and adjusted r 2 are nearer to 1(0.987117 and 0.987085) which shows the goodness of fit or overall fitness of model. both asian journal of economics and empirical research, 2016, 3(2): 156-162 161 akaike info criterion (aic) and schwarz info criterion (sic) which are used for the selections of better model suggest that the bg model is better as aic and sic have values 16.968 and 16.984 for the bg model as compared to the simple ols model (21.31769,21.32753). the p value and corresponding f-statistics (0.0000) are significant which measure the overall significance of the estimated regression. therefore, we consider the bg lm model reported in table 6 for our analysis. the estimated regression test result value helps in examining the informational content of open interest and volume for futures price. the regression result of table 6 shows that information content of open interest of pepper (oipepper) playing a major role for determining futures price of pepper. the positive sign of coefficient and significant p-value shows that impact of open interest is higher compared to trading volume. on the other hand the estimated coefficient of trading volume is negative impact on futures price. estimated p value and f statistics indicate that the overall fit of the model. r 2 and adjusted r 2 indicate that in case of futures price of pepper almost completely explained by the independent variables included in the model. regression coefficients specify that information content of open interest has a positive relation to determine futures price whereas trading volume has a negative impact. trading volume and open interest relationship provides insights into the structure of markets and is crucial to the debate regarding the distribution of speculative prices as the dominance of speculators and the presence of hedging and arbitrage activity. to understanding the value of open interest and volume one can often make profit in the futures market. when we compare the information content of open interest and trading volume on futures price, it is observed that both of them have statistically significant power (0.0000) to determine the futures price but coefficient shows that open interest has higher role. therefore the study strongly argues that the stockholders will be benefited through informational content of open interest and volume there by reducing the risk involved in the futures market. by monitoring the price trend, volume and open interest the technician is better able to measure the buying or selling pressure behind market moves. the number of open positions in the market is measured in terms of open interest, thus the open interest in a contract tells us about the popularity of the trend in the market. this information can be used to confirm a price move is to be trusted or that a price move is not to be trusted. this will provide traders with valuable information to develop a suitable pricing strategy and an appropriate production marketing plan for producers farming 6. conclusions this study makes an empirical analysis on the informational content of open interest and trading volume on commodity futures price determination on the basis of pepper and rubber. the study uses bg lm test technique for its empirical analysis. the result states that information content of open interest has significant positive impact on both the futures price of pepper and rubber during the study period. in case of trading volume, the results show that it is significant but its impact on futures price is negative. there are many reasons that traders pay attention to futures price and open interest. open interest, or the total number of open contracts, applies primarily to the futures markets. it is often used to confirm trends of futures contracts. an increase in open interest along with an increase in price is said to confirm an upward trend, while an increase in open interest along with a decrease in price confirms a downward trend. open interest depends on the futures price movements that have captured all relevant information about hedgers and speculators. volume and open interest help investors to find evidences on market movement and strengthen the chances of improving their financial position. therefore the study strongly argues that the stockholders will be benefited through informational content of open interest and trading volume there by reducing the hedge involved in the futures market. the price-trading volume, and open interest relation, is important as it provides insights to the structure of markets and is crucial to the debate regarding the distribution of speculative prices as the dominance of speculators and the presence of hedging and arbitrage activity. to understanding the value of open interest and volume one can often make profit in the futures market. in this empirical analysis the positive sign of open interest said that more traders are actively participating in the futures market of pepper and rubber. open interest is determining the future price in futures contracts. by monitoring the price trend, volume and open interest the technician is better able to measure the buying or selling pressure behind market moves. this information can be used to confirm a price move or advise that a price move is not to be trusted. this will provide traders with valuable information to develop a suitable pricing strategy and an appropriate production-marketing plan for producers farming operation. but theoretical study on the relationship between futures price, open interest and trading volume is limited and is a sturdy area for future research. references bessenbinder, h. and p.j. segain, 1993. price volatility, trading volume, and market depth: evidence from futures markets. journal of financial and quantitative analysis, 28(01): 21-39. view at google scholar | 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inc. franken, j.r.v. and l.j. parcell, 2003. cash ethanol cross-heading opportunities. journal of agriculture and applied economics, 35(3): 509516. view at google scholar | view at publisher geman, h., 2005. commodities and commodity derivatives: modeling and pricing for agriculturals, metals and energy. chichester: john wiley & sons ltd. gulati, d., 2012. relationship between price and open interest in indian futures market: an empirical study. pacific business review international, 5(1): 27-35. view at google scholar hull, j.c., 2002. options, futures, & other derivatives. 5th edn., upper saddle river, nj: pearson education asia, new delhi. https://scholar.google.com/scholar?hl=en&q=price%20volatility,%20trading%20volume,%20and%20market%20depth:%20evidence%20from%20futures%20markets http://dx.doi.org/10.2307/2331149 https://scholar.google.com/scholar?hl=en&q=trading%20on%20the%20information%20content%20of%20open%20interest:%20evidence%20from%20the%20us%20equity%20options%20market 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indian market. iup journal of financial economics, 8(3): 49-61. view at google scholar srivastava, s., 2003. informational content of trading volume and open interest – an empirical study of stock option market in india. nse research initiative working paper no. 29. available from http://ssrn.com/abstract=606121. suhashini, j. and k. chandrasekar, 2013. causality between volume, open interest, returns spot and future prices of currency futures trading in india. asia pacific journal of research, 3(10): 1-15. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://scholar.google.com/scholar?hl=en&q=production%20flexibility,%20stochastic%20separation,%20hedging,%20and%20futures%20prices https://scholar.google.com/scholar?hl=en&q=production%20flexibility,%20stochastic%20separation,%20hedging,%20and%20futures%20prices http://dx.doi.org/10.1093/rfs/6.4.935 https://scholar.google.com/scholar?hl=en&q=informational%20role%20of%20options%20open%20interests%20and%20volume%20in%20forecasting%20future%20prices:%20a%20study%20on%20indian%20market http://ssrn.com/abstract=606121 asian journal of economics and empirical research issn: 2409-2622 vol. 3, no. 1, 71-83, 2016 http://asianonlinejournals.com/index.php/ajeer 71 economic growth of west african countries and the validity of wagner’s law: a panel analysis udo, aniefiok benedict1  effiong, charles efefiom2 ogar, ohiama ochagu3 1,2 department of economics, university of calabar, calabar-nigeria 3 department of economics, cross river state college of education, akampka-nigeria ( corresponding author) abstract the volume of public expenditure has been on the rise especially in the developing economies and this has renewed the argument among economists on the validity of wagner’s law. whereas for keynes, the increase is needed to stimulate aggregate demand for economic growth to take place, wagner opine that public expenditure is a consequence rather than cause of national productivity hence; it plays no role in the growth of an economy. for the west african economies, which of these economic concepts prevails? this study seeks to determine the validity of these theories in the sixteen countries that make up west african region using a panel analysis. the result reveals that, first, there is a bidirectional effect or relationship between government spending and economic growth in five west african countries, unidirectional causality flowing from government expenditure to economic growth in four countries, while unidirectional causality from economic growth to government expenditure were in two countries. however, there were no causal relationship between government expenditure and economic growth in the remaining five countries in west africa. secondly, using different versions of wagner’s law, we observed that only goffman version is truly validated in the west african economies given the value of more than one per cent marginal effect of per capita growth on expenditure. therefore, for the countries that respond to keynes theory, there is need for appropriate policies with respect to government spending knowing that it affects the level of growth. keywords: government expenditure, economic growth, wagner law, granger causality, panel analysis and west africa. jel classification: h50. contents 1. introduction ......................................................................................................................................................................... 72 2. literature review ................................................................................................................................................................ 72 3. methodology and data......................................................................................................................................................... 77 4. empirical analysis and discussion of findings .................................................................................................................. 78 5. conclusion ............................................................................................................................................................................ 79 6. recommendation for further studies................................................................................................................................. 80 references ................................................................................................................................................................................ 80 appendix .................................................................................................................................................................................. 80 citation | udo, aniefiok benedict; effiong, charles efefiom; ogar, ohiama ochagu (2016). economic growth of west african countries and the validity of wagner’s law: a panel analysis. asian journal of economics and empirical research, 3(1): 71-83. doi: 10.20448/journal.501/2016.3.1/501.1.71.83 issn (e): issn (p): 2409-2622 2518-010x licensed: this work is licensed under a creative commons attribution 3.0 license contribution/acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained ethical: history: this study follows all ethical practices during writing. received: 4 april 2016/ revised: 28 april 2016/ accepted: 2 may 2016/ published: 9 may 2016 publisher: asian online journal publishing group http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.71.83 https://orcid.org/orcid-search/quick-search?searchquery=udo, aniefiok benedict https://orcid.org/orcid-search/quick-search?searchquery=effiong, charles efefiom https://orcid.org/orcid-search/quick-search?searchquery=ogar, ohiama ochagu http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.71.83 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.71.83 https://orcid.org/orcid-search/quick-search?searchquery=udo, aniefiok benedict https://orcid.org/orcid-search/quick-search?searchquery=effiong, charles efefiom https://orcid.org/orcid-search/quick-search?searchquery=ogar, ohiama ochagu http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.71.83 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.71.83 https://orcid.org/orcid-search/quick-search?searchquery=udo, aniefiok benedict https://orcid.org/orcid-search/quick-search?searchquery=effiong, charles efefiom https://orcid.org/orcid-search/quick-search?searchquery=ogar, ohiama ochagu http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.71.83 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.71.83 https://orcid.org/orcid-search/quick-search?searchquery=udo, aniefiok benedict https://orcid.org/orcid-search/quick-search?searchquery=effiong, charles efefiom https://orcid.org/orcid-search/quick-search?searchquery=ogar, ohiama ochagu http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.71.83 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.71.83 https://orcid.org/orcid-search/quick-search?searchquery=udo, aniefiok benedict https://orcid.org/orcid-search/quick-search?searchquery=effiong, charles efefiom https://orcid.org/orcid-search/quick-search?searchquery=ogar, ohiama ochagu http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.71.83 asian journal of economics and empirical research, 2016, 3(1): 71-83 72 1. introduction the volume of public expenditure has been on the rise in the developing economies if not almost all countries of the world because of the continuous expansion in the activities of the nations and other public agencies on several fronts. since the twentieth century, the increase in the functions of the state in social matters such as education, public health, commercial and industrial undertakings and so on, has increased public expenditure to a large extent. this increase in state expenditure is as a result of socio-political, economic and historical differences between developed and developing countries. however, the involvement of government in the activities of the state is dependent on the structure of economic development prevalent in the country under consideration. for countries that have gone pass primary and secondary level of production, the level of government expenditure will be high if compared with countries at the tertiary level of production where government spends less since the level of economic activities at this level is determine by the private sector. by and large, irrespective of production level and structure of the economy, the government is highly involved in providing an enabling environment for investors as well as provision of social amenities as a means of improving the standard of living of her citizens. this government effort towards provision of public goods which led to increase public expenditure and in the long-run economic growth is attributed to a german economist wagner. wagner (1883) observed that there is a strong relationship between economic growth and public spending which was later formulated as ‘wagner’s law of increasing state activities’. the fundamental idea behind this relationship is based on the fact that growth in public expenditure is a natural consequence of economic growth. this implies that, the percentage share of public expenditure increases with an increase in gross domestic product. this shows that, the growth elasticity of public expenditure is greater than one. according to wagner, the reason behind the expansion of state activities is a practical approach and is not based upon any formula but rather on the expectation that government will always provide social amenities and economic goods for industrial development. in west african countries, government over the years has made significant efforts towards welfare maximization. therefore, the increase in state expenditure in west african countries is needed because of three main reasons. wagner himself identified these as (i) social activities of the state, (ii) administrative and protective actions, and (iii) welfare functions. these factors are further segment into socio-political, i.e., the state social functions expands over time: retirement insurance, natural disaster aid (either internal or external), environmental protection programs, etc., economic which involves science and technology advance, consequently there is an increase of state assignments into the sciences, technology and various investment projects, etc. and historical were the state resorts to government loans for covering contingencies, and thus the sum of government debt and interest amount grow; i.e., it is an increase in debt service expenditure. african countries generally have a blotted public expenditure as a result of the existing low per-capita gdp, hence, the involvement of government in almost every sector of their economy. this informs the continuous yearly increase in public expenditure especially on recurrent expenditure. despite these increases in public expenditure in the west african economies, growth has not accelerated as expected in this region and as such poverty remains widespread and pervasive, particularly in the rural areas. this calls for argument among economists to find out; what is the role of fiscal policy in inducing economic growth, redistributing income and reducing poverty in the west african economies? could fiscal policy be designed so as to ensure economic growth and reduce poverty while maintaining macroeconomic stability in this region? furthermore, does government spending in the west african countries contribute to economic growth and development? these are critical questions to ask given the renewed interest of targeting poverty alleviation and given that fiscal policy is the arrowhead of the policy package of most of the african countries. this study intend to focus specifically on one side (government expenditure) in achieving the following objectives; 1. to determine the nature and direction of causality between government spending and economic growth in west africa, by testing for the wagner’s hypothesis and its reverse (keynesian approach). 2. determining the relationship between governments spending and economic growth in these countries. this will help to decide if the current pace of public spending in these economies is productive and should be encouraged or not. the paper has five sections; section one is the introduction, section two contains the literature review, section three is the methodology, section four is empirical results and discussion while section five is conclusion and policy recommendations. 2. literature review eberts and gronberg (1992) in an attempt to test wagner’s hypothesis of an expanding public sector as an economy develops, made use of pooled time-series cross-sectional data for u.s. states from 1964-1986. they did a comparison of government size among fiscal jurisdictions within a single nation to reduce the problems of data comparability and of controlling for cultural and institutional differences that plague the more common international test of this theory. they concluded that the results were inconsistent with wagner’s hypothesis due to the negative relationship between public sector size and output, though they opined that some empirical support is found in the protective service and public welfare components of government activity. lamartina and andrea (2008) analyzed the joint development of government expenditures and economic growth in 23 oecd countries using panel cointegration. their empirical evidence provides indication of a structural positive correlation between public spending and per-capita gdp which is consistent with the so-called wagner’s law. according to them, long-run elasticity larger than one suggests a more than proportional increase of government expenditures with respect to economic activity. furthermore, they maintained that the correlation is usually dominant in countries with lower per-capita gdp, suggesting that the catching-up period is characterized by a stronger development of government activities with respect to economies in a more advanced stage of development. verma and arora (2010) examine the validity of wagner’s law in india over the period 1950/51 to 2007/2008 by considering the six versions of wagner’s hypothesis given by different economists. the result supports the existence of long-run relationship between economic growth and growth of public expenditure. they made use of two structural breaks to test the impact of structural changes in indian economy on the growth of public expenditure. http://en.wikipedia.org/wiki/insurance http://en.wikipedia.org/wiki/disaster_relief http://en.wikipedia.org/wiki/government_debt asian journal of economics and empirical research, 2016, 3(1): 71-83 73 they also discovered that the first structural break given for mild-liberalization period causes insignificant changes in the growth elasticity of public expenditure. also, they maintained that change in the elasticity due to the second phase of intensive liberalization is statistically significant. they concluded that empirical evidences regarding the short-run dynamics refute the existence of any relationship between the economic growth and size of the government expenditure. magazzino (2010) assess the empirical evidence of wagner’s law in italy for the period 1960-2008 at a disaggregated level using a time series approach. he found a co-integration relationship for three out of five items. according to the granger causality test results, evidence exist in favour of wagner’s law only for spending for passive interests in the long-run, and for spending for dependent labour income in the short-run. kuckuck (2012) using historical data, test for the validity of wagner’s law of increasing state of activity at different stages of economic development for five industrialized european countries of united kingdom, denmark, sweden, finland and italy. to enable him investigate the coherence between wagner’s law and development stage, he classify every country into three individual stages of income development and apply advanced co-integration and vector error correction analyses. he discovered that the relationship between public spending and economic growth in these countries has weakened with advancement in stage of development. therefore, evidence from the research supports the notion that wagner’s law in its pure form may have reached its limit in recent decades. constantinos and persefoni (2013) attempted to analyze the causal relationship between income and government spending in the greek economy for such a long period (1833-1938), to enable them gains some insight into wagner and keynesian hypotheses. according to them, the time period of the analysis represents a period of growth, industrialization and modernization of the economy, a condition which is not only conducive for wagner’s law but also to the keynesian hypothesis. autoregressive distributed lag (ardl) co-integration method and tests for the presence of possible structural breaks were used for analysis. from their results, it was revealed that a positive and statistically significant long run causal effect exist, running from economic performance towards the public size which affirms wagner’s law in greece, whereas for the keynesian hypothesis some doubts arise for specific time sub-periods. oyinlola and akinnobosun (2013) examine the relationship between public expenditure and economic growth in nigeria in the period 1970-2009. a disaggregated public expenditure level was employed using the gregory-hansen structural break co-integration technique. their outcome confirms wagner’s law in two models in the long run and that there was a break in 1993 in which the political crisis that engulfed the nation was accountable. they also discovered that economic growth and development are the main objectives of government, especially investment in infrastructure and human resources all of which falls under social and community services, hence, there is need to maintain adequate levels of investment in social and economic infrastructure. as indicated by richter and dimitrios (2012) and quoted in udo and effiong (2014) there are six (6) different versions of wagner’s law: peacock and wiseman (1967);gupta (1967);goffman (1968);pryor (1968);musgrave (1969);goffman and marhar (1971) and mann (1980). these are listed below; 1. peacock-wiseman version 𝑳𝑮𝒕=𝒂𝟎+ 𝒂𝟏𝑳𝒀𝒕+𝒆𝒕𝒂𝟏>1 (1) notes: lg is the log of real government expenditures, lgc is the log of real government consumption expenditure, lp is log of population, l(g/y) is the log of the share of government spending in total output, l(y/p) is the log of the per capita real output, l(g/p) is the log of the per capita real government expenditures ,l y is the log of real gdp. 2. peacock-wiseman share version (mann version) (𝑮/𝒀)=𝛃𝟎+ 𝛃𝟏𝑳𝒀𝒕+𝒆𝒕𝜷𝟏>0 (2) 3. musgrave version (𝐆/𝐘)𝐭=𝛄𝟎+𝛄𝟏 (𝐘/𝐏) ⁄+𝒆𝒕𝜸𝟏>0 (3) 4. gupta version (𝐆/𝐏)𝐭=𝛅𝟎+(𝐘/𝐏)𝐭 ⁄+𝒆𝒕𝜹𝟏>1 (4) 5. goffman version 𝑳𝑮𝒕=𝛌𝟎+𝛌𝟏 (𝐘/𝐏) ⁄+𝒆𝒕𝛌𝟏>1 (5) 6. pryor version 𝑳𝑮𝑪𝒕=𝛉𝟎+ 𝛉𝟏𝐋𝒀𝒕+𝒆𝒕𝜽𝟏>1 (6) 2.1. structure of public expenditure in west african countries: some stylized facts figure-1. trend of government expenditure and national income in nigeria (1970-2012) source: computed by the authors asian journal of economics and empirical research, 2016, 3(1): 71-83 74 figure-2. trend of government expenditure and national income in togo (1970-2012) source: computed by the authors figure-3. trend of government expenditure and national income in niger (1970-2012) source: computed by the authors figure-4. trend of government expenditure and national income in guinea bissau (1970-2012) source: computed by the authors figure-5. trend of government expenditure and national income in guinea (1970-2012) source: computed by the authors asian journal of economics and empirical research, 2016, 3(1): 71-83 75 figure-6. trend of government expenditure and national income in burkina faso (1970-2012) source: computed by the authors figure-7. trend of government expenditure and national income in benin (1970-2012) source: computed by the authors figure-8. trend of government expenditure and national income in mauritania (1970-2012) source: computed by the authors figure-9. trend of government expenditure and national income in liberia (1970-2012) source: computed by the authors asian journal of economics and empirical research, 2016, 3(1): 71-83 76 figure-10. trend of government expenditure and national income in senegal (1970-2012) source: computed by the authors figure-11. trend of government expenditure and national income in ghana (1970-2012) source: computed by the authors figure-12. trend of government expenditure and national income in cape verde (1970-2012) source: computed by the authors figure-13. trend of government expenditure and national income in mali (1970-2012) source: computed by the authors asian journal of economics and empirical research, 2016, 3(1): 71-83 77 figure-14. trend of government expenditure and national income in gambia (1970-2012) source: computed by the authors figure-15. trend of government expenditure and national income in ivory coste (1970-2012) source: computed by the authors in nigeria, national income raise above total expenditure from 1978 to 2008 and move in the same direction except from 1977 to 1980 when they move in opposite direction (negatively related). for togo, niger, benin, mauritania and senegal the figure indicates that public expenditure exceeds their outputs but have direct relationship while liberia shows a non correlated pattern between economic growth and government intervention. in ghana economy, public expenditure and economic growth have positive relationship. this is applicable to cape verde economy, mali and gambia. the figure also reveals that most of the african economies are dominated by public activities even to the extent of having fiscal deficit in a good number of west african economies. 3. methodology and data this study adopts a quantitative method to evaluate the empirical evidence of the relationship between government expenditure and economic growth in west african economies to elucidate the evidence of either wagner or keynes theory. the method of analysis has been an econometric technique using panel regression models that is derived from various versions of wagner’s model. the data used in this study is secondary annual time series covering 1970 – 2012. the basic data for this analysis are rate of; gross domestic product (gdp), government total expenditure, income per capita, population and per capita expenditure. these data were collected from the world bank statistical record for these countries under review. based on the specific objectives of this study, we approached the methodology thus: objective 1 was analysed by using the granger causality test to ascertain the causal relationship between government spending and economic growth in west african countries. objective 2 was analysed by using panel regression analysis. this is a statistical method, widely used in social science, and econometrics, which deals with two-dimensional (cross sectional/times series) panel data. the data were collected over time and over the cross sectional individuals (west africa) and then a regression is run over these two dimensions. 3.1. model specification in this section, we postulate different models that seek to examine the existence of wagner’s hypothesis in an economy. these models will be used to examine the existence of this hypothesis in the west african economies. our specifications of these models are based on the different versions of wagner’s hypothesis that was listed in the literature. the models are symbolically represented below: given a common panel data regression model to be , (7) where asian journal of economics and empirical research, 2016, 3(1): 71-83 78 y is the dependent variable, x is the independent variable, a and b are coefficients, i and t are indices for individuals and time, is the error. we experimented with the different version of wagner’s equation relating fiscal and economic growth. 1. peacock-wiseman version 𝑳𝑮exi𝒕=𝒂𝟎+ 𝒂𝟏𝑳𝒀i𝒕+𝒆i𝒕𝒂𝟏>1 (1) 2. mann version (𝑮ex/𝒀) i𝒕= 𝛃𝟎+ 𝛃𝟏𝑳𝒀i𝒕+𝒆i𝒕𝜷𝟏>0 (2) 3. musgrave version (𝐆ex/𝐘) i𝒕= 𝛄𝟎+ 𝛄𝟏 (𝐘/𝐏) i𝒕 +𝒆i𝒕𝜸𝟏>0 (3) 4. gupta version (𝐆ex/𝐏) i𝒕 =𝛅𝟎 + (𝐘/𝐏) i𝒕+ 𝒆i𝒕𝜹𝟏>1 (4) 5. goffman version 𝑳𝑮exi𝒕= 𝛌𝟎 + 𝛌𝟏 (𝐘/𝐏) i𝒕 + 𝒆i𝒕𝛌𝟏>1 (5) where: lgex is the log of real government expenditures of each country under review, lp is log of population of each country under review, l(gex/y) is the log of the ratio of government expenditure to total output, (gdp) l(y/p) is the log of per capita real output, (per capita income) l(gex/p) is the log of per capita real government expenditures, ly is the log of real gdp. 4. empirical analysis and discussion of findings 4.1. granger causality result the table below shows the result of pair wise granger causality test. from the result, it is observed that there exist a unidirectional relationship flowing from government expenditure to national output in togo, mauritania, liberia and sierra leone economies while the opposite is the case in guinea and cape verde economies. these imply that keynes theory concerning stimulation of aggregate demand by the government holds in togo, mauritania, liberia and sierra leone economies. also, in guinea and cape verde economies, wagner’s hypothesis exists as shown in the causality test result. however, in nigeria, mali, ghana, gambia and ivory coast, the result shows that there is a bidirectional effect existing between national output (gdp) and government expenditure (gex). according to this result, government spending influence the level of output and the growth of output in turn influence the level of government spending in these economies. lastly, the rest of the economies in west africa show no relationship between these key macroeconomic variables as shown in table 1. table-1. summary of granger causality test gex → gdp gex ← gdp gex ↔ gdp no effect togo guinea mali benin mauritania cape verde ghana guinea bissau liberia nigeria senegal sierra leone gambia burkina faso ivory coast niger source: computed by the authors note: gex → gdp= unidirectional effect flowing from government expenditure. gex ← gdp= unidirectional effect flowing from gdp to government expenditure. gex ↔ gdp= bidirectional effect between the two variables. table-2. summary of panel analysis clarifying the existence of wagner’s hypothesis in west african economies version hypothesis emirical result decision wiseman 𝒂𝟏>1 𝒂𝟏<0 no validation mann 𝜷𝟏>0 𝜷𝟏<0 no validation musgrave 𝜸𝟏>0 𝜸𝟏<0 no validation gupta 𝜹𝟏>1 𝜹𝟏<1 no validation goffman 𝛌𝟏>1 𝛌𝟏>1 validated source: computed by the authors note: see details of the results in the appendix from the result, the peacock (mann version of wagner’s shows that there is an inverse (negative) relationship between national income and the share of government expenditure on national income in these economies under review. this shows that economic growth (increase in the output) will cause a reduction in the level of government expenditure in the west african economies, whereas wagner postulated a positive (greater than one) impact. this asian journal of economics and empirical research, 2016, 3(1): 71-83 79 implies that this version of wagner’s law does not hold in the west african economies. for the wiseman version of wagner, the impact of gdp to government expenditure is positive, showing that an increase in the level of gdp will cause a corresponding increase in government expenditure. but according to wagner’s law the coefficient of α must be greater than one while in the analysis it is less than one meaning that this law does not hold in west african economies. also, the musgrave version shows a negative impact of income per capita on per capita expenditure. since the coefficient is less than zero it implies that this version of wagner’s law is not validated in the west african economies. gupta also is not validated in west african economies given its less than one coefficient of per capita income though it has a positive effect on per capita expenditure. lastly, the effect of per capita gdp on government expenditure in goffman version of wagner’s law shows a validity of this law in the west african economies; given its coefficient to be more than one in the result (see detailed result in appendix). 4.2. policy implication of findings based on the empirical findings in this study, we have the following policy implications;  from the granger causality result which shows the causal relationship between economic growth, measured by gross domestic product (gdp) for all the west african countries, it’s depicts that togo, mauritania, liberia and sierra leone are strongly influence by the public sector. this is evidence in the unidirectional effect (flowing from government expenditure) between expenditure and economic growth. therefore it implies that the keynesian theory is applicable in these economies and hence prudent spending is needed to achieve desired growth. for guinea and cape verde, the results show that wagner’s law is applicable, as such, private sector should be encouraged to achieve economic growth which will affect the level of government expenditure. in the case of the giant of africa (nigeria), ghana, mali, gambia and ivory coast the results show a mixed economy implying the respond of some sectors of the economy to the keynesian theory while wagner’s hypothesis holds in others. also, this means that the level and nature of government spending will affect the rate of economic growth and the rate of growth too will in turn affect the level of government spending. government expenditure should be increased in the economy since this macroeconomic variable directly influences the economy to promote economic growth.  from the panel analyses, economic growth reduces the share of government expenditure to total output in all the west african economies. in the case of wiseman version, there is a direct effect of economic growth on the level of government expenditure whereas; per capita income does not promote the growth of share of government expenditure to output. however, it promotes the share of government expenditure on population in these economies and also government expenditure itself. this implies that when there is increase in the per capita income it will cause an increase in government expenditure and also the ratio of government expenditure to population. explaining the validity of wagner’s hypothesis in goffman version. 5. conclusion this study sought to appraise the nature and direction of causality to establish the relationship between government spending and economic growth in the west african economies. also, five econometric models were formulated and analyzed, base on different versions of wagner’s law, to further test for the validity of wagner’s hypothesis and its reverse (keynesian approach)spanning from 1970-2012. accordingly, starting from the nature and direction of causation, granger pair wise causality model was used while a panel regression model was used to estimate the equations, to evaluate the inherent connectivity between government spending and economic growth. in the analyses, firstly, there is a bidirectional effect or relationship between government spending and economic growth in five west african countries, unidirectional causality flowing from government expenditure to economic growth in four countries, while unidirectional causality from economic growth to government expenditure were in two countries. however, there were no causal relationship between government expenditure and economic growth in the remaining five countries in west africa. secondly, using different versions of wagner’s law, we observed that only goffman version is truly validated in the west african economies given the value of more than one per cent marginal effect of per capita growth on expenditure. whereas, wiseman version shows a positive marginal effect of economic growth on government expenditure but the value is not greater than one to fulfill the condition for its validity. given the outcome of our regression result, we came up with the following recommendations for policy reforms: (a) in the economies with unidirectional effect, flowing from government expenditure to economic growth (togo, mauritania, liberia and sierra leone) the achievement of rapid economic growth will be gotten through their governments identifying the sectors that are productive, so as to channel their expenditure to these sectors. this can be done by stimulating the aggregate demand through increase in government expenditure for rapid economic growth. (b) for guinea and cape verde economies, if government expenditure is increase it will rather fuel inflation instead of economic growth. therefore, wagner’s law should be promoted in these countries to achieve economic growth. (c) in the case of economies with bidirectional causality between economic growth and government expenditure, it is very pertinent for governments in these economies to identify the sectors that respond to wagner’s law and those that responds to keynesian theory. this is because the economic sectors that respond to keynesian theory will increase their total productivity when there is increase in public expenditure allocated to them while the ones that respond to wagner’s theory will not, but fuel inflation. however, the economic sectors that respond to wagner’s law will respond to private investment to increase their total output. in doing this, total productivity will be increase from both sectors and hence rapid economic growth achieve. asian journal of economics and empirical research, 2016, 3(1): 71-83 80 6. recommendation for further studies this study left behind another gap to be filled. this is; there should be a study for countries with bidirectional effect between government expenditure and economic growth in a sectoral form to further identify; the productive sectors in these economy; the sectors that respond to keynesian and those that respond to wagner’s. this will help the policy makers to make policies that will fit in these sectors in order to increase their total productivity. references constantinos, k. and t. persefoni, 2013. wagner’s law versus keynesian hypothesis: evidence from pre-www11 greece. panoeconomicus, 60(4): 457-472. doi 10.2298/pan13044577a. eberts, r.w. and t.j. gronberg, 1992. wagner’s hypothesis: a local perspective. working papers of the federal reserve bank of cleveland, working paper no. 9202. goffman, j.j., 1968. on the empirical testing of wagner’s law: a technical note. public finan, 3(3): 359–364. goffman, j.j. and d.j. marhar, 1971. wagner’s law of public expenditures in selected developing nations: six caribbean countries. public finance/finances publiques, 26(1): 57-74. gupta, s.p., 1967. public expenditure and economic growth: a time series analysis. public finan, 22(4): 423–461. kuckuck, j., 2012. testing wagner’s law at different stages of economic development: a historical analysis of five western european countries. working paper no 91, institute of empirical economic research, osnabrueck university, rolandstrasse 8, 49069 osnabruck, germany. lamartina, s. and z. andrea, 2008. increasing public expenditures: wagner’s law in oecd countries. paper presented at european central bank, kaiserstrasse 29, 60311 frankfurt am main, germany. magazzino, c., 2010. wagner’s law and italian disaggregated public spending: some empirical evidences. available from http//mpra.ub.unimuenchen.de/26662/mpra paper no.26662. mann, a.j., 1980. wagner’s law: an econometric test for mexico, 1925–1976. natl. tax jl, 33(2): 189-201. musgrave, r.a., 1969. fiscal systems. new haven and london: yale university press. oyinlola, m.a. and o. akinnobosun, 2013. public expenditure and economic growth nexus: further evidence from nigeria. journal of economics and international finance, 5(4): 146-154. doi 10.5897/jeif2013.0489. peacock, a.t. and j. wiseman, 1967. the growth of public expenditure in the united kingdom. london: george allen and unwin. pryor, f.l., 1968. public expenditure in communist and capitalist nations. london: george allen and unwind. richter, c. and p. dimitrios, 2012. the validity of wagner’s law in united kingdom. international network for economic research working paper. udo, a. and c. effiong, 2014. economic growth and wagner’s hypothesis: the nigeria’s experience. journal of economics and development, iiste, 5(16): 41-58. verma, s. and r. arora, 2010. does the indian economy support wagner’s law? an econometric analysis. eurasian journal of business and economics, 3(5): 77-91. wagner, a., 1883. three extracts on public finance, translated and reprinted. in r.a. musgrave and a.t. peacock (eds). classics in the theory of public finance. london: macmillan 1958. appendix peacock share version (mann version) dependent variable: gexgdp? method: pooled least squares date: 07/25/14 time: 13:40 sample: 1970 2012 included observations: 43 number of cross-sections used: 14 total panel (balanced) observations: 602 variable coefficient std. error t-statistic prob. c 2.551965 0.488541 5.223646 0.0000 nig--log(gdpnig) -0.066301 0.020064 -3.304507 0.0010 togo--log(gdptogo) -0.069884 0.023549 -2.967561 0.0031 mali--log(gdpmali) -0.065637 0.022882 -2.868523 0.0043 burk--log(gdpburk) -0.064552 0.022795 -2.831857 0.0048 gam--log(gdpgam) -0.073256 0.025005 -2.929714 0.0035 guib--log(gdpguib) -0.068441 0.025529 -2.680879 0.0075 sen--log(gdpsen) -0.065059 0.022165 -2.935141 0.0035 sier--log(gdpsier) -0.071285 0.023767 -2.999365 0.0028 ivor--log(gdpivor) -0.070332 0.021464 -3.276772 0.0011 gha--log(gdpgha) -0.064890 0.021791 -2.977795 0.0030 maur--log(gdpmaur) -0.065880 0.023667 -2.783584 0.0055 nigr--log(gdpnigr) -0.067539 0.022951 -2.942700 0.0034 beni--log(gdpbeni) -0.067232 0.023098 -2.910782 0.0037 lib--log(gdplib) -0.048201 0.024473 -1.969579 0.0494 r-squared 0.125781 mean dependent var 1.132804 adjusted r-squared 0.104931 s.d. dependent var 0.439328 s.e. of regression 0.415640 sum squared resid 101.4083 log likelihood -318.0890 f-statistic 6.032594 durbin-watson stat 0.488048 prob(f-statistic) 0.000000 asian journal of economics and empirical research, 2016, 3(1): 71-83 81 peacock-wiseman version dependent variable: log(gex?) method: pooled least squares date: 12/05/14 time: 17:38 sample: 1970 2012 included observations: 43 number of cross-sections used: 14 total panel (balanced) observations: 602 variable coefficient std. error t-statistic prob. c 0.490849 0.213837 2.295435 0.0221 nig--log(gdpnig) 0.976607 0.008782 111.2058 0.0000 togo--log(gdptogo) 0.980419 0.010308 95.11590 0.0000 mali--log(gdpmali) 0.983196 0.010015 98.16751 0.0000 burk--log(gdpburk) 0.984000 0.009977 98.62231 0.0000 gam--log(gdpgam) 0.980232 0.010945 89.56299 0.0000 guib--log(gdpguib) 0.985160 0.011174 88.16311 0.0000 sen--log(gdpsen) 0.982395 0.009702 101.2575 0.0000 sier--log(gdpsier) 0.979603 0.010403 94.16742 0.0000 ivor--log(gdpivor) 0.975733 0.009395 103.8580 0.0000 gha--log(gdpgha) 0.981785 0.009538 102.9330 0.0000 maur--log(gdpmaur) 0.984046 0.010359 94.99201 0.0000 nigr--log(gdpnigr) 0.981597 0.010046 97.71055 0.0000 beni--log(gdpbeni) 0.982163 0.010110 97.14818 0.0000 lib--log(gdplib) 0.986790 0.010712 92.12152 0.0000 r-squared 0.984931 mean dependent var 21.49009 adjusted r-squared 0.984572 s.d. dependent var 1.464670 s.e. of regression 0.181928 sum squared resid 19.42838 log likelihood 179.2894 f-statistic 2740.523 durbin-watson stat 0.525412 prob(f-statistic) 0.000000 musgrave version result dependent variable: log(gexgdp?) method: pooled least squares date: 12/05/14 time: 17:46 sample: 1970 2012 included observations: 43 number of cross-sections used: 14 total panel (balanced) observations: 602 variable coefficient std. error t-statistic prob. c 0.525652 0.092344 5.692311 0.0000 nig--log(gdppernig) -0.098174 0.015538 -6.318395 0.0000 togo--log(gdppertogo) -0.076686 0.016694 -4.593558 0.0000 mali--log(gdppermali) -0.070999 0.017242 -4.117894 0.0000 burk--log(gdpperburk) -0.068167 0.017248 -3.952224 0.0001 gam--log(gdppergam) -0.070759 0.016085 -4.398952 0.0000 guib--log(gdpperguib) -0.059515 0.017706 -3.361212 0.0008 sen--log(gdppersen) -0.066699 0.015120 -4.411418 0.0000 sier--log(gdppersier) -0.081858 0.017298 -4.732261 0.0000 ivor--log(gdpperivor) -0.088437 0.014416 -6.134404 0.0000 gha--log(gdppergha) -0.072986 0.015781 -4.625036 0.0000 maur--log(gdppermaur) -0.056171 0.014701 -3.820794 0.0001 nigr--log(gdppernigr) -0.077609 0.017421 -4.454822 0.0000 beni--log(gdpperbeni) -0.070951 0.016462 -4.310021 0.0000 lib--log(gdpperlib) -0.060411 0.017490 -3.454094 0.0006 r-squared 0.187596 mean dependent var 0.096765 adjusted r-squared 0.168220 s.d. dependent var 0.198410 s.e. of regression 0.180954 sum squared resid 19.22091 log likelihood 182.5208 f-statistic 9.681913 durbin-watson stat 0.525347 prob(f-statistic) 0.000000 asian journal of economics and empirical research, 2016, 3(1): 71-83 82 gupta version result dependent variable: log(gexper?) method: pooled least squares date: 12/05/14 time: 17:50 sample: 1970 2012 included observations: 43 number of cross-sections used: 14 total panel (balanced) observations: 602 variable coefficient std. error t-statistic prob. c 0.539177 0.112802 4.779874 0.0000 nig--log(gdppernig) 0.899647 0.018980 47.40003 0.0000 togo-log(gdppertogo) 0.920972 0.020392 45.16234 0.0000 mali-log(gdppermali) 0.926582 0.021061 43.99472 0.0000 burk-log(gdpperburk) 0.929413 0.021069 44.11335 0.0000 gam-log(gdppergam) 0.926984 0.019649 47.17723 0.0000 guib-log(gdpperguib) 0.938001 0.021629 43.36775 0.0000 sen-log(gdppersen) 0.931179 0.018469 50.41815 0.0000 sier-log(gdppersier) 0.915715 0.021130 43.33742 0.0000 ivor-log(gdpperivor) 0.909541 0.017610 51.64844 0.0000 gha-log(gdppergha) 0.924800 0.019276 47.97553 0.0000 maur-log(gdppermaur) 0.892518 0.017958 49.69970 0.0000 nigr-log(gdppernigr) 0.919947 0.021281 43.22926 0.0000 beni-log(gdpperbeni) 0.926740 0.020109 46.08665 0.0000 lib--log(gdpperlib) 0.937135 0.021364 43.86432 0.0000 r-squared 0.859886 mean dependent var 5.951108 adjusted r-squared 0.856545 s.d. dependent var 0.583600 s.e. of regression 0.221041 sum squared resid 28.68041 log likelihood 62.05595 f-statistic 257.3182 durbin-watson stat 0.370839 prob(f-statistic) 0.000000 goffman version result dependent variable: log(gex?) method: pooled least squares date: 12/05/14 time: 17:55 sample: 1970 2012 included observations: 43 number of cross-sections used: 14 total panel (balanced) observations: 602 variable coefficient std. error t-statistic prob. c 13.78146 0.214687 64.19329 0.0000 nig--log(gdppernig) 1.733100 0.036123 47.97774 0.0000 togo--log(gdppertogo 1.253460 0.038811 32.29610 0.0000 mali--log(gdppermali) 1.418781 0.040084 35.39496 0.0000 burk--log(gdpperburk) 1.433884 0.040099 35.75895 0.0000 gam--log(gdppergam) 1.010583 0.037396 27.02352 0.0000 guib--log(gdpperguib) 1.056679 0.041165 25.66944 0.0000 sen--log(gdppersen) 1.342827 0.035151 38.20176 0.0000 sier--log(gdppersier) 1.262261 0.040215 31.38785 0.0000 ivor--log(gdpperivor) 1.363682 0.033516 40.68722 0.0000 gha--log(gdppergha) 1.463489 0.036688 39.89064 0.0000 maur--log(gdppermaur 1.092683 0.034179 31.96985 0.0000 nigr--log(gdppernigr) 1.407208 0.040502 34.74427 0.0000 beni--log(gdpperbeni) 1.313191 0.038271 34.31270 0.0000 lib--log(gdpperlib) 1.193189 0.040661 29.34460 0.0000 r-squared 0.919423 mean dependent var 21.49009 adjusted r-squared 0.917501 s.d. dependent var 1.464670 s.e. of regression 0.420692 sum squared resid 103.8881 log likelihood -325.3613 f-statistic 478.4244 durbin-watson stat 0.140245 prob(f-statistic) 0.000000 asian journal of economics and empirical research, 2016, 3(1): 71-83 83 pairwise granger causality result pairwise granger causality tests date: 12/06/14 time: 19:37 sample: 1970 2012 lags: 2 null hypothesis: obs f-statistic probability gextogo does not granger cause gdptogo 41 2.45870 0.09979 gdptogo does not granger cause gextogo 0.65505 0.52550 gexbeni does not granger cause gdpbeni 41 0.09762 0.90723 gdpbeni does not granger cause gexbeni 0.51928 0.59934 gexmaur does not granger cause gdpmaur 41 2.74196 0.07791 gdpmaur does not granger cause gexmaur 1.87801 0.16757 gexguib does not granger cause gdpguib 41 1.57422 0.22110 gdpguib does not granger cause gexguib 1.93410 0.15928 gexmali does not granger cause gdpmali 41 4.83944 0.01376 gdpmali does not granger cause gexmali 6.64144 0.00351 gexlib does not granger cause gdplib 41 5.29277 0.00966 gdplib does not granger cause gexlib 0.06431 0.93783 gexgha does not granger cause gdpgha 41 2.78491 0.07507 gdpgha does not granger cause gexgha 4.35500 0.02024 gexsen does not granger cause gdpsen 41 0.01863 0.98155 gdpsen does not granger cause gexsen 0.23697 0.79024 gexsier does not granger cause gdpsier 41 8.47960 0.00096 gdpsier does not granger cause gexsier 0.31558 0.73136 gexburk does not granger cause gdpburk 41 1.90593 0.16339 gdpburk does not granger cause gexburk 1.71907 0.19362 gexnigr does not granger cause gdpnigr 41 0.66533 0.52031 gdpnigr does not granger cause gexnigr 0.07138 0.93124 gexgui does not granger cause gdpgui 41 1.73594 0.19066 gdpgui does not granger cause gexgui 2.46001 0.09968 gexnig does not granger cause gdpnig 41 9.54827 0.00047 gdpnig does not granger cause gexnig 6.26149 0.00464 gexcape does not granger cause gdpcape 41 0.94201 0.39924 gdpcape does not granger cause gexcape 6.09568 0.00525 gexgam does not granger cause gdpgam 41 6.11617 0.00517 gdpgam does not granger cause gexgam 6.43422 0.00408 gexivor does not granger cause gdpivor 41 10.0163 0.00035 gdpivor does not granger cause gexivor 6.28571 0.00456 asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. asian journal of economics and empirical research issn: 2409-2622 vol. 3, no. 1, 32-39, 2016 http://asianonlinejournals.com/index.php/ajeer 32 ethics, etiquette and purpose of life: in search of the coevolution's missing link in the strategic field pedro anunciação1  paulo hayashi jr.2 gustavo abib3 luis felipe batista4 1 coordinator professor and president of the technical scientific council of business school of setúbal, portugal 2 assistant professor university of campinas, brazil 3 assistant professor federal university of parana, brazil 4 bba student university of campinas, brazil ( corresponding author) abstract the world needs better human beings to be a better place to live. however, to reach a better world depends on the development of the organizational etiquette, the ethics, and individuals with a clear purpose of life. the coevolution means that all the stakeholders involved in different levels may have the possibility to influence, positively or negatively, in the process. this paper aims to develop an integral framework connecting different aspects of internal and external environment and the topics of ethics, etiquette and strategy. the integrative framework is an attempt to work on a complex and multidimensional phenomenon that concerns the individual, the company and society. thus, a primal objective of the executive should reconcile the person progress with the delivery of results. the competitive world is not a source of more cheats and injustices, but a motivation for more ethics actions and construction of better social etiquettes that will help to the coevolution of different stakeholders and, in the end, all the society will be better, little by little, through a continuous process of development keywords: ethics, etiquette, purpose of life, organizational strategy, coevolution, performance. contents 1. introduction ......................................................................................................................................................................... 33 2. organizational strategy....................................................................................................................................................... 33 3. etiquette ............................................................................................................................................................................... 35 4. ethics .................................................................................................................................................................................... 35 5. purpose of life ..................................................................................................................................................................... 36 6. coevolution and the integrative framework...................................................................................................................... 36 7. final considerations ............................................................................................................................................................ 37 references ................................................................................................................................................................................ 38 citation | pedro anunciação; paulo hayashi jr.; gustavo abib; luis felipe batista (2016). ethics, etiquette and purpose of life: in search of the coevolution's missing link in the strategic field. asian journal of economics and empirical research, 3(1): 32-39. doi: 10.20448/journal.501/2016.3.1/501.1.32.39 issn (e): issn (p): 2409-2622 2518-010x licensed: this work is licensed under a creative commons attribution 3.0 license contribution/acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained ethical: history: this study follows all ethical practices during writing. received: 17 november 2015/ revised: 20 january 2016/ accepted: 23 january 2016/ published: 27 january 2016 publisher: asian online journal publishing group http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.32.39 http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.32.39 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.32.39 http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.32.39 asian journal of economics and empirical research, 2016, 3(1):32-39 33 1. introduction a competitive world can be a source of challenges, mainly when the economic crises knock the doors and the stockholders urge for more profits and better measurements. if we accept that a competitive environment is a world full of cheats and the human relationship is only a tiny detail that disrupt good deals, so there is no escape in this vicious circle. however, in this article we argue that it is possible to think and act with etiquette and ethics and to be strategically valid for the firm, because the collaborators in different areas and organizations are human beings and the feelings and emotions are involved in the human relationships. due to it, a strategy based on the coevolution of the people with respect each person‟s purpose of life and personal values can be a source of sustainable relationships over the time. even though the word strategy is related to competition and zero-sum game, it is possible to think strategy as a way to construct, deliberately or not, paths for the overall progress. for overall progress, we are preoccupied with the collective of people instead of a minority. this way, the word stakeholder can be used. a stakeholder-based view is more ample than a stockholder-based view and it can be more interesting for the development of the social etiquette and the ethics. the aim of this essay is to propose an integrative framework for the ethics, etiquette and strategy. the framework is an attempt to work on a complex and multidimensional phenomenon that concerns the individual, the company and society. besides, the question of time is another important factor relevant for the development of the stakeholders. for example, the adaptability of the person over the time is a way to analysis the progress. thus, a primal objective of the executive should reconcile the person progress with the delivery of results. the competitive world is not a source of more cheats and injustices, aggression and abuses, but a motivation for more ethics actions and construction of better social etiquettes. would not be ethics a way to perform better as a human being? would not be etiquette a way to perform better as a social being? should not the purpose of life related to some sort of ethics and etiquette to construct a better place to live? should be kindness prohibited in the organization, because kindness costs time or should be kindness be encouraged? we argue that kindness and other human behaviors should be treated as an important element for the construction of the organization, mainly in times of crises and a highly competitive environment. the organization is a collective of people with a common and at the same time, different objectives. thus, the firm strategy is an important element of the union and collective action with the involvement of different areas of the organization to face the challenges of the environmental changes. because of it, the question of adaptability is a condition sine qua non for the survival of the organization over the time. 2. organizational strategy for both the economist friedrich hayek and the organizational theorist chester barnard the main organizational problem lies in the adaptability (williamson, 2005). for hayek, the adaptation is more related to the "wonder of the price system", while for barnard, the adaptation depends on the coordination of internal factors, and the importance of communication, cooperation and the direction given by the company's purposes. thus, lewin et al. (1999) remind us that the problem of adaptation is an important issue for organizational and strategy theorists. according to burnes (1996) organizations are not successful just because of their ability to predict and formulate strategies, but mainly for their ability to constantly realign with the environment. within the adaptation issue, it is necessary to comply with the strategic context, as well as their processes and content. this tripartition (context, content, and process) has its origin in the works by pettigrew (1998) and it has been considered legitimate in the strategic field, and being a holistic environment to research business strategies, including the timing issues (past, present and future) (rasche, 2007). the strategic context is directly connected to the external environment, as well as the need for the organization's adjustment (rasche, 2007). as for processes, the author refers to the "primacy of thought and reason", i.e., the strategic formulation/formation of the processes; whereas, for content, the completeness of the rules and organizational resources in relation to the products offered, and the markets served. in addition, lewin et al. (1999) note that the adaptation between the company and the environment occurs through the sharing of changes in the different environments. according to esser et al. (1996) the environment can be operationalized through the distinction of four levels: meta, macro, meso and micro levels (figure 1). figure-1. the organization and its environments source: esser et al. (1996) the meta level would be the country's, region's ability (cluster, for example) to create conditions for the players to be able to consistently mobilize their actions effectively (esser et al., 1996; meyer-stamer, 2005). according to meyer-stamer (2005): first, there is one issue where the players in a given society may succeed or fail in creating a favorable environment for private companies. as government's players whether or not asian journal of economics and empirical research, 2016, 3(1):32-39 34 they actually interact? how do they agree on the overview of where the economy is headed? do the key actors in a society share the basic guidelines on private enterprise, on the relative importance of the market control mechanisms, on the international trade guidelines (open or closed economy)? this is called the meta-analysis level, because it leads us to a level beyond the macroeconomic factors. in turn, the company's macro-environment consists of contextual elements such as economics, politics, ecology, technology, culture, and by trends that change over time. the elements of the macro-environment are not stable; therefore, they are constantly changing. however, the perception of such changes is often not an easy task, unlike the lower levels: the meso and the micro. the meso level is the field of specific policies, and business promotion instruments for both public and private companies (meyer-stamer, 2005). the meso level is superior to the industrial structure and the meso level contains the instruments for the development of particular policies to particular industrial sectors. thus, the industrial clusters are directed related with the meso level. on the other hand, the prefix micro means small and is also known as the operating environment or task environment. the micro-environment is composed of other organizations and individuals who may directly or indirectly affect the company's performance. the micro-environment has a direct and almost immediate influence in the organization and it is composed to the customers, the consumers, suppliers, competitors, government, media, labor unions, creditors, and partners. returning to a classical definition of what is an organization, it can be defined as a group of people working towards common goals and accumulating value in the production process, aiming at economic growth (hall, 1984). therefore, it follows that the organization is composed of people and that the elements belonging to the microenvironment are also composed by people. that is, the customers and the consumers‟ base are fashioned by people. suppliers are people too. our competitors are also formed by people. the government is made up of people. so is the media, unions, creditors and the partners are people with shared goals. therefore, we can summarize the organization and micro-environment in the following manner (figure 2): figure-2. people in the organization and in the micro-environment source: own ellaboration 651575473 in another words, the company and the micro-environment are formed by stakeholders, i.e., people who are interested, or who can influence, either positively or negatively, the company. relationships with stakeholders may be critical to the success of the organization. however, for the proper use of resources, and the company's adaptation to its environment, especially in the micro-environment, it is necessary for the people to work with synergy. it is important to emphasize the concept of synergy to the question of ethics and etiquette. according to ansoff (1979) the synergy can be defined as an "effect can produce a return of the combined company's resources, higher than the sum of its parts." the interaction between stakeholders and the company's resources provide opportunities for synergies to occur involving all in the chain, and they may benefit or be harmed according to the degree of integration and the existing mutual support (tantalo and priem, 2014). thus, adopting the scale indicated by esser et al. (1996) it is possible to establish different levels in each nod, corresponding to different combinations between the subjects and their respected characteristics. complementary, anunciação (2014) propones five levels: personal ethics, professional ethics, organizational ethics, economic ethics and societal ethics. figure-3. different ethical dimensions source: anunciação (2014) because the phenomenon of strategy and the intra and inter-relationship are multilevelness, the organizational etiquette appears as important “glue” to provide conditions to keep and development the relationships over the time. asian journal of economics and empirical research, 2016, 3(1):32-39 35 3. etiquette in portuguese, the word etiquette has a double meaning. it can mean both the set of rules and regulations on social occasions, first in the court's formalities, and as a brand, the label that identifies the product's manufacturer. it is common to relate "label clothing" with designer clothing, brand, prestige and often related to higher prices. for many people a good label is the one that is remembered by the consumer. despite the double meaning of the word, both are related and reinforce each other. that is, a company with good social conduct usually has a good employer "reputation" and vice versa. however, more than the question of the reputation and the label, we are interested in the business etiquette as practices and routines that respect and value not only the welfare of their employees, but also enable a work environment by promoting the moral and inhibiting egotistic and opportunistic actions. as the old adage: the opportunity makes the thief. a moralized environment prevents and it doesn't allow that an unethical person takes advantage or behaves in a harmful manner toward others (treviño and nelson, 2007). if an ethical person in a corrupt environment tends to be marginalized; conversely, a person with ethical failings in a moralized environment tends to feel the pressure to follow the dominant pattern. conduct codes are important, despite the prescription's insufficiency to solve behavior problems within and outside the company (parker, 1998; treviño and nelson, 2007). thus, it is important to distinguish the difference between justice and fairness as proposed by goldman and cropanzano (2015) “justice should be defined as adherence to rules of conduct, whereas fairness should be defined as individuals‟ moral evaluations of this conduct”. besides, it is the will and the individual character with the institutionalization of appropriate practices and motivators for the good. the leader as a role model plays an important factor for the booster of the individual development. according to hannah et al. (2014) “„leadership‟ is therefore a qualifying term for certain forms of influence: positive and socially acceptable forms. […] it is our opinion that leaders‟ credibility, and subsequent ability to influence, will be diminished unless their actions are deemed socially acceptable”. besides, “leaders serve as boundary spanners” (mumford and fried, 2014). another point is the ability to reach and align the organization's values with the values and principles of the individual. according to kaptein (2008) clarity, congruency, feasibility, supportability, transparency, discussability and sanctionability are examples of values that compose an ethical organizational culture. the institutionalization and promotion of the moral not only cause the individual to work in an ethical manner, and reduce the opportunism, but it also promotes the moral polishing of individuals with ethical lapses in their trainings. it is assumed that not all are equal ethically, there are people who are in more advanced stages of development while others are still awakening these qualities. according to morin (2007): "some individuals are more selfish, others are more altruistic; generally, to a certain extent, each one wavers between selfishness and altruism”. due to it, people present different levels of moral self or think differently whom they are and how they act (jennings et al., 2015). meanwhile, everyone deserves respect, the opportunity to act with consideration regarding the welfare of others and that all may reach the advanced platforms of development. if the institution is not capable of developing the individual‟s ethics, it needs to at least ensure environmental conditions, with possibilities for the individual development. rohden (2007) observes that, albeit imperfect, we are fully perfectible. thus, ethics is an individual quality that can be learned and perfected, same as the thinking ability and the creativity. finally, it is the practice of improvements where ethics can be a source of motivation and a destination, too. 4. ethics ethics is not only the ability to act with virtue, but it is also a cognitive process of thinking, feeling, the correct behavior awareness, the aptitude to recognize and know what to do. according to takala (2006) the ethics present an altruistic component; consequently, when included in the organizational environment provides a better quality of working life. thus, the well-known retaliation law "eye for eye, tooth for a tooth" is left in the background and the ability to engage in activities of cooperation and reciprocity improve their relationship with the individuals. as shown in figure 1 the ability to cooperate extrapolates beyond the boundaries of the organization itself and it influences the firm´s competitive position and adaptation (figure 2). however, it involves the acceptance that there are other goals to be pursued by the company beyond profit. one alternative goal can be the trust (gustafsson, 1998) and the perception of fairness (masterson et al., 2000; hollensbe et al., 2008) among the key players, which may reduce transaction costs (williamson, 2005). solidarity (morin, 2007) integrity (treviño and nelson, 2007) or even the long-term survival are example of another alternative goals (estola, 1998). in addition, more than a fad and organizational rhetoric (parker, 1998) ethics in organizations are a practical necessity. the firm survival is a long term game. however, the organizations are fertile ground for conflicts of interest, labor issues, human rights and consumer protection, discrimination, power, abuse, injustice, stress, occupational diseases (sonnentag, 2001; treviño and nelson, 2007; harris et al., 2011). more than revolutionize what does not work on the outside, one must learn to police oneself and seek self-perfection since the altruistic program is hindered by selfishness (morin, 2007). thus, according to goswamy et al. (2007) "nothing but, the consciousness must be experienced in order to be truly understood". more than a business project and the importance of organizational climate (parker, 2003) ethics is a personal project, each one seeking their own improvement and progress, as such, the company becomes a real laboratory of practices, influences, resiliencies and attempts. so, ethics is not a rhetorical prescription of morality, but the element of leverage of mankind's superior condition created by the individual, and supervised by his conscience. in another words ethics seeks to transcend the ego and superficiality interests for an intimate reform, deep, of what really counts for the self and its condition, is neither to moralize, nor to reproach, but for getting help by helping others. it is the voluntary choice to be a good person, and turning his life into a journey that resembles a work of art (rohden, 2007). moreover, both the "ethical footprints" and the "ecological footprint" register the beauty of the being's journey in the world. this journey should be related to the purpose of life. asian journal of economics and empirical research, 2016, 3(1):32-39 36 5. purpose of life the purpose of life is not a metaphysical concept, but a very pragmatic and the concept is directly related to the sense of being responsible and wise enough with his/her decisions and choices in life (frankl, 2008). viktor frankl was responsible for the development of a theory called logotherapy and it puts the purpose of life in the center of human being‟s actions. more than a scholar, frankl was a jewish psychiatry and psychology who has developed what is common called the 3 rd . viennese school of psychotherapy. the first school was developed by freud and it is related with the constant search to fulfill the human desires. the second school is adler‟s and his motivation of power to overcome the inferior complex. frank has had contact with both, freud and adler. however, for frankl it was not desire, neither power the intrinsic motivation of human actions. instead of it, the purpose of life was the enduring search for meaning. however, the frankl‟s works were subtly interrupted because of the world war ii. viktor frankl‟s family was a jewish family and his parents could not leave vienna out and he stayed until his last moments with his parents. all the viktor frankl‟s family, parents and brother, and sister, were dead in concentration camps. even viktor frankl was a prisoner in several nazi concentration camps such as auschwitz and dachau. besides, his first copy of the logotherapy book was lost during that period. he survived and soon after world war ii, the dictated his book by heart and what he remembered in nine days (xausa, 2013). the result was his book “man's search for meaning”. the seeds of logotherapy have been planted and accordingly to a survey conducted by the library of congress the book had sold over more than 10 million copies. like a greek temple, logotherapy is based in three columns: liberty of choice, will of meaning and meaning of life (xausa, 2013). the first one is directed related to responsibility. liberty without responsibility is portrayed by immature people. on the other hand, when liberty and responsibility walk together, the maturity and development of the human being is appreciated in a positive way. for frankl, the statue of liberty of the american east coast should be complemented with a west cost statue of responsibility (frankl, 2008). the will of meaning and the meaning of life are very important drivers for the human motivation. when a person knows his/her purpose in life, (s)he can be more resistant and resilient to transform obstacles and suffering in sources of inspiration and hope. frankl has perceived in his concentration camp mates who have maintained a purpose of life they have a higher chance of survival. in the logotherapy, the meaning is not born with the own existence of life, but it is found in the confrontation of life and existence. this way, man is responsible for the fulfillment of his existence through a dedication to a cause, a person or to win the difficulties and suffering of a context or specific situation (frankl, 2008). the challenge and overcoming of the suffering is a like the hero path who can transform the inevitable suffering in a human realization. in a sense, it is the crucible experience that transforms human beings into extraordinary leaders with an altered sense of identity (bennis and thomas, 2002). according to frankl “those who have a 'why' to live, can bear with almost any 'how'.” in a sense, due to his jewish background, frankl will transform every human action in a sacred action (aquino, 2014) and “every human action is his/her own monument”. lao-tsé, the famous east thinker says: “having completed a task means to be eternal” (frankl, 2012). 6. coevolution and the integrative framework the human being is a project under construction by him/herself (sartre, 2005). yet, when inserted in the organizational environment there must be an institutional support to help build relations, and synergistic relationships in search of better conditions for the stakeholders and also for himself. thus, not only the individual ethics becomes relevant, but also the organizational culture, the practices and routines found in the workplace (smith and peterson, 1998). in another words, it is necessary to have conditions to influence positively the coevolution among the collaborators. according to zuben (s/d)"in biology, coevolution is associated with the mutual influence between two evolutionary species presenting dependencies between them, so that one species selectively exerts pressure on the other." furthermore, the coevolution would be linked to the concept of adaptation, multiple adaptations through competition and/or cooperation. the competitive coevolution comes from the predator-prey link or the zero-sum games. conversely, the cooperative coevolution appears in the symbiosis, in the mutualism, etc. in another area that the term coevolution appears with some frequency is in computing, especially with works of evolutionary algorithms (ea) that assist in troubleshooting dynamic and complex programs, especially those that intensify over time. in 2003, ibm international business machine held a symposium on the subject. according to spohrer (2003) coevolution is when two or more systems evolve jointly and progressively, not isolated changes. for husbands and mill (1991) the adaptation of any individual in any given population is influenced by coevolution, when they share the same world. the sharing of scarce resources and limited environment turns the coevolution in a natural way for adaptation. besides, as observed by levinthal and fichman (1998) “as the amount of relationship-specific assets increases over time, the benefit of continuing the relationship increases”. in the organizational area, although the term coevolution is recent, the organization as a living being metaphor is nothing new (morgan, 1996). this metaphor provides conditions to explore aspects of survival, adaptation and cooperation in environments with different levels of hostility. it helps managers to achieve a better understanding of the individual-group-organizationenvironment relationship among the individual, group, organization and environment. the living organism metaphor adopts the assumption of an open system for the very sustenance of life (morgan, 1996). the issue of coevolution is inserted in the organizational context (lewin et al., 1999). however, the area still calls for more studies, especially in the contexts of the strategic choice (child, 1972) and of business strategies (lewin and volberda, 2006). the article by jacobides and winter (2005) for example, is one of the pioneers in the area. the authors assert the coevolution existence between the capabilities and the transaction costs. that is, how they change and interact. the causal relationships, the mechanisms, and the likely consequences are the reasons for studying the coevolution. the term can be understood as the simultaneous evolution of the organizations in their environments (baum and singh, 1994). conversely, mckelvey (2002) notes that the coevolution can serve as a bridge between the strategy, and the organizational theory, as well as the company's micro strategy, and the industry's macroevolution. moreover, it can assist in bringing together two areas that have had their differences: the organizational learning and the strategic planning (ansoff, 1991; mintzberg, 1991). according to hall (1992) companies which realize that the learning and asian journal of economics and empirical research, 2016, 3(1):32-39 37 operating processes work jointly can achieve sustainable competitive advantage. one possibility is presented by rodrigues and child (2008) with the institutional perspective. the authors follow the coevolution of the telemig public telecommunications company of minas gerais through its 27 years of existence. the company ceased to exist in 2000 but left behind a historic track record marked by several stages of transformation and evolution. however, mckelvey (2002) observes that the speed or the acceleration of the adaptation process, often refers only to the "the red queen paradox", i.e., it is necessary to keep running to stay in the race. this question refers to the queen of hearts from the book "through the looking-glass, and what alice found there" by lewis carroll who calls: "you have to run as much as possible to stay in place". perhaps, this is a great truth for both companies and humans. one question remains: is all the running or the financial gains really worth it? the classic phrase immortalized in shakespeare's hamlet can set up part of the discussion: "there are more things between heaven and earth, horatio, than are dreamed of in our vain philosophy." or as in master nazareno's words: "what is the use for a man to conquer the whole world and lose his soul in the process?" thus, in a preliminary way, it is presented the following integrative framework of ethics, etiquette, and organizational strategy (figure 3) for the coevolution of a person inserted in an environment of relationship and interaction with other stakeholders. figure-4. framework of the ethics, etiquette and strategy integration source: own ellaboration the relationship among strategy, etiquette and ethics is a complex, multilevel, non-linear and multidimensional phenomenon that concerns the individual, the company, and society. furthermore, the time dimension needs to be brought into play; thus, there is the formation of a spiral coevolution being operated mainly by the microenvironment, toward the meta environment as shown in figure 4: figure-5. spiral of progress source: own ellaboration moreover, to turn operational organizations and individuals that co-evolve in the spontaneous construction of good will becomes the right way for the improvements of mankind. however, more than a utopia, it is a challenge to be practiced every day and throughout life with hopes of mankind's own evolution as a whole. 7. final considerations this essay seeks to explore, the preliminary approach and dialog of ethics, etiquette, and organizational strategy. if the latter seeks better competitive conditions and the organizations' survival; the relationship between individual etiquette and the ethics seems to point to the very challenging issues of the individual's coevolution along with the other stakeholders. at this point, the existence of a healthy and motivating environment contributes to the spontaneous performance of good will. in another words, the organization's characteristics affect the individuals' behavior. however, the ethical condition of the being is a project to be pursued primarily by oneself for his/her own development, since it is through his/her "ethical footprint" that he/she will leave traces of his/her worthiness in the world. and it is against the selfishness impetus, latent in every imperfect being, that the individual must go about asian journal of economics and empirical research, 2016, 3(1):32-39 38 molding good habits to perform good will spontaneously. however, a good work environment may influence the people´s behaviors. thus the importance of the organizational etiquettes. the morality and the social well-being are very important characteristics to the group of people and its social norms. besides, the organizational etiquette can influence a median person to be better, if the group expect this kind of behavior. finally, it is important to the strategy to keep sustainable patterns of actions, because the organization survival is a long-term game. the quality of the relationship among the different stakeholders influence the firm capacity to compete and positive collaborations may mean high return in terms of financial and non-financial returns (tantalo and priem, 2014; garcía and aguilera, 2015). the relationship among organizational strategy, ethics and etiquette seeks to identify limitations and to provide conditions and opportunities for building trust, solidarity, and the integrity of interpersonal relationships. besides, the alignment among ethics, etiquette and strategy can be perceived through the degree of the coevolution that exists in a organization. for coevolution we mean that a collaborator helps other to improve and he/she receives as a return the helping for the other parts. in a few words, coevolution will be to help me through the service of others. ultimately, takala (2006) summarized it well: it is the search for a better quality of life; depending on how a company is running, it can be an example of heaven or hell, as paths leading to the coevolution or to favor nefarious actions that can considerably delay the individuals on their path to enlightenment. references ansoff, h.i., 1979. estratégia empresarial. são 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publicado. available from ftp://ftp.dca.fee.unicamp.br/pub/docs/vonzuben/ia707_1s06/aulas/topico_coevol.pdf [accessed janeiro de 2011]. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. http://www.almaden.ibm.com/coevolution ftp://ftp.dca.fee.unicamp.br/pub/docs/vonzuben/ia707_1s06/aulas/topico_coevol.pdf asian journal of economics and empirical research issn: 2409-2622 vol. 3, no. 1, 49-58, 2016 http://asianonlinejournals.com/index.php/ajeer 49 mergers, acquisitions and market concentration in the banking sector: the case of vietnam hoang thi thanh hang1  phan dien vy2 jay bandaralage3 1,2 banking university of ho chi minh city, vietnam 3 griffith university, australia ( corresponding author) abstract following the global trend, vietnam also started opening up its economy and domestic reforms in 1986 and implemented a number domestic market reforms including in the banking and finance system. the merger and acquisitions (m&a) of banks have been a main component of the reform process. there have not been serious attempts to evaluate the m&a process and its impacts on the banking industry in a systematic way. the main purpose of this study is to fill that literature gap by providing a historical narrative of the m&a activities in vietnam’s banking industry and analyzing its impacts on the system and market structure via quantitative and qualitative approaches, particularly using concentration indices. keywords: merger and acquisition (m&a), banking sector, market concentration, market structure, competitiveness, monopoly. contents 1. introduction ......................................................................................................................................................................... 50 2. an overview of m&a bank in vietnam: a historical narrative...................................................................................... 50 3. a brief literature review on m&a.................................................................................................................................... 52 4. methodology and data......................................................................................................................................................... 53 5. results and discussions ....................................................................................................................................................... 54 6. conclusion ............................................................................................................................................................................ 57 references ................................................................................................................................................................................ 58 citation | hoang thi thanh hang; phan dien vy; jay bandaralage (2016). mergers, acquisitions and market concentration in the banking sector: the case of vietnam. asian journal of economics and empirical research, 3(1): 49-58. doi: 10.20448/journal.501/2016.3.1/501.1.49.58 issn (e): issn (p): 2409-2622 2518-010x licensed: this work is licensed under a creative commons attribution 3.0 license contribution/acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained ethical: history: this study follows all ethical practices during writing. received: 13 february 2016/ revised: 27 february 2016/ accepted: 4 march 2016/ published: 8 march 2016 publisher: asian online journal publishing group http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.49.58 https://orcid.org/orcid-search/quick-search?searchquery=hoang thi thanh hang https://orcid.org/orcid-search/quick-search?searchquery=phan dien vy https://orcid.org/orcid-search/quick-search?searchquery=jay bandaralage http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.49.58 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.49.58 https://orcid.org/orcid-search/quick-search?searchquery=hoang thi thanh hang https://orcid.org/orcid-search/quick-search?searchquery=phan dien vy https://orcid.org/orcid-search/quick-search?searchquery=jay bandaralage http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.49.58 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.49.58 https://orcid.org/orcid-search/quick-search?searchquery=hoang thi thanh hang https://orcid.org/orcid-search/quick-search?searchquery=phan dien vy https://orcid.org/orcid-search/quick-search?searchquery=jay bandaralage http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.49.58 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.49.58 https://orcid.org/orcid-search/quick-search?searchquery=hoang thi thanh hang https://orcid.org/orcid-search/quick-search?searchquery=phan dien vy https://orcid.org/orcid-search/quick-search?searchquery=jay bandaralage http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.49.58 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.49.58 https://orcid.org/orcid-search/quick-search?searchquery=hoang thi thanh hang https://orcid.org/orcid-search/quick-search?searchquery=phan dien vy https://orcid.org/orcid-search/quick-search?searchquery=jay bandaralage http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.49.58 asian journal of economics and empirical research, 2016, 3(1): 49-58 50 1. introduction the banking sector in every country around the world has been rapidly changing in recent decades in order to adapt to the globalization, the marvelous development of technology and economic reforms. in vietnam, after the shift from mono banking system to a dual ones, vietnam banking industry has been growing quickly in terms of size and the number of networks, enabling vietnam’s economy to transform from a centralized planning economy to a market economy. for the past few years, however, the commercial banking industry has showed the inadequacies and shortcomings such as low charter capital and liquidity, increasing bad debt ratio, weak internal governance, nontransparent ownership structure in commercial joint-stock banks. to deal with these issues, on the 1st of march 2012 the prime minister approved the project 254 on: "restructuring the system of credit institutions in the stage of 20112015”. the experience of the implementation of the two-third of project so far demonstrates that there has been some success. however, the experience so far suggests that there are some failures and the implementation of the project is facing a number of problems: (1) the process of merger and acquisition is lagging behind and so that it has not achieved objectives set out for the period 2011-2015 (which requires the merger and acquisition of the weak credit institutions to reduce the quantity of low-performance banks); (2) the process of financial restructuring has not brought impressive results, in which the bad debt and cross-ownership are the key issues, (3) internal management of banks does not meet its objectives (which are to create a banking system with the efficient and advanced internal management. as a response to the above failures and problems, the government has implemented a series of measurements to make the project successful and rectify some problems it is facing. the merger and acquisition (“m&a”) of banks is one of these measurements and it can be considered as an effective method to improve the performance of commercial banks. although the m&a activities have been quite active in vietnam over the past 8 years, there is a long way to go despite the importance of the process of m&a in the banking sector in vietnam and its impacts on the overall economy, there has not been much effort to evaluate the process of m&a and its impact on the economy in vietnam. there is a limited amount of literature in vietnamese.. however, the impact of m&a on the degree of concentration and competition in the banking market has not been evaluated systematically in recent literature. indeed, a number of critical questions are to be further addressed, for example, how the progress of restructuring the banking system in vietnam through m&a is, whether this restructuring project brings any success or failure after the m&a, whether there is any obstacle in the process of restructuring, how to improve the progress of the restructuring. regarding the concentration of the banking market, a legal question is that as a form of economic concentration, whether the concentration and competitiveness level of vietnam's banking market after the restructuring (post m&a) is still in compliance with the conditions of market share (to avoid monopoly and unfair competition) under current vietnam’s law on competition in general and antitrust regulations of banking and finance area in specific. against the above background this study attempts to achieve a number of objectives. firstly, we expect to provide a historical narrative of m&a activities in banking industry from 1990 to 2005 in vietnam in order to understand the main issues and problems it is facing. base on that, we evaluated the impacts of m&a to banking business performance in term of number of banks, bank size, non – performing loan, human resource, management. (2) secondly, we attempt to measure the degree of concentration of vietnam banking sector in relation to competitive market structure. these issues have not been address systematically by previous research. the rest of this paper is structured as follows: section 2 provides a historical narrative on the process of m&a in vietnam; section 3 presents a brief literature survey on m&a in vietnam; section 4 discusses the methodology and data sources used in this study; section 5 present the results; and section 6 presents concluding remarks. 2. an overview of m&a bank in vietnam: a historical narrative the purpose of this section is to present a brief overview on the m&a process in vietnam. table 1 provides the historical details of m&a in vietnam. table-1. historical details of m&a cases in vietnam year number of m&a target banks or financial institutions acquirer banks impacts 1997 1 dong thap agriculture bank southern bank this acquisition did not have major impact on the market because the charter capital (of the target) is just around 1 billion vnd. 1998 2 dai nam bank southern bank this acquisition did not have major impact on the market because the charter capital (of the target) is just from 1-3 billion vnd. quang ninh bank hanoi housing bank (habubank) this acquisition did not have major impact on the market because the charter capital (of the target) is just around 1 billion vnd. 2001 3 long xuyen bank dong a bank this acquisition did not have major impact on the market because the charter capital (of the target) is just from 1-3 billion vnd. continue asian journal of economics and empirical research, 2016, 3(1): 49-58 51 nam do bank bidv this acquisition did not have major impact on the market because the charter capital (of the target) is just from 1-3 billion vnd. chau phu bank southern bank this acquisition did not have major impact on the market because the charter capital (of the target) is just from 1-3 billion vnd. 2002 1 thach thang (can tho) bank saigon thuong tin commercial joint stock bank (sacombank) this acquisition did not have major impact on the market because the charter capital (of the target) is just from 1-3 billion vnd. 2003 2 cai san (can tho) bank southern bank this acquisition did not have major impact on the market because the charter capital (of the target) is just from 1-3 billion vnd. tay do bank orient commercial joint stock bank this acquisition did not have major impact on the market because the charter capital (of the target) is just from 1-3 billion vnd. 2004 1 tan hiep (kiên giang) agriculture bank dong a bank this acquisition did not have major impact on the market because the charter capital (of the target) is just from 1-3 billion vnd. 2011 1 saigon commercial bank (scb) scb the three commercial banks were merged into one bank, named after the bigger bank saigon commercial bank. this merger had considerable impact on the market because after the merger: the accumulated charter capital is reaching vnd 10.583 billion. the total credit is at vnd 32.409 billion currently, it is ranked as the fourth biggest bank in vietnam in terms of charter capital and fifth biggest bank in terms of total asset. however, the nonperforming loan ratio also increases significantly. tin nghia bank first commercial bank 2012 1 habubank saigon hanoi bank (shb) this merger also has impact on the banking sector as the charter capital reached vnd 8.865billion. the non-performing loan grew from 12,88% to 21,32%. 2013 1 western bank petro vietnam financial company this acquisition did not have major impact on the market because the scale of the target bank is too minor. 2014 1 contruction bank vietinbank this merger also had minor impact because the scale of the target bank is small. 7/2015 3 mekong housing bank bidv this merger has several impacts as the mekong housing bank is a medium-sized socbs. we do not have specific statistic for this merger as this case is recent. petrol gas bank vietinbank this merger has some major impacts because the three acquired banks are quite large and have significant non-performing loan rate. we do not have statistic for this merger as this case is recent. global petrol bank ocean bank 18 source: compiled by authors using different sources. as shown in table 1 20 m&a cases have been conducted in the whole vietnam commercial bank system from 1990 to 2015. in terms of the significance of m&a in vietnam the history of m&a can be categorized into two periods. the first period is 1990 -2011. although there were a number of m&a cases during this first phase or period the size of cases was small and these activities were taken place within the framework of the process which converted credit cooperatives and rural joint stock banks to urban joint stock banks. therefore, the significance and the impact of m&a during the first period were considerable. the second period of m&a is 2011 -2015. this is the asian journal of economics and empirical research, 2016, 3(1): 49-58 52 most significant period of the history of m&a in the banking sector in vietnam because 9 large size m&a were taken place during this period. for example, scb, shb, vietinbank, bidv were mergered with or they acquired some smaller banks. however, it did not violate the law on competitiveness against monopoly and concentration. one of the main results of m&a in vietnam is the drop in the total number of banks in recent years as shown in figure 1. figure 2 demonstrate the magnitude of the activities of m&a in the banking sector. it indicates that m&a activities have been very significant in recent years. figure-1. number of bank in the period 2008-2015 source: calculated by authors figure-2. number of m&a in the period 1997-2015 source: calculated by authors 3. a brief literature review on m&a the purpose of this section is to undertake a brief literature survey on studies on m&a. we first focus on the literature in general in the first part of this section. then we move on to the literature on m&a in vietnam. mergers and acquisition have become more common characteristics in banking sectors in many developed and developing countries around the world. as a result, there is a large body of literature on activities of mergers and acquisitions around the world. the banking sector in the world has been on a major reform in recent years so as to deal with the aftermath of global financial crisis or regional economic issues (sharma and bal, 2010). mergers and acquisitions (of banks) are considered as an effective method used to handle the turmoil in the banking system by reducing the number of lowperformance banks. there are a number of studies on m&a activities in banking sector and the impacts of these activities on the banking system and the market concentration. the below studies are several relevant research:  walter (1987) this research argued that in the banking sector, the banks need a certain growth in the business cycle to maintain and increase market share, generate economic advantages and bring profits to shareholders. in this process, the merger and acquisitions play a key role to help the business grow faster than competitors, generate more profits for shareholders and refrain from going bankrupt. mergers and acquisitions is an important part of any well-growing economy, in this economy, businesses can generate revenue for both owners and investors.  benston et al. (1995): this study discussed one of the motives affecting the financial institutions’ decision to go for an m&a transaction is to increase revenue and to reduce costs. in addition, the study also indicated that the impetus for m&a of the enterprise is to maximize the value that the enterprise can, thereby improving operation efficiency in the post-m&a period.  davis (2007) this article referred to the empirical evidence showing the growth of the banking industry and the economy, and technology development will inevitably lead to high concentration in the banking market. the article also discussed the influence of the concentration of the banking sector on the stability of financial system. asian journal of economics and empirical research, 2016, 3(1): 49-58 53  sharma and bal (2010) the article examined the concentration level in india’s banking system and its impact on competition. the article focused on how to measure the relative and absolute concentration. the article found many evidences showing the changes in the structure of banks in india. the cr and hhi index are used as the indicators for the market in structure methods to measure competition, such as the structureconductperformance model (scp) and the efficient structure hypothesis (esh). the practical results showed that the concentration ratio based on hhi and k index fell during the 2008-2009 to 1998-1999, reflecting the unbalance between banks in the india. in general, the studies showed that the process of restructuring in the banking sector by reducing the number and increasing scale through m&a is one of the popular methods. m&a activities bring positive effects to the banks after m&a. this study inherited the theoretical and empirical research from the previous research and studies, especially the methodology to measure the bank concentration level and competition of banks on banking market.  vietnam’s researches on m&a and market concentration mergers and acquisitions (in banking sector) has developed for a long time in the developed countries, however this is still a new method for bank restructuring in vietnam. the legal framework has formed and been developing from the early 90s to the present, however there are a great number of researches on the m&a in vietnam as follows:  vuong et al. (2009) presented the concept of m&a, forms of mergers and acquisitions, the advantages and disadvantages of m&a in vietnam market. however, the research just discusses the m&a in general, but do not discuss the m&a in a specific field.  le (2014): this research measured the level of concentration and competition in vietnam’s banking sector through using two indices which are crk and hirschman-herfindal (hhi) to identify the market concentration level in 2007, 2009, 2012; simultaneously evaluated the market concentration level in vietnam’s banking system through the panzarrosse method with the unbalanced data chain of 33 banks in the period from 2004 to 2013. however, the article did not mention the status of m&a activity and the impacts of this activity. there were many research papers on m&a or analysing market structure in finance and banking industry worldwide as well as in vietnam. however, there was no previous research which analysed and evaluated systematically and comprehensively bank m&a activities and its impacts on market structure in vietnam. so, our research aim to : (1)firstly, we systematically described m&a activities in banking industry from 1990 to 2005. base on that, we evaluated the impacts of m&a to banking business performance in term of number of banks, bank size, non – performing loan, human resource, management. (2) secondly, we attempt to measure the degree of concentration of vietnam banking market in relation to competitive market structure. these issues have not been solved systematically by previous research. 4. methodology and data this section briefly outlines the methodology used in this study and the data sources. 4.1. methodology we use both qualitative or descriptive ap and quantitative approaches to evaluate the nature of m&a in vietnam and its impacts of the economy. as we explained in section 2, we use the descriptive approach to explain m&a activity in the vietnam banking sector in the period time from 1990 to 2014 by using data published by sbv in its report of commercial banks. the impact of m&a can also be evaluated by using the qualitative approach by describing the impact of m&a on commercial banks through the data before and after m&a of these banks and the report of state bank vietnam. we also use the quantitative approach to measure the competition and the concentration of the banking sector in vietnam with the process of m&a. as mentioned in the introduction, one of the objectives of study is to assess the level of market concentration in vietnam’s banking sector in the process of restructuring through m&a. the degree of concentration will lead to structural changes in markets thereby affecting the level of competition in the banking sector. bikker and haaf (2002) provide a comprehensive literature survey on the methodologies used in this area. as surveyed by them, the level of concentration is measured through concentration indicators. these indicators can be calculated to explain the level of competition in the banking market structure in each stage of m&a.  crk index crk is the total market share of a group’s banks with the largest market share. the simplicity and less data have helped this index to become one of the most commonly indexes used to measure the concentration in practice. this index assesses the degree of the concentration of market share has fallen in whether a group of banks or not. the index is determined by total market share of k largest banks in the banking sector: ∑ si is the market share of large banks i in the sector. normally, this index is calculated based on the number of banks from 3 or more depending on the size of the market. index value from 0% to 100%. the higher this ratio demonstrates the degree of market concentration greater when market power is located in the largest commercial banks. based on the level of concentration, the market can be classified into the following types:  perfect competition, with very small concentration ratio  quite competition, cr3 <65%, the average concentration  oligopolies or dominant market, cr3> 65%, high concentration  monopoly, cr1 is approximately 100% asian journal of economics and empirical research, 2016, 3(1): 49-58 54  hhi index in banking sector, the herfindahl-hirschman (hhi) is used to identify the degree of market competition is perfect or monopolistic. in the usa, the ministry of justice used this index to assess the level of monopoly or oligopoly in trading activities, m&a among banks. hhi index is calculated by squaring the market share of all commercial banks in the banking system. ∑ (1) n is the total number of banks and si is the share of banks i in the sector hhi index value from 1/n to 1, and the lowest value (1/n) when all the banks in the market are the same size, and has a value of 1 in case monopoly. hhi index may be determined by other means: (2) n: number of banks in the system v: the variance of banks’ market share ∑ if all banks have equal market shares (it means that if the market structure is perfectly symmetrical, ie si = 1/n for all i), then v = 0 and h = 1/n. if number of banks is constant, the larger variance due to the asymmetric level of market share among banks would create a higher index value. through hhi index, the market will be classified the degree competition as follows:  hhi <0:01: perfectly competitive market  0.01 ≤ hhi ≤ 0.1: the competition level is high  0.1 ≤ hhi ≤ 0.18: the competition level is average  0.18 ≤ hhi: the degree of concentration is high and tends to monopoly this is the underlying index when competition management authorities consider the change in market structure occurred after m&a. law on competition of many countries defined the degree of economic concentration through the hhi index in checking the evolution of economic concentration. in this study, due to the number of banks and the indicators about the scale of banking system (total asset, mobilization capital, loans) is determined, so this study uses the formula (1) ∑ (1) 4.2. data in order to measure the level of concentration of vietnam’s banking system data published in the state commercial banks and joint stock commercial banks’ audited financial statements have been used in this study. we collected data for the period 2008 – 2014 to calculate concentration measurements with 2.889 samples: year 2008 2009 2010 2011 2012 2013 2014 number of banks 43 43 43 41 40 39 38 to measuring the level of market concentration of vietnam’s banking sector assess the market structure with 3 aspects are used: (1) total assets; (2) market share in deposits and (3) market share of lending from 2008 to 2014. we have not been able to calculate concentration indicators for the years before 2008 due to unavailability of audited financial statements of commercial banks before 2008. data related to foreign banks and branches of foreign banks operating in vietnam are excluded because this study only focus on the market concentration of vietnam’s banking sector.  accessing the impacts after m&a data is used to assess the impacts of m&a of vietnam’s banking sector in the process of restructuring of credit institutions in the period from 2011-2015 under project 254, including reports of the typical m&as, with the largest scale in the process of m&a in vietnam’s banking sector. 5. results and discussions 5.1. the post – m&a impacts on vietnam commercial banking system over the period, m&a activities in vietnam commercial banking system generally have made positive impacts on individual banks as well as the whole system. fundamentally, it was corresponding to the goals of banking system restructuring project, such as:  impacts on non – performing loan resolving : obviously, the impact of m&a activities to banking system in term of npls was insignificant. the restructuring process through npls resolving and m&a lead to positive results, npls went down to approximately 3-4% currently. the business operation of these banks are stable and developing, banks after m&a focused on collecting debt, creating loan provisions and transferring debt to vamc. regarding m&a banks, the overall remarks is the rise of npls in several years after m&a and banks have concentrated on resolving it. specifically :  in 2010, before m&a execution, npls ratio of scb, tnb and fcb were 10.04%; 0.83%; 1.14% respectively ( the average of banking industry is 1.73%), they provided loan mainly to companies which is closely related to bank majority share holders. (“backyard companies’’), financing for variety of investment activities of companies which are owned by the same group of owners.  in case of shb, in 2011 before m&a execution, npls ratio of this bank was 2.33%, while this ratio of asian journal of economics and empirical research, 2016, 3(1): 49-58 55 hhb was 16.73% ; after m&a in 2012, npls of shb rose to 11.88% due to huge loan that hhb had provided to vinashin. impacts on banks size after m&a execution, some banks have experience a significant increase as the result of merging with or acquiring other banks. however, it didn’t lead to the change of banking market structure , because banks which joined in m&a cases was not a large bank compared to other banks in the banking system, specifically:  scb was not a small bank among vietnam commercial banks in term of total asset. when m&a deal was executed, total asset of scb was 77.985 billion vnd up to 3 rd quarter of 2011, was ranked 13rd in commercial banking system behind vpb – the smallest bank in group of 12 largest banks (g12) with 79.984 billion vnd total asset. tnb was placed in the position of 18 th with total asset reached 59.073 billion vnd and fcb was in the position of 35 th with 17.105 billion vnd total asset. after m&a, total asset of new scb reached 242.222 billion vnd, ranked 5 th among commercial banking system at that time. regarding shb, the total asset increased from 70.989 billion vnd before m&a to 116.537 billion vnd after m&a, total asset of scb reached 169.035 tỷ vnd in the end of 2014, was 2.4 times larger than this number before m&a and being ranked 10 th among the vietnam commercial banking system currently.  regarding market share of lending and deposit, all fcb, tnb and scb had minor proportion. at the end of 2010, the deposit and lending market share of g12 were 69,64% and 67,61% while this number of scb were 2,86% and 2,77% perspectively, ranked 9 th among vietnam commercial banking system. however, after m&a execution, all main indicators of m&a banks such as total asset, deposit and outstanding loan increase rapidly. table-2. indicators of scb and shb before and after m&a unit: billion vnd. bank total asset deposit loan before m&a after m&a % (+,-) before m&a after m&a % (+,-) before m&a after m&a % (+,-) scb 60.183 144.814 +140,62 35.122 58.633 + 66,94 32.409 64.419 +98,77 shb 70.990 116.538 + 64,16 34.786 77.599 +123,07 28.807 55.689 +93,32 sources: summarized from consolidated financial statement of scb and shb note: scb (before m&a is data of 2010, after m&a is data of 2011; shb (before m&a is data of 2011, after m&a is data of 2012). impacts on regulation on competitiveness and monopoly from bank m&a practices during the recent years, some of legal issues are related to bank m&a have been clarified. firstly, m&a activities are regulated by many of legal documents which promulgated and supervised by different government bodies , currently, vietnam do not have a separate law for bank m&a. secondly, state bank of vietnam lacks experience on forecasting and dealing with bank bankruptcy. impacts on organizational structure and human resource bank m&a affect to bank restructuring process in term of enhancing management and leadership capacity, acquiring experienced and high – skilled staff without spending time and money on recruiting and training. but the shaking of human resource before and after m&a may cause marked positive consequences to banks performance. according to towers watson consultant company, in 2014, about 10% of employees have quitted their jobs in banking industry to find jobs in other industries. several reasons can be explained for that facts, from banks – specific perspective, the merge and acquisition between banks may cause the personnel redundancy, otherwise human resource restructuring policy of banks to select the most efficient staff lead to the massive cutting down in banking labor market . for example, just in june 2014, 666 employees (approximately 15% of total employees) had to leave their jobs in shb. managerial personnel also experienced some change in 2015, such as:  in nam a bank, before general shareholder meeting (14/7/2015) , the bank had assigned mr. trần phúc vũ (ceo) and mr. trần ngọc tâm (deputy ceo) to leave nam a bank to become candidate for membership of b.o.d of eximbank 2015 -2020.  similarly, there were several change and swap of senior managers between ocb, vieta bank and techcombank  particularly, in solvency – problem banks acquired by state bank of vietnam at price of 0 vnd per share, all key personnels have been changed. for example, after being acquired by sbv, b.o.d and b.o.m of construction bank have been completely changed, all new members were from vietcombank by the steering of sbv. similarly, boards of ocean bank had been replaced by new members from vietinbank.  impact on shareholders interest:  the interest of minority shareholders may be ignored. the decisions to merge or acquire with/to other banks are made by members in b.o.d and b.o.m, who normally work as the representative of majority shareholders, corresponding to the will of majority shareholders. the suggestion of minority may be presented or reserved but the decisions are made by majority shareholders and it might conflict to the interest of minority shareholders. sometime, they even have been forced to transfer their share to other shareholders.  interest conflict between majority shareholders. in preparing for m&a deal bank owners or majority shareholders have to decide several issues, such as: m&a partners, consultant, lawyer, m&a model… these issues may cause conflict between shareholders in this group when they pursue different interests.  the impact on corporate culture: culture of banks could be changed. actually, culture of different banks can be mixed up after the merge and acquisition, the previous banks’ core values can be destroyed. it take a lot time for staff from different banks to adjust and integrate to the new working environment and colleagues. the new bank may select the outstanding cultural factors of the previous banks to built the new culture of bank on the basis of preserving and developing the existing core value or select the most prominent culture or built a quite new culture. asian journal of economics and empirical research, 2016, 3(1): 49-58 56 in summary, lacking of experienced experts, professional m&a consultant, the integration of employees and corporate culture are the main challenges of banks after m&a. 5.2. the degree of concentration of vietnam banking market the degree of concentration of banking market in the period 2008 -2014 can be measured by 3 main indicators: total assets, capital mobilized (deposit) and loan of the whole commercial banking system. table-3. the degree of concentration of vietnam banking market index indicators year 2008 2009 2010 2011 2012 2013 2014 hhi total asset 0.107 0.090 0.074 0.070 0.071 0.073 0.073 capital mobillization 0.128 0.105 0.096 0.093 0.094 0.097 0.090 loans 0.140 0.115 0.105 0.099 0.110 0.110 0.100 cr3 total asset 48.4% 42.8% 38.0% 36.1% 37.5% 38.6% 38.3% capital mobillization 54.1% 47.5% 43.9% 42.8% 40.7% 40.3% 38.1% loans 57.9% 50.6% 49.3% 47.7% 47.9% 46.8% 44.0% cr5 total asset 65.1% 59.9% 53.3% 52.4% 51.4% 52.4% 53.4% capital mobillization 70.0% 63.4% 60.0% 62.1% 55.9% 54.9% 54.9% loans 71.5% 70.1% 63.0% 62.1% 61.9% 60.7% 59.4% cr10 total asset 79.5% 76.3% 73.0% 72.3% 70.7% 70.1% 70.3% capital mobillization 84.4% 79.2% 76.9% 76.4% 74.3% 73.4% 74.9% loans 83.9% 83.7% 78.1% 78.0% 78.5% 76.8% 77.5% source: calculated by authors the degree of concentration tend to decrease in term of all three indicators. regarding total assets, hhi index declined from 1.017 ( 0.1 ≤ hhi ≤ 0.18 present the average competitiveness) to 0.07 ( 0.01 ≤ hhi ≤ 0.1 present the high competitiveness), it mean that the degree of concentration move from average to low level. however, regarding the deposit and loans, hhi index has experienced a decrease during 2008 – 2011 (from 0.128 – 0.093 and from 0.140 to 0.099 respectively) after the went up again in the period of 2012 -2014. it is one of the impacts of m&a execution during 2011 -2014 result in establish several large banks in term of total assets, deposit and loans. the volatility of hhi index was obviously presented in graph 2 all indicators went down during 2008 -2011, after experienced the stability and slightly increase from 2011 – 2014. nevertheless, the degree of concentration of vietnam commercial banks system is still belongs to group of high competitiveness and low concentration markets (0.01 ≤ hhi ≤ 0.1) despite of its increase due to restructuring processes through m&a activities. graph-1. hhi index 2008 – 2014 source: calculated by author regarding the degree of concentration among three largest banks (cr3) : this indicator in the period of 2008 2014 is showed in table 2. in which, market share of 3 largest banks regarding deposit and loan market share have experienced a continuously decrease. cr3 regarding deposit market share fell from 54.1% in 2008 to 38.1% in 2014; loan market share declined from 57.9% in 2008 to 44% in 2014 . the fall of this indicator present the higher competitiveness of vietnam commercial banking system. before that, soe commercial banks dominated banking market for a long period of time. graph-2. cr3 index 2008 – 2014 source: calculated by author asian journal of economics and empirical research, 2016, 3(1): 49-58 57 regarding the degree of concentration among five largest banks (cr5): the degree of concentration among this group tended to decrease continuously in term of 3 indicators : total asset, deposit and loans. another issue should be examined is the presence of new joint stock commercial banks in the group of 6 largest banks. in additional, the gap of size and market share between banks in this group have been narrowed gradually. it is the obvious impact of m&a execution. graph-3. cr5 index 2008 – 2014 source: calculated by author 5.3. cross – countries comparison hhi of vietnam banking system has tended to decrease gradually, moreover, the market concentration index of vietnam banking market including hhi and group concentration index (cr) of 3,5 and 10 largest banks in the system are in the medium level in compared to other countries (table 4). it is once again showed that the vietnam banking market become more and more competitive up to the time that this paper are being conducted. table-4. concentration indices for 20 countries, based on total assets (1997) countries index no. of banks hhi cr3 cr5 cr10 australia 0.14 0.57 0.77 0.90 31 austria 0.14 0.53 0.64 0.77 78 belgum 0.12 0.52 0.75 0.87 79 canada 0.14 0.54 0.82 0.94 44 denmark 0.17 0.67 0.80 0.91 91 france 0.05 0.30 0.45 0.64 336 germany 0.03 0.22 0.31 0.46 1,883 greece 0.20 0.66 0.82 0.94 22 ireland 0.17 0.65 0.73 0.84 30 italy 0.04 0.27 0.40 0.54 331 japan 0.06 0.39 0.49 0.56 140 luxembourg 0.03 0.20 0.30 0.49 118 netherlands 0.23 0.78 0.87 0.93 45 norway 0.12 0.56 0.67 0.81 35 portugal 0.09 0.40 0.57 0.82 40 spain 0.08 0.45 0.56 0.69 140 sweden 0.12 0.53 0.73 0.92 21 switzerland 0.26 0.72 0.77 0.82 325 uk 0.06 0.34 0.47 0.68 186 us 0.02 0.15 0.23 0.38 717 averages 0.11 0.47 0.61 0.75 vietnam* 0.07 0.38 0.53 0.70 34 source: calculated by authors cr-3. index in asia countries year 2001 2006 2011 thailand 48.40% 44.70% 45.30% indonesia 62.60% 47.30% 44.00% china 75.20% 70.10% 50.80% sigapore 97.80% 85.20% 90.00% nguyen hong son and et la 2008 2011 vietnam 48.44% 36.11% source: calculated by authors 6. conclusion vietnam commercial banking system have been experienced the significant change in the restructuring process by reducing the number of weak bank and creasing bank size through m&a activities which aim to building a safe banking system with high competitive competence. asian journal of economics and empirical research, 2016, 3(1): 49-58 58 the empirical research on vietnam commercial banking system in the period of 2008 -2014 by structured approach showed that: regarding m&a activities and its impacts on vietnam commercial banking system. m&a cases in banking sector had been conducted since 1990s, however these activities increased significantly in the period of 2011 -2015 in term of size and economics meaning. one hand, it presented the intrinsic adjustment of the banking system to the economics environment . on the other hand, it is the result of the change of sbv’s policy approach in regulating banking and financial business. generally, m&a activities have created the positive impacts on vietnam commercial banking system, achieving its targets in term of : reducing npls, increasing competence, stabilization and safety. the changes of personnel, organizational structure, management were generally appropriate aim to specialization and utilization. regarding the degree of concentration and market structure  the empirical research on vietnam commercial banking system in the period of 2008 -2014 by structured approach show that: despite of the higher concentration after some m&a cases, the degree of concentration still stay in the average level, it is right not only in the whole banking system but also in the group of largest banks. the high competitiveness in banking market is one of factors support vietnam commercial banking in enhancing its efficiency – one of the important goals of restructuring project.  the results also present that, the concerns about the size concentration by the m&a activities in vietnam commercial banking system will lead to the increase of monopoly or group monopoly, which may cause harm to competitive environment have not taken place up till now.  however, market situation may be changed significantly regarding the degree of concentration if one or several in the largest group are being merged. this is a notice for regulatory and supervisory body in the next time.  in addition, the concentration index can not fully reflect the influences of a group of bank on the market. hhi and cr5 measured in this research show the high degree of competitiveness, medium degree of concentration, however, all of four largest banks in vietnam commercial bank system are stated – own banks. there are concerns that policies from sbv and government may benefit these banks in some circumstances. for this reason, the index can not fully reflect the banking market structure. references benston, g.j., w.c. hunter and l.d. wall, 1995. motivations for bank mergers and acquisitions: enhancing the deposit insurance put option versus earnings diversification. journal of money, credit and banking, 27(3): 777-787. bikker, j.a. and k. haaf, 2002. measures of competition and concentration in the banking industry: a review of the literature. economic& financial modelling, 9(2): 53-98. davis, k., 2007. banking concentration, financial stability and public policy. structure and resilience of the financial system. reserve bank of australia: 255-284. available from http://www.rba.gov.au/. le, h.t., 2014. concentration and competition at vietnam's banking sector. banking technology journal, 23: 21-31. sharma, m.k. and h.k. bal, 2010. measures of concentration: an empirical analysis of the banking sector in india. journal of global business issues, 6(6): 95-107. vuong, h.q., t.d. tran and t.h.c.h. nguyen, 2009. the m&a market in process of shifting vietnam economy. economic and political research journal, 5: 16-19. walter, n., 1987. banking acquisitions: acquirer and target shareholder return. financial management review, 16(winter): 66-74. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. http://www.rba.gov.au/ asian journal of economics and empirical research issn: 2409-2622 vol. 2, no. 2, 91-99, 2015 http://asianonlinejournals.com/index.php/ajeer * corresponding author 91 monitoring and evaluation in the public sector: a case study of the department of rural development and land reform in south africa n.z hlatshwayo 1 --k k govender 2* 1 regenesys business school, johannesburg, south africa 2 regensys business school and university of kwazulu-natal, south africa abstract this work is licensed under a creative commons attribution 3.0 license asian online journal publishing group contents 1. introduction ............................................................................................................................................................................... 92 2. literature review ...................................................................................................................................................................... 92 3. research methodology .............................................................................................................................................................. 95 4. data collection .......................................................................................................................................................................... 95 5. sample and sampling................................................................................................................................................................ 95 6. data analysis ............................................................................................................................................................................. 95 7. findings ...................................................................................................................................................................................... 95 8. discussion ................................................................................................................................................................................... 96 9. conclusions ................................................................................................................................................................................ 97 10. recommendations ................................................................................................................................................................... 98 11. limitations and future research .......................................................................................................................................... 98 references ...................................................................................................................................................................................... 98 since the publication of the government-wide monitoring and evaluation policy framework (gwm&epf) by the presidency in south africa (sa), several policy documents giving direction, clarifying context, purpose, vision, and strategies of m&e were developed. in many instances broad guidelines stipulate how m&e should be implemented at the institutional level, and linked with managerial systems such as planning, budgeting, project management and reporting. this research was undertaken to examine how the „institutionalisation‟ of m&e supports meaningful project implementation within the public sector in south africa (sa), with specific reference to the department of rural development and land reform (drd&lr). this paper provides a theoretical and analytical framework on how m&e should be “institutionalised”, by emphasising that the im&e is essential in the public sector, to both improve service delivery and ensure good governance. it is also argued that the m&e has the potential to support meaningful implementation, promote organisational development, enhance organisational learning and support service delivery. keywords: corporate governance, monitoring and evaluation, public sector, service delivery. http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2015, 2(2):91-99 92 1. introduction 1.1. introduction and background to the study monitoring and evaluation (m&e) has the capacity to transform government departments and the public sector into a functional system that is participatory and representative (undp, 2013). the operations evaluation department (oed) of the world bank has thus undertaken numerous initiatives to support developing countries to strengthen their monitoring and evaluation (m&e) capacities and skills, as integral to achieving good governance, public sector transformation and service delivery (undp, 2013). in 2005, the paris declaration on aid and effectiveness (pdae) highlighted the capacity to „plan, manage, implement and account for the results of policies and programs through m&e systems (mosse and lewis, 2005). in south africa (sa), the government‟s national development plan (ndp) emphasizes the role of m&e in meeting its strategic and developmental objectives, poverty reduction, budget decision-making and project implementation processes (national development plan, 2012). in essence, m&e strengthens the management of government activities within ministries and in local governments, and supports accountability relationships within civil society. with poor service delivery and rampant corruption in the (sa) public sector, m&e supports transparency and builds a performance culture to support better management and policymaking, including the budgeting process (mosse and lewis, 2005). according to kambuwa and wallis (2002) in sa there is a growing gap between good policies of government departments and project implementation results. as such, it is important to follow participatory implementation and institutionalise processes for greater accountability, since it provides a vital evaluative link between policy development and project implementation (kambuwa and wallis, 2002). the (sa) government wide monitoring and evaluation framework (the presidency, 2007) seeks to transform the public sector by promoting capacity building, and decision making to support public service delivery. in this framework, the institutionalisation of m&e contributes considerably to policy making, innovation, growth and learning in the public sector. although sa is known for its progressive developmental policies and other legislative measures aimed at widespread social transformation, poor implementation and resultant slow service delivery raises questions on the „institutionalisation‟ of meaningful m&e within the policy management cycle. underpinned by the (sa) government-wide monitoring & evaluative framework (gwm&ef), this research explores various concepts and frameworks to report on the state of the im&e in the public sector. more specifically, the department of rural development and land reform unit (drd&lr) was used as a case study, and in this context, attention was given to the unintended consequences of policies and the important function of the im&e on project implementation. more specifically, the aim of this research (on which this paper is written) was to explore m&e theories in the context of the im&e, in order to support meaningful project implementation and service delivery. in addition, this research looked at internal and external processes that hinder or enhance m&e, especially its institutionalisation, as well as issues of „institutional capacity‟. in summary, the research attempted to ascertain how the drd&lr monitors and evaluates the implementation of the public policy, how is m&e institutionalised, and whether the institutional arrangements compatible with institutional capacity. 2. literature review 2.1. role and importance m&e in the public sector there are as many theories on m&e, as there are many methodologies and approaches to m&e in the public domain (mackay, 1989). often the concepts m&e are confused or conflated together as “a function of project management which provides information on the various stages of the project in order to make necessary adjustments,” (dobrea and ciocoiu, 2010). as such, m&e interventions are considered important tools that provide information on project management, which assist managers in decision making. the world bank (2006) posits that “the process of m&e can be approached and understood from a multi-stage perspective, namely, the budget and allocation of scarce public resources, accountability and transparency, performance of public programs, enhancement of equality of opportunity, and understanding what pubic investments and interventions work well.” according to in many instances, m&e is “commonly associated with evidence based policy-making (ebpm) or performance-based budgeting (pbb) or results-based management (rbm).” the aforementioned researchers also argue that by introducing m&e at the initial stages of a project, the project team will benefit from continuous feedback allowing for timely-corrective decision making, before evaluation happens. as such, m&e provides an „evidence base‟ for public budget resource allocation decisions and identifies mistakes and replicates success. therefore, monitoring provides the background for reducing schedule and budget cost overruns, while ensuring that the required quality standards are achieved in project implementation. evaluation can be understood as “an instrument for helping planners and project developers to assess to what extent the projects have achieved the desired objectives set forth in the project documents,” (solomon and young, 2007). m&e has experienced exponential growth, in recent years, thanks to the organisation for economic cooperation and development (oecd) and the world bank (wb). according to bamberger (2006) the traditional functions of m&e stress the managerial and accountability features of the process. however, emerging approaches put the governance and policy dialogue dimensions forward, where m&e functions as “an accountability mechanism, fostering greater transparency, enhances governance and democracy, and the voice of civil society,” (bamberger, 2006). although governments the world over continue to promote the importance of m&e in project implementation, in most developing countries, the need for m&e is initiated by outside institutions like multinational agencies, development banks and donors, to promote improved measurement, monitoring and management for result oecd (1996). mackay (2000) agues that “governments migrate to m&e since it provides feedback on the performance of departments, ministerial agencies and their staff.” monitoring and evaluation also helps “improve budgeting, decision making, inter-governmental fiscal control, enhance the quality of government policy and end corruption,” asian journal of economics and empirical research, 2015, 2(2):91-99 93 (mackay, 2006). another key driver of m&e is that it is considered “essential for public sector reforms aimed at changing the role of government, as well as for good management and service delivery,” dahler-larsen et al. (2006). in most developing countries, there is a move toward a results-based m&e system, as it “provides crucial information about public sector performance, a view over time on the status of a programme, promotes credibility and public confidence,” (mackay, 2006). results-based m&e systems help to formulate and justify budgets, identify good practices, focus on achieving outcomes, establish goals and objectives, permit managers to identify and take action to correct weaknesses, and supports the development agenda that is shifting towards greater accountability for aid (mackay, 2006). in the literature, there is no consensus on how m&e interventions contribute to outcomes or whether outcomes can be attributed to such interventions (deprez, 2008). earl et al. (2001) argue that “m&e does not assume a linear relationship between intervention and outcome, it focuses on intervention and behaviour change.” commonly, the successful implementation of projects is attributable to the use of m&e, even though the project manager is unaware or, is not consciously applying a monitoring and evaluation framework. as such, the attention is on the assessment of the project and achievement of outcomes, instead of attributing results to interventions. in the public sector, theories of change are widely used to take a long-term view with emphasis on implementation, knowledge management and impact assessment (dimaggio and powell, 1983). the linkage between change management and m&e ensures that “processes are adapted to the situation, and it also signals a shift towards more participatory methods,” (kusek and rist, 2004). gildemyn (2013) argues that “it is not enough to only analyse policy and how it is implemented, but it is equally important to understand to what extent it has met its objectives, as well as to know what worked, as this brings about accountability and feedback, as well as knowledge and insight to what has been accomplished.” in the last few decades, there has been a general movement, in developing countries, towards a: “a new public management approach” underpinned by the adoption of vigorous m&e systems (undp, 2000). the movement towards public sector reforms was propelled by a growing trend towards democracy, accountability and transparency which has placed substantial emphasis on the m&e of development and tracking of public resources (mcneil and malena, 2010). in the public sector reform process, there is no single, best approach to a national or sectoral m&e system, and each approach is based on what the system is intended to achieve, which is either to assist in the budgeting process or to support service delivery (mackay, 1999). various countries have adopted different approaches to public sector reforms according to their specific requirements, aligned with m&e systems. in brazil, m&e assumes a comprehensive “whole-of-government approach” from the setting of public program objectives to the creation of a system of performance indicators (mackay, 2006). while in colombia, public sector reforms are linked to the processes of public service monitoring impact evaluation of objectives (mackay, 2006). in africa however, value for money in expenditures, quality of budget m&e in uganda are fragmented, due to conflicting and multiple government and donor reporting formats (plaatjie and porter, 2006). in south africa, public sector reforms and the „institutionalisation‟ of m&e are linked to both the national development plan and other global commitments (engela and ajam, 2010). although the above in not a comprehensive discussion of m&e, as this is not the purpose of this paper, an attempt was made to explain the concepts (m&e) broadly, and the context of its application in the public sector in general, and south africa in particular. the discussion will now migrate to the „insitutionalizing‟ of m&e in the public sector. 2.2. institutionalization of m&e in the public sector governments, especially in developing countries, are required to adhere to various m&e methods and systems stipulated by donors, multilateral agreements and other undp prescriptions (undp, 2000). in recent years, south american countries‟ like brazil, chile and colombia have also adopted methods and designed systems that are mutually different but relevant to their individual country specifics. according to mackay (2007) chile‟s innovative approach “is nourished by the countries commitment to improved public service management and delivery, the role of the finance ministry adds impetus to its design and implementation.” in these instances, the different m&e methods are determined by, among others, situational context, purpose and resources, as well as the intended impact and output. invariably, the institutionalisation of m&e is linked to “broad public sector reforms geared towards results-based management, performance based budgeting and evidence-based policy making,” (plaatjie and porter, 2006). often, institutionalisation is used in the “pursuit of good governance and meaningful project implementation, as well as contributes to building institutional capacity, increasing skills, development of processes, structures and systems,” (may et al., 2006). in essence, institutionalization of m&e facilitates the creation of a support system which produces monitoring information and evaluation of findings which are judged valuable by key stakeholders. according to mackay (2006) “institutionalisation of m&e in the public sector requires key drivers and substantive demand from key government departments.” sivagnanasothy (2007) argues that when m&e is institutionalized, “it becomes an integral part of the development program, it leads to improved planning, policy making and achievement of objectives.” according to mackay (2006) the term institutionalisation is the “…creation of an m&e system, which produces monitoring information and evaluation findings, which are judged valuable by key stakeholders, which are used in the pursuit of good governance, and where there is sufficient demand for the m&e function to ensure its funding and its sustainability for the foreseeable future.” in recent years, with the move towards neo-liberalism and neo-classic economics in the developing countries, traditional approaches to capacity development have moved towards strengthening new public management approaches. broadly, the move brought about a shift in focus from individual organisations to the wider institutional environment encompassing the private and public sectors and non-government organisations. in the main, the emerging institutionalisation approaches emphasise government service delivery systems, public programs that reach neglected target groups, human resource management, and people-centred development asian journal of economics and empirical research, 2015, 2(2):91-99 94 (steenberg, 2013). thus, the im&e is a key factor in the transformation of the public sector to become efficient, effective and responsive to the needs of the people (plaatjie and porter, 2006). the process of „institutionalisation‟ can be approached from two different perspectives, namely, a microperspective where it looks at how to “institutionalise” m&e to support project implementation, and a macroperspective which looks at how government “institutionalises‟ m&e to achieve its policy objectives (steenberg, 2013). in addition, the process transforms government departments and the public sector into functional, accountable and transparent systems, it also supports participatory and representative processes. furthermore, the im&e in the public sector is pursued to enhance public policy and service delivery, and as such, must be vigorously implemented to achieve results (engela and ajam, 2010). in this process it is critical to continuously isolate institutional, structural and systemic factors that may work against or support implementation (steenberg, 2013). it is also critical that there is requisite capacity in the public sector that is linked to a results-based method (plaatjie and porter, 2006). on the whole, the im&e process helps implementers to have a better understanding of the various phases of policy making and implementation. over the years, many developing countries in latin america and africa have developed strategies aimed at the im&e, the key trends are based on policy making, especially on budgeting, policy development, management and accountability (world bank, 2006). although attempts towards „institutionalisation‟ are tailored to meet country specific priorities, based on the latin american experience. however, mackay (2006) cautions against “overengineering” as it might alienate strategic partners, and he argues that „institutionalisation‟ fails because of a lack of ownership of the project, lack of a modern culture based on evidence-based decision making, poor systems and processes, among others. although the benefits of the „institutionalisation‟ of m&e to enhance project implementation and promote accountability are appreciated, “if institutionalisation is badly conceptualised and implemented the process may lead to a waste of state and donor resources,” (plaatjie and porter, 2006). 2.3. monitoring and evaluation: an overview of the south african context the importance of m&e in sa government departments and public sector transformation is articulated clearly in the sa presidency‟s mid-term review document, which states that “m&e is the life-blood of sound and efficient planning and implementation, and for m&e to add value to policymaking, policy implementation and to the broader process of social transformation, it has to be „institutionalised‟ at all levels. m&e should be based on objective measurements that reflect the ideals of the constitution: to improve the quality of life of all south africans and ensure that south africa contributes to the creation of a better africa and a better world,” (the presidency, 2007). the government–wide monitoring and evaluation framework (gwm&ef) aims to “provide an integrated, encompassing framework for m&e principles, practices and standards to be used throughout government, and function as an apex-level information system, which draws from the component systems in the framework to deliver useful m&e products for its users.” (the presidency, 2007). the gwm&ef also describes how m&e should be practiced at the institutional level and linked with managerial systems such as planning, budgeting and project management. in addition, it sets out reporting requirements, accountability structures and the legal mandate relevant to the government wide system (engela and ajam, 2010). the m&e implementation guidelines and the training guides provide the necessary means to be employed in the implementation of m&e. the national treasury (2008) advocates an m&e that employs a mixed method, geared towards empowerment, promotes learning, and serves a transformational purpose. at the same time, the public service commission (2008) basic concept on monitoring & evaluation explains the values and the concepts in practice as well as analysis of the performance all government departments‟ policies, programmes and projects. in this context, the ministry on m&e in the presidency plays a vital role with regards to coordination, monitoring, evaluation, and communication on government policies and programmes, as well as accelerates integrated service delivery (the presidency, 2007). at least, in policy if not in practice, sa has developed vast m&e mechanisms to help harmonise corporate governance and intergovernmental relation sto improve results (plaatjie and porter, 2013). m&e is instituted according to section 195(1) (c) which states that “public administration must be development-oriented.” the constitution of the republic of south africa (1996) states that “institutions or government programmes should be designed in such a manner that they comply with this principle.” thus, m&e takes an all-inclusive approach that involves government, public and private sectors, donor organisations, non-governmental organisations and the broad citizenry, who are the intended recipients of government programmes. as such, the broad gm&eef is modeled around the constitutional principles of the “separation of powers within the different spheres of government, intergovernmental relations, national development plan and the various departmental objectives,” (engela and ajam, 2010). the framework is promulgated and regulated around the public finance management act (pfma), which is supported by institutions such as the auditor-general, national treasury and the public service commission (kusek and rist, 2004). m&e in sa is further bolstered by the establishment of the department of performance monitoring and evaluation (dpme) in the presidency to among others, introduce an outcomes-based approach to detail planning, implementation and monitoring and evaluation. in particular, to promote m&e in government; monitor the performance of public sector servants at national and provincial departments and municipalities; as well as monitor basic service delivery. upon adoption of the national development plan (ndp), to achieve progress in the implementation of economic and social reforms, the adoption of the gm&ef became essential in the formulation, implementation and review of national government policy, since it allows for provincial and municipal nuances, establishes a minimum threshold to be adhered to by all spheres of government and public entities. built around the logical framework, policy development, programme design and service delivery are interlinked in a programme management (pm) approach. generally, programmes are designed to attain the long-term departmental objectives, however, they will have immediate measurable deliverables. in this instance, deliverables are designed to be specific, realistic in time frames, allow for interventions and be measurable. programmes are implemented through an integrated and interrelated process of identification, planning, implementation, monitoring and evaluation. each component, managed by a sub-unit, which is responsible to identify institutional issues that asian journal of economics and empirical research, 2015, 2(2):91-99 95 relate to both programme and process, if need be, provide capacity and skills development training. to support programme implementation and ensure that the objectives are achieved, m&e establishes process indicators which measure what happens during implementation. in this way, „institutionalisation of m&e is allowed to permeate all levels of government policy and making and implementation. in light of the literature reviewed, this paper will explore the institutionalizing of m&e in one government department in sa, namely the drd&lr using the case study methodology explained below. 3. research methodology the research questions justify a qualitative approach, as it “employs a multi-method strategy, an interpretive analysis, naturalistic approach and attempts to understand and interpret phenomena,” (denzin and lincoln, 2005) and its use in the m&e processes emerged in the late 1980s as a counter reaction to the dominance of quantitative methods (may, 2011). consequently, the qualitative method with its flexibility to collect data economically and align it to the project is useful in m&e research design (jha et al., 2007). 4. data collection the tools used included questionnaires, interviews, focus group discussions, informal interactions, observations, as well as use of already published secondary data (creswell, 2003). the diversity of tools and techniques used for the research ensures cross-validation and cross-fertilisation of data (blanche and painter, 2006) and the triangulation of data “gives an acceptable degree of objectivity to the subjective perspectives” (royce et al., 2005). semi-structured interviews were conducted with experts, informants and other key stakeholders. the process provided an opportunity for exchange of thoughts and views by both the interviewer and interviewee, thus enriching the learning and growth (rubin, 2005). the almost hour-long interviews were both face to face and/or telephonic, and the focus was on the interviewees‟ understanding of m&e from the sa government‟s perspective, institutional arrangements and capacity. the primary researcher took detailed notes and also used an audio recorder. the primary researcher also facilitated a focus group meeting with senior management at the drd&lr to probe issues on im&e, institutional arrangements, organisational structures and capacity within the department. nonparticipant observation is a data collection method used extensively in case study research in which the researcher enters a social system to observe events, activities, and interactions with the aim of gaining a direct understanding (liu and mattis, 2005). the observations allowed the primary researcher to gain insight on “what happens naturally within an environment, allowing the researcher to draw understanding and learning,” (liu and mattis, 2005). the observation process also allowed the primary researcher to witness and document the organisational dynamics and processes on how im&e is being conducted. the researcher developed an observation guide that detailed the settings, participants, and what happened (babbie, 2002). the observations also lasted for about an hour, during which time, the researcher made detailed notes and recorded proceedings for analysis later. 5. sample and sampling since in qualitative research, “sampling is a deliberate selection of the appropriate candidates to be included in the study, based on purpose of the study,” (denzin and lincoln, 2005) purposive sampling the preferred method for selecting participants. as a non-probability sampling method, it allowed interviewees to identify other possible candidates to be interviewed, and the assumption is that the interviewees would know others who are familiar with the research matter (morgan, 2008). in view of the nature and scope of the research, the availability of participants, time limitations and anticipated costs, a linear-snowball sampling technique was considered appropriate for this purpose (babbie, 2002). by using a case study, the researchers took a broad over-view of the emergence of m&e as a „movement” to support programme implementation in the ndrd & lr, especially the m&e unit, which oversees the transfer of landownership through participatory processes. in its mandate, the aforementioned unit continuously monitors land claims from the stage of lodgment, as well as evaluates the process at certain critical intervals (lahiff, 2010). overall, the focus of the unit is on both the external and internal variables that impact on the process, as well as oversee the various stakeholders and civil society formations that are integral to the process (lahiff, 2010). the primary researcher interviewed personnel who are involved with the implementation of m&e. 6. data analysis the approach adopted was based on the work by friese (2012) who stresses the “interlink of noticing, collecting and thinking as ongoing back and forth processes, because the researcher is the main character in qualitative data analysis.” the data analysis involved triangulation of various sources of data to standardise the reliability and validity of the data collected (miles and huberman, 1994). in addition to creating a micro word file for all data, the researchers used the atlas software (caqdas) to code topics and summarise them into themes, for analysis. 7. findings it became evident that the drd&lr‟s m&e unit has sixteen (16) dedicated staff who are specialists in m&e with 69% junior staff; 19% in senior management and 12% in middle management. it also became apparent that severally and jointly, there exists a common vision of accountability, good governance, transparency, transformation, good performance and service delivery. it emerged that m&e is an integral part of policy-making and implementation, rather than an appendage, both at a micro and macro level, and figure 1 represents the „institutionalisation‟ of the m&e framework. it is also evident that the department‟s framework replicates the national framework, through which (at national, provincial and local level) programme implementation is supported and stakeholder participation is enhanced. asian journal of economics and empirical research, 2015, 2(2):91-99 96 figure-1. drd&lr monitoring and evaluation unit. source: psc (2008) basic concepts in monitoring and evaluation (p, 12) figure 1 also reflects the process, organisation structures, as well as integrated internal systems to bolster service delivery and ensure comprehensive programme implementation support. in addition, it fosters interaction and interrelationships both internal and external, ensures knowledge management, information flow, learning, capacity building and training. basically, the structure is designed to provide an integrated, overarching framework of m&e principles, practices and standards to be used throughout by government to improve the accountability of politicians and enhance managerial controls. figure 2 reflects that the overall focus of the department is on both the external and internal contexts that impact the process, as well as oversees the various stakeholders and civil society formations that are integral to the process. it is also evident from figure 2 that the contextual frameworks uphold the democratic principles of good governance, accountability, transparency, broad public participation and service delivery. the primary focus here is to highlight both the centrality and „institutionalisation‟ of m&e within the broad context of policy making, programme implementation and participation. figure-2. policy-making cycle source: psc (2008) basic concepts in monitoring and evaluation (p, 9) 8. discussion when the government-wide monitoring and evaluation framework was adopted, it was praised for its radical attempts to bolster good governance, improve accountability and expedite transformation, as well as transform public sector management, support programme implementation and increase service delivery. the framework introduced a more centralised, transparent, participatory and collaborative framework to monitor and evaluate government activities. in the main, the positive support was in response to many years of lack of transformation, rampant corruption, disaffected public servants and poor service delivery, leading to public protest and civil disobedience. as a result, the framework was welcomed as a panacea to the many challenges besetting ministerial performance, government, line departments, state institutions and public enterprises. however, though the framework was welcomed by many stakeholders, the framework has over the years experienced both conceptual challenges and practical hindrances, as a result of weak institutional and structural arrangement, lack of skills, limited capacity, poor knowledge and information management. asian journal of economics and empirical research, 2015, 2(2):91-99 97 in its wide and diverse scope, including theoretical underpinnings and practice‟s, monitoring and evaluation needs to be adapted to the politics, economics and social milieu of the host country. inevitably, it cannot ignore the prevailing socio-cultural, government priorities, skills levels and capacity within the broader society and public sector, in particular (kusek and rist, 2004). similarly, according to patton (2009) taking into consideration local dynamics is important to understanding the developmental challenges of the country. in this context, in south africa, m&e is instituted according to section 195(1) (c) which provides that “public administration must be development-oriented.” thus, m&e takes an all-inclusive approach that involves government, public and private sectors, donor organisations, non-governmental organisations and the broad citizenry, who are the intended recipients of government programmes. therefore, upon the adoption of the national development plan, to achieve progress in the implementation of economic and social reforms, the adoption of the government-wide monitoring and evaluation framework became essential in the formulation, implementation and review of national government policy. as a result, the government-wide monitoring and evaluation framework, which allows for provincial and municipal nuances, establishes a minimum threshold to be adhered to by all spheres of government and public entities. in doing so, it set a benchmark for further standard-setting, in this way emphasise the learning and development aspects of the framework. as such, despite their variance, the frameworks uphold the democratic principles of good governance, accountability, transparency, broad participation and service delivery. to this end, legislative and regulatory processes are set up to be followed in the public sector, however, interventions by state institutions to take corrective measures are not precluded. a key component in this process is the “professionalisation” of monitoring and evaluation, which should address the issue of skills, capacities, training, most important reduce the dependence on outside consultants and experts. in addition, performing departments have translated effective leadership into innovative performance improvements among public sector workers. hopefully, this would build a core of competent and dedicated public sector that is responsive to the needs of the broad public. the institutionalisation of monitoring and evaluation holds a great potential to meet governments development objectives, promote policy-decisions making, enhance implementation and transform the way in which services are delivered in the public sector (cooley, 2002). for the government and departments, it provides a basis to transform the public sector, ensure compliance with fiscal policy and increase broad stakeholder participation. according to mackay (2007) the main challenge with departmental monitoring and evaluation processes is to determine whether or not adequate policy and institutional arrangements are put in place to ensure its institutionalisation. however, despite general support many policymakers and practitioners struggle to develop and implement system wide strategies, most resort to ad hoc measures, rather than confront the many challenges presented by theoretical and practical considerations (mackay, 2007). according to woolcock (2014) lasting reform and heightened development effectiveness is not just a matter of “designing better policies” but learning how to build widespread organizational capability to implement them. the significance of the institutionalisation of monitoring and evaluation to support good governance and accountability is well established, especially with reference to service delivery to the majority of the citizenry. aware of the challenges and opportunities, policymakers and practitioners have developed strategies, methods and tools that streamline processes across various spheres of government and departmental units. similarly, the need to achieve synergies within and between government departments, multinational donors and stakeholders has contributed to the development of methodologies and approaches that harmonise development activities (mackay, 2006). moreover, its institutionalisation creates opportunities for possible foreign investments, economic growth, social cohesion and sustainable use of resources (engela and ajam, 2010). although, there are enormous challenges and opportunities there remains a general commitment among donors, governments departments and stakeholders to the adoption of monitoring and evaluation policies and systems to support sustainable development. a key and supported finding is that respondents recognise the importance of m&e, especially with regard to public policy formulation, transformation in the public sector and service delivery. overall, m&e should build a supportive institutional and structural environment, which clarifies the different roles and responsibilities for the different participants and define the expected outcomes. efficient institutional and structural arrangement are important to develop the capacity of the user and improve on existing systems. the presidency, working together with donor agencies, provides support to government departments and government agencies to improve public sector cooperation and coordination to support programme implementation. as such, the line department has supports the development and strengthening of institutional and structural arrangements as an integral components to achieve good governance and service delivery. both mechanisms highlight that m&e is more than accountability, control measures and assessment of results but include additional purposes such as learning, programme improvement, future planning and augments capacity. making general conclusions on the institutional and structural arrangements is difficult; given the different organisational mandates and objectives. however, with respect to the drd&lr, emerging themes emphasise autonomy, decentralisation as well as broad public participation. in addition, “lean” organisational structures are regarded as efficient and effective, as opposed to bloated organisation structures that are unable to deliver on their mandate. in general, results-based frameworks are, arguably, the best suited for greater institutional accountability. to support programme implementation and ensure that the objectives are achieved, m&e establishes, on the one end, process indicators which measure what happens during implementation. on the other end, output indicators are put in place to look at the material and financial outputs, as well as organisational processes and performance measures. based on the results achieved by the programme, it may be necessary to revisit the initial policy, or aspects of the policy and programme, implementation and resource allocation. in this way, institutionalisation of m&e is allowed to permeate all levels of government policy and making and implementation. 9. conclusions the review addresses some major issues on the role of the institutionalisation of m&e to support programme implementation. traditionally, m&e has been driven by exogenous factors, but at the drd&lr, it has been asian journal of economics and empirical research, 2015, 2(2):91-99 98 internalized and is driven by internal policies and practices. the government-wide monitoring and evaluation framework offers great flexibility which leads to poor implementation. although it potentially increases the levels of accountability, good governance, quality of participation and service delivery. monitoring and evaluation is becoming a powerful tool for public sector transformation and service delivery. monitoring and evaluation initiatives are implemented as barometers of democracy, equality and equity with different levels of success. 10. recommendations the challenges facing the institutionalisation of m&e, and the effectiveness of institutional and structural arrangements to support programme implementation needs to be addressed by considering inter-alia, the following recommendations. with respect to the government-wide monitoring and evaluation framework, there is need to close the theoretical and operational divide by adopting an integrative approach to be used system wide. a shift from the routine-functional approaches to a more process and developmental approach is required. there is need to combine ict and km to benefit from existing infrastructure and management systems. career opportunities should be established for public servants responsible for m&e to strengthen leadership and decision-making. a national platform must be created that brings together the various sectors of society, improves policy-making, implementation and increase public accountability. 11. limitations and future research the „limited‟ availability of information on the “institutionalization” of m&e, specifically on how it is understood, and access to internal documents and work plans, prevented a more comprehensive analysis of the true „state of affairs‟ in the drd&lr. although the research looked at various aspect of m&e with special focus on its „institutionalisation,‟ future research could explore the issue of “trust” in m&e in the public sector, because trust could be the single most important factor in the adoption and implementation of m&e systems, as it establishes 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2409-2622 vol. 3, no. 1, 40-48, 2016 http://asianonlinejournals.com/index.php/ajeer 40 fdi impact on employment generation and gdp growth in india ratan kirti1 seema prasad2 1 jss academy of technical education noida, u.p india 2 abes ghaziabad u.p india ( corresponding author) abstract in the era of homogenization of development all over the globe, capital has become crucial aspect and major concern for countries, especially for the developing ones. foreign funds inflow has become one of the major resources for this. countries are in a constant race to attract more of foreign fund inflows or foreign direct investment (fdi).the objective of this paper is to study the impact of fdi in india on the employment generation capacity and gdp growth it also tries to correlate gdp growth with employment trends, it will go through sector-wise inflow of fdi in india and analyze its ability to generate employment and productivity in india. keywords: foreign direct investment, elasticity of employment, employment, gdp growth. jel classification: f16, f21, g11, o30, o43. contents 1. introduction ......................................................................................................................................................................... 41 2. foreign direct investment scenario of india ...................................................................................................................... 41 3. employment generation scenario in india ........................................................................................................................ 43 4. employment generation capacity of fdi .......................................................................................................................... 45 5. conclusion ............................................................................................................................................................................ 48 references ................................................................................................................................................................................ 48 bibliography ............................................................................................................................................................................ 48 citation | ratan kirti; seema prasad (2016). fdi impact on employment generation and gdp growth in india. asian journal of economics and empirical research, 3(1): 40-48. doi: 10.20448/journal.501/2016.3.1/501.1.40.48 issn (e): issn (p): 2409-2622 2518-010x licensed: this work is licensed under a creative commons attribution 3.0 license contribution/acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained ethical: history: this study follows all ethical practices during writing. received: 1 september 2015/ revised: 23 january 2016/ accepted: 28 january 2016/ published: 2 february 2016 publisher: asian online journal publishing group http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.40.48 http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.40.48 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.40.48 http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.40.48 asian journal of economics and empirical research, 2016, 3(1):40-48 41 1. introduction there have been significant amount of research that have been carried out in almost all the developing countries especially african and indian sub-continent since china grew past all the economies since 1970’s, while the total fdi inflow in china surpassed its previous record every year during those days. it is pretty obvious that the main forces that triggered such growth were not only fdi but also its labor reforms with infrastructure development and opening of its economy, south korea also miraculously grew at a growth rate of 12% during that phase using similar methodology. after the liberalization of the indian economy since 1991 in the wake of balance of payment crises there has also been emphasis on fdi in india, as india strived to follow the same objective of economic growth many leaps and bounds followed it. employment generation and starting of new firms have always converged as empirical evidences indicate 1 , india on the other hand was struggling to help start new firms as it always had problems with the license system that it followed since its independence. there have always been concerns regarding this subject in india however after the liberalization of the economy this pessimism has definitely reduced and high hopes have gradually taken its place. india also had credibility issues that took a toll on its economic growth in the first half of 1990’s but later they were also slowly resolved with new reforms such as in rupee convertibility, fiscal reforms, flexible exchange rate and etc. after the realization by indian planners about the fact they cannot keep going in the same fashion of regulation of foreign trade and neglect their responsibilities about the balance of payment in the early 90’s they started liberalizing norms on foreign exchange as a result of gradually the fdi inflow incremented come to think of it-not much time has really passed since then and india has accumulated a cumulative fdi of u.s$ 364,785 million 2 by january 2015. employment generation ability in india has been dominated by agriculture as even in 2009-10 the percentage share of agricultural employment is 53.2%, while the share of manufacturing/ non-manufacturing and service sector are 11%/10.5% and 25.3% respectively. 3 it is not hard to see that the majority number of hands to feed a population of 120 billion has always been dominated by agriculture, even with the low earning that is derived from agriculture the economy has not only sustained but is also growing at a rate of 7% in 2015-it is miraculously true. even with a cyclic raising cpi the low wages derived from agriculture were able to sustain a jaw dropping population of 120 billion. in the context of the relation between population growth and employment generation we can say that it is significantly dependent on demographic factors that we cannot go into a detail about in this section, however we will mention the document of the world bank (http://data.worldbank.org/indicator/sl.emp.totl.sp.zs) in this regard. the relation between employment generation and fdi is very significant to understand in respect of indian scenario due to more or less stagnated employment share of agriculture. it is pretty puzzling that despite of the migration of people to urban areas in search of employment why are there such low employment share of service sector even after high fdi inflows? moreover, what are the factors that relate fdi to employment in india? these are key question that we will try to find answers to in this paper, after the liberalization of the indian economy much has changed governments launch ambitious programs like mgnrega (mahatma gandhi national rural employment guarantee scheme) and many other such programs further it reduces barriers to trade and allows fdi in all sectors this definitely spreads optimism in the domestic as well as foreign markets, we seek to know how far has india got riding on the back of much debated foreign direct investment. 2. foreign direct investment scenario of india the importance of fdi can be explained by analyzing its need and influence on indian economy, the need for fdi is pretty simple, as right after the balance of payment crises it became pretty clear that india will not have much domestic investment unless the private sector is liberalized and supported by the government. even if big bang reforms take place it will need some time to settle things down, so for the time being the major investment had to come from elsewhere i.e. fdi liberalization schemes must be rolled out. however, due to credibility issues in the international market it was pretty difficult for india to begin with such an idea but later on as india began to advertise about its huge market with approximately 95 billion consumers in telecommunication sector (in 1996) 4 for example things began to become more clear to the multinational companies. influence of fdi can be understood by the inferiority complex that almost all the south east asian countries felt after the rapid growth of china and south korea, there is no denying the fact that fdi inflow in china was one of the major factors responsible for this along with other reforms that took place during that period 5 . 1birch (1987). 2 dipp.nic.in/english/publications/fdi.../2015/india_fdi_january2015.pdf 3http://planningcommission.nic.in/data/datatable/sectoral%20break-up%20of%20employment%20&%20value%20added%20per%20worker%20(9394,%2099-00;%2004-05%20&%2009-10) 4 foreign direct investment in india: a critical analysis of fdi from 1991-2005 by kulwindar singh centre for civil society, new delhi research internship programme, 2005 5chen, lawrence and yimin (1995). http://data.worldbank.org/indicator/sl.emp.totl.sp.zs asian journal of economics and empirical research, 2016, 3(1):40-48 42 table-1. from april, 2000 to february, 2015 – rbi amount rupees in crores (us$ in million) ranks country 2012-13 ( april march) 2013-14 (april – march) 2014-15 (april ‘14 february, 2015) cumulative inflows (april ’00 february ‘15) %age to total inflows (in terms of us $) 1. mauritius 51,654 (9,497) 29,360 (4,859) 51,530 (8,447) 422,015 (86,972) 35 % 2. singapore 12,594 (2,308) 35,625 (5,985) 39,393 (6,429) 165,200 (31,874) 13 % 3. u.k. 5,797 (1,080) 20,426 (3,215) 7,463 (1,237) 108,348 (22,001) 9 % 4. japan 12,243 (2,237) 10,550 (1,718) 10,507 (1,725) 91,151 (17,993) 7 % 5. netherlan ds 10,054 (1,856) 13,920 (2,270) 20,076 (3,294) 76,374 (14,530) 6 % 6. u.s.a. 3,033 (557) 4,807 (806) 10,360 (1,697) 66,090 (13,625) 6 % 7. cyprus 2,658 (490) 3,401 (557) 3,596 (592) 39,325 (8,038) 3 % 8. germany 4,684 (860) 6,093 (1,038) 6,485 (1,058) 38,091 (7,577) 3 % 9 france 3,487 (646) 1,842 (305) 3,626 (594) 22,332 (4,472) 2 % 10. switzerlad 987 (180) 2,084 (341) 2,040 (333) 15,188 (3,040) 1 % total fdi inflows from all countries * 121,907 (22,423) 147,518 (24,299) 175,886 (28,813) 1,220,316 (246,516) source: fact sheet on foreign direct investment (fdi) 2.1. trends in fdi inflow india astoundingly way back in 1983 came a long way when we think only in terms of methodology adopted to bring in capital inflows some light on the situation can be thrown in by bilateral tax treaty between india and mauritius (dr. manmohan singh, 2007 imf working paper) an example for recent development regarding this issue can be of india-singapore comprehensive economic corporation agreement 2003. after reviewing the above given data it is very easy to interpret the crucial role played by bilateral tax agreement between india and mauritius i.e. fdi inflow of mauritius is not only highest but also 35% of fdi, similarly singapore constitutes of 13% of it. but that of the western countries constitute less than 50% of fdi even on summation. the impact of such treaties and agreement between countries is huge, sometimes big enough to over shadow many reforms that countries like india go through like labor reforms etc. the free trade agreement have played a significant role in developing countries of asia and africa especially when we consider political economy fta consolidation in asia—(as a group, the number of concluded ftas in asia increased from only three to 61 during that time). 6 what impact did these fta have on india? the increased integration of india with asian countries has expanded its presence in global markets where as the shares of asian developing countries in india’s exports and imports have raised but its share with developed countries has come down, despite of this fact they continue to be important destination for indian exports 7 . india’s fdi policy turned out to be beneficial for not only singapore and mauritius but also for other asian countries. while with the african partners there have been appreciable amount of investment from india instead, for instance investments by tata motors in south africa are market seeking because the cars built in south africa are sold in the country. 8 a look over the below given data can help in understanding that there have been constant increase in investment by india into the african countries as we see that us$ million 1,400 in 2006-07, us$ million 1,627 in 2007-08 and us$ million 2,555 in 2008-09, however the net outflow of fdi in india was just 0.4% of gdp in 2014 according to world bank data so we can conclude there is very little outflow of fdi in contrast to fdi inflow 3% of gdp in 2014. never the less india is surly on the path that was set as an objective during the liberalization of 1991. 6 the asean-india free trade agreement: a sectoral impact analysis of increased trade integration in goods* smitha francis 7smitha francis,"the asean-india free trade agreement: a sectoral impact analysis of increased trade integration in goods", [online] available: http://www.networkideas.org/ ideasact/dec09/pdf/smitha_francis_paper.pdf 8 cuts ccier working paper no. 1/2012 indian foreign direct investment in africa anusree paul* asian journal of economics and empirical research, 2016, 3(1):40-48 43 table-2. indian fdi to african countries country 1996-2002 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 botswana 3.46 0 0.05 0.02 0.02 0 2.3 8.11 burkina faso 0 0 0 0.05 0 0 0 0 cameroon 0 0.02 0 0 0 0 0 0 ethiopia 0.54 0.57 0.22 0.2 1.8 1.8 2.52 1.49 ghana 0.03 0.33 0.01 0 0.66 0.66 1.69 1.09 ivory coast 0.01 0 0 7.24 6.85 0.39 0.27 0.5 kenya 12.75 0.59 1.77 0.19 0.32 0.2 0.33 133.15 libya 30 0 0 0 25.28 75 0.02 12.67 liberia 0.28 0 0 0 154.94 0 17.74 16 mauritius 618.34 133.35 175.59 149.38 332.67 1162.79 1506.29 2086.97 morocco 32.49 0 0 0 0 0 0.44 2.65 mozambique 0 0 0 2.55 7.52 0 3.23 3.77 niger 0 0 0 0 0.01 0 0 0.5 nigeria 6.69 4.08 2.16 7.53 4.3 11.64 27.2 237 namibia 0.06 0 0 0 0 0 0 0 south africa 21.56 0.07 0.79 2.88 10.42 23.29 46.19 12.37 sierra leone 0 0 0 0.01 0 0 0 0 senegal 22.24 0 0 0 1 0 0.03 0 sudan 0 750 162.03 51.55 63.05 118.15 8.3 38.06 tanzania 4.02 0.01 0.08 0.34 0 0 10.47 0 tunisia 0 0 0 0 0 5.24 0 0 uganda 2.44 0 0.01 0.19 0 0 0 1 zambia 2.35 0 0 0.11 0 0 0 0.05 zimbabwe 1.11 0 0 0.18 0.3 0.95 0 0 africa 758.37 889.02 342.71 222.42 609.14 1400.11 1627 2555.37 source: http://finmin.nic.in/the_ministry/dept_eco_affairs/investment_div/invest_index.htm#actual_outflows (accessed on february 28, 2012) fdi has always been concerned with developed economies. as they attract a comparatively higher share of world-wide fdi than developing countries. in recent years, however, the increase in fdi flows to developing countries turned out to be higher than the increase in fdi flows to developed countries. average annual fdi flows to developing countries soared eight-fold 9 and india had a big role to play. 3. employment generation scenario in india when we discuss about the trend of employment in india employment elasticity can be a very useful tool for analysisemployment elasticity is a measure of the percentage change in employment associated with a 1 percentage point change in economic growth or we can say that 10 . table-3. employment elasticity: cagr approach year employment growth(cagr) gdp growth(cagr) employment elasticity 1972-73 to 1977-78 2.6 4.6 0.57 1977-78 to 1983 2.1 3.9 0.54 1983 to 1988-89 1.7 4 0.42 1988-89 to 1993-94 2.4 5.6 0.43 1993-94 to 1999-2000 1 6.8 0.15 1999-2000 to 2004-05 2.8 5.7 0.5 2004-05 to 2009-10 0.1 8.7 0.01 2009-10 to 2011-12 1.4 7.4 0.18 1999-00 to 2011-12 1.5 7.3 0.2 1993-94 to 2011-12 1.1 6 0.18 computed values 9 azeem and suhalia (2014). 10 w p s (depr): 06 / 2014 rbi working paper series estimating employment elasticity of growth for the indian economy sangita misra and anoop k suresh department of economic and policy research june 2014 asian journal of economics and empirical research, 2016, 3(1):40-48 44 as we can see that there is a definite decline in the employment elasticity indicating that with increase in gdp growth rate there was lesser and lesser increase in overall employment in india. one of the logical explanations behind this can be that as the economy progressed, the labor force was being replaced by capital or marginal rate of technical substitution kept declining ( ). but when we take a look at the employment generation trend in organised sector (table 4) we figure out that there is a positive growth in employment of organised sector since the past years with decreasing elasticity as shown ofcourse, now the below given bar chart can throw some light on the decreasing trend of labor contribution in gdp as on can easily make out that there is gradual but sure increase in tangent or first derivative of the curve given below (plot between gdp growth on y and employment on x axis in scales of millions.) either way, we can confirm that there is not much increase in labor employment with respect to national income growth in india. unorganized sector employment is doing fairly well if we see in terms of employment generation, but since data on unorganized sector is not available to us we can leave it at this optimistic expression. there has been a great deal of debates on the topic of employment generation by small and new firms in national and international fronts, most of the researchers considered it to be true 11 , this view has initiated a new program in india by the government, but we are yet to see the results. 11 do small businesses create more jobs? new evidence for the united states from the national establishment time series david neumark university of california, irvine, public policy institute of california, nber and iza brandon wall stanford university junfu zhang clark university and iza discussion paper no. 3888 december 2008 y = -0.0126x + 25.498 r² = 0.5809 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 elasticity of employment year asian journal of economics and empirical research, 2016, 3(1):40-48 45 table-4. employment generation in india-organized sector year public sector(endmarch) private sector(endmarch) number of persons on the live register(enddecember) 1975-76 13.63 6.79 9.78 1976-77 14.18 6.95 10.92 1977-78 14.73 7.11 12.68 1978-79 15.58 7.23 14.33 1979-80 15.12 7.24 16.2 1980-81 15.48 7.4 17.84 1981-82 16.28 7.53 19.75 1982-83 16.75 7.39 21.95 1983-84 17.22 7.36 23.55 1984-85 17.58 7.43 26.27 1985-86 17.68 7.37 30.13 1986-87 18.24 7.39 30.25 1987-88 18.32 7.39 30.05 1988-89 18.51 7.45 32.78 1989-90 18.77 7.58 34.63 1990-91 19.06 7.68 36.3 1991-92 19.21 7.85 36.76 1992-93 19.33 7.85 36.28 1993-94 19.45 7.93 36.69 1994-95 19.47 8.06 36.74 1995-96 19.43 8.51 37.43 1996-97 19.56 8.69 39.14 1997-98 19.42 8.75 40.09 1998-99 19.41 8.7 40.37 1999-2000 19.31 8.65 41.34 2000-01 19.14 8.65 42 2001-02 18.77 8.43 41.17 2002-03 18.58 8.42 41.39 2003-04 18.2 8.25 40.46 2004-05 18.01 8.45 39.35 2005-06 18.19 8.77 41.47 2006-07 18.06 9.24 39.97 2007-08 17.67 9.88 39.11 2008-09 17.8 10.38 38.15 2009-10 17.86 10.85 38.83 2010-11 17.55 11.45 40.17 2011-12 17.61 12.04 44.79 2012-13 na na 46.8 note: data from 1990-91 to 1998-99 and for 2002-03 onwards are based on quarterly employment review. also see notes on tables. source: directorate general of employment and training. ministry of labor and employment, government of india. 4. employment generation capacity of fdi foreign direct investments are long run programs initiated by multinational companies; they seek simple incentives such as markets, comparative advantage of labor in a country, cheaper raw material etc. but how does it increase employment? there are basically two kinds of investment 1) brown field investment—when a company purchases existing production facilities. 2) green field investment—when a company builds a new production facility. either way there is bound to be increase in employment due to investments made. but the extent of the employment generation depends on the nature of business these firms want to do, with entry of new firms in the country there must be increase in competition in the domestic markets, this gives diversity to the consumers, other positive implication of fdi is the improvement of technology and knowledge. in india most of the sector-wise distribution of fdi (appendix 1) has been in service sector (services sector includes financial, banking, insurance, non-financial / business, outsourcing, r&d, courier,) i.e. 17.18% of total fdi. while in construction development india has 9.76% fdi inflows. most of these industries are capital intensive in nature and we should not expect much growth in labor employment. agriculture sector— the primary sector employs 50% of the total employment directly while 12% indirectly, it has received about 0.16 % in agriculture services and 0.16% in agriculture machinery of fdi, though it is a small fraction of fdi it led to a steady growth in agriculture sector 12 . keeping in mind that agriculture sector contributes up to 19% in gdp of india we should expect more inflow of fdi in this sector, but when we compare the ratio of gdp contribution of primary sector to the labor employment we find that the theory of disguised unemployment to be true, moreover most of the employment generated belongs to the unorganized sector. the productivity of labor in agriculture sector has depleted to an alarming extent and the only way to raise living standard may seem to be that prescribed by professor arthur lewis in his labor surplus model for 12 neeraj (2015). asian journal of economics and empirical research, 2016, 3(1):40-48 46 developing countries. the fdi in other sector certainly seem to be pointing in the above mentioned direction of professor arthur lewis model, when we take a closer look at the employment trend of agriculture in india we find that there has been a steady decline. table-4a. employment shares of major sectors (%) sector 1972-73 1977-78 1983 1987-88 1993-94 1999-2000 agriculture 74 72.3 68.4 65.5 60.38 56.7 industry 11.4 12.3 13.7 15.5 15.82 17.56 services 14.6 15.4 17.5 18.4 23.8 25.74 source: nsso database the only way by which indian agriculture sector can improve its labor productivity is by employing more of capital intensive technology. such practices have already shown good results in u.s.a, mexico etc. industrial sector—indian industrial sector have had its leaps and bounds and is now expected grow at a much better pace though it has received a fdi share of 4.96% in automobile sector, 3.88% in power sector, 4.17% in fertilizers etc. it is still growing and contributed to 18% of employment in india. this share of fdi inflow in industrial sector does not reflect its incapacity by any means as the major benefit received by this sector has been transfer of technology and knowledge through multinational companies 13 . with this the productivity of indian labor has improved tremendously, the national manufacturing policy (nmp) ratified by the indian government aims at 25% contribution to gdp and 100 million employment by 2022, under such strong optimism this sector is likely to increase its share of fdi as well. there has been a steady increase in index of industrial production (iip) 14 in the recent past of the core industries of india and we can expect that this sector will do better in the future, with labor migrating towards the urban industrial areas in search of employment they need to increase their productivity which they are able to do as the results show. service sector—this sector is attracting a huge sum of fdi i.e. 17.18%, most of the fdi that came from mauritius and singapore was inclined towards the service sector but since the global financial crises in 2007-08 this percentage has dropped. it is clear that the service sector is sensitive towards the exports at least in india, with the plummeting service exports of -15% in 2015 this sector has gotten the worse hit since the crises, the rate of employment generation in this sector is pretty stable though. during the period of 2004-06 when the indian gdp was growing at a rate of 8% the service exports played the most important role also fdi inflow it this sector was at its peak. skilled labor from all over the country flooded into this sector but as soon as the exports were reduced this sector could not bear the labor cost and instead left it unemployed or did not hired them to begin with, moreover the fdi inflow was reduced to 2/3 of what it was in 2005. s. no sector amount of fdi inflows %age of total inflows in rupees (crore) in us $ million 1 service sector* 203,207.12 42,340.36 17.18 2 construction development: townships, housing, build-up infrastructure and construction development projects 113,115.96 24,060.36 9.76 3 telecommunications 83,829.32 17,015.99 6.91 4 computer software and hardware 72,264.91 14,862.02 6.03 5 drugs and pharmaceuticals 63,910.56 12,901.33 5.24 6 automobile industry 63,051.15 12,232.06 4.96 7 chemicals(other than fertilizers) 48,847.60 10,262.87 4.17 8 power 46,587.17 9,548.82 3.88 9 metallurgical industries 41,025.74 8,527.34 3.46 10 trading 43,076.80 7,944.67 3.22 11 hotel and tourism 40,744.64 7,862.08 3.19 12 petroleum and natural gas 31,651.33 6,519.70 2.65 13 food processing industries 36,632.82 6,259.42 2.54 14 miscellaneous mechanical and engineering industries 20,612.79 3,954.67 1.61 15 information and broadcasting (including print media) 19,197.30 3,897.50 1.58 16 electrical equipment’s 18,705.40 3,851.83 1.56 17 non-conventional energy 18,898.83 3,582.16 1.45 18 industrial machinery 18,753.01 3,569.30 1.45 19 construction(infrastructure) activities 16,924.88 3,264.96 1.33 20 cement and gypsum products 14,629.79 3,086.32 1.25 21 hospital and diagnostic centers 15,424.26 2,932.17 1.19 22 consultancy services 13,982.21 2,798.45 1.14 23 fermentation industries 11,657.67 2,187.33 0.89 24 rubber goods 9,642.98 1,754.55 0.71 25 agriculture services 8,636.38 1,745.83 0.71 26 mining 8,466.79 1,669.49 0.68 27 ports 6,730.91 1,637.30 0.66 continue 13 choudhaury, pyne and chowdhury (2013). 14 https://data.gov.in/resources/index-eight-core-industries-base-year-2004-05-upto-september-2015/download asian journal of economics and empirical research, 2016, 3(1):40-48 47 28 textiles(including dyed and printed 7,786.84 1,568.01 0.64 29 sea transport 7,449.32 1,514.40 0.61 30 electronics 6,795.56 1,424.32 0.58 31 prime mover(other than electrical generator) 6,310.04 1,202.57 0.49 32 education 5,717.84 1,082.47 0.44 33 medical and surgical appliances 4,846.02 925.45 0.38 34 paper and pulp(including paper products) 4,328.54 910.49 0.37 35 soaps, cosmetics and toilet preparations 4,713.62 894.45 0.36 36 machine tools 3,539.68 716.03 0.29 37 ceramics 3,330.05 700.89 0.28 38 diamond and gold ornaments 3,609.81 682.79 0.28 39 railway related components 3,426.40 634.27 0.26 40 air transport(including air freight) 2,762.57 569.44 0.23 41 vegetable oils and vanaspati 2,896.93 547.42 0.22 42 fertilizers 2,915.62 543.14 0.22 fdi contribution in indian gdp we can classify the effects as direct and indirect effect of fdi on any economy, similarly in indian context the direct contribution of fdi has been in balance of payments, and technology transfer etc. however the genrally disregarded effect of fdi is indirect effect. the foreign direct investment can be regarded as inflow of capital. it can be explained by the use of keynesian multiplier concept where here, y is national income and i is investment, explaination: if an investment of $100 is done, then the labor employed would earn $100 and consume say $80 on goods by purchasing it from certain person now this person earns $80 and similarly decides to purchase an item worth $64 from another person then this person earns $64 and story goes on until $0 is left to spend further, the total income generated here will be not be eual to $100 instead it will be 100+80+64… this concept is called the multiplier effect. though this theory has its shortcommings never the less it is gives an effective explaination. fdi contributes more to the economy this way and hence it becomes more important to understand its indirect effect, though direct effects should not be underestimated. never the less, the cluster of points in the below given graph can be explained by the initial phase of opening of the indian economy this part of the graph signifies that initially the growth of gdp was not increasing as rappidly in later phases also one can observe that fdi inflow did not follow a similar trend and continuosly increased with a few exceptions at the time of global slowdown indicating its sensitivity. the below given data is does not throw any light on the indirect or multiplier effect of fdi in india though it is relevent. y = 24.84x + 1e+06 r² = 0.8722 0 500000 1000000 1500000 2000000 2500000 3000000 3500000 4000000 4500000 5000000 0 20000 40000 60000 80000 100000 120000 140000 fd i gdp asian journal of economics and empirical research, 2016, 3(1):40-48 48 fdi inflows,gdp and fdi/gdp ratio in india(1991-92 to 201112) years fdi inflow in rupee crores growth rate of fdi inflow(%) gdp growth rate of gdp(%) fdi as a % of gdp 1991-92 409 0 1099072 0 0.037213 1992-93 1094 167.4817 1158025 5.363889 0.094471 1993-94 2018 84.46069 1223816 5.681311 0.164894 1994-95 4312 113.6769 1302076 6.394752 0.331163 1995-96 6916 60.38961 1396974 7.288207 0.49507 1996-97 9654 39.58936 1508378 7.974665 0.640025 1997-98 13548 40.33561 1573263 4.301641 0.86114 1998-99 12343 -8.8943 1678410 6.683371 0.735398 1999-00 10311 -16.4628 1786525 6.441513 0.577154 2000-01 12645 22.63602 1864301 4.35348 0.67827 2001-02 19361 53.1119 1972606 5.809416 0.981494 2002-03 14932 -22.8759 2048286 3.836549 0.729 2003-04 12117 -18.8521 2222758 8.517951 0.545134 2004-05 17138 41.43765 2388768 7.468649 0.717441 2005-06 24613 43.61652 3254216 36.22989 0.756342 2006-07 70630 186.9622 3566011 9.581263 1.980644 2007-08 98664 39.69135 3898958 9.336679 2.530522 2008-09 122919 24.58343 4162509 6.759524 2.953003 2009-10 123378 0.373417 4493743 7.957556 2.745551 5. conclusion india certainly can be considered as an emerging economic power and fdi has contributed to its growth in multidimensional way to it, but as far as the employment generation is considered there is yet to be methodology developed to establish a concrete relation between the two. we tried to establish a linier relation using ols but the corelation coefficient was too low i.e. 0.65 which cannot be considered any good so we leave it at that. but as far as the relation between gdp growth and employment generation is concerned we can be sure that there is a positive relation with decreasing rate of growth of labor employment, capital intensive technology is now taking up the major role as growth engine in india and there is expected to further reduction in elasticity of employment. we can also conclude from our study that agriculture sector though not contributing much to gdp might work wonders if capital intensive technology is provided this sector, it is not a surprise that manufacturing and service sector of india are on the rise and are likely to attract more investment and intelect from the world but since india skipped the traditional phase where it was suppose to have rise in manufacturing sector before the service sector it just might work fine as now the manufacturing sector is looking stornger than before. fdi in all these sectors clearly reflects the confidence of international community on the ablity of growth and incentive that it is likely to give. references azeem, a.k. and p. suhalia, 2014. global fdi inflows in india: an analysis. international journal of interdisciplinary research and innovations, 2(4): 74-87. birch, d.l., 1987. job creation in america: how our smallest companies put the most people to work. new york: free press. chen, c., c. lawrence and z. yimin, 1995. the role of foreign direct investment in china in post-1978 economic development. world development, 23(4): 691-703. choudhaury, r.b., k.p. pyne and r.a. chowdhury, 2013. determinants of manufacturing fdi in india: a sectoral analysis. journal of industrial statistics, 2(2): 217-231. neeraj, a., 2015. foreign direct investment and its impact on employment in agriculture sector of indian economy. hctl open international journal of technology innovations and research (ijtir), 14: 1-9. bibliography do small, 2005. do small businesses create more jobs? new evidence for the united states from the national establishment time series david neumark university of california, irvine, public policy institute of california, nber and iza brandon wall stanford university junfu zhang clark university and iza discussion paper no. 3888 december 2008. foreign direct investment in india, 2005. foreign direct investment in india: a critical analysis of fdi from 1991-2005 by kulwindar singh centre for civil society. new delhi research internship program. smitha, f., n.d. the asean-india free trade agreement: a sectoral impact analysis of increased trade integration in goods. available from http://www.networkideas.org/ideasact/dec09/pdf/smitha_francis_paper.pdf. w p s (depr), 2014. w p s (depr): 06 / 2014 rbi working paper series estimating employment elasticity of growth for the indian economy sangita misra and anoop k suresh department of economic and policy research june 2014. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. http://www.networkideas.org/ideasact/dec09/pdf/smitha_francis_paper.pdf asian journal of economics and empirical research issn(e) : 2409-2622 issn(p) : 2518-010x vol. 3, no. 2, 163-171, 2016 http://asianonlinejournals.com/index.php/ajeer 163 a panel data analysis for evaluating the profitability of the banking sector in bangladesh md. thasinul abedin1  md. muzammel dawan2 ( corresponding author) 1,2 graduated from accounting & information systems, faculty of business studies, university of dhaka, bangladesh abstract this study attempts to evaluate the profitability for a panel of 29 listed commercial banks of bangladesh. panel gmm approach along with pooled ols and random effect ols has been applied to discover the impact of key factors namely investment in government securities and shares, loan and advances, human resource, efficiency, and economy money supply growth on profitability using the data set from 20052015 for each bank. the study has found that loan and advances, human resource, efficiency, and economy money supply growth have significant positive impact on profit where investment in government securities and shares has significant negative impact. therefore, more loan and advances, more human resource, more efficiency, and more money supply growth unlike investment in government securities and shares will eventually boost up the profitability of banks. keywords: profitability, commercial banks, investment, loan and advances, human resource, efficiency, money supply growth, panel gmm, pooled ols, random effect ols. jel classification: c01, c33, c87, e22, g21. contents 1. introduction ....................................................................................................................................................................... 164 2. review of literatures ........................................................................................................................................................ 164 3. data source and descriptive statistics.............................................................................................................................. 165 4. econometric methodology ................................................................................................................................................. 166 5. conclusion and policy implications .................................................................................................................................. 170 references .............................................................................................................................................................................. 170 citation | md. thasinul abedin; md. muzammel dawan (2016). a panel data analysis for evaluating the profitability of the banking sector in bangladesh. asian journal of economics and empirical research, 3(2): 163-171. doi: 10.20448/journal.501/2016.3.2/501.2.163.171 issn(e) : 2409-2622 issn(p) : 2518-010x licensed: contribution/acknowledgement: this work is licensed under a creative commons attribution 3.0 license all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. history: received: 23 january 2017/ revised: 16 february 2017/ accepted: 23 february 2017/ published: 6 march 2017 ethical: this study follows all ethical practices during writing. publisher: asian online journal publishing group http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.2/501.2.163.171 https://orcid.org/orcid-search/quick-search?searchquery=md. thasinul abedin https://orcid.org/orcid-search/quick-search?searchquery=md. muzammel dawan http://search.crossref.org/?q=10.20448/journal.501/2016.3.2/501.2.163.171 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.2/501.2.163.171 https://orcid.org/orcid-search/quick-search?searchquery=md. thasinul abedin https://orcid.org/orcid-search/quick-search?searchquery=md. muzammel dawan http://search.crossref.org/?q=10.20448/journal.501/2016.3.2/501.2.163.171 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.2/501.2.163.171 https://orcid.org/orcid-search/quick-search?searchquery=md. thasinul abedin https://orcid.org/orcid-search/quick-search?searchquery=md. muzammel dawan http://search.crossref.org/?q=10.20448/journal.501/2016.3.2/501.2.163.171 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.2/501.2.163.171 https://orcid.org/orcid-search/quick-search?searchquery=md. thasinul abedin https://orcid.org/orcid-search/quick-search?searchquery=md. muzammel dawan http://search.crossref.org/?q=10.20448/journal.501/2016.3.2/501.2.163.171 asian journal of economics and empirical research, 2016, 3(2): 163-171 164 1. introduction a country‟s economic development largely depends on the banking sector. banking sector accelerates the economic growth providing fund to business organization as and when necessary and performing other supporting activates such as payment mechanism, money transfer, assurance and guarantee in international trade, foreign exchange activities etc. in addition, commercial banks collect scattered idle money and help depositors to earn from their idle money and also help shareholders to earn smart amount using fund efficiently. that is, commercial banks accumulate segregated money from surplus unit of society and supply that fund to deficit unit. thus idle money is invested and resources of society are utilized properly. consumption loan increases living standard. money multiplying activity of banks increases the money supply in the economy. in turn, employment opportunity increases in the economy. central bank implements its policy through commercial banks. thus, commercial banks become the part and parcel of modern economy. it is inevitable for banks to have profitability to uphold continuing activities and for theirs shareholders to have nondiscriminatory returns and at the same time it is also important for managers because it assures more flexible capital ratios even in the setting of a dicey business environment. amandeep (1999) has revealed that it is essential to keep reliability on the institution by shareholders, long term creditors, and management. in this fashion profitability aids to discern the financial soundness of a bank. therefore, a bank should raise more absolute amount of revenue and boost up its profit. profitability, as a life blood of a bank, works as a bridge by providing extra loan disbursement facility to the bank so that it can meet up its long and short term goals. not an exception to generate profitability as a basic aim of a bank, it is also an important factor for the smooth running of a bank in today‟s competitive setting. it has a significant impact on the financial proficiency of the banks to drive the economic development. so to identify profit determinants, management can usually concentrate on it at the time of decision making to track the driving forces. the efficiency argument for profit maximization outlines that corporations and their managers should maximize profits because this is the course of action that will lead to an „economically efficient‟ or „welfare maximizing‟ outcome (jensen, 2001; jensen, 2002). now a days, banking sector of bangladesh is exploring day by day. the total number of bank operation in bangladesh was forty-seven in 2012 but in 2014 this number is fifty-six. among these banks, thirty banks listed in dhaka stock exchange. among commercial banks, islami bank bangladesh limited is the best performing bank with asset base of about bdt 65242 crore. islami bank bangladesh limited (ibbl) is one of first 1000 banks in the world (source: bangladesh bank). ibbl enjoys highest average after tax net profit, highest average loan & advances, highest average deposit & others and highest average paid up capital. intellectual capital such as loyal customer base, loyal and efficient work force, ethical internal operating process, people‟s perception of its operation as true shariah based operation underlie the success of ibbl. moreover, off late the loan and advance base of commercial banks is scaling up (source: bangladesh bank). due to high growth in loan and advances and investment in shares and government securities and increase in human resource, a question usually comes into the mind that are the banks performing optimally with the high growth in loan and advances and investment in government securities and shares base in line with increased human resource? to answer this question, this paper has tried to discover the key determinants that affect profitability of banking sector by using econometric tools and techniques. since banks deal with the public money (mainly depositors), it is the duty of the banks to ensure the safety of the money. due to banks‟ default or suboptimal performance, a bulk portion of depositors may lose their life time savings. hence, a bad intention of public may work on the entire banking sector or simply depositors may feel insecurity to keep their money in banks. therefore, this paper will give a clear message to the public more specifically the depositors that whether keeping money in banks is relatively safe or not, whether banks are generating profit from their main sources of funding (loan and advances) to return depositors‟ money along with claimed return. this paper has been organized as followssection-1: introduction, section-2: literature review, section-3: data source and descriptive statistics, section-4: econometric methodology, and section-5: conclusion. 2. review of literatures profitability of commercial banks is a function of several key factors. most of the academicians and researchers are still inquisitive to detect those factors accurately. this section summarizes the core finding of previous literatures on determinants of profitability of commercial banks. in this regard, samad (2015) has found bank specific factors such as loan-deposit ratio, loan-loss provision to total assets, equity capital to total assets, and operating expenses to total assets have significant on profitability measured with return on asset (roa). bank size and gdp as macroeconomic variable have no impact on profitability (roa). islam (2010) has examined the impact of bank size (measured in total assets, total loans and total deposits) on bank profit performance using ols and found that bank sizes and bank profitability were positively related in bangladesh (see also(bourke, 1989; molyneux and thornton, 1992; loyd-williams et al., 1994; berger, 1995b; angbazo, 1997; iannotta et al., 2007; pasiouras and kosmidou, 2007; athanasoglou et al., 2008; alexiou and sofoklis, 2009; garcía-herrero et al., 2009). munyambonera (2013) has revealed that capital adequacy (eligible capital/total risk weighted assets), credit risk (growth in bank deposit), and inflation have positive and significant impact on profitability measured with return on average asset (roaa) and operational efficiency (cost/income), liquidity ratio (net loans/total assets), growth in gdp have negative and significant impact on return on average assets (roaa). ali (2016) has revealed that financial risk (total liabilities / total assets), gearing ratio (debt / equity), asset management (operating income / total assets), bank size (lntotal assets), loan to total asset ratio (loan / total asset), and inflation have positive and significant impact on profitability measured by return on asset (roa), operating efficiency (total operating expenses / total assets) of banks is negatively associated with return on assets (roa), liquidity (liquid assets / total assets) has negative and significant association with return on assets (roa), non-performing loan(npl) to total assets ratio (npl / total assets), and real gross domestic product (rgdp) has a negative and insignificant impact on return on assets (roa). guru et al. (2002) have studied the determinants of banks‟ profitability where they have grouped the explanatory variables into asian journal of economics and empirical research, 2016, 3(2): 163-171 165 two classes such as the internal determinants and the external determinants. internal determinants are liquidity, capital adequacy, and expenses management and external determinants are ownership, firm size, and economic conditions. the result showed that efficient expenses management was one of the most significant in explaining high profitability. among the external indicators, high interest ratio had negative impact on profitability and inflation was positively related with banks‟ profitability. sufiyan and habibullah (2009) have examined the determinants of the profitability and found that liquidity, credit risk, and capitalization have positive impacts on the state owned commercial banks‟ (socbs) profitability, while the impact of cost on profitability is negative. naceur and omran (2008) have found that bank specific characteristics such as credit risk and bank capital have positive and significant impact on bank profitability. however, they found no evidence of impact of macroeconomic variables on bank profitability. hefferman and fu (2008) have found that macroeconomic variable such as inflation has positive impact on bank profitability. mustaq et al. (2014) examined the determinants of profitability of commercial banks over the period from 2004 to 2010. they examined the impact of a set of explanatory variables on two dependent variables separately. they have found that equity to assets ratio, size of the bank, noninterest income to gross income have significant positive relation with return on equity(roe) and deposit to total assets, and provision ratio have significant negative impact on return on equity (roe). loan to total assets and inflation have negative impact on return on equity (roe). they have also found that equity to assets ratio, size of the bank, and provision ratio have significant positive impact on net interest margin and non-interest income to gross income and deposit to total asset have positive impact on net interest margin. only inflation has negative relationship with net interest margin. however, money supply as a determinant of inflation, has positive impact on banks‟ profitability (bourke, 1989; molyneux and thornton, 1992). zimmerman (1996) has found loan portfolio concentration is an important contributing factor in bank performance. wall (1985) has concluded that a bank‟s asset and liability management, its funding management and the non-interest cost controls all have a significant effect on the profitability record. different studies have confirmed that banks‟ profitability are affected several factors and most of the studies have used traditional and weak econometric tools and techniques (namely ols) and small sample sizes. due to inborn weakness in traditional econometric tools and small sample sizes, the results of the previous studies are very mixed and still no one in bangladesh has applied a panel gmm approach to find out the impact of key factors that usually affect banks‟ profitability. this paper in this regard will fill the gap in eliminating inborn weakness in traditional econometric tools by using modern econometric tools (panel gmm) and as a first time comprehensive study based on panel gmm in bangladesh it will definitely be an excellent contribution in the field of literatures. 3. data source and descriptive statistics all data have been collected from annual reports of each banks from 2005-2015 except economy money supply growth (msg). the data of net profit (netp), investment in government securities and shares (inv), and loan and advances (loan) are expressed in million bdt. banks‟ efficiency (rex) 1 is a unit free measure. broad money supply growth has been used as the economy money supply growth (msg). the data of economy money supply growth has been collected from the world bank development indicators. to check the stability of performance and efficiency of performance a few statistics are given below in table-1. table-1. a few statistics to check stability and efficiency of performance banks and panel mean profit sd of profit cv of profit aptl alarafah islami bank 1,337.66 817.43 61.11% 1.51% ab bank 1,666.51 1,089.98 65.40% 1.77% bank asia 1,327.73 750.99 56.56% 1.89% dhaka bank 1,225.48 635.68 51.87% 1.80% first security islami bank 418.12 326.29 78.04% 0.59% eastern bank 1,622.51 889.29 54.81% 2.38% dutch bangla bank 1,533.47 927.45 60.48% 2.14% city bank 1,243.33 1,044.65 84.02% 1.88% prime bank 2,074.93 925.71 44.61% 2.14% premier bank 711.88 472.8626 66.42% 1.60% united commercial bank 1,903.33 1,319.513 69.33% 1.98% trust bank 630.27 505.8244 80.26% 1.23% national bank 2,798.04 2,082.49 74.43% 2.93% mutual trust bank 615.54 367.55 59.71% 1.37% rupali bank 658.40 488.35 74.17% 0.85% ific bank 856.20 508.52 59.39% 1.46% exim bank 1,741.57 877.86 50.41% 1.82% one bank 1,087.36 689.71 63.43% 2.26% ncc bank 1,304.02 678.03 52.00% 2.06% jamuna bank 864.35 526.17 60.87% 1.95% mercantile bank 1,086.04 544.02 50.09% 1.59% islami bank bangladesh 3,406.71 1488.41 43.69% 1.21% pubali bank 2,071.47 942.89 45.52% 2.34% brac bank 1,204.86 736.67 61.14% 1.57% shahjalal islami bank 1,051.51 541.06 51.46% 1.84% south east bank 1,988.52 1,132.33 56.94% 2.11% social islami bank 838.12 748.27 89.28% 1.57% standard bank 932.00 466.65 50.07% 1.97% uttara bank 1,062.35 540.36 50.86% 2.20% panel 1,353.87 1,065.18 78.68% 1.76% note: sd stands for standard deviation, cv stands for coefficient of variation (stability of performance) and aptl stands for average profit to average loan and advances ratio (efficiency in performance). 1 efficiency has been defined as the total revenue divided by the sum of investment and loan and advances. asian journal of economics and empirical research, 2016, 3(2): 163-171 166 from the descriptive statistics, it has been observed that stability of performance of most of the banks has outperformed the stability of the entire banking sector performance (in terms of coefficient of variation, 76.68%). here, the lower the coefficient of variation, the more stable a bank‟s performance. islami bank bangladesh limited has experienced more stable performance during 2005-2015 (the lowest coefficient of variation of profit, 43.69%). in terms of efficiency ( average profit to average loan and advances), several banksuttara bank( 2.20%), standard bank (1.97%), south east bank (2.11%), shahjalal islami bank (1.84%), pubali bank (2.34%), jamuna bank (1.95%), ncc bank (2.06%), one bank (2.26%), exim bank (1.82%), national bank (2.93%), united commercial bank (1.98%), prime bank (2.14%), city bank (1.88%), dutch bangla bank (2.14%), eastern bank (2.38%), dhaka bank (1.80%), and bank asia (1.89%) have outperformed the efficiency of the entire banking sector performance (1.76%). eastern bank has experienced most efficiency in performance during 2005-2015 (the highest average profit to average loan and advances ratio, 2.38%). bank wise net profit from 2005-2015 has been highlighted in figure-1. figure-1. bank wise net profit (bdt in mn) from 2005-2015 (29 banks). 4. econometric methodology in this section details of the model development, logic behind the selection of the dependent variables, model estimation, and results and interpretation have been provided. 4.1. model development the impact of investment, loan and advances, human resource, efficiency, and economy money supply growth on net profit has been examined by the following model: 3i 5i it1i 2i 4i it 0 it it it it itnetp = a inv loan hr rex msg e      (1) the logarithmic transformation of equation (1) is given by: it 0 1i it 2i it 3i it 4i it 5i it it ln(netp ) = + ln(inv )+ ln(loan )+ ln(hr )+ ln(rex ) + ln(msg )+        (2) where, 0 0=ln(a ) , the subscript i represents ith company and t represents time period for each company. netp indicates net profit after tax for banks, inv indicates investment in government securities and shares for banks, hr indicates number of employees for banks, rex indicates the efficiency for banks, and msg indicates the economy money supply growth. the parameters 1 2 3, , ,   4 , 5 represent the elasticities of net profit with respect to inv, loan, hr, rex, and msg. the entire econometric analysis has been conducted in sata and eviews. all variables are expressed in logarithmic forms due to non-linear relationship among the variables. the scatter plotting of variables (with and without logarithms) is given in figure-1a, 1b, 2a, 2b, 3a, 3b, 4a, 4b, 5a, 5b. relatively deep cluster has been observed in figure1b, 2b, 3b, 4b, and 5b than figure-1a, 2a, 3a, 4a, and 5a. to get overwhelming conclusion, r 2 has been computed and given in table-2. from table-2, it has been concluded that better fitness has been observed after taking logarithm. 0 20 00 40 00 60 00 80 00 n et p ro fit 2005 2010 2015 year asian journal of economics and empirical research, 2016, 3(2): 163-171 167 figure-1a. plotting between netp and inv figure-1b. plotting between lnnetp and lninv figure-2a. plotting between netp and loana figure-2b. plotting between lnnetp and lnloana figure-3a. plotting between netp and hr figure-3b. plotting between lnnetp and lnhr figure-4a. plotting between netp and rex figure-4b. plotting between lnnetp and lnrex asian journal of economics and empirical research, 2016, 3(2): 163-171 168 figure-5a. plotting between netp and rex figure-5b. plotting between netp and rex table-2. summary of r2 inv loana hr rex msg netp 0.2482 0.4601 0.2675 0.0012 0.0021 lninv lnloana lnhr lnrex lnmsg lnnetp 0.3194 0.5523 0.3066 0.0142 0.0038 since logarithm gives more importance to small value and less importance to large value, the problem of nonlinearity will be fixed out with superior model fitness (table-2). logarithm sometimes helps to eliminate heteroscedasticity problem. 4.1.1. logic behind the selection of the explanatory variables loan and advances (loana): alexiou and sofoklis (2009); angbazo (1997); athanasoglou et al. (2008); berger (1995b); bourke (1989); garcía-herrero et al. (2009); iannotta et al. (2007); loyd-williams et al. (1994); molyneux and thornton (1992) and pasiouras and kosmidou (2007) have found that there is a positive relationship between banks‟ loan and advances and profitability. efficiency (rex): alexiou and sofoklis (2009); athanasoglou et al. (2008); dietrich and wanzenried (2011); garcía-herrero et al. (2009) and pasiouras and kosmidou (2007) have found a positive relationship between efficiency and profitability. the study has used asset turnover ratio as a proxy of efficiency. other variables namely total deposits, capital, and term loan have not been used as explanatory variables since loan and advances and investment in shares and government securities are the functions of total deposits, capital, and term loan.   therefore use of deposits, equity capital, and term loan as explanatory variables along with loan and advances and investment in shares and government securities will create multicollinearity problem. investment in shares and government securities (inv): boyd et al. (1998); park (2000) have found that equity investment has significant influence on profitability unlike (santos, 1999). human resource (hr): determining staffing levels is an important decision in retail operations. while the costs of increasing labor are obvious and easy to measure, the benefits are often indirect and not immediately felt. ton (2009) has found that increasing the amount of labor is associated with an increase in profitability through its impact on conformance quality but not its impact on service quality. molyneux (1999) found a positive relationship between staff expenses and total profits. money supply growth (msg): bourke (1989) and molyneux and thornton (1992) have found that money supply is significantly and positively related to banks‟ profitability. table-3. explanatory variables and expected signslnnetp as dependent variable variables expected sign suggested literatures lnloana +ve alexiou and sofoklis (2009); angbazo (1997); athanasoglou et al. (2008); berger (1995b); bourke (1989); garcía-herrero et al. (2009); iannotta et al. (2007); loyd-williams et al. (1994); molyneux and thornton (1992) and pasiouras and kosmidou (2007). lnrex +ve alexiou and sofoklis (2009); athanasoglou et al. (2008); dietrich and wanzenried (2011); garcía-herrero et al. (2009) and pasiouras and kosmidou (2007). lninv +ve / -ve boyd et al. (1998); park (2000) and santos (1999). lnhr +ve ton (2009) lnmsg +ve bourke (1989) and molyneux and thornton (1992). asian journal of economics and empirical research, 2016, 3(2): 163-171 169 test of multicollinearity : to check multicollinearity problem, correlation matrix and variance inflation factor (vif) have been used. table-4. correlation matrix lnnetp lninv lnloana lnhr lnrex lnmsg lnnetp 1.0000 lninv 0.5652 1.0000 lnloana 0.7432 0.7027 1.0000 lnhr 0.5537 0.5746 0.6915 1.0000 lnrex 0.1193 0.0271 -0.1836 -0.0549 1.0000 lnmsg 0.0617 -0.1572 -0.1559 -0.0824 0.0792 1.0000 table-5. variance inflation factor variables lnloana 2.85 0.35 lninv 2.15 0.47 lnhr 1.99 0.50 lnrex 1.10 0.91 lnmsg 1.04 0.96 from the result of correlation matrix and variance inflation factor (vif is greater than or equal to 10 determines the severe problem of multicollinearity), it can be concluded that there is no problem of multicollinearity. 4.2. estimation of the model at first pooled ordinary least square considering heteroscedasticity has been performed without taking into account auto-correlation problem. at second step random effect estimation technique has been used based on hausman (1978) test. later heteroscedasticity, cross sectional correlation, and auto correlation consistent estimation has been used for robustness check. for heteroscedasticity, cross sectional correlation, and auto correlation consistent estimation, arellano and bond (1991) second step gmm (gmm-1 and gmm-2) has been used to remove endogeneity problem (the regressors may be correlated with the error terms) and to remove firm specific unobserved (inborn) fixed effects. moreover, due to the presence of lagged dependent variable, auto-correlation problem may arise. therefore, to get rid of the auto-correlation problem first difference lagged dependent variable is also instrumented with its past levels. one key problem of second step difference gmm estimation is that the standard errors of the estimates may have downward bias. to fix out this problem, white period robust standard errors have been used. it is also notable that if panel has small time dimension (t) and long firm dimension (n), arellano and bond (1991) estimation can be used even if it is not necessary (roodman, 2006). hayakawa (2009) has shown that arellano and bover (1995) orthogonal deviation (gmm-3 and gmm-4) tends to work better than the first difference gmm estimation. 4.3. results and interpretation it has been found that money supply growth and loan and advances have significant positive impact on profitability of banks (suggested by pooles ols, random effect ols, gmm-1, gmm-2, gmm-3, and gmm-4). therefore, more loan and advances and economy money supply will scale up the profit of banks. human resource has significant positive impact on profit (gmm-1, gmm-2, gmm-3, and gmm-4). therefore, banks should increase the human resource in line with the increase in loan and advances. investment has negative impact on profit (gmm-1 and gmm-2). therefore, bank should control investment in shares and government securities to embrace more profit. more efficiency in banks will eventually increase the profitability (pooled ols, random effect ols, gmm-1, and gmm-2). as per heteroscedastic consistent pooled ols result, 100% increase in loan and advances, efficiency, and economy money supply growth, banks‟ profit will be increased by 98.15%, 106%, and 120% respectively and for 100% increase in investment in shares and government securities and human resource, profit will be increased by 1.4% and 3.95% respectively. the impact of loan and advances, efficiency, and economy money supply growth is significant at any level whether the impact of investment in shares and government securities and human resource is insignificant. as per random effect ols result, 100% increase in loan and advances, efficiency, and economy money supply growth, banks‟ profit will be increased by 98.35%, 93.32%, and 116.44% respectively ,for 100% increase in investment in shares and government securities, profit will be decreased by 4.23%, and for 100% increase in human resource, profit will be increased by 10.29%. the impact of loan and advances, efficiency, and economy money supply growth is significant at any level whether the impact of investment in shares and government securities and human resource is insignificant. as per gmm-1 result, 100% increase in loan and advances, efficiency, and economy money supply growth, banks‟ profit will be increased by 65.61%, 42.78%, and 138.06% respectively, for 100% increase in investment in shares and government securities, profit will be decreased by 27.85%, and for 100% increase in human resource, profit will be increased by 89.32%. the impact of loan and advances, efficiency, economy money supply growth, investment in shares and government securities, and human resource is significant. as per gmm-2 result, 100% increase in loan and advances, efficiency, and economy money supply growth, banks‟ profit will be increased by 62.86%, 41.05%, and 138.92% respectively, for 100% increase in investment in shares and government securities, profit will be decreased by 27.57%, and for 100% increase in human resource, profit will be increased by 94.16%. the impact of loan and advances, efficiency, economy money supply growth, investment in shares and government securities, and human resource is significant. as per gmm-3 result, 100% increase in loan and advances, efficiency, and economy money supply growth, banks‟ profit will be increased asian journal of economics and empirical research, 2016, 3(2): 163-171 170 by 61.38% (55.91% in gmm-4) , 40.80% (31.90% in gmm-4) , and 136.98% (132.80% in gmm-4) respectively, for 100% increase in investment in shares and government securities, profit will be decreased by 21.88% (20.29% in gmm-4) , and for 100% increase in human resource, profit will be increased by 72.70% ( 64.82% in gmm-4). the impact of loan and advances, human resource, and economy money supply growth is significant unlike the impact of efficiency and investment in shares and government securities (same as gmm-4). the results have been provided in table-6. table-6. estimation results variables expected sign pooled ols re ols gmm-1 gmm-2 gmm-3 gmm-4 constant -5.5849 *** (0.0000) -5.7400 *** (0.0000) lninv +ve / -ve 0.0140 (0.7140) -0.0423 (0.3750) -0.2785 * (0.0488) -0.2757 * (0.0559) -0.2188 (0.2340) -0.2029 (0.2154) lnloan +ve 0.9815 *** (0.0000) 0.9835 *** (0.0000) 0.6561 *** (0.0003) 0.6286 *** (0.0004) 0.6138 *** (0.0094) 0.5591 *** (0.0089) lnhr +ve 0.0395 (0.5280) 0.1029 (0.3130) 0.8932 ** (0.0149) 0.9416 ** (0.0108) 0.7270 ** (0.0227) 0.6482 ** (0.0341) lnrex +ve 1.0664 *** (0.0000) 0.9332 *** (0.0000) 0.4278 * (0.0570) 0.4105 * (0.0626) 0.4080 (0.1633) 0.3190 (0.2495) lnmsg +ve 1.1974 *** (0.0000) 1.1644 *** (0.0000) 1.3806 *** (0.0000) 1.3892 *** (0.0000) 1.3698 *** (0.0000) 1.3280 *** (0.0000) ar(2) coefficient 0.1382 (0.8901) 0.1615 (0.8717) j statistic 24.3085 (0.2784) 24.3166 (0.2780) 25.2009 (0.2385) 25.0619 (0.2445) note: ***significant at 1% level, **significant at 5% level, *significant at 10% level. there is no existence of serial correlation in all four gmm techniques. the higher the p-value of j-statistic, the stronger the model is. re (random effect) ols has been applied based on the result of hausman specification test (acceptance of null hypothesis). later by taking into account serial correlation, heteroscedasticy, and cross sectional dependence, gmm has been applied. in gmm-1 and gmm-3 all transformed independent variables have been used as instruments along with dynamic panel instruments of dependent variables. in gmm-2 and gmm-4, all transformed independent variables, first lag of independent variables, and first lag of first difference independent variables have been used as instruments along with dynamic panel instruments of dependent variables. gmm-1, gmm-2, gmm-3, and gmm-4 are reasonably good models suggested by small j-statistic and its high p-value (>0.05). in gmm-1, gmm-2, gmm-3, and gmm-4, consecutive three lags of dependent variable have been used as explanatory variables to eliminate auto-correlation problem. 5. conclusion and policy implications to get superior model fitness, a non-linear model (double log model) has been used in this study. in the estimated model, severe problem of multicollinearity has not been observed. to check the consistency in estimation, four separate gmms (gmm-1, gmm-2, gmm-3, and gmm-4) along with pooled ols and random effect ols have been used. in four gmms, the impact of loan and advances, human resource, and money supply growth on profit is consistent. from the estimated results from all techniques, it has been observed that both internal factors (investment in shares and government securities, loan and advances, human resource, and efficiency) and external factor (for example economy money supply) affect profitability of 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https://scholar.google.com/scholar?hl=en&q=bank%20specific%20and%20macroeconomic%20determinants%20of%20bank%20profitability:%20empirical%20evidence%20from%20china%20banking%20sector http://dx.doi.org/10.1007/s11459-009-0016-1 https://scholar.google.com/scholar?hl=en&q=factors%20influencing%20community%20bank%20performance%20in%20california https://scholar.google.com/scholar?hl=en&q=factors%20influencing%20community%20bank%20performance%20in%20california asian journal of economics and empirical research issn(e) : 2409-2622 issn(p) : 2518-010x vol. 3, no. 1, 84-93, 2016 http://asianonlinejournals.com/index.php/ajeer 84 modelling economic growth function in nigeria: an ardl approach chinwuba okafor1  ibrahim shaibu2 1 department of accounting, university of benin, benin city 2 department of business administration, university of benin, benin city ( corresponding author) abstract the objectives of the study were to identify the significant variables that underlie economic growth in nigeria, ascertain the stability of the economic growth model in nigeria over the sample period, and examine the forecasting performance of the linear dynamic model. this study applies a linear dynamic model based on pesaran et al. (2001) multivariate autoregressive distributed lag (ardl) modelling technique to analyze the short-run and long-run dynamics of economic growth in nigeria over the sample period between 1986 and 2013 using quarterly data. the empirical results show that economic growth in nigeria finds explanation in adaptive expectations. the main determining variables of economic growth in nigeria in the short-run and long-run are expected economic growth, population and trade openness. to achieve sustainable economic growth, it is suggested that government policies directed at improving the performance of the economy should largely consider the short-run and longrun behaviour of these variables and the policies should be pursued with high degree of transparency. keywords: adaptive expectation, ardl, co-integration, dynamic model, first difference, gross capital, growth, needs, openness, parsimonious model. contents 1. introduction ......................................................................................................................................................................... 85 2. theoretical framework and ardl specification .............................................................................................................. 85 3. empirical literature on the determinants of economic growth ...................................................................................... 86 4. pre-estimation analysis ....................................................................................................................................................... 87 5. estimation, diagnostics and interpretation of ardl model ............................................................................................ 89 6. discussion of findings, conclusion and recommendations ............................................................................................... 91 references ................................................................................................................................................................................ 92 citation | chinwuba okafor; ibrahim shaibu (2016). modelling economic growth function in nigeria: an ardl approach. asian journal of economics and empirical research, 3(1): 84-93. doi: 10.20448/journal.501/2016.3.1/501.1.84.93 issn (e): issn (p): 2409-2622 2518-010x licensed: this work is licensed under a creative commons attribution 3.0 license contribution/acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained ethical: history: this study follows all ethical practices during writing. received: 13 november 2015/ revised: 23 december 2015/ accepted: 17 february 2016/ published: 13 may 2016 publisher: asian online journal publishing group http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.84.93 https://orcid.org/orcid-search/quick-search?searchquery=chinwuba okafor https://orcid.org/orcid-search/quick-search?searchquery=ibrahim shaibu http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.84.93 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.84.93 https://orcid.org/orcid-search/quick-search?searchquery=chinwuba okafor https://orcid.org/orcid-search/quick-search?searchquery=ibrahim shaibu http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.84.93 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.84.93 https://orcid.org/orcid-search/quick-search?searchquery=chinwuba okafor https://orcid.org/orcid-search/quick-search?searchquery=ibrahim shaibu http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.84.93 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.84.93 https://orcid.org/orcid-search/quick-search?searchquery=chinwuba okafor https://orcid.org/orcid-search/quick-search?searchquery=ibrahim shaibu http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.84.93 asian journal of economics and empirical research, 2016, 3(1): 84-93 85 1. introduction nigeria, like any other nation, has a key policy objective of promoting a sustainable economic growth process that could improve the living standard of the people. nigerian is recognized globally as a country with great potentials required for achieving this broad objective of sustainable economic growth. however available statistics indicate that the country has been struggling to grow (omoke, 2010). given the limited resources available to support development and reforms, it is not possible to tackle all possible constraints and therefore the country as a matter of necessity must prioritize. understanding the determining variables of economic growth in nigeria is prerequisite to identifying critical areas that need reforms. this is useful in order to direct the available resources to the most binding determining factors. previous efforts at planning and economic reforms such as the structural adjustment programme (sap) (1986) the national economic empowerment development strategy (needs) (2003-2007) and the united nations (un)sponsored national millennium goals for nigeria (nmgn) (2000-2015), appear not to have accelerated the pace of economic growth to the desired threshold. this is evidenced in the adverse inflationary trend, undulating foreign exchange rates, the fall and rise of gross domestic product, unfavourable balance of payments as well as increasing unemployment rates. one reason adduced for the failure of these policy measures is the relatively weak scientific effort at explaining the dynamics of economic growth in nigeria. as a result, policy making has relied upon macroeconomic forecasts that are not anchored on scientific models that track major economic indices (adenikinju et al., 2009). the application of economic models in explaining the dynamics of economic growth will enable economic decision makers to exercise their judgmental analyses in a much more structured and quantified manner and to develop a more adequate understanding of macroeconomic time line. this study attempted to do this by identifying and estimating a linear dynamic model based on pesaran et al. (2001) multivariate autoregressive distributed lag (ardl) approach. 2. theoretical framework and ardl specification the starting point of conventional economic growth theorization is the neoclassical model developed by solow (1956) and swan (1956) which involved a series of equations showing the relationship between labour-time, capital goods, output, and investment. this model was the first attempt to model long-run growth analytically. this model assumes that countries use their resources efficiently and that there are constant returns to scale, diminishing marginal productivity of capital, exogenously determined technical progress and substitutability between capital and labour. according to this view, the role of technological change is very important. the role of technological progress as a key driver of long-run economic growth proposed by solow-swan has been put to scrutiny by some economists, who accept constant and increasing returns to capital (romer, 1990; grossman and helpman, 1991). unsatisfied with solow-swan explanation, they worked to "endogenize" technology. some studies (azege, 2004; adebiyi, 2006; bello and adeniyi, 2010; ighodaro and oriakhi, 2010; omoke, 2010; adediran, 2012; alani and isola, 2012) have investigated the factors underlying economic growth. using differing conceptual and methodological viewpoints, these studies have placed emphasis on different sets of explanatory parameters and offered various insights to the sources of economic growth. a major issue with growth modeling is the determination of the variables to include in the analysis which has resulted to well over ninety (90) different variables have being proposed as potential growth determinants (petrakos et al., 2007; ristanović, 2010) each of which has some ex ante plausibility. this issue results because of the open-endedness of growth theories whereby the validity of one causal theory does not imply the falsity of another. to deal with the issue of open-endedness, some researchers such as levine and renelt (1992) have proposed ways to deal with the robustness of variables in growth regressions by identifying a set of potential control variables for inclusion. inclusion of a variable in the final choice requires that its associated coefficient proves to be robust with respect to the inclusion of other variables. a coefficient is robust if the sign of its ols stays constant across a set of regressions representing different possible combinations of other variables. the bulk of modern empirical work on growth has focused on growth regressions of the type pioneered by barro (1991). a generic form for growth regression is: i i i ig x z     (1) where ig is real per capita growth in economy i over a given period of time. xi represents variables whose presence is suggested by solow’s growth model: a constant, initial income and a set of country-specific savings and population growth controls. the solow’s model is often treated as a baseline from which to build up more elaborate growth models, hence these variables tend to be common across studies. zi, in contrast, consists of variables chosen to capture additional growth determinants that a researcher believes are important and so generally differ across analysis. starting from the key macroeconomic relation, with an aim to considering the impact that relevant economic variables have on economic growth (proxied by gdp), equation (1) is augmented by the influence of exchange rate (excrt), financial deepening (find), foreign direct investment (fdi), government expenditure (govexp), gross capital formation (gcf), human capital (hcap), inflation (infn), interest rate (intr), oil price (oilp), population growth (pop) and trade openness (topen).   2t t t t t t t t t t t t tgdp excrt fdi find govexp gcf hcap inf intr oilp topen pop u            the autoregressive distributed lag (ardl) model deals with single equation modelling and was introduced by pesaran et al. (2001). the autoregressive distributed lag (ardl) approach is a co-integration technique for determining long-run and short-run relationships among variables under study simultaneously. following pesaran et al. (2001) the ardl representation of equation (2) is formulated and specified as follows: http://en.wikipedia.org/wiki/efficiency_(economics) http://en.wikipedia.org/wiki/technological_change asian journal of economics and empirical research, 2016, 3(1): 84-93 86 0 1 2 3 4 5 1 0 0 0 0 6 7 8 9 10 0 0 0 0 0 n n n n n t i t i i t i i t i i t i i t i i i i i i n k n n n i t i i t i i t i i t i i t i i i i i i rgdp rgdp excrt fdi find govexp gcf hcap infn intrt oilp                                                                11 12 1 1 2 1 3 1 4 1 0 0 5 1 6 1 7 1 8 1 9 1 10 1 11 1 12 1 + n n i t i i t i t t t t i i t t t t t t t t t topen pop gdp exrt find fodi gexp gcf hcap inf intr oilp pop topen                                                  (3) where : rgdp real gross domestic product, exrt exchange rate, find financial deepeni   ng, fodi foreign direct investment, govexp government expenditure, gcf gross capital formation, hcap human capital, infn inflation, intrt interest rate,       0 oilp oil price, pop population, topen trade openness   denotes the first difference operator, is the drift component, and is the residual. t       the left-hand side is the economic growth proxied by the gross domestic product (gdp). the expressions with the summation sign 1 12( )  on the right-hand side represent the short-run dynamics of the model. the first until twelve expressions 1 12( )  on the right-hand side correspond to the long-run relationship of the model. therefore, apriori expectations of the coefficients are: 1 3 4 5 6 7 10 11 12 2 8 9, , , , , , , , 0., , , 0.             3. empirical literature on the determinants of economic growth economic growth has long been considered an important goal of economic policy. economic growth is most frequently expressed in terms of increase in gross domestic product (gdp), a measure of the economy’s total output of goods and services. the issue of economic growth has received considerable attention from scholars. despite this growth in research efforts, the choice of a modelling framework has remained inconclusive both at the theoretical and empirical levels in nigeria. a literature survey on the relationship between the selected variables and economic growth in nigeria has been outlined in this session (see table 1). table-1. determinants of economic growth: literature survey variable study sample period country estimation technique main result exchange rate anthony et al. (2012). 1975-2008 nigeria ols technique a long run relationship dada and oyeranti (2012). 1970-2009 nigeria simultaneous equations model no strong relationship shehu and youtang (2012). 1970-2009 nigeria significant effects financial deepening abur et al. (2013). 1990-2011 nigeria co-integration and causality positive impact azege (2004). nigeria moderate positive nzotta and okereke (2009). 1986-2007 nigeria 2sls no impact foreign direct investment akinlo (2004). 1970-2001 nigeria ecm not significant ayanwale (2007). 1970-2002 nigeria 2sls not significant bello and adeniyi (2010). 1970-2006 nigeria ardl no long run relationship egwakhide (2012). 1980-2009 nigeria vecm lag effect government expenditure abu and abdullahi (2010). nigeria disaggregated analysis mixed ighodaro and oriakhi (2010). 1960-2007 nigeria cointegration test and granger causality test negative impact okoro (2013). nigeria ols long run positive impact gross capital formation adekunle and aderemi (2012). nigeria negative relationship ejiogu et al. (2013). 1981-2011 nigeria ols technique no causality ugwuegbe and uruakpa (2013). nigeria ols technique positive and significant impact alani and isola (2012). nigeria growth account model significant relationship human capital development anaduaka and eigbiremolen (2014). 1999-2012 nigeria augmented solow model positive impact ismail et al. (2010). 1970-2008 nigeria vecm significant impact inflation aminu and anono (2012). 1970-2010 nigeria granger causality test gdp causes inflation bassey and onwioduokit (2011). 19702006 nigeria ols negative & insignificant asian journal of economics and empirical research, 2016, 3(1): 84-93 87 relationship omoke (2010). 1970-2005 nigeria granger causality test no co-integrating relationship interest rate chete (2006). nigeria long run relationship obamuyi (2009). 1970-2006 nigeria ecm significant effect obansa et al. (2013). 1970-2010 nigeria var technique positive relationship oil price odularu (2007). 1970-2005 nigeria ols no significant effect olomola and adejumo (2006). 1970-2003 nigeria regression analysis no significant effect oriakhi and iyoha (2013). 1970-2010 nigeria var positive impact population adediran (2012). 19812007 nigeria trend analysis positive impact onwuka (2005). 1980-2003 nigeria negative impact trade openness adebiyi (2006). nigeria var positive effect seetanah et al. (2012). 1990-2009 selected african countries panel vector autoregressive model (pvar) positive effect source: authors’ computations from the array of empirical literature review, we found that there is no general consensus between economic growth and each of the various macroeconomic determinants. we also found that there have been few dynamic models estimated on the basis of quarterly data in explaining economic growth dynamics in nigeria. 4. pre-estimation analysis before estimation, the graphs of the time series under study are plotted, descriptive statistics are displayed, unit root test for the variables are performed, and co-integration analysis is done on the variables. the figures below show the line graphs of the historical performance of the variables used in this study. figure-1. variables at levels source: authors’ computations figure 1 shows the multiple graphs of the series at their level form 0 40 80 120 160 200 1990 1995 2000 2005 2010 excrt -100,000 0 100,000 200,000 300,000 400,000 500,000 1990 1995 2000 2005 2010 fdi 2 4 6 8 10 1990 1995 2000 2005 2010 find 0 10,000 20,000 30,000 40,000 50,000 1990 1995 2000 2005 2010 gcf 0 400,000 800,000 1,200,000 1,600,000 1990 1995 2000 2005 2010 govexp 20 24 28 32 36 1990 1995 2000 2005 2010 hcap -20 0 20 40 60 80 100 1990 1995 2000 2005 2010 infn 8 12 16 20 24 28 32 36 1990 1995 2000 2005 2010 intrt 0 20 40 60 80 100 120 1990 1995 2000 2005 2010 oilp 20,000,000 30,000,000 40,000,000 50,000,000 60,000,000 1990 1995 2000 2005 2010 pop 50,000 100,000 150,000 200,000 250,000 300,000 1990 1995 2000 2005 2010 rgdp 0 5 10 15 20 1990 1995 2000 2005 2010 tropen asian journal of economics and empirical research, 2016, 3(1): 84-93 88 figure-2. logarithm of variables source: authors’ computations the graphs show that there is little evidence to suspect the presence of structural break or outlier in the twelve variables but the graphs of logarithmic series display a more stable variance than the changes in the original series. 4.1. descriptive statistics the descriptive statistics of the transformed variables were also conducted. table 2 below provides a full descriptive statistics of the macroeconomic variables used for the research work. table-2. descriptive statistics of variables in nigeria (1986-2013) returns mean median std. dev. skewness kurtosis jarque-bera observations excrt 76.87 98.10 60.62 -0.003 1.22 14.75 (0.00) 112 fdi 81516.29 28619.66 103537.6 1.47 4.56 51.93 (0.00) 112 find 4.83 4.28 2.19 0.90 2.49 16.35 (0.00) 112 hcap 27.77 26.62 4.22 0.46 1.70 11.83 (0.00) 112 infn 21.61 13.00 20.54 1.44 4.02 43.71 (0.00) 112 intrt 19.34 18.64 4.28 0.74 5.07 30.21 (0.00) 112 lgcf 9.22 9.18 0.79 -1.22 6.57 87.12 (0.00) 112 lggovexp 11.74 12.21 1.77 -0.45 1.96 8.85 (0.00) 112 lpop 17.26 17.24 0.23 0.52 2.60 5.82 (0.00) 112 lrgdp 11.63 11.52 0.38 0.56 2.36 7.69 (0.00) 112 oilp 39.13 23.15 33.02 1.20 2.99 26.84 (0.00) 112 tropen 2.62 0.62 5.22 2.24 6.27 144.12 (0.00) 112 source: authors’ computations the table shows the mean, standard deviation, skewness, kurtosis, and normality of the variables. the mean of the variables shows their average values from 1986 to 2013. the standard deviation shows that there is some dispersion in all the variables. lastly, skewness, kurtosis and jarque-bera (jb) statistics showed that all the variables are normally distributed at 1% level of significance. 0 40 80 120 160 200 1990 1995 2000 2005 2010 excrt -100,000 0 100,000 200,000 300,000 400,000 500,000 1990 1995 2000 2005 2010 fdi 2 4 6 8 10 1990 1995 2000 2005 2010 find 20 24 28 32 36 1990 1995 2000 2005 2010 hcap -20 0 20 40 60 80 100 1990 1995 2000 2005 2010 infn 8 12 16 20 24 28 32 36 1990 1995 2000 2005 2010 intrt 5 6 7 8 9 10 11 1990 1995 2000 2005 2010 lgcf 8 10 12 14 16 1990 1995 2000 2005 2010 lgovexp 16.8 17.0 17.2 17.4 17.6 17.8 18.0 1990 1995 2000 2005 2010 lpop 10.8 11.2 11.6 12.0 12.4 12.8 1990 1995 2000 2005 2010 lrgdp 0 20 40 60 80 100 120 1990 1995 2000 2005 2010 oilp 0 5 10 15 20 1990 1995 2000 2005 2010 tropen asian journal of economics and empirical research, 2016, 3(1): 84-93 89 the absence of outliers, especially real gross domestic product (lrgdp), indicates that we can model economic growth in nigeria without having extreme large or small values that deviate from the historical real gross domestic product (rgdp) series. the descriptive statistics show that the variables have some variations and using them in the models will require identifying their stationarity properties. 4.2. unit root tests for the variables the use of ardl models does not impose pre-testing of variables for unit root problems. however, unit root tests are conducted in this study to find out if there are mixtures in the order of integration of our variables. the order of integration of the time series was investigated by applying the augmented dickey and fuller (1979) test. the augmented dickey-fuller (adf) unit root test results for the time series variables are presented in table 3 below. table-3. unit root test results variable adf test statistic 95% critical adf value order of integration remark d(excrt) -9.49* -2.888 i (1) stationary d(fdi ) -11.04* -2.888 i (1) stationary d(find) -4.93* -2.888 i (1) stationary d(hcap) -3.51* -2.888 i (1) stationary d(infn) -7.14* -2.888 i (1) stationary d(intrt) -9.79* -2.888 i (1) stationary d(lgcf) -9.92* -2.888 i (1) stationary d(lgovexp) -6.73* -2.888 i (1) stationary d(lpop) -5.02* -2.888 i (1) stationary d(lrgdp) -31.16* -2.888 i (1) stationary d(oilp) -9.94* -2.888 i (1) stationary d(topen) -11.08* -2.888 i (1) stationary source: authors’ computations note: * = 1percent significance; ** = 5 percent significance. in the results shown in table 3 above, the adf test statistic for each of the variables are greater than the respective critical values. thus, we accept the hypothesis of unit roots in each of the time series. in our final evaluation all the variables became stationary after first difference. hence, they are integrated of order i (1). once all the series are non-stationary in the level, one can estimate an econometric model only if they are co-integrated. thus co-integration tests can be applied for all variables. 4.3. co-integration test the two popular co-integration tests in applied time series modelling are the engel and granger (1987) cointegration test and the johansen and juselius (1990) co-integration test. the engel & granger co-integration test is adopted in cases of single equation models while the johansen and juselius co-integration test is used for system equation models. the autoregressive distributed lag (ardl) model is based on single equation modelling (pesaran et al., 2001). this therefore implies that engel & granger co-integration method is used in the co-integration test. using the engel and granger two-stage technique, the co-integration test result for the research model is presented in table 4 below. table-4. engel & granger residual based co-integration test series adf 5% critical value order of integration remark residual -5.88 -2.888 i (0) co-integrated source: authors’ computations. the results in table 3 show that there is co-integration among economic growth proxied by real gross domestic product (rgdp), exchange rate (excrt), financial deepening (find), foreign direct investment (fdi), government expenditure (govexp), gross capital formation (gcf), human capital formation (hcap), inflation (inf), interest rate (intrt), oil price (oilp), trade openness (topen), and population growth (pop). since the adf test value for the residual is greater than the critical value, it is said to be stationary. thus, the time series are co-integrated, implying that a long-run stable relationship exists among the variables used in this study. this means that any shortrun deviation in their relationships would return to equilibrium in the long-run. 5. estimation, diagnostics and interpretation of ardl model the autoregressive distributed lag (ardl) is a technique that allows us to simultaneously estimate the short-run and long-run coefficients of our model. in order to examine the long-run and short-run relationships between economic growth and its focus variables, the parametized version of ardl model (pesaran et al., 2001) with lag four is estimated. the diagnostic tests like breusch-godfrey serial correlation lm test, the arch test for heteroscedasticity, jarque-bera test for normality of the residual term, are performed on the model. finally, the model is used to forecast inflation in nigeria over the sample period and the forecast performance evaluated. 5.1. the parsimonious autoregressive distributed lag (ardl) estimates following hendry (1995) general to specific modelling approach, exchange rate, foreign direct investment and price of crude oil were deleted from the parametized model because of their insignificant coefficients to arrive at the parsimonious model. the parsimonious model equation can be formed as: asian journal of economics and empirical research, 2016, 3(1): 84-93 90 1 4 4 1( ) 24.4 0.30 0.73 0.03 0.02 0.001 ( 4.5) (4.5) (10.6) ( 1.8) ( 2.0) t t t t t tlrgdp lrgdp lrgdp find hcap intrt                   2 3 4 -1 -2 ( 0.95) 0.0003 0.001 0.0009 0.0004 0.02 ( 0.17) ( 0.8) (0.5) t t t t tintrt intrt intrt lgcf lgcf              -1 -2 -3 1 (0.04) ( 1.44) 0.07 0.03 0.08 2.4 1.27 (1.5) (0.55) t t t t tgovexp govexp govexp lpop lpop            2 -1 -2 -3 4 (1.6) (2.8) (2.1) 0.32 0.03 0.02 0.02 0.01 (0.6) t t t t tlpop topen topen topen topen           07 -1 -1 1 -1 -1 -1 (4.2) (3.9) (3.8) (2.7) 0.62 1.50 0.0048 0.03 0.09 e t t t t t tlrgdp fdi infn intrt lgcf lgoexp       -1 -1 ( 5.1) (1.6) (-1.7) (2.7) (3.5) (-3.8) 1.87 0.03 (4.7) (4.3) t tlpop topen    4 5.2. estimated ardl (4, 0, 4, 4, 2, 3, 2, 4) diagnostics after the estimation of the empirical ardl (4, 0, 4, 4, 2, 3, 2, 4) model, there are a variety of diagnostic and stability tests which enhance the credibility of the model. the model was tested for autocorrelation (breusch-godfrey serial correlation lm test), for heteroskedasticity (white test), for normality (jarque-bera test), and for specification error/omitted variables (ramsey reset test). the results of the respective diagnostic test are presented in table 5. table-5. ardl (4, 0, 4, 4, 2, 3, 2, 4) diagnostic tests test f-statistic p-value serial correlation: breusch-godfrey serial correlation lm test 5.75 0.00 autoregressive conditional heteroskedasticity: white test. 0.31 0.59 normality: jarque-bera test. 441.24 0.00 specification error: ramsey reset test 16.64 0.00 source: authors’ computations from the results reported in table 5 the diagnostics indicate that the residuals are serially uncorrelated, homoskedastic, normally distributed based on breusch-godfrey serial correlation lm test, arch lm test, and jarque-bera test respectively. this means that the model is valid and can be used for policy recommendations without re-specification. the model is well specified on the basis of the ramsey reset test. the existence of a stable and predictable relationship is considered a necessary condition for the formulation of economic policy strategies. instability of a model could result from inadequate modelling of the short-run dynamics characterizing departures from the long-run relationship. hence, it is important to include the short-run dynamics for constancy of long-run parameters. in view of this we apply the cusum-of-squares (cusum-sq) test, which brown et al. (1975) developed. if the plot of cusum-sq statistic stays within 5% significance level, then the estimated coefficients are said to be stable. a graphical presentation of this test for our ardl model is provided in figure 3 below. figure-3. cumulative sum (cusum) of recursive residuals plot source: authors’ computations the result in figure 3 clearly indicates that the model has been relatively stable apart from between 1999 and 2004. we are therefore safe to conclude that ardl economic growth function is stable and economic growth can be used as a target variable. 5.3. forecast and forecast evaluation for ardl (4, 0, 4, 4, 2, 3, 2, 4) model in the next step, forecast of nigerian inflation series using ardl (4, 0, 4, 4, 2, 3, 2, 4) model is conducted. smaller values of the coefficients are preferred. the duration of the forecasts is from 1986q1 to 2013q4. the forecasts are plotted in figure 4. -0.2 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 cusum of squares 5% significance asian journal of economics and empirical research, 2016, 3(1): 84-93 91 figure-4. forecast of economic growth by ardl (4, 0, 4, 4, 2, 3, 2, 4) model source: authors’ computations in figure 4 some forecasting measurements such as root mean squared error (rmse), mean absolute error (mae), and theil inequality coefficient are shown. their coefficient values from ardl (4, 0, 4, 4, 2, 3, 2, 4) model are tabulated in table 6. the results show that the model is relevant for forecasting economic growth in. table-6. forecasting performance of ardl (4, 0, 4, 4, 2, 3, 2, 4) forecast performance coefficient rmse 0.08 mae 0.05 theil inequality coeff. 0.00 source: authors’ computations from table 6 we can conclude that ardl (4, 0, 4, 4, 2, 3, 2, 4) model performs very well. in other words, ardl (4, 0, 4, 4, 2, 3, 2, 4) model can be applied in explaining economic growth dynamics in nigeria over the sample period. 6. discussion of findings, conclusion and recommendations the study empirically examines the economic dynamics in nigeria using the autoregressive distributed lag (ardl) framework using quarterly time series data that cover the period from the first quarter of 1986 to the fourth quarter of 2013 (1986q1-2013q4). the data were sourced from the publications of the central bank of nigeria (cbn) and the national bureau of statistics (nbs). by considering recent empirical studies in the context of economic growth, an empirical multivariate autoregressive distributed-lag model is constructed which emphasizes the effect of eleven (11) variables on economic growth. the study estimates a parsimonious ardl model. diagnostic tests for serial correlation (breusch-godfrey serial correlation lm test), heteroskedasticity (arch test), normality (jarque-bera test), specification error (ramsey reset test), and cusum-of-squares test were performed on the estimated model. in-sample forecast of economic growth dynamics using the estimated ardl (4, 0, 4, 4, 2, 3, 2, 4) model was conducted. some forecasting measurements such as root mean squared error (rmse), mean absolute error (mae), mean absolute percent error (mape), and theil inequality coefficient (tic) were computed. the empirical results from the parsimonious ardl (4, 0, 4, 4, 2, 3, 2, 4) model is reported in table 7 below. table-7. the parsimonious ardl (4, 0, 4, 4, 2, 3, 2, 4) result dependent variable: d(lrgdp) short-run dynamics independent variable coefficient probability constant -24.37 (-4.47)* 0.0000 independent variables first difference log of real gross domestic product with one-period lag 0.30 (4.53)* 0.0000 first difference log of real gross domestic product with four-period lag 0.73 (10.59)* 0.0000 first difference of financial deepening -0.03 (-1.78)*** 0.0784 first difference log of real gross domestic product with four-period lag -0.02 (-2.02)** 0.0469 first difference log of population 2.4 (2.75)* 0.0073 first difference log of population with one-period lag 1.27 (2.06)** 0.0431 first difference of trade openness with one-period lag 0.03 (4.19)* 0.0001 first difference of trade openness with two-period lag 0.02 (3.93)* 0.0002 first difference of trade openness with three-period lag 0.02 (3.76)* 0.0003 first difference of trade openness with four-period lag 0.01 (2.75)* 0.0075 10.8 11.2 11.6 12.0 12.4 12.8 13.2 88 90 92 94 96 98 00 02 04 06 08 10 12 lrgdpf ± 2 s.e. forecast: lrgdpf actual: lrgdp forecast sample: 1986q1 2013q4 adjusted sample: 1987q2 2013q4 included observations: 107 root mean squared error 0.077462 mean absolute error 0.053713 mean abs. percent error 0.450060 theil inequality coefficient 0.003322 bias proportion 0.000206 variance proportion 0.012260 covariance proportion 0.987533 asian journal of economics and empirical research, 2016, 3(1): 84-93 92 long-run dynamics log of real gross domestic product -0.6 (-5.12)* 0.0000 inflation -0.0004 (-1.77)** 0.0804 interest rate 0.004 (2.68)* 0.0090 log of gross capital formation 0.03 (3.53)* 0.0007 log of government expenditure -0.09 (-3.77)* 0.0003 log of population 1.87 (4.66)* 0.0000 trade openness -0.03 (-4.26)* 0.0001 r-squared 0.933064 adjusted r-squared 0.909036 f-statistic 38.83198 prob(f-statistic) 0.000000 source: authors’ computations t-statistics are in parenthesis; *, and ** imply significant at 1% and 5% confidence level respectively. table 7 presents the results of short-run and long-run coefficients of the estimated parsimonious model. the coefficient of determination ( = 0.93) of the estimated model shows that about 93% of the variation in economic growth of nigeria is jointly explained and accounted for by the independent variables in the estimated ardl (4, 0, 4, 4, 2, 3, 2, 4) model. this when adjusted for degree of freedom based on the adjusted coefficient of determination (adjusted r-bar squared = 0.91) shows that the ardl (4, 0, 4, 4, 2, 3, 2, 4) model has about 91% explanatory power with respect to variations in economic growth of nigeria. this implies that the ardl model has a satisfactory goodness of fit. the f-test which is used to determine the overall statistical significance of a regression model shows that the overall regression is statistically significant at 1% level. this therefore means that the overall ardl (4, 0, 4, 4, 2, 3, 2, 4) model (that is, the short and long run coefficients of the entire explanatory variables as they relate to the dependent variable) is statistically different from zero. the findings were discussed with the research objectives. as shown in table 7 in the short run, the first quarter lag and fourth quarter lag of gross domestic product are statistically significant at 1% with positive impact. this means that the economic growth function follows the adaptive expectation theory. the current level of financial deepening has a negative impact and significant at 10%. this result is not consistent with extant literature (azege, 2004; nzotta and okereke, 2009; abur et al., 2013). the fourth quarter lag of human capital has a negative and significant impact at 5%. this result is not consistent with extant literature (ismail et al., 2010; anaduaka and eigbiremolen, 2014). the current level of population has a positive impact and significant at 1% and the first quarter lag of population has a positive impact and significant at 5%. these results are consistent with adediran (2012) but not consistent with onwuka (2005). the first quarter, second quarter, third quarter and the fourth quarter lags of trade openness have positive impacts and significant at 1%. these results are consistent with adebiyi (2006) and seetanah et al. (2012). in the long-run, expected gross domestic product has a negative impact on economic growth at 1%. this also means that the economic growth function follows the adaptive expectation theory. government expenditure has a negative impact on economic growth at 1%. this result is consistent with the results of ighodaro and oriakhi (2010) and but not consistent with the result of okoro (2013). inflation has a negative impact on economic growth at 10%. this result is consistent with the results of bassey and onwioduokit (2011) but not consistent with the result of omoke (2010). trade openness has a negative impact on economic growth at 1% population on economic growth at 1%. this is not consistent with the results of adebiyi (2006) and seetanah et al. (2012). interest rate has a positive impact on economic growth at 1%. this result is consistent with the results of chete (2006); obamuyi (2009) and obansa et al. (2013). gross capital formation has a positive impact on economic growth at 1%. this result is consistent with the result ugwuegbe and uruakpa (2013) but not consistent with the result of adekunle and aderemi (2012). population growth has a positive impact on economic growth at 1%. this result is consistent with the result adediran (2012) but not consistent with onwuka (2005). this study has empirically attempted to investigate the relationship between economic growth and the selected explanatory variables by employing the ardl modelling technique. the study found that ardl (4, 0, 4, 4, 2, 3, 2, 4) model can provide information both on the short-run and on the long-run behaviour of economic growth in nigeria. the empirical results showed that the main determining variables of economic growth in nigeria in the short-run and long-run are expected economic growth, population and trade openness. to achieve sustainable economic growth, it is recommended that government policies directed at 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journal of finance and accounting, 4(9): 36-42. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. http://dx.doi.org/10.2307/1884513 asian journal of economics and empirical research issn: 2409-2622 vol. 3, no. 1, 11-16, 2016 http://asianonlinejournals.com/index.php/ajeer 11 ceiling limit a potential instrument of urban change-a descriptive study on the series of amendments in the development of bangalore city hemalatha r1 1 faculty economics, institute of management, christ university, kanmanikae, kumbalgod, mysore road, bangalore, india abstract this paper will discuss on land acquisition based on urban land laws, whether the recognized agent have been effective in administering the ceiling limit. with erratic growth of the city, how has the administrative policy been efficient in managing the demand for land. whether the amendments are in series, whether the authority has allocated the right space for the right users. with this query the paper discusses the urban land acts in the city and series of changes is glimpse upon. keywords: land policy, urban ceiling act. contents 1. introduction ......................................................................................................................................................................... 12 2. methodology......................................................................................................................................................................... 12 4. analysis and discussion ....................................................................................................................................................... 12 5. discussion ............................................................................................................................................................................. 14 6. conclusion ............................................................................................................................................................................ 15 references ................................................................................................................................................................................ 15 citation | hemalatha r (2016). ceiling limit a potential instrument of urban change-a descriptive study on the series of amendments in the development of bangalore city. asian journal of economics and empirical research, 3(1): 11-16. doi: 10.20448/journal.501/2016.3.1/501.1.11.16 issn (e): issn (p): 2409-2622 2518-010x licensed: this work is licensed under a creative commons attribution 3.0 license funding: this study received no specific financial support competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained ethical: history: this study follows all ethical practices during writing. received: 9 november 2016/ revised: 23 december 2016/ accepted: 27 december 2015/ published: 30 december 2015 publisher: asian online journal publishing group http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.11.16 http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.11.16 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.11.16 http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.11.16 asian journal of economics and empirical research, 2016, 3(1): 11-16 12 1. introduction bangalore land policy and city principles lay emphasis on in urban laws. bangalore is the capital city of karnataka and land acquisition act formulated at all india level, also apply to karnataka state. hence, bangalore also follows the approach of land acquisition act of 1894. along with this urban land acquisition, certain development scheme oriented to urban land came into enforcement from october 1959. this came into force for granting of loan to state government in categorize and go for bulky; land acquisition. urban land ceiling and regulation act is one such guiding law with respect to concentration of urban property. the governmental response to this, is then to decide prices on a no-profit no-loss basis and differentiation between locations is administratively difficult-specially in the case where the buyer has little preference; in the location land allocated. the inefficiencies resulting from the process of the urban land ceilings are quite similar to the assumption is that the public authority knows well, the desirable allocation for land use. the aim of equity is also not served well by such a regulation. competence of huge level public participation in the process of land acquisition and allocation is a must. therefore, under such a situation bangalore city, in symbiotic relationship between urban planning, the urban land and housing market works more effectively, as the city moves on in a dynamic way. the aim of land policy is to curb price rise through the market. this can really be regarded as an exercise which pushes the supply curve. with the constant tendency of the supply curve of land pushed up, with the fast growth of urban population, the test of land policy is to push it down. 1.1. objectives  to understand the overall urban land acts in the city  to discuss the series of set of laws and improvements in regulations of urban land act 2. methodology study has used simple descriptive analysis referring to comprehensive reports and reviews collected from previous researchers. 3. problem in the case of rural land it is moderately easy to designate standard acres like imposition of land ceilings in relation with the productivity of land, but it is difficult to do so with urban land. with city getting prematurely large in area, there is high costs have to be incurred by citizens. customary policy is to provide the land at cost plus rates to the users who are regarded as deserving in some sense, whether they are public institutions, housing cooperatives or the poor and to auction the rest for the remaining users. once very large tracts of land are acquired there is no rational way in which prices at different locations can be decided. 4. analysis and discussion to begin with analysis in a sequential manner, the researcher has reviewed the laws and as well discussion is referred immediately. to begin with first act is act of 1894. 4.1. land acquisition act of 1894 1 this act can be defined as any land that includes benefit to arise out of land and things attached to the earth or permanently fastened. the powers entrusted with the land all those officers are district collector, town and country planning, deputy commissioner, corporation, state government and co-operative society are duly entrusted to implement the act and carry out the functions. there are eight broad classification under which each part in the classification explains the way any additional asset that is created out of natural resource namely land, especially for urban utilization the procedures and formalities has to be negotiated based on the different sections explained as follows. the first part is the preliminary section of the document reveals about the title and commencement of land. it is based on survey conducted and exploration of agricultural land and incase if, the owner is ready to make asset out of his property other than seasonal production if, he is willing to surrender. section two, explains about the acquisition of land and preliminary investigation. that is powers of officers and payment transactions like damage payment. along with this in the same section the law underlines about the publication of preliminary notice in order to hear the objections for the acquisition. here, the collector is in charge to take over the acquisition. thereafter, the act underlines for marking measurement and planning for public purpose. here announcement and notification is made in order to know the names and interests of persons. in the third part of the document the collector makes statement to court for award and compensation in case if, there is objection. here once the court analysis the cost and awards it re-determines the award and compensation exactly. the fourth part of the document, the act specifies for apportionment and dispute for apportionment is finalized. in part five of the document the act specifies that once dispute and apportionment is finalized then payment of compensation via court is passed. and in case if the individual does not alienate money is deposited in other cases and interest is remitted for the same. sixth part of the document emphasizes on the temporary occupation of land and solution for the same. the officer in charge the magistrate to enter and find the difference for compensation. part seven of the legal document specifies in case land is required for industrial purpose then the case could be well handled in consultation with the previous government enquire and publish for agreement. however, section 39 and 42 does not apply for government land industries. for others restricted based on transfer and purpose. part eight of the document act indicates on the service caution notice with the direction given to magistrate enforcement for surrender and code of rules to be modified. this act of land acquisition is followed in karnataka state and the land acquisition department and the town and country planning officials confirmed that act has been applied and the procedures are followed as underlined in 1government of india, (n.d). asian journal of economics and empirical research, 2016, 3(1): 11-16 13 the act. an element of economic cost is taken into account, usually to confer considerable savings is taken into account. procedures in publishing the preliminary and final notifications with karnataka amendments in land acquisition is similar, to the one that is done in neighboring states like andhra pradesh, karnataka and kerala that are published in daily newspapers. in order to make aware and understand to public the gist of notification is published in regional language as well in official gazette. the amended act was developed and published in the year 1991. amendment section 4 of the land acquisition act, 1894 that substituted was, land in any locality is needed for any public purpose or for a company, a notification stating the purposes, its survey number, if any, and its approximate area shall be published in the official gazette and in two daily newspapers circulating in that locality of which at least one shall be in the regional language. the deputy commissioner may issue a copy of such notification to the owner, the occupier of the land. the notification published in the official gazette shall contain clearly, the description of the land by its boundaries, 'convenient places' includes location of in a village and the panchayat office within whose jurisdiction the land lies. amendment section 6declaration states the district in which the land is situated, the purposes for which it is needed, its approximate area and survey number if, any and where a plan shall have been made of the land, place where such plan may be inspected. 4.2. discussion the above mentioned amendments were discussed with respect to publication and cause notice that is announced in local newspapers. this is the change introduced while rest of the parts and paras remains the same. the main reason for this is in order to have proof of evidence through public announcement and also to know the interest of the person hearing and as well to minimize the litigation problem. the gupta r g urban ceiling act (1976) 2 : this act is meant to prevent concentration of urban property in the hands of few persons to bring socialization of urban land and to discourage construction of luxurious buildings/houses. the act is applicable to all the urban land, irrespective of land use, viz-residential, industrial, commercial, institutional. amendment based on section 6,10,11 and 23 were made, like persons holding vacant land in excess of ceiling limit to file statement exempted, after excluding the two categories, except residential as shown in the approved plan of a city, excess land should vest with the government automatically, subject to the payment of compensation, without going into other formalities. changes in section 11 imposed a payment amount of rs.10/per sq.mt for vacant land gained. although this interest payment is too low, however the amount of compensation is related to the time when it is paid, invested land in excess with a normal rate of interest. section-23 made a provision for allotment of excess land to any person for any purpose related to business trade. 4.3. land acquisition and development scheme based on government orders for the grant of loans to state governments for bulk acquisition and development of land for house building and connected purpose came into enforcement on 20 th october, 1959.  financial assistance under the scheme will be provided to the state governments in the shape of loans with a rate of interest of 4% per annum, to be repayable in 10 annual equated installments, with a moratorium period of five years.  while making allotment, preference would be given to those who are eligible for aid and under the various housing and slum clearance schemes in the order of priority like, slum clearance scheme, subsidized industrial housing scheme, low income group housing scheme, middle income group housing scheme and rental housing scheme for state govt. employees.  decided plots intended for commercial or commercial-cum-residential purposes shall be sold by public auction or open tender except for the above five categories. other plots are disposed on the pattern as the state government may think (discretion) it is appropriate.  the state government shall, however, ensure that there is no loss to the project and the entire profit gained by the sale of land for commercial purposes and to persons in higher income groups, would be used for the purpose of reducing the price of land to be utilized for public housing for people falling in the group of lig and below.  other conditions that apply would be that, not more than one plot to an individual, the land would be given on leasehold basis, building should come up within a reasonable period, avoid speculation inland, prohibit misuse of the land, prevent the transfer or resale of plot/house to persons not eligible for the benefits of the scheme.  the government of india modified the scheme of large scale acquisition, development and disposal on 18.07.67.the scope of the scheme was enlarged to the following extent for flatted factories, to single-storied sheds for group industries, ware-houses, for bus terminals, parking sites for idle trucks, development of districts, community, local and convenient shopping centers, construction of special markets, as cycle market vegetable market.  the scope of “large scale acquisition, development and disposal of land” was further enhanced government order dated 18 th december 1969, for the implementation of the master plan and the zonal plans.  the ministry of works and housing further modified the scheme, its order dated 5 th february,1970,to the extent as given under, allotment of residential plots to persons belonging to low income groups and middle income groups with a decision on size of plots, income category and reservation of plots for members of parliament, councilors of metropolitan council, salaried classes, scheduled castes/tribes etc., registration of 2 gupta r g urban ceiling act (1976). asian journal of economics and empirical research, 2016, 3(1): 11-16 14 new co-operative house building societies on group housing pattern, allotment of land to owners and tenants of properties in areas which have been declared as clearance areas under the slum areas improvements & clearance act, realization of premium/price of plots in installments according to the stage of development. 4.4. discussion as underlined by law it can inferred that there has been violation with respect to holdings of land and as well in the number of owners of plots in a family. there is no doubt the city has been following the above mentioned norms modified in the year 1969 and as well in 1970. however in the year 1976 when the city was administered and planned by city improvement trust board, the urban ceiling act was imbibed and as well there has been fair distribution of land to all those demanded for various activities. but however, subsequently this ceiling act of 1976 has been amended and is not followed for the past twelve years. the reason is many private players marketers have come into, utilization of land with limited space more of vertical rise is of high demand .and relaxation in city rules of raising many floors in order to cater to the need of demanding population. gupta (1992) 3 based on reference of india „s urban population of about 160 millions, total population, lives on 11.2 million acres (4.53 million hectares) of urban land, representing a meager 1.5 percent of the country‟s total land. nearly a fourth of the urban population is estimated to be living in substandard conditions. while details of land supply mechanisms constituting this section of the population are not forthcoming, a large percentage is made available through squatting and illegal land subdivisions, particularly do in metropolitan cities which account for the third of the urban population. he has taken references and highlighted the recommendations made by various five year plans and (culp) committee on urban land policy. various plans suggested taxation measures to make land hoarding unprofitable. thereby, to curb speculations, public intervention in acquisition and development for housing and other purposes as a solution to generally rising land prices. as a means of making available adequate land, at the right time and at right location. and finally stated that balanced development within and between urban areas as the broad objective of urban planning and land policy. it is noted that rising land prices were a result of speculation and of the generally increasing demand for urban land in response to pressures of population and economic growth. from the empirical study conducted the researcher, has found that it is obvious in the city of bangalore, with limited supply and concentration of too many activities within limited geographical location has pushed up the price and has ended with limited land supply. was recommendation of ulp been able to solve on issues on land policy that met during 1965.! querry moves ahead to find the suggestion about the act. 4.5. recommendations of committee on urban land policy, 1965 the culp emphasized the need for a long range urban land policy and noted that the “blueprint of land policy must cover a series of coordinated legal, administrative, financial and planning measures” it reaffirmed the social objectives of a land policy as spelt out by the (tcpo) town and country planning of 1961 as: i) to achieve an optimum social use of land, ii) to make available land in adequate quantity at the right time and at reasonable prices for public agencies and individuals iii) to encourage cooperative community efforts and bonafide individual builders iv) to prevent concentration of land ownership in a few hands and safeguards the interests of weaker sections. it went on to distinguish urban land into five categories, developed urban land within city limits, undeveloped urban land within city limits, land within urban limits, land beyond urban limits and land whose use is frozen for green belt or agricultural purposes. one of the first central schemes incorporated was the integrated urban development programme (iudp) for cities and areas of national importance operating during 1974-79. loans were given in the form of seed capital for land acquisition, development and disposal. the scheme was implemented with varying degrees of success but the land acquired was not substantial due to land acquisition delays and organizational problems and much of the allotted land remained vacant kirtee (1982) 4 in his critical analysis “in defense of the urban ceiling act “believes that the urban land ceiling act has been a major disappointment and that the objectives it was meant to serve have not been realized. despite all its imperfections and present-day failures the act has the potential to correct many imbalances, irrationalities and contradictions in the social and economic systems which, among other things shape grwoing cities. during the past fifty years when this recommendation was enacted the urban land ceiling act, despite its immediate failure and limitations is farsighted. significant social legislation when implemented vigorously and imaginatively after necessary modifications definitely changes will have the potential to become a major instrument of urban change. 5. discussion it is clear that urban ceiling act has been able to do justice in its implementation and in its allocation distribution based on land act of 1894, but with respect to ceiling, the city has not been able to follow the rules. it is all because of high density and existence of dual market for the natural resource for land. it is also observed that with high migration and floating population control has become erratic. non-availability of communication centres due to high spiraling speculation. there is larger scope for open market negotiation of transaction for land from outside boundaries. regulations formulated on site by bangalore development authority comprehensive development plan (1995) 5 restrictions and rules of the development authority in the allotment of site rules 1984 of bangalore development authority (bda) has been amended and the government of karnataka has brought back the leasecum-sale method. though lease-cum-sale method was in trend for many years, the relevant rule (rule no 7) was 3 gupta, r.c. (1992). 4kirtee, s. (1982). 5bangalore development authority comprehensive development plan, (1995). asian journal of economics and empirical research, 2016, 3(1): 11-16 15 omitted in the notification dated 23-10-2000. but, the state government in notification dated 27-4-2005 has reintroduced the rule no 7. for administrative justice administration ensures through lease-cum-sale method the allottees do not misuse the site and sell it to make quick money. in this case the allottee will not get absolute ownership of the site within short duration. he will enter into lease-cum-sale agreement with the bda and for certain period, he will only be a lessee of the bda and does not have the authority to sell the property. further, he has to construct a house as per the approved plan in the allotted site within specified period. only after the lapse of lease period and on fulfilling the conditions like construction of house, bda will execute absolute sale deed in favor of allottee. however, the user is entitled to avail housing, was omitted for the purpose of construction of house building. as stated earlier, this method was omitted from 23-10-2000 and bda was executing the absolute sale deed to the allottee immediately after the full payment made. this has reduced the work load procedure of administrative office and the allotted has an asset to fall back in case of necessity and emergency. this was due to acquisition of land and difficulties in legal procedures that caused inconvenience and therefore to simplify the procedures changes were made in a discretionary manner. misuse is abolition of lease-cum-sale which was done to help the public as land was misused. though, the site allotment rules prohibits anyone who owns a site or a house from applying for allotment, in case if, already possessed, many landlords, middlemen, and real estate agents started applying for sites through proxy candidates by suppressing the facts. there are many people, slum dwellers who sign the own sign as applications for some money. as soon as the allotment was done, the sites were sold at the prevailing market price making huge profits. this is in way contributed to price spiral apart from defeating the very purpose and social cause. reintroduction is to avoid this blatant misuse of development, agent sites, lease-cum-sale was re-introduced by government notification dated 27-4-2005. the reintroduced rule (rule 7) reads as follows: rule no. 7 indicates the site allotted under the rules shall be deemed to have been leased to the allotted on lease, unless the lease is determined or sites is conveyed in the name of the allotted in accordance with these rules. during the period of lease, the allotted shall pay to the authority before commencement of each year, rent at the rate of rs 5 per annum, where the area of the sites does not exceed two hundred square meters, rs 10 per annum where the area of the site exceeds two hundred square meters, but does not exceed five hundred square meters, and rs 20 per annum, where the area of the site exceeds five hundred square meters. the procedure is as follows: after the payment of the value of site, the authority invites the allot tee to execute lease-cum-sale deed in the prescribed from within 60 days which will be registered in the register office. the allot tee will be put in possession of the site. the lease-cumsale agreement contains various conditions like restriction or alienation of property, time-limit to construct house, ground rent payable. the allot tee shall construct a building as per the plane approved by the authority within a period of five year from date of agreement. the authority may extend this period at the request of the allot tee. if the allot tee fails to complete the construction of house within five years of permitted period, the lease will be cancelled. the authority forfeits 12.5 per cent of the value of the site paid and refunds the balance amount to the allot tee. after the expiry of 10 years of agreed lease period, the authority calls upon allot tee to get the absolute sale deed executed and registered and provide that the lease has not been cancelled earlier. though absolute legal title has not passed to the allot tee during the lease period, he shall pay taxes, fees, cess payable on the site or building. restrictions is imposed on the allotted, site cannot be sold within a period of 10 years from the date of possession. however, the site may be mortgaged in favor of central/state government, financial, institutions to secure loan for construction of building. if the site is sold within a lease period of 10 years, the authority after due notice may cancel the allotment, resume the site and forfeit the amount paid. surrender of site is if the allottee opts to surrender the site during the lease period for reasons beyond his control like insolvency etc., the authority with the previous government, will compensate the allottees as follows-in case of surrender of vacant site without building, the authority shall pay value of site paid by the allottee together with interest at the rate of 12 per cent per annum. if the building is constructed on the site, the authority shall permit the allottee to sell the property provided he pays interest at 12 per cent per annum to the authority on the value of the site paid. complications of title of course, the re-introduction of lease-cum-sale for administrative agency allotted sites is a right thing for the genuine end users. however, looking at the modus operandi of the allottees, they will try to sell the properties by way of gpa / agreement / affidavits / undertaking etc., this has lead to complication of title and delay in administrative process. 6. conclusion urban land laws have been followed with respect to land acquisition but ceiling on land has been withdrawn and administration have not been able to manage the domination of demand and as well in determining the limit. the city has become sporadic that it has started growing in its way with changes made in the administration policy during 2000. more domination with respect to private realtors has forced to enter into city, where the city has reached the saturation of further development and as tier i city among all major metros the utilization for various purposes has exhausted and the need for moving away to tier ii and tier iii is the target of the city. hence many reputed private realtors have started to enter in order to make the city to look wider in its perspective and as well continue the process of growth in a different manner. references bangalore development authority comprehensive development plan, 1995. decade report published by adminstrative town and country planning, volume i & ii,1989 and volume i& ii 1985, volume i & ii 1995, decade report of 1989 and 1985 are very much overlapping,therefore you can consider 1989 alone. government of india, n.d. government of india land acquisition act of 1894 modified and amended as on 1985, 1994 and 2000, ministry of law and justice: 1-34. asian journal of economics and empirical research, 2016, 3(1): 11-16 16 gupta r g urban ceiling act, 1976. director delhi development authority, times research foundation on land in metropolitan development, 1982: 31-38. (all trf are seminars and discussions at various city level). gupta, r.c., 1992. land assembly on indian metropolis, professor and head of department of regional planning school of planning architecture. new delhi: uppal publishing house. pp: 3-26. kirtee, s., 1982. indefence of the urban ceiling act. a seminar organized by the urban studies centre, the times research foundation. pp: 115. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. asian journal of economics and empirical research issn: 2409-2622 vol. 1, no. 2, 29-31, 2014 http://asianonlinejournals.com/index.php/ajeer 29 human resource planning management and their improving method ramezan jahanian department of education, college of psychology, karaj branch, islamic azad university, alborz province, iran maryam modaresi m.a. graduated in educational management from, karaj branch, islamic azad university, alborz province, iran abstract this work is licensed under a creative commons attribution 3.0 license asian online journal publishing group 1. defining human resource planning the first and the most simple definition that have in the human resource planning, belong to mlykoj and mahooti that said (human resource planning has predicated supply and demand of future staff in organization systematically). (jahanian, 2009) human resource planning considered a effort that predicting the future of firm as an environmental demands and provide using condition of human resource for performing and meeting its need. human resource planning is process that put one organization in suitable place by having number and correct kind of human resource and could do it in a effective method and reach to the total purpose of organization. (jahanian, 2009) 2. the importance of human resource planning 1continuous planning has facilitated and warranted leadership, if managers have left organization without planning, disorders has not been created in daily operation or this disorder has been decreased at least. 2providing staff and series of their skill have been facilitated strategic planning in future. 3 facilitating studying job demanding and staff abilities, changes understanding, job resource tendency in market. 4by defining staff demand in reaction strategic planning, facilitating resource and fund planning. 5 organization facilitating staff development by defining skills for obtaining leadership purpose and warranting job successful in organization. (jahanian, 2009) 3. the stages of human resource planning stage 1 : studying future purpose of organization stage 2 : studying quantity and quality condition of human resource in organization stage 3 : predicting human resource demands ( estimating the value of human resource ) stage 4 : predicting human resource demanding ( estimating the value of human resource from inside and outside resource) management should have suitable planning for all resource in his authority, nevertheless will have problem in estimating need and directing resource. in fact, planning is process that organization has combined all activities and trying for his purpose and his purpose is obtaining to organization result. therefore planning is framework of management element. according to the role and importance of human resource could have effective role in developing organization. planning human resource help to organization that ensure from the position of human resource, adding forces, lacking human resource in different parts or in balancing them and be sure that suitable staff in suitable job have in suitable time . planning management of human resource will help to organization that estimate organization changing relate to his activities to least costs. human resource planning makes us confident about the existence of unity and cohesion in personal activities. according this, giving a complete ,efficient model that could cover all human resource planning in a good way, is an unpreventable necessity. keywords: planning, human resource, improving, method, supply, demand, organization. http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2014, 1(2):29-31 30 stage 5: comparing the offers and the demands of human resources and defining organizational personal policies on that base. (lajavardi, 2004). management of human resource planning 1attracting planning of human resource (finding staff, selecting and ….) 2supportive planning (salary, beneficent, training and ….) 3 personnel information planning ( estimating , inventory and …) (mohamadi et al., 2005) 4. the process of human resource planning a) studying and predicting human need of organization b) studying and estimating existing human resource in organization c) comparing need and human resource inventory. a) studying and predicting human demand of organization demanding to human resource is variable in each organization and if organization strategies are developing, expanding, keeping existence position, without hesitate, it will be effective in quantity of human resource. for predicting human resource in organization, there are quantity and quality methods. from quality method, we could point to expert judicial and from quantity method; we could point to analyzing method and stimulation. the method of demand predicting has been divided into two methods: obsolete and possible method. in obsolete method, dropping and human resource attracting have been calculating in a certain time. from this method, human recourse has been considered as a demand human resource from inside. possible method has been predicting changes in terms of frequency of possible occurrence. possible method has been used in big organization and geography distributing and don’t have usage in relative small organization. b) studying and estimating existing condition of organization studying and estimating existing condition of organization has been done by helping two basic tools. experience and skill and staff training are non management and management inventory consist of information about managers and supervisor of organization and organization skill have been estimating with them. c) comparing existing position and d organization demands 1) resource balance: it means that resource inventory with need values of future have been equaled. here, action such as development and training, skills improving and increasing the ability of human resource have been done in balance keeping. 2) lack of resource: it means that resource is lower than need value in organization. in this position, action such as finding staff from internal and outside resource have been done. 3) resource adding: it means that resource is more than need value in future that in this case, it is done for decreasing balance and action resource such as sudden retirement, repaying, decreasing working hours. (mohamadi et al., 2005) 5. purpose and advantage of human resource planning 1decreasing human resource cost by using lack of predicting or increasing human resource and correcting the position of non balance of combination resource. 2requirement for training planning for staff. 3developing individual planning process. 4providing necessary tool for effective estimating of human resource according to purpose and strategy organization. 5defining policy, selecting and human resource training for purpose and organization planning. 6adapting personnel different activities or purpose and organization strategies .(lajvardi, 2004) the causes of none having planning for human resource: 1lack of experts for human resource planning 2not having strategic vision in organization 3low attention to human resource to financial resource obstacle of human resource planning performing: 1pessimistic toward planning and empowering operation unit ( not having linking between theory discussion and performing unit operation ) 2not having relationship between different activities in planning process 3opposite and conflict in human resource 4using from planning unsuitable technique 5 predicting future of human resource on the base of past policy without attention to need and future necessity 6not having attention to quality aspect ( developing special skill and individual potential operation ) 7looking to human resource planning as short time performing subject. character of human resource information systems and planning human resource: a) on time ; updating information and is providing for users on time b) correct and exact ; system consist of correct and exact information c) relating and need; system information should be related and also is needed for organization manager. d) fast; system should be in a way that all information for each kind of decision is fast in person hand. asian journal of economics and empirical research, 2014, 1(2):29-31 31 improving ways for human resource planning: 1. making standard human resource 2. define law for keeping human resource 3. adapting staff fund with organization financial policy 4. improving quality 5. correcting paying region of human resource salaries 6. thoughtful and creative human resource training 7. improving and organizing human resource structure 8. creating opportunities equal to training 9. developing management and developing human resource 10. planning training planning that is need for organization 11. predicting the supply value of human resource 12. judicial and right supporting from staff 6. conclusion planning organization human resource have been influenced such as increasing world completion , sudden changes, need to quality and service after selling . after many years of experience, world come to conclusion that if organization want to have more ability in economic and his working affair and not to put back in his competition, he should encounter with expert human resource, creative and high motivation. human resource form real wealth of one organization. one organization is series of combination of high culture humans, thought and common purpose that is put by group working in flexible regime of organization and his knowledge with increasing development of organization in management authority. therefore each person will have properties toward organization and his duty. references jahanian, r., 2009. improving method of tehran training and education, knowledge in training science, lesson planing. islamic azad university of khorasgan (esfehan), 24(6): 61-84 lajavardi, s.j., 2004. studying and analyzing human resource in bank system in countries. economic project, 14(26): 207-212. lajvardi, s.j., 2004. assessment and analysis of human resource planning of iran bank system. economical research magazine, 6(14): 145163. mohamadi, jeyran, azar, adel and m.h. zarei, 2005. designing human resource model for training hospital that is studied: ahvaz training hospital, scienceproject of behavior project, shahed university, 11(12): 87-92. views and opinions expressed in this article are the views and opinions of the authors, asian journal of economics and empirical research shall not be responsible or answerable for any loss, damage or liability etc. caused in relation to/arising out of the use of the content. asian journal of economics and empirical research vol. 4, no. 2, 49-60, 2017 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2017.42.49.60 49 determinants of technical inefficiency of saccos in kenya: a net operating cash flows output slack analysis leonard rang’ala lari1  philip mulama nyangweso2 lucy jepchoge rono3 ( corresponding author) 1,2,3school of business and economics, moi university-kenya abstract purpose: the purpose of this study was to evaluate the determinants of technical inefficiency of saccos in kenya. methodology: the explanatory research design was utilized. the financial statements data was collected from a census of 46 audited deposit taking saccos and methods used included estimation of technical inefficiency by employing a non-parametric dea method while the second step concerned determination of inefficiency using parametric sfa. the log truncated panel data was used for a period of 8 years (2007-2014). result: all the predictors jointly influence inefficiency and are significant except for prime regressors given nocf slack as hypothesized in agency, efficiency and intermediation theories. nocf slack regression reflects lack of managerial influence as indicated by gamma (1.13e-23) while dea result of all saccos indicated 0.976 mean efficiency. contribution to policy and practice: the npta, ca and fi predictors had significant influence on pure technical inefficiency, thus apt for decision making. keywords: saccos in kenya, technical inefficiency, net operating cash flows (nocf) output slack. citation | leonard rang’ala lari; philip mulama nyangweso; lucy jepchoge rono (2017). determinants of technical inefficiency of saccos in kenya: a net operating cash flows output slack analysis. asian journal of economics and empirical research, 4(2): 49-60. history: received: 25 august 2017 revised: 15 september 2017 accepted: 21 september 2017 published: 27 september 2017 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 50 2. literature review and background of the study ...................................................................................................................... 50 3. research methodology ................................................................................................................................................................... 52 4. spearman correlation and other key findings.......................................................................................................................... 55 5. conclusion ......................................................................................................................................................................................... 56 references .............................................................................................................................................................................................. 57 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://orcid.org/orcid-search/quick-search?searchquery=leonard rang’ala lari https://orcid.org/orcid-search/quick-search?searchquery=philip mulama nyangweso https://orcid.org/orcid-search/quick-search?searchquery=lucy jepchoge rono https://orcid.org/orcid-search/quick-search?searchquery=leonard rang’ala lari https://orcid.org/orcid-search/quick-search?searchquery=philip mulama nyangweso https://orcid.org/orcid-search/quick-search?searchquery=lucy jepchoge rono https://orcid.org/orcid-search/quick-search?searchquery=leonard rang’ala lari https://orcid.org/orcid-search/quick-search?searchquery=philip mulama nyangweso https://orcid.org/orcid-search/quick-search?searchquery=lucy jepchoge rono https://orcid.org/orcid-search/quick-search?searchquery=leonard rang’ala lari https://orcid.org/orcid-search/quick-search?searchquery=philip mulama nyangweso https://orcid.org/orcid-search/quick-search?searchquery=lucy jepchoge rono asian journal of economics and empirical research, 2017, 4(2): 49-60 50 1. introduction the efficiency of an organization is an overriding aspect in finance. a well-managed savings and credit cooperative society is expected to increase the members’ interest. since independence, the kenya savings and credit co-operatives societies’(or saccos) sub-sector has undergone a series of liberalizations and prudential regulation aimed at improving its relative act or efficiency (wanyama, 2009).this study seeks to find out the determinants of inefficiency given the net operating cash flow slack (inefficiency) as a dependent variable over a period of two eras using both data envelopment analysis(a linear programming approach) and stochastic frontier analysis methods. the co-operatives development regulation era in kenya involved enactment of prudential regulation of saccos through the saccos act, 2008 which legally commenced in september 2009 and gave birth to sacco societies regulatory authority or sasra with effect from october 2009 (ssa, 2008; mocdm, 2013). basically the preregulation era covered period 2010 and before. kenya saccos have high urge for shifting from savings and credit co-operatives to credit and savings cooperatives that is, they actually bend towards sourcing for external funds than relying on equity funding. capital inadequacy and insolvency risks are key factors influencing performance of deposit taking saccos (or fosa) in kenya (kivuvo and olweny, 2014). this behavior scores them well as candidates of capital rationing. the shifting appetite to credit and savings saccos come at an expensive interest charges from the lenders as the borrowed funds or credit facilities are meant for onward affordable lending to saccos’ members. according to sasra (2011) saccos in kenya total borrowings from banks in 2010 was estimated at kshs.15 billion compared to kshs. 5.6 billion in 2011. thus the sector is key financial channel in fostering access to credit. on the international front, the regulatory authorities and standards setting committees have been able to come up with acceptable information on the financial institutions’ efficient operations and risk management criteria (cooper et al., 2007). world council of credit unions is one similar body that offers related services. caprio et al. (2003) in their study in 44 countries, postulate that insignificant influence is experienced by banks due to regulation and supervision. 2. literature review and background of the study brealey and myers (1981) postulated that rationing of a firm’s capital in more than one period call for application of linear programming or net present value methods as a capital budgeting decision making techniques instead of other methods such as marginal rate of return which depict prominence of linear programming in the field of finance theory. this study adopted dea approach which is linear programming oriented based on a capital rationing argument, since the saccos’ external loan capital demand tend to fluctuate periodically (sasra, 2011). efficiency is a subset of performance (ozcan, 2008). an efficient organization identification assist in identifying the managers’ rewards and the kind of good practices employed or which can be copied by inefficient firms in the industry. adeptness also aid in identifying profitable areas of organizations to invest their assets (healy, 1988). an efficient measurement system is able to identify optimal resources allocation besides setting of targets. the inefficiency or efficiency measurement helps commercial and non-commercial entities in identification of best practice, identification of poor practice, in setting targets, in resource allocation and in monitoring efficiency changes periodically (beasley, 1996). however, barus et al. (2017) argues that financial performance of saccos in kenya is not significantly affected by management efficiency. studies have indicated that co-operative banks future in the long run is unknown as they will completely transform to banks, merge or just die, zvi (1998). this chain of events is likely to impact negatively on the steady or focused efficiency growth of saccos. a question that then arises is: do co-operatives transformations to banks or fosa exist for long term benefit of members? zvi (1998) states that credit co-operatives around the world do not exist to allocate credit to their members as only 30% 70% is allocated as loans and the rest is either in cash and cash equivalent. a study by johnson and nino-zarazua (2008) has shown that in kenya 12.8% of the population save with saccos and 4.1% borrow from them. in addition, saccos in kenya are principally either based on common bonds of farming or employment (johnson and nino-zarazua, 2008). it is also worth noting that in africa south of the sahara, kenyan saccos movement has the second largest number of saccos following ethiopia (woccu, 2009). for instance, in march 2013, the number of saccos in tanzania were 5,559 (magali, 2014) while in kenya the total number of registered saccos were estimated at about 7,500 in august 2013 (sasra, 2013). the efficiency of co-operatives during the era of economic liberalization (1980s up to 2004) was initially absolutely poor due to the government modus operandi (wanyama, 2009). however since the start of the second era period; co-operative development in the country is still not well understood. this is because there are a few studies in the area of co-operatives since 1990 (evans, 2002; petrie, 2002; emerson and wiren, 2005). further, these studies are basically based on absolute performance measures (such as increase in loans, increase in membership levels of delinquent loans, and growth in number of co-operatives) and interview responses from the stakeholders. the situation is slowly changing as other research are now coming up especially based on ratios, efficiency and multiple regression such as (tesfamariam et al., 2013; kivuvo and olweny, 2014; mirie, 2014; marwa and aziakpono, 2015). during the pre-regulation era in 2009, the world experienced a financial crisis that affected the efficiency of financial institutions over the period and this was amenably reflected in the levels of macro-economic indicators including gdp. in 2009, for instance the global economy contracted by negative 0.6% (imf, 2012) while in 2011 the country also experienced a down turn in the economy due to high fluctuation of the kenya shilling against the hard foreign currencies (sasra, 2011). in addition, the gdp percent change rate fluctuated to an average of 5.13% in 2012 before rising again to a mean of 5.62% in 2013 (imf, 2014). the down turn in an economy impairs the efficiency of commercial enterprises than it does to co-operatives. co-operatives have shown their ability to provide services to their members even during the financial crisis. however, in developing countries of africa the co-operatives’ resilience to financial crisis is not strong and this coupled with the internal political impact or mismanagement within co-operatives means, the crisis gets worse (wanyama et al., 2009). this then raises a corporate governance or integrity problem in co-operative movement asian journal of economics and empirical research, 2017, 4(2): 49-60 51 that was catered for, to some extent, in this study through the introduction of the number of women on the board predictor variable. according to prior studies, there is a conflicting result on effect of gender diversity on the boards. adams and ferreira (2008) argue that on average the presence of both gender on the boards in companies having no takeover prevention mechanism do experience inefficiency. on the contrary, higgs (2003) postulate that performance improvement result from gender diversity in the board room while gompers et al. (2003) conclude that gender is a good performance contributor in organizations with non-strong shareholder rights. the latest liberalization of co-operatives movement is in the area of devolution of co-operatives regulation from the national level to county levels as enshrined in the constitution of kenya 2010 (cok, 2010; mocdm, 2013). these changes are aimed at enhancing efficiency. however, despite the existence of the prudential regulations, the deposit taking saccos have continued to reveal mixed levels of management practices or inefficiency (sasra, 2013). in addition, a study by chavez (2006) indicates that the kenya sacco sub-sector reflects a seriously weak financial performance position that is pervasive. 2.1. theoretical review this research was guided by the theory of agency and the financial institutions efficiency measurement theories; more precisely, the intermediation theory. other discussed models relevant to this research are the financial institutions’ prudential monitoring standards. however, the regulator of deposit taking saccos in kenya advocates for the adoption of camels prudential reporting standards (kivuvo and olweny, 2014). further, this study utilized the bcc analysis based on inefficient results of dea as dependent variables (banker et al., 1984) which were used to identify the variables that best measure the pure technical inefficiency of the saccos by running a truncated-normal regression given a census of 46 deposit taking saccos that had by then attained the fosa operation requirements. 2.2. statement of the problem the co-operatives sector in kenya has gone through a historical development process known for inefficiency. the inefficiency was more prevalent during the liberalization period (wanyama, 2009). as a result, the need for regulation and inefficiency understanding becomes necessary to ensure the stability of saccos’ sub-sector and guaranteed efficiency. this study is also an addition to ongoing inefficiency of saccos’ research in the kenyan context. a few past researchers in kenya have studied saccos without utilizing sfa and identifying benchmark saccos , they based on performance: (olando et al., 2012; karanja, 2013; njagi et al., 2013; nyambere, 2013; okibo and karagu, 2014; barus et al., 2017). these studies ignored the aspect of efficiency measurement yet saccos unlike other commercial enterprises exist for purposes of service delivery to members and therefore are not highly profit oriented. a more recent study by mirie (2014) indicates saccos’ efficiency in kenya being within a range of 0.56 and 1.0. however, it failed to consider other specific variables of efficiency measurement such as the economic indicators, gender diversity on saccos’ boards, and net profit to total assets ratio beside the extent of management influence on saccos’ inefficiency. marwa and aziakpono (2015) studied technical and scale efficiency of saccos in tanzania using dea and concluded that on average majority of saccos scored 0.48 pure technical inefficiency and at least 75% of saccos exhibited an increasing returns to scale. a study by kipesha (2012) arrived at an efficiency of between 0.145 and 0.69 for the tanzanian micro finance bodies. similar researches in banking industry in subsaharan africa opine that technical efficiency falls between 0.6 and 0.9 (moffat, 2008; kamau, 2011). according to tesfamariam et al. (2013) efficiency of rural saccos in ethiopia indicated that efficiency is affected by both location and size of saccos. they also opine that on average efficiency ranged between 0.213 and 0.259 for small saccos, while larger saccos recorded higher efficiency compared to smaller ones. the study like magali (2014) in kenya also suggested future study in the area of saccos’ technical efficiency using the sfa. magali (2014) concludes that there is no prior studies on saccos in east africa that have assessed the influence of regulation on saccos performance while at the same time considering the impact of rural and urban areas’ location of saccos on performance. he further argues that scholars should extend to econometrics to expand saccos modeling. a few studies such as marwa and aziakpono (2015) in tanzania, and tesfamariam et al. (2013) in ethiopia, have researched on the efficiency of saccos in the african continent. considering the above mentioned gap of prior studies, this study examined whether saccos were more inefficient during regulation era than pre-regulation era. the stars saccos were also identified. essentially this study assessed the determinants of inefficiency of fosa. specifically the pure technical efficiency (a cost-efficiency measure) model was utilized (coelli et al., 1997). the creation of sasra as a regulator of saccos has been necessitated by the challenges of a liberalized economy. the question that arises then is: to what extent has the saccos’ market become efficient? these facts then point to the need to measure and determine the kenyan saccos’ pure technical inefficiency or efficiency. this study sets deliberate standards on how saccos in kenya can be monitored and peers emulated to ensure efficiency in their operations. 2.3. the general objective the general objective of this study is to establish the determinants of technical inefficiency of deposit taking saccos in kenya, given a net operating cash flow slack (an output inefficiency) as a dependent variable. 2.4. the specific objectives the specific objectives of this study are as follows: 1. measure the extent of managerial inefficiency over the pre-regulation and regulation eras. 2. establish the effect of macro-economic variables on the saccos’ net operating cash flows output inefficiency. asian journal of economics and empirical research, 2017, 4(2): 49-60 52 3. determine the effect of saccos’ specific predictor variables on saccos’ net operating cash flows output inefficiency. 4. determine the inefficiency mean scores over the two regulation and pre-regulation eras. 2.5. research hypotheses the study also tests the hypotheses that: 1. h01: the saccos operation is not influenced by managerial influence (inefficiency) as measured by gamma (ϒ) over the two eras. 2. h02: there is no strong relationship between the saccos’ macro-economic variables and net operating cash flows output inefficiency dependent variable. 3. h03: there is no strong relationship between the saccos’ specific independent variables and net operating cash flows output inefficiency dependent variable. 4. h04: pre-regulation and regulation eras have the same population of inefficiency mean scores. 2.6. the concept of technical inefficiency the conceptual framework model in figure 1 reflects the dependent variables derived from the output inefficiencies (specifically, the nocf slack), and independent variables relationship. the frontier preliminary analysis involved determination of correlation between each of the saccos’ variance regressors and prime regressors, and if a high correlation is discovered, such specific independent variable (prime regressor) is removed from the second or final stage regression process. however, no variable was removed and this estimation was also internalized within the stata14.1. further, prime regressors are also assumed to be measurement errors free (cooper et al., 2007). figure-1. conceptual frame work source: research (2015) 3. research methodology 3.1. design this explanatory study used a balanced panel data. the explanatory study research design was employed in soliciting for secondary information from the audited annual reports and websites of the regulators on determinants of saccos’ inefficiency in kenya. this study utilized a second stage data envelopment analysis by subjecting the resultant data to sfa. an econometric approach in estimation of saccos’ inefficiency determinants was utilized since sfa stipulates the functional form of cost or production frontier (cummins and zi, 1998). the panel data has benefit of assisting in studying the behavior of each sacco on cross-sectional and time-series or year basis (ongore and kusa, 2013). in addition, this study utilized a census technique whereby 46 licensed saccos under the regulator’s control within the two periods of study running from 2007 to 2010, and 2011 to 2014(a span of 8 years) were picked. 3.2. model specification the estimation of inefficiency was carried out utilizing the cobb-douglas cost frontier crosssectional panel data of saccos over two periods. truncated-normal distribution was assumed coelli et al. (2005) and cooper et al. (2011). stata 14.1 was used to decompose errors (jondrow et al., 1982; pascoe et al., 2003). the sfa was based on cobb-douglas logarithmic model iny ⃰ = β0+ inζkjt+vrjt+urjt, where: βr is the frontier deterministic component, vrjt is stochastic part and urjt presents the shortfall observed individual fails to hit the optimum asian journal of economics and empirical research, 2017, 4(2): 49-60 53 (frontier), j (j=1,…,n) is the cross-sectional identifier, t(t=1,…,t) is time identifier , y ⃰ is the first stage optimal slack(normalized) in output r of dmuj , βo is the intercept of output slack equation, ‘in’ is natural logarithm, and z has k(k=1,…,k) observable environmental factors (battese and coelli, 1995). 3.3. dea result the study examined the inefficiency and efficiency census of 46 saccos using a non-parametric variable return to scale (vrs) bcc or technical efficiency model. the model utilized was output oriented whereby the output included: total revenue, loans to members, net operating cash flows, and divided plus interest on members deposits while inputs were: operating costs, total borrowings and owners’ equity plus members deposits. the panel data model utilized using stata dea software was derived from 368 observations while technical efficiency was measured on scale of 0 up to a maximum of 1. dea result indicated that a total of 24 out of 46 saccos were strongly efficient and exhibited zero slacks across all output variables and this was attributed to net operating cash flows reported for the corresponding years. 3.4. output description table 1 presents the mean output as expressed in tr(total revenue slack), lm(loan to members slack), nocf(net operating cash flows slack), and div(dividend slack) in kshs.million for years 2007 to 2014. as reflected in the table 3.1 the mean tr, lm, nocf, div for the saccos sub-sector (fosa) was 427, 2234, 1038, and 148 respectively. the overall mean score as a percentage of the saccos’ sub-sector sum was 0.18% across all outputs. table-1. eight years mean outputs of saccos in kenya eight years mean outputs of saccos in kenya tr lm nocf div mean score 427 2234 1038 148 standard deviation 1114 6720 1380 596 mean as a % of industry sum 0.18 0.18 0.18 0.18 observations 368 368 368 368 source: research (2015) 3.5. descriptive statistics the descriptive statistics in table 2 presents specific variables that determine the inefficiency of saccos in kenya. as reflected in the table 2, the mean capital adequacy of saccos in kenya was 21%. the percentage is above 10% set by sasra (ssr, 2010). this indicates that saccos in kenya running fosa hold more capital than required. this was an indication that saccos running fosa in kenya were risk averse and in return earn less profit. on the contrary the ratio of net profit to total assets is high at 22%, an indication of mixed result pointing to the direction of inefficiency (brown, 2006). the market power of 2% is far below 70% standard market share that indicates a few firms being in control of an industry (ogebe et al., 2013). further, the average women on the board stood at 20 % with standard deviation of 12%.this is a low number and has little influence on saccos’ inefficiency (higgs, 2003). the table 2 also reflect mean defaulted loans ratio being 3% which is below 4% according to census research on saccos in meru county kenya (olando et al., 2012). this is an indication that the regulator role has played an impact in reducing the default risks to lower percentage and may point to the direction that in this sub-sector, loan guarantors carry next to 97% burden in case of any default thus lowering lp effect on inefficiency. according to brown and o’connor (1999) higher default rate lowers the relative efficiency of a money market. the average age of saccos was shown as 27 years with a standard deviation of 9 years, a reflection of a young industry. magali (2014) posit that age and size are correlated in the same direction and that a rise in age of a small firm has a positive relation with efficiency. table-2. descriptive statistics of predictor variables descriptive statistics of predictor variables variables ca bond npta mp w ms lp age-yrs. goklb age-yrs. mean 0.21 5.33 0.22 0.02 0.20 21245 0.03 27.07 2.72 27.07 standard deviation 0.15 10.78 0.02 0.04 0.12 36063 0.09 9.30 1.37 9.30 observations 368 368 368 368 368 368 368 368 368 368 source: research (2015) 3.6. operationalization of the study variables the study measurements used to operationalize the study specific variables are as indicated in table 3. asian journal of economics and empirical research, 2017, 4(2): 49-60 54 table-3. study variables study variable measurement capital adequacy(ca) core capital to total assets total assets(ta) natural log of total assets npta net profit to total assets area of operation (ao) dummies 1-city ; 0 -urban loan quality(lp) loans provision market power(mp) sacco deposit to total fosa deposits age number of years in operation clr compliance with regulations(average scores) atech computerization expenditures w fraction of women on the board ncfm net operating cash flows to members funds ms number of members wc current assets less current liabilities bond size of contributing common bond employers fi financial investments total amount source: research (2015) 3.7. model testing and random effects estimation the study test carried out to ensure that the data fits the linear regression assumptions include: 3.7.1. normality test the study tested for normality using shapiro-francia w test as the observations were less than 5000 and greater than 10 under log normality condition (stata, 2015). the result obtained is as shown in table 4 which indicates that only two variables reflected p-values greater than 0.05 thus a possibility of heteroscedasticity. the data used also underwent natural logarithm transformation. table-4. testing study variables for normality shapiro-francia w test for normal data variable w’ v’ z prob. > z age 0.89443 29.112 7.251 0.00001 ca 0.99163 2.307 1.798 0.03608 ta 0.98818 3.259 2.541 0.00553 npta 0.84112 43.814 8.13 0.00001 ao 1 0 -58.997 1 lp 0.74358 70.711 9.16 0.00001 mp 0.93325 18.406 6.265 0.00001 clr 0.70719 80.744 9.445 0.00001 atech 0.68281 87.468 9.617 0.00001 w 0.98012 5.482 3.66 0.00013 ncfma 0.34704 180.06 11.171 0.00001 ms 0.99448 1.522 0.904 0.1831 cpi 0.95686 11.896 5.326 0.00001 gdp 0.61534 106.072 10.032 0.00001 goklb 0.62312 103.927 9.988 0.00001 insp 0.90277 26.813 7.074 0.00001 flib 0.53518 128.178 10.439 0.00001 wc 0.13271 239.162 11.781 0.00001 bond 0.92325 21.164 6.565 0.00001 fi 0.80534 53.678 8.567 0.00001 source: research (2015) 3.7.2. multicollinearity test the possibility of strong relationship between predictor variables was checked using the correlation coefficientspearman rho as shown in the table ap.1 in the appendix. the result indicates a few scores of higher than or equal to 0.8, thus reflecting lack of serious multicollinearity among variables. thus coefficients computed were considered reliable. a second non observational method was utilized in testing for multicollinearity that is, variation inflation factor and the result for each dependent variable is as indicated in table 5. this result indicates nocf slack regressed against all independent variables confirm lack of serious multicollinearity possibility. studies have also indicated that a vif above 20 is the one that should be categorized as challenging (greene, 2012). goklb and clr being above 20 are the only two challenging, thus ignored. also a mean vif of around 4 is not problematic (stata, 2015). asian journal of economics and empirical research, 2017, 4(2): 49-60 55 table-5. dependent variable-nocf slack and all covariates vif results covariates variation inflation factor(vif) goklb 42.58 clr 25.17 ta 9.97 mp 10.59 gdp 5.79 cpi 6.07 age 5.08 flib 5.38 ao 2.49 w 2.04 insp 3.85 ms 2.64 ca 3.88 fi 4.09 ncfma 1.46 lp 1.79 bond 1.54 npta 1.69 atech 1.63 wc 1.42 mean vif 6.96 source: research (2015) 3.7.3. random effects estimation the hausman-taylor estimator method was used to confirm that none of the covariates of the panel-level models are correlated with unobserved panel-level random effects (urjt), although some of the covariates may be associated with the unobserved individual-level random effect. the result of the estimation summary is as indicated in table 6. the result indicates that the unobserved random effect δµ = 2.5589 greater than δerror = .63966, suggesting that large portion total error variance is as a result of urjt, idiosyncratic error. therefore, the fixed effects model and random effects model in the panel data are different(h1)and random effects model is preferred (that is, reject h0). meaning the ordinary least squares (ols) would give inconsistent result (stata, 2015). table-6. hausmann taylor estimation –slack nocf and covariates summary of items result number of observations 88 number of groups 36 random effect urjt ἱἱd wald chi sq.(20) 38.34 prob.> chi sq 0.0081 sigma urjt 2.5589 sigma error(vrjt) 0.63966 rho 0.9419(fraction of value due to urjt) source: research (2015). 4. spearman correlation and other key findings the results of the correlation in ap.i indicate that the working capital or insolvency measure had weak negative correlation of -0.2739 with nocf slack while women on the board at + 0.562. this correlation is not in compliance to a prior study which postulate that higher number of women on the board decreases inefficiency depending on the type of industry (ferreira and adams, 2009). capital adequacy is also negatively correlated (0.4108) to dependent variables of nocf slack in line with the expectation of the agency, financial intermediation and efficiency theories (famma, 1980; magali and pastory, 2013). the correlation also indicates that there is a negative relationship between log of total assets (size measure) and the nocf output slack (or inefficiency) at 0.4108. this finding ties well with prior study which found out an existence of positive relationship between the size of saccos and efficiency (magali, 2014). 4.1. ols regression correlation and stochastic frontier analysis results the correlation between environmental factors (prime regressors) and specific predictor variables was tested for purpose of eliminating highly correlated prime regressor(s). the results indicated are mixed with only one significant variable of compliance with regulation having r2 adjusted of 0.868 as shown in table 7. this lend to retention of all environmental predictor variables in the final model of this study. this study finding in table 8 also indicates that women on the board decrease results to increases in nocf inefficiency although insignificant. the influence of macroeconomic variables to dependent variable of nocf slack is also insignificant. a predictor variable of capital adequacy had a strong positive effect on nocf slack with coefficient of + 0.4077 (p-value, 0.028). this result is contrary to efficient holding of excess funds available in form of reserves with a core objective of stability and loan issue to sacco members. this kind of relationship may be possible where excess cash reserve is kept in banks instead of issue to members in form of loans. however, a contrary finding is seen with the relationship between npta with nocf slack, that is negative, with coefficient of 2.8567(p-value 0.001). the gamma of 1.13e-23 is not far away from zero. therefore, hypothesis h01 is accepted, h02 is also accepted while h03 asian journal of economics and empirical research, 2017, 4(2): 49-60 56 is rejected, all at 95% level of confidence. the result utilized 88 observations out of a total of 368 and indicates all predictors jointly influence inefficiency given wald chi sq. (20) =47.78 (p-value 0.0005). however, the influence of control variables on nocf slack variable is insignificant. the mean of truncated-normal distribution (mu) value of 17.6 is far from zero, thus a reflection of inability for study data to reduce to ols regression stata (2015). table-7. regress predictors: cpi, gdp, goklb, insp, & flib dependent variables adj. r2 prob. > f obs. (95% conf.int.) age 0.04 0.0011 368 ca 0.01 0.122 368 ta 0.06 0.0001 368 npta 0.012 0.097 368 ao -0.014 1.000 368 lp 0.118 0.000 368 mp -0.0005 0.439 368 clr 0.868 0.000 368 atech 0.046 0.0005 368 w -0.010 0.93 368 ncfma -0.006 0.699 368 ms 0.065 0.000 368 wc -0.0005 0.441 368 bond -0.0000 0.419 368 fi 0.0371 0.0022 368 source: research (2015) table-8. time varying inefficiency model-regression of net operating cash flows output slack to predictor variables: with control variables observations =88 wald chi 2(20) = 47.78 log likelihood =0.00 prob > c hi2 = 0.0005* slack nocf coef. std err. z p>|z| [95% conf. interval] age 0.157067 0.433208 0.36 0.717 -0.692 1.00614 ca 0.407726 0.185043 2.2 0.028** 0.045049 0.770403 ta -0.03452 0.151889 -0.23 0.82 -0.33221 0.263181 npta -2.85672 0.893375 -3.2 0.001* -4.6077 -1.10573 ao 0.168374 0.301135 0.56 0.576 -0.42184 0.758589 lp -0.02537 0.013373 -1.9 0.058*** -0.05158 0.00084 mp -0.02307 0.131165 -0.18 0.86 -0.28014 0.234012 clr 1.138453 1.380186 0.82 0.409 -1.56666 3.843569 atech 0.015717 0.012384 1.27 0.204 -0.00856 0.039988 w -0.23711 0.191488 -1.24 0.216 -0.61242 0.138194 ncfma -0.23542 0.146404 -1.61 0.108 -0.52237 0.051525 ms -0.08677 0.107158 -0.81 0.418 -0.2968 0.123253 cpi 0.349355 0.297242 1.18 0.24 -0.23323 0.931938 gdp 0.169315 0.139593 1.21 0.225 -0.10428 0.442912 goklb -0.39739 0.357685 -1.11 0.267 -1.09844 0.303663 insp 2.304661 2.155104 1.07 0.285 -1.91927 6.528587 flib -0.78406 0.495805 -1.58 0.114 -1.75582 0.187702 wc -0.04933 0.385944 -0.13 0.898 -0.80577 0.707104 bond 0.011092 0.116058 0.1 0.924 -0.21638 0.238562 fi 0.151101 0.07507 2.01 0.044** 0.003967 0.298235 cons -27.8296 11.68292 -2.38 0.017** -50.7277 -4.93146 /mu 17.60023 . . . . . /eta 0.005481 0.00319 1.72 0.086 -0.00077 0.011733 /lnsigma2 -0.88651 0.00544 -162.98 0 -0.89717 -0.87584 /ilgtgamma -52.8397 . . . . . sigma2 0.412093 0.002242 0.407723 0.41651 gamma 1.13e-23 . . . sigma_u2 4.65e-24 . . . sigma_v2 0.412093 . . . source: research (2015). significance levels: 1%*, 5%** and 10%*** 5. conclusion the general objective of this study was to establish the determinants of technical inefficiency of deposit taking saccos in kenya, given a net operating cash flow slack (an output inefficiency) as a dependent variable. to attain this objective, eight years panel data for 46 saccos was analyzed by the help of data envelopment analysis and stochastic frontier model using stata14.1 software. therefore, the effect of five macro-economic variables, thirteen specific saccos’ predictors and two control variables against dependent variable of nocf slack were evaluated. the dependent variable slacks (inclusive of nocf) were determined using data envelopment analysis model in stata14.1. it was found that 13 out of 46 saccos scored strong technical efficiency of 1 with an average technical efficiency of 0.976 for the whole census of the study. it was also found that specific variables influence saccos’ inefficiency given nocf slack at 95% level of confidence. a unique result to this study is that fi specific variable is negatively correlated to dependent variable asian journal of economics and empirical research, 2017, 4(2): 49-60 57 although regression indicates fi having a strong positive coefficient of 0.1511 (p-value, 0.044); at 95% level of confidence, given nocf output slack with control variables. this direction of influence is expected in an emerging sub-sector where investments are regulated and pegged at a certain percentage point. the study further indicates that capital adequacy had significant positive effect on the nocf slack with control variables, which is not as per the expectation unless a high incidence of cash reserves is idle in the banks instead of being loaned to members. however, the correlation between capital adequacy and nocf slack variable was as expected at -0.4108 (negatively correlated) at 95% level of confidence. generally, this study indicates that saccos’ specific variables given nocf slack variable are significant determinants of the technical inefficiency of saccos in kenya and that the saccos operation is not influenced by the management influence given nocf slack. 6. contribution to theory this study conclusion is in line with efficiency theory which states that inefficiency of decision making unit decreases as cost reduces and banks’ intermediation theory that postulates that banks’ efficiency is positively related to profitability. the study further strengthens the existing prior studies on influence of capital adequacy on inefficiency or efficiency of organizations. it supports the theory of inefficiency. further, it can be concluded that random error (lack of management influence) is observed given nocf slack with control variables presence as indicated by the level of gamma. this random error aspect signify the little influence of management in saccos, as members’ active participation may override the agency problem in management of saccos’ cash flows or resources. 6.1. contribution to practice and recommendations it can be concluded that the identification of strong saccos’ inefficiency or efficiency over different years can be used as benchmark. those saccos’ unique features can be adopted as the best management practices. further, another key contribution to practice is the evidence showing that nocf slack with control variables is a key contributor in determining non-management inefficiencies as expressed by gamma factor. the study also concludes that large size saccos exhibit less inefficiency characteristics and therefore the regulators should encourage merger of small or medium size saccos in the economy. the result also indicates that financial investments strongly and positively influences nocf slack, which agrees with a short run expectation in practice, although saccos have a core objective of issuing loans to members in both short and long run, thus limiting a possibility of the idle cash reserve. the introduction of variables such as npta, ca, and fi in the financial reports of saccos and efficiency benchmarking using dea and stochastic mechanism are important in regulation. 6.2. suggestions for further research the identified limitation to this study is in the area of drilling down to specific efficient saccos using a similar approach of study to find out at micro level what actually influences the individual inefficient or efficient saccos in the sector. it is expected that this will invite more researches in this area as the inefficiency of saccos over the two eras remained constant. other reasons as to why nocf slack is not relevant in identifying management influence (agency problem) should further be researched. it may be essential to consider other predictors such as stock price real index, growth domestic product real index, income of individual members and the square of age. the comparative inefficiency study on non-deposit and deposit taking saccos should also be studied in the future 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https://scholar.google.com/scholar?hl=en&q=financial%20practice%20as%20a%20determinant%20of%20growth%20of%20savings%20and%20credit%20co-operative%20societies%20wealth https://scholar.google.com/scholar?hl=en&q=determinants%20of%20financial%20performance%20of%20commercial%20banks%20in%20kenya http://.springer.com/978-0-387-75447-5 http://www.stata.com/ http://www.woccu.org/functions/viewdocument.php?id=2009 http://data.worldbank.org/indicator/ny.gdp.defl.zs asian journal of economics and empirical research, 2017, 4(2): 49-60 59 appendixes: table-ap.1. predictor variables correlation coefficient correlation coefficient spearman, (rho) age ca ta npta ao lp age 1 ca 0.8186 1 ta 0.7933 0.6833 1 npta 0.5654 0.45 0.5667 1 ao 0.5241 0.1035 0.6211 0.414 1 lp 0.1772 0.0667 -0.4167 -0.6 -0.5175 1 mp 0.3967 0.25 0.8167 0.3833 0.6211 -0.65 clr 0.0957 0.1632 0.0344 -0.1288 0.0533 0.1546 atech 0.5466 0.3598 0.3096 0.6109 0.5717 -0.5272 w 0.4979 0.2907 0.4189 0.1966 0.7434 0.094 ncfma 0.3713 -0.0333 0.5 0.2833 0.5175 -0.7333 ms 0.5739 0.65 0.8667 0.2667 0.414 -0.0833 cpi 0.3463 -0.1624 0.0171 0 -0.3717 -0.3762 gdp 0.4762 0.2821 0.1197 -0.0171 0.4779 0.342 goklb 0.7966 -0.5215 -0.3591 -0.342 -0.4779 -0.1026 insp 0.7793 -0.6754 -0.4788 -0.3762 -0.2655 0.1026 flib 0.8226 0.4873 0.4446 0.3249 0.5841 0.0342 wc 0.9283 0.9333 0.75 0.5667 0.414 -0.0833 bond 0.8405 -0.6299 -0.5533 -0.5193 -0.3701 0.4086 fi 0.6583 0.7 0.9167 0.3833 0.414 -0.1667 slack tr -0.3467 -0.4108 -0.4108 -0.4108 0.189 0.4108 slack lm -0.5547 -0.2739 -0.5477 0 -0.6614 0.1369 slack nocf -0.3467 -0.4108 -0.4108 -0.4108 0.189 0.4108 slack div -0.2017 -0.2988 -0.5179 0.1594 -0.3093 -0.1295 mp clr atech w ncfma ms cpi gdp goklb mp 1 clr 0.2147 1 atech 0.1506 0.0561 1 w 0.1453 0.1542 0.4507 1 ncfma 0.6833 -0.3177 0.2176 -0.1111 1 ms 0.6833 0.1889 0.0251 0.436 0.1333 1 cpi 0.2992 -0.163 -0.3391 -0.7193 0.2137 0.1197 1 gdp -0.1453 0.2952 0.4164 0.7807 -0.1453 0.0513 0.9474 1 goklb 0.1111 0.2687 -0.5881 -0.6842 -0.0769 -0.1881 0.6842 -0.7368 1 insp -0.1111 0.2247 -0.5538 -0.2982 -0.1624 -0.4104 0.0526 -0.2456 0.7193 flib 0.0256 -0.2687 0.5624 0.7105 0.1966 0.2736 0.6316 -0.7193 0.9825 wc 0.3167 0.1288 0.5941 0.5386 0.1 0.6167 0.3762 -0.4959 0.7182 bond -0.2894 0.2105 -0.671 -0.1528 -0.5703 -0.1788 0.2183 -0.3057 0.655 fi 0.7167 0.1116 0.0753 0.3676 0.2333 0.9833 0.1624 -0.0085 0.2308 slack tr -0.4108 0.1411 0 0.562 -0.5477 -0.1369 0.4215 0.4215 0.1405 slack lm -0.5477 -0.2117 -0.275 -0.4917 -0.4108 -0.5477 0.1405 -0.4215 0.4215 slack nocf -0.4108 0.1411 0 0.562 -0.5477 -0.1369 0.4215 0.4215 0.1405 slack div -0.5179 -0.3746 0.18 -0.3934 0.0697 -0.8367 0.1737 -0.0511 0.0307 insp flib wc bond fi slacktr slack lm slackno cf slackd iv insp 1 flib -0.7368 1 wc -0.7182 0.7011 1 bond 0.69 -0.655 -0.7406 1 fi -0.4873 0.3163 0.6667 -0.2979 1 slack tr 0.1405 0.1405 -0.2739 0.5595 -0.2739 1 slack lm 0.562 -0.562 -0.4108 0.3497 -0.5477 -0.125 1 slack nocf 0.1405 0.1405 -0.2739 0.5595 -0.2739 1 -0.125 1 slack div 0.2453 -0.0818 -0.249 -0.2086 -0.757 -0.2455 0.6547 -0.2455 1 source: research (2015) ap.ii: operational definition of terms common bond size: number of entities through which sacco members contribute funds (or share common interest) to the sacco where they own shares and deposits (research, 2015). cost inefficiency: saccos’ excessive cost relative to the frontier. it is the difference between a benchmark and achieved performance i.e. x-efficiency (or proxy of agency costs) (pagano et al., 1997). credit and savings co-operatives: saccos relying too much on external source of funds than share capital, reserves and member deposits (research, 2015). asian journal of economics and empirical research, 2017, 4(2): 49-60 60 dea: data envelopment analysis earnings management: in an organization when a governor fidgets with accounting numbers in order to report higher profits and subsequently pay high dividends is what is known as earnings management (barth et al., 2007). financial liberalization (fl): measured by monetary aggregate (money supply or m3xt) to gdp (cooper et al., 2007; research, 2015). gok net lending/borrowing as % of gdp (goklb): it measures the extent government is either putting financial resources at the disposal of other sectors in the economy (world bank, 2014). this is a proxy for financial depth and innovative activities in kenya. inefficiency (management inefficiency): the proportion by which the observed outcome or goal attainment fall short of optimum level. it is represented by one-sided error term ( rjtu ) with a non-zero mean. rjtu is normally assumed to be truncated-normal (aigner et al., 1977; greene, 2012). inflation consumer price index (cpi): measures changes in prices of goods and services that households consume that affect the consumers’ real purchasing power and their welfare in kenya. cpi and gdp deflator are cross-correlated (reis and mankiw, 2001). a proxy for market condition. interest spread (insp): average lending rate minus average borrowing rate (world bank, 2014). a proxy for risk pricing in kenya liberalization period (lp): era of economic reforms specifically 1980s-1990s and after (research, 2015). money supply (m3xt): m3xt is the currency in circulation measure in kenya that is all-encompassing (khainga, 2014). post-liberalization: after amendment of co-operatives act, 2004 (research, 2015). pre-regulation period: 2010 and before sasra time-from 2007 (research, 2015). regulation period: during sasra from 2011 and after to 2014 (research, 2015). sasra license: saccos operating fosa were required by saccos societies regulation 2010 of the sacco societies act, 2008 to have applied for license by 17 june 2011 (ssa, 2008). slack: amount by which either an output or input fail to attain the optimal efficiency. it is an equivalent of inefficiency level (cooper et al., 2007). specific predictor variables: independent study variables (variance regressors) that exclude the macro-economic independent variables (research, 2015). stochastic frontier analysis (sfa): a parametric method that can test hypotheses and can accommodate single output with multiple inputs. it also uses maximum likelihood econometric estimation and decomposes the error term (ᶒ) into two components (aigner et al., 1977). technically efficient: a firm operates on the frontier of the production technology (coelli et al., 1997). urban areas: town or municipality area. the urban areas are separated from cities according to kenya urban areas and cities act, no.13 of 2011, revised in 2015 (research, 2015). asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. asian journal of economics and empirical research vol. 4, no. 1, 8-13, 2017 issn (e) 2409-2622 / issn(p)2518-010x doi: 10.20448/journal.501.2017.41.8.13 8 health insurance and the demand for medical care: a case study from china zi-yi guo1 1corporate model risk group, wells fargo bank, n.a., charlotte, nc, usa abstract standard insurance theory expects that expenditures and coverage should be positively correlated, for two main reasons: first, high risky individuals prefer to choose a more generous coverage (selection effect); second, a more extensive coverage may increase health costs (incentive effect). we try to empirically separate the selection effect and incentive effect on the health care expenditures with a novel chinese dataset. with our estimation, we do find the evidences of selection effect, but fail to find the incentive effect. besides, we also find some evidences of physician-induced demand. keywords: selection effect, incentive effect, physician-induced demand. jel classification: c21, i11, i13. citation | zi-yi guo (2017). health insurance and the demand for medical care: a case study from china. asian journal of economics and empirical research, 4(1): 8-13. history: received: 24 march 2017 revised: 6 april 2017 accepted: 12 april 2017 published: 5 may 2017 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ......................................................................................................................................................................................... 9 2. the chinese health insurance system ........................................................................................................................................... 9 3. data .................................................................................................................................................................................................... 10 4. the model estimation and results .............................................................................................................................................. 11 5. conclusion ......................................................................................................................................................................................... 12 references .............................................................................................................................................................................................. 12 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2017.41.8.13 https://orcid.org/orcid-search/quick-search?searchquery=zi-yi guo http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2017.41.8.13 https://orcid.org/orcid-search/quick-search?searchquery=zi-yi guo asian journal of economics and empirical research, 2017, 4(1): 8-13 9 1. introduction health care industry, which consumes over 10 percent of gross domestic product of most developed nations, has become one of the world’s largest and fastest-growing industries. for united states, the health care expenditure accounted for 13.9% percent of gross domestic product (gdp) in 2001, and reached to 17.1 percent of gdp in 20141. a well-known explanation of this rapid increase has emphasized the spread of health insurance, since it has generated demand for both a higher quality and an increased quantity of medical services (feldstein, 1971;1977). standard insurance theory expects that expenditures and coverage should be positively correlated, for two main reasons. first, individuals who anticipate high health care costs may choose a more generous coverage (selection effect). second, a more extensive coverage might demand more health costs (incentive effect), either through an increase in the probability to undergo sickness (ex ante moral hazard) or through an increase in expenditures in a given health state (ex post moral hazard). even if these two explanations are theoretically different for the causality relationship between costs and coverage, they are quite difficult estimated separately, especially on cross sectional data (see, e.g. chiappori and salanie (2000)). nevertheless, there are some studies focusing on solving the selection versus incentive effects puzzle. the rand health insurance experiment (rhie) in 1974 conducted a randomized experiment to estimate how demand responds to changes in price of health care (manning, 1998). some natural experiments were also exploited, such as in chiappori and salanie (2000). finally several studies simultaneously estimate the demand for health care and the demand for insurance to identify both effects. some other recent studies include: cohen and siegelman (2010); chandra and skinner (2012); einav et al. (2013); nardi et al. (2016) and keane and stavrunova (2016). here, i want to study the selection versus incentive effects puzzle by using a novel chinese data set. in china, historical reasons, “hukou”, have separated rural area residents farmers from social health insurance system provided by the government. the low level of development in the insurance industry also prohibits them to buy commercial health insurance. at the same time, people who work in the urban area, especially in the government sector, have social health insurance, which is required to be provided by the employers. from this point of view, one may consider occupations as a natural instrumental variable of insurance selection after controlled some variables. meanwhile, people with some special occupations who live in the urban area are not protected by social health insurance and have the option to buy commercial health care insurance. therefore, this group of people serves for a good candidate to study the self-selection effects. manning et al. (1987) write a seminal paper in this topic. manning et al. employ the data from a randomized experiment and estimate how cost sharing, the portion of the bill the patient pays, affects the demand for medical services. a catastrophic insurance plan reduces expenditures 31 percent relative to zero out-of-pocket prices. the price elasticity is approximately -0.2. their results reject the hypothesis that less favorable coverage of outpatient services increases total expenditures (for example, by deterring preventive care or inducing hospitalization). gardiol et al. (2005) provide an analysis of the health insurance and health care consumption. they develop a structural microeconomic model of joint demand for health care and health insurance and estimate the model by the full maximum likelihood (mle) method using swiss insurance claims data for over 60,000 adult individuals. their empirical analysis illustrates robust and strong evidence of selection effects. while once selection effects are controlled for, a significant incentive effect (“ex-post moral hazard”) remains. the marginal demand for health care decrease from 100% to 0% by about 90% was induced by a decrease in the copayment rate from 100% to 10%. the correlation between health care expenditures and insurance coverage may be decomposed into the two effects: 25% may be attributed to incentive effects, and 75% to selection effects. in this paper, i revisit the problem why there is a positive correlation between health insurance policy and health care expenditures and investigate the selection effects and the incentive effects by using a novel chinese data. in our sample estimation, we confirm the positive correlation between health insurance policy and health care expenditures. however, after we try to separate the selection effect and the incentive effect from the positive correlation, we can only find the evidence of selection effect, but fail to find the incentive effect. there are increasing interests about the health care expenditures in china, such as lei and lin (2009); xu and yang (2009); yip and hsiao (2009a;2009b) and ramesh et al. (2014). my paper studies the chinese health care expenditures from a different perspective by focusing on comparison of the selection effect and the incentive effect. the paper is organized as follow. section 2 presents the chinese health insurance system. in section 3, i will describe the data and explain the instrumental variable which i use. section 4 will present the main empirical estimations and results. section 5 concludes. 2. the chinese health insurance system this part mainly comes from the annual report (2002)2, and aims to introduce the chinese health insurance system and shed light on the reasons why we select the instrument variables in the empirical studies. since my dataset is from 2002, i will focus on the system during that year. with historical reasons, medical insurance in china has been segmented into two structures, one for urban employees and one for rural citizens with the health and retirement system structure as one of the administrative tools. 2.1. urban health insurance in december 1998, the decision of the state council on establishing the urban employees’ basic medical insurance system was issued. this decision marked the beginning of a new attempt at developing a new social health care system in urban china since the old system is massively obsolete after the introduction of market reforms in the early 1980s. the old insurance system offered those covered people free health care in government run facilities. it had two-tiers, one covering the state owned enterprise employees and the other one covering military personnel, academics, social workers and the disabled. in contrast, the newly introduced urban system has 1 http://data.worldbank.org/indicator/sh.xpd.totl.zs 2annual report (2002). asian journal of economics and empirical research, 2017, 4(1): 8-13 10 only one tier in which participation is planned to be mandatory to all employees in both public and private companies, with the exception of the self-employed. however, instead of being free to those covered people, the new system employs a cost-sharing structure in which the government, employers and employees share the costs of health care. the employer contribution is 6 percent of total wages and the employee contribution is 2 percent of their wages, although local flexibility allows for some sway in contributions. local governments are then responsible for the management of two funds, a general medical trust fund, used mostly to pay for in hospital services, and an individual employee accounts fund. all of the employee contributions and 30 percent of the employer contributions are put into the individual employee accounts fund while the remaining 70 percent of the employer contributions is collected into the general fund. however, the new system is only for those covered people, and non-employed urban residents, with a few exceptions, must still rely on commercial health insurance or individually pay all the medical costs. unlike the old system which would subsidize healthcare costs of the dependents of workers who are covered by medical insurance by 50 percent, dependents are not covered at all by the new system. however, retired and laid-off workers are covered by the new system. re-employment centers pay laid-off workers by at a level of 60 per cent of the preceding year’s local workers’ average wage to be allocated following the same scheme as employed workers, sponsored by both the employee and employer contributions. the system covers retirees at no cost to them, but the legislation does not explicitly explain who bears their medical costs nor who contributes to their individual accounts, only citing that “the proportion of the amount of money charged into individual accounts of retirees and the medical expenses borne by individuals will be given appropriate preferential consideration,” which most likely allows the issue flexible and let local authorities to decide. otherwise, non-employed residents are not covered by any social health insurance coverage. the new system allows local governments the ability to negotiate with any health-care providers (including private) over terms, coverage, and reimbursement of services, separating governmentrun hospitals from health insurance, although the vast majorities (88 percent) of hospitals remain not-for-profit. since social health insurance no longer includes government healthcare institutions, a new form of distributing funds was also introduced. under the national plan distributions largely handled by the locality, but some national guidelines were created as cost cutting measures. these included: a ceiling on expenditures from the general fund of four times the local average yearly wage; a requirement for localities to create copayment system which determines minimum out-ofpocket payments; and a formulary of permitted prescription drugs (in general 5-10 percent of cost). according to the law, local governments are required to divide permitted drugs into classes which are then reimbursed at different levels. for instance, hunan province built a structure which includes 25 percent of drugs in a “class a” and 75 per cent of drugs into a “class b”, which are 70 percent and 63 percent respectively paid by the social health insurance system. 2.2. rural health insurance in the past, the rural healthcare system in china has actually witnessed great success, increasing the average life expectancy from 40 years in 1965 to 69 years in 1982. this belongs to the establishment of “barefoot doctors” in rural regions, who were community members receiving basic training from the government and could provide basic primary care for with low cost to the community. secondary care, pharmaceutical drugs, and inpatient care had a coinsurance cost, but were much less than the price these services became after the market reforms. since the old socialist cooperative health care system was not innovated and its funds fell to 15 percent of operating costs, the situation became more serious after market-reforms, forcing hospitals and doctors alike to fend for them in a privatized environment. to meet operating costs non-profit hospitals turned to selling expensive treatments which would be unnecessary for the patients. over-treatment is estimated to have reached over 60 percent of medical costs and 75 percent of drug prescriptions were considered to be unnecessary, meaning patients were paying inflated amounts for even basic problems that used to be free to treat. in 2000 over 87 percent of sick people in rural areas paid their own medical expenses in full, and 25 percent had to borrow in order to cover the costs (also see the survey in the annual report (2002)). basically, we can see the coverage of health insurance is geographically segmented into two parts. with the severe household registration system, it is very hard for individual to officially change their jobs. even if they find jobs in urban, they are still treated as residents from rural areas. therefore, we could think health insurance policy is an exogenous variable for individuals, except few urban residents with special occupations. 3. data our dataset is from the beijing shijitan hospital (used to be beijing railway hospital). the hospital is a marginal a-level hospital in beijing. there are two main reasons why we choose this hospital. first, the hospital is a very typical one in beijing. it is not very prestigious compared some hospitals in beijing with national reputations. therefore, we could expect almost all the patients are from beijing local, not other provinces, since if patients from other provinces want to pay such a huge fixed cost to travel to beijing for better medical care, they will be more likely to choose a better hospital with national reputations, such as xiehe, because the restrictive regulatory in health care prices has made the differences of prices across hospitals very small. second, relative to other provinces, beijing is geographically very small. therefore, we could assume urban area and the rural area in beijing are quite similar, across a variety of variables, such as household income, environmental condition and so on. this dataset provides all the hospitalization patients’ expenditures in the hospital in 2002 with 13,506 observations in total. the dataset has the patients’ information, including patients’ id; health care expenditures; health states before entering the hospital; health states after leaving the hospital; occupations; ages; gender; how many times have they been in the hospital because of this sickness; how many days they have stayed in the hospital; which section they have stayed in the hospital, total 11 variables. overall, the quality of the data set is pretty good. we delete one of the observations, whose health care expenditure is almost twenty times of the second largest one. also, there are around 127 observations with missing data. since they are quite randomly distributed, we delete them as well. after these implementations, we have asian journal of economics and empirical research, 2017, 4(1): 8-13 11 13,278 observations in total. since the health care expenditures are quite left skewed, we use log operation. after that, it is quite symmetrically distributed, but it is still not a normal distribution. we use kolmogorov-smirnov test to test is normality and it rejects at any kind of levels. in total, we have 62 occupations in the sample. since we are only interested in whether the individuals are from rural area, we focus on these two, farmers and manual workers. we create two dummy variables, which denote farmers and manual workers respectively. there are two different health states before entering the hospital: emergency and regular. we also create one dummy variable for emergency. some patients are very lucky to receive total recovery after the treatment; some patients become better, but not totally recover; some stay the same; unfortunately some even died in the hospital; and some others, unclear, may move to another hospital. we create four dummy variables for them except the regular one recovery. the summary statistics is as following in table 1. as we can see, in the whole sample almost half of the patients have insurance and almost 20 percents of the population are from rural area. seventeen percents of the patients are employee, which is a quite a huge number. my interpretation for the reason why it is so large is that perhaps some patients are the employees’ relatives and ask them to pay for them and give the money back to the employees. we also check the insurance distribution for each occupation. except farmers and manual workers, they are quite close. almost each occupation has around 60 percents insurance coverage. table-1. descriptive statistics of the variables variable mean std. dev. expenditure 7223.2 12809.9 times 3.917 4.949 age 45.432 21.482 days 19.578 32.777 gender 0.570 0.495 employee 0.174 0.194 emergency 0.168 0.322 better 0.272 0.283 norecovery 0.023 0.149 death 0.033 0.178 others 0.031 0.173 insurance 0.533 0.455 farmer 0.130 0.197 manual 0.051 0.061 source: author calculation based on the data from beijing shijitan hospital 4. the model estimation and results the self-selection problem is a very widely discussed problem in econometrics. the paper will employ the “heckman” selection model, which is analyzed in heckman (1979) a widely-used modeling choice in microeconometrics. to set up the self-selection issue, assume that we wish to estimate parameters β of the regression: i=xi i (1) for a population of individuals. in eq. (1), yi is the dependent variable, which is individual’s expenditure on health care. the variables explaining outcomes are xi, and the error term is i. xi includes a variety of explanatory variables, such as income, age, gender, insurance type, and so on. since individuals with bad health states have an incentive to increase their insurance consumptions, the problem of endogeneity comes out. the control function: i i=1{z +v } since we suspect insurance will be an endogenous variable, to fully identify one has to appeal to iv methodology. here we choose farmers and manual workers as two instrumental variables. i will explain why these two variables should be valid instruments in next paragraph. as i introduced in the section about the chinese health insurance system, historical reasons has separated the china into two segmented parts: rural area and urban area. the household registration system has almost made the impossibility for people to move from rural areas to urban areas. to acquire to urban area registration, people usually should pay a huge cost except through finding a job in government sector. especially in beijing, the cost in 2002 is around 200,000 rmb. to win a job in government sector, it is usually very competitive and only a small portion of people who are very well educated can have that chance. china only reforms its education system in 2000. before 2000, the entrance rate of college is below than 2 percents. even there exists a selection issue for jobs, we should expect the correlation between selection in jobs and selection in insurance policy should be very small. as i mentioned, beijing is very geographically small. actually, the difference between its rural area and its urban area is quite small, in a variety of context, such as household income and environment. one even can say its rural areas are just nominally named rural areas, while they actually are “urban area.” therefore, we can conclude there is no much difference in nature between people from its rural areas and people from its urban areas. at first we run a reduced form regression as follows. .3862 .0028 .0037 .0001 .0301 .1658gender+.7444employee+.0127better-.0258norecovery -.0190death-.0230others-.5588farmers-.3149manual+ insurance times age days emerg        . (1) except health states when leaving (including better, no-recovery and death), all other variable are significant at 5% significance level. so we can see both farmers and manual are negatively related with insurance policy. both farmers and manual workers have less access to insurance policy. the f-value of the joint test of the two coefficients is 290 and its p-value is around zero. since we have two instruments, to check their validity, we also asian journal of economics and empirical research, 2017, 4(1): 8-13 12 run the over-identification test. the value of sargan (score) test is: chi2(1) = 2.31773 (p = 0.1279), so one cannot reject the over-identification hypothesis. this gives us an indirect evidence of the validity of our instrumental variables. at first, we will run a pooled a regression to see without instrumental variables, how will be the results. log(expenditure) 7.288516 .0108 .0133 .0115 -.2048 .0792gender-.1690employee+ .0640better -.2094norecovery+.4475death-.7646ot times age days emerg      hers+.2517insurance+ . (2) all the coefficients are significant at 5% level. as one can see, without instrumental variable, people who have insurance will significantly increase their health care expenditure, by 25.17%, more than one quarter. to see whether the positive correlation is because of selection effect or incentive effect, we run the two-stage least square regression. log(expenditure) 7.351 .0113 .0140 .0115 -.1995 .1088gender-.2925employee+ .0662better-.2141norecovery +.4448death-.7703oth times age days emerg     ers+.0829insurance+ . (3) the t-value of the coefficient of insurance becomes 0.59, which means we cannot reject the null hypothesis. therefore, after we control the selection effect, we cannot find evidence of positive correlation between insurance and health care expenditure. basically, we cannot find incentive effect in our sample estimation, including either ex ante moral hazard or ex post moral hazard. another interesting finding in our estimation is that the coefficient of employee is negative and significant. our interpretation is that since employees have better information than regular patients, the asymmetric information between physician side and patient side becomes much smaller, so we can see the physician-induced-demand effect reduces by significantly. as mentioned in the handbook chapter by mcguire (2000) there is empirical support for physician-induced demand. the three mechanisms physicians may use to influence quantity of care provided to patients are: quantity setting of a non-retradable service, influencing demand by setting the level of noncontractible input (“quality”), and, in an asymmetric-information context, taking an action to influence patient preferences. with limit of data, we cannot check the effect separately, but we can make our argument: physicianinduced demand effect is significant in our sample estimation. 5. conclusion in the paper, we revisit the problem why there is a positive correlation between health insurance policy and health care expenditures by using a novel chinese data. in our sample estimation, we confirm the positive correlation. however, after we try to separate the selection effect and the incentive effect from the positive correlation, we can only find the evidence of selection effect, while failed to find the incentive effect. there are several directions for future research. first, the dataset is not based on a randomized experiment. since we use occupation as an instrumental variables, as we know occupation is strongly correlated 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introduction ........................................................................................................................................................................... 2 2. nigerian business environment ............................................................................................................................................ 2 3. nigerian maritime business .................................................................................................................................................. 2 4. environmental sustainability ................................................................................................................................................ 4 5. conclusions ............................................................................................................................................................................ 4 references .................................................................................................................................................................................. 5 citation | mohammed yusuf alkali; maryam ibrahim imam (2016). accountability and environmental sustainability: nigerian maritime experience. asian journal of economics and empirical research, 3(1): 1-5. doi: 10.20448/journal.501/2016.3.1/501.1.1.5 issn (e): issn (p): 2409-2622 2518-010x licensed: this work is licensed under a creative commons attribution 3.0 license contribution/acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained ethical: history: this study follows all ethical practices during writing. received: 2 november 2015/ revised: 17 november 2015/ accepted: 21 november 2015/ published: 25 november 2015 publisher: asian online journal publishing group maritime sector of nigeria is one of the largest administrative agencies in african continent that has greater impacted to nigerian and west african region economies. the industry expectation if managed very well, will significantly improve the economic development of nigeria. several reports in the sector provide evidence of non-performance, low productivity, corruption and non-compliance with the international maritime global best practice. in addition, the sector is marred with the challenges of political, regional instability and pirating within the coastal region. however, significant efforts have been made by the nigerian government to improve on the sector in order to attract local and global investors in the industry. from the last political and present administration of nigerian government has provide a good enabling environment for the growth of the industry. however, policy makers and government are expected to do more in the sector for the economic benefits of the country and west african region in general. keywords: accountability, environmental sustainability, economic development maritime, nigeria. http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.1.5 http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.1.5 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.1.5 http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.1.5 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.1.5 http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.1.5 asian journal of economics and empirical research, 2016, 3(1):1-5 2 1. introduction demand for greater change in the understanding of the maritime business has brought a more significant policy measures in the sector particularly to the environmental changes globally, with the increasing advancement in technology. the maritime industry globally accounts for more than 90 percent of the transportation requirements. the industry experienced a significant rapid change in technology and managements for many decades, which are an important element for sustainable development in emerging economies (crede and mansell, 1998). these rapid changes in the sector caught the attention of the global investors to invest in the business for both the developed and emerging markets. in particular, the nigerian maritime industry has impacted positively on the development of the nigerian economy. however, policy issues on accountability and environmental sustainability are predominantly in the discussions globally. reasons have been reported on these two questions and considered to be on the increase particularly in developing countries, thus, losing attraction for the local and global investors (johnson, 2014). though, nigerian maritime sector is considered to be vast and evergreen (ifeyinwa, 2015), but yet there was a bold attempt by the nigeria government to transform the look of the industry operations within its coastal and inland shipping. this lead to the establishment of nigeria cabotage act in 2003 that is designed to give stinging foreign involvement within the nigeria’s domestic coastal trade. accordingly, experts in the maritime sectors reported that, if the industry is to be managed adequately, the revenue generation of the industry will increase the federation accounts tremendously. statistically alone, in the year 2009 the agency reported over $1.99billion (ngn4.9trillion) on the three percent levy on freight only. this revenue generation is assumed to have increased over the years from 2009 and 2014 with little decline in 2015. from the period of independence to date maritime sector has employed an estimated 150,000 workers in the year 2013 with as much as usd15billion to the nigerian economy. the sector, been an important industry to the economy is contributing about 40% of nigerian gdp. several experts demonstrated that revenue generation in the area is expected to have a rise by over 300% has been neglected by the government (moses, 2015). the system of accountability and environmental protection in the system is highly uncoordinated and receive little attention from the government. corruption in the sectors has been endemic, bringing the industry to almost near collapse. many studies conducted shows corruption as a hindering block for investment, restricting trade, distortion of fact and economic growth of any industry (macn, 2014). also, since the year 1950 when nigerian started extraction of petroleum product, there was severe environment degradation in the region. in the year 1995, prominent environmental activist (ken saro-wiwa and others) were executed by the military regime for voicing out the maritime environmental problem in their region. to ensure improvement in the revenue generation, the government of nigerian hired private security consultant in the year 2013 to control and guarantee the safety of the nigerian waterways. the maritime authority of nigeria is the body responsible for making regulations related to shipping, coastal waters and maritime labour laws. the agency was known to be national maritime authority (nma) and later called the nigerian maritime administration and safety agency (nimasa). the maritime industry among its responsibilities is the provision of search and rescue operations, undertakes inspections and security to the marine coastal. the nigerian maritime environmental challenge witnessed from the piracy and armed robbery in the coastal region. this issue has caused a greater neglect of the industry by the multinationals. over the years, the government of nigeria provide many programmes such as; (i) national seafarers development programme (nsdp), (ii) nimasa science, (iii) technical college, okolona, okrerenkoko, (iv) nimasa maritime institute and, (v0 nimasa shipyard and dockyard, okerenkoko, delta state, nigerian maritime university (nmu) in the community. this programme has benefited over 2,500 young nigerian that are mostly in the region. 2. nigerian business environment the cia fact book reports nigeria as the most populous black nation in the world. the estimated population of the country is between 160 to 180 million, as stated from cia (2013). africa and particularly nigeria, will be in the leading global population rise over the next century and possibly larger than the us by 2050 by the united nation (un) in 2012. there are over 250 multi-ethnic and cultural groups in the country. these groups are divided into kingdoms as a result of their culture, norms and tribes. five major domains exist in the country before 1960 independence namely: the hausa kingdoms, who are mostly majority muslims from northern region, igbo kingdoms from southern east part of nigeria and mainly christians. the yoruba kingdoms in the south western region, while the nupe kingdoms from northern region and mostly muslims. the greater part of the population and three-quarters of the land mass of nigeria is in the northern part (john, 1972). by 1914, the country’s amalgamation between the two provinces of northern and southern by the british was signed. the nigerian government got it independence was granted on the 1st october 1960 from by the british government. this was followed by a democratic election in the country, as the northern part has the majority of the population, the election before the independence favored the northern party (npc). the party captured 134 seats out of 312 seats in the parliament. immediately after the civil war, nigeria has no money for economic development, reconstructions and meeting the demand of government expenditure requirements. this at the time the primary source of revenue in the country was from the agricultural product before the discovery of oil in 1950. petroleum industry becomes the boost of economic development as the revenue generation increases with the rise in the global oil prices from $3 to $7 in 1973-1974. the nigerian revenue generation increases with as the oil prices rise with foreign exchange. international communities moved into the country for investments. british, russia, france and us become great allies for economic development. the economic strength of nigeria depends largely on gas reserve and petroleum [roduct that make up over 90% percentage of the country’s foreign exchange revenue. 3. nigerian maritime business the location of nigeria geographically facilitated the establishment and development of maritime industry in the ocean-going or inland areas. in nigeria, there are two types of inland transportations in the rivers niger and benue asian journal of economics and empirical research, 2016, 3(1):1-5 3 with others that are small but provide a significant avenue for maritime activities. the major part of the maritime activities is within the atlantic ocean because of its border with the international maritime. thereby, assisting not only in transportations but contributing significantly to the economic development of the country economy. the sector is reported to be accountable for over 60% of the west african total seaborne traffic found in the region (comfort 2015). as a result of the contributions of industry to the nigerian economy, the maritime sector was first established through shipping policy decree of 1987 under the supervision of the federal ministry of transport. the national maritime authority (nma), was a predecessor of the nigerian maritime administration and safety agency, (nimasa). the principal obligations of the industry to the nigerian economy is to ensure not only the protection, orderly development and manpower training of the shipping industry. but to also, the nma has the responsibility of marine pollution monitoring as well as spillage within nigerian waters. furthermore, the vulnerability of the environmental sustainability of the region recognised the important role of the maritime as an agency to ensure the protection of the area (mwalimu, 2005). this importance of the organization gives birth to nimasa in 2006 as a result of the merger of nma with joint maritime labour industrial council. these two agencies were both parastatals from the federal ministry of transportation. the act that established nimasa in 2006 state that; (i) five percent of the annual income of the agency shall support maritime academy of nigeria (mac), and (ii) thirty-five percent of the annual income is to be employ for the development of maritime infrastructure. additionally, from the period of december 2009, the agency set up a ray (2015) described the importance of marine to the nigerian fund that will cover 40% cost for the education system in the delta region (ogbuokiri, 2010). economy to include;(i) transportation services, (ii) promotion of trade and commerce, (iii) generation of revenue, (iv) job opportunity and employment creation, (v) institutional development, and (vi) tourism promotion. some of the major functions of nigerian maritime sectors are find below:  ensuring the development of both shipping and regulatory matters that are related to seafarers and merchant shipping and seafarers.  handling all administrative, policy and regulation that are related to shipping licences.  maritime training as well as standard safety establishments  safety regulation, standards for shippers’ construction of ships and navigation.  to provide maritime search and rescue services  provision of direction and compliance safety with vessels security measures  to carry out air and coastal surveillance  controlling and preventing maritime pollution  developing and implementing regulations, policies and programmes  enhancing and administering the provisions of cabotage act. 2003  performing port and flagging state duties.  providing maritime security services 3.1. structure of the maritime authority of nigeria the maritime industry has three directorates. in each of the directorate there constitutes the leadership of executive director(ed). from the directorate, there are two or more primary units that are headed by a director. in overall, eight departments report to the reporting to the eds during the nine units report to the director-general or ceo. because of the nature of the organisational operations, several offices operate a zonal structure to improve effective management of its activities in the four significant maritime zones of nigeria. the zones and their respective headquarters are: western zone – lagos, (ii) central zone –warri, (iii) eastern zone port harcourt, (iv) northern zone – abuja and (v) head office in lagos. the largest distribution are is in lagos with its principal operations in (a) apapa (lagos), followed by warri, port harcourt, bonny, calabar, lokoja, abuja,yenagoa, onne, sapele, and eket. figure-1.1. agency structure source: nimasa (2014) asian journal of economics and empirical research, 2016, 3(1):1-5 4 3.2. accountability in nigerian maritime the general concern of the government of nigeria is the level of corruption among the maritime and petroleum industry. the memorandum of the governor of central of nigeria to the present of nigeria in 2013 has shown that; “non-repatriation to the federation account by nigerian national petroleum corporation (nnpc) of n49.8 billion accounting over 76% of the value of crude oil lifting in 2012 and 2013”. but the letter also contains complaints about “failure of nnpc to pay n22 billion nigerian export supervision scheme (ness) levy”, and “other related matters” (anago, 2014). the challenge of maritime industry is the political instability couple with the global economic turmoil. recently, in the year 2013 the nigerian government lost over 300,000 barrels of crude oil on a daily basis from the attacks on major export pipelines (macn, 2014). vandalism of the crude oil within the offshore and on-shore of nigeria has a significant impact on the nigerian economy (ejiofor and chineme, 2014). in the year 2014 the government sought of deregulating the downstream sector to improve the transparency and efficiency level of the petroleum and maritime sectors. the result of the enumeration of the consequences of deregulations that was assumed to be demanding in resources, discourage investments with the severe advantage to the wealthy, prompted the government to abandoned the initiative (meredith, 2005). the majority of the challenges identified in the sector includes weak internal ethics infrastructure in the ports (for example, lack of a code of conduct), underdeveloped systems and weak enforcement practices for investigating complaints from the bribe demands, payments facilitation. however, the findings of the accountability report by united national development programme and the maritime anti-corruption network in 2014 were classified into three components as; (i) organisational, (ii) environmental, and (iii) personnel. 3.2.1. organisational factor the accountability measure in the maritime does not provide a good formal channel for insider or complaint systems for whistle-blowing. also, in the sector, there are limited levels of policies compliance and decisions to strengthens current reforms that are taking place in the industry. several bureaucratic process of cargo clearance, within the ports, provides an avenue for corrupt practices. for example, in the processing of cargo in the harbour, it required several signatures (142) before clearances. lastly, the predictability, as well as celebrity on the decisionmaking process, is limited in the sector. 3.2.2. environmental factor in this sector, there are limited numbers of operational facilities in the port, which makes the port services a scare resource. this has provided undue advantages to the corrupt behaviour of the people in the industry. also, the organisation regarded corruption as an acceptable norm in which the industry will be to promote and business interest to be achieved. in the sector, most of the foreign firms are in compliance with the local traditions, rules and expectations to sustain their business, which include indulging in corruption. furthermore, the laws in the area have been outdated consisting of sanctions that are no longer a deterrent, un-effective enforcement of sanctions, and provisions remain weak in the industry. 3.2.3. personnel factor the maritime organisational sector is reported not to an emphasis on integrity in the place of work. there is a broader discretionary power with limited accountability. the system of corruption in the maritime has been accepted and widely rationalised by the staff. in the industry, no training routine is established to strengthening ethics and competence. the pressure of those in authority to comply with the already established corrupt practices is very high. 4. environmental sustainability reports on nigeria, by the local and international organisations, provide evidence of significant increase in the environmental disasters, like human activities and drought. for instance, the nigerian report rio+20 summit in 2012 (undp) reported that nigerian environment has been under threat from both natural and human activities. the challenging aspect of the environmental situations is visible in the sense that destruction of natural resource in the coastal areas of nigeria can be noticed easily. the report of undp in 2012 stated that nigerian larger populations are in great danger due to the environmental factors. the ecological damage in the delta region is caused by the fossil fuel use, in particular, oil and gas exploration. the coastal area of nigerian marine environment has about 853 km of the coastline and inland, for a distance of about 15km in lagos in the west, to about 150km in the niger delta region and about 25km east of the niger delta. in the study of undp in 2012, the nigerian maritime coastal area is afflicted with significant environmental problems, which have greatly been addressed for as an issue for sustainable development. the system of industrialisation, oil and gas explorations, urban development and exploitation has invaded on the community as well as their environment. this phenomenon leads to the opening of the pristine ecosystem (undp report, 2012). natural hazards like loads have clearly caused few of the environmental impacts, industrial events that have aggravated the condition. the major areas identified in the environmental sustainability in nigerian includes; (i) modification of the ecosystem in the coastal erosion, biodiversity loss, flooding, salt water intrusion and exotic species, (ii) pollution from oil spills, gas flaring industrial and agricultural effluents, solid wastes and sewage,(iii) depletion of fisheries resources (awosika, 2008). 5. conclusions nigerian maritime industry is the heart of that accounts for a greater percentage of the government revenue. despite the importance of the maritime sector to the nigerian economy, a significant neglect of the industry is asian journal of economics and empirical research, 2016, 3(1):1-5 5 noticed. over decades, the industry has not acquired attractions of required global and local investors. this challenge is attributed to the level of accountability and environmental issues. some professionals and experts in the area have attributed the lack of knowledge of the maritime sector, technical competency and understanding the operations of the industry contributed to low investments in the sector. the nigerian maritime sector is considered to be one of the largest industry in african and the most prominent in the west african region, but yet do not provide expected economic development in the area. nevertheless, other challenges like political instability, piracy and corruption have been the major hindering factor to the development of the sector. references anago, u., 2014. nimasa canvasses legal powers to prosecute pirates, sea robbers. available from http://businessdayonline.com/ [accessed september, 2015]. awosika, l., 2008. sustainable management of the nigeria coastal and marine environemnet: inportant ingredient for achieving millennium goals by 2015. paper presented at the first national summit on the environment, abuja, nigeria cia, 2013. human population through histry. world fact. book. available from https://www.cia.gov/library/publications/the-world-factbook/. comfort , o., 2015. fading interest in maritime worries stakeholders. available from http://www.punchng.com/business [accessed september, 2015]. crede, a. and r. mansell, 1998. knowledge societies. in a nutshell: information technologies for sustainable development. ottawa, canada: idrc. ejiofor, a. and o. chineme, 2014. nnpc: nigeria lost 109.5m barrels of oil in 2013. available from http://www.thisdaylive.com/articles [accessed sept, 2015]. ifeyinwa, o., 2015. how maritime can change nigeria. vanguard news paper nigeria. available from www.vanguardngr.com/. john, d.s.j., 1972. the nigerian civil war. london: hodder and stoughton publishing. johnson, a.h., 2014. capacity building and professinalism: lgredients to growth of nigerian’s mariime indutsry. buisness day tuesday october 2014: 21-22. [accessed september, 2015]. macn, 2014. corruption risk assessment in the nigerian port sector macn excutive summary. available from www.maritimeacn.org/s/macn-brief_web_oct14 [accessed september, 2015]. meredith, m., 2005. the fate of africa: a history of fifty years of independence. new york: fat public affairs publishing. moses, e., 2015. revenue from maritime sector critical to economic development. the guardian news paper nigeria. available from http://www.ngrguardiannews.com/2015/07/revenue-from-maritime-sector-critical-to-economic-development [accessed september, 2015]. mwalimu, c., 2005. the nigerian legal system: public law. new york, usa: peter lang publishing. nimasa, 2014. maritime environment management. available from http://www.nimasa.gov.ng/. ogbuokiri, p., 2010. un seafarers day mariner, others decry shortfall of seafarers. daily champion september 14, 2010: 7-8. [accessed september, 2015]. ray, e., 2015. why maritime transport is important for nigeria. news watch times nigeria. available from http://www.mynewswatchtimesng.com/maritime-transport-important-nigeria [accessed september, 2015]. undp report, 2012. nigeria’s path to sustainable development through green economy. country report to the rio+20 summit june 2012. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. http://businessdayonline.com/ http://www.cia.gov/library/publications/the-world-factbook/ http://www.punchng.com/business http://www.thisdaylive.com/articles http://www.vanguardngr.com/ http://www.maritime-acn.org/s/macn-brief_web_oct14 http://www.maritime-acn.org/s/macn-brief_web_oct14 http://www.ngrguardiannews.com/2015/07/revenue-from-maritime-sector-critical-to-economic-development http://www.nimasa.gov.ng/ http://www.mynewswatchtimesng.com/maritime-transport-important-nigeria asian journal of economics and empirical research issn: 2409-2622 vol. 1, no. 1, 6-9, 2014 http://asianonlinejournals.com/index.php/ajeer 6 instability in rice production in gujarat: a decomposition analysis narendra singh aspee college of horticulture & forestry, navsari agricultural university, navsarigujarat a k dikshit extension education and socio-economics section, central institute for research on goats, makhdoom b s reddy college of agriculture, bheemarayanagudi, karnataka surendra b. kuthe department of agriculture economics, nmca, navsari agriculture university (nau), navsari, gujarat abstract this work is licensed under a creative commons attribution 3.0 license asian online journal publishing group 1. introduction india has the world’s largest area devoted to rice cultivation, and it is the second largest producer of rice after china. rice is the most important and extensively grown food crop in india and in gujarat and it is the staple food for more than half of the world population (singh and varshney, 2010). in india, gujarat ranks 15 th in terms of area and production and 9 th in productivity (2011). rice production is confined to south and middle gujarat representing the agro-climatic zones, i, ii and iii. these zones exhibit a wide range of agro-climatic variation within and between individual zones. the cropping sequence under which the rice crop is grown in different agro-climatic zones is also different. such variations seem to have direct impact on the production and productivity of the rice crop in the state. the rice growing area of the state covers the districts of valsad, navsari, dang, surat, bharuch, narmada, vadodara, kheda, anand, dahod and panchmahals (pathak et al., 2011). the scope for expanding rice production lies in enhancing productivity. several studies have indicated that the adoption of recommended rice technology gives high yields and income to the farmers. the yield level of rice which is comparatively low compared to national level at present need to be increased substantially. higher rice production can be achieved by adoption of all the recommended technologies by large number of farmers. the instability in production transmitted wide variation in arrivals of the crop produce in the markets caused wide fluctuations in prices of the crop product. apart from increasing the overall total production, stability in rice is the most important and extensively grown food crop in india and is the staple food for more than half of the world population. in india, gujarat ranks 15 th in terms of area and production and 9 th in productivity (2011). the scope for expanding rice production lies in enhancing productivity. the growth rates of rice area, production and productivity during 1982-83 to 2011-12 were 0.41, 1.25 and 0.83 percent per annum respectively. the growth estimate from last 30 years data shows that negligible increase was recorded in area and production of rice. presently the yield level of rice in the state is comparatively low from national average need to be increased substantially. the magnitude of instability in area and production of rice has been higher in all the selected districts compared to state. variability in production has been at a higher rate compared to area and productivity variability in this crop. the area-yield co-variance had a stabilizing effect on reduction of instability in rice production it can be inferred that the wide fluctuation in production of rice crop have been due to the high variability in its productivity. the future development programmes should envisage on increase of yield for bringing stabilization in production of the crop. the area instability also needs to be reduced. this could be reduced by more investment on research for rice production technology in the state. keywords: growth, instability, rice production technology, variability, co-variance, investment. http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2014, 1(1): 6-9 7 production of the crop over the years is equally important in planning for agricultural development of any area. a pre-requisite for stabilizing of rice production is the necessity of examining and measurement of the extent of instability and also identification of the factors or sources causing the instability. as such an attempt has been made to examine the extent of instability and also to find out the factors responsible for causing instability in production of rice in the state of gujarat. the study has practical utility in policy planning for boosting the production of this crop for food security in the state. the paper is organized into four sections. the data and analytical approach used is discussed in the next section. salient findings are discussed in section 3. concluding remarks and policy implications are made in the last section. 2. data and methodology the study confines to the state of gujarat as this state is one of the major traditional rice producer in the country. further, south gujarat region, ahmedabad, valsad, vadodara, kheda and punchmahal districts being an important contributor to the state production of rice, were therefore selected for the present study. secondary data in respect of area, production and productivity for the last 30 years (1982-83 to 2011-12) were obtained from the publications and records of directorate of agriculture, government of gujarat, gandhinagar. 2.1. analysis of data growth rates: the compound growth rates of area, production and productivity of rice crop were worked out using exponential function of the form, y = a b x by taking logarithm of both sides, the equation takes the linear form: log y = log a + x log b on writing log a = a, log b = b and log y = y, the equation becomes y = a + bx where; y = dependent variable (area, production and productivity) x = time/year (independent variable) a = constant/intercept b = regression coefficient of y on x the compound growth rate (r) is = (b-1) x 100 the standard error of growth rate was estimated and tested for its significance with ‘t’ statistic. 2.2. instability in production the magnitude of instability in production of the crop was measured by working out the coefficient of variation (cv) based on time series data. area and yield data of each selected district were detrended using the linear equation. zt = a + bt + ut where; zt = dependent variable (area /yield) a = intercept b = parameters to be estimated t = time variable (years); and ut = error term with usual assumptions after detrending, the residuals (ut) were centered on the mean area and mean yield (z) for each district. the detrended time series data (z) for area and yield were calculated as z = ut + z the time series data of detrended production were calculated as the production of detrended area and yield. finally, the coefficient of variation (cvt) of rice production was estimated from the detrended series for the study period. the variance of production was decomposed into its constituent sources, viz., area variance yield variance and area – yield co-variance to examine the source of instability. v (q) = a 2 v (y) + y 2 v (a) + 2 a y cov (a,y) – cov (a,y) 2 + r where; v (q) = production variance a = mean area y = mean yield v(y) = yield variance v(a) = area variance cov (a,y) = area – yield co–variance cov (a, y) 2 = higher order co-variance between area and yield; and r = residual 3. result and discussion 3.1. growth rate of area, production and productivity of rice crop there was slight change in area under rice cultivation in gujarat state. during the period 1982-83 to 2011-12, there was slight increase in area by 0.41 per cent per annum (table 3.1). production and productivity of rice shown positive growth during the study period. among the selected districts, growth in area was ranges between 0.01 to asian journal of economics and empirical research, 2014, 1(1): 6-9 8 1.88 % pa. the production growth was ranges between 0.91 to 2.76 %pa. highest growth in production was observed in ahmedabad district. productivity growth was positive in the selected districts as well as in the state. table-3.1. compound growth rates of area, production and productivity of rice crop in selected districts, south gujarat region and gujarat state (%pa) district year 1982-1983 to 2011-12 area production productivity ahmedabad 1.88** 2.76** 0.87 vadodara 0.01 1.02 1.01 valsad* 0.26 0.84 0.58 kheda* 1.17 1.85** 0.68 panchmahal* 0.25 1.13 0.88 surat 0.43** 0.91** 0.49 south gujarat region 0.69 1.28 0.58 gujarat state 0.41 1.25 0.83 (1) valsad + navsari* (2) anand+kheda*, (3) panchmahal+dahod* (* areas computed taking into account districts as existing prior to their reorganisation). ** significant at 5% level of significance 3.2. instability in production, area and productivity of rice crop the coefficient of variation method was used to estimate the extent of instability in production, area and productivity of rice crop. the coefficient of variation as a measure of instability was estimated from detrended time series data as this method is advantageous over other methods (coppock’s instability index) because it directly gives the value of instability of the character under study. the coefficient of variation of production, area and productivity of rice crop was estimated from detrended time series data for the last 30 years (1982-83 to 2011-12) for the south gujarat region, state as a whole and also for the major rice producing districts of gujarat. the results are presented in table3.2. the coefficient of variation for production of rice in the state of gujarat was 20.50 per cent for the period 198283 to 2011-12. for the selected districts, the coefficient of variation varied from 28 to 70 percent during the study period. the coefficient of variation in production was markedly high for panchmahal district (70.90 percent) and vadodara (64.12 percent). instability was at moderate level in the districts of ahmedabad (46.16 per cent), surat (34.56 percent), kheda (29.01 percent),) and valsad (28.63 per cent). the coefficient of variation for rice production has been higher for the selected district compared to the state as a whole showing thereby that fluctuation in production was more in the selected districts compared to the state as a whole. table-3.2. coefficient of variation of production, area and productivity for rice in selected districts of gujarat during 1982-83 to 2011-12 (per cent) districts coefficient of variation production area productivity ahmedabad 46.16 21.69 34.19 vadodara 64.12 43.18 35.97 valsad* 28.63 21.19 14.36 kheda* 29.01 16.76 19.84 panchmahal* 70.97 20.58 59.63 surat 34.56 27.05 14.52 south gujarat region 17.90 10.68 14.41 gujarat state 20.50 8.71 16.75 (1) valsad + navsari* (2) anand+kheda*, (3) panchmahal+dahod* (* areas computed taking into account districts as existing prior to their reorganisation). the coefficient of variation for the acreage under rice crop in the state was 8.71 per cent during the study period (1982-83 to 2011-12). the variation in area was 16 to 43 percent under rice crop in the selected districts. the area instability for rice crop was found to 10.68 for south gujarat region which is higher from the state as a whole. the coefficient of variation for rice productivity of the state revealed that this has been 16.75 per cent during the study period. among the districts, coefficient of variation for productivity varied from 14 to 60 percent during the study period. the extent of variability in productivity has been higher for the districts compared to the state during the study period. the foregoing discussion led to conclude that the magnitude of instability for production of rice crop was higher in the districts as well as in the state as a whole. however, area variability has been at a lower rate compared to variability in productivity. the variability in all the three variables i.e. production, area and productivity has been higher in the districts compared to the state as a whole. the destabilizing effect on production was more compared to area and productivity. this was also corroborated earlier in the study by asopa and naik (1989). 3.3. sources of variance in rice production to analyse the variables, explaining the changes in instability of rice production, production variance was decomposed into area variance, yield variance and area-yield co-variance for the selected districts and state of gujarat using hazell (1982) decomposition technique. the results are presented in table3.3. yield variance accounted 66.17 per cent of total variance in rice production for the state. the area variance was next in line and accounted 17.90 per cent. the area-yield co-variance has been 15.92 per cent indicating thereby that area-yield co-variance has a destabilizing effect on instability of rice production. among the selected districts, yield fluctuation has been a dominant source of total variation in rice production in the districts of panchmahal (60.10 per cent), ahmedabad (52.13 per cent), kheda (45.03 percent), and south gujarat region (64.78 per cent) while the area asian journal of economics and empirical research, 2014, 1(1): 6-9 9 variance was a dominant source in total variation in production of rice in the districts of surat (59.78 per cent), valsad (54.11 percent), vadodara (41.99 percent) and kheda (32.13 percent). in south gujarat region, area-yield covariance has been negative indicating thereby the stabilizing effect on the instability in rice production. the areayield covariance has been positive in all selected districts which suggested that the combined forces of area and yield have affected the output instability in the same direction across the time period. table-3.3. sources of variation in rice production during 1982-83 to 2011-12 (per cent) districts area variance yield variance area-yield co-variance ahmedabad 20.98 52.13 26.89 vadodara 41.99 29.13 28.87 valsad* 54.11 24.87 21.01 kheda* 32.13 45.03 22.85 panchmahal* 7.16 60.10 32.74 surat 59.78 17.22 23.00 south gujarat region 35.58 64.78 -0.35 gujarat state 17.90 66.17 15.92 sum of variance = 100 (1) valsad + navsari* (2) anand+kheda*, (3) panchmahal+dahod* (4) ahmedabad + gandhinagar* (* areas computed taking into account districts as existing prior to their reorganisation). the results of this study are in conformity with the studies conducted by kumar and sankaran (1998) at country level for turmeric crop. the foregoing discussion concluded that the change in yield has been the dominant source of total variation in production of rice in the state as well as in selected districts. the area-yield co-variance has a stabilizing effect on instability of rice production in all districts as well as in the state. the results are in corroboration with the studies conducted by chand and raju (2008), bastine and palanishami (1994) and for ginger crop by gaikwad et al. (1998). 4. conclusion and policy implication area under rice crop in the state as well as in the major rice growing districts increased overtime and rice crop at present become one of the main competing crop of the kharif season in the area. on the other hand, productivity of this crop has not increased over time rather it has been lower than national average. it can be inferred that the wide fluctuation in production of rice crop have been due to the high variability in its yield as well as in production. the future development programmes should envisage on stabilization of yield for bringing stabilization in production of the crop. the yield instability also needs to be reduced. this could be reduced by more investment on research leading to evolving of suitable rice production technology for varied agro climatic conditions of the state. there is also an urgent need to popularize the available hyvs released by saus and identified by aicrip in the upland drilled ecosystem, which accounts for nearly 30% area. it is because of the poor productivity of this fragile ecosystem that brings down the total productivity. references asopa, v.n. and g. naik, 1989. export prospects for indian seed spices. proceedings of first national seminar on seed spices, oct. 24-25, jaipur. pp: 435-37. bastine, c.l. and k. palanishami, 1994. an analysis of growth and trends of principal crops in kerala. agriculture situation in india, 38(12): 885-891. chand, s. and s.s. raju, 2008. instability in andhra pradesh agriculture — a disaggregate analysis. agricultural economics research review, 21(2): 283-288. gaikwad, s.h., p.v. thorve and b.d. bhole, 1998. economics of ginger production in amravati district of maharashtra. journal of spices and aromatic crops, 7(1): 7-11. hazell, p.b.r., 1982. instability in indian foodgrains production. international food policy research institute, washington, u.s.a., research report no. 30. kumar, n. and p.g. sankaran, 1998. instability in turmeric production in india. journal of spices and aromatic crops, 7(1): 19-22. pathak, a.r., a.m. mehta and r.d. vashi, 2011. status paper on rice in gujarat. published at rice knowledge management portal (rkmp), directorate of rice research, rajendranagar, hyderabad. available from http://www.rkmp.co.in. singh, p.k. and j.g. varshney, 2010. adoption level and constraints in rice production technology. indian res. j. ext. edu., 10(1): 91-92. views and opinions expressed in this article are the views and opinions of the authors, asian journal of economics and empirical research shall not be responsible or answerable for any loss, damage or liability etc. caused in relation to/arising out of the use of the content. http://www.rkmp.co.in/ 36 asian journal of economics and empirical research vol. 5, no. 1, 36-59, 2018 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2018.51.36.59 analyzing short-run and long-run causality between fdi inflows, labor productivity and education in pakistan ayesha serfraz1 1assistant professor at university of the punjab, lahore, pakistan abstract this study empirically analyzes the causal relationship between fdi inflows, labor productivity and education in case of pakistan using time series data from 1971-2016. the present study concentrates only on labor productivity since pakistan is a labor abundant country where provision of education is solely the responsibility of government of pakistan. for empirical analysis, it uses the latest test for measuring causality i.e., breitung-candelon granger causality test in frequency domain (both old and new versions). the traditional approach of johansen cointegration test has also been applied to check robustness of results. both versions of bc test, i.e., breitung and candelon (2006) and breitung and schreiber (2016) suggest a univariate causality running from fdi to labor productivity only, whereas johansen cointegration approach suggests a long run relationship among three variables. therefore government of pakistan must give proper attention to education sector in order to gain maximum benefits from fdi inflows. keywords: fdi inflows, labor productivity, education, causality, pakistan. jel classification: f20; i24; i22; j24. citation | ayesha serfraz (2018). analyzing short-run and longrun causality between fdi inflows, labor productivity and education in pakistan. asian journal of economics and empirical research, 5(1): 36-59. history: received: 14 may 2018 revised: 8 june 2018 accepted: 12 june 2018 published: 14 june 2018 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 37 2. literature review ......................................................................................................................................................................... 37 3. discussion of literature and new dimensions added by the present study ....................................................... 41 4. empirical analysis ....................................................................................................................................................................... 41 5. empirical tests ............................................................................................................................................................................. 43 6. discussion of results .................................................................................................................................................................. 49 7. conclusion and policy recommendations .......................................................................................................................... 49 references .............................................................................................................................................................................................. 50 appendix ................................................................................................................................................................................................ 51 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2018.51.36.59&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://orcid.org/0000-0001-8954-2858 asian journal of economics and empirical research, 2018, 5(1): 36-59 37 1. introduction the benefits of foreign direct investment inflows (fdi) and their impact on emerging economies is one of the highly debated topics among researchers and policy makers. although fdi inflows bring capital and modern technology, but abortive capacity depends on factor productivity because development of an economy is the direct result of an efficient use of its factors of production. according to kipsang (2015), labor productivity being an indicator of technical efficiency, depicts the varying pattern of factors of production and their use. without continuous positive growth in labor productivity, economic growth cannot be achieved. pakistan is a developing economy having labor as the most abundant factor of production and consequently, the techniques of production are also labor intensive. theoretically, it can be argued that fdi inflows increase labor productivity by bringing new technology, innovation and r&d. in addition, multinational companies (mncs) also play a vital role in increasing productivity through the channel of training and introduction of new ideas for production based on modern technology. according to dar et al. (2016), the offshoot of globalization is attracting the developing countries to strive for achieving the same level of technological development as that of the developed countries. in order to get maximum benefit from this technological diffusion, sufficient level of human capital development in the recipient country is the pre-requisite so as to remove all hindrances of absorbing the fruits of technological transmission. on the other hand, the relationship between labor productivity and education cannot be ignored. high level of quality education leads to an increase in labor productivity which in present times of globalization, is also referred to as human capital. nelson and phelps (1966) in their study concluded that investment in education is directly related to technological progress since educated people act as a catalyst for development of technology which results in economic growth. according to them, the rate of return of the investment on technology directly reflects in the technological progress of the economy. through investment in education, a society can build more human capital which would result in higher tangible capital through dynamic technology. though the impact of labor productivity has significant implications on relationship between education and economic growth but no straightforward formula is available to prepare an index for measuring this relationship between education and the dynamics of production. same is the case in pakistan. on the one hand fdi inflows lead to an increase in labor productivity through technology transfer, establishment of mnc’s, technical know-how and training, whereas on the other hand, due to technological backwardness, labor is unable to completely digest the new techniques. on the contrary, government does not make sufficient domestic spending on education which acts as a hurdle in converting labor into human resource. although no benchmark level of government spending on education, especially in monetary terms, has ever been suggested which could be related to labor productivity, but taking lead from the developed countries, government of pakistan must make high school level of education free and compulsory. it has to be ensured that there are no drop-outs and this policy is implemented in letter and spirit. this would go a long way in increasing the labor productivity. keeping in view this phenomenon, present study analyzes the dynamic and causal relationship between fdi inflows, labor productivity and education. for this purpose two separate models are constructed. model 1 analyzes the causality between fdi inflows and labor productivity and model 2 examines the relationship between labor productivity and education. since labor productivity is the common factor in both models and focal point of research, major section of literature review shall be throwing light on labor productivity. for empirical analysis, breitung and candelon (2006) granger causality test in the frequency domain has been applied. later to check the robustness of results, new version of breitung and candelon (bc) test suggested by breitung and schreiber (2016) has been used. since bc tests are quite new, therefore the traditional johansen cointegration test has also been applied in later part of paper in order to avoid any possibility of error in the empirical results. for this purpose time series data of pakistan from 1971-2016 has been used. this study is divided into 7 sections. section 1 gives the introduction of the topic and explains objective of the study. section 2 throws light at the relevant literature. section 3 is based on discussion of literature and explains endeavors of present study. section 4 discuses empirical analysis in detail along-with the relevant research available on empirical methods being used in this study. in section 5, empirical tests have been applied whereas, results are discussed in section 6. the last section concludes the study. the details of bc graphs and their interpretation are presented in the appendix. 1.1. objective of study this study is an attempt to analyze the relationship between fdi inflows, labor productivity and education in case of pakistan. the innovative characteristic of this study is its emphasis on labor productivity while most researches are based on total factor productivity (tfp) which includes both labor and capital. whereas in case of pakistan, the production function is mainly dependent upon the relationship between labor and output whereas capital is more or less fixed. the use of traditional cobb douglas production function may lead to wrong estimations. on the other hand, capital cannot be completely ruled out for which the factor of education has been included which is mainly responsible for converting a simple labor into human resource. particularly in case of pakistan labor can benefit from technological spillovers through fdi inflows if it is professionally trained through education. this relationship will be analyzed by examining government spending (percentage of gdp) on education sector. for this purpose, time series data of pakistan over the period of 1971-2016 has been analyzed. the main focus of the study is breitung and candelon test in frequency domain (both old and new version with and without conditions) to empirically analyze this relationship. in addition, since this study is based on time series analysis, the traditional tests for stationarity and cointegration cannot be ignored. 2. literature review the relationship between fdi inflows, labor productivity and education has been discussed comprehensively in the literature. for an in-depth debate, literature review has been divided into three sub-sections where section 1 asian journal of economics and empirical research, 2018, 5(1): 36-59 38 discusses the relationship/impact of fdi inflows on labor productivity. section 2 concentrates on the studies presently available which analyze the relationship and effect of education on labor productivity. these two subsections throw light on international studies related to the subject under discussion. section 3 purely concentrates on studies related to pakistan. 2.1. relationship between fdi inflows and labor productivity according to ramirez (2006) fdi inflows bring capital and technical know-how to developing economies which result in an increase in labor productivity. the author empirically analyzed the impact of fdi inflows on labor productivity by taking chile as the subject country and cointegration technique as the main test for empirical analysis. the econometric results suggested a positive effect of fdi flows on labor productivity during the time period of 1996-2000. a comprehensive study by zhu and tan (2000) empirically examined the causal relationship between labor productivity and inward fdi for different cities of china. for this purpose they used pooled city level data set with 2032 observations covering a time period of 11 years. granger causality technique was used by the authors for empirical test. according to them, determinants of labor productivity include level of education, training and infrastructure. their empirical findings are divided into four parts. according to first finding, fdi intensity in terms of per capita amount has a positive impact on labor productivity. secondly, the results also suggest that high level of labor productivity attracts more fdi. thirdly, fdi intensity in terms of geographical size does not affect labor productivity and high level of labor efficiency draws more fdi inflows per unit geographical area. in case of infrastructure, fdi is directly related to areas having better infrastructure. finally they conclude that coastal cities with better human resource management and good infrastructure, show better performance in case of absorbing the benefits of fdi flows. some important implications can be drawn from their study. first labor productivity has a positive relation with fdi flows and vice versa but quality cannot be ignored. secondly the major finding of their study is related to geographical area. this result can have general implications for developing countries. geographical areas with better quality of labor/human resource attracts more fdi. demeti and rebi (2014) carried out an empirical analysis to investigate the relationship between fdi and labor productivity in case of albania. using the correlation analysis and granger-causality test, they found a strong correlation between fdi and labor productivity. whereas, granger test indicated a unidirectional causation running from labor productivity to fdi but no evidence of “fdi causes productivity” was suggested by the causality test. according to the authors, the reason for such contradictory results may be due to the limited role of mncs with high technology in albania. they suggested that to benefit from fdi, greenfield fdi must be attracted in industries producing exportable products. this will result in more technology transfer and innovation in local firms. consequently fdi will have a positive causation with labor productivity of host country. a detailed and comprehensive study has been undertaken by mebratie (2010). the author used firm level crosssectional data for the years of 2003 and 2007 to study south african manufacturing industries. three techniques have been employed for conducting an empirical analysis. in the first case, ols estimates indicated a positive and significant effect of fdi on labor productivity of domestic firms. in second case, pooled data for two years also gave the same results and suggested a positive and significant relationship between foreign presence and productivity of domestic labor. contradiction arose between the results obtained through meta-analysis which indicated no impact (positive or negative) of fdi on labor productivity of domestic firms. author argues that this is due to the controversial role of mncs which give importance to their own workers and hence productivity of host country labor is not given importance. on the other hand, due to fdi inflows, technology transfer and innovation takes place resulting in imitation effect; domestic labor learns new techniques which results in an increase of labor productivity of domestic firms. the author finally concludes that foreign firms improve productivity of local workers through training but it may be limited due to limited horizontal linkages 1 between mncs and domestic firms. here an important point is worth mentioning that while discussing about the relationship between fdi inflows and labor productivity, the role of mncs cannot be ignored but there is no consensus about the exact role of mncs in increasing the labor productivity since they give more importance to their own workers as compared to workers of host country. a similar conclusion has been drawn by a study carried out by contessi and weinberger (2009) which mainly discusses and analyzes two important macroeconomic relationship; fdi and national growth, mncs and labor productivity. the authors throw light on the studies using growth regression approach and conclude that empirical research that makes use of firm and plant level data lead to an evidence of mncs having more concentration on productivity of labor in their home country as compared to host country, yet there is a limited positive impact on labor productivity of host country. mallick (2013) conducted an empirical analyses on oecd regions taking data for 22 years covering a time period from 1990-91 to 2011-12. the author focused on analyzing the relationship between indicators of globalization and labor productivity. the major indicators included fdi inflows and economic openness. the results of multiple regression model conveyed a positive and significant relationship between indicators of globalization and labor productivity. the author argues that globalization has a positive link with labor productivity through fdi which is responsible for bringing new technology to developing countries as developed countries have better technology as compared to 1 in a value chain, horizontal linkages are longer-term cooperative arrangements among firms that involve interdependence, trust and resource pooling in order to jointly accomplish common goals. both formal and informal horizontal linkages can help reduce transaction costs, create economies of scale, and contribute to the increased efficiency and competitiveness of an industry. link: https://www.microlinks.org/good-practice-center/value-chain-wiki/horizontal-linkages-overview. horizontal, n.d. horizontal linkages--overview. available from https://www.microlinks.org/good-practice-center/value-chain-wiki/horizontal-linkagesoverview [accessed 4th, march, 2017]. https://www.microlinks.org/good-practice-center/value-chain-wiki/horizontal-linkages-overview http://www.microlinks.org/good-practice-center/value-chain-wiki/horizontal-linkages-overview http://www.microlinks.org/good-practice-center/value-chain-wiki/horizontal-linkages-overview asian journal of economics and empirical research, 2018, 5(1): 36-59 39 emerging economies. developing countries benefit through spillover effects which increase labor productivity through adoption of latest technology. tintin (2012) empirically tested the relationship between productivity spillovers and fdi for 20 countries (10 developed countries and 10 developing countries) over the time period of 1984-2008. the author divided productivity measure into two categories; tfp and labor productivity. the panel cointegration results indicated a strong significant relationship between fdi and labor productivity through spillover effects but a weak association was observed between fdi and tfp. the findings also suggested that developing countries with good quality of labor benefit more from fdi as compared to low quality labor countries. nozuko (2016) conducted an empirical study to examine the impact of fdi on labor productivity in industrial sector of south africa using time period of 1995-2013. the results of johansen cointegration discovered a long run relationship between fdi inflows and labor productivity in case of south africa. the author also suggested that policy makers should give more importance towards improving labor productivity through professional training in order to increase the growth rate of industrial sector and hence economy as a whole. 2.2. relationship between education and labor productivity role of education in labor productivity cannot be ignored since the factor of education ranks at the top of the list in converting a simple labor/unskilled worker into a human resource who is not only skilled but contributes to economic well-being of country. one of the most renowned research on this topic was carried out by solow (1956) who debated that fluctuations in national income of a country were significantly dependent upon country’s physical and human capital. berger and fisher (2013) in their report highlighted that investment in education not only increases economic opportunities for workers but also leads to a high wage rate which contributes to a better living standard. jones (2008) carried out an empirical study to investigate the relationship between education, productivity and wages in case of ghana. the study used a panel of 200 manufacturing firms organized under the world bank’s ‘regional program for enterprise development’ (rped) and collected data during the summer of 1992, 1993 and 1994. the empirical results suggested that a high level of education has a direct and positive relationship with productivity and wage rate. most of studies concentrate on relationship between labor productivity, level of education and wage rate but the role of government spending has not been given much importance. on the other hand, this relationship cannot be ignored specially in case of developing economies since they need more educated and skilled labor because most of emerging economies are labor abundant. a study conducted by arshad and ab malik (2015) concluded that high quality of education is directly linked with high labor productivity. their study used panel data of 14 states of malaysia for a time period of 2009-2012. results of generalized least square (gls) suggested that in order to achieve high labor productivity, government of malaysia must give attention to health and education sector in order to fulfil their target of achieving the status of developed country by 2020. jung and thorbecke (2003) studied the patterns of public expenditure on education for the economies of tanzania and zambia. they suggested that high expenditures on education lead to more employment opportunities and consequently poverty got reduced. therefore a significant amount of investment in education is required to increase labor productivity otherwise there would be no gains in the form of more employment opportunities. baldacci et al. (2008) used panel data of 118 developing countries and concluded that spending on education and health have a significant impact on accumulation of human capital. in addition, it leads to a high overall growth of economy. the available literature mainly analyses the relationship between education and economic growth and where education has been discussed with reference to labor productivity, that discussion has remained restricted to the levels of education (primary, secondary, tertiary, etc.). the government spending on education, particularly in case of developing countries, with the view to enhance labor productivity has not received much attention from the researchers so far. this paper intends to fill up this gap. 2.3. fdi inflows, education and labor productivity in case of pakistan the relationship between fdi inflows and labor productivity has been well explained by alam et al. (2013) (2), in their own words “a productive labor force possesses obligatory as well as additional dexterity and has the ability to improve the overall the economic growth of a nation. however, foreign direct investment fits in the relationship between labor productivity and economic growth in the sense that labor productivity is enhanced by the inflow of capital from foreign investors. hence, labor productivity and foreign direct investment have significant roles to play in the development of the economy.”(page 133) in case of effects of fdi inflows, most of the studies concentrate on the relationship between fdi inflows and economic growth but the effect on labor productivity has not been given required attention. rehman (2016) carried out an empirical analysis using time series data of pakistan from 1970-2012. the results of vecm suggested that in order to gain from fdi, policy makers must give importance to literacy rate as technological gains are not possible without educated labor. mahmood and chaudhary (2012) conducted an empirical study to find the effect of sector-specific fdi on sector-specific labor productivity. the study is based on primary, secondary and tertiary sectors data covering time period of 1972-2000. ardl cointegration results suggested that fdi inflows do contribute to an increase in labor productivity in all sectors of pakistan. choudhry (2009) in his research argues that extent of productivity depends on education level but in case of low income countries, majority of population is employed in agriculture sector and have poor level of education. these countries are unable to enjoy the full benefits of fdi. author’s results are based on an empirical study which attempts to identify the potential determinants of labor productivity for developing economies belonging to 2 http://pubs.sciepub.com/jbms/1/6/3/# http://pubs.sciepub.com/jbms/1/6/3/ asian journal of economics and empirical research, 2018, 5(1): 36-59 40 different income groups. the study uses cross country panel data set of 45 countries for the period of 1980-2005. the empirical results suggest a strong impact of education and fdi on labor productivity but not in case of low income countries which also include pakistan in data set. wahab et al. (2013) analyzed the relationship between endowment of human capital, government spending on hrd and productivity of labor force in pakistan. they concluded that productivity of labor in case of pakistan is falling because of low government spending on hrd as percentage of gdp. the only productivity increase has been witnessed in the services sector during the past few decades. they suggest that the governance of public sector education must be improved as it is not only important for attracting foreign investors but also for increasing domestic investment. the authors suggested that labor productivity can be increased by investing in education, health and vocational training. ahmad et al. (2012) carried out an empirical analysis using time series data of pakistan from 1971-2007. their results suggested that fdi inflows play an important role in increasing gdp (economic growth) of pakistan. moreover, fdi inflows can stimulate human resource development (hrd) via investment in education and training. this leads to an increase in stock of human capital resulting in high labor productivity and high rate of economic growth through fdi. shafique and hussain (2015) in their study also concluded that fdi inflows increase economic growth of pakistan but to get maximum benefits from fdi inflows, there must be a proper system for providing education in order to make them skilled. for this purpose, investment in education must be given proper attention as it leads to an increase in labor productivity which in return has positive effects on fdi. usman et al. (2014) performed a correlation analysis between higher education, infrastructure and fdi using a sample of 22 countries and found a positive correlation between these three variables for the chosen sample of countries. the correlation analysis also suggested that higher education is more significant for attracting fdi as compared to primary education since mncs hire skilled labor having a high level of education. based on their results, they recommended that government of pakistan should give more importance to higher education for attracting more fdi as level of education is directly related to level of productivity leading to an increase in human capital. mahmood and rehman (2012) undertook an empirical analysis using time series data of pakistan from 19712009. their research basically concentrates on analyzing the impact of human capital on economic development, fdi inflows and domestic investment in pakistan. for measuring human capital, the proxies used by authors include high school enrolment, other institutional enrolment e.g. secondary, vocational, colleges and universities, the employed labor force and expenditure on education as percentage of gnp. the ardl approach to cointegration suggested that human capital enhances economic growth, fdi and domestic investment in pakistan. all proxies of human capital suggested a positive impact except the expenditure on education. they suggested that enrolment rate must be increased at all levels of education. this would cause growth in workforce having technical skills and know-how and consequently productivity would get enhanced, causing an increase not only in economic development but also in foreign and domestic investment. although their research is comprehensive and covers all aspects of human capital but more emphasis is given to other measures for increasing human capital and productivity as compared to government expenditure which is equally important and cannot be ignored. according to the working paper series of akram and khan (1961) the 1973 constitution of pakistan makes it mandatory to provide free and compulsory secondary education within minimum possible period. the constitution further makes it obligatory for the state to make technical and professional education accessible to all on the basis of merit. it further enjoins on the state to enable the people of different areas, through education, training, agriculture and industrial development and other methods to participate fully in the form of national activities including that of women in all the spheres of national life(3). however, despite these constitutional provisions, successive governments have failed in allocating sufficient resources to education sector which could enhance labor productivity. table-1. expenditures on education graph-1. expenditures on education as % of gdp (1) see page 12 for details (2) economics survey of pakistan (2014-15) source link: http://www.finance.gov.pk/survey/chapters_15/10_education.pdf http://www.finance.gov.pk/survey/chapters_15/10_education.pdf asian journal of economics and empirical research, 2018, 5(1): 36-59 41 although no benchmark can be prescribed in monetary terms for allocation to the education sector but the benchmark in terms of the objectives to be achieved is very much specifically prescribed in the constitution. the state has to allocate that much of resources which would achieve the specified objectives. however, the insufficient expenditure on education as a proxy of human capital suggests that government of pakistan is not giving required importance to this sector. very low sums are allocated to education sector. this is also evident from following figures related to government spending on education in case of pakistan. some important figures (4) 3. discussion of literature and new dimensions added by the present study the forgoing discussion of available international literature on the subject reveals that fdi increases labor productivity. on the other hand, education enhances not only efficiency of labor but also its productivity on account of acquiring new skills and technical know-how. this analysis gets substantiated from the study of developed countries which achieved rapid economic growth by investing higher amounts in education. in case of developing countries, mixed results have been obtained by different researchers but the importance of fdi for developing countries has been accepted by all researchers and policy makers. in case of pakistan, it has been argued that fdi inflows do affect labor productivity but the effects may be negative or positive depending on absorptive capacity of new technology. more educated labor has high level of productivity and in this case, benefits from fdi can be achieved in a more efficient way. here an important point worth mentioning is that most of the studies have related education with the level (primary, secondary, tertiary etc.) while fdi demands an available package of educated and productive labor having skills and technical know-how. unfortunately due attention has not been given by the government for providing sufficient financial resources to education sector. the argument is that fdi inflows do not provide funds for higher education, rather mncs hire educated labor and polish them through training. in this process, a major portion of workforce gets ignored since either they are totally uneducated or have a low level of education making them less productive as compared to those who have attained higher education. this problem can be resolved if government of pakistan gives higher priority to education sector and allocates more funds for the growth of education in the country. the other relationship (labor productivity and education) is also dependent on the government spending on education. in literature, most of the studies have ‘recommended’ that government must give proper attention to education sector if pakistan wants to attract more fdi as well as more gains from fdi, but there is a lack of empirical work for testing this relationship since level of education has been taken as a proxy measure for higher productivity and hrd. however it is the responsibility of the government to not only provide more opportunities for higher education, but also it must make education free and compulsory at least at the level of high school. although some vocational training schools have been established in rural areas during the last few years but due to shortage of competent instructors and paucity of funds coupled with low level of education, both of the trainers and trainees, those are far away from providing sufficient number of the professionally skilled workers to the foreign investors. living example of this phenomenon can be found in the execution of mega projects under cpec (china pakistan economic corridor) where a large number of chinese workers are deployed on account of non-availability of the professionally skilled workers to the required extent. 4. empirical analysis the empirical part is divided into four sections. this paper uses breitung candelon test as the main test for empirical analysis; the approach needs to be explained in detail. therefore in section 1, literature related to frequency domain approach has been discussed, while unit root tests have been applied and analyzed in section 2. as for section 3, it deals with empirical analysis using breitung and candelon’s granger causality test (bc) in frequency domain (both old and new versions with and without conditions). finally section 4 shows the traditional cointegration test since bc test is quite new especially the latest version by breitung and schreiber, therefore the empirical conclusion cannot be drawn solely on the basis of bc test. two econometric software’s have been used for empirical purpose. unit root tests and cointegration have been conducted using eviews. since bc test cannot be applied in eviews, for this purpose gretl has been used. 4.1. what is frequency domain causality analysis? before explaining the framework of causality tests in frequency domain, it is necessary to highlight the difference between frequency domain and time domain. according to pavia et al. (2008) time domain graph shows how a signal changes over time whereas, frequency domain graph shows how much of a signal lies within each given frequency band over a range of frequencies. regarding causality tests, granger (1988) is of the view that causality tests can be useful for explaining cause and effect relationship but order of integration and control variables must be handled carefully to get a proper evaluation. earlier granger (1969) explains that in case of bivariate causality, the feedback mechanism can be divided into two causal relations. but in case of trivariate relations, the spectrum cannot be considered as a sum of two spectra and results can be misleading due to the influence of third variable. geweke (1982) on the other hand proposed that the causality between a bivariate series can be measured at a particular frequency by decomposing spectral density; “in the case of univariate series, the measure of feedback from x to y at a given frequency is a monotonic transformation of the fraction of the spectral density of y due to the innovation in x in a bivariate autoregressive representation rotated so that all instantaneous feedback has been removed from the x-toy relation.” (page 313) a similar concept was introduced by hosoya (1991) where causality between a multivariate stationary series can be examined in both way; overall effect and causality at a given frequency. this framework was later adopted by breitung and candelon (2006) to construct a causality test in frequency domain both in short run and long run. their empirical analysis was based on quarterly data of us economy covering the time period of 1959 (first asian journal of economics and empirical research, 2018, 5(1): 36-59 42 quarter) to 1998 (fourth quarter). the traditional test of stationarity suggested presence of unit root and data was converted into first difference of logged series. the present study uses the same technique to measure the bivariate causality between the series of two models; lfdi↔lprod and ledu↔lprod. moreover the test uses both ‘conditioning out’ and ‘conditioning’ i.e., the causality between two series with and without the presence of exogenous/control variable which in case of first model is ledu and in case of second model is lfdi. adopting the econometric framework used by fritsche and pierdzioch (2016) the vma of a bivariate var model is explained by the following equation yt = ψ(l)ηt, where ηt = white noise disturbance l = lag operator ψ(l) = the lag polynomial following vector shows the partitioning of ψ(l) into parts as ψ(l) = ψ11(l) ψ12(l) ψ21(l) ψ21(l) geweke (1982) suggests the following measure for testing granger non-causality at a specific frequency𝜔 my1→y2 (ω) which can be calculated as my1→y2 (ω) = 1 + |ψ12 (exp (−ίω))|x2 |ψ11 (exp (−ίω))|x2 where ί = imaginary number breitung and candelon (2006) show that for a given frequency ω0, my1→y2 (ω0) = 0 ↔ ψ12 (exp (−ίω)) = 0, which in turn implies (two) linear restrictions on the vma representations. graphical analysis has been explained in appendix. the results are summarized in table 2. same procedure was adopted by tiwari (2014). the author used frequency domain test to examine the granger-causality between primary energy consumption and gdp for the economy of us covering the time period from january 1973 to december 2008. the empirical results suggested that the causal relationship vary across frequencies; short term, medium term and long term. mermod and dudzevičiūtė (2011) carried out an empirical analysis to examine the relationship between consumer confidence, economic growth and retailed sales. their analysis is based on grangercausality tests in both time domain and frequency domain for a sample of both developed and developing economies. according to authors, “the granger causality tests indicate whether the past changes in x (y) have an impact on current changes in y(x) over a specified time period. nevertheless, these test results can provide results on causality over all frequencies. on the other hand, geweke’s linear measure of feedback from one variable to another at a given frequency can provide detailed information about feedback relationships between growth and consumer confidence over different frequency bands.” (page 6) they argue that frequency domain test is superior in the sense that grangercausality tests give an average measure of causality whereas frequency domain test decomposes the causality at each frequency. their study concluded that frequency domain test provides better results as compared to time domain causality test. krätschell and schmidt (2012) in their study, gave similar arguments regarding time domain and frequency domain causality tests. they used frequency domain granger –causality test of breitung and candelon to analyze both short run and long run causality between energy prices and prices of food commodities. in addition to bc test, they also used grangercausality test in time domain to compare the results. according to the authors, frequency domain granger tests is superior over time domain granger tests since granger-causality tests are constructed on one period ahead forecasts which do not clearly distinguish between short run and long run fluctuations but frequency domain causality tests do not suffer from loss of information as these tests are applied at different frequencies. their empirical findings also suggested different results based on time domain and frequency domain causality tests.  drawback of old version and introduction of new version according to breitung and schreiber (2016) bc test suffers from a drawback; it is designed to test at a single frequency point where as many tests require an interval rather than a single point to get a better insight of causality. present study also makes use of the new version along-with the old version. since it was introduced in recent past, not much literature is available, consequently the framework adopted for carrying out empirical analysis makes use of original empirical framework introduced by breitung and schreiber (2016). the null hypothesis in case of new version does not test ‘no causality’ at frequency 𝜔0, rather it tests the null hypothesis of no causality in interval (𝜔l, 𝜔u). in this case the interval has also been defined; number of frequencies in the interval [0.01; 3.14] lowest frequency starts from 0.01 which is almost 0 and maximum frequency 3.14. it can also be presented as [0, π] one of the most important point mentioned by authors is (in original words) “given that strict non-causality over a range of frequencies is impossible in this (linear) framework except if there is no causality at all, accepting the null hypothesis still means that some causality exists in the band of the null hypothesis. for practical purposes it may therefore be advisable to keep the specified frequency band reasonably short.” (page 24) asian journal of economics and empirical research, 2018, 5(1): 36-59 43 4.2. why this test? since the present study is also based on examining bivariate causality, bc tests (old and new version) are used to get a better insight of both short run and long run causality. moreover, the studies which have used this test have mentioned that why causality test (bc) in frequency domain is superior over traditional granger-causality test in time domain (see section 4.1 for details). application of new version also makes this study more innovative and scientific. three basic benefits of this approach are; firstly it does not cause any loss of information. secondly, it gives a better insight of both short run and long run relationship. most importantly, the new version of bc test covers the minute details, which have been missed by old bc test since new version uses interval frequencies instead of a single frequency point. moreover, application of both tests with and without conditions of exogenous or control variables will allow comparisons and also check robustness of results. 4.3. data details and sources  data for fdi inflows has been extracted from world development indicators (wdi), world bank. unit = current bop us dollars  education (government spending as % of gdp) extracted from unesco.org, theglobaleconomy.com and pakistan economic survey (various issues)  labor productivity (labor productivity per person employed in 2015 us$ (converted to 2015 price level with updated 2011 ppps) extracted from the conference board 2016. following abbreviations have been used for presenting data fdi = fdi inflows prod = labor productivity edu = education  abbriviations for tests  adf = augmented dicky fuller test.  kpss = kwiatkowski–phillips–schmidt–shin test.  bc = breitung candelon test.  bs = breitungschreiber (different notations have been used to differentiate between old (bc) version and new version (bs). 4.4. model and hypothesis model 1: relationship between fdi and prod hypothesis: fdi and prod have bi-directional causality both in short run and long run. (positive relationship between fdi and prod) model 2: relationship between edu and prod hypothesis: edu and prod have bi-directional causality both in short run and long run. (positive relationship between edu and prod) as empirical analysis is based on time series data of pakistan from 1971-2016. the data is converted into logarithms. rationale: according to lütkepohl and xu (2012) many time series analysis are based on converting series into their logarithms (logs). this transformation is generally considered useful as it tends to stabilize the variance of series. ariño and franses (2000) argue that it is a common practice to convert time series into logarithms before carrying out into any empirical analysis. the main reasons behind this strategy is that by doing so, the impact of outliers can be controlled. moreover, this practice is also helpful in controlling the variance of underlying time series. since the present study also uses time series data for empirical analysis, all series are converted into logarithms. 5. empirical tests 5.1. unit root tests unit root tests are the first step in any time series empirical analysis. for this purpose, two tests have been applied; adf test (most common unit root test) and kpss test (which has an opposite null hypothesis, i.e., series is stationary). generally graphical analysis is carried out before presenting the test statistic values since it gives a quick idea about stationarity status of data. also it can be easily observed whether the data has any time trend or deterministic trend which makes it easier to decide for further tests to be applied. asian journal of economics and empirical research, 2018, 5(1): 36-59 44 graph-2. lfdi (log fdi) at level graph-3. dlfdi (log dfdi) graph-4. lprod (log lprod) at level graph-5. dlprod (log dlprod) graph-6. ledu (log edu) at level graph-7. dledu (log dedu) the graphical analysis indicates that series contain trend component and they become stationary at first difference to get more clear results (whether series are trend stationary or difference stationary), unit root tests (adf and kpss) have been presented in following tables. table-2. adf test statistic (t-values) empirical results variables at level at first difference order of integration components of equation trend and intercept intercept trend and intercept intercept lfdi -4.57*** -2.98* -10.87*** -10.84*** i(1) lprod -0.74 -1.76* -6.00*** -5.64*** i(1) ledu -2.68 -2.85** -6.06*** -6.01*** i(1) source: author’s estimation based on eviews output  null hypothesis (h0): series has a unit root (nonstationary)  if t-values (absolute or positive) are greater than critical values at 1%, 5% and 10%, null hypothesis (h0) is rejected i.e., series does not have unit root (it is stationary) *significant at 10% level of significance **significant at 5% level of significance *** significant at 1% level of significance test details: schwarz info criterion (automatic)  lag length: maximum lags 9 (automatic) results: graphical analysis shows that all series have a trend and are not stationary at level. however, the results of adf test indicate that lfdi is stationary at 1% level if the test includes both trend and intercept. but this is not the case if test includes intercept only. moreover, ledu series is stationary at 5% if measured using intercept only. to get same order of integration, all series are tested again at first difference using both trend and asian journal of economics and empirical research, 2018, 5(1): 36-59 45 intercept and only intercept. in both cases all series give same result and become stationary at same level of integration. therefore it can be concluded that all series are integrated of order one i.e., i (1). this leads to application of cointegration test. but before applying cointegration test, another test for unit root (kpss) is used to have a cross check. table-3. kpss (kwiatkowski-pillips-schmedt-shin) test statistic (lm-stat) empirical results variables at level at first difference order of integration components of equation trend and intercept intercept trend and intercept intercept lfdi 0.161*** 0.825 0.0529*** 0.176*** i(1) lprod 0.205*** 0.816*** 0.103*** 0.323*** i(1) ledu 0.133*** 0.253*** 0.035*** 0.095*** i(1) source: author’s estimation based on eviews output  null hypothesis (h0): series is stationary (absence of unit root).  if lm-stat value is less than critical values at 1%, 5% and 10%, null hypothesis (h0) is accepted i.e., series does not have unit root (it is stationary) *significant at 10% level of significance **significant at 5% level of significance *** significant at 1% level of significance test details:  spectrum estimation method: barlett kernel (default)  bandwidth : newey-west bandwidth (automatic)  lag length : 3 (automatic) results: results of kpss test are in consistence with both graphical analysis and adf test. since kpss test has an opposite null hypothesis (series is stationary), all series show stationarity at level when both trend and intercept are included, means all series are trend stationary (also evident from graphical analysis). at first difference, both the graphical analysis and test statistic show that trend has been removed, therefore it is assumed and concluded that all series are integrated of order one i.e. i(1). after having a detailed analysis of stationarity status of series (both graphically and empirically), further empirical tests can be applied. the following table explains the causality between variables using bc test (old version). 5.2. breitung candelon granger – causality test in frequency domain (for details see appendix) source: author’s estimation based on gretl output  = reject non-causality × = do not reject non-causality table-4. empirical results of bc test test specifications causality direction without condition variables fdi→prod prod→fdi edu→prod prod→edu at level  × × × at first difference × × × × with condition at level  × × × at first difference × × × × to check robustness of results, bc test in frequency band (new version labeled as bs test) is applied and results are shown in table 5. 5.3. breitung candelon granger – causality test new version by breitungschreiber (for details see appendix) assessing causality and delay within a frequency band in this case, instead of a frequency point, a frequency band (interval) is taken to measure granger – causality. all details have been mentioned in the literature. the test has been applied both at levels and at first difference using three bands; [0.01, 0.2], [1.8, 2.4] and [1.58, 3.14]. same analysis is applicable, i.e., movement towards left shows oscillations for long run and towards right, short run oscillations are observed. as shorter frequency is linked to a longer time period (fritsche and pierdzioch, 2016) the test starts with a band of lowest frequencies. second band is for medium and third band, having highest frequency, is used for testing short run causality. asian journal of economics and empirical research, 2018, 5(1): 36-59 46 table-5. empirical results of bs test 5.4. the traditional approachjohansen cointegration test following are the results of johansen cointegration test for model 1 and model 2.  model 1 as model 1 uses two variables; fdi inflows and labor productivity, the johansen test empirically analyzes the relationship between these two variables without using the impact of education which is discussed in model 2. table-6. johansen cointegration test for model 1 (i) using lfdi and lprod trace test and maximum eigen value test (results) table 6 shows that there exists a long run relationship between fdi inflows and labor productivity. since there can be errors in cointegration test, vecm (vector error correction estimates) is carried out to remove all errors and the results are shown in table 7. test specifications causality direction in frequency bands without condition variables fdi→prod prod→ fdi edu→ prod prod→ edu for frequency band [0.01, 0.2] at level  × × × for frequency band [1.8, 2.4] × × × × for frequency band [1.58, 3.14] × × × × at first difference for frequency band [0.01, 0.2] × × × × for frequency band [1.8, 2.4] × × × × for frequency band [1.58, 3.14] × × × × with condition at level for frequency band [0.01, 0.2]  × × × for frequency band [1.8, 2.4] × × × × for frequency band [1.58, 3.14] × × × × at first difference for frequency band [0.01, 0.2] × × × × for frequency band [1.8, 2.4] × × × × for frequency band [1.58, 3.14] × × × × source: author’s estimation based on gretl output  = reject non-causality × = do not reject non-causality sample (adjusted): 1974 2016 included observations: 43 after adjustments trend assumption: linear deterministic trend series: lfdi lprod lags interval (in first differences): 1 to 2 unrestricted cointegration rank test (trace) hypothesized no. of ce(s) eigenvalue trace statistic 0.05 critical value prob.** none * 0.339472 20.16154 15.49471 0.0092 at most 1 0.052716 2.328726 3.841466 0.1270 trace test indicates 1 cointegrating eqn(s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level **mackinnon et al. (1999) p-values unrestricted cointegration rank test (maximum eigenvalue) hypothesized no. of ce(s) eigenvalue max-eigen statistic 0.05 critical value prob.** none * 0.339472 17.83281 14.26460 0.0131 at most 1 0.052716 2.328726 3.841466 0.1270 max-eigenvalue test indicates 1 cointegrating eqn(s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level **mackinnon et al. (1999) p-values source: author’s estimation based on eviews output asian journal of economics and empirical research, 2018, 5(1): 36-59 47 table-7. unrestricted cointegaring coefficients unrestricted cointegrating coefficients (normalized by b'*s11*b=i): lfdi lprod -1.911247 9.433070 -0.803850 8.014995 unrestricted adjustment coefficients (alpha): d(lfdi) 0.328434 0.038980 d(lprod) 0.005189 -0.005789 1 cointegrating equation(s): log likelihood 65.44582 normalized cointegrating coefficients (standard error in parentheses) lfdi lprod 1.000000 -4.935559 (0.44766) adjustment coefficients (standard error in parentheses) d(lfdi) -0.627717 (0.15351) d(lprod) -0.009918 (0.00824) source: author’s estimation based on eviews output  model 2 model two is based upon testing the relationship between education and labor productivity, the cointegration test has been applied and results are shown in table 8 which indicates existence of a long run relationship between education and labor productivity. again application of vecm shows error free long run results for second model (table 8). table-8. vector error correction model vector error correction estimates sample (adjusted): 1974 2016 included observations: 43 after adjustments standard errors in ( ) & t-statistics in [ ] cointegrating eq: cointeq1 lfdi(-1) 1.000000 lprod(-1) -45.27628 (4.31025) [-10.5043] c 81.95366 error correction: d(lfdi) d(lprod) cointeq1 -0.609825 (0.15148) [-4.02580] -0.001062 (0.00086) [-1.22819] d(lfdi(-1)) 0.144389 (0.16157) [ 0.89368] 0.001296 (0.00092) [ 1.40550] d(lfdi(-2)) 0.123377 (0.11956) [ 1.03192] -0.000157 (0.00068) [-0.22935] d(lprod(-1)) -9.596191 (30.7156) [-0.31242] 0.084855 (0.17536) [ 0.48388] d(lprod(-2)) -28.85594 (28.8514) [-1.00016] -0.020001 (0.16472) [-0.12142] c 0.184379 (0.11813) [ 1.56084] 0.001995 (0.00067) [ 2.95753] r-squared 0.367614 0.106228 adj. r-squared 0.282157 -0.014552 sum sq. resids 10.36238 0.000338 s.e. equation 0.529211 0.003021 f-statistic 4.301719 0.879517 log likelihood -30.41947 191.7042 akaike aic 1.693929 -8.637405 schwarz sc 1.939677 -8.391657 mean dependent 0.134147 0.002238 s.d. dependent 0.624617 0.003000 determinant resid covariance (dof adj.) 2.54e-06 determinant resid covariance 1.88e-06 log likelihood 161.4146 akaike information criterion -6.856491 schwarz criterion -6.283077 source: author’s estimation based on eviews output d (differences represent short run time period) asian journal of economics and empirical research, 2018, 5(1): 36-59 48 table-9. johansen cointegration test for model 2 (ii) using ledu and lprod trace test and maximum eigen value test (results) sample (adjusted): 1973 2016 included observations: 44 after adjustments trend assumption: linear deterministic trend series: ledu lprod lags interval (in first differences): 1 to 1 unrestricted cointegration rank test (trace) hypothesized no. of ce(s) eigenvalue trace statistic 0.05 critical value prob.** none * 0.277141 16.41007 15.49471 0.0363 at most 1 0.047262 2.130254 3.841466 0.1444 trace test indicates 1 cointegrating eqn(s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level **mackinnon et al. (1999) p-values unrestricted cointegration rank test (maximum eigenvalue) hypothesized no. of ce(s) eigenvalue max-eigen statistic 0.05 critical value prob.** none * 0.277141 14.27982 14.26460 0.0497 at most 1 0.047262 2.130254 3.841466 0.1444 max-eigenvalue test indicates 1 cointegrating eqn(s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level **mackinnon et al. (1999) p-values source: author’s estimation based on eviews output table-10. unrestricted cointegrating coefficients unrestricted cointegrating coefficients (normalized by b'*s11*b=i): ledu lprod -6.741064 0.148046 2.992155 -3.927138 unrestricted adjustment coefficients (alpha): d(ledu) 0.053880 -0.009455 d(lprod) 0.005149 0.005458 1 cointegrating equation(s): log likelihood 137.9505 normalized cointegrating coefficients (standard error in parentheses) ledu lprod 1.000000 -0.021962 (0.13369) adjustment coefficients (standard error in parentheses) d(ledu) -0.363207 (0.10369) d(lprod) -0.034711 (0.02819) source: author’s estimation based on eviews output table-11. vector error correction model vector error correction estimates sample (adjusted): 1973 2016 included observations: 44 after adjustments standard errors in ( ) & t-statistics in [ ] cointegrating eq: cointeq1 ledu(-1) 1.000000 lprod(-1) -0.021962 (0.13369) [-0.16427] c -0.620356 error correction: d(ledu) d(lprod) cointeq1 -0.363207 (0.10369) [-3.50294] -0.034711 (0.02819) [-1.23137] d(ledu(-1)) 0.227252 (0.14392) [ 1.57898] 0.042690 (0.03913) [ 1.09103] d(lprod(-1)) -0.075420 (0.56213) [-0.13417] 0.115503 (0.15283) [ 0.75578] c 0.007589 (0.01925) [ 0.39432] 0.018453 (0.00523) [ 3.52676] r-squared 0.241079 0.068777 adj. r-squared 0.184160 -0.001064 sum sq. resids 0.416388 0.030776 asian journal of economics and empirical research, 2018, 5(1): 36-59 49 s.e. equation 0.102028 0.027738 f-statistic 4.235466 0.984761 log likelihood 40.09392 97.40116 akaike aic -1.640633 -4.245507 schwarz sc -1.478434 -4.083308 mean dependent 0.007523 0.021109 s.d. dependent 0.112958 0.027723 determinant resid covariance (dof adj.) determinant resid covariance 6.48e-06 log likelihood 137.9505 akaike information criterion -5.815931 schwarz criterion -5.410433 source: author’s estimation based on eviews output for both models, johasen cointegration test and vecm indicate that there exists a long run relationship between fdi inflows, labor productivity and education in case of pakistan. empirically the focal variable of labor productivity is affected by both fdi inflows and education, which supports the main idea of present study. 6. discussion of results according to empirical findings of breitung and candelon (2006) test, evidence of causality is found only in case of fdi affecting productivity when test is conducted at level using both components of test, i.e., with and without condition of exogenous/control variable. there is no evidence of either uni-directional or bi-directional causality between other variables. same results are obtained in case of breitung and schreiber (2016) grangercausality test in frequency domain (using a frequency band). a uni-directional causality runs from fdi to productivity for frequency band of [0.02, 0.2] representing a long run time period when analyzed at level. this test also uses both the components of test, i.e., with and without condition of exogenous variable. there is no causality in case of other frequency bands (medium term or short term) whether the test uses first differences or conditions. details are mentioned in appendix. regarding time period, 0.01 corresponds to 628 periods wavelength (app 52 years for annual data). 0.2 represents 32 periods (3 years). 1.8 = 3.5 periods (app) 2.4 = 3 periods (app) 1.58 = 4 periods (app) 3.14 = 2 periods (app) considering the results of traditional tests, i.e., johansen cointegration, there is an evidence of long run relationship between fdi inflows, labor productivity and education. although the lags are different for both models, yet the evidence of a relationship between variables cannot be ignored. 7. conclusion and policy recommendations the empirical findings of bc test suggest that fdi inflows increase labor productivity in pakistan, whereas no causality has been observed between education and productivity. whereas the relationship is evident in case of johansen cointegration test. the difference in results may be due to the difference in approach, yet the results of cointegration test cannot be ignored and it can be concluded that fdi inflows affect labor productivity and that the labor productivity also gets affected by education in case of pakistan. this is consistent with the actual scenario of pakistan. the government of pakistan is hardly spending 2 percent of gdp (on average) on education. a large number of teenagers are out of schools. labor, though abundant, but on account of being unskilled, and mostly illiterate, does not get jobs in the organizations set up by mncs as a result of fdi. in pakistan different systems of education are in vogue simultaneously i.e. religious schools called madrasas, government schools and private institutions. religious schools are managed by ngos and mostly are run by contributions from the community and children of lower strata of the society seek admission in such institutions where religious education is free. most of the government schools charge nominal fees but lack proper facilities and are generally considered to be of low quality. there is mushroom growth of private educational institutions but those are invariably very costly which a common man cannot afford. in the recent past technical and vocational institutions have also come up, both in the public and some in private sector. the institutions in the private sector, being costly, are beyond the reach of common man. on account of paucity of funds as well as scarcity of trained staff and equipment, the institutions in the public sector are still far away from catering to the requirements of the projects set-up by the foreign investors. the empirical analyses has led to the conclusion that fdi increases labor productivity both over long and short run time period. since the government of pakistan is spending a small portion of its gdp on education, educated and professionally skilled workforce is not available in sufficient numbers to absorb the technological spillovers from fdi. another important reason behind this unique causality is related to training being provided by foreign investors which leads to increase in productivity of labor. moreover, technology transfer leads to innovation and r&d which results in establishment of export promotion and import substitution industries either at small scale or large scale depending on absorptive capacity. although the quality may differ, yet the benefits are gained by the educated workers leading to an increase in productivity. this is not the case in education sector since low level of education makes the available labor force ineligible for working with foreign investors and mncs resulting in unemployment. if government of pakistan wants to achieve maximum gains from fdi, it must allocate proper funds to education sector that can allow an unskilled worker to convert into human resource, which also acts like capital for any economy. for education to become a source of increase in 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https://scholar.google.com/scholar?hl=en&q=human%20resource%20development,%20government%20spending%20and%20productivity%20of%20human%20resource%20development%20in%20pakistan https://scholar.google.com/scholar?hl=en&q=foreign%20direct%20investment%20and%20labor%20productivity:%20new%20evidence%20from%20china%20as%20the%20host http://dx.doi.org/10.1002/1520-6874(200009/10)42:5%3c507::aid-tie2%3e3.0.co;2-k asian journal of economics and empirical research, 2018, 5(1): 36-59 51 appendix detailed results of breitung candelon granger – causality test in frequency domain test specifications (for all tests): lag order = 3 frequency points = 50 significance level = 0.05 (i) without condition of exogenous/control variable  at level graphical properties: bc = breitung candelon test statistic siglevel = significance level pi = frequency null hypothesis = no causality values above the threshold means that the hypothesis of no causality is rejected. movement towards left side means long run causality and movement towards right side means short run causality. (i) lfdi→lprod (ii) lprod → lfdi (iii) ledu → lprod (iv) lprod → ledu  at first difference (i) dlfdi → dlprod (ii) dlprod → dlfdi (iii) dledu → dlprod (vi) dlprod → dledu asian journal of economics and empirical research, 2018, 5(1): 36-59 52 interpretation of results: referring to long run and short run analysis carried out by krätschell and schmidt (2012) the evidence of granger causality can be found only in case of lfdi→lprod in the range of [0, 0.5]. as this is a bivariate system, therefore two graphs are shown for each case. the frequencies on x-axis range from [0-3.2]. since the time period and frequencies are determined using the formula 𝜔= 2π/t = 2πf, time period t can be determined through t=2π/ 𝜔. if frequency is 0.5, it corresponds to time period (t) of more than 12 months. movement towards left side represents long periods and the movement towards right shows short run. in all other cases, test statistic is below significance level, therefore there is no strong evidence of grangercausality. (ii) with condition of exogenous/control variable  at level (i) lfdi→lprod (exog=ledu) (ii) lprod→lfdi (exog=ledu) (iii) ledu→lprod (exog=lfdi) (iv) lprod→ledu (exog=lfdi)      at first difference (i) dlfdi→dlprod (exog=dledu) (ii) dlprod→dlfdi (exog=dledu) (iii) dledu→dlprod (exog=dlfdi) (vi) dlprod→dledu (exog=dlfdi) asian journal of economics and empirical research, 2018, 5(1): 36-59 53 interpretation of results: there is not much difference in results as compared to previous analysis (without condition). the evidence of grangercausality can be found only in case of lfdi→lprod in the range of [0, 0.5]. since all graphs show bivariate relationships, the evidence of bivariate causality is present only in (i) where rest of the graphs do not show a strong evidence (or no evidence) of granger causality at least in long run. the empirical testing is same in this case also. same analysis is used to measure time period and frequencies. detailed results of breitung candelon granger – causality test: new version by breitungschreiber assessing causality and delay within a frequency band without condition of exogenous/control variables  at level (with interpretations)  frequency band [0.01, 0.2] (i) lfdi→lprod (ii) lprod→lfd (iii) ledu→lprod (iv) lprod→ledu results: (i) reject non-causality (ii) do not reject non-causality. (iii)do not reject non-causality. (iv) do not reject non-causality. asian journal of economics and empirical research, 2018, 5(1): 36-59 54  frequency band [1.8, 2.4] (i) lfdi→lprod (ii) lprod→lfdi (iii) ledu→lprod (iv) lprod→led results: (i) do not reject non-causality. (ii) do not reject non-causality. (iii) do not reject non-causality. (iv) do not reject non-causality.  frequency band [1.58, 3.14] (i) lfdi→lprod (ii) lprod→lfdi (iii) ledu→lprod (iv) lprod→ledu results: (i) do not reject non-causality. (ii) do not reject non-causality. (iii) do not reject non-causality. (iv) do not reject non-causality. asian journal of economics and empirical research, 2018, 5(1): 36-59 55  t first difference (with interpretations)  frequency band [0.01, 0.2] (i) dlfdi→dlprod (ii) dlprod→dlfdi (iii) dledu→dlprod (iv) dlprod→dledu results: (i) do not reject non-causality. (ii) do not reject non-causality. (iii) do not reject non-causality. (iv) do not reject non-causality. note: (i) and (iii) are different graphs but values are very close.  frequency band [1.8, 2.4] (i) dlfdi→dlprod (ii) dlprod→dlfdi (iii) dledu→dlprod (iv) dlprod→dledu results: (i) do not reject non-causality (ii) do not reject non-causality. (iii) do not reject non-causality. asian journal of economics and empirical research, 2018, 5(1): 36-59 56 (iv) do not reject non-causality.  frequency band [1.58, 3.14]  (i) dlfdi→dlprod (ii) dlprod→dlfdi (iii) dledu→dlprod (iv) dlprod→dledu results: (i) do not reject non-causality (ii) do not reject non-causality. (iii) do not reject non-causality. (iv) do not reject non-causality. with condition of exogenous/control variables  at level (with interpretations)  frequency band [0.01, 0.2] (i) lfdi→lprod (exog=ledu) (ii) lprod→lfdi (exog=ledu) (iii) ledu→lprod (exog=lfdi) (iv) lprod→ledu (exog=lfdi) asian journal of economics and empirical research, 2018, 5(1): 36-59 57 results: (i) reject non-causality (ii) do not reject non-causality. (iii) do not reject non-causality. (iv) do not reject non-causality.  frequency band [1.8, 2.4] (i) lfdi→lprod (exog=ledu) (ii) lprod→lfdi (exog=ledu) (iii) ledu→lprod (exog=lfdi) (iv) lprod→ledu (exog=lfdi) results: (i) do not reject non-causality (ii) do not reject non-causality. (iii) do not reject non-causality. (iv) do not reject non-causality.  frequency band [1.58, 3.14] (i) lfdi→lprod (exog=ledu) (ii) lprod→lfdi (exog=ledu) (iii) ledu→lprod (exog=lfdi) (iv) lprod→ledu (exog=lfdi) asian journal of economics and empirical research, 2018, 5(1): 36-59 58 results: (i) do not reject non-causality (ii) do not reject non-causality. (iii) do not reject non-causality. (iv) do not reject non-causality.  at first difference (with interpretations)  frequency band [0.01, 0.2] (i) dlfdi→dlprod (exog=dledu) (ii) dlprod→dlfdi (exog=dledu) (iii) dledu→dlprod (exog=dlfdi) (iv) dlprod→dledu (exog=dlfdi results: (i) do not reject non-causality (ii) do not reject non-causality. (iii) do not reject non-causality. (iv) do not reject non-causality.  frequency band [1.8, 2.4] (i) dlfdi→dlprod (exog=dledu) (ii) dlprod→dlfdi (exog=dledu) (iii) dledu→dlprod (exog=dlfdi) (iv) dlprod→dledu (exog=dlfdi asian journal of economics and empirical research, 2018, 5(1): 36-59 59 results: (i) do not reject non-causality (ii) do not reject non-causality. (iii) do not reject non-causality. (iv) do not reject non-causality.  requency band [1.58, 3.14] (i) dlfdi→dlprod (exog=dledu) (ii) dlprod→dlfdi (exog=dledu) (iii) dledu→dlprod (exog=dlfdi) (iv) dlprod→dledu (exog=dlfdi results: (i) do not reject non-causality (ii) do not reject non-causality. (iii) do not reject non-causality. (iv) do not reject non-causality. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. asian journal of economics and empirical research issn: 2409-2622 vol. 1, no. 1, 10-15, 2014 http://asianonlinejournals.com/index.php/ajeer 10 molding the young for proper socio-economic development: the case for vocational guidance and counselling in the secondary school system in zimbabwe maxwell constantine chando musingafi zimbabwe open university: department of development studies, zimbabwe racheal mafumbate zimbabwe open university; department of counselling, zimbabwe abstract this work is licensed under a creative commons attribution 3.0 license asian online journal publishing group 1. introduction comprehensive developmental school counselling programmes positively impact students, parents, teachers, administrators, boards of education, other student services personnel, school counsellors, business, and industry. thus borrowing from shumba (1995), no child should go through secondary school education without having received guidance and counselling because this tends to lead students to develop unrealistic ambitions that result in them becoming discontented members of the society. in this paper we look at some of the benefits of vocational guidance and counselling in the secondary school system as supported by empirical evidence from the usa, uk, canada, hong kong, malawi and zimbabwe. the paper is based on literature review and content analysis. we place the benefits of guidance and counselling in the secondary school system into three categories as identified by chireshe (2006). these benefit categories include personal-social, scholastic-academic, career and vocational benefits. we start by exploring the meaning of important concepts before exploring the benefits of guidance and counselling and arguing the case for vocational guidance and counselling in the secondary school system in zimbabwe. 2. definition of terms guidance: the concepts guidance and counselling carry differing but overlapping meanings (chireshe, 2006). guidance is broader than counselling and contains the latter (mapfumo, 1992). guidance encompasses those services and programmes of the school, which are specifically intended to promote educational, career, and personal-social development of students (chireshe, 2006). bhatnagar and gupta (1999) define guidance as a process of helping the individual find solutions to his own problems and accept them as his own. it is thus a process, developmental in nature, by which an individual is assisted to understand, accept and use his/her abilities, aptitudes and interests and attitudinal patterns in relation to his/her aspirations. (guez and allen, 2000). guidance programmes for secondary school students are designed to address the physical, emotional, social and academic difficulties of adolescence in this desktop based paper we argue the case for school based vocational guidance and counselling services in zimbabwe. we establish that school based vocational guidance and counselling services help students to reflect on their ambitions, interests and abilities. young people experience problems, especially in their vocational development and eventually leading to a mismatch in the job market world. these include a lack of knowledge of their own aptitudes and interests; a lack of realism; indecision; inflexibility and unwillingness to change; a lack of occupational information; problem-solving skills; and gender stereotypes. our argument in this paper is that in the modern constantly changing world, students should be helped to seek and use current occupational information, clarify their own values, feelings and attitudes, and relate them to educational and vocational demands. we thus categorize the benefits of guidance and counselling into the following groups: personal-social benefits; scholastic-academic benefits; and career vocational benefits. keywords: guidance, counselling, socio-economic development, vocation, career, secondary school .school. http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2014, 1(1):10-15 11 (abid, 2006). it is thus an umbrella term encompassing many services aimed at students‟ personal and career development (hughes and karp, 2004). career / vocation: according to unesco (2000) a career is a sequence of major positions occupied by a person throughout life. it is the totality of work one does in a lifetime (sadock and sadock, 2003). a vocation is defined by unesco (2000) as an urge or commitment to work in a particular occupation. it is equated to a career or calling as the word is derived from the latin vocare, which means to call (http://www.wisegeek.com/what-isvocational-guidance.htm, accessed on 28 march 2014). vocational / career guidance: this is the portion of the guidance programme focused on students‟ career development. this can include career counseling or other career-related services (hughes and karp, 2004). unesco (2000) defines vocational guidance as the process of helping an individual to choose an occupation, prepare for it, enter it, and progress in it. it is guidance given to learners that is aimed at study method, occupational choice and planning, and developing the learners' future career. it includes self-knowledge, educational knowledge and occupational knowledge with a view to making meaningful occupational choices (crites, 1971).vocational guidance means helping someone find his or her calling or at least a suitable career choice (http://www.wisegeek.com/what-is-vocational-guidance.htm, accessed on 28 march 2014). counselling: counselling is defined as a one to one relationship between a counsellor and a client whereby the counsellor attempts to help the specific individual make personally relevant decisions that he or she can live with (chireshe, 2006). counselling may involve groups. in the secondary school setting thus counselling means helping students to help themselves. in this regard, school counsellors assist students to understand themselves and their opportunities, to make appropriate adjustments and decisions in the light of this insight, to accept personal responsibility for their choices and to follow courses of action in harmony with their choices. counselling is understood as a major guidance service (chireshe, 2006). career counseling: this is the portion of the guidance and counselling programme in which trained professionals interact with students to assist them with their career development (hughes and karp, 2004). counsellor: bulus (1990) defines a counsellor as “one who helps the client to explore his feelings, take appropriate decisions, and initiate new actions to resolve problems”. a counsellor is thus a patient listener who knows how to encourage client and gives reassurance, and has a deep understanding of human motives. in the secondary school setting the counsellor thus makes every effort to be very close to students in order to direct and modify their behaviour towards useful purpose (ogbodo, 2010). vocational adjustment: according to bholanath (2005), this is the outcome of the handling of vocational development problems encountered by the individual. it is the result of the interaction between one's personal resources including his / her vocational maturity (what one can bring to his / her encounters with reality on the one hand, and the reality demands on the other). crites (1971) defines this adjustment as career maturity. a person with career maturity is thought to be emotionally stable and have the ability to make good vocational choices (osipow, 1983). most theorists concur that if an individual's psychological development is inadequate, career development will not progress smoothly (pendergrass, 1987). career readiness: this refers to a level of maturity to acquire specific information on career options; to identify interests, values, and aptitudes; to use this information in career planning and course selection and to change plans when pertinent information is presented (bholanath, 2005). career readiness / maturity is thought to be the interaction between an individual's resources (crites, 1971). winecoff and lyday (1978) believe that reasonable career maturity for high school adolescents should involve the understanding of basic work values and attitudes including some initial experiences with several job clusters; an awareness of personal interests and abilities; higher levels of achievement in basic academic skills; a tentative selection of preferred job clusters; and a sense of civic responsibility. 3. benefits of guidance and counselling in secondary schools chireshe (2006) categorizes the benefits of guidance and counselling into personal-social benefits; scholasticacademic benefits; and career vocational benefits. 3.1. personal-social benefits according to the zimbabwe secretary‟s circular no. 2 of 2000, school guidance and counselling services are important for all students especially those who are unhappy, underachieving or at risk of dropping out of school. lonborg and bowen (2004) and lapan (2001) argue that in america, counselling programmes in the secondary school system create a safe school environment. lapan and kosciulek (2003) state the programmes engender greater student feelings of safety in schools. in this kind of environment, students have a sense of belonging. bruckner and thompson (1987) state that in america, students were able to make friends and hold their temper down as a result of the counselling services they would have received. thus school based counselling help students relate well with their immediate social environment. siann et al. (1982) posit that the main criterion in assessing the effectiveness of school based counselling programmes is whether or not the school counsellors were seen as helpful in problem situations. wiggins and moody (1987) state that in america, students surveyed gave excellent ratings to the school based counselling services they received. earlier on leviton (1977) found that the majority of american students revealed that the school counsellors had been helpful with students‟ problems. lee (1993) argues that students who participated in school based counselling services in american schools viewed themselves more positively and began to predict their own success in school. armacost (1990) says that many students in america indicated that they preferred to talk to the school counsellor about personal problems other than any staff. counselling in schools thus make students feel confident of both themselves and the school based counsellor. http://www.wisegeek.com/what-is-vocational-guidance.htm http://www.wisegeek.com/what-is-vocational-guidance.htm http://www.wisegeek.com/what-is-vocational-guidance.htm asian journal of economics and empirical research, 2014, 1(1):10-15 12 euvrard (1996) points out that effective south african high school guidance services operate in a preventive way and equip students with information, skills and attitudes which enable them to successfully negotiate the challenges of adolescence. adolescents are helped to develop social skills in getting along with the opposite sex. thus, effective school counselling services result in fewer personality or social maladjustments. the above argument is supported by (rowley et al., 2005) who state that effective school counselling services in america help students acquire developmental competencies such as establishing and maintaining peer relationships. zimbabwean teachers indicated that school based counselling services improve social, interpersonal and problem solving skills (mudhumani, 2005). nyanungo (2005) and badza (2005) reinforce the above point when they state that effective school based counselling services result in the decrease of cases of poor discipline among learners and reduced school dropout rates. the above views are supported by mukamwi (2005) who states that school based counselling services equip students with problem-solving and decision-making skills. chivonivoni (2006) adds that zimbabwean school based counselling services impart life skills, attitudes and values to students that enable them to solve problems and make sound decisions. chivonivoni (2006) further states that zimbabwean school based counselling services help adolescents address the social, psychological and emotional problems they experience. thus, school based counselling services help reduce irregular behaviour patterns emanating from social, psychological, emotional and developmental problems. it is thus concluded that school based counselling programmes help students adjust well to their personal and immediate social environment. such counselling programmes create base for successful adult relationships and therefore they can be regarded as social orientation to adulthood. 3.2. scholastic-academic benefits the nziramasanga (1999) reports that repeating or failing in zimbabwean schools may be minimised to a negligible level when cases of slow learners and learners who are not confident are spotted and provided with counselling services. mudhumani (2005) adds that school based counselling services reduce students‟ educational problems and make students discover occupations that suit their abilities. gerler (1985) reports that school counselling services in america positively influence the affective, behavioural and interpersonal domains of children‟s lives and thus affect students‟ achievement positively. it was also established in america that effective school counselling results in an increase of behaviours related to achievement such as improved study habits, efficient use of time and greater academic effort (otwell and mullis, 1997). st clair (gerler and herndon, 1993) adds that effective school based counselling services can improve classroom behaviour, reduce students‟ anxiety and improve self-concept. schmidt (1993) states that effective school counselling services in america assist students in becoming able learners. this assistance is achieved through helping teachers to adopt effective teaching methods and creating safe classroom environments. besley (2002) states that effective school based counselling services in scotland remove some barriers to learning that students may face and consequently, teachers concentrate on their major task of teaching. this results in better academic results. related to the above is carnevale and desrochers (2003), view that american school counselling, “helps students develop education strategies that will allow them to meet academic requirements and at the same time develop soft skills and attitudes that are typically learned in applied contexts”. lapan and kosciulek (2003) add that academic achievement in american schools is to be “best understood within a comprehensive framework that includes activities such as problem solving, classroom performance, work-based performance, standardised test scores and vocational skills development”. borders and drury (1992) cite studies in america that show increased academic achievement, academic persistence, school attendance and positive attitude towards school and others as a result of school counselling. lee (1993) found that american classroom guidance lessons led by counsellors can “positively influence students‟ academic achievement in mathematics”. in the same country, improved academic achievement resulting from receiving effective school based counselling services is also reported by sink and stroh (2003); gibson (1989); blum and jones (1993) and otwell and mullis (1997). hui (1998) reports similar experiences in hong kong. american students, parents and teachers viewed the school based counselling services as having a positive impact on students (hughey et al., 1993) whilst canadian school counsellors viewed themselves as having an impact on classroom behaviour problems (gora et al., 1992). it is thus established that school based counselling programmes help students enhance their academic performance. they make students comfortable at school, improve school attendance and result in the improvement of academic performance of under-achievers. 3.3. career and vocational benefits the nziramasanga (1999) reports that guidance and counselling assists learners in identifying their own talents and in making intelligent choices for their future careers. school guidance and counselling services foster better parental understanding of the potentialities and abilities of their children (mapfumo, 2001). okey et al. (1993) and jones (1993) say that in america, students who received school based counselling services reported that they learnt about careers, developed a clearer idea about possible careers for themselves, learned things about themselves and had been encouraged to learn more about careers. maluwa-banda (1998) supports the above when he states that malawian secondary school based counselling services help students understand their own interests, abilities and potentialities and develop them to the full. students are also helped to identify educational and vocational opportunities. lapan et al. (1997) report that american schools with effective school based counselling services had students reporting that they had earned higher grades, their education was preparing them for their future, their schools made more career and college information available and their school had a more positive climate. hartman (1999) states that in vocational guidance, effective canadian school based counselling services enable students to develop “decision-making skills to the point of being capable of making realistic choices from short term asian journal of economics and empirical research, 2014, 1(1):10-15 13 to longer term. that is, students are assisted in assessing their aspirations, values, interests and aptitudes when making career decisions and plans. taylor (1971) notes that british school counselling services help students throughout their secondary education, to plan their vocational and educational progress. the school counselling services help students learn of possible future educational and vocational opportunities. mudhumani (2005) found that ordinary zimbabwean secondary school teachers perceived the school based counselling services as addressing the students‟ career aspirations. zimbabwean school based counselling services help students to become aware of their career choices (badza, 2005). school based guidance and counselling is thus important for clearing the way students should follow. otherwise they are left in the dark. they need a roadmap for ensuring smooth sailing through into the world of adulthood and employment. 4. an overview of the argument for vocational guidance for secondary school students according to unesco (2000) vocational guidance was originally thought to be provided only prior to training and employment. however, it is a lifelong process for many individuals at various stages of their lives. at such stages individuals reconsider and re-diagnose their capabilities and match them against the opportunities available. in this way, vocational guidance is aimed at helping students to make not only specific choices but also good decisions (mapfumo, 2001). it recognizes that flexibility, and a willingness to change, may be as critical for a student as the ability to commit oneself to a particular goal. it has been established that career and vocational guidance helps people to reflect on their ambitions, interests, qualifications and abilities (mapfumo, 2001; chireshe, 2006). it helps them to understand the labour market and education systems, and to relate this to what they know about themselves. comprehensive career guidance tries to teach people to plan and make decisions about work and learning. career guidance makes information about the labour market and about educational opportunities more accessible by organising it, systematising it, and making it available when and where people need it (mapfumo, 2001). unesco (2000) argues that the provision of vocational guidance in educational institutions has been necessitated by great changes in society. automation and recession, for example, have forced many people into early retirement and retrenchment, resulting in unemployment. the rate of technological change and the isolation of young people from possibilities for employment have created problems in occupational choices. many students are not able to obtain an informal exposure to a variety of occupations, nor can they easily obtain relevant data about them. students have a limited knowledge of occupations and of the narrow range of alternatives available to them. this ignorance leads to unrealistic career aspirations (bholanath, 2005). there is, therefore, a need to assist students to have more realistic career expectations. several studies (burkheimer and jaffe, 1981; somers, 1981; ingels, 1990; lee, 1993; mau, 1995) suggest that many school-leavers remain vocationally immature, lack understanding of the importance of career planning, and lack the knowledge to plan their high school curricula. although junior secondary school learners appear to value the need for post-secondary education (larter, 1982), few understand the importance of preparatory work (mau, 1995) and the knowledge of career resources available to them (lee, 1993). the majority of young people leave school with only a vague knowledge of employment opportunities and with little insight as to the most appropriate career direction for their abilities, interests and personality. a large number of school-leavers receive no training at all beyond school and become virtually unemployable (bholanath, 2005). and yet, if pointed in the correct direction, could become assets to the national economy. helping learners to understand career readiness and nullifying the effects of vocational immaturity and underachievement is the basic premise for pre-tertiary interventions. in a meta-analysis study of 67 career interventions, evans and burck (1992) discovered that average ability students involved in career interventions appeared to profit the most in academic achievement. toepfer (1994) concurred by stating that children who learn to relate schoolwork with the real world experiences do better in school. career programmes in the early grades of high school can help children understand the changing circumstances that face them in trying to achieve the work ethic (toepfer, 1994). as life-long learning becomes a basic educational outcome, it is essential that young adolescents understand their need to become life-long learners. the value of education could be powerfully influenced by career programmes that connect them with potential employment and career interests (toepfer, 1994). career readiness in high school would include what winecoff and lyday (1978) calls a basic understanding of work values and attitudes such as an awareness of and some experience with job clusters, an awareness of personal interests and abilities, higher levels of achievement in basic academic skills, a tentative selection of preferred job clusters, and a sense of civic responsibility. bholanath (2005) observes that the variable of career readiness is critical to tertiary educational planning. it is believed that for one to develop aspiration, one needs to have some understanding of occupational information and self-awareness (interests, values, abilities, etc.). this understanding gives way to broad career possibilities and opportunities, the purpose of school, and the development of a career plan. without this understanding, one may lack the maturity to progress to the next development stage and / or succumb to internal and external negative impediments to post-secondary aspiration. cogen (1992) wrote that adolescents have a tendency to be negative, sensitive and defensive and spend more time alone in their rooms. cogen also felt that early adolescence is also a time of maturation in the thinking process. in high school, an early adolescent begins to consider hypothetical problems that begin with a whatif' mode of thinking and permits the child to move from one item into many possibilities. unfortunately, adolescence is also characterized as an age where one is preoccupied with thoughts of personal growth and peer relations. there is a tendency to value education less, especially if there is little relevancy between school-learning and their lives outside the classroom (cogen, 1992). asian journal of economics and empirical research, 2014, 1(1):10-15 14 early adolescents need assistance in planning and preparing for the future. carpenter and western (1992) feel that children in this age group need pre-tertiary counselling that develops aspiration, sustains motivation, promotes effective study skills, clarifies values, differentiates among programmes and courses, discusses graduation requirements, introduces guidance resources, and suggests the possibility of college and the availability of financial aid. according to toepfer (1994), career education should be a major preparation focus in the high school where early adolescents explore careers, develop attitudes, and understand work and employability skills. fouad (1995) writes that the goal of education should be focused on increasing, at an early age, a student's career knowledge, selfesteem, maths and science achievement, and high school course selection. 5. conclusion in this paper we argued that school based vocational guidance and counselling services help students to reflect on their ambitions, interests and abilities. young people experience problems in their social and vocational development. these include a lack of knowledge of their own aptitudes and interests; lack of realism; indecision; inflexibility and unwillingness to change, lack of occupational information; weak problem-solving skills; and gender stereotypes. in a constantly changing world, students should be helped to seek and use current occupational information, clarify their own values, feelings and attitudes, and relate them to educational and vocational demands. thus school based career guidance plays a key role in helping labour markets work and education systems meet their goals. it also promotes equity as social mobility relies on wider acquisition not just of knowledge and skills, but of an understanding about how to use them. it has therefore been established that school based guidance and counselling is of great necessity in the secondary school system to ensure proper alignment and placement of human resources for socio-economic development not only in zimbabwe, but the whole international community. references abid, h.c., 2006. effect of guidance services on study attitudes, study habits and academic achievement of secondary school students. bulletin of education and research, 28(1): 35-45. armacost, r.l., 1990. high school student stress and the role of counsellors. the school counsellor, 38(2): 105-112. badza, m., 2005. pupils and teachers‟ perceptions of the effectiveness of guidance and 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h.i.f., 1971. school counselling. london: macmillan. toepfer, c., 1994. vocational /career / occupational education at the middle level: what is appropriate for young adolescents? middle school journal, 25(3): 59-65. unesco, 2000. guidance: module 1. botswana. unesco. wiggins, j.d. and a.h. moody, 1987. student evaluations of counselling programmes: an added dimension. the school counsellor, 34(2): 353-361. winecoff, l. and j. lyday, 1978. an introduction to career education. in g. green & associates (eds.), the philosophy and practice of career education. london, ky: guifford-hiii. pp: 23-42. bibliography secretary‟s, c.n., 2001. curriculum policy: primary and secondary schools. harare: ministry of education, sport and culture. views and opinions expressed in this article are the views and opinions of the authors, asian journal of economics and empirical research shall not be responsible or answerable for any loss, damage or liability etc. caused in relation to/arising out of the use of the content. 180 © 2019 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 6, no. 2, 180-185, 2019 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2019.62.180.185 © 2019 by the authors; licensee asian online journal publishing group external environmental factors and failure of small and medium enterprises in kano metropolis salihu abubakar1 abubakar sambo junaidu2 ( corresponding author) 1department of business administration and management waziri umaru federal polytechnic, birnin kebbi, nigeria. 2department of business administration usmanu dan fodiyo university, sokoto, nigeria. abstract this study examines the relationship between external environmental factors and failure of smes in kano metropolis, using samples of failed smes in kano metropolis. questionnaire was used to collect primary data from the sampled failed smes using snow ball method. the data was analyzed using multiple regression technique and descriptive statistics in order to establish the significance of the estimated relationships. the outcome reveals that external environmental factors have significant impact on the failure of smes in kano metropolis, and inadequate infrastructure (ii) is the major contributing factor to the failure of smes in the kano; followed by market competition (mc), market demographics (md), and financial inadequacy (fi). in order to reduce smes failure and achieve significant positive contribution of smes sub-sector to the economic development of the state, the study recommends that government and relevant stakeholders should create an enabling business environment with adequate infrastructures, fear competition, sound market places and financial support. keywords: smes, external factors, failure, kano. citation | salihu abubakar; abubakar sambo junaidu (2019). external environmental factors and failure of small and medium enterprises in kano metropolis. asian journal of economics and empirical research, 6(2): 180-185. history: received: 15 august 2019 revised: 19 september 2019 accepted: 23 october 2019 published: 2 december 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 181 2. literature review .......................................................................................................................................................................... 181 3. methodology ................................................................................................................................................................................... 182 4. result and discussion ................................................................................................................................................................... 183 5. conclusion ....................................................................................................................................................................................... 184 6. recommendations .......................................................................................................................................................................... 184 references ............................................................................................................................................................................................ 185 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.62.180.185&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1136 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1136 asian journal of economics and empirical research, 2019, 6(2): 180-185 181 © 2019 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the existing literature by examining the relationship between external environmental factors and failure of smes in kano metropolis, using samples of failed smes in kano metropolis. 1. introduction smes sub-sector is an integral component of economic development and a key element in the fight against poverty and unemployment in both developed and developing economies. they are veritable vehicles in accelerating sustained growth and economic transformation in developed and developing economies, sitharam and hoque (2016). smes provide an effective means of stimulating indigenous enterprises, enhancing greater employment opportunities per unit of capital invested and aiding the development of local technology. consequently, the performance of smes sub-sector is closely associated with the performance of the nation. the argues that small businesses are the vehicle for rapid industrialization and development of any nation. they also account for 70% of national industrial employment if the threshold is set at 10 – 50 employees, and contribute 10% of manufacturing output. opines that 75% of the private sector in nigeria is dominated by smes, reiterating that the organized private sector (ops) is the engine of growth and creator of wealth and employment. kano state is the major commercial center of northern nigeria, with large concentration of smes, despite the increasing number of smes, smes in nigeria have not performed creditably well; hence, they have not played the expected role in the economic growth and development of the country. this may be because most of these smes in nigeria failed while some that still exist are not doing well due to one reason or the other (basil, 2005; fabayo, 2009; abeh, 2017). in 2014 the department of industries in the ministry of commerce and industries kano state conducted a survey of industries in three industrial estates namely sharada, challawa and bompai industrial estates tag kano state industrial survey 2014, the survey reported a total of 378 industries in the three industrial estates, out of which 233 industries are not operational. the rate at which businesses fail and fold up in nigeria is alarming, as business failures have an adverse effect on the economy, resulting in losses of incomes, employment and other difficulties to the entrepreneur. the success or failure of businesses depends on both internal and external business environment in which it operate, thus, the external environmental factors are those that are generally out of the control of the firm such as infrastructure, external sources of finance, the industry, technological changes, economical, and socio-cultural factors, including the external stakeholder such as competitors, creditors, customers, government. observes that there is an increased rate in business failure, as many new businesses rarely survived their first year in operation and many smes are closed down every year. the research on small business development has shown that the rate of failure in developing countries is higher than in the developed world (arinaitwe, 2006). therefore, the reason for the increased failure rate of smes in developing countries like nigeria is worth investigating. this study notes that in nigeria and kano in particular, such research effort on failed smes has not yet been made, thus, this study investigates whether external environmental factors contribute to smes failure in kano metropolis, in order to achieve the stated objective of the study; the following formulated hypothesis is proposed for testing: 1.1. hypotheses external environmental factors do not play significant role in smes failure in kano metropolis. this research work is organized into five sections: section one is this brief introduction, followed by the literature review, methodology, result and discussion and final section which is conclusions and recommendations. 2. literature review small and medium enterprises (smes) are very heterogeneous in nature. they are found in a wide array of business activities worldwide. the definition of smes varies by country and is usually based on employment, capital investment, sales turnover, accessibility, and output and in some cases, a blend of some or all of these criteria. due to its ease of collection, the most commonly used variable (criteria) is the number of employees. the criteria adopted in the recent micro, small and medium enterprises (msmes) collaborative survey in nigeria is that; micro enterprises is a venture with less than 10 employees, small scale enterprises is one that has between 10-49 employees medium, scale enterprises: 50-199 employees, and large scale enterprises 200 and above employees. this study adopted these criteria in identifying the smes. also, oshagbemi (2003) notes that one of the major criteria that have been used in the definition of smes in nigeria is the number of employees. according to ogundele (2007) smes represent 90% of the enterprises in african, caribbean and pacific (acp) countries. they also provide 70% of employment opportunities for the citizens and promote the development of local technology. in developing economies, the role of smes is even more obvious and conspicuous to the degree that they dominate economic activities, luftim et al. (2018). they are expected to provide the driving force for the industrialization and overall development of the nigerian economy (akoja and hasret, 2010; abeh, 2017) but their performance fall below expectation due to high rate of failure experience in the sector. the environment at its various levels of aggregation (global, regional, sector, enterprise), is the underlying determinant of the performance of businesses, francis (2000). the business environment consists of the factors that either help or hinder the development of business. business grows and prospers in a healthy environment, while the wrong environmental conditions, in contrast, lead to business failure, loss of jobs, and a low standard of living and quality of life. therefore understanding the external environmental factors that may lead to business failure is paramount to organizational effectiveness and efficiency. the external environment is also called the operating environment and comprises external stakeholders, mika (2003). the negative effect of external environmental factors cause business failure and consequently leads to an adverse effect on the economy. the failure rate in small and medium businesses in nigeria is a matter of concern. a high failure rate is a huge negative for an economy, especially a developing economy with limited capital such as nigeria (okpara and wynn, 2007). this situation however subsists in nigeria despite relevant government policies asian journal of economics and empirical research, 2019, 6(2): 180-185 182 © 2019 by the authors; licensee asian online journal publishing group and programmes to aid enterprises. sunday (2008) observed that nigerian business organizations are confronted with myriad of problems. there are diverse opinions among previous studies concerning the factors contributing to firm failure, a large number of factors seem to be associated with firm failure. the theory of multiple origins or causes of business failure as a perspective for explaining small business failure emphasises problems such as small business management difficulty, internal organizational environment issues and external business environmental problems, as barker (2005) and stanger (2010) confirm, this theory provides the theoretical validity for the conduct of this research. this study investigates whether; inefficiencies in infrastructure, market demographics, inadequate funding and market competition contribute to smes failure in kano metropolis. according to basil (2005) other challenges which smes face in nigeria includes: irregular power supply and other infrastructural inadequacies such as water, roads etc. sunday (2008) states that the external difficulties facing smes in nigeria include infrastructural problems. according to ayinla (2007) and okpara and wynn (2007) some of the obstacles to small business development in africa include: poor location and poverty among others, the issue of poverty here relates to consumers’ income. poor external market conditions, including stiff competition, slow market growth, and small market size, have been found to be major factors associated with firm failure not only by entrepreneurs but also by venture capitalists (syamala et al., 2017). fatoki (2014) find that some of the primary reasons for the discontinuance of new businesses in south africa include too much competition and a lack of customers. basil (2005) in his study identifies many factors as the possible causes or contributing factors to the premature death of smes, which include: inability to procure the right plant and machinery, cut-throat competition, lack of official patronage of locally produced goods and services. inadequate finance is a critical problem which has a huge impact on the growth of smes and even poses threat to their survival. bouazza et al. (2015) conclude that inability to access financial recourses/ credit from banks and suppliers is a critical failure factor of smes. find that the primary reasons for the discontinuance of new businesses in south africa are financial reasons. respondents said it was hard for them to get access to external fund, and it is clear that factors like interest rates, and the state of economy' would affect all ventures. from the above review, empirical examination of several studies made in the preceding sections indicates that there is vast literature on business failure, there by placing this study within the framework of existing literature. but this study notes that the results of most of these researches conducted have not been all conclusive in terms of environmental factors determining smes failure. this study also found that in nigeria, such research effort on failed smes has not yet been made. therefore, this study aims at investigating the external environmental factors determining smes failure in kano metropolis through study of failed smes in order to fill this gap in the literature. 3. methodology this research investigates the influence of external environmental factors on failure of smes in kano metropolis. the research is descriptive-explanatory in nature, so that the information collected can be statistically inferred on the population. the study also focuses on studying the business failure problem in order to explain the relationship between external environmental factors and smes failure in kano metropolis. the study adopts survey research strategy using questionnaire technique to examine the external environmental determinants of failed smes in kano metropolis from 2000 to 2018. the research uses primary data collected using questionnaire administered on the target respondents i.e. owners/managers of failed smes in kano metropolis. multiple regression statistics and descriptive statistics were used to analyze the data collected. the study uses four selected external environmental factors (i.e. inefficiencies in infrastructure, market demographics, financial inadequacy and market competition) for analysis in order to investigate the role of these selected environmental factors in the failure of smes in kano metropolis. the study uses these factors as variable for analysis and each of these factors is measured with three indicators as defined below: a) inadequate infrastructure (ii):relates to indicators such as; poor access road, inadequate water supply, and power supply. b) market demographics (md):relate to indicators such as; size of the market, population in the area, and consumer income. c) market competition (mc):relates to indicators such as; non-patronage due to competitors, competitors employs better technology, and they have more access to advertisement facilities. d) financial inadequacy (fi):relates to indicators such as; lack of access to external fund, high interest rate, and lack of collaterals. the population of interest to this study is all smes situated in kano metropolis that failed from 2000 to 2018, and to best of our knowledge there is no statistics of failed smes in kano state, no survey conducted on failed smes and there is no study conducted on failed smes. the 2014 industrial survey conducted at sharada, challawa and bompai industrial estates in kano state revealed that majority of those industries are medium and large scale industries. therefore since there is no existing database from which to clearly determine the population of failed smes in kano metropolis, the study deals with an infinite or unknown population. since population of this study is unknown, therefore the sample size was determined using a formula for determining sample size for unknown and large (infinite) population as follows: we arrive at the 150 sample size using the 1.96 z-score (95% confidence level), 50% standard deviation and 8% margin of error (sampling error). since there is no record of failed smes that will guide us in tracing and locating the owners or managers of failed smes, in order to make initial contact, the study created a database of failed smes containing business names and location addresses using nbs past (previous) and present (updated) records of existing smes in the state, that smes that appear in previous record and did not appear in the updated record is considered as failed asian journal of economics and empirical research, 2019, 6(2): 180-185 183 © 2019 by the authors; licensee asian online journal publishing group sme, which guides us during questionnaire administration. the owners or managers were identified by “tracing and locating approach” using snowball method. this is done by visiting the physical location of the failed smes to acquire information about owners/ managers. for the purpose of testing the hypothesis, the study uses multiple regression models. the independent variables are the four selected external environmental factors, while the dependent variable that is sme failure represented by life duration/ survival time of the sampled failed smes which is identified with the abbreviation smef in the regression equation. thus, the regression equation formulated for testing the hypothesis is as follows: smef = α + β1 ii + β2 md + β3 mc + β4 fi + ε where: smef = sme failure. ii = inadequate infrastructures. md = market demographics. mc = market competition. fi = financial inadequacy. 4. result and discussion this section presents some descriptive data analysis, and the result of inferential data analysis and test of hypothesis of the research. a total of 150 questionnaires were administered and 134 were retrieved out of which only 80 smes closed down between 2000 and 2018 which is the scope for this study and the data from those 80 failed smes are used for analysis. the table 1 summarise the outcome of the respondents’ rating of indicators of the four external environmental factors that determined the failure of smes in kano metropolis. table-1. respondents’ rating: the contributions of indicators of the selected external environmental factors to their smes failure in kano metropolis. possible determinants of smes’ failure ranking total outcome 1 2 3 4 5 not at all to a little extent to an average extent to a large extent to a very large extent inadequate infrastructures lack of good access road 31 26 9 7 7 80 lack of adequate water supply 7 20 33 14 6 80 lack of adequate power supply 1 5 2 5 67 80 market demographics size of the market 0 8 13 34 25 80 population 18 22 15 18 7 80 consumers income 1 12 21 28 18 80 market competition competitors enjoy better patronage by customers 6 14 41 12 7 80 competitors employ better technology 17 22 32 8 1 80 competitors have more access to advertisement facilities 18 26 27 8 1 80 financial inadequacy lack of access to external funds 15 11 11 26 17 80 high interest rate 6 11 26 31 6 80 lack of collaterals 6 12 25 31 6 80 the descriptive analysis of indicators of inadequate infrastructures as shown in table 1 indicates that majority of the respondents rated lack of adequate power supply as contributing to very large extent to the failure of smes i.e. 84% of the total respondents, which make lack of power supply as the major contributing factor under inadequate infrastructures. the findings agree with the study of charles (2006) where 50% of the respondents of his study indicated power shortage as the major cause of business failure. under market demographics; size of the market is the major contributing factor to smes failure in kano metropolis as 43% and 31% of the respondents rated size of the market as contributing to large extent and very large extent respectively. the findings on market size is in line with works of who agree that few customers and markets are the major factors influencing firm failure. table 1 indicate that the majority of the respondents rated all the three indicators of market competition as contributing to an average extent to the failure of their smes, but the findings still revealed that among the three indicators of market demographics lack of patronage (competitors enjoy better patronage by customers) is the major contributing factor to the smes failure in kano metropolis. similarly, egeln et al. (2010) agree that causes of business failure include problem with demand. under financial inadequacy all the three indicators make similar contributions to the smes failure in kano metropolis. kambwale et al. (2015) and iffat et al. (2015) reported that lack of financial support is among the major causes of smes failure. asian journal of economics and empirical research, 2019, 6(2): 180-185 184 © 2019 by the authors; licensee asian online journal publishing group 4.1. hypothesis testing external environmental factors do not play significant role in smes failure in kano metropolis. for the purpose of testing this hypothesis, four predictor variables were used and the multiple regression was ran on spss. the result from the analysis is presented in table 2; table-2. regression result on the role of selected external environmental factors on smes failure in kano metropolis. statistical variables business failure r 0.665 r square 0.416 adjusted r square 0.375 f statistics 5.179 b: ii md mc fi − 4.710 2.064 − 3.009 − 1.240 significance: ii md mc fi all factors 0.001 0.205 0.034 0.426 0.000 beta: ii md mc fi -0.441 0.192 -0.226 -0.126 from the statistical results in the table 2, the r value of 0.665 indicates that our model is well fitted, because the greater the r value, the better fit the model is. therefore the r2 of 0.416 indicates that 41.6% of the variations in the life duration of smes in kano metropolis is explained or accounted for by the variation in “inadequate infrastructures, market demographics, market competition and financial inadequacy”. the f statistics show a positive value of 5.179 which also indicates that external environmental factors have significant impact on the life duration of smes in kano metropolis. the b-coefficient on ii, mc and fi are all negative showing an inverse relationship with survival time of smes, this indicates that for every extra unit increase in hazard rate of ii, mc and fi we expect 4.710, 3.009 and 1.240 years reduction in survival time of smes respectively, holding all other variables constant. the b-coefficient for md is positive showing a direct relationship with survival time of smes, indicating that for every extra unit of “market demographics” increase, the survival time of smes is expected to increase by 2.064 years holding all other variables constant. table 2 also shows that ii and mc have significance value of 0.1% and 3.4% respectively which is less than 5% alpha, indicating that they make significant contributions to the failure of smes in kano metropolis, while the contributions of md and fi to the smes failure in the metropolis are insignificant with 20.5% and 42.6% significant values respectively. however, the joint or collective significant value of all the external environmental factors in the model is 0.0% which is less than 5% alpha. we therefore infer that external environmental factors make significant contribution in the failure of smes in kano metropolis, and consequently reject the hypothesis that “external environmental factors do not play significant role in smes failure in kano metropolis”. beta weight is a measure of the total effect of an independent variable on the dependent variable (lebreton et al., 2004). therefore beta values in this study indicate the hazard rate contributed by the selected external environmental to the smes failure in kano metropolis, the beta coefficients of −0.441, −0.226 and −0.126 for ii, mc and fi respectively, indicate a negative relationship between life duration (survival time) of smes, on one hand, and ii, mc and fi on the other. these findings revealed that ii is the most contributing factor to the smes failure in kano metropolis, follow by mc, then fi. the finding that inadequate infrastructures are most prominent factor causing smes failure, agrees with the works of basil (2005) and sunday (2008) who reported that one of the most critical external difficulties facing smes in nigeria is infrastructural inadequacies. 5. conclusion in view of the findings that emerged after data analysis and the test of hypotheses, as well as evidence that emerged from the review of empirical studies in the existing literature. the study concludes that external environmental factors contribute to the failure of smes in kano metropolis, but different environmental factors make different contributions to smes failure. among the selected environmental factors in this study, inadequate infrastructure (ii) is the major cause of smes failure in kano metropolis. 6. recommendations in view of the findings that emerged from this study, and the conclusions drawn, the study recommends that in order to reduce smes failure and achieve significant positive contribution of smes sector to economic development of kano state and nigeria in general; government and relevant stakeholders should create an enabling business environment by provision of power which will ease the operational problems experienced by smes in the metropolis. power supply can be enhanced by reorganizing the power holding company of nigeria (phcn) and nigerian electricity regulatory commission (nerc) in order to increase their operational efficiency, through restructuring the organizational structure and enhancing human resource management practice of the organizations that are geared toward improving discipline and dedication of the workforce. also to improve efficiency and productivity of those organizations more electricity generating, transmission and distributing stations should be provided in the state. asian journal of economics and empirical research, 2019, 6(2): 180-185 185 © 2019 by the authors; licensee asian online journal publishing group the problem of small market size and lack of access to market under market demographics can be minimised through government intervention by provision of market places, patronizing locally made products and purchases from local producers for exportation. the study also recommends provision of simple and affordable credit facilities to smes via microfinance institutions as well as grants from the government, relevant stakeholders and donor agencies such as ngos will reduce the financial problems face by smes 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10.20448/journal.501.2017.41.32.48 32 the enterprise risk management of foreign exchange exposures: evidence from taiwanese hospitality industry hsiao, chiu-ming1  zhang, wei-fang2 ( corresponding author) chiu, chi-chang3 huang, jung-chang4 huang, yu-ling5 1,2,3,4,5department of finance, national yunlin university of science & technology, taiwan abstract for this paper, i use the arima model to study the relationship between business performance and exchange rate fluctuations. through this model, the empirical results shows that the influences of foreign exchange rate fluctuations on the tourist hotel business performance are significant and different across currencies and firms. furthermore, according to the framework of kim (2013) we employ the modern portfolio theory proposed by markowitz (1952) to give an optimal foreign exchange allocation for each tourist hotel company's financial decision-makers, which will avoid the risk of exchange rate fluctuations expose and reduce losses due to the fluctuations of exchange rates, and complete the construction of enterprise risk management system (erm). keywords: foreign exchange exposures, modern portfolio theory, enterprise risk management. citation | hsiao, chiu-ming; zhang, wei-fang; chiu, chi-chang; huang, jung-chang; huang, yu-ling (2017). the enterprise risk management of foreign exchange exposures: evidence from taiwanese hospitality industry. asian journal of economics and empirical research, 4(1): 32-48. history: received: 6 april 2017 revised: 14 september 2017 accepted: 18 september 2017 published: 23 september 2017 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 33 2. methodologies .................................................................................................................................................................................. 34 3. data .................................................................................................................................................................................................... 37 4. conclusions ....................................................................................................................................................................................... 47 references .............................................................................................................................................................................................. 47 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://orcid.org/orcid-search/quick-search?searchquery=hsiao, chiu-ming https://orcid.org/orcid-search/quick-search?searchquery=zhang, wei-fang https://orcid.org/orcid-search/quick-search?searchquery=chiu, chi-chang https://orcid.org/orcid-search/quick-search?searchquery=huang, jung-chang https://orcid.org/orcid-search/quick-search?searchquery=huang, yu-ling https://orcid.org/orcid-search/quick-search?searchquery=hsiao, chiu-ming https://orcid.org/orcid-search/quick-search?searchquery=zhang, wei-fang https://orcid.org/orcid-search/quick-search?searchquery=chiu, chi-chang https://orcid.org/orcid-search/quick-search?searchquery=huang, jung-chang https://orcid.org/orcid-search/quick-search?searchquery=huang, yu-ling https://orcid.org/orcid-search/quick-search?searchquery=hsiao, chiu-ming https://orcid.org/orcid-search/quick-search?searchquery=zhang, wei-fang https://orcid.org/orcid-search/quick-search?searchquery=chiu, chi-chang https://orcid.org/orcid-search/quick-search?searchquery=huang, jung-chang https://orcid.org/orcid-search/quick-search?searchquery=huang, yu-ling https://orcid.org/orcid-search/quick-search?searchquery=hsiao, chiu-ming https://orcid.org/orcid-search/quick-search?searchquery=zhang, wei-fang https://orcid.org/orcid-search/quick-search?searchquery=chiu, chi-chang https://orcid.org/orcid-search/quick-search?searchquery=huang, jung-chang https://orcid.org/orcid-search/quick-search?searchquery=huang, yu-ling https://orcid.org/orcid-search/quick-search?searchquery=hsiao, chiu-ming https://orcid.org/orcid-search/quick-search?searchquery=zhang, wei-fang https://orcid.org/orcid-search/quick-search?searchquery=chiu, chi-chang https://orcid.org/orcid-search/quick-search?searchquery=huang, jung-chang https://orcid.org/orcid-search/quick-search?searchquery=huang, yu-ling https://orcid.org/orcid-search/quick-search?searchquery=hsiao, chiu-ming https://orcid.org/orcid-search/quick-search?searchquery=zhang, wei-fang https://orcid.org/orcid-search/quick-search?searchquery=chiu, chi-chang https://orcid.org/orcid-search/quick-search?searchquery=huang, jung-chang https://orcid.org/orcid-search/quick-search?searchquery=huang, yu-ling asian journal of economics and empirical research, 2017, 4(1): 32-48 33 1. introduction tourism industry has named the no-smokestack industry. the revenue generates from the tourism industry will increase as the growth of inbounds and the time period that they stay. as the economic viewpoint, tourism will create value from catering, hotels, aviation, transport and many other related industries. it also helps to revitalize the tourism industry association actives, the economic benefits, not only to create a tourism value, it also increases consumption and further boosts the economy, increases employment opportunities. in 2013, japanese prime minister shinzo abe implemented a policy combining fiscal expansion, “quantitative easing”, and structural reform in the hope of revitalizing japan„s domestic economy. indeed, this is so-called ― abenomics--results in a significant growth in japan„s domestic economy. accordingly, the impact of exchange rates on some industry becomes even more obvious and important, especially in the tourism industry while the japanese yen is depreciated in order to stimulate the economy fast. the impact of exchange rates on the part of the industry becomes even more obvious and important, especially in the tourism industry by the japanese yen depreciated under the influence of the economy back to temperature very fast. implementing quantitative easing policy that caused the depreciation of japanese yen increases japan„s foreign trade and also successfully lead the economy back to situation. surprisingly, the tourism industry has gained the most benefits of all. this paper, therefore, wants to study the case and examine if the situation could as well apply to the tourism industry in taiwan. oh (2005) addressed the causal relations between tourism growth and economic expansion for the korean economy. he employed the granger causality test and found that the korean tourism industry is economic-driven. kim et al. (2006) examined the relationship between tourism expansion and economic development in taiwan. they found a bi-directional causality between them. in other words, in taiwan, tourism expansion and economic development reinforce each other. min (2013) used panel data approach to test the tourism-led economic growth hypothesis. he found that the tourism-led growth hypothesis is more strongly supported when the time-specific effects are eliminated, which will cause a biased estimate in the granger causality test. according to the data of the world tourism organization in april 2015 announcement, the number of international tourist visited in taiwan in 2012 was estimated about 9.9 million, ranked as the world‟s 31 and created revenues about $ 14.7 billion. in 2014, taiwan inbound tourists grew 23.6%, ranking the 2nd place of the world‟s top 50 tourist destinations, only less than the japan‟s growth rate of 29.4%. tourism revenue has growth 18.9%, ranking the 4th place in the world‟s top 50 tourism revenue areas. gradually, taiwan‟s tourism has been recognized considerable potential. chen and zan (2009) have showed that the tourism industry greatly contributed to the taiwanese economy that is, taiwan is tourism-led economic. taiwan authority has opened the chinese group tourists to taiwan since the summer of 2008. in order to push up the number of tourists, taiwan government implements many projects to develop the tourism industry, such as doubling tourist arrivals plan (dtap) introduced in 2002 and „„challenge 2008‟‟, taiwan‟s 2015-2018 tourism action plan, mid-term plan for construction of major scenic sites (2012-2015), project vanguard for excellence in tourism, tour taiwan and experience the centennial, etc. according to taiwan tourism bureau, these plans are proposed to deepen of the “time for taiwan” core promotional program, and, to use “quality, uniqueness, intelligence, and sustainability” as strategies toward the goals of “development of international tourism, enhancement of domestic travel quality, and increased foreign-exchange revenues” to bring taiwan‟s new tourism allure to the attention of the world1. on the other hand, portnov and li (2013) suggested that in order to achieve a greater stability in the number of inbound tourist arrivals, taiwan should diversify sources of their inbound tourism, by giving priority to neighboring countries with relatively larger, more productive, and more steadily growing economies, such as china, malaysia, thailand, or the other emerging countries in south-eastern asia. according to the taiwan tourism bureau, the inbound number of tourists was 2,624,037 in 2000, 9,910,204 in 2014, growing about 3.8 times and over 10 million in the end of 2015. this tendency shows the visibility and attractiveness of international tourism in traveling to taiwan, which significantly increase the number of attentions. moreover, taiwan‟s foreign exchange earnings generated by tourism was from $3,738 million in 2000 to $14,615 million in 2014 and its share in total gdp also reach 2.76% from 1.13%. it shows that taiwan tourism industry earns a huge of foreign exchange earnings. thus, the fluctuations in exchange rates for taiwan‟s tourism industry is also an important factor for taiwan‟s overall economic development. the recent ten-year annual revenues generate from tourism, foreign exchange and domestic tourism are shown in the figure 1. the highest line is the tourism revenue (in red) which grows rapidly in 2009 due to the effect of opening of chinese tourists to visit taiwan. and the lowest line is the domestic tourism revenue (in purple) which attains the maximum (331 billion of nt dollars) in 2011 and declines in the following years. the foreign exchange earnings (in green) smoothly increases in years. 1 http://admin.taiwan.net.tw/public/public_en.aspx?no=6. http://admin.taiwan.net.tw/public/public_en.aspx?no=6 asian journal of economics and empirical research, 2017, 4(1): 32-48 34 figure-1. taiwan annual revenues generate from tourism, foreign exchange, and domestic tourism source: tourism bureau, m.o.t.c., republic of china (taiwan) taiwan„s tourism revenues have increased in recent years, the tourism industry plays an important role in the tourism industry, resulting in a huge source of foreign exchange earnings. among the tourists, the number of chinese tourists accounted for the largest cases, followed by japanese, european and the united states. bilateral trade between taiwan and china, japan, europe and the united states, respectively is not only very close, but also represents the effect of the changes in exchange rates. the number of tourists traveling to taiwan contributes the foreign exchange earnings. on the other hand, pritamani et al. (2005) divided the u.s. companies into five categories and found that neither exporters nor multinational firms were the most affected by changes in exchange rates. the firms that suffered most from exchange rate fluctuations were wholly domestic u.s. companies facing foreign competition. taiwan‟s hotel industry has the same situation. based on the above point of view, we mainly discuss taiwan‟s hotel industry for exposure to foreign exchange fluctuations and corporate risk management. through our study, it suggests the hedging strategies to the decision-makers of firms and then to enhance taiwan‟s hotel industry‟s risk management. the structure of our study is: methodologies will be discussed in section ii; data collection and their statistical descriptions are in the section 3. the empirical results and their analysis are shown in the section 4. the last section is our conclusion. 2. methodologies a. modern portfolio theory(mpt) modern portfolio theory is proposed by markowitz in 1952. in the paper, probability theory and linear algebra method are applied to investigate the correlation between the securities. it put forward the possibility to diversify the main investment risks for this theory is that the risks associated with some other securities regardless of the dispersion of individual investment targets can reduce the risk. in this way, individual company information becomes less important. the theory is mainly to solve the investor‟s risk-reward problem and to form a rational combination of its own funds in order to maximize the proceeds. according to the markowitz‟s framework, there is a certain special relationship between investment risk and return of a portfolio of financial assets. his assumptions: 1. assume the market is efficient, investors can learn more of the benefits and risks of financial market changes and their causes. 2. suppose investors are risk averse and are willing to get a higher rate of return if they must bear a greater risk to get a higher expected return as compensation. risk is the variability of yields as measured by standard deviation. 3. investors‟ choices are based on the expected returns and standard deviations of selected financial assets portfolio. they select portfolios with higher yields or lower risk. 4. the incomes between various financial assets are correlated with the correlation coefficient between each financial asset, it is possible to choose the lowest risk of the portfolio. and an efficient portfolio, it should be subject to the following conditions: under certain risk (standard deviation), this combination of securities has the highest average reward; and in certain average reward, it has the lowest degree of risk (standard deviation). therefore, the portfolio should be on the curve of efficient frontier. according to huang and litzenberger (1988); elton et al. (2007) suppose an economy which there are n risky assets with its return and standard deviation ir and i , ni , , , 21 , respectively. moreover, the covariance between any two assets is  jiji rrcov , , ， nji , , , 21 . if we denote the portfolio weight on each assets in the portfolio to be iw , ni , , , 21 , then the expected return of the portfolio is rwp  , where asian journal of economics and empirical research, 2017, 4(1): 32-48 35   nrrrr , , , 21 and   nwwww , , , 21 。and the variance of the portfolio is wwp 2 , where     nnjirvar   ,  is the variance-covariance matrix. hence, in the framework of markowitz (1952) and kim (2013) we have to minimize the degree of risk of the portfolio under a pre-specified return, 0 , and budget constrain. namely, wwp wi  2 1 2 2 min  (1)             niw wwj rw ts i n i in p , , , , 2110 1.. 1 0 (2) where,   n nj    111 , , ,  . using the lagrange multipliers method, the above problem can be transformed as follows:             wjrwwww n wi 1 2 1 20121min 21   , , , ,  . (3) hence, the f.o.c.is                                 01 0 0 2 0 1 21 pn p np wj rw jrw w         np jrw   1 2 1 1 *  . (4) and then we have,               11 2 1 1 0 1 2 1 1 nnn n jjrj rjrr                  02 0 2 02 0 1       d b d a bac ba d b d c bac bc , where, rra  1 , nn jrrjb     11 , nn jjc    1 , and 2bacd  . such that, the optimal wealth allocation portfolio is np jrw   1 2 1 1 *  nj d b d a r d b d c               1 0 1 0  . (5) the properties of this portfolio are 1. rj d b d a rr d b d c rw npp                   1 0 1 0 *  .000 2 00                 d d d bac b d b d a a d b d c 2. **2 ppp ww                          nj d b d a r d b d c 1 0 1 0                      nj d b d a r d b d c 1 0 1 0  nn jj d b d a rr d b d c                 1 2 0 1 2 0  njr d b d a d b d c              1 002                           00 2 0 2 0 2  d b d a d b d c b d b d a c d b d c a   cc b d c abc d 1 2 1 2 00 2 0         (6) such that, c p 12  and the equality holds when c b 0 . asian journal of economics and empirical research, 2017, 4(1): 32-48 36 next, considering a riskless asset can be invested, and then the pre-described model will be rewritten as follows: wwp wi  2 1 2 2 min  (7)   01..   rwrjwts fnp , (8) where, fr is the return of the riskless assets. again, by using the lagrange multipliers method, we have to solve the following problem:     fn w rjwrwwww i  1 2 1 021min   , , ,  . (9) thus, the f.o.c. is         01 0 0 fn fnw rjwrw rjrw        h r jrrw f nfp    01*  , (10) where,     21 2 ffnfnf rcrbajrrjrrh     . (11) the properties of this portfolio are: 1. fnppp rjwrw           1*   fnp f nf rjwr h r jrr              1 01          nnf ff nfnf f jjrr h rr jrrjrr h r           1010  fnp rjw          *1 . (12) 2. **2 ppp ww                          h r jrr h r jrr f nf f nf 0101      nfnf f jrrjrr h r             1 2 0                  nnfnf f jjrjrrrr h r 121 2 0 2    h r f 2 0    (13) hence, h r f p   0  , that is, pf hr   0 (14) b. autoregression integrated moving average models,  qdparima ,, in witt and witt (1992;1995) they use many econometric models to investigate the topics of tourism industries. empirically, they suggested that the autoregression and moving average models can be implemented to forecast the performance of tourism industries. here, we want to investigate the effects of the fluctuations of foreign exchange on the performance of hotel industry. according to bodie et al. (2002) we can use the roa or roe, reported in the annual financial statements, to be the measures of the corporate‟s performance. there are at least two reasons for applying roa/roe to proxy the firm‟s performance. first, since roa is the return of corporate‟s total assets, which is defined by the product of profit margin and total asset turnover, so it tells us how effectively a firm uses its assets to generate profits. therefore, a well-performed firm will have a higher roa. second, the definition of roe is the net profit over the average equity, so that by the dupont equation, we have ratioequity asset turnoverasset marginprofit net roe . (15) hence, it tells us how efficiently a company is operated. it also provides insights into the firm‟s use of assets via turnover. that is, a well-performed firm also has a higher roe. as a result, in our study, we will apply these two measures to be the proxies of the firm‟s performance and investigate the magnitude of the effects of foreign exchange rate‟s fluctuations. first, dumas (1978); adler and bernard (1980) and hodder (1982) implement the change of foreign exchange rates into the regression models to study the u.s. multinational firm‟s values. and jorion (1990) followed their studies and found that the stock returns of u.s. multinational firm are significantly positively correlated to the volatility of the u.s. dollar. moreover, bodnar and william (1993) studied the different effects of the fluctuations of foreign exchange rates on the different industries in u.s., canada and japan. and in hamid et al. (2013) discussed asian journal of economics and empirical research, 2017, 4(1): 32-48 37 the public relations agency (pra) in the people‟s republic of china (prc) by using importance-performance analysis (ipa). moreover, he and ng (1998) investigated japan 171 multinational firms there are about 25% firm‟s stock returns significantly positively correlated to the foreign exchange exposures, themselves. and the effects are increasing as firm‟s size increases. moreover, in fama and kenneth (1993;1995) they formed six portfolios of the stocks listed on nyse, amx, and nasdaq stock market by the firm‟s size and found that firm‟s size and be/me proxy for sensitivity to risk factors that capture strong common variation in stock returns and will help to explain the average returns and then firm‟s profitability. and morelli (2007) found the same effects of firm‟s size on the uk listed firms‟ stock returns. their results showed that the media personnel and travel agents/tour operators were basically satisfied with the pra‟s performance, although there is still room for improvement. on the other hand, maloney (1990) paid attention on the australian mining firms. he indicated that the fluctuations of the exchange rates between australia dollars against to the major currencies will affect the firm‟s profit. so he suggested that firm should find some strategies to manage the positions of foreign currencies in order to avoid the losses caused by the fluctuations of exchange rates and then reduce the firm‟s performance. bailey et al. (1992) and kim (2013) suggested that multinational enterprise may use the framework of the modern portfolio theory to form their own foreign exchange risk management strategies and to reduce the effect of foreign exchange exposures. here, we apply the framework of kim to investigate the effects of foreign exchange exposures on the performance of taiwan hospitality industry and try to propose some hedging strategies and strengthen their corporate risk management. therefore, in our regression models, we will impose the changes of exchange rates of several currencies to study the effects of the fluctuations of exchange rates on the performance of taiwan hospitality firms. our autoregression moving average model is given as follows:    p k ktikitmiiti eperformancrmrfeperformanc 1 , , , ,       q s stistii n j tjji asizefx 01 , , , ,  , (16)     itqpqpt , , , , , 2max1max  , ni , , , 21 . where, tieperformanc , represents the ith firm‟s performance in the tth quarter, and ktieperformanc  , is its kth lagged variable. in sharpe (1964) he defined that trmrf is the market portfolio‟s excess return in the t-th quarter, i.e., ftt rrmrmrf  , trm is the market portfolio‟s return and fr is the rate of return of riskless asset. furthermore, as indicated in smithson and simkins (2005) although the management of interest rate and foreign exchange rate risks does indeed add value, the effect is larger than would be expected. such that, let tjfx ,  be the percentage change of exchange rate of the jth currency in the tth quarter, which is defined by 100 1 1      tj tjtj tj e ee fx , , , , , (17) where tje , is the closed price in the end of the quarter in terms of direct quotation. and tisize , is the size of the ith firm in the tth quarter which is defined as  titi capsize , , ln , and ticap , is the capitalization of the firm in the tth quarter. tia , are the white noises. 3. data this paper selected 12 hospitality companies listed on taiwan stock exchange (twse), and downloaded their quarterly roa, roe and capitalization from taiwan economic journal (tej). they are hotel holiday garden (2702), the ambassador hotel ltd. (2704), the leofoo development co., ltd. (2705), first hotel company ltd. (2706), formosa international hotels corporation (2707), farglory hotel co., ltd. (2712), pleasant hotels international inc. (2718), chateau international development co., ltd. (2722), fx hotels group inc. (2724-f), janfusun fancyworld corp. (5701), the landis taipei hotel co., ltd. (5703), and hotel royal chihpen (5704). period is from 2000q1 to 2015q3 and sum to 489 firm-quarters. table 1 shows the descriptive statistics of the firm‟s roa and roe, respectively. table-1. (a). descriptive statistics of roa. roa (%) obs. mean std. dev. max min median 2702 hg 63 0.661 0.820 2.94 -1.43 0.740 2704 ambh 63 0.641 0.565 1.47 -1.29 0.740 2705 leofoo 32 -0.136 1.298 5.40 -5.03 -0.225 2706 first hotel 32 1.398 1.105 7.28 0.54 1.160 2707 gfrt 63 4.392 1.195 7.55 1.27 4.360 2712 fgh 11 1.383 1.244 3.68 -0.12 0.870 2718 ph 25 0.944 0.873 2.40 -1.20 0.840 2722 chateau 21 2.732 2.632 8.38 -0.60 2.380 2724 fx hotels 21 1.179 1.770 5.74 -2.45 1.550 5701 jfs 32 -1.462 1.341 1.73 -5.76 -1.470 5703 landis taipei 63 0.419 1.724 3.20 -8.97 0.740 5704 chihpen royal 63 1.040 1.381 3.62 -3.49 1.210 source: taiwan economic journal (tej). asian journal of economics and empirical research, 2017, 4(1): 32-48 38 table-1(b). descriptive statistics of roe. roe (%) obs. mean std. dev. max min median 2702 hg 63 0.804 1.276 3.77 -2.97 0.940 2704 ambh 63 0.704 0.956 2.18 -2.96 0.880 2705 leofoo 32 -0.415 2.565 11.04 -9.90 -0.695 2706 first hotel 32 1.668 1.339 8.71 0.67 1.390 2707 gfrt 63 6.645 2.205 11.13 1.50 6.700 2712 fgh 11 1.794 1.782 4.81 -0.44 1.100 2718 ph 25 1.220 1.109 2.99 -1.62 1.160 2722 chateau 21 3.313 3.335 11.24 -0.68 3.060 2724 fx hotels 21 1.418 3.958 6.96 -8.83 2.210 5701 jfs 32 -3.217 2.462 2.47 -11.24 -3.300 5703 landis taipei 63 0.612 2.338 4.48 -11.76 1.040 5704 chihpen royal 63 1.192 1.581 4.19 -3.83 1.300 source: taiwan economic journal (tej). in table 1, we may find that the formosa international hotels corporation (2707) has the highest roa and roe, however, janfusun fancyworld corp. (5701) has the lowest roa and roe. and except of janfusun fancyworld corp. and the leofoo development co., ltd. (2705), the others are well-performed since they all have a positive average roa or roe. moreover, the ambassador hotel ltd. (2704) has the lowest volatility of roa and roe. on the other hand, chateau international development co., ltd. (2722) and the fx hotels group inc. (2724-f) have the highest volatility of roa and roe, respectively. it may result from the shortest listing data of these two companies. next, we collect the foreign exchange rates from the website of the central bank of taiwan. the data period is from 2000 to 2015. and then calculate the quarterly and monthly percentage change of exchange rates for the currencies against to the nt dollars (ntd) according to the equation (13). table 2 shows the descriptive statistics of the monthly change of foreign exchange rates. table-2. descriptive statistics of the monthly change of exchange rates. monthly change (%) mean std. dev. max min median cv usd 0.0280 1.1865 3.3313 -3.5798 0.0232 42.3750 jpy -0.0353 2.3233 8.8309 -6.0498 -0.2280 -65.8159 gbp 0.0135 1.9269 5.7608 -8.0517 0.0901 142.7333 cny 0.1664 1.1449 3.0715 -3.4686 0.1749 6.8804 eur 0.1016 2.2251 7.1016 -5.2660 0.2209 21.9006 hkd 0.0294 1.1841 3.3179 -3.5798 0.0205 40.2755 krw 0.0170 1.8737 6.7195 -12.3726 0.2496 110.2176 cad 0.0940 1.8282 5.0170 -8.6264 0.0351 19.4489 sgd 0.1155 0.9621 3.0253 -3.4506 0.1384 8.3299 aud 0.1074 2.6040 6.9746 -13.5568 0.2725 24.2458 idr -0.3005 3.1096 20.7023 -13.5534 -0.2083 -10.3481 thb 0.0602 1.2869 3.6022 -4.5300 0.0806 21.3771 myr -0.0366 1.2266 3.0689 -4.0603 -0.0825 -33.5137 php -0.0412 1.5530 4.3555 -4.5580 -0.1633 -37.6942 source: central bank of taiwan. http://www.cbc.gov.tw/content.asp?mp=1&cuitem=36599. in table 2, the lowest percentage change (0.96%) of the exchange rate is the singapore dollar exchange rate against to nt dollar and has the highest percentage change (3.11%) of the exchange rate is the indonesian rupiah exchange rate against to nt dollar. since indonesian rupiah has a maximum appreciation (20.70%) and minimum depreciation (13.56%) against to nt dollar. moreover, the coefficient of variation, a nominal measurement, is also reported in table 2. the standard deviation of data describes the dispersion of the data away from the mean, in contrast, the coefficient of variation is the multiple of the standard deviation to the mean, i.e.,   cv . for comparison between data sets with different units or widely different means, we may use the coefficient of variation instead of the standard deviation. and, as described in scheel (1978) the coefficient of variation can also be a measure of relative risk in the elementary risk and insurance. such that, an asset with lower value of coefficient of variation means either a lower-risk asset among that of the same return or a higher-return asset among that of same level of risk. as shown in the table 2, china yuan (cny) and singapore dollar (sgd) has lower coefficient of variation, 6.8804 and 8.3299, respectively, and great british pound and korean won has higher coefficient of variation. it means that both great british pound and korean won are either high-risk or low-return. 3.1. empirical results and analysis first, we have to test whether the series of performance is stationary or not. that is, we should test the null hypothesis that it has a unit root. in tsay (2005) he indicated that the fundamental time series analysis is stationarity. a time series ty is said to be strictly stationary if the joint distribution of   kttt yyy , , ,  21 is identical to that of   ststst k yyy , , ,  21 for all k, where s is an arbitrary positive integer. in other words, strict stationarity requires that the joint distribution of   kttt yyy , , ,  21 is invariant under time shift. http://www.cbc.gov.tw/content.asp?mp=1&cuitem=36599 asian journal of economics and empirical research, 2017, 4(1): 32-48 39 table-3. the stationarity test results of company‟s performances. series obs. adf test statistic p-value stationarity 2702 hg roa 56 -1.539 0.5140 non-stationary troa 61 -14.607 0.0000 stationary 2704 ambh roa 56 -2.884 0.0472 stationary 2705 leofoo roa 56 -2.158 0.2217 non-stationary troa 61 -12.592 0.0000 stationary 2706 first hotel roa 56 -2.312 0.1683 non-stationary troa 61 -17.520 0.0000 stationary 2707 gfrt roa 56 -2.640 0.0849 non-stationary troa 61 -12.541 0.0000 stationary 2712 fgh troa 9 -3.466 0.0089 stationary 2718 ph roa 18 -1.651 0.4567 non-stationary troa 23 -9.001 0.0000 stationary 2722 chateau roa 14 -1.810 0.3755 non-stationary troa 19 -5.904 0.0000 stationary 2724 fx hotels roa 14 0.025 0.9606 non-stationary troa 19 -5.816 0.0000 stationary 5701 jfs roa 56 -1.476 0.5452 non-stationary troa 61 -11.789 0.0000 stationary 5703 landis taipei roa 56 -1.977 0.2967 non-stationary troa 61 -10.758 0.0000 stationary 5704 chihpen royal roa 56 -1.421 0.5722 non-stationary troa 61 -17.149 0.0000 stationary source: taiwan economic journal (tej). table-3(b). the stationarity test results of company‟s roe. series obs. adf test statistic p-value stationarity 2702 hg roe 56 -1.604 0.4814 non-stationary troe 61 -15.323 0.0000 stationary 2704 ambh roe 56 -2.993 0.0356 stationary 2705 leofoo roe 25 -2.061 0.2604 non-stationary troe 30 -8.296 0.0000 stationary 2706 first hotel roe 25 -2.441 0.1306 non-stationary troe 30 -13.890 0.0000 stationary 2707 gfrt roe 56 -1.808 0.3764 non-stationary troe 61 -11.738 0.0000 stationary 2712 fgh troe 9 -3.501 0.0080 stationary 2718 ph roe 18 -1.689 0.4365 non-stationary troe 23 -8.826 0.0000 stationary 2722 chateau roe 14 -2.132 0.2320 non-stationary troe 19 -6.034 0.0000 stationary 2724 fx hotels roe 14 0.394 0.9813 non-stationary troe 19 -7.304 0.0000 stationary 5701 jfs roe 25 -2.505 0.1143 non-stationary troe 30 -8.123 0.0000 stationary 5703 landis taipei roe 56 -1.942 0.3124 non-stationary troe 61 -10.652 0.0000 stationary 5704 chihpen royal roe 56 -1.332 0.6146 non-stationary troe 61 -17.278 0.000 stationary source: taiwan economic journal (tej). asian journal of economics and empirical research, 2017, 4(1): 32-48 40 and a time series ty is weakly stationary if both the mean of ty and  stt yycov , are time-invariant, where s is an arbitrary integer. in the table 3, we show the augmented dicky-fuller test results. as shown in table 3, we can find that almost all the roa/roe series are non-stationary except the ambassador‟s roa/roe. on the other hand, according to hurvich and tsai (1989) there will be biased estimates resulting from a nonstationary series. such that, applying wei (2006) we take the first-ordered difference on the series, i.e., 11  ttt roaroaroad and 11  ttt roeroeroed . (18) and then, we test the unit-root-test again to verify its stationarity. the augmented dicky-fuller test results are also shown in table 3. after differencing the series, all of them are stationary. next, patro et al. (2002) found the significant currency risk exposures in country equity index returns by using the garch model. and, polodoo et al. (2016) discussed the nexus between exchange rate volatility and manufacturing trade. they found that exchange rate volatility has an adverse effect on the real manufacturing trade of the africa countries. as shown in the study of ikechukwu (2016), he applied the dynamic panel regression approach to investigate the effects of exchange rate volatility on firm performance by examining 20 companies listing in nigerian stock exchange. it revealed that exchange rate volatility has significant negative impacts on the roas, atrs. here, that effects of the fluctuations of exchange rates on the firm‟s performance is the main purpose of this study. therefore, as the work in kim (2012) the autoregression moving average (arima) model can be specified as follows:    p k ktikitmiiti eperformancdrmrfeperformancd 1 11 , , , ,       q s stistii n j tjji asizefx 01 , , , ,  , (19)     itqpqpt , , , , , 2max1max  , ni , , , 21 . here, tieperformancd , 1 represents the first-ordered difference of the ith firm‟s performance in the tth quarter, and ktieperformancd  , 1 is its kth lagged variable. use the stata13 to find the regression results and show in the table 4. model i regresses road1 on all exchange fluctuations, lagged variables and the control variables. model ii regresses road1 on all variables but selected by eliminating higher p-value explanatory variables. table-4. regression on roa. company hotel holiday garden (2702) the leofoo development co., ltd. (2705) formosa international hotels corporation (2707) variables model i model ii model i model ii model i model ii const. 10.31 (7.59) 0.10 (0.09) 106.98 (81.09) 101.70** (47.14) 23.71 (16.21) -0.06 (0.14) rmrf 0.01 (0.01) -0.05 (0.07) -0.01 (0.02) usd 0.14 (0.14) 0.15 (0.33) 0.10 (0.20) jpy 0.03 (0.03) -0.01 (0.09) -0.05 (0.05) cny -0.09 (0.14) -0.38 (0.36) -0.21 (0.21) eur -0.05 (0.05) 0.09 (0.13) -0.00 (0.08) krw 0.02 (0.04) 0.28* (0.14) 0.20** (0.08) 0.04 (0.07) gbp 0.03 (0.05) -0.12 (0.17) -0.03 (0.08) sgd 0.05 (0.14) 0.51 (0.62) 0.41* (0.21) 0.06 (0.21) aud -0.04 (0.04) -0.04* (0.02) -0.21 (0.19) -0.20** (0.07) 0.06 (0.06) 0.09*** (0.03) idr 0.03 (0.03) 0.05** (0.02) 0.01 (0.13) -0.09* (0.05) -0.07** (0.03) thb 0.05 (0.06) 0.22 (0.20) -0.00 (010) myr -0.03 (0.07) -0.17 (0.21) -0.01 (0.11) php -0.04 (0.06) -0.07 (0.18) 0.09 (0.09) lag1 -0.83*** (0.18) 0.67*** (0.13) -0.91** (0.33) -0.76*** (0.18) -0.69*** (0.15) -0.57*** (0.12) lag2 -0.63*** (0.20) -0.49*** (0.14) -0.34 (0.34) -0.35** (0.17) -0.80*** (0.16) -0.67*** (0.12) lag 3 -0.45** (0.19) -0.45*** (0.11) 0.01 (0.33) -0.51*** (0.15) -0.35*** (0.11) lag4 0.01 (0.15) -0.04 (0.25) -0.13 (0.15) size -0.53 (0.36) -4.70 (3.57) -4.48** (2.08) -1.06 (0.73) adj. r2 0.46 0.51 0.03 0.32 0.38 0.44 obs. 59 58 32 32 58 58 source: taiwan economic journal (tej). asian journal of economics and empirical research, 2017, 4(1): 32-48 41 the regression model is given above. . , , , , , , , , titii n j tjji p k ktikitmiiti asizefxroadrmrfroad      11 11 (20) model i regresses 1,,,1   ttt roaroaroad on all exchange fluctuations, lagged variables and the control variables. and model ii regresses road1 on all variables but selected by eliminating higher p-value explanatory variables. the values in the parentheses are standard error of the estimates. and *, ** and *** stand for 10%, 5% and 1% level of significance, respectively. table-4. regression on roa (continued). company first hotel company ltd. (2706) pleasant hotels international inc. (2718) chateau international development co., ltd. (2722) variables model i model ii model i model ii model i model ii const. -8.17 (15.86) -14.17* 37.34 (58.01) 0.71*** (0.12) -1957** (542.5) 0.29 (0.85) rmrf 0.01 (0.01) -0.12 (0.10) -0.06** (0.03) 3.33*** (0.79) usd 0.06 (0.05) 1.54 (1.07) 0.66*** (0.15) -13.15** (4.20) jpy 0.01 (0.01) -0.30 (0.12) 3.14*** (0.76) cny -0.05 (0.06) -1.36 (0.72) -0.78*** (0.14) 12.03** (3.78) eur 0.00 (0.02) -0.29 (0.20) -0.16*** (0.04) 7.60** (1.96) krw -0.00 (0.02) 0.23 (0.23) -5.31** (1.49) gbp -0.02 (0.03) -0.26 (0.38) -6.44*** (1.50) sgd -0.05 (0.07) -0.66 (0.43) -0.66** (0.11) 1.41 (0.74) 1.89** (0.85) aud -0.01 (0.02) 0.21 (0.13) 0.13** (0.05) -4.36*** (0.91) -0.58* (0.29) idr 0.03 (0.02) 0.20 (0.08) 0.22*** (0.03) 0.59* (0.24) thb 0.00 (0.04) 0.58 (0.32) 0.55*** (0.12) -13.42*** (3.22) myr -0.02 (0.03) -0.06 (0.16) 3.75** (0.96) php -0.04 (0.03) -0.04*** (0.01) -1.06 (0.43) 18.45** (4.82) lag1 -1.05*** (0.22) -1.21*** (0.14) -1.90 (0.46) -1.46*** (0.10) lag2 -0.28 (0.24) -1.46 (0.44) -1.13*** (0.12) lag 3 -0.47 (0.27) -0.98 (0.63) -0.44*** (0.10) lag4 0.34*** (0.10) -0.30*** (0.07) -0.22 (0.25) size 0.41 (0.72) 0.67* (0.34) -1.80 (2.85) 92.79** (25.69) adj. r2 0.81 0.82 0.84 0.93 0.78 0.16 obs. 32 32 20 20 20 20 source: taiwan economic journal (tej). in the table 4, we can find that almost all estimates of the lagged variables are significant and negative, such as, leofoo development co., ltd. (2705), formosa international hotels corporation (2707), janfusun fancyworld corp. (5701), the landis taipei hotel co., ltd. (5703), and hotel royal chihpen (5704). it implies that those road1 are mean-reverting. as the estimates of third-lagged variables are also significant, then we can conclude that there is a seasonal effect on the company‟s roa. moreover, some estimates of size are significant in table 4. when it is positive, such as that in chateau international development co., ltd. (2722), the company may increase its own assets to increase its road1 , so to its roa, too. since it can operate efficiently its assets to generate more profit and then to be a well-performed company. on the other hand, when the estimate of size is negative, such as those in leofoo development co., ltd. (2705) and fx hotels group inc. (2724-f), the company may dispose some of its idle assets or non-performed assets to reduce the inefficient effect of these assets. as a result, the company‟s roa will be improved. asian journal of economics and empirical research, 2017, 4(1): 32-48 42 table-4. regression on roa (continued). company janfusun fancyworld corp. (5701) the landis taipei hotel co., ltd. (5703) hotel royal chihpen (5704) variables model i model ii model i model ii model i model ii const. 29.91 (30.30) -0.12 (0.18) 55.80 (50.46) 0.13 (0.17) 32.16* (19.05) 0.00 (0.12) rmrf 0.04 (0.05) 0.06 (0.03) 0.07*** (0.02) 0.05** (0.02) 0.03** (0.01) usd -0.24 (0.31) 0.10 (0.24) 0.07 (0.17) jpy -0.01 (0.08) -0.11 (0.08) 0.07 (0.05) cny 0.38 (0.36) 0.10 (0.27) 0.22 (0.19) 0.22*** (0.07) eur 0.03 (0.12) -0.11 (0.10) -0.12* (0.07) 0.01 (0.07) krw 0.08 (0.12) 0.10* (0.05) 0.07 (0.09) 0.27*** (0.07) 0.17*** (0.04) gbp -0.24 (0.15) -0.16** (0.06) 0.00 (0.10) -0.09 (0.07) sgd 0.29 (0.37) -0.05 (0.24) -0.31* (0.18) -0.29*** (0.09) aud -0.10 (0.12) 0.22** (0.09) 0.20*** (0.06) 0.02 (0.06) idr 0.08 (0.11) -0.02 (0.06) -0.01 (0.04) thb -0.21 (0.18) -0.12 (0.12) -0.20** (0.08) 0.00 (0.09) myr 0.06 (0.17) -0.17 (0.13) 0.04 (0.10) php 0.06 (0.15) -0.02 (0.10) -0.10 (0.07) lag1 -0.65** (0.28) -0.64*** (0.16) -0.77*** (0.12) -0.77*** (0.09) -1.08*** (0.15) -0.99*** (0.09) lag2 -0.31 (0.36) -0.31* (0.16) -0.32** (0.14) -0.35*** (0.09) -0.83*** (0.18) -0.66*** (0.12) lag 3 0.09 (0.37) 0.01 (0.13) -0.71*** (0.19) -0.56*** (0.09) lag4 0.14 (0.26) -0.07 (0.11) -0.11 (0.16) size -1.35 (1.36) -2.68 (2.41) -1.58* (0.93) adj. r2 0.07 0.39 0.59 0.63 0.75 0.76 obs. 32 32 58 58 58 59 source: taiwan economic journal (tej). next, table 4 shows significant effects on the performances of taiwan tourism industry due to the fluctuations of foreign exchange rates. the changes of foreign exchange rates have significant impacts on the d1roas. some are positive and some are negative. and the same currency has different impact on different companies. such as the singapore dollar has positive effect on the d1roa of leofoo development co., ltd. (2705), chateau international development co., ltd. (2722), and on the roa of ambassador hotel ltd. (2704), but negative effect on that of pleasant hotels international inc. (2718) and hotel royal chihpen (5704). moreover, the australian dollar has positive effect on the d1roa of formosa international hotels corporation (2707), pleasant hotels international inc. (2718), and landis taipei hotel co., ltd. (5703), and on the roa of ambassador hotel ltd. (2704), but negative effect on that of chateau international development co., ltd. (2722). and the korean won has a positive effect on the d1roa of leofoo development co., ltd. (2705), janfusun fancyworld corp. (5701), and hotel royal chihpen (5704), and then on those company‟s roa , too. furthermore, the number of significant variables and the component of significant variables are different to each company. for example, the significant variables of the pleasant‟s road1 are the change of usd, cny, eur, sgd, aud, idr, thb, however, that of the chateau‟s d1roa are only the changes of singapore dollar and australia dollar. as a result, the portfolio of currencies should be different for each company. asian journal of economics and empirical research, 2017, 4(1): 32-48 43 table-5. regression on roe. the regression model is given as follows: . , , , , , , , , titii n j tjji p k ktikitmiiti asizefxroedrmrfroed      11 11 (21) model i regresses 1,,,1   ttt roeroeroed on all exchange fluctuations, lagged variables and the control variables. and model ii regresses roed1 on all variables but selected by eliminating higher p-value explanatory variables. the values in the parentheses are standard error of the estimates. and *, ** and *** stand for 10%, 5% and 1% level of significance, respectively. company hotel holiday garden (2702) the leofoo development co., ltd. (2705) formosa international hotels corporation (2707) variables model i model ii model i model ii model i model ii const. 8.39 (10.97) 0.14 (0.13) 550.62 (305.52) 232.88** (110.24) 28.18 (15.24) 0.10 (0.21) rmrf 0.01 (0.02) -0.07 (0.21) -0.03 (0.04) usd 0.24 (0.19) -1.77 (1.44) 0.05 (0.31) jpy 0.05 (0.05) 0.08** (0.03) -0.64* (0.33) -0.39** (0.14) -0.12 (0.08) -0.09* (0.05) cny -0.16 (0.20) 1.37 (1.40) -0.27 (0.33) -0.25** (0.11) eur -0.11 (0.08) -0.07* (0.04) -0.00 (0.34) -0.10 (0.13) krw 0.05 (0.06) 0.08* (0.04) 0.47 (0.46) 0.08 (0.11) gbp 0.00 (0.07) -0.19 (0.42) -0.04 (0.12) sgd 0.22 (0.20) 4.02** (1.70) 1.74** (0.62) 0.34 (0.34) 0.39** (0.19) aud -0.00 (0.20) -0.63 (0.50) 0.06 (0.10) idr 0.02 (0.05) 0.12 (0.28) -0.13* (0.07) -0.09* (0.05) thb 0.11 (0.09) 0.10* (0.06) -0.52 (0.77) 0.02 (0.16) myr -0.06 (0.11) -1.36** (0.56) -0.68** (0.29) -0.01 (0.18) php -0.11 (0.08) 0.92 (1.24) 0.05 (0.13) lag1 -0.90*** (0.15) -0.88*** (0.12) -1.27*** (0.37) -0.64*** (0.18) -0.61*** (0.15) -0.61*** (0.12) lag2 -0.67*** (0.19) -0.58** (0.15) -0.15 (0.43) -0.66*** (0.16) -0.63*** (0.12) lag 3 0.41** (0.19) -0.42*** (0.18) 0.20 (0.33) -0.49*** (0.16) -0.46*** (0.12) lag4 -0.04 (0.15) 0.33 (0.28) -0.01 (0.16) size -0.39 (0.57) -24.32 (13.46) -10.28** (4.86) -1.26 (1.13) adj. r2 0.51 0.54 0.16 0.32 0.30 0.39 obs. 58 58 27 27 58 58 source: taiwan economic journal (tej). asian journal of economics and empirical research, 2017, 4(1): 32-48 44 table-5. regression on roe (continued). company first hotel company ltd. (2706) pleasant hotels international inc. (2718) chateau international development co., ltd. (2722) variables model i model ii model i model ii model i model ii const. -21.59 (37.72) 0.84** (0.38) 31.69 (89.17) 0.98*** (0.18) -2289** (737.7) -0.44 (1.05) rmrf 0.05* (0.02) 0.05*** (0.01) -0.15 (0.15) -0.08* (0.04) 3.87** (1.08) usd 0.39** (1.74) 0.12*** (0.04) 1.77 (1.66) 0.85*** (0.21) -15.42** (5.71) jpy 0.04 (0.03) -0.02 (0.18) 3.60** (1.03) cny -0.31* (0.16) -1.61 (1.12) -1.04*** (0.21) 14.08** (5.14) eur -0.05 (0.05) -0.37 (0.31) -0.24*** (0.06) 8.86** (2.67) krw -0.04 (0.05) 0.24 (0.35) -6.07** (2.03) gbp 0.01 (0.06) -0.35 (0.63) -7.56** (2.03) sgd 0.03 (0.14) -0.76 (0.72) -0.86*** (0.15) 1.93 (1.00) 2.46** (1.05) aud 0.03 (0.05) 0.25 (0.21) 0.16** (0.07) -5.22*** (1.24) -0.77** (0.36) idr -0.04 (0.05) 0.27 (0.13) 0.29*** (0.05) 0.77* (0.32) thb 0.05 (0.07) 0.77 (0.50) 0.74*** (0.17) -15.90** (4.38) myr -0.04 (0.06) -0.13 (0.25) 4.41** (1.30) php -0.08 (0.11) -1.32 (0.67) -0.93*** (0.23) 21.70** (6.56) lag1 -1.37*** (0.18) -2.88*** (0.37) -1.88 (0.55) -1.48*** (0.12) lag2 -0.31 (0.21) -0.82** (0.40) -1.50 (0.55) -1.15*** (0.13) lag 3 -0.19 (0.24) -0.99 (0.80) -0.44*** (0.11) lag4 0.50** (0.21) 1.86*** (0.36) -0.21 (0.29) size 1.06 (1.74) -1.51 (4.37) 108.51** (34.93) adj. r2 0.87 0.85 0.77 0.92 0.74 0.18 obs. 28 31 20 20 20 20 source: taiwan economic journal (tej). in table 5, model i regresses d1roe on all exchange fluctuations, lagged variables and the control variables. model ii regresses d1roe on all variables but selected by eliminating higher p-value explanatory variables. we may find that the results in table 5 are almost the same as in table 4. there is seasonal effect for taiwan hotel industry‟s roe, too. and the d1roe of first hotel company ltd. (2706) and pleasant hotels international inc. (2718) are mean-reverting. moreover, the number of significant variables and the component of significant variables are different to each company. for example, the significant variables of the roe of landis taipei hotel co., ltd. (5703) are the changes of euro, japan yen, australia dollar and malaysian ringgit, but that of the chateau international development co., ltd. (2722) are the changes of euro, pound, chinese yuan, japan yen, korean won, singapore dollar, australia dollar, thailand baht, malaysian ringgit, and philippine peso. therefore, it supports the results in the table 4, which the portfolio of currencies should be different for each company. asian journal of economics and empirical research, 2017, 4(1): 32-48 45 table-5. regression on roe (continued). company janfusun fancyworld corp. (5701) the landis taipei hotel co., ltd. (5703) hotel royal chihpen (5704) variables model i model ii model i model ii model i model ii const. 55.72 (141.90) 0.04 (0.42) 70.20 (69.75) -0.28 (0.23) 39.26* (21.32) 0.02 (0.14) rmrf 0.09 (0.33) 0.07 (0.04) 0.06** (0.02) 0.04** (0.02) usd 0.11 (1.45) 0.17 (0.33) 0.04 (0.19) jpy 0.12 (0.35) -0.15 (0.10) -0.15** (0.06) 0.08 (0.05) cny 0.01 (1.23) 0.11 (0.37) 0.28 (0.21) 0.25*** (0.08) eur 0.12 (0.45) -0.15 (0.14) -0.25*** (0.09) 0.02 (0.08) krw 0.37 (0.72) 0.08 (0.12) 0.30*** (0.07) 0.18*** (0.05) gbp -0.59 (0.43) -0.31** (0.14) -0.02 (0.14) -0.09 (0.08) sgd 0.16 (1.00) -0.09 (0.33) -0.36* (0.20) -0.32*** (0.10) aud -0.51 (0.37) -0.22* (0.11) 0.30** (0.12) 0.39*** (0.07) 0.01 (0.06) idr 0.23 (0.33) -0.03 (0.08) -0.01 (0.05) thb -0.42 (0.66) -0.11 (0.17) -0.00 (0.10) myr 0.51 (0.48) 0.36* (0.20) -0.23 (0.18) -0.24** (0.11) 0.05 (0.11) php 0.20 (1.13) -0.03 (0.14) -0.11 (0.08) lag1 -0.60* (0.31) -0.75*** (0.17) -0.76*** (0.13) -0.75*** (0.09) -1.09*** (0.14) -0.99*** (0.09) lag2 -0.29 (0.43) -0.52*** (0.17) -0.35** (0.15) -0.42*** (0.09) -0.83*** (0.19) -0.66*** (0.12) lag 3 0.30 (0.73) -0.01 (0.13) -0.73*** (0.19) -0.56*** (0.09) lag4 0.26 (0.48) -0.08 (0.11) -0.12 (0.16) size -2.50 (6.39) -3.37 (3.33) -1.93* (1.05) adj. r2 0.04 0.48 0.57 0.61 0.76 0.77 obs. 27 27 58 58 58 58 source: taiwan economic journal (tej). next, we‟ll analyze the portfolio will be foreign exchange position. because of our foreign trade is mainly denominated in us dollars, but also long-term focus taipei currency exchange on the usd/ntd, and therefore may have a greater proportion of dollar holdings. furthermore, since the chinese mainland tourists to taiwan surge trips, so that each of the hotel were increased demand for chinese yuan transactions, and thus the performance of the reaction in the performance of its roe or roa. on the other hand, taiwan is also the first choice for japanese and korean tourists traveling abroad, so accommodation for the korean won and the japanese yen in trading volume should not be underestimated. as shown in table 7, the 2012 tourist‟s sources distribution for taiwan major hotels aggregated by the tourism bureau, motc of taiwan, the japanese and korean inbounds are over 1/5 of guests in the half of the hotels. and as the pleasant hotel locates at taoyuan, closed to the taoyuan international airport, such that, most chinese mainland tourists stay at the hotel in order to entry and exit. jang and chen (2008); chen et al. (2011) employed the modern portfolio theory to investigate the mixes of inbounds of taiwan inbounds. they suggested that the government should take the high-reward/high-volatility option and shift more available resources to attract the japanese tourists. asian journal of economics and empirical research, 2017, 4(1): 32-48 46 table-6. regression on financial performances of the ambassador hotel. the regression model is given as follows: . , , , , , , , , tti n j tjj p k ktktmt asizefxyrmrfy 27042704 1 2704 1 27042704270427042704      (22) the dependent variable, y2704 represents the performance of the ambassador hotel, which is either roa2704 or roe2704. model i regresses y2704 on all exchange fluctuations, lagged variables and the control variables. and model ii regresses y2704 on all variables but selected by eliminating higher p-value explanatory variables. the values in the parentheses are standard error of the estimates. and *, ** and *** stand for 10%, 5% and 1% level of significance, respectively. performance roa2704 roe2704 variables model i model ii model i model ii const. -25.80 (34.26) 0.28** (0.11) -34.80 (58.29) 0.25* (0.14) rmrf 0.02 (0.01) 0.15** (0.01) 0.03 (0.02) 0.03*** (0.01) usd -0.21** (0.09) -0.32** (0.15) jpy 0.01 (0.02) 0.02 (0.03) cny 0.22** (0.09) 0.34** (0.16) eur -0.05 (0.03) -0.05** (0.02) -0.08 (0.06) -0.08** (0.03) krw 0.01 (0.03) 0.03 (0.05) gbp 0.04 (0.03) 0.06 (0.06) sgd 0.10 (0.10) 0.14** (0.06) 0.17 (0.17) 0.26** (0.10) aud -0.02 (0.03) -0.05 (0.05) idr 0.01 (0.02) 0.02 (0.04) thb 0.02 (0.04) 0.04 (0.07) myr -0.11** (0.05) -0.10*** (0.04) -0.18** (0.08) -0.17*** (0.06) php 0.02 (0.04) 0.01 (0.07) lag1 0.20 (0.14) 0.26** (0.12) 0.30** (0.14) 0.32*** (0.11) lag2 -0.06 (0.16) -0.06 (0.15) lag 3 -0.12 (0.14) -0.10 (0.14) lag4 0.25* (0.14) 0.28** (0.11) 0.24* (0.14) 0.24** (0.11) size 1.13 (1.48) 1.52 (2.52) adj. r2 0.27 0.40 0.30 0.36 obs. 59 59 59 59 source: taiwan economic journal (tej). table-7. distribution of guests‟ sources in 2012. hotel region royal hotel pleasant hotels (taoyuan) ambassador hotel landis taipei hotel formosa international hotels leofoo westin hotel holiday garden hotel farglory hotel domestic 55.16 17.99 33.96 24.15 21.33 9.73 61.24 94.92 oversea chinese 0.00 7.65 1.91 6.37 0.00 0.00 0.99 0.00 mainland 6.35 56.35 13.29 11.08 11.52 19.43 22.45 3.86 north american 4.73 0.29 6.94 10.31 8.42 20.81 0.76 0.20 japan 21.93 2.09 29.85 29.89 36.67 17.27 7.00 0.10 asian (exclusive japanese) 5.00 9.21 8.23 8.39 15.25 25.92 6.54 0.48 european 2.51 0.26 3.77 7.53 4.69 4.33 0.51 0.13 australia 0.28 0.03 0.41 1.83 0.90 1.35 0.53 0.02 others 4.05 6.13 1.64 0.44 1.23 1.17 0.00 0.30 total (%) 100 100 100 100 100 100 100 100 source: tourism bureau, m.o.t.c., republic of china (taiwan). here, refer to kim (2013) discussion of foreign exchange position to make recommendations in the following table. according to the analysis results in table 4, 5, and 6, we can form a portfolio of currencies that have asian journal of economics and empirical research, 2017, 4(1): 32-48 47 significant impacts on the company‟s roa/ roe. using the modern portfolio theory proposed by markowitz (1952) based on the weighted each company the average cost of capital (abbreviated as wacc), and calculated by matlab programs for foreign exchange positions, we may find an optimum allocation of currencies which has the lowest degree of risk under a pre-specified rate of return constraint. table-8. optimal portfolio of foreign currencies for each company. sec_id usd jpy gbp eur krw sgd cny aud idr thb myr php required return (%) portfolio risk 2702 2.32 20.47 3.84 52.35 1.73 19.28 10.0 0.4305 2704 13.79 84.35 1.85 12.0 1.8498 2705 1.30 1.56 3.84 83.81 9.49 13.5 0.5125 2706 0.00 2.09 62.18 30.56 0.00 5.17 0.00 12.8 2.5007 2707 0.00 0.00 19.47 74.37 6.16 9.5 0.3555 2718 6.35 0.00 0.00 73.79 7.14 0.00 5.53 7.19 12.6 0.4580 2722 3.27 0.00 6.07 0.00 5.17 85.48 10.6 0.5154 2724 2.26 0.00 0.31 0.00 4.47 82.84 5.47 4.66 9.8 0.4807 5701 2.24 0.76 85.53 11.47 13.2 0.5204 5703 0.11 6.04 79.93 0.90 13.03 11.5 0.4757 5704 34.33 14.90 0.00 13.80 36.97 9.8 2.0615 full 0.00 0.00 0.29 44.14 0.07 0.00 1.49 9.41 0.52 0.00 0.64 43.44 12.2 0.0554 source: taiwan economic journal (tej). the results in table 8 show the optimal allocation of currencies for each company. here, we can find that japanese yen, korean won, chinese yuan, australian dollar and malaysian ringgit configuration still the majority. among them, leofoo development co., ltd. (2705), formosa international hotels corporation (2707), pleasant hotels international inc. (2718), chateau international development co., ltd. (2722), fx hotels group inc. (2724-f), janfusun fancyworld corp. (5701), the landis taipei hotel co., ltd. (5703), in the configuration of the australian dollar reached 52.35%, 83.81%, 44.37%, 73.79%, 85.48%, 82.84%, 85.53% and 79.93 %, respectively, more than 50% have switched. the hotel holiday garden (2702), the leofoo development co., ltd. (2705), first hotel company ltd. (2706), chateau international development co., ltd. (2722), fx hotels group inc. (2724-f), janfusun fancyworld corp. (5701), and landis taipei hotel co., ltd. (5703) for the korean won configuration, respectively, 3.84%, 1.56%, 30.56%, 6.07%, 0.31%, 0.76%, and 14.90. as to the chinese yuan, formosa international hotels corporation (2707), chateau international development co., ltd. (2722), fx hotels group inc. (2724-f), and hotel royal chihpen (5704) should put the weight ranging from 4.47% to 19.47%. 4. conclusions recent years, changes in exchange rates will significantly affect the performances of a company, such as, roe, roa, etc. faced with dramatic changes in the international economic environment, as well as central banks continue to adopt a more aggressive monetary policy, such as: bank of japan negative interest rates, the ecb‟s monetary easing, china people‟s bank of china monetary easing, and the gradual recovery of the economy of the united states have taken action to raise interest rates and so on. under the auspices of monetary policy in these countries, it shows once again that the currencies flows across countries and international hot money have allowed changes in exchange rates and more intense. and taiwanese enterprises face to these monetary policies, foreign exchange positions should be actively managed in order to reduce the impacts suffered. in the past, the fluctuations in the foreign exchange markets are more stable in today. in addition to monetary policies that attract more investors to the market, the investment of foreign exchange market as well significantly affect the change in exchange rates among countries. therefore, a positive foreign exchange risk management will better help for future operation, which can significantly reduce the risk of foreign exchange movements. this study found that taiwanese hospitality companies, accounting for the largest part of the tourism industry, are subject to have the impacts on their performance and profitability due to the exchange rate fluctuations. multinational enterprises may apply the results developed here to manage their foreign exchange risk exposure, and then increasing the overall capacity and range of enterprise risk management (erm). by doing so, corporate can increase their profits and reduce the negative impacts of exchange rate changes on corporate roe/roa through foreign 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https://scholar.google.com/scholar?hl=en&q=comparisons%20of%20riskiness%20as%20measured%20by%20the%20coefficient%20of%20variation http://dx.doi.org/10.2307/251816 https://scholar.google.com/scholar?hl=en&q=capital%20asset%20pricing:%20a%20theory%20of%20market%20equilibrium%20under%20conditions%20of%20risk https://scholar.google.com/scholar?hl=en&q=capital%20asset%20pricing:%20a%20theory%20of%20market%20equilibrium%20under%20conditions%20of%20risk http://dx.doi.org/10.1111/j.1540-6261.1964.tb02865.x https://scholar.google.com/scholar?hl=en&q=does%20risk%20management%20add%20value?%20a%20survey%20of%20the%20evidence http://dx.doi.org/10.1111/j.1745-6622.2005.00042.x https://scholar.google.com/scholar?hl=en&q=forecasting%20tourism%20demand:%20a%20review%20of%20empirical%20research http://dx.doi.org/10.1016/0169-2070(95)00591-7 asian journal of economics and empirical research vol. 4, no. 1, 25-31, 2017 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2017.41.25.31 25 how chinese state-owned enterprises change their dynamics in new product innovation? xiaomin zhao1 ping lan2  ( corresponding author) 1business school, jilin university, p.r. of china 2school of management, university of alaska fairbanks, u.s.a. abstract the innovation of state-owned enterprises and its adaptation to the market competition have been in the spotlight of studies. according to the panel data form statistics on science and technologyoriented activities of industry enterprises, this research measures and contrasts the new product innovation investment and performance of chinese state-owned enterprises (soes) and nonsoes. it reveals that market competition is a positive effect on new product innovation input and output of state-owned enterprises, as non-soe, the relationship between competition intensity and new product innovation output of state-owned enterprises appears exponential relationship. furthermore, it discovers that non-soe is more sensitive to competition intensity than soe. under the different competitive environment, both of them play differents role on promoting development of innovation and stabilising the market. keywords: state-owned enterprises, market competition, competition intensity, new product, innovation. citation | xiaomin zhao; ping lan (2017). how chinese stateowned enterprises change their dynamics in new product innovation? asian journal of economics and empirical research, 4(1): 25-31. history: received: 29 june 2017 revised: 4 september 2017 accepted: 12 september 2017 published: 18 september 2017 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 26 2. basic literature and research hypothesis ................................................................................................................................. 26 3. data resources and variable description .................................................................................................................................. 27 4. data analysis and results ............................................................................................................................................................. 28 5. conclusion ......................................................................................................................................................................................... 31 references .............................................................................................................................................................................................. 31 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://orcid.org/orcid-search/quick-search?searchquery=xiaomin zhao https://orcid.org/orcid-search/quick-search?searchquery=ping lan https://orcid.org/orcid-search/quick-search?searchquery=xiaomin zhao https://orcid.org/orcid-search/quick-search?searchquery=ping lan https://orcid.org/orcid-search/quick-search?searchquery=xiaomin zhao https://orcid.org/orcid-search/quick-search?searchquery=ping lan asian journal of economics and empirical research, 2017, 4(1): 25-31 26 1. introduction with the increasingly fierce market competition, some state-owned enterprises (soes) have been navigated in a tough situation. during the 1930s, the structuralism theory proposed by harvard school presents that the behavior of the enterprises relies on the structure of market, but it can also exert an impact on market performance, only with a competitive structure can market play an effective role in competing and maintaining the normal order in market. therefore, the market competition intensity has an incentive effect on both input and output of new products. however, correlation theory and literatures still didn‟t give us a specific answer about what type should an enterprise pursue to develop the innovation of the enterprises. some research discovered an inverted “u”-shape of the relationship between the market competition and enterprise innovation (aghion et al., 2005; nie et al., 2008) and some came to a conclusion that market competition can obviously influence the efficiency of the enterprise innovation activities (bai and li, 2006) and the more fierce market competition situation is, the more input there will be provided for research project of soes (zhou, 2010).in spite of drawing these conclusions, we still don‟t have a specific answer about whether market competition can push innovation of new products of soes moving forward. more further and more detailed, is the effectiveness on new product innovation of soes exerted by market competition the same as the effectiveness on that of non-soes？ and soes or non-soes， which is more sensitive to market competition？ according to the panel data from statistics on science and technology-oriented activities of industry enterprises (sstaie) from 2006 to 2011, there are two aspects we can use to measure how market competition can affect the new product innovation of soes. first, we could measure the impact on input and output of the new product of soe exerted by market competition. second, we can investigate characteristics of innovation behavior and performance of the soes in terms of new products innovation of the non-soes. 2. basic literature and research hypothesis the basic view of schumpeter‟s hypotheses is that there is a tightened tie between the innovation and monopoly. further, high degree of market concentration will accelerate the research and development work of enterprises. however, some empirical analysis that have been conducted by subsequent scholars show that there isn‟t a consequent relation between innovation and market concentration which also means that larger business scale will facilitate innovation is not doomed (nickell, 1996). but aghion et al. (2005) find a theory that the relationship between market competition intensity （lerner's index) and innovation （patent number） is an inverted-“u” shape. market competition has a significant impact on the efficiency of the new product innovation of enterprises (bai and li, 2006). the enterprise that belongs to the industry of high degree of the market competition takes obviously faster steps to practice innovation than the enterprises belonging to the monopoly industry. while market competition intensity is continuously strengthened, the same input of research and development of the new product will contribute to more sales income from new product and patents invention. on the contrary, as for higher concentration of market it won't enhance the efficiency of the enterprise innovation activity it will reduce the efficiency of using the innovation resources because of being lack of competition. 2.1. attribution study of market competition and input of new product innovation scholars have made many researches to find the reasons why market competition can influence the enterprise innovation. hart (1983) earlier pushed forward that indolent behaviors of management will be declined by the competition of product market in terms of his formal analysis and research. but scharfstein (1988) found that the fiercer the market competition will be, the more indolently the management will act. raith (2003) found that product market competition promotes the effort level of management. similarly, many researches find that there is a close connection between the competition of product market and enterprise innovation. when an enterprise has a principal-agent relation, the negative impact of the delegation will reduce by the market competition, which will force enterprise to practice innovation more positively (fond and park, 1999). the theory of competition emphasizes the stimulating influence from competition mechanism and the external condition that has an impact on enterprises development and survival and also reveals that market competition can attach more efficiency to the market mechanism in allocating innovation resources. competition is a sustaining drive of technology innovation of enterprises. the essential factor of enterprise innovation should be found in the essential market and the innovation products should come into reality by market products competition. a fierce market competition situation will provide enterprise with more powerful external pressure. enterprises need to unremittingly pursue technology innovation and enhance their core competitiveness in order to their own survival and development. in this way, competition is an important reason for stimulating enterprise innovation. 2.2. influence of new product innovation of soes by market competition from the view of property rights, the soe is different from the non-soe. however, compared with property rights theory which stresses the stimulating influence from residual control right competition theory thinks that even though residual control right can be smoothly aliened, the problems of floating efficiency of soes is still existing. the key to the low efficiency of soes is about that managers of soes lack enough stimulation from competition and the market competition environment which can provide them with an effective stimulation and a strong constraint (lin, 1995). market competition is the fundamental premise to succeed in soes reform. the reform of property rights that are undergoing in the situation where managers of soes lack enough stimulation from competition can‟t overcome the problems such as information asymmetry of soes, incompatibility of stimulating mechanism and unequal responsibility and so on so that the efficiency of soes still cannot be promised (lin et al., 1997). the reason for these problems is that government as delegators places too much burden from all kinds of policies on the shoulder of soe, so that the profit rate cannot fully register the level of how hardworking soe‟s managers are. soes managers lack enough stimulating competition; as a result, it is hard to overcome the difficulties including information asymmetry of soes and government and incompatibility of stimulating mechanism. the matters including enterprise budget constraint softening and violation of the soe's management asian journal of economics and empirical research, 2017, 4(1): 25-31 27 from the ownership rights and interest may lead to low efficiency of soes and loss of state-owned assets, which will be difficult to avoid (lin et al., 1997). similarly, in the beyond property rights theory which stresses on competition mechanism, pushing manager to be hardworking by property rights reform should be premised on market competition (liu and li, 1998). summarizing the above discussion, we can easily find that sufficient competition can encourage soes‟ managers to enhance their production efficiency so as to increase input and output of new product innovation. therefore, we propose hypothesis 1: the intensity of market competition has a positive impact on input and output of new product innovation of soes. the ownership of soe is very different from that of non-soe. property rights theory points out that „absence of ownership‟ and „unclaimed property‟ in a soe lead to a situation where soe‟s managers lack internal stimulating mechanism from property rights. as a result, soes are always short of money from investment in implementing technology improvement and re-equipment (wang and zhou, 2000). principle-agent theory throws a light on that the problem existing in delegation and authorize in soes is more serious than this of non-soes (xu et al., 2006; li, 2009). because， considering short-term employment and evolution way which means income is linked up with current performance, these managers have to value short-term profit and current performance and their position more, instead of long-term development and technology innovation for enterprises (jia, 2002). government officials‟ intervention make the relation of soes delegation and agency as national ownership— government officials—managers (shapiro and willig, 1990) this kind of relation results in a mass consequence including multitasking and multiple principal-agent，besides some more serious delegation problems (holmstrom and milgrom, 1991). so what badly hinder input and concentration of innovation payment by soe managers are short-term behavior of government officials, government administration intervention to soes, employment decisions to soes managers and supervising them by government apartments (bai et al., 2004; koppell, 2007; li et al., 2007). therefore, we propose hypothesis 2: the impact that competition intensity has on input and output of soe new product innovation is weaker than those of non-soes. 2.3. correlation between market competition and new product innovation of enterprises brazilian economist mahmood ali ayoub and portuguese economist sven olaf hegstad published a research report in 1986 about “determinant of soe success” that points out market competition confronting soes influences soes‟ performance. australian economist, professor tittenbrun (1996) analyzed around 85 literature reviews about property rights and enterprise performance and drew a conclusion that property rights is one of the reasons that can influence enterprise performance, but the matter of property ownership is not the root of causing performance difference, which also cannot influence performance alone. according to correlated statistics from 25 transforming countries and 3300 enterprises, carlin et al. (2001) made a correlation analysis about enterprises performance and finally they released that the key factor that can promote the performance and enhance the efficiency of the enterprise is establishing competition mechanism(bai and li, 2006). therefore, not only ownership structure but also market structure and competition intensity and other instruments have a collective impact on enterprises performance (konings and xavier, 2003). in terms of earlier research which shows that the relationship between the market competition and business innovation is just like an inverted “u”-shape (aghion et al., 2005; nie et al., 2008) we can infer that the relationship between market competition and enterprises new product innovation may be nonlinear. to a certain extent, more fierce competition intensity will drive a higher innovation level of enterprises new product; competition has an exponential impact on new product innovation of both industries and soes. so we have our hypothesis 3: market competition has a positive impact on new product innovation of enterprises, but not a linear correlation. 3. data resources and variable description 3.1. variable description the indicators that can be used to measure the new product innovation activities of enterprises include input and output of new product. we use “r&d fund of new product” as indicator to measure innovation input, use new product quantity and output value of new product as an indicator to measure innovation output.the indicator we can use to measure market competition intensity includes herfindahl-hirschman index (hhi) and enterprises quantity. since it is difficult to figure the share of market of each enterprise, we use the number of enterprises above industrial average level as indicator to describe the intensity of competition in the industry. soes refer to stateowned and state-controlled enterprises; non-soes are all enterprises except soes. according to new product production and development by registered status from the statistics on science and technology-oriented activities of industry enterprises published by the office for national statistics, non-soes include private enterprises. macao-, hong kong-and taiwan-based investment and other foreign investment ventures are in this category. 3.2. data resource according to the sstaie from 2006 to 2011 and 2012 yearbook of statistics on science and technologyoriented activities of industry enterprises, we choose 39 industries as research sample. we obtain the figure of project quantity of new product by industrial sector and by soes, r&d fund of new product and output value of new product from “new products development and production by industrial sector”, “new products development and production by industrial state-owned and state-controlled enterprises”. and we obtain the number of employment of state-owned enterprises and enterprise quantity from “basic status of enterprises by industrial sector”, “basic status of soes and state-controlled enterprises by industrial sector”. by processing the data, we find that there is a big gap between 2012 statistical data and its former 6-year data from yearbook of statistics on science and technology-oriented activities of industry enterprises. for example, the number of industrial enterprise is about 40,000 from 2005 to 2010, which year-on-year growth rate is around 10%, however, this number of 2011 stands at 325735, even 6 times year-on-year growth rate as before. we guess probably changing the statistical caliber causes this data mutation. in order to prevent these mass data from destroying our asian journal of economics and empirical research, 2017, 4(1): 25-31 28 data accuracy, we won‟t use data of 2011. besides, we also rule out the 6th industry (mining industry of other minerals) and the 36th industry (wasting resource and waste material recycling and reprocessing industry) which are lack of some data. finally, we obtain the panel data from 37 industries from 2005 to 2010. 3.3. descriptive statistics table1 is the descriptive statistics of the major variable table-1. the descriptive statistics of the major variable ( 2005 ～ 2010 ) variable definition unit observed value min max mean s market competition intensity enterprise number of each industry 222 63 3646 1.01e3 851.87 quantity of new products new product number 221 10 25850 3.29e3 5064.81 quantity of new products of soes 222 10 13311 1.49e3 2424.44 quantity of new products of non-soes 222 0 18762 1.79e3 3000.91 r&d funds of new product total r&d fund of new product of industry million yuan 2.22 14.20 7.16e4 7.64e3 1.33e4 r&d funds of new product of soes million yuan 2.22 3.66 5.03e4 3.29e3 6.84e3 r&d funds of new product of non-soes million yuan 2.22 0 4.90e4 4.35e3 8.12e3 output value of new product total output value of new product of industry million yuan 2.21 1.00 1.67e6 1.29e5 2.55e5 output value of new product of soes million yuan 2.20 1.00 1.22e6 5.62e4 1.45e5 output value of new product of non-soes million yuan 2.22 0 1.14e6 7.27e4 1.55e5 source: statistics on science and technology-oriented activities of industry enterprises (sstaie) 4. data analysis and results 4.1. influence on the new product innovation of soe and non-soe by the market competition considering innovation behavior and performance of non-soes, we focus upon the impact on new product innovation of soes exerted by market competition. and we set this formulation: , , is input or output of enterprises new product innovation; is market competition. table-2. the influence of market competition intensity on new products innovation of soe and non-soe ps: the number in the brackets is t-value. * means sig<10%, ** means sig<5%, *** means sig<1% because the fitting results of the constant coefficient model conform to the requirements (r2> 0.6, f-value is significant on 0.01 level), we omit variable intercept time model and variable intercept industry model. in the constant coefficient model, market competition intensity correlates positively with the r&d funds of new product innovation of soes (  =0.456 , t-test = 31.26 , sig.< 0.01 ),new product quantity of soes (  =0.506 , t-test = 23.64 , sig.< 0.01 )and output value of new products of soes (  =0.387 , t-test = 47.42 , sig.< 0.01 ) as shown in table 2. therefore, hypothesis 1 is established. among them: the model coefficient data are coefficient=0.456 in showing the correlation between market competition intensity and the r&d funds of new product innovation of soes (t-test = 31.26, sig. <0.01), and coefficient=0.555 in showing the correlation between market competition intensity and the r&d funds of new product innovation of non-soes ( t-test = 28.221, sig. <0.01 ). this comparison reveals with increasingly fierce market competition, the investment in new product innovation will also increase. market competition has a positive it it it it y = a + x  1,2,3, ,39i = 2005,2006, ,2010t = ity itx  data analysis model independent variable r&d funds of new product of soes r&d funds of new product of nonsoes new product quantity of soes new product quantity of nonsoes output value of new products of soes output value of new products of nonsoe  (t-value)  (t-value)  (t-value)  (t-value)  (t-value)  (t-value) constant coefficient model (crosssection weight) constant term -0.049 (-3.87***) -0.088 (-7.63***) -0.123 (-7.06***) -0.074 (-5.62***) -0.03 (-4.49***) -0.09 (-6.76***) market competition intensity 0.456 (31.26***) 0.555 (28.22***) 0.506 (23.64***) 0.608 (30.08***) 0.387 (47.42***) 0.47 (20.28***) fitting effect 2r 0.82 0.784 0.72 0.804 0.91 0.65 f-value 977.3*** 796.4*** 559.0*** 904.86*** 2249*** 411.2*** asian journal of economics and empirical research, 2017, 4(1): 25-31 29 influence on both soes and non-soes, especially the non-soes. as shown in figure 1: in a low competition environment, r&d funds of new product innovation of soes is slightly more than non-soes, while, in a high competition environment, r&d funds of new product innovation of non-soes is slightly higher. figure-1. the different behavior of soes and non-soes investing in new product in different situation source: the panel data analysis from statistics on science and technology-oriented activities of industry enterprises the model coefficient data are coefficient=0.506 in showing the correlation between market competition intensity and new product quantity of soes (t-test =23.64, sig. <0.01), and coefficient=0.608 in showing the correlation between market competition intensity and new product quantity of non-soes ( t-test = 30.08, sig. <0.01 ). this comparison reveals that with increasingly fierce market competition, the new product quantity will also increase and the increase of new product of non-soes will be a little bit higher than soes. as we can draw a conclusion from figure 2 that the number of new product of soes is always smaller than non-soes, and under a high competition environment, this gap will be wider. figure-2. the different behavior of soes and non-soes in the part of new product quatity in different situation source: the panel data analysis from statistics on science and technology-oriented activities of industry enterprises the model coefficient data are coefficient=0.387 in showing the correlation between market competition intensity and output value of new products of soes (t-test =47.42, sig. <0.01), and coefficient=0.47 in showing the correlation between market competition intensity and output value of new product of non-soes (t-test = 20.28, sig. <0.01 ). the comparison is shown in the figure 3 that under a low competition environment, output value of new products of soes is a little more than non-soes, while with increasingly fierce market competition, the position of these two will exchange. figure-3. the difference from output value of new products of soes and non-soes in different situation source: the panel data analysis from statistics on science and technology-oriented activities of industry enterprises asian journal of economics and empirical research, 2017, 4(1): 25-31 30 no matter on the part of r&d funds of new product, new product quantity or output value of new product, the correlation between market competition intensity and soes is bigger than non-soes as shown in table 2. from figure 1, 2 and 3, we can clearly find that the slope of non-soe line is larger than soe line, so we can draw a conclusion that the non-soe is much more sensitive than the soe. therefore, hypothesis 2 is established. 4.2. the correlation of market competition and new product innovation of soes some scholar such as aghion et al. (2005) and nie et al. (2008) and so on think that the correlation relation between market competition and enterprise innovation is not linear but curvilinear. they consider this correlation as an inverted-u shape. so, according to these former researches, we set following formula: 2' it it 1it i 2 it t it ti+ uy x= a + x +   , 1,2,3, ,39i = , 2005,2006, ,2010t = ity is input or output of enterprises new product innovation; ' itx is market competition. table-3. panel data analysis of influence on new product innovation of soes by market competition ps: the number in the brackets is adjoining probability. * means sig<10%, ** means sig<5%, *** means sig<1% because the constant coefficient model considers influence from both industries and time and also has a stricter requirement to the data, we mainly take the reference from the analyzing results from this model. all fitting results of these constant coefficient model are very suitable (r2 > 0.7, f-value is significant on 0.01 level.) shown in the figure 3. therefore, we omit variable intercept time model and variable intercept industry model. in these four models, the square of market competition intensity is always positive, correlated coefficient is significant on 0.01 level, which means the relationship between the market competition and output value of the new product is a normal “u”-shaped, also the relationship between the new product quantity and market competition. this conclusion is inconsistent with the former conclusion that the relationship between market competition intensity and innovation is an inverted-“u” shape (aghion et al., 2005; nie et al., 2008). in the constant coefficient model, the inflection point in the inverted-“u” relation between market competition intensity and output value of new product is -0.93, we can find that according to the indicator on the industry competition intensity, the following 8 industries locates on the right of the inflection point, industry 2 (petroleum and natural gas extraction industry), industry 4 (ferrous metals mining and processing industry),industry 4 (colorful metals mining and processing industry),industry 5(nonmetal minerals mining and processing industry), industry 10 (tobacco processing industry), industry 22(chemical fiber), industry 38 (gas production and supply), industry 39 (water production and supply). that indicates in these industries the output value of new products will not fall with a decreasing market competition. as a view of sector characters, most of these industries are in the field of country fundmental and limited industries (which soes accounts for more than 30%). other 29 industries locate on the left of the inflection point, which indicates that their output value will be larger with a increasing market competition and the growth pattern is exponential but not linear. the inflection point in the inverted-“u” relation between market competition intensity and quantity of new product is -1.36. compared with the indicators of different industries, we find that all industries are on the left of the inflection point (the range of the standard value of the market competition by industry is >-1.1), that shows the market competition intensity has a respectively positive correlation with the quantity of new product project and the growth pattern is exponential but not linear. in the constant coefficient model of the market competition influence on quantity of new product project of soes and output value of new product of soes, the square of market competition are both positive value and coefficients are both significant on 0.01 level, which means the relationship between the market competition intensity and quantity of new product project of soes, as well the relationship between the market competition intensity and output value of new product of soes, is a normal-“u” shape. this conclusion is similar to the normal-“u” shape discovered in the relationship between the market competition and innovation product of the industrial sector. considering the inflection point of the u-shape, we find that the inflection point of the u-shape of market competition and output value of new product of soes is -3.688, which of the market competition and quantity of new product project of soes is -6.838, all indicators of market competition from different industries locate on the right of the inflection point(the range of the standard value of the market competition by industry is >-1.1), this means the market competition intensity has a respectively positive correlation with the quantity of new product project of soes and data analysis model independent variable the total output value of new products output value of new products of soes the total quantity of new product new product quantity of soes  t-value prob.  t-value prob.  t-value prob.  t-value prob. constant coefficient model (cross section weight) constant term -0.278 -23.71 -0.07 -12.43*** (0.0000) -0.226 -16.76 -0.118 -8.60*** (0.0000) market competition intensity 0.397 27.67*** (0.0000) 0.354 55.63*** (0.0000) 0.563 24.49*** (0.0000) 0.506 21.05*** (0.0000) the intensity of competition squared 0.240 22.18*** (0.0000) 0.048 9.92*** (0.0000) 0.206 11.04*** (0.000) 0.037 1.87* (0.0623) fitting effect 2r 0.88 0.941 0.75 0.817 f prob. 813.12*** (0.0000) 1716*** (0.0000) 323*** (0.000) 489.3*** (0.000) asian journal of economics and empirical research, 2017, 4(1): 25-31 31 output value of new product of soes and the growth pattern is exponential but not linear. therefore hypothesis 3 is established. 5. conclusion some scholars still do not think highly of the development and adaption of soes in a competitive environment (tan et al., 2005; koppell, 2007; li et al., 2007). however, in terms of the non-soes input and output of new product innovation, we have analyzed different behavior of soe new product innovation in different level of market competition intensity, and the result reveals that market competition intensity has a positive impact on new product innovation of both soes and non-soes, which both adapt the new environment by increasing input and output of innovation under the competitive pressure. what is different is that non-soes is more sensitive to market competition, which also means with increasingly fierce market competition, the increase of input and output of innovation of the non-soes will be a little bit higher than soes. given that the contrast of the innovation behavior between the soes and non-soes, we find that first, in a situation with a low market competitive intensity, the main new product innovation of one industry is contributed by the soes. in this kind of industries, it is soes that promote development of new product innovation. considering of society stability, market control and maintaining domestic economy peaceful and stable development, soes cannot disappear completely, that the chinese government allow the formation of a variety of industrial ownership existing is 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economics and empirical research issn(e) : 2409-2622 issn(p) : 2518-010x vol. 3, no. 1, 103-112, 2016 http://asianonlinejournals.com/index.php/ajeer 103 islamic versus conventional banking: an insight into the malaysian dual banking system khurshid ali1 zeeshan khan2  abdullah saleh3 1 salford university manchester uk 2 m.phil. scholar at pakistan institute of development economics (pide) 3 manchester metropolitan university ( corresponding author) abstract this research aims at examining to match the performance of both malaysian islamic and conventional banking through profitability, efficiency, solvency and liquidity and risk management ratios using independent t-test and discriminant regression models. fifteen financial ratios are applied to examine the competitiveness of the both industries created on the financial data of ten malaysian banks, five from both industries, over the period of six financial years (2009-2015). according to the independent t-test descriptive statistics, the result finds that conventional banks perform well than islamic banks in the context profitability and efficacy ratios. nevertheless, in terms of solvency and liquidity & risk management ratios islamic banks outperform conventional banks operating in malaysia. further, it has been revealed by the disciriminant analysis that in general conventional banks execute well than islamic banks operating in malaysia when it comes to the profitability, solvency, efficiency and liquidity & risk management ratios. keywords: islamic, conventional, malaysia, profitability, solvency. jel classification: g01, g24. contents 1. introduction ....................................................................................................................................................................... 104 2. literature review .............................................................................................................................................................. 105 3. data and research methodology ...................................................................................................................................... 105 4. results and discussions ..................................................................................................................................................... 106 5. conclusion .......................................................................................................................................................................... 107 references .............................................................................................................................................................................. 108 bibliography .......................................................................................................................................................................... 108 citation | khurshid ali; zeeshan khan; abdullah saleh (2016). islamic versus conventional banking: an insight into the malaysian dual banking system. asian journal of economics and empirical research, 3(1): 103-112. doi: 10.20448/journal.501/2016.3.1/501.1.103.112 issn (e): issn (p): 2409-2622 2518-010x licensed: this work is licensed under a creative commons attribution 3.0 license contribution/acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained ethical: history: this study follows all ethical practices during writing. received: 2 june 2016/ revised: 1 july 2016/ accepted: 6 july 2016/ published: 12 july 2016 publisher: asian online journal publishing group http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.103.112 https://orcid.org/orcid-search/quick-search?searchquery=khurshid ali https://orcid.org/orcid-search/quick-search?searchquery=zeeshan khan https://orcid.org/orcid-search/quick-search?searchquery=abdullah saleh http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.103.112 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.103.112 https://orcid.org/orcid-search/quick-search?searchquery=khurshid ali https://orcid.org/orcid-search/quick-search?searchquery=zeeshan khan https://orcid.org/orcid-search/quick-search?searchquery=abdullah saleh http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.103.112 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.103.112 https://orcid.org/orcid-search/quick-search?searchquery=khurshid ali https://orcid.org/orcid-search/quick-search?searchquery=zeeshan khan https://orcid.org/orcid-search/quick-search?searchquery=abdullah saleh http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.103.112 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.103.112 https://orcid.org/orcid-search/quick-search?searchquery=khurshid ali https://orcid.org/orcid-search/quick-search?searchquery=zeeshan khan https://orcid.org/orcid-search/quick-search?searchquery=abdullah saleh http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.103.112 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.103.112 https://orcid.org/orcid-search/quick-search?searchquery=khurshid ali https://orcid.org/orcid-search/quick-search?searchquery=zeeshan khan https://orcid.org/orcid-search/quick-search?searchquery=abdullah saleh http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.103.112 asian journal of economics and empirical research, 2016, 3(1): 103-112 104 1. introduction islamic finance in the middle east and especially in the southeast asian economies has now converted an important component in their societies’ development. the flexibility of the islamic financial system to the worldwide financial catastrophe and the comparative growth of oil wealth in the middle east allowed the islamic financial industry to develop with an extraordinary growth rate (masood et al., 2011). islamic banks emerged relatively unharmed from the initial banking collapse as they are not permitted to contract in mortgage-backed securities or credit default swaps, two of the main practices behind the financial crisis (alzalabani and nair, 2012). according to the president of islamic development bank (idb), ahmad mohammad ali, the total assets of islamic financial industry are expected to exceed $1.5 trillion by 2012 (idb seeks new economic order, 2011). as a result of these advancements, asia in particular is expected to remain as the world’s fastest growing region over the ongoing decade. according to imf world economic outlook report (2011) the region is expected to generate one third of the world’s output by 2015. malaysia’s extensive track record of, straddling over thirty years, emerging islamic financial industry empowered the country to offer compact basics for the anew evolving sector. malaysia initiated its islamic banking operations by the founding of bank islam malaysia berhad (bimb) in 1983. as a result of its outstanding performance, bimb soon floated on the malaysian stock exchange in 1992 (yahya et al., 2012). in order to meet the short-term investment necessities of islamic banking that are based on shariah principles, the islamic inter-bank money market (iimm) was introduced in 1994 which resulted in the formation of another islamic bank, bank muamalat malaysia berhad (bmmb). at present there are 40 financial instruments which are being used for islamic based financial intermediation. amongst them are: musyarakah (partnership), mudarabah (profit sharing), bai’ bithaman ajil (deferred payment sale), wadiah yad dhamanah (savings with guarantee), ijarah (leasing), ijarah thummah al-bai, murabahah (cost plus) and qardul hasan (benevolent loan). these instruments are analogous to conventional banks instruments but with adherence to shariah’s principles (yahya et al., 2012). as a result of these efforts, at present the malaysia islamic banking sector has extended from 6% to 22% of the overall malaysian banking sector while the sukuk (islamic bonds) market accounts for 55% of the debt securities market. as a result malaysia has appeared as a prominent international hub for islamic finance. malaysia being the world’s largest sukuk market and a leading islamic equity, islamic funds management and islamic banking and takaful (insurance) market, is home to most of the key international financial groups that offer islamic financial products and services. moreover, the modifications in the guiding infrastructure, it has been assessed, as an effect of malaysian economy changeover into great value added income economy, there is a massive prospective bazaar for islamic based financial products and services. it has been forecasted (see figure 1.1) that financing based on islamic principles would grow to account for 40% of total financing in 2020 (bnm financial sector blueprint, 2011-2020). the malaysian islamic banking model has been recognised by many muslim countries as a perfect model and many countries have started working to develop similar model (mokhtar et al., 2008). parallel to islamic financial industry a robust conventional financial industry exists in malaysia which has a catalyst role in the economic development of malaysia and of course it enjoys several advantages over islamic banks in malaysia i.e. it has a relative long history and experience, wider presence, more avenues for investments and much more developed technologies and human resource etc. the methods of processes of islamic and conventional banks differ considerably. the conventional banks operate on the basis of pre-fixed interest rate whilst islamic banking is based on profit and loss sharing. according to the malaysian islamic banking act 1983 (276) islamic banking business objectives and operation should not mix elements that are prohibited in islam. in other words, it is a system that is entirely value based that purposes at confirming moral and material welfare of individual and society as a whole (yahya et al., 2012) more precisely actions that include gambling (maisir) interest (riba) and speculative activities (gharar) which are strictly prohibited in islam. islamic banking is being guided by the principles of shariah (islamic law) where shariah prohibit dealing in interest (riba). moreover, shariah also prohibits trading in financial risks such as financial speculations like the one engineered by collateral debt obligation (cdos). on the contrary, conventional banks make profit by attracting deposits from customers at a lower price while resell them (in the form of debt) to entrepreneurs at higher prices. thus, both industries are based on two different paradigms where interest is the bedrock of one industry (conventional banks) while another completely negates it. 1.1. islamic banks and financial recession the world is still struggling to get out of the recession, on the contrary islamic banking is accomplishing reputation in developing as well as developed economies as it strengthened financial institutions evade the wickedest of the economic collapse (alzalabani and nair, 2012). as irresponsible banking practices, prevalent in the conventional industry, turned out to be the sole cause for bringing about the global financial crisis, as a result there has been a growing interest for islamic based financing. however, a question is always being discussed among financial analysts that the global financial crisis caused by housing bubbles and subprime credit disaster in the us could have been avoided had the islamic finance framework in place. in response to this question, masud (2009) argues that islamic finance would have resisted the sub-prime crisis leading to the global economic recession because the very establishing spirit of islamic finance is anti-speculations. besides, islamic finance explicitly negates dealing in usury or charging interest for the usage of money, investing in speculative financial produces such as definite derivatives and engaging in businesses, products and services that are prohibited in islam. most importantly islamic banking emphasise in profit and loss sharing, thus it is very unlikely that a situation like northern rock and rbs might happen where government of uk had to bailout both banks for not having sufficient liquidity to meet their customers’ deposits claims. it is because under the islamic law (shariah) lending money to make money is prohibited as well as debt cannot be taken lacking collateral or asset baking. the major factor behind the achievement of islamic banking is that all its products and services are being backed by real assets different conventional banking where securitization of the assets are in vague (alzalabani and nair, 2012). on the contrary, islamic banking does not create value without real assets which makes islamic banking asian journal of economics and empirical research, 2016, 3(1): 103-112 105 resilient to any potential financial crisis. it is through this structure that al rajhi bank, which is one the largest saudi banks, operated exceptionally well during the beginning of the recessionary period compared to any other banks globally. total assets of the bank (al rajhi) increased by 18% to sar 124.9 billion (usd 33.2billion) during 2007 and grew by another 31% during the first three quarters of 2008 (standard and poor, 2008). conventional banks, on the other side, have made considerable losses on personal loans in the ongoing financial recession as a result of their loans not had been backed by real assets. thus, hundreds of customers had been defaulted on their repayments obligations while the conventional banks had nothing to recover their deficits from. this is apparent from latest financial crisis which triggered by the subprime mortgage disaster recorded as an exceptional in the history, which cost the uk and the us in specific, about $11.9 trillion (imf put total cost of crisis at 7.1 trillion, 2009). looking the gauge of the catastrophe, which is a fifth of the whole global productivity, makes everybody i.e. government, standard setters, economic think tanks and individual to discover the way frontward for structural modifications in the conventional banking sector. 2. literature review a huge literature is existent aimed at investigating the financial soundness of both conventional banks (cb) and islamic banks (ib). in the malaysian context the literature can be categorized into two parts. the first part of study focus on the performance of islamic banks over a certain time period and then investigating whether they show refining performance (samad and hassan, 1999). the second part consists of comparing the performance of islamic banks with conventional banks both at specific time using time series analysis. on the basis of profitability and solvency, according to the recent findings of masruki et al. (2011); zoubi and olson (2008) suggest that cbs are more profitable, but ibs are more liquid than cbs. moreover, they found that cbs are more susceptible towards credit risks and insolvency as compared to ibs. similarly, on the basis of service quality the findings of ahmad et al. (2010); haron and azmi (2008); chazi and syed (2010); samad and hassan (1999); echchabi and olaniyi (2012) and dusuki and abdullah (2007) argued that the scale of the relationship between service quality and customers satisfaction is more in ibs than matched to cbs. in contrast, tafri et al., findings suggest that risk management tools of ibs are inadequate as compared to cbs. moreover, the findings of mokhtar et al. (2008) suggest that the performance of ibs were far better than the islamic windows. though, the efficacy level of ibs was still less effective than that of full-fledged cbs. similarly, johnes et al. (2010) argued that ibs are less cost efficient and more revenue and profit efficient than conventional banks operating in the gcc region. they further argue that gross efficiency is significantly higher in among cbs compared to ibs. according to the findings of rosly and bakar (2003) which argued that the performance of ibs and bimb is less convincing compared to conventional banks. moreover, johnes et al. (2010) argue that ibs products and services need to be more innovative and yet customised according to the operating region in order to gain wider acceptance. in contrast, the findings of samad (2004) revealed that in terms of profitability, measured by roa and roe, there exists no difference between ibs and cbs performance. however, he argues that credit performance of ibs is far better than their counterparts cbs. this is mainly because ibs are much liquid as a result of their cautious approach towards credit advancement. besides, ibs credit advancement is also limited by various factors such as shariah which prohibits investments in un-islamic avenues including gambling, pornography, alcohol and other associated projects. furthermore, being new entrants in the market, ibs cannot afford to sustain losses and dent the general repute of islamic banking system. 3. data and research methodology this empirical research undertakes to assess the performance of conventional and islamic banks in malaysia in terms of profitability, efficiency, solvency and risk and liquidity management on the bases of financial ratios. the evaluations of these four types of financial ratios would give indications whether islamic banking industry in malaysia has established itself to compete with its counterpart conventional banking industry in malaysia as well as to assess whether islamic banking industry has the capability to withstand financial recession and similar financial shocks. in order to undertake this assignment, a total of 10 banks have been selected containing five banks from each industry. this study mainly relies on data that will be retrieved from selected banks’ annual reports for the fifteen financial ratios. though there are 16 conventional banks in total but majority of the banks have recently entered the banks, thus, only six of them have been filtered out. the data used in this research is collected over the period of 2009 to 2015. though there are 16 islamic banks (see figure 3.1) and 18 (local and foreign) conventional banks in malaysia but only five banks have been selected from either industry (see table 3.1). the banks selection criteria from either industry were based on a number of variables to ensure that we have equal research sample for the intended research. this includes the selection of those banks from either industry that have almost equal assets, market capitalisation and operational bases; while also looking into the availability of data for the selected period. 3.1. hypothesis h0: there exist is no substantial variation concerning the performance of jointly conventional banks and islamic banks in malaysia. according to the different methodologies used in the literature in the context of malaysian dual banking system, financial ratios seem to be widely used indicators for measuring the financial performance of ibs and cbs as well as other financial institutions. it is because; ratios analyses remove the disparities in size, if existent in the sample, and bring them at par. thus, it further asserts the reliability of financial ratios to be used for comparing financial entities. however, the literature reveals that only limited statistical tools have been used (in the malaysian banking context) to asian journal of economics and empirical research, 2016, 3(1): 103-112 106 analyse financial ratios, therefore, the aid of mda analysis through this research work will prove to be much more appropriate to discriminate significantly between ibs and cbs. 4. results and discussions 4.1. descriptive statistics rendering to the descriptive statistics results (check table 4.1) the mean for roa transmits a positive value for both conventional and islamic banks. however, the mean for cbs (.01) is larger than the means (.00) for ibs but the relationship is not statistically significant as having p-value of .266. on the contrary, roe results in a relatively larger mean (.27) for ibs as compared to a mean (.11) for cbs but again the relationship is not statistically significant (p-value .316). omr, another probability ratio, also has a higher mean (21.81) for ibs compared to the mean (.29) for cbs however carries no statistical significance. rod on the other side has an equal mean (.01) for both ibs and cbs but is not statistically significant. however, iee, which is the last of the five profitability ratios, shows a higher mean (.038) for cbs than the mean (.002) for ibs and also statistically significant at the 99% confidence level (pvalue .000). this shows that in general, conventional banks appear to be more profitable than islamic banks in malaysia. however, these results are inconsistent with the results of zoubi and olson (2008) who argue that ibs are extra profitable than cbs in the gcc region. but the results are reliable with the results of masruki et al. (2011) who contend that cbs are more profitable than ibs in malaysia. the profitability of cbs can also be refers to some other factors prevalent in the malaysian conventional banking industry i.e. a comparative strong network, greater market stake, human resource capital and economy of scale. in order to measure how efficiently both islamic and conventional banks perform in malaysia four efficiency ratios have been statistically measured. the first ratios oea, which measures operating expense in relation to total assets, yields a higher mean (.01) for cbs than compared to a mean (.00) for ibs and the relationship is also statistically significant at the 99% confidence level (.000). this specifies that cbs incurs more expenses in order to generate profit from its existing assets than its counterpart islamic banks. on the other hand, oia, which measures operating income in relation to total assets, results in equal mean (.01) for both islamic and conventional banks but the relationship is not statistically significant. similarly, oer, which measures operating expense in relation to operating income, results in considerably higher mean (.49) for ibs than compared to a mean (.27) for cbs but again the relationship is not statistically significant. however, the last of the four efficiency ratios ato, which measures interest/commission income in relation to total assets, results in higher mean (.04) for cbs than the mean (.00) for ibs while the relationship is also statistically significant. it shows that cbs efficiency use its available funds to attract more revenue than its counterpart ibs in malaysia. thus, it can be argued that cbs are relatively more efficient in terms of using shareholders and customers funds than their counterpart ibs in malaysia. the obtained outcomes are reliable with the conclusions of sufian (2007) and mokhtar et al. (2008) who argue that ibs are not that efficient in association with conventional banks operational in malaysia. examining the solvency of both islamic and conventional banks in malaysia two ratios i.e. pea, which measures provision for loan losses against total loans and advance, and wrl, which measures actual bad debts against total loans and advances, have been statistically measured. pea results in a relative higher mean (.012) for ibs than the mean (.007) for cbs but the relationship is not statistically significant. however, wrl yields a higher mean (.009) for cbs than the mean (.001) for ibs and the relationship is also statistically significant at 99% confidence level (pvalue .000). this shows that cbs maintains less provision against loans and advances as compared to ibs but incurs more losses in the form of bad debts on its loans and advances than compared to ibs. this puts cbs at relative disadvantage in terms of solvency than compared to ibs which seems more solvent. these outcomes are supporting with the results of masruki et al. (2011) who contend that according to the risk and solvency analysis cbs are much more susceptible towards credit risks and insolvency compared to ibs in malaysia. this can, therefore, be contributed to the prevailing facts that ibs are found to be more resistant to financial recession than cbs (masood et al., 2011). further, to measure the level of liquidity and risk management of both islamic and conventional banks, four ratios i.e. cta, ctd, ltd and tle have statistically been measured. the cta, which measures the level of cash against total assets, results in higher mean (.26) for ibs than the mean (.14) for cbs while the relationship is also statistically significant at 99% confidence level (p-value .000). this shows that ibs are more liquid to withstand any potential financial shocks than cbs. similarly, ctd, which measure cash against total customer deposits, also results in higher mean (.29) for ibs than compared to the mean (.19) for cbs and the relationship is again statistically significant at 99% confidence level (p-value .000). this further proves that ibs maintain adequate level of liquidity to meet future contingency than cbs operating in malaysia. besides, ltd, which measures the level of total deposits embedded into non-liquid assets, results in higher mean (.78) for cbs than the mean (.61) for ibs and the relationship is also statistically significant at 99% confidence level (p-value .000). this reaffirms that cbs has concentrated high amount of liquid cash into non-liquid assets compared to ibs, which expose cbs to a high level of liquidity risk. finally, tle, which measure total liabilities in relations to shareholders’ equity, results in higher mean (11.54) for cbs than compared to a mean (10.46) for ibs, however, the relationship is not statistically significant (p-value .660). these results are supporting the early results of chazi and syed (2010) and samad and hassan (1999) who contend that ibs maintain better capital ratio to deal with any potential financial shocks than their counterparts conventional banks, thus ibs are less risky and more solvent. however, tafri et al. (2011) argue that risk management tools of ibs are inadequate compared to cbs in malaysia. 4.2. discriminant analysis wilks’ lambda model is applied to examine to check that whether independent variables estimated are correct to separate the performance of islamic and conventional banks operating in malaysia. the data in the subsequent table (4.2) depicts that the p-value is significant at 99% confidence level i.e. the independent variables are adequate to differentiate variable y. the p-value (.000) is also supporting the designed hypotheses and found that h0 is overruled asian journal of economics and empirical research, 2016, 3(1): 103-112 107 and h1 is accepted due to the value of significance level which is less than <95%. this indicates that significant levels of variances exist in the performance of conventional and islamic banks operating in malaysia built on their financial ratios. moreover, the chi-square (189.972) value that is high enough to demonstrate that discriminant analysis can be applied to differentiate between the two industries. the test depicts (see table 4.3) there are only four variables (ato, iee, ltd and wrl) that significantly distinguishing conventional and islamic banks included in the sample. the test more discloses that the statistic value (.042) for ato is the maximum ratio amongst variables discriminating the performance of the two groups or industries. to support the outcomes from stepwise test, a summary of discriminant function is applied. this will also benefit us to know the impact value of those four variables to the variable y (4.4). the following table displays the value of canonical correlation which is 98.4%. it shows that there is 98.4% impact en route for variable y from the four mentioned variables. it further strengthen the preceding stepwise test that those four variables highly influence the performance of conventional and islamic banks in malaysia and is valid measuring scales to differentiate between the position of the two industries. likewise the resulting table (4.5) indicates a discriminant function that is collected from all of the steps in discriminant analysis being in the research. on the basis of this function it can be examined that variables that have a greater value if coefficient would show a positive relationship to the performance of islamic and conventional banks while variables with lower or minus values of coefficients would reveal a negative relationship. according to the table ato has the highest positive value of 156.105 while wrl has the highest negative value of -69.605. discriminants function results are as follows: z scores = -7.113 + 136.603iee + 156.105ato 69.605wrl + 1.953ltd the using of the z score above would enable us to know which industry performance can be classified as improved performance or vice versa. function at group centroid (see table 4.6) will be applied to make a cut off value to differentiate it. the table (4.6) of function at group centroid below indicates the cut off value is 0 as the function both groups (conventional/islamic banks) have same number i.e. 5.333 for group 0 (islamic banks) and 5.33 for group 1 (conventional banks). using cut-off value as the midpoint we can determine that a group which has a z score above zero will be classified as an industry that has good performance while if a group has a z score below 0 (zero) will be classified as an industry which is not good enough. further, predicted group membership test are used to verify the results of z scores and to examine the reliability of the discriminant analysis. the outcomes indicates (see table 4.7) that the predicted value of 83.9% means that the actual number is 84% suitably classified after it has been tested with the recognized discriminant function. it shows the results obtained from this research using discriminant function are applicable and suitable for this research. 5. conclusion the performance of islamic banking industry is concluded to be diverse in terms of profitability and managerial efficiency associated to conventional banking industry. rendering to the descriptive statistics outcomes, the comparative higher mean of roa, omr and rod for conventional banks, although not statistically significant, is revealing the fact that conventional banks outperform islamic banks in terms of profitability. it is evident by the higher mean of iee for cbs than ibs and the relationship is also statistically significant. this shows that cbs has invested their funds in profitable avenues which results in higher return compared to the expenses they incur. however, roe carries greater mean for ibs than cbs but the relationship is not statistically significant. this supports the outcomes of masruki et al. (2011) who finds that cbs are more profitable than ibs operating in malaysia. similarly, looking into the efficiency ratios’ statistics of both industries, it is again evident that cbs exhibit greater efficiency than ibs. the relative higher mean of oea with statistical significance for cbs indicate that although cbs are profitable but yet incur more cost than their counterpart ibs. the subsequent ratios oia and oer exhibit no statistical significance although they have lower means for cbs than ibs. however, ato results in higher mean for cbs than ibs with statistical significance. thus, it can be argued in the context of efficiency ratios that cbs are relatively more efficient than ibs in using shareholders and customers’ funds to result in higher profit. these results also support the findings of sufian (2007) and mokhtar et al. (2008) who argue that ibs are less proficient than compared to their counterpart conventional banks operating in malaysia. while looking the solvency ratios, it has been found that ibs are more solvent than cbs operating in malaysia. this is well evident from the relative higher mean of wrl for cbs than ibs with statistical significance. this shows that cbs result in higher non-performing loan than compared to ibs. moreover, pea, which measures the level of provision for loan losses, carries smaller mean for cbs than compared to ibs but does not show statistical significance. however, it can be still argued that ibs are more solvent than cbs by maintaining an adequate level of provision against potential loan losses. in addition to this, ibs also seem to be making prudent financing decisions which results in minimal non-performing loans than that of cbs. these results, in terms of solvency, support the outcomes of masruki et al. (2011) who finds that according to the risk and solvency analysis cbs are much more susceptible towards credit risks and insolvency compared to ibs in malaysia. in order to evaluate the liquidity and risk management of both industries, cta and ctd, which measure the level of cash against total assets and cash against customers’ deposits respectively, carry higher mean for ibs than cbs with statistical significance. the significance of both ratios is indicative of the fact that ibs maintain an adequate level of liquidity to meet any financial contingency. moreover, ltd, which measures the level of total deposits embedded into non-liquid assets, results in higher mean for cbs than compared to ibs while also exhibits statistical significance. this reaffirms that cbs has concentrated considerable amount of liquid cash into non-liquid assets compared to ibs, thus increasing its risk exposure considerably. further, the outcomes attained by using discriminant analysis supporting that conventional banks perform well than islamic banks in malaysia based on profitability, efficiency, solvency and liquidity and risk management. the asian journal of economics and empirical research, 2016, 3(1): 103-112 108 result of discriminant analysis shows that conventional industry is still a vibrant sector in the malaysian dual banking market. however, the descriptive statistics have us to believe that the operations of conventional banking sector are much more vulnerable to financial shocks as compared to the ibs operations. these views are being supported by various researchers such as sufian (2007); mokhtar et al. (2008) and yahya et al. (2012). moreover, islamic banking industry in malaysia is indeed the fastest growing sector which succeeded in acquiring an asset base of usd 65.5 billion having mean growth rate of 15-20% annually. the industry has extended from 6% to 22% of the overall malaysian banking sector while the sukuk market accounts for 55% of the debt securities market making malaysia the biggest secondary market for islamic based financial instruments (bnm financial sector blueprint, 2011-2020). as far the resilience to financial recession of both industries concern, it can well be argued from the descriptive statistics findings that islamic banking seems to be more resilient to financial recession compared to conventional banking sector. this is well obvious from solvency and liquidity ratios of islamic banking with statistical significance which shows that in the event of financial turmoil islamic banking will be solvent enough to meet its payment obligations. islamic banks have prudent risk management tools in place to combat eventualities. the findings re-establish the prevalent claims that islamic banking has the capability to withstand financial recession than compared to its counterpart conventional banking. looking to the overall descriptive statistics results in relation to previous research work, it can be argued that although ibs seem to be less profitable than cbs but yet they consistently demonstrate improved enactment in-terms of solvency, liquidity and risk management techniques. however, not everything goes smooth for islamic banking i.e. it has its own problems to cope with. most importantly the problems include excess liquidity, scarce human capital, lack of geographic diversification and the unavailability of vibrant secondary market for the trading of islamic based financial instruments. references ahmad, a., k. rehman and m.i. saif, 2010. islamic banking experience of pakistan: comparison between islamic and conventional banks. international journal of business and management, 5(2): 137-143. alzalabani, a. and d.r. nair, 2012. financial recession, credit crunch and islamic banks: a case study of al rajhi bank in the kingdom of saudi arabia. journal of economics and business, 16(1): 15-36. bnm financial sector blueprint, 2011-2020. strengthening our future. available from http://www.bnm.gov.my/index.php?ch=en_publication_catalogue&pg=en_publication_blueprint&ac=7&lang=en&eid=box1. chazi, a. and a.m.l. syed, 2010. risk exposure during the global financial crisis: the case of islamic banks. international journal of islamic and middle eastern finance and management, 3(4): 321-333. dusuki, w.a. and i.n. abdullah, 2007. why do malaysian customers patronise islamic banks?. international journal of bank and marketing, 25(3): 142-160. echchabi, a. and n.o. olaniyi, 2012. malaysian consumers preferences for islamic banking attributes. international journal of social economics, 39(11): 859-874. haron, s. and n.w.w. azmi, 2008. determinants of islamic and conventional deposits in the malaysian banking system. managerial finance, 34(9): 618-643. idb seeks new economic order, 2011. arab news. available from http://www.arabnews.com/economy. imf put total cost of crisis at 7.1 trillion, 2009. the telegraph. available from http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/5995810/imf-puts-total-cost-of-crisis-at-7.1-trillion.html. johnes, j., m. izzeldin and v. paapas, 2010. efficiency in islamic and conventional banks: a comparison based on financial ratios and data envelopment analysis. 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financial sector: 2 source: (bnm, financial sector blueprint, (2011-2020) 1 for more details see financial sector blue-print (2011-2020). 2 for more details see financial blue-print (2011-2020). http://www.malaysia-chronicle.com/index.php?option=com_k2&view=item&id=44552:malaysian-banking-sector-shines&itemid=3 http://www.malaysia-chronicle.com/index.php?option=com_k2&view=item&id=44552:malaysian-banking-sector-shines&itemid=3 http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/8275848/sir-john-vickers-speech-on-banking-reform-in-full.html http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/8275848/sir-john-vickers-speech-on-banking-reform-in-full.html asian journal of economics and empirical research, 2016, 3(1): 103-112 110 appendix-iii appendix-iv figure-3.1. number of financial institutions in malaysia source: bnm, financial sector blueprint, 2011-2020 appendix-v asian journal of economics and empirical research, 2016, 3(1): 103-112 111 appendix-vi table-4.1. descriptive statistics variables n mean std. deviation std. error t-test for equality of means cbs ibs cbs ibs cbs ibs cbs ibs t-value p-value profitability ratios roa 30 29 .01 .00 .005 .019 .001 .003 -1.133 .266 roe 30 29 .11 .27 .056 .848 .010 .157 1.022 .316 omr 30 29 .29 21.89 .071 107.667 .013 19.993 1.081 .289 rod 30 29 .01 .01 .007 .020 .001 .004 -1.348 .187 iee 30 29 .038 .002 .004 .003 .000 .000 -32.20 .000 efficiency ratios oea 30 29 .01 .00 .003 .004 .000 .001 -10.56 .000 oia 30 29 .01 .01 .003 .019 .000 .004 -1.792 .084 oer 30 29 .27 .49 .046 .535 .008 .099 2.187 .037 ato 30 29 .04 .00 .006 .001 .001 .000 -36.92 .000 solvency ratios pea 30 29 .007 .012 .007 .027 .001 .005 .992 .328 wrl 30 29 .009 .001 .006 .002 .001 .000 -6.703 .000 risk and liquidity ratios cta 30 29 .14 .26 .056 .135 .010 .025 4.709 .000 ctd 30 29 .19 .29 .068 .119 .012 .022 4.105 .000 ltd 30 29 .78 .61 .134 .226 .024 .042 -3.431 .001 tle 30 29 11.54 10.46 2.357 12.866 .430 2.389 -.444 .660 appendix-viii table-4.3. the results of discriminant analysis: variables entered/removed a,b,c,d steps wilks' lambda exact f entered statistic df1 df2 df3 statistic df1 df2 sig. 1 ato .042 1 1 57.000 1290.899 1 57.000 .000 2 iee .038 2 1 57.000 716.673 2 56.000 .000 3 ltd .034 3 1 57.000 516.217 3 55.000 .000 4 wrl .032 4 1 57.000 413.474 4 54.000 .000 asian journal of economics and empirical research, 2016, 3(1): 103-112 112 appendix-x table-4.5. canonical discriminant function coefficients function 1 iee 136.603 ato 156.105 wrl -69.605 ltd 1.953 (constant) -7.113 unstandardized coefficients appendix-xi table-4.6. functions at group centroids d-vari function 1 0 -5.533 1 5.348 appendix-xii table-4.7. results obtained from predicted group membership: classification results b,c predicted group membership total d-vari 0 1 original count 0 29 0 29 1 0 30 30 % 0 100.0 .0 100.0 1 .0 100.0 100.0 crossvalidated a count 0 29 0 29 1 0 30 30 % 0 100.0 .0 100.0 1 .0 100.0 100.0 asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. asian journal of economics and empirical research issn(e) : 2409-2622 issn(p) : 2518-010x vol. 3, no. 1, 113-121, 2016 http://asianonlinejournals.com/index.php/ajeer 113 impact of government expenditure on economic growth in nigeria: a disaggregated analysis friday ebong1  fidelis ogwumike2 udeme udongwo3 olumide ayodele4 1,4 department of economics university of calabar, calabar 2 department of economics university of ibadan, ibadan 3 department of business administration university of calabar, calabar ( corresponding author) abstract the purpose of this paper was to assess the impact of government capital expenditures on economic growth in nigeria during 1970 and 2012. a multiple regression model based on a modified endogenous growth framework was utilized to capture the interrelationships among capital expenditures on agriculture, education, health economic infrastructure and economic growth. drawing on error correction and cointegration specifications, an ols technique was used to analyze annual time series. both short and long run effects of government capital expenditures on economic growth were estimated. government capital expenditures had differential effects on economic growth. capital expenditures on agriculture did not exert any significant influence on growth both in the long and short runs. similarly, the corresponding short-run and long-run impacts on growth of capital expenditures on education were 0.45 and 0.48, respectively. these results were positive and statistically significant at the 5% level. the short-run impact of health capital expenditures on economic growth was 0.21, while the long-run impact was 0.16. these impacts were negative and insignificant. expenditures on economic infrastructure had significant positive impacts on growth of 0.28 in the short-run and 0.32 in the long-run. moreover, these expenditures do not crowd-out private investment. these results indicate that government expenditure on human capital development through the social services sector tended to promote economic growth unlike that on agriculture. given that agriculture still remains a mass major provider of livelihood opportunities, it is still an important channel of economic growth. there is need, therefore, to strengthen the quality and sustainability of, especially, capital expenditures on nigeria’s agricultural sector. keywords: nigeria, capital expenditure, economic growth, co-integration, error correction model, productive spending. contents 1. introduction ....................................................................................................................................................................... 114 2. literature review .............................................................................................................................................................. 114 3. government capital expenditure patterns in selected sectors ...................................................................................... 116 4. empirical strategy ............................................................................................................................................................. 118 5. presentation and discussion of empirical results ........................................................................................................... 119 6. conclusion .......................................................................................................................................................................... 120 references .............................................................................................................................................................................. 120 citation | friday ebong; fidelis ogwumike; udeme udongwo; olumide ayodele (2016). impact of government expenditure on economic growth in nigeria: a disaggregated analysis. asian journal of economics and empirical research, 3(1): 113-121. doi: 10.20448/journal.501/2016.3.1/501.1.113.121 issn (e): issn (p): 2409-2622 2518-010x licensed: this work is licensed under a creative commons attribution 3.0 license contribution/acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained ethical: history: this study follows all ethical practices during writing. received: 16 december 2015/ revised: 8 march 2016/ accepted: 18 may 2016/ published: 18 july 2016 publisher: asian online journal publishing group http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.113.121 https://orcid.org/orcid-search/quick-search?searchquery=friday ebong https://orcid.org/orcid-search/quick-search?searchquery=fidelis ogwumike https://orcid.org/orcid-search/quick-search?searchquery=udeme udongwo https://orcid.org/orcid-search/quick-search?searchquery=olumide ayodele http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.113.121 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.113.121 https://orcid.org/orcid-search/quick-search?searchquery=friday ebong 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https://orcid.org/orcid-search/quick-search?searchquery=olumide ayodele http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.113.121 asian journal of economics and empirical research, 2016, 3(1): 113-121 114 1. introduction early development theories stressed the need for the state to create adequate physical infrastructure as well as institutions and social conditions for development. some called for implementing large-scale public investment programmes, economic planning and the formulation of policies to accelerate economic growth and development. these must have given governments in nigeria and other developing countries, where market failures and other socially unwarranted vices are rife, the impetus to exercise greater controls and discretion over their economies. they do this through periodic planning for the allocation of resources and productive spending in critical areas of need. thus, public spending has become an important factor for self – sustaining productivity improvements and long-term growth. for instance, government expenditure can contribute to agricultural growth and the latter can indirectly, through creating rural non – farm jobs and increased wages, generate economic growth. that way public expenditure policy has become critical, and equally so, the sectoral distribution of these expenditures (see (onimode, 1995; world bank, 2009)). the discovery of crude petroleum in commercial quantities in nigeria in the middle of the 1960s greatly enhanced the performance of the economy in the 1970s. the newly found oil wealth ensured that the economy performed impressively in terms of real gdp growth rates. these averaged 5 percent annually during the period 1970 to 1979. however, by the early 1980s, the economy had started to experience real problems. the crash in world crude petroleum prices in 1980/81, the severe economic crises in developed industrial countries, coupled with political instability and internal ad hoc economic policies following high regime turnovers at home, created hard times for the economy between 1980 and 1985. from 1980, therefore, the economy had begun to experience negative gdp growth rates which averaged about 0.24 per cent between 1980 and 1985, down from the 5.0 percent in the 1970s. real gdp growth was positive between 1986 and 1993, at an average of 4.62 per annum. however, and in spite of the structural adjustment program (sap), it fell to an average of 2.30 per annum during 1986 and 1993. real gdp growth rate appears to have been improving since 1999, averaging 4.79 per cent annually. in the 1970s, unprecedented nigeria’s oil revenue obviously permitted massive federal government expenditure. a dramatic jump in capital expenditure was noticeable between 1974 and 1980, reflecting the significant increase in government revenue following favourable developments in the international petroleum market. the period thus witnessed a boost in the provision of economic and social infrastructure such as highways, air and sea ports, hospitals, schools and housing. however, capital expenditures of the federal government as a percentage of gdp decreased steadily from 20.48 per cent in 1980 to 6.27 per cent in 1995. these reflected adherence to the prescriptions of sap and also the impact of the oil glut of the 1980s on revenue of government and by extension on its expenditure. between 1999 and 2010, it had fallen to a low of 0.30 per cent, from 5.23 per cent in 2000. in general, the period, 1990 – 1998, was characterised by high growth in capital expenditure in nominal terms, though in real terms, growth was only marginally. the upward trend in nominal capital outlay during the period reflected high rates of inflation and the consequent low value of the naira (see also oni (2014)). as yet, there is no complete theory of optimal expenditure policy that provides well-defined rules for expenditure allocation. however, various quantitative techniques (reduced form regressions, general equilibrium models, investment appraisal methods, incidence analysis) have been used with several types of data sets (cross section, time series, primary data, panel data) to compare marginal return to spending across sectors (see, for example, (fan and rao, 2003; loto, 2011; oni, 2014)). however, as currently implemented, such studies suffer various drawbacks. in a number of cases, specifications seem ad hoc and not drawn from any of existing economic theories. in addition, expenditure components covered by most of these studies are often a small fraction of all expenditure options available to governments. in many cases time periods covered are not sufficiently long to enable making meaningful inferences about short-term and long-term effects of government spending. opinions are, therefore, not agreed as to the impacts of public spending on economic growth, although there have been significant advances in quantifying linkages between expenditure components, on the one hand, and economic growth on the other (see musaba et al. (2013)). what is at stake here is how a government should allocate public spending across various sectors of an economy in order to maximize prospects of achieving its growth and development objectives. given the lack of consensus among researchers concerning the effects of public expenditure on economic growth, a preponderance of crosscountry studies and a relatively insignificant number of country-specific studies in this direction, our paper represents an attempt to re-examine the issues in the light of the nigerian experience. specifically, it is concerned with determining the relative contributions to economic growth in nigeria of government capital expenditures on agriculture, education, health and infrastructures. the importance of disaggregating government expenditure for proper appreciation of the role of the state in the nigerian economy is being underscored in this study. according to canning (1999) apart from affording a better understanding of the role of the state in the growth process, opportunity could then be taken to carefully restructure and scrutinize the composition of public expenditure so as to simultaneously enhance growth and promote the needed environment for private sector development along the lines suggested in the state – insociety model. the rest of the paper is organized into five sections. section 2 contains the literature review where the theoretical and empirical issues are highlighted. in section three, we take on government capital expenditure patterns in selected sectors of the nigerian economy. sections 4 and 5 are concerned, respectively, with the study’s empirical strategy and the presentation and discussion of empirical results. in the sixth and last section is the conclusion. 2. literature review 2.1. theoretical issues with respect to the relationship between government expenditure and economic growth, wagner’s law of increasing state activities is instructive. propounded by a german economist, adolph wagner (1835-1917), this law states that there are inherent tendencies for activities of different layers of governments to increase both intensively asian journal of economics and empirical research, 2016, 3(1): 113-121 115 and extensively. according to this position, there exists a functional relationship between growth of an economy and growth of government activities in which the government sector grows faster than the economy. the emphasis is on long-term forces rather than short-term changes in public expenditure (wagner, 1911). empirical evidence has also confirmed that all kinds of governments, irrespective of their levels, have same tendency of increasing their expenditures-with pace of increase being different for different branches of government (usman et al., 2011). wagner’s law is applicable to modern progressive governments that are interested in expanding public sector of the economy and undertaking other activities for general benefits. however, it does not provide any precise quantitative relationship as to extent to which public expenditure would increase and time this would take. this may be because his study was based on historical experience. that over time public expenditure has been increasing is hardly sufficient grounds for predicting extent to which public expenditure would change in future. there is the developmental state model which sees the state as the main catalyst in developing “late developer” economies. it assigns the role of shifting the frontier of industrialization rests solely on the state, the state leadership being expected to guarantee the guided control of the economy. according to this theory, overcoming barriers to economic growth requires an authoritarian state that is interested in economic development, since it is only the state that can create the necessary level playing ground for local industries to be competitive (see odusola (2006)). there is also the state-in-society model. this looks beyond the developmental state by coveting the active role of society in bringing about meaningful development. it rests on the principle that state-society relations are the principal determinants of successful national development. this strategy clearly acknowledges the existence of limits on the efficacy of state capacity to promote economic development and the need for society to fill this gap. there is a form of public-private partnership philosophy and some element of social contract with mutually agreed roles and responsibilities for each party. state and society interactions drive equitable growth and development, though the role of each party necessarily varies from time to time (see (schaltegger and torgler, 2006)). this is exemplified in the case of human resources development which is undertaken jointly by the state and the private sector). massive public investment in human resources development is expected, in the long-run, to speed up growth, as human capital would have been made more productive (oluwatobi and ogunrinola, 2011) besides, in their “sources of economic growth” studies, romer (1994) and lucas (1988) attribute growth in production to externalities created by investment in human capital, apart from technology and policy variables. 2.2. economic growth theories classical theories of economic growth assume existence of a perfectly competitive economy in which the “invisible hand” maximizes national output. the “trickle-down” doctrine then explains how the beneficence of growth affects all in society equitably. to the classical economists, capital accumulation is basic for economic growth. emphasis is, therefore, on mobilization of savings to generate adequate capital for investment with which to accelerate economic growth (todaro, 1994). on the other hand, neoclassical growth theories allow for factor substitution, diminishing returns to capital, and exogenous technical change in an environment of price-taking firms. using a production function framework, they generally predict that long-run per capita income growth rate is independent of savings rate, but dependent only on rate of technical advance. changes in savings rate only have transitory effects on growth as the economy adjusts from one steady-state level of per capita income to another. implication of this for cross-country growth differences is that differences in per capita growth rates will only persist if rates of technical advance differed across countries. without this, diminishing returns to capital will ensure that poor countries grow faster than the richer ones. this development is expected to eventually lead to convergence in per capita income levels across countries. in this theory output comes from one or more of three factors: increases in labor quantity and quality (through population growth and education); increases in capital (through saving and investment); and improvements in technology. unlike the traditional and neo-classical economic growth theories, the endogenous economic growth theories deal with models that can generate long-term growth without relying on exogenous changes in technology or population. a general feature of these models is the presence of constant or increasing returns in the factors that can be accumulated (see (lucas, 1988; romer, 1994)). there is a set of models in which private and social returns to investment diverge such that while private returns to scale may be diminishing, social returns – which reflect spillovers of knowledge or other externalities – can be constant or increasing (see romer (1994)). there is another set of models without externalities, in which privately determined choices of saving and growth are pareto optimal (see rebelo (1991)). these models rely on constant returns to (private) capital, broadly defined to encompass human and non-human capital (romer, 1994). there are yet others which derive from the original contribution of barro (1990) who theorized the linkage between public spending and economic growth by adopting an endogenous growth model. we have adopted the barro (1990) variant for this study, rewriting it in an extended production function framework which endogenizes government expenditure. 2.3. empirical evidence two dominant approaches have been adopted in the literature to investigate the link between government and economic performance: the public finance approach and the macroeconomic approach. investigations within the public finance approach are directed at establishing the validity or otherwise of the wagnerian hypothesis: that there exists a positive relationship between the size of a country’s public sector and its stage of economic development. thus the more/less developed a country is, the smaller/larger its public sector. studies in this group have generally questioned the validity of this hypothesis. landau (1986) in studies of less developed countries, report a negative relationship between government expenditure and growth both for less developed and developed economies. however, cheng and lai (1997) in a study of public expenditure dynamics in south korea, do not find any support for the hypothesis. however, several studies have been supportive of a positive relationship between government size and economic growth. ram (2006) study finds evidence in support a positive impact of government size on economic growth. asian journal of economics and empirical research, 2016, 3(1): 113-121 116 however, dritsakis and adomopoulos (2004) find support for the hypothesis only when tested with disaggregated public (capital or recurrent) expenditure data. with respect to nigeria, longe (1984) examines the profile of federal government expenditure for the fiscal years 1959/60 through 1979/80 and finds a rising size of government which he attributes to the country’s stage of development, and hence in support of the hypothesis (see also oni et al. (2014)). the thrust of macroeconomic impact studies, on the other hand, has been on the linkage between public expenditure, capital accumulation, and economic growth; along the lines suggested in the keynesian hypothesis. the latter treats public expenditure as an exogenous policy instrument designed to influence economic growth and correct short-term fluctuations in economic activities. to this end, the effects of government total expenditure or government consumption expenditure on growth have been tested in their aggregated and disaggregated forms, and have yielded mixed results. while public investment has been found to exert a beneficial impact on private investment, labor productivity, and profitability (munnell, 1992) a strong direct relationship could not been established between public investment and growth in the empirical literature (see ogiogio (1996)). barro (1990) employing theoretical models inspired by the new growth theory, find that initial increments to public capital accelerated growth. at some point, however, additional increments to public capital tend to reduce growth. and from a simultaneous equations model, loto (2011) reports a significantly positive relationship between public investment and economic growth based on disaggregated public capital expenditure. he notes that the impact of public capital on growth varies according to the category of public expenditure. in particular, infrastructure exerted a positive and significant impact. in such disaggregated analyses, akpan (2005) finds that at the aggregate level capital spending tends to have a more positive growth effect than current spending. among current items, spending on directly productive sectors has the most positive growth impact. among capital spending items, spending on social sectors and infrastructure tended to have a positive effect, with the stronger effect for the former, this finding agrees with ekpo (1996) who also investigates the relationship between aggregate government expenditure and growth performance for the period 1960 to 1992 in nigeria, using a modified denison-style growth accounting methodology. his finds some support for the claim of a positive relationship between economic growth and public expenditure (see also okoro (2013)). sattar (1993) using a simple growth modeling framework and time series data, however, finds evidence of differential impacts of public spending on the growth performance of developed and developing economies – “favorable for the latter and inconsequential for the former. his study also finds support for the hypothesis that an effective role for the state was directly linked with the state of backwardness of the economy: the more backward, the more critical the role of the state. according to him, since the ldcs suffer many of the “backwardness” syndromes, they seem to require more of the crutches of government support than their developed counterparts. kelly (1997) explores the effect of public expenditure on economic growth in a cross-section study of 73 nations covering the period 1970-1989. based on an econometric model of the relationship between economic growths, public investment generally and particularly public social expenditures, he finds that social expenditures enhance growth by fostering welfare and productivity improvements. his result contradicts a strand of the literature which continues to be dominated by the view that social expenditure is unproductive consumption expenditure which inhibits growth and emphasizes, rather, the importance of the complementarities of public and private actions, especially in developing countries. he argues, that such factors as severe income disparity; asset concentration, the disparate nature of production in the agricultural and industrial sectors, and fragmented financial markets, which characterize many developing countries may warrant substantial public investment programmes, which, he stresses, may be decisive for successful private sector activity and, hence economic growth. studies by aschauer (2000) and tests new classical growth models’ predictions of the complementarity between public and private capital, and find public expenditure to have a positive and statistically significant impact on economic growth. sectorally, they find that investments in transport and communications and in education have the largest impacts on growth, while the effects of investments in agriculture, health, housing, and industry were statistically insignificant. fan and rao (2003) estimate cobb-douglas production functions for africa, asia, and latin america, with national gdp as the dependent variable, using labour, non-government capital, and government expenditure on education, health, transportation and telecommunications, social security, and defense as independent variables. the government capital stock variables were constructed from past government spending (both current and capital) in each functional area. they find most coefficients significant at the 10 percent level with expected signs positive (except for defense), the only coefficients with the “wrong” signs being those for education in africa and latin america, which both have negative signs. for africa, the strongest positive effect was for health spending followed by agriculture, while defense spending had a strong negative effect (see aiyedogbon and ohwofasa (2012)). a second approach continues to see capital accumulation, (“capital” broadly defined to include human capital) as the driving force behind economic growth. it is therefore not the expenditure per se, but outcomes of such expenditure that are the concerns of this approach. this position is exemplified by studies using cross country regressions which results have pointed to the special role human capital plays in the growth process (see romer (1994)). but different authors have interpreted differently the positive partial correlation between growth rates and various proxies for the stock of human capital (see (schultz, 1999; paternostro et al., 2005; oluwatobi and ogunrinola, 2011)). consequently, there has not been much success in establishing macro-level links between indicators of human capital accumulation (e.g. health and education outcomes) and economic growth. however, at the aggregate level, the links between such measures and growth are tenuous and have not been found to be strong in empirical analyses (see oni (2014)). 3. government capital expenditure patterns in selected sectors table 1 shows total capital expenditure and capital expenditures on agriculture, education, health and infrastructure for selected years, each as a percentage of gdp. total capital expenditure was 3.56 per cent of gdp in 1970. this increased through 14 .94 in 1975 to 20.48 in 1980 but fell to 8.05 per cent of gdp in 1985, and rose marginally to 8.99 per cent in 1990. intense efforts at reducing the size of the federal government actually played up asian journal of economics and empirical research, 2016, 3(1): 113-121 117 in the declining proportions of its total expenditure to gdp. total capital expenditure fell from 6.27 per cent in 1995 to 3.56 per cent in 2005. it fell to only 0.03 per cent of gdp in 2010 and 2011. capital expenditures on each of agriculture, education, health and infrastructure as percentages of gdp were equally dismal. for all four, none was up to one per cent of gdp except expenditure on education in 2000. expenditure on agriculture appears to have been worst hit over the years. as a percentage of gdp, this remained at less than 0.01 per cent, except in 1975 and 1990 when it stood at 0.10 per cent each year; and at 0.14 and 0.11 per cent in 2000 and 2005, respectively (see table 1). however, as a percentage of total capital expenditure shown in table 2, capital expenditure on agriculture was 1.02 per cent in 1970. it fell to 0.70 and 0.17 per cent in 1975 and 1980, respectively. capital expenditure on agriculture increased gradually from 1.07 per cent of total capital expenditure in 1995 through 3.14 per cent in 2005 to 3.19 per cent in 2010. it was 4.48 per cent in 2011. these show that nigeria has not, over the years, met the required 10% minimum allocation to its agricultural sector. patterns of expenditure on social and community services were comparably different. as shown in table 1, capital expenditure on education (out of gdp) was 0.46 per cent in 1970. capital expenditure on education peaked at 1.26 per cent of gdp in 2000, from 0.90 per cent in 1990. it declined from 0.57 per cent in 2005 to 0.11 per cent in 2011. table-3.1. sectoral capital expenditure as percentage of gdp (selected years) year gdp growth (%) total agriculture education health infrastructure 1970 3.56 0.04 0.46 0.23 0.27 1975 5.00 14.94 0.10 0.59 0.17 0.15 1980 20.48 0.03 0.31 0.11 0.09 1985 8.05 0.03 0.38 0.19 0.22 1990 4.62 8.99 0.10 0.90 0.19 0.24 1995 5.98 6.27 0.08 0.50 0.17 0.09 2000 5.23 0.14 1.26 0.33 0.11 2005 4.72 3.56 0.11 0.57 0.38 0.12 2010 7.07 0.30 0.01 0.06 0.03 0.02 2011 10.08 0.30 0.01 0.11 0.08 0.06 source: computed by authors from cbn’s data intense efforts at reducing the size of the federal government showed up again in declines in the proportion of its total expenditure to gdp. this declined from 20.48 percent in 1980 to an annual average of 7.02 per cent between 1990 and 2000. it has been on the decline since 2005 (3.56 per cent). capital expenditure on health as a percentage of gdp had no discernible trend. it fluctuated between 0.23 per cent in 1970 and 0.11 per cent in 1980. however, expenditures were 0.33 and 0.38 per cent of gdp in 2000 and 2005, respectively. it was as low as 0.03 of gdp in 2010. as percentages of total capital expenditure, it did not fare any better between 1970 and 1995. intense efforts on the part of the federal government to down-size are likely explanations for the observed patterns. these observed patterns also account for the poor state of health facilities in the country today. things, however, improved from 2000 when capital spending on health was 6.36 per cent, increasing through 10.72 per cent in 2005 to 25.24 per cent in 2011. expenditure on infrastructure as a percentage of gdp was rather unfocussed. it declined from 0.37 per cent in 1970 to 0.09 per cent in 1980. expenditures were not more than 0.10 per cent between 1995 and 2011. as percentage of total capital expenditure, expenditure trend followed a similar pattern, falling to 0.45 per cent in 1980 from 7.00 per cent in 1970; and from 2.77 per cent in 1985 to 2.98 per cent in 2000. this shows that ever since the immediate post-war, rehabilitation of old and reconstruction of our facilities, infrastructure sector has not received much of a serious attention. this is borne out by the persistent decline in capital expenditure on infrastructure over the years. however, infrastructure development appeared to have started to receive attention from 2005 when it received 3.45 per cent of total capital expenditure. it was allocated 6.36 and 21.32 per cent, respectively, in 2010 and 2011 (see tables 3.1and 3.2). table-3.2. sectoral capital expenditure as percentage of total capital expenditure (selected years) year agriculture education health infrastructure 1970 1.02 13.01 6.65 7.60 1975 0.70 3.94 1.12 1.00 1980 0.17 1.53 0.52 0.45 1985 0.37 4.73 2.42 2.77 1990 1.07 9.99 2.08 2.64 1995 1.25 8.05 2.74 1.40 2000 2.65 24.20 6.36 2.08 2005 3.14 15.94 10.72 3.45 2010 3.19 19.32 11.21 6.36 2011 4.48 36.56 25.24 21.32 source: computed by authors from cbn’s data in general, patterns of economic and social expenditure were rather unfocussed. as could be seen from tables 3.1 and 3.2, spending (out of gdp) of 1.88 on education, 1.4 agriculture, and health were consistently lower than the levels expected by the un. these obviously non-performing expenditure patterns could neither arrest the absence of basic (essential) commodities nor rescue the decadence in the state of social facilities in the country. asian journal of economics and empirical research, 2016, 3(1): 113-121 118 4. empirical strategy 4.1. the model this is a policy-oriented empirical study of the impact of government expenditure on economic growth in nigeria. in this context, economic growth is expected to be achieved both directly through public investments in physical capital and indirectly through investments for mass improvements in the quantity and quality of human resources. it is reasoned that government expenditure for human development feeds through the enhanced labourproductivity and, together with physical capital accumulation, determine growth of output. to investigate the impact on economic growth of the patterns of government expenditure in nigeria, we adopted the following general model: gdp = f (k, l, g*) (4.1) where, gdp = gross domestic output of the economy k = physical capital l = total labour force; and g* = government capital expenditures because of the need to trace the responsiveness of economic growth to specific components of government expenditure, we have specified our model to incorporate government capital expenditures on agriculture, education, health, and infrastructure. a generalized cobb-douglas (c-d) production function has been utilized for the growth equation but augmented to include total capital expenditure of government disaggregated as suggested. thus g* enters the model as: g* = g(agrkex, edukex, hltkex, infrkex) (4.2) where, kexagr = capital expenditure on agriculture kexedu = capital expenditure on education kexhlt = capital expenditure on health kexinfr = capital expenditure on economic infrastructure consequently, to allow for this latter condition, the production relationship in equation (4.1) is rewritten as: gdp = f (k, l, kexagr, kexedu, kexhlt, kexinfr) (4.1′ ) each is expected to impact positively on economic growth. 4.2. data definitions and measurements gdp – gross domestic product. this is treated here as an indicator of economic performance. it is ultimately used here in its growth rates. measurement is in percentages k – this depicts the level of physical capital in the economy; gross fixed capital formation, (gfkf) being used ad the proxy. l this depicts total labour (labf)available in society. kexagr, kexedu, kexhlt and kexinfr are, respectively, annual capital expenditures on agriculture, education, health and infrastructure. 4.3. tests of time series properties of the variables the order of integration of the series was examined using both the augmented dickey-fuller (adf) and philipsperron (pp) approaches. there were only a few discrepancies in the results from both approaches which were resolved in favour of the adf approach (dickey and fuller, 1981). therefore, only adf results are reported here. that the variables are integrated of order one, i(1) series, is overwhelming. there was only one exception: the labour force, which was found to be integrated at order two (i.e. i(2)). an overwhelming number of series therefore needed to be differenced once to be made stationary and effectively eclipsed the impact of the only one that needed to be differenced twice to become stationary we also tested for cointegration using the engel-granger two-step procedure to see whether the variables can be used together to give meaningful results in the long-run. from the estimated static long-run regression equation, the associated residuals were tested for stationarity. stationarity of residuals implies that variables in the equation that generates the residuals are cointegrated (engle and granger, 1987). given the non-stationary nature of our data, and that the vector of variables in our equations are cointegrated, we have estimated our model within the framework of an error correction model (ecm). this was intended to provide short-run dynamics of the dependent variable in the stochastic equation. it also provided the basis for assessing both short-run behaviour and the speed of adjustment to the steady state. the ecm, which incorporates short-run information from the cointegrated properties of time series, allows for the integration of short-run dynamics with long-run equilibrium, in addition to preserving the causal linkage between two (or more) variables stemming from an equilibrating relationship. it says, essentially, what percentage of any disequilibrium in the long-term relationship will be corrected in the current period. it also tells whether, and to what extent, a given system has any in-built mechanisms to return to equilibrium after a shock. residuals from the cointegrating regressors lagged one period only (due to small size of our sample) were used as the error correction mechanism in the short-run dynamic equations. government investments are known to have long lead times in affecting production and their effects can be long term once they kick in. thus, one of the thornier problems to resolve when including government investment variables in a production or productivity function has to do with the choice of an appropriate lag length. like fan et al. (2004) we have used a free-form lag structure in our analysis since the shape and length of these investments are largely unknown. thus, we have included current and past government expenditures items in the respective equations, used appropriate statistical tests to determine appropriate length of lag in the case of tests of unit roots; but, constrained by the number of observations, we have used a maximum lag length of one in estimating the models. asian journal of economics and empirical research, 2016, 3(1): 113-121 119 4.4. sources of data annual time series data from 1970 to 2011 have been used in this study. they were sourced from both domestic and international sources. data were of two sets: macroeconomic data and welfare indicators. macroeconomic data were essentially economic performance indicators and public expenditure. these were extracted mainly from domestic sources: the central bank of nigeria’s statistical bulletin (various issues) and the national bureau of statistics’ (formerly, federal office of statistics) annual abstract of statistics, the digest of statistics (various issues), and the nigerian statistical facts (several issues). 5. presentation and discussion of empirical results 5.1. results of tests of time series properties of variables 5.1.1. unit roots test results the test shows that almost all the variables were integrated of order one. there were only one exception, labour force, found to be integrated of order three (i.e., i(2)), shown in table 5.1 table-5.1. adf stationarity test results variable lag length level remark 0 1 2 lngdp 1 -1.65 -3.87** i(1) lngfkf 1 -2.69 -2.83*** i(i) lnlabf 3 -1.84 -1.40 -3.09** i(2) lnkexagr 1 -2.88 -5.44*** i(1) lnkexedu 1 -2.56 -6.36*** i(1) lnkexhlt 1 -0.39 -4.29*** i(1) lnkexinfr 1 -2.60 -6.22*** i(1) critical values: 1% -3.65 5% -2.96 10% -2.62 note: *** => significant at 1% level; ** => significant at 5% level 5.1.2. cointegration test results the non-stationary nature of the series having been so established, it became necessary to check the prospect of long-run relationships between the variables in the equation. as was expected, its regression residual was confirmed as having zero mean and no deterministic trend. test, conducted without intercept and time trend, revealed that equilibrium error were integrated at level, i. e., i (0). consequently, the variables in the static equation were adjudged to be cointegrated and have been treated as such. however, the engle-granger test procedure had to be utilized in spite of the fact that it may not be that robust. besides, being guilty of small-sample bias, it may fail to detect a long run relationship even when one exists. 5.2. presentation of estimated model in an error correction model, a variable reacts to both short-run movements in other variables individually and to changes in the long-run cointegrating relationship, the latter being captured by the error correction term (ectt-1). the estimated form of this model, with capital public expenditures, is given in table 5. in estimating this model, total capital expenditures were disaggregated into their agriculture, education, health, and economic infrastructure components. results for short and long run estimates are as provided in tables 5.2 and 5.3 respectively. table-5.2. long – run estimates variable coefficient constant -3.60 (-1.02) ln gfkf 0.69*** (4.67) lnlabf 0.28 (1.51) lnkexagr -0.10 (-0,79) lnkexedu 0.45*** (3.26) lnkexhlt -0.16 (-0.72) lnkexinf 0.32*** (2.64) r-squared 0.97 adjusted r-squared 0.97 s.e. of regression 0.53 durbin-watson stat. 1.30 notes: i. ***=> significance at 1 per cent; **=> significance at 5 per cent ii. t-statistics in parentheses in the long run, capital expenditures on education and economic infrastructure have significant positive impacts of 0.45 and 0.32, respectively, on economic growth. these expenditures appear to have crowded-in gross fixed capital formation, which also makes a significant positive impact of 0.69 on economic growth. however, capital expenditures on agriculture and health make no impacts on economic growth in the long run. asian journal of economics and empirical research, 2016, 3(1): 113-121 120 table-5.3. short run estimates variable coefficient constant 0.08 (0.07) ∆lngfkf 0.85*** (6.02) ∆lnlabf -3.61 (-1.06) ∆lnkexagr -0.12 (-1.03) ∆lnkexedu 0.48*** (3.90) ∆lnkexhlt -0.21 (-1.06) ∆lnkexinf 0.28** (2.50) ecm(-1) -0.39** (-2.41) r-squared 0.98 adjusted r-squared 0.97 s.e. of regression 0.47 durbin-watson stat. 1.78 notes: i. ***=> significance at 1 per cent; **=> significance at 5 per cent ii. t-statistics in parentheses in the short run, capital expenditure on education has a significant impact of 0.48 on economic growth. similarly, capital expenditure on economic infrastructure also makes a significant impact of 0.28 on growth, corroborating loto (2011); musaba et al. (2013) and canning (1999). capital expenditures on agriculture, economic infrastructure and health make no short-run impacts on economic growth, contrasting fan and rao (2003). in particular, the result on health capital expenditure appears to support the view that social expenditure is unproductive consumption expenditure (see kelly (1997)). speed of adjustment to shocks in the short run is a mere 39.40 per cent. these results also corroborate the findings of loto (2011) and oni et al. (2014). 5.3. discussion of estimated results tables 5.2 and 5.3 provide information on relative contributions of different forms of capital expenditure to changes in rates of economic growth. with respect to economic growth, the contributions of capital expenditures on education and economic infrastructure stand very frustrating. good education and health care help make labour more productive and increase returns on investment. that expenditures on agriculture and health do not make any significant impacts on economic growth in nigeria is sad though expected. in an economy with a prominent oil sector, the battle for economic diversification may be difficult to win. apart from inherent instability in the relationships being examined, as indicated by a speed of adjustment of only 39 per cent, an unhealthy labour force coupled with an undeveloped agricultural sector paints a gloomy picture for the economy. concerted efforts are necessary to reverse their negative, though insignificant, impacts to enhance economic growth. 6. conclusion this study was about how a government can allocate its spending across various sectors to maximize prospects for achieving its growth and development objectives. in an effort to tackle this problem, an economic growth model was formulated and estimated within an error correction framework. within this framework, we have captured reactions of economic growth to short-run movements in disaggregated public spending as well as some control variables individually; and to changes in their cointegrating relationships (exemplified by error correction term). we consider disaggregated analysis invaluable from the policy point of view. the study has provided evidence suggesting that the structure of public spending is an important factor for economic growth. however, we have found that government spending was not consciously structured with growth promotion in mind. we find investment in education and infrastructure not only highly significant, but the magnitude of their impacts on economic growth is considerable. this may be due to the effect of strong externalities of these investments in raising the productivity of both human and physical capital as canvassed in the new growth literature. a notable strength of our work is the finding that the key sectors to which public expenditure should be targeted are education and economic infrastructure. in this respect, our opinion is that though increasing public investment in these sectors could generate more growth than focusing only on one sector, nigeria cannot afford an agricultural sector that is not contributing to economic growth. deliberate efforts are, therefore, commanded so as to make the agricultural sector relevant in the nigerian economy. references aiyedogbon, j.o. and b.o. ohwofasa, 2012. poverty and youth unemployment in nigeria, 1987 – 2011. international journal of business and social sciences, 3(20): 269–279. akpan, n.i., 2005. government expenditure and economic growth in nigeria: a disaggregate approach. cbn economic and financial review, 43(1): 61–67. aschauer, d.a., 2000. public capital and economic growth: issues of quantity, finance, and efficiency. economic development and cultural chang, 48(2): 391-406. barro, r.j., 1990. government spending in a simple model of endogenous growth. journal of political economy, 98(5): 103-125. canning, d., 1999. the contribution of infrastructure to aggregate output. policy research working paper no. 2246. washington, dc: world bank. cheng, b.s. and t.w. lai, 1997. government expenditures and economic growth in south korea: a var approach. journal of economic development, 22(1): 11–24. dritsakis, n. and a. adomopoulos, 2004. a causal relationship between government spending and economic development: an empirical examination of the greek economy. applied economics, 36(5): 457-464. ekpo, a.h., 1996. patterns of public expenditure in nigeria: 1960-1992. economic reform and macroeconomic management in nigeria. ariyo, a. eds., ibadan: ibadan university press. engle, r.f. and c.w.j. granger, 1987. co-integration and error–correction: representation and testing. econometrica, 55(2): 251-276. fan, s. and n. rao, 2003. public spending in developing countries: trend, determinants and impact. eptd discussion paper no. 99. washington, d.c: ifpri. asian journal of economics and empirical research, 2016, 3(1): 113-121 121 fan, s., x. zhang and n. rao, 2004. public expenditure, growth and poverty reduction in rural uganda. dsgd discussion paper no. 4.washington, d. c: ifpri. kelly, t., 1997. public expenditures and growth. journal of development studies, 34(1): 60-84. landau, d., 1986. government and economic growth in less developed countries: an empirical study for 1960-1980. economic development and cultural change, 51(1): 35-73. longe, j.b., 1984. the growth and structure of federal government expenditure in nigeria. nigeria journal of economic and social studies, 26(1): 85 – 102. loto, m.a., 2011. impact of government sectoral expenditure in economic growth. journal. economic and international finance, 3(11): 646 – 652. lucas, r.e.j., 1988. on the mechanics of economic development. journal of monetary economics, 22(1): 23-42. munnell, a., 1992. infrastructure investment and economic growth. journal of economic perspectives, 6(4): 189-198. musaba, e.c., p. chilonda and g. matchaya, 2013. impact of government sectoral expenditure on economic growth in malawi; 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lecturer, department of economics, northwest university, kano-nigeria 2 department of economics and agribusiness, universiti utara, malaysia 3 department of economics and agribusiness, universiti utara, malaysia ( corresponding author) abstract it is generally agreed among the researchers that farm credit has significant positive impact on agricultural production that would increase the farming output. in fact, the rising cereal production were more related to farm inputs that may be acquired through agricultural credit. in view of that, this article synthesizes and reviews different field studies on the determinants of demand for credit. moreover, it is clear from the reviewed studies that different models have been used in examining the factors that determine the demand for credit. however, most of the findings are inconclusive, due to the contextual, geographical, socio-economic, environmental and other variations across the study areas. based on that, the paper call the need for more empirical studies on the determinants of demand for credit for a specific region for better policy that may be suitable for that particular region. this has important implications on agricultural production in general and farm credit in particular, especially for developing economies. keywords: agricultural production, credit, determinants, demand, farming. contents 1. introduction ........................................................................................................................................................................... 7 2. literature review and empirical frameworks .................................................................................................................... 7 3. conclusion .............................................................................................................................................................................. 9 references .................................................................................................................................................................................. 9 citation | yusuf ibrahim kofarmata; shri dewi applanaidu; sallahuddin hassan (2016). determinants of demand for credit: a conceptual review. asian journal of economics and empirical research, 3(1): 6-10. doi: 10.20448/journal.501/2016.3.1/501.1.6.10 issn (e): issn (p): 2409-2622 2518-010x licensed: this work is licensed under a creative commons attribution 3.0 license contribution/acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained ethical: history: this study follows all ethical practices during writing. received: 28 november 2015/ revised: 13 december 2015/ accepted: 17 december 2015/ published: 21 december 2015 publisher: asian online journal publishing group http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.6.10 http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.6.10 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.6.10 http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.6.10 asian journal of economics and empirical research, 2016, 3(1): 6-10 7 1. introduction the significance of credit as one of the tools of production that has been found to spurs economic growth and sustainable development in rural areas could not be over emphasized. however, according to tang et al. (2010) due to the high degree of risks in particular and economic uncertainties associated with rural life in general, risk mitigating components such as insurance were missing or completely absent. even though, rural dwellers do help themselves in the unfortunate events, however, previous studies persistently were unable to prove that rural dwellers are able to insured each other (townsend, 1994). besides, lack of insurance facility couple with limited savings have placed small-scale rural households vulnerable to idiosyncratic shocks and several risks (tang et al., 2010). consequently, credit access is crucial on agricultural investment, production and consumption and more importantly rural life (eswaran and kotwal, 1990; udry, 1990). agricultural credit supports rural communities in a number of ways. access to farm credit increase the capability of rural farmer with limited savings to meet his financial demand for productive investments and farm inputs. moreover, farm credit encourage rural farmers to accommodate new farming techniques by increasing their capability to engage in more productive business but more risky (carter, 1984; rosenzweig and binswanger, 1993). similarly, greater credit access helps rural farmers to supplement their consumption during the economic downturn. besides, empirical studies has emphasized the significance of rural credit in rural economies. in china, feder et al. (1990) found that an extra yuan of credit will return 0.24 yuan of extra value of farm output. similar result was reported in malawi where diagne et al. (2000) confirmed that access to credit has positive significant impact on farmers’ welfare. while, using peruvian data, guirkinger and boucher (2008) shows that on average credit constraints farmers losses about 27 percent of their agricultural output. 2. literature review and empirical frameworks 2.1. formal and informal credit markets one very common attributes of credit markets in rural areas of the developing economies is the existence of informal and formal credit markets (hoff and stiglitz, 1990; besley, 1995; bell et al., 1997; kochar, 1997; barslund and tarp, 2008; guirkinger and boucher, 2008). two different arguments have been forward as the reasons of their co-existence. the first one explained that the existence of informal credit market was as the result of the stringent governments’ policies on the formal market sector (bell et al., 1997; kochar, 1997). most governments of developing economies have imposed some policies on the formal sector such as interest rate ceiling in order to strengthen the formal lending and discourage informal market which charge higher interest rate on one hand. but, interest rates ceilings on the other hand, has negative effect on loanable fund. it can also possibly stagnate the supply of credit from formal markets to the poor households. since this type of households are usually at risks, where at below the ceiling price, lending to poor households may not yields more return. in this aspects, a number of researchers such as bell (1990) and hoff and stiglitz (1990) envisages that government polices largely failed to yields desired results. due to the ceilings of interest rates in the formal markets, the informal credit markets has continue to dominate the transaction in the rural markets, with higher interest rate in many cases. this has raise some doubt in the reliability and the rationale behind the regulations in the formal sectors (hoff and stiglitz, 1990). another argument with respect to the formal and informal credit markets is associated with rationing in the credit market due to the information asymmetric between the borrower and lender. since asymmetric of information is prevalent in the credit markets, formal lender is only keen to release money to borrower with tangible assets on one hand. on the other hand, informal lender can release money to borrower even without physical assets that can be placed in the form of collaterals. informal lenders can able to take such risks, because they have informational advantage over the formal counterpart about borrowers habits and their productive capacities, so that they can employ different mechanisms to re-enforce repayment (zeller, 1994; bardhan and udry, 1999). though both the two arguments explained more on the factors affecting credit supply, while demand-side factors were skewed in the analysis. as a result, several studies have argued that the analysis of rationing in the formal financial sector has been overestimated (kochar, 1997). in this regards, many factors have been acknowledged in the literature as the factors that determine the overall rural households’ demand for loan. tang et al. (2010) identified savings and liquid assets as a significant factors that influence the overall demand for credit. idiosyncratic and covariate shocks were also another factor. high costs of transaction including bureaucratic loan process, tedious paper work related with formal credit, collateral risk and high interest rates (foltz, 2004; guirkinger and boucher, 2008). availability of formal credit market, political reasons and asymmetric information have all been recognized as the key factors that influence the demand for loan (zander, 1994). 2.2. factors affecting the demand for credit in the study conducted in uganda, mpuga (2010) found that age of the farmer is positively related to demand for credit and the quantity of loan applied. according to him, the young are likely to borrow, since they are very active and energetic and more aggressive to investment. while, old individuals are likely to rely more on the past earnings and accumulated capital, and therefore less inclined to need loan. even though contrary to mpuga, tang et al. (2010) found that old households are more probable to demand credit than the younger ones. because these type of households have higher social capital and social network that may likely increase their credit access. while, in a different study household’s age has no significant effect on credit demand (nwaru, 2011).asset acquisition by women is hindered by social restriction especially in developing countries. whereas, in rural communities there is segregation of gender activities. those among the women who engaged in productive and more independent economic activities will be traditionally seen as deviated from social norms. however, if this tradition is strong enough, women in this community may not demand any credit, even if they have gainful investment asian journal of economics and empirical research, 2016, 3(1): 6-10 8 (fletschner and carter, 2008). consequently, the likelihood to demand for credit in the formal market is decreasing with being female headed-household (bendig et al., 2009; nwaru, 2011). in a different study in ghana, using multinomial probit regression (bendig et al., 2009) shows that household size is positively related to demand for microcredit. this is because households with more members are likely to spend more in consumption and education, thus, they are likely to demand loan. while in a survey study in china, tang et al. (2010) indicated that education is one of the significant explanatory variables that influence the demand for loan. they also found that an additional year of schooling by household-head will raise the likelihood of borrowing by 2.5%. similarly, the probability to demand for loan will increase by 5.6% if the land endowment double. although, the influence of these factors varies considerably according to type of credit markets. for instance, while years of schooling increases households borrowing chances from formal financial institutions, it however reduces or have no effect with regard to the informal credit market. nonetheless, this does not always holds, as chen and chiivakul (2008) found that those with moderate education (primary and secondary level) are likely to demand for loan, but it has no impact with respect to tertiary education. this implies that highly educated households have already acquired wealth, and therefore have little credit demand. moreover, bendig et al. (2009) established that more educated households are likely to demand formal credit, and credit demand was considerably affected by transaction costs. this has been confirmed by many studies (zeller et al., 1998). for example, an extra kilo meters between the nearest bank and village reduces the borrowing probability from the formal lenders by 1% (tang et al., 2010). in contrast, mpuga (2004) has not established any significance evidence between village distance and demand for loan. chen and chiivakul (2008) argued that household may demand credit, while his current income is high due to the expectations of future income, which will guarantee his repayment. similarly, it may be possible that if the household level of income goes down, his consumption marginal utility will be high which may led to higher credit demand. additionally, households are expected to borrow once he possessed some tangible assets which can be placed as collateral. along this line, magri (2002) maintained that total wealth that represents current and future household’s endowment, is one of the significant factors of demand for credit. while, with growing endowment a household can expand his productive capacity and take care for his consumption variability, hence his credit demand will become very low. however, at some level of wealth, an increase in household’s endowment may probably raise the consumption needs, hence will upsurge the willingness for a household to demand for credit. following this, chen and chiivakul found that total assets have positive and significant impact on the demand for loan. but at higher level, an increase in wealth will significantly reduce the demand for loan. moreover, using household data from madagascar, zeller (1994) examined the demand factors for credit and credit rationing in the formal and informal credit markets. he found that being laborer, number of sick days, having social responsibility and being the head of the family are positively associated with borrowing. similarly, household’s occupation, level of education, land endowments and family size are very important determinants of credit constraints status of the farmers. household’s asset is a significant element that individual take in to account when it comes to borrowing decision. in this regards, duflo et al. (2008) shows that number of livestock owned has a decreasing effect on household’s demand for credit. however, mpuga (2010) contends that it is not the total amount of assets accumulated, rather total value of assets such as land and building owned by the household that have strong positive effect on the demand for loan. furthermore, bendig et al. (2009) concludes that wealth endowment and being employed in the administration encourage the use of financial service. however, individual who is receiving remittances do not exhibit demand for micro loan. this confirmed the general assumption that very poor households are less likely to be included in the formal credit market than wealthier households (mohieldin and wright, 2000; nguyen, 2007). the finding also specified that borrowers were characterized by greater assets and high earnings that could be served as collateral. households may need loan for investments decision, or to smooth consumption. in this way, households who experiences shocks are more likely to demand loan than those who demand credit for other purposes. events that were found to affect the demand for credit are bad harvest and social events such as marriage and other festivities. though the effect of these factors varies across different sources of credit. for example, being salary earner and distance from the village to the nearest banks have positive impact with respect to informal credit demand (nwaru, 2011). similarly, results from india shows that households’ entrepreneurial skills, occupation and off-farm investments are positively related to institutional borrowing (kumar et al., 2010). however, the amount of money a household may demand within the considerable time and his investment decision depend on his school years, farm size, household’s age, distance, socio-economic interaction and household size, ewuola and williams (1995). even though, by considering the profitability of investments and price of loan as one of the investment and borrowing conditions; a household may borrow capital if the expected project return is higher than the cost of borrowing (sylvanus, 2003). in a different study in ghana, koomson et al. (2014) indicates that the probability of being discouraged from credit applications increases with low savings and low income earnings. while, in a study conducted in vietnam, thanh et al. (2015) found that having owned residential area, per capita land area, education are the key determinants of access to credit. while, average years of schooling has significant impacts on the likelihood of acquiring higher amount of loan. their studies have yields an interesting finding that being native poor and percentage of off-farm income have positive effects with respect to formal borrowing. similarly, interest rate has statistical relevance on the loan amount demanded. in summary, these inconsistencies and inconclusive findings may be due to the regional variations with respect to weather, infrastructure, credit availability and government policies, while socio-economic attributes plays a vital roles in response to credit demand. this indicates that findings from one region may not be generalized to another region. asian journal of economics and empirical research, 2016, 3(1): 6-10 9 3. conclusion this article reviews the various field studies on the factors that influence the demand for credit by farmers. perhaps, empirical studies that have been reviews in this paper, methodologically can be categorized into three different groups, though not explicitly demonstrated in the review process. the first category are those that used categorical models as a tools of data analysis in order to investigate the factors that determine the demand for credit. these includes (zeller, 1994); guirkinger and boucher (2008); barslund and tarp (2008) among the others. the second group consists of those studies that analyses the determinants of demand for loan using ordinary least square and other truncated models such as nwaru (2011) and thanh et al. (2015). while, the third groups comprises of those that combined different methods in order to satisfy their conflicted objectives, such as mpuga (2010; 2004). additionally, it was demonstrated in this paper that various empirical studies used a number of different variables that depends largely on the researcher’s a priori expectations. though, in many cases, the variables do overlap in different studies, which result in different conclusions and inconsistent findings. this generally stems from the contextual and geographical variations across the case study areas. it may also arises due to the fact the socio–economic conditions of households given a particular region varies with other factors such as the quality of soil, climate conditions, cultural practices, and the characteristics of financial markets. therefore, more studies are needed with respects to credit market participation, the amount of loan and the choice of credit market especially in a specific regions of the developing countries. so that the findings of these studies will augment some policies that actually reflect the needs of those particular communities for rural sustainable development in general and agriculture in particular. references bardhan, p. and c. udry, 1999. development microeconomics. new york: oxford university press. barslund, m. and f. tarp, 2008. formal and informal rural credit in four provinces of vietnam. journal of development studies, 44(4): 485– 503. bell, c., 1990. interactions between institutional and informal credit agencies in rural india. world bank econ. rev, 4(3): 297–327. bell, c., t.n. srinivasan and c. udry, 1997. rationing, spillover, and interlinking in credit markets: the case of rural punjab. oxford economic papers, 49(4): 557–585. bendig, m., l. giesbert and s. steiner, 2009. savings, credit and insurance: household demand for formal financial services in rural ghana. working paper no. 94, german institute of global and area studies. besley, t., 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behaviour in less developed economies. oxford economic papers, 42(2): 473-482. ewuola, s.o. and s.k. williams, 1995. effects of institutional and borrowers’ characteristics on loan recovery: a study of ondo state agricultural credit corpoartion. journal of agriculture, food and development, 1(2): 104-113. feder, g., l.j. lau, j.y. lin and x. luo, 1990. the relationship between credit and productivity in chinese agriculture: a microeconomic model of disequilibrium. american journal of agricultural economics, 72(5): 1151-1157. fletschner, d. and m.r. carter, 2008. constructing and reconstructing gender: reference group effects and women’s demand for entrepreneurial capital. journal of socio-economics, 37(2): 672–693. foltz, j.d., 2004. credit market access and profitability in tunisian agriculture. agricultural economics, 30(3): 229–240. guirkinger, c. and s.r. boucher, 2008. credit constraints and productivity in peruvian agriculture. agricultural economics, 39(3): 295–308. hoff, k. and j.e. stiglitz, 1990. imperfect and rural information credit markets-puzzles and policy perspectives. world bank economic review, 4(3): 235–250. kochar, a., 1997. an empirical investigation of rationing constraints in rural credit markets in india. journal of development economics, 53(2): 339–371. koomson, i., s.k. annim and j.a. peprah, 2014. loan refusal, household income and savings in ghana. munich personal repec archive, no. 58049: 1-20. kumar, a., k. singh and s. sinha, 2010. institutional credit to agriculture sector in india: status, performance and determinants. agricultural economics research review, 23(2): 253–264. magri, s., 2002. italian households' debt: determinants of demand and supply. banca d'italia, no. 454, 454: 1-53. mohieldin, m.s. and p.w. wright, 2000. formal and informal credit markets in egypt. economic development and cultural change, 48(3): 657–670. mpuga, p., 2004. demand for credit in rural uganda: who cares for the peasants? a paper presented at the conference on growth, poverty reduction and human development in africa centre for the study of african economies. pp: 1–42. mpuga, p., 2010. constraints in access to and demand for rural credit: evidence from uganda. african development review, 22(1): 115–148. mpuga, p., 2010; 2004. demand for credit in rural uganda: who cares for the peasants? a paper presented at the conference on growth, poverty reduction and human development in africa centre for the study of african economies. pp: 1–42. nguyen, c.h., 2007. determinants of credit participation and its impact on household consumption: evidence from rural vietnam. center for economic reform and transformation, no. 03: 1–19. nwaru, j.c., 2011. determinants of informal credit demand and supply among food crop farmers in akwa ibom state, nigeria. journal of rural and community development, 6(1): 129–139. rosenzweig, m.r. and h.r. binswanger, 1993. wealth, weather risk and the composition and profitability of agricultural investments. 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asian journal of economics and empirical research, 2016, 3(1): 6-10 10 zeller, m., 1994. determinants of credit rationing: a study of informal lenders and formal credit groups in madagascar. world development, 22(12): 1895–1907. zeller, m., a. diagne and c. mataya, 1998. market access by smallholder farmers in malawi: implications for technology adoption, agricultural productivity and crop income. agricultural economics, 19(1): 219-229. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. asian journal of economics and empirical research issn: 2409-2622 vol. 2, no. 2, 52-61, 2015 http://asianonlinejournals.com/index.php/ajeer * corresponding author 52 applying a fuzzy analytic hierarchy process to demand considerations of households opting for mortgage loans otu larbi-siaw 1* -- michael owusu-akomeah 2 --fiifi okyere amaning 3 1,2,3 ghana technology university college, it business, ghana abstract this work is licensed under a creative commons attribution 3.0 license asian online journal publishing group contents 1. introduction ............................................................................................................................................................................... 53 2. literature review ...................................................................................................................................................................... 53 3. research method ....................................................................................................................................................................... 56 4. empirical results ...................................................................................................................................................................... 58 5. conclusions ................................................................................................................................................................................ 59 references ...................................................................................................................................................................................... 60 bibliography .................................................................................................................................................................................. 61 the need for high economic development across the entire globe and sub-saharan africa in particular has led to the awareness of the need to increase the housing base across the continent. the astronomical increase in population and urbanisation and its associated problems of accommodation call for the need to provide good housing for the people of ghana; the provision of which could depends largely on the availability of mortgage facilities. however, obtaining the right mortgage is as crucial as obtaining the right home, yet buyers seemingly do not invest as much time and effort in a mortgage search as in house searches. it is against this backdrop that this study investigates factors considered by households before acquiring mortgage loans. a questionnaire was administered within the accra metropolis, the area of ghana with the most mortgage loan providers. we employed the fuzzy analytic hierarchy process (fahp) to analyze the thought processes of households when making their decisions on acquiring a mortgage loan. the results indicated that factors considered by households when opting for a mortgage loan, ordered based on their degree of importance, were "employment", "housing market conditions", "personal factors", "economic factors", "mortgage lender policy", "housing alternatives", "knowledge", and "social factors". the weights of the first four factors were as high as 70.99% (buckley‟s method) and 69.70% (chang‟s method). these four items, have the most impact on household demand considerations when opting for a mortgage loan. if these factors are significantly improved, then, they can have a positive microeconomic impact on actual households demand for mortgage loans, in turn making the mortgage market a lucrative business. keywords: mortgage loan, fuzzy analytical hierarchy process, households, weight calculation. http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2015, 2(2): 52-61 53 1. introduction today, the demand for mortgage across the entire globe is on the ascendancy. perhaps, this is largely informed by the high growth of population and its accompanying developments. as economies develop, it appears that, the provision of housing finance is moving away from extensive reliance on special circuits towards integration of housing finance into broader financial markets. also, as populations continue to grow and urbanization accelerates, the necessity of providing adequate housing also becomes crucial. a recent publication by housing finance international (hfi) shows that, ghana is facing housing shortage which has worsened due to rapid population growth and increasing urbanisation; ghana real estate developers association (greda), and ghana statistical services (gss) have also revealed that the housing deficit in ghana as at 2009 stands at one million (1,000,000) housing units (contributor, 2009). this phenomenon of housing shortages in ghana to a large extent could be reduced if not eliminated through the availability of mortgage loans. the challenge confronting city dwellers in terms of accommodation is enormous. most residents of cities and large towns in ghana encounter serious accommodation problems as they desperately look for decent and reasonably priced houses to rent. according to coomson (2006), home ownership remains the key priority of most ghanaians. however due to limited sources of mortgages, this priority has remained a dream for a significant proportion of the population. the benefits of housing cannot be underestimated. housing provides shelter for individuals and corporate organisations, creating conducive environments for both the individual and corporate bodies to carry on their activities. in addition, the basic needs theory provides that, housing, like food and water, is a basic need and a necessity for the existence of man; the need for individual families to acquire their own private accommodation which they can call home, has become crucial. a nation‟s labour force is enhanced and further developed if it has a safe, decent and affordable means of accommodation. in the belief that „adequate housing‟ is a basic human need, the united nations general assembly (unga) unanimously adopted a resolution proclaiming 1987 the international year of shelter for the homeless (tshipinare, 1987). one of the major means of raising funds to finance the purchase of houses in many parts of the world is through the use of a mortgage. apart from using the mortgage instrument to raise funds for acquiring residential properties, it is also widely used as a means of raising capital for business purposes. in the united kingdom, for instance, about 95% of all business, responsible for nearly one third of all employments, rely on the mortgage as a method of raising finance to finance their operations (gyamfi-yeboah and boamah, 2003). the unique feature of housing finance and its relative longterm investment horizon requires large amount of long term finance (gyamfi-yeboah and boamah, 2003). the main aim of housing finance system is to provide funds to the producers and purchasers of housing of both rental and owner-occupied homes. this simple arrangement has spawned a broad array of institutional arrangements, ranging from contractual savings scheme to depository institutions specializing in mortgage finance, to the issuance, sale and trading of mortgage securities on the securities market. all these arrangements also help in channeling money from peoples who have excess funds to borrowers who are in need. according to smith (1996), the conventional approach takes a long time, often between five and fifteen years, for participants in the informal sector to complete the dwelling, which can massively increase construction costs. equally important, funds that could effectively be used for other income-generating ventures are tied up in the property causing business to thrive or operate on meagre funds and thereby creating a lot of dead capital. this approach is seen as expensive and ineffective (asare and whitehead, 2006), causing the housing deficit gap to be widened. after independence, the government‟s commitment to increase the housing stock in ghana necessitated the establishment of institutions like bank of housing and construction (now defunct) and the state housing company. failure for these institutions to live up to expectation lead to the supply of housing through the incremental and the conventional approach where people use sweat equity, barter arrangements and remittances from abroad to build their houses (erguden, 2002). to fill this gap, the government enacted the home mortgage finance law 1993, “pndcl 329”, which lead to the establishment of the home finance company now hfc bank ghana limited. the objective of this company was to provide the service of mortgage and also to raise funds for mortgage finance. even though hfc was particularly established to facilitate the development of the mortgage sector, the recent introduction of the universal banking license by the central bank has removed or blurred the boundary and thereby has allowed a number of banks (i.e. merchant and investment banks) and other private individual firms to enter into the sector. in view of this, other banks are now offering mortgage loans within the banking industry whiles hfc has ceased it functionality in this sector. residential property makes up a significant component of the stock of property in ghana but the irony of the matter is that ghana still faces housing shortage which has worsened in recent times due to rapid population growth and increasing urbanisation. notwithstanding the recent improvement in urban housing development activities by the both the government and individuals, increasing overcrowding, declining quality and access to services has characterise much of housing stock in the country. the most common method of residential building in ghana has been the incremental building, where owners become self-developers and rely on small crafts and trades to build their own units. this paper, however, seeks to investigate, factors considered before households decide to opt for a mortgage loan in ghana using a fuzzy analytical hierarchy process (fahp). by employing the fahp we obtain the weights of the most important factors considered in the decision process that leads to households opting for a mortgage loan. 2. literature review 2.1. defining mortgage the term is defined in oxford advance learners dictionary as a legal agreement by which a bank or similar organisation lends money to an individual to buy a property (house) and after repayment is made over a specified period of time; the sum of total payment includes the sum borrowed and interest. “mortgage” is nothing more than the name given to a particular type of loan; in this case, a real estate loan (mcdonald and thornton, 2008). however, the word mortgage alone, in everyday usage, most often means mortgage asian journal of economics and empirical research, 2015, 2(2): 52-61 54 loan. a home buyer or builder can obtain financing (a loan) either to purchase or secure against the property from a financial institution, such as a bank, either directly or indirectly through intermediaries. characteristics of mortgage loans such as the size of the loan, maturity of the loan, interest rate, method of paying off the loan etc. largely depends on the household and the individual and therefore varies considerably. in a set of theoretical papers based on standard microeconomic theory, the mortgage decision problem facing borrowers was initially modelled based on different assumptions (e.g., (statman, 1982; brueckner, 1986; alm and follain, 1987; brueckner and follain, 1988)). results from these studies showed that the optimal choice should depend on, for instance, income stream, age, inflation and the mortgage rate spread. campbell and cocco (2003) further developed this theoretical line in a much cited article where they described optimal consumption and mortgage choice through a life-cycle model showing that borrowers with rather small mortgages, stable income, low default costs and high probability of moving in the near future should choose adjustable rate mortgages (arms) over fixed rate mortgages (frms). 2.2. analytic hierarchy process and fuzzy analytic hierarchy process the analytical hierarchy process (ahp) was developed by saaty in 1971 (saaty, 1980). this technique is primarily applied to decision problems in uncertain situations with multiple assessment criteria. the function of ahp is to systemize complex and unstructured problems, which it resolves gradually from the high to lower levels. through quantitative judgment, ahp simplifies and improves earlier decision-making processes that relied on intuition to obtain the weights of each indicator and provide sufficient information for decision makers. items with greater weights have higher priority. using ahp to perform problem analysis can reduce the risk of mistakes in decision making (chen et al., 2012). however, ahp use cannot overcome the subjectivity, inaccuracy, and fuzziness produced when making decisions. however, introducing fuzzy set theory and fuzzy operation to ahp can ameliorate these failures. fuzzy set theory was first presented by zadeh in 1965 (zadeh, 1965); it emphasizes the fuzziness of human thinking, reasoning, and cognition of surroundings. a number of conventional quantitative analysis methods cannot analyze such things efficiently. the concept of fuzzy logic must be used to describe actual things and to compensate for the failings of traditional theory sets that use only binary logic to describe things. fuzzy logic uses the concept of membership function to describe things in a manner similar to common human language. furthermore, fuzzy logic can analyze ambiguity and vagueness. the fuzzy set can be defined as follows: { } (1) where is a fuzzy set. called the membership function. u is the universe of discourse. ranges between 0 and 1. this is called the degree of membership. the fuzzy set can better describe the characteristics of things compared to conventional binary logic. in conventional crisp sets, the value of the membership function can only be 0 or 1. equation 2 expresses its membership function. equations 3 to 6 show the rules of operation for the triangular fuzzy number. the defuzzification operation should be performed according to the three criteria of rationality, ease of computation, and continuity to identify an appropriate point to represent the fuzzy number. commonly used defuzzification methods include the mean of maximum method, the center of gravity method, and the center of area method (li and huang, 2008). { (2) (3) ( ) (4) (5) (6) 2.3. empirical review home purchase represents a major financial commitment for the homebuyer. for the majority, the finance required is borrowed from a lending institution (duffy and roche, 2005). several writers have extensively written on the subject of wealth acquisition being a factor why households buy mortgage. campbell and cocco (2007) as example wrote in their paper, how houses prices affect consumption – evidence from micro data, that housing is the dominant component of wealth for the typical household in the united states or the united kingdom; and in fact, housing wealth is particularly important for middle-class households. similarly, guiso et al. (2002) reported that real estate accounted for 35% of aggregate household wealth in the uk in the mid 1990‟s. tracy and schneider (2001), for example, showed that it accounts for almost two-thirds of the wealth of the median us household. rybár and zemcik (2008) conducted a survey on arm or frm: which mortgage contract is better for czech households? by using a non-random sample of 3000 households. the survey attempted to find out the welfare effects on fr and ar mortgage contract on czech households by calibrating and solving a life-cycle model used for this purpose by campbell and cocco (2003). they identified and developed models for variable such as household income, preferences, inflation, exchange rates, house prices, taxation and mortgage contracts to be the key factors that affected the choice between arm and frm, similar to what was found in campbell and cocco (2003). popplewell (2000) indicated that the reasons why a person might wish to raise funds for putting up the deeds of a property as security for a loan can broadly be divided into three. however, there are different requirements within these three broad segments. according to him the reasons may include whether to buy a house for the first time, to improve an existing one or buying additional houses for rental purposes (income generation). popplewell (2000) explained that, fist-time house buyers have several advantages over existing buyers to sellers. however, the existing buyers‟ credit history (credit worthiness) will be known to the seller. he said the risk that the asian journal of economics and empirical research, 2015, 2(2): 52-61 55 first time buyer may engage in moral hazards is minimal; they may also become the life time mortgage clients. in relation, first-time buyers may be better advised to borrow as much as possible on mortgage because of its long life span, rather than putting their own money into property. thirdly, popplewell (2000) further explained that many people from time to time seek to improve or extend their property and because the rate of interest charged by a mortgage lender is generally lower than other forms of borrowing, the house owner will, more often than not, look to raise funds by way of mortgage. usually, the formalities required in this category of lending are relatively simple in that, the lender will not necessarily need to carry out credit risk checks. asare and whitehead (2006) further indicated that low incomes and the problems in determining credit history have been argued to be relevant challenges as far as mortgage loans are concerned in developing economies. given the level of incomes in some developing countries like ghana, lenders are reluctant to grant loans affordable to customers, and borrowers are not prepared to accept the terms (with high rates) proposed by lenders. for example, karley (2002) emphasized the point that about 90% of all customers of a bank in accra withdraw almost all their salary by the next pay day and for that matter make credit worthiness assessment by banks difficult. this suggests that since nothing or relatively small amounts are left in the accounts, all things being equal, nothing or relatively insufficient amounts will be left for the monthly mortgage repayment. quite a number of researchers have focused on the area of mortgage affordability with different definitions and measurement variables. affordability is defined as the ability to purchase a dwelling of the appropriate size and minimum physical and sanitary standards and still have sufficient income to enjoy at least the minimum consumption of other essential goods and services (hegedüs and struyk, 2005). gan and hill (2009), showed that the concept of mortgage affordability can be thought of in at least three different ways. they drew distinction between the concepts of purchase affordability, repayment affordability and income affordability. according to them, purchase affordability considers whether a household is able to borrow enough funds to purchase a house; repayment affordability considers the burden imposed on a household of repaying the mortgage whilst income affordability simply measures the ratio of house prices to income. trimbath and montoya (2002) described affordability as a public policy target that moves in three-dimensional space measured by three variables, thus, home prices, household income and mortgage interest rates. the concept is also frequently interpreted as the relationship between household income and housing expenditure; housing is affordable if expenditure relative to income is reasonable or moderate (kutty, 2005). in an attempt to safeguard investors‟ investment in businesses, lenders in contemporary business ensure that, borrowers meet certain strict basic requirements; where borrowers are unable to satisfy, they are rejected. these controls help lenders to prevent adverse selection (saunders and cornett, 2008). these basic requirements are categorized into five cs – condition, character, capacity, capital, and collateral (karley, 2002). this litmus test is applied to the potential borrower to assess the ability of the borrower to honour his or her part of the contract (asare and whitehead, 2006; saunders and cornett, 2008). indisputably, the most important variable affecting preparedness to supply, or make funds available to borrowers as mortgage loans and its pricing is inflation and its associated currency depreciation risk (asare and whitehead, 2006). according to them, the problems are said to be two-fold anticipated inflation increases money interest rates and therefore nominal payments and generates a front loading payment problem in compensating for the loss in purchasing power of the income over time. the possibility of unanticipated inflation increases the real interest rate that both savers and lenders require increasing the real cost of mortgages. inflation in most developing economies has led to loss of purchasing power both in absolute terms and especially relative to the foreign currency like the dollar, and as a result, the use of the dollar as the standard pricing unit of account for some product including housing. levina and zamulin (2002) explained “...the firm‟s decision to denominate prices in dollars is a case of price stickiness. at the times of high inflation, quoting prices in the domestic currency would require frequent price adjustments. if price adjustment is costly due to some menu costs, sellers can prefer to denominate prices for their products in a stable foreign currency, which allows keeping prices unchanged for a much longer period”. the dollarization phenomenon, in the context of housing, allows the domestic inflation element to be taken out of the interest rate. the practice as noted by levina and zamulin (2002) does not require any actual use of that currency and in most cases transactions are carried out in the domestic currency, while the unit of account is in foreign currency. the choice of mortgage has been described as a complicated one (barr et al., 2008) and as one of the most complex transactions ever undertaken by the majority of consumers (woodward, 2003). the fact that individuals purchase mortgages infrequently (essene and apgar, 2007) and often negotiate them at the same time that they are undergoing a major life transition also adds to the complexity (campbell, 2013). scholars have also found that mortgagees are less than optimally knowledgeable about the possible future consequences of their choice. even the most financially sophisticated borrowers often find it difficult to shop effectively for mortgages (essene and apgar, 2007). moreover, researchers have found evidence that many consumers who enter into complex financial contracts, such as mortgages, are financially illiterate (lusardi, 2008a; 2008b). individuals frequently fail to understand the terms and conditions of consumer loans and mortgages, and those with lower levels of financial literacy are more likely to have a costly mortgage (moore, 2003). this evidence is also in line with findings by bucks and pence (2008), who found that borrowers experiencing large payment changes if interest rates rose were comparatively more likely to report not knowing their contract terms. it is imperative to note that there are rudiments necessary for a successful mortgage market. gyamfi-yeboah and boamah (2003) identified stable macroeconomic environment-that is a low inflation and interest rates as well as a stable currency to be inclusive. in addition to a sound macroeconomic environment, they also identified liquidity as most crucial factor for a vibrant mortgage market. to them liquidity is crucial because originators would need to asian journal of economics and empirical research, 2015, 2(2): 52-61 56 replenish funds to meet the demands for funds from other households (borrowers). campbell and cocco (2007) also said lack of liquidity would mean that lenders would have to wait for the full life of the loan which could in some cases range between 20 to 30 years before funds invested can be recovered from borrowers. this will cause a serious mismatch between the assets and liabilities (i.e. borrowing short and lending long) of the financial institutions, and can make lending more risky to the originators, especially in periods of interest rate fluctuations. it has been proven in most countries that secondary mm provides the level of liquidity required for a vibrant mm. in this market, originators are able to sell outstanding mortgage debts to other institutions that are willing to hold the debts for its life span. the successes chalked in the united states and some parts of europe in this field attest to this fact (gyamfi-yeboah and boamah, 2003), and it justifies the need for a secondary mm. 3. research method 3.1. questionnaire design and survey keeney (1999) conducted an important study on customer value and found that the most direct method for understanding the value acknowledged by customers was to ask them. however, different consumers have different opinions on value. value-focused thinking can be used to analyze and understand the correlation between these values. this method involves three steps. the first step is developing a series of values acknowledged by customers. the second step is using generalized types to express each value. the third step is to organize the acknowledged value and indicate their relationship. based on that study, we developed an assessment model for factors considered before households opt for mortgage loans. we conducted a literature review and interviewed six experts (mortgage advisors and property developers) to confirm the division of the assessment hierarchical structure for households decision criteria‟s when opting for a mortgage into selection factors of 3 levels, 8 aspects, and then 28 indicators (fig. 1). the first level is the mortgage decision selection assessment. the second level is the assessment aspects, personal factors, social factors, economic factors, employment, housing market conditions, mortgage lender policy and knowledge. the third level is the assessment indicators. these levels contain a total of 28 items. the questionnaires were administered to 500 mortgage owners in the accra metropolis. below is the diagrammatic representation of the 8 key indicator variables and the 28 evaluation indicators in the index (fig. 1). goal aspect index figure 1. hierarchical structure of household‟s assessment factors when acquiring a mortgage f6-5: default assessment factors considered by households before opting for mortgage loans f1: personal factors f1-1: age f2-2: income f3-3: savings f4-4: dependents f2: social factors f2-1: status f2-2: reference group f2-3: family f3: economic factors f3-1: inflation f3-2: interest rates f3-3: exchange rates f4: employment f4-1: number of years employed f4-2: job security f4-3: full-time/part-time f4-4: self employed f5: housing market conditions f5-1: house prices f5-2: availability of mortgages f5-3: loan to value f6: mortgage lender policy f6-1: payment terms f6-2: credit rating f6-3: second loan f6-4: refinance f7: housing alternatives f7-1: buy f7-2: build f7-3: rent f8: knowledge f8-1: education f8-3: mortgage experience f8-2: financial literacy asian journal of economics and empirical research, 2015, 2(2): 52-61 57 3.2. establishing an assessment model using ahp to analyze problems involves the following five steps: establishing a hierarchical structure, establishing a pairwise comparison matrix, calculating the eigenvalue and eigenfactor, and performing consistency tests and weight calculations. the consistency test examined whether the respondents‟ questionnaire answers are consistent and transitive. the consistency test comprised two levels. first, it examined whether the constructed pairwise comparison matrix was a consistent matrix. the basis for this test was the consistency index (c.i.; eq. 7). the second test examined whether the hierarchical structure was consistent. the basis for this test was the consistency ratio (c.r.; eq. 8) [20]. λmax -n (7) n 1 (8) in this equation, n is the level factor number and λmax is the eigenvalue of the comparison matrix. ri is the random consistency index obtained from numerous simulations, which varies according to the order of the matrix (table 1). table-1. random index (r.i.) values n 1 2 3 4 5 6 7 8 9 10 r.i. 0 0 0.58 0.90 1.12 1.24 1.32 1.41 1.45 1.49 ahp cannot overcome the subjectivity, inaccuracy, and fuzziness generated during assessments. therefore, we used fuzzy ahp (fahp) as the analysis tool in this study. fahp combines ahp and fuzzy theory, and its execution steps are largely identical to those of ahp. however, fahp requires additional steps for establishing fuzzy linguistics, defuzzification, and normalization. fahp is better able to resolve the clarity, vagueness, and blur of human thinking compared to ahp (huang, 2012). during the fahp calculation process, we adopted the column geometric mean method, “buckley‟s method” (buckley, 1985) and the extent analysis method, “chang‟s method” (chang, 1996) to calculate the weights. the steps are explained below: step 1. establish a hierarchical structure step 2. design a questionnaire: based on the established hierarchical structure, design a questionnaire that compares indicators to obtain respondents‟ opinions of two indicators. we used the semantic description method to allow the respondents to express their assessments and subjective judgments fully. we also used the triangular fuzzy number to express semantic judgment values. a 9-point scale was used to describe the relativity, as shown in table 2. table-2. the relative importance of fuzzy ratio scales (huang, 2012) relative importance linguistic variables triangular fuzzy number cij = 9 absolute importance (8,9,9) cij = 8 intermediate value (7,8,9) cij = 7 very strong importance (6,7,8) cij = 6 intermediate value (5,6,7) cij = 5 essential importance (4,5,6) cij = 4 intermediate value (3,4,5) cij = 3 weak importance (2,3,4) cij = 2 intermediate value (1,2,3) cij = 1 equal importance (1,1,2) step 3. establish a fuzzy positive reciprocal matrix a = [aij] (9) where aij =(lij , mij , uij ,), lij , mij , and uij are the lower limit, peak, and upper limit of the triangular fuzzy number: step 4. use the geometric means method to integrate the opinions of respondents. aij = (a 1 ij a 2 ij …. a n ij) 1/n (10) were aij is the triangular fuzzy number in the column and the row of the fuzzy positive reciprocal matrix and a n ij is the assessment value of respondent n. step 5. calculate the fuzzy weight (1) method 1: column geometric mean method wi = ri (r1 r2 … … rn) -1 (11) ri = (ai1 ai2 … … a 1 in) 1/n (12) where wi is the fuzzy weight value of each column in the fuzzy positive reciprocal matrix and ri is the geometric mean of the triangular fuzzy number. (2) method 2: extent analysis method si = ∑ m j gi [∑ ∑ m j gi] -1 (13) ∑ m j gi = [∑ lj , ∑ mj , ∑ uj] (14) [∑ ∑ m j gi] -1 = [ ∑ ∑ ∑ ] (15) asian journal of economics and empirical research, 2015, 2(2): 52-61 58 where si is the fuzzy weight in matrix m and m j gi (j = 1,2, … . . , m) is the triangular fuzzy number calculated after comparing the questionnaires. after comparing each indicator, a minimum was generated for each group (eq. 16). assume that d'(ai) is the minimum for each group (eq. 17), and create a set with the minimums of each group (eq. 18). v(m ≥ m1 , m2 , … … , mk) = minv (m ≥ mi ) , i = 1, 2, … … , k (16) d * (ai) = min v(si ≥ sk) (17) w‟ = (d‟ (a1) , d‟ (a2) , … … , d‟ (an)) t (18) standardize the minimums after comparison to obtain the defuzzification weights for each indicator (eq. 19). w = (d‟ (a1) , d‟ (a2) , … … , d‟ (an)) t (19) step 6. defuzzification: convert the fuzzy weights into non-fuzzy values (eq. 20). dfij = (20) a, b, and c are the lower limit lij, the peak (mij), and the upper limit (uij) of the triangular fuzzy number. step 7. perform normalization (eq. 21) to obtain the weights for each aspect and indicator. nwi = dfij nwi (21) ∑dfij step 8. perform hierarchical tandem to calculate the global weights of all indicators. 4. empirical results 4.1. the consistency test we used the consistency ratio (cr) to assess the reliability and credibility of the questionnaire. when cr ≦0.1, it indicates that the deviation in the respondents‟ estimation of each factor‟s weight when constructing the pairedcomparison matrix was acceptable, verifying the consistency. all cr values were lower than 0.1; therefore, all the judgments are consistent. this result demonstrated the accuracy of the results of the questionnaire survey. 4.2. weight calculation results the weights and sequences for each aspect and indicator obtained using the column geometric mean method (buckley‟s method) are shown in table 3. the weights and sequences for each aspect and indicator obtained using the extant analysis method (chang‟s method) are shown in table 4. tables 3 and 4 indicate that using either buckley‟s method or chang‟s method, the items households considered the most or were concerned with when opting for a mortgage loan within selection assessment aspects were, in sequential order, were, "employment", "housing market conditions", "personal factors", "economic factors", "mortgage lender policy", "housing alternatives", "knowledge", and "social factors". within the "employment" aspect, households were most concerned with job security. within the “housing market conditions "aspect, house prices was the most important for households. within the "personal factors" aspect, households were most concerned with savings. within the "economics factors" aspect, households were most concerned with interest rates. within the "mortgage lender policy" aspect, households were most concerned with the payment terms. within the "housing alternatives" aspect, households considered to build. within the "knowledge" aspect, financial literacy was the most important to households. within the "social factors" aspect, status was the most important indicator considered by households when deciding to opt for a mortgage loan. table-3. local weight and global weight for each criterion (buckley‟s method) aspecta local weightsb ranking indicatora local weightsb ranking global weightsc ranking f1 0.185 3 f1-1 f1-2 f1-3 f2-4 0.124 0.373 0.400 0.168 4 2 1 3 0.023 0.069 0.074 0.031 22 5 3 15 f2 0.055 8 f2-1 f2-2 f2-3 0.400 0.218 0.273 1 3 2 0.022 0.012 0.015 23 28 27 f3 0.0979 4 f3-1 f3-2 f3-3 0.174 0.664 0.286 3 1 2 0.017 0.065 0.028 26 6 16 f4 0.254 1 f4-1 f4-2 f4-3 f4-4 0.138 0.350 0.280 0.193 3 1 2 4 0.071 0.089 0.035 0.049 4 1 14 9 f5 0.173 2 f5-1 f5-2 f5-3 0.439 0.220 0.150 1 2 3 0.076 0.038 0.026 2 11 17 f6 0.0974 5 f6-1 f6-2 f6-3 f6-4 f6-5 0.595 0.257 0.452 0.380 0.544 1 5 3 4 2 0.058 0.025 0.044 0.037 0.053 7 19 10 13 8 f7 0.0780 6 f7-1 f7-2 f7-3 0.295 0.526 0.269 2 1 3 0.023 0.041 0.021 21 12 24 f8 0.0597 7 f8-1 f8-2 f8-3 0.402 0.436 0.302 2 1 3 0.024 0.026 0.018 20 18 25 a. for an explanation of the codes, please refer to fig. 1. b. local weight is determined based on judgments of a single criterion. c. global weight is determined by multiplying the weight of the criteria. asian journal of economics and empirical research, 2015, 2(2): 52-61 59 partial differences were observed for the sequence results obtained using buckley‟s method and chang‟s method in the weight sequences for the indicators within the aspects of "housing market conditions (f5)", "mortgage lender policy (f6)", and "knowledge (f8)". the rankings (f5) of the two methods for housing market conditions (f5-1), house prices (f5-2), availability of mortgages (f4-3) and loan-to-value were 1-2-3 (buckley‟s method) and 1-3-2 (chang‟s method). the rankings (f6) of the two methods for payment terms (f6-1), credit rating (f6-2), second loan (f6-3), refinance (f6-4) and default (f6-5) were 1-5-3-4-2 (buckley‟s method) and 1-4-3-5-2 (chang‟s method). the rankings (f8) of the two methods for education (f8-1), financial literacy (f8-2) and mortgage experience (f8-3) were 2-1-3 (buckley‟s method) and 1-2-3 (chang‟s method). the rankings for the remaining indicators within the other aspects were identical, indicating that buckley‟s method and chang‟s method had equivalent similarity and performance regarding identifying the important indicators. concerning the overall rankings for all indicators, the top ten (10) ranking of the indicator importance obtained using buckley‟s method and chang‟s method were identical. these indicators in order of rank were job security (f4-2), house prices (f5-1), savings (f1-3), number of years employed (f4-1), income (f1-2), interest rates (f32), payment terms (f6-1), default (f6-5), self employed (f4-4) and second loan (f6-3). the rankings for the other indicators differed slightly. this was caused by differences in computation logic between the two methods. table-4. local weight and global weight for each criterion (chang‟s method) aspect a local weights b ranking indicator a local weights b ranking global weights c ranking f1 0.137 3 f1-1 f1-2 f1-3 f2-4 0.102 0.327 0.352 0.205 4 2 1 3 0.035 0.067 0.072 0.036 13 5 3 11 f2 0.057 8 f2-1 f2-2 f2-3 0.557 0.034 0.293 1 3 2 0.016 0.010 0.019 25 28 24 f3 0.118 4 f3-1 f3-2 f3-3 0.040 0.651 0.097 3 1 2 0.024 0.063 0.026 17 6 16 f4 0.245 1 f4-1 f4-2 f4-3 f4-4 0.116 0.905 0.903 0.096 3 1 2 4 0.069 0.087 0.039 0.047 4 1 12 9 f5 0.199 2 f5-1 f5-2 f5-3 0.835 0.029 0.109 1 3 2 0.074 0.024 0.029 2 18 15 f6 0.105 5 f6-1 f6-2 f6-3 f6-4 f6-5 0.674 0.062 0.159 0.031 0.321 1 4 3 5 2 0.056 0.021 0.042 0.020 0.051 7 21 10 23 8 f7 0.131 6 f7-1 f7-2 f7-3 0.172 0.192 0.076 2 1 3 0.023 0.033 0.013 19 14 27 f8 0.060 7 f8-1 f8-2 f8-3 0.220 0.157 0.097 1 2 3 0.022 0.021 0.015 20 22 26 a. for an explanation of the codes, please refer to fig. 1. b. local weight is determined based on judgments of a single criterion. c. global weight is determined by multiplying the weight of the criteria. 5. conclusions the study sought to determine the considerations made by households before deciding on acquiring a mortgage loan. after critically assessing the data obtained from mortgage owners within the accra metropolis, an fahp was used to analyze the weights of the decision-making aspects and indicators considered by consumers when selecting home stays. the results indicate that the sequence of the four items with the highest weights of all the aspects were "employment", "housing market conditions", "personal factors", and "economic factors". the total weights for these four aspects were 0.7099 (buckley‟s method) and 0.6970 (chang‟s method). the least important items among the factors considered by households when deciding to acquire a mortgage loan "mortgage lender policy", "housing alternatives", "knowledge" and "social factors". the total weight for these four aspects was 0.2901 (buckley‟s method) and 0.3030 (chang‟s method). the four areas under consideration for mortgage lenders are: “employment”; the rate of employment within the nation is crucial for the mortgage market to be successful. job security an essential factor in the demand consideration or decision process of households in relation to opting for a mortgage loan, the longer a person has been in their job the safer they feel hence their likelihood in opting for a mortgage loan. government should look to create more jobs within the economy to enhance the mortgage market. the “housing market conditions”, price is a huge demand consideration factor. the prices of houses in ghana are rather on the higher side hence this needs for it to be reviewed. furthermore mortgage loans are not easily available to households and seems to be synonymous to a select few namely the rich and affluent of the society. making mortgages loans available for more class categories will help solve this issue. finally the loan-to-value is essential as households believe that the loan they are able to acquire should help them purchase the house of their choice or dreams and that they should have some satisfaction in the value. asian journal of economics and empirical research, 2015, 2(2): 52-61 60 thirdly “personal factors”, such as income, amount in savings, dependents and age of individuals also affect demand considerations. better per capita income, interest on savings and packages from mortgage lenders for families can help households in this criteria. lastly, “economic factors”, most importantly interest rates on repayments of mortgages need to be reasonable. furthermore, “exchange rates” in ghana as a demand consideration is not surprising as the nation is very dependent on the dollar. most houses are sold in dollars on the housing market and fluctuations in exchange rates can make house prices rise when the dollar appreciates against the cedi. causing its own form of inflation. 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answerable for any loss, damage or liability etc. caused in relation to/arising out of the use of the content. asian journal of economics and empirical research issn(e) : 2409-2622 issn(p) : 2518-010x vol. 3, no. 2, 145-155, 2016 http://asianonlinejournals.com/index.php/ajeer 145 impact of milk marketing channel choice decision on income, employment and breeding technologies among dairy farmer households in kericho county, kenya elijah k. ng’eno1 1 university of kabianga, department of agricultural biosystems and economics, kericho, kenya and phd student, moi university, eldoret, kenya abstract the study examined the impact of milk marketing channel choice decisions on dairy farmer household income, employment and breed technologies among dairy farmer households in kericho county. data was collected from 432 dairy farmer households using multistage cluster sampling technique. both primary and secondary data were used in the analysis. processing and analysis of survey data was carried out using stata version 12. multivariate probit and propensity score matching was used in data analyse. propensity score matching was also used to account for selection bias. matching results show that the average effect of the farmer household that sold milk to commercial buyers had higher probability of obtaining kenya shillings 16.00 per day as compared to households that did not sell milk to commercial buyer. while selling through commercial milk buyers had significant positive effect on farmer welfare, majority of dairy farmers were hesitant to engage with them. milk buyers value security in supply which comes from trusted relationships and contracts. establishing such relationships is in the long-term interest of the dairy farmer. therefore, to improve farmer welfare, group formation and partnership development should be strengthened, milk cooperative societies needs to be bolstered and an increased financial investment in livestock markets by national and county governments. keywords: propensity score matching, milk marketing channels, dairy farmer households. contents 1. introduction ....................................................................................................................................................................... 146 2. objectives ........................................................................................................................................................................... 146 3. research methodology ...................................................................................................................................................... 146 4. empirical results and discussion ..................................................................................................................................... 151 references .............................................................................................................................................................................. 155 citation | elijah k. ng’eno (2016). impact of milk marketing channel choice decision on income, employment and breeding technologies among dairy farmer households in kericho county, kenya. asian journal of economics and empirical research, 3(2): 145-155. doi: 10.20448/journal.501/2016.3.2/501.2.145.155 issn(e) : 2409-2622 issn(p) : 2518-010x licensed: this work is licensed under a creative commons attribution 3.0 license funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. history: received: 28 september 2016/ revised: 14 november 2016/ accepted: 17 november 2016/ published: 19 november 2016 ethical: this study follows all ethical practices during writing. publisher: asian online journal publishing group http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.2/501.2.145.155 https://orcid.org/orcid-search/quick-search?searchquery=elijah k. ng%e2%80%99eno http://search.crossref.org/?q=10.20448/journal.501/2016.3.2/501.2.145.155 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.2/501.2.145.155 https://orcid.org/orcid-search/quick-search?searchquery=elijah k. ng%e2%80%99eno http://search.crossref.org/?q=10.20448/journal.501/2016.3.2/501.2.145.155 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.2/501.2.145.155 https://orcid.org/orcid-search/quick-search?searchquery=elijah k. ng%e2%80%99eno http://search.crossref.org/?q=10.20448/journal.501/2016.3.2/501.2.145.155 asian journal of economics and empirical research, 2016, 3(2): 145-155 146 1. introduction output prices received by farmers significantly determine their welfare especially in rural areas where there is weak non-farm income which limits diversification of agricultural production amongst producers. while there is some debate about the actual and potential impacts of having a wide array of commercial milk buyers on broader welfare of the rural poor, case study evidence suggests that farmers are worst placed when faced with a privately owned or government-controlled monopsony (sadler, 2006; gorton 2007). the choice of a milk marketing channel depends on a number of aspects. these include availability of the markets, milk prices offered in the markets, distance to the milk market and the potential of the market to absorb the volume on sale (paterson, 1997). however, there is relatively little evidence linking milk marketing channel choices to dairy farmer household income and employment outcomes in the study area. while the theoretical arguments in favor of marketing cooperatives are well known, in practice their performance in developing countries has been patchy (glover, 1987). erratic rent seeking government intervention may reinforce these problems. while case studies (striewe, 1999; cocks et al., 2005; gorton et al., 2006) and aggregate market analysis identify these difficulties, there is an absence of cross-sectional data analysis on the impact of milk marketing channel choice decisions on income, employment and technology among dairy farmer households in kericho county, kenya. this study therefore, attempts to fill this gap by analyzing the impacts of the available commercial milk buying channels on dairy farmer households in kericho county, kenya. however, certain factors are beyond the scope of the dairy farmers in the study area. for example, weak rural infrastructure, land fragmentation and weak capital base. therefore, most dairy farmers are constrained by high transaction costs due to the great distances to milk markets, lack of adequate access to finance, and in some cases social factors (nkosi and kirsten, 1994). also, information about markets and market prices guide the farmer in making informed decisions (nkosi and kirsten, 1994). making uninformed decisions may result in the farmer accessing the market when it is not profitable to do so. this is a common situation where livestock farmers approach saturated markets with the wrong price signals (nkosi and kirsten, 1994). the study contributes to the literature by empirically examining the impacts of the milk marketing channel choice decisions on dairy farmer household income, employment and technology. the study used propensity score matching model to control for self-selection since the choice decision for a particular milk buying channel is not random, with the group of dairy farmers being systematically different. by considering the causal relationship between participation in selling milk to commercial milk buyers and dairy farmer household welfare, this paper seek to address counterfactual queries that could be important in forecasting the impacts of policy changes. the study analyzed independently both farmers selling under commercial channels and for those that sell to final consumers in order to assess their impacts on the choice decisions made by the dairy farmer. 2. objectives 2.1. general objective the general objective of the study was to evaluate the impact of milk marketing channel choice decision on dairy farmer household’s income, employment and technology adoption in kericho county, kenya. 2.2. specific objectives the specific objective of the study was to estimate the impact of milk marketing channel choice on dairy farmer household’s income, labor hours and breed technology in kericho county. 2.3. hypothesis the study tested the following hypothesis: ho1: the milk marketing channel choice has no impact on dairy farmer household income, labour hours and breed technology in kericho county. 3. research methodology 3.1. research design this study used cross-sectional and correlational research designs. a cross-sectional survey of dairy farmer households was carried out in early 2015. the study estimated income, employment and technology functions, endogenously stratified for each of the marketing channel used. 3.2. study area primary data was collect from smallholder dairy farmer households in six sub counties of kipkelion east, kipkelion west, kericho west, kericho east, sigowet/soin and bureti of kericho county as shown in table 2.1. table-1. smallholder livestock milk producers and cooperative societies sub – county number of households number of dairy farmers dairy cattle population average number of dairy cows /farmer dairy cooperative societies /companies dairy selfhelp groups kipkelion east 27791 13,996 20666 5 2 1 soin/sigowet 20940 15,141 12808 2 1 2 kericho west 31394 17,111 26007 2 1 0 bureti 30977 28,304 11400 2 11 24 kericho east 27700 8,150 10498.8 3 2 3 kipkelion west 14615 11,725 18667 4 4 3 kericho county 153417 94,427 100047 3 21 33 source: kericho county development profile, 2013 asian journal of economics and empirical research, 2016, 3(2): 145-155 147 3.3. target population the primary unit of analysis was the household with dairy cows with milk for marketing. the target population was restricted to the 94,427 smallholder livestock milk producers and marketers, divided proportionately amongst the six sub-counties of kericho county as shown in table 1. given the objective of the study, the population of interest was defined as the primary milk producer household who sell cows’ milk to another supply chain actor. therefore, farmers without dairy cows, those who did not sell any of the milk produced or those who processed all the milk themselves were excluded from the study. with the given focus, these restrictions were justified, and it meant that the sample could not be directly compared to official data on the structure of milk production. 3.4. sampling procedure a multistage cluster sampling procedure was used to get the total population and sample size of interest.to achieve the study objectives, the county was clustered into six sub-counties, namely, kipkelion east, kipkelion west, kericho west, kericho east, sigowet/soin and bureti as shown in table 2. these sub-counties formed the sample sites for the study and the mean of the results from all these sites constituted the results for the whole county. table-2. sub-county sampling areas constituency sub-counties divisions area (km 2 ) number of locations number of sub locations ainamoi kericho east ainamoi 239.9 11 24 belgut kericho west kabianga and belgut 337.4 12 27 sigoewet/soin sigowet soin and sigowet 473.2 13 38 kipkelion west kipkelion west kunyak, chilchila, kamasian and kipkelion 333 16 35 kipkelion east kipkelion east londiani, sorget and chepseon 774.4 14 32 bureti bureti bureti, roret and cheborge 321.1 19 53 source: county commissioner’s annual report, kericho, 2013 to achieve representative sample size, the six sub-counties formed the first-stage cluster that had the target population. these six clusters were selected based on the fact that small scale dairy farming was dominant and practiced throughout the county. furthermore, it reflected significant differences in structure of the dairy milk marketing industry in the county. further, within the six sub-counties, second-stage cluster sample of wards and villages with high concentration of small scale dairy farmers was then selected for the study. sample selection of dairy farmer households from the clustered wards was done using random sampling and effort was made to include statistically significant sub‐samples of dairy milk producers representing different milk marketing channels and sizes for each of the sub counties. the sampled milk producing nth smallholder farmer household was determined by the proportionate size sampling methodology (anderson et al., 2007). 2 2 0 e pqz n  (1) where 0n was the sample size, z is the standard normal value of 1.96 significant at 5 percent confidence level, e is themargin of error (the sampling error or desired level of precision), p is the estimated population proportion of smallholder dairy farmers with characteristics of interest assumed at 70 percent (table 3.3). thus taking p at 70 percent gave a representative size with minimal error making q = 1-p, i.e. 1-0.7 = 0.3, z = 1.96, and e = 0.04 for a good precision respectively. 504 04.0 3.0*7.0*96.1 2 2       n dairy farmer households. finally, based on the above calculation, the sample units (number of dairy farmers households) were calculated proportionately based on the number of dairy farmer households in each sub county and as a proportion of the total dairy farmers in the county against the desired sample size of 504 as shown in table 3. table-3. proportionate distributions of dairy farmer households sub – county number of households number of dairy farmers percent dairy farmer households total proportion kipkelion east 27,791 13,996 15 75 soin/sigowet 20,940 15,141 16 81 kericho west 31,394 17,111 18 91 bureti 30,977 28,304 30 150 kericho east 27,700 8,150 8 44 kipkelion west 14,615 11,725 12 63 total kericho county 153,417 94,427 100 504 source: author’s computation from county data, 2016 therefore, a random sample of 504 dairy farmer households was set for the whole county with the intention of sampling representative cross-section of small scale dairy farmer households selling raw milk to different marketing channels available at farm gate. after data entry and cleaning, a total of 432 households were finally used for data analysis (table 4). within the county, sampling was weighted to the six sub-counties that had significant dairy cow production. the results that were obtained were assumed valid for the whole county. asian journal of economics and empirical research, 2016, 3(2): 145-155 148 table-4. distribution of sample smallholder dairy households sub-county respondents percentage ainamoi 54 12.50 bureti 122 28.24 kericho west 70 16.20 kipkelion east 50 11.57 kipkelion west 61 14.12 soin/sigowet 75 17.36 total 432 100.00 source: author’s computation from survey data, 2016. 3.5. data types and sources both primary and secondary data were used in this study. primary data were collected through a survey. a structured pre-tested questionnaire was used and administered by trained enumerators through direct interviews amongst selected dairy farmer households. primary data was also collected through discussion and observations of the farmers’ dairy farming activities. seasonal observations were also used to correlate those dairy farmer households left out from the network with the secondary milk market in order to estimate their supply and price variations. this involved observing the natural behavior (nonverbal expression of feelings, determine who interacts with whom, how dairy farmers communicate with each other, and to check for how much time is spent on various activities) of the dairy farmer households in order to describe existing situations and to obtain information that was relevant to the goals of the study. secondary data was obtained mainly from various sources including economic surveys, economic journals, statistical abstracts, conference reviews, books, magazines, official government of kenya reports and documents such as statistical abstracts and bulletins, national and district development plans, national and county development and strategic plans, and kenya dairy board records and annual reports. different documents of livestock production and marketing, regional level reports and consultants’ reports as well as national bureau of statistics publications were reviewed to gather more relevant information. desktop literature and internet were also used to access credible information from available and accessible documents, published and unpublished reports, books and agricultural journals. farm records from a few dairy farmer households were also used to supplement secondary data sources. given the importance accorded to the involvement of smallholder milk producers in the various milk marketing channels in this study, data types encompassed representative sample of households representing various categories of households, types of marketing channels (commercial and non-commercial), and changing structure of dairy sector was adopted. in order to analyze the response of the smallholder milk producers, the study focused mainly on whether the dairy farmer household sold milk at farm gate to commercial milk marketing channels (y1) and if farmer household chose to sell also to final consumers (non-commercial channel) (y0) or otherwise. commercial milk marketing channels in this study were taken to mean three major marketing channels: organized cooperative societies, organized private sector milk buyers, and traditional/unorganized milk buyers. for a given village, there were four types of farmers: (i) farmers who chose to supply milk to the organized cooperative societies, (ii) farmers who chose to sell milk to the organized private sector milk buyers, (iii) farmers who chose to supply milk to the traditional or unorganized milk buyers such as milk vendors, restaurants, or directly to consumers and contractors and (iv) farmers who supplied milk to multiple channels like milk cooperative societies self-help groups, traditional and private milk buyers. the data collected included dairy farmers’ socio-economic characteristics, actual milk production, milk market competitiveness and other related obligations with the milk buyers. the socio-economic data collected comprised the farmer’s age, education level, household size, gender, and farm ownership, off farm income, access to credit, access to extension service, membership to milk cooperative society and access to other milk marketing channels. the farm production data collected comprised the size of land under dairy production, average volume of milk produced per year, amount of livestock inputs such as feeds, breeding methods, types of labor used, capital used, cost of inputs, and farm gate prices of livestock outputs. respondents were also expected to provide information regarding market competitiveness and an estimated total number of potential commercial buyers for their milk. this would capture the degree of switching power from one commercial buyer to the other that farmers have in marketing their milk. the study also included data on whether the farmer sold total milk output on contract or on signing agreements or on spot cash sale as an independent variable. farmers may sell their milk on signing agreements with milk buyers rather than via spot cash sales. agreements with buyers provide a greater degree of certainty for buyers regarding the availability of supply, for which a buyer may pay a premium (gow and swinnen, 2001). to capture the trustworthiness of commercial milk buyers, a measure of trust on the commercial milk buyer by the dairy milk farmer was included. this attribute was analyzed by a proxy that identified the perception that the dairy milk farmer had in relation to their trust in the commercial milk buyer. finally regarding milk marketing characteristics, a dummy variable was introduced that captured whether the farmer sells via milk cooling/chilling plants, milk sheds or milk bars or not. time series data on farm gate milk prices received by farmers over a period of three years (2013, 2014 and 2015) was also collected from the farmers. this entailed the use of pairwise comparison of the six sub county mean milk prices (means that were significantly different from each other) for the three years using tukey's hsd (honest significant difference) test. 3.6. instruments of data collection a structured questionnaire was used as an instrument for data collection. the questionnaire was designed to address the objectives of the study. the questionnaires were administered by trained enumerators. the enumerators were identified from among the people who were conversant with the sub county wards and villages in the county to asian journal of economics and empirical research, 2016, 3(2): 145-155 149 aid in data collection. the enumerators were trained for two days and the training culminated in the pre-testing of the questionnaire on the third week of december, 2015. pre-test of data collection tool on the four dairy farmer households was done in kericho east and bureti sub counties respectively. observations were also used to correlate those left out from the sampled population with the secondary milk marketing channels in order to provide estimates of their milk supply and milk prices received. 3.7. data analysis and diagnostics stata version 12 was used for data analysis. the collected primary data was collated, cleaned, coded and stored in excel worksheets and ibmspss version 21 before they were transferred to stata for analysis. empirical analysis in this study consisted of two stages. in the first stage, multivariate probit model was used to estimate the factors which determined the milk marketing channel choice decision equation, specifically whether farmers sell only to a commercial milk buyer or sell also to final consumers of milk. secondly, propensity score matching model was used to analyze the impact of farmers’ marketing choices on gross dairy income, milk yield, labor hours, and on breed technology). diagnostic tests were also conducted from the regression results of stata output. to check on multicollinearity, the study used variance inflation factor (vif) and contingency coefficient (cc) among discrete and continuous variables, respectively. all assumptions were tested and corrected accordingly using stata. 3.8. analytical frameworks 3.8.1. theoretical framework the farmer or producers behave like neoclassical firms who control the transformation of inputs into valuable outputs in order to maximize profits (varian, 2000). the decision on whether or not to adopt a new technology is considered under the general framework of utility or profit maximization (norris and sandra, 1987; pryanishnikov and katarina, 2003). it is assumed that economic agents, including smallholder subsistence farmers, use certain livestock milk marketing systems only when the perceived utility or net benefit from using such a method is significantly greater than is the case without it. again smallholder dairy farmers are assumed to be rational and they want to derive the highest utility from the choices they make; either to market their produce independently or under a certain milk marketing channel. they make their choices with respect to random utility theory, which states that a decision maker is guided by unobservable, observable and random characteristics when making a decision. although utility is not directly observed, the actions of economic agents are observed through the choices they make. suppose that yj and yk represent a household’s utility for two milk marketing choices, which are denoted by uj and uk , respectively. the linear random utility model could then be specified as: jij xu   and kikk xu   (2) where; uj and uk are perceived utilities of using a certain milk marketing channel j and k, respectively. xi is the vector of explanatory variables that determines and or influences the perceived desirability of the choice of the milk marketing channel, bj and bk are parameters to be estimated, and εj and εk are error terms assumed to be independently and identically distributed (greene, 2003). therefore, for the case of choice of a livestock milk marketing channel, if a household (dairy farmer) decides to use option j marketing channel, it follows that the perceived utility or benefit from option j marketing channel is greater than the utility from other options (say k) marketing channel depicted as follows: ),(()( 11 kikikjijij xuxu   k ≠ j (3) the probability that a dairy farmer will choose milk marketing channel j among the set of livestock milk marketing channels to market his milk instead of the k marketing channel could then be defined as )()|1( ijij uupxyp  (4) therefore, )|0( 11 xxxp kikjij   hence )|0( 11 xxxp kjikij   )(|0( *** ii xfxxxp   (5) where; p is a probability function, uij, uik,, and xi are as defined above, ε* = εj –εkis a random disturbance term, )( 11* kjj   is a vector of unknown parameters that can be interpreted as a net influence of the vector of independent variables influencing the decision to sell a commercial milk marketing channel, and )( * ixbf is a cumulative distribution function of the error terms (ε*) evaluated at ixb* . the exact distribution of f depends on the distribution of the random disturbance term, ε*. depending on the assumed distribution that the random disturbance term follows, several qualitative choice models can be estimated (greene, 2003). propensity score matching which is used in this study’s analysis requires no assumption about the functional form in specifying the relationship between outcomes and predictors of outcome, unlike the parametric methods mentioned above. however, the drawback of the approach is the conditional independence assumption (cia), which states that for a given set of covariates, participation is independent of potential outcomes (smith and todd, 2005). further, smith and todd (2005) note that there may be systematic differences between the outcomes of participants and non-participants, even after conditioning on observables. such differences may arise because of selection into treatment based on unmeasured characteristics. to address the selectivity bias problems associated with choice decision of a milk marketing channel, this study employed the matching techniques in assessing the impact of selling to a commercial milk marketing channel on average dairy farmer household’s gross income, employment and dairy breeding technology uptake. the propensity score matching approach addresses the problem of the limited distributional assumption of the errors, and more importantly allows for a decomposition of the treatment effect on outcomes (heckman, 1999). also the counterfactual framework could detect “two important sources of bias in the estimation of treatment effects. asian journal of economics and empirical research, 2016, 3(2): 145-155 150 these include the initial differences between the group selling to commercial milk market channels and those selling to final consumers in the absence of treatment, and the difference between the two groups in the potential effect of the treatment. 3.8.2. empirical modeling of effects of market channel choices on income, labor hours and technology farmer’s milk marketing channel choice decisions in this study were hypothesized to have not significant impact on various technological and economic parameters, such as income, productivity; employment and technology (breed composition). here, the study estimated income, employment and technology functions, again endogenously stratifying for each of the marketing channel used. since the separation of producers by market channel introduces a bias derived from an endogenous stratification of market channels, this bias needed to be corrected. the regression equations were estimated for the group selling to commercial milk market channels and those who sell to final consumers. therefore, the structural model that was adopted for the analysis was the propensity score matching model (psm) as shown in equation 2.7 and as adopted from heckman (1999). iiii ukxy   (6) where; yi is household income, employment or technology; xi is a vector of the explanatory variables, representing personal and household characteristics and assets, and distance; ki is the dummy variable representing one, if a dairy farmer sells to a commercial milk buyer and 0 for those selling also to final consumers;  are the coefficients and iu is the error term. the specification above in equation treats milk market choice decision by the dairy farmer household as an exogenous variable on the premise that households opts for a milk buyer to increase their income, employment of resources or to improve on their technological status. nonetheless, this need not be the case, since better-off dairy farmer households may be better predisposed to several commercial milk markets as compared to the poor dairy farmer households. furthermore, the decisions to choose or not to choose a particular milk marketing channel choice may be dependent on the benefits from the choice of the milk marketing channel. thus, the choice of the milk marketing channel is not random, with the group of dairy farmers being systematically different. however, selection bias occurs if unobservable factors influence both the error term ( u ) of the choice equation, and the error term (  ) of the income equation, thus resulting in correlation of the error terms. to evaluate the impact of various milk marketing channel choice decisions on smallholder dairy farmer’s income, both farmers selling under commercial channels and for those not were expected to show the same observable characteristics. the study assumed that those selling through commercial milk marketing channels were taken as treatment and those not were taken as control. the average treatment effect (ate) of involving commercial buyers is the difference between the actual income and the income for involving the commercial buyers in milk marketing, which is expressed as; 1/( 01  iii kyyeate (7) where; iy1 is the income when ith farmer sells to commercial buyer, iy0 is the income when the ith farmer markets independently to final consumers and ki is a dummy variable denoting the involvement of the commercial buyer, 1 = selling to commercial milk buyers, 0 = otherwise. the mean difference (d) between observable and control can be written as in equation 8 below.  atekyekyed ii )0/()1/( 01 (8) where;  is the bias. the estimated model used for the fourth hypothesis related to the impact on farmers’ milk marketing choices, y1i, (a binary variable which takes the value one if the farmer sells to commercial milk buyers only and zero if the farmer decides to sell also to final consumers), and their impacts on farmers’ income, employment, and technology (zij), is as specified in the equation below: ij ij uimrfamilysizelandsize expherdvetfdspartroadedcagez   1099 8765432,10 pr   (9) zij is a set of variables that were hypothesized to affect the farmer’s marketing channel choices (y1j). these were the gross dairy income, milk yield, employment, and share of crossbred animals as dependent variables. ideally, the dependent variable was the net dairy income. regrettably, it was quite difficult to obtain accurate data on the value of some of dairy inputs. this was mainly true of dairy inputs for which livestock markets were not well developed, such as labor, home grown feeds and fodder, home-made feed ratios and in some cases costs data were missing completely. a major reason why propensity score matching was employed was to address potential unobserved heterogeneity. as observed by hujer et al. (2004) a possible hidden bias might occur if there are unobserved variables that tend to influence simultaneously commercial milk marketing channel choice decision and dairy farmer household income, employment and breed technology. given that it is not possible to estimate the magnitude of selection bias with non-experimental data. rosenbaum and donald (1985) suggested the use of the bounding approach to examine the influence of unmeasured variables on the selection process. as a consequence, the study used gross dairy income per animal per household as the dependent variable in the second stage of the heckman model. the inverse mills’ ratio was also be used to correct the error terms in the impact equations to achieve consistent and unbiased estimates. 3.9. diagnostic tests for multinomial logit the study used variance inflation factor (vif) and contingency coefficient (cc) among discrete and continuous variables, respectively. potential multicollinearity among explanatory variables was tested and it was found not to asian journal of economics and empirical research, 2016, 3(2): 145-155 151 have any potential influence on estimates from the model. the highest pair-wise correlation was 0.4 whereas multicollinearity is a serious problem if pair-wise correlation among regressors is in excess of 0.5 (gujarati, 2004). an analysis of variance inflation factor did not show any problem since none of the vif of a variable exceeded 8 (greene, 2003). 4. empirical results and discussion probit model was used to estimate the propensity scores. the scores were only used to balance the observed distribution of covariates across the treated group (farmers selling to commercial buyers) and the untreated group (farmers not selling to commercial buyers). the independent variables used in the probit regression model to predict the propensity scores were based on past research on determinants of participation in nonfarm employment (barrett et al., 2001) in owusu et al. (2014). from table 5 results, most of the variables included in the estimation have the expected sign. in particular, participation in milk marketing and household size were found to be positively and significantly related to milk marketing. the coefficient for dairy farmer household participation in milk marketing was positive and significant. the presence of a milk buyer enhanced the probability of participation in the milk market. according to kousar and abdulai (2015) endowments with valuable household assets represents household’s wealth and the presence of a development project in an area enhance the probability of participation for both male and female in non-farm earning activities. the coefficient of household size was positive and significant balancing factor for propensity score matching. this suggests that the presence of labor availability in the household tend to increase the milk output levels which will then increase the probability of dairy farmer households selling their milk to commercial milk buyers. these results are in contrast to the study of barrett et al. (2001) and in line with the study of kousar and abdulai (2015) in the case of male labor supply. the distribution of propensity of propensity scores before and after matching clearly indicate that estimating the p-score appears to balance the treated and untreated groups extremely well than without the p-score, a result which underscored the significance of the propensity score matching approach for this study. table-5. probit estimates of the propensity score for dairy farmer household’s milk marketing involvement major farm gate milk buyers (commercial or final consumers) coefficient standard error z p>|z| age of household head -0.0026244 0.0083386 -0.31 0.753 education level 0.0103616 0.0597299 0.17 0.862 distance to milk market -0.0257749 0.0162404 -1.59 0.012** milk marketing participation 0.319914 0.1308435 2.45 0.014** price risk -0.2414148 0.1867471 -1.29 0.006* veterinary feeds 0.0512779 0.1309099 0.39 0.695 farming experience 0.0074178 0.0091395 0.81 0.017** total farm size 0.0105474 0.0100193 1.05 0.002* total household size 0.0484578 0.0275248 1.76 0.008* gross income 0.005435 0.0022667 2.40 0.016** net income -0.0042365 0.0021526 -1.97 0.049** employment hour 0.003493 0.0031162 1.12 0.002* technology (breeding) -0.0014355 0.0018119 -0.79 0.028** constant -0.1393711 0.454589 -0.31 0.759 key: caliper = 0.001 nearest neighbour = 1 number of observations = 432 lr chi 2 (13) = 25.97 prob > chi 2 = 0.0172 log likelihood = -284.59954 pseudo r 2 = 0.0436 * significant at 1 percent; ** significant at 5 percent; *** significant at 10 percent source: author’s computation from survey data, 2016 pseudo-r 2 from probit estimation indicated the goodness of fit of the model or how well the regressors explained the probability to sell to commercial buyers. from the table of results, after matching, pseudor2 was fairly low (0.0436), which showed that the matching procedure balanced the determining factors (covariates) very well for this study. 4.1. the mean differences in outcome variables in the matching analyses table 6 compares the mean differences in the outcome variables and other household and farm-level variables between dairy farmer households selling milk to commercial buyers and dairy farmer group not selling milk to commercial buyers. given that the mean difference comparisons do not account for the effect of other characteristics of farm households, they confound the impact on household gross income, employment and breed technology adoption (dairy breeding) status with the influence of other characteristics. the significance levels suggest that there are some differences between those who sell to commercial milk buyers and those not with respect to household and farm-level characteristics. with regard to the outcome variables, there were statistically significant differences in household income and employment hours between the two categories of dairy farmers. therefore, we again rejected the null hypothesis that the milk marketing channel choice has no impact on dairy farmer household income, labour hours and breed technology in kericho county. asian journal of economics and empirical research, 2016, 3(2): 145-155 152 table-6. propensity score (pscore) matching analysis variable sample treated controls difference s.e. t-stat net income unmatched 172.252586 148.97167 23.2809153 12.3018885 1.89 att 172.450649 154.408731 18.0419177 17.2355653 1.05 atu 148.849432 162.68549 13.8360576 . . ate 16.1310585 . . gross income unmatched 206.621994 190.094018 16.5279754 12.8656873 1.28 att 207.007684 188.762198 18.2454867 18.3727788 0.99 atu 189.250915 193.497668 4.24675287 . . ate 11.8854063 . . employment hours unmatched 10.8287367 9.75894024 1.06979644 2.48402087 0.43 att 10.925244 6.45855443 4.46668959 2.76165675 1.62 atu 9.85423381 8.3365533 -1.51768051 . . ate 1.74779545 . . technology unmatched 55.0968127 58.0400175 -2.94320479 3.50114827 -0.84 att 55.3412638 56.0343963 -0.693132423 5.2095683 -0.13 atu 58.5095023 60.2395584 1.73005617 . . ate 0.407801035 . . note: standard error does not take into account that the propensity score is estimated. source: author’s computation from survey data, 2016 results in table 6 further shows that the means of the treated group (farmers selling to commercial buyers) and the control group (farmers not selling to commercial buyers) are different. the magnitudes of the coefficients of the treatment effects indicate that the average treatment effects for the treated (att) are higher than the average treatment effects for the entire sample (ate) and the average treatment effects for the untreated (atu) except for technology outcome variable. the matching estimates generally indicated that selling to commercial milk buyers exerted positive, significant and unbiased impacts on household gross income and hence net income (table 6). these att effects demonstrate that dairy farmer households who sell milk through these commercial milk buyers increase their gross income thereby improving their welfare over and above those that are less motivated to commercial milk buying channels. after matching, dairy farmer households selling to commercial milk buyers raised their daily net income in the household by 18.00 kenya shillings on average per dairy cow. according to owusu and a. (2009) households that have a higher probability of participating in non-farm work are able to obtain higher incomes and improve their food security status over and above those that are less inclined to participate in non-farm work. this is in convergence with the current study findings. the matching estimates of the atu effect indicates that if farmer households who did not sell their milk to commercial milk buyers had actually sold the milk (counterfactual condition), then their household income and employment hours would be on average higher than that of those who did sell their milk to commercial milk buyers.owusu and a. (2009) further notes that the implication of such an outcome is that income and food security gains from participation in non-farm employment are slightly higher for households with a higher probability of participating than households with slightly lower chances of participating in non-farm employment. results further revealed that the matching estimates for gross income per animal on the treatment group, while balancing for the original level of gross income before and after treatment, also increased by 18.24 kenya shillings (the nearest neighbour estimate of the average gain) after matching. similarly, employment hours increased on average by 4 hour 46 minutes for dairy farmer households in the treatment group (those selling to commercial buyers) after matching results of the unobserved. this confirm earlier findings by heshmati (2007) that the underlying technologies employed defines a production function to estimate the mean output rather than the maximum output. after matching, the percentage of cows bred using modern breeding technologies for example ai or sexed semen decreased for the dairy farmer households in the treatment group (dairy farmer households selling milk to commercial buyers) by about 69 percent. this can be attributed to the high cost of dairy cow breeding in the study area that has been brought about by asymmetric information flow. of particular concern have been breeding (a.i) prices that do not fully reflect quality because dairy farmers and breeders do not have the same information. this result is in convergence and in conformity with earlier studies by eggertson (1990) who argues that before making a decision about how to market a product and to whom to sell it, producers must determine the price that they expect to receive. further, eggertson (1990) argues that transaction costs arise when market information is asymmetric as this induces activities such as information searchers, bargaining, market contracting, monitoring, enforcement and protection of property rights, which are, by nature costly. the magnitude of the coefficients of the treatment effects indicated that the average treatment effects for the treated (att) were higher than the average treatment effects for the entire sample (ate) and the average treatment effects for the untreated (atu) for the outcome variables except for technology (table 6). these results indicated that farmers who sold milk to commercial buyers had a higher probability of obtaining higher gross income per animal and had a higher probability of improving their welfare over and above those farmers who did not. the average effect of the treatment (ate) for a dairy farmer household drawn from the overall population at random was kenya shillings 16.00 higher because of selling to commercial milk buyers. this was because a positive effect was estimated for the dairy farmer households not selling to commercial buyers (atu). the atu effect by caliper matching estimates indicated that if farmer households that did not sell milk to commercial milk buyers had actually sold the milk, a counterfactual condition, then their household income and employment hours would be on average lower than that of those who did sell their milk to commercial milk buyers. the implication here is that the net income and employment hour gains from selling to commercial milk buyers are slightly higher for dairy farmer asian journal of economics and empirical research, 2016, 3(2): 145-155 153 households with a higher probability of selling to commercial milk buyers than to dairy farmer households with slightly lower chances of selling to commercial milk marketing channel. in performing psm using the common option imposes a common support by dropping treatment observations whose pscore is higher than the maximum or less than the minimum pscore of the controls (table 7). according to the results, five observations were dropped from the entire observations. three from the treated group (farmers selling to commercial buyers) and two from the untreated group (farmers not selling to commercial buyers), respectively. table-7. becker and ichino (psmatch2) psm estimation psmatch2 psmatch2 treatment assignment common support off support on support total untreated 2 194 196 treated 3 233 236 total 5 427 432 source: author’s computation from survey data, 2016 4.2. matching success for impact/outcome factors table 8 give result of t-test on the hypothesis that the mean value of each of the outcome variables; namely age, education level, distance to the milk market, milk market participation, price risk, livestock feeds, farming experience, total farm size, household size, gross and net household income, employment hours and breed technology adoption was the same for the treatment group (farmers selling to commercial buyers) and non-treatment group (farmers not selling to commercial buyers). it was done both before and after matching. pstest was used to check for the success of the matching for the outcome variables. further, a bias before and after matching was calculated for each of the variables and the change in the bias stated. table-8. indicators of matching quality before and after matching (psm results) major farm gate milk buyers commercial or final unmatched mean %reduction t-test v(t)/v(c) outcome variables matched treated control %bias |bias| t p>|t| age of household head u 48.75 47.995 6.5 0.67 0.504 0.95 m 48.639 51.12 -21.2 -228.5 -2.25 0.025* 0.89 education level u 3.0932 3.0561 3.5 0.36 0.717 0.91 m 3.0944 3.0215 6.9 -96.7 0.74 0.460 0.88 distance to milk market u 3.0275 3.4564 -10.9 -1.13 0.259 1.08 m 3.0399 3.378 -8.6 21.2 -0.93 0.352 1.10 milk marketing participation u 0.4661 0.3520 23.3 2.41 0.017 1.09 m 0.4592 0.4506 1.8 92.5 0.19 0.853 1.00 price risk u 0.8517 0.8725 -6.0 -0.62 0.536 1.13 m 0.8498 0.8584 -2.5 58.6 -0.26 0.794 1.05 veterinary feeds u 0.6568 0.6327 5.0 0.52 0.603 0.97 m 0.6567 0.7082 -10.7 -113.5 -1.19 0.233 1.09 farming experience u 19.127 18.041 10.3 1.06 0.290 1.09 m 19.03 21.485 -23.2 -126.0 -2.45 0.015* 0.99 total farm size u 5.4667 4.4128 15.8 1.61 0.109 1.90* m 4.885 4.4895 5.9 62.5 0.90 0.369 2.64* total household size u 6.4025 5.9745 18.8 1.95 0.052 0.88 m 6.382 6.4034 -0.9 95.0 -0.10 0.923 0.74* gross income u 172.25 148.97 18.5 1.89 0.059 1.66* m 172.45 148.45 19.1 -3.1 2.09 0.037* 1.87* net income u 206.62 190.09 12.5 1.28 0.200 1.56* m 207.01 182.98 18.2 -45.4 1.99 0.048* 1.68* employment hours u 10.829 9.7589 4.3 0.43 0.667 3.81* m 10.925 6.7606 16.6 -289.3 1.83 0.048* 5.00* technology (breeding) u 55.097 58.04 -18.1 -0.84 0.401 0.89 m 55.341 53.947 3.8 52.6 0.42 0.672 0.98 source: author’s computation from survey data, 2016 the bias before and after matching was calculated for each variable. this bias was the difference between the mean values of the treatment group and the control group, divided by the square root of the average sample variance in the treatment group and the not matched control group. table 8 shows the differences in the values of the exogenous variables between the two groups before and after matching. for example, 46.61% and 35.2% of the treatment and control group respectively participated in milk marketing. this means that the results have significant influence on the treatment probability. the indicators of matching quality presented in table 9 show substantial reduction in absolute bias for all the outcome variables for both the treated and non-treated. as indicated in the table (column 5), the mean bias in the covariates z after matching lies below the 20 % level of bias reduction suggested by rosenbaum and donald (1985). this indicates that the covariates were significantly balanced as a result of the propensity score procedure. asian journal of economics and empirical research, 2016, 3(2): 145-155 154 table-9. indicators of matching quality before matching and after matching sample ps r 2 lr chi 2 p>chi 2 mean bias med bias b r % var unmatched 0.044 25.97 0.017 11.0 10.3 49.3* 1.01 31 matched 0.032 20.77 0.078 10.7 8.6 40.5* 1.86 38 * if variance ratio outside [0.77; 1.29] for unmatched and [0.77; 1.29] for matched ps r 2 – pseudo r 2 , lr chi 2 – chi square likelihood ratio note:* p-value of likelihood ratio test (pr > 2 ) note: pseudo-r 2 from probit estimation indicates the goodness of fit or how well the regressors explain the probability to participate in an employment activity. source: author’s computation from survey data, 2016 the pseudo-r 2 from the propensity score estimation and from re-estimation of the propensity score matching on the matched samples for both the groups was 0.044 and 0.032, respectively (table 3.5). however, if p>0.05, the null hypothesis could not be rejected on the 5% significance level. therefore, the joint significance of the regressors on the treatment status could not be rejected after matching. it was, however, not rejected before matching either. the null hypothesis that the mean values of the two groups do not differ after matching cannot be rejected for the variables except for age, farming experience, and gross income. therefore, it is possible to generate a control group, which is similar enough to the treatment group to be used for the att estimation. the relatively low pseudor 2 after matching and the p-values of the likelihood-ratio test of the joint significance of the regressors imply that there is no systematic difference in the distribution of covariates between treatment and non-treatment groups after matching, suggesting that the overall results from the matching procedure are satisfactory in balancing the covariates between the treatment and non-treatment (caliendo et al., 2005). 4.3. distribution of the propensity scores for treated and untreated groups figure 1 gives the histograms of estimated propensity scores for the treated and non-treated groups of dairy farmer households. it shows the distribution and overlap (regions of common support) conditions of the propensity scores after matching for the two groups of dairy farmers (nearest neighbours).visual inspection of the results reveals that the densities of the mean propensity scores are similar after matching and there is a clear overlap of the distributions. propensity scores before and after matching as shown clearly indicate that estimating the p-score appears to balance the treated and untreated groups extremely well than without the p-score, a result which underscored the significance of the propensity score matching approach for this study. there is a clear balance between the two coordinates as they moved towards a central and a common area. figure-1. density distribution (covariate balance) of the estimated propensity scores source: author’s computation from survey data, 2016 4.4. summary and conclusions this study examined the impacts of milk marketing channel choice decisions on dairy farmer household income, employment and breed technologies, using a cross-sectional sample of 432 dairy farmer households from six sub counties in kericho county, kenya. a propensity score matching model was employed to account for selection bias asian journal of economics and empirical research, 2016, 3(2): 145-155 155 that normally occurs when unobservable factors influence both participation and non-participation in dairy milk marketing on the outcomes. the paper addressed dairy farmer heterogeneity by explicitly providing separate estimates for treated group (farmers selling to commercial buyers) and the untreated group (farmers not selling to commercial buyers). results of the propensity score matching showed that the magnitudes of the coefficients of the average treatment effects for the treated (att) were higher than the average treatment effects for the entire sample (ate), and the average treatment effects for the untreated (atu) for the outcome variables except for breeding technology. the results indicated that farmers that sold milk to commercial milk buyers had a higher probability of obtaining higher gross income per animal per day and could improve their welfare over and above those farmers who did not. the average effect of the treatment (ate) for a dairy farmer household drawn from the overall population at random was kenya shillings 25.60 higher because of selling to commercial milk buyers. the atu effect by caliper matching estimates revealed that if a farmer household who did not sell milk to commercial milk buyers had actually sold the milk, their household income and employment hours would be on average lower than that of those who did sell their milk to commercial milk buyers. the implication here is that the net income and employment hour gains from selling to commercial milk buyers are slightly higher for dairy farmer households with a higher probability of selling to commercial milk buyers than to dairy farmer households with slightly lower chances of selling to commercial milk marketing channel. the 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(ed.). pp: 175–187. varian, h.r., 2000. intermediate microeconomic theory: a modern approach eighth edi. j. repcheck, ed., cheltenham, uk: edward elgar publishing limited, uk. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. asian journal of economics and empirical research issn: 2409-2622 vol. 2, no. 2, 76-82, 2015 http://asianonlinejournals.com/index.php/ajeer * corresponding author 76 households’ perception of factors influencing agricultural productivity in ogoni community: an ordinal logit approach ojide makuachukwu gabriel 1* --onyukwu onyukwu e. 2 --ikpeze nnaemeka i. 3 1 research associate, socioeconomics unit, international institute of tropical agriculture, ibadan, oyo state, nigeria 2 reader in development economics, department of economics, faculty of social sciences, university of nigeria, nsukka, enugu state, nigeria 3 professor of economics, department of economics, faculty of social sciences, university of nigeria, nsukka, enugu state, nigeria abstract this work is licensed under a creative commons attribution 3.0 license asian online journal publishing group contents 1. introduction ............................................................................................................................................................................... 77 2. methodology .............................................................................................................................................................................. 77 3. results and discussion .............................................................................................................................................................. 79 4. conclusion .................................................................................................................................................................................. 81 5. acknowledgement ..................................................................................................................................................................... 82 references ...................................................................................................................................................................................... 82 agriculture is the principal means of livelihood in ogoniland of niger delta region of nigeria. ascertaining the determinants of agricultural productivity in the community is therefore important in meeting food security and income needs. this study uses survey data of 400 households in ogoni community. the data was collected using a multistage sampling method. an ordinal logit regression model was estimated. descriptive analyses indicate that 75.8% of the surveyed households were involved in agricultural production and that only 37.1% of the households involved in agriculture had lost their agricultural produce due to oil spoilage in the last two years. the ordinal logit regression model identifies government intervention towards cleaning of polluted land and water, land degradation, air pollution and household income as significant determinants of agricultural productivity in the community. however, land degradation and air pollution are negatively associated with agricultural productivity while government intervention towards cleaning of polluted land and water and household income are positively related to agricultural productivity in ogoni community. on the other hand, the result indicates that corporate social responsibility of oil firms towards cleaning of polluted land and water), oil spill and education attainment of household head are not among the significant determinants of agricultural productivity in ogoni community. keywords: agriculture, income, participatory development, oil spill, land degradation and air pollution. http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2015, 2(2):76-82 77 1. introduction agricultural growth is generally considered as one of the most effective means of addressing poverty in the developing economies. for instance, the department for international development (2003) estimates that a one percent increases in agricultural productivity could reduce the percentage of poor people living on less than 1 dollar a day by between 0.6 and 2 percent and that no other economic activity generates the same benefit for the poor in the developing economies. nevertheless, the major challenge in the agricultural sector of most developing countries is how to increase agricultural productivity to meet food security needs for the growing population and to also reduce poverty and malnutrition, and to do it in a sustainable way simtowe et al. (2012). consideration on the drivers of agricultural productivity in oil exploration communities has become an area of keen interest (ofuoku et al., 2008; unep, 2011). oil exploration activities in nigeria are mainly carried out in the niger delta region. rivers state is one of the niger delta states. it is bounded on the south by the atlantic ocean. ogoni community (also referred to as ogoniland) is in rivers state. the ogoni group includes a large number of dialects which can be grouped into four namely khana, gokana, eleme and ogoi. apart from the need for an indepth and intensive study, the choice of ogoniland for this study is based on the fact that the community was among the first places where oil was found in a commercial quantity in nigeria – shell began drilling in ogoniland in 1958 (nest, 1991). ogoni people are a distinct indigenous minority nationality. they live in an area of 1,000 square kilometers on the south eastern fringe of the niger delta region in nigeria. given an average population growth rate of 2.50 (2007 – 2010) and 831,726 population published by the national bureau of statistics (2006) the 2010 population of ogoni people is estimated to be around 914,899 (saro-wiwa, 1995; unpo, 2009; world bank, 2010; ojide and ikpeze, 2015). ogoniland is made up of four local government areas (lga). they are eleme, gokana, khana, and tai local government areas. the population of each of the lgas is as shown in table 1. table-1. number of inhabitants by lga (2010 estimate) lga inhabitants eleme 209,972 gokana 251,711 khana 323,639 tai 129,577 total 914,899 source: nbs (2006) and world bank (2010) given that improved agricultural productivity perhaps remains the single most important driver of economic growth and poverty reduction among developing economies, there is need to ascertain the determinants of agricultural productivity in oil producing communities such as ogoniland in niger delta region of nigeria. following the concept of „participatory development‟, this paper examines the factors influencing agricultural productivity in ogoni community in niger delta region of nigeria. participatory development is concerned about what the people themselves perceive to be their challenges, interests and needs (oecd, 1995; undp, 2006). the null hypotheses tested in this paper are: i. government intervention towards cleaning of polluted land and water (gicl) has no significant influence on agricultural productivity. ii. oil companies‟ intervention towards cleaning of polluted land and water (gicl) has no significant influence on agricultural productivity. iii. household income and education attainment of household head have no significant influence on agricultural productivity. oil exploration was considered in terms of oil spill, land degradation and air pollution from oil exploration activities. 2. methodology data used in this research were obtained using a multistage sampling method. interview schedule was adopted as the survey instrument. the unit of analysis in the study is households in ogoniland. the total number of households in ogoniland is as shown in table 2: table-2. number of households by lga (2010 estimate) lga inhabitants total no. of regular households eleme 209,972 45,397 gokana 251,711 54,422 khana 323,639 69,973 tai 129,577 28,015 total population 914,899 197,807 source: nbs (2006) and world bank (2010) the sample size formula specified by yamane (1967) was applied (see equation 1). the sample size was determined using 95 percent degree of accuracy. e = the degree of accuracy expressed as a proportion (.05). using equation 1, a sample size of 400 households was obtained. this sample size was distributed in proportion to number of households in each local government in ogoniland as shown in table 3. asian journal of economics and empirical research, 2015, 2(2):76-82 78 table-3. sample size distributed in proportion to lga population lga total no. of regular households sample size (household) eleme 45,397 92 gokana 54,422 110 khana 69,973 141 tai 28,015 57 total population 197,807 400 an interview schedule consisting of 57 questions, which were developed based on reviewed literature and preliminary interviews, was used in this study. the structured interview schedule which was predominately closed ended questions was used to enhance response rate and easy merging of data from all the four communities. some multiple choice questions also allowed respondents to comment further where necessary. as a result of the sensitive nature of the survey, indigenes of the selected communities were used as enumerators. they were trained on general techniques for successful questionnaire administration. in addition, they were given detailed review of each question – why the questions and expected range of responses – and how to ask the questions to avoid „leading question‟ bias. furthermore, they were instructed to adequately explain to the respondents the purpose of the survey as to avoid, as much as possible, biased responses. the use of educated indigenes of the communities enhanced communication and reduced security risks given the emotional and political nature of the subject of interest and the study area. the questions were asked by the enumerators who filled-in the responses into the interview schedule. this reduced the chances of misinterpreting the questions. the respondent in each of the selected households was the head of the household or the representative (who must be a spouse or adult son/daughter). in this study, an adult is considered to be a person not less than 18 years old. the interview schedule used in the study includes sections on demography, socioeconomic related issues, and environment related issues, as well as agricultural production. 2.1. pilot stage and test of the instrument the face and content validation of the interview schedule was conducted by research experts (including an indigene of the ogoni community). a reliability test was also conducted on the instrument. the reliability of the instrument was determined during the pilot study of 30 households randomly selected in tai local government area (which is one of the local government areas of the study). the interview instrument was administrated to the 30 households. the responses from the pilot study were examined using split-half reliability index – coefficient alpha (cronbach, 1951). the coefficient alpha in split-half technique is calculated using equation 2 (allen and yen, 1979): the coefficient alphas for the different sections of the instrument were computed. on the average, the research instrument achieved about 83% reliability. 2.2. model specification the “driving forces – pressure – state – impact response model” (dpsir) framework has been extensively applied in socioeconomic and environmental studies (walmsley, 2002; odermatt, 2004; fistanic, 2006; amajirionwu et al., 2008). despite its extensive use in socioeconomic and environmental researches, the dpsir framework has not been widely used in empirical studies (bell and etherington, 2009). nonetheless, the dpsir framework is globally recognized as a means of identifying meaningful indicators of cause-and-effect relationships (smeets and weterings, 1999; walmsley, 2002; bell and etherington, 2009; ojide and ikpeze, 2015). this study, therefore, evaluates the social aspects of dpsir framework using ordinal logit model as stated in equation 3. 3.............*   kkk xy  where y* is an unobserved, continuous, underlying tendency behind the observed ordinal response (rating). the xk represent the independent variables, while the βk represent the associated parameters. the error term (εk) captures stochastic (unobserved) variation. it is assumed to be distributed logistically. relating the unobserved y* to y through a series of “cut points” is as represented in equation 4: where y is the rating and the μ‟s represent thresholds of y* that delineate the categories of the ordered response variable. these threshold parameters are restricted to be positive where each one is greater than the previous. the first parameter μ1 is normalized to 0 so that one less parameter has to be estimated. that is not a problem because the scale of the latent variable is arbitrary (borooah, 2001). to avoid confusion and misinterpretation of estimates, y is restricted to a five-point likert item or less – measuring influence of the exogenous variables on agricultural productivity in the ogoni communities. using equation 3, equation 5 was estimated. variables are as defined in table 4. asian journal of economics and empirical research, 2015, 2(2):76-82 79 table-4. definition of variable variable code description agric household agricultural productivity (very low=1, low=2, mild=3, high=4, very high=5) ap air pollution (very low=1, low=2, mild=3, high=4, very high=5) ld land degradation (very low=1, low=2, mild=3, high=4, very high=5) os oil spillage (very low=1, low=2, mild=3, high=4, very high=5) income household income (18000 & below=1, 18100 50000=2, 50100 100000=3, 100100 – 250000=4, > 250,000=5) et education attainment of household head (no formal edu.=0, fslc=1,ssce=2,ond=3, b.sc & above=4) ccgg to giw below were coded as: low=1, average=2, high=3, very high=4 csrcl corporate social responsibility of oil firms towards cleaning of polluted land and water gicl government intervention towards cleaning of polluted land and water 3. results and discussion household survey, which started on december 3, 2013 and ended on january 17, 2014, was conducted in all the four local government areas (lgas) in ogoniland. tables 5 – 13 present household characteristics and agricultural production. analysis of gender distribution of respondents in all the four local government areas (pooled data) indicate that an average of 51.3% of the household representatives were male (see table 5). most of the respondents in the community (in the four lgas) were within the age range of 26 – 35 years (35.8%) and 36 – 50 years (26%). about 6.3% of the respondents were 51 years and above (see table 6). table-5. respondents sex male (%) female (%) tai 37 (64.9) 20 (35.1) eleme 27 (29.3) 65 (70.7) gokana 60 (54.5) 50 (45.5) khana 81 (57.4) 60 (42.6) pool 205 (51.3) 195 (48.8) table-6. respondents‟ age range 18-25 years (%) 26-35 years (%) 36-50 years (%) 51-65 years (%) 66 years & above (%) 125 (31.3) 143 (35.8) 107 (26.8) 18 (4.5) 7 (1.8) greater proportion (54%) of the respondents was household heads. table 7 indicates that the 46% non-household head respondents were wife (22.8%), son (34.8%) and daughter (42.4) respectively. the gender distribution of households, where respondents are not household heads, is as shown in table 8. table-7. category of respondent household head (%) 216 (54.0) non-household head (%) 184 (46.0) non household head wife (%) 42 (22.8) son (%) 64 (34.8) daughter (%) 78 (42.4) table-8. if respondent is not household head, sex of household head male (%) 137 (74.5) female (%) 47 (25.5) household size minimum 1 maximum 16 mean 6 standard deviation 2 table 8 also indicates that the average household size in the community is 6 persons with 2 as standard deviation. majority (81.5%) of the households surveyed were indigenes of ogoniland; while the rest are nonindigenes who are residing in the communities (table 9). about 79.5% of the households had lived in the community beyond 10 years (table 10). table-9. status of household head in the community ogoni indigene (%) 326 (81.5) not ogoni indigene (%) 74 (18.5) status of household head in the community tai (%) eleme (%) gokana (%) khana (%) ogoni indigene 55 (96.5) 43 (46.7) 106 (96.4) 122 (86.5) no ogoni indigene 2 (3.5) 49 (53.3) 4 (3.6) 19 (13.5) asian journal of economics and empirical research, 2015, 2(2):76-82 80 table-10. duration of the household in the lga below 5 years (%) 5 10 years (%) above 10 years (%) 28 (7.0) 54 (13.5) 318 (79.5) analysis of literacy level of household heads reveals that only about 3.8% of the household heads in the community had no formal education. majority of the household heads were literate with primary school (10.3%), secondary school (26.3%), national diploma (22.8) and first degree/post graduate degree (37%). table 11 shows that 75.8% of the surveyed households were involved in agricultural productivities. crops farming (70%) is the major agricultural activities among the farming households. about 16.8% and 13.2% had fishery and poultry production as their major agricultural activity. larger proportion of the households rated their productivity in crops, fishery and poultry farming as mild, high or very high (see table 12). table-11. household and agriculture household involved in agricultural productivity (%) 303 (75.8) major agricultural product by household (%) crops 212 (70.0) fishery 51 (16.8) poultry 40 (13.2) major agricultural product by household in each l.g.a. tai (%) eleme (%) gokana (%) khana (%) crops 37 (71) 42(82) 72 (69) 60 (64) fishery 10 (19) 2(4) 20 (19) 19 (20) poultry 5 (10) 7(14) 13 (12) 15 (16) table-12. productivity rating of all major agricultural activities in the household (%) rating of agricultural productivity very low low mild high very high crops 13 (6.1) 23 (10.8) 51 (24.1) 75 (35.4) 50 (23.6) fishery 2 (3.9) 6 (11.8) 10 (19.6) 18 (35.3) 15 (29.4) poultry 1 (2.5) 6 (15.0) 15 (37.5) 13 (32.5) 5 (12.5) table 13 indicates that only 37.1% of the households involved in agriculture had lost their agricultural produce due to oil spoilage in the last two years. among these 37.1% households, on the average, the estimated amount of money lost per household within the period is about ninety-five thousand naira (n95,000). however, on the average households in khana lost most (n111,355) followed by those in tai (n82,292). households in eleme were least affected as on the average each of the farming household lost only about two thousand, two hundred and seventy naira (n2,270). table-13. losses in agricultural produce due to oil spoilage in the last two years experience loss (%) 141 (37.1) average amount of money lost per household (naira) 95,070.37 estimated losses in agricultural produce due to oil spillage in each l.g.a.– average of the households that experienced losses in the past two years (naira) tai (n) eleme (n) gokana (n) khana (n) 82,291.67 2,267.50 56,155 111,354.54 note: naira-su dollar exchange rate as of the time of the survey = us$157.29 the result of the estimated ordinal logit model is presented in table 14. table-14. ordinal logistic analysis of economic impact models agric variable value 1, 2, 3, 4, 5 predictor coef odds ratio const (1) -3.9158* {0.000} const (2) -2.5141 * {0.000} const (3) -1.1170* {0.031} const (4) 0.5510 {0.284} gicl 0.5246* {0.021} 0.59* csrcl 0.1970 {0.468} 1.22 os -0.1139 {0.477} 0.89 ld -0.5302* {0.002} 1.70* continue asian journal of economics and empirical research, 2015, 2(2):76-82 81 income 0.26006* {0.005} 1.30* ap -0.2661* {0.048} 0.77* et 0.05489 {0.563} 1.06 test that all slopes are zero (g) 25.236* {0.001} goodness-of-fit test (χ 2 ) 987.056* {0.000} cases used 292 (73%) cases with missing values 108 (27%) notes: p-values are in parentheses – {}; percentages in brackets – (); * represents 5% significant 3.1. overall model in this model, 73 percent of the observations were used while the rest were excluded due to missing values. the excluded observations are mainly the non-farming households since only 75.8% of the surveyed households were involved in agricultural production. the goodness-of-fit test, chi-square (χ 2 = 987.056) with p-value of 0.000, indicates that the model is appropriate for the data. similarly, the overall relationship between the independent variables and the dependent variable is significant. this is because the statistic g (25.236), with p-value of 0.001, indicates that there is sufficient evidence to conclude that at least one of the estimated coefficients in the model is different from zero. thus, the independent variables are simultaneously significant. the model examined seven factors namely government intervention towards cleaning of polluted land and water (gicl), corporate social responsibility of oil firms towards cleaning of polluted land and water (csrcl), oil spill (os), land degradation (ld), air pollution (ap), household income, and education attainment of household head (et). the p-values of the predictors indicate that for 0.05 alpha-level, there is sufficient evidence to conclude that government intervention towards cleaning of polluted land and water (gicl), land degradation (ld), air pollution (ap) and household income have significant influence on household agricultural productivity in the community. however, land degradation and air pollution (ap) are negatively associated with agricultural productivity while government intervention towards cleaning of polluted land and water (gicl) and household income are positively related to agricultural productivity in ogoniland. on the other hand, the result indicates that corporate social responsibility of oil firms towards cleaning of polluted land and water (csrcl), oil spill (os) and education attainment of household head (et) are not among the significant factors affecting household agricultural productivity in ogoniland. this is because the coefficients of the later variables were not found to be statistically different from zero in the estimation. 3.2. marginal effect of individual predictors on the log-odds of the dependent variable the result indicates that a unit increase in government intervention towards cleaning of polluted land and water (gicl) and household income would result in about 0.53 and 0.26 units increase, respectively, in the log-odds of being in a higher category of agricultural productivity while the other variables in the model are held constant. on the other hand, a unit increase in land degradation (ld) and air pollution (ap) would also result in about 0.53 and 0.27 units reduction, respectively, in the log-odds of being in a higher category of agricultural productivity while the other variables in the model are held constant. crops exposure to high concentrations of different air pollutants can be detrimental to agricultural productivity. such injuries on crops include visible markings on the foliage, reduced growth and yield, and premature death of plant. 3.3. cumulative predicted probabilities for each score category and probabilities for the individual scores of the dependent variable at the means of the independent variables keeping the estimated parameters fixed (that is β = 0), cumulative predicted probabilities for each of the five categories and probabilities for the individual scores of agricultural productivity in the community were calculated (see table 15). table-15. cumulative predicted probabilities of agricultural productivity predictor coeff score cum prob(score) prob (individual score) const (1) -3.9158 1 0.019535 0.019535 const (2) -2.5141 1 or 2 0.074876 0.05534 const (3) -1.1170 1 or 2 or 3 0.246568 0.171693 const (4) 0.5510 1 or 2 or 3 or 4 0.634368 0.387799 cumulative scores (5) 1 or 2 or 3 or 4 or 5 1 0.365632 table 15 indicates that ogoni people have greater probability (0.387799 for very, and 0.365632 for very high – i.e.: 0.75343 all together) of being in high category of agricultural productivity. 4. conclusion following the concept of „participatory development‟, this paper examined the determinants of agricultural productivity in ogoniland of niger delta region of nigeria. the result indicates that about 75.8% of the surveyed 400 households earn their livelihood from agricultural production. among the farming households, 70% had crops farming as their major agricultural activity. only 37.1% of the households involved in the different agricultural activities indicated that they lost their produce due to oil spoilage within the last two years. asian journal of economics and empirical research, 2015, 2(2):76-82 82 the inferential analyses of the responses from the survey revealed that contrary to previous studies (amnesty international, 2009; undp, 2011) oil spill did not significantly impact on agricultural productivity in the communities. this however is in agreement with unep (2007). unep observed during the course of its study that vegetation had continued to grow and cover some oil contaminated land-areas even though remediation measures had not been carried out. unep concluded that this was partly because some vegetation types can vigorously survive hydrocarbon pollution and partly because many vegetation types need only limited clean amounts of topsoil to reestablish. thus, it is possible that most crops in ogoniland have developed resistance to oil contamination or that the farmers have adopted some strategies to ensure crop survival in oil contaminated land, both may as well be the case. however, land degradation and air pollution cause significant reduction in agricultural productivity in the communities. on the other hand, government interventions, in terms of cleaning polluted land and water, have positive effect on their agricultural productivity. this is unlike corporate social responsibility activities of the oil companies, in terms of cleaning polluted land and water, which did not have significant effect on the agricultural productivity. in addition, household income was established as one of the significant determinants of agricultural productivity in ogoniland. this paper recommends that agricultural research institutes should seek to develop crops or seeds that are tolerant to oil polluted soil. this could improve agricultural productivity in communities hosting oil exploration activities thereby enhancing the achievement of food security in such communities. government and oil firms should invest in such research. 5. acknowledgement the authors wish to acknowledge the contributions of the following people in providing suggestions, vetting the research instrument and proofreading: 1. prof. stall madueme, university of nigeria, nsukka 2. dr. emmanuel nwosu, university of nigeria, nsukka 3. dr. augustus legborsi – an indigene of ogoniland, river state, nigeria references allen, m.j. and w.m. yen, 1979. introduction to measurement theory. monterey, ca: brooks/cole. amajirionwu, m., n. connaughton, b. mccann, r. moles, j. bartlett and b. o'reaan, 2008. indicators for managing biosolids in ireland. j.environ manage, 88(4): 1361-1372. amnesty international, 2009. oil industry has brought poverty and pollution to niger delta. available from http://www.amnesty.org/en/newsand-updates/news/oil-industry-has-brought-poverty-and-pollution-to-niger-delta-20090630 [accessed february 20, 2014]. bell, s. and l. etherington, 2009. connecting the global and local: europe‟s regional seas. j. law soc, 36(1): 75-93. borooah, v.k., 2001. logit and probit: ordered and multinomial models. sage university 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from www.unep.org [accessed march 3, 2012]. unpo, 2008. ogoni. retrieved from united nation. available from http://unpo.org/members/7901 [accessed june 17, 2014]. walmsley, j.j., 2002. framework for measuring sustainable development in catchment systems. environ manage, 29(2): 195-206. world bank, 2010. available from http://www.worldbank.org [accessed january 10, 2013]. yamane, t., 1967. statistics: an introductory analysis. 2nd edn., new york: harper and row. views and opinions expressed in this article are the views and opinions of the authors, asian journal of economics and empirical research shall not be responsible or answerable for any loss, damage or liability etc. caused in relation to/arising out of the use of the content. http://www.amnesty.org/en/news-and-updates/news/oil-industry-has-brought-poverty-and-pollution-to-niger-delta-20090630 http://www.amnesty.org/en/news-and-updates/news/oil-industry-has-brought-poverty-and-pollution-to-niger-delta-20090630 http://www.eldis.org/go/home&id=14958&type=document#.vcrnbvnqm8j http://www.nigerianstat.gov.ng/nbsapps/connections/pop2006.pdf http://www.nigerianstat.gov.ng/nbsapps/connections/pop2006.pdf http://www.oecd.org/home/ http://www.ng.undp.org/ http://www.ng.undp.org/ http://www.unep.org/ http://www.unep.org/ http://unpo.org/members/7901 http://www.worldbank.org/ asian journal of economics and empirical research issn: 2409-2622 vol. 2, no. 1, 23-38, 2015 http://asianonlinejournals.com/index.php/ajeer 23 dynamics of business cycles in vietnam a comparison with indonesia and philippines le, thanh ha 1 1 economics department, national economics university, vietnam abstract this work is licensed under a creative commons attribution 3.0 license asian online journal publishing group contents 1. introduction ................................................................................................................................................................24 2. literature review .......................................................................................................................................................24 3. data and methodology ................................................................................................................................................25 4. empirical results ........................................................................................................................................................29 5. conclusions .................................................................................................................................................................32 references ......................................................................................................................................................................33 the main purpose of this paper is to investigate the impacts of structural shocks on macroeconomic fluctuations in vietnam, and then make a comparison to indonesia and the philippines. the study adopts the structural vector autoregressive (svar) originated by shapiro and watson (1988) and blanchard and quah (1989) with long-run restriction for small open-economy with flexibility of price, suggested by ahmed and park (1994) and gali (1992). the evidence for countries suggests that: (i) the main source of output variance is domestic supply shocks but there is a significant decrease in long-run; (ii) the fluctuations of trade balance are mostly due to external shocks, especially term of trade shocks in vietnam, as opposed to philippines and indonesia where is shocks play an important role; (iii) the fluctuations of real exchange rate are mainly driven by the domestic shocks but internal causes of each country are different; (iv) the two important sources of price’s movements are domestic shocks, especially is and nominal shocks in vietnam. keywords: structural shocks, business cycles in vietnam, fluctuations, svar. http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2015, 2(1): 23-38 24 1. introduction understanding and distinguishing among factors that affect macroeconomic fluctuations in the short-run and the long-run have been among the main area of quantitative macroeconomic research. lucas (1977) argued that understanding business cycle is critical for designing appropriate stabilization policies. the term business cycle refers to source of deviations from which a trend occurs because of the wavelike motion of real economic activity. over three decades, a large body of empirical business cycle analysis with many powerful tools have attempted to discover the main sources of macroeconomic fluctuations. kydland and prescott (1982) and long and plosser (1983) were pioneers in the real business cycle approach to economic fluctuation. in spite of unresolved issues, the research successfully explained some of the key empirical regularities of business cycle. subsequently, research developed and focused on deriving the driving forces of business cycle fluctuations (shapiro and watson, 1988; blanchard and quah, 1989). this line of research, however, has primarily focused on industrialized countries, thus there is a serious lack of empirical research in emerging countries. this is due to the lack of data from developing countries to conduct research in this field. moreover, these countries tend to experience sudden crises, which make it difficult to determine the sources of business cycles. recently, scholars have attempted to adjust and constructed new methods for developing countries which open new chances for economic research in this field in these countries (mendoza, 1991; hoffmasiter and roldos, 2001; thanh, 2007). but these methods might not appropriately apply to others because of distinct characteristics of business cycles as well as economic development models of each country. therefore, we need more business cycles analyses that are conducted for particular developing countries, especially in vietnam. economic reforms and international integration brought a high growth rate and a stable economic development, with average annual growth of 7.2%, vietnam was considered as a new emerging country with many potential developments. vietnam, however, experienced the asian financial crisis in 1997 and has recently faced macroeconomic instability. this instability has become more serious since 2007 when vietnam participated in world trade organization (wto). especially, the global financial and economic crisis in 2008 and its consequences prompt some key questions, such as whether the macroeconomic fluctuation could end soon or last for long, whether the internal or external shocks have more impacts on these fluctuations and others. vietnam’s policy aims to control these problems such as control prices and inflation, stabilize the value of money, and ensure the sound development of financial institutions. however, these policies tend to be inconsistent overtime, partly contributing to macroeconomic instabilities in vietnam. therefore, the study of business cycles and its sources has become an important goal to not only help vietnam overcome the current macroeconomic instabilities but help policy makers identify the main sources of these instability to design appropriate stabilization policies and reach stable economic growth in the long-run. however, no empirical study to date has investigated the business cycle in vietnam. following the above arguments, conducting research about the sources of macroeconomic fluctuation in vietnam has become a critical requirement. such study would serve two important purposes. on the one hand, it will attempt to explain the main sources of business cycles in vietnam, which help policy makers design stabilization policies to reach a long-term growth. on the other hand, this research also fills the serious gap in the empirical literature. the specific questions to be addressed are: (i) what are the main features of business cycles in vietnam?; (ii) how does the economy respond to various structural shocks, how relatively important is the contribution of each shock to macroeconomic fluctuations?; and (iii) what are the policy implications in the context of current macroeconomic instability? by adopting the structural vector autoregressive (svar) originated by shapiro and watson (1988), and blanchard and quah (1989) with long-run restriction for small open-economy with flexibility of price, as suggested by ahmed and park (1994) and gali (1992), the study attempts to investigate the main source of macroeconomic fluctuations in vietnam. moreover, this study compares the business cycle of vietnam with those of indonesia and the philippines, both members of the association of southeast asian nation (asean) with common social and economic characteristics, in order to identify and explain any similarities and differences. the main purpose of study is to indicate empirical evidences about impacts of five kinds of shocks, including term of trade shocks, external supply shocks, domestic supply shocks, is and lm shocks on macroeconomic fluctuations in some developing countries during 1996-2013 period. the remaining of this paper is organized as follows: chapter 2 briefly reviews the literature on the empirical methodologies as well as the evidence of business cycle in previous research. chapter 3 will represent the empirical methodology to investigate the features and main sources of business cycle. subsequently, the study will indicate and analyze the driving factors of macroeconomic fluctuations (chapter 4) in vietnam over period 1996-2013. finally, chapter 5 will show some conclusion of main finding and policy implications. 2. literature review structural vector autoregressive models (svar) has been the most popular method for business cycle analysis. furthermore, there was empirical research, which utilized other methods, for example ahmed and lougani (1998) utilized a vector-error correction model (vecm) to examine business cycle in asian countries and canada, respectively. regardless of the kinds of methodology, one of the most important goals of previous studies is to investigate the main sources of macroeconomic fluctuations. 2.1. sources of business cycles in developed countries research of blanchard and quah (1989) is a famous study about business cycles, which other researchers based on to investigate the main source of business cycles. the authors assumed that there were two kinds of disturbances having permanent and transitory effects which could be interpreted as supply and demand shocks. by carrying out a research in the us with bivariate var (real gnp growth and the unemployment rate) over the period 1965q1 to asian journal of economics and empirical research, 2015, 2(1): 23-38 25 1986q4, they found that demand disturbances significantly explained to output fluctuations in short-term and middle-term whereas the effects of supply disturbances increased steadily overtime. moreover, they indicated that the supply component of gnp positively correlated with real wages at high and medium frequencies. blanchard and quah’s study was also one of the pioneers in applying svar approach with long-run restriction. many empirical studies have applied similar approaches but imposed long-run restriction from different theories. ahmed and murthy (1994) utilized real business cycle theory with small open-economy framework to investigate main sources of business cycle in canada from 1973q1 to 1992q4 with seven variables. the authors found that domestic supply shocks played a vital role in explaining short-run fluctuations in output whereas real interest rate and term of trade had no effect. gali (1992) built model which relied on blanchard and quah (1989) who identify aggregate demand and aggregate supply shocks by using a long-run constraints. however, gali developed this method and imposed both long-run and short-run restriction to examine the sources output fluctuation in the us after the war. the author investigated the impacts of exogenous disturbances: supply, money supply, money demand, and is shocks on four variables: output, money, prices and interest. the main results of this study showed that supply shock significantly account for most of the output fluctuation in us. 2.2. sources of business cycles in developing countries business cycle analysis primarily focused on major developed economies and a limited number of developing countries. it is only since late 1990 that, this figure gradually increase toward emerging countries. the study of hoffmaister and roldos (1996) in groups of developing countries was remarkable. they carried out research, which compared business cycle in 15 asia and 17 latin american countries in the period 1,970-1993. the authors utilized structural var with a set of long-run economic restrictions. this study also extends to examine the role of world interest rate to provide a framework with many kinds of shocks namely term of trade, supply, fiscal and nominal shocks. the main results showed that supply shocks substantially explained to output fluctuations in latin american (65%) and asia (90%) in both short run and long run whereas term of trade shock played a key role in examine trade balance fluctuation but not for output or real exchange rate. what’s more, the nominal shocks had insignificant impacts on output and real exchange fluctuations. hoffmasiter and roldos (2001) continued utilizing the same method to examine the main sources of business cycle in south korea and brazil. they found that output variations in korea were mostly driven by domestic supply shocks whereas domestic demand shocks played a large role in brazil. siregar and ward (2001) investigating 5-variable var in indonesia in period 1984-1999, imposed two long-run restrictions related (a) a long-run money demand equation and (ii) a modified mccalumn (1994) policy reaction function on the cointegration matrix. accordingly, aggregate demand shocks were considered as the main source of output and other macroeconomic fluctuations whereas aggregate supply shocks are less important. authors indicated the reason for it was smallness of the economy. recently, thanh (2007) also utilize svar empirical approach with the imposition of long-run restriction which is guide by the stochastic mundell-fleming open economy to evaluate the impacts of structural shock on macroeconomic fluctuations in asean-5 countries. the 4-variable var model examine 4 types of disturbances including of external shocks, domestic supply shocks, domestic demand shocks and nominal shocks. the author found that output fluctuations in asean-5 countries were mostly driven by domestic supply shocks and domestic demand shocks were the main contributor to variations in trade balance. it is partly explain by a long period of high growth in the region. furthermore, the external and domestic supply shocks caused output to expand and this expansion was sustainable in the long-run. in contrast, the domestic demand shocks negligibly affected output in short-run. 3. data and methodology 3.1. data and variables analysis the model consists of five variables, which are term of trade (tot), foreign output (y f ), real output (y), trade balance (tb) and real exchange rates (rer) and consumer price index (p). the term of trade is the ratio of the export price index to the import price index .however, in some developing countries, such as vietnam, indonesia and philippines these indexes are not readily available. hence, we will compute our own export and import price by taking a weight average of export-weighted and import-weighted price level of major trading partner. this method was suggested by ahmed and lougani (2000) for some latin american countries. particularly, in the case of three countries, the author will calculate by utilizing the indexes of four main trade partners, including united states, japan, korea (republic) and singapore. several reasons underlie this choice. first, united states, japan, korea and singapore are 4 of 5 the main trade partner with vietnam, indonesia and the philippines. second, the information on export and import price is already available. the other variable is the level of foreign output which is an exportweighted of real gdp of five main trading partners (www.cia.gov, 2012). trade balance (tb) proxies by the ratio of net export to nominal output. the real exchange rate (rer) was considered as the ratio of ppi in us to cpi in vn multiplying nominal exchange rate which represents the relative price of non-traded goods and traded goods. finally, the domestic price level (p) was the cpi. other domestic variables were collected from many sources. all variables except for trade balance are in logarithm form and are covered from 1996 to 2013 from international financial statistics (ifs). several data in vietnam were taken from general statistics office of vietnam. furthermore, we also take the first differences of all variables and utilize them in the empirical model. this is to make sure that all variables are stationary which are necessary to satisfy the requirements of var model. after taking first differences, we need utilized some method to examine this characteristic of time series, such as augmented dickey-fuller (adf), phillips-perron (pp), kwiatkowski-phillips-schmidt-shin (kpss) and other methods. http://www.cia.gov/ asian journal of economics and empirical research, 2015, 2(1): 23-38 26 3.2. theoretical economic model structural var has commonly been utilized to analyze the dynamic characteristics of economic system. the main difference between individual studies is the theoretical model framework. blanchard and quah (1989) assumed that there were two kinds of disturbances which are supply and demand disturbances. they argued that the former had permanent effects on output and the latter did not. they utilized this assumption to investigate the properties of business cycle in us. other scholars, such as gali (1992), siregar and ward (2001) or recently thanh (2007) applied is-lm model for small open economy to explain the sources of business cycle. by using different theoretical framework, these scholars had different outlooks and interpretations for the same issues. this study considers vietnam, indonesia and philippines as developing countries with characteristics of small open-economy. hence, this section presents a simple version of the muldell-fleming small open-economy. 3.2.1. an open-economy is equation ( ) ( ( )) (1) where is exchange rate and ( ) is real exchange rate; is interest rate and ( ( )) is real interest rate. the equation (1) shows that the demand for domestic output positively correlated with the real exchange rate whereas there is a negative association between domestic output and real interest rate. a is structural shock, such as fiscal policy, term of trade shocks. 3.2.2. domestic money-market equilibrium (lm curve) ( ) ( ) ( ) the equation (2), (3), (4) represent equilibrium in domestic money market and and are money demand shocks and money supply shocks, respectively. equation (4) is lm curve. the equation indicates that money demand is affected by many factors, such as price level, opportunity cost of holding money (interest rate) and exchange rate. there are many previous studies conducting research about relationship between exchange rate and money demand in open economies. the substitution of domestic assets for foreign asset occurs when there is depreciation of domestic currency. the value of domestic asset will decrease while the price of foreign assets in domestic currency will increase. thus, it causes domestic money demand to increase. price adjustment equation ( ) ( ) where is the full-employment level of output (natural output); is domestic supply shocks. the equation (5) represents that whenever demand for domestic output deviates from natural output, price will adjust. 3.2.3. trade balance equation ( ) where is the domestic trade balance and is the real exchange rate. the equation (6) indicates that the trade balance depend positively on the real exchange rate but negatively on real output. we incorporate the structural shocks in the model by assuming that the stochastic process drive supply of output( ), the relative money ( ) and the relative demand shocks ( ). we have ( ) ( ) ( ) equation (7) and (8) illustrate that and perform as random walk series and equation (9) implies that any shocks to relative demand in period (t-1) are revered in period (t) by the parameter ( ) 3.2.4. the long-run equilibrium the studies of clarida and gali (1994) or recently applied research of to thanh (2007) about the long-run equilibrium consist a lot of important implications which help this study identify the impacts of shock over macroeconomic variables. the set of equation representing the long-run equilibrium is below ( ) ( ) ( ) ( ) [ ( ) ] ( ) [ ( )( ) ] ( ) where denotes real output, real exchange rate, domestic trade balance and relative price level. these studies and above equations indicate many important implications in the long-run: (i) the is, lm shocks do not have any impacts on real output; (ii) lm shocks (nominal shocks) do not affect the trade balance and real exchange rate; and (iii) price level is affected by all kinds of shocks. 3.2.5. output in response of term of trade shocks theoretically, we know that term of trade have positive impacts on trade balance. an increase in term of trade causes a country to earn more for its exports and pay less for its imports. in my model, i will consider that term of trade is captured by the price of intermediate inputs. like the study of hoffmaister and roldos (1996), the small open economy produce an exportable and a nontradable good in which the exportable good utilizes domestic inputs, asian journal of economics and empirical research, 2015, 2(1): 23-38 27 including capital (k) and labor (l) and an imported intermediate input (m). in order to examine the impacts of term of trade shocks on output, i will utilize the equation, which was mentioned by hoffmaister and roldos (1996), as follows     xnntnnmxt lskspay tt log/log/1 11                   (14) equation (6) represents the longt-run output in which txa and are exogenous shocks. hoffmaister and roldos (1996) argued that an increase in the price of intermediate inputs have the same impacts of negative technological progress. hoffmaister and roldos (1996) indicated that “an improvement in the term of trade and/or a structural reform that removes distortions leads to a positive response in total gdp.” (p.10). 3.3. empirical methodology in this study, we apply and develop some restrictions for small open-economy with flexibility of price which was utilized in the study of ahmed and park (1994) besides employing the aforementioned theoretical framework. additionally, we also impose other restrictions in order to analyze the impacts of other external shocks as well as internal shocks on macroeconomic stability which are more suitable for vietnam economy. i utilize some main restrictions. first, the external factor, such as term of trade are foreign output are exogenously given to the domestic country in the long run (the assumption for small open economy). second, the restriction is imposed to make sure that the long-run neutrality of money is held. finally, lm shocks (nominal shocks) have no impacts on trade balance in the long-run. 3.3.1. external factors in this study, we will investigate the main source of macroeconomic fluctuations in vietnam under 5 shocks: ε tot is the external shocks for term of trade, ε f is the external shocks for foreign output, ε ds is the domestic supply shocks, ε is and ε lm are the is and lm shocks, respectively. importantly, we assume that vietnam is small open economy with long-run flexibility of price, thus the foreign output and term of trade are exogenously given. the equation of term of trade and foreign output can be expressed ( ) ( ) ( ) ( ) ( ) where ( ), ( ), ( ) are a finite-order polynomial in the lag operator and , are a white noise. 3.3.2. domestic output the behavior of domestic output is described as follows ( ) ( ) ( ) ( ) where ( ), ( ), ( )are a finite-order polynomial in the lag operator and the processes , , ε ds , ε is and ε lm are a white noise. looking at the equation (17), we can see that the term of trade and external supply shocks directly affect the domestic output. the term of trade shocks are captured by the price of intermediate inputs. an increase in this price has the same impacts as negative technological process. kose et al. (2003) examined the correlation between term of trade and total output by using the small open economy model and the result indicated that there is a positive correlation between them. so, we need to carefully determine the sign of .the positive domestic supply shocks probably raise the domestic output in direct and indirect ways due to the substitution effects on the labor input. we might predict that the effect of domestic supply shocks on domestic output is more likely to be positive and persist over time. 3.3.3. balance of trade the following equation reflects behavior of trade balance ( ) ( ) ( ) ( ) ( ) according to ahmed and park (1994), there is not clear presumption about the direction of nominal shocks (lm shocks) on trade pattern, thus we impose the restriction =0 for my empirical study. the term of trade shock directly affect the trade balance through export and import but the sign might be ambiguous. the external shocks for foreign output and the domestic supply shocks is likely to be temporary but are expected have positive impacts on trade balance in short-run. the long-run response of the real exchange rate (rer) in response to the different shocks is represented by following equation ( ) ( ) ( ) ( ) ( ) hoffmaister and roldos (1996) argued that positive supply shocks result in the appreciation of real exchange shock because of a higher demand for non-tradables which leads to a reallocation of labor in non-traded sectors. this supply shocks might be a technological progress in the tradable sector or trade liberalization. the is shocks is expected to leads to the appreciation of real exchange rate through the mechanism of mudell-flemming model for a small opened economy. furthermore, we also impose a restriction that nominal shocks have no impact on the changes of real trade balance. 3.3.4. price level the inflation is a function of all the five shocks discussed above ( ) ( ) ( ) ( ) ( ) ( ) asian journal of economics and empirical research, 2015, 2(1): 23-38 28 we expect that the aggregate supply shocks and term of trade shocks cause price level to fall whereas the price level increase in response to aggregate demand shocks. thus, the sign of , , is negative and those of , is positive. 3.4. svar estimation strategy 3.4.1. svar model in this section, we will discuss about the empirical methodology. the reduced form of var model is expressed as following ∑ ( ) ( ) we assume that yt=[ tot, y f , y d ,tb, p] is a covariance stationary process. in the study, is a (5x1) vector of constant. et is (5x1) vector of serially uncorrelated structural disturbances and there exists a (5x5) non-singular matrix c(0) such that tt ce )0( implying that the reduced form residuals are a linear transformation of the structural shocks, where (ε tot , ε f , ε ds , ε is , ε lm ). ε tot is the external shocks for term of trade, the vector of ε f is the external shocks for foreign output shocks; ε ds is the internal domestic supply shocks; ε is and ε lm are the vector of the internal is shocks and domestic lm shocks or nominal shocks, respectively. al is a (5x5) matrix of lag polymonials. the reduced-form var can be written as the moving average expression (vma (∞)),which trace out the time path of various shocks: ( ) ( ) ( ) ( ) ∑ ( ) ( ) where μ = (i-all) -1 , bl = (i-all) -1 is the (5x5) matrix of lag polynomials where     0 . )( i i mnmnl libb . b(i) is a (5x5) matrix of coefficients for i = 0, 1, 2, …, k and b(0) = i. there exists a (5x5) non-singular matrix c(0) such that tt ce )0( where (ε tot , ε f , ε ds , ε is , ε lm ).then (12) can be rearranged as follows:         00 )()0()( i it i itt icciby  (23) the residual in the reduced-form var are represented by the structural shocks in model, including external shocks (term of trade shocks, foreign output shocks), domestic supply shocks and domestic demand shocks. y can be expressed into internal and external variables and also in structural demand and supply shocks, as follows                                                              lm is es f tot t t t t tt d t f t t t t t p rerortb y y tot y y y         5 1 2 1 ...,... )0()()( cibic  equation (22) is the svar model in moving average expression, in which yt is expressed by a function of history of innovations. the structural innovations are in the central role in the svar approach as they are the driving forces behind the stochastic dynamics of the system’s variables. the elements of matrix c(i) are impulse response functions. 3.4.2. identification of svar and specification of model from my business cycle analysis, i utilize some main restrictions. first, the external factor, such as term of trade are foreign output are exogenously given to the domestic country in the long run (the assumption for small open economy). second, the restriction is imposed to make sure that the long-run neutrality of money is held. finally, lm shocks (nominal shocks) have no impacts on trade balance in the long-run. additionally, we will utilize the long-run restrictions approach. thanh (2007) discussed some main reasons for using this approach. he indicated that model relied on implications of economic theories should impose long-run restrictions. moreover, he argued that “this approach does not restrict the short-run relationship among the variables in the system and the dynamics of the system are less constrained and determined by the data” (p.19). so, in the study, we also employ the long-run restriction approach. third, one of the most important purposes of this study is to examine not only the domestic shocks but also the external disturbances. hence, based on the ideas of mudell-fleming model, we clearly separate types of shocks to identity the main sources of business cycles. moreover, we also construct a block-exogeneity assumption which reflects the features of a small and open economy. this approach is quite similar to long-run restrictions of blanchard and quah (1989) and thanh (2007). the long-run impact matrix can be expressed in the formula: yt = μ + cεt and the long-run multipliers are ∑ ( ) . and we have asian journal of economics and empirical research, 2015, 2(1): 23-38 29                                                                        lm is es f tot t tt d t f t t x ccccc cccc ccc cc c p rerortb y y tot           5554535251 44434241 333231 2221 11 5 4 3 2 1 0 00 000 0000 4. empirical results in this study, i investigated the main sources of business cycle in vietnam following two structural var models. model 1 is run with five endogenous variables, including (tot, y f , y, tb, p) and model 2 explains the impacts on structural shocks on (tot, y f , y, rer, p). the selection of these variables was based on the theoretical framework as i discussed earlier for a small open economy. the main purpose is to compare the effects of structural shocks on domestic variables for two models and analyze whether the changes of structural shocks’ impacts when i run two model are significant or not. if they are different, i attempt to provide some explanations for these changes. additionally, by substituting the trade balance for real exchange rate, i can examine effects of shocks on a real exchange rate and provide knowledge to policy maker in order to design appropriate policies to limit these effects. this section depicts the empirical evidence about the impacts of external (term of trade, foreign output) and domestic (supply, is and lm) shocks on macroeconomic variables (output, real exchange rate and trade balance, prices) for vietnam, indonesia and the philippines. besides analysis of these effects summarized by the variance composition, i also illustrate the dynamic of adjustment through the impulse response functions. 4.1. output fluctuations 4.1.1. domestic shocks in vietnam, although output growth fluctuations are mainly explained by domestic shocks while external shocks account for a small fraction (around 25% in model 1 and 13% in model 2), the percentage of output fluctuations explained by domestic shocks is quite different in two models. in principle, the domestic supply shocks are most important determinant to explain output’s movements. particularly, in model 1, the supply shocks are the main sources which explain roughly 40% and the is shocks and lm shocks are 17% and 19% in short-run. however, the former decrease slightly by nearly 20% after 2 years, whereas the latter increase slightly in the long-run. in model 2, the supply shocks continue to play a vital role on explaining the fluctuations of output (approximately 80%) but this figure fall drastically to nearly 50%. in indonesia and philippines, the output fluctuations can also be explained by the domestic supply shocks, with nearly 70% and 55% in model 1 and around 65% and 70% in model 2, respectively. however, these figures tend to witness a decreasing trend over time. the results indicating the important role of supply shocks is similar to many other studies in this aspect, for instance shapiro and watson (1988), gali (1992), hoffmasiter and roldos (2001), hoffmaister and roldos (1996), to thanh (2007) and others. according to the impulse response figure, supply shocks drive up output at a far higher magnitude than any other kind of shocks in both short-term and long-term in three countries. clearly, the government of these countries should employ the supply side to push up the economy further. additionally, the is and nominal shocks explain insignificantly the changes of outputs but we should pay attention to these shock because it tends to increase in the long-run. in detail, the variance decomposition table for the two models indicate that impacts of is and lm shocks enlarge substantially over two years in vietnam. the increasing trend of these shocks in the next periods reflects that vietnam economy should carefully focus on fiscal and monetary policies to reach the stable state in the future. this is shown more clearly when we look at the impulse response figure in vietnam. these two kinds of shocks lead to fluctuations of output. hence, these policies should be implemented strictly and flexibly to control these fluctuations. the results also illustrate that philippines should concentrate on fiscal policy to limit the variations of output because is shocks seemly lead to a decrease in output in the long-run while they account for relatively high proportion (around 30%) of output’s fluctuations in the short-run and this figure remain stable in the long-run. in indonesia, these shocks play a small role and the output seems to not respond to them. 4.1.2. external shocks in vietnam, term of trade shocks represent a trivially increasing trend over time in model 1 while output’s changes are mainly explained by external supply shocks in model 2. specifically, term of trade shocks account for roughly 15% in short-run and gradually increase in the long-run in model 1. in contrast, although explained a small part in the short term, the figure for foreign output shocks experience an upward trend in model 2. focusing on the impulse response functions, the results indicates that the domestic output generally increases with respect to term of trade shocks, whereas the response to foreign output seems to decrease in the long run. there are several possible reasons to explain for this fact. vietnam apply export-led growth model that vietnam’s overall exports of goods grew nearly 20% in 2012. but the largest and fastest growing segments have mainly focused on relatively labor-intensive, low-value-added manufactured products, such as textile, footwear and others which account for one-third of vietnamese exports. indeed, vietnam exports the low end of the value-added than other countries in the same regions. therefore, vietnam still experiences a growth of exports even in the context of financial crisis. notwithstanding, the external shocks just play a small role on explaining the fluctuations of output as the decomposition tables represent. the external supply shocks mostly explain for the fluctuations of output but this impact decrease trivially in the long-term in indonesia, whereas the term of trade shocks play an important role but only in the long-run in philippines. particularly, the external supply shocks make up for nearly 20% in model 1 and 12% in model 2 and these numbers decrease to roughly 15% and 10% in the long-run in indonesia. what’s more, these shocks lead to asian journal of economics and empirical research, 2015, 2(1): 23-38 30 narrowing trend of output. the reason is that export and imports have declining shares of gdp because the commodity boom, the real contraction in manufacturing export. indonesia successfully started to diversity its export toward manufacturing export which the majority exports stem from manufacturing performance improvements not from production volume. moreover, according to imf estimation, china that the main partner of indonesia could lower indonesia’s growth through commodity prices as well as increase in production and export volume, especially on-oil and gas commodities namely coal, palm oil and rubber. in philippines, the output tends to decline in the longrun with respect to the term of trade shocks but term of trade shock only make up for small proportion of variation. the philippines economy has weathered global economy due to lower dependence on exports, relatively resilient from domestic consumption and a rapidly expanding business process outsourcing industry. in brief, domestic shocks mainly explain for output’s fluctuations in which domestic supply shocks are the most important disturbances in explaining in both short-run and long-run. these supply shocks lead to output expansion in three countries. is and lm shocks have trivially increasing impacts on output in vietnam and is shocks play a vital role in explain the variation of output in philippines. the impacts of external shocks vary across three countries. the outputs only response to term of trade shocks in long-run in philippines, while the variations of output in indonesia could be explained by external supply shocks. 4.2. trade balance the variance decomposition tables represent the result similar to what i expect in the theoretical framework session. the fluctuations of trade balance are mostly due to external shocks, especially term of trade shocks in vietnam. 4.2.1. domestic shocks amongst the domestic shocks, is shocks play an important role in explaining the fluctuations of trade balance in three countries. is shocks account for more than 25%, 40% and 50% in vietnam, indonesia and philippines, respectively in the short-run and this figure tend to diminish slightly in the long-run except for a significant increase in philippines. this result is consistent to the research of hoffmaister and roldos (1996) which fiscal policies explain over 70% of the movement in short-run for asian countries roughly 55% for latin america or the research of to thanh (2007) for asean countries. in general, the magnitude of is shocks in vietnam is lower than these countries and these shocks are largest in philippines. impulse response function also indicates that the is shocks lead to an expansion of trade balance in the long-term. the role of fiscal policy is so important to control the issues of trade balance. depending on the targets for trade balance, policy makers can mainly concentrate on fiscal policy and design appropriate policies to achieve these goals. moreover, although supply shocks account a modest part in the first period, this impact gradually improves over time in vietnam. if we observe changes in the long-run, we can see that the role of supply shocks cannot be taken for granted. in indonesia, we can see that the supply shocks are an important determinants besides the is shocks. theoretically, the change in trade balance is capture by its elasticity with respect to the real exchange rate and to output level. as the muldell-fleming model argued, the positive supply shocks lead to an expansion of output which enhances the demand for imports. what’s more, these shocks also have positive impacts on export through a depreciation of real exchange rate. previously, we indicated the impacts of supply shocks which cause output to expanse, thus then results in an expansion of trade balance. so, the effects of supply shocks are undeniable through theoretical framework as well as the empirical evidence in vietnam and indonesia. in philippines, the impacts of supply shocks are only relatively significant in the short-run. in conclusion, the is shocks play a vital role in both short-run and long-run and the magnitude of shocks in philippines are the largest. the trade balance experiences an expansion response to the is shocks. furthermore, we also pay attention to the role of supply shocks, especially in long-run for vietnam. 4.2.2. external shocks the external shocks account for roughly 65%, 15% and 16% in vietnam, indonesia and philippines of the variance of the trade balance, with the term of trade shocks that explain the bulk of the movements and external supply shocks explaining for around 20% in vietnam but not too much significant in indonesia and philippines in the short-run as well as in the long-run. amongst three countries, the magnitude of term of trade shocks in vietnam is the largest and decrease negligibly in the long-run. indonesia and philippines make up for the relatively similar percent but these figures in philippines tent to diminish over time. theoretically, we know that term of trade have positive impacts on trade balance. an increase in term of trade causes a country to earn more for its exports and pay less for its imports. particularly, according to impulse response figure, in vietnam, term of trade shocks lead to an expansion of trade balance within 1 year, but this expansion suddenly stops and starts decreasing after that. the possible explanation is that vietnam has a high demand for intermediate input due to lack of supporting industries and the export structure. vietnam’s exports mostly processed products and raw material. in 2012, the proportional of total exports for raw materials are so big (crude oil, ores and minerals reach $9.65 billion, account for 8.4%) and unprocessed or semi-processed agriculture and forestry, fishery products have a high proportion (about $27 billion, accounting for 23.6%). thus, in the long-run, the impacts of this shock will gradually decrease. in contrast, this kind of shocks causes trade balance in philippines and indonesia to increase in both short-run and long-run. these evidences are consistent to actual fact because both two countries started to diversity its export toward manufacturing export which the majority exports stem from manufacturing performance improvements. furthermore, the philippines now ranks as one of the most promising newly-industrialized industry, which its export moves away from low-added values, agriculture products to electronics and other goods. external supply shocks explain a small share (nearly 20% in vietnam) of the movement of trade balance in both short-run and long-run. the important role of external shocks is consistent to the result in research of hoffmaister asian journal of economics and empirical research, 2015, 2(1): 23-38 31 and roldos (1996) for asian and latin america. external supply shocks lead to expansion in vietnam as indicated by the impulse response figures. in brief, the fluctuations of trade balance are mostly due to external shocks, especially term of trade shocks in vietnam. the magnitude of term of trade shocks in vietnam is largest, compared to philippines and indonesia. for domestic shocks, is shocks mainly explain the variances of trade balance but we also pay attention to domestic supply shocks which are examined by the theory as well as evidences in vietnam and indonesia. 4.3. real exchange rate 4.3.1. domestic shocks as widely acknowledge, the negative is shocks can result in a transitory output deterioration and a real exchange rate depreciation and lm shocks also lead to some change in real exchange rate in the short-run. the variance decomposition table illustrates the main sources of real exchange rate’s fluctuations relatively vary across three countries. the real exchange rate variances in vietnam are mostly determined by the domestic shocks. the domestic shocks account for approximately 85% of its fluctuations in which is shocks explain a large share of movements, whereas the external shocks explain roughly 15%. specifically, is shocks are the most important determinant of real exchange rate in both short-term and long-term. the sources of real exchange rate’s movements are consistent to the results in asian and latin america suggested by hoffmaister and roldos (1996). in indonesia, changes of real exchange can be explained by both three shocks in which the nominal shocks account for the largest part and the proportion of supply and is shocks are relatively equal. the supply shocks and is shocks are the most important driving force of real exchange rate’s movement in both short-run and long-run in philippines. looking at the impulse response functions, is shocks lead to a remarkable increase of real exchange rate. although nominal shocks explain a large share of real exchange rate’s fluctuations in indonesia, the accumulated response implies that lm shocks causing real exchange rate to appreciate only have impacts in short-run. the supply and is shocks in the philippines indicate same trends. both shocks lead to appreciation of exchange rate in both longrun and short-run. 4.3.2. external shocks external supply shocks mainly explain the movement of real exchange rate in vietnam. the proportion of these shocks remains unchanged over time. external supply shocks result in an appreciation of real exchange rate at a higher magnitude over time. in contrast to vietnam, the movement of real exchange rate in philippines and indonesia are mainly driven by term of trade shocks (approximately 10%). the dynamic response to term of trade shocks in indonesia, however, leads to appreciation of exchange rate, whereas those in philippines are depreciated over time. in brief, the fluctuations of real exchange rate are mainly driven by the domestic shocks but internal causes of each country are different. in vietnam, is shocks or fiscal policy are the main determinant, thus vietnamese policy makers should design the appropriate fiscal policies in order to reach the stability of exchange rate. 4.4. price fluctuations 4.4.1. domestic shocks the variance decomposition table for model 1 represents that in the short-run, domestic shocks account for over 85% of price’s movement in which lm shocks explain a bulk of fluctuations in three countries. however, the share of nominal shocks decline dramatically by nearly a half after two years. conversely, although explaining a small share in the first period, those of supply and is shocks rocket up noticeably in the long-run, especially is shocks in vietnam with an increase from roughly 3% to 16% and supply shocks in indonesia (from 16% to 37%) and the philippines (from 13% to 26%). in the long-run, the price fluctuations can be explained by two kinds of domestic shocks in vietnam. for the model 2, is shocks are the main determinant of the variances of price in both short-run and long-run in vietnam. there are opposite trends for other shocks. supply shocks account for nearly 12% in the first period but this share remain stable over 2-year period, whereas there is a dramatic increase of lm shock’s proportion overtime. in general, the domestic policies play a crucial role in controlling the movement of price but this finding implies that vietnam should concentrate on fiscal and monetary in the long-run to obtain the stable inflation. the results also emphasize that the government of indonesia and philippines should design stabilization policies to limit impacts of nominal shocks. more interestingly, the dynamic impulse response to nominal shocks for the two models represents the same fact in three countries. the favorable nominal shocks lead to the increase of price and this trend seemly expand in the long-term. in contrast, the is shocks cause price to decrease at a high magnitude overtime in vietnam. the response of price to supply shocks increases in price in short-run, but decreases in the long-run. it is so important for policy maker in order to design policies to stabilize the price level in the long-run. supply shocks in indonesia and philippines behave in different ways. the supply shocks result in an increase in price in indonesia, as oppose to a decrease of price in the philippines. 4.4.2. external shocks both models represent that external shocks play a very small role in the short-run. however, these proportions, especially term of trade shocks improve significantly in the long-run in model 1 of vietnam. the external supply shocks continue to explain significantly in the model 2 of vietnam. the dynamic response to two kinds of external shocks illustrates the same trends. in a predicted manner, the reduction of price appears with respect to positive term of trade shocks and external supply shocks. the trend is quite stable for term of trade shocks in model 2. in philippines and indonesia, the impacts of external shocks made up for very small proportion in explaining the fluctuations of price. asian journal of economics and empirical research, 2015, 2(1): 23-38 32 in brief, the impacts of external shocks on price fluctuations are not significant. basing on the results from two models, the most two important sources of price’s movements in vietnam are fiscal and nominal shocks, whereas supply and nominal shocks mainly explain for these changes of price in indonesia and the philippines. in order to dampen the prolonged inflation rates, vietnam should concentrate on the domestic shocks, especially demand sidenominal and fiscal shocks. 5. conclusions the study empirically examined the sources of movements in domestic variables, including output, trade balance and real exchange rate, and price under the effects of external (term of trade and foreign output) and domestic (supply, is and nominal) shocks in vietnam, philippines and indonesia. this paper adopted the svar models with long-run restrictions, suggested by shapiro and watson (1988) blanchard and quah (1989) and many other studies in the same aspect. by developing the spirit of gali (1992) about the stochastic mundellfleming model and ideas about a small open economy of ahmed and park (1994) and hoffmaister and roldos (1996), we imposed some long-run restrictions, which are consistent with characteristics of business cycle in developing countries such as vietnam, indonesia and the philippines. we also attempted to make some comparisons in term of the size and trend of shocks on domestic variables between vietnam and developing countries in other papers. the data covered from 1996 to 2013. in order to obtain the results, we investigated the main sources of business cycle in vietnam following two structural var models. this study indicated some interesting and useful facts of the business cycle in vietnam. the main findings in vietnam are described as below. firstly, output growth fluctuations are mainly explained by domestic shocks while external shocks account for a small fraction. the percentage of output fluctuations explained by domestic shocks is a bit different in two models. in general, output’s movements are mainly explained by domestic supply shocks in the short-run. we witness a fall in the impacts of supply shocks on output in the longrun. we should pay attention to fiscal and nominal shock because it tends to increase in the long-run. is and lm shocks have trivially increasing impacts on output in vietnam. furthermore, the impulse response functions illustrate that the domestic supply shocks lead to an expansion of the real output in the two models but in the model 2, the real output has become more fluctuated than in model 1. the domestic output generally increases with respect to term of trade shocks, whereas the response to foreign output tends to decrease in the long-run, but the external shocks only play a small role in explaining the fluctuations of output. secondly, the fluctuations of trade balance are mostly due to external shocks, especially term of trade shocks in the short-run. term of trade shocks lead to an expansion of trade balance within one year, but this expansion suddenly stops and starts decreasing after that. the is shocks play an important role on explaining the fluctuations of trade balance. what’s more, although the supply shocks account for a modest part in the first period, this impact gradually improve over time. it implies that we cannot take supply shocks for granted. thirdly, the is shocks are the most important determinant of real exchange rate in both short-term and long-term. besides domestic shocks, the external supply shocks have a relatively large impact on real exchange rate. fourthly, the movements of inflation in vietnam are mainly determined by domestic shocks. the domestic policies play a crucial role in controlling the movement of price but this finding implies that vietnam should concentrate on fiscal and monetary policies (demand side) in the long-run to obtain the stable inflation. 5.1. policy implications firstly, in order to maintain the stability and raise the level of output, policy makers should propose some policies reflecting the change in supply. these policies may reflect the changes of labor market, the improvement of technology, changes in legal and regulatory systems such as a public sector restructures, privatization, infrastructure improvement, tax reforms, removal of trades and capital controls and so on. particularly, vietnam has currently pursed an investment-led growth model in which economy is growing quantitatively, based mainly on continuous increase in inputs. however, the effectiveness of using resources is still low, which lead to the inefficiency of economy. hence, vietnam should restructure the economy, change from out of date model to the modern one for economic development. that means vietnam concentrate on improving technology, infrastructures, learning experience of industrialized countries and then applying to vietnam, and so on. they step by step transform a modelgrowth based on inputs, resource into a modelgrowth relied on modern technology, capital. furthermore, becoming an official member of wto brought vietnam opportunities, expectations as well risks in the future relating to the low level of national competitiveness and enterprise competitiveness. secondly, the fiscal policies play a critical role in controlling the fluctuations of trade balance, real exchange rates, prices, specifically in long-term. the role of is shocks such as government spending, shocks to public preferences, shifts in domestic fiscal policies and others is undeniable in vietnam. in the long-run, vietnam should concentrate on improving the effectiveness of fiscal policies, avoiding the wasteful loss, corruption in the implementation process. tight fiscal policies are also an effective way to limit the fluctuations of domestic macroeconomic variables in vietnam. thirdly, lm (nominal) shocks such as money supply change by monetary authorities, appreciation or depreciation of domestic currency or financial innovation are determinants of the variances of output, real exchange rate and price and are not effective in improving the trade balance and real exchange rate. in order to achieve the goal of controlling trade deficit, vietnam should focus on other policies rather than nominal shocks. the theory representing the relationship between net export and nominal shocks might not be effectively applied in the case of vietnam. instead, fiscal policies will be a better choice to control the movement of trade balance and other problems. fourthly, inflation has currently become a sensitive problem not only in vietnam but also other countries. the results suggest that controlling inflation in vietnam should mainly focus on the effective fiscal policies and monetary policies. policies relating to demand side or lm shocks might effectively deal with the issues of inflation. additionally, we can see that the external factors share a small part in explaining the movement of inflation. hence, vietnam can concentrate on domestic tools to obtain their goals. asian journal of economics and empirical research, 2015, 2(1): 23-38 33 references ahmed, s. and p.n. lougani, 1998. business cycle in asia. working 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paper no. wp/97/9). mexico city, mexico. available from http://www.imf.org/external/pubs/ft/wp/wp9709.pdf [accessed january, 1997]. hoffmasiter, a.w. and j.e. roldos, 2001. the sources of macroeconomic fluctuations in developing countries: brazil and korea. journal of macroeconomics, 23(1): 11-30. kose, m.a., e. prasad and m.e. terrones, 2003. how does globalization affect the synchronization of business cycles. american economic review, 93(2): 57-62. kydland, f.e. and e.c. prescott, 1982. time to build and aggregate fluctuations. econometrica, 20(6): 1345-1370. long, j. and c. plosser, 1983. real business cycle. journal of political economy, 91(1): 39-69. lucas, r.e., 1977. understanding of business cycles. journal of monetary economics, 5(1): 7-29. mccalumn, 1994. monetary policy rules and financical stability, nber working paper no. 4692. national bureau of economic research. mendoza, e.g., 1991. real business cycles in a small open economy. the american economic review, 81(4): 797-818. shapiro, m. and m. watson, 1988. sources of business cycle fluctuations. nber macroeconomics annual, 3(1): 111-156. siregar, h. and b.d. ward, 2001. sources of fluctuations in the indonesia macroeconomy: an application of simple structural var model. singapore economic review, 45(1): 73-98. thanh, t.t., 2007. determinants of business cycle synchronization in asean-5. serc conference publication singapore economic review. appendix-a. statistical properties of data table-a1. unit root test variables adf unit root test kpss test level difference level differenc e k t-statistic k t-statistic t-statistic t-statistic vietnam tot 0 -2.507 0.109** yf 0 -1.149 0 -8.717** 0.231 0.224** y 4 -1.723 3 -2.712* 0.142* 0.358* tb 0 -4.287** 0.133** rer 1 -0.989 0 -6.284** 0.322 0.445* p 5 -0.789 0 -4.492** 0.277 0.584* indonesia tot 0 -0.923 0 -9.009** 0.935 0.106** yf 0 -1.428 0 -7.155** 0.613 0.078** y 0 -2.699 7 -2.837* 0.226 0.642* tb 0 -2.157 0 -8.121** 0.803 0.388** rer 0 -2.661 0 -6.348** 0.725 0.12** p 0 -3.227* 0 -3.795** 1.042 0.362** philippines tot 0 -2.887 0 -11.607** 0.580 0.372** yf 1 -1.956 0 -14.106** 0.267** 0.168** y 0 -2.867 0 -9.388** 0.157 0.196** tb 0 -5.931** 0.149** rer 1 -2.172 0 -5.886** 0.283 0.414* p 1 -2.714 0 -5.778** 0.072** note: k is the lag length in adf test which utilize schwartz bayesian criterion (sbc). tot is term of trade, yf and y are foreign and domestic output, respectively; tb is the ratio of net export to domestic output; rer is real exchange rate. all variables except for trade balance are in logarithm form. the model used in the test includes intercept. (*), (**) represent the statistically significant at 5% and 1% level. appendix-b. estimation results table-b1. variance decomposition of dy to different structural shocks-model 1 model 1 period s.e. tot shocks external supply shock supply shock is shock lm shock vietnam 1 0.104749 15.43357 5.883302 41.65114 17.32896 19.70303 5 0.132371 18.64764 4.588903 34.29532 18.53601 23.93213 10 0.161461 19.01917 6.732703 26.39958 23.19217 24.65638 20 0.186624 20.20232 5.902749 23.75745 23.12894 27.00854 indonesia 1 0.021661 2.600309 19.11047 68.61809 6.222064 3.449066 5 0.025190 5.018192 15.53978 66.26832 7.719778 5.453925 continue http://www.imf.org/external/pubs/ft/wp/wp9709.pdf asian journal of economics and empirical research, 2015, 2(1): 23-38 34 10 0.025191 5.018258 15.53973 66.26779 7.719734 5.454486 20 0.025191 5.018258 15.53973 66.26780 7.719733 5.454486 philippines 1 0.048873 3.264954 7.324838 54.03172 35.37717 0.001316 5 0.055566 10.07347 6.402956 48.43853 34.38355 0.701494 10 0.055912 10.02160 6.810396 48.01595 34.33595 0.816101 20 0.055917 10.02045 6.812478 48.01184 34.33745 0.817778 table-b2. variance decomposition of dy to different structural shocks-model 2 model 2 period s.e. tot shocks external supply shock supply shock is shock lm shock vietnam 1 0.125007 1.128674 0.966233 78.54021 6.339671 13.02521 5 0.179715 1.549277 10.06858 57.80404 11.54356 19.03455 10 0.211625 2.217165 12.24324 52.09896 12.14603 21.29460 20 0.240890 1.999871 12.56062 50.68082 11.38090 23.37778 indonesia 1 0.019405 0.498395 12.43726 65.93715 18.33312 2.794074 5 0.025001 2.992983 9.560449 57.43691 14.88876 15.12091 10 0.025197 3.015535 9.545461 57.28905 14.72872 15.42123 20 0.025201 3.016056 9.545080 57.28737 14.72587 15.42563 philippines 1 0.045038 0.111249 0.002206 70.80594 26.96525 2.115360 5 0.053741 16.80068 0.583399 50.07766 30.11340 2.424856 10 0.053744 16.79924 0.592402 50.07259 30.11078 2.424986 20 0.053744 16.79924 0.592411 50.07258 30.11078 2.424986 table-b3. variance decomposition of tb to different structural shocks-model 1 model 1 period s.e. tot shocks external supply shock supply shock is shock lm shock vietnam 1 0.070991 46.59476 21.60463 2.530645 25.66785 3.602119 5 0.094356 35.15379 23.49710 12.08301 22.55887 6.707230 10 0.103226 37.07373 23.53327 11.96863 21.05580 6.368562 20 0.107391 37.77742 22.37972 13.18307 19.95869 6.701101 indonesia 1 0.027415 13.67684 0.752873 31.31353 44.28228 9.974473 5 0.028668 14.28494 1.406631 29.71269 40.64398 13.95176 10 0.028673 14.28532 1.407901 29.72631 40.63146 13.94901 20 0.028673 14.28532 1.407901 29.72631 40.63146 13.94901 philippines 1 0.043780 15.90181 1.235312 18.38130 49.77882 14.70277 5 0.058384 10.53192 0.894100 12.99771 60.85288 14.72339 10 0.059447 10.32563 0.965367 13.34768 60.45623 14.90510 20 0.059466 10.32089 0.968045 13.35047 60.45552 14.90507 table-b4. variance decomposition of rer to different structural shocks-model 2 model 1 period s.e. tot shocks external supply shock supply shock is shock lm shock vietnam 1 0.024090 3.358150 11.53165 4.404060 74.56602 6.140126 5 0.025337 3.384267 11.73351 4.067711 74.05653 6.757981 10 0.025347 3.424356 11.72762 4.065953 74.00159 6.780483 20 0.025350 3.444421 11.72518 4.065108 73.98619 6.779090 indonesia 1 0.109427 9.998815 3.488800 22.46976 24.05687 39.98576 5 0.126525 7.853461 3.737768 25.85561 22.66973 39.88343 10 0.127280 7.814666 3.749512 26.19052 22.63556 39.60975 20 0.127293 7.813875 3.749615 26.19535 22.63555 39.60561 philippines 1 0.039945 11.36859 4.732956 36.97155 46.72122 0.205684 5 0.045135 9.619058 6.467142 29.03627 54.45476 0.422771 10 0.045135 9.619052 6.467487 29.03610 54.45450 0.422858 20 0.045135 9.619052 6.467488 29.03610 54.45450 0.422858 asian journal of economics and empirical research, 2015, 2(1): 23-38 35 table-b5. variance decomposition of d_p to different structural shocks-model 1 model 1 period s.e. tot shocks external supply shock supply shock is shock lm shock vietnam 1 0.012276 0.989840 12.03350 2.436868 3.670719 80.86907 5 0.022578 16.57978 27.74028 2.912921 16.01555 36.75147 10 0.024288 16.22104 25.70629 9.946381 15.87603 32.25026 20 0.025438 18.05540 24.86880 10.21539 16.40113 30.45929 indonesia 1 0.028424 7.123547 13.94734 16.66708 0.153550 62.10849 5 0.038800 7.127889 12.72402 36.99595 0.474995 42.67715 10 0.038828 7.143556 12.71125 37.04575 0.479893 42.61956 20 0.038828 7.143556 12.71125 37.04575 0.479893 42.61956 philippines 1 0.008076 10.79405 1.214785 13.03660 5.983466 68.97109 5 0.009875 13.62509 2.503921 26.11249 9.249280 48.50923 10 0.009928 13.54067 2.530870 25.96242 9.803112 48.16292 20 0.009929 13.53847 2.531820 25.96069 9.812208 48.15681 table-b6. variance decomposition of d_p to different structural shocks-model 2 model 2 period s.e. tot shocks external supply shock supply shock is shock lm shock vietnam 1 0.015072 3.343935 18.54039 12.99761 61.96704 3.151022 5 0.022609 2.238254 21.47009 10.70953 45.39163 20.19049 10 0.023178 2.285396 21.87421 11.67186 44.75266 19.41587 20 0.023423 2.368945 21.60510 12.35010 44.44678 19.22907 indonesia 1 0.026018 4.446995 5.362710 2.282927 12.67179 75.23558 5 0.038432 4.198649 7.635068 26.53634 8.252513 53.37743 10 0.038811 4.176565 7.648194 26.63012 8.245378 53.29974 20 0.038819 4.176280 7.648588 26.63386 8.244460 53.29681 philippines 1 0.008743 0.705432 0.767483 8.171775 2.302300 88.05301 5 0.009498 1.550477 0.878675 12.72542 2.836938 82.00849 10 0.009499 1.550456 0.879027 12.72562 2.838680 82.00622 asian journal of economics and empirical research, 2015, 2(1): 23-38 36 figure-1. impulse response of domestic variables: vietnam asian journal of economics and empirical research, 2015, 2(1): 23-38 37 figure-2. impulse response of domestic variables: indonesia asian journal of economics and empirical research, 2015, 2(1): 23-38 38 figure-3. impulse response of domestic variables: philippines views and opinions expressed in this article are the views and opinions of the authors, asian journal of economics and empirical research shall not be responsible or answerable for any loss, damage or liability etc. caused in relation to/arising out of the use of the content. asian journal of economics and empirical research issn: 2409-2622 vol. 2, no. 2, 83-90, 2015 http://asianonlinejournals.com/index.php/ajeer * corresponding author 83 vertical and horizontal integration as determinants of market channel choice among smallholder dairy farmers in lower central kenya james k.mutura 1* --newton nyairo 2 --maina mwangi 3 --stephen k. wambugu 4 1 stima sacco society ltd and phd (agricultural economics) candidate, department of agribusiness management and trade kenyatta university, nairobi kenya 2 department of agribusiness management and trade kenyatta university, nairobi kenya 3 department of agricultural science and technology kenyatta university, nairobi, kenya 4 department of agribusiness/geography, chuka university, chuka, kenya abstract this work is licensed under a creative commons attribution 3.0 license asian online journal publishing group contents 1. introduction ............................................................................................................................................................................... 84 2. review of literature ................................................................................................................................................................. 84 3. empirical model ........................................................................................................................................................................ 85 4. results and discussion .............................................................................................................................................................. 86 5. conclusions and recommendations ........................................................................................................................................ 88 references ...................................................................................................................................................................................... 89 bibliography .................................................................................................................................................................................. 90 this study sought to analyse vertical and horizontal integration as determinants of market channel among smallholder dairy farmers in lower central kenya. data was collected from 288 small holder dairy farmers in this region using multistage sampling technique. processing and analysis of the survey data was carried out using spss version 20 and stata version 12. multinomial logit regression model (mnl) was used to analyse factors influencing the choice of dairy market outlet by the small holder dairy farmer. level of education, milk output, access to information and transaction costs influenced the choice of marketing channel. vertically integrated households used own outlet as marketing channel while horizontally integrated households used cooperative and farmers associations as milk marketing channel. it is recommended that programmes relating to milk market information be made accessible to farmers. there is need to profile farmers on the basis of production, spatial location and education level and encourage them to use specific marketing channel. keywords: multinomial logit, marketing channels, smallholder dairy farmers. . http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2015, 2(2):83-90 84 1. introduction in kenya dairy farming accounts for about four percent of the country’s gross domestic product (gdp) and fourteen percent of total value of agricultural output (kenya national bureau of statistics, 2009). about eighty percent of the dairy output in kenya emanates from small holders, many of whom are situated in the central highlands (smallhloder dairy project, 2008). according to fao (2014) and mutua-kiio and muriuki (2013) about thirty five percent of total milk produced is consumed on farm by the calves and the famer’s family while the balance is available for sale. in the period 2005 to 2012, annual milk output exceeded quantity marketed through formal channels to consumers and processors. this resulted in surpluses against a background of economic growth with resultant increase in demand for milk and milk products (mulu-mutuku et al., 2009; government of kenya, 2010; knbs, 2013). the excess milk output increased from 1383.5 million litres in 2005 to 1929.45 million litres in 2012, while simultaneously the quantity of imported skimmed milk powder increased from 452 tonnes to 2753 tonnes. the recurring unprocessed surplus milk and concurrent increase in the volume of imported skimmed milk may be attributed to inefficiency of processing plants, which hardly utilize fifty percent of the installed annual processing capacity of 985 million litres (kenya dairy board, 2013) and lack of appropriate or weak marketing channels. with an average herd size of three dairy cattle, it is estimated that there are about 1.4 million smallholder dairy farmers in kenya (republic of kenya, 2013). smallholder dairy farming as an informal family business mainly utilize family labour with one or two hired workers, thus making their operations micro and small enterprises [m.s.e’s] which hardly enjoy the economies of scale (gok, 2012). smallholder dairy farmers fulfill numerous functions in the agricultural economy among them: food security equitable distribution of income and creation of employment opportunities especially to the rural poor (dorosh and steven, 2003) thus making the sector an important economic driver. on average, for every 1000 litres of milk produced at the farm level, 73 fulltime and 3 casual jobs are created while a similar quantity of milk creates 18 jobs in the informal sector and 13 fulltime jobs at the processing level (staal et al., 2008). dairy farmers as agents of economic growth would be expected to graduate their operations to medium enterprises through expanded herd size, use of modern technology, advanced operating skills, diversified portfolio of dairy products brought about by processing activities, and use of appropriate marketing channels (ortner et al., 2000). jari (2009) argues that despite the fact that smallholder farmers face difficulties in marketing, they continue to produce and survive in the face of unfavorable conditions some of which can be solved through integration. vertical integration occurs where two or more stages in the process of production and marketing are effectively controlled by single management (rehber, 1998). such integration is motivated by the type and nature of fixed investments and products. vertically integrated farmers maximize return on investments through value addition, complimenting own produce from other sources as well as offering diversified products from the same material inputs. when selling their products, such farmers will use marketing channels that enable their produce to reach the market at least cost per unit of output. horizontal integration occurs when a farmer gains control over other farmers performing similar activities at the same level in production and marketing (onumah et al., 2007). by pooling skilled manpower, horizontally integrated farmers who are chain actors are able to minimize on transaction costs, access market information and adhere to government regulations more easily. horizontally integrated dairy farmers are able to take collective action on securing new markets, bargaining for better prices for milk and milk products and use of the most effective marketing channel. such actions are taken against a background of strong associations by farmers who are trained and have a strong entrepreneurial orientation. vertical and horizontal integration as factors that determine the choice of marketing channels among the small holder dairy farmers in kenya has not been investigated. in kenya, market-oriented smallholder dairy farms tend to be concentrated close to urban centres because the effects of market forces over-ride many production factors. consequently, peri-urban smallholder dairy farmers should establish elaborate governance structures and act collectively in collection, processing and marketing of milk and milk products. most studies regarding the dairy farming in kenya have focused on productivity, genetics, nutrition, and value chain development (wambugu, 2000; kahi et al., 2004; gamba, 2006; kavoi et al., 2010; mugambi et al., 2011; murage and ilatsia, 2011; wambugu et al., 2011). this implies that there are gaps in literature on how vertical and horizontal integration act as determinants of market channel among smallholder dairy farmers. this paper seeks to analyse vertical and horizontal integration as determinants of market channel choice among smallholder dairy farmers in lower central kenya. 2. review of literature several approaches have been proposed in literature on the analysis of factors influencing the choice of market channel. here there is a single decision among two or more alternatives. analyzed occupational choice among multiple alternatives while mcfadden (1974) analyzed the travel mode of urban commuter as a choice among multiple alternatives. mburu et al. (2007) using a purposive multistage sampling procedure examined the determinants of smallholder dairy farmers' adoption of various milk marketing channels in kenya highlands. the study used a logit model in analysing farmers’ milk marketing channels choice either through itinerant traders (hawkers, neighbours and hotels) or through the dairy cooperative. the study found out that average milk price, total number of cows milked and farm acreage negatively influenced farmers' adoption of milk marketing through the dairy cooperative channel. sikawa and mugisha (2010) analysed the factors influencing south-western uganda dairy farmers’ choice of the milk marketing channel. the asian journal of economics and empirical research, 2015, 2(2):83-90 85 study categorized milk market choices in to a binary outcome of formal and informal market channels. using a heckman probit model was age of the dairy farmer, membership in cooperative, form of payment, volume of milk produced, level of education of the dairy farmer and marketing costs were found to influence the choice of milk marketing channel. the difference between mburu et al. (2007) and sikawa and mugisha (2010) studies and the current study is that the former studies collapses all the market alternatives in to a binary outcome while the current study does not. binomial logit and probit techniques are only suitable for problems involving the choice among two categories. the former studies combined several market outlets in order to make the dependent variable a binary outcome. for problems involving the choice among three or more categories, the multinomial logit technique is most often employed like the case in this study. staal et al. (2006) analysed the smallholder dairy farmer access to alternative milk market channels in gujarat, india. the study used a two-step analysis first to explain milk market participation using probit model while in the second step the study used mcfadden’s choice model, using a conditional (fixed-effects) logit to model milk outlet choice, and their determinants. the study found out three major milk marketing channels including direct sales to individual consumers, informal private traders and sale through cooperatives and private dairy processors. from this study it was established that the higher the number of adults in a household, the more likely the household is to sell through the private trader channel and cooperative/private processor channel than individual customers. households with external assistant in their dairy enterprise were more likely to select the private traders and dairy cooperatives/processor channels instead of the individual customer channel. households with more land were found to be less likely to sell through either the private traders channel or the cooperative/private processor channel. households keeping higher number of livestock were found to be likely to select both the private traders and dairy cooperative/processor channel as opposed to selecting the individual customer channel. the study found out that households were less likely to select channels that paid cash, or that took milk on informal credit as compared to channels that offered monthly payment or provided formalized credit terms in form of written contracts. the difference between staal et al. (2006) study and the current study is that the former used conditional logit model which is used when data consist of choice-specific attributes instead of individual-specific characteristics. conditional logit model is limited in that it only gives direct information on which individuals make what choices does not allow testing hypotheses why those choices are made. interpretation is based therefore on untested characteristics of alternatives available to particular individual (hoffman and duncan, 1988). the current study however utilizes the multinomial logit approach that analyses the choice of market on the premise of individual decision maker than the choice itself. shiferaw et al. (2006) employed descriptive statistics such as frequencies, cross-tabulations, means and ratios to analyse socio-economic assessment of legume production, farmer technology choice, market linkages, institutions and poverty in rural ethiopia. the paper did not attempt to undertake detailed econometric modelling to test correlations and cause and effect relationships between different variables. the difference between this study and the current study is that the former used descriptive analysis while this study used a more quantitative econometric analysis to estimate small holder farmers’ choice of marketing channels. it is worth noting that although simple descriptive statistics provide important information on behavioural trends, they do not offer much insight into the underlying complex interrelationships and behaviours driving observed phenomena as quantitative analyses do, which is the case in this study murage and ilatsia (2011) examined the determinants of smallholder dairy farmers’ use of breeding services in nyandarua and kiambu districts of central kenya. considering three breeding services, artificial insemination (ai), natural bull service, and a combination of ai and bull services, the study used a multinomial logit econometric model. ayuya et al. (2012) used both descriptive and multinomial logit to analyze small-scale farmers’ choice of organic soil management practices in bungoma county, kenya. in some other work, pundo and fraser (2006) used multinomial logit model to investigate the factors that determine household cooking fuel choice between firewood, charcoal, and kerosene in kisumu county. in a similar study in eastern cape province, south africa, jari and fraser (2009) used the multinomial regression model was used to investigate the factors that influence marketing choices among smallholder and emerging farmers. in another study, yayar (2012) used multinomial logit procedure was used to investigate the socioeconomic and demographic characteristics of consumers that determine households’ fluid milk consumption choices among packed, unpacked and both packed-unpacked milk consumption choices. multinomial logit model is the best approach for choices that are based on the attributes of the decision maker than the choice itself. studies by murage and ilatsia (2011). ayuya et al. (2012); pundo and fraser (2006); jari and fraser (2009) have all used the multinomial logit model approach in analysing the determinants of choice. the current paper adopts mnl as the econometric model. 3. empirical model in this study, an individual is assumed to have preferences defined over a set of alternatives. the choice variable (dependent variable) has more than two unranked/unordered options while the independent variables can consist of features/attributes of the alternatives and characteristics of the respondent e.g., age, education, income. mcfadden (1974) first introduced the multinomial logit model (mnl) to explain the choice of transportation modes of urban commuters with the random utility model. mnl continues to be a popular choice model because choice probabilities formula has a closed form and is readily interpretable. asian journal of economics and empirical research, 2015, 2(2):83-90 86 the model was preferred since it permits the analysis of decision across more than two categories in the dependent variable therefore making it possible to determine choice probabilities of different channels. in addition, mnl is simpler to compute compared to multinomial probit which poses a challenge in computing multivariate normal probabilities for any dimensionality above 2 (greene, 2002). assume the utility of household i choosing channel j is given by uij is a linear stochastic function of exogenous household characteristics x and endogenous household choices z: uij =α x + β z + ε the parameter estimates of the mnl model only provide the direction of the effect of the independent variables on the dependent (choice) variable; thus the estimates represent neither the actual magnitude of change nor the probabilities. marginal effects are used to measure the expected change in probability of a particular marketing choice being chosen with respect to a unit change in an independent variable from the mean (greene, 2002). assuming the errors εij are independently and identically distributed with an extreme value distribution, the probability that alternative j is chosen from n alternatives can be represented by a mathematical model as formulated below; ( ) β ∑ the above equation provides a set of probabilities for j+1 choices for a decision maker with characteristics xi while y denotes choices. marketing channels x is a 1* k vector with first element unity and βj is a k * 1 vector with j = 1, ….., j. prob (yi = j|xi) is determined once the probabilities for all j = 1, 2, …., j are known and the probability must sum up to unity. for the parameter estimates to be consistent and unbiased, it requires that the probability of using one choice by a given farmer be independent of the probability of choosing another choice. this means pj / pk should be independent of the remaining probability which is referred to as independence from irrelevant alternatives (iia). the parameter estimates of the mnl model only provide the direction of the effect of the independent variables on the dependent (choice) variable; thus the estimates represent neither the actual magnitude of change nor the probabilities. marginal effects are used to measure the expected change in probability of a particular marketing choice being chosen with respect to a unit change in an independent variable from the mean (greene, 2002). the following model was specified for market channel choice analysis; vihi 1312   where dm choice is the dairy market outlet used by the farmer (farm gate direct sales, middlemen, own distribution and dairy cooperatives), while are coefficients associated with each explanatory variable and the is the error term. several factors were hypothesized to influence the farmers’ choice of financial provision mode. the choice of these explanatory variables was mainly based on the general working hypothesis and partly on empirical findings from literature, and therefore, a positive or negative sign was assigned depending on the potential influence of a particular variable on choice of financial provision mode. 3.1. diagnostic tests for multinomial logit the assumption of independence from irrelevant alternatives (iia) is critical and leads to substantial computational difficulties involving the computation of multivariate integrals. if there is a change in the characteristics of any other alternative in the choice set, this property requires that the two probabilities must adjust precisely in order to preserve their initial ratio, that is, the percentage change in each probability should be equal. a hausman test was carried out and showed no evidence that the study did not meet iia assumption and therefore no need of using nested logit as an alternative potential multicollinearity among explanatory variables was also tested in a preliminary analysis where it was found not have any potential influence on estimates from the model. the highest pair-wise correlation was 0.4 whereas multicollinearity is a serious problem if pair-wise correlation among regressors is in excess of 0.5 (gujarati, 2004). an analysis of variance inflation factor (vif) did not show any problem since none of the vif of a variable exceeded 8 (greene, 2002). in addition a bruesch-pagan/ cook-weisberge test for heteroskedasticity which indicated a 2 (chi2) of 64.51 and prob > 2 of 0.8633 indicating that heteroskedasticity was not a problem. a skewness and kurtosis test of normality was carried out to test whether the data was normally distributed. greene (2002) argues that if a distribution has kurtosis values close to zero, and then it is likely to be normally distributed. the overall model had a kurtosis probability of 0.0000 meaning in general the assumption of normal distribution was not violated. to test for goodness of fit maximum likelihood r 2 was 0.646 indicating that the model fits well. further, the probability of pearson 2 (chi2) of 0.738 and that of deviance 2 of 1.000 confirmed the model fits the data well. 4. results and discussion out of the 13 variables hypothesized to influence market choice, 11 variables were found to be significant. table 1 presents the mnl results for the hypothesized variables. asian journal of economics and empirical research, 2015, 2(2):83-90 87 table-1. multinomial logistic regression result for determinants of milk market choice number of observations = 288; log likelihood = 85.17; prob > chi = 0.000 market channel choice 1. farm gate 2. middlemen 3. own distribution variables dy/dx std.err. p-value dy/dx std.err. p-value dy/dx std.err. p-value gender 0.016 0.849 0.985 -0.084 0.709 0.906 -1.842 1.804 0.996 education 0.34 0.376 0.367 -0.834 0.412 0.043** -0.152 0.9 0.548 age -0.176 0.421 0.677 0.452 0.39 0.246 0.933 1.742 0.277 no. of dairy cows -1.788 0.813 0.028** -0.941 0.486 0.053** -0.072 0.427 0.866 milk output/cow 0.756 0.71 0.287 -0.067 0.486 0.089* 12.889 0.893 0.994 % milk sales -1.134 0.867 0.191 1.285 0.808 0.112 9.763 0.386 0.996 training 1.49 0.827 0.142 -3.57 1.657 0.528 0.214 1.72 0.099* milk output -0.03 0.017 0.063* -0.011 0.013 0.392 0.027 0.03 0.361 information access -2.847 2.037 0.294 -3.044 1.728 0.595 1.03 0.987 0.092* land size 0.388 2.005 0.073* -0.878 5.876 0.881 21.715 0.659 0.998 transaction cost 0.14 0.531 0.044** 0.001 0.000 0.412 0.001 0.000 0.448 vertical integration -0.034 0.735 0.672 -0.246 0.487 0.759 0.163 0.021 0.051** horizontal integration -0.128 0.736 0.037** -0.361 0.023 0.167 0.773 0.004 0.218 source: author, 2014; base category is the cooperative; asterisks denote the level of significance * = 10%, **5% while ***is 1%. education level of the household head was negatively related to a household choice of middlemen over cooperative in dairy marketing at 5 percent significance level. the more the educated a household head is, the lower the likelihood for that household to use middlemen. it therefore means that households with more educated household heads are more likely to sell their milk through dairy cooperatives than through the middlemen (alene et al., 2008). the size of the farm possessed by a household was positively related to choice of farm gate market channel over through cooperatives at 10 percent level of significance. as the land size owned by household increases by one acre, the likelihood of that household selling its milk through farm gate over through dairy cooperatives increases by 3.4 percent. farmers who had large farm size were less likely to sell their milk through cooperatives as compared to the farmers with small farm sizes. the results found a negative relationship between the number of cows a household owned and choice of farm gate and through middlemen market channels at 5 percent significance level. a unit increase in the number of milking cows owned by a household reduced the probability of using farm gate market channel as compared to using cooperatives for its milk by 1.7 percent. likewise, a unit increase in the number of milking cows owned by a household by one unit reduced the likelihood of that household using middlemen market channel over cooperative by 0.94 units. other studies have reported herd size being a significant determinant in market channel participation for modern market channels (tsourgiannis et al., 2008). as the herd size increases, farmers’ shift to more organized dairy channels hence the negative relationship with farm gate and middlemen which could be argued to be less organized. large producers are likely to get price incentives or higher prices for their milk because of high bargaining power as well as lower transaction costs which could be achieved in more organized market channels like cooperative societies. in addition, the number of animals kept by the farmer determines the total production costs and therefore influencing the amount of working capital needed on the farm forcing farmers with a large herd size to prefer supplying their milk to channels that handle big volumes and pay the whole lump sum milk revenues for continuity running of their dairy operations. however these results are contrary to vijay et al. (2009) work who noted a negative relationship between herd size and choice of cooperative marketing channel among dairy farmers. this could be likely a case where farmers in cooperatives receive the same price like in other channels and in situations where there is no price incentive to farmers irrespective of quantity of milk they supply. the results found a negative relationship between the number of cows a household owned and choice of farm gate and through middlemen market channels at 5 percent significance level. a unit increase in the number of milking cows owned by a household reduced the probability of using farm gate market channel as compared to using cooperatives for its milk by 1.79 units. the results concur with a study of karli et al. (2006) in the south eastern anatolian region of turkey which reported that the probability of the membership decreases with the increase in the farm size. these results are also in agreement with that of tursinbek and karin (2010) who found that farm size has greater impact on farmers’ decision to join cooperatives in zhejiang in china. other studies such as mussie et al. (2001) and gockowski and ndoumbe (2004) found a negative relationship between farm size and decision to join or adopt farmer based organization. there was a positive relationship between choice of farm gate market channel and access to information. actually, access to information increased the household likelihood of selling its milk through the farm gate over cooperative by 2.5 percent at significance level of 10 percent. a positive relationship existed between farmers opting to distribute their own milk rather than sell through the cooperatives and access to market information. households that are vertically integrated were found to have a 16.3% likelihood of selling its milk and milk products through own distribution as compared to through cooperatives. the results indicated a positive relationship between farmers opting to distribute their own milk rather than sell through the cooperatives and access to market information. access to marketing information encourages farmers to venture into new innovations .however, it is farmers with higher level of education who have been argued to have superior ability to access and understand information and technology therefore applying that information to venture in to new opportunities than farmers with lower education (elzo et al., 2010). these results seems to affirm the notion that market information gotten by the farmer about a certain marketing channel increases a farmer willingness to participate in that channel hence and he is likely to increase his output sales through that market channel (otieno et al., 2009). the size of the farm possessed by a household was positively related to choice of farm gate market channel over through cooperatives at 10 percent level of significance. as the land size owned by household increases by one acre, asian journal of economics and empirical research, 2015, 2(2):83-90 88 the likelihood of that household selling its milk through farm gate over through dairy cooperatives increases by 0.39 units. these explain that farmers who have large farm size were less likely to sell their milk through cooperatives as compared to the farmers with small farm sizes. this could be because farmers with small land sizes may wish to benefit from cash, input subsidies, and service provided by the agricultural cooperatives. households with relatively smaller land holdings and limited access to grazing land can substitute capital for land to produce as much or even higher milk volumes as compared to those with land holding. to access such capital, such farmers are likely to join cooperatives where they are likely to get input at subsidized prices due to economies of scale emanating from collective action. an increase in total household milk output by 10 percent reduces the probability of that household selling its milk through farm gate as compared to through a cooperative by 3 percent. these results are consistent with tsourgiannis et al. (2008) study who reported a positively relationship between volume of milk produced by the farmer per day and choice of cooperatives marketing channel. this could be due to the cost reduction on the sides of cooperatives especially on transport where the cooperative collects milk from its members from collection centres. spatial distribution of small producers will have implications of the cooperative society operating costs. consequently, the quality of milk produced by big farmers having been argued to be of higher quality than small producers since big farmers have access to veterinary services (vijay et al., 2009). the implication of these results is that dairy farmers who produce fewer litres of milk could simply sell to vendors at the gate to avoid transport costs. marketing costs significantly influenced the choice of milk marketing channel at 5 percent level of significance. a unit increase in transaction cost incurred by a household increases the likelihood for such a household selling its milk through the farm gate over cooperative society by 14 percent. the longer the distance, the higher the transportation costs. the channel which is associated with higher transport costs reduces farmers’ gross margins. this research finding is consistent with the results of otieno et al. (2009) who reported that high transport costs significantly reduced the percentage of milk supplied to the marketing channel because they reduced farmers’ gross margins. more so, the higher the transaction cost incurred by dairy farmers, the less the interest of participation in the channel (artukoglu and olun, 2008). these results are contrary to manyong et al. (2008) who found out that institutional innovation such as group marketing mitigate the costs of accessing markets. there was a negative relationship between the level of education and choice of middlemen as compared to cooperatives. a unit increase in level of education by the household head level of formal education reduced the likelihood of such a household to sell through middlemen as compared to through cooperatives by 0.8 units. formal education enhances managerial competence and successful implementation of improved production, processing and marketing practices (marenya and barrett, 2009). additionally, education has an implication on the ability to understand and interpret extension information received by an individual. education levels affect market information interpretation and hence, market participation level of farmers (jari, 2009). the more educated a farmer is the more they are likely to spend less time doing marketing activities hence would rather sell through cooperatives than middle men. a negative and significant relationship was found between farm gate channel choice and the amount of milk produced per cow. it was found that farmers were 3% less likely to sell through farm gate as opposed to cooperative. this could be because cooperatives are more likely to buy in bulk compared to small traders who buy at farm gate and so for farmers that wish to sell a lot milk might sell faster through cooperatives. this finding is in line with findings of tsourgiannis and others who reported that volume of milk produced was highly significant in determining channel choice and that farmers who marketed their milk to big national / regional dairy firms were large scale farmers in terms of cultivated land, size of flock, volume of livestock and milk production (tsourgiannis et al., 2002) households that are vertically integrated have a 16.3% likelihood of selling its milk and milk products through own distribution as compared to through cooperatives. these findings were consistent with wambugu et al. (2011) who found out that farmers in kenyan highlands were more vertically integrated in order to receive a number of benefits including input supply stores (mainly feed), a.i. and credit services. 5. conclusions and recommendations the results of this study affirm that land size, number of dairy cows owned by a household, training, total milk output, access to market information, and household head education level significantly influence choice of household dairy market outlet. coordination of farmer associations in dairy production confers a lot of benefits to farmers, enabling them to produce profitably and especially through collective marketing. this result was consistent with jenson (2010) who found out that provision of quality services was the main criteria for farmers choosing between becoming members or non-members in a dairy cooperative. bagher (2011) using a probit model to evaluate the mechanisms of attracting participation in the cooperative entities, found out that supportive policies to members played important roles in influencing decision to join such associations. promotion of scientific and technical assistance among cooperative members were also crucial factors in explaining farmers’ likelihood to join farmer associations. households which received training on agricultural production were more likely to sell through farm gate as opposed to cooperatives. it results affirm the notion that extension offices mostly targets households with large land holdings which was positively related with choice of farm gate over cooperatives. households that were headed by more educated heads sold more through the cooperatives than through the middlemen. households producing more milk volumes had a higher likelihood of selling through cooperatives as opposed to farm gate marketing option. households that had up scaled valued addition and had access to information of market prices preferred to sell on their own than to sell through the dairy cooperatives. it 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research shall not be responsible or answerable for any loss, damage or liability etc. caused in relation to/arising out of the use of the content. 87 asian journal of economics and empirical research vol. 5, no. 1, 87-92, 2018 issn(e) 2409-2622/ issn(p)2518-010x doi: 10.20448/journal.501.2018.51.87.92 dynamism in economic policies to achieve economic stability: evidence from pakistan aaqib qayyum1  sadia manzoor2 ( corresponding author) 1,2department of economics, university of wah, quaid avenue, wahcantt, pakistan abstract economic policies always play a crucial role to achieve the country's economic stability through the mutual integration of fiscal and monetary policies. this study is one of the initiatives to analyze the dynamism of economic policies to achieve pakistan's economic growth while controlling public taxes, government expenditures, broad money supply, inflation, and unemployment during a period of 1980-2017. the study employed the ardl –bounds testing approach in order to obtain the shortand long-run elasticities under the cointegrated framework. the results show that in the short-run, tax rate largely supported the country’s economic growth, while this result is disappeared in the long-run, where high tax rate substantially decreases economic growth. the result concluded that contractionary fiscal policy is undesirable in the long-run due to large tax evasion, which negatively impacts on the country's economic growth. the results further reveal that money supply has a positive and significant impact on country's economic growth both in the short and long-run, which implies that expansionary monetary policy stimulates economic growth via the channel of domestic and foreign investment in a country. the study also suggests that state should focus on fiscal measures while monetary measures can be effective in long-term. keywords: monetary policy, fiscal policy, money supply, ardl-bounds testing approach, pakistan. jel classification: c22; e63. citation | aaqib qayyum; sadia manzoor (2018). dynamism in economic policies to achieve economic stability: evidence from pakistan. asian journal of economics and empirical research, 5(1): 87-92. history: received: 23 july 2018 revised: 13 august 2018 accepted: 15 august 2018 published: 17 august 2018 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 88 2. literature review ............................................................................................................................................................................ 88 3. data variables and methodology ................................................................................................................................................. 89 4. empirical results ............................................................................................................................................................................. 89 5. conclusions ....................................................................................................................................................................................... 92 references .............................................................................................................................................................................................. 92 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2018.51.87.92&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/248 https://orcid.org/0000-0001-2585-2780 http://asianonlinejournals.com/index.php/ajeer/article/view/248 https://orcid.org/0000-0001-2585-2780 http://asianonlinejournals.com/index.php/ajeer/article/view/248 https://orcid.org/0000-0001-2585-2780 asian journal of economics and empirical research, 2018, 5(1): 87-92 88 1. introduction today in third world economies, continuous development and sustainable growth are the major growth challenges. adam (1992) argued that policymakers should need to redefine economic policies in order to attain price stability in a country. there are two major macroeconomic strategies that act as a wheel for the growing economy, i.e., fiscal and monetary policy. both the policies worked under different economic tools, including public spending and revenues (for fiscal policy) and money supply and credit creation (for monetary policy). monetarists believe that monetary policy imposes the more significant effect on economic stability, while on the contrary side, keynesian were on the favor of a fiscal policy to stabilize price level in the country(asogu, 1998). economic growth and price level both are an interdependent factor that acts simultaneously to work for better health and wealth of the country. country's gdp shows the total production of a country in a given year, while unemployment is a state of the economic deprivation that an eligible person would like to work and search for it but hardly finds none (zaman et al., 2011). money supply is based upon central bank decision where the central bank imposes a number of policies on commercial banks to restrict excess money supply and credit in a country. fiscal policy on the other side, worked on public revenues and public expenditures to stabilize price level that simultaneously increase physical assets, like building infrastructure, health & education sector, communication and technology, transportation, etc., which bring economic activity in the economy (padda and akram, 2009; ogar et al., 2014). according to gop (2017) report, the growth rate of pakistan seems to be declined from the year 1980 to 1990 (6.8% falls to 4 %) but it takes a flight of 4.3% in the year 2017. money supply has been increased up to 48.2 % in 2017. unemployment and inflation rate rises due to the effects of rigid economic policies of a country. on the basis of significant discussion, the study analyzes the dynamism in economic policies towards economic stability for pakistan economy by controlling the number of macroeconomic factors, which is imperative for sustained growth. the more specific objectives are as follows: i) to analyze the impact of public expenditures and government taxes on the country's economic growth (keynesian view). ii) to examine the role of money supply in the country's economic development (monetarist view), and iii) to what extent changes in price level and unemployment rate affect the country's economic growth. these objectives required extensive empirical exercise to obtain policy remarks. 2. literature review the number of the previous literature finds the relationship between economic growth and country’s economic policies to stabilize macroeconomic issues, including, adefeso and mobolaji (2010) observed fiscal-monetary policy and its impact on the nigerian economy. the sample data was collected from 1970 to 2007. the results show that monetary policy is more effective in the economic stability of nigeria as compared to the fiscal policy. khosravi and karimi (2010) examined economic growth in iran for the time span of (1960-2006). bounds testing and cointegration confirm the relationship between macroeconomic policies and economic growth in a given country for long-term economic stability. bhuiyan (2008) investigated the impact of monetary shocks in canada from 19942007. the results of the study indicated that money supply played effective role in the economy by changing the interest rate policy. nouri and samimi (2011) studied the impact of monetary factors on the economy of iran, during the time period of 19742008. the study found a positive association between economic growth and monetary policy. havi and enu (2014) investigated the impact of macroeconomic strategies on the economic growth of ghana. the study found that monetary policy is more effective in the stability of ghana’s economy that largely delimits excessive money supply in a country. benos (2009) studied the impact of fiscal policy on the economic stability of 14 eu countries. the results of the study reveal that government spending has a positive connection with the country’s economic growth via the imposition of expansionary fiscal policy across countries. tesfay (2010) evaluated the impact of macroeconomic strategies on ethiopian economic growth, to find out their strength in deviating economy. the results of the study concluded that money supply and government spending both found to be insignificant that need to careful economic decisions for applying appropriate economic policies for broad-based growth. chowdhury and afzal (2015) examined the impact of financial policies on the economic stability of bangladesh. the cointegration tests revealed that economic policies largely promote country’s economic growth. ogunmuyiwa and ekone (2010) studied nigerian economy and found that expansionary monetary policy is more effective to promote country’s economic growth. douanla (2014) studied panel data on fourteen countries and analyzed that money supply is positive and inflation is negatively affecting the economic growth across countries. mohammad et al. (2009) studied the pakistan’s economy and found that monetary policy has a positive connection to stabilize price level in a country. jawaid et al. (2010) predicted the financial policies for pakistan economy and shows that there has been a positive behavior of financial policies in the growth of pakistan’s economy. the study recommends that monetary policy needs to be revised, in order to lead pakistan’s economy on the path of sustainable growth. enache (2009) analyzed the fiscal policy contribution in the economic growth of romania, during the time period of 1992 – 2013. the study provides no evidence of fiscal policy intervention to boost country’s economic growth, which need re-define economic policies to stimulate economic drivers for broad-based growth. another study were conducted by mutuku and koech (2014) study used impulse response function to fund out the impact of macroeconomic policies. the conclusion revealed that fiscal policy is contributing more in the output of kenya, as compared to monetary policy. ihsan and anjum (2013) considered a case study of pakistan and evaluated inflation-interest-gdp nexus by using a time series data from 2000 to 2011 and found that cpi and interest rate move along with the country’s gdp while inflation bear no impression on gdp. hussain and siddiqi (2012) found the interrelationship between macroeconomic policies and pakistan’s economic growth and confirmed that macroeconomic policies largely support country’s economic development through monetary and fiscal instrumentations. the current studies largely worked on different areas by applying monetary and fiscal policy instruments across different economic settings, i.e., banking crisis see, dosi et al. (2015) total factor productivity and financial crisis (see, darovskii (2017)) great inflation and agent’s belief see, bianchi and ilut (2017) stagflation and sustainable economic growth (see, darovskii (2017)) investment and aggregate demand (see, bar-yam et al. (2017)) asian journal of economics and empirical research, 2018, 5(1): 87-92 89 rate of interest and resource constraints (see, lee and werner (2018)) etc. these studies largely confined the importance of monetary and fiscal policy instruments to balance such economic affairs for long-term growth. 3. data variables and methodology 3.1. data in this study, the data was collected from the world development indicators published by world bank (2017). gdp is taken as a dependent variable, while others serve as independent factors. the data is presented in table 1 for ready reference. table-1. data description variables measurement time period data type data source gdp annual % 1980-2017 time series wb (2017) unemployment annual % 1980-2017 time series wb (2017) inflation annual % 1980-2017 time series wb (2017) government expenditures % of gdp 1980-2017 time series wb (2017) money supply % of gdp 1980-2017 time series wb (2017) taxes % of gdp 1980-2017 time series wb (2017) source: wb (2017). 3.2. methodology 3.2.1. econometric from of model . . . . . (1) where, gdp = gross domestic product un = unemployment rate inf = consumer price index, inflation ge = government expenditures m2 = broad money supply t = tax rate t = time period β0 = intercept β1, β2, β3, β4, β5 = regression coefficients ε = stochastic error term we found an appropriate econometric technique after checking the stationarity of the variables. 3.2. empirical procedures to further proceed, first, we are going to find out the unit root of all the variables by using the adf test. this test determines which empirical technique is applicable. the mix order of integration among the variables gives good justification to used ardl-bounds testing approach to obtain shortand long-run parameter estimates. 3.2.1. autoregressive distributed lag (ardl)model –bounds testing approach ardl method gives robust parameter estimates both in the shortand long-run through the present value of regressand based on the present value of regressors and its lag values. ardl is the standard least squares regression technique that includes lag of both the dependent variable (y) and explanatory variables (x) as regressors. the study results confirmed that the dependent variable has an order of integration is one, while inflation and government expenditures are stationary at the level, thus it shows zero order of integration. the rest of the variables, including broad money supply, unemployment rate, and tax rate exhibit differenced stationary series, having an order of integration is i(1). hence, ardl technique accommodates a mixture of the order of integration in econometric testing to gives robust inferences. ardl general model is given below ∑ ∑ 4. empirical results table 2 shows descriptive statistics for ready reference. table-2. descriptive statistics variables minimum maximum mean standard deviation gdp 1.014 10.215 4.892 2.096 unemployment 0.600 8.300 4.444 2.014 inflation 2.539 20.286 8.155 3.894 government expenditures -10.213 48.323 6.173 10.253 broad money supply 38.594 58.867 46.499 5.937 taxes 2.420 1.600 6.220 3.310 source: wb (2017) table 2 shows that the mean value of gdp is about 4.892%, followed by unemployment rate is 4.444% and the inflation rate is about 8.155%. the maximum value of government spending, broad money supply, and the tax rate is about 20.286% of gdp, 48.323% of gdp, and 58.867% of gdp respectively. the average value is 6.173% of asian journal of economics and empirical research, 2018, 5(1): 87-92 90 gdp for government expenditures, 46.499% of gdp for broad money supply, and 6.220% of gdp for the tax rate. table 3 shows the estimates of the correlation matrix for ready reference. table-3. correlation matrix correlation gdp government expenditures inflation money supply (m2) taxes unemployment gdp 1 government expenditures 0.184 1 inflation -0.184 -0.220 1 money supply -0.247 0.136 0.092 1 taxes -0.152 0.072 -0.192 0.761 1 unemployment -0.026 0.009 -0.226 -0.101 -0.135 1 source: author’s estimation. table-4. unit root results variables at level 1st difference decision gdp -1.285 (0.178) -2.473** (0.015)c i(1) unemployment -1.981 (0.293) -7.326* (0.000)a i(1) inflation -4.041* (0.004)a -7.334* (0.000)b i(0) government expenditures -6.586* (0.000)b -6.891* (0.000)b i(0) money supply -1.634 (0.455) -4.319* 0.002a 1(1) taxes -0.916 (0.943) -6.972* 0.0000a 1(1) note: *1% level of significance, ** 5% level of significance, a,b,cshows intercept, trend & intercept, none respectively. the correlation results show that government spending has a positive correlation with the country's economic growth, while inflation, money supply, taxes, and unemployment rate largely decreases the country's economic growth. the result implies that higher public spending substantially improves the country's economic programmes, which is imperative for sustained growth. the high inflation rate and contractionary monetary and fiscal policy in the form of high tax imposition and high-interest rate both influenced foreign investors and domestic consumers in order to withdraw production and consumption. the unemployment rate has a negative correlation with the country's gdp, which implies that high unemployment rate largely influenced economic growth, which needs growth-oriented strategies to provide employment opportunities in a country. table 4 shows the unit root estimates. the results confirmed that gdp, unemployment rate, broad money supply, and tax rate are differenced stationary variables and having an order of integration is one, i.e., i(1) variable, while the remaining variables, including inflation rate and government expenditures, exhibit a level stationary variables, hence its order of integration is zero, i.e., i(0) variables. thus, ardl technique is good justification for empirical illustration on the above model for reliable estimates. table 5 shows the ardl-bounds testing results for establishing the long-run relationship between the variables. table-5. ardl bounds test f-statistics 3.730 critical values bounds significance level i(0)lower bounds i(1)upper bounds 10% 2.26 3.35 5% 2.62 3.79 2.5% 2.96 4.18 1% 3.41 4.68 source: author’s estimation. table 5 demonstrating results of f-statistics, if f-statistics value more than the critical value of upper bounds, it shows the long-run relationship exists among the projected variables. the results show that f-statistic value is 3.730 that fall to upper bounds at 10% level of significance; hence it confirmed the cointegration exists between the variables. table 6 shows the long-run elasticity estimates of ardl model for ready reference. table-6. long-run coefficients of ardl (1,2,0,0,3,3) model dependent variable: ln (gdp) regressors coefficient std.error prob. constant 16.153* 5.614 0.009 ln(gc) 0.082 0.137 0.554 ln(inf) -0.104 0.161 0.527 ln(ms) 2.704** 1.051 0.018 ln(tax) -1.128* 0.358 0.005 ln(une) 0.037 0.159 0.818 note: * indicates 1% and ** indicates 5% significance level. the results show that broad money supply and country's gdp both are moving in the same direction and having a positive relationship between them with an elasticity estimate of 2.704%, p<0.050. it implies that if 1% asian journal of economics and empirical research, 2018, 5(1): 87-92 91 increases in the money supply there would be an increase of 2.704 % in gdp. the results are in favor of the expansionary monetary policy in order to gear economic growth over a long period of time. the impact of the tax rate on economic growth is negative with an estimated elasticity value of -1.128%. the result implies that higher imposition of tax rate lead to decrease economic growth many times, thus it is favorable to apply the expansionary fiscal policy in order to generate sufficient tax resource base in a country. taxes impose an inverse effect on gdp, as the taxes increased people tend to save more, this is affecting the production sector and also the investment. the following studies are linked with the study's results, i.e., anastassiou and dritsaki (2005); padovano and galli (2001); poulson and kaplan (2008) etc. these studies largely supported the country's economic policies for longterm sustained growth. table 7 presented the short-run results of ardl-bunds testing approach. table-7. short-run results of ardl (1, 2, 0, 0, 3, 3) model dependent variable δln(gdp) variables coefficient std. error prob. δln(gc(-1)) -0.129*** 0.067 0.070 δln(inf) -0.106 0.159 0.511 δln(ms) 2.766** 1.162 0.027 δln(tax) 1.664* 0.458 0.0017 δln(une(-1)) 0.454** 0.203 0.037 δln(une(-2)) -0.228 0.187 0.237 ecm(-1) -1.022* 0.210 0.0001 note: r2= 0.650,adj.r2 = 0.405. *shows 1%, ** shows 5%, and *** shows 10% level of significance. the short-run results show that money supply has a positive impact on the country's economic growth, which further supported the long-run positive impact of money supply on economic growth. the tax rate has a positive impact on the country's gdp, however, this result is disappeared in the long-run. there is a direct association between the unemployment rate and economic growth, which shows the structural flaws of the labor market that need to e corrected by long-term economic policies. the error correction term shows how model come to equilibrium after an economic shock. in the short-run,1st lag of government expenditures is the significant but negative impact on gdp, which quite visible that government need to re-correct economic policies to spend income on such productive expenditures that would yield a positive return. stability tests are used to check how the model is stable, at 0.05 % level of significance. if the estimated line lies between two dotted lines then the model is considered stable, bahmani-oskooee and ng (2002). from the figures, it can be shown that the plots of cusum values fall within the critical boundaries. -15 -10 -5 0 5 10 15 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 cusum 5% significance figure-1. model stability by cusum test source: author’s estimation. -0.4 0.0 0.4 0.8 1.2 1.6 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 cusum of squares 5% significance figure-2. model stability by cusum square source: author’s estimation. the study concludes that taxes, money supply (m2) and government expenditures are significant policy factors that affect pakistan's economic growth. it is a prime responsibility of the government to re-correct taxation policy in order to generate sufficient revenues through fiscal instruments to increase the number of taxpayers and efficient collection of income tax. asian journal of economics and empirical research, 2018, 5(1): 87-92 92 5. conclusions the objective of the study is to analyze the keynesian and monetarist viewpoint of economic policies to stabilize the price level and stimulate the country's economic growth. the study considers a case study of pakistan to evaluate fiscal and monetary policy instruments on pakistan's economic growth by using an annual time series data from 1980 to 2017. the results confirmed that in the short-run, money supply, and tax rate both supports country's economic growth while government expenditures decrease economic growth and unemployment rate increases, which represent the structural flaws in the labor market in the form of wage rigidity and labor demand issues. in the long-run, the majority of the short-run results have disappeared, i.e., that money supply increases while high tax rate decreases economic growth, which supported the monetarist viewpoint, where expansionary monetary policy supports to country's economic growth. on the basis of results, the following policies recommend for pakistan's sustained growth, i.e., i) government should increase spending on education and health and reduce the tax burden to stimulate aggregate demand. ii) the state should expand its spending in order to create job opportunities. iii) political instability also plays a vital role in promoting unemployment, hence it is imperative to stabilize our institutions to 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ghana technology university college, it business, ghana abstract this work is licensed under a creative commons attribution 3.0 license asian online journal publishing group contents 1. introduction ................................................................................................................................................................................. 2 2. literature review ........................................................................................................................................................................ 2 3. methodology ................................................................................................................................................................................ 4 4. data analysis and findings ........................................................................................................................................................ 5 5. conclusion .................................................................................................................................................................................... 6 references ........................................................................................................................................................................................ 6 bibliography .................................................................................................................................................................................... 7 the study investigates the influence of selected macroeconomic and financial level variables on bank deposits in ghana. it specifically examines the dynamic effect of deposit interest rate, inflation, monetary policy rate, growth of money supply and stock prices (all share index) on the level of bank deposits. the dataset for the study consisted of quarterly data spanning the years of 2000 to 2013 gathered from the bank of ghana (bog) monetary time series database and the world development indicator (wdi) database. employing a co-integration analysis and fully modified ordinary least square (fmols), both short and long run elasticity’s of the model are estimated. the preliminary test for unit root indicated that all the variables are integrated of order one (an i (1) process) and the cointegration revealed the presence of one co-integrating equation. empirical findings form the study indicates a significantly negative short-term impact of both inflation and growth of money supply of bank deposits in ghana. the long-run effects of the various independent variables on bank deposit are also discussed. some of the variables conformed to priori expectations, albeit insignificant. appropriate measures are also recommended based on the findings thereof. keywords: bank deposits, cointegration, deposit interest rate, inflation, monetary policy rate, growth of money supply, all share index. http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2015, 2(1):1-7 2 1. introduction the capacity of ghanaian banks, especially commercial banks, is to accept deposits from the general public for the purport of lending and investment. this makes depositors the major stakeholders of the banking system. while sundry deposits products by banks are assigned different names for which they are designated to accommodate varying purposes, the deposit products of commercial banks can be broadly categorized into demand deposits, savings deposits, and term or fixed deposits. the banks provide various services to sectors of the economy, e.g., liquidity services, information, maturity intermediation, transaction cost, credit allocation, payment services, and money supply services, among others (elsevier, 2014). the size of the local economy and prevailing legal restrictions as well as consumers propensity to save, coupled with other financial variables have an important influence on the growth of deposits with banks. with competition intensified through the process of financial liberalization, banks are being compelled to compete for deposits in various forms (haron and wan azmi, 2006). the banking sector in ghana is expected to be very vibrant in coming years as it is currently faced with unused lending capacity and depressed market values; situations that leave the industry and for that matter most banks ripe for takeovers and acquisitions with preparatory discussions already held with a number of financial institutions from south africa (sa) and nigeria for possible acquisition. recent development is the acquisition of procredit savings and loans company ghana limited by fidelity bank ghana limited. however, the nation has seen the sale and merger of some banks in ghana due to the inability of these banks to meet the bank of ghana’s deadline for the recapitalization of local banks to gh¢60 million (bog, 2014). deposits from individuals and private enterprises have been and continued to be contribute the largest share of bank’s total deposits. savings according to conventional economists is the excess income over consumption expenditure (keynes, 1936). accepting deposits is one of the basic functions of all commercial banks. a number of factors have been found to influence deposits of bank, especially commercial banks. in malaysia, haron and wan azmi (2006) investigates the structural determinants of deposits level of commercial banks. the study found rates of profit, rates of interest, base lending rates, money supply, consumer price index (cpi), kuala lumpur composite index, and gross domestic product (gdp) to have significant impact on deposits. this study however employs some economic and financial variables in examining how the variables determine deposits of commercial banks in ghana. bank operations are usually dependent on demand and supply factors as well as legal issues. the resource supply of the bank, the demand for its services and legal requirements are all major determinants of the level of bank operations. individual and firm deposits at the bank play important role in the survival of commercial banks. commercial banks are recognized as a vital institution in the business environment and in the economic development of a nation. in developing economies like ghana, commercial banks play vital role in the economy as they aid individuals, and organizations (small, medium, or large) continue to meet their ever growing credit demands. for commercial banks to be able to meet this growing demand for credit by both micro and macro units (households and firms), it is however necessary to enhance the deposit rate or the willingness of the public to reduce the propensity to hold cash (nishat and bilgrami, 1989). the recent and persistent increases in the cost of living resulting from major cost indicators (i.e. depreciation of the cedi, increase in fuel prices, high tariff on imports, among others) with its associated increases in prices of goods and services, leads to increased consumption expenditure (given that households maintain their level or volume of consumption) all things being equal. this situation leaves less in the hands of individuals or households to put into savings with non-commensurate increases in incomes and profits (for individuals and firms). according to the bank of ghana report on the general liquidity of the sector, although the central bank anticipated a possible slowdown in economic activities the sector is said to still remain strong and making remarkable strides with improved financial indicators, with robust portfolio quality, earnings, liquidity, and capital adequacy. the financial soundness indicators like inflation, and depreciation of the ghana cedis against the major trading currencies (british pound, us dollar and the euro) indicates that the sector still remains sound and solvent (bog, 2014). this situation of the banking sector contrast the expectation of changes in the macroeconomic variables on the performance of the economy, especially the banking sector (given the recent depreciation of the local currency and its anticipated effect on savings behavior of households and firms). it is therefore imperative to explore and expose the determinants of bank deposits by the general public in order to aid commercial banks succeed in their quest to enhance customer deposits in the face of the current economic dispensation. 2. literature review 2.1. theories of savings behaviour according to haron and wan azmi (2006), there are three theories of savings from the depositor’s perspective: the traditional models of the life-cycle hypothesis by modigliani and brumberg (1954), the permanent income hypothesis (friedman, 1957), and the buffer-stock theory (deaton, 1991; carroll christopher, 1992). these theories explain why the individual depositor would like to hold part of his or her asset portfolios in savings. 2.2. the life-cycle hypothesis of savings this model of savings, the life-cycle hypothesis was developed by franco modigliani and his student, richard brumberg in the early 1950s. according to them, the rational individuals makes their consumption decision based on the resources available to them over their life time, and also on their stages in the life cycle. thus, the life-cycle hypothesis of savings postulates that the individual’s consumption in a particular period depend on their expectation about lifetime income so as to ensure a smooth consumption pattern over the lifetime. further, the model predicts that in order to ensure a smooth level of consumption over time, by individual tend to save more in the early ages of asian journal of economics and empirical research, 2015, 2(1):1-7 3 life in order to provide for retirement. this theory assumes the individual to be a net saver during the early stages of life, and dissevers during retirement. and as haron and wan azmi (2006) put it, the cornerstone of the life-cycle hypothesis is age related consumer heterogeneity. according to the predictions of the this model of savings, the savings curve takes a hump-shaped pattern which peaks in the middle ages of one life, with low savings during the young and old ages. 2.3. the permanent-income hypothesis of savings the permanent-income hypothesis was first propounded by economist milton friedman in his treatise “a theory of consumption” in 1957. this model abstracted from retirement saving decisions. this theory distinguishes between permanent and temporary income. income is argued by this model to consist of the permanent (anticipated and planned) component which is the expected long-term average income, and the temporary (transitory or windfall gain or unexpected) component. according to the permanent-income hypothesis, consumption at a particular point in time is dependent on not only on one’s current income but also on their expected future income (permanent income). the theory postulates that a consumer will save only if he expects that his long-term average income (permanent income) will be less than his current income. 2.4. the buffer-stock theory of savings this theory of saving is usually termed as the precautionary savings model. it argues that consumers are impatient and prudent in the face of unpredictable income fluctuations. the buffer-stock theory assumes consumers to be impatient because they resort to borrowing against future income in order to meet (finance) current consumptions if income were certain, and also as prudent because they have precautionary motives. to avoid or avert the dangers associated with future fluctuations in income and also retain a smooth consumption pattern, individuals are forced to set aside some precautionary reserves by way of reducing current consumption in order to save against the contingent occurrences. therefore, one would expect savings rate to be pro-cyclical, with individuals saving more when incomes are higher, in order to smoothen consumption in bad times. 2.5. empirical review although research on savings behaviour of individuals is enormous, much has not actually been done on determinants of deposit levels of commercial banks. according to haron and wan azmi (2006), efforts has been made by some researchers to examine the determinants of private saving and private saving behaviour within countries as well as cross-country comparison of private savings behaviour. in a similar study conducted in indonesia and employing the case of bank muamalat indonesia, by mangkuto (2004) examined the effect bank deposit yield and interest rate on the level of deposits. using data monthly for the period january 2000 to july 2004 the study found a direct correlation between the level of islamic bank deposit and its yield which reflects the attractive nature of higher returns on bank deposits. with a negative correlation between the conventional interest rate and bank deposits, the results also indicated the significance of interest rate in affecting customers saving decisions in the islamic banks. on the empirical determinants of saving in the islamic banks in indonesia, kasri and kassim (2009) also found conventional interest rate and real rate of return to be significant in determining the level of deposits with the islamic banks. the study employed the cointegration technique, the vector autoregressive (var), and impulse response functions (irf) analysis. a similar study in colombia by cardenas and andreas (1998) to study savings behaviour revealed a perfect correlation between savings and investment. savings was found to positively influence growth; with urbanization, age dependency and higher taxation negatively affecting savings. again on islamic banks, muhammad et al. (2011) studied the impact of crisis and some macroeconomic variables on islamic banking deposits in malaysia. the study uses monthly data from january 2000 to december 2010, a cointegration test and vector error correction model the study found interesting results. the variables adopted in the study are the average rate of return in conventional banking fixed-deposits, the consumer price index as proxy of inflation, growth of industrial production index, the base lending rate as a proxy for rental rate, and a dummy for crisis. the variables displayed an i(1) process with the cointegration result indicating at least one cointegration exists at 1% level of significance. the vecm found interesting results. they found negative relationship for both inflation and base lending rate on bank deposits. the growth of industrial productivity index was also found to negatively impact on the level of bank deposits. in conformity to findings of haron and ahmad (2000); kasim et al. (2009) and kasri and kassim (2009), the study also found negative and positive effect rate of return in islamic and conventional banks respectively on bank deposits. apart from the crisis and inflation results, however, muhammad et al. (2011) could not provide strong evidence of the short run effect of shocks in the other variables of the model. the study also tested for model robustness or efficiency and found that the model was efficient. there model was normal, no serial correlation, absence of heteroscedasticity, and there also no evidence of arch effects in the disturbance term. in the study by kasim et al. (2009) which employed monthly data for the period of january 1999 to december 2006, they examined the impact of monetary policy shock on balance sheet of islamic bank in malaysia. findings from the study suggested that the effect of policy shocks on islamic bank are more destabilizing than on conventional banks study by dadzie kofi et al. (2003) found age and formal education variables to be insignificant in influencing the level of personal savings. empirically, the study revealed a significantly positive relationship between savings on one side, and income, service quality, income and demographic characteristics (number of dependents and location) on the other hand. similarly, masson et al. (1998) looked at the factors that influence private savings behaviour of developed and developing countries. the study found demographic characteristics to be very significant in determining the rate of saving in both countries. findings also indicated that factors such as gdp growth, changes in the terms of trade, and asian journal of economics and empirical research, 2015, 2(1):1-7 4 real interest rate had positive relation with saving for both group of countries although the magnitude of the relationship differed for the countries. contrary to theory, the level of foreign savings was found to have a negative relationship with savings in the developing countries. the savings behavior in oecd countries was investigated by sarantis and chris (2001). demographic factors and credit constraints were significant and had the anticipated sign in the overwhelming majority of oecd countries. greater financial liberalization and integration minimized the liquidity constraints, thus leading to lower savings. one of the interesting findings presented by the authors is that government deficit does not increase savings, which is in contrast to the ricardian equivalence. cohn richard and bharat kolluri (2003) also used developed nations in their study. they examined the long run relationship between per capita households saving and the real rate of interest, government savings and social security contributions. their results indicated that savings reacted positively to interest rate, but negatively to government savings and social security contributions. a literature on savings behavior by hondroyiannis (2004), who used cointegration approach in estimating the behavior of greece households. he provided empirical evidence that in the long run savings function is sensitive to fertility changes, old dependency ratio, real interest rate, liquidity and public finance. the work of haron and wan azmi (2006) found a significantly positive result for money supply on savings account. according to them, an increase in money supply will would mean individuals will have more money to hold for speculative motive as postulated by the liquidity preference theory. afanasieff et al. (2002) examines the determinants of banks interest spreads using macro and micro variables in brazil and find that macroeconomic variables have the most impact on bank interest spread in brazil. naceur (2003) investigates the impact of banks characteristics, final structure and macroeconomic indicators on banks net interest margin and profitability in tunisian banking industry for the 1983-2000 period. high net interest margin and profitability tend to be associated with banks that hold o relatively high amount of capital, and with large overheads. naceur finds that inflation and growth rates have negative and stock market development has positive impact on profitability and net interest margin. athukorala and long pang (2003) employing the standard life cycle hypothesis examined the effect of disposable income growth, population, social security contribution, financial reforms, and credit availability on savings. they found growth of disposable income, the aged population, changes in social security contributions, and credit availability to be significant determinants of the level of savings. findings also shows that interest rate had a significant positive impact on savings, while results on inflation variable showed a significant negative effect on savings. ozcan et al. (2003) in a study to investigate the savings behaviour in turkey found a significantly positive effect of inflation, financial depth and measures, and income level on savings. the research in switzerland, dietrich and wanzenried (2009) found significant differences in profitability between commercial banks and these differences can to a large extent be explained by the factors included in the analysis. it found that, better capitalized banks seem to be more profitable. also, in case that a bank’s loan volume is growing faster than the market, the impact on bank profitability is positive. they find that banks with a higher interest income share are less profitable. the most important factors are the gdp growth variable, which affects the bank profitability positively, and the effective tax rate and the market concentration rate, which both have a significantly negative impact on bank profitability in switzerland. 3. methodology 3.1. data and model specification the study evaluates the determinants of bank deposits in ghana using time series data of financial (bank level data) and macroeconomic variables for the period 2000 to 2013. the methodology of the study provides a brief description of the model, estimation technique, data source, and definition of the variables of the model with the prior expectations. this study employ two broad category of time series variables; economic and financial variables in the deposit determinants of banks in ghana. the economic variables were the growth of money supple (gm2+), consumer price index (cpi), the monetary policy rate (mpr), and the all share index (asi) whereas the financial variables consist of the interest rates on deposits (din). in order to determine the effect of the above mentioned economic and financial variables on customer deposits at banks in ghana, the study employ the mathematical model as below: ( ) ( ) where d = total deposit balance at banks din = deposit interest rate mpr = monetary policy rate gm2+ = growth of broad money supply asi = composite index (all share index) cpi = consumer price index; and t denotes time. the dependent variable of the model is the total bank deposits (including current account balance, savings account balance, and fixed deposit balance) and the independent variables are deposit interest rate (din), monetary policy rate (mpr), growth in money supply (gm2+), consumer price index (cpi), and all share index (asi). table.1 below shows the variables of the model, and expected effect of the various variables on consumer deposits. table-1. variables, their denotations and expected signs variables denotation unit expected sign total bank deposit d ghc interest rate din percentage + monetary policy rate mpr percentage + continue asian journal of economics and empirical research, 2015, 2(1):1-7 5 3.2. empirical model and estimation technique the relationship of the various variables under consideration against time are used in examining the trend of bank deposits (d), inflation rate (cpi), money supply (m2+), all share index (asi), monetary policy rate (mpr), and deposit interest rate (din). with the objective to examine the determinants of bank deposits. the model to be estimated is as follows: ( ) where d, din, mpr, asi, gm2+, and cpi is as defined above, and l denote the log i, i=0,1,2…. is the parameter estimates of the regressors, and is error term. annual data is employed to undertake the analysis in examining the effect of the selected macroeconomic variables on bank deposits. there is the need to ensure that the data coverage is sufficient enough for meaningful analysis hence the period under consideration is 2000 -2013. 4. data analysis and findings 4.1. unit root test – augmented-dickey fuller the results of the unit root test (table. 2) demonstrate that all the variables asides growth of money supply are not stationary at the level. growth of broad money supply is i(0) at the level showing the acceptance of the null hypothesis that there is unit root or i(1) for those variables. nonetheless, all display stationarity after the first distinction i(1). the i(1) time series variables subsequently warrants the conduction of a johansen-juselius cointegration analysis. below are the results of the unit root test: table-2. augmented dickey fuller (adf) test for unit root variables test statistic level of integration ld *** -7.534 i(1) lgm2+ * -3.796 i(1) ldin ** -3.349 i(1) lcpi ** -3.123 i(1) lmpr *** -4.530 i(1) lasi *** -3.843 i(1) *, **, & *** represent stationarity at 10%, 5%, & 1% respectively. 4.2. cointegration test johansen-juselius multivariate while one of the variables was i(0) at the levels, five variables were found to be stationary only after the first difference. having such a cumulation of i(0) and i(1) series made it imperative for a cointegration test to be conducted to ascertain if the variables have a long run relationship, otherwise a drift away will not be impermanent. in the test for cointegration, we use the johansen-juselius multivariate cointegration test. the results show that there is a long run relationship between the variables or cointegration. the residuals are stationary which confirms the long run relationship or convergence of inflation (the dependent variable) and the explanatory variables. table-3. johansen-juselius multivariate cointegration test variable order of integration residual series i(0) table-4. residual diagnostic test for model efficiency variables coefficients t-values din = deposit interest rate 0.0258 0.271 mpr = monetary policy rate 0.0103 0.125 gm2+ = growth of broad money supply -0.010 -1.756* asi = composite index (all share index) cpi = consumer price index; and t denotes time -0.0106 -0.6862 -0.107 -2.362** din = deposit interest rate 0.0258 0.271 *** (**)* indicate that the null hypothesis is rejected at 1%, 5% and 10% respectively. table 4 above presents the short-run elasticities between the variables and their lags. the r-squared and adjusted r-squared values of 0.651 and 0.585 respectively is an indication that the model is a good fit. this means more than 65% of variations in bank deposit were explained by the model. the f-statistics of 6.851, with a probability ratio of 0.004 indicates that the overall model is highly significant and that all the independent variables are jointly significant in causing variation in bank deposit. evidence from the table indicates that deposit interest rate and monetary policy rate have a positive insignificant relationship with bank deposit. this implies that deposit interest rate and monetary policy rate are not a major factor in explaining the short run dynamics of the commercial banks’ deposit in ghana. however, all share index have an insignificant negative relationship with bank deposit. inflation represented by consumer price index is shown to be statistically significant (5%) in explaining levels of bank deposits. the relationship however is negative. the negative relationship between inflation and bank deposits could be attributed to the fact that inflation increases the cost of living, “ceteris paribus”. consumers in an attempt to maintain the same standard of living will forgo current savings, hence the possibility of a negative relationship all share index asi numeral growth of money supply gm2+ percentage inflation cpi percentage asian journal of economics and empirical research, 2015, 2(1):1-7 6 between inflation and bank deposits in the short-run. in other words, higher inflation would mean that people will need more money for expenses which will lead to cash withdrawals and a reduction in the level of deposits in general. this finding is in line with the findings of muhammad et al. (2011). furthermore, the growth of money supply also has a significant negative relationship with commercial bank deposits. the bank’s deposits increases with an increase in money supply and vice versa. as expected, increase in money supply reduces the cost of loanable funds which in turn leads to increased borrowing and increased consumption which will mean less savings (reduction in bank deposits) all things being equal. this result for money supply contrasts the work of haron and wan azmi (2006) that found a significantly positive result for money supply on savings account. according to their findings, an increase in money supply would mean individuals will have more money to hold for speculative motive as postulated by the liquidity preference theory. 5. conclusion the study revealed that apart from growth of money supply, the variables of the model are not stationary at levels. however they become stationary after first difference (an i(1) process). the test for cointegration also reported one cointegrating equation at the 5% level of significance for both trace and maximum eigenvalue test statistics. the cointegration equation for the model also suggested that in the long run, a change in deposit interest rate and inflation (cpi) are negative and will both have negative effect on bank deposits, furthermore, a change in monetary policy rate, growth of money supply, and all share index negatively impact bank deposits. the short run effects of a change in the independent variables on bank deposit were found to have the expected influence on bank deposits. however, only inflation and growth of money supply variables were found to be significant in explaining the short run dynamics of bank deposit. a change in the growth of money supply produced a negative sign as expected by the model and a change in cpi also produced a negative impact on bank deposit, which conforms to theory. the study results also reported a significant speed of adjustment (error correction term) with the sign of the error correction factor indicating that the variables share a common trend in the long run, and that approximately 15 per cent of any disturbances in the model is corrected every year. the results also revealed that the saving pattern of the ghanaian depositor conforms to existing theories, although there were some deviations. the study found that inflation as a measure of consumer price index (cpi) negatively impacts on bank deposits in both the short run and long rum. this means that in periods of high inflation, economic agents, both households and firms are forced to supplement their expenses by drawing from the bank accounts, hence a reduction in bank deposits. it is therefore imperative for banks to adopt some promotional campaigns and other prudent measures to curb the adverse effects of inflation on deposits. in anticipation of inflation, banks could adjust their deposit interest rate in some high volume deposits in order to minimize the level of leakages (withdrawals) from the bank’s vaults. again, the growth of money supply was found to have both negative and positive impacts on the level of bank deposits in the short and long run. however the long run positive effect of growth of money supply on bank deposits was found to far outweigh the negative effect in the short run. it is however also important that the bank curbs the level of withdrawals in the short run when there is an increase in money supply. on the macroeconomic level also, this result serves as a tool to the policy makers, especially the central bank in its monetary policy. thus, if the bank of ghana wants to reduce the level of loan advancement by commercial banks in the short-run, it could achieve this by implementing a contractionary policy through decreases in money supply. this results in excess demand for money which increases the cost of loanable fund, hence a reduction in people’s willingness to acquire or take bank loans all things being equal. 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in oecd countries: evidence from panel cointegration tests. the manchester school supplement, 69(s1): 22-41. bibliography friedman, m. and l.j. savage, 1984. the utility analysis of choice involving risk. the journal of political economy, 56(4): 270-304. kiiza, b. and g. pederson, 2011. household financial savings mobilization: empirical evidence from uganda. journal of african economics, 10(4): 390-409. views and opinions expressed in this article are the views and opinions of the authors, asian journal of economics and empirical research shall not be responsible or answerable for any loss, damage or liability etc. caused in relation to/arising out of the use of the content. asian journal of economics and empirical research vol. 4, no. 1, 14-24, 2017 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2017.41.14.24 14 measuring the efficiency of tertiary care hospitals and medical colleges in punjab, an application of nonparametric approach dea asima ihsan1 ( corresponding author) 1punjab economic research institute (peri), planning and development department(p&dd), lahore abstract efficient utilization of resources required that the healthcare units should operate at their full capacity and increase their efficiency to yields best quality healthcare services and more savings. to measure the capacity utilization of medical collages/attached teaching hospitals in punjab, the study incorporated the data envelopment analysis (dea). this is a cross sectional study for the academic year 2015, by using the primary data collected by “punjab economic research institute (peri)“. the main objective to address the efficiency issue in this study is to provide empirical evidence for public policy to provide for tertiary health care facilities. the results showed that 78% medical colleges in a sample data are unity, indicating that they are perfectly utilizing their resources while the remaining 22% have more close to unity, showing that they have only small capacity to increase their output within available resources. in case of teaching hospitals, there are 56% hospitals in punjab, which are not operating at their maximum level of output indicating that they have the capacity to provide more services. while 44% are using their resources efficiently. the higher efficiency score of medical colleges/teaching hospital in provincial capital reflected the fact that decision making units (dmus) in lahore are relatively more efficient in the management of resources. in the second stage, by using a tobit regression, the inefficacies are regressed against various indicators of inputs and outputs. finally, the finding of this study suggests some policy recommendation to make the medical colleges/teaching hospitals more resource effective in order to accelerate the highest efficiency scores. keywords: data development analysis, medical colleges efficiency, hospitals efficiency, tobit regression. contents 1. introduction ...................................................................................................................................................................................... 15 2. public health sector in punjab ..................................................................................................................................................... 15 3. private and public-sector tertiary care hospitals in punjab ............................................................................................... 17 4. objective of the study .................................................................................................................................................................... 17 5. significance of the study ................................................................................................................................................................ 17 6. organization of the study .............................................................................................................................................................. 18 7. theoretical framework of dea ................................................................................................................................................... 18 8. mathematical frame work of dea ............................................................................................................................................. 18 9. constant return to scale and variable return to scale .......................................................................................................... 19 10. data and variable selection ........................................................................................................................................................ 19 11. variable and its description ....................................................................................................................................................... 19 12. descriptive analysis of inputs and output variables of medical colleges/universities .............................................. 20 13. the efficiency and productivity estimates of medical colleges ........................................................................................ 20 14. pearson correlation of inputs indicators and efficiency scores ......................................................................................... 22 15. econometric analysis of the efficiency scores and its determinants ............................................................................... 22 16. results of tobit regression ........................................................................................................................................................ 22 17. data and variable selection for teaching hospitals in punjab .......................................................................................... 23 18. descriptive analysis of inputs and output variables of attached teaching hospitals ................................................. 23 19. the efficiency and productivity estimates of teaching hospitals by using output oriented dea ......................... 24 20. policy recommendation.............................................................................................................................................................. 24 references .............................................................................................................................................................................................. 24 https://orcid.org/orcid-search/quick-search?searchquery=asima ihsan asian journal of economics and empirical research, 2017, 4(1): 14-24 15 citation | asima ihsan (2017). measuring the efficiency of tertiary care hospitals and medical colleges in punjab, an application of nonparametric approach dea. asian journal of economics and empirical research, 4(1): 14-24. history: received: 21 march 2017 revised: 7 july 2017 accepted: 13 july 2017 published: 26 july 2017 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. 1. introduction service-oriented commercial world is getting growing apprehension in all over the world. consequently, the researchers are now more interested to incorporate the efficiency analysis in service sector than to industrial and production sector e.g. the healthcare and education institution. health sector has been emerged as a fastest growing sector in the global world during last few decades. the health care providing system involves high costs, especially in the developing areas like punjab because the health service facilities in punjab are very much resource intensive. so, the efficient utilization of resources required that the healthcare units operates at their full capacity and increase their efficiency to yields best quality healthcare services and more savings. however, unlike other types of service organizations, the management of health sector in punjab focus more on the supply side of clinical, and non-clinical healthcare physical infrastructure such as to upgrade the infrastructure, building up new primary, secondary and tertiary heath units but the quality issues get less consideration by them. unfortunately, these clinical and non-clinical considerations are often found to be simple medical error when appraisal of the decisions making is taken. the basic reason is that the policy makers often do not come up with lessons and insights on how to deal with the basic requirement through knowledge based real and applied studies and practices, which is more relevant, useful and sensitive to indigenous people. these inaccuracies in healthcare facilities can be magnificently resolved if hospital management is aware of global better practices. these types of inefficiencies by the management generates the requirement for endorsing access to high-quality healthcare services that is efficient, effective, and equitable the demand for operational research in the health is needs of time and is rising very fast since last few decades. it is for this reason the hospitals and medical colleges efficiencies are regularly evaluated in many developed and developing countries in order to streamline the health activities and to increase control over quantity, quality and efficiency of resources. many studies have been conducted in this perspective but most of the researchers consider only operational attributes; there are only few studies in literature which have also considered the qualitative indicator such as patient satisfaction level from health service, the data on such indicator is obtained via patient satisfaction surveys quality in healthcare services but however, it is a difficult perspective and not easy job to quantify it. the global demand for operational research in health care services and succeeding action produced many studies over the years around the world, resulting in extensive literature on healthcare services efficiency measurement. some of the researchers measure quality and performance of the hospitals which incorporate quality of health care service and efficiency of the practice. some techniques used by researchers’ measures a mixture of quality & quantity attributes and operational efficiency or they checked the productivity of governmental reforms in healthcare. thus, the hospitals’ efficiency and productivity can be measured by using specific indicators so that the promoted efficiency in health system can be realized, by analyzing and planning for a better efficiency index. this study intends to make use of non-parametric technique, collectively known as data envelopment analysis (dea) that is intensively used in measuring the hospital efficiency. the methodological framework of dea enables the researchers to evaluate the efficiency of those particular organizations which possess multiple homogenous inputs and outputs, and where data about prices is missing. thus, the technique is well fitted for calculation of hospital efficiency. in reality, multiple inputs/outputs are commonly recurring rationalization for using dea-type approaches. furthermore, the decision makers can also use dea as analytical tool for monitoring purposes such as to point out hospitals with deviating performance structures. such monitoring may help the management to identify the gaps and increase the efficiency of the hospital. it offers an idealized benchmark to evaluate economic performance of healthcare service. secondly; the efficiency scores can also be helpful as contextual information in the distribution of resources to different hospitals. this is particularly relevant not only for the regulated tertiary care hospital sectors of punjab but also for all other health care units in punjab health system. so, this study incorporates the efficiency measurement of tertiary care hospitals and medical colleges in punjab. 2. public health sector in punjab the population of punjab is more than ten million, which is about 56 percent of the total population of pakistan. in spite of the fact that the province has an extensive network of primary, secondary and tertiary health care infrastructure, health indicators have not reached the desired level. i77/1000 live births infant mortality ratio, 112/1000 live births under 5 mortality rate. 300/100,000 live births maternal mortality ratio (information & communication cell, 2016) is recorded in year 2015, total fertility rate has been reached to 4.7, the malnourished children in province are about four million, and about a third of all pregnant women are estimated to have iron deficiency anemia. stunting and wasting is estimated to be 34 percent and 10 percent respectively. undernourishment is found to be a major contributor to maternal and infant deaths. with these highest mortality ratios, pakistan slipped from 147th to 149th position in global ranking (ikram, 2015). table 1 provides broad indicators of health infrastructure in the state. http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2017, 4(1): 14-24 16 table-1. number of functional and reporting health facilities in punjab 2015 health facility dhos thq dhq rhc bhu mch disp shc tbc total 33 109 27 302 2483 224 319 26 14 per 100,000 population 0.032 0.106 0.026 0.296 2.43 0.219 0.312 0.254 0.013 source: district health information report (dhis) 2015 besides the above-mentioned health care infrastructure, there is also network of health services that has been specifically designed for implementing various national health programmes. in terms of availability of workforces in health sector, the punjab has 74500 registered doctors (pm and dc, n.d) of which about 1/7th are working in public health units. besides doctors, there is qualified manpower such as nurses, technicians, lhvs, lhws, dispensers, vaccinators, midwives etc., in health sector as well. the total allocated beds allocated to all public health units are 37,272; hospital beds work out to be 37 beds per lakh of population or one bed for 2736 persons. health department of punjab provides preventive, curative and promotive types of care, preventive health facilities aim to prevent diseases through different interventions, curative services aims to cure diseases once they befell and health promotive services are associated to health education. to deliver these services, health units in punjab are divided into three categories. first, primary health care contains rural health centers (rhcs), basic health units (bhus), dispensaries and maternal and child health centers (mchcs). secondly, figure-1. tertiary care hospitals and medical education nominal budgeting structure source: annual development programme (adp) & current budget statements, punjab secondary health services comprises of tehsil headquarter hospitals (thqs), and district headquarter hospitals (dhqs) which are first and second level referral facilities to provide critical, ambulatory and inpatient health care. the third category includes the teaching hospital or tertiary care hospital (tch) which are the main health units with specialized facilities under the administrative authority of province. this study made use of tertiary care hospitals and medical colleges’ data in private and public sector to measure the capacity utilization of resources of the units fall in third category. given the declining development budget allocations to the tertiary health sector and generous more focus on preventive health in punjab has made it critical and very significant the efficient use of existing resources. tertiary care health service is the expensive and advance level of health care compared to primary and secondary health care. curative tertiary care health is the necessity and fundamental right for individuals at micro level, and a crucial requirement for human capital growth and development in a country at the macro level. the total public sector budgetary expenditure on health sector shows positive but not promising figures in last 4 years, however, the share of development spending on tertiary health facilities is still very low (see figure 1). the total public sector expenditure on health has increased from rs 58.11billion in 2012-13 to rs 82.504 billion in 2015-16 but the development budget presents worst picture in year 2015-16 as the share has been reduced to 34% which was 43% in 2014-15. in case of infrastructure provision, availability of inpatients beds varies across private and public sector, from one bed per 4730 inhabitants in public sector to 9716 in private sector. both, the number of beds per head of population and the occupancy rate are comparatively high. admission rates and turnover rates have also been relatively high in provincial tertiary care hospitals. asian journal of economics and empirical research, 2017, 4(1): 14-24 17 table-2. population to bed ratio in private and public sector tertiary care medical facilities public sector private sector beds population to bed ratio beds population to bed ratio essential specialties 25356 8984 7248 13990 allied specialties 10147 9993 3188 31806 total 21434 4730 10436 9716 overall public and private sectors population to bed ratio beds population to bed ratio essential specialties 18535 5470 allied specialties 13335 7604 total 31870 3181 source: author’s calculation by using available data of tertiary heath sector punjab 3. private and public-sector tertiary care hospitals in punjab besides public health and medical institutions, punjab has a significant existence of private medical colleges and affiliated teaching hospitals. the influence of many of these health units in serving the inhabitants and addressing their health needs is quite impressive. these private sector health and medical institutions have also the managerial capacity to generate their own resources through user fees and donations. the government of punjab has set some guidelines for these private sector institutions to run which implies that these institutions do not have complete autonomy in their decision making such as in admissions of medical students, recruitment, procurement of supplies and capital investment etc. most of the decisions are held under the rules of pakistan medical and dental council (pm&dc). the improvement in of quality services, efficiency and performance must be the key indicators in these decisions. they generate most of their revenue by the user fees. another source of revenue can be to raise funds through donations and grants from community and trusts including private sector and industry. this gives them much better financial flexibility. the public sector medical institutions and health units are mostly funded by the public sources. the distribution of medical colleges/attached teaching hospitals in punjab is given in table 3. in punjab, there are 19 medical colleges and 28 affiliated teaching hospitals in public sector out of which, 6 medical colleges and 8 affiliated hospitals are in lahore. in private sector, there are 35 medical colleges and 56 attached teaching hospitals. the tertiary care health sector in punjab is facing breaks and diversion in the accessibility of funds due to more concentration and allocations on the procurement of preventive health care facilities in previous some years as has been shown in figure 1 that the development budget spent on tertiary care facilities has been decreased by 43 percent to 34 percent in 2015-16. the primary objective to measure efficiency in health sector is to improve the productivity of existed resources of health care (romley, 2009). table-3. private and public medical colleges and teaching hospitals in different districts source: pakistan medical & dental council(pm&dc) 4. objective of the study  the primary objective of this study is to evaluate the relative efficiency of public and private tertiary care hospitals and medical colleges of punjab by using nonparametric approach.  the second objective is to compare the aggregate efficiency of private sector tertiary health care units to public units.  to provides suggestion for two sets of institutions on the basis of empirical findings by using data set in specific time period. 5. significance of the study several attempts by various researchers have been made to evaluate the efficiency of public and private sector’s hospitals in different countries of the world by using different parametric and non-parametric methods particularly in developing economies like china (sun, 2016) saudi arabia (al-shayea, 2011) india (mogha, 2012) etc., but only few studies have been found in punjab especial in the area of measuring the efficiency of medical colleges/universities, so this study is an attempt to fill this gap. this study would also provide guidance to the management of each dmu in the institution to make improvement in the use of resources and providing services. this study would highlight the weak aspects of the management of institutions through comparative inputs/outputs analysis and provide proposition to make changes in quantity and quality of inputs and outputs variables in order to achieve high rank of efficiency. district with medical colleges/teaching hospitals public medical institutions attached tertiary care hospital private medical institutions attached tertiary care hospital lahore 06 08 14 22 faisalabad 01 02 03 04 sialkot 01 02 02 05 multan 01 01 03 03 gujarat 01 01 01 03 rawalpindi/islamabad 03 07 09 14 sargodha 01 01 01 02 sheikhupura 00 00 01 02 wah cantt 00 00 01 01 sahiwal, gujranwala, bahawalpur, rahim yar khan, dg khan 05 (01 each) 06 0 0 total 19 28 35 56 asian journal of economics and empirical research, 2017, 4(1): 14-24 18 6. organization of the study the rest of the study is ordered as the next part gives a brief view of data envelopment analysis literature and mathematical framework. part 7-11 discusses the theoretical and mathematical framework of methodology, selected variables and its description, data compilation etc. part 12-19 talked about the results derived from empirical data. the conclusion with the final comments and future extension has been given in last part. 7. theoretical framework of dea the concepts of efficiency used in this study means the technical efficiency. a decision-making unit (dmu) is considered technically efficient if it is an efficient producer of the product or service relative to others. the classical linear programming provides rationale for data envelopment analysis (dea) technique. dea sometimes known as frontier analysis is non-parametric mathematical procedure used to calculate the relative efficiency and productivity of managerial decision making units which possess several inputs and outputs. the dea has been pioneered by charnes et al. (1978). the dea model given by charnes was known as ccr model. the ccr model was initially applied only on those technologies distinguished by constant return to scale. some extensions were made in ccr model by banker et al. (1984) to address the technologies categorized by variable return to scale. until now, the significant developments in dea were acknowledged by. at the present time, the usage of dea methodology to compute the relative efficiency of homogenous decision making units of profit and non-profit organization, for example universities, schools, police stations, public and private libraries, agricultural farms, hospitals, insurance companies, commercial banks, national parks have become very common. the following table gives us information about record of the references published on the use of dea methodology from 1978 through 2016. this information table supported the growth of dea as an acknowledged effective tool in a various set of fields. table-4. list of the most popular keywords by number or publication keywords number of publications keywords number of publication bank or banking 4730 non-parametric 3540 dea or data envelopment analysis 17600 mathematical programming 13200 decision making units 29600 health care or hospital 69 decision theory 36800 non-parametric statistics 2620 economics of dea 16300 education 9520 efficiency 651000 optimization 4700 linear programming 17900 multivariate analysis 1680 management 16,100 regression analysis 5530 mathematical models 19100 production 753 operational research 18900 benchmarking 1960 performance (management or evaluation) 9090 resource utilization 2700 productivity 48200 parametric 80 technical efficiency 22,000 statistical analysis 58 source: authors search by using google scholar search engine 8. mathematical frame work of dea dea model in mathematical form can be written as following: if all decision-making units are expressed by n, every dmu has m inputs and n outputs. the technical efficiency score of every dmu can be measured by solving the following model proposed by charnes et al. (1978)   for each dmu p = 1,2,3.......... p n u y j j p j = i maximize =e p m v x k k p k = 1 n u y j j ij = 1 subject to £1 " i m v x k k ik = 1 u v ³0 " k, j 1j, k     where k = 1, 2, 3………. n j = 1, 2, 3………...m i = i, 2, 3………...n = the amount of output j produced by ith unit, = the amount of inputs k utilized by ith unit, = weights given to output j = weights given to inputs asian journal of economics and empirical research, 2017, 4(1): 14-24 19 the problem set shown in can be transformed into linear programming as following; decision variables the weights are unidentified as priory. the unknown weights of outputs ju and weights of inputs kv are calculated via dea software, by using the data set of variables, as a method of measuring the relative efficiency of each dmu. these unknown weights are estimated individually for each unit of organization so that the level of highest efficiency score can be attained. furthermore, these inputs and outputs weights should be categorically positive so that the chance that some inputs or outputs might be omitted in the process of measuring the efficiency of each dmu can be avoided. 9. constant return to scale and variable return to scale the productivity change can be measured under constant return to scale and variable return to scale. the constant return to scale approach was pioneered by charnes et al. (1978). while the variable returns to scale approach was introduced by banker et al. (1984). by constant return to scale it means that one unit change in inputs will cause one unit change in output produced while variable return to scale means that each additional unit of input will increase the output more than one unit. to measure the relative efficiency of wildlife and public and private tertiary care hospitals and medical colleges, dea has been used in this study. the tertiary care hospitals in urban areas and wildlife parks are considered one of the very important tool of curative health and to generate economic gains for many people around the area of hospital by producing so many activities. consequently, a competent, adequate, well organized and efficient hospital allows metropolitans to offer healthy human capital and also grows as catalysts for economic, social and ecological development. 10. data and variable selection no computerized and centralized data of medical colleges was available publicly. the data of 35 medical colleges and 54 attached teaching hospitals in both public and private sector for the year 2015 has been collected through survey by the punjab economic research institute (peri) team. the variables selected are different from other health sector dmus (hospitals, bhus, rhcs) due to change in responsibilities of each. only those inputs and outputs variable are selected for analysis, which reflect the informative, comprehensive and general results. for medical colleges, we have considered three outputs such as total revenue from student fee, total number of enrolled undergraduates student (salleh et al., 2016) in each medical colleges of punjab, total number of enrolment of postgraduate trainees (ruggiero, 2016) quantity of undergraduate degrees 1 (johns, 2006). total number of medical teaching staff (deng, 2016) is incorporated here as an input variable. furthermore, medical/lab equipment, fine buildings and essential utilities are all fundamental elements of medical colleges/universities infrastructure that support students, trainees and teaching faculty to perform their work efficiently, accordingly, total number building infrastructure facilities 2 is also included as an indicator of input, total available training beds, total employment related expenses are also indicators of inputs. 11. variable and its description in medical teaching institutes, many inputs have been used by the management to yield a particular health care outputs through a production process. the eventual goal/output of establishing medical institute in a society is to produce competent professionals in healthcare system to bring the quality change in health status but this indicator is intangible and very hard to measure. consequently, some intermediary outputs as given in table 5 customarily become the primary indicators to measure the output. this production process does not occur in a vacuum; besides many internal factors, it is also being influenced by a number of economic, political, social and environmental factors. both factors are important and equally influence the efficiency of production units. due to data constraints on external variables, only those indicators are selected for analysis which is considered to be well-regulated by the hospital managers. the figure illustrates the connection between medical college system inputs, the production process, and the outputs. 1 all the students cleared the degree exam are considered eligible for mbbs degree only undergraduate’s degrees are included for analysis because in many private sector colleges, there is no facility of postgraduation 2 building infrastructure includes all basic and essential clinical departments, faculty area, tutorial rooms and labs or museum as per pmdc approved criteria. the facilities are counted in numbers only. asian journal of economics and empirical research, 2017, 4(1): 14-24 20 figure-2. internal and external factors influence the production process source: author’s selection by using available literature 12. descriptive analysis of inputs and output variables of medical colleges/universities the wide variation can be observed across medical colleges in private and public sector.by means of the descriptive statistics (mean, slandered deviation, minimum and maximum) (table 6). the total number of undergraduate students vary between 46 to 1713. the annual fees from undergraduate students are the major source of revenue in medical colleges which vary from rs. 1.6 billion to 5.17 billion/year. similarly, the employment related expenses vary from minimum 2.711 billion to maximum 11.2 billion/year table-6. descriptive statistics of the inputs and outputs of medical colleges in punjab (n = 35) variables n mean std. dev. min max total operational revenue 35 197709778.9 176420781.9 16608390 517484000 total numbers of undergraduate student 35 726.6857 503.1613 46 1713 total number of enrolled pg trainees 35 104.257 139.0360 0 447 quantity of undergraduate degrees awarded 35 125.800 123.6275 0 463 total number of medical teaching staff 35 206.114 126.0672 38 653 total number of building infrastructural facilities 35 5.314 1.58618 5 6 total number of training beds 35 752.886 675.9040 25 3216 total number reading material in libraries 35 22334.257 26014.7935 1780 94936 total employment related expenses 35 271182058 112411691.2 123200100 698873640 source: author’s calculation the output oriented dea technique has helped us to measure the relative efficiency of 35 private and public sector medical colleges. for given a fixed quantity of inputs, when decision making units (dmus) are expected to produce output as much as possible, the output oriented model in suitable to apply. the results have been obtained by using deap 2.1 software. 13. the efficiency and productivity estimates of medical colleges both the vrs (variable return to scale) and crs (constant return to scale) has been executed for calculation, because practically, all decision-making units dmus) are not functioning at an optimal scale. figure 4 provides the relative efficiency estimates 35 public and private medical colleges in punjab. dea results have been divided into 3 categories to show the efficiency of medical colleges. these categories are crs, vrs and scale efficiency (se). the efficiency aggregates in table 6 shows that 71% hospitals are technically efficient under crs and 82% under vrs. the average vrs efficiency score illustrating that inefficient medical colleges are 10% less utilized their current resources. the average scale efficiency is 96% indicating that the existing medical colleges have the capacity of only 4% to alternate their scale without interrupting their output level. the maximum efficiency score is 100 or 1 whereas, the minimum efficiency score is 0.305. seven (20%) medical colleges are functioning under drs indicating that their medical education and relating health care services outputs is expected to increase by a lower proportion for any increase in inputs. these medical units are not required to increase their size to achieve optimal level of output or at crs level. four dmus are functioning under irs and 17 are operating under constant return to scale implying that these dmus are operation at their optimal level and that increase in inputs will give an equal proportion of output. asian journal of economics and empirical research, 2017, 4(1): 14-24 21 figure-3. technical efficiency estimates of medical colleges in punjab source: authors estimations by using deap software scale inefficiency does not appear to be a common problem in medical colleges of punjab, 71% medical colleges are found technically scale efficient. the mean of e scale efficiency score is 93% which illustrates that on average, the scale inefficient medical colleges can supposedly shrink or increase their size by 7% without upsetting their current productivity level. table-7. ranking of medical colleges on the base of vrs technical efficiency scores medical college name ranki ng return to scale medical college name rankin g return to scale king edward medical university lahore 1 crs wah medical college 1 crs fatima jinnah medical university lahore 1 crs sharif medical & dental college, lahore. 1 irs services institute of medical sciences 1 crs pak red crescent medical and dental college 1 crs sheikh khalifa bin zayed al-nahyan medical and dental college , lahore 1 crs rai medical college sargodha 1 crs ameer-ud-din medical college 1 crs aziz fatima medical & dental college fsd 1 irs sargodha medical college 1 crs islam medical college 1 drs nashtar medical college 1 drs sialkot medical college 1 crs gujranwala medical college 1 rashid latif medical college 1 crs cmh lahore medical college and institute of dentistry 1 sahiwal medical college 1 drs rawalpindi medical college 1 drs sheikh zayed medical college r.y.k 2 drs dera ghai khan medical college 1 irs quaid-e-azam medical college 3 drs khawaja safdar medical college, sialkot 1 drs punjab medical college faisalabad(allied) 4 allama iqbal medical college. 1 crs university medical & dental college faisalabad 5 drs fmh college of medicine & dentistry 1 crs nawaz sharif medical college university of gujrat 6 drs central park medical college 1 crs avicenna medical college 7 drs azra naheed medical college 1 crs lahore medical & dental college 8 drs rehabber medical & dental college, lahore 1 crs continental medical college lahore 9 irs independent medical college faisalabad 1 crs source: author’s calculations the total number of efficient medical colleges in punjab are 20 under crs and 26 under vrs. the 20 colleges are found scale efficient. the maximum efficiency score is 100% while the minimum efficiency score under crs is 0.232 obtained by the continental medical college in private sector. table-8. summary of efficiency aggregates efficiency aggregates under crs under vrs scale efficiency number of efficient medical colleges 20 27 20 number of inefficient medical colleges 15 8 15 maximum efficiency (percentage) 1.00 1.00 1.00 minimum efficiency(percentage) 0.227 0.232 0.233 source: author’s calculations asian journal of economics and empirical research, 2017, 4(1): 14-24 22 14. pearson correlation of inputs indicators and efficiency scores the pearson correlation has been computed between input indicators mentioned in table 4 and vrs efficiency scores. these indicators are not expected to be the defining factors of efficiency scores. these indicators must not be highly correlated to the efficiency scores, because they only partially measure the relation between some inputs and outputs. all the indicators are found insignificantly correlated to efficiency scores (table 7) except employment related expenses. the employment related expenses however are negatively and significantly correlated with the vrs efficiency scores. the higher the employment related expenses of dmu would resulting a lower efficiency score. 15. econometric analysis of the efficiency scores and its determinants the relative efficiency scores of medical colleges calculated in the previous section was regressed by using tobit regression in this section against both discretionary and nondiscretionary factors indicated in figure 2. there are number of regression techniques which can be usefully applied at this second stage to identify the most influencing factors of inefficiency such as the maximum likelihood (ml) based probit, logit, the ordinary least square method(ols) and censored & truncated regression (tobit). in this analysis, we employ the tobit model or censored normal regression model because of the condition that all values of dea efficiency scores are clustered around 0 to 1. for computational convenience, the tobit model is assumed to be left censored to zero. for tobit regression analysis, the first step is to transform the vrs dea efficiency scores into inefficiency scores. for transformation, the formula given below is used. (see equation 1) inefficiency score = 1 1 vrsefficiencyscore  ………… (1) to investigate the relationship between inefficiency of medical colleges and its determining factors, the standard tobit model can be defined as follows: * *ify* 0 y 0 i i i i i y x y y otherwise       ………………… (2) where 2~ (0, )i n  , β represent the coefficient parameter for all explanatory variable xi. after the transformation of dea scores, the coefficient of the tobit model can be interpreted as if it is a coefficient of an ordinary least squares regression that represent the proportionate change in response variable, due to a one unit change in explanatory variable while keeping constant. to significantly explain the determinants of inefficiencies, we have selected some potential variables. by using an iterative process, the models consist of several endogenous and exogenous variables have been run but the finally selected model to explain the empirical results is based on chi square and is given below: 1 2 3 4 5 6deg expineffmc tenrolled ug tr tstaff own             total undergraduate enrolled students in the institution and undergraduate degrees issued by the institution are the important output of any medical institution. accordingly, both variables are incorporated here. student’s fees are the major operating revenue of medical college/university. the indicators of total expenditures in term of teaching staff salaries and total number of staff is also incorporated in model. the dummy variable of medical college/university ownership status has also been included in the model to reflect the effect on the inefficiencies 16. results of tobit regression it is observed that the coefficients of all variables are not jointly equal to zero(prob>chi2), so we are in the position to reject the null hypothesis that the regression coefficients of all independent variables are jointly equal to zero, consequently the model as a whole is fit significantly. the coefficient of total number of enrolled undergraduate students reflect negative sign but the coefficient is statistically insignificant at the selected level. total number of ug enrolled students in the institution are negatively linked to the inefficiencies and is statistically significant to determine the inefficiency. one unit increase in number of ug students is likely to decrease the inefficiency score by .00205%. total revenue from student fee(tr) is also found statistically significant which means that this indicator has negatively influencing feature on the inefficiency of medical colleges during the period of analysis. employment related expenses variable is also found statistically significant and is positively linked to determine the inefficiency of unit. total teaching staff, available training beds and ownership status are not significant indicators to explain the inefficiency of medical colleges. we can conclude that the management and ownership of medical colleges are likely to be more efficient if focus on the significant indicators influencing the inefficiency of medical colleges. asian journal of economics and empirical research, 2017, 4(1): 14-24 23 figure-4. efficiency scores of teaching hospitals source: author’s calculations table-10. results of tobit model variables coefficient t p>|t| total number of undergraduate enrolled (t enrolled) -.002327 -1.43 0.164 quantity of undergraduate degrees (ug deg) -.002055 3.75 0.001 total revenue from students’ fee(tr) -.0000075 -2.62 0.014 total teaching staff (t staff) .0016315 0.47 0.645 total available training beds (tb) -.0001604 0.17 0.863 total employments related expenses .000000586 1.90 0.069 ownership 1.5591 -0.47 0.644 source: author’s calculations number of observations = 35 lr chi2(7) = 20.66 prob > chi2 = 0.0043 log likelihood =214383 pseudo r2 = 0.3252 17. data and variable selection for teaching hospitals in punjab the most important output of any hospital is the number of inpatient and outpatient (mogha, 2012) so both variables are incorporated here for analysis as outputs. different types of diagnostic test are one of the important source of revenue of teaching hospitals whether they are operated in public or private sector, so used in this study as outputs but are segregated as low, medium and high, on the base of cost per test. total number of serving staff (mujasi, 2016) and total beds allocated (mujasi, 2016) in each hospital are used as inputs 18. descriptive analysis of inputs and output variables of attached teaching hospitals descriptive statistics showed a wide variation across teaching hospitals. the total inpatients vary between 408 to 7080000. the diagnostic laboratory tests are the major source of revenue in teaching hospitals. revenue from low cost diagnostic test vary from 40210 to 70200000. in some teaching hospital, there is no facility of medium and high cost diagnostic test, so minimum values are zero. similarly, the total allocated beds vary from minimum 25 to maximum 2330. table-12. descriptive statistics of the inputs and outputs of teaching hospitals (n = 54) variables n mean std. dev. min max total inpatients revenue 54 106701 171446.1 408 7080000 total outpatients’ 54 217088.03 176323.5 3510 734483 total low diagnostic test 54 15700000 .000952 40210 70200000 total medium diagnostic test 54 3630000 .000676 0 31400000 total high diagnostic test 54 2320000 .000425 0 20400000 total serving staff 54 433.8333 576.5917 28 3759 total allocated beds 54 518.5741 475.3034 25 2330 source: author’s calculations by using stata 13.0 asian journal of economics and empirical research, 2017, 4(1): 14-24 24 19. the efficiency and productivity estimates of teaching hospitals by using output oriented dea the relative efficiency estimates of 54 public and private teaching hospitals in punjab under crs, vrs and scale efficiency (se) are showed in figure 9. the average efficiency under crs is about 60% which indicates that inefficient teaching hospitals are 40% less utilizing their resources than the optimal level. the resource utilization of teaching hospitals under vrs assumption is 73% indicating that the inefficient teaching hospitals have 27% more capacity to better make better utilization of their resources. 20. policy recommendation  to make the analysis more definitive, the qualitative and quantitative data on all relevant inputs and output of all private and public sector medical colleges/ teaching hospitals should be frequently composed. health sector, pm&dc and uhs can initiate if the data of all type of indicators of medical education/hospitals is available then it can be organized as a part data-collection platforms such as district health information reports and demographic health surveys etc. furthermore, in order to attract the donor agencies such as the usaid, world bank, unicef for strong funds/aids flowing into the health sector, all types of management weaknesses and resources waste is necessary to be eliminated or significantly reduced. technical inefficiency is an example of such weaknesses.  for efficient utilization of resources, the system performance assessment should be a priority area of policy makers.  for efficient service delivery of medical education and tertiary health care, basic missing staff vacancies must be fulfilled. staff training to improve the quality of service is also necessary. the government can take initiative to establish a training institute for medical teaching doctors/service providers for capacity building in both private and public sector and to meet the international standers.  total number of students enrolled every year and undergraduate degrees issued by the institution are needed to be revised. the inefficiency of medical institutions is likely to be improved by increasing the number of seats.  majority of the medical teaching institutes/ teaching hospital in both private and public sector are located in lahore and these are operating at their full capacity level. the government should take initiatives to establish the new tertiary health care institution in other cities also.  continuous monitoring and evaluation of the institutions are necessary as in most of the institutions, the serving staff does not meet the pm&dc criteria. the check list of pm&dc is also needed to revised according to efficiency estimates.  missing specialties in inefficient teaching hospitals are needed to be established to facilitate the inpatients and outpatients.  there is a great burden of inpatients and outpatients in teaching hospitals at lahore. the current data shows that the patients are treated beyond the capacity of the hospitals and doctors. government is required to make policies to establish similar facilities in teaching hospitals of other districts as well so as to lower the burden and to provide access to speedy health facilities. the private teaching hospitals may have encouraged in this perspective by enhancing their facilities and 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https://scholar.google.com/scholar?hl=en&q=measuring%20hospital’s%20units%20efficiency:%20a%20data%20envelopment%20analysis%20approach https://scholar.google.com/scholar?hl=en&q=some%20models%20for%20estimating%20technical%20and%20scale%20inefficiencies%20in%20data%20envelopment%20analysis http://dx.doi.org/10.1287/mnsc.30.9.1078 https://scholar.google.com/scholar?hl=en&q=measuring%20the%20efficiency%20of%20decision%20making%20units http://dx.doi.org/10.1016/0377-2217(78)90138-8 http://health.punjab.gov.pk/punjab_health_profile https://scholar.google.com/scholar?hl=en&q=data%20envelopment%20analysis%20and%20its%20application%20to%20the%20measurement%20of%20efficiency%20in%20higher%20education http://dx.doi.org/10.1016/j.econedurev.2005.02.005 http://www.pmdc.org.pk/ http://www.pmdc.org.pk/statistics/tabid/103/default.aspx https://scholar.google.com/scholar?hl=en&q=efficiency%20and%20its%20measurement:%20what%20practitioners%20need%20to%20know https://scholar.google.com/scholar?hl=en&q=efficiency%20and%20productivity%20changes%20of%20the%20malaysian%20community%20colleges http://dx.doi.org/10.6007/ijarbss/v6-i12/2505 asian journal of economics and empirical research issn(e) : 2409-2622 issn(p) : 2518-010x vol. 3, no. 2, 130-138, 2016 http://asianonlinejournals.com/index.php/ajeer 130 performance evaluation of uk acquiring companies in the pre and post-acquisitions periods khurshid ali1 zeeshan khan2 numan khan3 abdul-hamid ibrahim alsubaie4 fazal subhan5 moumen kanadil6 1 salford university manchester, uk 2 pakistan institute of development economics (pide) 3 center for management & commerce, university of swat 4 university of liverpool, uk 5 subject specialist economic department of elementary secondary education, kp, pk 6 salford university manchester, uk. ( corresponding author) abstract this paper has two objectives: first, it examines the financial performance of twenty uk based acquiring companies over the period of five years (2009-2013) using financial ratios of liquidity, profitability and solvency in order to empirically determine whether there is any significant financial performance changes in the operation of the underlying companies as a result of acquisitions. both average ratio and paired t-test analysis have been conducted. the analysis concludes that none of the ratios proved statistical significance which shows that the underlying acquisitions did not influence changes in the financial performance of the acquiring companies. the paper also examines whether shareholders make short-term gain while opting for acquisitions by analyzing stocks return over 58 days window period i.e. 29 days prior to acquisition announcement and 29 days after acquisition announcement by applying capm model and aar and caar analysis. the analysis concludes that none of the results show statistical significance which further asserts that uk shareholders do not make gain in the short-term as a result of the acquisition activities they have undertaken. keywords: financial performance, liquidity, profitability, solvency, acquisition, capm, aar, caar. contents 1. introduction ....................................................................................................................................................................... 131 2. literature review .............................................................................................................................................................. 132 3. research methodology ...................................................................................................................................................... 133 4. hypothesis .......................................................................................................................................................................... 134 5. research design ................................................................................................................................................................. 134 6. empirical analysis ............................................................................................................................................................. 135 7. discussion ........................................................................................................................................................................... 135 8. conclusion .......................................................................................................................................................................... 136 references .............................................................................................................................................................................. 137 appendices ............................................................................................................................................................................. 137 citation | khurshid ali; zeeshan khan; numan khan; abdul-hamid ibrahim alsubaie; fazal subhan; moumen kanadil (2016). performance evaluation of uk acquiring companies in the pre and post-acquisitions periods. asian journal of economics and empirical research, 3(2): 130-138. doi: 10.20448/journal.501/2016.3.2/501.2.130.138 issn(e) : 2409-2622 issn(p) : 2518-010x licensed: contribution/acknowledgement: this work is licensed under a creative commons attribution 3.0 license all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. history: received: 19 august 2016/ revised: 24 september 2016/ accepted: 30 september 2016/ published: 13 october 2016 ethical: this study follows all ethical practices during writing. publisher: asian online journal publishing group http://www.uswat.edu.pk/index.php/departments/management-commerce/ http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.2/501.2.130.138 https://orcid.org/orcid-search/quick-search?searchquery=khurshid ali https://orcid.org/orcid-search/quick-search?searchquery=zeeshan khan https://orcid.org/orcid-search/quick-search?searchquery=numan khan 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https://orcid.org/orcid-search/quick-search?searchquery=khurshid ali https://orcid.org/orcid-search/quick-search?searchquery=zeeshan khan https://orcid.org/orcid-search/quick-search?searchquery=numan khan https://orcid.org/orcid-search/quick-search?searchquery=abdul-hamid ibrahim alsubaie https://orcid.org/orcid-search/quick-search?searchquery=fazal subhan https://orcid.org/orcid-search/quick-search?searchquery=moumen kanadil http://search.crossref.org/?q=10.20448/journal.501/2016.3.2/501.2.130.138 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.2/501.2.130.138 https://orcid.org/orcid-search/quick-search?searchquery=khurshid ali https://orcid.org/orcid-search/quick-search?searchquery=zeeshan khan https://orcid.org/orcid-search/quick-search?searchquery=numan khan https://orcid.org/orcid-search/quick-search?searchquery=abdul-hamid ibrahim alsubaie https://orcid.org/orcid-search/quick-search?searchquery=fazal subhan https://orcid.org/orcid-search/quick-search?searchquery=moumen kanadil http://search.crossref.org/?q=10.20448/journal.501/2016.3.2/501.2.130.138 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.2/501.2.130.138 https://orcid.org/orcid-search/quick-search?searchquery=khurshid ali https://orcid.org/orcid-search/quick-search?searchquery=zeeshan khan https://orcid.org/orcid-search/quick-search?searchquery=numan khan https://orcid.org/orcid-search/quick-search?searchquery=abdul-hamid ibrahim alsubaie https://orcid.org/orcid-search/quick-search?searchquery=fazal subhan https://orcid.org/orcid-search/quick-search?searchquery=moumen kanadil http://search.crossref.org/?q=10.20448/journal.501/2016.3.2/501.2.130.138 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.2/501.2.130.138 https://orcid.org/orcid-search/quick-search?searchquery=khurshid ali https://orcid.org/orcid-search/quick-search?searchquery=zeeshan khan https://orcid.org/orcid-search/quick-search?searchquery=numan khan https://orcid.org/orcid-search/quick-search?searchquery=abdul-hamid ibrahim alsubaie https://orcid.org/orcid-search/quick-search?searchquery=fazal subhan https://orcid.org/orcid-search/quick-search?searchquery=moumen kanadil http://search.crossref.org/?q=10.20448/journal.501/2016.3.2/501.2.130.138 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.2/501.2.130.138 https://orcid.org/orcid-search/quick-search?searchquery=khurshid ali https://orcid.org/orcid-search/quick-search?searchquery=zeeshan khan https://orcid.org/orcid-search/quick-search?searchquery=numan khan https://orcid.org/orcid-search/quick-search?searchquery=abdul-hamid ibrahim alsubaie https://orcid.org/orcid-search/quick-search?searchquery=fazal subhan https://orcid.org/orcid-search/quick-search?searchquery=moumen kanadil http://search.crossref.org/?q=10.20448/journal.501/2016.3.2/501.2.130.138 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.2/501.2.130.138 https://orcid.org/orcid-search/quick-search?searchquery=khurshid ali https://orcid.org/orcid-search/quick-search?searchquery=zeeshan khan https://orcid.org/orcid-search/quick-search?searchquery=numan khan https://orcid.org/orcid-search/quick-search?searchquery=abdul-hamid ibrahim alsubaie https://orcid.org/orcid-search/quick-search?searchquery=fazal subhan https://orcid.org/orcid-search/quick-search?searchquery=moumen kanadil http://search.crossref.org/?q=10.20448/journal.501/2016.3.2/501.2.130.138 asian journal of economics and empirical research, 2016, 3(2):130-138 131 1. introduction companies from across the world are increasingly looking to mergers and acquisitions (m&as) as one of the most appropriate means for strategic expansion into other markets (reynolds and teerikangas, 2016). as m&as provide greater opportunities for companies to enter international markets to build new competencies and capabilities as well as to reach their global clients (singla et al., 2012). among developed countries uk’s companies in particular showed greater interest in m&as across the world which is evident from the acquisition of 7,026 companies by uk acquirer companies during 1996 to 2005 while the number of deals further raised to 1008 during 2006 (ahammad and glaister, 2008). moreover, the post-recession (2007/08) scenario shows an increasing trend in merger and acquisition as revealed by bloomberg (2015) that $467 billion worth of m&as deals have been announced in the first quarter of 2015 which is predicted to even over take pre-recession growth witnessed during 2007; majority of the deals were executed in either usa or uk which can be attributable to the free market and corporate friendly practices in both of the economies. however, one third of all m&as deals announced during 2014 in europe collapsed at the final stages of execution where some of the biggest deals even failed to meet the market expectations. for example, pfizer’s $53 billion bid for astrazeneca made a lot of buzz in the market but soon the us drug maker’s takeover passion fell flat in front of the uk takeover panel’s rules (the telegraph, 2014). throughout the history of m&as, uk in particular remained a breeding ground for m&as activities as evident from research literature that during 1995 to 2005 uk companies had the highest merger and acquisitions deals in the usa, europe and asia pacific region (ahammad and glaister, 2008). this trend was fueled by many determinants however the more encouraging determinant of m&a for uk companies was to acquire more market share in order to gain long term financial objectives as well as to maintain global presence in order to remain competitive (jansson et al., 1994). even in the post-recession period the uk economy shows higher surge in m&as activities as in the first quarter of 2014 £37.5 billion worth of m&a deals were struck which is by far the largest development since 2007. the uk’s healthcare sector witnessed the largest m&as activities accounted for 26.9 percent of the preceding figure where the sale of glaxosmithkline’s oncology division to novartis for £8.6 billion was one of the mega mergers (raconteur, 2014). the surge in m&as deals is contributable to the rather healthy economic indicators prevalent in the uk as institutions and investors alike looking for avenues to generate higher return on their long kept capital. uddin and boateng (2011) has empirically supported this by arguing that gdp, money supply and share price have statistically significant influence on the level of uk’s mergers and acquisitions activities across the world. in spite of the surge in m&as across the world, it is still ambiguous whether m&as result in value creation for shareholders. as many researchers advocate that agency problems overwhelm and often ignore the objectives of m&as to create shareholders value (danbolt, 2004). the management of bidding company often pursue their own utility maximization through acquisition that may include increasing their own power, status and salary etc. other researchers such as firth (1991) and bliss and rosen (2001) cited by danbolt (2004) also support the argument that cross border mergers and acquisitions often found to be benefiting managers rather than shareholders as managers of the bidding company often overestimate the value of the economic benefit of the proposed merger resulting in extra cost to acquiring companies. nevertheless, substantial research finding also support the argument that merger and acquisition lead to value creation for shareholders. looking at a relatively broader aspect of merger and acquisition, it is always proved to be a gateway to adapt firm to the external macro level changes such as the ever increasing economic integration of nations, cultural homogenization, and the liberalization of trade and capital markets; thus m&as may not benefit in short-term however the long term benefit is inevitable to come (elango, 2006). through acquisition firm gain quick control of an established firm in the host country as is evident by the example of tesco acquisition of star bazaar stores in india from tata group that enabled tesco to quickly gear up its corporate strategy according to local market needs through which tesco penetrated with greater speed than would have been possible through greenfield operation. however, there can be pitfalls as often argued by researchers such as over valuation of the target firm, increased cost as a result of cultural dissimilarities, acquisition of undesirable assets, and successful integration can lead to drastic consequences. moreover, certain portion of policymaker in the uk do believe that m&as do not benefit uk economy that came out more evidently during the kraft foods bid for cadbury plc during 2009 where the deal faced considerable resistance. as a result the uk takeover panel presented a number of changes to uk takeover codes aimed at protecting the interest of the target firm. the failure of pfizer and astrazeneca $53 billion deal is the result of uk’s protectionist policy that can severely damage uk’s reputation of being a corporate friendly market famous for high value m&as deals. similarly, the short-term value gain for shareholders as a result of merger and acquisition is also being widely debated in the literature, however, handful of researchers such as hassan et al. (2004); du and boateng (2014) and dutordoir et al. (2014) empirically defend that m&as result in short-term gain for shareholders as they argue that capital markets react to acquisition announcement positively that in turn result in abnormal gain for underlying stocks. in any case value creation through m&as remains central to every m&a deal. however, value creation at the same time is attributable to several factors i.e. effective global competition, growth potential of the hosting market, favorable input cost, improved distribution network, lower cost of capital, regulatory infrastructure of host country and favorable exchange rate etc (picot, 2002 cited by ray and ray (2014). however, in the longer run most of the mergers deals fail from shareholders’ perspective when measured against the stock price because the abnormal gain in the short run is quickly incorporated in the security price. moreover, the post-acquisition phase often involve complex operations that lead to considerable delay resulting in the erosion of net present value of cash flow that causes negative impact on the overall process of m&as underlying plan resulting in total failure (businessweek, 2002, cited by macdonald (2005)). the m&a deal between rover and bmw well explains the scenario where the deal was prematurely cancelled because the post-merger integration process took several years which destroyed the anticipated shareholders value instead of gaining from the merger while daimler and chrysler also met the same fate (kursten, 2008). this leads to the understanding that shareholders value creation through m&as is wide area to be researched in order to determine whether shareholders value creation in the short term can be attained. asian journal of economics and empirical research, 2016, 3(2):130-138 132 2. literature review value creation through mergers and acquisition (m&a), in the context of uk’s bidders and target firms, has been discussed widely in the literature; however, whether it creates value for uk shareholders in the short-term is either supported or ruled out by various findings. as evident by the findings of uddin and boateng (2009) who investigate cross border acquisitions of 373 uk’s acquiring firms during 1994 to 2003 in order to determine the factors influencing the short term performance, argue that uk’s bidding firms do not earn positive abnormal return in the short-run by examining stock price performance of 373 uk bidding firms involved in cross border mergers and acquisition during 1994 to 2003. they further argue that the absence of abnormal return through m&a can be contributable to the competitive nature of uk’s market where any new information is being quickly incorporated in the security price. however, contrary to this, chanmugam et al. (2005) by writing an investigative article to measure the performance of 350 post-merger integration engagement aimed at determining common grounds for successful m&a, argue that the entire m&a process hardly create value for shareholders because the valuation process for any potential m&a has become much more familiar as it (m&a) leads to almost similar synergies and therefore the market does not react abnormally. however, they argue that value creation can still be achieved by focusing on several areas i.e. treating m&a as holistic process, giving emphasis on value creation rather than integration and minimizing the time required to execute merger and acquisition. another study conducted by delaney and wamuziri (2004) who investigate the financial performance of uk’s construction companies that have carried out any merger or acquisition deals in order to empirically examine the impact of merger announcement on both acquiring and merging firms stocks performance, reveals that shareholders of target firms earn abnormal positive returns prior to the announcement of an acquirer firms bid; however, it does not last long enough. the study further reveals that the bidder firms found to be having greater returns in the longer period following the merger announcement mainly after forty days period. this shows that market does not react instantly to the bidders’ firms stocks prices because for market post acquisition scenario seems to be much more important that appropriately judges the success or failure of any underlying m&a; as goergen and renneboog (2003) who investigate the short-term wealth effects of large (intra)european takeover bids to determine whether short-term gain can be achieved through m&a, argue that in most of the cases the shareholders of target firms demand a premium over and above the current stock price as a condition to accept the acquisition offer, therefore, the acquiring firm would require efficient managerial strategy to cover the cost of the m&a as well as create value for the shareholders. this puts greater emphasis on the acquirer firm capabilities to generate increased cash flow stream that exceeds the acquisition bid premium. this is well evident by the findings of schoenberg and bowman (2010) who, by proposing a typology of acquisition value creation logics and recommending implementation process based on governance, cost and knowledge variables, argue that value creation in the merger and acquisition process is entirely dependent on the organizational capabilities of the acquirer to cover successfully the post implementation phase. according to schweiger and very (2003) who investigating the complex relationship between valuation, pricing, strategic objectives, synergies and integration in the m&a process, argue that it is the successful integration of m&a that leads to value creation as previous records show that majority of the m&as proved to be unsuccessful in terms of financial expectations which is contributable to lack of strategic fit or inadequate due diligence. similarly, ray and ray (2013) who propounding a different connotation of synergy for cross border m&as, also argue that value creation can only be achieved through successful implementation of post-acquisition integration plan. this shows that m&a is holistic process where in addition to incremental cost other aspects such as over valuation, potential synergies etc should be examined prudently. in order to expand and reap the benefits of synergies companies across the world strive hard to make acquisition deals more than ever before as is evident by bloomberg findings that reveals that $467 billion worth of m&a deals have been announced in the first quarter of 2015 while it predicts that if the deals continued with this pace it can beat prerecession period of summer 2007 when m&a proposals reached to $933.4 billion (bloomberg, 2015) more than fifty percent of the deals occurred in america and britain where both having open markets for corporate (the economist, 2014). nevertheless, one of the senior funds manager (cited by the economist (2014)) argue that m&a deals only benefit executives and enrich bankers at the expense of shareholders, as he argues that when firm announce acquisition share prices of the acquiring firm starts to fall because investors fear that the premium they pay could exceed the benefits from the potential synergy. contrary to this mckinsey consulting firm argues (cited by the economist (2014)) that since 2012 share prices of the acquiring firms either remained stable or have risen which certainly leaves a room for further empirical investigation. in the context of uk market merger and acquisition is being viewed as the major strategic tool through which companies can gain short-term financial gains for shareholders. however, the more encouraging determinant of m&a for uk companies is to acquire more market share in order to gain long term financial objectives as the findings of jansson et al. (1994) revealed who carried out investigating the determinants of cbma of uk manufacturing companies in europe. as evident from the past literature uk companies had the highest investments in foreign industrialized countries through the acquisition of foreign companies. eu companies in particular were the highest targets for uk companies however between 1995 to 2005 uk companies acquired us firms which accounted for 29 percent of the overall cross border mergers during the mentioned period. similarly, asia-pacific region also remained a third target for the uk firms as argued by ahammad and glaister (2008) who investigated the driving forces behind the ever increasing m&a deals and also reviewed the recent trend of cbma by uk firms. the uk companies follow standard term i.e. they have acquired manufacturing companies in europe, canada and american, however, in the asia-pacific region the uk companies concentrated on the acquisition of service sector companies. this shows that expansion through cross border merger and acquisition (cbma) is much more common for uk companies across the world. the uk economy in particular shows strong economic recovery indicators since the financial crash in 2007/08 therefore companies position themselves for growth mainly through mergers and acquisition. in the second quarter of 2014 £37.5 billion worth of m&a deals were struck which is by far the largest development since 2007 witnessed by asian journal of economics and empirical research, 2016, 3(2):130-138 133 the uk’s market. the uk’s healthcare sector witnessed the largest m&a activities accounted for 26.9 percent of the preceding figure where the sale of glaxosmithkline’s oncology division to novartis for £8.6 billion was one of the mega mergers (raconteur, 2014). according to market analysts cited by raconteur (2014) surge in mergers and acquisition in the uk’s market is contributable to several factors however strong economic growth in particular has played a greater role as the uk’s gdp has witnessed a 3 percent growth in the third quarter of 2014 as compared to previous year while the grim economic indicators in the euro zone, as a result of potential euro zone breakup, has started to subside that has considerably helped the market to recover. ian sale, a managing director at lloyds bank commercial banking acquisition’s finance, says: ″we have seen demand and supply conditions for m&a improved markedly over the past year. investors looking for yield, cash-rich trade buyers, a hungry banking sector and private equity houses with funds to deploy have all contributed to a highly liquid market.″ (raconteur, 2014). nevertheless, value creation as a result of mergers and acquisition still remains an intriguing area as several research findings such as chanmugam et al. (2005); kursten (2008); macdonald (2005) support the idea that most of m&a deals benefit executives rather than shareholders. however, yet substantial research findings support the idea of value creation for shareholders as a result of mergers and acquisition. as argued by boyer and choi (2007) who by investigating the reasons that contribute to the consolidation of financial services industry and also examine some cases of successful and unsuccessful m&as, argues that synergy or value creation for shareholders is an inevitable result of mergers and acquisition subject to the successful implementation of integration, adequate valuation and limited diversification. similarly, kursten (2008) while investigating why shareholders should be prudent when managers assure value gains from a potential synergetic mergers, argue that even synergetic merger cannot guarantee any benefits to shareholders unless the value of the synergy exceed certain level, thus he rules out the idea of shortterm gain for shareholders however he argues that in the longer run shareholders can benefit from synergetic m&a. that is why macdonald (2005) while elaborating his viewpoint on shareholders’ value creation, argues citing businessweek findings that during 1995 to 2000 majority of the mergers were failure from shareholders point of view when measured against the price of the stock. the study further complements that often the mergers deals were overvalued resulting in compromising shareholders’ value creation. another study conducted by hassan et al. (2004) in the context of us pharmaceutical industry which investigates short term abnormal returns of 405 m&a during 1981 to 2004 finds that abnormal short term gains were witnessed in the case of acquiring companies but overall, except roa and cash flow improvements in some instances, most of the measures were found to be insignificant statistically. this can be argued that although pharmaceutical companies carry out high volume of transactions to forge m&a deals mostly often in billions dollars however still do not result in short term gains which cast some doubt on the efficacy of the mergers of large firms. nevertheless, there are instances where large companies m&a deals have become success stories as evident from numbers of research findings. as evident by the findings of du and boateng (2014) who by investigating the effect of state ownership and institutional influences on value creation through cbma by chinese firms using a sample of 468 firms during 1998 to 2011, findings empirically support the argument that cbma results in short-term gain for shareholders in the context of chinese acquirer firms that have earned abnormal returns over 10 days event window and founds that chinese security market reacts positively to acquisition announcement. moreover, their findings further assert that government and institutions play a decisive role in cbm&a value creation. however, value creation cannot be confined to government or institutions role but rely on several variables that lead to value creation for shareholders. the findings of dutordoir et al. (2014) who by investigating bidding firms’ motives for disclosing a synergy forecast when announcing a merger or acquisition, best illustrate the example by proving it empirically that the disclosure of potential synergy information by acquiring firms is being perceived positively by the security market that in turn results in value creation for shareholders in the short-term. thus it can be argued that value creation is much broader term that requires a holistic approach to ensure value creation rather than relying on predefined variables. that is why singla et al. (2012) by investigating cross border merger and acquisition on the financial performance of indian acquiring companies, argue that value creation determinants of cbm&a such as profitability ratios, cash flow measures and stock market estimates compared to industry peers vary from country to country. in other words, in some countries stock market estimates may trigger value creation but in other country security market may not be efficient enough to reflect the success of a particular m&a. this is well evident by the findings of elango (2006) who by investigating the impact of international acquisition announcement on an insurance firm’s shareholder’s wealth, argue that overseas acquisition were found to be insignificant statistically in terms of market returns which the author contributed to factors i.e. the degree of wealth of the host country, amount of bilateral trade between host and home country, extent of potential liabilities of foreignness (lof) faced by the firm, and economies of scope. moreover, some of the m&a deals may not be meant to create short term shareholders value but rather be aimed for like growing bigger in size or achieving global status in order to ensure long term strategic growth as argued by singla et al. (2012). 3. research methodology a number of researchers have investigated empirically the short-term gain of uk acquiring firms and have also reported statistically significant positive return for uk shareholders delaney and wamuziri (2004); hassan et al. (2004) and du and boateng (2014). however, some of the researchers such as chanmugam et al. (2005); kursten (2008); macdonald (2005) do not support that view that m&as can result in short-term gain for shareholders. nevertheless, researchers like dutordoir et al. (2014) and singla et al. (2012) argue that there are several variables that contribute in the creation of shareholders value as a result of mergers and acquisition deals both in the short and long-term scenarios. researchers have applied both quantitative and qualitative methods to dig deep into the area whether shareholders benefit from any proposed merger/acquisition deals. however, majority of the researchers such as singla et al. (2012); du and boateng (2014); hassan et al. (2004) and delaney and wamuziri (2004) have carried out quantitative empirical research based on time series data of the respective companies stocks to determine whether there is any influence on the movement of security as a result of merger/acquisition. this study also aims to examine asian journal of economics and empirical research, 2016, 3(2):130-138 134 the impact of cross border merger and acquisition on the financial performance of uk acquiring companies by using financial ratios i.e. profitability, liquidity and solvency analysis. moreover, to analyse the immediate impact of cross border merger and acquisition on the uk acquiring companies shareholders’ wealth time series data of stocks prices has been analysed through regression analysis. 4. hypothesis h0 (1): the financial performances of uk acquiring companies do not change significantly after the acquisition compared to their pre-merger/acquisition level. h0 (2): the shareholders of uk acquiring companies do not gain significant value from mergers and acquisitions activities. 5. research design the current study undertakes an empirical research aimed at determining whether merger/acquisition by the uk acquiring companies result in short-term gain for uk shareholders. the study is based on 20 uk based companies from various sectors that have gone through merger/acquisition activities during 2009 to 2013. prior to this work several researchers such as uddin and boateng (2009) have attempted to investigate value creation through m&as in the context of uk but are conducted in either pre-recessionary period i.e. before 2007 or confined to specific industry such as the work by delaney and wamuziri (2004) and jansson et al. (1994) carried out research work for either uk construction industry or manufacturing industry respectively. thus, the sample of this study would provide a relatively greater insight of the uk m&as activities as the sample incorporate leading companies from almost all the uk’s industries as well as the sample period covers both the recession period (2009/2011) and period when uk’s economy started recovering from the financial recession during 2012 and 2013. table 1 provides detailed illustration. in order to assess pre-merger and post-merger impact on companies’ performance, a sample of 5 years (20092013) has been selected which consist of 2 years prior to acquisition and 2 years after acquisition coupled with acquisition year in order to assess the pre-merger and post-merger performance of the underlying firms stocks. out of the twenty sampled companies 4 companies carried out acquisition in 2009 followed by 7 in 2010 and 3 in 2011. one company had acquisition in 2008 and 2 companies had acquisition in 2013. in order to test the first hypothesis profitability, liquidity, debt and solvency ratios of the sampled companies are calculated. the analysis involves computing the underlying ratios for the period of two years prior to merger and two years after the merger as well as the calculation for the acquiring year. the industry average number has been used to nullify the effect of other factors on corporate performance in the underlying period. these ratios i.e. profitability, liquidity and solvency have been chosen to continue with researchers tradition as many prominent researcher have used these ratios to examine the financial performance of different organizations. as liu et al. (2013) profitability, solvency and liquidity ratios to examine financial differences between chinese and japanese firms; similarly liquidity and profitability ratios have also been used by borhan et al. (2014) to examine the financial performance of chemical company. finally, tan et al. (1997) used profitability, liquidity and solvency ratios among other to measure the financial performance singapore listed companies. moreover, in the context of mergers and acquisitions singla et al. (2012) liquidity, profitability and solvency ratios to investigate the financial performance of indian acquiring companies using 15 companies over the period of four years i.e. 2005 to 2008. therefore, based on the wide application of liquidity, profitability and solvency ratios in the literature of measuring financial performance of companies the following ratios have been selected for this study. the ratios are explained as follow; 1. liquidity ratio: current assets / current liabilities this ratio measures the company’s short-term assets, i.e. cash, cash equivalent, marketable securities, receivables and inventory, to determine whether the company can meet its short-term liabilities efficiently. the higher ratio exhibit better liquidity position of the company. 2. operating profit ratio: operating profit / sales this ratio measures the level of a company’s revenue leftover after paying for variable cost i.e. wages, raw materials etc. a higher operating ratio would indicate that the company is stable enough to service its debt obligation. 3. debt equity ratio: total liabilities / total assets – total liabilities or net assets this ratio measures the level of debt a firm has against each dollar it owns. higher ratio in this instance would pose a considerable for an organization as it would be burdened with greater amount of debt than which can be viewed as unsustainable in the eyes of lenders. 4. net profit: profit after tax / sales this ratio measures the percentage of money a company actually earns per dollar of sales. the higher ratio would indicate that the company has good cost management in place that results in higher net earnings. 5. ronw (return on net worth): profit after tax or net income / equity this ratio measures the firm’s profitability by revealing the extent of profit the company generates by deploying shareholders’ equity. the higher ratio would indicate that company has efficiently deployed its resources to generate more income. financial ratios have been used extensively in the literature mainly to measure firms’ financial performance such as samad and hassan (1999) used financial ratios to measure the financial performance of malaysian banks. in the context of merger and acquisition singla et al. (2012) have used financial ratios to determine indian companies’ financial performance both in pre-merger and post-merger periods. in order to test the second hypothesis, event methodology has been applied. this will measure the reaction of acquirer’s companies stocks to the announcement of merger activities in order to determine whether abnormal return can be gained or not. the following equation is being used; art = rt – e(rt) (1) where t = day relative to an event, art = abnormal return on the stocks for the day t, rt = actual return on the security for the day, e(rt) = estimated rate of return on the security for the day t. in order to calculate the estimated asian journal of economics and empirical research, 2016, 3(2):130-138 135 rate of return of the security capital asset pricing model (capm) is being used where a period of 180 days prior to the event window is used for estimating the stocks’ beta. using the equation (1), the abnormal return for all the 20 acquiring firms has been computed for 58 days window period i.e. 29 days prior to the acquisition announcement date and 29 days after the acquisition announcement date. the abnormal return has been summed up for each day in order to determine the pattern of cumulative average abnormal return (caar). 6. empirical analysis the analysis of prominent financial ratios (see table 4.1) i.e. liquidity, profitability and solvency ratios indicate no statistical significance both in the pre-merger and post-merger periods. in order to nullify the effect of other factors, although cannot be ruled out entirely, in the industry the ratios are averaged two years before the merger/acquisition and two years after the merger/acquisition. the five ratios show no statistical significance in any of the periods thus it all leads to the acceptance of first null hypothesis that the post-merger/acquisition financial performance of the uk acquiring companies is not significantly different from pre-merger/acquisition financial performance. the results are consistent with findings of singla et al. (2012) who, in the context of indian acquiring companies, found that none of the financial ratios showed statistical significance in the both pre and post-merger periods. moreover, the analysis of individual companies ratios on yearly and two yearly bases, both in the pre-merger and post-merger periods, also reveals no significant financial performance thus it can be concluded that no abnormalities has been observed in the financial performance of the acquiring companies as a result of merger/acquisition announcement. the average liquidity ratio shows almost equal position in the two years before and two years after the m&as activities. this shows that acquiring firms’ liquidity position has not been affected by the underlying mergers and acquisitions activities. moreover, debt to equity ratio showed exactly the same pattern in the two years before and after the acquisition. similarly, operating profit ratio followed the same pattern, however, net profit ratio declined slightly in the two years after the acquisition which can be contributable to the relative rise in expenses as a result of the underlying acquisition. finally, ronw ratio showed negative trend, almost shrank by 60 percent, in the two years after acquisition which shows that uk shareholders incurred considerable losses as a result of acquisition, however, the same ratio remained stable during the one year after the acquisition which can be contributable to the short span of time where post-acquisition process are still underway while in the longer run such as in the twenty four months period the net present value of cash is being negatively affected because of the prolonged post-integration process that erodes profitability. to further verify the aforementioned results the paired t-test results (see table 4.2) reveals that none of the financial ratios are significant statistically as the mean difference of the two periods i.e. pre and post-mergers are minimal which suggest there was no significant improvement in the financial performance after the acquisition. moreover, the ronw ratio although shows negative effect after the acquisition however is not statistically significant as evident from the t-test results. thus, the first null hypothesis can be accepted. the standard deviation shows that beta, calculated for 30 days period, remained stable for all the companies both in the pre-merger and post-merger 58 day window period except trifast, brady, optos dead and omg where the standard deviation of the respective companies’ beta showed negative trend. thus, it can be argued that on average the underlying companies stocks did not react abnormally to changes in the market or to the announcement of the acquiring companies’ merger/acquisition news. hence, this leads to the acceptance of second null hypothesis that there is no significant impact on the acquiring companies’ shareholders’ wealth due to the announcement of cross border merger/acquisition news. moreover, the paired t-test results for the stocks shows no statistical significance over the 58 days window period that further confirms that no significant gain was observed as a result of acquisitions announcement by the underlying companies. the results of average abnormal return (aar) (see figure 4.1) shows that prior to acquisition announcement aar remained negative for almost over two weeks period; however only sharp positive increase of .81 and .84 percent were observed one week prior to acquisition announcement date but soon followed by negative trend. similarly, after the announcement of acquisition date the aar suddenly goes in an upward direction reaching .96 percent following for over two weeks with slight variation followed by a negative trend in the last week of the 29 days window period in the post-acquisition time. this, however, shows that as a result of acquisition activities market react positively to the changes that in turn result in short-term gain for shareholders as argued by delaney and wamuziri (2004). thus, shareholders of the acquiring firms had marginal gain only for a short while after acquisitions. however, the cumulative average abnormal return (caar) (see figure 1) shows negative trend for the entire period and even reached to -5.04 percent after the acquisition announcement. this shows that over the 58 days period shareholders incurred considerable losses rather than gain. the relative longer negative trend of caar in both pre and post-acquisition announcement period can be contributable to the relative grim economic indicators prevalent in the uk market during 2009 to 2013 where capital market in particular found to be more sceptic to such announcements following the collapse of northern rock, rbs as well as the bailout of big financial institutions in the uk triggered by economic recession during 2007/08. the outcomes of caar are inconsistent with the results of singla et al. (2012) cumulative average abnormal return where caar of the indian acquiring firms showed almost marginal gain instead. moreover, the results of this study are also inconsistent with the findings of delaney and wamuziri (2004) who argue, in the context of uk construction companies, that shareholders of bidding firms earn abnormal positive returns prior to the announcement of an acquirer firms bid; however, it does not last long enough as was the case in this study findings of arr where the gain reached to .96 percent but for a short period of time. 7. discussion greater portion of the literature review examined until now empirically support the arguments that shareholders of the bidding firms do not gain from the acquisition process as well as they argue that bidding firms do not seem to improve their financial position as a result of acquisitions. the results of this study in the context of uk’s acquiring asian journal of economics and empirical research, 2016, 3(2):130-138 136 companies also support the findings of the earlier studies. the examination of financial ratios mainly liquidity, profitability and solvency over the two years window period before acquisition and after acquisition report no significant improvement as well as the acquiring year also shows no financial improvement. the insignificance of the results can be contributable to number of reasons. uddin and boateng (2009) giving one potential reason by explaining that uk has competitive capital market that instantly absorb any new information therefore shareholders cannot make abnormal returns as a result of acquisition announcement instead the market closely observe the activities therefore, as evident from the results, no financial improvement is observed in the short-term i.e. two years after the acquisition. secondly, chanmugam et al. (2005) explain that the non-value creation of mergers/acquisitions can be contributable to the relative mature process of m&as as every company uses identical process to undertake m&as activities that often lead to overestimating the potential synergies that in turn leads to financial losses rather than gain. as evident by the prevalent literature that during implemental or integration phase most of the m&as cost increases as a result of complex structural and cultural issues. thus, the companies under investigation might also have the met the same of incurring post-mergers/acquisitions problems. thirdly, the results of this study can also be contributable to the sample period (2009 to 2013) as the uk economy was passing through the worst ever recessionary period during this time that brought the entire economic activities to almost a standstill. as evident from the findings of uddin and boateng (2011) that gdp, money supply and share price has significant impact on the cbm&as activities in the uk. they further argue that managers need to time acquisitions activities with macrolevel variables, i.e. the relative upward movement of gdp, in order to make value for shareholders. the investigation of the underlying companies stocks through capm model over the 58 days window period also proved to be insignificant statistically i.e. the stocks observed an insignificant abnormal return over the underlying 58 days window period. this can also be the result of the relative downward trend witnessed in the overall stocks market during the sampled period as grim economic indicators were prevalent in the uk, europe and usa in particular. moreover, mergers/acquisitions activities are being carried out at a larger scale than ever before as $467 billion worth of m&a deals have been announced in the first quarter of 2015 only (bloomberg, 2015) therefore market closely observe the underlying cost of m&as, the potential synergies and the successful implementation of the integration process. furthermore, it becomes a growing concern in the capital markets across the world that acquisition result in the sudden fall of acquiring companies stocks as investors fear that the potential synergy as a result of m&as may be of less economic value than the premium they pay to the target firms. hence, the outcomes of campm in this study may also be the result of the general perception about m&as prevalent in the market. contrary to the preceding results, aar (average abnormal return) exhibited positive abnormal gain one week prior to acquisition date which although did not last long but yet shows that market receive the acquisitions news positively that in turn give rise to shareholders return in the short-run. moreover, in the post-acquisition announcement period abnormal return was seen positive for almost over two weeks with slight variation that again reaffirm the general notions that the uk acquiring companies shareholders gain in the short-term as a result of acquisitions activities. nevertheless, the results of cumulative average abnormal return (caar) of this study is also consistent with the proceeding results i.e. both in pre and post-acquisition period caar a continuous negative trend has been observed in the stocks return and that shows that market did not react positively to the announcement of acquisition deals as supported by majority of the literature. thus the findings of delaney and wamuziri (2004) that uk shareholders gain from acquisition activities in the short-term can be ruled out in the context of this study. the outcomes of the caar in this study is also inconsistent with the findings of singla et al. (2012) who witnessed abnormal cumulative return in the post-announcement period in the context of indian acquiring companies. 8. conclusion the analysis of financial ratios of profitability, liquidity and solvency of the acquiring firms reveals no significant change. in other words neither in the pre-acquisition period nor in the post-acquisition period has no significant financial improvement been observed in the financial performance of the uk acquiring companies. the ratios were also analysed using paired t-test analysis to nullify the effect of other industrial variables but none of the ratios found to be statistically significant. this can mainly be the result of the general economic downward of the uk economy during 2009 to 2013 as a result of financial recession where big corporations in particular suffered severe financial problems across developed countries’ markets. that is why the acquiring companies’ pre-acquisition financial position could be the result of financial recession while the post-acquisition financial performance can be contributable to the relative premium share price they pay to the target companies that result in higher cost which can only be recovered in the longer period subject to acquiring companies’ management efficiency (goergen and renneboog, 2003). moreover, the analysis of the acquiring companies stocks through capm model over 58 days window period, i.e. 29 days prior to acquisition and 29 days after the acquisition, reveals no abnormal average return during all the 58 days event window further confirm that no significant gain was made by the uk shareholders as a result of the underlying acquisitions activities. this can be contributable to the fact that greater number of m&as are being carried out in the uk therefore the market do not react instantly to the news as acquisitions are often being viewed by investors as long term process that takes considerably longer to result in profitability (chanmugam et al., 2005). secondly, during the sampled period most of the companies’ stocks experienced downward trend as a result of financial recession in the uk hence this could have greater influence on the analysis. moreover, the cumulative average abnormal return (caar) of the acquiring companies showed consistent negative return over the entire period of 58 days window period before and after acquisition announcement. however, aar result showed positive trend prior to acquisition announcement and after acquisition period but did not last long but yet it can be established, at least in the context of aar analysis, that shareholders had a marginal gain over the short-term period before and after acquisitions. the outcomes of the caar in this study however are not consistent with the findings of several asian journal of economics and empirical research, 2016, 3(2):130-138 137 researchers such as delaney and wamuziri (2004); boyer and choi (2007); hassan et al. 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p. very, 2003. creating value through merger and acquisition integration. advances in mergers and acquisitions, 2(1): 1-26. singla, r., a. saini and r. sharma, 2012. cross border mergers and acquisitions: a performance evaluation of indian acquiring companies. asia-pacific journal of management, research and innovation, 8(2): 127-132. tan, m.s.p., c.h. koh and c.l. low, 1997. stability of financial ratios: a study of listed companies in singapore. asian review of accounting, 5(1): 19-39. the economist, 2014. the new rules of attraction. retrieved from http://www.economist.com/news/business/21632675-latest-boomdealmaking-appears-more-sensible-its-predecessors-valuations-are [accessed 10th august 2015]. the telegraph, 2014. tesco to invest in india. retrieved from http://www.telegraph.co.uk/finance/personalfinance/expatmoney/10740210/tesco-to-invest-in-india.html [accessed 11th august 2015]. uddin, a. and a. boateng, 2009. an analysis of short-run performance of cross-border mergers and acquisitions. review of accounting and finance, 8(4): 431-453. uddin, a. and a. boateng, 2011. explaining the trends in the uk cross-border mergers & acquisitions: an analysis of macro-economic factors. international business review, 20(5): 547-556. appendices table-3.1. list of acquiring companies companies companies 1 smith & nephew 11 huntsworth 2 prudential 12 g4s 3 advanced med.sltb.gp 13 allocate software dead 4 trifast 14 national express 5 cobhem 15 pearson 6 brady 16 ultra electronics hdg 7 immigination technologies 17 inmarsat 8 optos dead 18 associated brit. foods 9 omega diagnostics group 19 halma 10 rsa insurance group 20 omg source: samples for the study through yahoo finance and companies annual reports. http://www.bloomberg.com/news/articles/2015-08-04/smartphones-on-the-beach-for-london-dealmakers-sweating-m-a-boom http://raconteur.net/finance/m-and-a-grows-as-uk-economy-recovers http://www.economist.com/news/business/21632675-latest-boom-dealmaking-appears-more-sensible-its-predecessors-valuations-are http://www.economist.com/news/business/21632675-latest-boom-dealmaking-appears-more-sensible-its-predecessors-valuations-are http://www.telegraph.co.uk/finance/personalfinance/expat-money/10740210/tesco-to-invest-in-india.html http://www.telegraph.co.uk/finance/personalfinance/expat-money/10740210/tesco-to-invest-in-india.html asian journal of economics and empirical research, 2016, 3(2):130-138 138 table-4.1. pre and after results calculation for uk based companies sampled in this study average 2 years before average 1 years before average years of acquisition average 1 years after average 2 years after liquidity ratio 1.99682 1.96472 1.88070 1.86611 1.80036 debt profit ratio 1.25093 1.18827 1.22486 1.09945 1.25525 operating profit ratio 0.10196 0.12138 0.10477 0.11841 0.11976 net profit ratio 0.09512 0.07966 0.07876 0.12452 0.06264 ronw 0.12758 0.10864 0.10951 0.11789 0.08776 source: author’s own calculation through excel table-4.2. t-tests and descriptive statistics for pre and after merger and acquisition ratio mean mean difference standard deviation t-test liquidity before 1.9808 0.0227 liquidity after 1.8332 -0.1475 0.0465 0.0563 dept equity before 1.2196 0.0443 debt equity after 1.1774 -0.0422 0.1102 0.6648 operating profit before 0.1117 0.0137 operating profit after 0.1191 0.0074 0.0010 0.4165 net profit before 0.0874 0.0109 net profit after 0.0936 0.0062 0.0438 0.8640 ronw before 0.1181 0.0134 ronw after 0.1028 -0.0153 0.0213 0.4809 source: author’s own calculation through excel figure-4.1. aar and caar results source: author’s own calculation through excel. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. asian journal of economics and empirical research issn: 2409-2622 vol. 2, no. 1, 8-22, 2015 http://asianonlinejournals.com/index.php/ajeer 8 measuring the stance of monetary policy in vietnam: a structural var analysis le, thanh ha 1 1 economics department at national economics university, vietnam abstract this work is licensed under a creative commons attribution 3.0 license asian online journal publishing group contents 1. introduction ................................................................................................................................................................................. 9 2. literature review ........................................................................................................................................................................ 9 3. monetary policy framework ................................................................................................................................................... 11 4. methodology .............................................................................................................................................................................. 13 5. results ........................................................................................................................................................................................ 16 6. conclusions ................................................................................................................................................................................ 21 references ...................................................................................................................................................................................... 21 this study aims deriving the state bank of vietnam’s operating procedures based on a model that considers three channels of monetary transmission, including interest rate channel, the exchange rate channel, and the money channel. there are 4 main finding in this study. firstly, the reactions of the money demand, exchange rate and interest rate to diverse innovations are generally consistent in different periods, but there were some changes in the period after the global financial crisis. secondly, instead of concentrating particularly on one target, the monetary policy implementation has become more effective and pervasive, if the central bank attempts to control a combination of these targets. thirdly, the stance measure derived from the model consistently reflects the historical performance of monetary policy which the central bank implemented to affect the gdp growth and inflation in vietnam. among three policy variable, the exchange rate comprises the remarkable amount of information about the policy stance. finally, this study also examines the relationship between the stance and inflation and output growth and realizes that the theory about these relationships is statistically held in vietnam under assumption that there is no other shock or the policy dominates other. keywords: monetary policy, svar, monetary stance, monetary policy index, monetary transmission, operating procedure jel-classification: e52, e58. http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2015, 2(1): 8-22 9 1. introduction one of the most important challenges for policy makers as well as monetary authority is to determine how to conduct the monetary policy to meet development goals of a country. among them, measuring a stance of monetary policy has become an increasingly important issue which is the premise to not only help precisely evaluate policy impacts but keep the economy in the line with objectives. as indicated by blinder (1998), a “tight”, “neutral” or “loose” relative to a country’s objectives could be quantitatively measured as the stance of monetary policy. therefore, if the stance of monetary policy is accurately measured, it will help policy makers come up with some ideas of policy transmissions; as well as estimate impacts of policy on macroeconomic variables. however, there have been a lot of difficulties that economic researchers have faced when they attempt to measure the stance of monetary policy. one of the greatest challenges is to determine which a policy indicator should be implemented in the manner that changes in this policy indications only represent shift in the policy stance and do not affect nonpolicy variables. moreover, it is toilsome to analyze influences of monetary policy on the economic performance due to many other external shocks. several previous studies have invested their time in an effort of finding out the optimal indicator. for example, bernanke and blinder (1992); christiano and eichenbaum (1992a) regarded the federal fund rate and non-borrowed reserves as an appropriate measure of policy stance, respectively. however, one of the biggest limitation of these studies is they only consider a single variable as a measure of policy stance. recently, many authors have illustrated that the combined indicators is a better one. specifically, bernanke and mihov (1997; 1998) considered total reserves, non-borrowed reserves and the federal funds rate as policy variables when they investigated in the united states, before expanding their model to germany. other researchers like (fung and yuan, 1999) suggested that the interest rate (overnight rate), term spread, an exchange rate and money reserve should be included in the policy blocks to measure the monetary stance in canada. a composite indices, rather than individual indicator which better measure the stance of monetary policy, is one of the main conclusion in the study of shun (2014) in the people’s banks of china. nevertheless, this area of monetary stance has mostly focused in some developed countries, and their approaches as well as conclusions could not be simply applied to others, especially in some developing economies where measurement is regime dependent and the operating procedures of central bank in these countries are different. moreover, another culprit of this shortage could be partly the paucity of reliable and long span data in these countries. so, it is imperative to measure the stance of monetary policy in these economies with adjustments corresponding with their operating procedures. meanwhile, vietnam has struggled with a lot of macroeconomic instability, which has become increasingly serious, especially when vietnam internationally integrated in the world market and become the official member of world trade organization (wto) in 2007. the external negative shocks, including the soaring of commodity and gasoline price in the world market and the global financial crisis in 2008 has been prompt to main question that how economic researchers and policy makers can encounter these problems or the same thing in the future. looking at the past, although the main purposes of monetary policy are to control the issue of inflation, make sure a sound economic development and stabilize currency, they are seemingly inconsistent overtime and partly aggravate the current macroeconomic instability in vietnam. therefore, the study of policy, especially measuring the stance of monetary policy has been extremely important. however, no pragmatic studying to date about this area is performed in vietnam. following the above arguments, conducting the research which measure the stance of monetary policy, has become a mandatory requirement for a purpose improve the quality of monetary policy implementation. this study is also in an effort to fill the gaps of previous studies in some developing countries like vietnam. the specific question to be handed here are: (i) which policy indicators has the state bank of vietnam (sbv) been targeting to conduct the monetary policy? (ii) could a single indicator or the composite indices effective measure the stance of monetary policy in vietnam? (iii) what is the most effective and appropriate measure which sbv’s operating procedures should follow to overcome difficulties when they face some external negative shocks, especially the global financial crisis in 2008? by adopting the bernanke and mihov (1997; 1998) approach and use two-stage structural auto-regression (var) model, this study attempts to examine the policy stance in vietnam. at the first stage, i regression var model, incorporating two groups of variables namely policy and non-policy block. however, instead of employing total reserves, non-borrowed reserves and the federal funds rates as the policy variables in bernanke and mihov’s study, i examine the real exchange rate, interest rate and the money aggregate. at the second stage, i construct a range of equations with the residuals in the first stage which characterize the state bank of vietnam’s operating procedures. these equations are based on the theory and process of policy implementation in vietnam during period 1996-2014. the paper is organized as follows, besides introduction (chapter 1) the study begins with a brief literature review in chapter 2 which will describes the empirical methodologies as well as the evidence of measuring the stance of monetary policy in previous research. chapter 3 briefly reviews backgrounds of vietnamese monetary policy. chapter 4 will represent the empirical methodology which could be applied in this study. subsequently, the study will indicate and analyze some empirical evidences in vietnam. finally, chapter 6 will show some conclusion of main finding and policy implications. 2. literature review 2.1. the single measures of policy stance there have been many studies which attempted to measure impacts of monetary policy changes on the economy. traditionally, the previous studies employed one specific monetary instrument to reflect changes in monetary policy. the most archaic approach considered innovations of money stock to be an adequate indicator of monetary shocks. however, as bernanke and mihov (1998) indicated, this approach has some limitations because non-policy influences affect the growth of monetary aggregates. one of the most severe issues related to this traditional asian journal of economics and empirical research, 2015, 2(1): 8-22 10 approach is “liquidity effect” which implies increases in interest rates following innovations in money (gordon and leeper, 1992). moreover, bernanke and mihov also suggested that this approach make us difficult to distinguish between changes in money demands and in money supply. with financial innovation, deregulation and other factors, the money growth alone are more unlikely a good instrument of policy. recognize the limitations of employing the money stock growth as a measure of monetary policy stance, the later studies has concentrated on alternative indicators. bernanke and blinder (1992) regarded the fund rates as a good indicator of monetary policy because it sensitively reflects shocks to the supply of bank reserves; and the fund rate innovations as a measure in monetary policy. by using 30-year data in the us, they concluded that the monetary policy works through credit and money channels. also adopting the var approach, the analysis of christiano and eichenbaum (1992b) employed different measures of open market operations, such as non-borrowed reserves, the monetary base, including m0 and m1 as well as different identifying assumption to measure shocks to monetary policy. they found that while the quantity of non-borrowed reserves is accepted as a good measure of policy stance, either using m0 or m1 led to the liquidity effects or implausible implication for real output. strongin (1995) proposed and estimated the new measure of monetary policy stance using non-borrowed reserves. the result indicated a strong persistent liquidity effect with this specification. the alternative monetary instruments are mentioned in previous studies. particularly, armour et al. (1996) had examined whether an operational measure of monetary policy, the overnight rate, is a good measure of the bank of canada’s policy over the past 35 years. by using 2 measures of overnight rate, including the day-loan rate and the current measure of overnight rate, the authors concluded that the innovations in the overnight rate reasonably account for the monetary policy shocks. other authors, such as fung and kasumovich (1998) argued the important role of the stock of money in the transmission mechanism. the paper had investigated the monetary shocks by using var approach with over-identifying restrictions over six industrialized countries and shown that the innovation in money stock (m1) could be considered as the shocks to monetary policy. in short, all aforementioned studies only considered a single variable as a policy indicator. however, there has been a heated controversy over the accuracy which the single-indicator model captures. unfortunately, there are many disagreements that these models could precisely examine the stance of monetary policy. therefore, we would need other models that combine the distinct policy instruments to explain the monetary policy actions. 2.2. the composite measures of policy stance bernanke and mihov (1998) indicated that “there is evidently little agreement on which of the various measures most accurately captures the stance of policy, leading many authors to hedge by using a variety of indicators” (p.3). a single instrument model could hardly and inaccurately explain the stance of monetary policy. instead, bernanke and mihov (1998) constructed a var methodology that consisted of all policy variables discussed in previous studies in the us. not only would the new approach permit authors to perform statistical comparisons between potential measures, but it also helps to choose the optimal policy indicators which reflect the operating procedure and the market for bank reserves and other policy actions. a simple model of market for commercial bank reserves and the operating procedures of federal reserve were built to measure the stance of policy in the us over two different sample periods. with such policy variables as total reserves, non-borrowed reserves and the federal funds rate, the authors considered five alternative identifications of unrestricted model. this “semi-structural” var indeed provided a more precise method to measure the stance of policy. this methodology has been widely recognized and applied to other countries. bernanke and mihov (1997) had investigated the stance of monetary policy in germany. the author utilized a set of policy variables, including shortterm interest rates and reserves measures. the authors found that the lombard rate had proven as the most pertinent policy indicator as compared to the call rates. furthermore, kasa and popper (1996) also applied this methodology to study operating procedures of the banks of japan between 1975 and 1994. the modified model considered total reserves, borrowed reserves, non-borrowed reserves and the use of moral suasion to be policy indicators to measure the stance of monetary policy in japan. the authors represented some evidences reflecting that both the call money rate and non-borrowed reserves could be interpreted as good policy indicator and the bank of japan also utilized the “moral suasion” to counter shocks in the demand for borrowed reserves. fung and yuan (1999) had examined the stance of monetary policy in canada using var basedapproach with 4 policy instruments, including the overnight rate, the real money supply, the term spread and the price of foreign exchange. the result indicated that only overnight rate played a significant role. based on both recursive and structural specification, amarasekara (2008) investigated the effects of interest rate, money growth and the nominal exchange rate on the real gdp growth inflation in sir lanka from 1978 to 2005. like previous studies, amarasekara also indicated that the interest rate was considered as the main monetary policy variable. in addition to interest rate, the exchange rate was also utilized as the policy indicators. moreover, amarasekara also impose identification restrictions on the policy block which represent the different targeting regime, including interest rate, monetary aggregate and the exchange rate. the monetary policy index was estimated for sir lanka and he concluded that a reduction in the gdp growth could be explained by the anticipated policy, whereas both anticipated and unanticipated components of monetary policy explained for a drop in inflation. recently, shun (2014) examined the people’s bank of china’s operating procedures by employing two-step auto-regression model in period 2000-2013. he indicated that composite indices, rather than individual indicator would help better measure the stance of monetary policy in china. in short, determining that which policy indicator could be validly used to measure the stance of monetary policy has become increasingly important in the process of conducting the monetary policy. the two-step auto-regression model is becoming the most popular approach to derive a valid good policy indicator. however, a little bit different from previous studies, which mainly found the interest rate as a good indicator, the current study illustrate that the composite indicator could be perform better in measuring the stance of monetary policy, rather than a single component. asian journal of economics and empirical research, 2015, 2(1): 8-22 11 3. monetary policy framework 3.1. legal framework according to the article 1 of the “law on the state bank of vietnam”, the state bank of vietnam (sbv) is a body of the vietnamese government and is directly governed by this law. the sbv is mainly responsible for issuing currency, managing monetary policy and giving some related advice for the vietnamese government, such as exchange rate policy, interest rate policy, foreign reserves, laws on banking and credit institutions, the management of state-owned commercial banks and so on. on the other word, the main function of the sbv is to implement the monetary policy through different instruments and manage all banking activities. the government takes responsibility of preparing an annual plan for monetary policy, such as the prediction of the inflation rate as well as the economic growth, and then they submit these plans and wait for the approval of the national assembly. national assembly has the different roles. firstly, they set the annual targets for the inflation rate with respect to the state’s budget and objectives of economic growth. moreover, they also directly supervise the implementation of monetary policy. therefore, the state bank, the national assembly, the government and national monetary policy advisory together manage the process of monetary decisions in vietnam. the independence of the sbv however, there has been a heated controversy over the independence of the sbv in term of conducting the monetary policy in vietnam. firstly, in term of policy, the much independence of sbv on the government is indicated through the article of the state banks law that implies that “a ministerial agency of the government which performs the state management of monetary and banking activities and acts as the central bank of the socialist republic of vietnam, and performs the state management of public services under the jurisdiction of the state bank”. that means that the government employs an agency belonging to its body in order to issue additional money to compensate its deficit. as a result, it probably leads to an increase in the inflation in vietnam. moreover, the government also has the power to adjust the interest rate and the exchange rate. the way of working could be considered as a “political based” operation rather than the “market-based” or “economic-based” way. secondly, the sbv has a low position in term of adjust and regulate the financial market to obtain the particular target. obviously, if the sbv has a higher controlling position, it can strongly make some adjustments. however, according the article 26, the government is one that funds the financial activities of the sbv based on the state’s budget. it makes us realize that the sbv is heavily depend on the both the government and state’s budget. finally, the law of state bank also mentions that sbv is a part of the government and the governor should be a member of the government (the council of ministers). these formalized links to the government mitigates the independence of the central bank in vietnam once again. in short, the aforementioned reasons have indicated the limited interdependence of the sbv that is extensively controlled by the government in various aspects. clearly, it leads to its operational inefficacy, especially a stabilization of inflation, the money market and the financial system in vietnam. 3.2. implementation of monetary policy in vietnam 3.2.1. the inefficiency of monetary policy in vietnam the main objective of sbv when conducting monetary policies is to promote the propensity of economy, stabilize the value of currency and control the issue of inflation. however, this goal is seemingly unobtainable. the vietnam economic growth has been mainly affected by the negative external shocks. in the period 1996-2014, vietnam has been experiencing several negative external shocks, including the asian financial crisis in 1997, an increase in the price of gasoline and commodity on the world market in 1997; and the global financial crisis in 2008; a surge of international petroleum prices in early of 2008. all of these shocks had resulted in disastrous consequence on vietnamese economy. specifically, they led to high inflation (over 23% in 2008 and 18.13% in 2011) accompanied by the low level of economic growth after experiencing a long period of stable economic development with average growth of 7% from 2000 to 2007. the government as well as the sbv has proposed some measures in order to help vietnam overcome difficulties caused by these external shocks. however, these policies sometime tend to be inconsistent overtime and partly contribute to macroeconomic instability in vietnam. particularly, some stimulus policies had been utilized when vietnam faced the asian financial crisis in 1997. on one side, these policies resulted in a higher growth rate in the following year. on the other side, the increase of price level was also triggered and the inflation rate reached a zenith of 12.63% in 2007. figure-1. gdp and cpi growth from 1996 to 2014 note: data taken from international financial statistics (ifs) asian journal of economics and empirical research, 2015, 2(1): 8-22 12 similarly, in order to cope with the external shocks of gasoline prices soaring in 2008; as well as a high inflation rate as a result of expansionary policy for a long period of time, the government had tightened monetary policy (also narrow the fiscal policy). a high rate of interest rate was ratified which led to many difficulties of economy. the interest rate was utilized as a main instrument to deal with these external shocks, but an inappropriate measure not only did not solve existed problems but also driven the inflation to higher level. a high interest rate had exerted many serious impacts on the whole economy. difficulties of enterprises and a sluggishness and freeze of both stock market and real estate market were a direct result of impertinent policy. the downward trend in 2008 because of ineffective monetary policy was strengthened when the global economic recessions had hit vietnam. under this circumstance, an expansionary monetary with large stimulus packages had been placed the narrow one. although, vietnam still experienced a low growth rate of 5.32% in 2009, the domestic economic had a sign in recovery in 2010. an expansion of policy in this period proved its efficacy. the recovery of the world economy in 2010 led to increasing demands for gasoline and other material which pushed the price of inputs up dramatically. the combination between these demand shocks and the expansionary policy in previous period had resulted a surge of inflation to 18.67%. during 2011 and early 2012, a tightening monetary policy had been implemented with a quick succession of rate cuts. interest rate continued to be a main policy tool at this time. the policy rates were raised in 2011 and 2012. the sbv also publicly stated that the maximum of domestic currency depreciation would be limited from 2 to 3 percent in 2012 in the absence of adverse external shocks. the tightening policy directly led to a slight decrease of the growth rate to 5.24% in 2012. 2013 was considered as an impressive year with successes of monetary policy. a reduction of lending interest rate was ratified which recover the production and trading. it directly contributed to the national economic recovery accompanied with a drop in the inflation in vietnam. in short, through the analysis the monetary strategy in vietnam in period 1996-2014, some conclusions can be derived here. firstly, sbv as well as the government employ interest rate as a policy tool to conduct monetary policy. in addition to interest rate, the exchange rate could be used to deal with the negative external shocks. secondly, although the main goal of the sbv is to make a sound development and control the problem of inflation, if they implement the policy instruments inappropriately, they will adversely affect the domestic economy. therefore, the effective and pertinent monetary policy implementation has become extremely important in order to face the negative shocks. 3.2.2. vietnam’s monetary instruments before the global financial crisis in 2008 in 2000, vietnamese economy experienced a low level of economic growth with a potential of deflation as the inflation in 1999 was only 0.1%. under this circumstance, the sbv carefully loosed monetary policy to achieve objectives of money value stabilization, inflation control no more than 5%, and economic development. due to the fact that the operating monetary policy adhered to targets, vietnamese economy witnessed a low level of inflation accompanying with the gradual economic growth between 2000 and 2003.in order to accomplish the target of 5-year plan (2000-2005), the government mainly concentrated on the economic growth targets (8-8.5%) in 2004 and 2005. the open market operations (omo) were considered as a main tool to stimulate the economic propensity and control inflation as targets set by the national assembly. as a result, the economic growth was recorded at a high rate with 7.79% and 8.44% in 2004 and 2005, respectively. in the meantime, the state bank also committed to keep a stable exchange rate (not decrease over 1%) which although probably brought some negative impacts on foreign market and exports, it was a reasonable choice at this moment. the stable exchange rate was executed through an increase in interest rate as well as a higher profit in vnd deposit as compared to the foreign currency deposit. after the global financial crisis in 2008 due to a huge amount of foreign currency in 2007 such as an increase in remittances from oversea, huge inflows of foreign direct investment, vietnam potentially faced with severe challenges of inflation. indeed, the consumer price index climbed to the zenith of over 23% in 2008, according the data compiled by the general statistics office. so, the primary purpose in this period was to control the issue of inflation by prudently implanting monetary policy to control total liquidity. what is more, the state banks proposed some measures to reduce money in circulation, control credit growth. the monetary policy in the period after this period was much more complicated than the previous period. the sbv concentrated on tightening monetary in 2007 with different policy instruments, especially open market operation (omo). some monetary policies were conducted to ensure the safety of system in this period, including withdrawing money from circulation, remaining the interest rate, reserve requirements and so on. instead of pegging the exchange rate in previous period, the floating exchange rate regime under control was utilized to control the vnd. figure-2. sbv interest rate source: sbv and press asian journal of economics and empirical research, 2015, 2(1): 8-22 13 the serious macroeconomic instabilities (the growth rate of vietnam declined from 8.2% in the period 20042007 to nearly 6% in 2008-2011 period and inflation rocketed up to 23%), the dangerous rate of budget deficit (and vietnam’s budget deficit made up for 1.3% of gdp in 2003-2007 and almost double to 2.7% in 2008-2012 were the most popular issues in vietnam in 2008. a variety of monetary policy was implemented to curb inflation and stabilize the macro-economy. particularly, the money has been withdrawn from circulation through some ways. firstly, the sbv enhanced the required reserve ratio by 1% and issued vnd 20.300 billion required treasury bills. secondly, the short-term loan was supported through omo and short-term refinancing implementation. furthermore, the sbv had also increased the rate of different interest rate such as the base rate, the refinancing rate and the discount rate. the monetary policy continued to tighten but gradually loosened at the end of 2008. a multitude of monetary policies were carried out in hopes to improve the current economic situation in vietnam, such as an adjustment of treasury bills interest rates (from 7.8% to 13% per year); an increase in reserve requirements interest rates (from 1.2% in august to 10% in october); a reduction in the interest rate; a fall in the reserve requirement ratio for deposit in vnd (11% to 6%) as well as the foreign currency (11% to 7%) and so on. in the years after that, vietnam continued to suffer from pressures in the global financial crisis. however, the positive sign of macroeconomic has appeared as a result of a range of monetary policy in 2009. the different instruments was utilized to stable the vietnamese economy, including operating monetary policy instruments, exchange rate instruments, interest rate instrument and others. in 2010, the sbv has combined the monetary policy instruments and administrative measures to reduce the interest rate and promote the economic growth. 4. methodology 4.1. bernanke and mihov’s methodology bernanke and blinder (1992), and bernanke and mihov (1998) proposed the strategy for measuring the dynamic effects of monetary policy which assumes that the “true” economic structure would be described as follows: ∑ ∑ ∑ ∑ where t indexes time, and b, c, a y , d, g, and a p are used to be indicator vectors or square matrices of variables coefficient. the two equations describe the relationships between a vector of non-policy variables, y, and a vector of policy variables, p. particularly, non-policy variables consist of such macroeconomic variables as real output, price index and others. y variables provide information about the state of the economy as well as the objectives of central bank. in order to achieve these purposes, the central bank has capacity to directly affect the variables included in p. the equation (1) represents a structural relationship in the rest of economy that non-policy variables depend on current and lag values of y, but only on lagged values of p ( (bernanke and blinder, 1992) and the equation (2) indicates the policy stance under impacts of lagged values of macroeconomic variables and policy variables. the indicate mutually orthogonal random disturbances. as mentioned in bernanke-mihov method, i would concentrate on one element of vector of policy, that reflects the unanticipated part of stance of monetary policy. the study aims at measuring the dynamic response of variables to a policy shock, . the equation (1) and (2) can be rewritten to reflect y and p in term of only their past values. according to bernanke-mihov method, i assume to be the part of var residual in the non-policy block which satisfies . by dropping subscripts and superscripts, i can perform the relationship between the observable disturbances, , and unobservable residual, as below  u = gu +av (3) the equation (3) depicts that the relationship between the observable disturbances, and unobserved structural shocks, which are derived from a standard structural var (svar). contains the exogenous policy shocks, . i also utilize the associated impulse-response functions to represent the dynamic responses of all variables to the policy shocks. then, the equation (1) and (2) would be transformed as below ∑ ∑ ∑ ∑ the equation (4) and (5) could be understood as a reduced-form var after moving all the contemporaneous term yt and pt to the left-hand side. hence, , are residual matrixes which could be derived by regressing equation (3) and (4), respectively. like the research of fung and yuan (1999), i also impose a recursive casual ordering of the non-policy variables and restrict a y to be diagonal. it means that the first ordered variable in nonpolicy block would not contemporaneously react to other variables in both policy and non-policy blocks (fung and yuan, 1999). 4.2. modeling the policy blocks for vietnam monetary policy in order to apply bernanke and mihov’s method, some modifications are made with respect to vietnam’s conditions. particularly, the policy variables include the lending interest rate (ir); real broad money or high-powered money (m) which is the sum of money and quasi-money divided by cpi; and nominal exchange rate (er). the asian journal of economics and empirical research, 2015, 2(1): 8-22 14 lending rate is considered as the bank’s policy instrument because the state bank of vietnam employs it as the monetary tool to acquire goals. particularly, the sbv has controlled two lending facilities, including the discount rate and refinancing rate in which the refinancing rate can be regarded as the ceiling and the discount rate is the floor rate. actually, another interest rate, which can be the monetary instrument, is the base rate. this base rate, however, has rarely changed overtime and have not reflect the supply and demand in the money market, thus it is not pertinent for purposes of this study. furthermore, the broad money is utilized to supplant for the reserves variables in bernanke and mihov’s study because this candidate consistently responses to effects of monetary shocks. using this set of policy variables was implemented in some previous studies such as fung and yuan (1999) in canada, fung (2002) in east asian, amarasekara (2008) in sir lanka. with some changes, i construct the following set of equations: money demand: (6) exchange rate: (7) interest rate: (8) the equation (6) illustrates the money demand, influenced negatively by innovations in the interest rate ( ) and exchange rate and positively demand disturbances ( ). looking at equation (7), the innovation of exchange rate ( ) can be explained by innovation in interest rate ( ) and money reserve shocks ( as well as exogenous exchange rate shocks ( . finally, equation (8) describes that the innovations in the interest rate could be explain by some unobservable structural disturbances such as money demand shocks ( ); exchange rate shocks ( ); and monetary policy shocks ( ) within a given period. the impacts of these shocks on interest rate innovation is reflected by coefficients , , 1 respectively. the term is extremely important because it contains information of exogenous monetary policy shocks that i want to measure in this study. to solve the system including from (6) to (8) equations, i firstly make assumption to simplify it. particularly, i restrict =0 which innovation in in money reserve plays relatively small role in explaining innovations in exchange rate. shocks to money reserve can be influenced by shocks in exchange rate but the opposite side is not true. this assumption is similar to several previous studies, such as fung and yuan (1999). putting all three equations into a matrix form, we can rewrite these equations in term of (i-g)u = av as follows [ ] [ ] [ ] [ ] (9) we can compute the exogenous monetary policy shocks by inverting equation and we have v= (a -1 )(i-g)u (10) [ ] [ ( ) ( ) ( )] [ ] (11) finally, we have ( ) ( ) (12) (13) with ( ) ( ) equation (12) depicts that the monetary policy could be explained by a linear combination of all residuals of variables in policy block, p. however, these residuals do not equally weight, but by some combinations of model parameter, as we can see in the equation (13). just-identified model the number of required restrictions for just-identified model with 3-variable policy block is 12 1 , but there are only 11 restrictions in the above matrix. therefore, i would impose one more addition restriction to construct the just-identified model. in this study, i impose disparate restrictions to reflect different regime in vietnam. just-identified model 1: like (bernanke and mihov, 1998), i also base on strongin’s assumption, which the demand for total reserves do not react to the interest rate innovations in the short-run. it is tantamount to α=0 in this study. with this restriction, the monetary shock is now: ( ) ( ) (14) just-identified model 2: similar to amarasekara (2008), i also impose a restriction to reflect an assumption that the exchange rate is not contemporaneously influenced by the interest innovations. it means that = 0 and the structural shock would turn into: ( ) ( ) (15) over-identified model based on the approach of amarasekara (2008), i construct three alternative identification of the unrestricted model to represent the disparate targeting regime, including the interest rate target, exchange rate target and reserve money target. these kinds of model need more than 1 restriction. over-identified model 1 (interest rate target): as bernanke blinder’ assumption, the central bank targets the interest rate to conduct the monetary policy. it corresponds to the restrictions: = =0. from (12), the monetary 1 the number of required restrictions: asian journal of economics and empirical research, 2015, 2(1): 8-22 15 policy shock equation is now transformed into = . over-identified model 2 (exchange rate target): the corresponding restrictions to reflect this target are = 0 and = 1. so, we have ( ) ( ) (16) and (17) over-identified model 3 (reserve money target): many previous studies have provided evidences of reserve money target. for the purpose of examining this evidence in vietnam, this study also impose restrictions to reflect the reserve money target. it is straightforward to see that the restrictions corresponding to this target are α = β = 0 and =1; and we have ( ) ( ) (18) and (19) 4.3. estimation of monetary policy index from the given relationships described in equation (10) and the vector of policy variables, i can achieve the following vector of variables: (a -1 )(i-g)p (20) following equation (20), the monetary policy index in the case of vietnam could be calculated as bellows [ ( ) ( ) ( ) ] [ ] ( ) ( ) (21) with ( ) ( ) equation (19) depicts that the monetary policy index is a linear combination of money supply (m), exchange rate (er) and interest rate (ir). in order to analyze signs of , , and , i base on theory as well as pragmatic evidences of monetary implementation in vietnam. a change in a variable belonging policy block (p), which leads to an increase in the mpi, reflects the “easing” of monetary policy. on the other hand, a “tight” of monetary policy is reflected in a decrease in the mpi as a block of policy variables changes. theoretically, i expect and to be negative. particularly, an augmentation of money supply or a depreciation of exchange rate leads to a decline in the mpi, which indicates an “easing” of monetary policy. conversely, the sign of is expected to be positive because an increase in interest rate is considered as a ”tight” in monetary policy. 4.4. data description the study consists of policy variables (p) and non-policy variables (y) in vars. the vector y includes variables which indicate either the ultimate policy objectives or information about these targets that the central bank would affect directly the policy variables to achieve. the non-policy vector y used in model consists of 3 variables which are real output (gdp), consumer price index (cpi), the world commodity prices (wcpi). the real output proxied by monthly indicator like the industrial production. due to the fact that since 6/2011, general statistic office of vietnam has been reporting the industrial production index, thus i cannot have data of industrial output from 6/2011 to the present time. instead of using this indicator, i have transformed quarterly real gdp into the monthly series by using quadratic match sum method. the real gdp and cpi are chosen since they might be better representative indicators of macroeconomic conditions. i also include the index of commodity price to capture expectations about future price as suggested by sim (1992) in order to avoid the price puzzle effects. another assumption is employed in this study is that vietnam is considered as a small open economy which means that vietnam plays a relative important role in the world economy and is unable to affect the world commodity price. therefore, the order of variables in the model should be wcpi, gdp, cpi to reflect this assumption. the variables which the central bank has some degree of direct control should be included in the vector p and the relationships between these variables are described in equation (6) through (8). the study utilizes the real broad money (m), interest rate (ir) and nominal exchange rate (er) as policy variables. in addition to these variables, the study also includes such other foreign variables as real gdp, cpi and the federal fund rate in the us as the exogenous variables to reflect impacts from outside world on vietnamese monetary policy. the data for this research is collected from disparate sources. most vietnamese data are taken from general statistic office of vietnam and state bank of vietnam, ranging from 1996 to 2014 in monthly frequency. other variables such as the world economy price index, foreign output is from the international financial statistics (ifs) of the international monetary fund. all variables except for interest rate performed in var model are in logarithm form. the data should be monthly due to the fact that it is difficult to defend the assumption of no feedback within the period if we utilize quarterly or annual data (bernanke and mihov, 1998). test for stationarity of variables in applied econometrics in solving time series, one of the most important things is to check whether variables are stationary or not. there have been a lot of controversies over the question whether a stationary or non-stationary variable should be utilized in the applied model. technically, if variables are integrated of order one or more, they asian journal of economics and empirical research, 2015, 2(1): 8-22 16 will lead to some serious problems such as coefficient bias and spurious results. however, if the linear combination between non-stationary variables is stationary, it is no longer problematic. in order to stave off from mistakes, this study strictly test and control all of problems relating to this kind of issues. some methods like augmented dickey fuller (adf), kpss test could be employed to check the stationarity of variables. the below table reports the results table-1. adf and kpss test note. k is the lag length in adf test which utilize schwartz bayesian criterion (sbc). all variables except for interest rate are in logarithm form. the model used in the test includes intercept. (*), (**) represent the statistically significant at 5% and 1% level. the table illustrates that all variables in logarithm form are non-stationary except for interest rate, and after taking the first different, these variable become stationary. 5. results 5.1. semi-structural var estimates by applying bernanke-mihov method with restrictions for disparate regimes, the stance of monetary policy could be measured with the full sample (from 1996m1 to 2014m8), the pre-crisis sub-sample (from 1996m1 to 2008m9) and the post-crisis sub-sample (from 2008m10 to 2014m8). all results are reported in the table 4. in this section, i discuss in detail about the sign as well as the significance of parameters in each model. generally, and β could be interpreted as the short-term interest rate and exchange rate elasticity of money demand, respectively; and represents the impact of demand shocks. similarly, while is considered as the influences of exchange rate shocks to exchange rate, parameters and in the exchange rate equation illustrates the impact of interest rate and money reserves on the exchange rate, but here i assume that =0 for the simplicity reason, thus i just consider and analyze . finally, and indicate the reaction of the interest rate to money demand and exchange rate shocks. interestingly, the parameter in all regimes carries the positive sign in the regression of full sample and the pre-crisis period, whereas it is negative as expected in the post-crisis period. however, it is extremely small and not statistically significant in all models. this result is fairly similar to bernanke and mihov (1998), amarasekara (2008) and shun (2014). fung and yuan (1999) indicated that this parameter was positive but also is not statistically significant. all of studies seem pertinent as strongin’s assumption in his study which assumes that the short-run demand for money reserves is rigid and inelastic with respect to changes in the short-run interest rates. the results indicate that the just-identified model 1 in my study, which assume that =0, is acceptable model in both theory and practice. the sign of β is also positive in the full sample and sub-sample 1, but it is negative in the post-crisis period as predicted by theory. this coefficient is considerably large in all models, but the small impact of exchange rate is recorded in the exchange rate regime. in the period starting from september 2008, the depreciation in exchange rate elasticity seemingly leads to a decline in the money reserves. the same thing in three samples is a statistical insignificance in almost models except for the interest rate regime where the magnitude and size of impact β are consistent with results of all regimes. the negative sign of β implies table-3. parameter estimates for all structural var model that under exogenous negative impacts shocks of the global financial crisis, vietnamese policy makers can tighten the monetary policy to promote the domestic demand. the parameter carries a positive sign as expected and asian journal of economics and empirical research, 2015, 2(1): 8-22 17 statistically significant is all regimes. the impact of demand shocks on monetary reserves approximates 0.02 in the full sample and in the period before the crisis. this coefficient, however, are considerably lower in the post-crisis period. in the exchange rate equation, the response of exchange rate to the interest rate shocks is consistent for what is predicted by theory. the parameter is negative in all models running with disparate samples. although, in almost case this coefficient is statistically significant, its magnitude is remarkably small just -0.003; -0,001 and -0.004 in the full sample, the first and second sub-sample, respectively. similarly, the sign of is reasonable in both theory and practice. in all regimes utilizing diverse samples, the external shocks positively affect the exchange rate but the magnitude is not significant. moreover, in smaller in the second sub-sample compared to results in other periods. subsequently, i look at the interest rate equation to analyze the reaction of interest rate to the money demand shocks and exchange rate innovations. in general, the impacts of these innovations are not statistically significant. the table 3 illustrates that in the exchange rate target regime, only is large in both number and statistic, whereas has a vital role in the monetary reserve target regime. however, all regimes indicate that and accounted for a very small part in explaining the changes of interest rate. this result coincides with impositions of fung and yuan (1999). in their study, they imposed a restriction that demand and exchange rate shocks have no impact on the exchange rate. the results here seemingly advocated the idea that the model with over-identified restrictions reflecting the interest rate regimes has been the most effective one to measure the stance of monetary policy in vietnam. what’s more, the significance of other parameters in the tables is also depicted in this regime. probably, vietnamese policy should target interest as a priority instrument to conduct monetary policies. however, until now we still say nothing about it. in short, although the over-identifying test proves futile because all tests reject specific models, the analysis of magnitudes and signs of parameters have indicated some main implications. firstly, there are some changes between two sub-sample and these impacts become more serious in the sub-sample 2 as a result of the global financial crisis. secondly, after all things, although interest rate target might be a more reasonable regime rather than the exchange rate regime or money reserve regime, it is better if the central bank in vietnam combine the different policy instruments to conduct the monetary policy. 5.2. exogenous monetary policy shocks in this section, we will analyze the exogenous monetary policy shock which can be derived from the estimated model discussed above. as mentioned in the study of fung and yuan (1999), amarasekara (2008), is very volatile, thus i computed the 18-month moving average of instead of normal one and plot it here. the cogent reason to explain for using 18-month moving average is that the monetary policy needs take approximately from 18 months to 24 months in order to affect the economy (bernanke and mihov, 1998), (fung and yuan, 1999). the zero line is considered as the benchmark at which all policy actions are fully predicted. inflation and industrial output is expected to stay on the long-run trend if no further monetary shock happens. as explained in previous studies, if the policy is tighter than anticipated if is higher than zero-line, whereas it is easier than anticipated if is below the zero line. furthermore, in order to analyze the impact of exogenous monetary policy shocks on inflation and industrial output growth, i will plot each of them in the same graph and review how changes in monetary shocks affect the main macroeconomic variables. to make it more simple, i will divide the full sample into 4 small period, including period 1(1997-2000), period 2 (2001-2005), period 3 (2006-2009) and period 4 (2010-2014). looking at the figure 3, i have found out some evidences. firstly, the top panel of figure depicts that the period 1 and period 3 were mostly easier than expected, whereas the tighter than expected was recorded in the period 2 and period 4. secondly, if i compare the exogenous monetary policy shocks with industrial output and inflation, these shocks are seemingly consistent with the trend of inflation in the whole period. for industrial output, although in the first two periods, there was no clear relation between them, in the period 3 and 4, the relationship between the trend of industrial output and the derived policy shocks has become more consistent. period 1 (1997-2000) the derived monetary shocks was generally lower than zero which implied that policy stance was easier than expected in general except for period from mid-1998 to near end of 1998. only in this period indicated a remarkable higher than zero line which depicted a tightened monetary policy of sbv. this was extremely reasonable because vietnam just experienced the first asian financial crisis in 1997, a tightened of monetary policy was reasonable to limit the impacts of these exogenous shocks. unsurprisingly, the cpi growth tended to decrease considerably as a result of a tightness of monetary policy. if i considered the bottom panel of the figure, the gdp growth also decreased significantly, before being suddenly supplanted by a substantially upward trend. everything was completely consistent to what had happened in vietnam in this period. admittedly, the asian financial crisis had not brought serious consequences in vietnam since vietnam did not fully integrate into the world economy. period 2 (20012005) the second period was mostly tighter than expected as illustrated in the figure. policy became increasingly tighter from 2000 before reaching the zenith in the early 2002. from this time onward, the level of tightness began to diminish. at the end of 2004, the policy was neutral and all policy activities were fully anticipated. in fact, from 2003 to 2005, the government and the sbv were loosening the monetary policy in order to pursue economic development. this partly explained a decrease in the level of tightness in this period. as a result of monetary strategies this period, there was a substantially upward trend of cpi growth in this period. in addition to the easing of monetary policy, a high growth of cpi in this period resulted from the domestically and internationally exogenous shocks, such as the soaring price of input and other goods (steel, coal, rice and others), a rise in instability of the asian journal of economics and empirical research, 2015, 2(1): 8-22 18 world economy which putted more and more pressure on cpi. however, the economic growth in this period gradually improved. this was mainly explained by the fact that the government as well as the sbv concentrated on the economic growth target in the 5 year plan (2000-2005). through using the open market operations (omo), the economic growth was recorded at a high rate with 7.79% and 8.44% in 2004 and 2005, respectively. the high percent of economic growth was the direct result of concentrating particularly on this target of 5 year plan. period 3 (2006-mid2008) from 2006 to mid-2008, the policy was mostly easier than expected from early 2006 to early 2008, and then tighter than expected until at the end of 2010, based on the result of derived exogenous monetary shocks. looking at the figure, vietnamese economy experienced a high volatile of output as well as a recorded level of inflation. in order to explain what was going on in this period, i indicated some realistic evidences. firstly, these were the first years of conducting the 5 year plan (2006-2010), the national assembly continued to target the economic growth as the priority to conducting the monetary policy. besides, they also set up other targets controlling the fluctuations of inflation. the easing of monetary policy stimulated domestic production, consumption and economic growth, but it was pushing the inflation greatly. moreover, this period was remarked by an occasion which vietnam has become an official member of world trade organization. this has brought a plenty of opportunities as well as challenges for vietnam. due to this fact, vietnam was increasingly influenced by the global financial crisis which pushed more pressures on the inflation. early 2008, the monetary policy was tightened by a plenty of strong policies such as (i) an increase of the required reserves by 1 percent (statement 187/2008/qd-nhnn); (ii) issuing the 20,300 billion vnd treasury bills (346/qd-nhnn); (iii) imposing restrictions to manager the stock market and others. as a result, the inflation reached a zenith of over 23% in 2008. period 4 (from 2009 to 2014) the policy shocks depicted in the figure implies that policy was mostly tighter than expected and also rather volatile from mid-2008 to at the end of 2011, and then became easier than expected for about 3 years until at the end of 2014. in this period, vietnam experienced high fluctuations of both inflation and the output growth. at the end of 2008, when vietnamese economy had a sign of depression caused by the global financial crisis, the government and the central bank had loosened the monetary policy by lower interest rate, for instance slightly lower the interest rate; lower the required reserve ratio (from 8% to 6.5% and then to 3%). since 2010, the central bank persistently pursued targets concentrating particularly on controlling the inflation by a growth of money supply. therefore, the inflation was controlled at the low level in 8/2010, while the growth rate in the first 6 month was around 5.57% (lower than target). this led to the pressures of the figure-3. exogenous monetary policy shocks, inflation and industrial output growth note: data taken from gso and author’s calculation asian journal of economics and empirical research, 2015, 2(1): 8-22 19 pursuing the high growth target. the policy has become more easing by a sanction of such policies as (i) decreasing the lending interest rate; (ii) refinancing some banks (such as 10,000 billion vnd for the commercial banks and vietnam bank for agriculture and rural development. eventually, the money supply rocketed up which drove the inflation up. at the end of 2010, the easing policy was suddenly replaced by a tight one when the central increased base interest rate to 9%. by 2011, the central bank persistently pursued the targets controlling the inflation by a set of tight monetary policies. from at the end of 2011 to 2014, an easing monetary policy has been verified to acquire the targets. in short, the changes of exogenous monetary policy shocks have been broadly consistent for which policies the sbv had historically implemented with respect to the development of gdp growth and inflation. the monetary policy has proved itself as the foremost medium which helps the central bank as well as the government to attain the goals. 5.3. measure of the monetary policy index by applying the methodology discussed earlier, i calculate a monetary policy index for vietnam. this index, however, is different from other studies such as bernanke and mihov (1998), kasa and popper (1996) or fung and yuan (1999) which have used the parameter from the just-identified model for the full sample, i will utilize an average of parameter estimate in all model to sever for this analysis. this method was applied in the study of amarasekara in sri lanka in 2008. there are several plausible reasons to explain for this approach. firstly, the author believes that the sole regime could not fully explain the structure of monetary policy in each country, thus this approach permit me to avoid concentrating solely on a specific regime. secondly, in general, all estimated parameters are approximately equal, thus using the average parameter will help us precisely compute the monetary policy index. by using this method, i come up the results as bellows table-5. average parameter values for monetary policy index α β full sample 0.0014 0.7744 -0.0034 0.0211 0.0103 -0.038 0.1978 1.800 -17.814 1.0691 α β sub-sample 1 0.0017 0.7373 -0.0017 0.0243 0.0098 -0.0419 0.0991 1.7249 -8.8662 1.0199 α β sub-sample 2 -0.0049 -0.2479 -0.0024 0.0066 0.0063 0.3345 0.1057 -50.8259 -8.6373 1.2921 source: author’s calculations as discussed earlier, i expect and to be negative, whereas those of is positive. the table 5 illustrates that in the full sample, the sign of and is the same as predicted by theory, while the sign of is different. moreover, the exchange rate has a considerably larger weight than the money reserve and the interest rate. the result running on the pre-crisis sample is similar to those of full sample. conversely, the sign of weights is the exactly same as expected when i run on the post-crisis, and weights of money reserve is significantly high as compared to others. based on the results of the full sample, probably the exchange rate contains the most significant amount of information about the policy stance. the results seemingly advocated the idea of packard (2005) or le and pfau (2009) who indicated that exchange rate was considered as an important channel in vietnam. figure-4. money policy stance in vietnam asian journal of economics and empirical research, 2015, 2(1): 8-22 20 source: author’s calculation bernanke and mihov (1998) suggested that the policy variables should be transformed by subtracting them from their own 36-months moving average before estimating the monetary policy index. fung and yuan (1999) applied this method with a small adjustment which take the difference form it an 18-month moving average of its past value. and then i measure the monetary policy index input the policy variables into the equation (21). as mentioned by bernanke and mihov (1998), zero is considered as the “normal” monetary policy which implies that policy does not deviate from the average stance in the past 36 months. kasa and popper (1996) also emphasized that “since only second moments are being used here, these plots cannot say anything about the stance of policy in some absolute sense. only the stance of policy relative to the historical average is identified”(p.291). bernanke and mihov (1998) and like fung and yuan (1999) explained that the pressure on recent inflation can be captured by this normalized stance measure. therefore, a positive stance implies the future inflation will decline to a point below the average inflation rate of the past 18 months in the absence of other shocks, vice versa. on the other hand, if the stance is neutral, inflation will go along its 18-month moving average, additionally, i also compute inflation and gdp growth as the deviations from their 18-month moving average. assuming that there is no other demand or supply shock or there is a domination of monetary shocks over others, thus a tight (easy) policy stance is followed by a decrease (increase) in inflation and output. the second and third panel of figure 5 depicts the relationship between the monetary policy stance and inflation, and the gdp growth, respectively. this section aims mainly examining whether these relationships are held or not. firstly, i check the relationship between the stance and cpi by looking at the second panel of figure. in the pre-crisis period, although the monetary stance seemed very volatile, this relationship generally held. for example, when policy was expansionary in mid and end 1998, the inflation rose above the past values; a contradiction of policy in 1999 and 2000 was followed by a fall below the past values. in the period after the global financial crisis, this relationship has become clearer. specifically, when the policy stance became easier than its past average in mid2008, inflation increased above the average values; and then when the policy become tighter in 2009, the inflation declined to a level targeted by the central bank. similarly, the relationship between the gdp growth and the stance has also been examined by the bottom panel of figure 5. a contradiction of policy such as in end 1997, early 1999, early 2001 and so on was followed by a reduction of the output growth to a point below the average past values. generally, this relationship is not completely clear as seen in the cpi due to a limitation of data for gdp in vietnam. furthermore, the changes in inflation and output not only are determined by the monetary policy, but also other shocks. in the different points of time, impacts of these shocks probably outweigh the monetary policy. figure-5. monetary stance, inflation and gdp growth source: author’s calculations asian journal of economics and empirical research, 2015, 2(1): 8-22 21 in short, these relationships between the stance and inflation and output growth were generally held. however, the graph illustrates the stance of inflation more clearly than counterpart. more importantly, like previous study, i assume that there is no other shock or the policy dominates other, thus i just analyze the monetary stance and other macroeconomic variables. realistically, this assumption is not guaranteed, thus it is essential to meticulously analyze these relationships. 6. conclusions by applying model of bernanke and mihov (1998) and fung and yuan (1999), this study mainly aims deriving a measure the stance of monetary policy in vietnam. some pragmatic findings are summarized as follows so as to answer main research questions in my study. firstly, the reactions of the money demand, exchange rate and interest rate to diverse innovations are generally consistent in different periods, but there were some changes in the period after the global financial crisis, especially the response of money demand to exchange rate innovations; interest rate to money demand shocks. secondly, instead of concentrating particularly on one target, the monetary policy implementation has become more effective and pervasive, if the central bank attempts to control a combination of these targets. thirdly, the stance measure derived from the model consistently reflects the historical performance of monetary policy which the central bank implemented to affect the gdp growth and inflation in vietnam. among three policy variable, the exchange rate comprises the remarkable amount of information about the policy stance. finally, this study also examines the relationship between the stance and inflation and output growth and realizes that the theory about these relationships is statistically held in vietnam under assumption that there is no other shock or the policy dominates other. policy implications more importantly, after answering the research questions, i also give some recommendation for purposes of providing the fundamental theory for policy makers to design more appropriate policies. firstly, the sbv should control a combination of different targets and utilize the monetary tool effective to obtain the goals. secondly, the study also confirmed that the exchange rate and money have proven themselves as more effective medium to conduct monetary policy in vietnam than interest rate channel. moreover, in volatile conditions like the financial crisis, the policy makers should pay more attention to money channel to design monetary policies. thirdly, due to the fact that the relationships between the monetary stance and output growth and inflation are held in vietnam, policy makers can meticulously design policies. limitations of the study one of the greatest issues of this study is that all over-identifying restrictions are rejected by the model. although this help me support the idea that the monetary history of vietnam cannot be identified with only one target regime, but a combination of disparate regimes, it is essential to find out an exact regime which helps vietnam to perform the monetary stance effectively. furthermore, due to problems of data available for real gdp in vietnam, i have to transform the quarterly data into monthly data and use it in my research. finally, although i employ three main channels, based on realistic evidences of vietnam and theory, the quality of study can improve significantly, if i construct a model to examine unconventional channels. it is vital because it will provide more useful policy implications for the central bank and the government to better regulate the monetary and select alternative channel to improve the performance of monetary policy in vietnam. references amarasekara, c., 2008. the impact of monetary policy on economic growth and inflation in sri lanka. staff studies, 38(1&2): 1-44. armour, j., w. 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[accessed july 2007]. shun, r., 2014. what measures chinese monetary policy. paper presented at the ces 2014 china annual conference, china. sim, c.a., 1992. interpreting the macroeconomic time series facts: the effects of monetary policy. european economic review, 36(5): 9751000. strongin, s., 1995. the identification of monetary policy disturbances: explaining the liquidity puzzle. journal of monetary economics, 35(3): 463-498. views and opinions expressed in this article are the views and opinions of the authors, asian journal of economics and empirical research shall not be responsible or answerable for any loss, damage or liability etc. caused in relation to/arising out of the use of the content. http://www.networkideas.org/feathm/oct2007/pdf/tu_packard.pdf asian journal of economics and empirical research issn: 2409-2622 vol. 3, no. 1, 94-102, 2016 http://asianonlinejournals.com/index.php/ajeer 94 power sector reforms and electricity supply growth in nigeria edet okon anwana1  boniface akpan2 1 banking and finance department akwa ibom state polytechnic ikot ekpene, akwa ibom state, nigeria 2 department of economics obong university obong ntak, akwa ibom state, nigeria ( corresponding author) abstract adequate power supply constitutes the nucleus of operations and subsequently the engine of growth for all sectors of the economy. despite the abundance of electricity generation sources in nigeria, electricity distribution network and voltage profile are very poor resulting to more that 50 percent of the populace living without electricity supply. to salvage the electricity problem, the power sector has gone through some reforms, the major one being the enactment of the electric power sector reform act of 2005. this was intended to restructure the electricity market from monopoly to a more competitive structure. this study is therefore undertaken to empirically evaluate the impacts of the reforms on electricity supply growth in the country. this study is based on the elementary supply theory. it covers from 1981 to 2015. econometric approach for the study relies on time series data regression. the study adopted the contemporary econometric approach of error correction mechanism (ecm). the results showed that all the variables were stationary and statistically significant. there exist a unique long-run equilibrium relationship between all the variables of the model and so, cointegrated and normalized coefficients were reported. ecm results revealed the speed of adjustment of 92.1 percent between the short-run and the long-run behaviors of electricity supply with its independent variables. from the analysis, reforms’ coefficient (ref) had a positive sign but statistically insignificant. the other variables, electricity price (elp), government investment in the power sector (govinv), annual rainfall (rain) and per capita gdp (pcgdp) conformed to apriori expectations in terms of sign and were statistically significant. the study concludes that the present reform efforts in the power sector will bring great improvements in the power sector of the country if properly harnessed. from the results, the study recommends that government should totally transfer ownership in all electricity production and supply chain to the private investors and only monitor or regulate the market. keywords: electricity supply, power sector, reforms, electricity market, economic growth. contents 1. introduction ......................................................................................................................................................................... 95 2. empirical literature ............................................................................................................................................................ 97 3. theoretical framework ....................................................................................................................................................... 98 4. the model and data ............................................................................................................................................................ 99 5. empirical results ................................................................................................................................................................. 99 6. discussion ........................................................................................................................................................................... 101 7. conclusion and recommendations ................................................................................................................................... 101 references .............................................................................................................................................................................. 101 citation | edet okon anwana; boniface akpan (2016). power sector reforms and electricity supply growth in nigeria. asian journal of economics and empirical research, 3(1): 94-102. doi: 10.20448/journal.501/2016.3.1/501.1.94.102 issn (e): issn (p): 2409-2622 2518-010x licensed: this work is licensed under a creative commons attribution 3.0 license contribution/acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained ethical: history: this study follows all ethical practices during writing. received: 4 june 2016/ revised: 23 june 2016/ accepted: 28 june 2016/ published: 2 july 2016 publisher: asian online journal publishing group http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.94.102 https://orcid.org/orcid-search/quick-search?searchquery=edet okon anwana https://orcid.org/orcid-search/quick-search?searchquery=boniface akpan http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.94.102 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.94.102 https://orcid.org/orcid-search/quick-search?searchquery=edet okon anwana https://orcid.org/orcid-search/quick-search?searchquery=boniface akpan http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.94.102 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.94.102 https://orcid.org/orcid-search/quick-search?searchquery=edet okon anwana https://orcid.org/orcid-search/quick-search?searchquery=boniface akpan http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.94.102 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.94.102 https://orcid.org/orcid-search/quick-search?searchquery=edet okon anwana https://orcid.org/orcid-search/quick-search?searchquery=boniface akpan http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.94.102 asian journal of economics and empirical research, 2016, 3(1): 94-102 95 1. introduction for a meaningful economic growth to take place in an economy there must be adequate supply and demand for energy. one of the most desired energy in this direction is electricity. adequate generation, transmission and distribution of electricity will empower the people to work at home and the cottage industries through to large scale industrial, commercial and services activities. it constitutes the nucleus of operation and subsequently the engine of growth for all sectors of the economy (ayodele, 2001; ubi and effiom, 2013). electricity is generated from primary energy sources such as solar, water, waves, wind, oil, gas, coal, tide, etc. nigeria is well blessed with all these sources of energy. the country has an annual average daily sunshine of 6.25 hours, an average solar radiation of about 5.25 kilowatts/m 2 /day and receives about 4.851 x 10 12 kilowatts (kw) of energy per day from the sun (odetunde, 2008; solar energy international, 2011). proven crude oil reserves for the country as at 2013 is 37.2 billion barrels and proven natural gas reserve is 182 trillion cubic feet. its coal reserve is estimated at 2 billion metric tonnes (sambo et al., 2010; united states energy information administration (useia), 2013). the country is bounded on the south by atlantic ocean. rivers niger, benue and many others traverse the country from north to south. there are many waterfalls, abundant wind, tides and waves. despite the abundance of electricity generation sources, nigeria as reported by cia (2014) has one of the lowest net electricity generation per capita rates in the world. electricity distribution network and voltage profile are very poor resulting to more that 50 percent of the populace living without electricity supply (osueke and ezugwu, 2011). electricity production and distribution system are weak and susceptible to major setbacks. the weak and inefficient system results from old and decaying infrastructure. some of the electricity generation stations were built in the 1970s and are still being operated without major rehabilitations, retrofit or upgrade (oyedepo, 2012). they are also poorly maintained. also, until very recently, electricity generation, production and distribution has been an exclusive preserve of the poorly managed government monopoly under national electric power authority (nepa) and later power holdings company of nigeria (phcn). the inefficiency as well as inadequate facilities to boost electricity supply in the face of increasing population, new and electronic based technologies, vast geographical landscape and an increasing business environment all combines to create electricity supply problems. while demand for electricity is rising, supply tends to be falling. this supply inadequacy has damaging consequential impact on all sectors of the economy and therefore encourages the people to source for alternative, but unhealthy, electricity supply sources via the generators (small power generating sets). this situation generates additional costs to physical health (noise and air pollution) and businesses, leading to high prices, discouraging entrepreneurship, encouraging unemployment, elevating poverty and dampening industrial and economic growth. to salvage the electricity problem in the country, the power sector has gone through some reforms recently. the major reform was set through the enactment of the electric power sector reform act of 2005. this was intended to restructure the electricity market from monopoly to a more competitive structure, produce and supply more power and therefore enhance productive activities in the country. more than ten years has gone since the introduction of this reform agenda. as it is expected, the reform should transform the power sector and engender the needed improvements in the power sector. this study is therefore undertaken to empirically evaluate the power sector and examine the impacts of the reforms on electricity supply growth in the country. 1.1. electricity sector reforms in nigeria nigeria’s electricity history dates back to 1896, fifteen years after it was introduced in england. a pioneer electric power generating plant with total capacity of 60 kw was installed at marina in the present lagos state. the public works department (pwd) was in charge of its management. the northern and southern protectorate amalgamation of 1914 to form a new nigeria created room for other towns to generate electric power for themselves. in 1946, the controlling powers of public works department over lagos electricity generation and distribution was handed over to the nigerian government electricity undertaking (ngeu), who took over the responsibility for supplying electricity in lagos as well as the assets and liabilities of the former operator. electricity corporation of nigeria (ecn) came into being from 1950 and took over all electric power supply facilities within nigeria. meanwhile, niger dams authority (nda) also came into being and was inaugurated for the benefit of generating electricity through hydro power systems (isola, 2012; awosepe, 2014). this led to great improvement in power generation, transmission and supply in the country. with increasing demand for electricity, some projects were carried out in ijora, oji river, kano and ibadan power stations to improve availability and quality of power delivery (isola, 2012; awosepe, 2014). in the year 1962, the niger dams authority (nda) was legally set up through an act of parliament. they were entrusted with dam construction after discovering the benefit that will accrue from such a project. this led to the construction of kainji dam in 1962 which was completed in 1968. the wide network of electricity transmission of grid power commenced from 1966 through the collaborative efforts of nda and ecn. these efforts saw the linkage of different towns to the national grid and the extension of electricity power to all the regions that made up nigeria. for instance, lagos was linked to kainji, kainji was linked to kaduna and extended to kano and zaria, oshogbo was linked to benin and ugheli, benin was linked to onitsha and afam. despite the great size of nigeria’s land mass, the national grid now links the thirty-six state capitals and the federal capital territory, abuja. on “first of april 1972, ecn and nda were merged to form the popular national electric power authority (nepa)”with the actual merging taking place on the sixth of january 1973 with the appointment of its first manager. the network continued to grow under nepa and between 1978 and 1983, the federal government sponsored two panels of enquiry to fashion out models for restructuring nepa into an independent unit or toward privatization. this empowered it to supply power to rural areas and new cities (isola, 2012; awosepe, 2014). by 1999-2005 (the advent of democratic government), an act was enacted establishing power holding company of nigeria (phcn), an initial holding company (ihc), as a result of government effort to revitalize the power sector. this was an intended name for privatization which was meant to transfer assets and liabilities of nepa to asian journal of economics and empirical research, 2016, 3(1): 94-102 96 phcn. “it was officially commissioned on the fifth of may 2005 and was to carry out business of nepa which were still on”. in the same vein, the national integrated power projects (nipp) was inaugurated in 2004 to quicken the upgrading of capacity in the country. this was basically a private initiative which was supervised by the niger delta power holding company (ndphc) (awosepe, 2014). the phcn was disaggregated into 18 independent firms as follows: six electricity generating firms, one electricity transmission firm, and eleven electricity distribution firms. the generating companies are egbin electricity generating company (eegc), and those at sapele, ughelli, afam, shiroro and kainji. there are also some new independent power producers under the auspices of the niger-delta power holding company (ndphc). the “eleven distribution companies are the electricity distribution companies of abuja, benin, eko, enugu, ibadan, ikeja, jos, kaduna, kano, port-harcourt, and yola respectively” (awosepe, 2014). in 2010, the federal government rolled out the road map for the power sector in lagos with targeted achievements as shown in table 1. table-1. the road map for enhanced power generation, transmission and distribution capability in nigeria period available power generating capacity (mw) power transmission capacity (mw) power distribution capacity (mw) 330.0 kv lines 132.0 kv lines 2 nd quarter 2010 4612.00 5155.00 6677.00 5768.00 last quarter 2010 5379.00 5515.00 7328.00 6334.00 first quarter 2011 7033.00 5995.00 7328.00 6900.00 last quarter 2011 9769.00 6555.00 7488.00 7485.00 last quarter 2012 11879.00 7866.00 8986.00 8061.00 last quarter 2013 14218.00 8653.00 9885.00 9059.00 source: olugbenga et al. (2013) the transmission company of nigeria (tcn) is 100 per cent owned by the government. 20 percent of the generating companies (gencos) belong to the government and 80 per cent to private sector ownership. for distributing companies (discos), 60 per cent is owned by private investors and 40 per cent by the government. from 30th september 2013, generation and distribution of electricity have been transferred to the private investors with the handing over to them of certificates of ownership by the government. on wednesday february 12, 2014, the nigerian electricity regulatory commission (nerc) at a meeting with power generating and distributing companies in the country agreed to continue with the transition electricity market (tem). this means that electricity industry in the country presently operate under transition regime (isola, 2012; awosepe, 2014). 1.2. structure of electricity market in nigeria in nigeria, most electricity energy is generated through gas sources followed by hydropower, oil and then coal. out of an installed generation capacity of 8,227 megawatts (mw), actual generation is only 3,716 mw giving a gap of 4511 mw. transmission as well as distribution coverage is low compared to the vast land mass of nigeria. out of an estimated national electricity demand of 10,000 mw, generation deficit was 5,750 mw, indicating that more than about 57.5 percent of nigerians are without public power supply. table 2 gives available thermal installed plants in the country where aggregate installed capacity for the power generation plants is 5,976 mw but operational capacity is 2,589 mw, less than 50 percent of installed capacity. from table 2, sapele station was established over 26 years ago with total installed capacity of 1,020 mw but only 90 mw is currently available, the same story goes for afam, egbin and other old stations. this may be due to poor management of those stations. table-2. thermal installed plants generatin g station state status age installed capacity (mw) number of units installed current number available capacity available (mw) operational capability (mw) egbin lagos existing 23 1320 6 4 880 600 egbin aes lagos existing 7 270 9 9 270 220 delta delta existing 18 840 18 12 540 330 sapele delta existing 26 30 1020 10 1 90 65 omoku rivers existing 3 150 6 4 100 70 ajaokuta kogi n/a 110 2 2 100 80 okpai existing 3 480 3 3 480 400 geregu kogi existing 2 414 3 3 414 414 omotosho ondo existing 1 335 8 2 80 75 olorunshogo ogun existing 1 335 8 2 80 35 afam rivers existing 26 702 20 3 350 300 total 5976 93 44 3384 2589 sources:obadote (2009); eberhard and gratwick (2012); olugbenga et al. (2013) table-3. existing integrated power projects project name/site (technology) state located 1 st phase installed capacity (mw) 2 nd phase installed capacity (mw) calabar cross river 563 egbema imo 338 ihovbar edo 451 gbarain bayelsa 225 sapele delta 451 omoku rivers 225 continue asian journal of economics and empirical research, 2016, 3(1): 94-102 97 alaoji abia 504 1000 olorunshogo ogun 335 754 omotosho ondo 335 754 geregu kogi 414 414 ibom power akwaibom 193 450 okpai 450 eket (mobil jv) akwaibom 500 obite (totalfina elf) 450 ijede (chevreon) 250 800 mambilla (hydro) taraba 2600 7837 4622 sources: obadote (2009); eberhard and gratwick (2012) table-4. hydro power generating plants in nigeria generating station location (state) age status installed capacity (mw) units installed units available capacity available (mw) operational capability (mw) kainji niger 38-40 existing 760 8 6 440 400 jebba niger 25 existing 578 6 4 358.6 300 shiroro niger 22 existing 600 4 4 600 300 mambilla taraba planned 2600 zungeru niger planned 950 total 5488 18 14 1431.6 1000 source: obadote (2009); tallapragada pvsn (2009); olugbenga et al. (2013) table-5. profile of the electricity industry infrastructure in nigeria generation: pre-1999 post-1999 thermal 4,058 mw 5,010 mw hydro 1,900 mw 1,900 mw installed capacity 5,996 mw 6,910 mw available capacity 1,500 mw 4,451 mw transmission: 330.0 kv line 4,800.00 km 4,889.20 km 132.0 kv lines 6,100.00 km 6,284.06 km transformer capacity: 330/132 kv 5,618.00 mva 6,098.00 mva 132/33 kv 6,230.00 mva 7,805.00 mva 33kv lines 37,173.00 km 48,409.62 km 11kv lines 29,055.00 km 32,581.49 km 415kv lines 70,799.00 km 126,032.79 km 8,342.56 mva 12,219 mva source: maigida (2008) table 3 shows the structure of the independent power plants (ipp) in the country. installed capacity for all the ipp in the country is put at 12,459 mw but some of them are yet to fully function while some are yet to be completed. table 4 gives a breakdown of hydro power plants in the country. from the table, out of installed capacity of 5,488 mw only 1,000 mw is available from all the plants, a short fall of about 82 percent. table 5 gives a summary of electricity infrastructure before and after 1999, from here it is shown that after 1999, improvements were recorded on the megawatts of electricity generated, transmitted and distributed in the country, though the rate of improvements was not significant enough to fill the existing lacuna between electricity supply and demand in the country. 2. empirical literature empirical studies have been undertaken about issues concerning electricity supply and its impact on industrial or economic growth. however, this study concentrates its focus on the determinants of electricity supply in a developing economy as nigeria. focus on impacts of electricity supply is however borne out of the importance of electric energy as a vital source of economic or industrial growth of a country. jonah et al. (2013) investigated the impact of electric energy supply on the industrial sector productivity of nigeria between 1970 and 2010. data for the study were obtained from the reports and bulletins of central bank of nigeria. the study adopted multiple regression analysis and modern econometric methodology. the results from the study showed that electricity supply in nigeria does not significantly impact on industrial productivity of the country. however, the adf tests results indicated that all the variables for the study were stationary at first difference and that there is a possibility of convergence of industrial output to equilibrium at the nearest future with equilibrium line points of -0.945. this result depicts the poor state of electricity supply in the country, because economic expectations are that electricity supply should contribute positively and significantly to industrial sector growth and hence economic growth. in line with jonah et al. (2013); olayemi (2012) evaluated the impact of electricity crisis on manufacturing productivity growth in nigeria. time series data from 1980 to 2008 were analyzed using ols multiple regression. the study’s results showed that electricity generation and supply in nigeria impacted negatively on manufacturing productivity growth. this was attributed to unnecessary government spending on non economic and unproductive sectors. they advised that electricity generation and distribution should be restructured through the initiative of independent power projects, i.e. there should be a reform of the power sector. this study did not however indicate asian journal of economics and empirical research, 2016, 3(1): 94-102 98 whether the non economic and unproductive sectors include the power sector, because it took as one of its variables government capital expenditure on infrastructures. contrary views on the strength of contribution of electricity supply in nigeria were given in ubi and effiom (2013). they studied the relationship between electricity supply and economic development in the country. time series data for the study were analyzed using modern econometric technique. stationarity and cointegration tests were carried out and estimation technique adopted was the error correction mechanism. the results indicated that despite the poor state of electricity supply in the country, it influences economic development, although its impact is relatively very low. based on this, they recommend among others that more power projects should be completed, i.e. more power generation efforts should be made. this result corroborates alawiye (2011) whose study showed that the power sector in nigeria impacts positively on industrial development. also, nwankwo and njogo (2013) used data from 1970 to 2010 and adopted the multiple regression model to show that electricity supply is positively related to real gdp per capita in nigeria. these and other conflicting studies on the relationship between electricity supply and growth of the economy may not give impetus for definite conclusion on the impact of electricity supply in the country’s efforts to develop. in some instances however, the concept of electricity are misunderstood and conflicting data and variables are employed to determine electricity supply in nigeria. more so, available studies on electricity supply determinants are few. hence, there is need for more studies in this regard. in recognition of this lacuna, ubi et al. (2012) in an attempt to link electricity supply to economic development status of nigeria, attributed the situation to the inability of policy makers to identify the determinants of electricity supply for effective policy formulation and implementation. in a bid to defining these determinants, their study, using parametric econometric methodology of ols employed time series data from 1970 to 2009 to show that: technology, government funding, and the level of power loss were the statistically significant determinants of electricity supply in nigeria. they recommended among others, the injection of more funds into the sector and more power plants to generate more electricity. this study made a giant stride in unfolding electricity supply determinants in the country, however, it failed to take into consideration reforms in the power sector and hence the impact of such reforms on electricity supply in the country and on the market structure of the electricity market which hitherto was monopolistic in nature. it is therefore needful that with the reforms in the power sector in nigeria, structural changes due to such reforms should be captured as a variable that can determine electricity supply in the country. in an attempt to capture the effect of electricity sector reforms, isola (2012) undertook a purely descriptive study on the implication of electricity market structure on energy sector reforms and management in nigeria. the focus of the study was on market structure, market design and supply gap in electricity generation within the context of power sector reforms. considering the nature of the nigerian political, social and economic climate, they concluded that electricity market reforms may be likened to fire, which if not regulated may produce more problems and if regulated will give better results. as noted earlier, the study was merely descriptive without strong analytical powers to determine the impact of the reforms processes on electricity supply in the country. on the global scale, most studies available confirm the importance of electric energy to economic growth of any economy. as far back as the 1960s, odell (1965) study for colombia shows that electricity was very important for the growth and development of such a rapidly developing economy. akinlo (2008) using the ardl bound test showed that energy consumption has a significant positive long run impact on economic growth in sub-saharan african countries of cameroun, cote d’ivoire, gambia, senegal, sudan and zimbabwe. allcott et al. (2014) study adopted hybrid leontief/cobb-douglas production function model and simulation calibrated to annual survey of industrial plants from 1992 to 2010 for india. their analysis revealed that electricity supply shortage reduces average industrial output by five percent and raises energy costs by 0.24 percent of revenues, reduces productivity by 0.05 percent and reduces revenue by 0.78 percent. in the same vein, scott et al. (2014) used data from the world bank enterprise surveys from six countries: bangladesh, nepal, nigeria, pakistan, tanzania, and uganda to study the impact of electricity insecurity on small and medium scale firms. their statistical analysis showed that electricity insecurity negatively affects total factor productivity and labor productivity of manufacturing small and medium scale enterprises’ overall costs and it influences investment decisions and location. these further affirm the importance of electricity to economic process of any form of economy. nepal and jamasb (2011) studied the impact of power sector reforms on the economic, technical and environmental aspects of power sector, and the interactions between power sector reforms and economy wide sectoral level institutions since 1990. this was to examine the role of country level institutional structure and framework in explaining why some power markets (supply) work and some do not, based on the new institutional economics. the study was undertaken for a set of 27 diverse countries in central eastern europe and baltic states, south eastern europe, and common wealth of independent states. a panel data econometrics based on bias corrected dynamic fixed effect analysis was performed to assess the impact of reform on macroeconomic and power sector outcomes. the results showed that power sector reform is greatly interdependent with reforms in other sectors in the economy. they concluded that the success of power sector reforms on power sector outcomes in developing countries will largely depend on the extent to which countries are able to synchronize inter sector reforms in the country. 3. theoretical framework isola (2012) submits that the performance of an organization, measured in terms of operational efficiency, is determined by its form of organizational structure. the two extremes of such structures are perfect competition and monopoly. while perfect competition is highly participatory with finite number of firms, free entry or exit, etc. monopoly is highly restrictive with one firm industry and restrictive entry. also, perfect competition which is consumer friendly and protective encourages higher levels of economic activities and increases efficiency, while monopoly encourages inefficiency, limits economic activities and is consumer unfriendly. in between the two extremes exists other market structures such as oligopoly, monopolistic competition, etc. however, it has been recognized that the electricity industry cannot fit into the more general perfect competition and asian journal of economics and empirical research, 2016, 3(1): 94-102 99 monopoly models, because such models do not take into consideration the peculiar nature of such industry’s market. as suggested by isola (2012) oligopolistic competition models are the most suitable models for analyzing electricity market. the model is able to take cognizance of the technical characteristics, operational models and firms’ behavior in the electricity market. following borenstein and bushnell (1999), for electricity market, cournot competition is preferred to bertrand competition which according to blake (2003) are the two major oligopolistic alternatives to consider. preference for cournot competition hinges on the fact that demand for electricity is high and electricity suppliers have limited capacity and increasing marginal costs and may not realistically fix prices below other competitors as suggested by bertrand’s assumptions (hobbs, 1986). the nigerian electricity market has been under the monopoly of government agency from its early inception until about 2005 when major restructuring was made in the market through the electric power sector reform act (epsra), the law was aimed at liberalizing the power sector. the long period existence of the market on monopolistic structure has no doubt affected electricity products in the country. therefore this study, in line with ubi et al. (2012) employed as its theoretical framework the elementary supply theory where supply in this context is not necessarily total stock of products produced, but that amount of the products actually supplied (i.e. offered for sale). supply theory has it that the quantity of goods/services produced and supplied at a given time are determined by factors such as price of the commodity, cost of production, state of technology, natural phenomenon like weather condition, government policy, structural changes in the market, etc. the quantum and quality of electricity production and supply are also most likely determined by these factors. it is on the basis of these factors that we adopt the elementary supply theory as the framework for specifying the model for this study. 4. the model and data this study covers the period from 1981 to 2015, which captures the period before and after major structural changes in the electricity market in nigeria. econometric approach for the study relies on time series data regression. the data for the study were sourced from central bank of nigeria statistical bulletins and annual reports, ministry of power, national electricity regulation commission, and world bank climate change knowledge portal. the model specified follows those of ubi et al. (2012) and subair and oke (2008). after testing for unit root and cointegration, the study estimated the error correction model by adopting the general to specific approach to determine the parsimonious estimate and eliminating jointly insignificant variables. the model for the study is: els = f(pcgdp, elp, tech, elcon, rain, govinv, ref) (1) where: els = electricity supply in mega watt pcgdp = per capita gross domestic product measured in millions of naira is a proxy for income; elp = electricity prices in naira of mega watt of electricity per hour (n/mw/hr) is electricity tariff charged by the electricity distribution agencies in nigeria; tech = technology (time variance, a year is a data point) elcon = electricity consumption in megawatt of electricity per hour rain = rainfall measured in millimeters (mm) of rainfall per year in nigeria; govinv = government investment (expenditure) in the power sector (electricity) in millions of naira ref = structural changes in the electricity market (0 and 1 for periods before (1981 to 2004) and after (2005 to 2015)) major market reforms in the power sector in nigeria respectively. for the regression function to be in an estimation form, equation (1) is reformulated to include the stochastic error term: els = b0 + b1pcgdp + b2elp + b3tech + b4elcon + b5rain + b6govinv + b7ref + v (2) where: v = stochastic error terms. other variables are as defined earlier; b1 to b7 are the parameter estimates measuring the impact of the explanatory variables. apriori expected parameter values are: 0 < b1 to b7 5. empirical results table-6. correlation matrix for electricity supply equation els pcgdp govinv elp elcon rain tech ref els 1.0000 0.9587 0.6457 0.9296 0.9253 0.5362 0.8672 0.8330 pcgdp 0.9587 1.0000 0.9183 0.8907 0.8498 0.4160 0.7830 0.8338 govinv 0.6457 0.9183 1.0000 0.7872 0.7302 0.2958 0.6220 0.6655 elp 0.9296 0.8907 0.7872 1.0000 0.6533 0.7681 0.9357 0.7529 elcon 0.9253 0.8498 0.7302 0.6533 1.0000 0.5203 0.8385 0.8092 rain 0.5362 0.4160 0.2958 0.7681 0.5203 1.0000 0.7992 0.3995 tech 0.8672 0.7830 0.6220 0.9357 0.8385 0.7992 1.0000 0.9573 ref 0.8330 0.8338 0.6655 0.7529 0.8092 0.3995 0.9573 1.0000 source: computed by the author (2016) table-7. the results of the augmented dickey-fuller (adf) unit root tests variables level 1st difference 2nd difference remarks govinv 0.493694 -4.603638*** i(1) elcon -0.962527 -8.148139*** i(1) elp 1.181042 -5.412346*** i(1) pcgdp 2.692490 -7.514412*** i(1) rain -1.551040 -5.836048*** i(1) els 0.720391 -7.857469*** i(1) ref -0.594089 -5.744563*** i(1) source: computed by the author (2016) note: test critical values (constant): 1% level = -3.6422; 5% level = -2.9527; 10% = -2.6148 *** signify significance at 1%; ** signify significance at 5%; *signify significance at 10% asian journal of economics and empirical research, 2016, 3(1): 94-102 100 table-8. lag order selection criteria lag logl lr fpe aic sc hq 0 -1197.727 na 3.05e+26 75.17046 75.39948 75.24637 1 -1073.391 202.0466* 6.27e+23* 68.96193* 70.33606* 69.41742* 2 -1053.591 25.98750 9.82e+23 69.28693 71.80616 70.12199 3 -1024.473 29.11831 1.07e+24 69.02954 72.69388 70.24416 source: computed by the author (2016) * indicates lag order selected by the criterion lr: sequential modified lr test statistic (each test at 5% level) fpe: final prediction error; aic: akaike information criterion; sc: schwarz information criterion hq: hannan-quinn information criterion table-9. cointegration tests results hypothesized trace 0.05 no. of ce(s) eigenvalue statistic critical value prob.** none * 0.993593 555.9773 219.4016 0.0000 at most 1 * 0.962501 389.3158 179.5098 0.0000 at most 2 * 0.950886 280.9624 143.6691 0.0000 at most 3 * 0.896882 181.5131 111.7805 0.0000 at most 4 * 0.766678 106.5410 83.93712 0.0005 at most 5 0.463444 58.51488 60.06141 0.0671 at most 6 0.407584 37.96962 40.17493 0.0819 at most 7 0.302867 20.69260 24.27596 0.1326 at most 8 0.233522 8.786889 12.32090 0.1819 at most 9 0.000320 0.010552 4.129906 0.9333 source: computed by the author (2016) trace test indicates 5 cointegrating eqn(s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level **probability-values table-10. parsimonious ecm results variable coefficient std. error t-statistic prob. d(elp) 17.80081 6.939658 2.565084 0.0160 d(pcgdp(-1)) 6.290377 1.333352 4.717716 0.0001 d(govinv(-1)) 1.600000 0.413000 3.874092 0.0012 d(rain(-1)) 2.924752 1.315747 2.222882 0.0345 dum 1.569726 1.025153 1.521458 0.1407 ecm(-1) -0.921981 0.477699 -1.930046 0.0638 c 70.40807 38.47160 1.830131 0.0779 r-squared 0.855014 mean dependent var 110.8559 adjusted r-squared 0.792695 s.d. dependent var 220.1628 s.e. of regression 197.8166 akaike info criterion 12.17134 sum squared resid 1095679. schwarz criterion 12.84070 log likelihood -224.7128 hannan-quinn criterion. 12.66320 f-statistic 2.575349 durbin-watson stat 1.905232 prob(f-statistic) 0.048816 source: computed by the author (2016) pair-wise correlation analysis was undertaken to determine the level of relationship among the variables in the model. it was found that all the regressors in the model were found to have positive relationship with electricity supply. some variables were found to highly correlate with others, for instance, the level of correlation between technology (tech) and electricity price and also with reforms (ref) were about 94 percent and 95 percent respectively. equally, electricity consumption (elcon) was found to be highly correlated with electricity supply (els). to avoid the problem of multicollinearity and also gain degrees of freedom, tech and elcon were expunged as variables for estimation. both the augmented dickey-fuller and philip-peron tests were undertaken to determine the stationarity of the series regression for all the macroeconomic variables. results of the tests using the augmented dickey-fuller technique indicated that all the variables in the equations were stationary at first difference at one percent significance and are therefore integrated of order one. the johansen cointegration results indicated at most five cointegrating equations at five percent level of significance. this shows that there exist unique long run equilibrium relationships between the variables in the equation. to assess the impact of power sector reforms on electricity supply in nigeria, ref was regressed on aggregate electricity supply. electricity price (elp), per capita gdp (pcgdp), government investment in the power sector (govinv), and aggregate volume of rainfall (rain) were also added as major determinants of electricity supply. the parsimonious ecm result reveals that the error correction coefficient, which predicts the rate of speed with which the dynamic model restores back to equilibrium when it deviates and the speed with which variables would return to equilibrium was (-0.921 or 92.1 percent) negative and significant with t-statistics of -1.93 (approximately 2.0). as revealed, the speed of adjustment of 92.1 percent between the short-run and the long-run behaviors of electricity supply with its independent variables implies that adjustment is covered up within one year. the level of efficiency and validity of an error correction model depends on the lag structures. the optimum lag length selection was undertaken using the following criteria: final prediction error (fpe); akaike information criterion (aic); schwarze information criterion (sc); and hannan-quinn information criterion (hq). the values of the four criteria all indicate that the chosen optimal lag length in error correction model (ecm) for the model asian journal of economics and empirical research, 2016, 3(1): 94-102 101 should be one (1). the value of adjusted r 2 which is 0.7926 means that about 79 percent of total changes in electricity supply is determined through variations in the independent variables. this shows a good fit for the equation. the f-statistics which measures the overall significance of the independent variables in the equation depicts that they are statistically significant at 2.58. also, the durbin-watson statistics of 1.90 (approximately 2.0) indicate the absence of serial correlation in the equation, thus, the equation is good for policy analysis. the results of the analysis further shows that reforms (ref) coefficient has positive sign (1.569) and was statistically insignificant with t-statistic of 1.52 and p-value of 0.14. this result indicates that structural changes in the power sector in nigeria through the reforms of 2005 had positive coefficient but was statistically insignificant. this means that if the current market structure of the power sector in the country is improved and sustained, over time, it will help to boost electricity supply in nigeria. electricity price (elp), government investment in the power sector (govinv), annual rainfall (rain) and per capita gdp (pcgdp) all had positive coefficients and were statistically significant. the result here implies that increases in these variables will translate to increased electricity supply. 6. discussion the results affirm that structural changes in the power sector do not have significant impact on electricity supply in nigeria though it possess positive coefficient. the structural changes here include the power sector market reforms which came into effect from 2005 with the commercialization, privatization and unbundling of the power sector. the positive coefficient may mean that if the reform is effectively sustained and synchronized with positive reformations in the different sectors of the economy, this could bring about positive impacts on electricity supply in the country. as shown by nepal and jamasb (2011) successful reformation of the power sectors in developing economies is largely dependent on the rate at which such economies will be able to effectively and simultaneously manage reforms in other sectors of their economies. as isola (2012) noted, competition on its own does not guarantee success, rather, there should be a blend of competition with credible institutions. electricity price (elp), government investment in the power sector (govinv), per capital gdp and annual rainfall (rain) were shown to impact electricity supply positively and significantly. these are in line with the apriori expectations of this study and economic prescriptions. this goes in tandem with ubi et al. (2012) that these variables are among the major factors that determines the megawatts of electricity supplied in nigeria, although their study showed that electricity price does not have reliable influence on electricity supply in nigeria. the result here implies that increases in these variables will translate to electricity supply growth. the coefficient of rainfall reflect the nature of electricity generation sources in nigeria, one of which is the hydro which constitutes about 36 percent of electricity generation sources in nigeria after gas with 39.8 percent. the hydropower sources depend on the amount of rainfall. also, since electricity production is highly capital intensive, proper funding of the sector as well as adequate pricing of electricity products are expected, as shown, to propel supply growth 7. conclusion and recommendations based on the results of this study, it is concluded that the present reform efforts in the power sector aimed at restructuring the electricity market from monopolistic to competitive structure will bring great improvements in the power sector of the country if properly harnessed and made to work simultaneously with similar reforms in other sectors of the economy. reforms in the power sector should be encouraged to work more efficiently with time, but there is need for the government to rather play the role of monitoring and regulating the market than being an active participant as is currently the case where it has 100 percent share in transmission, 40 percent share in distribution and 20 percent share in generation. it is therefore recommended that government should totally transfer ownership in all units of electricity production and supply chain to private investors. since the reforms in the power sector cannot effectively work in isolation or with inefficiently and ineffectively government managed sectors of the economy, for instance the petroleum sector, other sectors of the economy should also be reformed alongside to enhance simultaneous effective performance in all the sectors of the nigerian economy the study indicates that electricity price has positive impact on electricity supply. this means that with proper pricing of electricity services, supply can be enhanced. though the current pricing system is geared towards achieving this, consumers should not be billed out of consumption, rather, as it is obtained in other electricity markets in the world, consumers in nigeria should be made to pay only for what is actually consumed and not estimated consumption that is open to abuse by the electricity distribution agency officials. so, policy on electricity pricing should be made to be consumer, and as well market friendly. also, proper measurement of electricity consumption should be made with internationally standardized meters. from the results obtained from this study, it is shown that proper funding of the power sector will enhance electricity production positively. since the sector is highly capital intensive, it needs adequate funding for it to be effective, policy should be directed at making adequate funds available to investors in the power sector. financial institutions should be encouraged to provide funds at a lower cost to such investors. these funds will enhance the purchase and replacement of old and worn out transformers and other infrastructures that will help boost electricity supply in the country. however, when the funds are acquired, they should be appropriately channeled to meet the purpose for which they were acquired. references akinlo, a.e., 2008. energy consumption and economic growth: evidence from 11 sub-sahara african countries. energy economics, 30(5): 2391-2400. doi org/10.1016/j.eneco.2008.01.008. alawiye, a.b., 2011. the power sector and industrial development in nigeria case: power holding company of nigeria. bachelor’s degree thesis, international business, lahti university of applied sciences. asian journal of economics and empirical 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african journal of accounting, economics, finance and banking research, 3(3): 18-26. tallapragada pvsn, 2009. nigeria’s electricity sector – electricity and gas pricing barriers. international association of energy economics: 29-34. ubi, p.s. and l. effiom, 2013. the dynamic analysis of electricity supply and economic development: lessons from nigeria. journal of sustainable society, 2(1): 1-11. ubi, p.s., l. effiom, e.o. okon and a.e. oduneka, 2012. an econometric analysis of the determinants of electricity supply in nigeria. international journal of business administration, 3(4): 72-82. united states energy information administration (useia), 2013. nigeria. d:/energy/ nigeria-analysis u.s. energy information administration (eia).htm. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. http://www.cenbank.org/ http://www.cia.gov/library/publications/download/ http://www.eprg.group.cam.ac.uk/ asian journal of economics and empirical research issn: 2409-2622 vol. 3, no. 1, 59-70, 2016 http://asianonlinejournals.com/index.php/ajeer 59 effectiveness and usefulness of personal tax reliefs: a study of ghana revenue authority’s domestic tax division edinam agbemava1 albert k. bediako2 israel kofi nyarko3  1,2 department of accountancy, ho polytechnic, ghana 3 department of marketing, ho polytechnic, ghana ( corresponding author) abstract this study examined the effectiveness and usefulness of personal tax relief administration in ghana and the challenges facing the ghana revenue authority domestic tax division in the quest to meet its personal tax administration objects. questionnaires were administered to twenty taxpaying persons and ten tax officials from the ghana revenue authority (domestic tax division) in the volta region of ghana. statistical package for social sciences software was used to analyze data gathered. the study found that the administration of personal tax reliefs is very helpful to the tax payer but it is not effective as it should be. inadequate tax education, improper completion of it forms 21 and 51, and low staff motivation were identified as key reasons for the ineffectiveness. recommendations are however provided and if they are well implemented, would solve the problems of administration of personal tax reliefs. keywords: tax reliefs, ghana, revenue authority, personal tax, ho. contents 1. introduction ......................................................................................................................................................................... 60 2. literature review ................................................................................................................................................................ 61 3. methodology......................................................................................................................................................................... 63 4. results and discussion ......................................................................................................................................................... 64 5. conclusion and recommendations ..................................................................................................................................... 69 references ................................................................................................................................................................................ 70 bibliography ............................................................................................................................................................................ 70 citation | edinam agbemava; albert k. bediako; israel kofi nyarko (2016). effectiveness and usefulness of personal tax reliefs: a study of ghana revenue authority’s domestic tax division. asian journal of economics and empirical research, 3(1): 59-70. doi: 10.20448/journal.501/2016.3.1/501.1.59.70 issn (e): issn (p): 2409-2622 2518-010x licensed: this work is licensed under a creative commons attribution 3.0 license contribution/acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained ethical: history: this study follows all ethical practices during writing. received: 9 january 2016/ revised: 8 february 2016/ accepted: 12 february 2016/ published: 17 february 2016 publisher: asian online journal publishing group http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.59.70 https://orcid.org/orcid-search/quick-search?searchquery=edinam agbemava https://orcid.org/orcid-search/quick-search?searchquery=albert k. bediako https://orcid.org/orcid-search/quick-search?searchquery=israel kofi nyarko http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.59.70 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.59.70 https://orcid.org/orcid-search/quick-search?searchquery=edinam agbemava https://orcid.org/orcid-search/quick-search?searchquery=albert k. bediako https://orcid.org/orcid-search/quick-search?searchquery=israel kofi nyarko http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.59.70 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.59.70 https://orcid.org/orcid-search/quick-search?searchquery=edinam agbemava https://orcid.org/orcid-search/quick-search?searchquery=albert k. bediako https://orcid.org/orcid-search/quick-search?searchquery=israel kofi nyarko http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.59.70 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.59.70 https://orcid.org/orcid-search/quick-search?searchquery=edinam agbemava https://orcid.org/orcid-search/quick-search?searchquery=albert k. bediako https://orcid.org/orcid-search/quick-search?searchquery=israel kofi nyarko http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.59.70 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.59.70 https://orcid.org/orcid-search/quick-search?searchquery=edinam agbemava https://orcid.org/orcid-search/quick-search?searchquery=albert k. bediako https://orcid.org/orcid-search/quick-search?searchquery=israel kofi nyarko http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.59.70 asian journal of economics and empirical research, 2016, 3(1): 59-70 60 1. introduction 1.1. background of the study according to dalton (1920) "a tax is a compulsory contribution imposed by a public authority, irrespective of the exact amount of service rendered to the taxpayer in return, and not imposed as penalty for any legal offence." tax is also defined as a “compulsory monetary contribution to the state's revenue, assessed and imposed by a government on the activities, enjoyment, expenditure, income, occupation, privilege, property, etc., of individuals and organizations” (www.ditionary.com/definition of tax). each and every nation is endowed with resources, be it by nature or an act of man. the resources of a nation have to be properly managed and efficiently allocated for the betterment of the citizenry. these resources ultimately must come from the public and private sectors. one of these resources is revenue or capital for running the affairs of the nation. the sources of revenue for every government are taxes (direct and indirect), charging of fees, borrowings (external and internal) and receiving of foreign loans/grants. in ghana, it is obligatory for every citizen above the age of eighteen (18) who is earning revenue to pay tax. income tax is paid by income earners, value added tax for service providers and consumers, import and export duties for both importers and exporters respectively. the payment of tax places some sort of burden on the taxpayer. in order to lessen the burden of the taxpayer, some tax reliefs are granted. personal tax reliefs are legally approved deductible allowances intended to reduce ones taxable income and thereby lessening the tax burden. they are intended to cushion the effect of tax on the individual and to enable him or her to pay the tax. they are given based on the equity rules of taxation and are normally based on the personal circumstances of each taxpayer. a person who is married and has children attending school will normally be more pressed than a person who is single. hence, in a progressive tax administration, a person’s position in relation to his commitment is considered by granting him/her the reliefs to ease the tax burden on him/her, (adam, 1776). one basic consideration in tax is the ability to pay. it is therefore, the responsibility of the government to ensure the taxpayer has the ability and understands why he/she has to pay the tax which is being levied. the personal tax reliefs in ghana fall under direct income tax which is administered by the commissioner of internal revenue service. taxation started in the form of custom duty levied on imported goods in the year 1850 in ghana. income tax was first introduced in ghana (then gold coast) in the year 1943. the law income tax ordinance (no. 27) was modelled on the principles of income tax acts then in force in the uk. there were amendments to this law in 1961, 1963, 1965, and 1966. two consolidations were done in 1966. it was the major source of tax authority until 1975, when smcd5 was promulgated as a major tax law. this was followed by a taxation act in 1971 (act 388). there were some other decrees and amendments between 1975 and 2000 when the internal revenue act, 592 was passed. this new consolidation was made to cater for income tax, gift tax and capital gain tax, with effect from january 2001. the current consolidation in force is the which came into effect in january 2010, and is aimed at harmonizing the various individual laws by tax types and bringing them under one management (section 3). personal tax reliefs were first introduced in ghana by united kingdom, ghana’s colonial masters in the ordinance number 27 of 1943 part vii, which was on ascertainment of chargeable income and personal reliefs stated that the chargeable income of any person’s payments under order of deed, deduction for life assurance, and passages; journey to and from the gold coast. unfortunately, these reliefs were abolished in 1961 during dr. kwame nkrumah’s regime. this was done upon the advice of professor nicholas kaldor, the then minister responsible for economic affairs. one of the reasons for abolishing the reliefs among others was the need for the government to raise revenue for the various capital projects it had embarked upon. notably, among the projects were the building of tema township, akosombo hydro-electric dam and tema motorway. the nlcd 78 brought some changes to the personal relief. in the case of life assurance, it was restricted to the tax payer, thus, excluding his wife. the nlcd78 also introduced new reliefs for pension or social security contribution. that is, pension or providence society or fund approved by the commissioner of the irs or any contribution made under the social security act 1965 (act 279). smcd 5 of 1975 did not differ from nlcd 78 in respect of personal reliefs. the differences were the elimination and substitution of lower and higher figure respectively. apart from the reliefs discussed, a further deduction may be allowed against the assessable income of an individual in respect of the following contributions/donations made by him/her:  contribution made to a charitable institution or fund approved by the government, example donations to the ghana national trust fund and save our souls  any donation made towards the cost of construction of schools and clinic by ghana muslim representative council subject to such conditions as the minister responsible for finance may determine  donations to refugee fund  donation towards sports development or sports promotion as approved by the minister responsible for sports. 1.2. statement of the problem lately, there are lots of labour agitations for increment in salaries and wages, unemployment issues, high rate of inflation, high cost of living and judgment debts among others coupled with the government’s position of lack of funds to meet these demands. the researchers have realized that the major source of revenue to the government to solve these hitches is through the payment of tax. the ghana revenue authority, an institution tasked to collect taxes on behalf of the government, on the other hand, complains of tax evasion and avoidance by eligible payers. since there is an exception to every rule, the researchers have found out that the exception in the payment of tax is the availability of personal tax reliefs. these reliefs are actually meant to induce the payment of tax. the above problems give rise to the following questions:  why even in the wake of the personal tax reliefs, people evade tax?  how are the personal tax reliefs administered? asian journal of economics and empirical research, 2016, 3(1): 59-70 61 1.3. objectives of the study the main objectives of this study were to ascertain: 1. the kinds of reliefs made available to personal tax payers 2. the awareness of tax payers about personal tax reliefs 3. the practical ways of enjoying tax reliefs 1.4. research questions the aim of this research is to find solutions to the following questions.  what personal tax reliefs are available in ghana?  do taxpayers claim personal reliefs?  what are the procedures for enjoying personal tax reliefs?  are taxpayers aware of personal tax reliefs?  how do the personal tax reliefs lessen the financial burden on the tax payer?  how are the taxpayers sensitized and motivated to pay the tax? 1.5. significance of the study the study sought to assess the implication and effectiveness of personal tax reliefs in ghana and specifically to:  serve as a guide for the management of gra(dtd) in the implementation and effective administration of personal tax reliefs  help taxpayers to have confidence in the tax laws and tax officials  assist other people who may have interest in this topic as a source of information  help get reasons for the ineffectiveness of personal tax reliefs and come out with recommendations to address the problems associated with personal tax reliefs 1.6. scope of the study the study was limited to tax payers in both public and private sector organizations to enable the researchers assess the implication and usefulness of the personal tax reliefs. 1.7. limitation of the study this research work was limited to ghana revenue authority (domestic tax division) ho, ghana. the sample chosen for the study was small in relation to the entire population of the taxpaying public in ghana. thus some of the results obtained should not be used as representative of the entire taxpaying population. such a generalization could be misleading as it may not represent the facts as they pertain to the entire country and hence affect the reliability of the study. 2. literature review 2.1. administration of personal tax reliefs in ghana whilst the responsibility for making correct returns for the purpose of assessment and claiming of any reliefs to which one may be entitled rest in the hands of the taxpayer, the general attitude of the gra staff should be one of readiness to assist the taxpayer in every reasonable way. accordingly, the commissioner for gra desires that all officers should at all times, as far as practicable, undertake the following:  draw the attention of taxpayers to any deductions or reliefs to which they appear to be clearly entitled to but which they may have forgotten to claim and respond fully to all requests that may be made by taxpayers for advice as to their right and liabilities or for guidance in making returns , claims to reliefs , objections etc.  there must be no differentiations of treatment between classes of taxpayers or between different nationalities. the provision of the decree (nlcd 78) and (smcd5) must be applied strictly in accordance with the wording of the decree, and assessing officers have no discretion to deal with any case because the decree does not contain a provision for a relief which the assessing officer ought to apply or to restrict the relief the tax payer is entitled to in order to balance some other matter which he/she feels doubtful about. the principles of tax administration must be fair to all taxpayers, with effectiveness to those who need help and fairness to those who attempt to evade tax (http//:www.gra.gov.gh). the procedure for applying for tax reliefs begins with the filing of income tax return form 21(it form 21) by the tax payer. this form after completion is submitted to the commissioner of gra. in addition, if the taxpayer is an employee, the accountant at his/her workplaces completes and countersigns a tax deduction schedule form (it form 21) supplementary on behalf of the taxpayer. this form shows the amount of taxes suffered every month by the taxpayer. gra officials go through all these forms to ensure the correctness of the computations on the it form 51 supplementary and also ensure the proper completion and accuracy of information provided on the it form 21. the procedure also involves the inspection of other documents deemed necessary. if a taxpayer after working for some time decided to apply for tax relief in a particular year, he/she is required to file tax returns for the six preceding years. this is to ensure that, the taxpayer has consistently fulfilled his/her tax obligations and also to ascertain his/her source of income over the year. the return forms thus, income tax (it 21) and deduction schedule form (it 51) must be filed not later than three months after the end of the assessment year (income tax year). the annual return forms having been completed make it possible for the calculation of total income and to ascertain the reliefs which may be claimed by the individual taxpayer. the declaration in each of the annual returns form must be duly signed and accompanied by accounts indicating other sources of income, except in the case of employees who have no other source of income and also the illiterate who are to make oral declaration of their income must swear affidavit to that effect. all returns received must be acknowledge promptly and action taken as to that regard. under the tax laws, one can only file returns in the asian journal of economics and empirical research, 2016, 3(1): 59-70 62 following year basis. for instance annual returns for the fiscal year 2013 can be filed the following year that is the year 2014. after arriving at the total income, the reliefs are set against it to ascertain the chargeable income. this is the income on which tax is imposed. if it is realized that, the taxpayer has been over taxed as a result of the reliefs granted, the excess tax paid is giving back to him/her in the form of a tax refund. on the other hand, if the taxpayer has under paid tax (this comes about when certain taxable allowance and benefit in kind are not taxed) he/she is ask to pay the deference in the actual tax paid and what was supposed to be paid. the income tax decree (smcd 5), charges employees and self-employed persons to pay taxes on their incomes. employees’ salary is subjected to tax under the pay as you earn (paye) system. it is the routine deduction of tax from one’s income at the end of every month. the paye system was introduced in ghana from july 1, 1961. the rationale behind its introduction is in two-fold;  it is a means for government to ensure that all salary workers who are eligible to pay tax, do so thereby receiving more revenue into the national coffers; and  by deducting tax at source, the tax burden is spread over a longer period and therefore become lighter and tolerable to the taxpayer. in the case of self-employed person, income tax is paid at specified rates based on annual assessments made by the commissioner of oaths. taxes may be paid in the form of equal installments by the end of each quarter that is march 31; june 30; september 30; and december 31 of each year of assessment. the year of assessment for income tax purposes is from january 1 to december 31 each year. a self-employed person may decide to have his/her own accounting date different from the governments (http//:www.faq.gra.gh). as already mentioned, ptr is an approved deductible allowance intended to reduce one’s taxable income and thereby lessen the tax burden. it also ensures fairness in the tax system. ptr is granted based on the individual’s circumstance and is granted on annual basis. ptr currently available to individuals are:  marriage reliefs  children’s education relief  disabled relief  age dependent relative relief  old age relief  social security relief  life assurance relief and  training and development relief 2.3. theoretical literature the main purpose of taxation was to raise money to finance public expenditure, but while this obviously remains an important function of tax, it is also accepted that taxation is one of the main weapons used by government to manage the economy. therefore, taxation may be to improve certain economic aims of the government such as full employment, fighting inflation and the stimulation of economic growth. taxation made possible the provision of public goods and services to correct the effect of externalities and help redistribute income (citizen-state relations, 2010). abdallah (2008) states that: “taxation is the levying of compulsory contributions by public authorities having tax jurisdiction, to defray the cost of their activities. no specific reward is gained by the tax payer”. the darity (2008) defines taxation as “a general concept for devices used by government to extract money or other valuable things from people or organization by the use of law”. it could be deduced from the above definitions that, taxation is:  compulsory , legal and enforceable by law;  paid by citizens and non-citizens of the nation  a transfer of resources from a private to the public sector; and  there is no direct relation between the tax paid and the benefit received. generally, taxes are classified into two thus, direct and indirect taxes. direct taxes are on the income, profit or wealth of individuals or companies. the most well-known direct tax is income tax (http//:www.faq.gra.gh) according to pritchard (1987) “income tax has the largest yield of any tax in britain and was first introduced in 1799 at the time of napoleonic wars and was withdrawn when those wars came to an end in 1815. it was then reintroduced in 1842 and it was thought that tax would be temporary and therefore it was only made an annual tax and even had to be re-introduced annually by the finance act. however, it had lasted without a break since 1842 and has now become the most important source of government revenue. he continues that, it has long been a policy that income tax in the united kingdom is levied progressively, so as to fall proportionately more heavily on those with the larger incomes. however, allowances for personal circumstances are mainly granted, if the taxpayer is married or single and has a mortgage or not.” in nigeria, the purpose of introducing direct tax in the protectorate was to consolidate and cleanse the precolonial tax system of its imperfections as well as to provide a source of revenue for both the government and the native authorities. the direct tax soon became the financial foundation on which the native authority system was built. indirect taxes on the other hand, are those taxes on transactions and good/services. they are only indirect on the taxpayer; a well-known example is sales tax. the distinction between direct and indirect tax is fairly artificial and of little significance as ultimately the burden of taxation is borne by individuals. for example, suppliers have to pay vat but they pass on the burden to consumers by raising prices. the statutory or formal incidence of tax lies on the supplier but buyers bear much of the real tax burden as the economic {or effective} incidence falls on them. even though the system of indirectly taxing people is unfair, indirect taxes are easier to collect and administer in our part of the world. indirect taxes contribute greatly to government tax revenue in ghana than direct taxes. this is always seen in the annual target given to the administrator of these types of taxes. the excise and preventive services administers indirect taxes and internal revenue service administers direct taxes. in the developed countries asian journal of economics and empirical research, 2016, 3(1): 59-70 63 like united states of america and great britain, both direct and indirect taxes are administered by one body. in spite of the immense contribution to tax revenue by indirect taxes, direct taxes have great potentials. these potentials, if properly harnessed, will change the trend in the developing countries to that of the developed countries. personal tax relief (ptr) is a relief given to a taxpayer in order to reduce the burden on the taxpayer, it relates to only the taxpayer, it is deducted before net income is taxed, and is carried out by gra. tax needs to be paid for the development of the country. the income tax department which was a civil service department was responsible for collecting the taxes. in addition to more taxes and the personal tax reliefs, the tax collecting department renamed the central revenue department in july, 1963 to reflect and cater for the broad scope of the taxes collected and the granting of the personal tax reliefs on behalf of the taxpayer in ghana. however, in july 1986, the government took a decision to make some changes in the department which brought the name internal revenue service (irs) law, 1986 (pndcl143). these changes and the reforming system helped irs to increase the system of taxpaying from both the employees and self-employed. according to cavalcanti and li (1999) the reforming tax expenditure programs that were introduced in 1992 to compensate lower income taxpayers for the proliferated, making the normative tax system difficult for the average taxpayer to understand, reducing the tax base. cavalcanti and li (1999) contend that strengthening the administration of system tax expenditure programs was the first step towards making them effective and equitable limiting their costs and preventing the tax base from shrinking. it has been discuss that the options for increasing the scrutiny of the tax expenditure programs, defining their opportunity cost and effect on the tax system. currently, the programs enjoy a funding advantage over direct spending programs because it is not subjected to systematic review in that to limit the expansion of these programs and reduce their less desirable effect on the dates for the system, cavalcanti and li suggest defining a benchmark tax structure, establishes sunset dates for the programs, forecasting their cost, and reviewing their economic effectiveness, efficiency and equity by comparing them with direct expenditure. the reforming and changes that was made in the tax administration will help taxpayers to get a good access into tax system for claiming of the tax refunds and the reliefs as well. ptr is an element of well-balanced program, which at its core should focused on satisfying the employee. and evaluation on reliefs on ethical evaluations in an equitable relief which assessed revenue to know whether it will help revenue authority in order to improve the relief system. fleischman & li valentine has developed a new equitable relief subset of the revised innocent spouse rules which was helpful when making relief decisions. in addition, it was addressed that the ethical and gender issues associated with equitable relief. meanwhile, it was suggested that several equitable reliefs factors are useful as discriminators in the relief decision and demonstrate that the recognition of an ethical issue and perceptions of moral intensity affected the decision to grant relief in innocent spouse situations in that the numerous personal and societal implications for businesses, gra agents as well as other nations wishing to reform their tax structures while assessing between equity tax revenue generation. the tax structure of the equitable relief system assessment will help improve the personal tax relief system. 2.4. empirical literature all over the world most especially, the commonwealth nations, personal tax reliefs are essentially the same. the differences are in the amounts granted in respect of reliefs and the mode of operation, that is, the administration of the reliefs. in the united kingdom, employers have been given the authority to grant personal tax relief to employees upfront. that is, once employees` circumstances are known (through a return form) he/she is granted an equivalent relief each month and individual have to fill another return form only when his/her circumstances change. for instance, where a husband and wife are separated or divorced. comparing the british and american system of tax wrote personal allowances of roughly $200 are given in respect of the following: a. single person b. married person c. blind person; and d. children and dependant relative thus, man supporting his wife and two children will be entitled to tax free allowances of $800. if the wife has an income over $200 per annum, she will file a separate return and is treated as a separate person for all proposes. instead of an earned income allowance, the tax payer in the united state is entitled to a standard deduction of 10% of his taxable income of $1000 ($350) whichever is less. alternatively, he can claim the following deductions:  contributions –charities and religious organizations  mortgage interest and high purchase charges; and  medical and dental expenses  local rates and car licenses  alimony  uncompensated losses by means of theft, fire, etc. the balance of the taxable income is taxes at a progressive rate which is based on a percentage rate. there is no standard rate of tax as such according to h touch, the american fills and computes his or her own tax liability. the australian system is much the same as the british that is only income is subject to tax and nothing else. for individuals, the basis of assessment is the current year and the accounts are rendered to 30 th june each year. no standard rate exists like the american system and wives too are assessed separately. the 30 th june may be inconvenient time for balancing the account but generally, the australian system is simpler and does not involve the many delays in the british system. 3. methodology 3.1. research design the study employed descriptive survey. creswell (2003) defines descriptive survey as a method of collecting data for the purpose of testing hypothesis or answering research questions concerning the current status of the subjects under study. descriptive survey is a design used to gather data at a particular point in time with the intention asian journal of economics and empirical research, 2016, 3(1): 59-70 64 of describing the nature of existing conditions or identifying standards against which existing conditions can be compared or determining the relationship that exist between events. thus, a descriptive study is undertaken in order to ascertain and be able to describe the characteristics of the variables of interest in a situation. the target population of a study constitutes the group of persons, objects or institutions that defines the objects of the investigation. staff and the registered taxpaying public in ho township constitute the population for the study. the sample was made up of respondents from both the formal and informal sectors of the economy’s employees and the self-employed. the sample size was thirty (30) which was made up of ten (10) tax officials of gra and twenty (20) tax payers (employed and self-employed). due to the large population, the researchers made use of the simple random sampling for data collection. this method of sampling was preferred because it gives equal chance for each member of the group to be selected for the study. respondents were selected at random but care was taken to ensure that each group was adequately represented. the data collected were in two forms thus, the primary and the secondary data. the primary data was in the form of administration of questionnaires and interview with tax officials of gra tax paying public. the questionnaires were in two forms: one for the gra staff and the other for tax payers. in all, thirty (30) questionnaires were administered: ten to staff of gra and twenty to the tax payers. the questions used in this research were in two forms: open-ended and close-ended questions. the open-ended was used because, it allows respondents to express their views in the manner they want or know. the close-ended was used to obtain specific answers. the basic interview tool used was the face-to-face method. typically, interviews in a qualitative study are done with unstructured or minimally structured format. the interview was crucial to this research because interviews are one of the principal tools used to obtain descriptions for many a case study as it can gather the multiple realities inherent in a case. the motive of including tax officials (gra) in the study was to ascertain first-hand information and also, they are solely responsible for income tax payers despite the busy schedule of the gra tax officials, the researchers were able to interview some of them. the secondary data used for this study was obtained for this study was obtain from the gra head office, relevant textbooks, the internet and other research materials collected in the same field of study. the secondary data were also acquired from library (textbooks) journal, tax records and web sites. even though secondary data may not necessarily be as accurate as primary data, they prove to be very useful in this type of research. the data analysis and description were based on the responses that were received from the questionnaires and interviews. the questionnaires were administered to tax payers and the gra officials. microsoft excel 2010 version was used for the presentation of figures and tables. 3.2. validity and reliability the questionnaires used for the collection of data were pre-tested. this was done by administering five (5) questionnaires to tax officials of gra and ten (10) to taxpayers. errors detected in the questionnaires were corrected immediately before used for the actual field work. acts, codes and existing literatures were consulted in relation to field data gathered to attest the authenticity of information received from the respondents; therefore, this research work could be relied on. 4. results and discussion 4.1. bio data analysis this section deals with the respondents’ gender, age, place of residence, occupation, employment status, and level of education. the bio data were obtained from both the staff of gra and tax payers. therefore, the analysis on bio data was based on data from both groups of respondents. figure-1. gender distribution of respondents source: field data, september 2015 figure 1 above shows that seventeen of the respondents were males representing 57% of the respondents and the rest of the respondents are females which represents 43% of the population. this means that the majority of the respondents were males which imply that fifty-seven percent of the views expressed in this paper are skewed towards male perspectives. asian journal of economics and empirical research, 2016, 3(1): 59-70 65 table-1. age distribution of respondents ages frequency percentage (%) 21-40 19 63 41-60 8 27 61 and above 3 10 total 30 100 source: field data, september 2015 table 1 above shows the age distribution of the respondents. from the table, 19 representing 63% of the respondents fell within the range of 20-40 years, 8 respondents were within the age of 41-50 years which represent 27%, and the rest 3 of the respondents were aged 51 years and above, representing 10% of respondents. this means that the majority of the respondents were young people within the age range of 20-40. figure-2. occupation of the respondents source: field data, september 2015 the above diagram shows the various occupations of the individual respondents. out of the thirty (30) respondents; 7 were public servants, 3 were tax officials, 6 teachers, 2 police officers, 3 traders, 2 accountants and other occupations got 1 respondent each. this implies that the highest group of respondents was public servants. figure-3. employment status of respondents source: field data, september 2015 the above chart shows that 24 of the respondents representing 80% were employees, while 6 respondents representing 20% said they were self-employed. this means the majority of the respondents were employees. 4.2. awareness of personal tax reliefs this section of the questionnaire was answered by 10 respondents from the ghana revenue authority and the responses are analyzed below. all the staff of gra (domestic tax revenue division) agreed that there were policies instituted to educate the public on the need to pay tax. the following are the means indicated by the gra staff respondents for the sensitization:  one on one basis  the mass media; electronic and print media  periodicals; newspapers, public address system ( gra public education van)  tax audit  seminars and workshops asian journal of economics and empirical research, 2016, 3(1): 59-70 66  organized sensitization in institutions all the ten respondents also agreed that there was an increase in the awareness of tax reliefs. and the above responses indicated that the gra was leaving no stone unturned in creating awareness of personal tax reliefs, for that matter, the payment of tax. 4.2.1. problems encountered in sensitizing tax payers six of the respondents indicated that they did not encounter any problem in the sensitization programme whilst four of them confirmed the existence of problems. the four respondents gave the following as challenges in educating the public:  poor procedure compliance by taxpayers  lack of law sensitivity on the part of the taxpayers  lack of interest in payment of tax by those who are eligible. 4.3. administration of personal tax reliefs this section enumerates the types of reliefs available to tax payers and how personal tax reliefs are administered by the gra. 4.3.1. forms of reliefs available to tax payers according to the gra (dtrd) staff respondents, eight forms of personal tax reliefs were available to tax payers. the assessable income of an individual for a year of assessment would be reduced by the following reliefs. personal income tax review effective jan. 2011): a. marriage relief this would be enjoyed as follows:  a married man who maintains his wife and the household.  a married woman who maintains her husband and the household.  an unmarried man with two or more dependent children; and  an unmarried woman with two or more dependent children. marriage relief would be granted on the production of a marriage certificate or a certified copy of the registration of marriage to support the claim. it is currently at ghs100.00 b. children’s education relief this relief is granted to individuals who have children or wards in recognized and registered educational institutions in ghana. the individual may only claim a relief in respect of three children or wards. where two or more persons qualify in respect of the same child or more, only one person shall enjoy the relief. the relief will be granted only on the production of a certificate issued by the head of educational institution concerned, stating that the child or ward is a student of that institution. the current amount granted is ghs100.00 c. disabled relief this relief is granted to a person who proves to the satisfaction of the commissioner for gra that he/she is disabled. the relief is limited to 25% of the disabled person’s income from trade, business, profession, vocation and employment. d. old age relief this is granted to persons over 60 years. like disabled reliefs, it is granted only in respect of income from trade, profession, vocation or employment. to grant such a relief, the applicant must show proof of date of birth (e.g. birth certificate) and any other document. the current relief is ghs100.00 e. dependent relative relief it is granted to any person who proves to the satisfaction of the commissioner of gra that he/she has agedrelatives who depend on him or her for provision of necessities of life. the relief is granted in respect of not more than two aged relatives. as a supporting document, one needs to submit an affidavit certifying that he or she is truly responsible for the upkeep of the dependant relative. ghs50.00 is the current amount of relief granted. f. social security relief any person who contributes towards the social security scheme in ghana qualifies for this relief. conditions for granting the relief include:  the contribution by an employer in respect of his employee shall be 12.5% of the employee’s total remuneration.  contribution by employee shall be 5% of his total emolument  deduction by self-employed person in respect of contribution in favor of him or herself shall not exceed 17.5% of his or her income from his/her profession, vocation, business or occupation. g. life assurance relief the following conditions must be fulfilled for an individual to qualify for life assurance reliefs:  the amount paid by way of insurance premium shall not exceed 10% of such person’s income. income in this context shall be considered to include all income chargeable to tax under section one of the decree (smcd 5) asian journal of economics and empirical research, 2016, 3(1): 59-70 67  the premium should be paid in ghana currency.  the policy shall be on the life of the claimant. it should be noted that, the amounts mentioned as reliefs are not cash allowances payable to claimants of the reliefs. they are deducted from one’s assessable income before the calculation of the tax. h. training and development relief in the case of an individual who has undergone any training to update his professional, technical or vocational skills or knowledge, the cost of the training is ghs200.00 4.3.2. conditions that can disqualify one from enjoying tax reliefs all the respondents agreed that there are conditions under which one cannot enjoy tax reliefs. these are:  failure to apply for the reliefs  wrong status declaration  failure to file returns  unmarried tax payers cannot enjoy marriage reliefs  falsification of information  if one does not meet the conditions of enjoying specific reliefs 4.3.3. provision of accurate information by tax payers seven out of the ten gra staff responded that most tax payers fail to provide accurate information. they gave the following as measures put in place to address any misinformation:  desk top audit  field audit  educating tax payers on how to provide accurate information  drawing the attention of the tax payers to the blunder figure-4. difficulties in the computation of reliefs source: field data, september 2015 the above figure shows that four respondents indicated that they actually encounter difficulties in the computation of the reliefs to be earned by the tax payer. the four further indicated that when wrong income is declared, it affects the amount of reliefs to be granted as the difficulty. on the other hand, six respondents confirmed that they do not encounter any challenge at all, because, the errors committed by the tax payers are corrected before the computation. in all, it means the gra has less difficulty in computation of the reliefs. 4.4. personal tax reliefs this section of the data presentation is based on the questionnaires responded to by only tax payers. table-2. awareness of personal tax reliefs response frequency percentage (%) yes 14 70 no 6 30 total 20 100 source: field data, september 2015 the above table shows that 14 respondents confirmed that they are aware of the existence of personal tax reliefs representing 70% and the remaining 6 (30%) respondents declared that they are not aware. this confirms that the gra is making much effort in the sensitization process. asian journal of economics and empirical research, 2016, 3(1): 59-70 68 figure-5. abolishing personal tax reliefs source: field data, september 2015 from the above figure, there were only 2 respondents representing 7% who consented that the personal tax reliefs should be abolished to increase the revenue base of the government to meet its numerous demands. the majority thus; 28 respondents representing 93% of the respondents strongly agreed that the personal tax reliefs should never be abolished. they further pointed out how helpful the personal tax reliefs were in the following ways:  serve as a cushion to the tax payer  encourage the payment of tax  disabled relief is of great importance in reducing street begging by physically challenged  increase standard of living  lessen ones’ tax obligation  cut down on unemployment in a way a tax relief is an approved deductible allowance intended to reduce your taxable income and thereby lessen your tax burden. for example, a married person with children attending school will normally be harder pressed than a single person with no dependants. therefore, ghanaian tax law grants you relieve to lighten the tax burden (revenue mobilization support, 2006). 4.5. personal interviews it became necessary to conduct personal interview with both the gra staff and the taxpayers to acquire other information which we could not indicate in the questionnaire. 4.5.1. interview with gra staff an interview with some personnel of the ghana revenue authority was to find out some challenges that the gra and the applicants encounter in the administration of the reliefs and why it takes the gra much longer to process the application. the officers confirmed that most applicants do not complete the forms properly thus, leaving vital questions unanswered. this they pointed out to be one of the most common challenges with applicants. besides, individuals’ tax return (it) forms; 21 and51 (supplementary) must be signed by designate authorities but the applicants do submit the forms being signed by unqualified persons or not signed at all. though this they said is frustrating, it is intended to ensure authenticity and sincerity. the applicants also, provide false and inaccurate information which creates inconsistency of the information and quite difficult to deal with. the gra now requires marriage and insurance policy as evidence. 4.5.2. interview with the tax payers the study revealed that almost all the respondents who are married, have children varied from 1-6. the level of education of the children also ranges from kindergarten to tertiary but most of the children are in kindergarten, primary, junior high and senior high with few ones in the tertiary level. in addition, most of the children have their fathers as the financier of their education, few being financed by both parents and an insignificant number of them being taken care of by the mother. some of the tax payers interviewed also indicated having dependants and these dependant’s ages are above 60, and are either parent(s) or relative(s). with the question of either a respondent is a disabled or physically challenged, none was found. in terms of application for the reliefs, only few respondents admitted having applied for the reliefs as many others find it so cumbersome especially when the forms need to be accompanied by the required statutory documents. for instance, for marriage reliefs, one must present evidence of marriage certificate obtainable from the registrar general’s department. and this certificate takes much longer and efforts to acquire making the process tiresome. it was found out that the ghana revenue authority has put so many measures in place to sensitize the general public, not only on personal tax reliefs but also on general important information that the tax payers need. the gra creates this awareness through the following means:  one on one basis  the mass media; electronic and print media  periodicals; newspapers, public address system asian journal of economics and empirical research, 2016, 3(1): 59-70 69  tax audit  seminars and workshops  organized sensitization in institutions this is revealed by ten (10) gra staff who rated the taxpayers’ awareness at 57% and the tax payers themselves confirmed their awareness at 70%. the effect was the increase in the application for the reliefs. it was indicated to the researchers that the gra as a human institution, encounters some problems in the processing of returns forms of the applicants. some of these problems are; applicant’s inability to complete the form properly; for example, leaving some vital information unanswered and having the form endorsed by unqualified person. all these are contributing factors to the delay in accessing the reliefs. the study discovered that there are some circumstances under which a person is disqualified from enjoying the reliefs and among them are, failure to apply for the reliefs, wrong status declaration, failure to file returns, falsification of information and if one do not meet the credentials of enjoying specific reliefs. 5. conclusion and recommendations conclusively, most personal income tax payers do not make use of personal tax reliefs because of the inadequate awareness. even those who are aware have refused to apply for the personal tax reliefs due to long delay, cumbersome procedures and other frustrations. nevertheless, the researchers anticipate that this study will generate some interest among students and researchers who might want to do a further detail investigation into personal tax reliefs in ghana. the researchers conclude that the personal tax reliefs are very useful to the tax payer by reducing his/her tax obligation. also, the administration of personal tax reliefs in ghana is not effective as it should be. this conclusion is based on the fact that, notwithstanding the many measures put in place by gra in educating tax payers on personal tax reliefs, these do not reflect in the pockets of many of the tax payers in terms of the reliefs being granted to them. based on the findings of this study, the following recommendations have been made to improve on the 1. public education on personal tax reliefs should be intensified, if possible giving it the same publication as being received by the payment of income tax. if policy makers deem the filing of income return as important as to necessitate the passing of act 2000 (act 592) on the delivery of returns, then the awareness of personal tax reliefs must also be equally be created 2. benefiting from reliefs is supplementary to filing of returns. this education will make the taxpayers aware of their civic responsibility of filing tax returns and also make them aware of their right to access personal tax reliefs. thus, the gra should focus more on the benefits of paying tax such as the personal tax reliefs and the provision of basic amenities rather than laying emphasis on payment of tax in general. 3. as a benefit to the gra for that matter the government, as more returns are filed, it becomes easier for the gra to identify tax payers and their various sources of income which were hitherto unknown. this will eventually bring more income earners into the tax net and increase the income of the government. 4. frequent television and radio advertisements on tax reliefs will yield tremendous results. the daily and weekly newspapers could also carry very useful advertisement and articles on tax reliefs. since 70% of the respondents claimed to have heard of tax reliefs from these sources: television, radio and newspapers, it will be very strategic to intensify the education there. 5. regular seminars and symposia should be organized by the gra for both employers and employees to properly educate them on how to deal with the it forms 21 and 51. these would keep them abreast with current changes in the tax laws and requirements. 6. field officers should be trained and dispatched to workplaces and associations such as the market women’s association, the beauticians and dress makers association and other self-employed groups to talk to their members on the need to file tax returns and the usefulness of tax reliefs. 7. structures such as bill boards could be erected along major streets and such places of interest as the sport stadia and cinema houses to educate the public on tax reliefs in particular and taxes in general. stickers and posters with very attractive phrases about tax reliefs could also be designed for cars, doors and files. 8. the gra must also work in collaboration with the social welfare and the physically challenged rehabilitation centers to educate them on the provision on tax reliefs on their incomes. 9. tax refund should be readily available for payment to deserving taxpayers. this will let taxpayers have trust in the tax law as well as the tax officials. tax courts should be established to prosecute taxpayers for failing to submit return forms including officials of gra. this will deter other taxpayers from evading and avoiding their tax obligation. 10. gra should liaise with national commission for civic education (ncce) to carry tax education programs. tax and government officials should set the pace by filing their returns regularly and consistently, thus leadership by example. developing a shared interest for economic growth; governments which depend on taxes have stronger incentives for promoting economic growth 11. the procedure for the application and the processing of personal tax reliefs need to be simplified to improve the rate of tax relief utilization by tax payers. already, the gra has simplified the previous complicated it form 21, but more needs to be done. for example the gra can depend on the social security and national insurance trust (ssnit) for certain information on employees. this will reduce the burden on the tax payer of having to provide evidence to support the information they disclose on the it form 21. sometimes one has to go through a lot of frustrations in order to obtain these documents and these discourage most people from filing returns. a simple procedure will therefore go a long way to encourage the filing of returns. computerization will reduce long delays and the complex nature of processing tax relief computation. 12. generally, the whole system of income tax should be computerized to reduce delays, frustrations and the tedious procedure of manually processing of personal tax reliefs. the system should be networked via internet with a unique pin number as an identification code. the procedure for administering personal tax asian journal of economics and empirical research, 2016, 3(1): 59-70 70 reliefs should be decentralized into different departments so as to give easy access to taxpayers to file their tax returns. although computerization may be expensive, it is strongly believed that its benefits will far exceed the cost in this instance. the simplification should not do away with the legal documents and procedures but should make the institutions that issue these documents to be active and speedy in their service delivery. references abdallah, a., 2008. taxation in ghana –principles, practice and planning. 2nd edn., cantonments – accra: black mask ltd. adam, s., 1776. proposed canons of taxation; equity, certainty, convenience and efficiency. london: oxford university press. cavalcanti, c.b. and z. li, 1999. reforming tax expenditure programs in poland. policy research working papers no. 2465. citizen-state relations, 2010. improving governance through tax reform. organization for economic cooperation and development. creswell, j.w., 2003. research design: qualitative, quantitative and mixed methods approaches. 2nd edn., california: sage publications. dalton, h., 1920. the measurement of the inequality if incomes. uk: blackwell publishing for the royal economic society. darity, w.a.j., 2008. the encyclopedia of social science. usa: macmillan reference. pritchard, w.e., 1987. income tax. 15th edn., london: printwell press. revenue mobilization support, 2006. basics of ghanaian tax law. ghana: german technical cooperation. bibliography ghana revenue authority, 2010. mission, vision and core values of the new ghana. accra: gra (http//:www.faq.gra.gh.) internal revenue service, 2003. taxpayer’s registration and identification number. accra: irs. internal revenue service, 2006. a guide to income taxation in ghana. accra: irs. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. http://www.faq.gra.gh/ asian journal of economics and empirical research issn: 2409-2622 vol. 1, no. 2, 40-47, 2014 http://asianonlinejournals.com/index.php/ajeer * corresponding author 40 inbound tourism and social factors in nigeria: evidence from an ardl-ecm model emmanuel okokondem okon 1 department of economics, kogi state university, anyiba, kogi state, nigeria abstract this work is licensed under a creative commons attribution 3.0 license asian online journal publishing group 1. introduction nigeria, known as the giant of africa, is filled with the history of many ethnic groups, beautiful beaches and wonderful natural landscapes. for years, the oil industry has overshadowed any thought of showing off the beauty of nigeria. however, recently nigeria has been attempting to slowly turn this sector around and make nigeria a more accessible and safe place for tourists (arasi, 2011). in terms of tourism as an economic product, people have a critical central role to play. the richness of a people’s cultural heritage, warmth and hospitality must be central to tourism development in nigeria. when a people are given to reclusive and introversive ways of life, their level of hospitality is likely to be low. social vices, restrictive cultural practices could considerably reduce a country’s ranking as a tourist destination. high theft rate, murder and similar vices are capable of planting scares into the minds of prospective tourists, both local and foreign. on these indices, nigeria today does not have a high rating. the over 15 years of military dictatorship has left indelible marks on the psyche of nigerians (njoku, 2003). the multiple problems, bottled over the years are now being unleashed on the body polity. the lingering crisis in the oil-rich states of the south of nigeria, the ethnic conflicts (tiv-jukuns, umuleri-aguleri, ife-modakeke, etc); the restive problem of communities in the niger delta; poverty and lack of opportunity for many young people, especially in urban areas, have led to major crime; the recent spate of assassination in the wake of general elections are sour points to mention (njoku, 2003). this paper attempts to investigate the effect of different social factors on inbound tourist arrivals in nigeria. these factors are examined in relation to travel decision making and destination selections (sirakaya et al., 1996). a better understanding of these determinants of tourism demand could help policymakers design the appropriate strategies needed to develop the tourism sector further, and correct these social issues, given the basic objective of making nigeria the ultimate tourism destination in africa (saheed and egwaikhide, 2012).the paper is structured in the following manner: following the introduction is the review of related literature in section 2.section 3 examines some social issues and tourism in nigeria. section 4 presents the methodology, analytical framework and model for the study. section 5 hosts the estimation and discussion of empirical result, while section 6 summarizes the findings, proffers policy recommendations and points out some limitations associated with the study. 2. literature review international tourism demand analysis has been discussed broadly; even comprehensive reviews have also been delivered by several scholars (crouch, 1994a;1994b; lim, 1997; song and witt, 2000; li and song, 2007). these reviews indicate the main determinants in international tourism demand analyses from 1960s to the beginning of 2000s were predominated by income of origin countries, relative prices, substitute prices, travel costs, exchange rates, and time disturbance dummy variable. (crouch, 1994a) observed ‘dummy variables mostly represent political this paper investigated the relationship between social factors and inbound tourism in nigeria between 1990 and 2012. phillip perron unit root test revealed stationarity of the variables at their first difference while the autoregressive distributed lag (ardl) bounds testing approach to cointegration also established the long run relationship among the variables. in the short run, log(ill), log(crm(1))and dlog(mpr(-1)) exhibited negatively significant relationship with inbound tourism in nigeria while log(urb(-1)) has a positively significant relationship. the long run result indicates that log(urb) is positively related with tourism demand (log(tar)). on the other hand, log(mpr) shows an inversely significant relationship with log(tar). nigerian government should still do more in the area of awareness of malaria prevention and compliance. also, more commitment should be made in fighting illiteracy especially at the rural level. keywords: social factor, tourism demand, inbound tourism, nigeria, unit root test, cointegration, autoregressive distributed lag (ardl) ecm model. http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2014, 1(2): 40-47 41 unrest, terrorism, limitation of foreign spending, special occurrence, and other transitory disturbances that are difficult to quantify’. furthermore explanation related to the relationship of three most applied explanatory variables, namely income of origin country, tourism price/relative price and transportation cost is delivered by lim through her meta-analytical study. income and tourism price relationship to international tourism demand are founded following microeconomic consumption theory, where income has a positive relationship while tourism price has a negative one. unlike the other two explanatory variables, she found transportation cost had less clear relationship to international tourism demand (lim, 1999). demand of international tourism can be explained by various potential factors (song and witt, 2000). besides income and price, as demand theory suggested, abundance of explanatory variables is utilized in the existing empirical studies depending on the research objectives. among the increasing interest in international tourism assessments is examining the role of economic, social and political conditions in the destinations. among others, narayan (2004) and oh (2005) find economic growth strongly lead to tourism development in the case of fiji and korea, respectively (sinclair, 1998) mentioned that the conditional differences between developing and developed country make a difference in term of benefiting tourism. 3. tourism and social issues in nigeria the nigerian tourism sector is structurally faulty and in need of a coherent modification plan, this is based on the fact that the sector has only been able to attract tourist from low income countries, thereby exacerbating its low tourism receipts. in 2005, nigeria received more than 2.7 million tourists (peter, 2011). the largest contingents came from niger(620,658), benin (393,215), liberia (107,401), and cameroon (107,108) (library of congress, 2008). according to fapohunda (1975), the informal economy is estimated to range between50 to 75 percent of the total economy. hence most segments of the sector are swallowed in the pervasive underground economy in nigeria; this has rendered this vital sector out of government control and regulation. thus tourists are left at the mercy of crooks and goons. however, globally, the number of tourist arrivals has been increasing, and nigeria has been getting its own fair share, going with the world bank, international tourist arrivals increased from 1010000 in 2005, to 1111000 in 2006, to 1212000 in 2007 and 1313000 in2008 (peter, 2011). the unwto records show that in 2009 international arrivals was 1414000, also for 2010 the organization claims that arrivals increased by 7 percent in nigeria (peter, 2011). see table 1 in appendix for tourist attraction in nigeria. although nigeria’s gdp per capita has been increasing through the course of time in nominal us dollar terms, many nigerians are still living in poverty (ucha, 2010). obviously, the average income per capita does not give the real picture due to nigeria’s high income inequality. according to the world resources institute’s environmental resource portal earth trends, about 71 percent of nigerians live on less than $1 a day and about 92 percent live on less than $2 a day. it is clear that given the rich natural resources, the level of poverty in nigeria is remarkably high and in addition, the country ranks third in the world for the most people living with hiv/aids and has the third highest death rate as a result of hiv/aids (cia, 2011). nigeria’s infant mortality rate has been estimated to be currently 99 per 1000 births, which implies that nigeria has the thirteenth highest infant mortality rate in the world (cia, 2011). the infant mortality of children under the age of 5 was 189 per 1000 births in 2007. these high mortality rates are mostly due to mothers not having enough money to take care of their children. many mothers are also ignorant of some preventive measures such as immunizations and vaccines. the immunization rate against diphtheria, pertussis and tetanus (dpt) for children between 12-23 months was about 54 percent in 2007. many children in nigeria die as a result of malaria, diarrhea, tetanus and similar diseases. most of these are preventable and curable diseases, but due to inadequate health care facilities and lack of money far too many children die off from them. like the grown-up population, many children also lack access to safe water and sanitation, which typically leads to several diseases. when compared to sub-saharan africa, nigeria seems to be better off in a few economic and social aspects but worse off in most. this is illustrated with some selected economic and social data in table 2 (see appendix). 4. methodology according to (crouch, 1994a; 1994b) and lim (1997), international tourism demand variables are often represented by the number of tourist arrivals and departures, the expenditures and receipts of tourism sector and tourist-nights and the average length-of-stay. due to lack of monthly data disaggregating tourists by purpose of visit and country of origin, this paper will only examine tourism demand international tourist arrivals to nigeria from all countries rather than from a particular country of origin. since single-equation estimation still provides useful insights to factors that influence international tourism demand and remains the most widely used estimation framework. this study adopted a single-equation framework to analyze international tourism demand for nigeria. only social factors that are perceived to be of risk to tourists and can influence the decision to travel to nigeria are considered. to account for the dynamics of the tourist’s decision-making process, the autoregressive distributed lag model and cointegration/error correction models were adopted. 4.1. model specification and estimation technique to investigate the effect of different social factors on inbound tourist arrivals in nigeria, the following demand function is specified: tar= ƒ(urb, ill, pvl, ump, crm,mpr) ………….(1) where, tar, is tourist arrivals (or demand) from other countries to nigeria; urb means urbanization rate which is usually an indicator of development in a country; ill is the inability to meet a certain minimum criterion of reading and writing skill; ump is unemployment rate i.e., the percentage of the labor force that is without jobs in the asian journal of economics and empirical research, 2014, 1(2): 40-47 42 country; pvl is poverty level, i.e., population below poverty line; crm is the crime rate which is proxy by kidnapping in the country, i.e., offences against persons; mpr is prevalence of malaria (per 100,000). malaria has been identified as a health risk that lowers tourism (gallup and sachs, 2000). the apriori expectation is negative coefficient for most of the variables except for urb (urbanization rate). following a double-log transformation of equation (1), the ardlerror correction model is given as: intat = έ0 + σ p i-1πintat-1+σ p i-1αinurbt-1+σ p i-1γinltrt-1+σ p i-1μinpvlt + σ p i-1χinumpt+σ p i-1жincrmt-1+ σ p i1ψinmpr t+ φ1intat-1+φ2inurbt-1 + φ3inltrt-1+ φ4incrmt-1 + © …………..(2) where: π α, γ, μ, χ, ж and ψ are the short run dynamic coefficients of the ardl model; φ =1,2,3 and 4 are the long run multipliers and p is the optimal lag length. 5. estimation and discussion of empirical result the result of unit root test based on phillip perron tests is presented in table 3 (see appendix). all the variables under scrutiny were i(i) process, which means that they are stationary at first difference. this result is particularly important in that it confirms the use of the ardl bounds testing approach that is applied as the most appropriate and useful cointegration procedure in the context of this paper. regarding the bounds test, first, the double-log transformation of equation (1) was estimated. the purpose was to establish the long run relationship among the variables. next, the short-run dynamics of the ardl-ecm is estimated. the calculated f-statistics for the long run model and short run error correction model is presented in table 4. the critical values are based on critical values reported in pesaran et al. (2001). table-4. f-statistics for testing for the existence of long run relationship computed f-statistics (long run model) 41.21571 computed f-statistics error correction model 93.93288 bound testing critical value 5% lower (2.365); upper (3.553) source: computational results using eview 7.0 the critical values are taken from pesaran et al. (2001), unrestricted intercept and no trend with seven variables at 1 per cent is 3.027 to 4.296; at 10 per cent are 2.035 to 3.153. the calculated f-statistics for the long run model is 41.22 and that of the short run model is 93.93. these values are higher than the upper and lower bound critical values at 5 per cent levels of significance. this implies that the null hypothesis of no co-integration cannot be accepted at 5 per cent and 10 per cent levels of significance and therefore, there is a long run relationship among the variables under scrutiny. the long run result (see table 5 in appendix) indicates that log (urb), log (ump) and log (mpr) are significant social factors influencing tourism demand in nigeria. a closer examination reveals that log (ump) does not conform to economic expectation. however, a 1 per cent increase in log (urb) leads to 1.006102 per cent increase in tourism demand and statistically significant at 5 per cent level. on the other hand, log (mpr) shows an inverse relationship with log (tar). a one per cent increase in log (mpr) leads to 0.466424 decrease in tourism demand (log (tar)). this result shows statistical significance at 1 per cent level. a highly significant error correction term is a strong confirmation of the existence of a stable long run relationship as observed by gujarati (2004). as such, the paper proceeds to estimate the error correction model following the estimation of the long run coefficients. the paper adopts the general to specific approach (see table 6 in appendix) to arrive at the parsimonious (see table 7 in appendix) estimate by eliminating jointly insignificant variables. the result indicates that log(ump), log(ill), dlog(tar(-1)), log(urb(-1)), log(crm(-1)), dlog(mpr(-1)), dlog(ump(-1)), dlog(tar(-2)) and dlog(ill(-1)) are significant social factors influencing tourism demand in nigeria in the short run. a closer look at the result in table 7 (see appendix) reveals that log(ump), dlog(tar(-1)), dlog(ump(-1)), dlog(tar(-2)) and dlog(ill(-1)) are contrary to economic expectation. however, log(ill), log(urb(-1)), log(crm(-1)) and dlog(mpr(-1)) are the few variables which do not only conform to apriori economic expectations but are also statistically significant at 1 and 5 per cent levels of significance. their statistical significance strongly suggests that a 1 per cent increase in log (ill), log (crm (-1)) and dlog (mpr (-1)) leads to about -0.453687, -0.155721 and -1.228129 per cent decline in tourism demand respectively. however, a 1 per cent increase in log (urb (-1)) results to a 4.622329 increase in tourism demand (log (tar)). the result of the error correction model indicates that the ecm1 variable is statistically significant but does not have the correct apriori sign. however, ecm 2 does have the expected negative sign. in particular, about 229 per cent of disequilibrium from long run tourism demand in the previous two periods is corrected in the current year. that shows a high level of convergence. the durbin watson (dw) statistics value of 1.8 shows the absence of first order serial autocorrelation in the model. the value of adjusted r 2 of 0.98 indicates a good fit. in particular, the model explains about 98 per cent of total variations of the dependent variable around its mean. 5.1. diagnostic test the stability of the model is tested using the standardized residual chart and confidence ellipse. from the standardized residual graph (see figure 1 in appendix), it is apparent that the model is averagely stable across time asian journal of economics and empirical research, 2014, 1(2): 40-47 43 and space. nonetheless, there are few periods that the oversight of the union exceeds the residual limit; however, these occurrences are insignificant. the confidence ellipse in figure 2 were made on a 4-basis points to capture the stability effects of the quadrants of the square box, from the chart it is seen that the ellipse were saturated within the confidence square box signifies which the stability of the overall specification of the model. nonetheless, there are some cases that the ellipses were not saturated within the confidence square box; however, these occurrences are still negligible. in table 8 (see appendix), almost all of the centred variance inflation factor (vif) are less than 10, suggesting that a low degree of multicollinearity is present. on the other hand, the uncentred vif showed some of the variables with values greater than 10, indicating a severe multicollinearity. the forecast for the dependent variable indicates constancy throughout the sample period (see figure 3 in appendix). this is because it stayed within the plus and minus two standard errors (2.s.e line). 6. summary, conclusion and policy recommendations this study attempted to investigate the impact of social factors on inbound tourism in nigeria from 1990 to 2012. the result of the unit root test showed that the variables are stationary at first difference, thus warranting the adoption of bounds testing approach to cointegration. the long run result indicates that log (urb), log(ump) and log(mpr)are significant social factors influencing tourism demand in nigeria. in the short run, log(ump), log(ill), dlog(tar(-1)), log(urb(-1)), log(crm(-1)), dlog(mpr(-1)), dlog(ump(-1)), dlog(tar(2)) and dlog(ill(-1)) are significant social factors influencing tourism demand in nigeria. based on the findings, nigerian government should adopt an integrated approach to the provision of water, electricity, sanitation, drainage and solid waste management in urban area. similarly, private sector and community participation in urban renewal activities, housing and infra-structural provision should be encouraged. though nigeria is making a big investment in malaria, it should still do more in the area of awareness of malaria prevent and compliance; and intensification of the fight against fake malaria drugs. adequate operational facilities should be given to the police force to assist in their fight against kidnapping and other criminal activities. this can be complemented by effective community policing in the country. in addition, the joint security forces should be given free role to report and destroy kidnapper’s hideouts. when they are rendered homeless, it will be difficult for them to carry-out their regular criminal operations. information is power, as such; the media should be encouraged to organize more public programs against kidnapping and other crimes. when adequate information is given about the various measures to curb kidnapping, it could serve as threat to the perpetrators. more commitment should be made to fight illiteracy in nigeria especially at the rural level. this is because illiteracy is much greater in rural areas than in urban areas. in the same vein, there is need to raise national awareness on girl-child education and increasing political and financial commitment through advocacy and sensitization of policy makers at all levels, parents, school authorities, other leaders and girls themselves. given the fact that the size of the sample in this study is relatively small, the degree of freedom in the model estimation is consumed and data were not adequate on some specific variables such as terrorist casualties and incidents that would have made the study more policy relevant. while the study gives some useful guidance to policy makers, a number of points could be clarified by further work, and this should give greater specificity to policy guidelines. a primary suggestion for future research is that the tourism demand model should be expanded to accommodate other variables as a means to greater understanding of the tourism industry in nigeria. in addition, more advanced econometric measures than those used in this paper should be employed, to more accurately capture the nature of any effect on tourism demand, and what sources contribute to that effect. references arasi, t., 2011. 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http://placidnjoku.com/government%20policies%20and%20their%20effects%20on%20tourism.htm. oh, c., 2005. the contribution of tourism development to economic growth in the korean economy. tourism management, 26(1): 39-44. http://nyuiba.com/ibj/2011/02/nigerias-tourism-problem/ http://www.cia.gov/library/publications/the-world-factbook/fields/2144.html http://lcweb2.loc.gov/frd/cs/profiles/nigeria.pdf http://www.nigeriasite.com/touristsite.html http://placidnjoku.com/government%20policies%20and%20their%20effects%20on%20tourism.htm asian journal of economics and empirical research, 2014, 1(2): 40-47 44 pesaran, m.h., y. shin and r.j. smith, 2001. bound testing approaches to the analysis of level relationships. journal of applied econometrics, 16(3): 289-326. peter, a.a.n., 2011. nigerian tourism sector and the impact of fiscal policy: a case study of the 2000-2009 federal budgets. being a project submitted in partial fulfillment of the requirement for the award of a bachelor of science (b.sc.) degree in the department of economics, faculty of social sciences, university of jos, plateau state, nigeria. available from http://www.slideshare.net/attahpeter/the-nigerian-tourism-sector-and-the-impact-of-fiscal-policya-case-study-of-2000-2009-federalbudgets. saheed, z.s. and c.i. egwaikhide, 2012. impact of social crises on economic development: theoretical evidence from nigeria. american international journal of contemporary research, 2(6): 176-864. sinclair, m.t., 1998. tourism and economic development: a survey. the journal of development studies, 34(5): 1-51. sirakaya, e., r.w. mclellan and m. uysal, 1996. modeling vacation destination decisions: a behavioral approach. journal of travel and tourism marketing, 5(1): 57–75. song, h. and s.f. witt, 2000. tourism demand modeling and forecasting: modern econometric approaches. 1 edn., oxford: pergamon. ucha, c., 2010. poverty in nigeria: some dimensions andcontributing factors. global majority e-journal, 1(1): 46-56. world bank, 2008. nigeria at a glance. available from http://devdata.worldbank.org/aag/nga_aag.pdf. table-1. tourist attractions in nigeria source: nigeriasite.com (2002). table-2. selected poverty and social data for nigeria and sub-saharan africa source: world bank (2008) abia state tourist centres include the national war museum, umuahia, the azumini blue river, ukwa east, and the long juju of arochukwu. adamawa state it has historical places of interest like the lamido's palace (the seat of emir of adamawa in yola, old palace of harriman yaji at madagali german rule, german rest house at kowogol) and a host of other places of interest. akwa ibom state notable among the tourist attraction are the ibeno beach which stretches over 330 km along the atlantic coast line of the state with excellent opportunities for water sporting. others include the mobil tank farm, the oron museum, theibom connection etc. bauchi state tourist attraction include the yankari game reserve, premier game reserve, rock paintings at goji and shira, the state museum among others. bayelsa state tourist attractions include its numerous beaches, fishing festivals, the canoe war displays and boat regattas and dances. borno state tourist attractions include the kyarimi park in maiduguri for animal and bird lovers and where the only captured hippopotamus in west africa is harboured, the shehu's palace, rabeh's fort at dikwa, yamtarawala tomb at biu. others are lake chad, sambissa game reserve and jaffi falls among others. cross river state the important tourist attractions are obudu cattle ranch, obudu, old residency museum, calabar, agbokin waterfalls, ikom, etanpim cave, in odukpani local government area and mary slessor's tomb, calabar, cross river national park and kwa falls in akamkpa local government area, obubra lake, obubra and the calabar cenotaph, calabar. beaded works which are a peculiarity of cross river state are sold in crafts shops. common works are beaded bags, beaded wall hangings, shoes, ekpe masquerade made with rafia, cane chairs, brass trays, rafia clocks, motif work and a lot more. ebonyi state there tourist attraction in the state include: the ndibe beach at afkpo, uburu salt lake, uburu, ishiagu pottery works, ishiagu. edo state edo state has a rich cultural heritage. benin city, the state capital is famous for its unique bronze, brass and ivory works of arts which are found all over the world in museums. tourist attractions in the state are the royal palace of benin, benin museum, benin moat (iya), emotan status, somorika hills in akoko-edo. others are udo tourist centre in esan east local government area and okomu wildlife sanctuary near benin city. ekiti state ekiti state is a popular tourist haven. the popular ikogosi warm spring resort is located in ikogosi, ekiti. other tourist attractions are arinta water falls, ipole-iloro, olosunta hills, ikere-ekiti, fajuyi memorial park, ado-ekiti, ero dam, ikun-ekiti, egbe dam, egbe-ekiti and natural caves in ikere-ekit. closely linked to the tourismpotencial of the state is the festivals that are held seasonally. http://www.slideshare.net/attahpeter/the-nigerian-tourism-sector-and-the-impact-of-fiscal-policya-case-study-of-2000-2009-federal-budgets http://www.slideshare.net/attahpeter/the-nigerian-tourism-sector-and-the-impact-of-fiscal-policya-case-study-of-2000-2009-federal-budgets http://devdata.worldbank.org/aag/nga_aag.pdf asian journal of economics and empirical research, 2014, 1(2): 40-47 45 table-3. phillip -perron test source: computational results using eview 7.0 n/b * significant at 1%; ** significant at 5%; and ***significant at 10% table-5. long run result (dependent variable :log(tar) source: author’s calculation using eviews 7.0 table-6. overparametized result variable coefficient std. error t-statistic prob. c 8.567778 3.048189 2.810777 0.0672 log(urb) 0.628280 0.731649 0.858717 0.4536 log(pvl) 0.032546 0.153787 0.211629 0.8460 log(ump) 0.075020 0.032254 2.325876 0.1025 log(crm) -0.004076 0.039271 -0.103781 0.9239 log(mpr) 0.062546 0.161131 0.388167 0.7238 log(ill) -0.242887 0.366927 -0.661951 0.5553 dlog(tar(-1)) -2.931149 0.800881 -3.659907 0.0352 log(urb(-1)) 4.374084 1.028130 4.254407 0.0238 log(crm(-1)) -0.156965 0.046516 -3.374424 0.0433 dlog(mpr(-1)) -1.100777 0.411115 -2.677537 0.0752 dlog(ump(-1)) 0.200643 0.068541 2.927357 0.0611 log(pvl(-1)) 0.038846 0.157628 0.246440 0.8212 ecm(-1) 1.670354 0.557255 2.997469 0.0578 dlog(ill(-1)) 0.520487 0.284719 1.828075 0.1650 ecm(-2) -1.887201 0.800629 -2.357147 0.0997 dlog(tar(-2)) -1.193235 0.496285 -2.404333 0.0955 r-squared 0.994860 mean dependent var 13.76242 adjusted r-squared 0.967445 s.d. dependent var 0.265855 s.e. of regression 0.047968 akaike info criterion -3.433676 sum squared resid 0.006903 schwarz criterion -2.587304 log likelihood 51.33676 hannan-quinn criter. -3.268456 f-statistic 36.28930 durbin-watson stat 2.348385 prob(f-statistic) 0.006422 source: own computations using e-view 7.0 table-7. parsimonious result variable coefficient std. error t-statistic prob. c 10.55581 0.788202 13.39225 0.0000 log(ump) 0.084241 0.017646 4.773942 0.0014 log(ill) -0.453687 0.178420 -2.542809 0.0346 dlog(tar(-1)) -3.060628 0.319266 -9.586456 0.0000 log(urb(-1)) 4.622329 0.313700 14.73486 0.0000 log(crm(-1)) -0.155721 0.021029 -7.405024 0.0001 dlog(mpr(-1)) -1.228129 0.146329 -8.392947 0.0000 dlog(ump(-1)) 0.210969 0.031726 6.649644 0.0002 ecm(-1) 1.716480 0.247575 6.933171 0.0001 ecm(-2) -2.285549 0.326664 -6.996646 0.0001 dlog(tar(-2)) -1.137318 0.163300 -6.964594 0.0001 dlog(ill(-1)) 0.681170 0.145508 4.681308 0.0016 r-squared 0.992317 mean dependent var 13.76242 adjusted r-squared 0.981753 s.d. dependent var 0.265855 s.e. of regression 0.035912 akaike info criterion -3.531770 continue variables levels 1st difference order of integration tar -6.468075* i(1) crm -7.160327* i(1) mpr -4.262807* i(1) ump -4.504039* i(1) pvl -5.584180* i(1) ill -4.717893* i(1) urb -5.431349* i(1) variable coefficient std. error t-statistic prob. c 15.35294 1.681768 9.129045 0.0000 log(urb) 1.006102 0.454069 2.215744 0.0416 log(pvl) 0.074487 0.115350 0.645745 0.5276 log(ump) 0.125522 0.025464 4.929367 0.0002 log(crm) -0.031426 0.022954 -1.369090 0.1899 log(mpr) -0.466424 0.111022 -4.201194 0.0007 log(ill) 0.059563 0.225584 0.264038 0.7951 r-squared 0.939231 mean dependent var 13.72990 adjusted r-squared 0.916443 s.d. dependent var 0.261562 s.e. of regression 0.075608 akaike info criterion -2.080732 sum squared resid 0.091464 schwarz criterion -1.735146 log likelihood 30.92841 hannan-quinn criter. -1.993818 f-statistic 41.21571 durbin-watson stat 2.307907 prob(f-statistic) 0.000000 asian journal of economics and empirical research, 2014, 1(2): 40-47 46 sum squared resid 0.010317 schwarz criterion -2.934331 log likelihood 47.31770 hannan-quinn criter. -3.415144 f-statistic 93.93288 durbin-watson stat 1.786203 prob(f-statistic) 0.000000 source: researchers’ computation, 2013, adapted from regression result using e-view 7.0 table-8. variance inflation factors coefficient uncentered centered variable variance vif vif c 0.621263 9634.333 na log(ump) 0.000311 18.90028 3.076095 log(ill) 0.031834 7315.360 3.272630 dlog(tar(-1)) 0.101931 18.75643 17.45092 log(urb(-1)) 0.098408 2316.420 8.473092 log(crm(-1)) 0.000442 197.0850 6.326360 dlog(mpr(-1)) 0.021412 4.246299 3.986672 dlog(ump(-1)) 0.001007 3.839127 3.707170 ecm(-1) 0.061293 4.165472 4.150121 ecm(-2) 0.106709 7.399972 7.395053 dlog(tar(-2)) 0.026667 4.907016 4.565470 dlog(ill(-1)) 0.021173 2.379201 2.345330 source: researchers’ computation, 2013, adapted from regression result using e-view 7.0 figure-1. standardized residuals graph source: computer adaptation figure-2. confidence ellipse source: computer adaptation -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 standardized residuals .04 .08 .12 c( 2) -.8 -.4 .0 c( 3) -4 -3 c( 4) 4 5 c( 5) -.20 -.16 -.12 c( 6) -1.6 -1.2 -0.8 c( 7) .2 .3 c( 8) 1.0 1.5 2.0 c( 9) -3 -2 c( 10 ) -1.6 -1.2 -0.8 c( 11 ) 0.4 0.8 10 12 c(1) c( 12 ) .05 .10 c(2) -.5 .0 c(3) -4 -3 c(4) 4 5 c(5) -.20 -.16 -.12 c(6) -1.6 -1.2 -0.8 c(7) .2 .3 c(8) 1.0 1.5 2.0 c(9) -3 -2 c(10) -1.6 -1.2 -0.8 c(11) asian journal of economics and empirical research, 2014, 1(2): 40-47 47 figure-3. forecast source: computer adaptation views and opinions expressed in this article are the views and opinions of the authors, asian journal of economics and empirical research shall not be responsible or answerable for any loss, damage or liability etc. caused in relation to/arising out of the use of the content. 400,000 600,000 800,000 1,000,000 1,200,000 1,400,000 1,600,000 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 tarf ± 2 s.e. forecast: tarf actual: tar forecast sample: 1990 2012 adjusted sample: 1993 2012 included observations: 20 root mean squared error 20312.51 mean absolute error 17083.63 mean abs. percent error 1.866446 theil inequality coefficient 0.010017 bias proportion 0.000028 variance proportion 0.000556 covariance proportion 0.999415 asian journal of economics and empirical research vol. 4, no. 2, 91-98, 2017 issn(e) 2409-2622/ issn(p)2518-010x doi: 10.20448/journal.501.2017.42.91.98 91 causality between government expenditure and government revenue in nigeria balogun abdulrasheed1 1department of economic planning, research & statistics federal capital territory administration, abuja, fct nigeria abstract this study seeks to establish the causality between government expenditure and government revenue in nigeria. the type of research adopted is ex post-facto and the updated annual time series data between1986-2015 were obtained through statistical data bulletins and annual reports of central bank of nigeria in order to evaluate the variables such as total revenue and aggregate public expenditure of the federal government. the study applied co-integration statistical method and vector autoregressive techniques comprising an error correction model (ecm) and augmented dickey fuller as the methods of analyses. the findings showed that there is spendrevenue practice in nigeria in line with the theory of barro (1974); peacock and wiseman. (1979) indicating that changes in government expenditure triggered changes in government revenue. the co-integration tests also revealed that there is existence of long run equilibrium relationships between government revenue and expenditure variables. the outcome of this study showed that increase in government expenditure without a simultaneous increase in revenue could broaden the budget deficit. keywords: public revenue, public expenditure, fiscal administration. citation | balogun abdulrasheed (2017). causality between government expenditure and government revenue in nigeria. asian journal of economics and empirical research, 4(2): 90-98. history: received: 10 may 2017 revised: 19 june 2017 accepted: 3 october 2017 published: 24 october 2017 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 92 2. methodology ..................................................................................................................................................................................... 94 3. results and analysis of findings .................................................................................................................................................. 95 4. discussions of the findings ........................................................................................................................................................... 97 5. conclusion and recommendation ................................................................................................................................................ 97 references .............................................................................................................................................................................................. 97 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://orcid.org/orcid-search/quick-search?searchquery=balogun abdulrasheed https://orcid.org/orcid-search/quick-search?searchquery=balogun abdulrasheed asian journal of economics and empirical research, 2017, 4(2): 91-98 92 1. introduction oil revenue has remained the major source of revenue to nigeria over decades, over reliance on oil has therefore crippled other potential sources of revenue. the recent dwindling in oil revenue due to series of factors such as vandalisation, oil theft, mismanagement, non-remittance, connivance and general corrupt practices etc has open up avenue for other non-oil sector to be explored, which includes taxes, customs duty and tariff, fees, penalties among others. government expenditure and revenue have over the years remained significant and critical interplay variables in fiscal administration. the government in nigeria takes transparency and accountability in treasury management very seriously. the implementation of a treasury single account to receive revenues and monitor financial flows at the centre, high level probe of government contracts and physical and forensic accreditation of staff to detect ghost workers are key ways that show that new government in nigeria is determined to ensure efficiency and effectiveness in financial and economic management (fakile, adegbie and faboyede 2014). improving fiscal strategy is inevitable to mobilize needed resources for socio-economic development but that can only be achievable with efficient methods with significant development progress in infrastructure, social services and job creation. although this may be controversial, reducing or removing fuel subsidies is also a viable way to raise revenue. drummond, daal, srivastava and oliveira (2012) argued that given the limited resources available for implementation of the vast infrastructure required in some african countries, mobilizing more income and improving on the economic reconstruction is a priority for them. these countries have huge improvement plan to execute, but weak revenue drive is the genesis of fiscal disparity that these countries in the region experience. nwogwugwu and okoronkwo (2015) also posited that governments at different levels have the responsibility of mobilizing revenue to meet the requirements of the public by providing infrastructural needs and making sure that the well-being of the people are guaranteed. most states in nigeria encountered serious issues concerning people’s level of tax obligation fulfillment which sometimes result to their unjustifiable reliance on constitutional sharing of federation account. fakile et al. (2014) agree that despite the opportunity for domestic resource mobilization, the need for foreign aid and private sector investments cannot be overemphasized. the best results for economic management can only be achieved in an atmosphere where the due process of law is respected; improved security system is guarantee and investment environment good for investors is assured. improving fiscal strategy and efficient financial and economic management system will provide needed resource climate for sustainable development of the country. therefore considering the causality between the government expenditure and revenue, there is the need to analyse the type of relationship and the shape of the direction that exist between them in nigeria as was done in several other countries. mainoma and aruwa (2015) in their most recent study and several other past literatures that were reviewed such as von furstenberg et al. (1986); anderson et al. (1986); nwogwugwu and okoronkwo (2015); mohsen and abbas (2014); al-zeaud (2015); saeed and somaye (2012); mohsen et al. (2011); li (2001); fasano and wang (2002); al-qudair (2005) and nwosu and okafor (2014) have conducted studies to establish the relationship between government revenues and government expenditure. the study of mainoma and aruwa (2015) therefore, using time series data covering a period of 30years between1979-2008, employed the impulse response functions and vector autoregressive(var) model for the purpose of analysis discovered that causality runs from revenue to public expenditure by supporting revenuespend hypothesis and aligning with blackley (1986) and ram (1988). but this study failed to capture the effect of growth in government expenditure and revenue that translated to recent positive economic growth that catapulted nigeria to become the biggest economy in africa after rebasing in 2013. in order to investigate this position, we intend to update and extend this study to 2015 to capture this effect. the study however uses time series data covering 30years period between 1986 and 2015. therefore, the objective of this study is to determine the causal relationship between aggregate government revenue and aggregate government spending in nigeria. the following hypothesis will be answered; ho there is no significant causality between government revenue and government expenditure in nigeria. h1 there is significant causality between government revenue and government expenditure in nigeria. 1.1. conceptual issues there are different hypotheses regarding the relationship between government revenue and expenditure. first hypothesis was proposed by buchanan and wagner (1977) and friedman (1978) which holds that government revenues solely determined its expenditure which indicates a unidirectional causality that runs from revenues to expenditure. according to friedman, high taxes imply more spending leading to a larger budget deficit at the end. in the case of nigeria, government expenditure is financed mostly through oil exports revenues that accounted for about 80% of total government revenues and non-oil revenue accounted for 20%. second hypothesis was proposed by barro (1974); peacock and wiseman. (1979) holds that government determines its expenditure prior to its revenues which is regarded as spend and tax hypothesis. peacock and wiseman argues that during crises, government increases its expenditure which; eventually, lead to higher taxes. hence, there is a unidirectional causality runs from government expenditure to revenues. in the case of nigeria, the policy makers consider the expected government expenditure when they determine the optimal level of government revenues (nwosu and okafor, 2014); (anderson et al., 1986). third view argued by musgrave (1966) and meltzer and richard (1981) who posited that government makes simultaneously its revenues and expenditure which means that there is a bidirectional relationship between government revenues and expenditure. this hypothesis, the fiscal synchronization hypothesis or the fiscal neutrality hypothesis indicates bidirectional relationship between revenue and spending. if the bidirectional causality between public revenue and public expenditure does not hold, it means that public expenditure decisions are made free of public revenue decisions and vice versa (darrat, 1998); (von furstenberg et al., 1986); (chang et al., 2002). finally, baghestani and mcnown (1994) are of the view that none of the above hypotheses illustrate the relationship between public revenues and expenditure. government expenditure and asian journal of economics and empirical research, 2017, 4(2): 91-98 93 revenues are separately determined by the long run economic development showing the institutional separation between public revenues and expenditure. this final hypothesis is the institutional separation hypothesis where separate decisions on revenue are decided independent of allocations on government expenditure, and therefore no causal relationship between revenue and spending is expected (al-qudair, 2005). 1.2. empirical literature review different empirical studies in this area of study have revealed as follows; hasan and lincoln (1997) carried out a research on this issue for united kingdom by using co integration technique and they used quarterly data from 1961-93 for this purpose, the outcome showed that government tax revenue granger causes government expenditures. owoye (1995) examined the g7 countries and discovered bidirectional relationship in five of the seven countries while in japan and italy he discovered causality running from revenue to expenditure. kollias and makrydakis (2000) discovered tax and spending relationship in four countries namely; greece, portugal, spain, ireland which are comparatively poorer countries in european union. they found that co integration prevails in only greece and ireland whereas there is no long run relationship in the models for spain and portugal. chang et al. (2002) conducted a study to examine this relationship in ten industrialized countries including three newly industrialized asian economies namely, taiwan, south korea and thailand. in this study, gdp variable is also included in the model as a control variable along with government expenditures and tax variables and johansen cointegration technique is exercised for analysis. they claimed that co integration among the variables prevails for seven countries and found causality from government revenues to government expenditures for uk, usa, south korea, japan and taiwan while causality runs from government expenditures to revenues for south africa and australia. this study also found independence between revenues and expenditures for new zealand and thailand. fasano and wang (2002) investigated this relationship for oil-dependent gcc countries and found evidence of unidirectional causality running from revenue to expenditure in bahrain, the united arab emirates and oman while they found bidirectional causality for kuwait, qatar and saudi arabia. they advise that the gcc countries could improve the effectiveness of their fiscal procedure by allowing budget expenditure to be less driven by revenue availability. li (2001) by applying the co integration and error correction models over the period 19501997 for china found bidirectional causality between government expenditure and revenue. in another study, narayan and narayan (2006) found tax-and-spend hypothesis for mauritius, el salvador, chile, paraguay and venezuela. for haiti, fiscal synchronization hypothesis was discovered, while in, while in peru, south africa, guatemala, guyana, uruguay and ecuador there is evidence of neutrality by application of the toda and yamamoto (1995) test for granger causality. craigwell et al. (1994) examined government revenue and expenditure causality in the presence of seasonality in barbados. applying seasonal unit roots, co-integration test, granger causality and vector error correction methodologies, their results established that the variables are significantly co-integrated, and that a unidirectional causality from government revenue to total government expenditure exists. the outcome further revealed that bivariate and multivariate techniques showed a proof of a unidirectional movement from revenue to spending. alqudair (2005) examined the relationship between public expenditure and revenues in saudi arabia applying co integration technique, error correction model (ecm) and granger causality test. the co integration test showed the presence of long run equilibrium between public expenditure and revenues. in pakistan ali and shah (2012) who examined government revenue and expenditure mix using yearly data for the period 1976-2009. they applied the johansen co-integration and granger causality techniques and discovered no relationship in the variables both in the long run and the short run granger. this result supports institutional separation hypothesis. in nigeria, the following studies were conducted to examine the causal-relationship between government expenditure and government revenue, mainoma and aruwa (2015) using vector error correction model based causality test for the periods 1979 to 2008. their findings showed that causality runs from revenue to public expenditure in nigeria, their causality test and impulse response analysis confirm that government revenue has a significant impact on public expenditure in nigeria. also, aregbeyen and taofik (2012) also investigated the long run relationships and dynamic interactions between the government revenues and expenditures in nigeria over the period 1970 to 2008. using autoregressive distributed lag experiment, the outcome showed that there is a long run relationship between public expenditures and revenues, and no evidence of a long run relationship was found. therefore, the taxspend hypothesis was established. emelogu and uche (2010) also conducted a study in nigeria to investigate the relationship between public revenue and government expenditure. they used yearly data from 1970 to 2007. they also applied the engel-granger co-integration technique, the johansen co-integration method and the granger causality test within the error correction modeling (ecm) framework and discovered a long-run relationship between the two variables and a unidirectional causality running from public revenue to expenditure in nigeria, ogujiuba and abraham (2012) also examined the revenue-spending hypothesis for nigeria using largescale data from 1970 to 2011. they applied correlation analysis, granger causality test, regression analysis, lag regression model, vector error correction model and impulse response analysis, they report that revenue and expenditure are linked and that causality runs from revenue to expenditure in nigeria. the vector error correction model also proves that there is a considerable long run relationship between revenue and expenditure and finally, nwosu and okafor (2014) examined the relationship between both total expenditure and total revenue in nigeria using yearly data from 1970 to 2011. their study employed co-integration techniques and vector autoregressive (var) models with an error correction term as the methods of analyses. the co-integration tests showed the presence of long run equilibrium relationships between government revenue and expenditure variables. the var results also show that total government expenditure, capital and recurrent expenditures have long run unidirectional relationships with total revenue, as well as unidirectional hypothesis running from expenditure to revenue.the outcome aligned with the spend-tax hypothesis in nigeria implying that changes in government expenditure bring about changes in government revenue. asian journal of economics and empirical research, 2017, 4(2): 91-98 94 1.3. the theory of public expenditure public expenditure refers to the expenses which government incurs in the performance of its operations. with increasing state responsibilities to citizens, it may be difficult to evaluate what portion of public expenditure can be attributed to the maintenance of government itself and what portion to the advantage of the society and the economy in general. in spite of the fact that public expenditure has increased rapidly over the years, and despite of its growing responsibility and significance in the national economy, the area of public expenditure becomes relatively unexplored. studies have generally been concentrated on taxation and the effects of public expenditure on employment and prices. two notable theories of public expenditure are examined, namely: (i) the law of increasing state activities a german economistadolph wagner in 1890 postulated this theory. according to him, there are intrinsic inclinations for the activities of government to grow, both intensively and extensively. he added that there exists a functional relationship between the growth of an economy and that of government activities, and that the governmental sector develops faster than the economy. all categories of governments, irrespective of their levels, intentions and sizes, had exhibited similar tendencies of increased expenditure (wagner, 1890). keynes (1936) on the other hand, raise the idea that during economic downturn the use of fiscal policies boosts economic activities i.e expansionary fiscal policies, expanding public expenditures, increase economic growth (mainoma and aruwa, 2015); (buchanan and wagner, 1978). (ii) the displacement theory peacock and wiseman (1961) put forth the theory that public expenditure does not increase in a straight or continuous manner, but in "jack or stepwise" fashion. at times, some social or other disturbances occur which show the need for increase in public expenditure, which the current level of revenue cannot meet. therefore, public expenditure increases will make the failure of the current level of revenue clear to everyone. the movement from the initial and insufficient level of expenditure and taxation to a new and greater level is known as the "displacement effect," while the insufficiency of the revenue as compared with the required expenditure creates the "inspection effect." both government and the people would attain a new level of "tax tolerance" by reviewing the revenue position and finding solution to the problem of inadequate finance. since each major disturbance will compel government to assume a larger proportion of the national economic activities, the outcome is the 'concentration effect'. therefore, 'concentration effect' is the tendency for government activities to grow faster than the economy. 2. methodology this study follows the fasano and wang (2002) method by utilizing co-integration and error correction term modeling framework; we also adopt the normal vector error correction model based granger causality method and augmented dickey fuller. the work also updates the data used in nigeria by mainoma and aruwa (2015) and nwosu and okafor (2014). annual data for the period from 1986 – 2015 are used in this study. these data are obtained from the central bank of nigeria (cbn) statistical bulletin, and were transformed to logarithms to eliminate the problem of heteroskedasticity. we select these period because time series data on government revenue and government expenditure are only available for this period (central bank of nigeria, 2015). the relationships between government revenues and expenditures are specified empirically below: totexp=β0+ β1totexpt-1+β2torev+ƹ1…………………….….(1)a torev=β0+β1torevt-1+β2totexp+ƹ1…………………………(1)b the variables are as defined above. the constant terms are represented by β0 s as the coefficients to be estimated and ƹ1 are the stochastic error terms with all the standard attributes. a priori, we expect the independent variable in all the equations to be positively signed, i.e. b1 > 0 time series properties of the variables (a) unit root tests we determine the stationarity properties of the variables using test of unit roots of the augmented dickeyfuller (adf) test. while the adf procedure is likely to be the most frequently used test, it does not however requires homoscedastic and uncorrelated errors in the underlying arrangement (akaike, 1969);(dickey and fuller, 1979);(dickey and fuller, 1981);(perron, 1989);(phillips and perron, 1988). (b) co-integration tests to test for co-integration, the johansen maximum-likelihood approach was used. it is necessary to find out if the two series are cointegrated. two or more variables will co-integrate if they are bounded by a common trend. furthermore, the series are tied by some long run equilibrium relationship and in the short-run they may deviate but at the end, they will still exhibit the same stochastic trend. the johansen-juselius also provides likelihood ratio statistics with exactly known distributions. if the variables are co-integrated, the last stage of the time-series analysis is to construct dynamic error correction models (ecms) that considers the underlying co-integration properties. the ecm differs from the standard granger-causality models in equations because they add another regressor in each equation namely, the estimated residuals (the error correction, ec, terms) obtained from the associated co-integrating equations(johansen, 1988);(johansen and juselius, 1990);(miller and russek, 1990). (c) error correction model and granger causality after the co-integration model of the variables is determined, an error correction model (ecm) can then be estimated. the error-correction model arises from the long-run co-integration relationship. the error correction asian journal of economics and empirical research, 2017, 4(2): 91-98 95 term (ecm) will then be used to check for the speed of adjustment of the model from the short run to the long run equilibrium. the greater the coefficient of the error correction term, the faster the speed of adjustment of the model from the short run to the long run(engle and granger, 1987);(granger, 1969);(granger, 1988);(granger and newbold, 1974). table-1. aggregate public revenue and expenditure in nigeria from 1986-2015 year aggregate public expenditure (n' billion) total revenue(torev) pexp lnpexp rev lnrev 1986 16.22 2.79 12.60 2.53 1987 22.02 3.09 25.38 3.23 1988 27.75 3.32 27.60 3.32 1989 41.03 3.71 53.87 3.99 1990 60.27 4.10 98.10 4.59 1991 66.58 4.20 100.99 4.62 1992 92.80 4.53 190.45 5.25 1993 191.23 5.25 192.77 5.26 1994 160.89 5.08 201.91 5.31 1995 248.77 5.52 459.99 6.13 1996 337.22 5.82 523.60 6.26 1997 428.22 6.06 582.81 6.37 1998 487.11 6.19 463.61 6.14 1999 947.69 6.85 949.19 6.86 2000 701.06 6.55 1906.16 7.55 2001 1018.03 6.93 2231.60 7.71 2002 1018.16 6.93 1731.84 7.46 2003 1225.97 7.11 2575.10 7.85 2004 1426.20 7.26 3920.50 8.27 2005 1822.10 7.51 5547.50 8.62 2006 1938.00 7.57 5965.10 8.69 2007 2450.90 7.80 5727.50 8.65 2008 3240.82 8.08 7866.59 8.97 2009 3452.99 8.15 4844.59 8.49 2010 4194.58 8.34 7303.67 8.90 2011 4712.06 8.46 11116.90 9.32 2012 4605.39 8.43 10654.75 9.27 2013 5185.32 8.55 9759.79 9.19 2014 4587.39 8.43 10068.85 9.22 2015 4988.86 8.51 6912.50 8.84 source: cbn (2015) 3. results and analysis of findings table-2.aggregate public expenditure unit root test at level adf test statistic -4.043958 1% critical value* -3.6852 5% critical value -2.9705 10% critical value -2.6242 *mackinnon critical values for rejection of hypothesis of a unit root. augmented dickey-fuller test equation dependent variable: d(lnpexp) method: least squares date: 09/04/16 time: 22:37 sample(adjusted): 1988 2015 included observations: 28 after adjusting endpoints variable coefficient std. error t-statistic prob. lnpexp(-1) -0.081350 0.020116 -4.043958 0.0004 d(lnpexp(-1)) -0.556256 0.153807 -3.616594 0.0013 c 0.828314 0.145862 5.678770 0.0000 r-squared 0.471346 mean dependent var 0.193681 adjusted r-squared 0.429054 s.d. dependent var 0.223790 s.e. of regression 0.169098 akaike info criterion -0.615721 sum squared resid 0.714853 schwarz criterion -0.472985 log likelihood 11.62009 f-statistic 11.14496 durbin-watson stat 2.323330 prob(f-statistic) 0.000346 source: output from eviews econometric software 4.0(2009) asian journal of economics and empirical research, 2017, 4(2): 91-98 96 table-3.total revenue (torev) unit root test at level adf test statistic -2.537597 1% critical value* -3.6852 5% critical value -2.9705 10% critical value -2.6242 *mackinnon critical values for rejection of hypothesis of a unit root. augmented dickey-fuller test equation dependent variable: d(lnrev) method: least squares date: 09/04/16 time: 22:42 sample(adjusted): 1988 2015 included observations: 28 after adjusting endpoints variable coefficient std. error t-statistic prob. lnrev(-1) -0.084179 0.033173 -2.537597 0.0178 d(lnrev(-1)) -0.208888 0.189143 -1.104390 0.2799 c 0.837787 0.255462 3.279501 0.0031 r-squared 0.208869 mean dependent var 0.200254 adjusted r-squared 0.145578 s.d. dependent var 0.346295 s.e. of regression 0.320098 akaike info criterion 0.660575 sum squared resid 2.561561 schwarz criterion 0.803311 log likelihood -6.248054 f-statistic 3.300162 durbin-watson stat 1.999060 prob(f-statistic) 0.053469 source: output from eviews econometric software 4.0(2009) table 2 – 3 above show the adf test results of the time series. the results revealed that the null hypothesis (ho) of unit root test can be rejected at level for public expenditure and public revenue showing that the test is significant at 1%, 5% and 10% significant level, the p-value is less than 0.05 level of significance and all the variables (i.e lnpexp, lnrev) are therefore stationary at the level. adf statistics are obtained by taking akaike information criterion (aic) into consideration, lagged differences are shown table by table and the levels of significance are shown at 1%, 5%, and 10%. the tables above also showed the performance of the model 𝑅2, the adjusted 𝑅2, the standard error of estimate and durbin-watson 𝑅. table 2show 𝑅2, the performance of the model =0.471 and this shows that 47.1% percentages of the variation in the dependent variable (public expenditure) are accounted for by the independent variable (public revenue) while the remaining 52.9% will be due to other factors unknown. the adjusted 𝑅2 shows that when the effect of increase in the number of observations for the variables is removed, the amount of variation that will be accounted for will be 42.9%. while durbin-watson statistic indicates that there is no serial correlation. as a rule of thumb a value of 2 indicates the absence of auto correlation. however results from the durbin-watson table also confirms the absence of serial correlation. since the all variables are clearly stationary in table 2 and 3, the variables of each version of wagner’s law can be integrated of order one. a. predictors: (constant), lnrev b. dependent variable: lnexp the test hypothesis is given as 𝐻0: 𝑅2 = 0 vs 𝐻1: 𝑅2 = 1 the decision rule is to reject 𝐻0 if p-value (sig) is less than 0.05level of significance, otherwise we accept. hence, since the p-value (sig)=0.00 is less than 0.05, we reject 𝐻0 and conclude that there is a significant relationship between the dependent variable (government expenditure) and independent variable (government revenue).for ftest statistics, the decision rule is that reject ho if f-calculated is greater than f-tabulated, if otherwise, accept. therefore comparing the figure from the table, the fcalculated is greater than the ftabulated at all levels of difference for both lnrev and lnexp, hence we reject the ho and conclude that there is significant relationship between the dependent variable and the independent variable. the model is well formulated. table-4. johansen cointegration test date: 09/04/16 time: 22:47 sample: 1986 2015 included observations: 28 test assumption: linear deterministic trend in the data series: lnpexp lnrev lags interval: 1 to 1 likelihood 5 percent 1 percent hypothesized eigenvalue ratio critical value critical value no. of ce(s) 0.428242 25.46338 15.41 20.04 none ** 0.295570 9.810249 3.76 6.65 at most 1 ** *(**) denotes rejection of the hypothesis at 5%(1%) significance level l.r. test indicates 2 cointegrating equation(s) at 5% significance level unnormalizedcointegrating coefficients: lnpexp lnrev -0.002498 0.110451 -0.932075 0.810425 normalized cointegrating coefficients: 1 cointegrating equation(s) lnpexp lnrev c 1.000000 -44.22331 302.3088 (3532.98) log likelihood 5.297447 source: output from eviews econometric software 4.0(2009) the results of co-integration analysis are presented in table 1.3 above. the co-integration test results suggest that the null-hypothesis of no co-integration between public expenditure and public revenue is rejected. since the variables are stationary, integrated of order one, and co-integrated. asian journal of economics and empirical research, 2017, 4(2): 91-98 97 table-5.vector error correction model – based causality pairwise granger causality tests date: 09/04/16 time: 22:49 sample: 1986 2015 lags: 2 null hypothesis: obs f-statistic probability lnrev does not granger cause lnpexp 28 0.42234 0.66049 lnpexp does not granger cause lnrev 2.91095 0.04465 source: output from eviews econometric software 4.0(2009) table 5presents the direction of causality between public expenditure and public revenue as investigated using vector error correction model (vecm) causality test. the vec model results confirm that causality runs from government expenditure to public revenue for the sampled periods 1986-2015 in nigeria. the causality test analysis confirms that government expenditure has a significant impact on public revenue in nigeria. ect is consider good if the range between 0 ~ 1 but not more than 2. ect should be in negative number and if positive value means explosive and not reasonable. for example, if the ect (-1) estimated coefficient is -0.87 (the estimated coefficient indicates that about 87 per cent of this disequilibrium is corrected between 1 year (if annually data). but if the ect (-1) are -1.07 as an example (the estimated coefficient indicates that about 107 per cent of this disequilibrium is corrected between 1 year and this does not make sense). 4. discussions of the findings based on the above results, the causality runs from public expenditure to revenue in nigeria. this finding rejects revenue-spend hypothesis of buchanan and wagner (1977) and friedman (1978) but agrees with the spend-tax hypothesis of barro (1974); peacock and wiseman. (1979) supported by findings of nwosu and okafor (2014); von furstenberg et al. (1986); anderson et al. (1986); islam (2001); fasano and wang (2002). this result is therefore at variance with the results of mainoma and aruwa (2015); blackley (1986); ram (1988); emelogu and uche (2010); narayan and narayan (2006) and aregbeyen and taofik (2012). the study revealed that the levels of revenue and expenditure are co-integrated i.e. they move on a common trend as long as temporal budget constraint is binding over the long run, therefore the co-integration showed a long run relationship between expenditure and revenue. also, each time series in the study are first tested for their orders of integration by using augmented dickey-fuller (adf) test. the result shows that expenditure and revenue are integrated of order one or 1(1) and are also significant at all levels i.e 1%, 5%, and 10%. 5. conclusion and recommendation this paper deals with the concept of causality between government expenditure and revenue in nigeria, using time series data from 1986 to 2015. the study adopted a var model which included vector error correction model (ecm) as the method of analysis. the results from the analyses show that expenditure has long run unidirectional relationships of spend-tax between government revenue and public expenditure in nigeria. this causality runs from expenditures to revenue. this however confirm the spend-tax hypothesis of peacock and wiseman. (1979) and agrees with the studies of nwosu and okafor (2014); von furstenberg et al. (1986); anderson et al. (1986); islam (2001); fasano and wang (2002). the policy implication derivable from this study is that increase in government expenditure without corresponding increase in revenue will expand the budget deficit and government will have to resort to borrowing which could increase indebtedness to multilateral creditors. to make budget expenditure less driven by revenue availability, government should explore a medium term expenditure framework, so that expenditure can be planned and protected from unstable short term revenue availability. therefore, government should discover other sources of revenue especially the non-oil minerals sector, and also reduce the size of huge recurrent expenditure and move towards capital and other investment expenditures. government should also try as much as possible begins expenditure restructuring that is implementable and resultoriented through effective budget packaging and not legislative paddling. federal government should also as a matter of urgency 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http://dx.doi.org/10.2307/2336182 http://dx.doi.org/10.2307/2336182 https://scholar.google.com/scholar?hl=en&q=additional%20evidence%20on%20causality%20between%20government%20revenue%20and%20government%20expenditure http://dx.doi.org/10.2307/1059018 https://scholar.google.com/scholar?hl=en&q=relationship%20between%20government%20spending%20and%20revenue:%20evidence%20from%20oil%20exporting%20countries https://scholar.google.com/scholar?hl=en&q=statistical%20inferences%20in%20vector%20autoregressions%20with%20possibly%20integrated%20processes http://dx.doi.org/10.1016/0304-4076(94)01616-8 https://scholar.google.com/scholar?hl=en&q=tax%20and%20spend,%20or%20spend%20and%20tax? http://dx.doi.org/10.2307/1925496 asian journal of economics and empirical research issn: 2409-2622 vol. 1, no. 1, 1-5, 2014 http://asianonlinejournals.com/index.php/ajeer 1 fama-french three factors model in indian mutual fund market n. s. santhi department of business administration ksr college of engineering tiruchengode k. balanaga gurunathan department of finance, alliance university, chikkahadade cross, chandapura, bangalore abstract this work is licensed under a creative commons attribution 3.0 license asian online journal publishing group 1. introduction mutual funds are the best vehicle for investors, looking for ways to put their savings into stock market (ajit dayal, 2011). tax saving mutual fund schemes were established with the objective of inviting indian tax assessees into the stock market-oriented investment. all tax saving mutual fund schemes have same the objective but each scheme differs in returns produced and risks involved. tax saving mutual fund is one avenue which offers an investor the opportunity to avail tax exemption on investment along with market-related return with the diversified risks. as such, analyses have been made in this paper to measure the performance of indian mutual funds market by using fama french three factor model. in particular 32 growth-oriented open-ended tax saving mutual fund schemes have been analyzed in this paper. table 1 shows various growth-oriented open and closed-ended schemes. from the table, it is also noted that the number of schemes increased after the year 2005. sbi magnum was the first tax saving mutual fund scheme launched in the 1993. since, union kbc tax saver scheme was launched during november 2011, it has not been considered for the present study. 2. studies already conducted fama and french (1993), identified five common risk factors in the returns on stock and bonds. among the five, three factors are related to stock market namely, overall market, firm size and book-to-market equity. the other two factors related to bond-market are maturity and default risks. stock returns are linked to both stock market factors and bond market returns. pablo rogers and jose roberto securoto (2007) have made an analysis on portfolios, in accordance with the fama and french (1993). they applied two sub-samples of stocks with available data in the sao paulo stock exchange (bovespa). they concluded that the results support the fama and french three-factor model to explain future returns. tax saving mutual fund schemes were established with the objective of inviting indian tax assessees into the stock market-oriented investment. tax saving mutual fund is an avenue which offers an investor the opportunity to avail tax exemption on investment along with diversified risk and market-related return. all tax saving mutual fund schemes have same the objective but each scheme differs in returns produced and risks involved. the mutual fund performance is based on the performance of market and there is no assurance on return of mutual fund investments. as such, an analysis have been made in this paper to measure the performance of indian mutual funds market by using fama french three factor model. in particular, 32 growth-oriented open-ended tax saving mutual fund schemes have been taken for the study. the performance of the tsmf has been compared with the market benchmark s&p cnx nifty. it is found that there is a difference between expected return and actual return of mutual funds. it is also found that there are certain mutual fund schemes have underperformed than the market benchmark. not all the mutual fund schemes are safe and secured. it is the responsibility of the investors to find the better performing funds. keywords: mutual funds, tax saving, growth oriented, open-ended, india, fama french three factor model. http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2014, 1(1):1-5 2 jan bartholdy and paula peare (2002) compared the performance of stock returns using capm and fama french three factor model. they estimated individual stock returns based on capm using different time frames, data frequencies, and indexes. they obtained individual stock returns based on the fama and french model using five years of monthly data. joseph chen et al. (2004), analyzed u.s diversified mutual funds for the period of 37 years from 1962 to 1999 by using monthly returns. the author used standard deviation, capital asset pricing model of william f. sharpe, eugene f. fama and keneeth r. french three-factor model for the analysis. one month treasury bill return was considered by the author for risk free rate of return. it has been found that these funds’ family size does not significantly erode the performance of this fund. bhavna (2006) studied the fama and french three-factor model of stock returns along with its variants, including capital asset pricing model for 79 stocks listed on the bse-100 stock market index and found that factor portfolios that explain the returns are the market factor, size factor (smb) and value factor (hml). the author concluded that the fama and french fairs better in explaining the cross-section of returns in the portfolios than its variants and the capm. yash pal (2010) analyzed 187 companies by using capm and the fama french for the period of five years from june 2004 to june 2009. the study concluded that efficiency of fama french model, for being a good predictor, cannot be ignored in india but either of the two factors (size and value) might improve the model. vanita tripathi (2008) examined the relationship between four company fundamental variables (viz. market capitalization, book equity to market equity ratio, price earnings ratio and debt equity ratio) and equity returns in indian stock market using monthly price data of a sample of 455 companies forming part of s&p cnx 500 index over the period june 1997 to june 2007. table-1. open-ended tax saving mutual fund schemes growth s. no open-ended schemes (as on march 2011) date of inception 1. sbi magnum tax gain scheme 24-february-1993 2. canararobeco equity tax saver 25february -1993 3. hdfc taxsaver 18-december-1995 4. licmf tax plan 11-january-1997 5. sahara tax gain 31december -1997 6. franklin india tax shield 10-april-1999 7. icici prudential tax plan 09-august-1999 8. uti etsp 15-november-1999 9. escorts tax plan 01april -2000 10. hdfc long term advantage fund 26december -2000 11. ing tax savings fund 12february -2004 12. sundaram tax saver oe 04-may-2005 13. reliance tax saver (elss) fund 25-july-2005 14. l&t tax saver fund 27-september-2005 15. kotak tax saver-scheme 29september -2005 16. bnp paribas tax advantage plan (elss) 07november -2005 17. fidelity tax advantage fund 05january -2006 18. dws tax saving fund 24january -2006 19. birla sun life tax plan 03-october-2006 20. hsbc tax saver equity fund 20november -2006 21. religare tax plan 20november -2006 22. dsp black rock tax saver fund 27november -2006 23. taurus tax shield 05-march-2007 24. jm tax gain fund 24december -2007 25. bharti axa tax advantage fund-eco plan 12february -2008 26. bharti axa tax advantage fund-regular plan 12february -2008 27. birla sun life relief 96 03-june-2008 28. idfc tax advantage (elss) fund 01december -2008 29. quantum tax saving fund 10december -2008 30. jpmorgan india tax advantage fund 18december -2008 31. edelweiss elss fund 26december -2008 32. axis tax saver fund 17december -2009 source: (www.amfiindia.com) 3. tools applied to measure risk and return the aim of this study is to examine the performance of tax saving mutual fund schemes. daily nav is used for computing annual returns of tax saving mutual fund schemes (john sorros, 2003). mean returns are calculated by averaging the monthly returns over the relevant time period. fama-french three factor model is used analysis the performance of tsmf. fama–french three-factor model is designed by eugene fama and kenneth french to describe stock returns. this model uses three variables namely market, size and stocks with a high book-to-market ratio (btm, customarily called value stocks, contrasted with growth stocks). r = rf + β3 (km – rf) +bs . smb + bv. hml + α asian journal of economics and empirical research, 2014, 1(1):1-5 3 where, r = portfolio's expected rate of return rf = risk-free return rate km = return of the whole stock market smb = small [market capitalization] minus big hml = high [book-to-market ratio] minus low 4. fama-french three factor model the traditional asset pricing model capital asset pricing model (capm) uses only beta to describe the returns of a portfolio with market returns. whereas, the fama–french model uses three variables such as market, size of the portfolio and value of the portfolio. this model used smb for “small (market capitalization) minus big” and hml for “high (book-to-market ratio) minus low”. it measures the excess returns of small caps over big caps and value stocks over growth stocks. the assets of all the 31 schemes as on march 2012 have been considered for the study. smb is the difference between the average return of smallest 30% of tax saving mutual fund schemes and the average return of the largest 30% of the schemes assets (kent womack and ying zhang, 2003). a positive smb indicates that small cap stocks outperformed large cap and a negative smb indicates the large caps outperformed in a particular period. the five schemes with least assets are bharti axa tax advantage fund-eco plan, escorts tax plan, jpmorgan india tax advantage fund, quantum tax saving fund and edelweiss elss fund which is having less than 10 crore assets. the schemes with greatest assets are icici prudential tax plan, sundaram tax saver oe app, reliance tax saver (elss) fund, hdfc taxsaver and sbi magnum tax gain scheme 1993 which is having more than 1000 crores. table 2 shows the assets of the schemes. table-2. assets of the tax saving mutual fund schemes s. no tax saving mutual fund schemes asset (cr) 1. bharti axa tax advantage fund-eco plan 3.1 2. escorts tax plan 3.8 3. jpmorgan india tax advantage fund 4.2 4. quantum tax saving fund 5.5 5. edelweiss elss fund 5.9 6. saharatax gain 11.1 7. l&t tax saver fund 27.8 8. ing tax savings fund 29.5 9. bharti axa tax advantage fund 32.5 10. lic mf tax plan 34.2 11. jm tax gain fund 40.8 12. birla sun life tax plan 45.2 13. dws tax saving fund 58.7 14. taurus tax shield 72.8 15. religare tax plan 111.5 16. bnp paribas tax advantage plan 118.6 17. idfc tax advantage (elss) fund 134.9 18. hsbc tax saver equity fund 196.2 19. canararobeco equity tax saver 362.4 20. kotak tax saver-scheme 433.1 21. uti – etsp 461.6 22. dsp black rock tax saver fund 724.4 23. birla sun life relief 96 765.9 24. franklin india tax shield 812.4 25. hdfc long term advantage fund 840.5 26. fidelity tax advantage fund 1,167.10 27. icici prudential tax plan 1,278.40 28. sundaram tax saver oeapp 1,391.30 29. reliance tax saver (elss) fund 1,972.80 30. hdfc taxsaver 3,114.10 31. sbi magnum tax gain scheme 1993 4,778.50 source: secondary data hml has been constructed to measure value premium with high book to market values. hml is the difference between the average return of the 50% of the schemes with the highest book to equity and the 50% of the schemes with the lowest book to equity of the schemes (kent womack and ying zhang, 2003). a positive hml indicated value scheme outperformed in a particular period and a negative hml indicates growth schemes outperformed in a month. table 3 shows the book to market ratio of the tax saving mutual fund schemes. the five schemes with least book to market ratio are sbi magnum tax gain scheme 1993, hdfc long term advantage fund, icici prudential tax plan, franklin india tax shield and hdfc taxsaver. the schemes with high book to market ratio are asian journal of economics and empirical research, 2014, 1(1):1-5 4 jm tax gain fund, birla sun life relief 96, dws tax saving fund, birla sun life tax plan and hsbc tax saver equity fund. table-3. book to market of tax saving mutual fund schemes tax saving mutual fund schemes book to market jm tax gain fund 1.5916 birla sun life relief 96 0.9930 dws tax saving fund 0.8390 birla sun life tax plan 0.7669 hsbc tax saver equity fund 0.7170 l&t tax saver fund 0.7072 bnp paribas tax advantage 0.6926 dsp black rock tax saver fund 0.6324 religare tax plan 0.5794 kotak tax saver-scheme 0.5775 jpmorgan india tax advantage fund 0.5724 idfc tax advantage (elss) fund 0.5353 edelweiss elss fund 0.5227 bharti axa tax advantage fund 0.4812 bharti axa tax advantage fund-eco plan 0.4778 fidelity tax advantage fund 0.4747 reliance tax saver (elss) fund 0.4695 quantum tax saving fund 0.4538 canararobeco equity tax saver 0.3852 lic mf tax plan 0.3702 ing tax savings fund 0.3627 taurus tax shield 0.3058 sahara tax gain 0.2743 uti – etsp 0.2661 escorts tax plan 0.2642 sundaram tax saver oeapp 0.2384 sbi magnum tax gain scheme 1993 0.1714 hdfc long term advantage fund 0.0747 icici prudential tax plan 0.0736 franklin india tax shield 0.0468 hdfc taxsaver 0.0448 source: secondary data table 4 summarizes the results of fama french three factor analysis. the tables shows the coefficients of rmrf, smb and hml that is obtained by regressing ri-rf with rm-rf, smb and hml. these coefficients are substituted in fama french three factor model to obtain the expected rate of return. additionally, actual rate of return of these schemes have been calculated by using the historical values of past three years from 2009-10 to 2011-12. table 4 shows that reliance tax saver (elss) fund, canararobeco equity tax saver, religare invesco tax plan, saharatax gain and bharti axa tax advantage fund-eco plan performed well with high difference in expectation and actual return. sundaram tax saver oeapp, kotak tax saver-scheme, dws tax saving fund, franklin india tax shield and l&t tax saver fund-cumulative were not performed well. the actual return of these schemes was lower than the expected return. 5. conclusion performance of tax saving mutual fund schemes were analyzed by using fama french. the performance of the tsmf has been compared with the market benchmark s&p cnx nifty. there will be a difference between expected return and actual return of mutual funds. the minimum difference between actual and expected return on funds show a stable performance in the market. there are certain funds where the minimum returns are expected by the investors but the funds might give a higher return and there are certain funds where the maximum returns are expected by the investors but those funds might give a lower return. it is found that there are certain schemes which have been underperformed than the market benchmark. there are certain funds that outperform the market benchmark. it is found that, reliance tax saver (elss) fund, canara robeco equity tax saver, religare invesco tax plan, sahara tax gain and bharti axa tax advantage fund-eco plan have performed well with high difference in expectation and actual return. from the analysis, it can be concluded that there has to be some other factors other than the factors considered by fama french model that would explain the performance of variation among the indian tax saving mutual fund market. table-4. coefficients, expected return and actual rate of return of the tax saving mutual fund schemes s. no tax saving mutual fund schemes coefficient expected return actual return difference rm-rf smb hml 1 reliance tax saver (elss) fund 0.7517 -0.4336 1.2158 0.1342 1.9581 1.8240 continue asian journal of economics and empirical research, 2014, 1(1):1-5 5 2 canararobeco equity tax saver 0.8306 -0.2054 0.3408 0.3615 1.3303 0.9688 3 religare tax plan 0.6067 -0.3036 0.8697 0.1476 1.1113 0.9637 4 sahara tax gain-growth 0.8473 -0.0524 0.9628 0.1849 1.1274 0.9425 5 bharti axa tax advantage fund-eco plan 0.9886 0.2817 1.4450 0.0695 0.9150 0.8456 6 bharti axa tax advantage fund 0.9914 0.2838 1.4270 0.0749 0.9028 0.8279 7 quantum tax saving fund 0.7430 0.4863 -0.0847 0.3398 1.1484 0.8086 8 birla sun life relief 96 0.9323 -0.3519 0.8731 0.2845 1.0911 0.8066 9 ing tax savings fund 0.8720 0.1051 0.4753 0.2996 1.0819 0.7823 10 hdfc taxsaver 0.8094 -0.2273 -0.1059 0.4722 1.2322 0.7600 11 fidelity tax advantage fund 0.7594 0.0826 0.1812 0.3339 1.0646 0.7307 12 sbi magnum tax gain scheme 1993 0.8256 -1.0357 0.8475 0.3442 1.0743 0.7301 13 bnp paribas tax advantage plan 0.6877 -0.3951 0.9244 0.1788 0.8860 0.7072 14 taurus tax shield 0.9297 0.5048 0.8527 0.1685 0.8719 0.7034 15 hdfc long term advantage fund 0.8248 0.0310 -0.3155 0.4966 1.1849 0.6883 16 idfc tax advantage (elss) fund 0.7319 -0.1575 1.2269 0.0845 0.7571 0.6726 17 edelweiss elss fund 0.6976 -0.4201 1.3587 0.0733 0.7367 0.6634 18 birla sun life tax plan 0.7991 -0.4789 1.2689 0.1458 0.7698 0.6240 19 hsbc tax saver equity fund 0.7725 -0.1209 0.7870 0.2102 0.8338 0.6236 20 dsp black rock tax saver fund 0.8269 -0.0431 0.2150 0.3699 0.9531 0.5831 21 jm tax gain fund 0.8106 -0.1832 1.6051 0.0214 0.5077 0.4863 22 jpmorgan india tax advantage fund 0.7487 1.1519 0.0204 0.2213 0.7066 0.4854 23 uti – etsp 0.7642 0.0118 0.4400 0.2784 0.7116 0.4331 24 lic mf tax plan 0.8821 -0.1357 0.6201 0.2997 0.5659 0.2661 25 escorts tax plan 0.9388 1.3115 0.4344 0.1677 0.4120 0.2443 26 icici prudential tax plan 0.8569 0.0149 0.1210 0.3983 0.4720 0.0738 27 sundaram tax saver oeapp 0.8731 -0.5069 1.0954 0.2246 0.2360 0.0113 28 kotak tax saver-scheme 0.8961 0.1592 0.7727 0.2243 0.0463 -0.1780 29 dws tax saving fund 0.7232 -0.2497 1.1125 0.1237 -0.1377 -0.2615 30 franklin india tax shield 0.7210 -0.1676 0.0995 0.3748 0.1093 -0.2655 31 l&t tax saver fund 0.9494 -0.2921 0.5659 0.3629 -0.0883 -0.4512 source: secondary data note: fama french model was employed with 31 open ended schemes for the three years (2009-11 to 2001-12) as the required data is available only for that period. references ajit dayal, 2011. quantum asset management company. outlook profit. anniversary special, 1(1): 74-75. bhavna, b., 2006. testing the fama and french three-factor model and its variants for the indian stock returns. available from http://ssrn.com/abstract=950899. fama, f.e. and r.k. french, 1993. common risk factors in the returns on 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mutual funds and indian capital market-performance and profitability. new delhi: kanishka publishers, distributors. the financial express, 2011. available from www.financialexpress.com [accessed may 31]. views and opinions expressed in this article are the views and opinions of the authors, asian journal of economics and empirical research shall not be responsible or answerable for any loss, damage or liability etc. caused in relation to/arising out of the use of the content. http://ssrn.com/abstract=950899 http://ssrn.com/abstract=350100 http://ssrn.com/abstract=1247717 http://www.amfiindia.com/ http://www.amfiindia.com/nav-history-download http://www.moneycontrol.com/mutualfundindia/ http://www.nseindia.com/chartapp/install/charts/mainpage.jsp http://www.sebi.gov.in/ http://www.financialexpress.com/ asian journal of economics and empirical research vol. 4, no. 2, 99-105, 2017 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2017.42.99.105 99 randomness of stock return in nigerian banking sector obisesan oluwaseun g.1 ajayi boboye l.2 ( corresponding author) 1,2department of banking and finance, faculty of management sciences, ekiti state university, ado ekiti, nigeria abstract this study presents a test of random walk hypothesis in the nigerian stock market, with a view to determining if stock price changes conform to predetermined probability distribution. a sample of thirteen deposit money banks which are listed on the nigerian stock exchange between 2007 and 2014 were used in the analysis. secondary daily price data for the period were sourced from the capital assets section of nse fact book. the methods used were; augmented dickey-fuller test (adf), phillips-perron test (pp) and kwiatkowski, phillips, schmidt and shin test (kpss) unit root tests were used to test non-stationarity while descriptive statistics of jaque-bera were used to check for normality. the adf, pp and kpss unit root test results imply that the changes in stock prices are stationary at level while descriptive statistics results indicate that the changes in stock prices do not follow a normal distribution. the findings of this study show that stock price changes are stationary and not normally distributed. based on the findings, the changes in nigerian deposit money banks’ stock price in nigerian stock exchange do not follow a random walk. in other words, nigerian stock market is not weak form efficient. the study recommends that since changes in stock prices are not indeterminable or caused by random events, the investor should endeavour to identify what determines the prices in the past in order to ensure judicious and prudent allocation of their investable funds. keywords: random walk, deposit money bank, daily stock return, adf, kpss. citation | obisesan oluwaseun g.; ajayi boboye l. (2017). randomness of stock return in nigerian banking sector. asian journal of economics and empirical research, 4(2): 99-105. history: received: 4 may 2017 revised: 12 october 2017 accepted: 27 october 2017 published: 30 october 2017 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 100 2. literature review .......................................................................................................................................................................... 100 3. research method ........................................................................................................................................................................... 101 4. results and discussions ................................................................................................................................................................ 102 5. concluding remarks ..................................................................................................................................................................... 104 references ............................................................................................................................................................................................ 104 bibliography ........................................................................................................................................................................................ 105 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://orcid.org/orcid-search/quick-search?searchquery=obisesan oluwaseun g. https://orcid.org/orcid-search/quick-search?searchquery=ajayi boboye l. https://orcid.org/orcid-search/quick-search?searchquery=obisesan oluwaseun g. https://orcid.org/orcid-search/quick-search?searchquery=ajayi boboye l. https://orcid.org/orcid-search/quick-search?searchquery=obisesan oluwaseun g. https://orcid.org/orcid-search/quick-search?searchquery=ajayi boboye l. asian journal of economics and empirical research, 2017, 4(2): 99-105 100 1. introduction whenever money is put into any investment, the expectation of such investor is profit in form of return. in the same vein, an investor in the stock market has expectation of generating a profit on the capital invested. market efficiency, championed in the efficient market hypothesis (emh) was formulated by fama in 1965. it suggests that at any given time, prices fully reflect all accessible information on a particular stock in a given market. thus, according to the emh, no investor has an advantage in predicting a return on a stock price because no one has access to information not already available to anyone else. in efficient markets, prices turn out to be not predictable but random in nature, so no investment pattern can be discerned. a planned approach to investment therefore, is not possible. stock market efficiency has significant implication for these investors as well as the regulatory authorities. a lot of investors attempt not only to make a profitable return, but also to beat the market. random walk of prices, commonly spoken about in the efficient market hypothesis school of thought results was due to the collapse of any investment strategy that aims to outperform consistently. in nigeria, the validity of random walk hypothesis has attracted the attention of researchers in the recent years. the empirical evidences such as aktham (2003) and samuel (2007) for developing countries, graham and hyun-jung (2003) for a developed country, godwin (2010) and mojekwu and ogege (2013) in nigeria, etc. produce mixed results. in view of this, the question still remains; are present stock prices dependent on past stock prices in nigeria stock market? and do changes in stock prices in nigeria stock market conform to some probability distribution? it is in an attempt to answer these questions that the study is set out with a view to contribute to the ongoing debate. the fundamental objective of this study, therefore, is to examine the weak-form efficiency of nigerian stock exchange. specifically the study intends to determine if stock price changes conform to predetermined probability distribution in the nigerian stock market. the rest of the paper is organized in to three sections, namely the review of existing literature; the research method; results and discussion and the conclusion and recommendation. 2. literature review randomness means something that is dynamic in nature or not steady/static. it is the trend of events, a movement of an object that occurs spontaneously and unpredictably. it is synonymous with the movement of a drunkard whose steps are uncoordinated and irrational and therefore, unpredictable (joel and sunday, 2015). random walk hypothesis postulate that successive price changes in individual securities are independent random variables. according to fama (1965) and kendall (1953) in a random walk market, stock prices fluctuate randomly around their intrinsic values, return quickly towards the equilibrium and fully reflect the latest information available in the market. although the price adjustments may be imperfect, it is unbiased; meaning that sometimes the market will overadjust and other times it will under-adjust, but it cannot be predicted which one will occur at any given time. according to bodie et al. (2009) because security prices adjust to all new information the security prices should reflect all information that is publicly available at any point in time. the security prices that prevail at any time should be an unbiased reflection of all currently available information, including the risk involved in owning the security. the combined effect of information coming in a random, independent, unpredictable fashion and numerous competing investors adjusting stock prices rapidly to reflect this new information is that one would expect price changes to be independent and random. random walk hypothesis shows that prices of shares and stocks are not stable due to the fact that future prices cannot be determined by previous prices (today’s price does not depend on yesterday i.e. stock prices are independent). as new information become available the price of the stock also changes. the theory of random walks in stock prices actually involves two separate hypotheses. the hypothesis which the study aimed at testing is whether the changes in stock prices conform to some probability distribution. graham and hyun-jung (2003) evaluated the random walk hypothesis for european emerging stock markets, using the multiple variance ratio tests. it was discovered that the stock market price does not follow random walk hypothesis. worthington and higgs (2004) tests for random walks and weak-form market efficiency in european equity markets. combination of serial correlation coefficient and runs tests, augmented dickey-fuller (adf), phillips-perron (pp) and kwiatkowski, phillips, schmidt and shin (kpss) unit root tests and multiple variance ratio (mvr) tests were analyzed. the result indicated that from the emerging markets, only hungary is characterized by a random walk and hence is weak-form efficient, while in the developed markets only germany, ireland, portugal, sweden and the united kingdom comply with the most stringent random walk criteria. am´elie and olivier (2009) examined the random walk hypothesis for chinese stock markets using variance ratio tests. the study examines the random walk hypothesis for the shanghai and shenzhen stock markets for both a and b shares. the hypothesis is tested with new multiple variance ratio tests. it was found that class b shares for chinese stock exchanges do not follow the random walk hypothesis, and therefore are significantly inefficient while the class a shares seems more efficient. kavalerchik (2011) investigated the random walk hypothesis based on stock prices, dividends, and earnings. the augmented dickey-fuller (adf) test for unit roots, while the data for the assorted indices and stocks date back to various dates, all data used end on october 1, 2009. the finding suggested that earnings data have some predictability for stock prices. hussain et al. (2011) for the period from january 2006 to december 2010 studied karachi stock exchange for day of the week effect and stock returns by using time series (regression equation), anova test as research methodology. they concluded that investor gets constant returns for the six days out of seven days of the week, only the tuesday has significant impact on the pakistani stock markets which results in abnormal returns for the investors. aktham (2003) evaluated the random walk hypothesis in the amman (jordan) stock exchange. ols, arch and garch, jargue bera normality and nonlinearity test were used to run the daily data collected. the study found that daily returns from the amman (jordan) stock exchange do not conform to a random walk. samuel (2007) studied why share prices might follow a random walk. empirical evidence is used to investigate the arguments for and against the model. it was discovered that the efficient markets hypothesis no longer holds the asian journal of economics and empirical research, 2017, 4(2): 99-105 101 impervious position in finance it once did; consequently the assumption that share prices follow a random walk is now uncertain. in a comparative analysis of india and pakistan stock markets, ishaq et al. (2014) use adjusted daily prices descriptive statistics, adf test, auto-correlation test and jarque-bera statistic, runs test to analyze the data for the period ranging between 2003 and 2013. the study found out that the stock markets of both economies are not efficient in weak form. bhanu and bishnoi (2005) test random walk hypothesis for indian stock market indices. the indices have been tested for normality, autocorrelation using q-statistic & dickey-fuller test and analyzed variance ratio using homoscedastic and heteroscedastic test estimates. the results support that indian stock market indices do not follow random walk. godwin (2010) studied the stock market prices and random work hypothesis in nigeria. autocorrelation and run test were used to analyze the data. the results of the three tests show the evidence of weak form efficiency and a confirmation of random walk. also, that successive price changes are not dependent. nwosa and osheni (2011) examined efficient market hypothesis and nigeria stock market using pp, adf, autocorrelation and regression methods. the correlation results shows that successive daily price changes tend to have the same sign hence the nigerian stock market is informational inefficient. more so, the previous stock prices are statistically significant in determining the current. mojekwu and ogege (2013) carried out econometric investigation of the random walk hypothesis in the nigerian stock exchange. ordinary least square method, correlation matrix, adf and pp were adopted in analyzing the data collected. it was found, inefficiency in price determination and opportunity for some investors to earn abnormal profit, hence the absence of random walk. afego (2012) tests the random walk hypothesis for the nigerian all share monthly index returns using the nonparametric runs test and goodness of fit test over the period 1984 to 2009. the results from this study suggest that stock price changes on the nse are not random and that according to technicalist, exploitable patterns exist, making it possible for arbitrage portfolios to be constructed based on trading rules and making sub-optimal allocation of investable funds within the economy a possibility. market inefficiencies is a feature of nigerian stock market. ajao and osayuwu (2012) tested the weak form of efficient market hypothesis in nigeria capital market. auto-correlation test and runs test was used in analyzing the data collected. the study reveals that the nigeria capital market is efficient in the weak form due to the prerequisite for a weak form of efficient market. also, that the past and future prices of stock market are independent. osisanwo and atanda (2012) carried out a time series analysis of the determinants of stock market returns in nigeria using ordinary least square. from the study, it can be found that external shock and other macroeconomic variables dictate the movement of stock market prices performance. nwidobie (2014) carried out empirical investigation of the random walk theory in the nigerian capital market. adf and unit root model was used to run the analysis. it was discovered that random walk hypothesis is not supported by findings in nigerian capital market. also, there exists market inefficiency in the market. victor (2010) tested the weak-form efficiency market hypothesis in nigerian stock market. auto correlation tests and run test was adopted in the analysis and the finding reveals that stock market is inefficient in the weak form. also, emeh and obi (2014) evaluated the weak form of efficient market hypothesis from nigeria. unit root test and johnason co-integration test, the finding shows that there exist random walk model revealing inefficiency in the weak form of the market. yacout and samuels (1981) tested the correlation of weekly prices of 21 companies quoted at the nigerian stock exchange (nse). the result revealed that the price follow a random walk thus confirming the efficiency of the market. 3. research method according to fama (1965) one of the main hypotheses of random walk is that successive price changes conform to some probability distribution. 3.1. model specification the study adopts the random walk model of lo and mackinlay (1988) which is specified as follows: spt = ƒ(spt-1) (i) spt = δ + αspt-1 + µ (ii) where: δ = constant α = coefficient of past stock price spt = present stock price spt-1 = past stock price µ = stochastic error term on a priori, changes between present stock price and past stock price are expected to be non-stationary and normally distributed. 3.2. estimation technique in this study, the statistical tests that are employed include descriptive statistic, unit root test, autocorrelation test and variance ratio tests to determine the dependency among successive stock price changes. 3.3. unit root tests unit root is a necessary condition for random walk. here series of changes in stock prices are expected to have unit root (non-stationary). for a test of unit root, the study employs augmented dickey-fuller, phillips-perron tests and kpss. asian journal of economics and empirical research, 2017, 4(2): 99-105 102 3.4. augmented dickey-fuller tests this test will be used to achieve the second objective of the study. the time series variables characteristics and order of stationarity will be determined using the adf and pp unit root tests developed by phillips and perron (1988). this is based on the following model: t m titt yyy       1 111 (with intercept) (iii) t m titt yyty       1 1121 (with trend and intercept) (iv) where yt represents the values of each variable in the two equations. the t-statistics was used to test the null hypothesis of 1 = 0 (i.e. no stationary) against the alternative that 1<0 (i.e. stationary). if the series were not stationary at level, i.e. i(0), it would be differenced d times to be stationary and to determine its order of integration. i.e i(1) or i(2) 3.5. phillips-perron test the pp estimates the non-augment df test. the pp is based on the statistic; ũ = ( )½ ( ) ( ) (v) where ( ) is the estimate, and the t-ratio ratio of , ( ) is coefficient standard error, and is the standard error of the test regression. in addition, is a consistent estimate of the error variance in the equation. {calculated as( [ ] ), where is the number of regressors). the remaining term, is an estimator of the residual spectrum at frequency zero. 3.6. kwiatkowski, phillips, schmidt and shin test (kpss) kpss differs from other unit root tests in that the series yt is assumed to be trend stationary under the null hypothesis such that: = δ + (vi) the statistic is being defined as: lm = ∑ ( ( ) ) (vii) where is an estimator of the residual spectrum at frequency zero and where ( ) is a cumulative residual function. 3.7. description of data and sources the data used in this study are described as follows: spt = stock price at time it is used to describe present change in stock (i.e. price today minus price yesterday) such that: acce = today yesterday stock price of access bank fide = today yesterday stock price of fidelity bank fcmb = today yesterday stock price of fcmb bank gtbb today yesterday stock price of gtb stam today yesterday stock price of stanbic ibtc bank skye = today yesterday stock price of skye bank ster = today yesterday stock price of sterling bank ubab = today yesterday stock price of uba bank unio = today yesterday stock price of union bank unit = today yesterday stock price of unity bank wema = today yesterday stock price of wema bank zeni = today yesterday stock price of zenith bank spt-1 = is the present stock price lagged by one period. it is used to represent past stock price changes i.e. (price yesterday minus price day before yesterday). these data are obtained from secondary sources, namely the capital asset section of nse fact book 4. results and discussions a stock market is believed to follow a random walk if changes in stock prices is non-stationary and of normal distribution. the results of the descriptive analysis used to ascertain the normality of stock price changes is presented in table 1. table 1 shows the descriptive statistics of the data series used in the current study. acce averaged 0.0002and vary from a minimum of -1.4 to a maximum of 1.2. diam, fide, fcmb, gtbb, stam, skye, ster, ubab, unio, unit, wema and zeni. has a mean of 0.0012, 0.00029, 0.00088, 0.00338, 0.00234, 0.012125, 0.00077, 0.0118, 0.00784, 0.00133, 0.00121 and 0.00326 ranges from a minimum of -22.86, -13.79, -4.75, -11.88, -10.02, 16.38, -2.32, -19.17, -12.6, -5.59, -13.4 and-23.45 to a maximum of 22.76, 22.51, 4.6, 13.38, 8.95, 17.49, 2.26, 6.44, 9.47, 5.32, 13.4 and 13.72 respectively. the p-value of jarque-bera statistics are less than 5% which implies a rejection of null hypothesis of normality at 1% significance level. it means that acce, diam, fide, fcmb, gtbb, stam, skye, ster, ubab, unio, unit, wema and zeni are not normally distributed. the statistics for kurtosis shows that diam, fide, fcmb, gtbb, stam, skye, ster, ubab, unio, unit, wema and zeni are leptokurtic since their distribution are peaked relative to normal. the statistics for skewness asian journal of economics and empirical research, 2017, 4(2): 99-105 103 shows that all acce, diam, fcmb, gtbb, ubab, unio, wema and zeni were negatively skewed while fide, stam, skye, ster, and unity are positively skewed. table-1. descriptive statistics mean maxi mini std. dev. skewness kurtosis jarque-bera rob observ. acce -0.00021 1.2 -1.4 0.289114 -0.13035 5.868646 652.3593 0.00 1887 diam -0.0012 22.76 -22.86 0.803235 -0.11285 690.9823 37214760 0.00 1887 fide -0.00029 22.51 -13.79 0.825933 10.10152 416.2998 13462555 0.00 1887 fcmb -0.00088 4.6 -4.75 0.297327 -0.54223 95.72956 676170.8 0.00 1887 gtb 0.003381 13.38 -11.88 0.741046 -0.10617 103.6356 796280 0.00 1887 stam -0.00234 8.95 -10.02 0.491746 0.961407 195.6611 2918717 0.00 1887 skye 0.012125 17.49 -16.38 0.786781 0.630416 295.4806 6726091 0.00 1887 ster -0.00077 2.26 -2.32 0.139317 0.295989 99.87715 737937.5 0.00 1887 ubab -0.0118 6.44 -19.17 0.742066 -9.28936 251.389 4878075 0.00 1887 unio -0.00784 9.47 -12.6 0.737305 -2.50881 100.2811 746056.7 0.00 1887 unit -0.00133 5.32 -5.59 0.276318 4.354445 254.5712 4981986 0.00 1887 wema -0.00121 13.4 -13.4 0.645295 -0.20856 371.1329 10655420 0.00 1887 zeni -0.00326 13.72 -23.45 1.082186 -5.33067 185.0033 2613406 0.00 1887 source: author’s computation (2016) 4.1. unit root tests since a unit root is a necessary condition for a random walk, the augmented dickey-fuller test is used to test the null hypothesis of a unit root. the results of augmented dickey-fuller for a unit root in stock price changes are presented in table 2. table-2. unit root test: adf variables adf test statistics makinnon critical value @ 5% prob. conclusion acces -36.75468 -2.862869 0.0000 reject diam -33.31875 -2.862871 0.0000 reject fide -31.26660 -2.862871 0.0000 reject fcmb -47.21351 -2.862869 0.0001 reject gtbb -41.69622 -2.862869 0.0000 reject stam -39.93105 -2.862869 0.0000 reject skye -37.27772 -2.862870 0.0000 reject ster -44.45369 -2.862869 0.0001 reject ubab -37.66112 -2.862869 0.0000 reject unio -41.53341 -2.862869 0.0000 reject unit -19.79650 -2.862872 0.0000 reject wema -35.10079 -2.862871 0.0000 reject zeni -51.04354 -3.433617 0.0001 reject source: author’s computation (2016) the hypothesis for the adf is that the null hypothesis claims that a unit root is present (i.e series are not stationary). the more negative the test statistic is, the stronger is the probability of rejecting the null hypothesis; that there is a unit root at the given level of confidence. table 4.3.1 shows that the test statistics are all above the critical limits at 5%, for acce(36.75468 > 2.862869), diam (33.31875 > 2.862871), fide(31.26660 > 2.862871), fcmb(47.21351 > 2.862869), gtbb(41.69622 > 2.862869), stam(39.93105 > 2.862869), skye(37.27772>2.862870), ster(44.45369 > 2.862869), ubab(37.66112 > 2.862869), unio(41.53341 > 2.862869), unit( 19.79650 > 2.862872), wema(35.10079 > 2.862871) and zeni(51.04354 > 3.433617). the adf tests reject a unit root at the 5 % significance level, therefore, we reject null hypothesis of unit roots against the alternative of stationarity at level. in order to increase the robustness of the tests, the phillips-perron and the kpss tests are carried out. the hypothesis for the adf and the phillips-perron are the same. the test result for pp is presented in table 3. table-3. unit root test pp variables pp test statistics makinnon critical value @ 5% prob. conclusion acces -36.53841 -2.862869 0.0000 reject diam -77.72028 -2.862869 0.0001 reject fide -56.14167 -2.862869 0.0001 reject fcmb -47.16359 -2.862869 0.0001 reject gtbb -41.68274 -2.862869 0.0000 reject stam -39.86895 -2.862869 0.0000 reject skye -56.98352 -2.862869 0.0001 reject ster -44.45286 -2.862869 0.0001 reject ubab -37.78229 -2.862869 0.0000 reject unio -41.51167 -2.862869 0.0000 reject unit -62.44460 -2.862869 0.0001 reject wema -81.03781 -2.862869 0.0001 reject zeni -51.63814 -2.862869 0.0001 reject source: author’s computation (2016) using e-view statistical package, version 7.0 table 3 shows that the test statistics are all above the critical limits at 5%, for acces (-36.53841 > -2.862869), diam (-77.72028 > -2.862869), fide(-56.14167 > -2.862869), fcmb(-47.16359 > -2.862869), gtbb(-41.68274 > -2.862869), stam(-39.86895> -2.862869), skye(-56.98352>-2.862869), ster(-44.45286 > -2.862869), asian journal of economics and empirical research, 2017, 4(2): 99-105 104 ubab(-37.78229 > -2.862869), unio(-41.51167 > -2.862869), unit( -62.44460 > -2.862869), wema(-81.03781 > -2.862869) and zeni(-51.63814 > -2.862869). the adf tests reject a unit root at the 5 % significance level; therefore, we reject null hypotheses of unit roots against the alternative of stationarity at level. the kpss test works the other way around. it tests the null hypothesis of stationarity against the alternative of a unit root. the test result is presented in table 4. table-4. unit root test: kpss variables kpss test statistics makinnon critical value @ 5% conclusion acces 0.169844 0.463000 reject diam 0.075795 0.463000 reject fide 0.031495 0.463000 reject fcmb 0.236417 0.463000 reject gtbb 0.065273 0.463000 reject stam 0.074637 0.463000 reject skye 0.114795 0.463000 reject ster 0.093857 0.463000 reject ubab 0.088436 0.463000 reject unio 0.132893 0.463000 reject unit 0.049643 0.463000 reject wema 0.133313 0.463000 reject zeni 0.094489 0.463000 reject source: author’s computation using e-view statistical package, version 7.0 it can be seen from table 4 that kpss test statistics are less than critical value at 5% significant level, suggesting that the changes in stock prices are stationary. 5. concluding remarks jarque bera test was conducted to determine whether changes in stock prices are normally distributed or identically distributed random variables. the jarque-bera test statistics shows that null hypotheses of normality are rejected at 5% significance level. it means that changes in stock prices are not identically distributed random variables. the finding is at variance with the apiori expectation and weak form efficient market theory. the finding is consistent with victor (2010) in nigeria, who investigated weak form efficiency of nigerian stock market and found that the nse is inefficient in weak form. the null hypothesis that there is a unit root in stock price changes was determined using adf, pp and kpss tests. at level, unit root is strongly rejected for all the stocks. nigerian banking industry stocks do not show signs or evidences of random walk. the finding is at variance with the apiori expectation and weak form efficient market theory. the finding is consistent with nwosa and osheni (2011) in nse which found based on the results of the pp and adf that nse is informational inefficient. the finding discloses that the nigerian banking industry stock price changes does not follow a random walk. this implies that changes in stock prices do not follow the step of a man who is drunk and that nigerian stock market is not efficient in weak form. this finding has implication for the regulatory authorities, investors, and market operators. also, the findings implies that there are certain factors which the investors and other market operators can study which affect stock price changes and that previous changes is one of those factors. this information is of vital importance to these categories of people who want to invest profitably and provide reliable investment advisory services to their clients. the finding reveals that changes in stock prices are not identically distributed random variables as put forth by the proponents of random walk hypothesis. the implication is that stock price changes are not determined by random events and that the 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comprised of 400 cocoa farmers selected from five major cocoa producing states in nigeria of which 321 farmers responded. questionnaire technique supplemented by oral interview was used for the study. the data were analysed using multiple regression, likert rating and percentages. the results show that few cocoa farmers invested in new planting and replanting programme. there is no positive relationship between percentage of annual income invested in new planting and replanting by the cocoa farmers and the number of hectares of farm holding while age of farmers , years of experience as a cocoa farmer and average annual income show marginal positive relationship, however, farmers education has very high positive relationship with a coefficient of 0.935. the result also shows that the independent variables (farmer annual income, number of hectares owned by the farmers, age of the farmers, education and experience of the farmers) have marginal impact on the dependent variable with coefficient of variation of 0.033. the study concluded that cocoa farmers did not invest adequately in new planting and replanting because of lack of capital and non ploughing lack of capital and low ploughing back of kincome due to low income and social needs. keywords: cocoa farm, cocoa farmers, hectares, investment, replanting, new planting, farm holding, capital, farmers income. contents 1. introduction ......................................................................................................................................................................... 18 2. materials and methods ........................................................................................................................................................ 18 3. methodology......................................................................................................................................................................... 19 4. results and discussion ......................................................................................................................................................... 19 5. conclusion and recommendations ..................................................................................................................................... 21 6. recommendations ................................................................................................................................................................ 21 references ................................................................................................................................................................................ 21 appendices ............................................................................................................................................................................... 22 citation | olowolaju philip segun (2016). investment in cocoa planting and rehabilitation by cocoa farmers in nigeria. asian journal of economics and empirical research, 3(1): 17-24. doi: 10.20448/journal.501/2016.3.1/501.1.17.24 issn (e): issn (p): 2409-2622 2518-010x licensed: this work is licensed under a creative commons attribution 3.0 license funding: this study received no specific financial support competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained ethical: history: this study follows all ethical practices during writing. received: 4 november 2015/ revised: 23 november 2015/ accepted: 21 december 2015/ published: 2 january 2016 publisher: asian online journal publishing group http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.17.24 http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.17.24 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.17.24 http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.17.24 asian journal of economics and empirical research, 2016, 3(1): 17-24 18 1. introduction nigeria ranked as one of the leading cocoa producing countries in west africa before the oil boom. cocoa was a major export crop for the nation as it fetched a sizeable percentage of the nation’s foreign exchange, regrettably crude oil displaced the agricultural sector of the nation’s economy from the early 1970 and till date, the sector has been faltering. despite the dwindling production of cocoa in nigeria, the crop still contributes to the nation’s economic development in terms of foreign exchange earnings. no single agricultural export commodity has earned more than cocoa. with respect to employment, the cocoa sub-sector still offers quite a sizeable number of employments both directly and indirectly. in addition, cocoa is an important source of raw materials, as well as source of revenue to governments of cocoa producing states (nkang et al., 2009) the investment by cocoa farmers in new planting and replanting in nigeria has been at low ebb. the objective of this paper is to assess the cocoa farmers’ investment in cocoa planting and replanting 2. materials and methods over 70% of nigeria’s estimated 150million population lived in the rural areas and subsist on agriculture (arnon, 1987). before independence and shortly after, the country was able to feed itself and export cash crops including cocoa, palm oil, coffee, and groundnut (isoun, 1987; adewumi, 1998). in the first decade of the nigeria’s independence, the agricultural sector served as the engine of growth of the overall economy (ogen, 2003). the agricultural sector has the potential to be the industrial and economic springboard from which a country development can take off ogen (2007). from the view point of the occupational distribution and contribution to gdp, the agricultural sector as the leading sector in non oil export , has low output growth rate, with the major source of nigeria foreign exchange coming from oil since 1970 (olagbaju and fasola, 1966; olagunju, 2008). according to osalor (2010) traditional involvement with agriculture and the existence of diverse ecological conditions across the country offers great potential for growth of flourishing and suitably inter linked agro processing industry. nigerian ambitions for accelerated and inclusive economic growth are contingent on achieving a vibrant agricultural sector that can support extensive industrial development and employment. as expressed by matthewdaniel (2011) the nigerian economy was characterised by the dominance of export activities before independence and there was no viable industrial sector and after independence, agriculture continued as the mainstay of the economy. he stated further that in spite of fluctuations in world prices of agricultural products, agriculture contributed about 65% of the gdp and represented about 70% of total exports. agriculture provided the foreign exchange that was used in importing raw materials and capital goods. many nations like brazil and malaysia have encouraged investment in agricultural sector. malaysia is currently the world largest producer and exporter of palm oil and this is achieved through large scale investment in this sector (basorun, 2007). brazil’s phenomenal agricultural growth has been the backbone of the nation’s economy throughout much of its history. this important sector and its country mineral deposits have helped her to become one of the leading manufacturing nations. brazil possesses large and well developed agricultural, mining, and manufacturing sectors (isoun, 1987). the agricultural potential of nigeria is not fully tapped and this explains the reason why nigeria has not been able to meet its ever increasing needs for food for the teeming population and raw materials for its agro allied industries. eboh (2005) stated that the agricultural sector despite being the dominant economic sector with the greatest potential for growth stimulation and poverty reduction; it has the poorest capital accumulation and the lowest quality of private sector investment. he stated further that many private sector concerns lack adequate capacity and knowledge for agricultural sector investment, there is acute shortage of capacity and experiences for agricultural investments among high echelons of private sector and critical private sector investments are also constrained by the inadequate supply of highly skilled and motivated agricultural enterprise managers. the annual cocoa beans production in nigeria within the last five years (2008 -2012) ranges between 200,000 tonnes to 240,000 tonnes. this production level is considered very low when compared with that of ghana which ranges between 730,000 tonnes and 870,000 tonnes and cote d’ivoire ranges between 1,431,000 tonnes and 1,668,000 tonnes in the same period (international cocoa organisation (icco), 2012). this production level in nigeria indicates that not much investment is done in planting and rehabilitation of cccoa farms. investment decision in cocoa by cocoa farmers in the cocoa value chain are very important for the development of cocoa sector in nigeria. larrrea and lynch (2012) defined sustainable cocoa economy as where each person investing time and money into the cocoa supply chain would be able to earn a decent income for themselves and their family, work in good condition and in a manner which would not harm the environment. they asserted that in latin america and the carribean (lac) the producers do not have enough financing, which has been the major limiting factor for the growth of cocoa sector in lac. also, in cote divoire majority of the farmers are at subsistence level with limited ability to invest in their farm. the financial instability of cocoa producers also contributes to the slow growth in the sector. the investment in cocoa create positive financial returns, there are also an array of possible social and environmental impacts that such investment may generate. however, poor access to finance has been one of the most significant barriers to the growth of cocoa sector in nigeria. lack of investment in cocoa sector in nigeria has created a major constraint to its expansion, creating investment level of productivity, preventing business development and market growth. investment has been deemed to be both the engine of economic activity and the primary cause of economic malaise since the time of adam smith and karl marx, modern theories of investment generally begin from fisherian capital theory, which explains investment in terms of optimal decision-making over time. the investment decisions of a firm are generally known as the capital budgeting decisions which are the firm decision to invest its current funds most efficiently in the long term assets in anticipation of an expected flow of benefits over a series of years (pandey, 2010). for a cocoa farmer to plant or replant his cocoa farm, is a capital budgeting decision aimed at increasing expected future earnings over a series of years. when it comes to the creation of value, the investment decision is the most important decision. as stated by dwived (2002) investment is an activity of spending resources asian journal of economics and empirical research, 2016, 3(1): 17-24 19 (money, labour, and time) in creating assets that can generate income over a long period of time or which enhances the returns on the existing assets. there is a very large number of constraints affecting investment in the nigerian economy in general and the agricultural sector in particular. manyong et al. (2003) identified constraints from different sources under eleven constraint categories, namely technical, infrastructural, economic, financial, political, social, policy, institutional, environmental, external environmental and labour market constraints. policy instability is the most mentioned nature of policy constraints. the specific nature of economic constraint includes poor economic and investment climate, economic mismanagement, high cost of production, poor access to market information, high investment risk among others. social constraint is mainly in the forms of corruption, indiscipline, insecurity of life and property, social instability/crises among others. political constraint manifests in the form of political instability, high country risk and poor governance ajuwon and ogwumike (2013) and onyenweaku (2000). financial constraint is mainly in the forms of inadequate supply of credit, inadequate financial services and high external debt burden (okafor, 2010; adebayo and waziri, 2012). finance is very crucial to investment (mckinnon, 2006). financial institutions must pool savings and direct them through viable investment if growth must take place. private sector credit and retention of earnings are very significant in the finance of business concern (okpara, 2010). therefore a farmer need to have access to credit and retain some of its earning to enhahce growth of his farm holdings. 3. methodology the sample for this study consists of 400 farmers selected from ondo, ekiti, osun, oyo and edo states. these five states produced the bulk of cocoa in nigeria. the questionnaire and oral interview techniques were adopted to gather the primary data for the study. the questionnaire contains questions on variables specify in the model form the study and other relevant question related to investment in cocoa farming. the model specification for the study is as follows: i = a + bx1 +bx2 +bx3 +bx4 + bx5 where: i = percentage of income invested in cocoa planting (average percentage invested in cocoa planting/ rehabilitation (2009-2013) x1 = average yearly income of farmers (2009 -2013) x2 = average hectares of farm holding (2009 – 2013) x3 = years of experience of cocoa farmers x4 = age of cocoa farmers x5 = education of cocoa farmers (farmers education was given quantifiable factors as follows: the data collected for the study were subjected to statistical analysis using simple percentage, multiple regression analysis, analysis of variance and likert rating and subjected to duncan multiple range test 4. results and discussion out of a sample of 400 farmers from five cocoa producing states a total of 321 completed the questionnaire which were then analysed. the study reveals that 62% of the cocoa farmers aged above 50 years while 38 % were less than 50 years. the mean age of the farmers was 49.4 years with a standard deviation of 8.3 years. the results is an indication that majority of the farmers were ageing. the result also corroborates the findings of kyei et al. (2011) and idowu et al. (2007) which revealed that 65% and 68% of cocoa farmers in ashanti region in ghana and southwest nigeria respectively were over 50 years of age. none of the farmers was less than 20 years of age while only 4.1% were between the age of 21 to 30 years, this also indicates that less youth were taking part in cocoa farming. the study shows that 30.9% of the respondents cocoa farmers had no formal education, 39,6% of the farmers are educated up to primary school level, 5.6% had adult education while only 18.1% and 5.9% had secondary and tertiary education respectively. this indicates that majority of cocoa farmers had little or no education. table 1 shows the new planting between 2008 and 2013 of 321 farmers. the table revealed that (47.9%) of the farmers had not done any new planting during this period, , 26.2% and 13.4% had planted between 1 and 2 hectares respectively in this period.. only a negligible percentage of 1.87% planted above 5 hectares within this period. this is an indication that investment in new cocoa plantation is very low. table 2 shows the farm holding of the farmers. majority (72%) of farmers held less than 4 hectares of cocoa farm. only few of the farmers (4.7%) held more than 10 hectares of cocoa farm. the result further revealed that 21.3%, 19.8%, 11.4%, 10.5% and 6.5% of ondo, ekiti, osun, oyo and edo states cocoa farmers respectively held between 4 and 8 hectares of cocoa farm. out of the 15 farmers (4.7%) that had over 10 hectares of cocoa farm, 9 (2.8%) were from ondo state. this indicates that farmers invested more in cocoa farming in ondo state than any other states in nigeria .this was due to the cultivation of cocoa in new openings in the forest reserves. table 3 revealed that 76% of the farmer invests less than 20 % of their income on new planting, replanting and rehabilitation. this result clearly shows that farmers only plough back very little percentage of their income for further investment in cocoa planting no formal education 1 adult education 2 primary education 3 secondary education 4 post secondary 5 asian journal of economics and empirical research, 2016, 3(1): 17-24 20 table-1. new planting between 2009 and 2013 by cocoa farmers number of respondents number of hectares o n d o % e k it i % o su n % o y o % e d o % t o ta l % o f t o ta l 0 27 29.35 41 50.62 49 62.03 29 76.32 8 25.81 154 47.98 1 34 36.96 19 23.46 14 17.72 5 13.15 12 38.71 84 26.17 2 8 8.70 13 16.05 12 15.19 2 6.26 8 25.81 43 13.39 3 7 7.60 5 6.17 3 3.80 2 5.26 1 3.22 18 5.60 4 10 10.87 2 2.45 1 1.26 2 6.45 17 5.29 5 and above 6 6.52 1 1.24 6 1.87 total 92 100 81 100 79 100 38 100 31 100 321 100 (source: field survey 2015) table-2. farm holding in hectares number of respondents hectares o n d o % e k it i % o su n % o y o % e d o % t o ta l % o f t o ta l 0 2 11 11.96 21 25.92 38 48.10 25 63.79 25 80.64 120 37.38 2 4 37 40.22 33 40.74 29 36.71 8 2.11 4 12.90 111 34.58 4 6 13 14.13 11 13.58 7 8.86 4 10.53 1 3.23 36 11.21 6 7 7.16 5 6.17 2 2.53 1 3.23 15 4.67 8 15 16.30 8 1 1.26 1 26.32 25 7.79 10 9 9.78 3 3.70 2 2.53 15 4.67 total 92 100 81 100 79 100 38 100 31 100 321 100 (source: field survey 2015) table-3. percentage of yearly income invested on planting number of respondents o n d o % e k it i % o su n % o y o % e d o % t o ta l % o f t o ta l 0 – 20% 77 83.70 55 67.90 67 84.81 26 68.42 19 61.29 244 76.01 21 – 40% 1 9.78 17 20.99 8 10.13 9 23.68 4 12.90 47 14.64 41 – 60% 4 4.35 2 2.47 3 3.80 1 2.63 5 16.13 15 4.67 61 – 80% 2 2.17 7 8.64 1 1.27 2 5.26 3 9.68 15 4.67 81 – 100% total 92 100 81 100 79 100 38 100 31 100 321 100 (source: field survey 2015) the study identified some factors that influenced investment in new planting and rehabilitation, which include availability of land, funding, labour, government support and seedlings. the mean ratings for these factors were 2.17, 2.27, 2.75, 2.76 and 3.00 for land availability, funding, labour, government support and improved seedlings respectively (table 4).there was a significant difference (f = 29.338, p < 0.05) in the ratings of the factors . all the factors were inadequate except improved seedling (3.00) which was fairly adequate. farmers interviewed confirmed that there were government agencies that take care of providing seedlings to cocoa farmers at avoidable prices table-4. adequacy of factors determining investment in new planting v er y a d eq u a te a d eq u a te f a ir ly a d eq u a te in a d eq u a te g ro ss ly in a d eq u a te t o ta l r es p o n se w ei g h te d s co re m ea n r a ti n g land availability 22 (7%) 14 (4%) 28 (9%) 188 (59%) 69 (21%) 321 695 2.17d funding 11 (3%) 29 (9%) 37 (12%) 203 (63%) 41 (13%) 321 729 2.27c labour 30 (9%) 12 (4%) 161 (50%) 84 (26%) 34 (11%) 321 883 2.75b government support 29 (9%) 37(12%) 128 (40%) 81 (25%) 46 (14%) 321 885 2.76b seedlings 41 (13%) 23 (7%) 167 (52%) 75 (23%) 15 (5%) 321 963 3.00a (source: field survey 2015) analysis of variance: f = 29.338, p < 0.05, means followed by the same letter are not significantly different (p < 0.05) note: rating 1 grossly inadequate 2 inadequate 3 fairly adequate 4 adequate asian journal of economics and empirical research, 2016, 3(1): 17-24 21 5 very adequate the result of the regression equation shows that: i = 8,745 + 0.0000007x1 0.335x2 +0.054x3 +0.050x4 + 0.935x5 where: i = percentage of income invested in cocoa planting( average percentage invested in cocoa planting/ rehabilitation (2009-2013) x1 = average yearly income of farmers (2009 -2013) x2 = average hectares of farm holding (2009 – 2013) x3 = years of experience of cocoa farmers x4 = age of cocoa farmers x5 = education of cocoa farmers the regression equation obtained as shown above reveals that there is no positive relationship between percentage of annual income invested in new planting and replanting by the cocoa farmers and the number of hectares of farm holding. other independent variables show marginal positive relationship except farmers’ education with a very high positive coefficient of 0.935. this indicates that if there are more educated farmers, there will be more awareness of investing more percentage of farmers’ income in new planting and replanting the summary of the multiple regression model is shown below:: r 0.183 r square 0.033 adjusted r square 0.018 standard error of estimate 10.93841 the coefficient of correlation r and the coefficient of determination r square measure the explanatory power of multiple regression models. from the above data, there is low correlation (0,183) between the dependent variable (percentage of income invested in planting and replanting) and the independent variables (farmer annual income, number of hectares owned by the farmers, age of the farmers, education and experience of the farmers) this implies that there is a low positive relationship between the variables and therefore the independent variables does impact positively on percentage of annual income invested in planting though very low.. the r square shows the coefficient of determination which is .033 and it implies that the independent variable has marginal impact on the dependent variable. the adjusted r square shows a small positive result of .018. this result is not unexpected in view of the fact that most farmers income is still generally very low and the substantial portion of their income are expended on many social and domestic issues. interview of cocoa farmers conducted indicated that they have received little support from cocoa major marketers, cocoa processors and the government especially in time of finance for new planting they opined that policy need to be put on place to allow cocoa farmers have easy access to finance from agricultural bank, without much encumbrance. 5. conclusion and recommendations the study covered 400 cocoa farmer selected from five major cocoa producing states in nigeria farmers from which a response rate of 80,25% was obtained. majority (76.01) % of the farmers invested between 0 and 20% of their income in new planting some of the farmers(47.98%) have not invested in new planting between 2009 and 2013 while only 1.87% have invested in new planting of more than five hectares, there is high positive correlation between percentage of cocoa farmers income invested in planting and the level of education of the farmers. based on the findings of the study, the following suggestions and recommendations are made to improve the farmers willingness to invest in new planting and replanting programme. 6. recommendations (i) farmers must be encouraged to invest in new cocoa farm and replanting by having access to credit without much encumbrance which should be channeled through cocoa farmers’ cooperative unions. (ii) there should be reawakening of the farmers to join co-operative unions to encourage farmers to save from their income which can be ploughed back for new planting and replanting programme.. (iii) in view of the land tenure system in nigeria, government should acquire land and create farm settlement for young farmers to plant cocoa and they should be given necessary improved seedling and stipend to sustain them during the gestation period. the above recommendations would lead to increase in investment in cocoa farming in nigeria and the rebirth of cocoa industry in nigeria references adebayo, o.f. and b.a. waziri, 2012. cultural impediments to socio-economic development in nigeria: lessons from the chinese economy. journal of sustainable development, 5(7): 127-136. adewumi, b.a., 1998. status of cocoa processing industry in nigeria. proceeding of the 20th annual conference and general meeting of the nigerian society of agricultural enginners, lagos nigeria, 20: 175-187. ajuwon, o.s. and f.o. ogwumike, 2013. uncertainty and foreign direct investment: a case study of agriculture in nigeria. mediterranean journal of social sciences, 4(1): 155-165. arnon, i., 1987. modernisation of agriculture in developing countries: resources, potentials and problems. new york usa: john wiley and sons. basorun, y., 2007. palm production through sustainable plantations. journal of science and technology, 109(4): 289-295. dwived, d.n., 2002. managerial economics. new delhi: vikas publishing house, pvt ltd. eboh, e., 2005. legislative and policy agenda for nigerian agriculture. african institute for applied economics, agricultural sector study team policy briefs series, 2(1): 1-14. idowu, e.o., d.a. osuntogun and o. oluwasola, 2007. effects of market deregulation on cocoa (theobroma cacao) production in southwest nieria. african journal of agricultural research, 2(9): 429-434. asian journal of economics and empirical research, 2016, 3(1): 17-24 22 international cocoa organisation (icco), 2012. icco annual report 2010/2011. pp: 2-3. available from www.icco.org. isoun, t.t., 1987. evolution of science and technology in nigeria: the experience of rivers state university of science and technology. port harcourt: riverside communication. kyei, l., g. foli and j. ankoh, 2011. analysis of factors affecting the technical efficiency of cocoa farmers in offingo district – ashanti region, ghana. african journal of social and management sciences, 2(2): 208-206. larrrea, c. and m. lynch, 2012. market research for sustainable investment: an overview of the sustainable cocoa sector in latin america and the carribbean. canada: finnance alliance for sustainable trade montreal. manyong, v.m., a. ikip, j.k. olayemi, s.a. yusuf, r. omonona and f.s. idachaba, 2003. agriculture in nigeria: identifying opportunities for increased commercialisation and investment. research report funded by usaid/nigeria. matthew-daniel, b.j., 2011. the nigerian economy in the 21st century. nigerian. available from wwwonlinenigeria.com [accessed 23rd april 2011]. mckinnon, r.i., 2006. money and capital in economic development. abuja: brooklyn institution national planning commission (npc) economic performance review. pp: 1-11. nkang, n.m., e.a. ajah, s.o. abang and e.o. edet, 2009. investment in cocoa production in nigeria: a cost and return analysis of three cocoa production management systems in the cross river state cocoa belt (report). african journal of food agriculture, nutrition and development, 9(2): 713-727. ogen, o., 2003. pattern of economic growth and development since 1960. in: s. o. arifala and gboyega ajayi (eds) (2003) essays in nigeria contemporary history. lagos: first academic publishers. ogen, o., 2007. the agricultural sector of nigeria development: corporative perspectives from the brazilians agro–industrial economy. journal of economic development and financial studies, 1(1): 184-193. okafor, b.o.n., 2010. investment climate reform in nigeria: challenges and prospects. central bank of nigeria economic and financial review, 46(2): 59-89. okpara, g.c., 2010. investigation of the critical sources of investment finance in nigeria ojo, s. (2003): fundamental principles of nigerian tax. lagos: sagtibre tax publications. pp: 248 – 249. olagbaju, j. and j. fasola, 1966. post independence economies changes and development in west africa. in: ogunrami, g. o. and faluyi, e. k. (eds). (1966). an economic history of west africa since 1950. ibadan: rex charles. olagunju, f.i., 2008. economies of palm oil processing in southwestern nigeria. international journal of agricultural economics and rural development, 1(2): 62 -71. onyenweaku, c.e., 2000. policy issues and strategies for agricultural production. a paper presented at the national workshop on enhancing research and development in agriculture and roots crops towards poverty alleviation and rural development in nigeria. national root crops research institrute, umudike. osalor, p., 2010. nigeria agro allied industry a starting point for enterprises revolution. available from http://allafrica.comstories/201008230156 [accessed february 22, 2011]. pandey, i.m., 2010. financial management. new delhi: vikas publishing house, pvt ltd. appendices appendix-1. adequacy of factors determining investment in new planting anova sum of squares df mean square f siq between groups within groups total 123.243 1679.246 1802.489 4 1599 1603 30.811 1.050 29.338 .000 duncan multiple range test result post hoc tests homogenous subsets duncana,b appendix-2. regression descriptive statistics mean std. deviation n % of income invested 14.6729 11.03838 321 no. of hectare 4.49 3.089 321 average income 212772.5857 1.86184e5 321 education 2.63 1.254 321 years of experience 16.93 6.927 321 age 49.42 8.276 321 factors subsets for alpha =0.05 n 1 2 3 4 land availability funding labour government support seedling sig. 321 320 321 321 321 2.1651 1.000 2.5813 1.000 2.7508 2.7570 .939 3.0000 1.000 http://www.icco.org/ http://allafrica.comstories/201008230156 asian journal of economics and empirical research, 2016, 3(1): 17-24 23 correlations % of income invested no. of hectare average income pearson correlation % of income invested 1.000 -.053 .102 no. of hectare -.053 1.000 .358 average income .102 .358 1.000 education .113 -.059 .049 years of experience .045 -.004 .011 age .047 .055 .036 sig. (1-tailed) % of income invested . .172 .034 no. of hectare .172 . .000 average income .034 .000 . education .021 .147 .189 years of experience .209 .469 .424 age .202 .162 .259 n % of income invested 321 321 321 no. of hectare 321 321 321 average income 321 321 321 education 321 321 321 years of experience 321 321 321 age 321 321 321 education years of experience age pearson correlation % of income invested .113 .045 .047 no. of hectare -.059 -.004 .055 average income .049 .011 .036 education 1.000 -.081 -.063 years of experience -.081 1.000 .492 age -.063 .492 1.000 sig. (1-tailed) % of income invested .021 .209 .202 no. of hectare .147 .469 .162 average income .189 .424 .259 education . .075 .130 years of experience .075 . .000 age .130 .000 . n % of income invested 321 321 321 no. of hectare 321 321 321 average income 321 321 321 education 321 321 321 years of experience 321 321 321 age 321 321 321 variables entered/removed model variables entered variables removed method 1 age, average income, education, no. of hectare, years of experience a . enter a. all requested variables entered. model summary model r r square adjusted r square std. error of the estimate 1 .183 a .033 .018 10.93841 a. predictors: (constant), age, average income, education, no. of hectare, years of experience anovab model sum of squares df mean square f sig. 1 regression 1301.250 5 260.250 2.175 .057 a residual 37689.405 315 119.649 total 38990.654 320 a. predictors: (constant), age, average income, education, no. of hectare, years of experience b. dependent variable: % of income invested asian journal of economics and empirical research, 2016, 3(1): 17-24 24 coefficientsa model unstandardized coefficients standardized coefficients b std. error beta t sig. 1 (constant) 8.745 4.087 2.140 .033 no. of hectare -.338 .213 -.095 -1.588 .113 average income 7.623e-6 .000 .129 2.160 .031 education .935 .492 .106 1.902 .058 years of experience .054 .102 .034 .531 .596 age .050 .085 .037 .584 .560 a. dependent variable: % of income invested asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. asian journal of economics and empirical research issn: 2409-2622 vol. 2, no. 1, 39-46, 2015 http://asianonlinejournals.com/index.php/ajeer * corresponding author 39 taxation and capital structure: evidence from russian companies elena makeeva 1* --tatiana kozenkova 2 1 department of finance, national research university higher school of economic, russia 2 department of financial management, financial university under the government of the russian federation abstract this work is licensed under a creative commons attribution 3.0 license asian online journal publishing group contents 1. introduction ............................................................................................................................................................................... 40 2. literature review ...................................................................................................................................................................... 40 3. data and empirical methodology ............................................................................................................................................ 42 4. conclusions ................................................................................................................................................................................ 45 5. acknowledgement ..................................................................................................................................................................... 46 references ...................................................................................................................................................................................... 46 this paper presents a study of the impact of taxation on the capital structure of russian companies, based on the graham model. the study revealed that it is more appropriate to include the effective tax rate in the model, rather than use the marginal tax rate since it is more applicable for the russian companies. keywords: taxation, capital structure, russian companies, bankruptcy probability, effective tax rate, debt. jel classification: g32, g38 and r3. http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2015, 2(1):39-46 40 1. introduction to date, the possibility of having a definitive capital structure for each company, by itself, has caused much controversy, as well as the question: do the companies, issuing debt or equity, try to make their ratio unified, or do they only have instantaneous motifs and pay attention to exogenous factors that change with time? considering that companies, by virtue of their nature, are economically rational, it is supposed that, by taking one or another decision, the company aspires to maximize its price. hence these considerations also define the decision about their capital structure. in this respect, it isn’t surprising that this question is widely discussed among the economists in different countries, since it is the key to understand the companies’ motivation, as well as to develop a definitive strategy assuring the best results. as early as in 1958, modigliani and miller (1958) put forward a hypothesis that the company’s price didn’t depend on the corporate securities’ structure (the equity to debt ratio), with allowance for a «perfect capital market», absence of information asymmetry, corporate and individual income taxes, transaction costs etc. but soon the researchers published another scientific effort (modigliani and miller, 1963), aimed at amending the previous one, where they introduced the pre-condition about corporate income taxes. this time, they came to the conclusion that taxes influence directly the capital structure of the company, because when using debt, the so-called tax shield appears that appreciates the company’s price, being directly dependent on the amount of debt. the present conclusion implies that in theory every company should omit the ownership equity and convert to debt financing, in an effort to increase their price. however, that was not the case in reality. from this point on, many researchers have tried to loosen the original terms of the modigliani – miller hypothesis by indicating the imperfections in the model, such as individual income taxes, costs of financial distress, caused by the usage of debt etc. most of the theories, however, couldn’t explain and, what’s the most important, establish a prognosis for the amount of used debt for different companies. the influence of corporate income taxes on the capital structure is, nevertheless, is indubitable, which is why the majority of the researchers were guided exactly by this condition, when trying to explain the choice of the company’s capital structure. this work presents the approach of different researchers to this issue, it follows the scientific thought in its effort to explain empirical observations, and thoroughly examines the model, created by graham (1996), as well as gives the own approach, based on graham’s concept. 2. literature review graham put a lot of effort (graham, 1996; 2000) trying to show the influence of tax factors on the company’s strategy about changing of its capital structure. in particular, he concluded that companies with high taxation rate resort to debt more frequently than the other ones. as the main tax factor, graham uses the marginal tax rate (mtr) that fairly defines the taxable status of the company. by the marginal tax rate we mean present tax value the company should pay additionally during the running and the forward period, in case of a $1 increase in income in the running period. in contrast to effective tax rate, calculated as ratio of effective paid taxes to the taxable base for a certain period, the mtr can’t take negative values. it also depends on such specific factors of the tax system, as tax loss carryforward/carryback, investment tax credits, and the alternative minimum tax, considered below. if the company has enough similar non-debt tax shields (ndts) to decrease the estimated mtr, the company will issue less debt, than a similar company that doesn’t take advantage of ndts. the author uses incremental changes in the debt, in contrast to the cumulative level. to illustrate it, he gives us the following example: the company that doesn’t use debt faces a high mtr and decides to issue debt for further use of interest deductions. at that, the dependency between the tax rate and the debt option takes a positive value, as is evident. at the same time, increase of debt obligations reduces the expected marginal rate, because the probability goes higher that the company is at a loss and won’t pay out the debt. the result is that the observations can contribute to finding the inaccurate negative dependency between the tax rate and the mtr. the principle of tax loss carryforward/carryback says that if the company has a negative profit in the running period, it has the right to offset losses against taxable gains for the last 3 years (until all the losses are offset against gains), thereby refunding the tax on income from the budget. if a part of losses still remains after the setoff, it can be carried forward in the following 15 years. so, tax loss carryforward is only possible if there are no possibilities for its carryback. the dependency between losses and the mtr can take positive value. for example, the company’s losses in the running period are exactly the same as the amount of gains for the last 3 years. in this case, one earned dollar reduces the amount of refunded taxes for the prior periods by the amount tc (corporate income tax rate). in other words, the mtr can be high, even if there are losses in the running period. reverse situation is also possible, when the company is profit-making in the running period but expects losses in the forward periods, so the taxes for the running period will be refunded from the budget during the next period. in this case the mtr equals the difference between tc and tc, discounted for one period, namely in absolute terms it’s a relatively low rate, in spite of positive profit in the running period. one of allowances specific for the american tax system is the investment allowance. it is based on the principle, according to which the company can offset 7% of capital costs for the first $25 000 of the tax and for 85% of the amount of tax over $25 000. the present allowances can be also carried back/forward during 3 (15) years. later on, the particularities of this legislative act have changed, but, as the graham’s research concentrates on the period from 1980 to 1992, the present provisions seriously influence the mtr. speaking about the alternative minimum tax (amt), introduced during the 1986 tax reform, the present principle was used to make sure that companies with positive profits pay the taxes anyway. for such tax, the taxable base was calculated a bit differently for such tax, and the tax rate amounted to 20% at the time. furthermore, the companies were obliged to pay out the biggest amount out of two – the effective income tax or the alternative minimum tax, calculated according to the specified method. it was evident that companies with profits being about zero were the most often subjects to this principle. asian journal of economics and empirical research, 2015, 2(1):39-46 41 the option of tax loss carryforward/carryback brings us to rational examination of profits during the 18 year period for each particular company, to calculate the mtr more objectively. to forecast taxable profit, graham judges on the observed average profit changes in the sample, as well as on a normally distributed random variable with expected value 0 and a dispersion equivalent to the one in the sample of average changes. when calculating the mtr for the running period, in the first place you should find the anticipated levels of taxable profit in the next 18 periods. then you take into account the tax loss carryforward/carryback and calculate the effective income tax liability in each of the 3 periods prior to the running period, and of the 18 periods following. the tax liabilities, due to be paid out after the running period, are discounted according to the average yield rate of corporate bonds. then you proceed to conversion of present value of payable taxes, due to adding $1 to the running period’s profits. the difference between the two values is exactly the marginal tax rate for the company, for the present period, based on the simulation of profits. this procedure is performed 50 times to generate different variations of the estimated profit in following periods. later on, you calculate the average rate basing on the 50 previously generated, which is exactly the estimated mtr for the company, for the present period. 2.1. the dependent variable the author uses change in the book cost of the long-term debt for the running period, divided by the sum of the company’s market price for the previous period, as the dependent variable. the company’s market price is the sum of book cost of debt and the market price of the stockholders equity. 2.2. explanatory variable: marginal tax rate mtr is used as one of the explanatory variables. the technology for its calculation has been described earlier. what is more, to avoid the situation when the debt changes reduce the marginal tax rate by artificial means, which can affect the faithfulness of the results, the author resorts to isolated lag for the mtr. income volatility also impacts the debt policy, which is very relevant for companies facing the nonresidue of interest expenditures. volatility reduces the mtr of the companies that can’t exclude interest expenditures because of the loss carryforward. in this case, a high standard deviation of the mtr can be indicative of higher tax payable, and provoke a more aggressive debt policy (in other words, the coefficient before the σmtr should take positive value). at last, graham uses the difference between the active and the marginal tax rate for the previous period as explanatory variable, explaining that the managers of certain companies, while choosing the financial policy, draw on the active, official tax rate. so, for companies with higher difference between these two rates, the probability of debt issue is higher than for companies with equal marginal and fixed rates. 2.3. explanatory variables: individual tax assessment this variable adds to the dependency the investor’s attitude towards the debt, namely his estimates for profitability of different kinds of securities. to return to the earlier described works of miller (1977), deangelo and masulis (1980), for an investor who doesn’t care for choice of securities, the condition of the balance: ( ) ( )( ) [1] where the mtr* is the marginal tax rate, so that it doesn’t matter for the company, which kind of securities should be issued. so, if the effective mtr is higher than mtr*, the company has the motivation to issue debt, in contrast to issuing securities. to include this effect into the model, graham uses the advdebt variable, defined as: ( ) ( )( ) [2] is the difference between the annualized gain for the municipal and taxable securities for the previous period, is the income tax rate for capital gains for the previous period. 2.4. explanatory variables: probability of bankruptcy as a variable defining the probability of the situation when the company can’t be liable, the author resorts to the approach of altman (1968), namely the zprob variable: [3] as a certain element of bankruptcy is already included into the mtr variable in terms of probable nonresidue of interest expenditures, the zprob variable can show other direct and indirect expenditures connected with bankruptcy, such as costs of legal services, running out of credit for suppliers and clients, managing time expenditures, agency costs etc. as an alternative way to calculate the probability of bankruptcy, the author suggests introducing a variable that shows the carryforward of losses. as a rule, the attitude of creditors and suppliers towards such companies is rather cautious, because they are distressed that the company can’t be liable again. so it is an additional disincentive for issuing the debt. for this purpose, the author includes dummy-variables into the regression: the mtrnol, equal to the mtr in case of tax carryforward/carryback, and equal to 0 otherwise, and the mtr non nol with reverse values. furthermore, to exclude multicollinearity of the variables, graham includes these variables into the supplementary regression, which doesn’t include the mtr. at last, contrary to the approach of deangelo and masulis (1980), who claimed that the non-debt tax shield (ndts) drives out the profits from deduction of interest and, therefore, has an adverse effect on the debt, the author claims that large and profitable companies won’t necessarily follow that logic. so a high ndts will have a negative asian journal of economics and empirical research, 2015, 2(1):39-46 42 impact on debt, only when the probability of bankruptcy (zprob) is high (for example, a company that has used up all the possible ways of deduction, provided by the ndts, are very unlikely to use debt, as the interest expenditures will be driven out by the ndts). to include this factor, the author, following the logic of mackie-mason (1990), includes the ndts*zprob factor into regression. 2.5. explanatory variables: other variables among other variables, important for choosing the debt policy, the author includes into regression the so-called control variables that define free cash flow 1 , investment opportunities 2 , amount 3 , r&d spending 4 , advertising expenditures 5 , materiality of assets 6 etc. 7 . what is more, some variables are presented in the form of the first difference, to maintain the consistency with the dependent variable. to make a sample for the regression analysis, the author chose 10,240 companies from the statistics of compustat, and, respectively, 54,181 observations from the period from 1973 to 1992. the sample didn’t include financial companies, due to their tax regime, which differed from the standard taxation scheme. the sample also didn’t include the companies with changes in debt or in other variables being larger in in absolute terms than the market price of the company for the previous period. 2.6. results having shown debt linearly depending from the above-described factors, graham concluded that the variables presented by him can explain 5% of the variation in the debt level (judging from the adjusted r 2 ). p-value was less than 1%, which, altogether, confirms the significance of the equation. every valuable, explaining tax factors, except for the zprob, is statistically significant at a level of 5%. the coefficient before the mtr is positive. that corresponds to the put forward hypothesis about the complete association between the debt and the tax rate. the positive coefficient before the valuable, explaining the difference between the effective and the marginal tax rates, also answers expectations, as it is evident that not many companies generate the marginal tax rate when taking decisions about the financing. some of them consider only the fixed rate active for the moment. the coefficient before the standard deviation of the mtr also takes positive value, which confirms the speculations about complete association of tax payable and the issue of debt. the coefficient before the advdebt, depicting the influence of personal income taxes, has the value other than supposed, which can be possibly due to relative advantages of debt being already included into the coefficient before the mtr. indeed, when calculating the auxiliary regression without the mtr factor, the coefficient before the advdebt takes a positive value, though the explicative power of the regression decreases in general. the author nevertheless comes to the conclusion that the tax assessment for the ownership equity and debt capital on the investors’ level is not substantial for the finance policy of the company in the way it was originally supposed. the values of the coefficients before the zprob and the ndts*zprob, are negative, as it is thought to be, the coefficients themselves being though virtually non-significant. also a regression for observations has been made, in which the absolute change in debt was more than 2% of the market value of the company, thereby eliminating the possibility of interference in the data. as a result, the number of cases decreased by almost half, but the explanatory power of the regression almost doubled (new, adjusted r2 is 0,113). furthermore, additional regressions have been made, in which the variable mtr was replaced by two dummy variables, the earlier described mtrnol and mtrnonnol. in additional regressions, the results were almost identical to the basic regression, but the explanatory power was slightly higher. the inclusion of dummy variables showed that the companies are more sensible to tax status when they have losses that can be carried forward, in contrast to the ones that do not have such losses. thus, empirical analysis detected the statistical significance of the relationship between financial decisions and the tax status. in order to compare explanatory degree brought up by the tax factors, the author made a regression of the relationship between the level of debt and all other factors, except for tax factors. the comparison of the adjusted determination coefficients showed that tax factors add about 14,7% explanatory power of the regression (16,3% if the mtr is replaced by two dummy variables). 3. data and empirical methodology to study the given problem, it was decided to build a special model, based on the above-described graham's theory. the question, whether the taxes impact the financial policy of russian companies, or is the choice of capital structure subject to other, non-systematic factors, is of particular interest. the main question is, whether it is possible to claim that russian companies are guided in their financial decisions by the same motives as the western ones. and if it is true, how much stronger or weaker is the tax influence on the debt policy for russian companies. in this case, the results can be completely unpredictable, because the level of political and economic stability in the country, the country's investment rating, and some other factors also play a considerable role. however, before citing any differences between countries and starting to build a model based on the study of graham, it is necessary to analyze the differences in the 90s tax system of the usa and the current russian tax system. both countries have the same approach to defining the tax base, namely, only those revenues are subject to corporative income tax that were earned in the country or from russian sources (such as dividends, capital gains, 1 free – free cash flow before taxes, interest charges, free from investments and cash flows, connected with issuing and acquitting debt/ stockholders equity 2 δmaturity – the change in book cost of the assets, divided by the company’s market price 3 δsales – the change in the sales logarithm 4 δrd – the change in the amount of r&d spending, divided by the sales level 5 δad – the change in the amount of advertising expenditures, divided by the sales level 6 δintan – the change in the intangible assets, divided by the total assets 7 δplant – the change in machinery and equipment, divided by the total assets, δndts – the change in the non-debt tax shields, divided by the company’s market price. asian journal of economics and empirical research, 2015, 2(1):39-46 43 etc.). just as in the us, interest charges are deductible from the tax base for the purposes of the income tax, i.e., the concept of use of debt increasing the tax benefits due to the reduction in taxes payable, is still relevant for the russian market. the corporate income tax rate in russia currently is 20% (up to 2010 it has been 24%). however, for different regions with certain market conditions, the tax rate can be reduced to 13,5%. also dividends received from foreign and russian sources have a different tax rate (9 and 15%, respectively). moreover, the russian tax system also offers the possibility of tax loss carry-forward (similar to the above-mentioned tax loss carryforward system in the united states). however, the conditions are somewhat different from that of us law. first of all, the russian tax system makes it impossible to carry the losses to prior periods, reducing the tax payable for previous periods and demanding refund from the budget. in accordance with art. 283 of the tax code, losses may be carried and offset against future profits for ten years after the loss occurrence (as opposed to 15 years in the us tax system). as for tax incentives for capital investments, such rules (i.e. the option to offset a certain share of capital investments against the tax payable) in russia are absent in the form, in which they existed in the 90s tax system of the usa. in return, there is a preferential tax treatment in case of acquisition of fixed assets or investments into the capital in the form of specific bonus depreciation. in accordance with the russian tax system, the cost of fixed assets purchased should be offset straight-line, judging from the calculated depreciation period, however, for depreciable property, a one-time bonus depreciation of 10% (30% for certain types of property) is allowed, which sometimes can significantly reduce the taxable base in the period under report. thus, we can conclude that the tax system in russia is a bit more straight-line than the american system. in this regard, it was decided not to refer to marginal tax rate in the model, as defined by graham. the decision was also due to the technically demanding estimation of the expected net profit, a large number of iterations to forecast deviations from the average profit value. the study will be based on the assumption that there is no optimal level of debt, to which the company tends infinitely. in each specific case the company decides on the capital structure, judging from the conditions, available at the time. all variables in the model are adjusted to the same scale through dividing by the assets/company's price (depending on the message), taking natural logarithms, etc. thus, the risk of exceedingly lengthy coefficients in the summary data is eliminated. also, to maintain consistency between the dependent and explanatory variables, all factors in absolute terms are represented in form of the change for the corresponding period. the explanatory variable, in the same manner as graham used it, is the change in the level of long-term liabilities, in relation to the company's price (δdebt). in this case, the value of debt cash flow is more informative than the sum of debt at specified date, as it includes the change in debt for the period, caused by a number of factors, while the cumulated sum of debt is much harder to explain. the foremost purpose of this research is to prove the existence of the tax factor impact on the company’s capital structure change. therefore, the tax rate is considered as the primary variable. it has been decided to replace the marginal tax rate with the company’s effective tax rate (ef rate) since the latter can be extracted from the financial statements, it is quite demonstrative (the company’s effective tax rate is slightly varying and commonly remains almost the same), and it allows to predict the effective tax rate, which would be applied by the company after the estimation of all losses (including income taxable at different rates). furthermore, the main advantage of the effective tax rate variable is the fact that due to its simplicity and straightforwardness it is more likely to be analyzed by the manager while making financial decisions. taking into consideration the fact that in the decision-making process regarding a period the manager has the information of only the previous period, the effective rate shall be calculated with a measurement error. hypothesis 1: effective tax rate has a positive impact on the debt issuance. the next explanatory variable to be used is bankruptcy probability (defined by altman (1968)) as opposed to the interest deduction profits: [4] it is the same variable that was used in graham model analyzed earlier. this research is not aimed at analyzing altman’s paper altman (1968) in which the aforementioned formula was derived and proved, therefore, this formula is regarded as given. the main advantage of this variable is that it is easily calculated, as far as the financial statements (balance sheet and profit and loss statement) contain all the necessary data. supposedly, the greater bankruptcy probability is, the lesser debt the company shall issue since the adoption of additional debt obligations will lead to even greater risk of the future insolvency. hypothesis 2: bankruptcy probability has a negative impact on the debt issuance. another factor influencing the debt issuance is the company’s sales change (δsales). it is important to mention that the model operates the difference in the sales natural logarithms to reach the common scale. this variable was also analyzed in the initial graham model where it was regarded as the company’s size indicator. greater company’s size implies to the fact that fewer information gaps on debt issuance will occur. besides, bigger companies face financial instability costs less frequently and have lesser bankruptcy probability as far as they are diversified at a greater extent. hence it can be said that greater amount of the company’s revenue demands for more debts. hypothesis 3: sales change has a positive impact on the debt issuance. one more variable was included in the model. it reflects intangible assets change (patents, projects) (δintan). this variable is a kind of growth indicator, i.e. the more the company invests in intangible assets, the greater growth probability it has, so, by analogy with the previous factor, the higher its demand for the debt equity is. to reach the common scale the intangible assets changes were divided by the amount of the total assets. hypothesis 4: intangible assets changes have a positive impact on the debt issuance. asian journal of economics and empirical research, 2015, 2(1):39-46 44 the fifth and the last explanatory variable is the company’s fixed assets changes (δfixed assets)/total assets ratio. the companies with the great amount of the assets for debt usually may have preferential terms of demand for debt equity. fixed assets include real estate, automobiles, and equipment. hypothesis 5: increase of fixed assets has a positive impact on the debt issuance. thus, the model under consideration is as follows: [5] since the model [5] does not show the debt change in full (or does not show it at all), the determination coefficient is expected to be not sufficient. as it has been already said, in the graham’s research the adjusted r 2 equals 0.051, and after excluding from the sample all the elements with disproportionately high debt changes, this variable becomes equal 0.114. 3.1. search and analysis of baseline data the baseline data has been collected from the ruslana database (the database of russian companies analogous to the amadeus database. both databases are provided by the information agency bureau van dijk). we focus on the non-financial private sector in russia. the companies with the previous year revenue less than rub 13 mln were also eliminated, hence all the small private companies with low turnover are eliminated, because their demand for debt is not caused by financial planning, but by the current need for money. as it can be seen 971 russian companies meet the criteria. moreover, the corresponding data concern the available information of three recent years (2011, 2012, and 2013). it means that the total number of sample elements equals 1950. the search for corresponding elements for the sample is reduced to 1050 elements since most of them do not have certain data and thus cannot be included in the sample. the explanatory variables for the regression were pre-research analyzed. the analysis results can be seen in the table 1. the comparative statistics shows that the mean value of the effective tax rate equals 26.4%, and that is more than 24% applicable at the time of the research is made. this can be explained by the fact that the earnings specified in the profit and loss statements and the taxable profit have different calculation procedures. the calculation procedure for fiscal accounting is frequently stricter than the book keeping procedure since there are certain types of expenditures that are not deductible for tax purposes (for instance, the cost of consulting services). the same reason stands for the presence of negative tax rate values, i.e. the cases when the book keeping profit is negative, but the taxable profit is positive, and the company pays the income tax. the presence of abnormally high rates (maximum value 2105.6%) can be explained by the analogous considerations. nevertheless the median value is 19.8% which means that the majority of companies face the rate which is lower than the effective tax rate. this fact can be explained by the presence of losses offset against profits of the current fiscal period and income taxable at a rate lower than 24% (for instance, dividends and capital investments income). the bankruptcy probability mean value for the given sample is approximately 20%. at the same time for the companies under consideration this variable can be both equal zero and as well as be 30%. the sales natural logarithms changes are 22% on the average; the median value is 14.8%. this fact characterizes the positive dynamics of the russian economy development. particularly, some companies reached sixteen-fold sales growth. the fixed assets dynamics of the analyzed companies is negligible. the fixed assets value was increased by 5% on the average. at the same time the median value equals 2%, it means that half of the companies faced the growth lower than 2%. the intangible fixed assets value of the analyzed companies remained practically unchanged. the mean and median values are less than 0.01% of the total assets value, wherein changes in intangible assets range from (0.228) to 0.274. the total intangible assets change of the entire sample is negligible. the next point to discuss is the data characterizing the debt change for a period. the mean value is 33.7%, though the median value is lower (which is 13.9%), this can be explained by the fact that the sample contains only a small number of the companies with a significant debt change. in this case the median value is regarded as more demonstrative, i.e. the majority of companies of the sample faced the long-term debt increase at the rate of 10-15%. the table 2 demonstrate pair correlations of the explanatory variables. the check of the variables for pair correlations identified three significant dependences (more than 0.1). for illustrative purposes the table 2 below shows the pair correlations: 1) positive dependence between the sales and fixed assets levels, which is quite obvious, since both indicators to some extent characterize the size of the company. a significant increase in the number of the equipment, tools, machines, etc. reasonably presumes the increase in revenues due to the growth of the company’s activities scale. 2) positive dependence between the fixed assets change and the bankruptcy probability, which is probably caused by the principle of deriving the zprob variable, where the numerator is the total assets value. 3) negative dependence between the sales change and the bankruptcy probability, which also might be caused by the zprob calculation procedure, since the denominator of the bankruptcy probability formula includes the level of sales. 3.2. analysis of results the table 3 repots the estimation results. as is evident from the data obtained, the regression in the model 1 is significant (the f value below any reasonable level of significance). in addition, our assumption of a low but significant level of adjusted r2 proved to be correct, it is 0,049, slightly lower than that in the study of graham. thus, the presented study factors explain the behavior of russian firms in the financial policy slightly less than 5%. asian journal of economics and empirical research, 2015, 2(1):39-46 45 this result answers expectations, since, in fact, the decision to raise the debt is defined by an infinite number of factors, and all of them can't be taken into account at once. the significance of the regression suggests that the factors represented in the model really have an impact on the level of debt. an exception is the rate of change in intangible assets. his p-value of 0,85, which means that the variable has no effect on the debt. a similar result can be explained by the absence of significant changes in intangible assets in the companies under review, and, consequently, by a small growth potential for new patents/inventions. the insignificant factor was excluded from the model as ''excessive", and the regression was rebuilt. the new model 2 looks as follows: [6] without intangible assets the adjusted r2 increased to 0,05, i.e., the explanatory power of the regression increased, which once again confirms that intangible assets have no effect on the unknown variable. at the same time, this change almost doesn’t affect other indicators. to find the impact of the tax factor, represented by the effective tax rate, a regression of dependence of changes in debt from all other non-tax factors. for this purpose, we used the following model 3: [7] in this case, the adjusted r2 has dropped by more than 2 times (to 0,024). consequently, the inclusion of effective tax rate increased the explanatory power of the regression by 108%. this indicator is significantly different from the one in the model of graham, where tax factors increased the power of the regression by approximately 15%. detailed regression results are represented as the table 3 model 3. thus, although the chosen model 3 has a lower explanatory power as a whole than the study of graham, among the used variables the tax factor has a much more impact on the level of debt. such an unexpected result may be associated with a more correct choice of variables that characterize the tax component. as stated before, the managers, when deciding on issue of debt, are more likely to draw on the effective tax rate, which is "on the surface", rather than on the marginal tax rate, the calculation of which may seem too difficult and time consuming for many. as for the marks before the variables, the coefficient before the tax rate is positive, as expected. the higher it is, the greater the benefits the company will receive from debt as a source of financing (due to the possibility of deducting the cost of debt servicing). this conclusion doesn't come under strong criticism from the economic community because of its obviousness and transparency. thus, the 1st hypothesis is not rejected. the coefficient of the probability of bankruptcy is negative, which is also reasonable. the higher the probability is that the firm can no longer be liable, the less of additional risks it will take, and, therefore, the less it will use debt. this conclusion also conforms to the results obtained by graham. the 2nd hypothesis is not rejected. the change in sales, contrary to our predictions, affects negatively the dynamics of debt, and this factor is significant. the initial reasoning drew on the fact that high sales is descriptive of the company's size, and that, by virtue of its scale and diversification, it may raise debt with favorable conditions, without colliding with the high costs of financial uncertainty. perhaps the initial reasoning was not entirely correct, because the factor of changes in sales is not as revealing, as the absolute value of revenues. theoretically, small companies can raise large loans, and large companies not resort to debt in general, so in this case, the logic is wrong. a possible explanation for the negative dependence between changes in sales and raising debt may be the fact that the higher the sales of the firm are, the larger are retained earnings, and hence the probability of funding for the company's own funds. so the 3rd hypothesis is rejected. the next factor to consider, the change in intangible assets, is insignificant, as detailed earlier, so it was excluded from the regression, which increased its explanatory power. the reason is probably the fact that small changes in patents/licenses do not provide sufficient additional growth potential to say that raising debt is profitable. the 4th hypothesis is rejected. the coefficient before the last factor, showing the change in fixed assets, has a predictable positive sign. our estimate about the influence of powerful software on creating favorable conditions to raise the debt proves to be true. slight contradiction arises due to high correlation between the property assets and sales, as it turned out, both factors have the opposite effect on the dynamics of raising debt. however, given such a low importance of the coefficient (the p-value is 0,1), these discrepancies are not necessary to be taken into account, because in the case of a higher level of importance, this factor would be excluded from the model. the 5th hypothesis shouldn't be rejected. so, the present model is a good analogue to the one presented by graham. it has nearly the same explanatory power, but the effect of the tax factor in our model is much higher. the inclusion of the effective tax rate increased the explanatory power more than 2-fold, which significantly exceeds the same result of graham, with his 15%. it can be concluded that the study was successful. it prove that taxes really affect a company's debt policy, giving the comparison of the tax factor with other factors, and confirming a higher relative impact of taxes compared to the similar study in the west. 4. conclusions the main part of this work includes the study based on the model of graham, but with a slightly different set of factors. in particular, the marginal tax rate was replaced by the effective interest rate, which is supposed to be more convenient for financial managers. in addition, the model includes the probability of bankruptcy, change in fixed assets, changes in intangible assets, and changes in sales. the results showed that including the effective tax rate is appropriate, because this factor plays a significant role, and in terms of its contribution to the explanatory power of the regression it is comparable with all other factors combined. at the same time, the impact of changes in intangible assets has proven to be insignificant, which is most probably related to changes being too insignificant to cause growth potential and increase levels of debt. the overall results of the study were positive, almost all the coefficients were significant, most of the hypotheses were confirmed, namely, the hypothesis about the influence of probability of bankruptcy, fixed assets and the effective tax rate. hypotheses about the impact of changes in sales and intangible assets have been rejected, with the reasons for the inconformity explained. also, you should consider that in reality asian journal of economics and empirical research, 2015, 2(1):39-46 46 companies issuing debt are often guided by other motives, such as the ability to transfer profits to shareholders abroad with minimal losses. raising debt capital, in certain cases, is a more attractive way of financing than issuing securities, as it is possible to deduct the interest expenses from the tax base, which is not the case of dividends. many companies use debt issued by parent companies to transfer funds to a higher level of ownership structure at appropriate rate. tax authorities, considering such practice, bring in restrictive measures to avoid abuse of duty. among such measures there is the "thin capitalization" principle, limiting the deduction of interest on debts from affiliated persons. another way to struggle with such structures is setting limits on interest payments. in general, there are many factors affecting a company's financial policy, some of them measurable and verifiable, some not, however, it's not deniable that the taxes affect directly the choice of debt, and that the influence of the tax factor is probably underestimated by the economic community of nowadays. 5. acknowledgement this article is an output of a research project implemented as part of the basic research program at the national research university higher school of economics (hse) references altman, e., 1968. financial ratios, discriminant analysis, and the prediction of corporate bankruptcy. journal of finance, 23(4): 89-609. deangelo, h. and r.w. masulis, 1980. optimal capital structure under corporate and personal taxation. journal of financial economics, 8(1): 3-29. graham, j.r., 1996. debt and the marginal tax rate. journal of financial economics, 41: 41-74. graham, j.r., 2000. how big are the tax benefits of debt. journal of finance, 55(5): 1901-1941. mackie-mason, j., 1990. do taxes affect corporate financing decisions. journal of finance, 45(5): 1471-1493. miller, m.h., 1977. debt and taxes. journal of finance, 32(2): 261-275. modigliani, f. and m.h. miller, 1958. the cost of capital, corporate finance and the theory of investment. american economic review, 48(3): 261-297. modigliani, f. and m.h. miller, 1963. corporate income taxes and the cost of capital: a correction (in communications). american economic review, 53(3): 433-443. table-1. summary statistics lr debt efrate zprob delta sales delta fa delta intan mean 0.337 0.264 0.191 0.22 0.053 0 standard error 0.083 0.034 0.002 0.028 0.004 0 median 0.139 0.198 0.203 0.148 0.019 0 standard deviation 2.945 1.097 0.061 0.904 0.128 0.016 sample variance 8.675 1.204 0.004 0.816 0.016 0 minimum (35.4) (4.524) 0 (4.955) (0.657) (0.228) maximum 42.95 21.056 0.303 16.941 0.997 0.274 sum 426.062 276,899 200.772 230.546 55.872 0.426 count 1050 1050 1050 1050 1050 1050 table-2. pair correlations of the explanatory variables efrate zprob delta sales delta fa delta intan efrate 1 zprob (0.00832) 1 deltasales (0.01448) -0.1434 1 deltafa 0.013201 0.198914 0.303292 1 deltaintan (0.00494) 0.01987 (0.01562) 0.011384 1 table-3. regression analysis independent variables dependent variable: (debt) model 1 model 2 model 3 intercept 2.091** (1.96) 2.091** (1.94) 2.399845** (4.34) efrate 0.975** (6.71) 0.975** (6.58) zprob -14.207** (2.97) -14.216** (2.91) -14.507** (2.57) deltasale -0.951** (5.21) -0.951** (5.22) -0.979** (3.93) deltaintan -2.274 deltafa 2.679* (10.83) 2.676* (10.86) 2.874* (8.9) observations 1500 1500 1500 r 2 0.049 0.050 0.024 asterisks represent statistical significance at 1 percent (**), 10 percent (*) levels. views and opinions expressed in this article are the views and opinions of the authors, asian journal of economics and empirical research shall not be responsible or answerable for any loss, damage or liability etc. caused in relation to/arising out of the use of the content. asian journal of economics and empirical research issn(e) : 2409-2622 issn(p) : 2518-010x vol. 3, no. 2, 139-144, 2016 http://asianonlinejournals.com/index.php/ajeer 139 role of ekc and phh in determining environment quality and their relation to economic growth of a country ahmad zomorrodi1 xiaoyan zhou2 1 p.hd candidate, school of business, university of international business and economics (uibe), beijing, china 2 professor in management, school of business, university of international business and economics (uibe), beijing, china ( corresponding author) abstract globalization, liberalization of international trade and recent economic developments have resulted in widespread pollution and therefore degrading environment quality in many countries over the world. this study tries to examine the role of environmental kuznets curve (ekc) and pollution haven hypothesis (phh) in shaping the relationship between environmental quality and the economic growth of a country. to this end, a comparative overview of developing and developed countries across the world have been evaluated for their economic growth and the resultant impact on environmental quality, and their use of ekc and phh to determine it. descriptive analysis is used in the estimation. results have shown that no clear conclusion can be determined as the role of ekc and phh varies across economies, however both the theories are evident more in case of developing countries. the environmental quality depends on whether the country is developed or developing along with the imposition of stringent regulations as well as the propensity to act on the regulations effectively. keywords: ekc, phh, economic growth, environmental quality. jel classification: f21, q53, b23, c87. contents 1. introduction ....................................................................................................................................................................... 140 2. literature review .............................................................................................................................................................. 140 3. discussion ........................................................................................................................................................................... 141 4. conclusion .......................................................................................................................................................................... 143 references .............................................................................................................................................................................. 143 citation | ahmad zomorrodi; xiaoyan zhou (2016). role of ekc and phh in determining environment quality and their relation to economic growth of a country. asian journal of economics and empirical research, 3(2): 139-144. doi: 10.20448/journal.501/2016.3.2/501.2.139.144 issn(e) : 2409-2622 issn(p) : 2518-010x licensed: contribution/acknowledgement: this work is licensed under a creative commons attribution 3.0 license all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. history: received: 31 october 2016/ revised: 8 november 2016/ accepted: 14 november 2016/ published: 19 november 2016 ethical: this study follows all ethical practices during writing. publisher: asian online journal publishing group http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.2/501.2.139.144 https://orcid.org/orcid-search/quick-search?searchquery=ahmad zomorrodi https://orcid.org/orcid-search/quick-search?searchquery=xiaoyan zhou http://search.crossref.org/?q=10.20448/journal.501/2016.3.2/501.2.139.144 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.2/501.2.139.144 https://orcid.org/orcid-search/quick-search?searchquery=ahmad zomorrodi https://orcid.org/orcid-search/quick-search?searchquery=xiaoyan zhou http://search.crossref.org/?q=10.20448/journal.501/2016.3.2/501.2.139.144 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.2/501.2.139.144 https://orcid.org/orcid-search/quick-search?searchquery=ahmad zomorrodi https://orcid.org/orcid-search/quick-search?searchquery=xiaoyan zhou http://search.crossref.org/?q=10.20448/journal.501/2016.3.2/501.2.139.144 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.2/501.2.139.144 https://orcid.org/orcid-search/quick-search?searchquery=ahmad zomorrodi https://orcid.org/orcid-search/quick-search?searchquery=xiaoyan zhou http://search.crossref.org/?q=10.20448/journal.501/2016.3.2/501.2.139.144 asian journal of economics and empirical research, 2016, 3(2): 139-144 140 1. introduction an inverted u-shaped relationship between environmental quality and per capita income, commonly known as environmental kuznets curve (ekc) and pollution haven hypothesis (phh) have gained much attention in the past due to its crucial role in determining environmental quality (dietzenbacher and mukhopadhyay, 2007; antonio, 2013). the quality of the environment initially worsens with the economic development or growth and increases at the later stage due to increase in income levels and firms tend to use more environment friendly technologies. however, evidences have shown that inverted u-shaped phenomenon is not true when applied universally and nshaped and constantly increasing ekc scenarios also prevailed (dinda, 2004). the developing economies lack proper environmental regulations which attract huge foreign investments in setting up of polluting industries. as a result, the developed countries may rely on developing countries to supply them pollution intensive goods. the growth of international trade lead to increase in pollution as the country ultimately leading to the occurrence of pollution haven hypothesis (antonio, 2013). so, in case phh holds true, then ekc implies a shift of pollution from developed to developing economies rather than reducing the overall pollution level (cole, 2004). such trade patterns are generated by phh while ekc explains the reason of reduction in pollution in high income economies. with the advent of liberalization, privatization and globalization (lpg), most countries of the world have witnessed an overall economic growth but this growth comes at a cost i.e. increased pollution deteriorating environmental quality. according to the report published by world health organization (2016) people living in lowincome cities are more prone to rising pollution and more than 80% of the people in urban areas are exposed to air quality that exceeds the who limit. during 2008-2013, overall global urban emissions increased by 8%, mostly affecting developing economies. the american economy has shown a different scenario where air quality has improved with the growth in the economy reducing the concentration level of major air pollutions. with the increase in income levels, people are increasingly concerned about the environmental issues, thus improving the air quality of a handful of countries like the usa (environmental protection agency (epa), 2016). developing economies lack proper environment protection rules and regulations which result in huge pollution levels. unregulated industries and rapid industrialization has increased the exploitation of natural resources. for example, india has to bear $80 billion a year pollution and environmental degradation cost attributed to contaminated water and hazardous air quality (ndtv, 2013). so, industrial growth is resulting in environmental quality degradation. the contribution of this study lies in studying the role of environmental kuznets curve and pollution haven hypothesis (phh) by empirically analyzing the contributions made by various researches till date. the research also tries to establish the link between the economic growth and quality by citing examples of various nations, developing and developed. 1.1. aims and objective of the study the aim of the study is to identify the role of environmental kuznets curve (ekc) and pollution haven hypothesis (phh) in determining environment quality and their relation to investment or economic growth of a country. to this end, countries under „developing‟ and „developed‟ categories have been considered with various „growth‟ parameters such as gdp (gross domestic product), fdi (foreign direct investment), per capita income, etc. 2. literature review 2.1. pollution haven hypothesis the pollution haven hypothesis was first proposed and identified by copeland and tylor in 1994 and argued that with increase in the trade liberalization the pollutant industries will move to the poor countries which have less regulated environment policy from the rich countries. according to the pollution haven hypothesis the inflow of the foreign direct investment will increase in those countries where the rules and regulation related to environmental are more liberal. eskeland and harrison (2003) defines pollution haven hypothesis as : “ pollution haven hypothesis is, perhaps, best seen as a corollary to the theory of comparative advantage, as pollution control costs begins to matter for some industries in some countries , other countries should gain comparatively advantages in those industries , if pollution control costs are lower there ( for whatever reason)” (eskeland and harrison, 2003). according to the study of aliyu (2005) the pollution haven hypothesis has three main dimensions. relocation of the pollution industries to the developing countries from the developed countries is the first one and the increasing in the globalization has help to move the polluting industries to the poor countries. the second dimension of the pollution haven hypothesis is related to the dumping of the hazardous and perilous products generated during the production process in the poorer countries. the last dimension is related the exploitation of the nonrenewal resources from the developing countries which can have impact on the sustainable development agenda of the developed countries 2.2. environmental kuznets curve in recent years, the environmental kuznets curve (ekc) hypothesis has received much attention and consideration in the environmental economics literature. the literature in 1995 builds on the seminal article by kuznets in which he derived a hump-shaped relationship between per capita income and pollution in 1965. the hypothesis of the environmental kuznets curve contends that as an economy develops, environmental problems will get more serious initially, but will decline eventually. it has been observed that for high incomes the relationship between pollution and income is positive again, or maybe even that the environmental kuznets curve is u-shaped. one underlying idea is the following. environmental deterioration can be split and divided into two parts: pollution and the reduction of natural resources (land, forest, grass and mineral resources). the u-curve reflects the fact that environmental degradation in underdeveloped asian journal of economics and empirical research, 2016, 3(2): 139-144 141 countries is related to population pressure, extensive production modes, and the overexploitation and overusing of natural resources. similarly arguments have been put forward that, as people become wealthier, they tend to push for stricter environmental policies, this may give rise to a relationship between per capita income and emissions along the effects of per capita income on, for example, taxes on pollution or environmental standards. third, one has to consider the structural effect. a typical time path of the sectorial composition of an economy is one in which countries are initially characterized by a large agricultural sector, followed by a period of industrialization and subsequently followed by de-industrialization and a rising service sector 3. discussion cole (2004) examined the linkages between trade, ekc and phh. according to the researcher, pollution havens are limited and are confined to certain sectors and regions. trade openness has negatively impacted the air quality because of the ease in getting “greener” production technologies. similarly research conducted by poon et al. (2006) examines the relationship between china‟s economic development and its environment by modeling the effects of energy, transport, and trade on local air pollution emissions using the environmental kuznets model. the findings showed that soot levels have not declined with increase in income because of lack of government policies whereas so2 levels have decreased due to adoption of cleaner technologies and stringent regulations on polluting industries. kubatko (2008) studied the impact of per capita income on the pollution levels using the ekc model in ukraine. the dependent variables considered in the study were concentration of pollution and emissions and per capita income, atmospheric precipitation, wind speed, average temperatures and % of precipitations as the independent variables. the author applied model of ekc using pooled data. he concluded an inverted u-shaped relationship between pollution and income, suggesting that ukraine follows the ekc for certain pollutants only. there is an increase in pollution levels of dust and carbon dioxide in ukraine. jula (2015) studied the impact of long term impact of economic growth (using gdp) on co2 emissions of romania during the period 1960-2010 and did not use any other variables and used the ng-perron test with optimal point. they found a significant relationship between the two variables in the form of an n-shaped curve, supporting the ekc theory for romania. he et al. (2009) investigated the applicability of the ekc theory for studying the impact of economic growth (using gdp as indicator) on co2 emissions of canada. they studied the co2 emissions and gdp data of canada for the period 1948-2004 using time series method. cubic parametric model of ekc was applied to this effect, and the results showed limited presence of the inverted u-shaped curve between gdp and co2, following which they applied more flexible methods such as hamilton‟s model. this test too showed similar results, i.e. no presence of kuznets curve. rashid (2009) tested the relationship between co2 emissions and gdp growth in usa and the bric nations for the period 1981-2006. while the author finds mixed but probable evidence of the existence of a kuznets curve in usa, the evidence was strong in case of bric. however he also found a contradicting result in the analysis, i.e. the threshold for improvement in air quality was higher in case of the usa as compared to bric. the author also found evident presence of phh in case of bric countries where investment was increasing rapidly since they are developing countries, thus enjoying the benefits of cheaper labor. recent study by apergis and ozturk (2015) test the environmental kuznets curve over a period 1990-2011 for 14 asian economies. another study by al-mulali (2015) examined the ekc hypothesis for ninety-three countries using ecological footprints as an indicator of environmental degradation. the findings of both the research show that ekc model is not true for low and middle income countries as they are in the initial stage of development and is relevant only for high-income economies. in the table below, a brief overview of recent studies conducted on the applicability of the kuznets curve in various countries and regions in provided. the findings of each of the studies indicate that while the curve is definitely present in case of developing countries, especially those which are becoming a global hub for production such as mexico, india, china and brazil, the curve is not so evident in developed economies such as usa and canada. as it can be seen in the table above, most studies have confirmed the validity of ekc in their respective study regions. only in case of he et al. (2009)‟s study, the ekc was not evident in canada. on the other hand, the pollution haven hypothesis (phh) too has been studied extensively by many researchers, in some cases together with ekc. as mentioned before, the phh postulates that so called „dirty goods‟ will be moved to poor countries for manufacturing purpose, because of the lack of environmental regulations in these countries, whereas the „clean goods‟ will remain in developed countries. therefore most studies on phh take into consideration only developing countries from asia africa and south america. pollution haven hypothesis has also comes under criticism because of lacking credible and use of traditional instrumental variables (taylor, 2005; millimet and roy, 2011). doytch and uctum (2011) examine the impact of globalization and sectorial foreign direct investment (fdi) on the environment conducting a multi country analysis from 1970 – 2000. the main findings and results of the study were that the inflow of fdi in manufacturing sector shows the evidence for the pollution haven hypothesis while the inflow of fdi in service sector supports the halo effect hypothesis. similarly the inflow of fdi in the poor countries shows more harmful effect on the environment as compared to rich countries. dietzenbacher and mukhopadhyay (2007) conducted empirical analysis of pollution haven hypothesis for india taking into account heckscher-ohlin theory. the findings of the research showed that india is no longer a pollution haven and has gained from international trade. according to ho theory, it will be in the interest of capital abundant country to produce pollution intensive goods. since indian economy is labor abundant, the pollution haven hypothesis did not apply. asian journal of economics and empirical research, 2016, 3(2): 139-144 142 table-1. recent studies conducted on kuznets curve theory author name and year country/ region emissions or concentrations aim and methodology variables time period findings taguchi (2012) east and south-east asian economies (19 countries) emissions gdp (independent); carbon and sulphur (dependent) 1950-2009 definitive presence of kuznets curve regarding sulphur emissions sayed and sek (2013) 40 countries (developed and developing) emissions to detect the existence of ekc using 5 pollutants (co2, sulphur, ghg, spm10 and bod) by applying panel data analysis; using hausman test and redundant tests gdp (independent); co2, sulphur, ghg, spm10 and bod (dependent) 1961 2009 presence of ekc in developed countries for co2 and bod; while it is so2 in case of developing figueroa and pastén (2009) 73 high and low income countries emissions to estimate ekc to analyze the relationship between income and pollution. random coefficient model was used to test ekc hypothesis for each country pollution (dependent) and income (independent) 1960-1990 ekc hypothesis is strongly present in case of high-income countries. lipford and yandle (2014) mexico emissions examining the effect of economic growth on mexico‟s environmental quality for preand postnafta period co2 (dependent); rgdp per capital (independent) 1950-2004 kuznets curve is present in pre and post-nafta period, but the emissions are growing at a slower pace after nafta sunday (2015) sub-saharan african region emissions the paper examines the presence of ekc for ssar using panel data analysis. gdp (independent); co2, clq, csf, cin (independent variables) 1980-2012 different pollutants produce different ekc results. bibi (2014) pakistan emissions to find out the presence of ekc in pakistan using ardl model gdp (independent); co2 per capita (dependent) 1972-2011 the ekc is valid in case of pakistan with tipping point of ekc at 338.34 lim (1997) south korea emissions to explore the presence of ekc in south korea gdp (independent); so2, no2, tsp, bod (dependent) 1960-1995 inverted u-shape curve, i.e. ekc. while co2 emission and deforestation have worsened, sp2, o2, tsp and bod have improved with economic growth ivanova and vertkina (2015) russia emissions to assess the impact of economic growth on environmental degradation and to check the validity of ekc in russia using ols estimates. average monthly wages (independent); air pollution (dependent) 2011 ekc is present in case of russia given below is a table on various authors who have empirically studied the phh in the context of developing and developed economies throughout the world to determine if the hypothesis is applicable or not. thus, it can be seen from the above table that all the studies validate the presence of phh in case of developing countries. however, contrary to studies reviewed in the literature, phh is also evident in case of semi-developed countries in europe, establishing the fact that any country with growing manufacturing activities is likely to witness a rise in dirty emissions. asian journal of economics and empirical research, 2016, 3(2): 139-144 143 table-2. recent studies conducted on pollution heaven hypothesis author name and year country/ region aim and methodology variables time period findings kheder and zugravu (2008) central & eastern europe; emerging and developed countries in oecd to study the presence of phh comparatively in developed & developing economies in europe tfp, corruption, political stability, market potential (dependent variables); air pollution (independent variable) 1996-2002 phh is present in the strongest manner in emerging countries. fdi inflow in emerging countries is more due laxity rather than severity of regulations. aliyu (2005) 14 developing countries to detect the impact of environmental policy on location of production for the outflow of fdi into “dirty goods”. environmental tax (independent) carbon emissions (dependent) 1990-2000 fdi is responsible for the growth in pollution levels i.e. co2 emissions in a number of developing countries, validating the presence of phh. mukhopadhyay (2006) thailand to test the validity of phh and factor endowment hypothesis (feh) in the case of thailand. carbon emissions (dependent); consumption, trade with oecd, import-export price indexes, exchange rate, labor and capital stock, fdi (independent) 1980, 1990 and 2000 phh matters for thailand but feh does not with fdi being one of the major contributors to this occurrence. wu (2013) european union to examine the presence of phh in european union caused by the eu trading scheme using cross section and cross-time bilateral trade flow data co2 (dependent); import-export (independent) 2000-2011 phh is present in case of middle and upper middle income counties. akbostanci et al. (2004) turkey to validate the presence of phh in case of turkey using panel data approach. total manufacturing activity (independent); industrial waste output dependent 1994-1997 the demand for turkish products too increased, validating the presence of phh in turkey 4. conclusion in this study, the research has addressed the problem of the environmental kuznets curve and pollution haven hypothesis in determining the environmental quality. the empirical studies show that pollution haven holds true in case of developing economies due to transfer of pollution intensive industries from developed to developing countries. developing countries are becoming pollution havens because of imposition of less stringent regulations. however, these economies have lower standards because of high costs involved in imposing pollution standards. next, these economies lack trained personnel to impose such standards. corruption is deeply rooted in such economies which again possess the problem. finally, the pollution intensity increases due to the shift from agricultural to manufacturing sector on account of rapid urbanization and population growth. environmental kuznets model when applied globally show evidences that only high-income countries have benefitted from increase in economic standards resulting in better environment standards. other middle and low income economies are still in the clutches of poor air quality affecting the lives of millions of people. the research finds that many developing economies like china, india and brazil do not follow the principles of environment kuznets curve hypothesis (ekc) and have become a pollution haven due to its high carbon dioxide emissions. india has moved away from being pollution haven because of the comparative advantage in the production of labor intensive goods. the economy of united states has been benefitted with the rise in per capita income. with the growth in technology and standard of living, people become more focused on environmental problems which helped u.s. in achieving better environmental quality along with economic growth. the turkish economy is also benefitted from rising income levels and its environmental quality has improved in recent past. to conclude, the validity of ekc hypothesis increases with increase in income levels, as seen in case of high income economies. low income economies are still not able to adopt cleaner technologies and renewable resources because of huge costs involved in such applications. references akbostanci, e., g.i. tunç and s. türüt-asik, 2004. pollution haven hypothesis and the role of dirty industries in turkey‟s exports. ankara: erc economic research center, middle east technical university. asian journal of economics and empirical research, 2016, 3(2): 139-144 144 al-mulali, u., 2015. investigating the environmental kuznets curve (ekc) hypothesis by utilizing the ecological footprint as an indicator of environmental degradation. ecological indicators, 48: 315–323. aliyu, m.a., 2005. foreign direct investment and the environment: pollution haven hypothesis revisited. eight annual conference on global economic. pp: 1-35. antonio, l., 2013. pollution haven hypothesis in emissions embodied in world trade: the relevance of global value chains. the wealth of nations in a globalizing world. retrieved from http://congresse2kw.uclm.es/files/2013/12/eee-o5.pdf [accessed september 1, 2016]. apergis, n. and i. ozturk, 2015. testing environmental kuznets curve hypothesis in asian countries. ecological indicators, 52: 16–22. bibi, m., 2014. a new economic dimension to the environmental kuznets curve: estimation of environmental efficiency in case of pakistan shahid ali asian economic and financial review. asian economic and financial review, 4(41): 68–7968. cole, m.a., 2004. trade, the pollution haven hypothesis and the environmental kuznets curve: examining the linkages. ecological econemics, 48(1): 71–81. dietzenbacher, e. and k. mukhopadhyay, 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curves: a random coefficient approach applied to high-income countries. estudios de economía. estudios de economía, 36(1): 5–32. he, j., p. richard and g. edi, 2009. environmental kuznets curve for co 2 in canada. cahiers de recherche, 69(5): 1083-1093. ivanova, v. and d. vertkina, 2015. environmental kuznets curve: russian cities‟ case. proposal for the international academic conference on econemic and social development. jula, d., 2015. environmental kuznets curve. evidence from romania. theoretical and applied economics, 22(1602): 85–96. kheder, b.s. and n. zugravu, 2008. the pollution haven hypothesis: a geographic economy model in a comparative study. paris. available from https://halshs.archives-ouvertes.fr/halshs-00344845 [accessed october 28, 2016]. kubatko, o., 2008. the environmental kuznets curve: evidence from ukraine(master thesis). kyiv school of economics. retrieved from http://www.kse.org.ua/uploads/file/library/2008/kubatko.pdf [accessed october 02, 2016]. lim, j., 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geography and economics, 47(10): 1–17. rashid, s., 2009. the environmental kuznets curve case for the usa and the bric countries. georgia institute of technology(master thesis). retrieved from https://smartech.gatech.edu/bitstream/handle/1853/31819/rashid_shehryar_200912_mast.pdf. sayed, a.r.m.a. and s.k. sek, 2013. environmental kuznets curve: evidences from developed and developing economies. applied mathematical sciences, 7(22): 1081-1092. sunday, j., 2015. environmental kuznets curve hypothesis in sub-saharan african countries-evidence from panel data analysis. international journal of environment and pollution research, 3(20): 20–33. taguchi, h., 2012. the environmental kuznets curve in asia: the case of sulphur and carbon emissions. is climate change hindering economic growth of asian economies? taylor, m.s., 2005. unbundling the pollution haven hypothesis. calgary. world health organization, 2016. who | air pollution levels rising in many of the world‟s poorest cities. retrieved from http://www.who.int/mediacentre/news/releases/2016/air-pollution-rising/en/ [accessed september 15, 2016]. wu, m., 2013. testing the pollution haven hypothesis: evidence from european union emissions trading scheme. georgia institute of technology. retrieved from http://www.freit.org/workingpapers/papers/tradepolicyregional/freit614.pdf [accessed august 11, 2016]. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. http://congresse2kw.uclm.es/files/2013/12/eee-o5.pdf http://freit.org/workingpapers/papers/foreigninvestment/freit440.pdf http://www.epa.gov/air-trends http://www.kse.org.ua/uploads/file/library/2008/kubatko.pdf http://wwwdocs.fce.unsw.edu.au/economics/research/workingpapers/1998_2.pdf http://www.ndtv.com/world-news/pollution-costs-india-80-billion-a-year-world-bank-528678 http://www.ndtv.com/world-news/pollution-costs-india-80-billion-a-year-world-bank-528678 http://www.who.int/mediacentre/news/releases/2016/air-pollution-rising/en/ http://www.freit.org/workingpapers/papers/tradepolicyregional/freit614.pdf 121 asian journal of economics and empirical research vol. 5, no. 2, 121-138, 2018 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2018.52.121.138 an analysis of the behaviour of prime lending rates in sri lanka w. s. navin perera1 1senior economist, modelling and forecasting division, economic research department, central bank of sri lanka abstract the prime lending rate is the rate at which commercial banks loan funds to their most creditworthy customers, and hence, is usually lower than other market lending rates; reason why it is considered a “base or reference rate”. in sri lanka, the central bank of sri lanka (cbsl) has been compiling the average weighted prime lending rate (awpr) since january 1986. this paper examines the determinants of prime lending rates in sri lanka using weekly data from january 2004 to june 2013, while attempting to capture any asymmetries in prime rate changes to monetary policy decisions. empirical evidence suggests that the prime rate is highly persistent, while the call money rate also remains a key determinant. however, domestic liquidity was statistically insignificant and even if it was, it has only a marginal impact in determining the prime lending rate. furthermore, there is also evidence of asymmetric adjustment in awpr. keywords: prime lending rate, awpr, asymmetries, persistence, sri lanka. jel classification: e43; e52. citation | w. s. navin perera (2018). an analysis of the behaviour of prime lending rates in sri lanka. asian journal of economics and empirical research, 5(2): 121-138. history: received: 9 july 2018 revised: 22 august 2018 accepted: 7 september 2018 published: 14 september 2018 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: the author wishes to thank dr c amarasekara for the valuable feedback and unstinted support extended towards making this study a success. the author also wishes to thank mrs s gunaratne, mr c p a karunatilaka and dr r a a perera for their valuable comments, and mrs k m pathirage for editorial assistance. the author wishes to state that this study was completed in june 2014 and the views expressed in this paper are the author‟s own and do not necessarily reflect those of the central bank of sri lanka. any errors and omissions are however the author‟s. funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 122 2. literature review .......................................................................................................................................................................... 124 3. data and statistical/econometric tools used........................................................................................................................ 125 4. analysis and findings ................................................................................................................................................................... 125 5. conclusion and policy implications ........................................................................................................................................... 135 references ............................................................................................................................................................................................ 136 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2018.52.121.138&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/252 https://orcid.org/0000-0002-0989-7665 http://asianonlinejournals.com/index.php/ajeer/article/view/252 https://orcid.org/0000-0002-0989-7665 http://asianonlinejournals.com/index.php/ajeer/article/view/252 https://orcid.org/0000-0002-0989-7665 http://asianonlinejournals.com/index.php/ajeer/article/view/252 https://orcid.org/0000-0002-0989-7665 asian journal of economics and empirical research, 2018, 5(2): 121-138 122 1. introduction 1.1. the prime lending rate and its importance? financial intermediation, which involves transfer of funds from surplus units (i.e., savers or lenders) to deficit units (i.e., borrowers) of an economy, is traditionally, the primary activity of banking institutions worldwide. banks, or financial intermediaries for that matter, mobilise deposits and lend the same to customers who require, but short of funds. the loaning of funds will be at different rates of interest determined by those individual banks, which depends on various factors such as the type, size and creditworthiness of the customer, term and purpose of the loan, inter alia. the prime lending rate (herein referred to as the prime rate), as the name implies, is the rate of interest charged by banks from their most creditworthy and/or high net worth clients for short-term loans. since the likelihood of prime customers defaulting on loans are minimal, the rate of interest charged by banks on prime lending would be relatively lower compared to that charged from non-prime customers. due to this reason, the prime rate is usually considered to be a “base or reference rate” that banks use to price other types of loan products offered by them for both personal and commercial purposes. further, according to dueker and thornton (1994) business corporates use the prime rate as a benchmark to evaluate their own creditworthiness. 1.2. the prime lending rate in sri lanka: awpr 1.2.1. historical background the central bank of sri lanka (cbsl) has been publishing the average weighted prime lending rate (awpr) since 1986, based on the information collected by commercial banks on prime lending. this has been used as an indicator of the average lending rate charged by commercial banks from their most creditworthy customers, predominantly on short-term loans. since the commencement of compiling and publishing of awpr, it has served as a guiding indicator to the financial institutions as a benchmark lending rate as it offered a clear reflection of short-term money market interest rates. more importantly, awpr was used as a leading indicator interest rate by the cbsl to monitor the impact of monetary policy measures and the monetary policy transmission mechanism. 1.2.2. current practice and compilation methodology the banking system in sri lanka consists of the central bank of sri lanka (cbsl), which is the monetary authority and 33 other banks (by end june 2013), of which 24 are licensed commercial banks (lcbs) while the rest are licensed specialised banks (lsbs). both lcbs and lsbs cater to the public, which includes customers from individuals to large corporates. both these institutions have their prime as well as ordinary customers when it comes to lending and every individual bank determines the rate to be charged on loans from their prime customers, which is the prime rate of that particular bank. based on the information provided by all commercial banks on new lending (which are usually on a short-term basis) to their prime customers during the week, the cbsl compiles the awpr on a weekly basis, which is subsequently communicated to the public via their official website, along with bankwise awpr. the formula to calculate the awpr is as follows: w ∑ (m r)n i ∑ (m)n i (1) where, m mount of new loans r interest rate n o. of new loans the guidelines1 on reporting transactions for the compilation of awpr are as follows: i. interest rates applicable to the ten lowest cost borrowers in respect of overdrafts and other short-term advances, which have an original maturity of three months or less and which have been re-priced or disbursed during the week, along with the relevant outstanding amounts are to be reported. ii. only interest rates pertaining to domestic rupee operations with the private sector customers are to be reported. iii. credit to government corporations and departments are to be excluded. iv. dvances granted to prime customers, i.e., most creditworthy customers who are in the top tier of each bank‟s risk grading grid are to be reported and not the advances granted to prime sectors such as exports, agriculture, etc. v. subsidised lending including refinance loans are to be excluded. vi. advances that are fully secured by cash deposits or government securities are excluded. vii. call money-market transactions are excluded. viii. interest rates on unadvised credit lines and penal interest rates are excluded. ix. only transactions above rs. 10 million are to be reported. the significance of awpr in sri lanka has increased in the recent years as it has been increasingly used by almost all commercial banks as a base rate in place of other short-term market interest rates such as the 91-day treasury bill rate or the sri lanka interbank offered rate (slibor) when pricing their loans. thus, the prime rate is considered to be one of the most important interest rates in sri lanka, especially for large corporates, as changes in the prime could affect their cost of funds and ultimately the profitability of their business ventures. 1the guidelines are issued by the economic research department of cbsl. asian journal of economics and empirical research, 2018, 5(2): 121-138 123 figure-1. weekly awpr vs. weekly average liquidity source: cbsl figure-2. weekly awpr vs. weekly average of awcmr source: cbsl figure-3. awpr-awcmr spread vs. weekly average liquidity source: uthor‟s calculations, cbsl this paper aims to analyse the behaviour of the prime lending rate in sri lanka. to start with, this study is attempts to identify the key determinants of the prime lending rate and their statistical significance. moreover, corporates claim that prime lending rates of commercial banks respond slow to changes in monetary policy, especially during policy relaxation periods and insist that the prime lending rate of the current week, charged by commercial banks, is set based on the preceding week‟s w published by cbsl. in order to verify the above , econometric tests are conducted to test for asymmetric adjustments during different monetary policy cycles in the economy. further, the above experiments are extended to examine the existence of prime rate persistence, followed by an analysis of its implications on policy. in doing so, this paper is organised as follows. section 2 discusses literature on determinants of interest rates, particularly the prime lending rate, and asymmetries in prime rate changes and persistence. section 3 details data asian journal of economics and empirical research, 2018, 5(2): 121-138 124 and statistical/econometric tools used in this exercise, followed by section 4, which presents the model, findings and analysis. the final section, section 5, will present the conclusions of the study and policy implications. 2. literature review many researchers have observed that banks respond quickly to changes in the stance of monetary policy by way of increasing their loan rates much faster during tightening cycles than reducing when monetary policy is eased (diebold and sharpe, 1990; cover, 1992). however, this is barely true when deposit rates are concerned, as banks react faster by lowering deposit rates during relaxing cycles compared to policy tightening cycles, where the deposit rates are sluggishly raised (neumark and sharpe, 1992; hutchison, 1995). the same irregularity has been noticed by many analysts when it comes to changes in the prime lending rate (dueker and thornton, 1994; mester and saunders, 1995). such asymmetries slow the pass-through and neutralise the full effects of monetary policy. however, some analysts have found little or no evidence of such asymmetries (goldberg, 1982; laderman, 1990; tkacz, 2001; amarasekara, 2005). the downward stickiness of lending rates in general and the prime rate in particular as highlighted by most researchers is likely to be due to the following;  to maximise the bank‟s profitability by increasing the prime lending rates immediately or quickly after policy rates are raised.  delaying the reduction in the prime rates when policy rates are lowered in order to compensate for or recover the increased cost of funds accrued by mobilising deposits at high rates of interest.  banks would choose to delay lowering of rates or not lower rates at all if switching costs of customers are significantly high.  banks, in order to avoid problems of adverse selection, moral hazard and the increased credit risk of companies during cyclical downturns in the economy, end up charging a higher prime or delay reducing the prime, albeit the downward adjustment of policy rates by the monetary authority in order to revive economic activity. it is also noteworthy that the significance of the prime rate has diminished in some countries as pointed out by arak et al. (1983); dueker and thornton (1994) and dueker (2000) due to the increased amount of loans that have been made below the prime rate. arak et al. (1983) explaining the behaviour of the prime rate in the us during 1972 1983, highlighted that there was minimal or no asymmetry in the prime rate in relation to the market lending rates during the early 1970s. however, the degree of asymmetry increased during the late 1970s and early 1980s on account of the development of substitutes to domestic bank lending such as the growth of the commercial paper market and increased access to sources of funds abroad, thereby providing banks the opportunity to charge varied rates from both interest-sensitive and non-interest-sensitive borrowers. laderman (1990) using vector autoregression (var) to study the responsiveness of the prime rate to open market interest rates in the us, found out that that the prime rate‟s responsiveness to treasury bill rates, which was rather poor during 1964 – 1982, improved and became more closely linked in the subsequent period (1983 – 1990) due to increased competition from the commercial paper market and advancements in technology. mester and saunders (1995) found out that adjustments to the prime rate will occur only when the returns from the difference of the optimal prime rate and the current prime rate exceeds the costs of changing the prime. further, they observed that banks raise their prime rate dramatically when cost of funds increase, but delay reducing prime rates as cost of funds reduce so as to make short-term profits. dueker and thornton (1994) using an ordered probit model to measure asymmetry in the prime rate, identified that banks respond strongly and speedily to increases but sluggishly to decreases in the federal eserve‟s discount rate with the rationale for such downward stickiness being to make an allowance for or charging a risk premia by reducing lending rates slowly during cyclical downturns. in line with the above, dueker (2000) again in his paper on asymmetries in the prime rate, pointed out that contractionary monetary policy have greater effect than relaxed monetary policy in the us, but accentuated that if not for asymmetry, banks would lend fewer funds as asymmetry is perhaps the reaction of the market to odds of borrowers defaulting or making late payments during economic downturns. however, tkacz (2001) using a simple threshold model considering weekly data from the early 1970s till the late 1990s concluded that prime rate changes respond symmetrically to changes in the fed funds rate while the prime rate adjustment is more definite when the disparity among the prime and the fed funds rate movements broaden and is more. thompson (2006) applying threshold autoregressive (tar) and momentum threshold autoregressive (mtar) models found asymmetries in the us prime lending-deposit rate spread during the period of october 1979 to march 2003, which supports the theory that banks adjust their lending rates at snail's pace as the spread widens. whilst agreeing with most other researchers on the asymmetric adjustment of the prime rate to changes in the fed funds rate over the period from february 1987 to october 2005, payne and waters (2008) concluded that the prime rate was more upward rigid (i.e., the prime rate adjusted slower to a decrease in the fed funds rate) as opposed to being downward rigid as claimed by mester and saunders (1995); dueker and thornton (1994); dueker (2000) and thompson (2006). findings on the above in the sri lankan context would be appropriate to look into. however, there is very limited literature on the above area under discussion. amarasekara (2005) examined the interest rate pass-through from policy interest rates to call money rates and from that to retail interest rates of commercial banks over the period of june 1990 – december 2004, and found out that there is a fuller pass-through from policy rates to the call money market rate, while a complete and faster pass-through from call money rates to the prime lending rate could also be observed, unlike to other retail bank interest rates, showing no indication of an asymmetry in the passthrough. as stated above, prior empirical studies on the prime lending rate in sri lanka and asymmetries in adjustment of prime lending rates to changes in the monetary policy stance are very limited. further, there was no published asian journal of economics and empirical research, 2018, 5(2): 121-138 125 literature found on the subject of persistence of the prime rate in sri lanka. hence, this study, which attempts to discuss all of the abovementioned issues, is likely to set the platform along with few other research studies on the area of interest rates in sri lanka with a greater emphasis on the prime lending rate, its determinants, asymmetries, persistence and implications on policy. data and statistical/ econometric tools that would be used for this exercise to fulfill the achievements of this study would be discussed in the next section. 3. data and statistical/econometric tools used 3.1. description of data as specified before, the purpose of this study is to analyse the behaviour of prime lending rates in sri lanka, while emphasizing on its determinants, asymmetric behaviour in prime rate movements, persistence and its policy implications. following extensive analysis of prime lending rates in sri lanka, it has been noted that changes to the prime rate are likely to be caused by changes in the short-term money market interest rates triggered by changes in the monetary policy stance, i.e., changes in the policy interest rates as decided by the monetary board of the central bank. it has also been identified that changes in the levels of domestic money market liquidity also contribute to changes in short-term money market rates, which could, in effect, affect the prime lending rate. hence, for the purpose of this study, we use weekly awpr, and weekly averages of the average weighted call money rate (awcmr) and liquidity in the domestic money market from the period ranging from 01 january 2004 to 27 june 2013, which includes 496 observations. definitions of the awcmr and domestic money market liquidity are given below. a) average weighted call money rate (awcmr) – this is the weighted average of the rates at which banks transact with other banks in the interbank call money market. b) domestic money market liquidity – this refers to the excess or shortfall of funds in the domestic money market. this is measured as reserves held by commercial banks with the central bank in excess of the required reserve. data on awcmr and domestic money market liquidity are available on a daily basis. however, for the purpose of this study, weekly averages of both awcmr and domestic money market liquidity are used as data on awpr is available only on a weekly basis. these 3 variables are denoted as follows: i. wkawpr – weekly average weighted prime lending rate (in per cent) ii. wkavgawcmr – weekly average of average weighted call money rate (in per cent) iii. wkavgliq – weekly average liquidity in the domestic money market (in billion sri lanka rupees) to further aid our analysis, it was to be decided whether obtaining the first differences and/or the detrended series of the above variables would be vital to effectively support the range of econometric tests that was to be performed as part of this exercise. normally, interest rates are stationary but in the case of sri lanka, due to episodes of high inflation, interest rates tend to be non-stationary. detrending interest rates using the hodrickprescott filter (hp filter) allows the analysis to be done based on a gap approach where the trend component and the cyclical component are separated, facilitating a more effective analysis. therefore, it was decided to detrend wkawpr and wkavgawcmr using the hp filter, whereby cyclical and trend series of the above variables were obtained using a smoothing parameter of lambda (λ) 270,400, as those were weekly data. the cyclical or detrended series of wkawpr and wkavgawcmr is denoted as hpcycleawpr and hpcycleawcmr, respectively. also, a dummy variable was created to reflect the monetary policy stance adopted by the cbsl. dummyup is the dummy variable defined as 1 to indicate periods of monetary policy tightening or increase in policy interest rates. 3.2. description of statistical/ econometric tools used in order to identify the determinants of prime lending rates, asymmetries in prime rate changes and persistence, the following statistical methods and econometric tests were used: a) descriptive statistics, namely, mean, median, standard deviation, maximum and minimum of time series data to identify the properties of the dataset. b) augmented dickey-fuller (adf) test, a unit root test, was used to test for stationarity of the data prior to using these for econometric analysis so as to avoid any spurious or nonsensical regressions. c) correlation tests were carried out to identify any statistical relationships among the above variables d) granger causality tests introduced by clive granger were used to test causality between awpr, awcmr and liquidity to identify whether changes in awcmr and liquidity causes changes in awpr or vice versa. e) ordinary least square regressions were used to identify whether call money rates and domestic money market liquidity are key determinants of the prime lending rate in sri lanka. further, it also aids in testing persistence, which is a key objective of this study. f) a vector autoregression (var) model was drawn to test how a one-time shock to the independent variables, i.e., the call money market rate, domestic money market liquidity, and the lagged prime lending rate, could bring about a change in awpr in the current period. 4. analysis and findings 4.1. descriptive statistics prior to performing other complex econometric analyses, it will be useful to look into the descriptive statistics to better understand and explain the properties of the data variables that are used in this study. table 1 exhibits the descriptive statistics, including mean, median, maximum, minimum and standard deviation of these series. asian journal of economics and empirical research, 2018, 5(2): 121-138 126 table-1. descriptive statistics wkawpr wkavgawcmr wkavgliq sample period 01/01/2004 06/27/2013 observations 496 495 496 mean 13.0933 10.7941 16.3874 median 12.1850 9.6540 7.3516 maximum 21.1900 31.1650 140.0539 minimum 8.8900 7.4343 -21.1787 std. dev. 3.4509 3.2788 26.5432 source: uthor‟s calculations based on cbsl data descriptive statistics indicate that wkawpr, on average, has been 230 basis points higher than wkavgawcmr, although the maximum wkavgawcmr remained higher at 31.165 per cent in april 2007 particularly due to the increased demand for funds during the festive week and that too in a short week, while the surge in call rates were predominantly due to uncertainties in the financial market of sri lanka following the triggering of the global economic downturn in 2007. the maximum wkawpr was recorded at 21.19 per cent in late 2008. however, considering the mean and minimum interest rates, it appears that the spread between wkawpr and wkavgawcmr is larger when the mean rates are concerned, as opposed to the minimum rates presenting higher spreads when market interest rates are high in contrast to an era with low interest rates. the standard deviation of wkawpr is marginally higher than wkavgawcmr and denotes relatively low volatility in awcmr possibly due to the weekly averaging of awcmr, which is computed on a daily basis. wkavgliq has been in excess, on average, during this period and peaked to around rs. 140 billion with the receipt of international sovereign bond proceeds in late 2010. 4.2. testing for stationarity to verify the stationarity of the time series, the variables were subjected to the augmented dickey-fuller (adf) unit root test (dickey and fuller, 1979) to avoid any spurious regressions. the tests were performed using a maximum lag length of 4, from which the appropriate lag length was chosen automatically based on the schwarz information criteria (sic). as shown in table 2, the detrended variables (i.e. hpcycleawpr and hpcycleawcmr) were stationary on levels at 1 per cent significance level. wkavgliq was stationary on levels at 1 per cent level when the test equation included the constant, but when both the constant and the trend components were included in the test equation, wkavgliq was stationary only at the 10 per cent level. however, wkawpr and wkavgawcmr were not stationary on levels in both instances where the test equation included the constant in one and both the constant and the trend components in the other. subsequently, unit root tests were performed on first differences for wkawpr and wkavgawcmr, resulting in those variables being stationary at a very high level of significance. since the series of hpcycleawpr, hpcycleawcmr and wkavgliq was i(0) and the series of wkawpr and wkavgawcmr were i(1), it was concluded that testing for co-integration between these variables was not necessary. the series of hpcycleawpr would be used as the series representing awpr, hpcycleawcmr would be used as the series representing awcmr and wkavgliq would be used as the series representing domestic money market liquidity. the detrended series of awpr and awcmr was used for this analysis as i(1) data (i.e., data that is stationary at first differences) leads to excessive volatility while also concealing the dynamics, nature and behaviour of the data, whereas such dynamics are preserved to a greater extent, relatively, in the detrended series of data (see figure 4 – 5) reason why it may be more appropriate for this exercise. figure-4. average weighted call money rate (awcmr) source: cbsl asian journal of economics and empirical research, 2018, 5(2): 121-138 127 figure-5. average weighted prime lending rate (awpr) source: cbsl table-2. adf unit root test results series level first difference lags included lags included constant constant & trend constant constant & trend wkawpr 1 -1.6826 -1.6276 0 -26.527* -26.5341* (0.4395) (0.7809) (0.0000) (0.0000) wkavgawcmr 4 -2.4239 -2.5241 3 -17.3682* -17.3708* (0.1357) (0.3163) (0.0000) (0.0000) wkavgliq 0 -3.1984* -3.4112*** 0 -23.3774* -23.3539* (0.0207) (0.0510) (0.0000) (0.0000) hpcycleawpr 1 -5.7453* -5.7359* 3 -14.6709* -14.6645* (0.0000) (0.0000) (0.0000) (0.0000) hpcycleawcmr 1 -9.1632* -9.1537* 3 -17.5429* -17.5254* (0.0000) (0.0000) (0.0000) (0.0000) note: mackinnon (1996) one-sided p-values are in parentheses below the t-statistic values test critical values: constant constant &trend 1% level (*) -3.4434 -3.9767 5% level (**) -2.8672 -3.4189 10% level (***) -2.5698 -3.1320 source: uthor‟s calculations based on cbsl data 4.3. testing for correlation hpcycleawpr, hpcycleawcmr and wkavgliq were used to test for cross-correlations. table-3. correlation matrix stationary variables hpcycleawpr hpcycleawcmr wkavgliq hpcycleawpr 1.0000 hpcycleawcmr 0.6431 1.0000 wkavgliq -0.2011 -0.1219 1.0000 source: uthor‟s calculations based on cbsl data as per findings following the test for cross-correlations as shown in table 3, it was observed that the call money rate (hpcycleawcmr) has a high degree of positive correlation with the prime lending rate (hpcycleawpr). however, liquidity in the domestic money market (wkavgliq) seems to have a relatively weak correlation with the prime lending rate as well as the call money market rate, although the nature of correlation is negative as it should be in theory. although statistically it appears that liquidity in the domestic money market has a weak correlation with the prime lending rate, it is theoretically and practically a fact that domestic money market liquidity is also an important determinant of market interest rates. the hodrick-prescott filter (hp filter) was used to obtain cyclical and trend series of domestic money market liquidity and scatter plots were drawn using the cyclical series of data on domestic money market liquidity and the prime lending rate (i.e. hpcycleawpr) to identify their relationships during monetary policy easing cycles as well as tightening cycles. figure 6 confirms that during policy easing cycles, the relationship between money market liquidity and the prime lending rate is overtly weak, although negatively correlated. however, during policy tightening cycles, as shown in figure 7, the relationship between these variables are relatively stronger indicating that money market asian journal of economics and empirical research, 2018, 5(2): 121-138 128 liquidity is a rather important determinant of the prime lending rate, among other factors, during periods of contractionary monetary policy compared to its effect on the prime during loose monetary policy episodes. figure-6. relationship between liquidity and awpr (in policy tightening cycles) source: uthor‟s calculations based on cbsl data figure-7. relationship between liquidity and awpr (in policy tightening cycles) source: uthor‟s calculations based on cbsl data 4.4. granger causality test results next, we test for causality to verify the existence of unidirectional or bidirectional causality among the aforementioned variables (i.e., between prime lending rate and the call money market rate, and between prime lending rate and domestic money market liquidity). for this, we have performed granger causality tests (granger, 1981) on 3 data samples. first, we have checked for causality by taking the entire sample of data from the period 01/01/2004 to 06/27/2013, which is shown in table 4. secondly, we have determined periods of upward and downward trends in the call money rates, and thereafter checked for causality among these variables (table 5). finally, upward and downward trends of domestic money market liquidity have been identified and these variables were then again tested for causality, which is shown in table 6. the hp filter was used to draw trend graphs in order to identify upward and downward periods of call money market rates and domestic money market liquidity, which were subsequently used for the second and third attempts to test for causality. the results are also presented for five chosen lag lengths, which are in weeks; 1, 2, 4, 12 and 26 lags. test results of table 4 indicates that changes to call money market rates leads to changes in the prime lending rate in lag lengths 2 through 26. it also indicates that the prime lending rate causes changes in the call money market rates at lag lengths 12 and 26, indicating bidirectional causality. further, increasing bidirectional causality could be observed when the lag lengths increase, indicating signs of cointegration between the two variables. however, causality between domestic money market liquidity and the prime lending rate is relatively weaker as indicated by table 4. as per the causality test findings in table 5 and table 6, when different periods of upward and downward trends of both call money market rates and domestic money market liquidity are considered, the position on causality cannot be commented on and therefore is inconclusive. data in table 5 suggests that changes in call money rates causes changes in prime lending rates in lag lengths 4 and 12, except in the second upward period (02/17/2011-10/18/2012) of call money market rates. the same causality is evident in the first upward and downward period in lag length 2, and in the two upward cycles in lag length 1. it also shows that changes in domestic money market liquidity causes changes in prime lending rates in both upward periods in lag length 1, 4 and 26 but no evidence of causality could be seen in the downward periods. in addition, data in table 6 shows asian journal of economics and empirical research, 2018, 5(2): 121-138 129 mixed results. however, changes in call money market rates (hpcycleawcmr) and domestic money market liquidity (wkavgliq) causes changes in prime lending rates (hpcycleawpr) when the entire sample is considered at a lag length of 2. bidirectional causality exists between the two variables hpcycleawpr and hpcycleawcmr when the lag length is 12 and 26, while the null hypothesis of wkavgliq does not cause hpcycleawpr, is rejected at the lag length of 2, implying that domestic money market liquidity causes changes in prime lending rates. on the whole, following those results from the causality tests, it can be deduced that both the call money market rate as well as domestic money market liquidity are key determinants of the prime lending rate in sri lanka. table-4. granger causality test: entire sample (01/01/2004 06/27/2013) null hypothesis p value of f-statistic 1 lag 2 lags 4 lags 12 lags 26 lags hpcycleawpr does not cause hpcycleawcmr 0.8505 0.3204 0.2904 0.0533 0.0071 hpcycleawcmr does not cause hpcycleawpr 0.3737 0.0565 0.0001 1.e-05 4.e-07 wkavgliq does not cause hpcycleawpr 0.1240 0.0390 0.1800 0.6957 0.8926 hpcycleawpr does not cause wkavgliq 0.0478 0.1248 0.3771 0.9096 0.9586 source: uthor‟s calculations based on cbsl data table-5. granger causality test: changes in awcmr sample null hypothesis p value of f-statistic 1 lag 2 lags 4 lags 12 lags 26 lags upward period: 01/01/200412/27/2007 hpcycleawpr does not cause hpcycleawcmr 0.4378 0.9422 0.2760 0.0348 0.0381 hpcycleawcmr does not cause hpcycleawpr 0.0771 0.0005 0.0082 0.0004 0.0005 wkavgliq does not cause hpcycleawpr 0.0743 0.0019 0.0013 0.0033 0.0015 hpcycleawpr does not cause wkavgliq 0.0001 0.0015 2.e-05 0.0001 0.0013 downward period: 01/03/200802/10/2011 hpcycleawpr does not cause hpcycleawcmr 0.1581 0.0428 0.0682 0.2457 0.0558 hpcycleawcmr does not cause hpcycleawpr 0.6591 2.e-05 0.0006 0.0199 3.e-06 wkavgliq does not cause hpcycleawpr 0.3654 0.3098 0.6869 0.9827 0.9914 hpcycleawpr does not cause wkavgliq 0.2002 0.1727 0.2899 0.7669 0.8936 upward period: 02/17/201110/18/2012 hpcycleawpr does not cause hpcycleawcmr 0.0022 0.0073 0.0250 0.0814 0.7070 hpcycleawcmr does not cause hpcycleawpr 0.0253 0.1636 0.5513 0.4656 0.8730 wkavgliq does not cause hpcycleawpr 0.0674 0.1638 0.0866 0.3450 0.0495 hpcycleawpr does not cause wkavgliq 0.3432 0.1675 0.3674 0.6656 0.0800 downward period: 10/25/201206/27/2013 hpcycleawpr does not cause hpcycleawcmr 0.3245 0.5533 0.7515 0.8764 na hpcycleawcmr does not cause hpcycleawpr 0.2172 0.2060 0.0488 0.0809 na wkavgliq does not cause hpcycleawpr 0.8297 0.6338 0.2922 0.1602 na hpcycleawpr does not cause wkavgliq 0.7750 0.1549 0.2717 0.3692 na source: uthor‟s calculations based on cbsl data 4.5. ordinary least square (ols) estimate of the model and findings to analyse the significance and influence of the call money market rate, domestic money market liquidity and lagged w in the determination of the current week‟s w , a series of ordinary least squares estimates were performed.2 up to 8 lags of all the above variables were tested but as per the regression results, only lags 1 and 4 of the prime rate proved to be statistically significant in determining the current week‟s w . the model proved to be less robust as the number of lags of hpcycleawpr was increased further. likewise, hpcycleawcmr and its first and fourth lags turned out to be statistically significant, although lags 2 and 3 proved otherwise, just as in the case of hpcycleawpr. also, lags of wkavgliq turned out to be statistically insignificant. further, to capture the effects of the prevailing monetary policy stance in the determination of the current week‟s w , the dummy variable of dummyup, which reflects the period of tight monetary policy in the economy or increase in policy interest rates by assuming a value of 1, was used, which was then interacted with hpcycleawcmr. hence, the multiple regression model for the determination of awpr is as follows: h c cle w t + ∑ h c cle wc t-i i +∑ h c cle w t-i i + w vgli t + (du u *h c cle wc t) + t (2) ordinary least square (ols) estimates of the above model (using robust standard errors) are shown in table 7. 2 alternate multiple regression models and their ols estimates are shown in appendix 1 asian journal of economics and empirical research, 2018, 5(2): 121-138 130 results of the above regression showed that the average weighted call money rate in the current week (i.e., hpcycleawcmrt) along with that of the preceding week, is an important determinant of the current week‟s average weighted prime lending rate (hpcycleawprt). its combined effect on the current week‟s w was about 20 per cent. however, domestic money market liquidity, thought to be a key determinant of interest rates, proved to be statistically insignificant as per the above model, with its impact on the prime lending rate was extremely weak at about 0.06 per cent, although the relationship is negative, as reflected in the estimated coefficient. the most remarkable finding was the existence of prime rate persistence, which is measured by the lagged prime rate coefficient. table-6. granger causality test: changes in liquidity sample null hypothesis p value of f-statistic 1 lag 2 lags 4 lags 12 lags 26 lags upward period: 01/01/200403/24/2005 hpcycleawpr does not cause hpcycleawcmr 0.9530 0.2932 0.7703 0.9859 na hpcycleawcmr does not cause hpcycleawpr 0.0044 0.0214 0.0092 0.2520 na wkavgliq does not cause hpcycleawpr 0.0017 0.0141 0.0365 0.0257 na hpcycleawpr does not cause wkavgliq 0.4801 0.4376 0.9879 0.9754 na downward period: 03/31/200511/23/2006 hpcycleawpr does not cause hpcycleawcmr 0.7434 0.9426 0.3139 0.2019 0.0965 hpcycleawcmr does not cause hpcycleawpr 4.e-07 2.e-07 1.e-06 2.e-05 0.0010 wkavgliq does not cause hpcycleawpr 0.5419 0.0301 0.0912 0.6471 0.6307 hpcycleawpr does not cause wkavgliq 0.0026 0.0031 0.0280 0.3069 0.0380 upward period: 11/30/200605/31/2007 hpcycleawpr does not cause hpcycleawcmr 0.9289 0.7750 0.1895 0.1417 na hpcycleawcmr does not cause hpcycleawpr 0.4304 0.1221 0.4168 0.4283 na wkavgliq does not cause hpcycleawpr 0.1425 0.0380 0.2522 0.5128 na hpcycleawpr does not cause wkavgliq 0.0163 0.0849 0.0167 0.5952 na downward period: 06/07/200710/02/2008 hpcycleawpr does not cause hpcycleawcmr 0.6474 0.3973 0.8978 0.2976 0.4019 hpcycleawcmr does not cause hpcycleawpr 0.0384 0.2846 0.5292 0.2385 0.2840 wkavgliq does not cause hpcycleawpr 0.0006 0.0055 0.0387 0.1012 0.4775 hpcycleawpr does not cause wkavgliq 0.1116 0.3142 0.2437 0.2241 0.4350 upward period: 10/09/200801/27/2011 hpcycleawpr does not cause hpcycleawcmr 0.1804 0.0601 0.2115 0.1676 0.0008 hpcycleawcmr does not cause hpcycleawpr 0.7250 0.0166 0.0656 0.0531 0.0013 wkavgliq does not cause hpcycleawpr 0.6306 0.5501 0.8408 0.7978 0.7102 hpcycleawpr does not cause wkavgliq 0.6654 0.7595 0.8545 0.8434 0.8027 downward period: 02/03/201111/22/2012 hpcycleawpr does not cause hpcycleawcmr 0.0026 0.0081 0.0292 0.0990 0.6027 hpcycleawcmr does not cause hpcycleawpr 0.0146 0.1368 0.5180 0.4883 0.8332 wkavgliq does not cause hpcycleawpr 0.0820 0.2533 0.1934 0.5073 0.1732 hpcycleawpr does not cause wkavgliq 0.3836 0.1586 0.3059 0.6698 0.2789 upward period: 11/29/201206/27/2013 hpcycleawpr does not cause hpcycleawcmr 0.1369 0.2922 0.4373 0.6860 na hpcycleawcmr does not cause hpcycleawpr 0.4121 0.3594 0.0963 0.1301 na wkavgliq does not cause hpcycleawpr 0.8920 0.6923 0.3618 0.3465 na hpcycleawpr does not cause wkavgliq 0.9723 0.2848 0.4326 0.6714 na source: uthor‟s calculations based on cbsl data rime rate persistence could be observed with the preceding week‟s w accounting for 6 .5 per cent of the current week‟s w ; statistically significant at the per cent level. this phenomenon, as highlighted by market participants, especially by those prime borrowers, implies the presence of prime rate persistence, where commercial banks consider the preceding week‟s prime lending rate as a benchmark when setting prime lending rate for the current week. also, such a high degree of persistence, along with other factors, could result in rigidity of the prime asian journal of economics and empirical research, 2018, 5(2): 121-138 131 lending rate, especially downwards, thereby leading to asymmetric adjustments following changes in monetary policy. r-squared and the adjusted r-squared recorded around 0.85, while the probability value of the f-statistic indicates that all variables in the regression jointly can influence the dependent variable, which is the prime lending rate. the above model was estimated using robust standard errors (heteroscedasticity consistent covariances) by white (1980) to obtain consistent estimates of coefficient covariances as the residuals appeared to be heteroscedastic. further, the breusch-godfrey serial correlation lm test (godfrey, 1978); (breusch, 1978) was conducted to test for serial correlation, which resulted in the null hypothesis of no serial correlation in residuals not being rejected. this result was confirmed by the durbin-watson statistic reported above, which is 2.03 per cent (durbin and watson, 1951). table-7. ols estimates of hpcycleawpr (using robust standard errors) independent variables coefficient p-value constant 0.0046 0.8035 (0.0183) hpcycleawcmrt 0.2721 0.0000 (0.0527) hpcycleawcmrt-1 -0.0739 0.0435 (0.0366) hpcycleawcmrt-2 -0.0208 0.5483 (0.0346) hpcycleawcmrt-3 0.0125 0.7277 (0.0358) hpcycleawcmrt-4 -0.0841 0.0017 (0.0266) hpcycleawprt-1 0.6355 0.0000 (0.0803) hpcycleawprt-2 0.0720 0.3806 (0.0821) hpcycleawprt-3 -0.0117 0.8716 (0.0727) hpcycleawprt-4 0.1882 0.0007 (0.0550) wkavgliqt -0.0006 0.1981 (0.0005) (dummyup*hpcycleawcmr)t 0.0020 0.9682 (0.0505) no. of observations (after adjustments) 491 r-squared 0.8568 adjusted r-squared 0.8535 log likelihood -164.1038 durbin-watson statistic 2.0341 f-statistic 260.5427 0.0000 note: standard errors are in parentheses below the estimated coefficients. source: uthor‟s calculations based on cbsl data 4.6. vector autoregression (var) model findings next, in order to identify how the present level of each variable in the model depends on past movements in that particular variable as well as in all other variables of the model and to test how a one-time shock to the independent variables in this study could bring about a change in the prime lending rate (i.e. awpr), an unrestricted vector autoregressive (var) model is formed and expressed in the following form: hpcycleawcmrt = 0 + 1 hpcycleawcmrt-p + 2 wkavgliqt-p + 3 hpcycleawprt-p + 4 dummyup1t + ɛ1t (3) hpcycleawprt = β0 + β1 hpcycleawcmrt-p + β2 wkavgliqt-p + β3 hpcycleawprt-p + β4 dummyup2t + ɛ2t (4) wkavgliqt = γ0 + γ 1 hpcycleawcmrt-p + γ 2 wkavgliqt-p + γ 3 hpcycleawprt-p + γ 4 dummyup3t + ɛ3t (5) where, p = number of lags included in the model ɛt = vector of residuals prior to estimating the above var model, it is important to test the appropriate lag length. for this purpose, a test to determine the lag length criteria was performed. as suggested by var lag order selection criteria, the var model was then estimated using six lags (see table 8). the six lag structure was suggested as the optimal for the model by the „sequential modified l test statistic‟ (each test at 5 per cent level), final prediction error (f e) and akaike information criterion (aic). the schwarz information criterion (sc) and the hannan-quinn information criterion (hq), however, suggested that the optimal lag structure would be one and two, respectively. asian journal of economics and empirical research, 2018, 5(2): 121-138 132 table-8. var lag length criteria var lag order selection criteria endogenous variables: hpcycleawcmr hpcycleawpr wkavgliq exogenous variables: c dummyup lag logl lr fpe aic sc hq 0 -3657.947 na 646.6709 14.98547 15.03691 15.00567 1 -2699.731 1896.838 13.32395 11.10319 11.23179* 11.15370 2 -2681.282 36.29339 12.81897 11.06455 11.27031 11.14536* 3 -2674.972 12.33559 12.96098 11.07555 11.35847 11.18667 4 -2656.298 36.27916 12.45846 11.03598 11.39606 11.17741 5 -2647.083 17.78964 12.44796 11.03510 11.47234 11.20684 6 -2637.341 18.68688* 12.41090* 11.03207* 11.54647 11.23411 * indicates lag order selected by the criterion lr: sequential modified lr test statistic (each test at 5% level) fpe: final prediction error aic: akaike information criterion sc: schwarz information criterion hq: hannan-quinn information criterion var lag exclusion wald tests were performed to test for the joint significance of all endogenous variables and it was observed that the p-value for lag 3 was insignificant (table 9). considering the above, the var model was re-estimated with lags of one to two and four to six. (see appendix 2) table-9. var lag exclusion wald tests var lag exclusion wald tests chi-squared test statistics for lag exclusion: numbers in [ ] are p-values wkavgliq hpcycleawpr hpcycleawcmr joint lag 1 390.1815 251.5190 104.5307 760.6224 [ 0.000000] [ 0.000000] [ 0.000000] [ 0.000000] lag 2 0.395948 11.47597 17.14491 23.37176 [ 0.941078] [ 0.009412] [ 0.000660] [ 0.005413] lag 3 0.201685 1.980146 9.352212 11.60456 [ 0.977317] [ 0.576538] [ 0.024957] [ 0.236531] lag 4 6.267360 5.865745 2.178221 29.41485 [ 0.099303] [ 0.118328] [ 0.536251] [ 0.000551] lag 5 2.611404 7.555177 12.46814 25.57248 [ 0.455494] [ 0.056158] [ 0.005940] [ 0.002399] lag 6 1.795580 16.08006 10.61492 18.97502 [ 0.615897] [ 0.001092] [ 0.014001] [ 0.025406] df 3 3 3 9 source: uthor‟s calculations based on cbsl data next, it is imperative to ensure the stationarity of the series. for this purpose, the inverse roots of the autoregressive characteristic polynomial was examined and as per figure 8, the var model is stationary (stable) since all roots lie inside the unit circle. figure-8. stationarity of the var model the impulse response of the prime lending rate to unanticipated increases in call money market rates (awcmr) and domestic money market liquidity, based on var estimates, were obtained for a period of 26 weeks asian journal of economics and empirical research, 2018, 5(2): 121-138 133 and these responses included „analytic (asymptotic) standard errors‟. the impulse responses of w to shocks on awcmr, domestic money market liquidity and awpr is shown in figure 9. as per the first graph in figure 9 it is visible that a positive shock to the call money market rate has a positive impact on awpr after the first lag, peaks at lag four, shows a slight negative effect and subsequently stabilises thereafter. figure-9. impulse response of awpr to shocks on awcmr, domestic money market liquidity and awpr source: uthor‟s calculations based on cbsl data awpr declines somewhat immediately following a positive shock to domestic money market liquidity, peaks at lag two, and the effect dies down after about fifteen lags. the third graph shows the response of awpr to an unexpected increase in the awpr itself. the effect of the shock is significant and felt immediately, but stabilises only after about twenty lags, indicating that awpr, itself, is one of its key determinants. the variance decomposition over 26 weeks is presented in figure 10. the variance decomposition offers information about the relative importance of each random innovation in affecting the dependent variable of awpr in the estimated var model. as per the findings, about 4 per cent of the variance in awpr is due to domestic money market liquidity, while awpr itself accounts for about 92 per cent of the variance. however, the variance in awpr due to awcmr is relatively insignificant (about 2 per cent). figure-10. variance decomposition source: uthor‟s calculations based on cbsl data asian journal of economics and empirical research, 2018, 5(2): 121-138 134 4.7. presence of asymmetries tested using observations from raw data and impulse response functions (irfs) another important purpose of this study was to test for the presence of asymmetries in the adjustment of prime lending rates following changes in the monetary policy stance in sri lanka. a new data series on the reverse repurchase (reverse repo) rate3 was used to aid this examination. it is denoted as revrepo in this study. using the above data series on the reverse repurchase rate, along with the call money market rate and the prime lending rate, a basic analysis was done using raw data, while an attempt was made to test for the same using a var model and impulse response functions (irfs). 4.7.1. observations from raw data to identify the presence of asymmetric adjustment in the prime lending rate, the series of wkawpr, wkavgawcmr and revrepo was used. based on the changes in the monetary policy stance in sri lanka, the sample period was segmented to policy cycles and assigned names to assist the study (refer table 10). table-10. segmented policy cycles period type period name 01/01/2004 11/11/2004 easy easy 1 11/18/2004 02/05/2009 tight tight 1 02/12/2009 02/02/2012 easy easy 2 02/09/2012 12/06/2012 tight tight 2 12/13/2012 06/27/2013 easy easy 3 source: uthor‟s calculations based on cbsl data next, the movements of all the above variables were tracked, findings of which are shown in table 11. table-11. changes in interest rates during monetary policy cycles in bps period reverse repurchase rate awcmr awpr awpr=(awcmr) x easy 1 +135 +53 0.4 tight 1 +350 +543 +1052 1.9 easy 2 -350 -540 -856 1.6 tight 2 +125 +163 +276 1.7 easy 3 -75 -195 -221 1.1 source: uthor‟s calculations based on cbsl data based on the outcome of the above exercise, a clear assessment on the results of the first cycle (i.e., easy 1) cannot be done as the sample period in this study commences from january 2004 and there has been no change in the reverse repurchase rate since 01 january 2004 up until mid-november 2004, where steps were taken to tighten monetary policy, which is the starting point of the „tight ‟ cycle. however, it can be noted that despite the first cycle being an „easy‟ cycle, both wc and w has risen quite significantly. with mounting inflation and monetary growth in 2004, the cbsl aggressively conducted open market operations (omo), as a first step, to absorb the excess liquidity in the domestic money market, which induced an upward adjustment in the short-term market interest rates; hence the increase in both awcmr and awpr. subsequently, monetary policy was tightened further by way of increasing the policy interest rates in ovember , and during the period of „tight ‟, the everse epurchase rate was increased gradually by 350 basis points up until the next easing cycle. during this period, awcmr rose by 543 basis points, while awpr rose by 1,052 basis points. during the third cycle, „easy ‟, the everse epurchase rate was brought down by 5 basis points. despite awcmr declining by 540 basis points during this period, awpr declined by only around 850 basis points, indicating the relative downward rigidity in the prime lending rate (when compared with „tight ‟, where the change in the reverse repurchase rate is the same); an example of asymmetric adjustment. in the following period (tight 2), which is the shortest tightening cycle ever in sri lankan history, the reverse repurchase rate was raised by 125 basis points, whereas awcmr and awpr increased by 163 basis points and 276 basis points, respectively. in the last monetary policy cycle, „easy ‟, wc and w have reduced by 95 basis points and basis points, respectively, in response to the reduction in the reverse repurchase rate (by 75 basis points). the final column of table 11 indicates that during the easing cycles of monetary policy, the multiple of awcmr is relatively lesser that during tightening cycles, signifying that the magnitude-wise adjustment by commercial banks during an interest rate rising setting is relatively higher than the interest rate relaxing setting. this indicates the presence of asymmetric adjustment of the prime lending rate to varying policy cycles. 4.7.2. findings from var and irfs in this exercise to test for asymmetric adjustment in the prime lending rate, a var estimate was conducted for the different monetary policy cycle periods. however, the first and the last monetary policy cycles were not considered for this exercise as those were not full-cycle periods, as constrained by the chosen sample for this study. the chosen lag length was 1 based on var lag order selection criteria and following the var estimation, impulse response functions for those three cycles („tight ‟, „easy ‟ and „tight ‟) were generated as shown in figure 11. 3 this is a key policy rate that forms the upper bound of the interest rate corridor for the call money market rate. it is the rate charged by the cbsl on overnight borrowing by commercial banks. in other words, it is the overnight lending rate of the cbsl. however, with effect from 2 january 2014, the reverse repurchase rate was renamed and is now known as the standing lending facility rate (slfr). asian journal of economics and empirical research, 2018, 5(2): 121-138 135 figure-11. impulse responses of awcmr and awpr to shocks on the reverse repurchase rate source: uthor‟s calculations based on cbsl data as per the above figure, during tightening policy cycles, the response of both hpcylceawcmr and hpcycleawpr to one-time shocks on the reverse repurchase rate appears to be quite similar. however, in the easing policy cycle, hpcycleawpr seems to rise till about lag 5 before adjusting down and moving towards the trend path, while hpcycleawcmr declines almost immediately. this asymmetric adjustment could be attributed to the existence of persistence in the prime lending rate of sri lanka. however, it should be noted that this particular exercise was done with the limited available information and could prove spurious if a larger data sample was considered. 5. conclusion and policy implications this paper analyses the behaviour of the prime lending rate in sri lanka during the period january 2004 – june 2013. the main objective of this paper is to identify the determinants of the prime lending rate in sri lanka, with special focus to prime rate persistence and asymmetries. this study was inspired by the growing interest on the attributes and importance of the prime lending rate among those in the private sector, commercial banks as well as the central bank. it was often argued that the prime lending rate, i.e., awpr, outshined as the key benchmark lending rate, as opposed to the sri lanka interbank offered rate (slibor) earlier. the downward rigidness of awpr during periods of easing monetary policy was often critiqued. this study reveals that in addition to the call money market rate being a key determinant of the prime lending rate in sri lanka, prime rate persistence, is also a major factor in the determination of the current week‟s w . esults from this study confirmed this phenomenon. lthough it could be considered acceptable for commercial banks to charge relatively higher rates of interest on prime lending during business troughs as a means of charging a premia on potential risk of default as observed by dueker and thornton (1994) and dueker (2000) holding up the rates high with the motive of making and maximising short-term profits seem unacceptable as it could deter credit obtained by the private sector, thereby also affecting the long-term asian journal of economics and empirical research, 2018, 5(2): 121-138 136 growth of the country. also, increased prime rate persistence is likely to be a partial causal factor for the asymmetric adjustment in the prime lending rate to changes in the monetary policy stance in the nation. persistence in the prime lending rate, especially during policy easing cycles where market lending rates would be slow in adjusting downwards, will continue to be a phenomenon as long as it does not lead to loss of competitiveness of the respective banks. however, data reflects that the adjustment takes place gradually, although may not be fully. the higher borrowing requirement of the government, especially witnessed towards the end of the sample period, could also be a reason for market lending rates, including the prime lending rate to not adjust downwards fully. a faster adjustment could have been possible had the government reliance on bank borrowings being less over the years, thereby facilitating a quicker and fuller pass through of monetary policy actions taken by the central bank. although ols estimates state that domestic money market liquidity is an extremely weak and statistically insignificant determinant of the prime lending rate, it can be observed that since the global financial crisis, the spreads between awpr and awcmr have increased when overnight liquidity was at a balanced position. however, when overnight liquidity was high and in excess, market lending rates and their spreads narrowed. this suggests that it would be ideal if the economy could maintain an excess of about rs. 15 – 25 billion in the overnight domestic money market, which would not only aid the economy and its stakeholders to enjoy low rates of interest, but would also help increase the affordability of credit, thereby increasing demand for credit by the private sector, which would subsequently lead to long term economic growth. alternatively, several measures could be taken to improve the computation of awpr as the weekly computed rates are largely susceptible to transactions of large borrowers (where the prime rate could be relatively more volatile in their absence during a particular business week). moreover, as highlighted in section 1.2.2., only transactions exceeding rs. 10 million are considered for the computation of awpr. this could cause prime lending of relatively smaller amounts (eg: rs. 9 million) by small banks to be excluded from the computation of awpr. this issue could also be addressed when a new computation methodology is designed. finally, this study could be extended to cover a larger sample period, while including any other explanatory variables. also, basic econometric techniques were used when testing for asymmetries in this study. this could be further extended by using more advanced techniques such as arch/ garch, ordered probit or tar/mtar, which would be useful in observing asymmetric adjustments in the prime lending rate during various monetary policy cycles. references amarasekara, c., 2005. interest rate pass-through in sri lanka. germany: university library of munich. arak, m., s. englander and e.m. tang, 1983. credit cycles and the pricing of the prime rate. quarterly review: 12-18. breusch, t.s., 1978. testing for autocorrelation in dynamic linear models. australian economic papers, 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2006. asymmetric adjustment in the prime lending–deposit rate spread. review of financial economics, 15(4): 323-329. available at: https://doi.org/10.1016/j.rfe.2005.12.002. tkacz, g., 2001. endogenous thresholds and tests for asymmetry in us prime rate movements. economics letters, 73(2): 207-211. available at: https://doi.org/10.1016/s0165-1765(01)00489-x. white, h., 1980. a heteroskedasticity-consistent covariance matrix estimator and a direct test for heteroskedasticity. econometrica: journal of the econometric society, 48(4): 817-838. available at: https://doi.org/10.2307/1912934. asian journal of economics and empirical research, 2018, 5(2): 121-138 137 appendix-1 – alternate multiple regression models and their ols estimates i. model i: ∑ (6) ols estimates of model i dependent variable: hpcycleawpr method: least squares variable coefficient std. error t-statistic prob. c 0.033492 0.032740 1.022962 0.3068 hpcycleawcmr 0.235121 0.011367 20.68438 0.0000 hpcycleawpr(-1) 0.533687 0.034191 15.60906 0.0000 hpcycleawpr(-2) 0.083408 0.040524 2.058252 0.0401 hpcycleawpr(-3) 0.098982 0.033270 2.975079 0.0031 wkavgliq -0.001389 0.000721 -1.925165 0.0548 dummyup -0.027959 0.038463 -0.726916 0.4676 r-squared 0.827491 mean dependent var -0.001067 adjusted r-squared 0.825361 s.d. dependent var 0.892322 s.e. of regression 0.372899 akaike info criterion 0.879080 sum squared resid 67.58018 schwarz criterion 0.938722 log likelihood -209.6933 hannan-quinn criter. 0.902498 f-statistic 388.5411 durbin-watson stat 1.672131 prob(f-statistic) 0.000000 model ii: ∑ ( ) (7) ols estimates of model ii dependent variable: hpcycleawpr method: least squares variable coefficient std. error t-statistic prob. c -0.004430 0.035255 -0.125668 0.9000 hpcycleawcmr 0.111015 0.046001 2.413308 0.0162 hpcycleawpr(-1) 0.533037 0.033957 15.69750 0.0000 hpcycleawpr(-2) 0.082120 0.040248 2.040346 0.0419 hpcycleawpr(-3) 0.095907 0.033060 2.900967 0.0039 wkavgliq -0.001167 0.000721 -1.619088 0.1061 dummyup*hpcycleawcmr 0.131905 0.047396 2.783016 0.0056 dummyup 0.007834 0.040305 0.194364 0.8460 r-squared 0.830203 mean dependent var -0.001067 adjusted r-squared 0.827752 s.d. dependent var 0.892322 s.e. of regression 0.370338 akaike info criterion 0.867294 sum squared resid 66.51792 schwarz criterion 0.935456 log likelihood -205.7879 hannan-quinn criter. 0.894057 f-statistic 338.7639 durbin-watson stat 1.675623 prob(f-statistic) 0.000000 asian journal of economics and empirical research, 2018, 5(2): 121-138 138 appendix-2. var estimates vector autoregression estimates hpcycleawcmr hpcycleawpr wkavgliq hpcycleawcmr(-1) 0.487731 0.065730 0.493830 (0.06781) (0.02524) (0.37976) [ 7.19311] [ 2.60439] [ 1.30037] hpcycleawcmr(-2) 0.126578 0.010851 0.135373 (0.06650) (0.02475) (0.37243) [ 1.90352] [ 0.43840] [ 0.36348] hpcycleawcmr(-4) -0.024470 -0.074717 0.645027 (0.06921) (0.02576) (0.38763) [-0.35356] [-2.90037] [ 1.66402] hpcycleawcmr(-5) 0.026294 -0.044850 -0.209016 (0.07205) (0.02682) (0.40356) [ 0.36492] [-1.67226] [-0.51793] hpcycleawcmr(-6) 0.034461 0.027217 -0.331251 (0.06329) (0.02356) (0.35448) [ 0.54448] [ 1.15533] [-0.93447] hpcycleawpr(-1) -0.211750 0.558659 -0.045427 (0.17963) (0.06686) (1.00609) [-1.17878] [ 8.35531] [-0.04515] hpcycleawpr(-2) 0.189880 0.154478 -0.186369 (0.18423) (0.06857) (1.03183) [ 1.03067] [ 2.25273] [-0.18062] hpcycleawpr(-4) -0.054738 0.173032 -0.962634 (0.18548) (0.06904) (1.03884) [-0.29511] [ 2.50628] [-0.92664] hpcycleawpr(-5) 0.428498 0.213369 0.757157 (0.21076) (0.07845) (1.18040) [ 2.03314] [ 2.71991] [ 0.64144] hpcycleawpr(-6) -0.472971 -0.233352 0.679687 (0.16793) (0.06251) (0.94055) [-2.81645] [-3.73321] [ 0.72265] wkavgliq(-1) -0.009814 -0.005451 0.922914 (0.00836) (0.00311) (0.04682) [-1.17403] [-1.75189] [ 19.7133] wkavgliq(-2) 0.010653 0.005436 -0.040283 (0.00977) (0.00364) (0.05471) [ 1.09056] [ 1.49522] [-0.73632] wkavgliq(-4) -0.003124 0.001258 0.126524 (0.00972) (0.00362) (0.05441) [-0.32159] [ 0.34778] [ 2.32526] wkavgliq(-5) 0.002703 -0.001757 -0.094245 (0.01134) (0.00422) (0.06350) [ 0.23837] [-0.41629] [-1.48419] wkavgliq(-6) -0.000291 0.000183 0.039502 (0.00842) (0.00313) (0.04716) [-0.03452] [ 0.05833] [ 0.83758] c -0.111864 -0.037765 1.725674 (0.12208) (0.04544) (0.68372) [-0.91635] [-0.83112] [ 2.52396] dummyup 0.202319 0.070872 -1.800806 (0.14094) (0.05246) (0.78938) [ 1.43549] [ 1.35096] [-2.28130] r-squared 0.329725 0.702169 0.924201 adj. r-squared 0.307003 0.692073 0.921632 sum sq. resids 842.0625 116.6635 26414.41 s.e. equation 1.335676 0.497160 7.480824 f-statistic 14.51176 69.54945 359.6895 log likelihood -826.7447 -343.4757 -1669.245 akaike aic 3.450899 1.474338 6.896709 schwarz sc 3.596645 1.620085 7.042456 mean dependent -0.000245 -0.001410 16.47175 s.d. dependent 1.604485 0.895927 26.72268 determinant resid covariance (dof adj.) 11.06347 determinant resid covariance 9.949260 log likelihood -2643.321 akaike information criterion 11.01972 schwarz criterion 11.45696 note: standard errors in ( ) & t-statistics in [ ] asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. asian journal of economics and empirical research vol. 4, no. 2, 61-67, 2017 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2017.42.61.67 61 yield curve and momentum effects in monthly u.s. equity returns: some nonparametric evidence somya tyagi1 sikandar siddiqui2  ( corresponding author) 1frankfurt school financial services gmbh, frankfurt, germany 2scdm germany gmbh, frankfurt, germany abstract in this paper, two largely familiar stock market anomalies – the yield curve and the momentum effects are re-examined for the s&p 500 index by using nonparametric regression. the results essentially confirm the existence of both of these phenomena, but also indicate that the stochastic linkages between the explanatory variables and future index returns are nonlinear and mutually dependent. it hence turns out that the greater flexibility offered by nonparametric regression enables the detection and characterisation of some features of the underlying relationship that would have been gone unnoticed under the linearity and additivity assumptions underlying simpler regression approaches. keywords: stock market, yield curve effect, momentum, nonparametric regression. jel classifications: g10, c58. citation | somya tyagi; sikandar siddiqui (2017). yield curve and momentum effects in monthly u.s. equity returns: some nonparametric evidence. asian journal of economics and empirical research, 4(2): 61-67. history: received: 20 september 2017 revised: 5 october 2017 accepted: 14 october 2017 published: 18 october 2017 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 62 2. background and literature review.............................................................................................................................................. 62 3. data .................................................................................................................................................................................................... 63 4. empirical methodology .................................................................................................................................................................. 63 5. results ................................................................................................................................................................................................ 65 6. conclusions ....................................................................................................................................................................................... 66 references .............................................................................................................................................................................................. 66 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://orcid.org/orcid-search/quick-search?searchquery=somya tyagi https://orcid.org/orcid-search/quick-search?searchquery=sikandar siddiqui https://orcid.org/orcid-search/quick-search?searchquery=somya tyagi https://orcid.org/orcid-search/quick-search?searchquery=sikandar siddiqui https://orcid.org/orcid-search/quick-search?searchquery=somya tyagi https://orcid.org/orcid-search/quick-search?searchquery=sikandar siddiqui asian journal of economics and empirical research, 2017, 4(2): 61-67 62 1. introduction in its “weak”, i.e. least restrictive form, the capital market efficiency hypothesis states that at any given time the market price of an asset reflects all the relevant information contained in historical data (see e.g., fama (1970)). this once popular assertion has, in recent years, repeatedly been challenged by a variety of research outcomes. from the application of statistical forecasting models to historical time series of asset prices, mostly from the equity markets, a considerable number of potential leading indicators have emerged to which some prognostic potential for price movements has been ascribed. examples include momentum, i.e. the relative change in the observed asset price over one or more a pre-defined past time windows (see, e.g., the pioneering work by jegadeesh and titman (1993) seasonal indicators (gultekin and gultekin, 1983) measures of intrinsic value like, e.g., price/book or price/earnings ratios (basu, 1977; rosenberg et al., 1985) as well as macroeconomic indicators like interest rates (chen et al., 1986) to name but a few. it seems that to date, the method of choice for testing the validity of the weak-form efficient market hypothesis, or identifying departures from it, has often been linear regression. this way of proceeding is based on the implicit assumption that the deterministic part of the underlying statistical relationship between the dependent variable (here: the asset return over the forecast horizon) and the supposed leading indicators is adequately represented mathematically by a linear, additive function. given the large variety of non-linear or mutually interlinked patterns according to which two or more factors of influence could jointly impact a random variable of interest, this premise might easily be looked upon as an undue simplification. if adopted in an unchallenged manner, it could thus lead users to miss out on important features of the unknown, actual data-generating process. a possible solution attempt to this problem would be to replace the linear function used for the conditional mean of the dependent variable by functional forms that allow for a greater degree of flexibility in the representation of (possibly) complex relationships. among the most important advances in this field are the threshold time series models pioneered by tong (1983) where one or more threshold values of an explanatory variable are used to define intervals among which the values taken by the regression coefficients are allowed to differ. the same applies to the markov switching model by hamilton (1989) which allows for two or more régimes between which the behaviour of the time series investigated differs systematically, and in which transitions from one régime to another are controlled by a latent state variable of which the current level is a function of its most recent past value. the above approaches, however, are built on the premise that the functional relationship between the variables under investigation is known a priori up to a finite number of parameters, which might still be regarded as questionable. this makes the case in favour of considering nonparametric regression, in which the conditional mean function is not determined a priori but derived entirely from the data, as an alternative. on this background, the purpose of this paper is to investigate whether, and how, applying the nonparametric method of local least squares regression can assist in characterising two frequently perceived stock market anomalies, i.e. the momentum and the yield curve effects, using the example of the s&p 500 equity market index. the remainder of the paper is organised as follows: section 2 provides some additional background and a (necessarily selective) overview of the relevant literature. a brief description of the data in use is provided in section 3, whereas section 4 focuses on the empirical methodology employed. the estimation results obtained are summarised and discussed in section 5. the paper ends with a summary of the main conclusions and suggestions for future research (section 6). 2. background and literature review among the market anomalies that have, so far, attracted the attention of both academics and practitioners, the momentum effect is arguably among the most thoroughly investigated. one of the earliest wide-ranging investigations of this topic has been provided by jegadeesh and titman (1993) who found that an equity investment strategy that combines long positions in the best-performing u.s. stocks from the past 3-12 months with short positions in the worst performing ones during the same formation period, would, on average, bring about a monthly rate of return of around 1% during the subsequent 1 to 3 months. following up on this topic at a later stage, the authors (jegadeesh and titman, 2001) reach the conclusion that such momentum returns continued to prevail during the 1990s (and find that equity returns have a tendency to revert over longer time horizons). a considerable number of other studies have essentially confirmed the prevalence of momentum effects in several segments of the international equity markets; examples include rouwenhorst (1998;1999) for europe and several emerging markets, as well as chui et al. (2003) for a number of asian countries. for stock market indexes and exchange trade funds, rather than individual shares, significant momentum effects have been reported, inter alia, by asness et al. (1996); richards (1997); chan et al. (2000) and tse (2015) among others. a number of mutually complementary explanations for these phenomena exist. one of them is that news relevant to valuation spread gradually, rather than instantaneously, among market participants, and that different investors require different amounts of time to figure out what exactly a piece of newly arrived information actually implies for asset prices. this possibility is consistent with the hypothesis by jegadeesh and titman (2001) that investors initially tend to underreact to new information. moreover, some investors might seek to learn by watching others whom they consider more sophisticated, or better informed, before rebalancing their own portfolios. this would be in line with the model by hong and stein (1999) according to which two investor groups – informed investors (who are equipped with a competitive advantage in obtaining and processing relevant information) and technical traders (who form expectations on future returns based on perceived patterns in past price movements) – exist. the delayed reaction of the second group to price movements caused by transactions by members of the first can cause asset prices to overor undershoot their fundamentally justified values. the overreaction hypothesis also discussed in jegadeesh and titman (2001) also points in this direction. moreover, if many investors tend to base their expectations of future asset returns at least partially on trends from the recent past, and trade accordingly, the subsequent price impacts of this behavioural pattern may generate consecutive, temporarily self-perpetuating “feedback loops” (shiller, 2005). asian journal of economics and empirical research, 2017, 4(2): 61-67 63 for quite some time, economists have also argued that the slope of the yield curve, i.e. the difference between long and short-term interest rates for credit products of a given quality class, is a promising candidate variable for a leading indicator of turning points in the business cycle. this presumption is supported by (at least) two mutually complementary theoretical considerations: (1) commercial banks typically engage in maturity transformation, i.e. they refinance longer-term lending transactions through revolving short-term borrowings, and hence tend to gain from a steeper yield curve (see, e.g., alessandrini and nelson (2012)). by boosting a bank’s profit margins, such a constellation tends to encourage commercial banks to lend more freely to nonbanks, with the likely impact of stimulating aggregate demand and output – at least if the economy does not yet operate at full capacity utilisation. a flat or downward sloping yield curve, in contrast, tends to depress bank profit margins, choke new lending, and slow down the growth of aggregate demand. (2) central banks serve as lenders of last resort to the domestic commercial banking sector. by unilaterally setting the refinancing rates at which it lends central bank money to commercial banks, the central bank of a currency area can strongly impact (albeit not perfectly control) short-term rates prevailing on the interbank market for central bank balances. towards the long end of the yield curve, interest rates, while being far from unaffected by central bank actions, are commonly believed to be more strongly influenced by market expectations on future short-term rates and inflation, as explained in estrella and mishkin (1996). hence, a flat or even downward-sloping yield curve is usually indicative of a restrictive central bank policy that aims at limiting money supply growth and reducing inflation, albeit at the cost of a (temporary) slowdown in economic activity. conversely, an upward slope that appears outstandingly steep by historical standards often is a by-product of an expansionary monetary policy stance. meanwhile, several empirical findings have supported the above line of reasoning. among the early examples for this are the works by estrella and hardouvelis (1991); estrella and mishkin (1996;1998) as well as smets and tsatsaronis (1997) more recent related contributions include papers by stock and watson (2003); ang and piazzesi (2003) and diebold et al. (2006). if market participants do indeed react gradually, and at different speeds, to the arrival of new information, the suggestion by siegel (1998) that a reliable predictor of turning points in the business cycle would also be a useful tool in timing the stock market would hence encourage to use the slope of the yield curve as a lead indicator for the equity market, too. by now, a considerable body of literature has accumulated that essentially confirms this perception. examples of related studies include campbell (1987); fama and french (1989); schwert (1990); campbell and ammer (1993) and boudoukh et al. (1997) as well as resnick and shoesmith (2002). 3. data in the context of this paper, the one-month lagged slope of the yield curve (referred to by the abbreviation slope-1) is measured by the difference between the seasonally unadjusted end-of-month values of the 10-year treasury constant maturity rate and the effective federal funds rate, as published federal reserve bank of st. louis1. for calculating the monthly rates of return on the s&p 500 index (r1m) and the lagged momentum indicator mom-1, the end-of-month index levels made available by yahoo! finance2 are used. in line with a common practice, the time horizon over which momentum indicator was calculated amounts to 12 months. the sampling period ranges from 1960 to 2015. descriptive statistics of the variables in use are provided in table 1 below. table-1. descriptive statistics of variables in use r1m slope-1 mom-1 mean 0.0053 0.0106 0.0638 standard deviation 0.0428 0.0168 0.1573 skewness -0.6750 -1.1364 -0.9188 excess kurtosis 2.5693 2.1463 1.3873 minimum -0.2454 -0.0651 -0.5934 5% quantile -0.0680 -0.0207 -0.2191 10% quantile -0.0483 -0.0083 -0.1489 25% quantile -0.0181 0.0017 -0.0194 median 0.0090 0.0124 0.0927 75% quantile 0.0337 0.0226 0.1686 90% quantile 0.0528 0.0297 0.2372 95% quantile 0.0696 0.0328 0.2735 maximum 0.1510 0.0385 0.4249 # observations 671 671 671 4. empirical methodology 4.1. problem formulation and objective in the following, yt denotes the rate of return on the s&p 500 stock market index between the last trading days of two subsequent months t and t-1. moreover, x1,t-1 stands for the lagged 12-month rate of return on the same index, and x2,t-1 the difference between the par yield on ten-year u.s. treasury bonds and the federal funds rate. the last month for which an observation of y is available in the dataset is denoted by t. the objective pursued here is to estimate the conditional mean function of yt without imposing any overly restrictive preconditions (such as linearity and additivity) on the form of the statistical relationship between yt and the two explanatory variables x1,t-1 , and x2, t-1. it is assumed that the regression equation by which this unknown relationship can be expressed reads 1 see https://research.stlouisfed.org/fred2 2 see http://finance.yahoo.com/ asian journal of economics and empirical research, 2017, 4(2): 61-67 64 tttt uxxgy   ),( 1,21,1 (1) where ut is the time-specific realization of a scalar random variable with mean zero that is independent of x1 and x2. 4.2. estimation method as shown by hastie and tibshirani (1993) one way of estimating an unknown function like g(.) above is to use a pre-defined function of both the explanatory variables and a set of unknown parameters , 1, and 2 in its place, all of which are allowed to vary with the specific values taken by the explanatory variables. in our application, this would imply approximating (1) by tttttttttt xxxxxxxxy    ),(),(),( 1,21,121,21,21,111,11,21,1 (2) here, the scalar t represents the cumulative impact of the random error ut and any possible approximation error incurred when replacing g(.) by the corresponding term in (2). then, for any combination { * 1x , * 2x } of values lying inside the empirically observed range of x1,t-1 and x2,t-1, a set ),,(ˆ * 2 * 1 xx ),,(ˆ * 2 * 11 xx and ),(ˆ * 2 * 12 xx of related estimates can be calculated my minimizing the criterion function            t t ththttt xkxkxxy 2 1,21,1 2 1,221,1121 ,, ~~~, ~ , ~ ,~ 21  (3) with respect to the trial parameters 21 ~ , ~ ,~  and . in the above equation, the expression   ,1,tih xk i , i = 1, 2, termed a kernel function, is a weighting function of which the value shrinks as the distance between xi,t-1 and xi * increases. in this application, the kernel function is set to               i iti i tih h xx h xk i * 1, 1, 1 ,  (4) where   stands for the standard normal density. (several other symmetric univariate probability density functions could also have been used in its place without substantially affecting the accuracy of the estimates; see, e.g., härdle (1990) section 4.5). the scalar quantities h1 and h2are bandwidth parameters which jointly determine how quickly the weight placed on an individual observation  1,21,1 ,,  ttt xxy in (3) declines as the distance between * ix and 1, tix (with i = 1, 2) grows. 4.3. bandwidth choice for given values of the bandwidth parameters h1 and h2, (3) is a standard, analytically tractable, weighted-least squares problem. selecting appropriate values for h1 and h2 is of crucial importance: if, on one hand, the chosen bandwidth parameters are “too small”, the resulting estimates tend to “fit the noise”, i.e. to be too sensitive to the specific realizations of the random influences present in the data, to possess excessive variance, and to be poorly generalizable. on the other hand, choosing them to be “too large” will cause important features in the unknown, true function g(.) to remain unnoticed. what further complicates the issue is that using a globally constant set of bandwidths might simultaneously lead to an undesirably large bias of the fitted function in areas densely populated with data points, and to an overly erratic behaviour in areas where only few observations are located. in line with li and racine (2007) section 14.8, the solution to this problem advocated here is to relate the bandwidth hi to * ix (i = 1, 2) by setting    ** , iiii xkdxh  (5) where  *, ii xkd is the absolute difference between * ix and its ki-th closest neighbouring observation among the itx for t = 1, …, t-1. by allowing different values of ki for i = 1 and 2, we account for the possibility that the profile of the function g(.) to be estimated might be (close to) linear in one dimension but considerably more variable in the other. for non-integer values of ki, , the corresponding value of  *, ii xkd can be obtained by linear interpolation between the two adjacent whole numbers. then, a possible solution to the trade-off between the goals of mitigating the bias inherent in the approximate nature of (2) and avoiding to “fit the noise” is to follow härdle (1990) (section 5.1.1.) in choosing the “optimal” combination  )( 2 )( 1 , optopt kk of bandwidth parameters by minimizing the cross validation criterion      t t ttttttttttttt xxxxxxxxycv 2 2 1,21,1,21,21,21,1,11,11,21,1 ),(ˆ),(ˆ),(ˆ  (6) simultaneously with respect to k1 and k2. in equation (5), the symbols t̂ , t,1̂ , and t,2̂ denote “leave-one-out” estimates of the related parameters, i.e. estimates calculated along the same lines as ),,(ˆ 1,21,1  tt xx ),,(ˆ 1,21,11  tt xx and ),(ˆ 1,21,12  tt xx (see equation (3)) but by deliberately leaving out the data point  1,21,1 ,,  ttt xxy . minimizing (5) constitutes a two-dimensional optimisation problem with possibly more than one local minimum. from the number of optimisation heuristics that can be used to tackle such a problem (see, e.g., the survey by gilli and winker (2009) the differential evolution algorithm by storn and price (1997) has been chosen here. readers interested in the details of its implementation are referred to gilli and schumann (2010). 4.4. estimation of pointwise confidence intervals following a recommendation by racine (2008), pointwise confidence intervals for both the parameter estimates and the fitted values of y are estimated by bootstrapping (see efron (1979)). in its simplest variant, which has been asian journal of economics and empirical research, 2017, 4(2): 61-67 65 employed here, this involves creating a large number b (here: 1,000) of pseudo-samples, each having the same number of observations as the original dataset, by randomly sampling from the original sample with replacement. then, the quantities of interest are re-estimated for each of these pseudo-samples separately, and the estimated confidence bands for these quantities are inferred from the empirical quantiles of the b resulting estimates. in what follows, an estimate is said to be significantly above (below) zero if zero lies outside the corresponding 95% confidence interval. 5. results figure 1 displays a two-dimensional surface plot of the estimated mean one-month rate of return on the s&p 500 (r1m) index as a function of both the one-month lagged realisations of the slope of the yield curve (slope-1) and the 12-month momentum indicator mom-1, together with the related 95% confidence interval. figure 2 reproduces the same relationship in the form of a two-dimensional altitude chart, in which those areas where the estimated mean one-month rate of return on the s&p 500 (r1m) significantly differs from zero are highlighted in grey to facilitate their detection, and the individual data points are shown as black dots. the results thus summarized support the hypothesis that a statistical relationship between the s&p 500 index returns and both explanatory variables in use does indeed exist. however, they also convey the impression that slope-1 and mom-1 interact in a way that is neither linear nor additive when determining the conditional expectation of r1m. this is also underscored by the optimized values of k1 and k2 (see equation 5), which stand at 413 and 546, respectively, and thus are not only finite but lie well below the sample size. figure-1. regression surface with 95% confidence interval upper and lower bounds figure-2. regression results as altitude chart more specifically, a statistically significant momentum effect only appears to be present in situations where the slope of the yield curve is either positive or, at least, exceeds a threshold of (roughly) minus 40 basis points. for all values of slope-1 below that boundary, the estimated lower limit of the 95% confidence interval lies below zero. in addition, it can be seen that for all values of slope where a statistically significant momentum effect can be detected, the estimated relationship between the momentum indicator and the one-month ahead rate of return on the s&p 500 appears neither linear nor even monotonic. rather, there seems to be a threshold for mom somewhere near between 0.05 and 0.15 (the exact value of which varies with slope), up to which the higher values of mom-1 tend to be associated with higher values of r1m (as suggested by much of the earlier empirical literature), but above which this relationship flattens out or even becomes negative. generally speaking, towards both ends of the momentum scale, the confidence intervals for the estimates widen substantially, thus indicating that in the sequel of unusually large jumps or drops in the index during the past 12 months, statistically asian journal of economics and empirical research, 2017, 4(2): 61-67 66 meaningful inferences about the expected size and direction of future stock index movements are not possible. this can, at least in part, simply be attributed to the very limited number of data points in these regions of the data range. seen from the other angle, the findings obtained are also largely in line with earlier findings indicating a positive association between the slope of the yield curve and the magnitude of expected stock index returns. however, they also indicate that this relationship is not a “global” phenomenon, i.e. one that prevails with equal strength in all situations, but rather a “local” one that is most pronounced in terms of statistical significance in cases where the momentum indicator (again, roughly speaking) lies in a range from -15% to + 25%. for values of mom-1 that lie outside this interval, again, a statistically significant linkage of the above type cannot be identified, most probably because near the boundaries of the plane spanned by the empirically observed ranges of slope and mom, observations are both too sparse and too widely scattered to allow any substantial conclusions. in the above, the highest estimates of the mean one-month ahead s&p 500 return are obtained for cases of a joint occurrence of a steep, positively sloped yield curve and a moderately positive momentum factor. this indicates that slope-1 and mom-1 impact the dependent variable in a complementary, mutually reinforcing manner. since the federal reserve bank can exert considerable influence on the slope of the yield curve by setting the short-term rates at which it provides liquidity to commercial banks, this finding has an important monetary policy implication: monetary policy actions that have the primary objective of keeping inflation inside (or, at least, near) a pre-defined target range may have the unintended side effect of influencing the likely direction of future stock market returns or even abetting temporarily self-sustaining upward or downward trends in equity market prices. for the time being, it is an open question whether, and to what extent, such partially policy-induced trends and their eventual reversal (due to exogenous economic shocks and/or changes in the course of monetary policy) can have detrimental side effects on the stability of the financial sector or the economy as a whole. however, if they do, central bankers may find themselves facing a dilemma between the goals of maintaining a stable price level on one hand, and avoiding any unfavourable interference with the price formation processes on equity markets on the other. 6. conclusions this paper has re-examined two largely familiar anomalies in the stock market, the yield curve and the momentum effect, using the nonparametric method of locally linear regression. while essentially confirming the existence of both of these phenomena, the outcome of our empirical analysis nevertheless indicates that the patterns according to which the two indicators under consideration relate to future stock index returns are both nonlinear and mutually interlinked. hence, it should be evident that the greater flexibility offered by the nonparametric regression model applied here enables the detection and statistical characterisation of some features of the empirical relationship under investigation that would have been remained undiscovered under the assumptions of linearity and additivity on which simpler regression models are based. at this stage, however, it might easily concluded that this paper actually raises more questions than it answers. one might, for instance, ask whether the observed empirical relationships are mere statistical artefacts that would cease to prevail if additional relevant explanatory variables were taken into account. moreover, the possibility that not just the most recently observed levels of the explanatory variables, but also the variability of the underlying quantities in a given, past time window may impact the dependent variable is clearly worth considering. also, the question may arise whether the explanatory variables in use 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© 2019 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 6, no. 2, 101-107, 2019 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2019.62.101.107 © 2019 by the authors; licensee asian online journal publishing group external debt, exchange rate, foreign investments and economic growth interrelationships further empirical evidence from nigeria abina, praise adedigba finance & banking department, university of port harcourt, port harcourt, nigeria. abstract it is crystal clear for countries to thrive and for industries to compete with themselves there is need for product diversification, these create a niche for foreigners to contribute both in capital and technical skill, this will further lead to exchange of currency across borders and it will also facilitate growth in the receiving country. this propelled this paper on external debt, exchange rate, foreign investments and economic growth inter-relationships. further empirical evidence from nigeria, 1981-2018. the study made use of autoregressive distributed lag bond test (ardl) as the statistical technique. it was revealed that foreign investment to total exports ratio has a positive and an insignificant relationship with external debt to total exports ratio, the result agreed with the earlier anticipated apriori expectation, but the insignificant relationship arises as a result of instability identified between naira to other foreign currency, it also arises as a result of the increase identified with prices of goods and services in the country. it does appear that there is need for foreign investors to participate in the country and for this to take place policies on investment friendly environment will need to be reviewed and corrective measures that will improve the policy will need to be put in place this environment will stimulate and boost foreign participants which will in the long run boost the value of the local currency and make the foreign market of the country to be competitive. keywords: foreign investments, exchange rates, external debt, economic growth, export. jel classification: f24, f35, f39. f43, f55. citation | abina, praise adedigba (2019). external debt, exchange rate, foreign investments and economic growth interrelationships further empirical evidence from nigeria. asian journal of economics and empirical research, 6(2): 101-107. history: received: 20 may 2019 revised: 25 june 2019 accepted: 31 july 2019 published: 18 september 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 102 2. theoretical underpinning............................................................................................................................................................ 102 3. research methodology ................................................................................................................................................................. 104 4. presentation and analysis of result .......................................................................................................................................... 104 5. concluding remarks and policy recommendations .............................................................................................................. 106 references ............................................................................................................................................................................................ 106 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.62.101.107&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/1005 https://orcid.org/0000-0002-5829-5636 http://asianonlinejournals.com/index.php/ajeer/article/view/1005 https://orcid.org/0000-0002-5829-5636 http://asianonlinejournals.com/index.php/ajeer/article/view/1005 https://orcid.org/0000-0002-5829-5636 asian journal of economics and empirical research, 2019, 6(2): 101-107 102 © 2019 by the authors; licensee asian online journal publishing group contribution of this paper to the literature: this study contributes to existing literature by examining the relationship between external debt, exchange rate, foreign investments and economic growth inter-relationships. 1. introduction countries interact with the external world in terms of trade and openness has made it possible for the subject matter of interest to be a major economic priority. developing countries see external debt as a form of deficit financing tool, nation can harness excess revenue through revenue generated from foreign trade and tax that is levied on foreign countries or multinationals in the home country. there have been several debates on the interrelationships between foreign investment, external debt and the effect of fluctuation in the exchange rate in nigeria. foreign investment helps in technology transfer and reallocation of physical resources. ezirim et al. (2000); ezirim et al. (2000) and awosusi and awolusi (2014) opined that foreign investment productivity and growth can be enhanced, it can also be a booster to growth of lost country, the works of lee and tan (2006) discovered that knowledge spillover can be enhanced by foreign investment, empirics have shown that the cost of transferring knowledge and technology is expensive (teece, 1976) thus this transfer is enabled by trade liberalization. hameed et al. (2008) in ezirim et al. (2007) and khan (2007) support the argument that fdi helps in accumulation of capital which will result to economic growth. umaru et al. (2015) recapitulated benefits that is achieved in a country if they are able attract foreigners or multinationals to invest in their country. ajayi (2006); falki (2009); ojong et al. (2015) articulate few of the benefits which included; access to international markets, access to huge fund, technology spillover, effective and efficient exploitation and utilization of local raw materials and a source of employment. on the other hand, ezirim et al. (2000) stated some conceivable reasons why foreign investment is not been felt in less developed country, and they include exchange rate fluctuation, political index and the present inflation trend in the country. in another investigation, ezirim et al. (2007) contradicts the findings of ezirim et al. (2000) that exchange rate condition either favorable or unfavorable is not a condition that foreigners will examine to ascertain if they will invest or not. while obadan (2004) opined that one major problem receiving country face is that foreign investor and its country tend to share out of the good fortune of sound investment in the country. odozi (2003); akinlo (2004); olaniyi (1995) and adelegan (2008) reported negative contribution of fdi in nigeria. danja (2012) noted that payment of interest on loan facility, repatriation or diversion of proceeds also create potential problem to fdi not been able to achieve its desired result. in a further investigation by ezirim et al. (2006) they reported that capital flight and debt service payment also contribute to problem home country faces in their dealings with foreign investors. in comparison (uzoma et al., 2015) noted that lesser risk is attached to fdi than external debt as a source of capital accumulation to receiving country because it does not add to debt accumulation of the receiving country. in ezirim et al. (2004) it was discovered that both debt stock if properly utilized and its servicing contribute positively to output. this contradicts the findings of ezirim et al. (2006) which stated that in nigeria foreign debt have been used for capital accumulation, source of financing budget deficit. also, domestic expenditure is often partly financed by external debt. the aim of this paper is to investigate empirically the interrelationship among external debt, exchange rate and foreign investments in a developing or an emerging economy using nigeria as the proxy. 2. theoretical underpinning 2.1. new growth theory traditionally, economic theory favors the removal of barriers which will help to hasten growth and placed emphasis on the role of foreign investment as a driver of economic growth, similarly, trade liberalization (removal or reduction of trade barriers) is emphasis is placed on the fact that new and up-to-date technology needs to be acquired in order for local and international markets to compete with each other thereby creating employment opportunity which leads to growth. dependency theory: this theory negates the existence of foreign investors or multinationals in developing countries. the participation of multinational distorts development in the host country in the long run. furthermore, anyanwu (1993) and aremu (2005) observed that drivers of fdi are exploitative and they are biased in terms of remuneration or payment of wages to the local labour force. they dump outdated technology to the receiving country, and manipulate key sectors in the economy in furtherance of their business motives. harrod domar growth model: in an attempt to investigate an interrupted working of an economy, harrodian model and that of domar emphasized the dual structure and function of investment placing them at high priority, (demand effect and supply effect) the first role of investment as it increases the capital stock, while the second is it creates additional income, the later helps to enhance capacity in form of production while the former helps in income enhancement in terms of profit generated from sound investment decision. there are key conditions to this, the first which is that so long as investment continue to take place in any economy then capital stock in the form of goods and services (output) and real income will always expand, because this investment will be used for expansion in production and its co-determinant, figuratively there is need for real income and output to expand at the same rate. this will help to maintain full employment, the moment there is a slight modification in any of them without affecting the second then there will be idleness in the capacity utilization, leading to reduction in the income of people in the country. 2.2. empirical review this section explicitly analyzed a number of econometric and finametric studies that have showed the interrelationship which exist between external debt, exchange rate and foreign investments. ogunbiyi and abina (2017) examined foreign investments, exchange rates and external debt inter-relationships in africa. further empirical evidence from africa. further empirical evidence from nigeria, the study used predictors as exchange rates, external debt burden, and oil prices in the international markets. the study employed phillips-perron unit root test and autoregressive distributed lag bond test (ardl) as the econometric tools. the results of the descriptive statistics showed that all the explanatory variables were leptokurtic in nature, the study made use of phillipsasian journal of economics and empirical research, 2019, 6(2): 101-107 103 © 2019 by the authors; licensee asian online journal publishing group perron unit root test to avoid spurious estimates. it was discovered that external reserve has a positive but insignificant affiliation with ratio of foreign investment to total exports, while inflationary pressure had positive at level and lag 1 and negative contribution to the ratio of foreign investment to total exports at lag 2. umaru et al. (2015) investigates if any association exists between growth and foreign direct investment in nigeria. after conducting all necessary tests, it was discovered that there is no serial correlation between the variables. the study discovered that causality flows one way from gross domestic product to foreign direct investment. the same result was shown between gross domestic product and openness. however, causality does not exist from exchange rate to gross domestic product. the study therefore recommends that stability in the country’s exchange rate and openness policy of the country need to be streamlined, which will serve as a sweetener to foreign investors in the country. ebekozien et al. (2015) analysed the trend in the inflow of foreign direct investment in nigeria. they made used of secondary data which were converted to percentage. the study made use of twenty-year (20 year) data points which were split into two. in addition, duncan multiple range test, regression analysis and granger test were statistical techniques used in the study. the duncan multiple range showed that fdi is attracted more from the processing and manufacturing sector in the country while that of the construction sector is very poor. the result of regression analysis revealed that the null is accepted in the first hypothesis which states that no significant flow exists between foreign direct investment into construction sector. (f13.2), but in the second hypothesis, the alternate is accepted which states that there is a significant flow between construction sector and foreign direct investment (f155.133). in order to harness much-needed funds, the study concluded that there is need for enforcement of prevailing laws. beyond this, huge investment is needed in infrastructure to boost output in industrial sector. they also suggested that there is need for partnership of both the private and the public in construction of air and sea ports, roads, and dams which will build foreign confidence of potential investors. macroeconomic situations are worst by debt burden. this propelled (ezirim et al., 2007) to investigate foreign investment burden, exchange rates and external debt crises in nigeria. the historical data from 1970-2001 were used while four models were developed to carry out the investigation. ordinary least square (ols) and exact maximum likelihood (eml) were the two techniques that aided the research work. it was discovered that increase in debt burden did not and was not a motivating factor for foreigners to invest in the country. they also found out that exchange rate is not a major determinant which foreigners consider if they should invest or not. an increase in oil price leads to a decline of 56% in investment burden in the country. the study recommends that revenue generated from oil proceeds need to be judiciously utilized. this will help to cut down foreign investor’s participation in the country. okumoko and karimo (2015) investigates the endogenous effects of the nexus between economic growth and foreign direct investment in nigeria. thirty-two years time series archival data was used in the study while johansen’s cointegration test, vector autoregression, kwiatkowski-philips-schmidt shin (kpss) and phillips perron unit root tests were the employed econometric techniques. it was discovered that fdi persuades growth and not the other way-round. the endogenous effect is rejected in the study. it was recommended that intensive efforts are needed in order to entice foreign investments. uzoma et al. (2015) attempted to investigate if fdi is growth averse or pro to growth. the study made use of annual time series data which were transformed to log from 1981-2009 for the investigation. the model for the study was drawn from the monetarists and structuralists views. it was discovered that the unfavorable environment, fluctuation in exchange and inflation rate have led to fdi’s insignificant affiliation in the country. equally the causal relationship suggests a one-way causal relationship exists between gdp and fdi in the economy. growth which is achieved by domestic investment leads to foreign investment, they further recommend that there is need to address the problem of insecurity in the country. they opined that if properly addressed, it will lead to increase in domestic investment as well as foreign investors’ confidence. in ojong et al. (2015) foreign investment was proxied on market capitalization, openness, level of economic activities and gross fixed capital formation as the exogenous variables which were used to ascertain the determinant of fdi in nigeria. the study made use of secondary data obtained from the country’s apex bank. the least square multiple regression technique was used. it was discovered that openness and level of economic activities attract more fdi in the country while a negative association exist between gross fixed capital formation and market capitalization in the country. therefore, reorientation is needed in order to increase savings and reduce consumption. there is need for more jobs to be created and this can be achieved with the help of both the private and public sector. in an ex-post facto research design, ezirim et al. (2006) attempted to investigate the impacts of external debt burden and foreign direct investment remittances on output level in nigeria. the study utilized data from 1970-2000. after conducting various diagnostic tests, it was revealed that the data can be used for forecasting. a two-fold causality was also discovered between foreign direct investment and external debt burden; neither of them contribute positively or significantly to growth. it was also discovered that proceeds from foreign exchange will serve as remittance of income in nigeria. in nigeria (egbetunde, 2012) examined the causal relationship between public debt and economic growth using ex-post facto research design with historical data from 1970 to 2010. on the long run, there is a positive reinforcement relationship between public debt and output, the study recommends that there is need for loan to be sourced within the country because of the revolving effect it has on the economy. dewan and hussein (2001) suggested that apart from growth in the labour force, investment in both physical and human capital as well as low inflation and open trade policies are necessary for economic growth. but antwi et al. (2013) studied the impact of macroeconomic factors on economic growth and discovered a long-run economic growth is largely explained by physical capital, foreign direct investment, foreign aid, inflation and government expenditure. it is also evident that economic growth is not affected by short-term changes in labour force. over time, it has been seen that changes in the microeconomic variables always directly affect changes in macro-economic activities of the nation’s production, consumption and expenditure. this is because when a nation has excess in production, she engages in international trade, furthermore, this is also made possible as countries face different opportunity costs in their production choices while the excess mainly flow from the contributions of the micro activities in the country. it is also opined that technology poses a threat to the full participation of the micro variable. solow (1956) model also pointed it out that production is a function of three things which technology is one of them. lopez (2005) opined that an increase in production is as a result of openness. gries and redlin (2010) strived to examine the dynamics of the asian journal of economics and empirical research, 2019, 6(2): 101-107 104 © 2019 by the authors; licensee asian online journal publishing group relationship between gdp growth and trade openness. their findings confirmed a long run relationship between the variables as well as a short run adjustment to equilibrium. in the long-term causality was found to be bidirectional moving from trade openness to growth and vice versa while a negative adjustment was found in the short term. edoumiekumo and opukri (2013) is of the opinion that the benefits of international trade are that it has a robust impact on her economic growth. tan and tang (2012) also opined that technology is a factor that helps in explaining growth in the country. ismaila and imoughele (2015) discovered that foreign trade has no robust impact on a country. they noted that the cost of doing business in the country was very high in as much as the infrastructure and business environment are not friendly. the country witnessed deficit in her balance of trade as at early in the year. this has led regulatory bodies to place restrictions and bans on goods imported. on the long run, goods in the country became scarce and there was shortage in the availability of raw materials which automatically led to few goods pursuing much profits in the market. aurangzeb and ul haq (2012) asserted that investment plays an important role in driving growth through increase in productivity levels. they also discovered that foreign direct investment brings technology and creates employment. fdi helps to adopt new methods of production and enhances productivity by bringing competition in the economy. ullah and rauf (2013) evaluate the impacts of macroeconomic variables on economic growth, they found out that there is a positive relationship between foreign direct investment and saving rate while exports have negative impacts on economic growth but labour force and tax rates have no impact on economic growth for some selected countries. 3. research methodology 3.1. estimation methods and analytical techniques the model below was built and anchored on ezirim et al. (2006) and ogunbiyi and abina (2017). before arriving at a conclusive decision about a particular technique to be used, stationarity test was first conducted to ascertain the linearity of the trend and reliability of the data and if the data can be used or not for estimation or forecasting in the long run. this stationarity test was conducted using philip perron (pp) unit root tests, the data for the study was compiled and computed from the annual statistical bulletin of the central bank of nigeria, while the time scope for the study is between the period 1981-2018. 3.2. model specification 3.2.1. functional model rxde= f (fivt, exhr, exre, iop) (1) 3.2.2. econometric model thus, the econometric form of the equation 1 is stated as follows: the equation 1 was further transformed to equation 2 by taking the log value in model one: lnrxde= b0 + b1lnfivtt+ b2lnexhrt+1+b3lnexre t+1+ b4iop t+1+ ϒt (2) apriori = b1>0, b2>0, b3>0, b4<0. where: rxde =external debt to total exports ratio (percentage of export that are being financed by external debt. fivt= foreign investment to total exports ratio (percentage of export that are being financed by foreign investment). exhr=real exchange rate. exre=ratio of external reserve to export (percentage of external reserve that are being financed by export). iop =inflationary pressure. ln =log. t+1 =lag period. ϒt=stochastic error term. on the basis of the results gotten from the unit root test, the autoregressive distributive lag (ardl) could be designed thus; the equation 3 represents the ardl model which is a statistical tool used when stationarity level is missed. ∑ ∑ (3) where: xt = dimension of 1(1) variable which are not stationary. ß1 = represent the matrix which makes autoregressive process stable. = error term. 4. presentation and analysis of result table-1. unit root test output. variables pp stat critical val. at 5% p-value order of integration rxde -4.316377 -3.557759 0.0090 1(0) fivt -5.382512 -3.557759 0.0006 1(0) exhr -3.562882 -3.562882 0.0501 1(1) exre -8.086545 -3.562882 0.0000 1(1) iop -6.627304 -3.562882 0.0000 1(0) source: extraction from e-views output. the condition for autoregressive distributive lag (ardl) as stated in the model above is validated from the result above, since the result in table 1 from the stationarity test is mixed stationarity was identified in this order; asian journal of economics and empirical research, 2019, 6(2): 101-107 105 © 2019 by the authors; licensee asian online journal publishing group in the order of 1(1) and 1(0) integration, that is the variables under investigation were stationary at exre and exhr were stationary at the order of 1(1) while rxde, fivt and iop became stationary at level 1(0). table-2. heteroskedasticity test. heteroskedasticity test: harvey f-statistic 7.377041 prob. f(4,25) 0.3715 obs*r-squared 16.24059 prob. chi-square(4) 0.6827 scaled explained ss 14.36647 prob. chi-square(4) 0.9462 source: extraction from e-views output. the residual and normality in the model will be checked via the result of the heteroskedasticity test table 2, with an estimated sample of 25 shows a probability level of 0.3715 which is greater than the 0.05 significance level, the observed r2 exhibit a coefficient of (16.24059) which is greater than 0.05%, this leads to the acceptance of the null hypothesis which shows that there is an existence of heteroskedasticity in the employed study model showing that variables are influenced from the error term more than internally and it also validates the clrma assumption. table-3. presentation of bound test co-integration output. ardl bounds test date: 04/03/19 time: 13:37 sample: 1981 2018 included observations: 38 null hypothesis: no long-run relationships exist test statistic value k f-statistic 7.986137 4 critical value bounds significance i0 bound i1 bound 10% 2.45 3.52 5% 2.86 4.01 2.5% 3.25 4.49 1% 3.74 5.06 source: extraction from e-views output. from the result of table 3, since the f-statistics of 7.986137 is greater than the upper and lower bound statistics at all levels (1%-10%), the null hypothesis will further be rejected, therefore we can conclude that there is a long run association between the variable under investigation. table-4. autoregressive distributive lag (ardl) . dependent variable: rxde method: ardl date: 04/03/19 time: 23:05 sample (adjusted): 1981 2018 included observations: 48 after adjustments maximum dependent lags: 3 (automatic selection) model selection method: akaike info criterion (aic) dynamic regressors (1 lag, automatic): fivt exhr exre iop fixed regressors: c number of models evaluated: 48 selected model: ardl(1, 0, 1, 1, 0) note: final equation sample is larger than selection sample variable coefficient std. error t-statistic prob.* rxde(-1) 0.605073 0.141164 4.286324 0.0003 fivt 0.002181 0.002493 0.874698 0.3904 exhr 0.013822 0.006224 2.220799 0.0361 exhr(-1) -0.017429 0.007012 -2.485383 0.0203 exre 0.012507 0.003093 4.043870 0.0005 exre(-1) -0.006861 0.003557 -1.929126 0.0656 iop -0.005597 0.007618 -0.734636 0.4697 c 0.264099 0.474778 0.556258 0.5832 r-squared 0.859961 mean dependent var 1.417000 adjusted r-squared 0.819116 s.d. dependent var 1.444972 s.e. of regression 0.614553 akaike info criterion 2.076474 sum squared resid 9.064202 schwarz criterion 2.442908 log likelihood -25.22358 hannan-quinn criter 2.197937 f-statistic 21.05441 durbin-watson stat 1.942748 prob (f-statistic) 0.000000 . *note: p-values and any subsequent tests do not account for model selection. source: extraction from e-views output. 4.1. global and relative analysis the long run dynamic relationship is shown in the table 4, it was discovered from the result above that two of the indicators used above (fivt and iop) at level has positive but insignificant relationship with rxde while exhr (-1) has negative but significant relationship with rxde, exre (-1) has negative and an insignificant asian journal of economics and empirical research, 2019, 6(2): 101-107 106 © 2019 by the authors; licensee asian online journal publishing group relationship with rxde. exhr and exre has positive and significant relationship with rxde. the global statistics has it that the co-efficient of determination which is the (r2) r-squared is 86% which means the model is fit and the variable jointly account for about 86% while the remaining 14% is not accounted for in the model. the f-statistics (21.05441) alongside the p-value 0.000000 established that inter-relationship exist between external debt, exchange rate, foreign investments and economic growth in nigeria. the implication of this result will be further analyzed below so as to cushion the effect of debt crises in the country. foreign investment to total exports ratio (fivt) was revealed to have a positive (co-efficient of 0.002181) and an insignificant relationship (p-value 0.3904) with external debt to total exports ratio (rxde), this means for every one percent increase in fivt, (percentage of export that is been financed by foreign investment) there will be about 0.002181% increase in the percentage of export that is been used to finance external debt these result agrees with our apriori expectation stated in the model. this means the more foreigners invest in the economy the more their funds will be used to finance production of goods and services produced in the country for export purpose and part of the proceed that is gotten from the exportation of goods and services that will be used to finance debt taking from international financial institutions. foreigner’s invest their foreign currency which is to be converted to domestic currency this will also improve and boost the foreign exchange market of the home country. as expected naira real exchange rate (exhr) has a positive (co-efficient of 0.013822) and a statistical significant relationship (p-value of 0.0361) with rxde in the short run, this means for every one percent increase in exhr it will lead to an increase of about 0.013822% to (rxde) the percentage of exports that are being financed by external debt, but in the long run exhr (-1) has a negative (co-efficient of -0.017429) and an insignificant relationship with percentage of exports that are being financed by external debt (rxde), this means the fluctuation in the value of exchange rate negatively affects the prices of goods and services but since the probability shows that it’s significant that means there is every possibility that exchange rate if properly managed and attain stability it will boost export and in turn help to increase the percentage of exports that are being financed by external debt. the ratio of external reserve to export (exre), it can be seen that the percentage of external reserve that are being financed by export had a positive (co-efficient of 0.012507) and a significant relationship (p-value 0.0005) with rxde, this means for every one percent increase in exre there will be a corresponding increase of about 0.012507% in the proportion of external debt to total exports ratio, this agrees with the apriori expectation stated above, while in the long run exre(-1) has a negative (co-efficient of -0.006861) and an insignificant relationship (with a p-value of 0.0656), this means for every one percent increase in the proportion of external reserve that are being financed by export there will be a reduction of -0.006861% in the percentage of export that is being financed by external debt. it can be deduced that in the short run proportion of external reserve that are being financed by export will contribute positively and significantly to the proportion of export that are being financed by external debt, while in the long run it was discovered that the external reserve is weak and does not have the capability to finance production of goods and services as well as reduce the percentage of exports that are being financed by external debt. inflationary pressure (iop) has a negative (-0.005597) and insignificant relationship (p-value 0.4697) with rxde, this means for every one percent increase in iop it will lead to a reduction of about -0.005597 in the percentage of export that is used to finance external debt. this implies that inflationary pressure affects the volume of goods and services that are to be produced for export purpose, it also affects naira exchange rate between two countries. 5. concluding remarks and policy recommendations this paper investigates external debt, exchange rate, foreign investments and economic growth interrelationships. further empirical evidence from nigeria. the data for the study was compiled and computed from the annual statistical bulletin of the central bank of nigeria, within the period 1981-2018, the data for the study attained stationarity at mixed level after applying the phillips perron unit root tests, after carrying out various diagnostic tests to ascertain how reliable and useful the data generated will be for analytical purposes. the paper further made use of autoregressive distributive lag bond test was then used as the statistical technique for decision making, it was revealed that foreign investment to total exports ratio has a positive and an insignificant relationship with external debt to total exports ratio. as expected naira real exchange rate has a positive and a significant relationship with external debt to total exports ratio in the short run, but in the long run naira real exchange rate (-1) has a negative and an insignificant relationship with percentage of export that are being financed by external debt. the percentage of external reserve that are being financed by export had a positive and a significant relationship with percentage of exports that are being financed by external debt, while in the long run, the ratio of external reserve to export (-1) has a negative and insignificant relationship with external debt to total exports ratio. finally, inflationary pressure (iop) has a negative and insignificant relationship with percentage of export that are being financed by external debt, the result accepts the harrod domar growth model discussed above on how investment increase the capital stock of nations. based on the result of the ardl it does appear that there is need for foreign investors to participate in the country and for this to 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investment: evidence from a developing country nwaiwu, johnson nkem faculty of management science, university of port harcourt, port harcourt, rivers state, nigeria abstract this work is licensed under a creative commons attribution 3.0 license asian online journal publishing group 1. introduction the relationship between corporate governance structure and institutional investment has evoked much interest among researchers. while some studies revealed a positive relationship between the two constructs (see (john and sembet, 1998; abdullah, 2006; li et al., 2006; nguyen and faff, 2006). others indicate a negative (jennings, 2005; wymeersch, 2006; zubarira, 2006); and still others (sanda et al., 2005; brown and caylor, 2006; gregory and simmelk, 2007) establish no relationship between corporate governance structure and institutional investment. though a positive relationship between corporate governance, and institutional investment has prevailed in many studies (abarbanell et al., 2003; ihendinihu, 2009), results still remain inconclusive (ogbowu, 2014). such inconclusiveness creates ground for further investigation. corporate governance has been the subject of numerous theoretical and empirical studies especially after the fraudulent financial reporting scandals such as enron, world.com, adelphia, parmalat, tyco, aig, global crossing, hih insurance, lever brothers, and the eight nigerian banks of 2009, have increased attention and concerns about corporate governance. these corporate meltdowns raised the consciousness of regulators and policy makers to the negligence or weakness of corporate governance/organizations. corporate governance refers broadly to the systems or structures (internal and external) – processes, rules, regulations and control mechanisms – that govern the conduct of an organization for the benefit of all stakeholders. an effective corporate governance, for example, creates organizational efficiency by (see (dockery and herbert, 2000)), pacifying the rights and responsibilities of owners (shareholders); employees (managers and staff) and third parties (woidtke, 2002; miller, 2004). balancing shareholder interests with those of other key stakeholder groups, including customers, creditors, government and communities (klapper and love, 2004); ensuring that the organization operates in accordance with the best practices and accepted ethical standards (aaboan, 2006; ow-yong and kooi, 2006); instituting incentive and control techniques to mitigate abuse of corporate power and other egregious frictions and distortions within the firm (sanda et al., 2005). in short, effective or good corporate in recent times, the corporate governance structure debate has tended to expand the objective of business beyond the maximization of shareholders’ wealth to include discharge of duty to the society. this study examines the influence of corporate governance structure and institutional investment of 32 listed companies on the nse, covering the period of 2006-2010. the postulated hypotheses were tested, using multiple linear regression (mlr) analysis. the empirical results showed no significant influence between corporate governance and institutional investors. rather, institutional investors exert a significant and, positive influence on corporate governance structure. the studies advocate that given more attention to the large institutional investment, since there is a positive relationship between corporate governance structure and the whole number of institutional investors. and a negative influence between corporate governance structure and volume of institutional investors. to have better monitoring by large institutional investors, they should set up board of investee companies in order to have wider bird’s view image the capital market authority and nse should set regulations that prevent a percentage holding of share in the companies to protect the control by few institutional investors. the study also recommends further investigations into the influence of corporate governance structure and institutional investors, using larger sample size, covering more years, and including particularly the banking sectors that has witnessed major reforms since 2005 and plays a critical role in the economic development of nigeria. keywords: corporate governance structure, developing country, institutional investment, number of institutional investors, value of institutional investors, nigeria, quoted companies. http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2014, 1(2): 48-56 49 governance is the joining of both the letter and spirit of the law to achieve all of the above (see also (moshirian et al., 2006; carleton et al., 2007; javed and iqbal, 2007; blanca et al., 2009)). despite these governance and rapid changes regarding who owns firms and how they go about imposing pressure on boards and managers to act in specific ways, our empirical knowledge of the effect of different forms of firm owners and how they affect firm outcomes is advancing rather slowly especially in emerging economics. the introduction of institutional investors in nigeria programme raises empirical concerns. first, as a new phenomenon, there is no literature evidence of its adoption in any other country companies’ policy. consequently, the institutional inventors’ model has not been subjected to any empirical analysis to determine its superior performance efficacy visà-vis extent models used hitherto in nigeria and in other climes. although the investors’ method bears some of the characteristics of brada (1996) second and third methods, there are however distinguishing features. although, we shall empirically differ a more complete statement of the institutional investor organizational framework until section 2.3, suffice it observe here that under the nigerian listed companies policy, on investor is characterized as one who possess the simultaneous complementarily technical know-how (ihendinihu, 2009) financial capacity (maxwell, 2011) managerial competence (nwaiwu and dan jumbo, 2014) to turn around the fortunes of the companies. on the relationship between corporate governance and institutional investment in nigeria, the mixed evidence inherent in previous studies (see (adenikinju and ayovinde, 2001; sanda et al., 2005; ogbowu, 2014) makes further empirical investigation imperative. the aim of this paper is to empirically bring to the mainstream of the study of corporate governance analysis, the stylized institutional investors. in the 1990’s, nigeria started the experimentation of institutional investors model ostensibly as a panacea to the unrelenting corporate governance and performance failures in the country’s quoted companies. this study delineates the conceptual and practical issues in corporate governance and evaluates its institutional efficacy as both as ownership structure and corporate governance mechanism. through this, we seek to enrich the existing literature by bringing into the mainstream discourse and testing the hypotheses concerning the relationship between corporate governance and institutional investment drawing on the experience of nigeria. the remainder of this paper is structured as follows: section two provides the theoretical framework and review the literature related to the phenomenon of interest. section three presents the methodology, section four analyses the data and discusses the results while section five concludes the paper and makes recommendations. 2. review of related literature 2.1. theoretical framework the contextual background to the study of corporate governance structure generally is traceable to international concerns about the possible adverse consequences of the separation of ownership rights and control rights in a modern corporation. smith (1776) provides the antecedent framework in this regard, followed by veblen (1924) who canvassed for the transfer of control from capital – owners to engineer – managers in the belief that such would lead to consequential growth and economic importance of diffuse corporate ownership. however, systematic inquires into the effect of corporate governance structure on the value of institutional investors and number of institutional investors are rooted in the seminal works of berle and means (1932) whose concern was on the adverse effect of the separation of owners and control on institutional investment of firms. these early concerns set the tone and context for modern explication of the agency perspective and systematic enquiry into the influence of corporate governance structure on investment outcomes. the agency theory postulates behavioural attribute of the economic man with respect to transactional characteristics as a devious, self-interest seeking being with divergent, opportunistic and suboptimal pursuit different from efficiency goal pursuit of the firm (dockery and herbert, 2000). the corporate activities in the corporate governance structure in corporate reporting literature is that absent monitoring and other incentive stratagems, managers are likely to promote opportunism with guide, display sensitivity to divergent expectations and other expose manifestations of moral hazard to the atmospheric detriment of the firm. the theory further maintains that maximization of firm value/performance will be infeasible under managerial discretions that provide opportunities to expropriate wealth (turnball, 1997). for organizational benefits to be realized require that incentives, monitoring and regulatory devices be institutionalized to checkmate egregious managerial excesses. violation of governance principles can create internal market frictions and moral hazards and these can be mitigated by a strong corporate activity which is often a reflection of firms’ institutional investment. 3. nature and concept of corporate governance structure corporate governance structure broadly refers to the systems or structures (internal and external) – processes, rules, regulations and control mechanisms – that govern the conduct of an organization for the benefits of all stakeholders. an effective corporate governance structure, for example, creates organizational efficiency by (a) specifying the rights and responsibilities of all stakeholders, to it: owners (shareholders), employees (managers and staff) and third parties, (b) balancing shareholder interests with those of other key stakeholders groups, including customers, creditors, government and communities (c) ensuring that the organization operates in accordance with the best practices and accepted ethical standards; and (d) instituting incentive and control techniques to mitigate abuse of corporate power and other egregious frictions and distortions within the firm. in short, effective or good corporate governance is the joining of both the letter and spirit of the law to achieve all of the above (see also (sanda et al., 2005; carleton et al., 2007; javed and iqbal, 2007)). an important objective of corporate governance structure, therefore, is to secure accountability of corporate managers as shareholder’s agents who are provided with authority and incentives to promote wealth-creating strategies (dockery and herbert, 2000). there is, therefore a strong connection between corporate governance structure and institutional investors because the former is considered to be one of the core governance mechanisms asian journal of economics and empirical research, 2014, 1(2): 48-56 50 along with others such as, debt structure, board structure, incentive-based compensation structure, dividend structure, and external auditing (faro et al., 2007). the need for corporate governance derives from the “expectation gap” problem which arises when the behaviour of corporate enterprise falls short of the shareholders’ and other stakeholders’ expectation (achua, 2002). sanda et al. (2005) attribute the phenomenal pre-eminence accorded to corporate governance recently to the increasing incidence of corporate fraud and corporate collapse on a previously unimagined scale; the dominance of the corporation in modern business, occasioned principally by privatization and consolidations; the collapse of socialism and centralized planning and; greedy bosses. the variety of corporate governance structures commonly investigated in extant literature includes the dominant/largest shareholders, diffuse versus concentrated, insider (board or managerial) ownership, institutional owner. the focus of the present study is on corporate governance structure and institutional investment have emerged as the preferred governance mechanisms in nigeria’s differing and conflicting policies on corporate governance through the indigenization programmes (see (federal government of nigeria (fgn), 1972 & 1999)). 4. empirical studies the influence of corporate governance structure and institutional investment has been a subject of several empirical investigations since the seminal work of berle and means (1932). many empirical studies have documented a positive and significant effect (hartzell and sturks, 2002), others’ negative effect (gompers et al., 2003), and some mixed and significant effect between corporate governance structure and institutional investment (claessen and fan, 2002; bushee and noe, 2004). the average conclusion from these studies is that corporate governance structure influences institutional investment. however, contrarian view’s surfaced from firth (1985) and johnson et al. (1995) in new zealand, simon et al. (1992) in malaysia, and carson et al. (2003) in australia, ogbowu (2014) in nigeria, among others about the influence of institutional investment and corporate governance. the findings of these studies do not have positive relationship between institutional investment and corporate governance structure. in fact, carson et al. (2003) aver that institutional investments do not linearly influence corporate governance structure. but ogbowu (2014) argues that institutional investment influence corporate governance, even when there are no distinguishable differences in literature. so far, there appears to be no consistent or discernible empirical evidence about the direction of the influence between corporate governance structure and institutional investment or institutional investment and corporate governance. in the light of this, more empirical evidence or further research is warranted, especially from developing and less developed countries (dldcs) geographical contexts, in particular sub-saharan african countries that have witnessed very little research in this area (bushee et al., 2007; bushee and goodman, 2007). although, empirical literature of most relevant studies examining this effect with their authors are display in webometric analysis in terms of the sample, variables, methodology and results. this seeks to add to the stock of knowledge on the phenomenon of interest. other than these empirical works, surveys have been conducted by various organizations to evaluate the effect between the two issues corporate governance and institutional investors. a study performed by credit lyonnais securities asia. (cisa) in 2002 indicates the existence of the positive link between corporate governance on almost 500 developing economy companies. in a prior study conducted in 2001, clsa generated on index for 495 firms from 25 emerging markets to find out their corporate “governance rankings. this report demonstrated that firms that rank high in this index display better operating and marketing performance. another striking and more recent research was performed by the association of british insurers (abi) in 2008. the aim of that study was to address the two main questions of whether corporate governance enhances institutional investors and whether corporate governance creates value for the uk listed companies. that study utilized a total of 654 companies with 2007 firm-year observations during the period between 2004 and 2007. the results were positive in terms of the influence between the governance system of the firm and it investors. the companies that demonstrated the best governance records were found to outperform others by generating 18% higher investors. other findings showed that a breach of governance best practice led to about one percentage point decline in the firms’ industry adjusted number of investment. table-4.1. webometric analysis of corporate governance structure research. s/n author/year sample explanatory variable dependent variable methodology results 1 mehdi (2007) 24 tunisian firms (2000-2005) corporate governance structure institutional investment panel regression model evidence of a strong relationship between governance and institutional investment. 2 mashcyekhi and buzaz (2008) 240 tehran firms (2005-2006) corporate governance mechanism number of institutional investors multiple regression analysis board size is negatively associated with institutional investors. 3 brown and caylor (2006) 2363 firms (2003) 51 individual governance factor number and value of institutional investors ols regression analysis ten of 51 governance provisions are positively and significantly related to at least one of our two investors’ measures. 4 freeman and reed (2010) 20 californian firm 1999-2003 a new perspective on corporate governance volume and percentage holdings of institutional investment manu whitney u “test” no significant relationship between corporate governance and volume of institutional investors and positive relationship between corporate governance and percentage holdings. asian journal of economics and empirical research, 2014, 1(2): 48-56 51 5 blanca et al. (2009) 21 non-listed firms spain outsider on the board of directors institutional investors multiple regression analysis a positive relationship between outsider on board of directors and institutional investors. 6 kurt (2012) 55 listed companies in illinois ownership structure, audit independence institutional investors ols regression ownership structure and audit independence have significant positive influence on institutional investors. 7 theo et al. (2013) 40 groningen companies board composition institutional investors ols regression find support for a negative influence between the board composition and institutional investors 8 ogbowu (2014) 32 listed companies in nigeria 2004-2008 board size, board independence, shareholders representative in audit committee, size of audit committee, audit committee independence number, volume and percentage holdings multiple regression analysis bard size have a significant influence on number of institutional investors and board independence, shareholders representative in audit committee, size of audit committee and audit committee independence have positive influence on institutional investors. the major reason why the presence of institutional investors in a firm ownership structure is taken into account in this study is due to the significance of these investors in corporate practices. based on mckinsey & company’s 2002 survey, institutional investors are found to prefer investing in companies with sound corporate governance structure. therefore, we try to provide. 5. corporate governance and institutional investors corporate governance has recently received much attention due to adelphia, enron, world.com, failed eight nigerian banks, and other high profit scandals, serving as the impetus to such recent u.s. regulations as the sarbanes – oxley act of 2002, considered to be the most sweeping corporate governance regulation in the past years, and enhancing the long standing bandwagon for increasing shareholder power, according to (hugghebaert and hulle, 2004), corporate governance concerns the development of performing to structures in corporate organization. one of the important dimensions of corporate governance is the creation of effective monitoring of managers, voting by shareholders is a legal exercise for monitoring management. regularly, many questions have been raised if institutional investors should be assigned to an influential role in corporate governance. during the past decades, institutional investors become increasingly important as shareholders. there are two views about institutional investors activism, the one is active monitoring. the opposite view is represented by the “passive monitoring” hypothesis. on the other hand, a study was conducted by david and kochhar (2006), they argued that various institutional obstacles, such as barriers derived from business relationships, the regulatory environment and information processing limitations, may interrupt institutional investors from exercising their corporate governance role. leech (2000) argues that many institutional shareholders do not seek control over companies in which they invest for many reasons, which include the fear of obtaining price sensitive information, so institutional investors are more likely to influence rather than complete control. although, much literature have written about the influence of corporate governance and institutional investment in sub-saharan africa due to the newly established securities markets and the new trend in institutional investment especially the foreign once. very few studies were conducted concerning corporate governance and institutional investment at the nigeria stock exchange (nse), was conducted by maxwell (2011). this study relates corporate governance on a number of institutional investors for companies listed at the nse by considering board of independence as one of governance dimensions, they found that institutional investors is negatively correlated to board of independence that weakens the corporate governance and value of institutional investors at all. they reported that nigerian listed companies have corporate governance that affects information disclosure and transparency that have an inverse effect on institutional investors. another european study was conducted by dim tropouls and asterion (2010) who examine the influence of corporate governance structure (board size, board independence, shareholders representation in audit committee, audit committee and audit committee independence) on number and volume of institutional investors for 97 non-financial firms listed on the athens stock exchange in greece for the year 2000-2004. they use the modified jones model to measure the two variables of institutional investment and consistent with anglo-american countries studies, they found that corporate governance structure does not influence institutional investment rather, institutional investment influence corporate governance structure. prior studies provide evidence on the influence of institutional investors on corporate governance structure. ogbowu (2010) extends this argument by suggesting that institutional investment influences corporate governance structure due to their ability to distribute the work load over a greater number of observers. the majority of the previous literature supports this argument, by finding that institutional investment are strongly associated with level of corporate governance structure (david and kochhar, 2006). all in all, the vast majority of previous empirical findings suggest that boards with a high preparation of independence outside directors enhance the integrity of the financial reporting process and provide assurance to shareholders on the quality of reported earnings. however, while the studies from the u.s.a, u.k, canada and australia, that is anglo-american countries with slender differences in their institutional environments, advocate for asian journal of economics and empirical research, 2014, 1(2): 48-56 52 board independence as essential in ensuring financial reporting quality, the spanish and asian studies draw attention to the argument that different institutional contexts have different needs in corporate governance and there is no one model that fits all environments. base on the literature, this paper empirically attempts to answer the following questions. 1. can corporate governance structure influence value of institutional investors of quoted nigerian companies? 2. does corporate governance structure influence number of institutional investors of quoted nigerian companies? 3. is there any difference between the involvement of institutional investors and corporate governance of quoted nigerian companies? based on the above mentioned questions, the foregoing discussion provides the context for three important hypotheses that track the influence between corporate governance structure and institutional investment, formulated in the null form, to wit: h01: corporate governance structure does not have any significant effect on the value of institutional investors of quoted nigerian companies. h02: corporate governance structure does not have any significant influence on number of institutional investors of quoted nigerian companies. h03: institutional investment does not have any significant influence on corporate governance structure of quoted nigerian companies. figure-1. conceptual framework of corporate governance structure and institutional investment. source: conceptualized by the author (nwaiwu and dan jumbo, 2014) 6. research methodology numerous studies in the literature have investigated on the relationship between corporate governance and institutional investment. some of the studies are conducted as survey (aaboan et al., 2006; brenes et al., 2009), while others are performed as empirical analyses. the study sample was drawn from listed companies on the first tier of the nigerian stock exchange (nse) as compiled by the nse fact book, using the census method of sample selection. the census method eliminates sampling error and provides data on all the individuals in the population (israel, 2009). this approach is in accordance with prior investigations such as okike (1991), sanda et al. (2005), chuntad (2005), liu (2007), kantudu (2008), and ogbowu (2014). further, the adoption of panel data analysis model in this longitudinal study imposed the following requisite characteristics on the sample elements: 1) the companies must have been listed on the first tier of the nse on or before 1 st january 2001 and remained listed throughout the five years understudy. 2) the company’s financial statement must cover the 12 months period ending 31 st december of each calendar year. this condition is consequent upon the criterion that the observations must be captured in periods with fixed and constant intervals between them as espoused by patibardla (2006), omran et al. (2008); suegoshi (2010). the general format of the panel data model specification can be expressed as: yit =  + kxk, i,t + ui, t --------------(1) where by the dimension of cross-sectional units are represented by i and that of time-series is represented by t. yit denotes the institutional investment measure, which is the dependent variable of the model; k represents the parameters to be estimated with k = 1, 2, 3, 4, 5, showing the independent variables; ui, t represents the stochastic error term. the multiple regression procedure is utilized based on the results of the modified regression test for heter oskedastcity (woolridge, 2003). furthermore, the different models used are not found to suffer from serial regression based on the results of the wooldridge test for auto regression (woolridge, 2003). corporate governance structure board size (bs) board independence (bind) shareholders rep. in audit committee (srac) size of audit committee (sac) audit committee independence (aci) institutional investment value of institutional investors (vininv) number of institutional investors (nininv) asian journal of economics and empirical research, 2014, 1(2): 48-56 53 7. empirical results the central research question to be investigated in this section is whether there is a significant causal link between corporate governance structure and institutional investment among quoted nigerian companies. hypothesis 1: the effect of corporate governance structure on the value of investment in quoted nigerian companies. table-7.1. the effect of corporate governance structure on the value of institutional investment in quoted nigerian companies variables/test statistic linear exponential semi-log double-log constant 3.936e8* (.695) 16.883*** (8.979) -2.215e9*** (-3.857) 9.270*** (4.981) x1: board size 3.183e7* (1.490) .030* (.423) 3.127e8* (1.491) .182* (.268) x2: board independence -1.6344e8* (-.407) -.959* (-.719) -1.160e8* (-.506) -.810* (-1.091) x3: shareholders representatives in audit committee 1.205e8* (.194) -.388* (-.944) 3.365e8* .915 -1.682* (-1.411) x4: size of audit committee 1.402e8* (1.666) 1.062*** (3.801) 6.780e8* (1.496) 6.025*** (4.101) x5: audit committee independence -1.740e9*** (-2.878) -2.870* (-1.430) -1.280e9*** (12.805) -1.991* (-1.346) r: .697 .726 .701 .744 r 2 .486 .527 .491 .554 adjusted r 2 .388 .436 .394 .468 std error of the estimate 3.10854e8 1.03200 3.09338e8 1.00260 f – ratio 4.924*** 5.801*** 5.024*** 6.456*** durbin – watson 1.862 2.455 1.828 2.407 source: extracted from panel data 2006-2010. note: *** = significant at 1%; ** = significant at 5%; and *= significant at 10% and above. t-values are shown in parenthesis. based on the number of significant variables and the statistical values of the test statistic, the double-log form yielded the best fit and is according used in our discussion. the function produced an r of .744 indicating a strong influence between corporate governance structure on the value of investment in quoted nigerian companies and the identified predictors (x1, x2, ----x5). with an r 2 of .554, our results that corporate governance structure accounts for 55.4% of changes in institutional investment and 44.6% due to other factors. the appropriateness of the model specification is further highlighted by the f-ratio of 6.456 which is significant at 1% probability level. however, board independence, shareholders representatives in audit committee are all shown to have insignificant effect on and are negatively correlated with, the value of institutional investment. this finding is consistent in previous studies by bushee and goodman (2007) who found a positive causal link between corporate governance structure and institutional investment in japan. hypothesis 2: effect of corporate governance structure on number of institutional investors in quoted nigerian companies. in terms of the number of significant variables and the statistical values of the test statistic, the exponential function yielded the best fit and is accordingly used in our discussion. this function produced an r of .489 indicating a weak positive influence between corporate governance structures on number of institutional investors. with r 2 of .240. the study evidenced that only 24.0% of variations in the number of institutional investors’ changes is attributed to changes in the existing corporate governance structure. f-ratio of 1.638 was not significant highlighting the inappropriateness of the model specification. the result revealed that board size, board independence, size of audit committee, audit committee independence is not significant determinants of the number of institutional investors. however, only shareholders representatives in audit committee were significant at 5% level. table-7.2. effect of corporate governance structure on number of institutional investors in quoted nigerian companies. variables/test statistic linear exponential semi-log double-log constant 2.720* (1.410) 1.365* (1.885) 1.922* (.970) .881* (1.185) x1: board size -.081* (-1.114) -.040* (-1.461) -.727* (-1.003) -.386) (-1.420) x2: board independence -908* (.663) .267* (.519) .599* (.757) .201* (.678) x3: shareholders representatives in audit committee -.861* (-2.043) -.389** (-2.458) -2.320* (-1.827) -1.057** (-2.219) x4: size of audit committee .536* (1.870) .210* (1.950) 2.774* (1.772) 1.014* (1.881) x5: audit committee independence -.579* (-.281) -.442* (-.571) -.905* (-.574) -.564* (-.954) r: .433 .489 .417 .477 r 2 .188 .240 .174 .227 adjusted r 2 .032 .093 .015 .079 std error of the estimate 1.05907 .39738 1.06800 .40055 f – ratio 1.203* 1.638* 1.096* 1.530* durbin – watson 2.294 2.308 2.370 2.403 source: extracted from panel data 2006-2010. note: *** = significant at 1%; ** = significant at 5%; and *= significant at 10% and above. t-values are shown in parenthesis. asian journal of economics and empirical research, 2014, 1(2): 48-56 54 we therefore accept our null hypothesis and conclude that corporate governance structure does not have significant influence on number of institutional investors in nigerian companies. these findings offer support to previous studies on corporate governance structure our result is not in concordance with the findings of bushee et al. (2007). but the test result for testing h01h02 does not confirm with the existence of any significant influence of corporate governance structure on any of the components of institutional investment. the values of the durbinwatson statistic are consistently above 2, thereby conforming the existence of multi-collinearnity. we accordingly investigated the effect of institutional investment on corporate governance structure and the result is as shown below: hypothesis 3: effect of institutional investment on corporate governance structure. table-7.3. effect of institutional investment on corporate governance structure of quoted nigerian companies. variables/test statistic eigen coefficients/ (t-values) tolerance vif value constant 12.682*** (8.011) 3.198 value of institutional investment 1.884ea*** (1.564) .911 1.097 .547 number of institutional investors -.338** (-.752) .964 1.037 .196 share % holding by institutional investors .071*** (3.244) .925 1.082 .059 r .757 r 2 .573 adjusted r 2 .549 standard error of the estimate 80.77524 f-ratio 5.400*** durbin-watson .712 source: extracted from panel data 2006-2010. note: *** = significant at 1%; ** = significant at 5%; and *= significant at 10% and above. t-values are shown in parenthesis. the able table 7.3 provides a puzzling result. contrary to our expectations and results in h01 – h03, it is institutional investment that affects cgs with about 57.3% of the changes in the later being attributable to variations in institutional investment. two of the three measures of institutional investment were shown to have positively and significant influences on corporate governance structure. thus, increases in the value and percentage – holding of institutional investors are most likely to strengthen corporate governance structure. this result stands out as a major contribution of this work, with strong advocacy for enabling environment to attract more institutional investments in nigerian companies. 8. concluding remarks and recommendations the investigation attempts to add to the literature by providing evidence from an emerging market on the influence of corporate governance structure and institutional investment. one of the distinguishing features of this study is the development of additional models to consider the influence of institutional investment. furthermore, the use of panel data analysis enhances the results by empirically investigating the issue from both a cross-sectional and a time series dimension. the main motivation of this study is the lack of empirical evidence regarding issues of corporate governance structure and institutional investment for nigerian listed companies. therefore, the results of our study are critical in terms of providing insight into the influence of corporate governance structure and institutional investment, which is a topic receiving considerable attention after the recent financial reporting scandals. from the previous analyses, institutional investors are the majority owners of most corporations listed on nse. the results presented in this paper show contradiction findings. in one hand, it revealed a significant positive effect between corporate governance structure and number of institutional investors; this result was found in 2004-2007, but not in 2008. on the other hand, a significant negative effect was between corporate governance structure and volume of institutional investors in 2005-2008 only. these results can be explained in light with some dimensions; board size, board independence, share holders representative in audit committee, audit independence and audit committee independence. the results are somewhat consistent with other studies but are inconclusive findings, results for number of institutional investors and corporate governance structure are consistent with existing evidence, and other variables (volume and percentage holdings) results are somewhat consistent or less consistent due to the weak efficiency in the securities market in nigeria. 9. recommendation  given more attention to the large institutional investment, since there is a positive relationship between corporate governance structure and the whole number of institutional investors. and a negative between corporate governance structure and volume of institutional investors.  it is important to work on knowledge and informative programmes about the good influence of the large number of institutional investors and the bad influence of few large institutional investors who controls boards of investee company, enhancing low governance practices.  to have better monitoring by large institutional investors, they set on board of investee companies in order to have wider bird’s view image  the capital market authority and nse should set regulations that prevent a percentage holding of share in companies to protect the control by few institutional investors.  the study also recommends further investigations into the influence of 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licensee asian online journal publishing group asian journal of economics and empirical research vol. 6, no. 2, 108-112, 2019 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2019.62.108.112 © 2019 by the authors; licensee asian online journal publishing group fiscal policy and growth of real economic activities in nigeria (1980-2016) gbadebo salako1 olusola joel oyeleke2 ( corresponding author) 1,2department of economics, emmanuel alayande college of education, nigeria. abstract several empirical studies have investigated the effect of fiscal policy on various macroeconomic variables such as inflation, debts, interest rates, unemployment and growth (gdp) for diverse economies, using variant methods. this paper examined the influence of fiscal policy on growth of real economic activities in nigeria from 1980-2016, using 2010 as base year to adjust for price level. secondary data sourced from central bank of nigeria (cbn) (2016) were analysed. after verifying the stationarity property of the variables, johansen cointegration test result revealed evidence of long run relationship among public revenues, expenditure, real gdp and inflation. the results from vector error correction method (vecm) showed that government expenditure positively and significantly impacted real economic activities’ growth, but converse was the effect of public revenues on rgdp. the results, therefore, imply that government should cut tax to increase disposable income which has aptitude to enhance real aggregate production in nigeria. keywords: cointegration, fiscal policy, growth, nigeria, real economic activities, vecm. jel classification: e31; o4. citation | gbadebo salako; olusola joel oyeleke (2019). fiscal policy and growth of real economic activities in nigeria (19802016). asian journal of economics and empirical research, 6(2): 108-112. history: received: 12 june 2019 revised: 17 july 2019 accepted: 21 august 2019 published: 9 october 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ............................................................................................................................................................................................................ 109 2. descriptive statistics of variables ..................................................................................................................................................................... 109 3. empirical review ................................................................................................................................................................................................... 109 4. data and methodology ......................................................................................................................................................................................... 110 5. cointegration .......................................................................................................................................................................................................... 110 6. estimation technique ........................................................................................................................................................................................... 111 7. discussion of results ............................................................................................................................................................................................ 111 8. conclusion ............................................................................................................................................................................................................... 112 references .................................................................................................................................................................................................................... 112 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.62.108.112&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/1052 http://asianonlinejournals.com/index.php/ajeer/article/view/1052 asian journal of economics and empirical research, 2019, 6(2): 108-112 109 © 2019 by the authors; licensee asian online journal publishing group contribution of this paper to the literature: this study contributes to the existing literature by examining the effect of fiscal policy on growth of real economic activities in nigeria with particular interest in period after 2008-2009 global financial crisis, using 2010 rebased real gdp. 1. introduction instability of macroeconomic environment confronting economies all over the world is not a new phenomenon. however, in the past few decades, the challenge has worsened and begun to manifest itself in severe forms ranging from plunging purchasing powers, devastating unemployment rate, balance of payment disequilibrium and many more, particularly in developing countries of asia, latin-america and africa. most often, if not well managed, the conditions degenerate to recession such as financial recession of 2008-2009 as the case may be for all economies around the world. several efforts at revamping these disorders have given birth to devising numerous monetary and fiscal policies by authorities. in most of developing economies, nigeria inclusive, fiscal policy relative to monetary policy is preferred by authorities to combat epileptic economic growth, fluctuating foreign exchange earnings, deteriorating unemployment rate, crazy poverty level and even unstable price regimes, among others. the preference is hinged on their belief in theoretical ideology of neo-keynesian economists which emphasizes efficacy of fiscal policy in stabilizing economic activities and most especially moving economy out of recession. also, significance of fiscal policy resides in its connection with basic functions of government in term of allocation and redistribution of resources. hence, not a few empirical studies have documented existence of association between fiscal policy and other macroeconomic variables for various economies (ekpo, 1994; ocran, 2011; ogbole et al., 2011). in nigeria, strategies to secure sustainable economic growth and stable price regime over time, following the perceived ineffectiveness of monetary policy to guarantee the objectives, have lent credence to desirability of fiscal policy. more importantly, discussion on the efficacy of fiscal policy as mechanisms for stimulating economic growth and achieving stable price regime has been unsettled, given the inconsistent results of empirical studies (abu-bader and abu-qarn, 2003; ogbole et al., 2011; oyeleke and orisadare, 2018). more importantly, attempts to secure sustainable economic growth over time and stable price regime aimed at engendering reduction of poverty level, following the perceived ineffectiveness of monetary policy to guarantee the objectives, have lent credence to desirability of fiscal policy in nigeria. therefore, the debate over the efficacy of fiscal policy in wielding positive influence on economic output of nigeria is still ongoing. also, the 2008/2009 global financial crisis which led to economic recession during the same period has made the discussion relevant in nigeria. summary statistics of the variables follows this section, while the remaining part is divided into five sections. next section presents the review of literature while section that follow deals with data and methodology. section four is on model estimation and section five anchors discussion of results. lastly, section six holds conclusion. 2. descriptive statistics of variables jarque-bera statistic tests normality of the residuals with the joint hypothesis that skewness is 0 and kurtosis is 3. jarque-bera’s null hypothesis states that residuals in observations are normally distributed. when computed p-value of jarque-bera is low, null hypothesis that the residuals are normally distributed is rejected and otherwise when it high (gujarati and porter, 2009). from table 1, jarque-bera probability statistics for other variables, except inflation (ifn), show that we could reject their null hypothesis of normal distribution, given their individual p-value of (0.022), (0.161), (0.001), and (0.041) respectively. kurtosis statistics for all variables are not extremely high, signifying thin tails of generated distribution. table-1. descriptive statistics of variables. statistics tge rgdp inf tgr mean 1316.550 17956.69 39.32688 1076.796 median 457.6650 4350.315 25.00820 396.2450 maximum 5185.320 89043.62 145.7960 4031.830 minimum 9.640000 144.8300 0.493799 5.820000 std. dev. 1680.501 25929.83 43.86516 1349.642 skewness 1.153373 1.476472 1.016894 1.038561 kurtosis 2.869747 3.934800 2.875605 2.550797 jarque-bera 7.562230 13.59112 5.881673 6.397976 probability 0.022797 0.001119 0.052822 0.040803 sum 44762.71 610527.4 1337.114 36611.06 sum sq. dev. 93194736 2.22e+10 63497.02 60110579 observations 34 34 34 34 3. empirical review since keynes has emphasized importance of government spending in revamping economy during recession, a wide empirical studies have explored impact of fiscal policy on economic growth for different economies, using panel and time series data. barro (1990) has documented association between public spending and economic growth. also, barro (1991) explores the association between public expenditure and gdp in a cross-country study of 98 countries from 1960–1985. investigating influence of public spending on growth of nigerian economy from 1970-2011, maku (2015) uses engel-granger cointegration test and ols method. results reveals fiscal policy exerts sizable effect on gdp. agu et al. (2015) examine effect of fiscal policy on nigerian gdp from 1961-2010. employing both descriptive and ols methods, the findings show that public expenditure augments growth of gdp in nigeria under the period review. asian journal of economics and empirical research, 2019, 6(2): 108-112 110 © 2019 by the authors; licensee asian online journal publishing group ubesie (2016) explores impact of public financing on gdp of nigeria with data from 1985-2015. using different components of fiscal policy, results from ols method indicates public revenues rather than expenditure wields enormous positive effect on nigerian gdp. employing panel data on g20 countries between 2000-2010, hanusch et al. (2017) discover that public spending on innovation exerts more influence on economic growth rather than any other variables included in the study. on empirical association between fiscal policy and inflation, afonso and jalles (2017) investigates effect of fiscal policy on inflation dynamics on 54 countries from 1980-2013. the findings show a substantial positive association between fiscal policy adjustment and inflation variability. karagöz and keskin (2016) using bayesian vector autoregressive method, explore the impact of fiscal policy on macroeconomic variables in turkey. the study finds that components of fiscal policy have no substantial effect on variables such as gdp, interest rates, external debts, inflation and stock market index. however, investigating whether fiscal policy propel economic growth in eu countries, maşca et al. (2016) find that fiscal policy account for upward trend of economic activities in economies investigated. abata et al. (2012) investigated the impact of fiscal policy on nigerian economy and find that there is positive correlation between the variables. 4. data and methodology secondary data used in this study are sourced from cbn (2016). data include total government revenue (tgr), total government expenditure (tge), real gross domestic product (rgdp) and inflation rate (ifr). inflation is chosen as control variable, given the rebase of the real economic activities of nigeria in year 2010. before, year 2010, nigerian economy had been using 1990 general price level for real economic activity determination. this study follows maku (2015) model, though with modifications, to examine influence of fiscal policy on growth of real economic activities in nigeria. the production model is, therefore, given as: rgdp = f(k, l) (1) where rgdp is real economic activities in nigeria, k represent capital and l stands for labour. in econometric form, while introducing tge, tgr and ifr instead of capital and labour as production factors, and white noise disturbance term, equation 1 is written as follow: rgdp = + tge + tgr + r + (2) where is error term capturing the influence of unidentified variables. stating equation 2 in log form to address transformation since inflation is included among the variables, hence, the equation 2 becomes: lnrgdp = + tge + lntgr + ifr + (3) using var method, equation 3 could be written in equation 4, given that policy implemented in previous years produce effect on the current economic activities as well, therefore a dynamic model: ∑ (4) where represents first difference operator, i stands for lag length and p is the maximum lag length distribution. and the coefficients to be estimated. table-2. unit root test results. variable adf pp level first difference level first difference ifr 1.14724 -3.47145*** 2.9231 -3.71297* lrgdp 1.2445 -3.3129* 4.4709 -3.0462** lexp 3.23419 -3.8085** -1.3266 -7.2030* lrev -0.18744 -5.1589* -0.31825 -5.2917* note: *, ** and *** denoted 1%, 5% and 10% significance levels respectively. from table 2, results of adf test show that inf, lnrgdp, lntge and lntgr are first difference variables at 1%, 5% and 10% level of significance respectively. similarly, the results of pp also reveal that all variables are first difference variables at 1% and 5% levels of significance, suggesting that the variables are i(1) process. since the variables have the same order of integration, i.e. first difference series, i(1), then vector autoregressive (var) method is applicable. 5. cointegration after stationarity properties and integrating orders of variables have been obtained, the next thing is to proceed to testing cointegration among the variables. cointegration is performed to define if there is long run relationship among the variables. to achieve this, johansen and juselius (1990) cointegration technique is employed. null hypothesis designates no cointegrating relationship, while alternative hypothesis denotes presence of equilibrium. if probability value of the calculated test is larger than 0.05, is not rejected and it is interpreted there is no cointegration relationship between the series. table 2 presents the johansen cointegration test results. it shows there are three cointegrating equations in the system, indicating evidence of long run relationship amongst the variables. null hypothesis of no cointegrating among the variables is therefore rejected, using mackinnon et al. (1999) p-values. table-3. cointegration results (with a linear) where r is the number of co-integrating vectors. trace test 5% hyp. max-eng. 5% hyp. 120.4359 49.30158 47.85613 r = 0* 29.79707 r ≤ 1* 71.13432 31.37470 27.58434 21.13162 r = 0* r ≤ 1* 17.92688 15.49471 r ≤ 2* 17.89042 14.26460 r ≤ 2* 0.036454 3.841466 r ≤ 3 0.036454 3.841466 r ≤ 3 source: authors computation, 2019. asian journal of economics and empirical research, 2019, 6(2): 108-112 111 © 2019 by the authors; licensee asian online journal publishing group 6. estimation technique as revealed in table 1, unit root test results show integration of all variables is i (1), likewise table 2 shows there exits three cointegrating equations among the variables. thus, the study adopts vector error correction model (vecm) to estimate short run effect among real gdp, total government spending, total government revenue and inflation. vecm is general dynamic specification which applies lag of endogenous and the lag of contemporaneous exogenous variables simultaneously. it is restricted var technique of estimation which provides both contemporaneous and lagged information about short run dynamic effect of all variables as endogenous. it also indirectly presents long run relationship among variables. therefore, vec model is specified for three cointegrating equations as: equations 5, 6 and 7 are specified in vec models to analyse effect of fiscal policy on real growth of economic activities in nigeria between 1980 and 2016. all the variables are as described above. ecm is the error correction term that measures the adjustment of the dependent variable back to equilibrium, in case of any distortion. γ, and are the coefficients of error correction terms respectively. 7. discussion of results from table 4, in the short run, expenditure variable lagged by one year statistically significantly influenced the variation occurred to real gdp, given the t-statistic value (5.150). this empirical incidence is in consonance with keynesian’s postulation which encourages government to spend more for economy to grow, especially during recession. the result is consistent with findings of medee and nenbee (2011) and maşca et al. (2016) for eu countries. again, it is evident that the past two years’ value of rgdp provides effect on the present value of itself. this is evident in the t-statistic value of rgdp lagged by 2. similarly, government expenditure lagged by two years with t-statistic value (2.519) exerts positive and statistically significant influence on the current performance of government revenue in the economy of nigeria. this implies that, to a reasonable extent, the previous government spending is enhancing present government revenue generation. the evidence suggests that government has been investing part of its expenditure in nigeria. table-4. vector error correction results. model variable δ(lnrgdp) δ(lntge) δ(ifr) δ(lntgr) c 309.8227 270.9401* 0.933849 229.2935* [ 1.42607] [ 6.20769] [ 1.46745] [ 3.69496] δ(lnrgdp(-2)) 0.686527* 0.097022 0.115242* [ 4.87531] [ 3.42960] [ 2.86515] δ(lntge(-1)) 4.517040* -0.214520 [ 5.15038] [-0.85633] δ(lntge(-2)) 1.102928* 0.847431* [ 4.66150] [ 2.51910] δ(ifr(-1)) 278.2362* 0.671954* -4.610655 [ 3.74595] [ 3.08849] [-0.21732] δ(ifr(-2)) -223.9109* -53.14348* [-2.69095] [-3.17913] δ(lntgr(-1)) -5.825155* -1.501392 -1.295405* [-5.32731] [-6.83475] [-4.14759] δ(lntgr(-2)) -0.076379 -1.616278 -1.710994* [-0.05404] [-5.69261] [-4.23843] -0.017961 -0.017110* 7.20e-07 -0.013443* [-1.75227] [-8.30916] [ 0.02398] [-4.59141] r-squared 0.973407 0.853138 0.852241 0.644500 adj. r-squared 0.962009 0.790197 0.788915 0.492143 f-statistic 85.40784 13.55458 13.45812 4.230194 note: t statistics in parentheses. *, **and *** denotes significance at 10%, 5% and 1% level respectively. furthermore, immediate past year inflation rate positively and significantly impacts rgdp of nigerian economy, given its t-statistic value (3.746), while two-year inflation value (-2.910) provides negative significant asian journal of economics and empirical research, 2019, 6(2): 108-112 112 © 2019 by the authors; licensee asian online journal publishing group effect on the economy. the implication of this result is that it takes two solid years before persistent rise in price level could reduce economic activities in nigeria. this finding conforms with the theory that increased general price level discourages growth of output. in another development, total government revenue exerts negative but statistically significant effect on real gross domestic product in nigeria, owing to its negative t-statistic value (5.327). it could therefore be inferred that government revenue constitutes withdrawal from the economy, mopping up funds available for private investments in the economy. this finding is in tandem with the results of cooray (2009); ocran (2011) for south africa, and ebimobowei (2010). in summary, given the findings of this study, it is evident that fiscal policy influences the variability that occurred to real gross domestic product in nigeria within the period under review. 8. conclusion this paper examined the relationship between fiscal policy and real aggregate output in nigeria from 1980 to 2016. having verified the stationarity property of the variables and discovered that all were i(1) process, equilibrium was established among the variables as well. using vector error correction methodology (vecm), the findings revealed that fiscal expansion i.e. government expenditure supported the growth of aggregate output while government revenue as withdrawal clamped down on economy. generally, the study found that fiscal policy exerted statistically significant effect, both positively and negatively on economic output in nigeria during the period under review. the findings, therefore, are in consonance with the keynesian theoretical argument that government revenue generated through taxes constitutes withdrawals from economy, while increase in government spending promotes economic activities, most especially during recession. references abata, m.a., j.s. kehind and s.a. bolarinwa, 2012. fiscal/monetary policy and economic growth in nigeria: a theoretical exploration. international journal of academic research in economics and management sciences, 1(5): 75-88. abu-bader, s. and a.s. abu-qarn, 2003. government expenditures, military spending and economic growth: causality evidence from egypt, israel, and syria. journal of policy modeling, 25(6-7): 567-583.available at: https://doi.org/10.1016/s0161-8938(03)00057-7. afonso, a. and j. jalles, 2017. fiscal activism and price volatility: evidence from advanced and emerging economies (no. 2017/04). iseglisbon school of economics and management, department of economics, universidade de lisboa. agu, s.u., i.m. okwo, o.d. ugwunta and a. idike, 2015. fiscal policy and economic growth in nigeria: emphasis on various components of public expenditure. sage open, 5(4): 2158244015610171.available at: https://doi.org/10.1177/2158244015610171. barro, r.j., 1990. government spending in a simple model of endogenous growth. journal of political economy, 98(5): 103-126. barro, r.j., 1991. economic growth in a cross section of countries. the quarterly journal of economics, 106(2): 407-443.available at: https://doi.org/10.2307/2937943. central bank of nigeria (cbn), 2016. statistical bulletin. cooray, a., 2009. government expenditure, governance and economic growth. comparative economic studies, 51(3): 401-418.available at: https://doi.org/10.1057/ces.2009.7. ebimobowei, a., 2010. an evaluation of audit expectation gap: issues and challenges. international journal of economic development research and investment, 1(2): 129-141. ekpo, a., 1994. public expenditure and economic growth in nigeria 1960 to 1992: final report. nairobi: africa economic research consortium (aerc). gujarati, d.n. and d.c. porter, 2009. basic econometrics. 5th edn., new york: mcgraw hill inc. hanusch, h., l.s. chakraborty and s. khurana, 2017. fiscal policy, economic growth and innovation: an empirical analysis of g20 countries (no. 883). working paper. johansen, s. and k. juselius, 1990. maximum likelihood estimation and inference on cointegration—with applications to the demand for money. oxford bulletin of economics and statistics, 52(2): 169-210.available at: https://doi.org/10.1111/j.14680084.1990.mp52002003.x. karagöz, k. and r. keskin, 2016. impact of fiscal policy on the macroeconomic aggregates in turkey: evidence from bvar model. procedia economics and finance, 38: 408-420.available at: https://doi.org/10.1016/s2212-5671(16)30212-x. mackinnon, j.g., a.a. haug and l. michelis, 1999. numerical distribution functions of likelihood ratio tests for cointegration. journal of applied econometrics, 14(5): 563-577.available at: https://doi.org/10.1002/(sici)1099-1255(199909/10)14:5<563::aidjae530>3.3.co;2-i. maku, o., 2015. fiscal policy and economic growth: a study on nigerian economic perspective. journal of economics and sustainable development, 6(15): 86-92. maşca, s.g., i.c. cuceu and v.l. văidean, 2016. the fiscal policy as growth engine in eu countries. 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journal of economics and finance, 10(7): 99-107.available at: 10.5539/ijef.v10n7p99. ubesie, c.m., 2016. the effect of fiscal policy on economic growth in nigeria. journal of finance and accounting, 4(3): 140-145.available at: https://doi.org/10.11648/j.jfa.20160403.16. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. asian journal of economics and empirical research issn(e) : 2409-2622 issn(p) : 2518-010x vol. 3, no. 1, 122-129, 2016 http://asianonlinejournals.com/index.php/ajeer 122 labour utilization and productivity of primary health care programmes of beneficiaries in north-east benue, nigeria ater p.i.1 odoemenem i.u.2 ama i.i.3 1,2,3 department of agricultural economics, university of agriculture makurdi, makurdi, benue state, nigeria ( corresponding author) abstract this study assessed labour utilization and productivity of primary health care beneficiaries in the northeastern zone of benue state, nigeria. data where sampled from 140 beneficiaries and 100 non beneficiaries making pooled sample size of 240 respondents. both secondary and primary data were used for this study. the result revealed that beneficiary respondents recorded higher productivities for maize (1.81 tons/ha), rice (2.84 tons/ha), guinea corn (2.39tons/ha), yam (1.42tons/ha), cassava (2.29tons/ha), pepper (1.49tons/ha), melon (1.87tons/ha), bambaranut (1.81tons/ha) and beniseed (2.42tons/ha) when compared with the output of non beneficiaries in soyabeans (1.21tons/ha), groundnut (0.85tons/ha), potato (1.13tons/ha), tomato (0.52tons/ha) and cowpea (0.94tons/ha). the study further revealed that on the average, beneficiary respondents worked on their farms 10 times/week, while non beneficiary respondents worked for 7 times/week indicating that the beneficiaries worked for higher number of times and hours on their farms per week when compared to non beneficiaries. beneficiary respondents also worked for higher number of hours (9 hours) when compared to the non beneficiaries (6 hours). similarly, the number of times sampled respondents had fallen sick within the past three years showed that on the average beneficiary respondents had fallen sick for 5 times, while non beneficiary respondents fell sick for up to 10 times within the past three years. the number of days a farmer stayed at home/hospital on the basis of health stood at an average of 11 days per household for beneficiary respondents, while non beneficiary respondents had 26 days. the result for the study showed that 84% and 68% of beneficiary and non beneficiary respondents used hired labour. respondents who did not use hired labour made used of family labour or did the farm work themselves. however, a greater majority of sampled beneficiary (66%) and non beneficiary respondents (70%) had malaria attack suggesting that malaria is a major sickness that seriously affected farmers’ health in the study area when compared to other sicknesses. respondent’s major constraints were high input cost, high cost of tractors and hire services which should be subsidized to encourage mechanized agriculture in the area. farm inputs such as quality seeds and seedlings and fertilizer should also be sold at a cheaper rate to farmers to further boost their farm outputs. it is recommended that primary healthcare services be extended to all communities at reasonable affordable rate in addition to mechanized tractor hire services along side improved inputs supply for better productivity and healthier rural labour force. keywords: primary healthcare services, output, labour productivity, beneficiaries, non beneficiaries. contents 1. introduction ....................................................................................................................................................................... 123 2. literature review .............................................................................................................................................................. 123 3. methodology....................................................................................................................................................................... 124 4. results and discussion ....................................................................................................................................................... 124 references .............................................................................................................................................................................. 128 citation | ater p.i.; odoemenem i.u.; ama i.i. (2016). labour utilization and productivity of primary health care programmes of beneficiaries in north-east benue, nigeria. asian journal of economics and empirical research, 3(1): 122-129. doi: 10.20448/journal.501/2016.3.1/501.1.122.129 issn (e): issn (p): 2409-2622 2518-010x licensed: this work is licensed under a creative commons attribution 3.0 license contribution/acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained ethical: history: this study follows all ethical practices during writing. received: 25 may 2016/ revised: 23 may 2016/ accepted: 23 june 2016/ published: 25 july 2015 publisher: asian online journal publishing group http://creativecommons.org/licenses/by/3.0/ http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.122.129 https://orcid.org/orcid-search/quick-search?searchquery=ater p.i. https://orcid.org/orcid-search/quick-search?searchquery=odoemenem i.u. https://orcid.org/orcid-search/quick-search?searchquery=ama i.i. http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.122.129 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.122.129 https://orcid.org/orcid-search/quick-search?searchquery=ater p.i. https://orcid.org/orcid-search/quick-search?searchquery=odoemenem i.u. https://orcid.org/orcid-search/quick-search?searchquery=ama i.i. http://search.crossref.org/?q=10.20448/journal.501/2016.3.1/501.1.122.129 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501/2016.3.1/501.1.122.129 https://orcid.org/orcid-search/quick-search?searchquery=ater p.i. 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122-129 123 1. introduction the present food shortage in nigeria is attributable to a number of factors. declining productivity and depletion in rural labour-force are highly implicated in the food shortage (oyenuga, 1985). other contributing factors could be instability of government and policy, rural urban migration of able-bodied youths leading to old aged farming population in rural areas and most important of all is death and illness of farmers. furthermore, it has been concluded that bad health condition reduced productivity and generally labour output and thus farmers food output (barlow and grobar, 1986; adewale et al., 2004). the problems of dwindling labour force and productivity notwithstanding, agriculture remains the largest single employer of labour force both directly and indirectly. there is therefore the need to undertake all in depth study of revitalising health programmes meant to ill health and increase the number of man hours available for agricultural production. farmers have for a long time borne the brunt of feeding the nation, but only healthy people can practice agriculture successfully (adewale et al., 2004). by examining farmer’s health status one might be examining important factors affecting economic growth and agricultural productivity. hence, the study broadly identifies prevalent diseases in the study area, describes the health status of the households and examines the effects of the health indices on agricultural output of the households. this is with a view to highlighting the policy implications of our findings. specifically, the research has the following objectives, to: i. assess the influence of primary healthcare services on productivity of different crops enterprise in the study area; ii. examine the influence of primary health care on productive man hours of labour on the farm; iii. ascertain the level of utilization of hired, family and self labour by respondents in the study area; iv. examine respondents responses as victims of most common disease. 2. literature review the success of agriculture livelihoods depends on the health of the workforce, and agricultural production systems can have impact on workers’ health, nutrition, and well-being. the labour market consequences of poor health are likely to be more serious for the poor, who are more likely to suffer from severe health problems. similarly the effect will be more on those working in jobs for which strength and energy is more required, therefore good health is required (strauss and thomas, 1998). this opinion provides an overview of current knowledge of the impact of agriculture on health, based on a review of the relevant studies of agricultural regions throughout the developing world. the long-term impact if ill health include loss of farming knowledge, reduction of land under cultivation, planting of less labour-intensive crops, reduction of variety of crops planted, and reduction of livestock. the ultimate impact of ill health is decline in household income and possible food insecurity that is, a severe deterioration in household livelihood (brieger and guyer, 1990). good health must be seen as both an investment and consumption asset, like agricultural production, in that it has compounding returns. health problems, conversely, may trigger a cycle of lowered agricultural productivity and poor health. at the household level, the investment in health can improve resilience and enhance the ability to cope with emergencies, including ill health. but an investment in health in turn requires an adequate livelihood. access to appropriate inputs (knowledge, land, tools, fertilizer, and seeds) and remunerative markets is necessary to improve the productivity, health, and resilience of farm households (mcneil, 2001). literature has shown that a number of factors can limit the extent to which lost labour time due to illness will reduce farm output though depending on the nature of crop and whether the farmer can fully replace lost labour. when family and hired labour are not perfect substitutes, it is likely to reduce output (antle and pingali, 1994). in cases of temporary disability of a farmer, the household workforce may provide a cushion for the period of absence of the disable member, limiting the loss of output. when illness of a productive household member results in death, this leads to a permanent loss of one source of labour in the farm household. in mozambique, it was found that death of a household head increased the likelihood of the use of child labour (mather et al., 2004). in zambia, increased involvement of children in farming activities in households with an aids death was observed (fasaz/fao, 2003). a household death further affects labour availability as healthy individuals divert their time and energy from the farm to mourn and attend to the funeral and related matters. all these have an impact on agricultural production. when a household member gets sick, arrangements are made to take care of the person and this may further aggravate the household labour situation. in northern zambia, aids-affected households, particularly those headed by women, reduced the total area under cultivation due to labour shortages (food and agricultural organisation (fao), 2003). in tanzania, women spent 60% less time on farming activities taking care of their husbands suffering from aids (rugalema, 1998). in ethiopia, women were found to spend about 100 hours a week which is equivalent to about 4 days nursing aids-affected household members, largely at the expense of their farms (international labour organization (ilo), 2000). this care giving burden can also affect technology adoption, largely because of lack of labour for farm activities. in the tigray region of ethiopia, the opportunity costs of caring for sick family members significantly affect adoption of productivity-enhancing technologies (ersado et al., 2003). beyond the direct impacts due to loss of labour, illness undermines long-term agricultural productivity in a number of ways: when illness leads to long-term incapacitation, households may respond through withdrawal of savings, the sale of important assets (such as jewelry, textiles, breeding animals, farm equipment, and land), withdrawing children from school, or reducing the nutritional value of their food consumption. all of these responses can have adverse effects on the longterm labour productivity of household members. asian journal of economics and empirical research, 2016, 3(1): 122-129 124 3. methodology 3.1. the study area benue state is one of the 36 states in nigeria located in the north-central part of nigeria. its geographic coordinates are longitude 7 0 47’ and 10 0 0’ east and latitude 6 0 25’ and 8 0 8’ north. benue state has a population of 4,780,389 (national population commission (npc), 2006) and occupy a landmass of 35,518km 2 , comprising 23 local government areas which are divided into agricultural zones a, b and c. the climate is tropical manifesting of two distinct seasons. the rainy season is from april to october and the dry season is from november to march. annual average rainfall varies from 1750mm in the southern part to 1250mm in the north. benue state is the food basket of the nigeria because of the abundance of its agricultural resources, with 80% of the population deriving their livelihood from agriculture. crops produced are cassava, yam, rice, beniseed and maize. others include sweet potato, millet, soya beans, sugar cane, oil palm, mango, citrus and bananas. 3.2. population, sampling technique and sample size the population for the study was 12,767 beneficiaries and 9,315 non beneficiaries making a total defined population of 22,080 respondents from 5 different villages in vandeikya and kwande local government areas of benue state. the sample sizes are 140 sampled beneficiaries and 100 sampled non beneficiaries making a total sample size of 240 respondents. sampling methods used include purposive, stratified and simple random techniques. beneficiaries and non beneficiaries of primary healthcare programme in vandeikya and kwande l.g.as were selected by means of simple random sampling using benue state primary healthcare programme list of communities that have benefited and those that have not benefited from primary healthcare programmes, and the national population commission list of households as sampling frame. in the first stage, two (2) local government areas were selected because they have excelled so well in primary health care programmes when compared to other local government areas in the zone (benue state ministry of health, 2013). the second stage involved a random selection of five council wards from each of the two local government areas. furthermore, five (5) different villages were randomly selected from all the five council wards in the third stage. the fourth and the final stage involved sampling of 1.1% of beneficiary and non beneficiary household population in all selected villages using simple random sampling technique to give a sample size of 140 and 100 beneficiary and non beneficiary household respectively. 3.3. method of data collection both secondary and primary data were used for this study. secondary data used include research reports, official statistics from benue state ministry of health, publications in the internet, library materials such as text books and journals. primary data were gathered via questionnaire administered to sampled beneficiary respondents of the two local government areas with the aid of trained enumerators. 3.4. data analysis/model specification simple descriptive statistics, mean, median, mode, percentage, frequency and standard deviation were used to analyse the data. the null hypothesis was tested using student t-test. the t-test analysis 2 2 2 1 2 1 21 n s n s xx t     (1) where: t= calculated standard value x1 and x2 are parameters of interest s1 and s2 are variance for the parameters ∑=summation sign n1 and n2: are sample sizes of relevant variables 4. results and discussion 4.1. influence of primary healthcare services on productivity of different crop enterprises by respondents in the study area analysis in table 1 compared the productivity of different crops obtained by beneficiaries and non beneficiaries. the result showed that, on the average, the beneficiary respondents had about 1.81ton, 2.48tons, 2.39tons, 1.42ton, 2.29tons, 1.21ton, 0.85ton,1.13ton, 1.49ton, 0.52ton, 1.87ton, 1.81ton, 0.94ton and 1.42ton of maize, rice, guinea corn, yam, cassava, soyabeans, groundnut, potato, pepper, tomato, melon, bambaranut, cowpea and beniseed were 1.62ton, 1.04ton, 1.07ton, 1.19ton, 1.18ton, 1.88ton, 1.37ton, 1.22ton, 0.70ton, 1.11ton, 1.20ton, 0.56ton, 1.12ton and 1.25ton respectively. however, the overall output of crops indicates that sampled beneficiary respondents recorded higher output of maize, rice, guinea corn, yam, cassava, pepper, melon, bambaranut and beniseed, implying that beneficiary respondents are healthier and more fit in carrying out farming activities thereby making them to generate higher output per unit. in contrast, the output of rice, guinea corn, cassava, soyabeans, groundnut, pepper, tomato, melon and bambaranut obtained by beneficiaries are significantly different (-3.567 ≤ t ≤ 4.328; p<0.1) from that of non beneficiaries. the result further suggests that primary healthcare services and programmes have made significant impact on labour productivity in the production of rice, guinea corn, cassava, soyabeans, groundnut, pepper, tomato, asian journal of economics and empirical research, 2016, 3(1): 122-129 125 melon and bambaranut. this agrees with the findings of barlow and grobar (1986) that good health status and conditions of farmers increases their productivity and labour. in all cases of higher productivity of beneficiaries, in relation to non beneficiaries, the difference was statistically significant at 10% level of t-statistics. however, non beneficiary’s productivity for soya bean, groundnut, potato and cowpea though higher was not statistically significant even at 10% level of t-test comparison. table-1. summary statistics of the productivity of different crop enterprises cultivated by respondents in east zone of benue state variables (tons) category mean medium mode std dev min max maize beneficiary 1.81 0.79 0.78 2.16 0.03 8.00 non ben. 1.62 0.84 0.06 1.82 0.03 6.00 rice beneficiary 2.48 0.90 0.60 2.43 0.45 9.00 non ben. 1.04 0.36 0.15 1.27 0.09 5.00 guinea corn beneficiary 2.39 1.75 3.00 1.80 0.30 6.00 non ben. 1.07 0.18 0.06 1.43 0.03 5.60 yam beneficiary 1.42 0.85 3.00 1.15 0.12 4.50 non ben. 1.19 0.24 0.06 2.29 0.02 12.0 cassava beneficiary 2.29 1.75 3.00 1.85 0.30 8.00 non ben. 1.18 0.30 0.30 2.11 0.09 9.00 soya bean beneficiary 1.21 0.43 0.09 1.63 0.03 6.00 non ben. 1.88 1.10 0.78 1.86 0.30 8.00 groundnut beneficiary 0.85 0.42 0.30 1.30 0.06 8.00 non ben. 1.37 0.66 0.60 1.87 0.24 10.0 potato beneficiary 1.13 0.64 0.67 1.49 0.02 8.00 non ben. 1.22 0.29 0.15 2.37 0.03 10.0 pepper beneficiary 1.49 1.22 3.00 1.15 0.03 4.69 non ben. 0.70 0.32 0.03 0.96 0.03 4.00 tomato beneficiary 0.52 0.25 0.15 0.69 0.01 4.00 non ben. 1.11 0.67 0.45 1.13 0.03 4.50 melon beneficiary 1.87 1.10 0.78 1.86 0.30 8.00 non ben. 1.20 0.42 0.09 1.63 0.03 6.00 bambaranut beneficiary 1.81 0.79 0.78 2.16 0.03 8.00 non ben. 0.56 0.34 0.34 1.38 0.10 10.0 cowpea beneficiary 0.94 0.58 1.00 0.94 0.03 4.50 non ben. 1.12 0.85 0.78 0.86 0.15 4.00 beniseed beneficiary 1.42 1.00 1.00 1.05 0.15 4.00 non ben. 1.25 1.00 1.00 0.97 0.09 4.50 source: field survey, 2014 table-2. test of difference between enterprise productivity of beneficiaries and non beneficiaries in benue east variables (tons) t df sig (2-tailed maize 0.494 238 .662 ns rice 3.828 238 .000* guinea corn 4.328 238 .000* yam 0.703 238 .484 ns cassava 0.385 238 .003* soya beans -2.080 238 .040* groundnut -1.813 238 .072* potato -0.254 238 .800 ns pepper 3.964 238 .000* tomato -3.567 238 .001* melon 2.070 238 .040* bambaranut 3.606 238 .000* cowpea -1.100 238 .274 ns beniseed 0.907 238 .366 ns source: data analysis, 2014 *= t-ratio significant at 10% 4.2. primary health care influence on productive man hours of labour on the farm table 3 summarized the number of times a respondent goes to farm in a week. the result indicates that, on the average, sampled beneficiaries worked on the their farm 10 times/week, while sampled non beneficiaries worked for 7 times/week which indicates that sampled beneficiaries worked for higher number of times on their farms per week when compared to non beneficiaries. this agrees with the findings of ogunbekun et al. (1999) that healthy individuals can work as many time as possible daily when compared to unhealthy persons. the distribution on the number of times of work on the farm specifically indicates that 64% and 18% respectively of sampled beneficiary and non beneficiary respondents worked on the farm 9-12 times a week. furthermore, sampled beneficiary and non beneficiary respondents who worked for between 5-8 times in a week were 36% and 72% respectively. the result implies that greater majority of the sampled beneficiary respondents worked on their farms 9-12 times in a week. the results further implied that most of the sampled beneficiaries and non beneficiaries that worked between 9-12 times in a week are full time farmers, while farmers that visit their farms 1-4 times and 5-8 times a week have other secondary occupations they carryout apart from farming. overall, the result implies that sampled beneficiaries visited the farm as many times as possible in a week (9-12 times/week) probably because they are healthier and more fit when compared to non beneficiaries. asian journal of economics and empirical research, 2016, 3(1): 122-129 126 the result on the number of man hours utilized on the farm by sampled respondents per working day shows that the average response for sampled beneficiaries is 9 hours per working day, while that for sampled non beneficiaries is 6 hours per working day, indicating that beneficiary respondents worked for more hours when compared to non beneficiary respondents. furthermore, 39% and 78% respectively of sampled beneficiary respondents worked for 5-8 hours per working day. similarly, 61% and 2% respectively of sampled beneficiary and non beneficiary respondents worked for between 9-12 hours in a day. the result indicates that greater majority of sampled beneficiary and non beneficiary respondents worked on their farms between 5-8 hours in a day, the result further implies that greater percentage (61%) of sampled beneficiary respondent worked for longer number of hours when compared to non beneficiaries probably because they are healthier and have benefited so well from primary healthcare initiatives in the area. this agrees with the findings of ravallion et al. (2007) that the success of agricultural livelihoods depends on the health of the workforce. the result for the number of times sampled respondent felt sick within the past three years showed that on the average, sampled beneficiary respondents had fallen sick for 5 times, while sampled non beneficiaries felt sick for more than 10 times within the past three years, suggesting that sampled beneficiary respondents had fallen sick for a lesser number of times compared to non beneficiary respondents. moreover, sampled beneficiary and non beneficiary respondents who felt sick between 1-5 times within the last three years were 59% and 18% respectively, while 39% and 40% of sampled beneficiaries and non beneficiary respondents felt sick for between 6-10 times within the last 3 years. this implies that greater majority (59%) of sampled beneficiary respondents in the study area felt sick for a shorter period of time when compared to the non beneficiaries. obviously, sampled beneficiary respondents felt sick for shorter period of time. it would imply good and quality healthcare services they might have received from primary healthcare centres thereby shortening the duration of illness. the result on the number of days sampled respondents stayed at home/hospital on the basis of sickness showed an average of 11 days per sickness period for sampled beneficiary respondents, while that for sampled non beneficiary respondents was 26 days. the distribution of number of days lost to sickness shows that sampled beneficiary respondents who stayed in the hospital between 1-15 days are 90%, while 50% of sampled non beneficiaries stayed in the hospital for the same number of days. however, sampled beneficiary and non beneficiary respondents who stay in the hospital between 16-30 days are 6% and 14% respectively, while sampled beneficiaries and non beneficiaries who stayed in the hospital between 31-45 days during the course of illness are 1% and 20% respectively. the result implies that majority (90%) of sampled beneficiaries stayed for lesser period time in the hospital, when compared to non beneficiaries. the result further implies that sampled beneficiaries never stayed more than a period of one month in the hospital, while non beneficiaries stayed for more than one month in the hospital during the course of their illness. overall, the confirmatory test of significance in table 4 indicates that the number of times sampled beneficiaries go to farm in a week and the number of hours they worked on the farm were significantly (7.773≤t≤11.637; p<0.05) higher than the number of times sampled non beneficiaries go to farm in a week (7 times per week) and the number of hours they worked on the farm (6 hours per working day), implying that non beneficiaries of primary healthcare programmes lost significant number of labour hours as a result of sickness however, the number of times sampled beneficiary respondents felt sick and the number of days they stayed at home/hospital within each sickness period were significantly (-7.223≤t≤-3.237; p<0.05) lower than the number of times non beneficiary respondent felt sick (10 times within the past three years) and the number of days they stayed at home/hospital within each sickness period (26 days). similarly, this also implies that non beneficiaries of primary health care programmes lost significant number of labour hours as a result of illness. this agrees with the findings of brieger and guyer (1990) that bad health condition reduces productivity and generally labour output during sickness. overall the result implies that primary healthcare services have tremendous impact on beneficiary communities. thus the number of times beneficiary respondents felt sick and the number of days they stayed in the hospital as a result of sickness were drastically reduced compared to those observed among non beneficiaries. table-3. summary statistics of respondents responses on, weekly farm visits, productive labour hours, sickness period and illness frequency for beneficiaries and non beneficiaries beneficiary non beneficiary variables respo nse freque ncy percent % freque ncy percent % weekly farm visits: 1-4 10 10 5-8 50 35.7 72 72 9-12 90 64.3 18 18 total 140 100 100 100 mean 9.51 7.10 median 9.00 8.00 mode 8.00 8.00 std dev 1.67 1.69 min 6.00 2.00 max 12.00 9.00 productive man labour hours per day: 1-4 20 20 5-8 54 38.6 78 78 9-12 86 61.4 2 2 total 140 100 100 100 mean 9.26 5.92 continue asian journal of economics and empirical research, 2016, 3(1): 122-129 127 median 9.00 6.00 mode 8.00 7.00 std dev 1.48 1.64 min 6.00 2.00 max 12.00 9.00 illness frequency: 1-5 82 58.6 18 18 6-10 54 38.6 40 40 11-15 4 2.9 32 32 16-20 10 10 total 140 100 100 100 mean 4.84 9.78 median 4.00 9.00 mode 2.00 8.00 std dev 2.94 4.54 min 1.00 1.00 max 12.00 18.00 illness duration: 1-15 126 90 50 16-30 8 5.7 14 14 31-45 2 1.4 20 20 46-60 8 8 >60 4 2.9 8 8 total 140 100 100 100 mean 11.00 26.00 median 6.00 16.00 mode 7.00 3.00 std dev 23.96 27.09 min 1.00 2.00 max 180 150 source: field survey, 2014 table-4. independent sample t-test for weekly farm visits frequency, illness frequency, illness duration and productive labour hours per day for beneficiaries and non beneficiaries in benue east variables t df sig (2-tailed) weekly farm visits 7.773 238 .000** productive man-labor hour per day 11.637 238 .000** illness frequency -7.223 238 .00** illness duration -3.237 238 .002** source: data analysis, 2014 ** = t-ratio significant at 5% 4.3. utilization of hired, family and self labour by respondents table 5 summarized the opinion of respondents on the type of labour used in their farms. the result showed that 84% and 68% of beneficiary and non beneficiary used hired labor. respondents who did not use hired labour made use of family labour or did the farm work themselves. furthermore, analysis of the use of family labour shows that 59% of beneficiary respondents made use of family labour compared with 38% of non beneficiary respondents, implying that beneficiary respondents relies on family labour than the non beneficiaries. analysis of the use of self labour revealed that 60% of beneficiary respondents executed their farm work themselves compared with 52% of non beneficiaries. the result implies that greater majority of sampled respondents do the farm work themselves. however larger majority of beneficiaries participate actively in farming activities. this is because they are healthier farmers. table-5. summary statistics of respondents opinion on the type of labour used on the farm beneficiary non beneficiary variables response frequency percent% frequency percent% hired labour no 22 15.7 32 32 yes 118 84.3 68 68 total 140 100 100 100 family labour no 58 41.4 62 62 yes 82 58.6 38 38 total 140 100 100 100 self labour no 56 40 48 48 yes 84 60 52 52 total 140 100 100 100 source: field survey, 2014 4.4. respondents’ response as victims of most common disease in benue east analysis in table 6 summarizes respondent’s responses on the kind of sickness that have affected their productivity. the result showed that (14%, 4% and 66%) and (24%, 6% and 70%) of beneficiary and non beneficiary respondents respectively suffered from typhoid fever, hepatitis, and malaria. the result implies that lesser percentage of beneficiaries and non beneficiaries have suffered typhoid fever and hepatitis implying that these diseases are not asian journal of economics and empirical research, 2016, 3(1): 122-129 128 common among the respondents relative to malaria. a greater number of the sampled respondents have suffered from malaria suggesting that malaria is a major sickness that have seriously affected farmers health in the study area. this agrees with the study conducted by roll (2003) programme that malaria may have slowed down economic growth in african countries by as much as 1.3 percent per year. contrary to the almost widespread infection by typhoid, hepatitis and malaria, the result shows that guinea worm is not a major disease in the study area as 100% of the sampled respondents have never been infected with the disease. table-6. respondents victims of most common diseases in eastern zone of benue nigeria beneficiary non beneficiary variables response frequency percent% frequency percent% typhoid no 120 86 76 76 yes 20 14 24 24 total 140 100 100 100 guinea worm no 140 100 100 100 yes total 140 100 100 100 hepatitis no 134 96 94 94 yes 6 4 6 6 total 140 100 100 100 malaria no 48 34 30 30 yes 92 66 70 70 total 140 100 100 100 source: field survey, 2014 5. conclusion and recommendations the study concludes that beneficiary respondents recorded higher productivity in cereals: (maize 1.81tons/ha, rice 2.84tons/ha, guinea corn and 2.39tons/ha) as well as in tubers: (yam 1.42tons/ha, cassava 2.29tons/ha). vegetables that recorded higher productivity were pepper (1.49tons/ha) and melon (1.87tons/ha). bambaranut 1.81tons/ha and beniseed 1.42tons/ha were the two legumes that recorded higher productivity among beneficiaries. productivity of non beneficiaries for soya beans (1.21tons/ha), groundnut (0.85tons/ha), potato (1.13tons/ha), tomato (0.52tons/ha) and cowpea (0.94tons/ha) were slightly higher than that of beneficiaries but not statistically significant at 10% level. the study further revealed that on the average, beneficiary respondents worked on their farms 10 times/week, while no beneficiary respondents worked for 7 times/week. beneficiaries recorded higher number of farm visits per week and also worked for higher number of hours (9hours) when compared to non beneficiaries (6hours). similarly, comparison of illness frequency shows that beneficiary respondents felt sick for 5 times within the last 3 years, while non beneficiary respondents felt sick for 10 times within the same period of years. the number of days respondents stayed at home/hospital on the basis of sickness showed an average of 11 days per sickness period for beneficiary respondents, while that for non beneficiary respondents was 26 days per sickness period. absence of primary healthcare services more than doubled wasted man-hour labour in non beneficiary households. obviously beneficiaries (84%) and non-beneficiaries (68%) utilised hired labour while 59% and 38% of both respondents categories respectively utilised family labour. however, the proportion of beneficiaries (60%) who actively utilised self labour was higher than non beneficiaries (52%). healthcare services benefits could have assisted greater proportion of beneficiary household to be actively involved in energy demanding farming activities. both respondents category used rudimentary implements for farming with small parcels of cropped area indicating that use of tractors and improved inputs could bring about increased productivity. the study therefore recommends scaling up healthcare services to cover all communities and villages alongside improved inputs provision for 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(ed). agriculture productivity in nigeria. pp: 10-12. ravallion, m., s. chen and p. sangraula, 2007. new evidence on the urbanization of global poverty. population and development review, 33(4): 667-701. roll, b.m., 2003. economic costs of malaria. who. available from http://www.rbm.who.int/cnc_upload10/000/015/363/rbminfosheet_10.htm. rugalema, g., 1998. it is not only the lost of labour: hiv/aids, lost of household assets and household livelihoods in bukoba districk, tanzania. paper presented at the east and southern africa regional conference on responding to hiv/aids, june 8-12, harare.-(1999). consequences of lost of labour due to hiv/aids in small holder households in a buhaya village, bukoba district, tanzania. in aids and african small holder agriculture, ed. g. mutangadura, h. jackson and d. mukurazita. harare: safaids. pp: 34-41. strauss, j. and d. thomas, 1998. health nutrition and economic development. journal of economic literature, 36(2): 766-817. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. http://www.acc.msu.edu/agecon.2001abstract.htm http://www.nigerianstat.gov.ng/ http://www.rbm.who.int/cnc_upload10/000/015/363/rbminfosheet_10.htm 45 © 2019 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 6, no. 1, 45-51, 2019 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2019.61.45.51 © 2019 by the authors; licensee asian online journal publishing group financial inclusion and health shocks: a panel data analysis of 36 african countries popoola, oladayo timothy1 1lecturer at the department of economics, ahmadu bello university, zaria, kaduna state, nigeria. abstract numerous evidence has revealed that african countries lagged behind in the attainment of healthrelated targets of the recent past millennium development goals (mdgs). perhaps because most africans depend largely on out-of-pocket payments for medical-care services during their health shocks experiences. evidently, this has been a great concern to both citizens and policy makers across africa for a long time. therefore, this paper investigates the impact of financial inclusion on health shocks in 36 african nations over the period of 2004 to 2016. the fixed effects model result indicates that increase in numbers of depositors with commercial banks proxy for financial inclusion is positive and significant to predict longevity in african nations. however, rise in population growth (the control variable) have a significant role to reduce average life expectancy in africa. thus, both african governments and their financial institutions may improve average life expectancy and human capital for more economic development through enhanced financial inclusion. keywords: savings, financial inclusion, life expectancy, africa, panel data models. jel classification: c23, e44, i15, n27. citation | popoola, oladayo timothy (2019). financial inclusion and health shocks: a panel data analysis of 36 african countries. asian journal of economics and empirical research, 6(1): 45-51. history: received: 2 november 2018 revised: 10 december 2018 accepted: 14 january 2019 published: 20 march 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 46 2. literature reviews ........................................................................................................................................................................... 46 3. methodology ..................................................................................................................................................................................... 47 4. findings and discussions of results ............................................................................................................................................ 49 5. conclusion, policy implications and recommendations ......................................................................................................... 50 references .............................................................................................................................................................................................. 51 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.61.45.51&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/265 https://orcid.org/0000-0002-1785-0728 http://asianonlinejournals.com/index.php/ajeer/article/view/265 https://orcid.org/0000-0002-1785-0728 http://asianonlinejournals.com/index.php/ajeer/article/view/265 https://orcid.org/0000-0002-1785-0728 asian journal of economics and empirical research, 2019, 6(1): 45-51 46 © 2019 by the authors; licensee asian online journal publishing group 1. introduction researchers to date have made considerable effort in estimating the effects of health insurance and spending on health outcomes in developing countries (alam and mahal, 2014; witter et al., 2017; dake, 2018; dorfleitner and rößle, 2018). however, little is known about the extent to which financial inclusion affects health shocks in africa, where formal health insurance is hardly accessible and limited. observably, african countries lagged behind in the attainment of healthand welfare-related of recent past millennium development goals (novignon et al., 2015) perhaps because most africans depend largely on out-of-pocket payments for medical-care services during their health shocks experiences. health shocks, the unpredictable illnesses that reduce longevity and that quickly diminish health status of individuals (leivea and xub, 2008) is often sudden events. this has been a great concern to both citizens and policy makers across africa for a long time. it also appears to be the biggest obstacle in achieving sustainable development goals (sdgs); where several of the africa’s countries are still low-income nations due to high poverty prevalence and deteriorating welfare system (see ellyne and mahlalela (2017)). these factors also associated with african’s citizens inability to access timely and appropriate healthcare services during the periods of health shocks. all citizens that experience health shocks are frequently affected by income loss because of their inability to work and needs for medical-care treatment payments. therefore, it is pertinent to note that the first safety net that people rely on during health shocks is their own financial resources. though people often employ different health financing strategies to cope with their health shocks. these strategies could be from the use of savings, borrowing funds from family and friends, selling of assets and properties, or take out loan probably using collateral. all these associated with the degree of financial inclusion in their societies perhaps, to improve longevity or average life expectancy at birth and achieve an efficient health system in africa, improved financial inclusion is fundamental for easy access to credit and savings. this makes it imperative to understand how to facilitate healthcare financing through easy access to savings and credits to improve longevity for africans. thus, the purpose of this paper is to explore empirically the impacts of financial inclusion on health shocks; however, due to limited data availability on health shock, the study proxy average life expectancy at birth for health shock in 36 africa countries (algeria, angola, burundi, benin, burkina faso, botswana, cameroon, comoros, cote d’ivoire, democratic republic of congo, congo republic, cabo verde, ghana, guinea, gambia, guinea-bissau, kenya, lesotho, malawi, madagascar, mali, morocco, mozambique, namibia, niger, nigeria, rwanda, senegal, sao tome and principe, seychelles, togo, tunisia, tanzania, uganda, south africa and zimbabwe). these nations vary in their level of total health expenditure, numbers of depositors with commercial banks per 1,000 adults, extent of financing healthcare, and average life expectancy. for instance, the average longevity ranges from a low of 44.5 years in zimbabwe to a high of 63 years in ghana for 2004 and 2016 respectively. furthermore, the pursuit of the study is based on two interrelated factors; (i) equitable access to healthcare services during health shocks periods remain a big challenge in africa; and (ii) timely healthcare financing improves longevity and economic activities. therefore, the paper started with an introductory section followed by a review of related literature in section two. section three dwells on methodology, while section four presents the empirical findings. section five concludes the paper with policy recommendations. 2. literature reviews health shock concern unpredictable illnesses that quickly diminish health status of individuals with great impact on the economic well-being of individuals (leivea and xub, 2008). it implies that health shock is a sudden event that requires attention. in developing countries, health shocks and illnesses from non-communicable diseases (such as, strokes, heart disease, cancers, diabetes, chronic lung and respiratory diseases) are on the increase over the recent years (who, 2018). figure 1 depicts annual global deaths from various ill-health, where health shocks that leads to sudden illness from non-communicable diseases (ncd) alone responsible for over 36 million deaths per annual globally. nearly half (17.7 million) of these yearly deaths are from cardiovascular diseases (stroke and heart diseases) only. worse still, 9 million people die prematurely every year before the age of 60 from brief illness that associated with these diseases. while 8 million of deaths occurred in lowand middle-income countries most especially the africa countries (who, 2018). figure-1. annual global deaths from various ill-health causes. source: who (2018). asian journal of economics and empirical research, 2019, 6(1): 45-51 47 © 2019 by the authors; licensee asian online journal publishing group africa region also has the highest prevalence of hypertension which affects 46% of adults aged over 25 years (who, 2017b). further, heart disease and strokes are the 2nd leading causes of chronic illnesses in africa after malaria (who, 2017a). this is because most africans still depend largely on out-of-pocket payments for medicalcare. consequently, the unpredictable ‘health shock’ diminish longevity or the average life expectancy (at birth) of individuals, where table 1 shows the comparative life expectancy across the regions of the world. the statistics shows that africa continent performs relatively poorly against all others. though the average longevity in africa increased slightly from about 60 years in 2000 to about 66 years in 2015, compare to the global average of 67.6 and 71.7 years in 2000 and 2015 respectively. table-1. world average life expectancy at birth (total). year global average ssa middle east & north africa africa average* oecd members east asia & pacific north america 2000 67.6 50.3 69.8 60.1 77.1 71.4 76.9 2005 69.0 52.7 71.0 61.9 78.2 73.1 77.8 2010 70.5 56.3 72.1 64.2 79.5 74.2 78.8 2015 71.7 58.9 73.1 66.0 80.3 75.1 79.1 source: compiled from world bank development indicator, 2018 *computed from column 3 and 4. table 2 further indicates that most nations in africa had low life expectancy (le). for instance, the le in nigeria increased marginally from 46 years in 1995 to about 53 years in 2015, while rwanda’s le rose from 31 years to 65 years during the same period (world bank, 2018). for ghana, her life expectancy rises steady from 1975 to 2015; where it rose from 50.8 years in 1975 to 56 years in 1990, and 61.4 years in 2015. comparatively, the leb in nigeria is lower compared with rwanda, ghana and south africa probably as a result of ill-health issues in the nation. although the average life expectancy in recent years is merely higher than the cote d’ivoire. table-2. comparative average life expectancy at birth (total) in africa. country 1975 1980 1985 1990 1995 2000 2005 2010 2015 2016 cote d’ivoire 47.7 50.7 52.6 52.6 49.5 46.7 47.7 50.1 51.9 53.6 ghana 50.8 52.3 54.1 56.7 57.5 56.9 58.7 60.6 61.4 63.7 south africa 54.2 56.9 59.9 62.1 61.4 55.8 51.5 54.4 57.4 62.8 rwanda 44.9 47.9 50.4 33.4 31.6 48.1 54.7 61.4 64.5 67.1 cote d’ivoire 43.4 45.5 46.3 46.1 46.1 46.6 48.6 51.3 53.0 53.4 source: compiled from world bank development indicator, 2018. these statistics shows that several african nations recorded low le in the world. meanwhile, a dominant strand of health financing literature (see: (alam and mahal, 2014; witter et al., 2017; dake, 2018; dorfleitner and rößle, 2018)). these studies have underscored the key role of financial inclusion in the process of assuring ease access, availability and usage of the formal financial system by all members of economy especially in periods of health shocks. furthermore, considering the role of savings and access to credits towards healthcare accessibility cannot be downplayed. as pointed out by grossman (1972) these can be viewed as ease of investments during sudden illnesses that reduce longevity and that quickly diminish health status of individuals. 3. methodology 3.1. analytical framework grossman (1972) suggest that longevity and health status of individuals ( ) depreciate during their lifetime due to health shocks , but such individuals can invest in their health to offset this depreciation or health shocks. that is, (1) where; = longevity or citizens’ healthiness at current period; = health shocks or illness through diseases and sick-days; = rate of depreciation; while it = gross investment on health status. this implies that: (2) where will always be positive when , that is, when citizens invest more in their health status . on the other hand, will be negative anytime . therefore, to improve , grossman (1972) opine availability of financial resources. from the foregoing, the analytical foundation for this study is predicted on grossman approach. the framework considers the role of investment in health status during health shocks. schema 1 thus provides a lucid exposition of the transmission channels from financial inclusion during health stock to improve longevity in africa. asian journal of economics and empirical research, 2019, 6(1): 45-51 48 © 2019 by the authors; licensee asian online journal publishing group schema-1. pathways of financial inclusion on longevity. source: author’s initiative, 2018. notably, the arrow lines in schema 1 show the direction of the flow of impact from financial inclusion to longevity. ample recent empirical evidence indicated that an improved financial inclusion propels and play a vital role in promoting access to credit, use of mobile and atm, savings and easy access to payments (see (naceur et al., 2015; dorfleitner and rößle, 2018). the motivation for increased financial inclusion is to ensure all adults members of all nations to have easy access to extensive financial products, personalized towards their health needs and provided at reasonable costs (okoroafor et al., 2018). access to credit from family and friends or financial institutions is associated with good health (leivea and xub, 2008). for instance, a well-functioning financial system improves access to healthcare services by building a platform for providing credit and health-risk management products to people with a range of health-needs. savings also exert positive impact on longevity by reducing health-shocks. quality savings play a vital role in promoting both direct and indirect capabilities of people to access healthcare services during health-shocks (love and peria, 2012). it impacts longevity directly through enabling the provision of financial resources via timely payments, and indirectly through enabling borrowing and granting access to new credits opportunities for the lowincome earners (witter et al., 2017; dake, 2018). hence, an inclusive financial system is key to build a platform for financial institution to permits an easy broad-based access to financial services especially during health shocks periods. without financially inclusion systems, the poor would rely on their inadequate savings (naceur et al., 2015). 3.2. model specification the model adopted for this study is in the spirit of the grossman (1972). however, the specification of this study differs from the aforementioned in that the paper empirically estimates the impact of financial inclusion on longevity in 36 african nations. the model is specified as follows: (3) where the subscript i is the selected african nations and t represents the time frame considered. the paper relies on average life expectancy at birth (leb) as a proxy for longevity. leb refers to the average number of years an infant is expected to live if a mortality pattern at the time of birth remains constant in the future. it is the average-period that a person is expected to live as determined taking account of current economic situation. it also reflects the overall mortality level of a population and summarizes the mortality pattern that prevails across all age groups (who, 2017a). it also indicates the number of years an infant would live provided the patterns of mortality continues at the time of birth were to stay the same throughout his life. hence, it is an important index of long life. for financial inclusion in africa (fi), the study employed the numbers of depositors with commercial banks per 1,000 adults; and population growth rate (pgr) as the control variables. from equation 3, it implies that: (4) hence, the econometric model from equation 4 is explicitly specified as: (5) where 𝝻 is the error term assumed to satisfy the gaussian white noise condition; α is the intercept, β1 and β2 are parameters or slope of relationship for fi and pgr respectively. apriorily, fi is expected to exert positive influence on longevity; while pgh is negatively related. 3.3. estimation procedures the paper empirically investigates the impact of financial inclusion on longevity in africa by employing panel regressions. three regressions models were estimated based on the unobserved characteristics. these techniques were – pooled ordinary logistic (pol), fixed effects (fe) and random effects (re). since the intercept αi is unobserved heterogeneity which is fixed for nations in africa and uit the residual. in estimating pol, αi becomes a component of residual. thus, the composed residual is: (6) however, βs in pol can be inefficient because of the unobserved effect in . this generate serial autocorrelation; thus, robust test will be needed to deal with the issue. re assume unobserved effect is unknown and can be captured by random variable and treated as part of it also imposes more restrictive assumption than pol, because it includes the unobserved heterogeneity in vit to obtain consistent and efficient βs. for fe, the asian journal of economics and empirical research, 2019, 6(1): 45-51 49 © 2019 by the authors; licensee asian online journal publishing group model assumes that α varies but fixed over time. the basic idea of fe model is that a set of αit can capture all the unobserved heterogeneity. to check for the homogeneity or heterogeneity of the dataset, breusch-pagan lagrange multiplier test was employed. the null hypothesis (ho) of the test is homoskedasticity of countries in africa, that is, pol might be the appropriate model. notably, because of the potential of inconsistency of pooled regression for large observation bias, the study used the bias-adjusted variant of breusch and pagan lagrange multiplier (lm) test statistic (balm) proposed by pesaran et al. (1999). they showed that the balm test has desirable finite sample properties, successfully control for size and maintains appropriate power when the repressors are exogenous and errors are normal. however, the balm test statistic is only valid for static models unlike pesaran et al. (1999) test statistic that extends to dynamic models. 3.4. data for the study the sources of data for this study are annual data from wb (2018) for the period of 2004 to 2016. the study considered 36 african countries for which data on the variables of interest were readily available. 4. findings and discussions of results table 3 shows some descriptive statistics on the numbers of depositors with commercial banks per 1,000 adults (ndcb) as proxy for financial inclusion, average life expectancy at birth (total) and annual gdp growth (%) of the 36 african countries. the average numbers of depositors with commercial banks is 307,000 adults; cabo verde has the highest ndcb of 1,860,000 depositors in 2015, while angola have the lowest ndcb of 369 depositors in 2004 among these african nations analyzed. statistics on longevity indicates that the average life expectancy at birth is about 60 years old, where algeria has the highest average longevity of 76 years while zimbabwe has the lowest of 44 years. table-3. descriptive statistics of variables. variable observation mean standard dev. min. max. le 468 59.86 7.11 44.57 76.08 fi 468 307.12 367.53 0.37 1860.85 pg 468 2.50 0.86 -2.63 4.61 source: own computation from stata 13. on the other hand, the correlation matrix table presented in table 4 reveal high direct correlation between numbers of depositors with commercial banks (fi) and longevity (le). however, inverse relationship exists between population growth rate (pgr) and average life expectancy (le). overall, the correlation matrix table suggest that an increase in the numbers of depositors with commercial banks (the financial inclusion) is linked to improve average life expectancy in africa. table-4. correlation matrix, 1990 to 2017. le fi pg le 1.0000 fi 0.5624 1.0000 pg -0.3844 -0.5637 1.0000 source: own computation from stata 13. table 5 reports the key findings of the panel regressions of life expectancy (le) on the financial inclusion (fi). all the models control for population growth. for pooled ols model, the fi has a positive sign and statistically significant at 1% level, suggesting that the importance of fi on le is not small. population growth rate (pg), on the other hand, is also strongly but negatively associated with longevity. for example, the coefficient 0.01 suggests that a 1% rise in population growth in africa leads to 1% decline in life expectancy. for both fixed effect (fe) and random effect (re) models, the magnitude and significance of the effects of financial inclusion on longevity are also similar. the coefficient 0.006 for life expectancy (le) suggests that a 1% rise in financial inclusion would increase longevity by 0.6% for fe model; and 1% increase in numbers of depositors with commercial banks (the financial inclusion) related with life expectancy at 1% level for re model. these findings suggest the need to test for heterogeneity among the three models – pols, fe and re models. table-5. estimation results for financial inclusion. variables pols fixed effects random effects financial inclusion 0.0098*** (0.0009) 0.0063*** (0.0006) 0.0068*** (0.0006) population growth rate -0.8144** (0.3809) 1.3748*** (0.4011) 0.9702*** (0.3775) constant 58.89*** (1.1625) 54.49*** (0.9911) 55.36*** (1.3183) observations 468 468 468 f-statistics 110.89 63.57 134.67 probability 0.0000 0.0000 0.0000 note: *** denotes significant at 1% level and ** indicate significant at 5%. standard errors are reported in parentheses. source: author’s compilation from stata 13. 4.1. heterogeneity test: breusch-pagan lagrange multiplier generally, the likelihood ratio statistics as indicated by f-statistics (110.9 for pols, 63.6 for fe and 134.7 for re) was highly significant at probability (p < 0.0000) suggesting that all models have a strong explaining power. asian journal of economics and empirical research, 2019, 6(1): 45-51 50 © 2019 by the authors; licensee asian online journal publishing group the estimation findings as shown in table 5 was based on three models – pols, fe and re models. the pols model assumed that all countries in africa are the same; however, severe biases can arise if households are pooled because it suggests that there are no unique attributes of individual nations within the african continent. such assumption is highly restrictive in a panel with heterogeneous countries. hence to check the homogeneity or heterogeneity of the nations in africa, breusch-pagan lm test was employed following the study of molla et al. (2017). the null hypothesis (ho) of the test is homoskedasticity of nations in africa, that is, pol might be the appropriate model. table-6. homogeneity test results. estimated results var sd = sqrt (var) le 50.53 7.11 e 6.05 2.46 u 29.9 5.47 prob. = 0.0000 note: since the p-value of breusch-pagan lm test is very low (for instance, < 0.001), the model is heterogenous. source: researcher’s computation using stata 13. the results of breusch-pagan lm tests with the p-values of 0.0000 as shown in table 6 was very low as the model does not suffer from heteroskedasticity. the computed value of likelihood ratio and wald tests are 1,809.7, this further demonstrated that the model is not homogeneous as ho assumed. thus, the study concluded that all the 36 countries in africa were heterogeneous; that is, pol model is insignificant to explain the impact of financial inclusion on longevity in africa. this was consistent with the studies of novignon et al. (2015) that nations in africa are not the same. 4.2. hausman specification test the fe models assumed there are unique attributes of individual nations in africa, thus suggest the use of least square dummy variable (lsdv). re model assumed there are unique time constant attributes of nations that are not correlated. thus, to specify the appropriate model between fe and re, hausman test was applied. the null hypotheses (ho) for hausman test is that re model is appropriate and consistent when the p-value is high, against the alternate (h 1 ) of fe model is consistent when p-value is close to zero. from the table 7, since the pvalue of the hausman test is as low as 0.0018, the study assumed fe model is more consistent and appropriate. table-7. hausman test results. chi-squared 12.68 prob 0.0018 source: researcher’s preparation. 4.3. robustness checks the study checked if the results were sensitive to exclusion of single countries. the findings were robust against this check. similarly, the paper estimated the models with financial inclusion lagged by one-year. the findings did not change in any significant manner. 4.4. discussion of findings several evidence has revealed that african countries lagged behind in the attainment of health-related targets of the recent past mdgs; perhaps because most africans depend largely on out-of-pocket payments for medicalcare services during their health shocks experiences. therefore, this study proposed an analytical framework to analyze how financial inclusion affects longevity in africa. the main conclusions drawn from fixed effects model is that there is an indication that numbers of depositors with commercial banks (the financial inclusion) directly and significantly predicts longevity in africa. however, rise in population growth have a significant role to reduce average life expectancy in africa. the results shed new light on the grossman (1972) argument that various factors that determines the health of citizens. a potential explanation to the study’s findings is that the paper’s findings differ in that i focused only on the developing countries (africa); and i use panel data models which allow controlling for unobserved country heterogeneity. the findings on financial inclusion is consistent with prior research (dorfleitner and rößle, 2018). though the mechanisms through which financial inclusion increases longevity might be through access to financial resources and savings; however, financial inclusion is strongly linked to longevity in africa. it is possible that societies with inadequate financial inclusion might have to struggle more in order to maintain their health in periods of health shocks. 5. conclusion, policy implications and recommendations the findings of the study show that in developing countries especially in africa, financial inclusion has an important effect on life expectancy. given the importance of longevity on welfare as well as sustainability of an economy, financial inclusion associated with african’s citizens inability to access timely and appropriate healthcare services during the periods of health shocks. notably, all citizens that experience health shocks are frequently affected by income loss because of their inability to work and needs for medical-care treatment payments. for the panel regression models, financial inclusive improve longevity by 0.06% in africa. the findings therefore suggest that for policy makers to improve longevity in developing countries, policies should focus on increasing the numbers of depositors (adults) with banks accounts. further studies could also focus on the effects of internet in terms of the cost of transactions, distance, and time to access financial activities via the use of mobile and the atm on health in africa. this is suggested because, it has implication to increase the capacities of credit delivery in remote areas and to access healthcare services. asian journal of economics and empirical research, 2019, 6(1): 45-51 51 © 2019 by the authors; licensee asian online journal publishing group references alam, k. and a. mahal, 2014. economic impacts of health shocks on households in low and middle-income countries. a review of literature. globalization and health, 10(21): 1-18. dake, f.a., 2018. examining equity in health insurance coverage: an analysis of ghana’s national health insurance scheme. international journal for equity in health, 17(1): 1-10.available at: https://doi.org/10.1186/s12939-018-0793-1. dorfleitner, g. and f. rößle, 2018. the financial performance of the health care industry: a global, regional and industry specific empirical investigation. european journal of health economics, 19(4): 585-594.available at: https://doi.org/10.1007/s10198-017-0904-8. ellyne, m. and n. mahlalela, 2017. the impact of remittances on poverty in africa: a cross-country empirical analysis. the paper presented at the 14th african finance journal conference, 17-18 may, 2017, victoria fall, zimbabwe. grossman, m., 1972. on the concept of health capital and the demand for health. the journal of political economy, 80(2): 223-255.available at: https://doi.org/10.1086/259880. leivea, a. and k. xub, 2008. coping with out-of-pocket health payments: empirical evidence from 15 african countries. bulletin of the world health organization, 86(11): 849-856.available at: https://doi.org/10.2471/blt.07.049403. love, i. and m.m.s. peria, 2012. how bank competition affects firms’ access to finance. world bank policy research working paper, no. 6163. molla, a.a., c. chi and a.l.n. mondaca, 2017. predictors of high out-of-pocket healthcare expenditure: an analysis using bangladesh household income and expenditure survey, 2010. bmc health services research, 17(1): 94.available at: https://doi.org/10.1186/s12913-017-2047-0. naceur, s.b., a. barajas and a. massara, 2015. can islamic banking increase financial inclusion? , washington: international monetary fund (imf). novignon, j., j. nonvignon and e. arthur, 2015. health status and labour force participation in sub-saharan africa: a dynamic panel data analysis. african development review, 27(1): 14-26.available at: https://doi.org/10.1111/1467-8268.12119. okoroafor, d.o., a.s. oluseyi and a. emmanuel, 2018. empirical analysis of the determinants of financial inclusion in nigeria: 1990-2016. journal of finance and economics, 6(1): 19-25. pesaran, m.h., y. shin and r.p. smith, 1999. pooled mean group estimation of dynamic heterogeneous panels. journal of the american statistical association, 94(446): 621-634.available at: https://doi.org/10.1080/01621459.1999.10474156. who, 2017a. fact sheet on cholera. geneva, switzerland: world health organization. who, 2017b. levels and trends in child mortality report for 2017. geneva, switzerland: who. who, 2018. who statistics 2018: monitoring health for the sdgs. geneva: who. witter, s., v. govender, t.s. ravindran and r. yates, 2017. minding the gaps: health financing, universal health coverage and gender. health policy and planning, 32(suppl_5): v4-v12.available at: https://doi.org/10.1093/heapol/czx063. world bank, 2018. world development indicators. washington dc: world bank. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. asian journal of economics and empirical research issn: 2409-2622 vol. 1, no. 1, 16-23, 2014 http://asianonlinejournals.com/index.php/ajeer 16 teacher perceptions of factors that cause high levels of stress: the case of the zimbabwean rural primary school teachers zadzisai machingambi zimbabwe open university, faculty of applied social sciences kumbirai, c. ngwaru zimbabwe open university, faculty of applied social sciences maxwell constantine chando musingafi zimbabwe open university, faculty of applied social sciences abstract this work is licensed under a creative commons attribution 3.0 license asian online journal publishing group 1. background to the study stress as a psychological phenomenon is not only ubiquitous, but also as old as mankind. from a biblical perspective episodes are abound that illustrate that, the very first human beings adam and eve were severely stressed after being hoodwinked by a serpent, leading to the subsequent introduction of the concept of death. however occupational stress as hayes (1994) reveals, is traceable to the inception of the industrial revolution. the advent of organized labour brought into existence a whole host of concepts that are positively correlated to job stress. such concepts inter alia, include supervision, leadership style, remuneration, performance management and organizational climate, (stoner and freeman, 1989). it was not until after the end of the second world war, that systematic studies on occupational stress were conducted. since then, psychologists have been interested in stress and its effects on human behaviour (lazarus, 1993). the original focus of research and theory was on the physical causes of stress; (seyle, 1956), but soon interest broadened to include psychological factors. from the mid of the 19 th century, studies conducted yielded a rich pool of theories and models that were instrumental in the conceptualization of stress (seyle, 1956; holmes and rahe, 1967; glass, 1977). in recent times, research on stress had not only intensified but has improved in scope and frequency (rolf, 1992; bond, 1998); and (antonovsky, 1979). the main thrust of this investigation was to use a descriptive survey research design to study teacher perceptions of factors that cause high levels of stress. data were collected through a questionnaire and an interview schedule. the research instruments and data analyses procedures were pilot tested and subsequently refined. teacher perceptions were analyzed within the framework of selected demographic factors. it is on the basis of these factors that hypotheses were formulated to guide the study. the study unveiled the following findings: the majority of teachers perceived most job factors to be highly stressful, and to contribute significantly towards an unfavourable work environment. factored dimensions perceived to be stressful encompassed; low levels of remuneration, poor incentives package, high teacher-pupil ratio, high amount of clerical work, unfavorable supervisory climate and unprogressive leadership styles. as a result of these findings some conclusions were drawn. school based factors tended to shape perceptions more than any other factors. the study also observed that teacher perceptions did not vary significantly with selected demographic characteristics. recommendations on reducing stress among zimbabwean rural primary school teachers were structured around the key focus issues that underpinned the study. keywords: teacher perceptions, stress, rural, primary school, zimbabwe, supervision, psychological phenomenon. http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2014, 1(1): 16-23 17 2. statement of the problem research by baron and bryne (1997) has shown that the physical and psychological effects of stress have direct and adverse consequences on productivity at work places. in view of the above observation, the writers have noted that due to the insurmountable circumstances unleashed by the decade long economic meltdown in zimbabwe, teachers in rural areas have largely become acutely vulnerable to stress. however, from the foregoing it has emerged that research on occupational stress is much more developed in the western world. besides this, research on stress that specifically targeted teachers seemed to be virtually missing. consequently it was deemed necessary to determine teacher perceptions of factors that predispose them to high levels of stress at their work places from a zimbabwean perspective. it was against this background that this study was conceived. 3. statement of the purpose this study was concerned with the determination of teacher perceptions of job related factors that predispose them to high levels of stress. the study sought to find out if an association exists between teacher perceptions and selected demographic factors such as gender, professional qualifications, length of teaching experience and area of specialization in the primary education sector. the focal point of this investigation were primary school teachers based in zimbabwe’s rural areas. 4. hypotheses hypotheses have been presented below in null form, to guide the researcher to test whether an association between teacher’s perceptions and selected demographic factors, is statistically significant. ho1: there is no significant difference in teacher perceptions of factors that cause high levels of stress, when all teachers are considered in general. ho2: there is no statistically significant difference in teacher perceptions of causes of high levels stress when gender is considered. ho3: there is no difference in perceptions of factors that cause high levels of stress among teachers with different professional qualifications. ho4: there is no statistically significant difference in teacher perceptions of factors that cause high levels of stress when length of teaching experience is considered. ho5: there is no significant difference in teacher perceptions of factors that cause high stress levels among teachers in different operational areas of the primary education sector. 5. significance of the study this study was considered significant from a variety of perspectives. it sought to analyze teacher perceptions of factors that cause high levels of stress in zimbabwe. knowledge generated through the study was deemed critically useful to policy makers, school managers, teachers themselves, central government, multilateral agencies and nongovernmental organizations concerned with the welfare of teachers particularly those operating in rural areas. information on the pattern of teacher perceptions was observed to be instrumental in empowering school managers and other relevant stakeholders to reduce and manage stress among teachers (hayes, 1994; sue et al., 1997; chiremba and maunganidze, 2004). many studies (seyle, 1956; holmes and rahe, 1967; glass, 1977; baron and bryne, 1997) have shown a correlational link between stress and the development of psychopathology. in this connection, this study attempted to profer guidelines on stress management in educational work settings. besides this, recommendations eventually propounded were tailored to take into account the unique and diverse characteristics of teachers as differentiated by gender, professional qualifications, length of teaching experience and areas of specialization. the above cited dimensions are all important in designing stress management interventions. the study was also considered significant in the sense that, it attempted to place stress as a psychological phenomenon into perspective in as far as it was prevalent among rural primary school teachers in zimbabwe. thus the prevalence of stress was examined within the context of the professional, economic and social dynamics as they obtained at the time to the study. hence it is these critical considerations that formed the bedrock of the study. 6. related studies studies by getzel and jackson (1963) in chicago found that there are certain characteristics that differed between male and female teachers, due to socialization and stereotyping. in this connection gender differences were found to be critical in shaping teacher perceptions of factors that cause job stress. hence it was of utmost interest to find out whether the pattern of responses to the research questionnaire depicted gender differences. holmes and rahe (1967) propounded a theory of stress, they branded the social readjustment rating scale (srrs). the construction of the (srrs) is premised on the assumption that all life changes are stressful regardless of whether they are desirable or not, planned or not, anticipated or not. this study was considered significant in the sense that it highlighted the link between stress and development of psychopathology inter alia. however, while holmes and rahe (1967) outlined a general theory of stress focusing on people in formal employment, this study instead focused singularly on rural primary school teachers in so far as they were affected by factors within their work settings. morrison and mcintyre (1969) concluded from their study, that sex had a pervasive influence on teacher perceptions of different factors within their work environment. when faced with the same stressful circumstances at the workplace male teachers are expected to be more resilient than their female counterparts. women are regarded as emotionally fragile to effectively deal with stressful episodes. asian journal of economics and empirical research, 2014, 1(1): 16-23 18 though widling (1984) did not focus exclusively on teachers, nonetheless he conducted a large scale investigation on the impact of stress among different categories of workers. the research underpinned stress as a common variable behind the observed physical responses to events in the work environment. the issue of work related stress has aroused a lot of interest among researchers. zheng and lin (1994) conducted a study that sought to determine teacher perceptions of factors that cause stress, at the workplace. the study revealed that mainland chinese teachers ranked leadership styles 4 th in causing work related stress. american teachers ranked the same factor second. however across all samples teachers tended to regard low remuneration as one of the greatest source of occupational stress. zheng and lin (1994) inter alia, concluded that though stress contributes to physical and psychological illness, it does not cause illness itself. the same position is echoed by sue et al. (1997). yet still, in another study widom (2007) carried out an investigation that involved 1200 teachers. she sought to determine the influence of childhood abuse and neglect on the development of stress symptoms later in adult life. this study was deemed significant in the sense that it shed light on the factors that explain chronic vulnerability to stress. widom compared 680 teachers who had reported abuse and neglect in their childhood with 520 teachers of similar age, race and social status, but were not exposed to abuse and neglect. the study revealed that 59% of teachers with a background of abuse and neglect had an increased risk of encountering high levels of stress that developed into life time depression. widom’s findings show that the tendency to develop symptoms of stress among teachers may not be explained singularly in terms of work related factors, but an individual’s socio-cultural and psychological background also come into focus. this brings into perspective an important discourse on how to ascertain the relative contribution of factors within the work environment to the development of stress among individuals chronically predisposed to the condition. this study, however sought to find out the extent to which factors within the work environment cause stress amongst rural primary school teachers. 7. methodology this was a descriptive research which dealt with teacher perceptions of factors that cause high levels of stress. the descriptive research design was adopted for the study since it is appropriate for the studying contemporary phenomenon. the questionnaire and the interview schedule were the two principal information gathering instruments. the participants for the study were generated using a random sampling design. 7.1. sample for feasibility and practicability reasons a random sample of 60 teachers was drawn from 10 rural primary schools in zaka district of masvingo province. zaka district has 90 rural primary schools, and a teacher population of 2 000. the 60 teacher participants were subjected to conditions of service similar to those exposed to other rural teachers across the country. consequently this sample was considered representative enough to be basis for credible generalizations. the lottery method was used to generate the sample. 7.2. instrumentation the principal data collection instrument was the questionnaire. however, cognizance was made of the limitations of questionnaire data. as a result an interview schedule was used to circumvent the pitfalls of the questionnaire. a teacher perception questionnaire (tpq) was designed for the purpose of this study by the researcher. section (a) of the questionnaire sought demographic information about the respondents. section (b) elicited information on teacher perceptions of factors that cause high levels of stress. the interview schedule also contained two sections. section (a) contained questions that enabled the respondents to elaborate more on expressed perceptions. 7.3. method of data analysis data collected through the questionnaire was pooled together and scored. for positively worded items, the scoring was in the order 5,4,3,2 and 1 for strongly agree (sa), agree (a), undecided (u), disagree(d) and strongly (sd) respectively. in the case of negatively worded items, the scoring was reversed (oguneymi, 1995). with this scoring technique it was possible to estimate that the maximum score was 3 000 (5 x 10 x 60). thus for ho1, if the respondents scored below the mean score of pooled responses (1 500), it was assumed that there was no significant difference in perceptions of factors that cause high levels of stress among all teachers in general. if the pooled score was found to be above the mean score, then variations in teacher perceptions were said to be statistically significant. all the other hypotheses (ho2, ho3, h04 , ho5) were tested using the chi-square test, at the 0,05 probability level. interview data was reported on, using percentages, (guilford and fruchter, 1981). 8. results the major findings of this study are presented in the tables below. summary of interview data is also unveiled in the second segment of this section. 8.1. summary of findings on ho1 table-1. teacher perceptions of factors that cause high levels of stress statements sa a u d sd 1.the current level of remuneration is highly stressful 48 9 0 2 1 2. low incentives is a source of stress 34 23 2 1 0 3. the high teacher-pupil ratio is a cause of high levels of stress 18 34 2 6 0 4. the workload of 10 subjects per day is a source of stress 20 21 6 9 4 5.perfomance management cycle is not cumbersome and stressful 6 11 7 13 23 continue asian journal of economics and empirical research, 2014, 1(1): 16-23 19 6.leadership style contributes towards the creation of a stressful work environment 25 26 3 4 2 7. supervision practices are a source of stress 5 18 9 22 6 8. amount of clerical work involved is a cause of undue pressure leading to stress 27 19 8 4 2 9. limited availability of basic resources is not a cause of stress 2 13 5 21 19 10.staff development activities place extra work demands leading to stress 5 10 6 32 7 key 1: positively worded items (1, 2, 3, 4, 6, 7, 8 and 10) negatively worded items (5 and 9) 2: scoring technique sa a u d sd i) positively worded items 5 4 3 2 1 ii) negatively worded items 1 2 3 4 5 the first null hypothesis (ho1) stated that there would be no significant difference in teacher perceptions of factors that cause high levels of stress among rural primary school teachers in general. with the scoring technique described in the key above, it was estimated that the maximum score possible for the respondents would be 3 000 (ie 5 x 10 x 60). research data in table 1 shows that respondents scored (2238), a score that is above the mean score of (1 500). the first null hypothesis (ho1) is therefore rejected since the overall score (2 238) is greater than the expected mean score (1 500). this finding leads to the conclusion that teacher perceptions of factors that cause high levels of stress varied significantly when all respondents in general, were considered 8.2 summary of findings on ho2 using the x 2 table-2. x 2 scores on teacher perceptions of factors that cause high levels of stress according to gender. (n = 60: m = 36 f = 24) sex male female item nos on questionnaire observed expected observed expected total 1 33 31.7 24 25.2 57 2 34 31.7 23 25.2 57 3 31 28.9 21 23.0 52 4 19 22.8 22 18.1 41 5 10 9.4 7 7.5 17 6 27 28.3 24 22.6 51 7 13 12.7 10 10.2 23 8 24 25.5 22 20.4 46. 9 9 8.3 6 6.6 15 10 8 8.3 7 6.6 15 total 208 166 374 table-3. calculation of x 2 for teacher perceptions of factors that cause high levels of stress according to gender. o e o – e o – e/2 (o-e) 2/e 33 31.7 1.3 1.69 0.05 34 31.7 2.3 5.29 0.16 31 28.9 2.1 4.41 0.15 19 22.8 -3.8 14.44 0.63 10 9.4 0.6 0.36 0.03 27 28.3 -1.3 1.69 0.05 13 12.7 0.3 0.09 0.01 24 25.5 -1.5 2.25 0.08 9 8.3 0.7 0.49 0.05 8 8.3 0.3 0.09 0.01 24 25.2 -1.2 1.44 0.05 23 25.2 -2.2 4.84 0.19 21 23.0 -2.0 4.00 0.17 22 18.1 3.9 15.21 0.80 7 7.5 -0.5 0.25 0.03 24 22.6 1.6 1.96 0.08 10 10.6 -0.6 0.36 0.03 22 20.4 1.6 2.56 0.12 6 6.6 -0.6 0.36 0.05 7 6.6 0.4 0.16 0.02 374 0.00 x2 = 2.76 8.3. summary of findings on ho3 using x 2 table-4. x 2 scores on teacher perceptions of factors that cause high levels of stress according to professional qualifications. (n = 60: certificate = 8, diploma = 44 and graduate = 8) professional qualification item nos on questionnaire certificate diploma graduate observed expected observed expected observed expected total 1 7 6.2 44 44.1 6 6.6 57 continue asian journal of economics and empirical research, 2014, 1(1): 16-23 20 2 7 6.1 42 43.3 7 6.5 56 3 8 5.6 38 40.2 6 6.0 52 4 7 5.5 36 39.4 8 5.9 51 5 1 1.8 14 13.1 2 1.9 17 6 2 5.3 40 37.9 7 5.7 49 7 2 3.6 28 25.5 3 3.8 33 8 7 5.0 34 35.6 5 5.3 46 9 0 1.3 12 9.2 0 1.4 12 10 1 1.3 10 9.2 1 1.4 12 total 42 298 45 385 table-5. calculation of x 2 for teacher perceptions of factors that cause high levels of stress according to levels of professional qualifications. o e o-e (o-e)2 (o – e)2/e 7 6.2 0.8 0.64 0.10 7 6.1 0.9 0.81 0.13 8 5.6 2.4 5.76 1.00 7 5.5 1.5 2.25 0.40 1 1.8 -0.8 0.64 0.35 2 5.3 -3.3 10.89 2.05 2 3.6 -1.6 2.56 0.71 7 5.0 2.0 4.00 0.80 0 1.3 -1.3 1.69 1.30 1 1.3 -0.3 0.09 0.06 44 44.1 -0.1 0.01 0.00 42 43.3 -1.3 1.69 0.03 38 40.2 -2.2 4.84 0.12 36 39.4 -3.4 11.56 0.29 14 13.1 0.9 0.81 0.06 40 37.9 2.1 4.41 0.11 28 25.5 2.5 6.25 0.24 34 35.6 -1.6 2.56 0.07 12 9.2 2.8 7.84 0.85 10 9.2 0.8 0.64 0.06 6 6.6 -0.6 0.36 0.05 7 6.5 0.5 0.25 0.03 6 6.0 0.0 0.00 0.00 8 5.9 2.1 4.41 0.74 2 1.9 0.1 0.01 0.00 7 5.7 1.3 1.69 0.29 3 3.8 -0.8 0.64 0.16 5 5.3 -0.3 0.09 0.01 0 -1.4 -1.4 1.96 1.4 1 1.4 -0.4 0.16 0.11 385 385 0.00 x2 = 11.52 table 3 above depicts the calculation of x 2 . only the strongly agree and agree responses were pooled together and considered. the hypothesis that stated that there is no statistically significant difference in teacher perceptions of factors that cause high levels of stress between male and female teachers was tested. the observed x 2 value of 2.76 was located in the non –critical zone since at the 0.05 level of significance, for 9 degrees of freedom a critical value 17.00 was established. hence the null hypothesis was confirmed. conclusively teacher perceptions of factors that cause high levels of stress did not vary significantly by gender. data from table 4 above was used to calculate x 2 as shown in the table 5. only the strongly agree (sa) and agree (a) responses were pooled together and considered. the null hypothesis that stated that there was no significant difference in teacher perceptions of factors that cause high levels of stress among teachers with different professional qualifications was tested. for 18 degrees of freedom at the 0.05 level of significance x 2 value of 28.90 was reported. this was just above the calculated x 2 value of 11.52. thus the null hypothesis was confirmed. this finding suggested that teachers’ perceptions did not vary with level of professional qualifications. 8.4. summary of findings on ho4 using x 2 table-6. x 2 scores on teacher perceptions of factors that cause high levels of stress according to length of teaching experience (n = 60:0-10 yrs – 26 ; 11 – 19 years – 24 and 20+ years) length of teaching experience 0-10years=26 11 – 19 years=24 20 + years=10 items nos. on questionnaire observed expected observed expected observed expected total 1 26 27.0 24 23.1 10 9.8 60 2 26 26.5 24 22.7 9 9.6 59 3 22 22.5 18 19.3 10 8.1 50 4 20 18.4 14 15.8 7 6.7 41 5 8 8.1 8 6.9 2 2.9 18 6 25 24.3 22 20.8 7 8.8 54 7 11 12.6 13 10.8 4 4.5 28 8 22 22.9 19 19.6 10 8.3 51 continue asian journal of economics and empirical research, 2014, 1(1): 16-23 21 9 6 6.7 7 5.7 2 2.4 15 10 10 6.7 2 5.7 3 2.4 15 total 176 151 64 391 table-7. calculation of x2 for teacher perceptions of factors that cause high stress levels according to length of teaching experience. o e o –e (o-e)2 (o-e) 2/e 26 27.0 -1.00 1.00 0.03 26 26.5 -0.5 0.25 0.00 22 22.5 -0.5 0.25 0.01 20 18.4 1.6 2.56 0.13 8 8.1 -0.1 0.01 0.00 25 24.3 0.7 0.49 0.02 11 12.6 -1.6 2.56 0.20 22 22.9 -0.9 0.81 0.03 6 6.7 -0.7 0.49 0.07 10 6.7 3.3 10.89 1.62 24 23.1 0.9 0.81 0.03 24 22.7 1`.3 1.69 0.07 18 19.3 -1.3 1.69 0.08 14 15.8 -1.8 3.24 0.20 8 6.9 1.1 1.21 0.17 22 20.8 1.2 1.44 0.06 13 10.8 2.2 4.84 0.44 19 19.6 -0.6 0.36 0.01 7 5.7 1.3 1.69 0.29 2 5.7 -3.7 13.69 2.40 10 9.8 0.2 0.04 0.00 9 9.6 0.l6 0.36 0.03 10 8.1 1.9 3.61 0.44 7 6.7 0.3 0.09 0.01 2 2.9 -0.9 0.81 0.27 7 8.8 -1.8 3.24 0.36 4 4.5 -0.5 0.25 0.05 10 8.3 1.7 2.89 0.34 2 2.4 -0.4 0.16 0.06 3 2.4 0.6 0.36 0.15 391 0.00 x2 = 7.52 data presented in table 6 above was used to calculate the x 2 as reflected in table 7.this provided basis for testing the null hypothesis that stated that there was no statistically significant difference in teacher perceptions of factors that cause high levels of stress according to length of teaching experience. at the 0.05 level of confidence, and for 18 degrees of freedom, a critical value of 28.90 was established. this was greater than the observed x 2 value of 7.57 hence the null hypothesis was confirmed. 8.5. summary of findings on h05 using x 2 table-8. x 2 scores on teacher perceptions of factors that cause high levels of stress according to area of specialization (n = 60:infant = 15; lower junior = 20; upper junior = 25). areas of specialization infant lower junior department upper department item nos on questionnaire observed expected observed expected observed expected total 1 14 14.2 19 18.8 24 23.8 57 2 15 14.7 20 19.5 24 24.7 59 3 13 13.21 16 17.5 24 22.2 53 4 10 9.7 14 12.9 15 16.3 39 5 4 4.2 5 5.6 8 7.12 17 6 14 12.2 17 16.2 18 20.5 49 7 4 6.23 8 8.2 13 10.4 25 8 13 12.46 17 16.5 20 20.9 50 9 5 3.4 3 4.6 6 5.8 14 10 2 3.4 6 4.6 6 5.8 14 94 125 158 377 on the basis of data presented above in table 8, it was possible to calculate the x 2 and subsequently test the null hypothesis ho5 for the data presented in tables 8 and 9, only the strongly agree (sa) and agree (a) responses were pooled together and considered. once more the null hypothesis that stated there was no difference in teachers’ perception of factors that cause high stress levels among rural teachers operating in different areas of the primary education sector was subjected to the court of empirical evidence. the computed x 2 value of 4.93 was found to be smaller than x 2 critical value of 28.90 for 18 degrees freedom (df) at 0.05 level of significance. thus the observed x 2 value was located in the non critical region; hence null hypothesis was confirmed. consequently it was possible to deduce that teacher perceptions did not vary with area of specialization. asian journal of economics and empirical research, 2014, 1(1): 16-23 22 table-9. calculation of x 2 for teacher perceptions of factors that cause high levels of stress according to area of specialization. o e o – e (o – e)2 (o-e) 2/e 14 14.2 -0.2 0.04 0.00 15 14.7 0.3 0.09 0.00 13 13.2 -0.2 0.04 0.00 10 9.7 0.3 0.09 0.00 4 4.2 -0.2 0.04 0.00 14 12.2 1.8 3.24 0.26 4 6.2 -2.2 4.84 0.78 13 12.4 0.6 0.36 0.02 5 3.4 1.6 2.56 0.75 2 3.4 -1.4 1.96 0.5 19 18.8 0.2 0.04 0.00 20 19.5 0.5 0.25 0.01 16 17.5 -1.5 2.25 0.12 14 12.9 1.1 1.21 0.09 5 5.6 -0.6 0.36 0.06 17 16.2 0.8 0.64 0.03 8 8.2 -0.2 0.04 0.00 17 16.5 0.5 0.25 0.01 3 4.6 -1.6 2.56 0.55 6 4.6 1.4 1.96 0.42 24 23.8 0.2 0.04 0.00 24 24.7 -0.7 0.49 0.01 24 22.2 1.8 3.24 0.14 15 16.3 -1.3 1.69 0.10 8 7.12 0.88 0.70 0.10 18 20.5 -2.5 6.25 0.30 13 10.4 2.6 6.76 0.65 20 20.9 -0.9 0.81 0.03 6 5.8 0.2 0.04 0.00 6 5.8 0.2 0.04 0.00 377 377 0.00 x2 = 4.93 8.6. summary of data collected through the interview schedule as a follow-up to the questionnaire, respondents were afforded the opportunity to elaborate on factors they perceived to be highly stressful. consequently an interview schedule was used to collect data on factors perceived to be causes of stress, at the work place. responses were pooled together and reported using percentages. in descending order of magnitude, the following 5 factors were cited as major causes of high levels of stress at the work place; remuneration (100%) low incentives (100%) laborious amount of clerical work (96%); work load of 10 subjects per day (90%) and undemocratic leadership styles (85%). 9. discussion of major findings data collected through both the questionnaire and interview schedule came up with almost common themes in terms of factors perceived to be most stressful. generally the salient factors identified as major stressors encompassed; low level of remuneration, poor incentives package, high workload per day, tedious clerical work, poor leadership styles and an unfavorable supervisory climate. these findings seemed to concur with part of (zheng and lin, 1994) research results which attested to the influence of leadership style and remuneration as chronic causes of stress among teachers. the first hypothesis sought to determine the general pattern of teachers’ perceptions of factors that cause stress. when all teachers were considered variations in teacher perceptions were detected. the second hypothesis postulated that there would be no significant difference in teacher perceptions by gender. the major finding of this hypothesis was that teacher perceptions did not vary significantly with gender, hence the initial conjectural position was confirmed. this was not surprising because both male and female teachers were exposed to the same conditions of service and it was most unlikely that they would exhibit perceptions differentiated by gender. the third hypothesis had predicted no significant relationship between teachers’ perceptions and professional qualifications. a significance test run on the hypothesis revealed that teacher’s perceptions were almost homogenous and were not differentiated by professional qualifications. an underlying factor was that teachers regardless of selected demographic characteristics were likely to demonstrate similar perceptions on factors that cause high levels of stress, given the universality of conditions of service to which they were exposed. the fourth scenario had hypothesized that there would be no significant association between teacher perceptions and length of teaching experience. similarly this hypothesis was not rejected. the significance test showed that perceptions did not vary with length of teaching experience. this finding was in tandem with data obtained through interviews. the majority of interviewees demonstrated almost similar attitudes towards factors that cause stress. convergence of opinions was also demonstrated on possible intervention strategies to mitigate work related stress. the fifth hypothesis had ruled out an association between teacher perceptions and area of specialization. consistent with findings on the preceding three hypotheses, the results showed that teacher’ perceptions did not vary significantly with area of specialization in the primary education sector. the finding was in tandem with the assumption that regardless of area of specialization teachers were subjected to the same conditions of service and would show similar perceptions of factors that cause work-place related stress. asian journal of economics and empirical research, 2014, 1(1): 16-23 23 10. summary, conclusions and recommendations this study was premised on the assumption that teachers’ perceptions of factors that cause high levels of stress among primary school teachers would vary with selected demographic variables. significance tests run on the 5 hypotheses depicted quite interesting results. when responses for the 60 participants were pooled together and considered in general, significant variations in teacher perceptions emerged. however, when mutually inclusive categories such as gender, qualifications, teaching experience and area of specialization, were considered no significant variations in teacher perceptions were depicted. both questionnaire and interview data gave credible evidence suggesting that certain factors manifest in the work environment caused high levels of stress among primary school teachers operating in rural areas. in descending order of significance, some of the major factors unveiled by the study included: low remuneration; low incentives package; tedious amount of clerical work; workload of 10 subjects per day and ineffective leadership styles. on the basis of the above findings and conclusions, some recommendations were enunciated. thus it was recommended that:  salary/remuneration levels be adjusted upwards in line with regional pay rates.  the salary structure be reviewed to reasonably differentiate salary levels by grade, qualifications and length of teaching experience.  incentives be abolished to remove the rural –urban pay disparities and in conformity with the equal pay for the same job labour principle.  if the government wants to retain the concept of incentives, it should pay rural based teachers a substantial rural allowance to cushion them from low incentives.  central government should accede to international donors’ offer to incentivize rural school teachers.  a systematic streamlining of unnecessary documentation by teachers be undertaken to allow for maintenance of only basic professional records.  subject specialization be introduced in the primary education sector as a mechanism to control high teaching loads and duplication of effort.  heads of schools be regularly staff developed on sound school management principles and the need to establish a conducive organizational climate.  central government should make available basic resources for implementing the concept of performance management.  further research be conducted to unravel other factors, besides those unearthed by this study, that contribute towards the prevalence of high levels of stress among primary school teachers, particularly those operating in rural areas. references antonovsky, a., 1979. health, stress and coping. san francisco: josey bass. baron, r.a. and d. bryne, 1997. social psychology. 8th edn., london: alyn and company. bond, m., 1998. stress and self awareness. new york: heinemann nursing. chiremba, w. and l. maunganidze, 2004. health behaviour: module hpsy 401. harare: zou. getzel, j.w. and p. jackson, 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for any loss, damage or liability etc. caused in relation to/arising out of the use of the content. 132 asian journal of economics and empirical research vol. 4, no. 2, 132-141, 2017 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2017.42.132.141 the japanese asset price bubble: evolvement and consequences andre tomfort1 1professor for international finance, berlin school of economics and law, germany abstract asset price bubbles and deep financial crises have occurred frequently during the past three decades. it began with the japanese stock and housing market in the eighties, the technology bubble in stock markets before the millennium, and the housing bubble in the us and other countries, just to name a few. such a degree of financial instability with extreme economic and social costs is unusual in economic history. to be able to find measures and their optimal timing to protect against these events a deeper understanding of the causes, evolvement and consequences of asset price bubbles is needed. the aim of this paper is to contribute to an improvement of that understanding by analyzing the historical case of the japanese asset price bubble on the housing and stock market. the added value of such an analysis may come from the availability of today´s research, experiences and econometric techniques. keywords: japanese asset price bubble, historical descriptive and empirical analysis, eclectic valuation approach. citation | andre tomfort (2017). the japanese asset price bubble: evolvement and consequences. asian journal of economics and empirical research, 4(2): 132-141. history: received: 1 november 2017 revised: 14 december 2017 accepted: 20 december 2017 published: 27 december 2017 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 133 2. the run up to the asset price bubble .................................................................................................................................... 133 3. how big was the bubble really? ............................................................................................................................................... 135 4. graphical results ........................................................................................................................................................................... 136 5. the collapse ................................................................................................................................................................................... 138 6. lost decades ................................................................................................................................................................................... 139 7. conclusions ..................................................................................................................................................................................... 140 references ............................................................................................................................................................................................ 140 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2017.42.132.141&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://orcid.org/orcid-search/quick-search?searchquery=andre tomfort https://orcid.org/orcid-search/quick-search?searchquery=andre tomfort asian journal of economics and empirical research, 2017, 4(2): 132-141 133 1. introduction in recent decades, sharp asset price increases with a following deep financial crisis happened within short frequencies (bordo and wheelock, 2007; brunnermeier and öhmke, 2013). these events had the typical characteristics of an asset price bubble such as an outstanding market valuation according to common valuation techniques, an euphoric investor base, a significantly stronger growth of private fixed investments and credit than the overall economy, which can be interpreted as an overinvestment and overleveraging of economic and financial activity. in the earlier stages of the bubble formation process often an expansionary monetary policy with low interest rates could have been observed as well as a deregulation of the financial sector (tomfort, 2017). such a bubble took place in japan in the late eighties, in several asian countries in the late nineties, in many stock markets before the millennium, and in the real estate market in the us and in parts of europe up to 2007 (schnabl and hoffmann, 2007). many of these bubbles have caused high social and financial costs and some of them have led to a long-lasting economic crisis. to be able to find measures and an optimal timing for their use to protect against these events a deeper understanding of the causes, evolvement and consequences of asset price bubbles is required. the aim of this paper is to contribute to an improvement of that understanding by analysing the historical case of the japanese asset price bubble on the housing and stock market. the added value of such an analysis may come from the availability of today´s research and experiences that includes recent bubble cases as well new econometric techniques. to assess a potential existence and the size of an asset price bubble an eclectic approach has been applied based on a simple discounted cash flow model, and a cointegration model that links asset prices with selected macroeconomic and financial variables. furthermore, a gap of credit and private fixed investments to gdp were measured to recognize whether the japanese economy was facing an overleveraging and overinvestment. they could have been responsible for the long-lasting and harmful deleveraging process japan and other countries have suffered from. in contrast to most other studies in the field which are based on large sized cross sectional analysis, the chosen procedure is rather an inductive one for two reasons. the advantages compared to the crosscountry approaches are that a major bubble will be analysed and not simple market overreactions and the individual bubble analysis avoids certain losses of information that may happen in the aggregation process of a cross-country analysis. the structure of the paper is as follows: it begins with a historical analysis of the time and the conditions before the asset price bubble started to evolve. this analysis is followed by a closer view on the business cycle, monetary and the development at the time when the asset price bubble was building up. in a third chapter it shall be tested whether really an asset price bubble has happened and what it´s size was by running a comparison with estimated fundamental market values. the results were graphically shown together with the measured credit and investment gap versus gdp to assess to what extent an overleveraging and overinvestment of the japanese economy had taken place. in chapter 4 the collapse of the financial system and the economy are analysed. a major focus was here on the role of monetary policy and financial acceleration processes and their interaction with the real economy. in the last chapter of this paper the reasons for the so called “lost decades” shall analysed with an assessment on the former fiscal and monetary policies. 2. the run up to the asset price bubble after the severe destruction of the second world war, nippon's economy began an extraordinary upward trend. domestic companies were shielded from outside competition in the domestic market and abroad they quickly acquired market shares. giant conglomerates formed, the so-called "keiretsu". one such "keiretsu" consisted, for example, of mitsubishi bank, mitsubishi heavy industries and mitsubishi motors. the cross-shareholdings ensured mutual dependencies and stable long-term business relationships (colombo, 2012). in the 1980s the companies, with the support of the government, increasingly focused on the technology and consumer electronics sectors (glasmeier, 1988). products were created which were cheap and competitive thanks to innovative and efficient production methods. the automotive sector was particularly successful. as a result, the country's current account surplus continued to rise, as did prosperity. the gross domestic product per capita exceeded that of many western industrialized countries (chang and hirono, 1984). there was a high profit growth of companies and banks. the japanese financial system was primarily focused on banks, while capital markets tended to play a subordinate role. numerous interdependencies and regulations ensured that the growth of the lending business was evenly distributed across all banks. this was described as a "convoy system". the interest on deposits was regulated and there was a strict separation between the credit, securities and insurance business. the banks were essentially supervised by the ministry of finance. in order to prevent financial institutions to surround these regulations, bonds were strictly regulated as well. in the seventies, the reform pressure on the financial system increased. japanese companies began to become more and more internationalized by being active in foreign markets. in addition, the collapse of the bretton woods system led to fluctuations in the currencies between major trading partners so that companies needed new financial services, such as hedging transactions that took place on international markets (hotta, 1992). the growing debt of the state played a further role, creating a large market for government bonds. as a result of the increase in bonds, the securities brokerage (gesaki market) became popular, which enabled the players to get loans more easily and at short notice (horiuchi, 1996). markets for bearer securities were created as well. at the same time, the market for corporate bonds also picked up momentum and trade in options and futures contracts was expanded (remolona, 1993). in the eighties, the financial sector was then consistently deregulated. capital transactions with the rest of the world were fundamentally permitted by means of a continuous easing of the foreign exchange and trade control act (masunaga, 1996). in may 1984, the "yendollar agreement" was concluded, obliging the japanese government to take comprehensive measures to open up the japanese financial market. money, bond and stock markets became accessible for foreigners. tokyo became a large, international offshore market, which was freed from regulations and obligations. this liberalization wave revolutionized the investment and financing behaviour of japanese companies. bank loans lost their importance, and companies raised a larger portion of their required capital on financial market. shares, bonds and money market paper gained importance. in a study, it was found that the monetary transmission in the 1980s had become asian journal of economics and empirical research, 2017, 4(2): 132-141 134 noticeably more dependent on the financial markets than before (hoffmaister and schinasi, 1994). rising land and share prices increased the collateral that banks can dispose of if a customer becomes insolvent. this made it easier for banks to trust their borrowers and to offer loans. a reciprocal process of rising prices of land and stocks on the one hand, and lending on the other, started. loans were easy to get and the risk of investment projects grew (hoffmaister and schinasi, 1994). for banks, competition intensified with lower interest and profit margins. they responded by investing more in riskier projects where higher yields could be achieved. the risks in their credit portfolios increased. in addition, japanese financial institutions turned more to private households and the real estate sector, as well as small and medium-sized businesses, in order to serve new markets (heinz and manzenreiter, 2003). this created the prerequisites for a speculative bubble. it was easy to receive money and loans, and the risk tolerance of all parties involved was high. the mood indicators for industry and consumers were positive (uemura, 2009). 2.1. business cycle, monetary policy and asset prices in the middle of the 1980s, the americans put pressure: while japan's current account surplus was growing steadily the deficit in the usa increased correspondingly (uemura, 2009). political tensions between the two countries came up. the americans urged the japanese to open their business for foreigners even more and stimulate their economy vigorously. in 1985 the plaza agreement was convened, in which the japanese committed themselves to stimulate their economy to boost imports. monetary policy now became much more expansionary (okina et al., 2000). when the economy slowed down a short time later as a result of a strong appreciation of the yen against the dollar after the plaza agreement, monetary and fiscal stimulation efforts became even more supportive. interest rates fell from 5% to 2% in 1988. debt from the private sector expanded strongly, which was also due to the margin pressure in the banking sector as a result of the described deregulation. the growth of loans was significantly higher than gdp over the whole of the eighties. the debt of private households multiplied sevenfold from 1979 (9 trillion yen) to 67 trillion yen in 1991. the volume of real estate loans also doubled between 1985 and 1989 (weingarten, 2010). it came to a run on real estate. land and property prices doubled, even quadrupling in metropolitan areas such as tokyo and osaka (hoffmaister and schinasi, 1994). shares tripled in value between 1985 and 1989.1 the nikkei 225 index rose from 11,542 points in december 1984 to 39,000 points five years later. at that time, nikkei made a third of the world's equity capitalization (weingarten, 2010). two ponzi schemes played a major role for the spectacular rise of asset prices: speculative gains could be booked as a gain in company's balance sheet (colombo, 2012). as a result, rising share prices led to higher profits, which in turn led to rising share prices. the second scheme was based on the fact that rising prices in the equity and real estate markets aroused each other: a company that owned land rose in value as land prices increased so that also stock prices moved up. the higher share price enabled the companies to get fresh capital through the issuance of new shares in order to purchase land and buildings (ito and iwaisako, 1995). in both asset markets, strong herd behaviour was observed. authors who had empirically investigated the relationship between land and stock markets found that land prices were strongly influenced by past land and stock prices (ito and iwaisako, 1995). the players in the real estate sector were particularly inclined to continue the latest trends into the future. a certain autocorrelation could also be proved in the case of share prices with past share and land prices, which, however, was markedly less pronounced. herd behaviour usually occurs persistently when economic conditions have remained stable over a long period of time (valev, 1996). this includes a long-term economic upswing as well as an established positive price trend in the market. under these circumstances, the information content of past purchase decisions by other actors seems to be particularly valuable and reliable. herd behaviour, however, is problematic for two reasons. it promotes exaggerations on the market and important private information is lost to the market's information pool because agents simply copy the decisions of each other instead of using their own information. this reduces the efficiency of the market and the pricing reflects to a lesser extent the fundamental value of the market. there is a lot of evidence that this was the case in japan at the time as can be seen on figure 1. the autocorrelation of housing prices and thus the assumed herd behaviour was particularly pronounced in the time span from 1986 to 1990 – the most dynamic stage of the bubble formation2. the autocorrelation was measured on the basis of a rolling twelve-month average. figure-1. the autocorrelation on the real estate market source: data stream and own calculations autocorrelation and the boom land and housing prices were supported by the tax legislation and state regulations at that time. taxes on land property were very low during this period, while taxes on the sale of land 1 time after the plaza-accord 2 see chapter 3 asian journal of economics and empirical research, 2017, 4(2): 132-141 135 and capital gains were high. the inheritance tax on land was comparatively low so that land was an attractive heritage as a result landowners had very little incentive to sell their land despite rising prices. at the same time interest on loans could be used to reduce income taxes. against this backdrop, there was an artificial scarcity of land supply, which had accelerated the price increase (okina et al., 2000). the mood on the markets became euphoric. not even institutional investors at that time believed that the japanese market was overvalued. 82% of all companies, private households and financial institutions estimated the future positively (shiller et al., 1992) just before the crash happened in 1990. they bought more and more stocks and real estate and financed them through loans. this resulted in a dangerous interrelationship between rising prices and risk tolerance that ended up not only in extreme market valuations, but also heavily indebted the entire financial system, making it highly vulnerable to higher interest rates or corrections of market values. this process is typical for the development of asset price bubbles. if prices on the real estate or equity market have risen over a longer period, as has been the case in japan, investors are increasingly able to record book gains in their portfolios. these book gains shift the risk appetite of investors towards riskier transactions because – psychologically they are perceived as gifts for which investors had nothing to do. if these gains are lost again, the loss pain is comparatively small. this risk perception has been demonstrated in a series of experimental psychological studies and finds its precipitation in the "dynamic prospect theory" (barberis et al., 2001). 3. how big was the bubble really? a first problem analysing asset price bubbles is that there is no commonly accepted view what an asset price bubble is. often quoted is the definition of kindleberger: an asset price bubble is as a sharp rise in the price of an asset or range of assets in a continuous process, with the initial rise generating expectations of further rises and attracting new buyers generally speculators, interested in profits from trading in the assets rather than in its use as earning capacity (kindleberger, 1978). another widely recognized definition characterizes an asset price bubble as an explosive and isometric deviation of the market price of an asset from its fundamental value, with the possibility of a sudden and significant reverse correction (kubicova and komarek, 2011). thereby, the fundamental value is characterized by the net present value of the asset. shiller states, that a bubble is a situation in which temporarily high prices are sustained largely by investors´ enthusiasm rather than by consistent estimation of real value (shiller, 2000). what can be drawn out of these definitions? asset price bubbles contain a strong speculative element. the fundamental value will be at least partially neglected by investors, and a strong market correction has to be expected once the bubble bursts. in addition, the process of the bubble formation is explosive and non-linear. these definitions refer to extreme market events as they shall be investigated in this paper. borio and lowe (2002) run an asset bubble study for 34 countries for the years 1960-1999. according to them, asset price bubbles move along with an investment boom in the real economy as well as strong credit expansion and a high financial leverage in the banking and corporate sector. this combination seemed to be particularly dangerous for the stability of a financial system. the two authors confirm in their study that indications exist which can be used to detect or recognize asset price bubbles. these characterisations of an asset price bubble and the results from borio and lowe are the basis for the following empirical analysis. it begins with a simple discounted cash flow model to assess the fundamental value of the japanese housing and stock market. after that, an autoregressive distributed lag model for cointegration has been introduced to test for a long-term equilibrium between financial prices of the two markets and several macroeconomic or financial indicators. long-term variation coefficients have been derived if cointegration was found and been used to calculate another fundamental value. the differences of the market values from the two independent fundamental values can be interpreted as an asset price bubble if they were found to be extraordinary large. in a further empirical analysis the credit and investment-to-gdp growth will be compared to investigate whether the bubble process in financial markets is moving along with a leveraging and investment boom in the real economy. if this was found, a truly and devastating asset price bubble is at place. 3.1. the discounted cash flow model for stock and housing markets the value of real estate or stocks can be estimated by a simple discounting the future expected rents/dividends. (1) i dividendsnts p sh /re /  ph/s stands for the estimated fundamental value of a house or stock, and i – the discount rate for representative interest or mortgage rates. ph/s stands for the price level of the housing or stock market. in the academic discussion, it was not undisputed whether cointegration based present value estimates can be used (campell and shiller, 1987). therefore, the standard dcf-approach was applied here. its aim was to measure the size of a possible market overvaluation in percentage terms. of course, this dcf-approach is linked to several important weaknesses. rents or dividends may artificially be boosted by the bubble formation process so that calculated values are underestimating the true overvaluation of the market. in addition, market prices are forwardlooking while current cash flows are used. this time gap may also lead to wrong conclusions. despite these limitations, the dcf-approach belongs to the most reliable valuation measures available. 3.2. autoregressive distributed lag models and cointegration the aim of this methodology is to find macroeconomic or financial variables that form a long-term equilibrium path with stock and housing market prices. that path can be used to calculate another fundamental value for stock and housing market prices. several cointegration approaches could be applied in this context but most of them would require that the variables included have to have the same order of integration. this would exclude a lot of potential variables and limit the quality of the model substantially. therefore, an alternative cointegrating technique is used the autoregressive distributed lag (ardl) approach. this approach allows the use of variables with different orders of integration (pesaran and shin, 1999). the distribution of f-statistics is non-standard irrespective of the integration order of the included variables. two sets of critical values are provided, one in which asian journal of economics and empirical research, 2017, 4(2): 132-141 136 all variables are assumed to be of integration order one and another in which all variables are assumed to be of zero order. these two sets form a band covering all possible classifications of the variables in terms of their integration order. if the computed f-statistic is above the values of this band, the analysis can continue without knowing the order of integration of the underlying variables. if it falls within the band than a distinction of the variables becomes necessary. the ardl approach provides a linear error-correction model to test the significance of the underlying variables and their cointegration. in addition, long-run coefficients based on ardl models selected by aic and sbc criteria can be estimated to use them for the calculation of a macroeconomic based fundamental value for housing and stock prices. according to economic pretesting for the japanese housing market prices (jphp) the unemployment rate (ur), business failures (bf), and business confidence (bc) could be cointegrated based on an integration order of one. the equation takes the following form: (2) to bcbfurjphp   321 the error correction version of the ardl model is as follows: 1 1 1 1 1 1 3 4 1 5 1 6 1 6 1 1 n n n t o i t i i t i i t i i i i n i t i i t i t i t i t t i jphp jphp ur bf bc jphp ur bf bc                                          the model for the japanese housing market was calculated by using monthly data from m1 1980 to m12 1992. the data was transformed into logarithms except for interest rates. the augmented dickey-fuller test showed that all variables were of integration order zero or one. only japanese housing prices varied between order one and two. for simplicity it was assumed that they were also of integration order one. for the japanese stock market a cointegration based model was not found. 3.2.1. the ardl model and its long-run coefficients the unemployment rate, the amount of business failures, and business confidence were statistically significant and cointegrated with housing prices. the economic foundations for these variables are as follows: the level of unemployment is affecting disposable income to finance housing. business failures had an impact on the demand for housing since corporations were heavily invested in the real estate sector at that time. another channel of influence was that the willingness of banks to finance housing activities of corporations was dependent on the amount of business failures. business sentiment influenced the readiness of corporations to invest in the housing market. the ardl showed the following results for the error correction version of the model. table-1. ardl (2,0,0,0) error correction presentation est. variable 0.574* djphpt-1 -0.197* dur 0.067* dbf 0.419* dbc –0.135* ec1t-1 stde 0.0739 -0.0058 -0.0351 0.2071 0.0273 t-r. (7.76) (-3.39) (-2.52) (2.02) (-4.94) prob. (0.00) (0.001) (0.013) (0.045) (0.00) source: own calculations table-2. estimation & diagnostic statistics r-squared = 0.447 r-bar-squared = 0.422 f-statistics = 17.63 (0.00) dw-statistics = 1.726 f-statistic: 5.479 95% low. bound / 95% up. bound / 90% low. bound / 90% up. bound 3.3202 4.433 2.774 3.830 source: own calculations table 1 show that the included variables were statistically significant according to their t-ratios. all three variables had the theoretically expected sign as well as the error correction term that was highly significant and had a negative variation coefficient. it was -0.135 suggesting that 13.5% of the deviation from equilibrium that may result from a shock will disappear after a month. the assumption of cointegration was proven by the f-statistic value of 5.479 that was above the critical 95% and 90% upper bound level. the r-squared was indicating high correlation, although it might have been somewhat distorted from the autocorrelation of residuals as hinted by the durbin-watson coefficient. the next step is to derive the long run coefficients out of this ardl model as presented in table 3: table-3. long-run coefficient estimates and diagnostics constant ur bf bc 0.01405 (3.72) -0.146 (-3.23) -0.496 (-3.20) 3.105 (2.39) source: own calculations the upper row shows the results for the long-term variation coefficients of the explanatory variables. the values in brackets are the t-statistics. all variables have the theoretically expected signs and are significant as in the error-correction version. these values can now be used to derive a cointegration based fundamental value for the japanese housing market. the outcome will be presented in the following graphs. 4. graphical results for the assessment of the valuation models and the investment as well as the credit gap calculations, a ten-year rolling window for the assessed time series was introduced. from historical experience it is known that the bubble formation process lasts about that time so this time window seems to be the most appropriate. (3) asian journal of economics and empirical research, 2017, 4(2): 132-141 137 figure-2. japanese housing market & ardl long-run coefficient and dcf source: datastrem and own calculations the dotted line represents the discounted cash flow model results, the slashed line the ardl-estimates, the continuous line the housing market. both fair value model estimates indicated that the housing market was overvalued by a level of around 100%. the price bubble entered its final and explosive phase from 1988 onwards when market prices decoupled from the estimated values. the dcfresults showed a higher fair value than the ardl-model. since the two largely independent approaches pointed towards a highly overvalued housing market, one may conclude that an asset price bubble was at place. while this calculation was based upon an average countrywide house price index, prices in large cities such as tokyo or osaka moved up four times as much. to a certain extent one may say that the degree of the asset price bubble was rather understated by the used data. figure-3. japanese stock market and dcf-fair value estimates source: datastream and own calculations the dotted line represents the discounted cash flow model, and the continuous line the stock market. the dcf-fair value indicated that the stock market was overvalued by more than 100%. probably this calculation is underestimating the degree of overvaluation because the underlying cash flows are also likely to be inflated in that period. this is one of the typical disadvantages of the dcf-approach. nevertheless, also for the stock market a fair conclusion is that an asset price bubble took place from 1987 onwards until the early months of 1990. for the stock market it can be said that it entered its final and explosive phase already in from 1986 onwards when market prices decoupled from the estimated fair values. figure-4. credit and investment to gdp growth before the japanese housing bubble source: datastream and own calculations the assessment that japan was in a true asset price bubble as described in the beginning of this paper could be seen by the growing gaps of credit and investment relative to gdp. the continuous line represents gdp, the slashed line credit expansion, and the dotted line investments. credit demand began to accelerate sharply in the late seventies and stimulated investments in housing and business equipment. this move was due to the asian journal of economics and empirical research, 2017, 4(2): 132-141 138 deregulation of the financial sector that happened at that time. interest rates were still at levels of 6% or higher and not supportive in the early stage of the considered time period. the credit gap became less pronounced in the following years despite falling interest rates. however, it was effective until the bubble burst and contributed to its development. one would expect that credit is expanding particularly fast in the last three years of the bubble when buying assets on margin seems to be very lucrative. this was not the case here. however, the large early gap was sufficient to finance the bubble in housing and stocks as well as the overinvestment in the economy. once a portion of the investment boom turns out to be unprofitable – which is usually the case when a recession sets in a financial deleveraging will be forced in the private, corporate and banking sector. the larger the rise of the credit and investment boom was the deeper and longer the deleveraging process that follows. from august 1988 onwards all of the four bubble measures in this paper were above the proposed threshold value of the 10 year average plus half the standard deviation. the central bank and the government would have had two years to tackle the growing bubble. 5. the collapse the japanese central bank became increasingly concerned about the rising prices of goods, services and financial assets in 1989. the strong growth of the economy for several years finally was felt in terms of inflation. towards the end of the 1980s, the economy hit its capacity limits. after ending the recession at the end of 1986, the economy continued to expand for four years and three months until february 1991. this was the longest economic expansion since the late 1960s. during this period, real gdp grew on average with an annual rate of 5.5% and industrial production with 7.2%. the output gap was positive in 1987 and continued to grow towards the end of 1989 (okina et al., 2000). so the economy grew significantly above potential. inflation had remained moderate for quite some time but in 1989 a noticeable increase happened. in november 1990 it accelerated to 3%. at that time, the price bubble on the financial markets had long been fully developed and the crash had started. the inflation risks were only visible when the price bubble had burst. this outcome is clearly contradicting the jackson hole consensus among central bankers (bernanke and gertler, 2001) which is claiming that as long as inflation is tame also the economy and financial markets are in equilibrium. it was striking that rents decoupled from the sharp price rise of properties to a large extent. they increased continuously, but at a moderate pace (shimizu and watanabe, 2010). this contributed significantly to the fact that inflation remained tamed for a long time. one reason for this phenomenon could have been the existence of long-term contracts between tenants and landlords, whose changes are also limited by state regulations. from may 1989 onwards, the central bank began to increase interest rates gradually. other central banks in the western world had already done so but not as strongly as in japan. until august 1990, the japanese raised their interest rates from 2.5% to 6%. these interest rate increases hit a high level of private sector debt, which in the second half of the 1980s had grown extraordinarily strongly both in absolute terms and relative to the gdp (hoffmaister and schinasi, 1994). the balance sheets of the financial sector ballooned accordingly. nine of the ten largest banks in the world came from japan (patrick, 1998). the high level of debt and the inflated balances of financial institutions made the economy particularly vulnerable to the effects of a restrictive monetary policy. initially, the first interest rates of the central bank remained ineffective the economy and financial markets continued to flourish. toward the end of the year the sentiment suddenly changed and the stock market collapsed. the "zaitech effect" now turned into its opposite the profits of companies shrank dramatically and the prices on financial markets followed. this also led to a rise in risk premiums for the granting of loans. a number of investment projects, which were launched and designed in the previous years, now turned out to be unprofitable (hoffmann and schnabl, 2009). the growth rate of the return on equity was already negative in 1990. the overall economic demand weakened and the increased interest rates dampened investment and speculation. an intensifying downward spiral of falling prices on the stock market, a worsening of the mood and a declining demand for goods and services was the consequence. the real estate market, on the other hand, remained remarkably resistant (shimizu and watanabe, 2010). despite the growing worries and risks, prices rose even slightly. as a result, private households were still spared the crisis to some extent. however, about one year later, the boom in the real estate market also ended. first, prices for commercial real estate broke down. the same happened to the price of land in the metropolitan areas, especially in tokyo. the delay of the real estate market reaction was due to the fact that current real estate and land prices do not really reflect the actual situation on the market, but move with a time-lag. this is due to a lack of transparency. on the stock market, prices are quoted every second, provided the market is open. there is also a relatively high number of transactions per trading day. this is completely different on the real estate market. unlike stocks, real estate is not homogenous at first no real estate is exactly the same. then far less real estate is traded in some submarkets sometimes not for weeks. this makes the market value far more obscure and many owners are only willing to accept a fallen price level with a greater delay. once also housing prices started to fall it became increasingly difficult for companies to get financing for new housing, and financing became also considerably more expensive because of increased risk premiums. new offices and factories were no longer needed. once private properties also lost value, the financial situation of private households fell into disrepair. their collateral fell to levels below their debt, so loans from banks were terminated earlier or not extended. in the same way, corporations run into financial troubles. the crisis took full steam. after the bubble burst, the nikkei fell from 40,000 points in december 1989 to below 8,000 points in 1999. land prices lost 80 of their value between 1991 and 1998. unemployment rose steadily from 2.1% in 1998 to 4.7% in 2000. for japanese conditions this increase was enormous and shocked the japanese who were used to job security. their social systems found this development largely unprepared. this resulted in a veritable and long-lasting demand crisis. as soon as the first crash wave had passed between 1989 and 1991, the country's past optimism changed into an excessive pessimism, which accelerated the decline in financial market prices. for example, the consumer sentiment index fell from over 50 points in december 1989 to just 36 points in 1993. this was also supported by the onset of herd behaviour on the negative side. assets were sold because all did and because the long lasting capital losses triggered panic. in addition, companies were forced to adjust their balance sheets and reduce their debt levels. furthermore, the asian journal of economics and empirical research, 2017, 4(2): 132-141 139 company's inflated capital stock had to be reduced (yoshino et al., 2012). this led to further losses in investment demand and accelerated the decline in financial market prices. there were bankruptcies and defaults encumbering bank balances, which triggered a long-lasting negative financial acceleration. all this turned into high risk premiums for new loans and in the equity market as well as into banks' extremely low willingness to lend. the demand for investments fell dramatically, the decline in financial market prices accelerated. unusual high levels of bankruptcies resulted in a long-lasting credit crunch. the fact that banks had been so reliant on land and real estate on their loans made a significant contribution to the long-lasting balance-sheet problems. their equity melted and hidden reserves became hidden burdens. a total of 170 financial institutions had to file for bankruptcy (patrick, 1998). 6. lost decades all this was followed by the "lost decades". slow or no growth and deflation were their hallmarks. unprofitable, heavily indebted banks and companies had been artificially kept alive through state subsidies and a zero-percent-interest-rate-policy. measures that should prevent a hard landing of the economy in the short term prevented a real clean-up of the problems over the long run (weingarten, 2010). the creeping downward trend did not end. in 2004, the property market in tokyo was just 10% of its value, which was paid for in 1990. japanese equities were still trading for a quarter compared to the boom year. gdp growth was only 1.1% on average in the period 1992-200, compared to 3.8% in the period between 1974 and 1991. in the late 1990s a creeping deflation began in japan. this was also due to falling nominal wages, which was not observed in any other oecd-country. unaccustomed unemployment was a major cause in this regard (heinz and manzenreiter, 2003). despite massive support measures through monetary and fiscal policy, the japanese economy was still unable to recover sustainably. the monetary policy was in a liquidity trap due to the described problems in the financial sector. a number of economists were of the opinion that the japanese government should have encouraged companies and banks to write down unprofitable investments, clean up balance sheets and continuously reduce debt (okina, 1999). instead, the government and central bank delayed this process of adjustment by ensuring that market prices remained artificially high, impacted savings with negative incentives, and stimulated consumer demand through short-term spending programs. this exceedingly interventionist policy had no success. between 1990 and 2000, japan experienced ten such government stimulus programs that cost more than 100 trillion yen (weingarten, 2010). in addition, aid for the banking sector and credit guarantees for companies were provided. all this led to a massive increase in the national debt, which in 2000 amounted to more than 100% of gdp without the country being able to free itself from the crisis. this was still the case for 2010. only the national debt had now doubled to 200% of gdp. an important reason among others for this negative development may have been the rampant corruption. loans were not always awarded according to economic criteria, but because of political relations. the result was a large number of failed investment projects. the main beneficiary of government expenditure programs was the construction industry, which traditionally belonged to the supporters of the governing ldp (kawata, 2011). from an economic point of view, this has led to a tying of resources into sectors that could have been used in other sectors much more efficiently and more profitably. companies that did not have such political relations found it even more difficult to get money, because the few loans that banks still offered, were given to those companies, to which the state's programs promised a better future in the short term. in this way it lasted until the turn of the millennium, before the profitability of capital began to recover slowly. figure-5. development of capital profitability source: fukao et al. (2014) as can be seen in the next graph, credit institutions did not manage to curb the increase in bad loans in their balance sheets by the turn of the millennium. it amounted to about 7% of gdp. however, even this figure was under suspicion, to have been beautified (hanazaki and horiuchi, 2002). mainly responsible for the length of the credit crisis was the long-lasting decline in land prices and the ever-new lending to debtors threatened with bankruptcy in order to prevent the final depreciation of bad loans. asian journal of economics and empirical research, 2017, 4(2): 132-141 140 figure-6. distressed loans in the banking system after the collapse source: financial services agency, japan, 2002 apart from the unstoppable rise in government debt, japan's economic policy has two further negative consequences: banks and companies that generate little or no income from their capital are artificially kept alive by state aid and economic stimulus programs. as a result, the economy is permanently deprived of part of its growth potential. moreover, the japanese central bank's unceasing supply of money jeopardizes the stability of other countries. capital seeks its way to higher yields. if these are not sufficiently found in japan, then it flows abroad. for example, some economists attribute the financial crisis of a number of asian economies to the flow of money from japan towards the end of the 1990s (hoffmann and schnabl, 2009). and even today, the stream of japanese money wafts through the world financial system and could contribute to the emergence of a new price bubble in other countries. to get away from this path of economic policy has become extremely difficult after such a long time. although the country's debt has risen to more than 200% of gdp it “only” has to pay 25% of its tax revenues for interest rates (satyajit, 2013) because of interest rates on government debt being kept so low. if the interest rate were to rise to 4%, which corresponds to the long-term historical average of the industrialized countries, the country would have to spend its whole national budget on the interest rate service alone. 7. conclusions the japanese long-lasting financial crises had been caused by major asset price bubbles in the real estate and stock market. the applied two valuation approaches, which were to a large extent independent of each other, supported this assessment for the housing market and the dcf-approach for the stock market alone. the reasons for the evolvement of these bubbles had been quite typical according to what can be learnt from economic history. a long-term economic upswing in combination with an increasingly expansionary monetary policy and a far reaching deregulation of the financial sector laid the ground for it. tax laws played an additional role by reducing the sell side of the housing market. during the bubble formation phase two ponzi processes were at work which accelerated the boom on the markets. if such ponzi processes can be observed together with an overleveraging of the economy and patterns of overinvestment – as it was the case in japan – governments, central banks and investors should react by strengthening the financial system, increasing interest rates and reducing investment risks. the collapse set in once the bank of japan was forced to raise interest rates due to increasing inflationary pressures and concerns about extreme market valuations. also this was a typical pattern from a historical prospective. the jackson hole consensus among central bankers that the economy as well as financial markets are in equilibrium as long as inflation remains stable had been proven wrong as in many other historical cases. inflation is a lagging economic indicator and financial markets are forward-looking so when inflation finally becomes visible it is too late because the bubble has already built up. in addition, in a world of open and globalised economies it takes a longer time before an economy 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for asia – banking behavior and the asset bubble. preliminary paper. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://scholar.google.com/scholar?hl=en&q=the%20japanese%20technopolis%20program:%20high-tech%20development%20strategy%20or%20industrial%20disguise http://dx.doi.org/10.1111/j.1468-2427.1988.tb00453.x https://scholar.google.com/scholar?hl=en&q=the%20classification%20and%20identification%20of%20asset%20price%20bubbles https://scholar.google.com/scholar?hl=en&q=monetary%20policy%20under%20zero%20inflation:%20a%20response%20to%20criticisms%20and%20questions%20regarding%20monetary%20policy https://scholar.google.com/scholar?hl=en&q=housing%20bubbles%20in%20japan%20and%20the%20united%20states https://scholar.google.com/scholar?hl=en&q=housing%20bubbles%20in%20japan%20and%20the%20united%20states 191 asian journal of economics and empirical research vol. 5, no. 2, 191-200, 2018 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2018.52.191.200 stock market efficiency and price limits: evidence from korea’s recent expansion of price limits h. r. seddighi1 il-hyun yoon2  ( corresponding author) 1business school, university of sunderland, st. peter’s campus, st. peters way, sunderland, tyne and wear sr6 0dd uk 2division of business administration, dongseo university, 47 jurye-ro, sasang-gu, busan 47011 korea abstract this paper examines the efficiency of the korean stock exchange market with reference to the recent relaxation of price limits effective on june 15, 2015 for the period from january 2012 to november 2017 and compares the efficiency between sub-periods before and after the police change which saw expansion of daily price limits from 15% to 30%. the daily returns of the market index and 60 stocks selected from different industrial sectors are used to test the random walk hypothesis under two different price limits regime using the lo-mackinlay variance ratio tests and multiple variance ratio tests. the empirical evidence found that the market index showed weak form market efficiency along the lines of random walk hypothesis while individual sample stocks behaved differently according to the different price limits periods. the number of stocks following the random walk process increased under the 30% price limits regime in comparison with that under the 15% regime, indicating korea’s stock market appears to become more efficient as daily price limits are expanded although the findings are rather suggestive than definitive. keywords: daily price limits, efficient market hypothesis, korean stock market, kospi, multiple variance ratio tests, random walk process jel classification: c12; g14. citation | h. r. seddighi; il-hyun yoon (2018). stock market efficiency and price limits: evidence from korea’s recent expansion of price limits. asian journal of economics and empirical research, 5(2): 191-200. history: received: 26 july 2018 revised: 30 august 2018 accepted: 3 october 2018 published: 6 november 2018 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 192 2. methodology ................................................................................................................................................................................... 193 3. data analysis .................................................................................................................................................................................. 194 4. empirical results ........................................................................................................................................................................... 196 5. conclusions ..................................................................................................................................................................................... 198 references ............................................................................................................................................................................................ 198 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2018.52.191.200&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/259 https://orcid.org/0000-0002-2645-775x https://orcid.org/0000-0003-3679-0545 http://asianonlinejournals.com/index.php/ajeer/article/view/259 https://orcid.org/0000-0002-2645-775x https://orcid.org/0000-0003-3679-0545 http://asianonlinejournals.com/index.php/ajeer/article/view/259 https://orcid.org/0000-0002-2645-775x https://orcid.org/0000-0003-3679-0545 http://asianonlinejournals.com/index.php/ajeer/article/view/259 https://orcid.org/0000-0002-2645-775x https://orcid.org/0000-0003-3679-0545 asian journal of economics and empirical research, 2018, 5(2): 191-200 192 1. introduction prediction of security prices is of great importance to investors in financial market to beat the market for better performance than others. since the significant study by fama (1965) in which he empirically presented that mutual fund investments for stocks of the dow-jones industrial average do not outperform randomly selected portfolio with no evidence of the fund managers having superiority to the average investors, a large number of researchers in both academic and industry sector have focused on the efficiency of stock markets across the world. in an efficient market, according to the efficient market hypothesis (emh), stock prices “fully reflect” available information therefore investors cannot earn abnormal returns over the market average (fama, 1970; 1991). the market efficiency has been tested with the random walk process where security prices moves randomly and serially independent. therefore, under the random walk hypothesis, future stock prices cannot be predicted with the past price history since the relevant information would have already been fully reflected in an efficient market which is specifically known as weak form efficient market.1 statistically speaking, random walk process is that stock prices move independently and their changes are identically distributed. a large body of empirical research on random walk process test for examination of efficient market hypothesis has been done for the various stock markets in both developed and emerging economies since the works of fama (1965;1970) and produced mixed results. earlier studies on random walks of stock price movement were mainly conducted by use of conventional methods such as serial correlation, unit root test or runs test. however, since (lo and mackinlay, 1988) proposed a new method, the variance ratio test, to investigate the weekly stock returns in the us and rejected the random walk process for the us stock market, the variance ratio tests have been extensively used in recent studies because of its powerfulness. several studies have been devoted to the investigation on the random walk hypothesis for the korean stock markets, such as ayadi and pyun (1994), narayan and smyth (2004) and hasanov (2009) with mixed results. some studies have been conducted to compare korean stock market with other different stock markets in asian region in terms of market efficiency using the market indexes. huang (1995) rejected the random walks for korean stock market while hoque et al. (2007) and kim and shamsuddin (2008) suggested that korean stock market is efficient. recently, korean authority expanded daily limits of stock prices in korea to 30 per cent on june 15, 2015 for the first time since the government had eased the then-existing 12 per cent of price limits to 15 per cent in december 1998 in an effort to induce foreign direct investment into the country’s financial market in order to deal with the financial crisis which broke out in late 1997. the korea’s price limit system has been steadily relaxed amid the persistent criticisms of market inefficiency it may cause due to the possible manipulation of stock prices and restriction of trading opportunities. as korea joined the oecd, the daily stock price limits had been expanded since november 25, 1996 to 8 per cent from the previous 6 per cent limits. following the 1997 korean financial crisis, the price limits were relaxed to 12 per cent on march 2, 1998 and 15 per cent on december 7, 1998 in an effort to encourage foreign investment into the country’s capital market.2 this regime change of daily limits reinvigorated interest in the effect of stock price daily limits on the efficiency of stock markets. to prevent stock market from excessively fluctuating, some countries, including china, taiwan and japan, use daily price limits system where stock prices are allowed to move up or down within a maximum price range from the previous closing prices in a day.3 although an abundance of research has been carried out with reference to the efficiency of stock markets, there are few studies on the effect of price limits on the stock market efficiency. some of research on the price limits focused on the association between price limits and stock market volatility. lee and kim (1995) investigated the effects of price limits on the korean stock market to find that price limits decreased stock price volatility over the period 1980-1989 while (berkman and lee, 2002) examined the effects of expansion of price limits on volatility and trading volume for korean stocks for the period from april 1, 1994 to april 1, 1996 to find that expansion of price limits increased weekly volatility and decreased trading volume. for studies on the stock price limits and market efficiency, lee and chung (1996) tested 30 stocks randomly selected from korean stock exchange to find that the price limits system results in a lower volatility and that korean stock market seems to be inefficient because of the biased price movements due to the price limits. later, ryoo and smith (2002) examined the random walk hypothesis for the korean stock market with the use of multiple variance ratio tests for a sample of 55 actively traded stocks selected from different industries for the period march 1988 to december 1998 which saw five changes of daily price limits. as price limits are eased, more stocks are found to follow the random walk process. lim and brooks (2009) compared the effects of change in price limits on the stock market efficiency among korea, china and taiwan. using the rolling bicorrelation test statistic on the daily market indexes, they suggested that price limits do not weaken market efficiency. however, their findings may have some drawback in that they used market indexes for analysis rather than individual stock prices because the price limits are imposed on the individual stock prices not the market index. it would be of great interest to examine whether relaxed price limits regime in korea stock market have contributed to the market efficiency as hoped by the authority. to fill the gap in the literature on this topic, this paper aims to investigate the effects of the recent widening of price limits on efficiency of the korean stock market based on a random walk model. based on the methods of alternative variance ratio tests, this study uses 60 companies listed in the korea exchange selected from different industries as well as korea composite stock price index (kospi). daily closing stock prices for the sample companies are collected over the period from january 2, 2012 to november 30, 2017, which is divided into two sub-periods of january 2, 2012 – june 14, 2015 and june 15, 2015 – november 30, 2017 for comparison of market efficiency between before and after the relaxed price limits effective on june 15, 2015. 1 in emh, according to the three available information set, there are three different efficient markets, i.e., weak form, semi-strong form, and strong form efficient market. for more details, refer to fama (1970). 2 detailed explanation and history of daily price limits system in the korean stock market is well documented in section iii of ryoo and smith (2002). 3 at present japan’s daily price limits are set in absolute yen from the previous day’s closing price, for example, price limit for the stock with previous day’s closing price of less than 1,000 yen is ±150 yen. in china and taiwan, daily price limits of stocks are set at ±10 percent of the previous day’s closing price (see http://www.jpx.co.jp/english/equities/trading/domestic/06.html, http://english.sse.com.cn/tradmembership/rules/c/3977570.pdf, and http://www.twse.com.tw/en/page/products/trading_rules/mechanism01.html#5). asian journal of economics and empirical research, 2018, 5(2): 191-200 193 the rest of the paper is organized as follows. section 2 discusses the research methodology to test the random walk hypothesis. the data used for analysis is presented in section 3. section 4 discusses empirical results and implications of the results before concluding the study in section 5. 2. methodology multiple variance ratio tests were employed to test the random walk process for daily stock returns in an attempt to investigate the effect of significant expansion of daily price limits on the efficiency of korean stock market.4 variance ratio tests proposed by lo and mackinlay (1988) have been popular and extensively used in testing the random walk process for examination of the market efficiency across the world including korea (for example, ayadi and pyun (1994), huang (1995), ryoo and smith (2002), hoque et al. (2007) and kim and shamsuddin (2008). in an efficient (weak form) market, stock prices tend to follow a random walk process, hence stock prices cannot be predicted by the past information as all available information have been absorbed in current prices. for the test of the market efficiency, the random walk model is used, defined as; pt = μ + pt-1 + εt (1) or, ∆pt = rt = pt – pt-1 = μ + εt (2) where ∆pt (rt) is the continuously compounded rate of return for a stock at time t, pt and pt-1 is the natural log form of the stock price at time t and t-1, µ is a drift parameter, and εt is a random disturbance term. under the random walk hypothesis, εt is independent and identically distributed (i.i.d.) and uncorrelated. if μ = 0, it is a random walk without drift, and if μ ≠ 0, it is a random walk with drift. the variance ratio methodology is based on the idea that “the variance of random walk increments is linear in all sampling intervals”, meaning that the “variance of k-period return of the time series (yt), rk = yt−yt−k, is k times the variance of one-period return, rt = yt−yt−1” (amélie and darné, 2009). the variance ratio of k-period return, vr(k), is defined as: ( ) ( ) ( ) ( ) ( ) ∑ . ( ) / (3) where ρi is the ith lag autocorrelation coefficient of (malkiel and fama). vr(k) is a linear association of the first (k−1) autocorrelation coefficients. when returns are not correlated over time, ( ) should be kvar(rt), i.e., vr(k) = 1. the variance ratio test is a test of h0 : ρ1=···=ρk=0, i.e., returns are serially uncorrelated. consequently, it tests the hypothesis that the return of a time series (yt), rt = yt−yt−1, follows a random walk. two test statistics for the random walk process are estimated according to the assumptions of the data series. under the assumption of homoscedasticity (i.e., i.i.d.), the test statistic z1(k) for the null hypothesis of v(k) = 1, is given by ( ) ( ) ( ) (4) where φ(k) is asymptotic variance and defined by ( ) ( )( ) (5) under the assumption of conditional heteroscedasticity, the heteroscedasticity robust test statistic z2(k) for the null hypothesis of v(k) = 1, is given by ( ) ( ) ( ) (6) where ( ) ∑ 0 ( ) 1 ( ) (7) ( ) {∑ ( ̂) ( ̂) } * ,∑ ( ̂) + (8) the lo-mackinlay variance ratio tests are designed to test the null hypothesis for an individual value of the holding period k. however, since the null hypothesis needs to be tested for all holding periods of k, the tests should be conducted jointly over a set of holding periods. to overcome the weakness of ignoring the joint nature of testing (lo and mackinlay, 1988) tests, this study employed the multiple variance ratio tests proposed by both chow and denning (1993) and richardson and smith (1991). the multiple variance ratio tests consider the joint null hypothesis h0i: vr(ki) = 1 for all i = 1,···, m, against the alternative h1i: vr(ki) ≠ 1 for any i = 1,···, m. for the tests of the joint null hypothesis, the test statistic developed by chow and denning (1993) is defined as √ | ( )| (9) where z1(ki) is defined in equation (4). the decision-making for the null hypothesis is based on the maximum absolute value of the individual variance ratio statistics. the studentised maximum modulus (smm) distribution with m parameters and t degrees of freedom at α significance level, i.e., smm(α,m,t), are applied in the tests. similarly, the heteroscedasticity robust statistic m2 is given as √ | ( )| (10) where z2(ki) is defined in equation (6). the random walk hypothesis is rejected if the maximum absolute value, m1 or m2, is greater than the critical value of smm at a chosen level of significance. alternatively, we used another joint test developed by richardson and smith (1991) which uses the wald statistic defined in equation (11). ( ) ( ) ( ) (11) where r is the (k+1) vector of sample k variance ratios, 1k is the (k×1) unit vector, and φ is the covariance matrix of r. the rs(k) statistic is based on the chi-squared distribution with k degrees of freedom. 4 variance ratio, individual and multiple, tests are well documented in amélie and darné (2009). asian journal of economics and empirical research, 2018, 5(2): 191-200 194 this test is argued to be more powerful than multiple variance ratio tests of chow and denning (1993); fong et al. (1997). however, this test is useful only in the homoscedastic tests (amélie and darné, 2009). hence richardson-smith tests were only applied under no heteroscedastic assumption in this study. 3. data analysis for the analysis on the efficiency of korea’s stock market, this study used daily closing prices of 60 stocks listed in the korea exchange as well as the market index, kospi. the sample period runs from january 2012 to november 30, 2017, corresponding to 1,459 observations and the data were obtained from yahoo finance database. the period is divided into two sub-periods i.e., the period for january 2, 2012 to june 14, 2015 under daily price limits regime of 15% and the period for june 15, 2015 to november 30, 2017 under the 30% daily price limits regime with 850 and 609 observations, respectively. as of november 30, 2017, the number of companies listed in kospi market is 770 with total number of listed stocks being 883 and its market capitalisation amounts to 1,607 trillion won, equivalent of 1,477 billion dollars. korea’s stock market is composed of a number of key industries as shown in table 1. special care is taken to select the samples that are actively traded so as to represent the industries well, considering the number of stocks belonging to the industry and their market capitalisation with respect to aggregate market capitalisation. accordingly, six stocks come from finance industry, five stocks are chosen from each of industries such as chemicals, services, distribution, electrical & electronic equipment and transport equipment. in the industry of iron & metal products, medical supplies, machinery, food & beverages and construction, four stocks are sampled from each industry and two stocks are selected from each of electricity & gas, communication and transport & storage. three stocks are chosen from textile & wearing apparel, non-metallic mineral products and other manufacture. table 2 reports sample stocks classified by industry, each sample’s market capitalisation and the number of listed shares with its percentage vis-à-vis those of aggregate market and ratio held by foreign investors. a sample of 60 stocks constitutes 56 per cent of total market capitalisation and 25 per cent of total number of shares listed in korea’s stock market. table-1. overview of listed companies by industry (as of nov 2017) industrial classification no of listed companies no of listed shares (thousand) capital stock listed (mil won, %) market cap (mil won, %) kospi market 770 42,313,258 107,486,916 (100.00) 1,607,169,301 (100.00) finance 115 12,294,653 42,554,280 (39.59) 316,091,598 (19.67) chemicals 93 2,927,784 6,348,142 (5.91) 163,974,550 (10.20) services 73 3,124,206 3,648,543 (3.39) 123,069,555 (7.66) distribution 59 2,966,748 4,914,762 (4.57) 82,679,537 (5.14) electrical and electronic equipment 54 3,943,099 10,151,032 (9.44) 491,579,552 (30.59) transport equipment 54 3,178,910 9,948,482 (9.26) 120,227,496 (7.48) iron & metal products 45 1,422,641 3,151,818 (2.93) 57,171,528 (3.56) medical supplies 41 1,250,815 1,268,274 (1.18) 51,604,430 (3.21) machinery 41 1,927,585 2,594,990 (2.41) 19,858,694 (1.24) foods & beverages 39 1,300,254 1,312,162 (1.22) 34,295,813 (2.13) construction 31 1,626,633 5,586,149 (5.20) 20,468,693 (1.27) textile & wearing apparel 25 624,299 527,899 (0.49) 6,198,328 (0.39) non-metallic mineral products 22 682,581 1,257,597 (1.17) 8,128,040 (0.51) transport & storage 21 1,443,321 3,655,461 (3.40) 20,204,123 (1.26) other manufacture 12 468,236 1,176,699 (1.09) 18,784,711 (1.17) electricity & gas 10 808,503 3,930,721 (3.66) 31,098,019 (1.93) communication 4 865,739 4,226,743 (3.93) 35,462,277 (2.21) others 31 1,457,248 1,233,161 (1.15) 6,272,357 (0.39) note: finance includes banks, securities, insurance and other financial companies. others include paper & wood, medical & precision machines, fisheries industry, and mining industry. the continuously compounded rate of return for market index and each sample stock for the sample period are used for the empirical analysis and its descriptive statistics are summarized in table 3. the average mean of daily returns for 60 stocks (0.012%), as well as the index (0.021%), is positive for the entire sample period, reflecting the overall rise of the korean stock market during the sample period. the average for the period after the expansion of daily price limits on june 15, 2015 (0.0117%) is higher than that of period before the change of price limits (0.0113%). as for the volatility of stock returns, the average standard deviation of the period under the 30% price limits regime is 0.0219 and appears to be more volatile than the period with the 15% of price limits (0.0213). in contrast, standard deviation of kospi in the 15% regime of daily price limits (0.0078) is higher than that of the 30% price limits regime period (0.0074).5 5 comparative descriptive statistics for the sub-periods before and after the price limits regime change are not reported here due to the limited space. the information is available from the authors upon request. asian journal of economics and empirical research, 2018, 5(2): 191-200 195 table-2. sample companies companies market cap no of listed shares ratio held by foreigner million won (%) thousand (%) finance samsung life insurance co., ltd. 25,600,000 1.59 200,000,000 0.47 16.59 kb financial group inc 25,044,881 1.56 418,111,537 0.99 69.21 shinhan financial group co., ltd. 22,951,260 1.43 474,199,587 1.12 69.05 woori bank co., ltd. 10,951,200 0.68 676,000,000 1.60 27.39 mirae asset daewoo co., ltd. 6,829,743 0.42 666,316,408 1.57 11.81 hanwha life insurance co., ltd. 6,479,234 0.4 868,530,000 2.05 19.29 chemicals lg chem, ltd. 29,472,303 1.83 70,592,343 0.17 40.23 s-oil corporation 13,453,644 0.84 112,582,792 0.27 77.5 lotte chemical corporation 12,270,600 0.76 34,275,419 0.08 31.89 hyosung corporation 4,740,856 0.29 35,117,455 0.08 23.24 hankook cosmetics manufacturing co., ltd 250,166 0.02 4,532,000 0.01 0.62 services naver corporation 26,370,143 1.64 32,962,679 0.08 59.29 ncsoft corporation 9,576,383 0.6 21,939,022 0.05 43.25 kakao corp. 9,267,968 0.58 67,897,203 0.16 22.32 kangwon land, inc. 7,947,890 0.49 213,940,500 0.51 29.38 cheil worldwide inc. 2,312,329 0.14 115,041,225 0.27 33.41 distribution e-mart inc. 7,624,036 0.47 27,875,819 0.07 49.25 lotte shopping co., ltd. 5,905,630 0.37 28,122,047 0.07 17.49 hotel shilla co.,ltd 3,324,316 0.21 39,248,121 0.09 22.38 shinsegae inc. 2,825,567 0.18 9,845,181 0.02 23.37 hyundai department store co., ltd. 2,288,759 0.14 23,402,441 0.06 25.82 electrical and electronic equipment samsung electronics co., ltd. 327,910,175 20.4 129,098,494 0.31 53.25 sk hynix inc. 55,910,582 3.48 728,002,365 1.72 48.21 lg electronics inc. 14,728,303 0.92 163,647,814 0.39 32.99 taihan electric wire co., ltd. 984,944 0.06 856,473,009 2.02 0.65 sindoh co., ltd. 652,178 0.04 10,080,029 0.02 25.85 transport equipment hyundai motor company 36,235,481 2.25 220,276,479 0.52 45.34 hyundai mobis co., ltd 26,623,547 1.66 97,343,863 0.23 48.55 kia motors corporation 13,640,477 0.85 405,363,347 0.96 37.87 korea aerospace industries, ltd. 4,883,503 0.3 97,475,107 0.23 18.64 samsung heavy industries co., ltd 4,660,500 0.29 390,000,000 0.92 19.87 iron & metal products posco 29,207,590 1.82 87,186,835 0.21 55.76 korea zinc co., ltd. 9,180,255 0.57 18,870,000 0.04 24.21 hyundai steel company 8,006,747 0.5 133,445,785 0.32 24.91 dongkuk steel mill company limited 1,068,847 0.07 95,432,737 0.23 29.81 medical supplies hanmi pharm. co., ltd 6,352,004 0.4 11,163,452 0.03 12.34 yuhan corporation 2,566,497 0.16 11,665,896 0.03 24.47 green cross corporation 2,512,606 0.16 11,686,538 0.03 25.94 daewoong pharmaceutical co., ltd. 1,575,774 0.1 11,586,575 0.03 5.93 machinery hanon systems 7,046,160 0.44 533,800,000 1.26 19.53 doosan infracore co., ltd. 1,842,780 0.11 207,520,257 0.49 11.3 doosan heavy industries & construction co., ltd. 1,745,973 0.11 106,461,787 0.25 8.25 hyundai elevator co., ltd. 1,298,133 0.08 24,632,513 0.06 32.86 foods & beverages cj cheiljedang corporation 5,280,768 0.33 13,168,998 0.03 27.62 ottogi corporation 2,731,360 0.17 3,440,000 0.01 18.7 nongshim co., ltd. 2,223,206 0.14 6,082,642 0.01 21.43 samyang corporation 986,792 0.06 10,289,803 0.02 3.94 construction hyundai engineering & construction co., ltd. 3,903,020 0.24 111,355,765 0.26 29.5 daelim industrial co., ltd. 2,877,960 0.18 34,800,000 0.08 34.01 daewoo engineering & construction co., ltd. 2,331,643 0.15 415,622,638 0.98 12.34 gs engineering & construction corporation 1,953,150 0.12 71,675,237 0.17 11.6 electricity & gas korea electric power corporation 24,073,653 1.5 641,964,077 1.52 31.15 korea gas corporation 4,084,850 0.25 92,313,000 0.22 10.15 communication sk telecom co., ltd. 21,316,868 1.33 80,745,711 0.19 41.78 kt corporation 7,950,855 0.49 261,111,808 0.62 49 transport & storage hyundai glovis co., ltd. 5,493,750 0.34 37,500,000 0.09 32.18 korean air lines co., ltd. 2,973,379 0.19 94,844,634 0.22 16.06 textile & wearing apparel lf corp. 897,668 0.06 29,240,000 0.07 37.73 non-metallic mineral products ssangyong cement industrial co., ltd. 2,055,747 0.13 100,771,919 0.24 3.73 other manufacture kt&g corporation 16,749,685 1.04 137,292,497 0.32 53.24 total 902,004,316 56.13 10,633,963,390 25.13 source: korea exchange website (http://www.krx.co.kr/main/main.jsp ) asian journal of economics and empirical research, 2018, 5(2): 191-200 196 out of 60 stocks, daily returns of 19 stocks have negative skewness with distributions skewed to the right. skewness measures how symmetric the observations are around the mean. for a normal distribution, the skewness is 0. kurtosis coefficients of all stock returns are greater than 3, indicating the leptokurtosis characteristics with fat-tailed distributions. as a result, all data are not believed to be normally distributed, which can be also confirmed by the jarque-bera test for normality. table-3. descriptive statistics for daily returns of index and stocks company mean std. dev. skewness kurtosis jarque-bera prob obs kopsi 0.000209 0.007677 -0.13721 4.722613 184.8443 0 1458 samsunglife 0.000319 0.015837 0.315095 6.543054 786.7352 0 1458 kbfin 0.000347 0.015533 0.214527 3.750836 45.4314 0 1458 shinhanfin 0.000138 0.01563 0.28115 4.330016 126.6713 0 1458 wooribk 0.000382 0.018427 0.189501 8.17524 1635.8 0 1458 miraeasset -6.66e-06 0.020966 0.392167 6.541649 799.3765 0 1458 hanwhalife 2.72e-05 0.016577 0.162107 5.496956 385.1491 0 1458 lgchem 0.000182 0.021007 -0.186041 6.156657 613.7528 0 1458 s-oil 0.000119 0.019377 0.288715 5.831054 507.1586 0 1458 lottechem 0.000125 0.024794 -0.289786 5.405647 371.9748 0 1458 hyosung 0.000643 0.022677 0.082342 5.590436 409.3017 0 1458 hankookcos 0.001834 0.043023 1.491198 9.666196 3239.97 0 1458 naver 0.000781 0.027375 0.748076 60.98742 204410.3 0 1458 ncsoft 0.00025 0.026432 -0.128478 5.770905 470.4445 0 1458 kakao 6.75e-05 0.023278 0.799622 7.496731 1383.774 0 1458 kangwonland 0.000191 0.017575 0.3718 5.68505 471.5681 0 1458 cheilworldwide 6.06e-05 0.021144 -0.096618 7.007528 977.9307 0 1458 e-mart 7.56e-06 0.018381 0.204654 4.052233 77.43965 0 1458 lotteshopping -0.00032 0.020224 -0.171025 8.229201 1668.288 0 1458 hotelshilla 0.000512 0.024411 -0.107169 6.804839 882.2566 0 1458 shinsegae 0.000117 0.021877 0.611311 7.276117 1201.634 0 1458 hyundaistore -0.00032 0.018277 0.381316 4.046029 101.804 0 1458 samsungelect 0.000587 0.016517 -0.087436 4.896512 220.3609 0 1458 skhynix 0.000814 0.021522 -0.071395 3.832229 43.31444 0 1458 lgelect 0.000115 0.019017 0.600833 6.596744 873.6196 0 1458 taihanelect -0.003102 0.036225 -1.31431 36.07573 66880.5 0 1458 sindohco 0.000184 0.015464 0.086927 5.32571 330.4285 0 1458 hyundaimotor -0.000176 0.018203 0.011697 5.057263 257.1474 0 1458 hyundaimobis -4.61e-05 0.018527 0.107988 5.643242 427.2775 0 1458 kiamotors -0.000467 0.016821 -0.040053 4.74995 186.4261 0 1458 koreaaerospace 0.000166 0.023778 0.139853 10.43533 3363.26 0 1458 samsungheavy -0.000496 0.024074 0.306583 4.838954 228.2817 0 1458 posco -7.92e-05 0.016844 0.22126 4.698362 187.1256 0 1458 koreazinc 0.000334 0.020201 -0.24653 6.628705 814.6944 0 1458 hyundaisteel -0.00031 0.019129 0.286007 4.296309 121.9628 0 1458 dongkuksteel -0.000323 0.024342 0.253416 5.591266 423.521 0 1458 hanmipharm 0.001642 0.031604 0.478023 11.24867 4188.99 0 1458 yuhan 0.000408 0.020855 -0.390394 9.016523 2236.097 0 1458 greencross 0.000295 0.022358 0.349194 7.562143 1294.029 0 1458 daewoongpharm 0.001067 0.027472 0.559751 9.884005 2955.05 0 1458 hanonsystems 0.000776 0.024959 -0.012913 5.230211 302.2014 0 1458 doosaninfracore -0.000483 0.027436 0.440325 8.392877 1813.914 0 1458 doosanheavy -0.000938 0.023369 0.092154 5.372312 343.9564 0 1458 hyundaielevator -0.000523 0.028584 0.668203 8.002758 1628.924 0 1458 cjcheiljedang 0.000211 0.017791 0.120747 4.21328 92.96984 0 1458 ottogi 0.001129 0.023906 0.341965 5.395803 377.1137 0 1458 nongshim 0.000296 0.019986 0.310585 5.013822 269.8109 0 1458 samyang 0.000463 0.024049 0.855911 10.96519 4032.252 0 1458 hyundaiengcon -0.000493 0.020917 0.114031 5.261803 313.9416 0 1458 daelim -6.03e-05 0.022966 -0.003726 5.172659 286.7706 0 1458 daewooengcon -0.000413 0.022764 0.108734 6.469954 734.3382 0 1458 gsengcon -0.000797 0.025995 -0.161396 7.206933 1081.501 0 1458 kepco 0.000275 0.016796 -0.039169 4.918855 224.0545 0 1458 koreagas 7.50e-05 0.019372 0.426826 4.926668 269.7768 0 1458 sktelecom 0.000438 0.01565 0.102381 4.033367 67.41883 0 1458 kt -0.000103 0.012309 0.273508 6.3605 704.2254 0 1458 hyundaiglovis -0.000178 0.021283 -0.298002 7.681086 1352.768 0 1458 kal -0.000223 0.021332 0.512896 7.454483 1269.351 0 1458 lfcorp -0.000203 0.018534 0.132134 5.45836 371.3873 0 1458 ssangyongcement 0.001279 0.028079 1.300272 17.79263 13704.27 0 1458 kt&g 0.000295 0.016533 -0.087064 3.840069 44.7142 0 1458 average of stocks 0.000115 0.021640 (15% regime average) 0.000113 0.021322 (30% regime average) 0.000117 0.021876 source: outcome from eviews 7 4. empirical results in order to investigate the stock market efficiency in korea, the variance ratio tests are performed, using eviews statistical package, to test the random walk hypothesis for the daily return data of the index and 60 stock prices for the two periods of the different price limits regimes. the test periods are based on 5 observations per week and five intervals are set as “2, 5, 10, 15, 20”, spanning four weeks following (ryoo and smith, 2002). additionally, the multiple variance ratio tests for the five periods are also carried out to jointly test the null asian journal of economics and empirical research, 2018, 5(2): 191-200 197 hypothesis for the multiple individual periods. since economic and financial time series data tend to have timevarying volatilities (lo and mackinlay, 1989) the heteroscedasticity robust random walk process is tested for the index and stock returns. the outputs of the multiple tests for the index return (chow and denning, 1993); (richardson and smith, 1991) along with individual tests, are presented in table 4. the chow-denning multiple tests (expressed as joint tests in table 4) are the variance ratio tests of the joint null hypothesis for five periods, and the variance ratio tests for each individual periods are reported at the bottom of the table (expressed as individual tests). the maximum |z| statistic of chow-denning tests, defined as in equation (10), under the 15% price limits regime is 0.530 and p-value is 0.9893. the null hypothesis of a random walk cannot be rejected. the individual statistics, defined as in equation (6), for all five periods, also cannot reject the null hypothesis as p-value is significantly greater than 0.05. the results under the 30% price limits regime are reported in right-hand side and similar to those under the 15% price limits regime. furthermore, the individual and multiple variance ratio tests under the assumption of homoscedasticity are conducted and the results are reported in table 5. the chow-denning maximum |z| statistic, defined as in equation (9), and the richardson-smith wald test statistic, defined as rs in equation (11), for the joint hypotheses are obtained in addition to the individual test statistics, defined as in equation (4). the results are similar to the above heteroscedasticity robust tests for the kospi return series. the test results indicate that korean stock market index follows the random walk process. table-4. variance ratio tests for kospi (heteroscedasticity robust) null hypothesis: log kospi is a martingale 15% price limits regime 30% price limits regime joint tests value df probability value df probability max |z| (at period 20)† 0.530025 849 0.9893 0.988527 608 0.8577 individual tests period var. ratio std. error z-statistic probability var. ratio std. error z-statistic probability 2 0.991607 0.032826 -0.25568 0.7982 1.024005 0.046775 0.513211 0.6078 5 1.003745 0.081563 0.045919 0.9634 0.982631 0.106457 -0.16316 0.8704 10 0.961831 0.129035 -0.2958 0.7674 0.843203 0.161262 -0.97231 0.3309 15 0.965247 0.162963 -0.21325 0.8311 0.801874 0.200425 -0.98853 0.3229 20 0.898934 0.190681 -0.53003 0.5961 0.850036 0.232998 -0.64363 0.5198 †probability approximation using studentized maximum modulus (smm) with parameter value 5 and infinite degrees of freedom. table-5. variance ratio tests for kospi (homoscedasticity assumption) null hypothesis: log kospi is a random walk 15% price limits regime 30% price limits regime joint tests value df probability value df probability max |z| (at period 20)† 0.825914 849 0.9278 1.362125 608 0.6135 wald (chi-square) 7.396466 5 0.1928 7.122531 5 0.2117 individual tests period var. ratio std. error z-statistic probability var. ratio std. error z-statistic probability 2 0.989271 0.03432 -0.31262 0.7546 1.020637 0.040555 0.50886 0.6109 5 0.994304 0.075191 -0.07576 0.9396 0.969733 0.088852 -0.34064 0.7334 10 0.941535 0.115877 -0.50454 0.6139 0.818404 0.136931 -1.32619 0.1848 15 0.933658 0.145787 -0.45507 0.6491 0.765341 0.172274 -1.36213 0.1732 20 0.859126 0.170567 -0.82591 0.4089 0.797696 0.201556 -1.00371 0.3155 †probability approximation using studentized maximum modulus (smm) with parameter value 5 and infinite degrees of freedom. the above processes are repeated for each of 60 sample stock returns to compare two different price limits periods and the results are summarized in table 6, which shows the number of stocks rejecting the null hypothesis of random walk process along with percentage of companies following random walk out of 60 sample stocks, based on the chow-denning multiple variance ratio tests and richardson-smith wald tests. detailed results of multiple variance tests are reported in appendix. for the period from january 2, 2012 to june 14, 2015 under the 15% price limits regime, the number of stocks rejecting the null hypothesis is 13 and slightly decreased to 10 for the period from june 15, 2015 to november 30, 2017 under the 30% price limits regime, meaning that proportion of sample stock returns following the random walk process under the eased price limits regime slightly increased to 83.3% from the previous 15% regime of 78.3%. this study is generally consistent with the findings of ryoo and smith (2002) that the korean stock market becomes more efficient as the price limits are eased, albeit the findings are rather suggestive than definitive. however, homoscedastic chow-denning multiple variance ratio tests and richardson-smith wald tests produced the different results. the proportion of sample stock returns following the random walk process under the eased price limits regime increased to 76.7% from the previous 15% regime of 63.3% in homoscedastic chow-denning tests while richardson-smith wald tests showed 75% up from 65% under the previous regime. when significance level is applied at 10%, the difference is more noticeable as random walk proportion was found to increase from 66.7% to 80%, 56.7% to 70% and 48.3% to 68.3% based on three different multiple variance ratio tests, respectively. asian journal of economics and empirical research, 2018, 5(2): 191-200 198 table-6. results of multiple variance ratio tests for 60 stock returns no of rejected null at 5% significance (percentage of random walk process) chow-denning tests richardson-smith tests heteroscedasticity robust homoscedasticity assumption wald tests 15% regime 13 (78.3%) 22 (63.3%) 21 (65%) 30% regime 10 (83.3%) 14 (76.7%) 15 (75%) no of rejected null at 10% significance (percentage of random walk process) chow-denning tests richardson-smith tests heteroscedasticity robust homoscedasticity assumption wald tests 15% regime 20 (66.7%) 26 (56.7%) 31 (48.3%) 30% regime 12 (80%) 18 (70%) 19 (68.3%) note: wald test is only used for homoscedasticity assumption because this method is not consistent with the heteroscedasticity robust tests (qms, 2010). in addition, to identify the effect of market capitalisation on the market efficiency to find out the answer to the common hypothesis that large capitalisation stocks tend to more follow the random walk process than small capitalisation stocks, we divided the sample stocks into two groups in terms of market capitalisation for comparison. the 30 large-cap stocks have the average market capitalisation of 25,266 million dollars in stark contrast to 2,369 million dollars of that of the 30 sample-cap stocks. under the 15% price limits regime, 47 stocks following a random walk consist of 22 large-cap and 25 small-cap stocks while 50 stocks following a random walk include 23 large-cap and 27 small-cap stocks suggesting that market capitalisation does not play a significant role in the market efficiency. 5. conclusions this study examined the efficiency of korean stock market, within the framework of a random walk model, to compare the results before and after a substantial relaxation of daily price limits effective on june 15, 2015. chowdenning and richardson-smith multiple variance ratio tests have been employed to find out the effect of expansion of price limits on the market efficiency. the daily returns for the korean stock market index and 60 stocks listed in the korea exchange were examined over the period from january 2, 2012 to november 30, 2017 which was divided into two sub-periods i.e., period from january 2, 2012 to june 14, 2015 and period from june 15, 2015 to november 30, 2017 for the comparison purpose. the sample stocks were selected from different industries to represent well the stock market. according to the results of the tests, the daily return of kospi, the korean market index, followed the random walk process for both the periods under the 15% and 30% price limits. for the returns of sample stocks, the number of stocks following random walk hypothesis slightly increased from 47 stocks (78.3%) under 15% price limits to 50 stocks (83.3%) under 30% price limits in the heteroscedasticity robust tests. based on the homoscedasticity assumption tests and wald tests, the number of stocks accepting the null of random walk hypothesis increased from 38 stocks (63.3%) and 39 (65%) under 15% price limits to 46 stocks (76.7%) and 45 (75%) under 30% price limits, respectively. overall findings suggested that within the framework of a random walk model, the market index showed market efficiency in a weak form during both two sub-periods. individual stock returns do not behave in the same way as that of the market index in terms of the random walk possibly because information is processed differently across individual companies and their stocks. however, this study suggests, daily returns in more stocks in the korean stock market appear to behave in weak form efficient way as the price limits are eased. in view of the findings in this study and the resilience the stock market has shown since the substantial relaxation of daily price limits, it seems that consideration should be given for the price limits to be removed completely further down the line to enhance the informational efficiency of the country’s stock market so as to be on a par with well-developed global stock markets. references amélie, c. and o. darné, 2009. variance-ratio tests of random walk: an overview. journal of economic surveys, 23(3): 503-527. available at: https://doi.org/10.1111/j.1467-6419.2008.00570.x. ayadi, o.f. and c.s. pyun, 1994. an application of variance ratio test to the korean securities market. journal of banking & finance, 18(4): 643-658. available at: https://doi.org/10.1016/0378-4266(94)00012-3. berkman, h. and j.b.t. lee, 2002. the effectiveness of price limits in an emerging market: evidence from the korean stock exchange. pacific-basin finance journal, 10(5): 517-530. available at: https://doi.org/10.1016/s0927-538x(02)00040-9. chow, k.v. and k.c. denning, 1993. a simple multiple variance ratio test. journal of 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2007. a comparison of variance ratio tests of random walk: a case of asian emerging stock markets. international review of economics & finance, 16(4): 488-502. available at: https://doi.org/10.1016/j.iref.2006.01.001. huang, b.-n., 1995. do asian stock market prices follow random walks? evidence from the variance ratio test. applied financial economics, 5(4): 251-256. available at: https://doi.org/10.1080/758536875. kim, j.h. and a. shamsuddin, 2008. are asian stock markets efficient? evidence from new multiple variance ratio tests. journal of empirical finance, 15(3): 518-532. available at: https://doi.org/10.1016/j.jempfin.2007.07.001. asian journal of economics and empirical research, 2018, 5(2): 191-200 199 lee, s.b. and j.s. chung, 1996. price limits and stock market efficiency. journal of business finance & accounting, 23(4): 585-601. available at: https://doi.org/10.1111/j.1468-5957.1996.tb01027.x. lee, s.b. and k.j. kim, 1995. the effect of price limits on stock price volatility: empirical evidence in korea. journal of business finance & accounting, 22(2): 257-267. available at: https://doi.org/10.1111/j.1468-5957.1995.tb00682.x. lim, k.-p. and r.d. brooks, 2009. price limits and stock market efficiency: evidence from rolling bicorrelation test statistic. chaos, solitons & fractals, 40(3): 1271-1276. available at: https://doi.org/10.1016/j.chaos.2007.09.001. lo, a.w. and a.c. mackinlay, 1988. stock market prices do not follow random walks: evidence from a simple specification test. the review of financial studies, 1(1): 41-66. available at: https://doi.org/10.1093/rfs/1.1.41. lo, a.w. and a.c. mackinlay, 1989. the size and power of the variance ratio test in finite samples: a monte carlo investigation. journal of econometrics, 40(2): 203-238. available at: https://doi.org/10.1016/0304-4076(89)90083-3. malkiel, b.g. and e.f. fama, 1970. efficient capital markets: a review of theory and empirical work. the journal of finance, 25(2): 383-417. available at: https://doi.org/10.2307/2325486. narayan, p.k. and r. smyth, 2004. is south korea's stock market efficient? applied economics letters, 11(11): 707-710. available at: https://doi.org/10.1080/1350485042000236566. qms, 2010. eviews 7 user’s guide. irvine: quantitative micro software. richardson, m. and t. smith, 1991. tests of financial models in the presence of overlapping observations. the review of financial studies, 4(2): 227-254. available at: https://doi.org/10.1093/rfs/4.2.227. ryoo, h.-j. and g. smith, 2002. korean stock prices under price limits: variance ratio tests of random walks. applied financial economics, 12(8): 545-553. available at: https://doi.org/10.1080/09603100010015789. appendix multiple variance ratio test statistics for 60 sample stock returns heteroscedastic statistic homoscedastic statistic wald max |z| (at period m)† chi-square companies 15% regime 30% regime 15% regime 30% regime 15% regime 30% regime cheilworldwide 1.830471 2.98077** 2.31569* 3.296791*** 7.454514 14.06022** cjcheiljedang 1.400717 1.525446 1.501797 1.902277 7.186084 7.684503 daelim 0.926926 1.83969 1.027427 2.01704 3.467691 11.23829** daewooengcon 1.921652 0.762597 2.395033* 1.012034 10.90901* 2.499223 daewoongpharm 0.950224 0.922933 1.454914 1.294702 3.298798 6.867637 dongkuksteel 2.539775* 1.079783 2.605329** 0.700443 11.56606** 2.307117 doosanheavy 1.397336 0.862376 1.503681 0.923065 2.458352 1.97465 doosaninfracore 1.078199 0.930743 0.934098 0.722355 4.21221 6.382559 e-mart 3.209016*** 1.551378 3.327977*** 1.771856 12.45615** 3.343391 greencross 2.537801* 1.10672 3.686419*** 1.736259 19.91317*** 5.415741 gsengcon 3.110408*** 1.879613 3.643245*** 2.15631 15.82106*** 6.161089 hankookcos 2.508704* 1.094399 4.237859*** 2.434904* 21.34202*** 18.07949*** hanmipharm 3.174363*** 1.572038 4.182833*** 2.275697 23.43258*** 12.17233** hanonsystems 4.291285*** 2.90924** 5.107231*** 3.083673** 27.14011*** 9.661571* hanwhalife 4.259112*** 2.648061** 4.831154*** 3.19802*** 27.61024*** 10.86202* hotelshilla 1.573146 2.336372* 1.907031 2.238132 10.79997* 9.961223* hyosung 1.8139 3.002945** 2.163361 3.479095*** 10.01349* 14.19565** hyundaielevator 2.463976* 2.092203 3.771594*** 2.422467* 20.68373*** 16.40827*** hyundaiengcon 0.717199 1.144545 0.561167 1.399212 1.926149 3.84586 hyundaiglovis 2.203864 2.165131 2.606913** 2.434932* 10.67691* 8.966991 hyundaimobis 2.313648* 1.071227 2.525827* 1.23627 10.57079* 4.604662 hyundaimotor 2.087575 1.152455 2.124651 1.411901 12.46144** 5.488485 hyundaisteel 0.682776 1.868506 0.907463 1.873965 2.071319 4.860405 hyundaistore 1.626004 1.682304 1.942525 1.970486 5.287735 6.097439 kakao 1.060967 1.264343 1.691145 1.361967 7.611878 7.74993 kal 0.692759 1.055248 0.777423 1.32823 3.041238 8.90783 kangwonland 5.342544*** 4.096564*** 6.025009*** 4.907403*** 36.98488*** 25.43356*** kbfin 0.893272 1.531725 1.09417 1.724666 6.929764 6.658761 kepco 1.242672 1.006188 1.472569 1.248996 4.433857 4.28597 kiamotors 1.100244 2.301497 1.257512 2.402959* 3.812318 9.03386 koreaaerospace 2.481467* 0.720739 2.958371** 1.119777 10.47648* 3.646556 koreagas 0.909882 0.87493 0.944601 1.213744 2.659921 2.971023 koreazinc 1.493785 1.790442 1.756351 2.075135 3.762902 6.591293 kt 3.115139*** 0.617785 3.334546*** 0.760366 18.86552*** 3.220231 kt&g 3.070249** 3.396537*** 3.586073*** 3.821462*** 22.9986*** 16.3575*** lfcorp 2.234635 4.301014*** 2.391303* 5.30149*** 6.443256 31.90549*** lgchem 2.103715 1.676146 1.923756 1.917326 10.07772* 4.39537 lgelect 0.601538 2.197447 0.592522 2.133737 4.623386 6.028885 lottechem 1.951746 2.800803** 1.694539 2.941596** 5.402075 8.893145 lotteshopping 0.941289 1.708618 1.177646 2.159162 4.201193 18.91795*** miraeasset 1.95235 1.645519 2.026068 1.846841 12.36496** 10.90002* naver 2.478585* 1.940929 4.9703*** 2.070704 27.6874*** 6.939239 ncsoft 0.383054 2.744801** 0.564089 3.084269** 1.795207 12.34522** nongshim 3.512174*** 2.205882 4.255583*** 2.903073** 19.33253*** 8.879528 ottogi 0.889206 0.980894 1.06053 1.402369 6.037349 7.849578 posco 0.509972 1.710562 0.805075 1.833721 2.642859 6.835128 s-oil 0.779485 2.436092* 0.673538 2.59231** 1.433071 11.92663** samsungelect 1.430405 1.542095 1.620774 1.784725 8.869967 14.86456** samsungheavy 1.403647 0.380853 1.620409 0.579986 3.548904 1.883451 samsunglife 3.490284*** 3.124508*** 4.276263*** 3.280744*** 19.42029*** 12.61047** samyang 3.013633** 1.177964 5.545115*** 1.911286 43.77612*** 7.858755 shinhanfin 1.647953 2.292464 1.867316 2.583072** 8.030287 8.490821 shinsegae 0.666579 1.12446 0.969206 1.530295 3.790255 5.069083 sindohco 3.680686*** 0.779974 4.544415*** 1.050148 24.58498*** 4.201971 asian journal of economics and empirical research, 2018, 5(2): 191-200 200 skhynix 2.780166** 2.006817 3.005425** 2.263952 9.973038* 6.32449 sktelecom 1.768145 1.342539 1.996377 1.591287 10.96239* 2.616864 ssangyongcement 0.874101 0.302373 0.734473 0.602898 3.621956 0.839615 taihanelect 1.918576 1.584975 2.621028** 5.773004*** 15.15008*** 41.87059*** wooribk 0.812129 0.91053 1.297525 1.012803 12.15334** 1.782574 yuhan 2.27097 1.150643 2.718627** 1.396158 9.354121* 3.275828 no of null rejected 13 (20 at 0.1) 10 (12 at 0.1) 22 (26 at 0.1) 14 (18 at 0.1) 21(31 at 0.1) 15 (19 at 0.1) †probability approximation using studentized maximum modulus (smm) with parameter value 5 and infinite degrees of freedom. *, ** and *** indicate significance at the 10%, 5% and 1%, respectively. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. asian journal of economics and empirical research vol. 4, no. 2, 75-90, 2017 issn(e) 2409-2622 / issn(p)2518-010x doi: 10.20448/journal.501.2017.42.75.90 75 the economics of foreign aid: time series evidence from a less developed country (ldc) md mahadee hassan1 1deputy secretary, economic relations division, ministry of finance, and government of bangladesh abstract empirical literature on aid-growth nexus mostly centered within cross-country framework exploiting typical ordinary least squares (ols) estimation. as a result, scarcity prevails studies empirically examine country-specific causes of aid-growth nexus exercising distinct methods. this study aims to fill this gap, taking the case of bangladesha leading aid recipient country. empirical findings based on vector error correction modeling and granger causality test unearth absence of long-run and short-run causality of aid on gdp growth. therefore, this study argues that although aid remains a major component of ldcs macroeconomic framework; however, it is yet to emerge as a significant player in their economic growth. keywords: aid-growth nexus, vector error correction modeling, causality, bangladesh. citation | md mahadee hassan (2017). the economics of foreign aid: time series evidence from a less developed country (ldc). asian journal of economics and empirical research, 4(2): 75-90. history: received: 1 october 2017 revised: 13 october 2017 accepted: 18 october 2017 published: 23 october 2017 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. background ....................................................................................................................................................................................... 76 2. aid-growth models, instrumentation, and estimation strategies ....................................................................................... 77 3. methodologies .................................................................................................................................................................................. 78 4. estimation strategies and empirical findings .......................................................................................................................... 79 5. conclusions ....................................................................................................................................................................................... 82 references .............................................................................................................................................................................................. 83 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://orcid.org/orcid-search/quick-search?searchquery=md%20mahadee%20hassan https://orcid.org/orcid-search/quick-search?searchquery=md%20mahadee%20hassan asian journal of economics and empirical research, 2017, 4(2): 75-90 76 1. background ‘foreign aid’ popularly known as official development assistance (oda) is a saga of over seven decades (dalgaard et al., 2004). starting its expedition at the end of world war two (ww2) and intensifying in 1960s and since then aid-growth nexus has been staying a key area of research interests (boone, 1996; alesina and dollar, 2000; dalgaard et al., 2004; doucouliagos and paldam, 2009). for example, last five decades (19602010) have witnessed a revolution in aid-growth paradigms where record number of cross-country growth regressions proved insufficient justifying aid effectiveness (or ineffectiveness) (sala-i-martin, 1997a;1997b; hansen and tarp, 2000; clemens et al., 2004; hendry and krolzig, 2004). major reasons of this aid-growth impasse is because of great controversies in model specification, instrumentation and estimation strategies (easterly, 2003; bourguignon and sundberg, 2007; rajan and subramanian, 2008; deaton, 2010; galiani et al., 2014). more pertinently, studies before 1990s were unable to draw adequate inferences due to shortage of data, and standard instrumentation and estimation strategies (easterly, 2003). while, considering donors’ point of views, growth is absent in the core of their major aid agendas. instead, development assistance largely extended to respond emergency and humanitarian needs, and these sorts of external resources normally originate negative causal link towards growth (clemens et al., 2004). in addition, aid packages frequently designed to serve other purposes including promoting political systems, supporting democracies, and addressing health and environmental issues. although, growth is prompted around those kinds of aid but hardly in the long run (clemens et al., 2004). however, alesina and dollar (2000) find nothing significant regarding humanitarian role of aid and argue that it is simply continuing to serve political motives and this notion strongly supported by rajan and subramanian (2008) who branded ‘political motives’ as noneconomic reasons. final category of clemens et al. (2004)classified foreign aid is exploited for productive purposes and in particular, supporting budget, balance of payments, and invests in infrastructure and other development projects. research evidence suggests that this type of development assistance maintain robust short run causal link towards economic growth (clemens et al., 2004). aid effectiveness literature (ael)1 has come across a number of phases reaching its extant form (clemens et al., 2004; roodman, 2007). classification of those phases magnificently recorded in a good number of outstanding literature notably in doucouliagos and paldam (2009);roodman (2007);clemens et al. (2004) and hansen and tarp (2000). these exceptional works label the phases as; early, first, second and third generation. early stage includes studies of 1960s predominantly explain impact of aid on savings and investments rather than examining its effectiveness on growth (clemens et al., 2004; roodman, 2007; doucouliagos and paldam, 2009). this early phases’ particular academic interest intensified due to the influences of harood-domar model, where significance of savings on growth has been strongly argued (roodman, 2007). two pioneering early studies are, rosenstein-rodan (1961) and chenery and strout (1966). among the authors, rosenstein-rodan and chenery held world banks’ chief economist position one time each. while, hansen and tarp (2000) identify that first generation studies ranging from early 1970s to 1980s also focusing on aid-savings link, and major works include griffin and enos (1970); weisskopf (1972); papanek (1972); papanek (1973); griffin (1978); gulati (1978) and mosley (1980). second generation studies counting from early 1980s to early 1990s explore aid effects on investments and growth, and this generation dominated by a number of works of mosley (1986;1987) and mosley et al. (1987). finally, third generation begins with boone (1996) and continuing tills the date. although, ael has a vibrant legacy; however, this paper centered mainly within third generation works. more importantly, third generation ael enter in a new order with the emergence of ‘conditional growth studies’ in early 2000s (easterly, 2003). burnside and david (2000) led this uprising and more significantly, majority of third generation ael organized in such a fashion keeping (burnside and david, 2000) ‘influential’ conclusions that ‘aid works better in good policy environments’, in the middle (easterly et al., 2003). on the other hand, most of the ael based on cross-country empirics exploiting typical ols estimation (hansen and tarp, 2001; doucouliagos and paldam, 2009). in addition, more difficulties would appear when ols estimations deliver ‘spurious’ outcomes (wassell and saunders, 2005). for this reason, scholars and practitioners express their reservations capitalizing conventional ols estimations in policy implications due to ‘unclear and ambiguous results’ (bourguignon and sundberg, 2007). accordingly, major objectives set for this study consist of estimating development assistances’ impact on growth within country-specific framework through applying a logical instrumentation approach. moreover, we want to employ rational estimation strategies which have the mechanisms of amending typical ols estimation errors. in doing so, we adopt popular econometric methodologies of augmented dickey-fuller (adf) test, johansen test of cointegration, vector error correction modeling (vecm), and granger causality test. selecting the case, we consider size of the economy, stability in growth, population, and volume of development assistance. we take bangladesh, an economy of $227 billion2 identified as one of the new growth-engines of asia3 experienced an average gdp growth over 6 per cent (6.22%)4 for the last ten years (2007-2016), and forecasts show that she will grow at the rate of 7 per cent (7%)5 in the next six years (2017-2022) also (international monetary fund (imf), 2017). more importantly, bangladesh is a major aid-recipient country who consistently manages sizable amount of development assistance measuring nearly 2 per cent (1.5%) of gdp6 during the period of 2005 to 2014 (world bank, 2017). remainder of the article is structured as follows: section 2 reviews major aid effectiveness literature focusing on models, instrumentation and estimation strategies adopted there. section 3 deals with this works’ modeling and instrumentation strategies. section 4 runs an exclusive analysis on estimation strategies, and present and discuss empirical findings. finally, section 5 summarizes the findings and makes concluding remarks. 1we take the term ael from doucouliagos and paldam (2009). 2according to imf world economic outlook 2017, volume of bangladesh’s gdp in 2016 stands at $227 billion 3in his inaugural speech at the asian development bank (adb) 50thboard of governors annual meeting on 6 may 2017 at yokohama, japan, president takehiko nakao outlines six member countries as the new growth-engines of asia. among the six countries bangladesh is one of them. other five countries are: india, indonesia, myanmar, the philippines and vietnam (source: http://www.thedailystar.net/frontpage/asias-new-growth-engines-1401721) 4 authors’ calculation based on imf world economic outlook 2017 5authors’ calculation based on imf world economic outlook april 2017 6 authors’ calculation based on world bank world development indicators 2017 asian journal of economics and empirical research, 2017, 4(2): 75-90 77 2. aid-growth models, instrumentation, and estimation strategies after surveying vast pile of ael we find that numerous arguments derived in the formulation of aid-growth strategies. majority of those debates are well documented in two classic studies of deaton (2010) and doucouliagos and paldam (2009)who systematically scrutinize the methods applied in key aid-growth studies. ultimately, a consensus emerged from this couple of documents along with other relevant literature that test of aid effectiveness on economic growth has been a regular practice of typical ols estimation within cross-country framework using standard growth regressions (hansen and tarp, 2000; hendry and krolzig, 2004; doucouliagos and paldam, 2009; deaton, 2010). as a result, organizing our review initially we focus on highly exploited typical barro (1991) crosscountry growth regression commonly outlined in the form of: γ = α + β1 .x1 + β2 .x2 + ……….. + βn .xn+ ε (1) in this model γ represents the vector of rates of economic growth, αis the constant, and x1,...,xn are vectors of explanatory variables usually have different numbers and forms depend on the characteristics of particular research work and author (doppelhofer et al., 2000). while, in classical aid-growth strategy, growth means real gdp growth, universally expressed in terms of gdp per capita (doucouliagos and paldam, 2009). examining contemporary aid-growth strategies we want to concentrate on legendary work of deaton (2010). deaton (2010) aid-growth strategy structured in the form of following expression: δinyct+1 = β0+ β1inyct+ β2 + β3hct+ β4zct+ θact+ μct (2) where y is the per capita gdp, i represent investments, h is an indicator of measuring human capital, a is the ratio denoting share of aid to gdp, and z remains for other control variables. in addition, subscripts c stands for country and t for time. deaton (2010) acknowledges that this approach basically an extension of solow growth model except the inclusion of a, and z variables. deaton (2010) is extremely critical regarding instrumentation strategies but praises (boone, 1996) who pioneers employment of standard set of instruments in growth regressions. estimating country-specific effects (boone, 1996) uses several dummies and incorporates log of population size. defending the significance of population size, deaton (2010) argues that aid is extended primarily on the country basis, instead of considering size of the population. hence, populous countries per capita aid receipt is lower than those of less-populated countries, and it bears great significance since, performance of aid frequently evaluated on the basis of per capita gdp. therefore, influenced by boone (1996) next generation influential aidgrowth studies7 widely capitalize both of gdp per capita and population size or one of these variables in their growth regressions (deaton, 2010). however, deaton (2010) is not convinced with the quality of instruments overcoming ‘exogeneity’ and ‘heterogeneity’ problems, and identifies inadequacy of standard theories validating the competency of instruments. accordingly, deaton (2010) conclude that with the current set of instruments it is quite challenging reaching to a robust conclusion on aid-growth nexus. deaton (2010) raises all important concern that typical aid-growth estimation strategy considers whole volume of aid is duly invested. however, this is quite unrealistic, therefore, for better inferences, at first, it is required to identify the status of tangible investments and then to conclude on effectiveness. another constraints noted, is the use of instrumental variables as deaton (2010) shows great reservation in this regard; since, major ael are in great jeopardy justifying the adoption of instrumental variable methods. deaton (2010) warns that econometric estimation strategies changed drastically and centered merely within the statistical program evaluation packages rather than to focus on models originated from theories. therefore, incorporation of instrumental variables in the estimation strategy creates severe disputes and which is leading to quasi-randomization (deaton, 2010). similarly, mishandling of instruments explode confusions and challenge the potentials of econometric analysis responding all important empirical enquiries (deaton, 2010). let we concentrate on another exceptional survey of doucouliagos and paldam (2009) whose epic analysis on 97 econometric studies covering a period of four decades (mid-1960s to mid-2000s) summarizes overall standard aid-growth estimation strategy in the following form: git = α + μhit + γjx’jit +uit (3) explaining equation-3, git is the real growth rate expressed in gdp per capita, hit is the percentage aid to gdp/gni, xjit is the vector of j control variable, and uit is the residuals, μ and γ are the two commonly estimated coefficients. more importantly, doucouliagos and paldam (2009) organize existing aid-growth models into three ‘family’ groups specified as ‘accumulation’, ‘growth direct’, and ‘conditional’. among those paradigms, ‘accumulation’ strategies frequently hypothesize that rise of domestic savings and balance of payment; particularly, ‘accumulation’ factors are vital for growth. the next family ‘growth direct’ is the overall model stated in equation3, and more explicitly, while estimating ‘accumulation’ impact; growth of domestic savings (sit) and investments (iit) are measured instead of real gdp growth (git). accordingly, this couple of ‘accumulation’ strategies frequently estimated in the form of following two equations: sit= α + μhit+ γjx’jit+ μit (4) iit= α + μhit+ γjx’jit+ μit (5) apart from above aid-growth paradigms, emergence of ‘good policy’ studies led by burnside and david (2000) surge most sensational arguments in aid effectiveness literature (easterly, 2003; clemens et al., 2004; roodman, 2007). undoubtedly, this development drives entire aid-growth debate into a new height, and doucouliagos and paldam (2009) place ‘good policy’ studies into the family of ‘conditional growth model’, and branded this group of scholars as ‘world bank group’ since they are sponsored or somehow affiliated with aid industry8 world bank. in ‘good policy’ paradigm it is strongly argued that aid is effective simply in good policy environments. burnside and david (2000) ‘good policy’ strategy structured splendidly in roodman (2007) in the following way: 7deaton (2010). list of next generation studies includes burnside and david (2000). hansen and tarp (2000;2001). guillaumont and chauvet (2001). lensink and white (2001). clemens, radelet and bhavnani (2004). dalgaard, hansen and tarp (2004). easterly, levine and roodman (2004). roodman (2007). and rajan and subramanian (2008). 8doucouliagos and paldam (2009).use the term ‘aid industry’ while branding influential aid organizations the world bank, and danish international development agency (danida). asian journal of economics and empirical research, 2017, 4(2): 75-90 78 δy= αa+ βa× p + γp + xδ + ε (6) where y is the per capita gdp, aid is represented by a, policy is denoted by p, x is a vector of controls, and ε is the error term. similarly, doucouliagos and paldam (2009) prescribed ‘good policy’ models’ unique feature is that it employs a right hand side ‘good policy’ variable z, and which is the good policy index of particular country comprising weighted sum of budget surplus, inflation rate, and trade openness. in addition, two more coefficients δ and ω are also estimated. consequently, doucouliagos and paldam (2009) outline ‘good policy’ model estimation strategy in the following manner: git = α + μhit + δzit+ ωhitzit + γjitx’jit + uit (7) regarding origins, burnside and david (2000) approach based on neoclassical growth model, and their ever dominant theory suggests that aid works positively on growth until recipient country’s gdp growth stays below the zenith of her transitional growth rate. according to burnside and david (2000) negative impact of aid caused due to the presence of distortionary economic policies. therefore, burnside and david (2000) advocate for policy development achieving enhanced aid effectiveness, but they are not certain that inclusion of policy instruments will act properly because other factors can make whole spectrum complicated. however, burnside and david (2000) two universal hypotheses are: aid and ‘good policy’ combination is most effective, and effects of ‘good policy’ triggered by foreign aid. while, corresponding ‘good policy’ study of collier and dollar (2002) analyze real aid allocation scenarios through developing a poverty-efficient aid allocation framework using world bank ratings of aid recipient countries national policies on aid utilization plans. for example, a country with severe poverty but has good policies is fit to be in the priority of poverty-efficient aid allocation framework. their findings suggest that existing aid allocation mechanisms is not poverty-efficient although, aid works magnificently bringing out millions of people from absolute poverty. dollar and kraay (2002) add a couple conditions to burnside and david (2000) original variables precisely, stability in inflation and small government size. overall, dollar and kraay (2002) conclude that governance, good trade policies, robust financial systems have little systematic effects on growth. another branch of ‘conditional growth’ studies pioneered by dalgaard et al. (2004); dalgaard and hansen (2001); hansen and tarp (2001) and hansen and tarp (2000) employ different types of policy instruments in estimation strategies. for example, dalgaard et al. (2004) claim that ‘climate-related circumstances’ are the vital factors prompting degree of growth. however, dalgaard et al. (2004) remain in suspicion concerning the competence of policies in aid effectiveness. their concluding remarks indicate that size and structural characteristics of aid inflow and policies ‘may’ influence aid effectiveness. similar inferences also outlined in hansen and tarp (2001) as they suggest that aid has ‘likelihood’ influences on growth but not conditional on ‘good policies’. more significantly, ‘estimated’ aid effectiveness highly depends on the set of exploited instruments. for instance, positive impact of aid is absent when ‘investment’ and ‘human capital’ is controlled. overall, hansen and tarp (2001) suggest that extensive theoretical works on aid effectiveness require before capitalizing existing literature in policy formulations. correspondingly, hansen and tarp (2000) widespread survey on three decades cross-country literature comprehensively examine aid-growth, aid-savings, and aid-investment relationships. after careful scrutiny, hansen and tarp (2000) confirm that burnside and david (2000) ‘good policy’ model considerably discarded in existing empirical cross-country literature. moreover, hansen and tarp (2000) explore that aid effectiveness is not conditional on good policies; instead, it also works significantly in such environments where good policies are absent. dalgaard, hansen, tarp and fellow scholars’ association with danish international development agency (danida) highlighted remarkably in doucouliagos and paldam (2009). keeping consistency with the ‘world bank group’ they are identified as ‘danida group’, and their model labeled as ‘medicine model’ exploits an ‘aid squared’ term in the right hand side and more notably, aid is treated as a condition in the estimation strategies. since, aid itself is a condition; therefore, doucouliagos and paldam (2009) empirically define ‘medicine model’ in the following way by reducing equation 7: git = α + μhit + ωh2 it+ γjitx’jit + uit (8) 3. methodologies 3.1. model specification and instrumentation strategy the origin of our aid-growth model is derived from production functions. in addition, setting the instrumentation strategies we are inspired by a number of works of ackerberg et al. (2015); yeoh and stansel (2013); bloom et al. (2012); lee et al. (2005) and aschauer (1989) who capitalize production technology while investigating economic growth and productivity. more importantly, production function’s universal recognition as a fundamental theory of economics and its long history of being capitalized for more than two centuries (ackerberg et al., 2015) propel us to exploit one of its advanced formthe cobb-douglas production function. moreover, cobb-douglas functions’ intensity in illustrating ‘real-world production processes’ makes it a better technology and a credible strategy in econometric estimation process (besanko and braeutigam, 2011). besides, wide ranges of literature suggest that cobb-douglas production function is a substantial instrument for linear estimation of various productivity activities (lee et al., 2005). general framework of cobb-douglas production function structured in besanko and braeutigam (2011) in the following form: q= alαkβ (9) in this framework q stands for quantity of output derived from l units of labor and k units of capital, and a, α, and β are positive constants. while, cobb-douglas production function’s convenience as an augmented neoclassical model encouraged many scholars modifying its original framework. for example, while estimating public expenditures (g) productivity on the economy (aschauer, 1989) exploits cobb-douglas method in the form of: yt = at *f (nt, kt,gt) (10) aschauer (1989) add an extra right hand side variable, public expenditure (g) with employment of labor (n), and stock of nonresidential capital (k). similarly, examine the role of it on firms’ productivity (bloom et al., 2012) extend original model by employing two more right hand side variables, materials (m) and it capital (c) in addition to labor (l) and capital (k). therefore, remodeled cobb-douglas production function organized in bloom et al. (2012) in the way of: asian journal of economics and empirical research, 2017, 4(2): 75-90 79 qit= ait+ ait mmit+ ait l lit+ ait kkit + ait ccit (11) alongside, investigating ict’s impact on the economy (lee et al., 2005) expand cobb-douglas model in the form of: y= aictβ1 kβ2 lβ3 (12) in their approach (lee et al., 2005) incorporated ict as a new instrument with existing labor (l) and capital (k). where a is a constant represents other elements of production, β1, β2, and β3 are the elasticities of production resources. we follow both bloom et al. (2012); lee et al. (2005) and aschauer (1989)approaches studying the role of foreign aid (oda)9 in economic growth. therefore, we rewrite cobb-douglas production function in the below form: y= aodaβ1 k β2lβ3 (13) where oda is the net disbursement flows of official development assistance measured as the percentage of gni, k is the gross capital formation in terms of percentage of gdp. due to the inadequacies of labor statistics we proxy labor (l) with population growth (poplg)10. because, growth of population stimulates productivity in a couple of ways; through supplying additional labor force and create extra demand in the economy (oxley and greasley, 1998). therefore, we argue that economic growth of bangladesh is the function of foreign aid (oda), gross capital formation (capital), and population growth (poplg). accordingly, we organize of our aid-growth strategy in the subsequent way: y= aodaβ1 capitalβ3poplgβ3 (14) finally, for estimation conveniences we capitalize classical (barro, 1991) cross-country growth regression and structure the above function in the following form: y= α + β1oda+ β2capital+β3poplg + ε (15) 3.2. the data we use annual time series data of world bank’s world development indicator (wdi). the data has a span of 42 years ranging from 1973 to 2014, and comprises 4 series including per capita gdp (current prices and in us$), net oda received as percentage of gross national income (gni), gross capital formation as percentage of gdp, and population growth. we rely on this single source because no other institutional sources have comprehensive time series data on bangladesh for longer period than world bank has. in addition, we consider that other source resources may not act properly with world bank data because of different methodologies applied in data collection and processing and which eventually lead to inconsistencies in estimation and analysis11. 4. estimation strategies and empirical findings setting the estimation strategies we carefully consider following two factors: at first, inability of typical ols estimation extending standard inferences for policy implications (deaton, 2010) and the recent surge of time series application (for example, (nowak-lehmann et al., 2012; juselius et al., 2014; lof et al., 2015; juselius et al., 2017)) in growth studies. both reasons prompted us exploiting time series instruments in our empirical strategies. in addition, time series applications’ universal acceptance as a superior technology of handling stationary data, motivated us in a great deal (phillips and perron, 1988). generally, time series data are nonstationary in nature and models with nonstationary variables and their statistical significance vastly a debated issue (wassell and saunders, 2005). since, regressions between two or more nonstationary series often produce spurious outcomes; notably, in the form of high coefficient of determination (r2), and significant t-statistics even in the absence of sensible correlation (granger and newbold, 1974; phillips and perron, 1988; wassell and saunders, 2005). for this reason, regressions output derived from nonstationary series frequently disqualify for rational policy implications (wassell and saunders, 2005).to address this problem, time series techniques initially examine (unit root test) quality (stationarity) of data before using it in empirical investigations. 4.1. testing stationery: the unit root test unit root testis predominantly exploited to identify the stationarity (whether a variable is stationary or nonstationary) of a series (gujarati, 2004). major features of stationarity is that when mean and autocovariances of a series does not depend on time then the series is stationary; and in contrast, a series which mean and autocovariances depend on time labeled as nonstationary (gujarati, 2004). a typical nonstationary series is the random walk can be expressed in the following form: yt= ρyt-1 + ut (16) in this model ut is a white noise error term. the variance of series y is changing over time since it depends on the condition of t. while random walk is a difference stationary series and the first difference of y is stationary and can be written in the form of: δyt = δyt-1 + ut (17) estimating above equation we take null hypothesis δ= 0, if ρ=1 then δ= 0 meaning that series under consideration has a unit root, and the series is not stationary. the notion is that a difference stationary series is integrated and symbolized as i(d), and d denotes order of integration, the number of unit roots a series contained or the number of difference operations required to make a series stationary. for example, a series has one unit root signified as i(1) series, and a stationary series free of unit root symbolized as i(0) series. in analytical environments several types of unit root test practiced. among those tests, we utlize a popularly accepted method of an advance option of dickey-fuller (df) testuniversally known as augmented dickey-fuller (adf) test (ng and perron, 1995).generally, df test conducted in three distinct forms considering diverse possibilities, and the options are: random walk process has no drift, random walk process may have drift, and random walk process may have both deterministic and stochastic trends (gujarati, 2004). while, conducting a df test, hypothesis is that error term ut 9we proxy foreign aid as the net disbursement flows of official development assistance (oda) 10 details of the variable descriptions stated in appendix c 11according to world bank (2017). bangladesh’s per capita gdp (current prices) in 2014 is us $1,086.80. on the contrary, imf world economic outlook april 2017 shows that bangladesh’s per capita gdp (current prices) in 2014 is us $ 1,162.74. αi m i=1 asian journal of economics and empirical research, 2017, 4(2): 75-90 80 remains uncorrelated (gujarati, 2004). however, difficulties surfaced when ut is correlated. to resolve this, dickey and fuller (1979) developed a modified version by ‘augmenting’all three types of df test equations and adding a lagged value of dependable variable δyt. however, in this paper we estimate the regressions based on the following two adf test equations12 (gujarati, 2004): δyt = β1 + δyt-1+ δyt-i + εt (18) δyt= β1 + β2t + δyt-1 + δyt-i + εt (19) table-1. augmented dickey-fuller (adf) test output (5% level of significance) variable adf test statistic (t-statistic) test critical values (t-statistic) prob. constant constant, trend constant constant, trend constant constant, trend level gdp -2.935001 -3.523623 3.553140 1.660312 1.0000 1.0000 oda -2.936942 -3.540328 -0.479362 -2.056948 0.8848 0.5514 capital -2.936942 -3.526609 -1.581257 -3.330771 0.4827 0.0759 poplg -2.938987 -3.529758 0.392503 -2.200237 0.9801 0.4762 first difference d(gdp) -2.936942 -3.526609 -4.222689 -5.446197 0.0019 0.0003 d(oda) -2.936942 -3.526609 -9.563917 -9.593832 0.0000 0.0000 d(capital) -2.936942 -3.526609 -5.269162 -5.291244 0.0001 0.0005 d(poplg) -2.938987 -3.529758 -9.291159 -8.351394 0.0000 0.0000 the adf test statistic displayed in table 1, indicate that all four variables are integrated in order of 1 meaning that all four variables are i(1)series. since, the variables are i(1), therefore, we need to identify the number of cointegrating vectors in the subsequent analytical process (oxley and greasley, 1998); (masih and masih, 1997). however, conducting remaining tests, we need to determine optimal lag length, at first. 4.2. selection of optimal lag order determining optimal lag length we follow toda and yamamoto (1995) approach. in doing so, we capitalize usual methods and conduct an unrestricted var estimate involving data in levels with automatic 2 lag order. the lag order selection output exhibited in table 2, and five lag selection criterions (lr, fpe, aic, sc, hq) suggest that optimal lag length is 3. for cross checking, we attempt another unrestricted var estimation with 4 lag order. nevertheless, this calculation also recommends same lag length, 3. since, all the series are integrated in order of i(1), therefore, following t-y approach we decide optimal lag order is 4 (3+1) by adding an extra lag. consequently, we use 4 lag orders in all the remaining estimations. table-2. var lag order selection output lag logl lr fpe aic sc hq 0 -375.7156 na 5617.1111 19.98503 20.15741 20.04636 1 -177.8088 343.7328 0.392830 10.41099 11.27288 10.71764 2 -139.9454 57.79162 0.128150 9.260282 10.81168 9.812257 3 -98.49156 54.54447* 0.036300* 7.920608* 10.16152* 8.717906* 4 -82.76160 17.38575 0.043093 7.934821 10.86524 8.977441 source: authors’ calculation * indicates lag order selected by the criterion lr: sequential modified lr test statistic (each test at 5% level) fpe: final prediction error aic: akaike information criterion sc: schwarz information criterion hq: hannan-quinn information criterion 4.3. testing cointegration using johansen’s methodology analysis of this chapter involves testing cointegration. to move forward, we conduct johansen (1991;1995) multivariate system of cointegration test to ascertain cointegration relations among the variables. engle and granger (1987) are the pioneer of cointegration methodology (ahmed and kenji, 2017). however, emergence of johansen (1991;1995) and johansen and juselius (1990) methodologies and their procedural supremacy due to system-based evaluation technologies of cointegration vectors has gained sensible edge over engle and granger (1987) theory (ahmed and kenji, 2017).while, in a multivariate time series approach with maximum likelihood procedures; johansen’s methodolgy considered as an advanced option (masih and masih, 1997). typically, johansen methodology is suitable in such an environment where all the variables integrated in order of i(1) (österholm and hjalmarsson, 2007). since, all variables of our model qualify to this criteria therefore, it would be an appropriate practice to apply johansen’s method. moreover, within a vector error correction (vec), framework johansen’s methodology extensively utilized to develop substantial strategies identifying cointegrating relations between the variables (oxley and greasley, 1998; ghosh, 2002). accordingly, determining cointegration vectors we estimate following equation with order of p: yt = μ + a1yt-1 +.........+ apyt-p + bxt + ϵt (20) 12equation 16 estimates regression with intercept, while in equation 17 regressions’ estimated with trend and intercept αi m i=1 asian journal of economics and empirical research, 2017, 4(2): 75-90 81 in this framework yt is a vector of nonstationary i(1) variables, xt is a vector of deterministic variables and ϵt is a vector of innovations. we can rewrite the equation in the following form also: table-3. johansen cointegration test output (lags interval in first differences: 1 to 4) hypothesized no. of ce(s) test statistic 0.05 critical value prob.** trace max-eigen trace max-eigen trace max-eigen trend assumption: linear deterministic trend none 119.5347* 61.00638* 47.85613 27.58434 0.0000 0.0000 at most 1 58.52829* 38.02562* 29.79707 21.13162 0.0000 0.0001 at most 2 20.50268* 16.66634* 15.49471 14.26460 0.0081 0.0205 at most 3 3.836339 3.836339 3.841466 3.841466 0.0501 0.0501 trend assumption: linear deterministic trend (restricted) none 160.7710* 62.71900* 63.87610 32.11832 0.0000 0.0000 at most 1 98.05200* 48.77429* 42.91525 25.82321 0.0000 0.0000 at most 2 49.27772* 32.61259* 25.87211 19.38704 0.0000 0.0004 at most 3 16.66513* 16.66513* 12.51798 12.51798 0.0096 0.0096 source: authors’ calculation a. trace and max-eigen value test indicates 3 cointegrating equations at 0.05 levels under the linear deterministic trend b. trace and max-eigen value test indicates 4 cointegrating equations at 0.05 levels under the linear deterministic trend (restricted) *denotes rejection of hypothesis at 0.05 level **mackinnon et al. (1999) p-values to identify cointegration relationships firstly, we capitalize estimation within linear deterministic trend with 4 lag order to conclude on null hypotheses of 0, 1 and 2cointegration vectors. the output sited in table 3 indicates that both trace (119.5347; 58.52829; 20.50268), and max-eigen value (61.00638; 38.02562; 16.66634) statistic are significant at 0.05 critical level, and which confirms existence of 3 cointegrating vectors. similarly, testing null hypotheses of 0, 1, 2 and 3 cointegrating vectors, output of another estimation with 4 lag order and within linear deterministic trend (restricted) find that trace (160.7710; 98.05200; 49.27772; 16.66513), and max-eigen value (62.71900; 48.77429; 32.61259; 16.66513) statistic also remain significant at 0.05 critical level confirming 4 cointegratiing vectors. thus, existence of multiple cointegrating vectors has been proved through this test. 4.4. vector error correction estimate in the preceding two tests we examine quality of data. the initial one, adf test determines that order of integration of all series stand at i(1) confirming the existence of unit roots and more specifically, data will be stationary at first differences. however, major concern is that data in levels suffer significant damage of information linked to their co-movement while making it stationary through first differencing operations (wahab and applanaidu, 2015). subsequent investigation, johansen maximum likelihood (ml) test of cointegration locates multiple cointegrating vectors and which indicates presence of long-run equilibrium relationship among the variables. considering such an environment, engle and granger (1987) suggest that a vector error correction modeling (vecm) is the appropriate approach instead of a typical var estimation to explain the relationships. therefore, we capitalize (engle and granger, 1987) vector error correction framework in the following form to identify causal relationships: δgdpt = α+ σβ1δgdpt-n+ σβ2δodat-n+ σβ3δcapitalt-n+ σβ4δpoplgt-n+ λectt-n+ εt (22) where α is the constant, λ stands for coefficient of error correction term, ectt-n is the error correction term and εt is the white noise error term. in addition, n is the optimal lag length and β1, β2, β3 and β4 are the coefficients which explain short-run granger causality of explanatory variables on dependent variable. while coefficient of ect exploited to determine the long-run equilibrium relationships, and for granger causality it must be negative and significant (ahmed and kenji, 2017). table-4. vector error correction estimates output variable coefficient t-statistic prob. model a: dependent variable δgdp ect -0.018332 -1.654018 0.1146 c 32.67681 1.834772 0.0822 δ gdpt-1 0.192055 0.743635 0.4662 δ gdpt-2 -0.132601 -0.603823 0.5531 δ gdpt-3 0.326056 1.735313 0.0989 δ gdpt-4 -0.021262 -0.103901 0.9183 δ odat-1 0.944205 0.114328 0.9102 δ odat-2 2.950476 0.259035 0.7984 δ odat-3 4.675114 0.469008 0.6444 δ odat-4 0.230430 0.032125 0.9747 δ capitalt-1 -8.834268 -0.827020 0.4185 δ capitalt-2 -7.986122 -0.876074 0.3019 δ capitalt-3 2.340438 0.306893 0.7623 δ capitalt-4 0.218031 0.032159 0.9747 δ poplgt-1 574.9397 1.388137 0.1812 δ poplgt-2 -917.3912 -1.020177 0.3205 δ poplgt-3 682.4348 0.777814 0.4463 δ poplgt-4 -136.3971 -0.337605 0.7394 asian journal of economics and empirical research, 2017, 4(2): 75-90 82 there are 4 models emerged from the vector error correction estimates (details in appendix, e-2). out of 4 models we are basically focus on a solo model which is taking gdp as the dependent variable. for analytical convenience, we define this model as model-a. similarly, we define rest of the three models as model-b (dependent variable δ oda) model-c (dependent variable δcapital), and model-d (dependent variable δ poplg). all coefficients of vector error correction estimates (displayed in table 4) of model-a found insignificant at 5% and 10% significance level stating the nonexistence of short-run or long-run causality among the explanatory variables and gdp growth (δgdp). since, major purpose of this study is to explain aid-growth nexus therefore; we check four aid coefficients through conducting wald test (taking null hypothesis δodat-1 = δodat-2= δodat-3= δodat-4= 0). results displayed in table 5, and it indicates the absence of short-run causality of aid on gdp growth. table-5. output of wald test null hypothesis: δodat-1 = δodat-2 = δodat-3 = δodat-4 = 0 test statistic value df probability f-statistic 0.113678 (4,19) 0.9761 chi-square 0.454714 4 0.9778 on the contrary, error correction term (ect), which is used to examine long-run causality estimated at: coefficient, -0.018332 and probability (prob.) 0.1146 respectively. the ect also confirms the nonexistence of longrun equilibrium relationships among the dependent and explanatory variables. 4.5. vector error correction granger causality/block exogeneity wald tests identifying causal relationship we conduct another testgranger causality/block exogeneity wald tests using vector error correction framework. the output (details in appendix, f) in table 6 demonstrates the absence of granger causality while taking δgdp as the dependent variable. in contrast, when δoda, δcapital, and δpoplg are considered dependent variable we can reject null hypothesis of no causality at 5% significance level and that confirms the presence of granger causality. therefore, this estimation endorses our analytical approach since, it is consistent with one of the important features of the significance of vec models that cointegrated variables must have causality ‘at least one direction either unidirectional or bidirectional’ (granger, 1986; granger, 1988; masih and masih, 1997). table-6. vector error correction granger causality/block exogeneity wald tests output model dependent variable independent variable chi-sq df prob. a δgdp δoda δcapital δpoplg 10.42330 12 0.5789 b δoda δgdp δcapital δpoplg 22.25028 12 0.0348 c δcapital δgdp δoda δpoplg 31.27932 12 0.0018 d δpoplg δgdp δoda δcapital 27.84601 12 0.0058 4.6. residual diagnostic tests of vecm we examine model-a’s significance through conducting several residual diagnostic tests (details in appendix, g) and output exhibited in table 7. at first, we conduct breusch-godfrey serial correlation lm test to check serial correlation. estimated f-statistic and corresponding probability (prob.) reveals that model-a is free of autocorrelation problem. while, three types of heteroskedasticity tests including breusch-pagan-godfrey, harvey, and arch carried out to identify the heteroskedasticity of time series regression of model-a. all three estimated f-statistic and corresponding probabilities suggest that null hypothesis of no heteroskedasticity is not in a position for rejection. finally, we conduct histogram normality test of jarque-bera to check data distribution status. the jarque-bera statistic and corresponding probability (prob.) suggests that data are normally distributed. therefore, all the residual diagnostic tests confirm the significance of model-a. in addition, model-a’s statistical significance also established in other ways particularly, with a good r2 of 0.692773 and a significant prob. (f-statistic) of 0.027249 (appendix, e-2). table-7. summary of residual diagnostic tests breusch-godfrey serial correlation lm test* heteroskedasticity test histogramnormality test breusch-pagangodfrey harvey arch** fstatistic prob. (4, 15) f-statistc prob. f (20, 16) f-statistc prob. f (20, 16) fstatistc prob. f (20, 16) jarquebera probabilit y model: dependent variable δgdp 0.926414 0.4746 1.047583 0.4686 1.661351 0.1532 0.843695 0.5094 0.846931 0.654774 source: authors’ calculation * lag to include 4 **number of lag 4 5. conclusions we endeavor to answer few crucial issues raised at the prevailing aid-growth literature including model specification, instrumentation, and estimation strategies. firstly, we address the issue of model specification proposing an aid-growth approach exploiting both neoclassical cross-country growth model (barro, 1991) and cobb-douglas production technology. in relation to instrumentation strategies, we intensely survey ‘conditional growth studies’ where it is argued that aid effectiveness depends on good macroeconomic, trade, political, and environmental policies. however, we simply rely on conventional macroeconomic statistic instead of incorporating policy variables; since, highly rated (rajan and subramanian, 2008) remain unsuccessful finding any significance of development assistances while incorporating policy variables with conventional macroeconomic variables following asian journal of economics and empirical research, 2017, 4(2): 75-90 83 four major ‘conditional aid-growth studies’13. we consider this will act to get back the aid-growth debate on the right track. in the next, we address the concerns of deaton (2010) and rajan and subramanian (2008) regarding the inability of typical cross-country ols estimations to get rid of the ‘spurious regressions’ problem due to the existence of noise in the data. we adopt country-specific approach by taking the case of a leading aid-recipient country. our estimation strategies equipped with error correction techniques which are able keeping the outcomes free of ‘spurious regressions’ problem. capitalizing vector error correction modeling and granger causality test within the vector error correction framework, we do not find any short-run or long-run causality of development assistance on real gdp growth. therefore, our findings strongly support (rajan and subramanian, 2008) and reject the conclusions of so-called ‘conditional growth studies’. we consider this study has great policy implications since; core development planning of ldcs still depends on the size of oda. given this context, country’s like bangladesh who aspires rapid economic development need to redefine major growth strategies and to revisit existing approaches regarding oda financed development programs. references ackerberg, d.a., k. caves and g. frazer, 2015. identification properties of recent production function estimators. econometrica, 83(6): 2411-2451. view at google scholar | view at publisher ahmed, k.y. and y. kenji, 2017. source of economic growth in ethiopia: an application of vector error correction model. australian academy of business and economics review, 2(4): 285-292. view at google scholar alesina, a. and d. dollar, 2000. who gives foreign aid to whom and why? 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https://scholar.google.com/scholar?hl=en&q=is%20public%20expenditure%20productive:%20evidence%20from%20the%20manufacturing%20sector%20in%20us%20cities,%201880-1920 asian journal of economics and empirical research, 2017, 4(2): 75-90 85 appendix b: the data year gdp per capita in us $ (gdp) oda(percent of gni) gross capital formation (percent of gdp) (capital) population growth (poplg) 1973 117.7819065 5.198165 8.712006898 1.585485524 1974 179.1641755 4.243359853 7.374857223 1.703316829 1975 272.9701785 5.512471456 6.147905815 1.997715897 1976 138.7232244 4.927019983 9.911362042 2.334804116 1977 128.942513 8.162886773 11.5232178 2.596271472 1978 172.6062003 7.5161892 11.54679855 2.766916511 1979 196.6780059 7.48378619 11.20387213 2.810825619 1980 222.9242646 7.08665606 14.4393913 2.769204023 1981 242.2224312 5.337540043 17.15576644 2.710344222 1982 215.7421858 7.096030945 17.36327909 2.677536855 1983 199.6916194 5.751979043 16.56273677 2.658002448 1984 208.9325984 6.100986381 16.48425757 2.661362183 1985 239.5138363 4.972468716 15.8309437 2.675519221 1986 227.8791364 6.432029907 16.17645483 2.689529516 1987 247.5620475 7.208769256 15.47344203 2.683137929 1988 263.7341157 5.938576105 15.73598307 2.64460664 1989 278.3516037 6.116851021 16.12091443 2.567501631 1990 298.144992 6.492388153 16.45867552 2.466950281 1991 285.296976 5.946636189 16.89594746 2.355938926 1992 285.6978098 5.598726634 17.30502928 2.257783657 1993 292.3645263 4.060145962 17.94683201 2.187760068 1994 291.3258679 5.004785042 18.40255619 2.155122135 1995 320.3619277 3.27837883 19.11979582 2.1457187 1996 383.8299551 2.577291706 20.7299506 2.138090473 1997 390.4079054 2.04049926 21.81621451 2.115690607 1998 396.1696495 2.26168444 22.12141282 2.078586608 1999 398.2295463 2.307716612 22.7213703 2.021669268 2000 406.5317405 2.128498674 23.80856257 1.94944844 2001 403.5945462 1.876225243 24.17430673 1.882916186 2002 401.7081533 1.592481356 24.34141614 1.816606212 2003 434.0465632 2.228824518 24.67918886 1.726004223 2004 462.2748798 2.08147327 24.99183394 1.605803333 2005 485.8528881 1.818585047 25.83043551 1.47034775 2006 495.8537802 1.609564116 26.14414575 1.326957091 2007 543.0822631 1.788530336 26.17849707 1.203348026 2008 618.0758836 2.098240471 26.2022714 1.125881485 2009 683.6144223 1.108309467 26.20605702 1.109061795 2010 760.3319352 1.126595014 26.24665618 1.134879634 2011 838.5478017 1.074870504 27.42097337 1.172933905 2012 858.9333626 1.485229114 28.26233501 1.199882864 2013 954.3963997 1.622223223 28.38962075 1.216351172 2014 1086.800087 1.31122154 28.57787571 1.214377385 source: world bank world development indicators 2017 appendix c: data description variable description gdp gdp per capita is gross domestic product (current prices in us $) divided by midyear population. oda net official development assistance (oda) consists of disbursements of loans made on concessional terms and grants by official agencies of the members of the development assistance committee (dac), multilateral institutions, and non-dac countries to promote economic development and welfare in countries and territories in the dac list of oda recipients, expressed at percentage of gross national income (gni). capital (capital) capital is the gross capital formation expressed in percentage of gdp consists of outlays on additions to the fixed assets of the economy plus net changes in the level of inventories. population (poplg) annual population growth rate for year t is the exponential rate of growth of midyear population from year t-1 to t, expressed as a percentage. source: world bank world development indicators 2017 asian journal of economics and empirical research, 2017, 4(2): 75-90 86 appendix d: johansen cointegration test date: 06/04/17 time: 9:49 sample (adjusted): 1978 2014 included obervations: 37 after adjustments trend assumption: linear deterministic trend (restricted) series: gdp odp captial poplg lags interval (in first differences): 1 to 4 unrestricted cointegration rank test (trace) hypothesized no. of ce(s) elgenvalue trace statistic 0.05 critical value prob.** none * 0.807724 119.5347 47.85613 0.0000 at most 1* 0.642178 58.52829 29.79707 0.0000 at most 2* 0.362653 20.50268 15.49471 0.0081 at most 3* 0.098491 3.836339 3.841466 0.0501 trace test indicates 3 cointegrating eqn (s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level **mackinnon et al. (1999) p-value unrestricted cointegration rank test (maximum eigenvalue) hypothesized no. of ce(s) elgenvalue max-eigen statistic 0.05 critical value prob.** none * 0.807724 61.00638 27.58434 0.0000 at most 1* 0.642178 38.02562 21.13162 0.0001 at most 2* 0.362653 16.66634 14.26460 0.0205 at most 3* 0.098491 3.836339 3.841466 0.0501 max-eigenvalue test indicates 3 cointegrating eqn (s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level **mackinnon et al. (1999) p-value date: 06/04/17 time: 10:03 sample (adjusted): 1978 2014 included obervations: 37 after adjustments trend assumption: linear deterministic trend (restricted) series: gdp odp captial poplg lags interval (in first differences): 1 to 4 unrestricted cointegration rank test (trace) hypothesized no. of ce(s) elgenvalue trace statistic 0.05 critical value prob.** none * 0.816421 160.87610 63.87610 0.0000 at most 1* 0.732390 42.91525 42.91525 0.0000 at most 2* 0.585806 25.87211 25.87211 0.0000 at most 3* 0.362633 12.51798 12.51798 0.0096 trace test indicates 4 cointegrating eqn (s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level **mackinnon et al. (1999) p-value unrestricted cointegration rank test (maximum eigenvalue) hypothesized no. of ce(s) elgenvalue max-eigen statistic 0.05 critical value prob.** none * 0.816421 62.71900 32.11832 0.0000 at most 1* 0.732390 48.77429 25.82321 0.0000 at most 2* 0.585806 32.61259 19.38704 0.0000 at most 3* 0.362633 16.66513 12.51798 0.0096 max-eigenvalue test indicates 4 cointegrating eqn (s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level **mackinnon et al. (1999) p-value appendix e 1 vector error correction estimates date: 04/06/17 time: 14:15 sample (adjusted): 1978-2014 included observations: 37 after adjustments standard errors in ( ) & t-statistics in [ ] cointegratingeq: cointeq1 gdp (-1) 1.000000 oda (-1) 124.4875 (154.249) [0.80705) capital (-1) 92.06700 (78.0954) [1.17890] population (-1) 2489.280 (408.444) [6.09454] c -7928.584 error correction d (gdp) d (oda) d (capital) d (poplg) cointeq1 -0.018332 (0.01108) [-1.65402] -0.000722 (0.00029) [-2.50244] -0.000296 (0.00023) [-1.31052] -5.76e-07 (5.1e-06) [-0.11193] asian journal of economics and empirical research, 2017, 4(2): 75-90 87 d (gdp(-1)) 0.192055 (0.25827) [0.74363] -0.010328 (0.00673) [-1.53548] 0.005085 (0.00527) [0.96510] -4.77e-05 (0.00012) [-0.39738] d (gdp(-2)) -0.132601 (0.21960) [-0.60382] -0.003558 (0.00572) [-0.62202] -0.005496 (0.00448) [-1.22676] -2.01e-06 (0.00010) [-0.19708] d (gdp(-3)) 0.326056 (0.18789) [1.73531] -0.006538 (0.00489) [-1.33610] 0.003398 (0.00383) [0.88644] 0.000121 (8.7e-05) [1.38744] d (gdp(-4)) -0.021262 (0.20464) [-0.10390] 0.011214 (0.00533) [2.10410] -0.008723 (0.00417) [-2.08938] -3.52e-05 (9.5e-05) [-0.36988] d (oda(-1)) 0.944206 (8.25877) [0.11433] -0.819793 (0.21510) [-3.81128] -0.237344 (0.16848) [-1.40873] 0.001366 (0.00384) [0.35597] d (oda(-2)) 2.950476 (11.3903) [0.25904] -0.818083 (0.29666) [-275769] -0.163204 (0.23236) [0.70237] 0.005637 (0.00529) [1.065081] d (oda(-3)) 4.675114 (9.96808) [0.46901] -0.606285 (0.25962) [-2.33532] -0.204697 (0.20335) [-1.00662] 0.003029 (0.00463) [0.65406] d (oda(-4)) 0.230430 (7.17290) [0.03213] -0.351906 (0.18682) [-1.88371] -0.038276 (0.14633)[[0.026157] 0.002578 (0.00333) [0.77349] d (capital(-1)) -8.834268 (10.6821) [-0.82702 -0.717825 (0.27821) [-2.58015] 0.350906 (0.21792) [1.61028] 0.004207 (0.00496) [0.84761] d (capital(-2)) -7.986122 (9.11581) [-0.87607] -0.214859 (0.23742) [-0.90498] -0.358030 (0.18596) [-1.92526] 0.004375 (0.00424) [1.03290] d (capital(-3)) 2.340438 (7.62624) [0.30689] -0.557906 (0.19862) [-2.80887] 0.076628 (0.15558) [0.49254] -0.005680 (0.00354) [-1.60306] d (capital(-4)) 0.218031 (6.77971) [0.03216] -0.333128 (0.17658) [-1.88661] -0.006779 (0.13831) [-0.04901] 0.008697 (0.00315) [2.76098] d (population(1)) 574.9397 (414.181) [1.38814] -16.34547 (10.7872) [-1.51527] -14.58656 (8.44938) [1.72635] 1.993824 (0.19245) [10.3604] d (population(2)) -917.3912 (899.247) [-1.02018] 41.35613 (23.4206) [1.76580] 30.92362 (18.3448) [1.68568] -1.439530 (0.41783) [-3.44527] d (population(3)) 682.4348 (877.375) [0.77781] -37.31820 (22.8509) [2.33422] 11.24026 (8.24197) [1.36378] 0.349115 (0.40767) [0.85638] d (population(4)) -136.3971 (404.014) [-0.33761] 24.56161 (10.5224) [2.33422] 0.496043 (0.36332) [1.36378] -0.001850 (0.18772) [-0.00986] c 32.67681 (17.8097) [1.83477] 0.876607 (0.46385) [1.88986] 0.496043 (0.36332) [1.365301] -0.007797 (0.00828) [-0.94217] r-squared 0.692773 0.624266 0.765374 0.980194 adj. r-squared 0.417886 0.288082 0.555446 0.962473 sum sq. resids 12619.18 8.559883 5.251719 0.002724 s.e. equation 25.77144 0.671208 0.525744 0.011975 f-statistic 2.520211 1.856919 3.645887 55.31306 log likelihood -160.3937 -25.41984 -16.38202 123.5532 akaike a/c 9.642906 2.347019 1.858488 -5.705580 schwarz sc 10.42659 3.130708 2.642177 -4.921890 mean dependent 25.88804 -0.185180 0.460937 -0.037348 s. d. dependent 33.77807 0.795504 0.788518 0.061814 determinant resid covariance (dof adj.) 0.002483 determinant resid covariance 0.000173 log likelihood -49.71323 akaike information criterion 6.795310 schwarz criterion 10.10422 asian journal of economics and empirical research, 2017, 4(2): 75-90 88 2. vector error correction estimates appendix f: vec granger causality/ block exogeneity wald tests dependent variable: d(gdp) method: least squares (gauss-newton / marquardt steps) date: 05/30/17 time: 13:21 sample (adjusted): 1978 2014 included observations: 37 after adjustments d(gdp) = c(1)*( gdp(-1) + 124.487483696*oda(-1) + 92.0669986939 *capital(-1) + 2489.28043071*poplg(-1) 7928.5843028 ) + c(2) *d(gdp(-1)) + c(3)*d(gdp(-2)) + c(4)*d(gdp(-3)) + c(5)*d(gdp(-4)) + c(6)*d(oda(-1)) + c(7)*d(oda(-2)) + c(8)*d(oda(-3)) + c(9) *d(oda(-4)) + c(10)*d(capital(-1)) + c(11)*d(capital(-2)) + c(12) *d(capital(-3)) + c(13)*d(capital(-4)) + c(14)*d(poplg(-1)) + c(15)*d(poplg(-2)) + c(16)*d(poplg(-3)) + c(17)*d(poplg(-4)) + c(18) coefficient std. error t-statistic prob. c(1) -0.018332 0.011084 -1.654018 0.1146 c(2) 0.192055 0.258265 0.743635 0.4662 c(3) -0.132601 0.219603 -0.603823 0.5531 c(4) 0.326056 0.187894 1.735313 0.0989 c(5) -0.021262 0.204640 -0.103901 0.9183 c(6) 0.944205 8.258765 0.114328 0.9102 c(7) 2.950476 11.39025 0.259035 0.7984 c(8) 4.675114 9.968084 0.469008 0.6444 c(9) 0.230430 7.172901 0.032125 0.9747 c(10) -8.834268 10.68205 -0.827020 0.4185 c(11) -7.986122 9.115808 -0.876074 0.3919 c(12) 2.340438 7.626244 0.306893 0.7623 c(13) 0.218031 6.779708 0.032159 0.9747 c(14) 574.9397 414.1807 1.388137 0.1812 c(15) -917.3912 899.2467 -1.020177 0.3205 c(16) 682.4348 877.3752 0.777814 0.4463 c(17) -136.3971 404.0136 -0.337605 0.7394 c(18) 32.67681 17.80975 1.834772 0.0822 r-squared 0.692773 mean dependent var 25.88804 adjusted r-squared 0.417886 s.d. dependent var 33.77807 s.e. of regression 25.77144 akaike info criterion 9.642905 sum squared resid 12619.18 schwarz criterion 10.42659 log likelihood -160.3937 hannan-quinn criter. 9.919192 f-statistic 2.520211 durbin-watson stat 1.891938 prob(f-statistic) 0.027249 vec granger causality/block exogeneity wald tests date: 05/30/17 time: 14:10 sample: 1973 2014 included observations: 37 dependent variable: d(gdp) excluded chi-sq df prob. d(oda) 0.454714 4 0.9778 d(capital) 2.913232 4 0.5724 d(poplg) 3.250685 4 0.5168 all 10.42330 12 0.5789 dependent variable: d(oda) excluded chi-sq df prob. d(gdp) 6.991891 4 0.1363 d(capital) 15.11521 4 0.0045 d(poplg) 13.57706 4 0.0088 all 22.25028 12 0.0348 dependent variable: d(capital) excluded chi-sq df prob. d(gdp) 6.078254 4 0.1934 d(oda) 3.926476 4 0.4160 d(poplg) 7.677406 4 0.1041 all 31.27932 12 0.0018 dependent variable: d(poplg) excluded chi-sq df prob. d(gdp) 2.178736 4 0.7029 d(oda) 1.822800 4 0.7683 d(capital) 11.49740 4 0.0215 all 27.84601 12 0.0058 asian journal of economics and empirical research, 2017, 4(2): 75-90 89 appendix g: residual diagnostics 1 breusch-godfrey serial correlation l m test 2. heteroskedasticity tests breusch-pagan-godfrey breusch-godfrey serial correlation lm test: f-statistic 0.926414 prob. f(4,15) 0.4746 obs*r-squared 7.329830 prob. chi-square(4) 0.1195 test equation: dependent variable: resid method: least squares date: 05/30/17 time: 14:13 sample: 1978 2014 included observations: 37 presample missing value lagged residuals set to zero. variable coefficient std. error t-statistic prob. c(1) 0.018832 0.070014 0.268982 0.7916 c(2) 0.760697 3.267906 0.232778 0.8191 c(3) -0.169576 0.822695 -0.206123 0.8395 c(4) 0.256660 0.646442 0.397035 0.6969 c(5) -0.162085 1.089713 -0.148741 0.8837 c(6) -6.310117 9.289973 -0.679240 0.5073 c(7) -7.948015 14.58463 -0.544958 0.5938 c(8) -6.127644 12.02688 -0.509496 0.6178 c(9) -5.035852 12.79780 -0.393494 0.6995 c(10) -6.649461 13.64556 -0.487298 0.6331 c(11) 6.855772 34.09074 0.201104 0.8433 c(12) 7.840021 31.75620 0.246882 0.8083 c(13) 0.465407 7.692474 0.060502 0.9526 c(14) 15.23944 438.5801 0.034747 0.9727 c(15) -726.7694 1913.512 -0.379809 0.7094 c(16) 1024.182 2425.276 0.422295 0.6788 c(17) -530.9792 1511.716 -0.351243 0.7303 c(18) -32.49555 118.4548 -0.274329 0.7876 resid(-1) -0.920582 3.344450 -0.275257 0.7869 resid(-2) -0.190278 0.381904 -0.498237 0.6255 resid(-3) -0.509558 0.390503 -1.304876 0.2116 resid(-4) -0.480914 0.401685 -1.197243 0.2498 r-squared 0.198104 mean dependent var 0.000000 adjusted r-squared -0.924552 s.d. dependent var 18.72252 s.e. of regression 25.97341 akaike info criterion 9.638346 sum squared resid 10119.27 schwarz criterion 10.59619 log likelihood -156.3094 hannan-quinn criter. 9.976030 f-statistic 0.176460 durbin-watson stat 2.082360 prob(f-statistic) 0.999818 heteroskedasticity test: breusch-pagan-godfrey f-statistic 1.047583 prob. f(20,16) 0.4686 obs*r-squared 20.97907 prob. chi-square(20) 0.3984 scaled explained ss 7.501930 prob. chi-square(20) 0.9947 test equation: dependent variable: resid^2 method: least squares date: 05/30/17 time: 14:16 sample: 1978 2014 included observations: 37 variable coefficient std. error t-statistic prob. c -4022.146 5353.060 -0.751373 0.4633 gdp(-1) -2.295792 6.225320 -0.368783 0.7171 oda(-1) -186.8592 194.6259 -0.960094 0.3513 capital(-1) 170.4243 278.9498 0.610950 0.5498 poplg(-1) -647.3674 9708.019 -0.066684 0.9477 gdp(-2) -2.677819 7.849666 -0.341138 0.7374 gdp(-3) 7.695602 6.487008 1.186310 0.2528 gdp(-4) -6.905654 7.133606 -0.968045 0.3474 gdp(-5) 7.919689 5.455991 1.451558 0.1660 oda(-2) 128.1970 217.4604 0.589519 0.5637 oda(-3) -115.4529 222.4529 -0.518999 0.6109 oda(-4) 219.5739 192.0088 1.143562 0.2696 oda(-5) 238.5780 186.6494 1.278215 0.2194 capital(-2) -234.5552 311.9238 -0.751963 0.4630 capital(-3) 228.8284 257.3921 0.889027 0.3872 capital(-4) -202.2138 240.7063 -0.840085 0.4132 capital(-5) 151.7398 157.2671 0.964854 0.3490 poplg(-2) 354.0182 28946.88 0.012230 0.9904 poplg(-3) 7822.916 38353.49 0.203969 0.8409 poplg(-4) -10393.10 27361.20 -0.379848 0.7091 poplg(-5) 2810.952 8827.230 0.318441 0.7543 r-squared 0.567002 mean dependent var 341.0588 adjusted r-squared 0.025754 s.d. dependent var 569.4236 s.e. of regression 562.0433 akaike info criterion 15.79784 sum squared resid 5054283. schwarz criterion 16.71215 log likelihood -271.2601 hannan-quinn criter. 16.12018 f-statistic 1.047583 durbin-watson stat 2.471773 prob(f-statistic) 0.468576 asian journal of economics and empirical research, 2017, 4(2): 75-90 90 3. harvey 4. arch 5. hisgram –normality test appendix h: wald test null hypothesis: δodat-1 = δodat-2 = δodat-3 = δodat-4 =0 test statistic value df probability f-statistic 0.113678 (4,19) 0.9761 chi-square 0.454714 4 0.9778 null hypothesis summary normalised restriction (= 0) value std. err. δodat-1 0.944205 8.258765 δodat-2 2.950476 11.39025 δodat-3 4.675114 9.968084 δodat-4 0.230430 7.172901 restrictions are linear in coefficient asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. heteroskedasticity test: harvey f-statistic 1.661351 prob. f(20,16) 0.1532 obs*r-squared 24.97409 prob. chi-square(20) 0.2024 scaled explained ss 30.42615 prob. chi-square(20) 0.0632 test equation: dependent variable: lresid2 method: least squares date: 05/30/17 time: 14:23 sample: 1978 2014 included observations: 37 variable coefficient std. error t-statistic prob. c 8.244155 20.24627 0.407194 0.6893 gdp(-1) -0.028725 0.023545 -1.219967 0.2402 oda(-1) -1.458669 0.736111 -1.981589 0.0650 capital(-1) -0.665133 1.055040 -0.630434 0.5373 poplg(-1) 23.59535 36.71753 0.642618 0.5296 gdp(-2) -0.003045 0.029689 -0.102576 0.9196 gdp(-3) 0.051833 0.024535 2.112591 0.0507 gdp(-4) -0.027703 0.026981 -1.026779 0.3198 gdp(-5) 0.027118 0.020636 1.314139 0.2073 oda(-2) -1.134605 0.822475 -1.379500 0.1867 oda(-3) 0.863611 0.841358 1.026449 0.3199 oda(-4) 1.260613 0.726213 1.735873 0.1018 oda(-5) -0.210078 0.705943 -0.297585 0.7698 capital(-2) -1.180052 1.179754 -1.000253 0.3321 capital(-3) 1.879983 0.973505 1.931149 0.0714 capital(-4) -1.179576 0.910396 -1.295674 0.2135 capital(-5) 0.808679 0.594813 1.359551 0.1928 poplg(-2) -86.76647 109.4825 -0.792515 0.4397 poplg(-3) 140.1535 145.0600 0.966176 0.3483 poplg(-4) -100.6748 103.4851 -0.972843 0.3451 poplg(-5) 24.21549 33.38622 0.725314 0.4787 r-squared 0.674975 mean dependent var 4.061506 adjusted r-squared 0.268694 s.d. dependent var 2.485783 s.e. of regression 2.125752 akaike info criterion 4.642934 sum squared resid 72.30115 schwarz criterion 5.557239 log likelihood -64.89428 hannan-quinn criter. 4.965270 f-statistic 1.661351 durbin-watson stat 2.415947 prob(f-statistic) 0.153242 heteroskedasticity test: arch f-statistic 0.843695 prob. f(4,28) 0.5094 obs*r-squared 3.549594 prob. chi-square(4) 0.4704 test equation: dependent variable: resid^2 method: least squares date: 05/30/17 time: 14:27 sample (adjusted): 1982 2014 included observations: 33 after adjustments variable coefficient std. error t-statistic prob. c 280.1903 160.9962 1.740353 0.0928 resid^2(-1) 0.302805 0.193264 1.566797 0.1284 resid^2(-2) -0.015255 0.202813 -0.075215 0.9406 resid^2(-3) 0.227692 0.255746 0.890306 0.3809 resid^2(-4) -0.228803 0.258363 -0.885588 0.3834 r-squared 0.107563 mean dependent var 378.9030 adjusted r-squared -0.019927 s.d. dependent var 592.5022 s.e. of regression 598.3766 akaike info criterion 15.76505 sum squared resid 10025528 schwarz criterion 15.99179 log likelihood -255.1232 hannan-quinn criter. 15.84134 f-statistic 0.843695 durbin-watson stat 1.944376 prob(f-statistic) 0.509383 0 2 4 6 8 10 12 14 -50 -40 -30 -20 -10 0 10 20 30 40 50 series: residuals sample 1978 2014 observations 37 mean 0.000000 median -1.413219 maximum 45.46958 minimum -46.67750 std. dev. 18.72252 skewness 0.102723 kurtosis 3.712146 jarque-bera 0.846931 probability 0.654774 70 © 2019 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 6, no. 1, 70-75, 2019 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2019.61.70.75 © 2019 by the authors; licensee asian online journal publishing group does peso depreciation or more government debt affect aggregate output? the case of chile yu hsing1 antoinette s phillips2 carl phillips3 yun-chen morgan4 ( corresponding author) 1,2,3,4college of business southeastern louisiana university hammond, louisiana 70402 usa. abstract this paper attempts to determine whether real peso depreciation/appreciation or fiscal expansion would be effective in raising output in chile. real peso depreciation tends to stimulate exports but raise import costs and domestic inflation. more government debt-financed spending tends to increase aggregate demand but cause the crowding-out effect. based on an extended is-mp-as model (romer, 2000) incorporating the monetary policy function and the advanced egarch process, this study shows that real peso appreciation increased output during 2006.q1-2011.q3 whereas real peso depreciation raised output during 2011.q4-2016.q4 and that a higher lagged government debt ratio raised output. in addition, a lower u.s. real interest rate, real crude oil price or expected inflation helped increase output. hence, real peso depreciation or appreciation may increase or reduce output depending upon the development phase, and expansionary fiscal policy is effective. although more government debt-to-gdp ratio has a positive effect on output, fiscal discipline needs to be pursued as the effect of debt-financed government spending seemed to be leveling off in recent years. keywords: peso depreciation or appreciation, government debt-to-gdp ratio, world interest rates, crude oil prices, is-mp-as model, monetary policy function. jel classification: f41; e62. citation | yu hsing; antoinette s phillips; carl phillips; yun-chen morgan (2019). does peso depreciation or more government debt affect aggregate output? the case of chile. asian journal of economics and empirical research, 6(1): 70-75. history: received: 2 april 2019 revised: 8 may 2019 accepted: 10 june 2019 published: 15 august 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 71 2. literature survey ............................................................................................................................................................................. 71 3. the model ......................................................................................................................................................................................... 72 4. empirical results ............................................................................................................................................................................. 73 5. summary and conclusions ............................................................................................................................................................. 74 references .............................................................................................................................................................................................. 74 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.61.70.75&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://www.asianonlinejournals.com/index.php/ajeer/article/view/919 https://orcid.org/0000-0003-1537-0293 https://orcid.org/0000-0002-9910-6854 https://orcid.org/0000-0002-9673-9867 https://orcid.org/0000-0002-1455-0543 http://www.asianonlinejournals.com/index.php/ajeer/article/view/919 https://orcid.org/0000-0003-1537-0293 https://orcid.org/0000-0002-9910-6854 https://orcid.org/0000-0002-9673-9867 https://orcid.org/0000-0002-1455-0543 http://www.asianonlinejournals.com/index.php/ajeer/article/view/919 https://orcid.org/0000-0003-1537-0293 https://orcid.org/0000-0002-9910-6854 https://orcid.org/0000-0002-9673-9867 https://orcid.org/0000-0002-1455-0543 http://www.asianonlinejournals.com/index.php/ajeer/article/view/919 https://orcid.org/0000-0003-1537-0293 https://orcid.org/0000-0002-9910-6854 https://orcid.org/0000-0002-9673-9867 https://orcid.org/0000-0002-1455-0543 http://www.asianonlinejournals.com/index.php/ajeer/article/view/919 https://orcid.org/0000-0003-1537-0293 https://orcid.org/0000-0002-9910-6854 https://orcid.org/0000-0002-9673-9867 https://orcid.org/0000-0002-1455-0543 http://www.asianonlinejournals.com/index.php/ajeer/article/view/919 https://orcid.org/0000-0003-1537-0293 https://orcid.org/0000-0002-9910-6854 https://orcid.org/0000-0002-9673-9867 https://orcid.org/0000-0002-1455-0543 asian journal of economics and empirical research, 2019, 6(1): 70-75 71 © 2019 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this paper makes several contributions. first, a rigorous theoretical model including comparative static analysis is presented. second, the advanced egarch process is used in empirical work. third, the binary variable technique is applied to capture any potential structural break of the impact of exchange rate movements on output. 1. introduction chile’s economy shows both strengths and weaknesses. according to the international monetary fund, its real gdp grew1.59% in 2016, which was lower than those in 2014 and 2015. the relatively low inflation rate of 3.86% is consistent with the inflation rate target. the unemployment rate of 6.1% in 2016 was comparable to its neighboring countries. there have been trade surpluses since 2014. the stock market reached a recent high of 4,927.5 in 2010 and then decreased to 4,151.4 in 2016. the government deficit-to-gdp ratio reached 6.63% in 2016.q4. the government debt as a percent of gdp rose from a recent low of 13.09% in 2008.q2 to a recent high of 80.06% in 2016.q4 because the government engaged in fiscal expansion to save economic downturns triggered by the recent global financial crisis. the chilean peso depreciated 40.03% from a recent low of 483.36 pesos per u.s. dollar in 2011 to 676.83 in 2016. the focus of this paper is to evaluate the effects of real peso depreciation/appreciation and more government debt on aggregate output in chile based on an advanced macroeconomic model (romer, 2000). other related variables will also be considered. several previous studies (morley, 1992; bahmani-oskooee, 1998; moreno, 1999; bahmani-oskooee et al., 2002; kim and ying, 2007; an et al., 2014; kim et al., 2015) examining the effect of real currency depreciation or appreciation on output apply the traditional keynesian model and use the money supply to represent monetary policy. romer (2000) proposes that the lm function can be replaced by the monetary policy function (taylor, 1993;1999) incorporating inflation targeting. because chile has adopted inflation targeting since 1999 (morandé, 2002) the extended is-mp-as model (romer, 2000) would better capture monetary policy conducted by the central bank of chile. an analysis of previous studies shows that there are some research gaps for the reasons that (1) some previous studies based on the panel data may not capture unique features of individual countries such as chile; (2) there was lack of a rigorous macroeconomic model in studying aggregate output; and (3) inflation targeting which has been adopted by the central bank of chile was not incorporated in the model. this paper makes several contributions. first, a rigorous theoretical model including comparative static analysis is presented. second, the advanced egarch process is used in empirical work. third, the binary variable technique is applied to capture any potential structural break of the impact of exchange rate movements on output. 2. literature survey real peso depreciation tends to increase exports, import costs and domestic inflation and decrease capital inflows into chile whereas real peso appreciation is likely to lower exports, import costs and domestic inflation and increase capital inflows into chile. hence, the net impact of real depreciation or appreciation is unclear. several studies including chile and other related countries in the sample have examined the effect of currency depreciation or devaluation on aggregate output. using a sample of 28 ldcs with stabilization programs, morley (1992) reveals that devaluation hurts output mainly because of the enormous decline in investment expenditures. using a sample of 27 advanced, latin american, and asian countries, kamin and klau (1998) show a lack of evidence of the negative impact of devaluation on output in the long run and that there was no major difference in the impact of devaluation among these three groups of countries. frenkel (2004) reveals that a 10% real depreciation would lead to a 5.6% decline in the unemployment rate two years afterwards. for chile, a 10% real depreciation would result in a 8.8% decrease in the unemployment rate. rodrik (2008) indicates that real depreciation is expansionary in seven selected developing countries. his results are consistent if different measures of real exchange rates or estimation methods are used. mejía-reyes et al. (2010) report that real depreciation has a severe contractionary effect on aggregate output in argentina, chile and mexico, less severe contractionary effect in columbia, and an expansionary effect in brazil and venezuela. based on a sample of 17 countries in latin america and the caribbean, mesquita moreira et al. (2017) show that a 10% currency depreciation would cause import penetration to decline by 4.1% to 5.6%. whether a higher government debt would affect output depends on whether the crowding-out effect would partially or completely cancel out the positive impact of the debt-financed government spending or whether the debt-to-gdp ratio has reached a turning point or threshold. barro (1974;1989) argues that the effect of debtfinanced fiscal expansion is neutral over the long run. cebula (1997;2014a;2014b) shows that more government deficits tend to raise the real interest rate and crowd out private spending. kumar and woo (2010) show that if the initial debt-to-gdp ratio rises 1 percentage point, subsequent average gdp growth will decline 0.2 percentage points. the impact is smaller for advanced countries. reinhart and rogoff (2010) estimate the threshold to be 90%, meaning that if the debt ratio is above 90%, it would reduce growth and that if the debt ratio is below 90%, its impact on growth is relatively weak. cecchetti et al. (2011) find the turning point to be 85%. mencinger et al. (2015) reveal that the turning point is estimated to be 44% 45% for emerging economies and 90% 94% for developed countries. tran (2018) estimates the debt threshold for 14 emerging countries including chile during 1999-2016. he finds the turning point for latin american countries to be 35% of gdp, which is less than the 40%-55% of gdp for non-latin american countries. these thresholds suggest that sustainable public finances are more demanding for several latin american countries facing a higher debt and default risk. vu et al. (2019) study the relation between economic growth and government debt for eight latin american countries including chile during 1990-2015. they show that if the debt ratio is above 35.0%, growth volatility would increase and that if the debt ratio is above 75.0%, growth would decline. vu et al. (2019) explores the threshold of the government external debt ratio for ten emerging economies including chile during 2005-2015. the threshold was estimated to be 33.17% of gdp. he reveals that when the ratio is less than 33.17%, a 1% increase in the external debt ratio will asian journal of economics and empirical research, 2019, 6(1): 70-75 72 © 2019 by the authors; licensee asian online journal publishing group raise the growth rate by 0.056% and that if the external debt ratio is above 33.17%, a 1% rise in the ratio will reduce the growth rate by 0.02%. 3. the model it is postulated that aggregate expenditure is positively affect by real income or gdp, government expenditures and real peso depreciation and negatively influenced by the real lending rate, government tax revenues, and the real crude oil price per barrel, that the real policy interest rate in the monetary policy function is determined by the inflation gap, the output gap, the real exchange rate and the world real interest rate, that the actual inflation rate is determined by the expected inflation rate, the output gap, the real crude oil price per barrel, and the real exchange rate, and that the real lending rate is positively affected the real policy interest rate. we can express an extended is-mp-as model (romer, 2000; hsing et al., 2019) as: (1) (2) (3) (4) where y = real gross domestic product (gdp) in chile, l = the real lending rate, g = government expenditures, t = government revenues, e = the real exchange rate (an increase means real depreciation of the peso.), o = the real crude oil price per barrel, r = the real policy interest rate of the central bank of chile, = the actual inflation rate, = the target inflation rate, = potential gdp, = world real interest rate, and = the expected inflation rate. it is assumed that and are constants over the short term. as government debt is an accumulation of government deficits and as the sovereign debt crisis is a major concern by investors, we replace the government deficit (g – t) with government debt (d). solving for , and we find equilibrium as: ̅ (5) figure 1 shows that y and e seemed to have a negative relation during early years and a positive relation during later years. specifically, real peso appreciation raised y during 2006.q1-2011.q3 whereas real peso depreciation increased y after 2011.q3. real gdp also showed seasonal patterns during the sample period. thus, an interactive slope binary variable, an intercept binary variable and three seasonal binary variables are included in the estimated regression: ̅ (6) + ? where b = 0 during 2006.q1 – 2011.q3, b = 1 during 2011.q4 – 2016.q4, and s2, s3 and s4 are seasonal binary variables for the 2nd, 3rd and 4th quarters. as chile imports most of its energy needs from abroad, a higher real crude oil price tends to shift short run aggregate supply leftward and cause equilibrium real gdp to decline. figure 2 suggests that y and the debt ratio appeared to have a positive relation during the sample period. figure-1. scatter diagram between real gdp (realgdp) and the real exchange rate (rer). source: international monetary fund. asian journal of economics and empirical research, 2019, 6(1): 70-75 73 © 2019 by the authors; licensee asian online journal publishing group figure-2. scatter diagram between real gdp (realgdp) and the debt-to-gdp ratio (debty). source: international monetary fund. 4. empirical results sources of the data came from the central bank of chile and the international financial statistics and the world economic outlook published by the international monetary fund (2017). y is expressed in million pesos. e is measured as units of the peso per u.s. dollar times the respective prices in the u.s. and chile. hence, an increase in e means real peso depreciation, and vice versa. the lagged debt ratio is used in order to consider the potential impact lag. is represented by u.s. real federal funds rate. e is represented by the crude oil price per barrel measured in the peso and adjusted by the consumer price index. is estimated as an average inflation rate in the last four quarters. the sample runs from 2006.q1 to 2016.q4. the data for the expected inflation rate before 2006.q1 are unavailable. the adf unit root test on the regression residual shows that the test statistic of -3.8166 is less than the critical value of -3.5925 at the 1% level. hence, these time series variables are cointegrated. the estimated regression and related statistics are presented in table 1. the egarch process (nelson, 1991) is employed. the egarch process has fewer restrictions on parameters than the garch process by allowing negative values in the parameters and asymmetric positive and negative effects. an analysis of empirical results shows that the estimated coefficients in the conditional variance equation are significant at the 1% level, suggesting that the egarch process is appropriate. the independent variables with significant coefficients can explain 94.72% of the change in real gdp. except for the insignificant coefficient of the seasonal binary variable in the third quarter, other estimated parameters are significant at the 1% or 2.5% level. real gdp has a positive relation with real peso appreciation during 2011.q4-2016.q4, the lagged debt ratio, and the binary variables representing the second and the fourth quarters and a negative relation with real peso depreciation during 2006.q1-2011.q3, the u.s. real federal funds rate, the real crude oil price and the expected inflation rate. the estimated mean absolute percent error of 1.9689% indicates that the forecast error is expected to be relatively small. specifically, a 1% real appreciation would cause y to increase by 0.3706% during 2006.q1-2011.q3 whereas a 1% real depreciation would cause y to rise by 0.1503% during 2011.q4-2016.q4. a 1% increase in the lagged debt ratio would raise y by 0.0488%. a 1 percentage point increase in the u.s. real federal funds rate would cause the log of y to decline by 0.0054. when the real crude oil price rises 1%, y would decline 0.0470%. the base regression represents the first quarter. in the second quarter, the intercept will increase 0.0316; and in the fourth quarter, the intercept will increase 0.0624, suggesting that real gdp tends to rise during the holiday season in the fourth quarter. the positive significant coefficient of the lagged debt ratio is consistent with the threshold of 90% reported by reinhart and rogoff (2010) who indicated that a higher government debt ratio raises economic growth provided that the debt ratio is less than 90%. the data for the debt ratio shows that the highest debt ratio was 68.41% in 2016.q3, which is less than 90%. table-1. estimated regression of log (real gdp) in chile. variable coefficient z-statistic probability c 19.81669 10079.82 0.0000 log(real exchange rate) -0.370559 -23.39766 0.0000 log(real exchange rate)*binary variable 0.520874 8.396828 0.0000 binary variable -3.109181 -8.178066 0.0000 log(lagged debt-to-gdp ratio) 0.048834 6.279259 0.0000 u.s. real federal funds rate -0.005449 -3.537850 0.0004 log(real oil price) -0.046995 -4.232089 0.0000 expected inflation rate -0.004164 -2.258580 0.0239 q2 0.031559 6.505786 0.0000 q3 -0.000249 -0.035955 0.9713 q4 0.062362 8.949695 0.0000 r-squared 0.947220 adjusted r-squared 0.931226 akaike information criterion -4.213700 schwarz criterion -3.646004 sample period 2006.q1-2016.q4 number of observations 44 mape 1.9689% source: international monetary fund and the central bank of chile. asian journal of economics and empirical research, 2019, 6(1): 70-75 74 © 2019 by the authors; licensee asian online journal publishing group the negative and significant coefficient of the real federal funds rate indicates that the central bank of chile reacts positively to monetary policy of u.s. federal reserve bank. when the fed raises the target federal funds rate, the central bank of chile tends to respond and raise its policy interest rate. other interest rates tend to follow in varying degrees. higher interest rates in chile tend to reduce consumption and investment spending, shift aggregate demand leftward, and reduce equilibrium real gdp. the negative and significant coefficient of the real crude oil price tends to shift short-run aggregate supply leftward and cause equilibrium real gdp to decline. in comparison, the finding that real depreciation was expansionary in chile during 2011.q4-2016.q4 is consistent with frenkel (2004) and rodrik (2008) and in contrast with morley (1992) and mejía-reyes et al. (2010). the finding that real appreciation was expansionary in chile during 2006.q1-2011.q3 is different from other studies. several other versions were considered. if the government deficit-to-gdp ratio substitutes for the government debt ratio, its estimated coefficient is positive and significant at the 1% level. if the real federal funds rate is replaced with the u.s. real prime lending rate, its estimated coefficient is negative and significant at the 1% level and is close to the coefficient of the real federal funds rate. if the simple lagged inflation rate substitutes for the expected inflation rate, its negative coefficient is insignificant at the 10% level. 5. summary and conclusions this study has analyzed the effects of real peso depreciation or appreciation, more government debt and other relevant macroeconomic variables on real gdp in chile based on an advanced macroeconomic model. major findings indicate that real peso appreciation raised output during 2006.q1-2011.q3 whereas real peso depreciation increased output during 2011.q4-2016.q4 and that a higher lagged government debt-to-gdp ratio is expansionary. in addition, a lower u.s. real federal funds rate, real crude oil price or expected inflation rate would help increase output. these results may have some policy implications. it appears that the relation between real gdp and the real exchange rate had a structural change during the sample period and that the impact of real depreciation or appreciation on real gdp depends on the level of economic development. hence, the government may need to review their relation periodically in order to determine whether the current relation may be subject to changes. fiscal expansion measured as a higher lagged debt-to-gdp ratio or deficit-to-gdp ratio is effective in raising output. it suggests that the negative crowding-out effect is relatively small and does not nullify the positive effect of more debtor deficit-financed spending. the central bank of chile 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10.20448/journal.501.2019.62.140.147 © 2019 by the authors; licensee asian online journal publishing group owner-manager competencies and performance of the firms: evidence from small restaurant businesses in urban tanzania ruth elias1 joshua mwakujonga2 ( corresponding author) 1collage of business studies and law, university of dodoma, dodoma, tanzania. 2department of business studies, mzumbe university, dar es salaam campus collage, tanzania. abstract this study was set out to examine the influence of ownermanager’s competences on the performance of small restaurant businesses in urban tanzania since there are patchy empirical evidences on the same. to achieve this, criterion and simple random sampling techniques were employed to obtain a sample of three hundred, ninety two (392) small restaurant businesses from the list of all licensed small restaurants in ilala and dodoma district. information was collected from owner-managers of these entities by using structured questionnaires. data was analyzed both descriptively and by using structural equation modelling for making inference. confirmatory factor analysis was performed to validate the items measuring the owner-manager entrepreneurial, managerial and functional competencies as latent variables. performance of small restaurant was measured subjectively by considering the number of customer’s dynamics and changes in lifestyle of the owner-manager as a result of the business undertaken over past three years of operation. it was found that owner-manager’s managerial and functional competencies contribute significantly to the performance of the small restaurant businesses in urban tanzania. this is true but they cannot be in operation unless entrepreneurial competencies are in place. this implies that, performance relies on base (entrepreneurial) and operational (managerial and functional) that need to be improved. as such, policy makers may not only rely on entrepreneurial aspects but also extend to the managerial and functional aspects of performance. keywords: owner-manager, entrepreneurial, managerial, functional, competencies, performance, small restaurant businesses. jel classification: m 5, m 10. citation | ruth elias; joshua mwakujonga (2019). owner-manager competencies and performance of the firms: evidence from small restaurant businesses in urban tanzania. asian journal of economics and empirical research, 6(2): 140-147. history: received: 6 august 2019 revised: 10 september 2019 accepted: 14 october 2019 published: 25 november 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 141 2. literature review .......................................................................................................................................................................... 141 3. methodology ................................................................................................................................................................................... 142 4. results .............................................................................................................................................................................................. 143 5. discussion ........................................................................................................................................................................................ 145 6. conclusion and policy implications ........................................................................................................................................... 145 references ............................................................................................................................................................................................ 146 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1115 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.62.140.147&domain=pdf&date_stamp=2017-01-14 https://orcid.org/0000-0002-6840-9334 https://orcid.org/0000-0002-4582-0454 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2019, 6(2): 140-147 141 © 2019 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the body of literature that, the three competencies complement each other in the performance of small restaurant business. the managerial and functional competencies play great roles in the performance of small restaurant business. however, they cannot be in operation unless entrepreneurial competencies come first. entrepreneurial competencies are static in nature because they explore the prevailing opportunities of the business and set operational needs of the business on which managerial and functional is attached to ensure the performance. on the other way, entrepreneurial competencies may be important in explaining performance to other sector, nature, size, or competition of the business. unless it is measured in different size, nature, sector and competition of the business we may not know if they can improve performance. 1. introduction the performance of restaurant industry has captured the awareness of researchers due to their overall contributions to the country’s economy (jenkins, 2015; jogaratnam, 2017). literature shows that the industry is the second largest employers in many countries as it builds labour opportunities for skilled and unskilled individuals given a range of business capital in their operation (khan, 2010; frazer, 2012; jenkins, 2015). in tanzania specifically, the hospitality sector contributes 5.5 per cent of national gross domestic product (gdp) (miga, 2002). estimates suggested that small hotels and restaurants add over 70 per cent of these contributions (sharma and upneja, 2005). in additional the sector brings greater economic benefit in providing employment opportunity (nangale, 2012). despite its economic benefit to the society, it has been documented that small restaurant businesses tend to lose customers as compared to other food related service providers like food vendors, take away food service providers, pubs, bars, and catering services (parsa et al., 2011). as a result, small restaurant businesses performance and their survival remain questionable (parsa et al., 2011). statistical evidences shows that, statistical evidence show that, 60% of the small restaurants businesses collapse within three years of their operation (frazer, 2012) in which small restaurant business in tanzania is of no exception. on the other hand, it is reported that in order to operate a small restaurant business in tanzania urban areas, municipal/urban laws and regulation requires one to own or rent a premise with good design, sanitation system and storage facilities in an appropriate location for their safety and efficiency. despite the good intention of the laws, regulations and design procedures for the small restaurant businesses, practically they impose challenges to the restaurant business owners. as a result, owner-managers seem to be unable to comply for such requirements due to their capital margins. in addition, these small restaurant businesses operates in a competitive environment with rapid changes in customer tastes and preferences (dirisu et al., 2013) . therefore, under the given business environment, the author is of the view that, competencies of the owner-manager might be the necessary input for the performance of the small restaurant businesses. this is because large proportion of the difference in performance among small restaurant businesses can be explained by the individual who own and operates the businesses (frazer, 2012; sabir et al., 2014; jenkins, 2015). academic literature shows scant evidence on the effect of owner-manager competencies to the performance of small restaurant businesses against the larger business (anyim et al., 2012). besides the findings from the studies on individual competencies revealed from large businesses cannot be generalized to all businesses as they are relative and specific to the size/scale and sector of the business. however, competencies to the performance of the large business are absolutely complimented with many people, discipline and department from which small business sector is deprived of as it is managed by individuals. thus, applicability and generalization of their findings are questionable based on the nature of small restaurant businesses as they differ in ownership, number of employees, capital as well as the sector. the focus of this paper therefore is to find out the relationship between owner-manager competencies and performance of small restaurant businesses in urban tanzania context. 2. literature review 2.1. theoretical and empirical review human capital theory shows that an individual with necessary competencies (skills and knowledge) can perform better than those who do not have one (becker, 1964). in a small business, the owner-manager often approves on the way things are done. moreover, the owner-manager is the one who is responsible for entrepreneurial, managerial and functional roles of the business (ahmad et al., 2010). thus, the success or failure of these businesses depends on owner-manager competencies to perform such roles (longenecker et al., 1999; munene et al., 2013). 2.1.1. entrepreneurial competencies the modern marketing orientation asserts that to undertake entrepreneurial activities successfully, ownermanager needs different skill/knowledge that relate with the performance of those activities. pieces of literature have consistently shown different skills and knowledge (competencies) on fulfilling entrepreneurial activities in large business performance (fatoki, 2013; tendai, 2013; mothibi, 2015). however, the applicability of those skills in small business may not be appropriate; rather it gives out the base for the research in small business. therefore, the reviewed literature shows that; the owner-manager who wishes to make the business successful and build competitive advantage in gaining customers must have the ability to identify and anticipate the needs of their customers (suchánek et al., 2015) taking problem as opportunity (man, 2001) sell food and services at low price than competitors (kaura, 2012; gagić et al., 2013) and search for future information regarding the restaurant customers (koutroumanis, 2011). the knowledge helps the owner-manager to provide the product according to the customers’ expectations (gursoy and swanger, 2007). this will help the business to maintain and attract more customers for business performance. however, these results are limited to large businesses. asian journal of economics and empirical research, 2019, 6(2): 140-147 142 © 2019 by the authors; licensee asian online journal publishing group 2.1.2 managerial competencies for the owner-manager to undertake managerial activities successfully, he/she needs different competencies that are related to the performance of those activities. researchers have consistently shown different skills and knowledge (competencies) on fulfilling managerial activities for business performance (fatoki, 2013; tendai, 2013; mothibi, 2015). the appropriateness of the managerial competencies that match with the activities undertaken is based on the nature, size, and location of the business, as well as the type of customers, served and quality of employees. for example; literature shows that drivers towards success can be traced on the ability of the manager to lead employees, motivate employees (anyim et al., 2012) delegate (eddie, 2002) and create good network with competitors (tendai, 2013) however, much of knowledge about management of employees has relevance to large organizations and fails to address the distinctive characteristics of the small business. it is thus the work of this study to unpack the experience from small restaurant businesses. 2.1.3. functional competencies the owner-manager, who has the overall control of all activities of the firm and especially in the small firm, must undertake functional activities. in which these activities are related to the technical ability of the ownermanager to perform in the business. masoud (2013) findings showed that there is a significant impact of the functional competencies on the business performance, and explains that (57.6%) of the variation in business performance are from the low level of technical competencies. technical competency is a significant component that owner-managers should possess to perform the jobs associated with the technical field within a firm in an effective way (mohamad and sidek, 2013). the technical ability of the owner-manager is necessary for product/service differentiation. there is a consensus among the social scientists that it is crucial for the individual to have the ability of technical know-how in handling the business successfully (chandler and hanks, 1994; bird, 1995; chu et al., 2005; chu and benzing, 2009; ahmad et al., 2010; mohamad and sidek, 2013). drawing on the concept of functional competencies, factor ranging from appropriate use of modern equipment on food preparation, food preparation skill and the ability to deliver food to customer's places are contributing to the success of restaurant businesses. likewise, the ability to be visible by customers while preparing food and attractive restaurant environment (chen and hsieh, 2011; mandabach et al., 2011) were also identified as the factor that attracts customers to dine in a certain restaurant. besides, findings of the studies show different results among researchers. 3. methodology 3.1. research approach and design this study followed the explanatory cross-sectional design because the purpose of the study was to explain the relationship. the study borrowed already identified item measuring competencies from the literature and tests their causal effect relationship with performance on small restaurant business into tanzania context (man, 2001). it is also a cross-sectional design because it is a population-based survey. the choice of cross-sectional design was also based on the nature of our research objective as well as on the fact that our unit of analysis (small restaurant businesses) does not keep proper secondary data of their undertakings. 3.2. study population and sampling this study examined the influence of owner-manager competencies on performance of small restaurant businesses by using quantitative method approach. the definition of small business in tanzania based on sme policy of 2003 is a business with 5 to 49 employees, and with a capital of from 5-200 million (u.r.t., 2003). in the case where a business falls under more than one category, the level of investment is the deciding factor. however, during the pilot study the author found that most of licensed small restaurant businesses had capital of 5-20 million and employ not more than 10 employees. thus, necessitated the study to take sample with aforementioned criteria. furthermore, similar characteristics of these small restaurant businesses helped the study to have homogeneity units of analysis to avoid issues of biasness. the study also selected the small restaurant business that has been in operation for at least three 3-10 years during the interview in order to be able to capture the experience of the owner-manager competencies for at least past three years and not more than ten years to avoid biasness of the result as most of them when they reach ten years in business graduate to medium business. furthermore, the sample size of this study comprised of 392 small restaurant businesses. sample size was selected through proportional allocation to size within two municipalities in order to have representative sample for generalization. 3.3. data collection method and tool the main tool of data collection was a structured questionnaire. it was selected because of its ability to cover a large area and quickly gaining some details about one’s population of interest within a short period of time. it is also a major tool in survey method. the design of the questionnaire was based on achieving the research objectives. furthermore, five smes experts and five academicians were invited to pre-test the questionnaire for clarity of the questions, suitability to the participants, needed time, and any possible hindrance on getting appropriate information. after correction, then the questionnaire was piloted to 10 owner-managers to test the validity and reliability of each question in capturing the information used. 3.4. measurement of study variables due to challenges of obtaining financial information in small business, researchers often assess small business performance by general subjective measures that can reflect objective measures (tundui, 2012). moreover, the analysis from the previous studies revealed a high level of positive correlation between objective and subjective measures as well as it was suggested that, there is strong reliability of either measure adopted (zulkiffli, 2014). this implies that the correct use of a subjective measure of performance is valid and reliable. asian journal of economics and empirical research, 2019, 6(2): 140-147 143 © 2019 by the authors; licensee asian online journal publishing group the dependent variable is the performance of firms measured with two variables: change in lifestyle of the owner-manager as a result of the business and change in number of customers respectively as reflected on table 1. table-1. measurement of study variables. s no. dependent variable: performance measurement 1 number of customers the categorical variable measured as the trend of number of customers over the past three years, decreased, decreased fairly, stable, fairly increased and increased. 2 changes in lifestyle of the ownermanager in terms of : categorical variable measured by three items the food that bought on a daily basis has changed the categorical variable measured as the changes in food of the owner-manager as a result of business operations over the past three years, as a lot less, less, stayed the same, more, a lot more. the health care services purchased has changed the categorical variable measured as the changes in health care of the owner-manager as a result of business operations over the past three years, as a lot less, less, stayed the same, more, a lot more. the shelter has changed the categorical variable measured as the changes in the shelter of the owner-manager as a result of business operations over the past three years, as a lot less, less, stayed the same, more, a lot more. source: developed from literature review, 2018. the independent variable includes owner-manager entrepreneurial, managerial and functional competencies measured by number of statements representing skills and knowledge of individual for the betterment of the performance. owner-manager competency measures have been adopted from man (2001) and grouped as proposed by ahmad et al. (2011) basing on the three main responsibilities of an owner-manager in the business. on measuring it was required for the owner-manager to indicate their level of agreement on being able to undertake the described entrepreneurial, managerial and functional skills/knowledge based on the item specified in each category. five scales were used for this purpose: strongly disagree, disagree, neither agree nor disagree, agree, strongly agree. for that way, they were indicating the competency they have for performing prescribed activities. 3.5. quantitative data analysis the quantitative data collected were summarized, coded and analysed using statistical package for social sciences (spss) computer programme version 21 and stata 15. data analysis was started by descriptive statistics which was used to explain the essential features of the demographic characteristics of the owner-manager and the characteristics of the business surveyed. structural equational model (sem) was used in analysing the influence of owner-manager competencies on performance of small restaurant businesses because it is very powerful, convenient and flexible tool used in predicting the relationship between latent and observed constructs. sem is the second generation of the statistical analytical tool that combines the assessment of the measurement model (confirmatory factor analysis) and structural model estimation (hair et al., 2006). confirmatory factor analysis (cfa) is the process of validating latent constructs which was done before modelling their interrelationship in sem. to archive the cfa, we assessed the unidemintionality, construct validity, convergent validity and discriminant validity of the latent constructs as indicated on section 4.2 of the analysis. on the other hand, structural model shows the structural relation on how constructs are related to other constructs. it is the structural section of the model which specifies the hypothesized relationships among variables of the study. specifically, it had undergone structural relation of owner-manager competencies and performance of the business. the coefficients generated to describe the strength of this relationship are interpreted in much the same way as regression weights. 4. results 4.1. descriptive results the aim of this research was to determine the influence of owner-manager competencies on the performance of the small restaurant businesses in urban tanzania. prior to inferential analysis, descriptive statistics were considered to make an initial analysis as supporting evidence on the results from the model. the descriptive statistics results shown in table 2 indicate that; performance of the restaurant business is a function of owner-manager’s competence which is contributed by level of education, marital status and age of the business (elias et al., 2018). the results show that 86% (n=337) of sampled owner-managers with primary and secondary education level probably be affected by deprived skill/knowledge of which contemporary is presumed to be acquired from college and university levels. though most of them have limited knowledge and skills, 69.4% (n=272) of sampled owner-managers were married, their family and marriage experience seem to compliment skills to the performance of the restaurant businesses. in addition, the descriptive statistics show that 24% (n=94) of the enterprises interviewed had more than six (6) years of operation. thus, experiences and challenges endured during the life time of the restaurant business seem to enhance competence of owner-managers but in this case they were few hence most of restaurant businesses fail to operate within early years of operation (frazer, 2012; jenkins, 2015). the descriptive statistics imply that level of education; marital status and age of the business form the competence of owner managers to performance and sustainability of the small restaurant business. asian journal of economics and empirical research, 2019, 6(2): 140-147 144 © 2019 by the authors; licensee asian online journal publishing group table-2. descriptive statistics. no variable number of owner-managers(n) percentage (%) 1 formal education of the owner-manager (n) collage/university education 55 14 secondary education 211 54 primary education 126 32 total 392 100 2 marital status of the owner-manager (n) married 272 69.4 single 90 22.9 divorced/widow 30 7.7 total 392 100 3 sex of the owner-manager male 235 59.9 female 157 40.1 total 392 100 4 age of the business 6-mar 298 76 10-jul 94 24 total 392 100 5 no of employees 5-jan 260 66.3 10-jun 132 33.7 total 392 100 source: field data, 2018. 4.2. confirmatory factor analysis to determine the influence of owner-manager competencies on performance of the firm; we first run confirmatory factor analysis among the owner-manager competencies (entrepreneurial, managerial and functional) construct. confirmatory factor analysis was meant to test whether the measures of these construct are consistent with the researcher’s understanding of the nature of that construction. likewise, all measurement models must be validated and accepted prior to modeling the structural model. the polled confirmatory factor analysis (borrowed from the study by elias et al. (2018) was used to validate the competencies (latent construct) which are presents in table 3. table-3. the cfa report for every construct in the model construct. construct item factor loading entrepreneurial processing food and services that customer wants 0.93 processing food that brings benefit to customers 0.98 sell food at a cheaper price 0.99 take new problem as an opportunity 0.99 assess the trend of small restaurant customers 0.99 prioritize work in alignment with the business goal 0.99 managerial lead employees 0.98 motivate employees 0.99 delegate 0.94 interact with customers 0.89 networking 0.99 use of business support services 0.96 family support 0.90 functional use modern processing facilities 0.92 use special knowledge in food processing 0.93 offering delivery services 0.90 visibility during processing of food 0.95 design restaurant environment 0.92 source: data analysis 2018. in this study, we had 3 dimensions which are entrepreneurial competencies (6), managerial competencies (7) and functional competencies (5). according to zainudin (2015) the factor loadings for each item should be 0.6 or higher for an established item. it is apparent from table 3 that, factor loading are above 0.6. therefore, confirmatory factor analysis shows that all of the 18 measuring items from three competencies are relevant and were retained for further analysis. table-4. the fitness indexes for the polled measurement model. s no. name of category name by index index value level of acceptance comments 1 absolute fit root mean square of error approximation (rmsea) 0.075 <0.08 the required level is achieved 2 incremental fit turker-lewis index (tli) 0.929 >0.90 the required level is achieved 3 parsimonious fit chi-square/degree of freedom (chisq/df ) 3. 250 <0.30 the required level is achieved source: data analysis, 2017. asian journal of economics and empirical research, 2019, 6(2): 140-147 145 © 2019 by the authors; licensee asian online journal publishing group the analysis goes on with the examination of the fitness indexes. therefore, in order to retain or reject the hypothesized model, incremental fits, absolute fits and parsimonious fits were examined. the examination of the fitness indexes as presented in table 4 (borrowed from the study by elias et al. (2018) indicates that the indexes values obtained meet the required level of the model fit. therefore, we confirmed that the data fit well the model. table 4 shows the fitness of the measurement model, an index was archived; which guaranteed the study to go on modelling for structural equation model. 4.3. empirical results the latent exogenous variable owner-manager entrepreneurial, managerial and functional competencies have been regressed to endogenous variable performance (changes in life style of the owner-manager as well as in the changes in number of customers purchasing from the business) in one structural model. the level of significance (p-values) was used to test the influence of each variable on performance. table-5. results for the effect of owner-manager competencies on the performance of small restaurant businesses. construct coef. std. error. z p-value changes in lifestyle entrepreneurial 0.81905 0.782326 1.05 0.349 functional 0.13618 0.025435 5.35 0.001 managerial 0.59637 0.216348 2.76 0.006 number of customers entrepreneurial 0.301590 0.282464 1.06 0.110 functional 1.256077 0.251787 4.99 0.001 managerial 1.042405 0.266409 3.91 0.001 source: researcher, 2017. the result on the influence of owner-manager competencies toward the level of performance revealed a significant and positive influence on managerial and functional competencies for the number of customer and changes in lifestyle as reflected on table 5. additionally, entrepreneurial competencies we’re not found to influence both performance measures as indicated in table 5 results. the p-value is > 0.05 to mean that entrepreneurial competencies are not a determinant of small restaurants business performance. 5. discussion the aim of this study was to determine the influence of owner-manager competencies on performance of small restaurant businesses in urban tanzania. contrary to theory and other studies, this study did not find a significant relationship between entrepreneurial competencies and performance of small restaurant businesses. some authors have speculated that, in most cases the entrepreneurial competencies are used at the initial stage of the business, where the owner-manager needs to establish the business. the reason behind is, the routine attainment or change in the provision of service to customers involves additional costs in which it can raise price of the food offered, thus can decrease customers because customers are sensitive to price. these findings are in line with the studies by sarwoko et al. (2013); ahmad et al. (2010) and man et al. (2002). the current study shows that, owner-manager managerial competencies influence performance of small restaurant business in terms of number of customers as well as changes in lifestyle of the owner-manager as results of the business. this is because most of these businesses employ unskilled labor therefore, motivating, leading them is very important for the performance of the business. these findings are in line with, mothibi (2015) and chandler and hanks (1994). our result also supports that there is positive and significant relationship on the influence of owner-manager functional competencies and performance in small restaurant businesses in both measures. therefore, the ability of the owner-manager to use modern processing facilities helps in increasing speed of offering services and especially at picks times hence customer satisfaction. furthermore, the ability of the owner-manager to deliver services to customers’ locations increases customers as most of them save time while saved within their offices. likewise, the ability to design an attractive business environment offers the possibilities of customers to be attracted to dine within the restaurant. these findings are in line with chu et al. (2005); chu and benzing (2009) and mohamad and sidek (2013). it was also observed that male owner-managers have more ability to apply managerial and functional skills in relation to the performance of commercial enterprise than their female counterparts. this implies that restaurant owned by males has higher chances of performing better than those owned by females. the explanation behind this observation is that male owner-managers have been found to have higher motives in business than females because they equip themselves to attain more of the competencies to perform. 6. conclusion and policy implications based on empirical findings, we conclude that, managerial and functional competencies are important predictors of small restaurant businesses performance in terms of changes in lifestyle of the owner-manager and changes in number of customers within the businesses. also male owner-managers apply competencies for business performance more than female owner-managers. this has also been highlighted by the study by elias et al. (2018) that majority of female owner-managers are found in micro-scale due to multi responsibility they have in the family. dividing their time to manage the business as well as the family matters reduces the effort to gain and use competencies for performance. the findings imply that, special training can be designed for female’s owner managers to enable them to separate business and family responsibilities. the policy also can consider providing incentives for the new established firm to ensure growth in gaining experience for more major competencies toward performance. one of the more insignificant and surprising findings to emerge from this study is that an entrepreneurial competency is not the determinant of small restaurant business performance in terms of both asian journal of economics and empirical research, 2019, 6(2): 140-147 146 © 2019 by the authors; licensee asian online journal publishing group changing in lifestyle and the number of customers. given the importance of entrepreneurial competencies into the performance of the business, it can therefore be assumed that, entrepreneurial competencies set operational needs on which managerial and functional competencies are attached to ensure the performance. this is because, entrepreneurial competencies are static in nature, and it explores the prevailing business opportunities at first. it is therefore implies that, performance relies on base/platform (entrepreneurial) and operational (managerial and functional) that need to be improved. as such, policy makers may not only base on entrepreneurial aspects but also extend to the managerial and functional aspects of performance. theoretically, it implies that, unless entrepreneurial competencies can be measured in other size, nature, sector and competition of the business, then we can know if they can improve performance. thus, human capital theory can advance in showing that, different businesses need different skills and knowledge for their improved 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doi: 10.20448/journal.501.2019.61.52.58 © 2019 by the authors; licensee asian online journal publishing group demand for imports and components of final expenditure: an empirical study with special reference to the korean import demand function il-hyun yoon1 h. r. seddighi2 ( corresponding author) 1division of global business administration, dongseo university, 47 jurye-ro, sasang-gu, busan 47011 korea. 2business school, university of sunderland, st. peter’s campus, st. peters way, sunderland, tyne and wear sr6 0dd uk. abstract this paper presents a detailed empirical investigation of korea’s demand for imports. in particular, our study provides fresh estimates of partial elasticities of demand for imports with respect to each key component of final expenditure including final consumption expenditure, and expenditure on capital formation. a johansen multivariate co-integration analysis is employed on the post-global financial crisis quarterly macroeconomic data such as final consumption, gross fixed capital formation, exports and relative import prices for the sample period 2009-2018. in support of the empirical framework used in this study, we have found significant differences to exist between various long-run partial elasticities of demand for imports while import elasticity of demand with respect to expenditure on fixed capital formation is found to be negative. this latter result appears to imply that incremental increases in capital formation can provide an effective mechanism for reducing reliance of korea on imports in the long run. according to the short-run forecasting model, we have found that the current period changes in the demand for imports are related only to the previous period changes in relative price of imports. keywords: cointegration, economic policies, error correction model, korea, partial elasticities, unit root. jel classification: c32; f14. citation | il-hyun yoon; h. r. seddighi (2019). demand for imports and components of final expenditure: an empirical study with special reference to the korean import demand function. asian journal of economics and empirical research, 6(1): 52-58. history: received: 7 november 2018 revised: 21 december 2018 accepted: 17 january 2019 published: 11 april 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 53 2. modeling framework and data .................................................................................................................................................... 53 3. empirical results ............................................................................................................................................................................. 54 4. a short-run error correction forecasting model for aggregate imports ........................................................................ 55 5. conclusions ....................................................................................................................................................................................... 56 references .............................................................................................................................................................................................. 57 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.61.52.58&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/266 https://orcid.org/0000-0002-2645-775x https://orcid.org/0000-0003-3679-0545 http://asianonlinejournals.com/index.php/ajeer/article/view/266 https://orcid.org/0000-0002-2645-775x https://orcid.org/0000-0003-3679-0545 http://asianonlinejournals.com/index.php/ajeer/article/view/266 https://orcid.org/0000-0002-2645-775x https://orcid.org/0000-0003-3679-0545 http://asianonlinejournals.com/index.php/ajeer/article/view/266 https://orcid.org/0000-0002-2645-775x https://orcid.org/0000-0003-3679-0545 asian journal of economics and empirical research, 2019, 6(1): 52-58 53 © 2019 by the authors; licensee asian online journal publishing group 1. introduction there have been a plethora of empirical studies over the past decades on estimation of aggregate import demand based on the national income and relative price of imports in various countries across the world, reflecting the significance of import for trade policies not just to researchers but also to policymakers. studies have been conducted on the basis of both multi-country comparison and country-specific investigation. for multi-country examinations, there are asseery and peel (1991) for five developed economies, bahmanioskooee (1998) for six less developed nations, sinha (2001) for five nations in asia, alias et al. (2001) for five asean countries, and matsubayashi and hamori (2003) for g7 member countries. examples of country-specific investigation, to name a few among many, include salas (1982) for the mexico, doroodian et al. (1994) for saudi arabia, abbott and seddighi (1996) for the uk, carone (1996) for the us, sinha (1997) and ahad et al. (2017) for pakistan, arize et al. (2000) for thailand, alias and tang (2000) for malaysia, tang (2003a); wang and lee (2012); and gozgor (2014) for china, and arize and walker (1992) and tang (2003b;2006;2008a;2008b;2015) for japan. several studies have also been done for import demand for korea. arize and ndubizu (1992) based on engle and granger (1987) method, documented that there is cointegration among aggregate imports, gdp, relative import price and current account balance in korea. mah (1992) used annual data for the period of 1971-1988 with the ordinary least squares approach to find that the income is significant factor with the import price insignificant in estimation of korean import demand. mah (1993) reexamined import demand behavior for korea by using quarterly data for period of 1971-1988 to produce different results with the income being less significant and the price being insignificant to the country’s aggregate imports after 1981. bahmani-oskooee and rhee (1997) analyzed quarterly data over the period from 1971 to 1988 to find that at least one cointegrating vector exists among imports, gross national product (gnp) and relative price of imports based on maximum-likelihood method by johansen and juselius (1990). senhadji (1998) analyzed annual data for the period from 1960 to 1993 and found a long-run relationship among real imports, relative import prices and income in korea. bahmani-oskooee (1998) found that there are two cointegrating vectors for korea among imports, relative price of import, domestic income and exchange rate in the multi-country study for the less developed economies based on quarterly data of 19731990. later, min et al. (2002) examined korean aggregate import demand with the annual data for the period from 1963 to 1998 to find that the major determinants of import in the long run are final consumption expenditure, import price and export demand with elasticities of 1.04, -0.6 and 0.49, respectively. more recently, tang (2005) examined the long-run relationships of aggregate import demand behavior in korea, using bounds test procedure with quarterly data from 1970 to 2002 to show evidence of a cointegrating relation which is consistent with earlier studies. chang et al. (2005) also used the bounds test method to examine the korea’s aggregate import demand function for the period from 1980 to 2000 and found that imports, income and relative prices are cointegrated. almost all of the above studies on the estimation of aggregate import demand have used total domestic income (gdp) and relative import price on the assumption that long-run elasticity of import demand relating to each component of aggregate demand is the same, thus using a single regressor to represent aggregate demand in the import is function. however, if each component of final expenditure has different import content, the use of a single variable in the aggregate import demand function could cause aggregation bias, hence leading to incorrect estimates (see gorman (1953); theil (1954) and stoker (1993) for more details). furthermore, there is some evidence from the eu member countries which appear to suggest aggregate imports react differently to changes to each component of aggregate demand (see, for example, eurostat (2010)). accordingly, in this paper, we will distinguish between different categories of final expenditure in the import demand equation to investigate the response of aggregate imports to a change in expenditure in each one of final demand category. this type of disaggregation of final demand in the import function is consistent with the treatment of aggregate demand in a number of pioneering empirical studies which have found robust results on various elasticities of demand for imports (for example, abbott and seddighi (1996)). this study would follow abbott and seddighi’s methodology to empirically examine korea’s aggregate import demand under the reformed economic paradigm currently in place in korea. the remainder of this paper is structured as follows. section 2 discusses the model, data and methodology used. section 3 reports the results of empirical analysis and implications. section 4 presents additional analysis of the short-run error correction model before concluding the paper in section 5. 2. modeling framework and data based on economic theory, we have disaggregated aggregate expenditure into its key components in the demand for import function as follows: (1) where impt is demand for aggregate imports, fincon is the final consumption expenditure, invt is expenditure on investment goods measured by gross fixed capital formation and expt is the total amount of exports, all measured in constant prices. price represents the relative price of imports to domestic prices (pm/pd) measured by the ratio of import price deflator (pm) (defined as ratio of imports in current prices over imports in constant prices) by the index of domestic prices (pd) (measured by the gdp deflator). all variables are in natural logarithmic form. the data used in this study are quarterly from 2009:1 to 2018:4 obtained from economic statistical system (ecos) of the bank of korea. in order to test for the existence of the long-run relationship between demand for imports and variables specified by economic theory in the import demand function equation 1, we have employed a multivariate cointegration analysis consisting of the following steps: 1. using an adf test to test for the order of integration of each variable. 2. using co-integration tests, including trace and eigen–value tests, to investigate whether or not there exists a unique cointegrating vector linking variables specified in the import demand function. asian journal of economics and empirical research, 2019, 6(1): 52-58 54 © 2019 by the authors; licensee asian online journal publishing group 3. determining the long-run relationships between variables identified in the import demand function, on the basis of steps 1 and 2. 4. deriving a short-run error correction forecasting model, using a general to specific methodology. the results of the each step in this empirical investigation will be presented in the following sections. 2.1. a summary characteristics of data used in the empirical investigation table 1 shows the descriptive statistics of the variables used in this study. normal distribution characteristics appear not to be present in the data series as it is indicated by the jarque-bera, skewness and kurtusis statistics. most of the variables are shown as flat (platykurtic) with respect to the normal as the kurtosis is less than 3. the skewness statistics are negative in most of variables, indicating a longer tail to the left than to the right side and the skewed distribution to the left. table-1. descriptive statistics. variable impt fincon invt expt price mean 32.50766 33.03716 32.28471 32.6251 -0.09238 median 32.53556 33.0377 32.25921 32.64229 -0.05395 maximum 32.70107 33.17553 32.47589 32.78553 0.1715 minimum 32.18521 32.88508 32.10842 32.26074 -0.404477 std. dev. 0.128178 0.075547 0.104083 0.12173 0.169606 skewness -0.878776 -0.001962 0.452384 -1.246295 -0.163357 kurtosis 3.044742 2.122575 1.990439 4.227326 1.640127 jarque-bera 5.151655 1.283149 3.06303 12.86557 3.259992 probability 0.076091 0.526463 0.216208 0.001608 0.19593 sum 1300.306 1321.486 1291.388 1305.004 -3.695208 sum sq. dev. 0.640755 0.222589 0.422501 0.577914 1.121877 observations 40 40 40 40 40 note: the figures for impt, cons, invt, govt, and expt are the natural log transformation of the volumes in korean won for the imports, the private final consumption expenditure, the expenditure on investment goods denoting gross fixed capital formation, the government final consumption expenditure and the exports. price indicates the natural log of the value of the import price deflator divided by an index of domestic prices. 3. empirical results table 2 displays the results of the adf unit root tests at level and first difference series of each variable. the test results confirm that all series are stationary after first differencing. table-2. unit root test. variable level first difference adf t-statistic p-value adf t-statistic p-value* impt -2.2576 0.1904 -7.4089 0 fincon -1.0660 0.7195 -7.5529 0 invt -1.1394 0.6904 -6.0760 0 expt -3.4529 0.0149 -11.8261 0 price -0.8443 0.7950 -2.6966 0.0842 *mackinnon (1996) one-sided p-values. in order to implement the johansen’s cointegration test (johansen, 1988) the appropriate lag length is to be selected for the var. on the basis of the schwarz information criterion (schwarz, 1978) and hannan-quinn information criterion (hannan and quinn, 1979) the lag length was chosen to be one period. under this specification, results of the trace test are shown in table 3. these results appear to indicate that at most one cointegrating vector to exist with regard to variables specified in the model. table-3. johansen cointegration test. null hypothesis trace max-eigen no. of ce(s) eigenvalue statistic 5% critical value prob.** statistic 5 % critical value prob.** none* 0.5432 73.4387 69.8189 0.0250 0.5432 33.8769 0.143 at most 1 0.3798 43.6655 47.8561 0.1172 0.3798 27.5843 0.4824 at most 2 0.3165 25.5122 29.7971 0.1439 0.3165 21.1316 0.3283 at most 3 0.2430 11.0496 15.4947 0.2085 0.2430 14.2646 0.1767 at most 4 0.0123 0.4712 3.8415 0.4924 0.0123 3.8415 0.4924 trace test indicates 1 cointegrating equation while maximum-eigenvalue test indicates no cointegrating equation at the 0.05 level. cointegrating coefficients impt fincon invt expt price 49.1308 -13.7890 13.5036 -51.5676 -11.6531 normalized cointegrating coefficients (standard error in parentheses) impt fincon invt expt price 1 -0.2807 0.2749 -1.0496 -0.2372 (-0.2203) (-0.1545) (0.0832) (-0.0553) * denotes rejection of the hypothesis at the 0.05 level. ** mackinnon et al. (1999) p-values. the maximum eigenvalue test, which is considered to be more powerful than the trace test (johansen and juselius, 1990) is also presented. according to the results of both the trace and the maximum eigenvalue tests, there appears to be at most one statistically significant cointegrating vector with regard to the variables specified asian journal of economics and empirical research, 2019, 6(1): 52-58 55 © 2019 by the authors; licensee asian online journal publishing group in the model. this cointegrating vector is shown in table 3 with corresponding coefficient estimates, normalized on aggregate imports. according to the above results, the long-run relationship among components specified in the model may be represented in equation 2 as follows: (2) the estimated coefficients represent estimates of long-run partial elasticities of demand for imports. according to these results, demand for imports with respect to final consumption expenditure are both inelastic with a value of 0.28, approximately, implying that in the long run for each 1% increase in either of these two types of expenditure imports are likely to rise by only 0.28 of one percent. similarly partial elasticity of demand with respect to to a change in exporting expenditure is found to be approximately 1.05, indicating to an elastic demand for imports with respect to this category of final expenditure. this category of final expenditure appears to dominate the response of demand for imports with respect to changes in final expenditure indicating that changes in demand for exports plays a key role in bring about changes in demand for imports in the long run, which appears to be consistent with the korean’s export –led growth policies . the partial elasticity of demand for imports with respect to a relative price change is found to be only +0.24 which indicates to an inelastic nature of demand for imports with respect to relative prices in the long run. the sign of this coefficient is expected to be negative, according to economic theory, however, this estimate could indicate that imports are considered to be a type of giffen goods (spiegel, 1994). this result implies that exchange rate policies which design to impact trade via changes in relative prices would be ineffective policy tool in reducing demand for imports in korea in the long run. with regard to the investment expenditure (measured by gross domestic fixed capital formation), according to the above results, elasticity of import with respect to this category of expenditure is found to be approximately 0.27, which implies a fall of 0.27 % in imports for every 1% rise in this category of expenditure. this is an unexpected but an interesting result, as one expects this partial elasticity to be positive and similar in magnitude to other estimated coefficients of final expenditure. however, there is clearly a difference between the responses of imports to changes in this category of final expenditure compared to those relating to other components of final demand. furthermore, the estimated coefficient appears to indicate to the key role of investment expenditure as a policy tool in reducing dependency on imports in korea in the long run. as more resources are allocated to fixed capital formation, this result seems to suggest that imports decrease as a result of growth in domestic productive capacity of the economy. moreover, as imports appear to be price inelastic, increase in investment expenditure seems to be most effective policy tool for reducing imports in the long run. 4. a short-run error correction forecasting model for aggregate imports since variables employed in our modeling framework are confirmed to be non-stationary series and cointegrated, we can investigate the short-run behavior of the demand for imports via an error correction forecasting (ecm) model. to this end, the lagged residual error derived from the cointegrating vector was incorporated into a general error correction model as follows (engle and granger, 1987): (3) where is the intercept, is the coefficient of the error correction term, ~ are the short-run coefficients of independent variables and is the white noise error term. is one period lag residual of the long-run model expressed as equation 2, also known as the error correction term. equation 3 represents that changes in the import demand are a function of the level of disequiribrium in the cointegrating relationship represented by the error correction term along with changes in independent variables. the guides each variable to restore the equilibrium relation, i.e., to correct disequilibrium. the coefficient measures at what rate it correct the previous period disequilibrium of the system, i.e., the speed of the adjustment towards the long-run equilibrium relationship. this general model was estimated by using a general to specific methodology, and the results of the vector error correction estimation are shown in table 4. the appropriate number of lags was set as one period in accordance with the schwarz information criterion (schwarz, 1978) and hannan-quinn information criterion (hannan and quinn, 1979). the top panel illustrates the results from the first step johansen procedure. the bottom panel shows the coefficients of the error correction term, which is denoted cointeq1, and other independent variables estimated by equation 3. table-4. vector error correction estimates. cointegrating eqn impt(-1) fincon(-1) invt(-1) expt(-1) price(-1) c 1 -0.2807 0.2749 -1.0496 -0.2372 2.1159 (-0.2203) (-0.1545) (-0.0832) (-0.0553) [-1.2742] [1.7794] [-12.6187] [-4.2909] standard errors in ( ) & t-statistics in [ ] error correction: dependent variable = impt cointeq1 impt(-1) fincon(-1) invt(-1) expt(-1) price(-1) 0.3150 -0.3514 -0.4408 0.4960 -0.1688 0.7283 0.0189 source: outcome from eviews 7. asian journal of economics and empirical research, 2019, 6(1): 52-58 56 © 2019 by the authors; licensee asian online journal publishing group table 5, in addition, reports the results of the significance test of each variable including its standard error and t-statistic. the test results implies that there is no short-run causality running from private consumption, investment expenditure and government spending to import demand while exports and relative price of imports have short-run impact. in order to measure goodness-of-fit of the model, the result of the f-test for the overall significance of the model is presented, which is assumed to be satisfactory. given the above results, the short-run behavior of korean aggregate imports may be presented by a simplified equation 4 as follows: (4) where the ecm is an error correction term. according to this short-run forecasting model, the current period changes in the demand for imports are related to the previous period changes in relative price of imports, and an ecm term. this result may be taken to imply that exchange rates policies which directly work through relative prices could provide an effective policy tool for targeting a desired change in demand for imports in the short run. table-5. error correction model estimates. variable coefficient std. error t-statistic prob. 0.3150 0.4512 0.6981 0.4903 -0.3514 0.3554 -0.9887 0.3305 -0.4408 1.8958 -0.2325 0.8177 0.4960 0.4838 1.0253 0.3131 -0.1688 0.2857 -0.5908 0.559 0.7283** 0.2367 3.0771 0.0043 0.0189 0.0162 1.1632 0.2536 f-statistic 3.4560. prob(f-statistic) 0.0099. note: ** indicate significance at the 5%. table 6 and table 7 also confirms that the dynamic error correction model estimated in this study has neither serial correlation nor heteroskedasticity, as test results of breusch-godfrey test and breusch-pagan-godfrey test for residuals shows that null hypothesis of no autocorrelation and no heteroskedasticity cannot be rejected as p value is 0.0544 and 0.2588, respectively. table-6. autocorrelation test. breusch-godfrey test: f-statistic 3.2369 prob. f(1,30) 0.0821 obs*r-squared 3.7001 prob. chi-square(1) 0.0544 source: outcome from eviews 7. table-7. heteroskedasticity test. breusch-pagan-godfrey f-statistic 1.3088 prob. f(10,27) 0.2752 obs*r-squared 12.4062 prob. chi-square(10) 0.2588 source: outcome from eviews 7. figure 1 illustrates the result of the diagnostic tests which indicates that the short-run model appears to be well behaved with a white noise error term, suggesting that the model tracks the data well. figure-1. actual fitted residual graph. source: outcome from eviews 7. 5. conclusions this study was motivated by the need to provide a rigorous examination of korean import demand function in order to add to current debate on maintaining a positive balance of trade in the long run in this country. to this end, in this paper, we used the post-global financial crisis data to investigate the country’s import demand under the reformed economic regime to avoid structural breaks in the time series data in the wake of the global financial crisis which broke out in 2007-8. to allow for different impact of each component of final expenditure on aggregate asian journal of economics and empirical research, 2019, 6(1): 52-58 57 © 2019 by the authors; licensee asian online journal publishing group imports, in this study, we disaggregated final demand into final consumption expenditure, investment expenditure, and expenditure on exports. within this framework, a multivariate co-integration analysis was then carried out to examine the long-run behavior of the korean import demand function. the empirical findings suggest that a long-run relationship is existent among aggregate imports, final expenditure components and relative price of imports. furthermore, significant differences are found to exist among the long-run partial elasticities of imports as regards different macro components of final expenditure. particularly, while partial elasticities with respect to final consumption and exports all appear to be positive, imports seems to respond negatively to changes in investment expenditure, implying that an increase in gross capital formation could result in a reduction in demand for imports in the long run. with regard to the relative import prices, our results appear to indicate to a insignificant influence on the aggregate imports in korea in the long run. however, an error correction model designed for predicting the short-term variability shows that changes in relative import prices have a significant impact on changes in aggregate demand for imports in the short run. these findings appear to have significant implications for policy makers in korea in their quest to improve the country’s trade balances in the long term. particularly, exchange rate policies that have a direct influence on import prices are found to have little long-term effect on korea’s import demand, but might be used to bring a desired change in demand for imports in the short run. furthermore, policies targeted to increase gross 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economic modelling, 29(6): 2591-2596.available at: https://doi.org/10.1016/j.econmod.2012.08.002. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 76 © 2019 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 6, no. 1, 76-84, 2019 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2019.61.76.84 © 2019 by the authors; licensee asian online journal publishing group housing consumption of the “soon-to-retire” in hong kong: a cross-sectional regression analysis wadu mesthrige jayantha1 lebunu hewage udara willhelm abeydeera2 ( corresponding author) 1rmit university, melbourne, australia. 2the hong kong polytechnic university, hong kong. abstract availability and quality of housing have long been serious problems in hong kong over the years. it is now apparent that the rapidly increasing aging population (those over 65 years) seems to make the housing issue an even more serious one. as the demographic and social structures of the society continue to evolve, government‟s housing policy should be reviewed and revised from time to time, accordingly, in order to satisfy the changing needs of the society. the main objective of this study is to explore the significant determinants of housing consumption of the „soon-to-retire‟ group and suggest an explanation for their underlying dynamics. based on a sample survey data, a cross-sectional regression model is employed to identify significant determinants that influence housing consumption of this group. empirical results reveal that housing consumption of this group is influenced not only by market and demographic factors but also by the health status of the household. heath status of the household, of this age group, is very important as this group is nearing their retirement. the empirical results further reveal that average household size and housing tenure as significant determinants of housing consumption of this study group. by introducing this new factor, we attempt to broaden our knowledge about the housing consumption of this less explored aspect of the housing market. keywords: housing consumption, soon-to-retire, health status, housing policy, hong kong. jel classification: r21, r31, o18. citation | wadu mesthrige jayantha; lebunu hewage udara willhelm abeydeera (2019). housing consumption of the “soon-toretire” in hong kong: a cross-sectional regression analysis. asian journal of economics and empirical research, 6(1): 76-84. history: received: 4 april 2019 revised: 14 may 2019 accepted: 17 june 2019 published: 15 august 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 77 2. literature review ............................................................................................................................................................................ 79 3. methodology ..................................................................................................................................................................................... 80 4. empirical analysis ........................................................................................................................................................................... 81 5. summary, conclusions and discussion ....................................................................................................................................... 82 references .............................................................................................................................................................................................. 83 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.61.76.84&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://www.asianonlinejournals.com/index.php/ajeer/article/view/920 https://orcid.org/0000-0002-9909-884x https://orcid.org/0000-0002-6304-9093 http://www.asianonlinejournals.com/index.php/ajeer/article/view/920 https://orcid.org/0000-0002-9909-884x https://orcid.org/0000-0002-6304-9093 http://www.asianonlinejournals.com/index.php/ajeer/article/view/920 https://orcid.org/0000-0002-9909-884x https://orcid.org/0000-0002-6304-9093 http://www.asianonlinejournals.com/index.php/ajeer/article/view/920 https://orcid.org/0000-0002-9909-884x https://orcid.org/0000-0002-6304-9093 asian journal of economics and empirical research, 2019, 6(1): 76-84 77 © 2019 by the authors; licensee asian online journal publishing group contribution of this paper to the literature the present study adds knowledge to the housing literature in several ways: (a) this is the first comprehensive study in hong kong to explore critical determinants of housing consumption behavior of this group; and (b) a new variable, health status (effect of health) was introduced to the housing consumption model. 1. introduction availability, adequate size, and quality of housing have long been serious problems in hong kong over the years. it is now apparent that the rapidly increasing aging population (those over 65 years) seems to make the housing issue an even more serious one. the proportion of the population in hong kong who are aging has continued to grow faster during the last ten years, raising the concerns for the housing of seniors in the community. for instance, the median age of the hong kong population rose from 10.1% in 1996 to 12.4% in 2006 and further to 15.9% in 2016 (census and statistics department, 2016). the authorities forecast the median age continues to rise to 47.7 in 2031. most importantly, people aged between 45-64 years old or the „soon-to-retire‟ collectively comprised 17.26% of the total population in 1991, 21.8% in 2001, and continued to rise to 31.28% by 2011. it has become the largest age stratum in hong kong, with already more than 2.2 million people. by looking at the population in domestic households living in different types of housing by age in the past decade table 1, one may notice that number of elderly people (age 65 and above) living in various types of housing (except temporary quarters) has been increasing while public rental housing (prh) remains the most common type of housing for the elderly. the number of elderly households living in subsidized sale flats has surged in the past decade by 58% from 95,886 in 2001 to 151,152 in 2011 and 204,985 in 2016. a significant increase (34%) is also noted in the number of elderly people dwelling in private residential flats from 240,105 in 2001 to 457, 216 in 2016. the most important phenomenon noticed is that the group of „soon-to-retire‟ is taking up a large proportion of the total population in hong kong. unlike the category of aged 65 and above (who are retired and mainly living in prh), a majority of the people in the „soon-to-retire‟ (42% of the total age stratum) are living in private residential flats, as they may be more capable to support themselves with private housing. however, when this category of „soon-to-retire‟ starts their retirement, their sources of income may not enough to afford private housing anymore (as they may lose housing allowances or other payments). then they have to rely on other means (like pensions/ mandatory provident fund, investment returns, etc.,) forcing them to change their housing consumption pattern accordingly. table-1. population in domestic households by age and type of housing/quarters, 2001, 2006, 2011and 2016. age type of housing/quarters population in domestic households 2001 2006 2011 2016 45 64 public rental housing units 505 434 580 396 646 728 671,398 subsidized sale flats 235 152 354 575 428 012 414,998 private residential flats 584 906 732 340 1, 067, 211 1,158,791 non-domestic quarters 3 685 3 484 5 010 7,573 temporary quarters 18 205 12 711 14 521 15, 947 65 and over public rental housing units 293 371 315 242 331 957 392, 575 subsidized sale flats 95 886 127 193 151 152 204, 985 private residential flats 240 105 275 645 368,322 457, 216 non-domestic quarters 1 072 948 1 468 3, 409 temporary quarters 9 914 6 981 7 784 10, 740 source: extracted from interactive data dissemination service (various years), census and statistics department. as this group of „soon-to-retire‟ takes up the largest proportion of the population of hong kong, their housing needs should not be overlooked as the authorities did in the past. people in the age of 45 to 64 comprise the largest age stratum in hong kong, and this age group is forecast to increase further in the coming decade figure 1 (csd, 2016). the population of this specific group is over 1.2 million figure 2 that indicates the importance of giving special attention to the need for housing consumption of this group in hong kong. when a group of people consists of more than 30% of the total population, its behaviors and characteristics are worth studying, with the view to implementing better governmental policies. as the demographic and social structures of the society continue to evolve, government‟s housing policy should be reviewed and revised from time to time, accordingly, in order to satisfy the changing needs of the society. it is thus important and insightful for the government, private property developers and academic scholars to investigate and identify the housing needs of this population group and their underlying determinants in order to prepare a long-term detailed housing strategic plan. since the supply of housing has long been a serious issue in hong kong; the government is currently under serious criticism about its housing and land supply policy, and the government authorities are being forced to rethink the policies including reinstating the homeownership scheme (hos) in order to ease the current situation. while the authorities focus on the housing policy for the elderly, that is, the immediate need, housing consumption of the „soon-to-retire‟ should not be neglected, as this group of people will be the main target user of the senior housing in the near future. thus, it is high time for authorities to embrace this particular group as an important element in their new housing strategies. a better understanding of the housing consumption of the „soon-to-retire‟ is necessary for more effective housing policy for the elderly in the future. as housing issues with high-density dwelling units in hong kong is already an extremely serious problem, this issue warrants serious attention by the government, society, and academics. asian journal of economics and empirical research, 2019, 6(1): 76-84 78 © 2019 by the authors; licensee asian online journal publishing group figure-1. population structure of hong kong in 2016. source: csd (2011). figure-2. population size and growth of the age group 45-64 and over the past 50 years. source: csd (2011). although housing is a serious issue in hong kong, research efforts investigating the aging problem in relation to housing consumption in hong kong have been quite limited. there are some studies on housing demand of the elderly in the literature (chiu et al., 2003; chui and ko, 2003; chiu and ho, 2006; cheung, 2008; hui and yu, 2009) yet comprehensive studies on housing needs and behavior of the „soon-to-retire‟ remain limited in hong kong. this paper aims to fill this gap in understanding by evaluating the housing consumption of this large group of people who are aged between 45-64 years old. the main objectives of the present study are (a) to evaluate levels of housing consumption of this soon-toretire group, and (b) to explore significant determinants of housing consumption of this group and suggest an explanation for their underlying dynamics. the study would contribute to the housing literature in several aspects. first, this study is the first of its kind in hong kong to evaluate housing consumption behavior and determinants of this group. second, and most importantly, the health issue (effect of health), which to the authors‟ knowledge has not been introduced in a comprehensive housing consumption analysis, is to be incorporated into the housing model. the findings of this research will be of special interest to policy-makers and academics in hong kong concerned with housing policy planning (e.g. new development area in north east new territories) and other land and housing policy measures, including housing affordability issues. the paper is structured as follows. the following section (section 2) reviews the existing studies in the area of housing consumption, in a particular housing consumption of elderly and the „soon-to-retire‟ categories will be asian journal of economics and empirical research, 2019, 6(1): 76-84 79 © 2019 by the authors; licensee asian online journal publishing group reviewed, whilst section 3 provides the theoretical framework for a regression model of the housing demand of the soon-to-retire. section 4 discusses empirical estimates of the tested model, and the study concludes in section 5 with a summary and some suggestions for future research. 2. literature review there is a significant body of literature on various aspects of housing consumption, including studies in the usa, western countries and elsewhere (e.g. (bayer and harper, 2000; clark and drever, 2000; lawler, 2001; davey, 2006; boldy et al., 2011; rioux and werner, 2011; basaraba, 2016)). a reasonably rich body of housing studies is also evident recently in china (e.g. (fu et al., 2000; li, 2000a;2000b; huang and clark, 2002; huang, 2003a;2003b; yu, 2004; chui, 2008)) which is more relevant to hong kong. different studies view and analyze housing consumption in different perspectives. their analyses are mainly based on two different approaches, with the first being mainly concerned with economic perspectives that emphasize, largely underlying, market factors. this group argues that households try to maximize housing consumption within a given budget (silberberg and suen, 2001; wong et al., 2012). many studies (e.g. (chui, 2001; davey, 2006; oswald et al., 2011; emlet and moceri, 2012; chen et al., 2015)) show that factors such as income, wealth, and house prices influence housing consumption behavior significantly. the second approach mainly emphasizes demographic factors within an economic viewpoint. according to its proponents, demographic characteristics of a family or household influence housing demand significantly. for example, age, family size of households, sex of the household head, and life-cycle events are significant factors (davey, 2006; rubin et al., 2009; lavery, 2015; tsang, 2016). thus, household size is positively related to housing consumption (e.g. (chui, 2001; leung, 2014)). wong et al. (2012) also found a positive relationship between age and housing demand. housing consumption according to them can also be determined by changes in the housing market apart from factors related to characteristics of households (clark and dieleman, 2000). housing consumption is expected to improve over time because of a decline in household size, an increase in the overall housing stock, and the „trading up‟ process (silberberg and suen, 2001). the most important factor, which is specifically relevant to the present study, under the demographic characteristics is the life cycle events of a household/person. it is known that households tend to adjust their housing consumption as they experience changes within households and as they progress through the life cycle (bayer and harper, 2000; chen et al., 2015). according to the life-cycle theory, housing consumption varies according to various stages of the life of an individual. people make choices about how much they spend at each of their age as the resources available for them on different stages of their lives varies (deaton, 2005) and thus their rate of consumption and savings follow a life-cycle pattern (chen et al., 2015). there are some empirical analyses supporting the life cycle theory. for example, chui (2001) show there is an increase in the housing demand between the ages of 20 and 30 and a drop of about 1% per year after the age of 40. under the demographic characteristics, in the literature, health status and the risk of health deterioration of a person have been widely recognized as significant determinants that influence consumption and saving decisions (finkelstein et al., 2008; karagiannaki, 2009). glass and balfour (2003) concludes that during the working-age, poor health may constrain labor supply, decreasing lifetime earnings and benefits and possibly result in lower total wealth and a lower degree of consumption capacity. some studies even investigated the impacts of health shocks on housing consumption. yet, the studies that investigate the relationship between health status and housing consumption of the „soon-to-retire‟ remain relatively limited in number. in a sociological perspective, the relationship between health status and housing selection has long been a controversial issue. most studies state that there is a causal relationship linking housing conditions and physical and mental disease (glass and balfour, 2003). it has been shown that an overcrowded housing environment can lead to poor mental and physical health, while poor social relations at home adversely affect the mental development of children (menec et al., 2011). although there are a significant number of studies available on analyzing the effect of housing environment on health conditions, not many of them evaluate the influence of health status on housing consumption. thus, this study attempts to address this causal linkage, in particular on a specific age stratum of people. glass and balfour (2003) states while the health status of a person can be influenced by the housing condition, it is also possible that people select their housing according to their health status. moreover, wolf and wilmoth (2010) find that health issues are strongly associated with the changes in housing consumption. by using the classification scheme, lecovich (2014) uses brown county, united states as an example and classifies the life cycle of the household into eight stages. the study concludes that there is a substantially strong relationship between changes in the life cycle and housing consumption. it is found that movements along different life-cycle stages lead to characteristic changes in the size and composition of households, and, consequently, in their housing requirements. lecovich (2014) further explains that when a household progresses to the middle of the life cycle, they will adjust their consumption accordingly. first, they will move to a larger rental unit, then to buy a house. and after reaching the peak (i.e. around stage 6 and 7) of household size, they begin to reduce their housing consumption by moving to smaller houses or renting smaller units. however, the life-cycle theory does not apply to the choice of household tenure. some scholars (e.g., (davey, 2006; lecovich, 2014; leung, 2014)) think tenure choices are affected by the changes in socioeconomic status only and not through one‟s life cycle per se. in a recent study, using 1996 national survey data, huang (2003b) analysis of dynamics of housing consumption in urban china after the housing reform concluded that household characteristics had relatively more influence over housing consumption than before. the study further concludes that factors such as life cycle, household income, and city size have had similar effects on housing consumption and residential crowding as in market economies. this shows that changes in the life cycle of a household are important in determining housing consumption. in a more recent study, based on a time series analysis (blake and simic, 2005) investigated the housing consumption of the elderly (in their paper, elderly refers to someone 62 years of age or older). they analyzed how housing consumption of the elderly has changed over time and attempted to understand the potential asian journal of economics and empirical research, 2019, 6(1): 76-84 80 © 2019 by the authors; licensee asian online journal publishing group housing consumption pattern of this category of households in the future. this study is similar to the present study though the present study is based on a cross-sectional regression analysis. while there are some studies addressing various aspects of housing consumption in hong kong, few focus on a particular age stratum, and none of the group „soon-to-retire‟, to the knowledge of the author. this important gap in our understanding – examination of housing consumption of the soon-to-retire in hong kong has not been properly investigated for some reason. in particular, factors affecting housing consumption behavior of this group have not yet been systematically investigated in the housing market. 3. methodology 3.1. model and data description the study is to explore the critical determinants of housing consumption of the „soon-to-retire‟ and evaluate whether subjective health concerns will affect housing consumption. as literature shows, theoretically, housing consumption can be explained mainly by two sets of factors: market factors and household demographic characteristics. though health status, as we observed in the literature, comes under the household characteristics, the present model treats it as a separate category, and thus our model could be specified as: hct = α + β (mfactt) + π (hhchat) + ω (hstatt) +µt (1) where hct is the housing consumption during time period t, and mfact, hhcha and hstat represent market factors, household characteristics, and subjective health status of the target group, respectively. α denotes the intercept term while β, π and ω represent corresponding regression coefficients. definitions and descriptions of all the variables with data sources are summarized in table 2. housing consumption, which is the dependent variable, in the study is measured by the amount of space per person spp (m2). a questionnaire-based sample survey was carried out targeting the soon-to-retire group (who are currently living in private residential flats) during january – march, and june-august 2017, covering a few districts in hong kong. the sample of 1200 households was selected randomly from a few private housing schemes in sham shui po, wong tai shin, tsuen wan, and north point, which reasonably covers the entire territory, and thus avoids any bias of the sample. the profile of age and marital status of the respondents in the sample survey carried out are shown in table 3. the questionnaire basically comprised three sections, with the first section aiming at background information of the respondents such as age, gender, marital status and educational level and so on. in the next part, detailed household characteristics including household size, housing size, type of housing and household income were included, while the last part aims at exploring personal opinions on housing consumption after retirement and the impacts of health status changes on housing consumption. table-2. descriptions of variables identified for data analysis. category variables descriptions source of data dependent variable space per person (spp) amount of average living space (in terms of square feet) consumed by each person in a household questionnaire survey independent variables market factors housing price (hp) unit housing price at the time of the survey questionnaire survey household income (hi) amount of household income, monthly questionnaire survey household size (ahs) the average number of people in a household questionnaire survey household characteristics housing size (hsize) size of the living unit occupied by the household questionnaire survey housing ownership (ho) whether the respondent is living in a self-owned flat or rental flat questionnaire survey education level (edu) education background and attainment of the study subject questionnaire survey individual health concern subjective health status (shs) individual self-rated health status questionnaire survey among the completed questionnaires collected, only 1088 of them were used for the analysis as 112 sets of questionnaires were discarded due to their incompleteness. most of the discarded questionnaires were because the respondents were unwilling to disclose their household income or were unaware of the housing size of their living units. table-3. percentage distributions of total respondents by age and sex. age % sex % 45-49 41 male 44 50-54 27 female 56 55-59 15.5 60-64 16.5 3.2. variable description a cross-sectional regression analysis was carried out to explore significant determinants of housing consumption of the soon-to-retire group. the dependent variable of the model of this study is the housing consumption of the respondents of the survey, and it is measured in term of space per person (spp), which is computed by dividing the total gross floor area of the unit by the number of persons in a household. asian journal of economics and empirical research, 2019, 6(1): 76-84 81 © 2019 by the authors; licensee asian online journal publishing group housing consumption is measured in various ways in the literature. in market economies, with the assumption of competitive equilibrium, housing expenditure is often used as a measure of housing consumption (menec et al., 2011). housing consumption can be measured by the amount of living floor space occupied by one person, or space per person (jayantha and lau, 2008; jayantha and hui, 2012) or the number of rooms per person (the metlife, 2010; wolf and wilmoth, 2010). holding other factors constant, when the household size expands, the space per person or rooms per person will decline. housing consumption in the present study is also measured in terms of floor space per person. the model uses three different sets of independent variables: market, demographic and health status in its empirical analysis. theoretically, it is expected that housing prices (hp) negatively link with housing consumption, whilst household income (hy) is expected to have a positive relationship with space consumption. the study thus hypothesizes that higher the property price the smaller the amount of space consumption and vice versa, and on the other hand the higher the household income, the more actual floor space the household occupies. the study also hypothesizes a negative relationship between housing consumption and household size. it is expected that as average household size (ahs) increases, space consumption per person declines, while the size of the house remains unchanged. average housing size (hsize) is another important variable that affects floor space consumption per person. in the study, it is measured in terms of gross floor area (gfa). it is not difficult to comprehend that the larger the housing size, the greater the space consumption per person, and vice versa, ceteris paribus. it is noted in the literature that housing consumption per person is relatively larger in owner-occupied houses and less crowded than rental housing (huang and clark, 2002). according to their study, floor space per person for owner-occupied flats is 23.35 square meters, whilst it is 14.03 square meters per person for rental apartments. in this view, housing ownership is expected to be positively related to housing consumption. in this model, ho is a dummy variable which amounts to “1” if the respondent owns the living property and “0” if otherwise. education level (edu) is another important variable that can influence space consumption level and pattern of an individual. it is known that as a person attains higher levels of education; he/she may have a relatively stronger will and affordability to pursue better living and higher housing consumption. therefore, it is hypothesized that there is a positive relationship between education level (edu) and housing consumption. last, but not least, subjective health status (shs), which is the most important element in this study, is a significant factor that can influence housing consumption of an individual. this factor has not been properly addressed in the literature. as karagiannaki (2009) states, people with poor health status are very likely to face financial hardships with lower income and wealth and spend less compared to people with good health conditions. housing as a durable consumer good, in this study, it is assumed that health condition and housing consumption are positively related: i.e., poor health condition with lower consumption and vice versa. 4. empirical analysis 4.1. descriptive analysis average housing consumption in hong kong has been quite low compared to many other cities. the median housing consumption (average floor area per person) of the soon-to-retire category is found to be 155 square feet table 4. this figure is in line with the previous findings. for example, according to hui et al. (2004) and planning department (1999) it was found 151 square feet (14 square meters). this slight difference is due to the fact that those two studies focus on average population whilst the present study is on the „soon-to-retire‟ category, which is more capable and willing to consume more space for living than the general population. this, however, gives an idea of housing consumption and residential crowding in hong kong. table-4. descriptive statistics of variables. variable mean σ min. max. spp 154.90 82.83 64 600 hp 9847.97 13663.21 4000 16250 hi 39735.14 22194.79 8000 140000 ahs 3.87 1.29 1 6 hsize 543.45 231.94 220 1500 ho 0.56 0.49 0 1 edu 5.21 0.78 1 3 shs 3.02 1.23 1 5 4.2. statistical interpretation in the model standard statistical techniques including the t-test, f-test and adjusted r2 are used to interpret the results of the regression model. all the parameters of the model will be tested using t-test by comparing the empirical t-value with the critical t-value. if the absolute t-statistic for a particular parameter is greater than the critical value, it means that particular variable is significant. the overall significance of the model, on the other hand, is tested by using the f-test in the model. the overall significance of a model is said to be good when the empirical f-value is larger than the critical value. finally, the explanatory power of the model is reflected through the adjusted r2 value, with the value of it ranges from 0 to 1: higher the value the better the model. 4.3. regression results the results of the regression model including explanatory power and goodness-of-fit measures are reported in table 5. all the coefficients are of the anticipated sign and are statistically highly significant at conventional levels (except two variables). demographic factors seem to have influenced housing consumption significantly. among the variables, ahs, ho and shs seem to have a significant impact on housing consumption. for example, ahs (coefficients: -56.22) and ho (coefficients: 0.26) seem to be the most influential, indicating that housing asian journal of economics and empirical research, 2019, 6(1): 76-84 82 © 2019 by the authors; licensee asian online journal publishing group consumption in hong kong is influenced significantly by demographic factors. this finding is in line with some previous research findings in hong kong (e.g., jayantha and hui (2012)). as for the homeownership variable (ho), the estimated coefficient of 0.26 indicates that homeowners exert a significant effect on floor space consumption per person. this supports our theoretical hypothesis that housing consumption per person in owner-occupied housing is higher compared to renters. owners are in a better position to consume larger housing and are less likely to experience residential crowding. table-5. regression results of the model. independent variable coefficient t-statistic p-value constant 170.4300 8.6930 0.0000 hp -0.0000 -0.5730 0.5670 hi 0.0010*** 3.6860 0.0000 ahs -56.2280*** -17.5580 0.0000 ho 0.2600*** 13.2670 0.0000 hsize 3.2910 0.5360 0.5930 edu 8.5730** 1.7620 0.0800 shs 6.9760*** 2.5490 0.0120 adjusted r-squared f-statistic 0.7730 90.2760 prob (f-statistic) 0.0000 note: (***), (**) denote that the estimated coefficients of the variables are significant at the 1%, and 10% level respectively. the variable edu is also found to be significant while carrying the expected sign, which implies higher education is linked with higher housing consumption. in general, it is expected household income to increase as a person attains higher education as higher education leads to one having a relatively highly paid employment. chances of getting hired are relatively high when someone is more educated and very likely to earn more, which will certainly lead to a better living standard. as expected, hi, as a market factor, stimulates housing consumption significantly. it was found that hi is highly significant (at 99 percent significance) and carries the expected positive sign, even though the degree of a coefficient is relatively smaller. this indicates that households with greater income have a greater chance of using a larger amount of space per person as they can afford a larger housing unit. this finding is supported by some previous studies (e.g., (luffman, 2006; oswald et al., 2011; jayantha and hui, 2012)). the empirical estimate suggests that a 1 percent rise in household income leads to a 0.1 percent increase in housing consumption per person. as the housing market in hong kong is dominated by the market forces, it is expected household income plays an important role in floor space consumption. however, it is extremely surprising that the estimated coefficient of housing price (hp) is found to be insignificant even though it carries the expected negative sign. this is perhaps partly due to the fact that housing price in hong kong is subject to changes in many national and global scenarios and is, therefore, less controllable. the public sector intervention in the housing market might have also affected hp in the private housing market. this finding is however consistent with some previous findings. for example, jayantha and lau (2008) found that housing prices have only a moderate influence on the supply of new housing in hong kong, whilst luffman (2006) reveals that changes in housing price influence the home-ownership in the short-run, but not in the long-run. the most important variable introduced into the model is the health status (shs) of the household. to the knowledge of the authors, this is the first time health concern was introduced into a housing consumption model. importantly it was found to be highly significant, and also carrying the anticipated sign. the positive sign of the shs variable implies that the health status of an individual is positively related to housing affordability and consumption of that person. this finding is consistent with some research findings of the urban sociology researchers in their field of research. for example, health status and the risk of health deterioration of a person were recognized as an important factor that can influence consumption and saving decisions (finkelstein et al., 2008; karagiannaki, 2009). lecovich (2014) also states that it is possible people chose their housing according to health status, whilst wolf and wilmoth (2010) mention that health stocks are strongly associated with the changes in housing consumption. however, the present study is one of the earliest formal studies that evaluate the influence of health status on housing consumption in hong kong, though there are some studies available on analyzing the effect of housing environment on health conditions in the housing literature. in summary, housing consumption of this age group is determined by a combination of market and demographic factors. most importantly, this study reveals an important finding: housing consumption is positively influenced by the health status of the household in this soon-to-retire age stratum. 5. summary, conclusions and discussion using a cross-sectional regression model, the main objective of this study is to explore significant determinants of housing consumption of the „soon-to-retire‟ group, and suggest an explanation for their underlying dynamics. empirical results reveal that average household size and housing tenure as significant determinants of housing consumption of this age group. results suggest that larger households are more likely to experience residential crowding and under consumption. in fact, overcrowding has been a serious issue in hong kong over the last few decades. more than one family living in one housing unit is not uncommon in hong kong (see tang (2008)). with several households sharing a small unit, overcrowding is even much more evident in private housing units (ho and wong, 2009). housing floor space consumption by many households in hong kong is much lower than they needed, with a very low space per consumption level compared to developed countries. findings of all these studies support the finding of our study that household size plays an important role in floor space consumption per person. the empirical analysis also suggests that better-off households (households with larger income) and households who own their housing units tend to consume larger space per person with less residential crowding. asian journal of economics and empirical research, 2019, 6(1): 76-84 83 © 2019 by the authors; licensee asian online journal publishing group this is an expected phenomenon, which is in line with findings of previous studies (e.g., (luffman, 2006; oswald et al., 2011; jayantha and hui, 2012)). however, housing price was found to be insignificant which is quite surprising. this finding, however, is also consistent with some previous findings (e.g., (perez et al., 2001; jayantha and lau, 2008)). in the study, we found that housing consumption of this group is influenced not only by market and demographic factors but also by the health status of the household. health status of the household, in particular of this age group is very important as this group is nearing their retirement. soon after they begin their retirement, not only may they not receive the previous amount of income (from the employment), but also they have to spend a considerable amount of their income on health matters, which will severely hinder the strength of housing affordability and amount of consumption. the present study adds knowledge to the housing literature in several ways: (a) this is the first comprehensive study in hong kong to explore critical determinants of housing consumption behavior of this group; (b) most importantly, a new variable, health issue (effect of health) was introduced to the housing consumption model, and to the authors‟ knowledge this variable has not been introduced in a comprehensive housing consumption analysis in the housing literature, in particular in this age stratum. by introducing this new factor, we attempt to broaden our knowledge about the housing consumption of this less explored aspect of the housing market. the findings of this study trigger some important implications. overall, the findings of this study will be of interest to scholars and policy-makers in hong kong concerned with housing issues and other housing policyrelated measures including housing affordability issues. for policymakers, the results of this paper may shed light on the necessity of housing policies that can better cope with the needs of this large group of housing users in the future. the housing consumption pattern of this group is a little different from the existing elderly. for example, floor space usage per person of this group is a little higher than the rest of the households in general, which indicates “soon-to-retire” has a stronger will and ability to consume more. as this group of people, which take up a large proportion of the total population in hong kong, private property developers, as well as government authorities, may need to take a note of their preference in order to better understand their housing needs in the future. findings of this study thus may also help to further refine housing policy and other policies related to the housing issue. references basaraba, s., 2016. what does aging in place mean for older adults? available from https://www.verywell.com/what-does-aging-in-placemean-for-older-adults-2223464 [accessed 18 may 2016]. bayer, a.h. and l. harper, 2000. fixing to stay: a national survey of housing and home modification issues. washington dc: aarp. blake, k.s. and a. simic, 2005. elderly housing consumption: historical patterns and projected trends. u.s. department of housing and urban development., isa rc 39, usa. boldy, d., l. grenade, g. lewin, e. karol and e. burton, 2011. older people's decision regarding „ageing in place‟: a western australian 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shocks. center for retirement research at boston college, chestnut hill, ma. wong, f., e. hui, k.w. chung, t. li and e. lui, 2012. housing for the elderly in hong kong – affordability and preferences, the hong kong polytechnic university, hong kong. available from https://www.hkis.org.hk/ufiles/elderly-finalreport.pdf [accessed 28 september 2017]. yu, z., 2004. heterogeneity and dynamics in china‟s emerging urban housing market: two sides of success story from the late 1990s. habitat international, 30(2): 277-304.available at: https://doi.org/10.1016/j.habitatint.2004.02.010. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. http://www.scmp.com/news/hong-kong/health-environment/article/2054276/hong-kong-urged-think-ways-fund-long-term-elderly http://www.scmp.com/news/hong-kong/health-environment/article/2054276/hong-kong-urged-think-ways-fund-long-term-elderly http://www.hkis.org.hk/ufiles/elderly-finalreport.pdf 113 © 2019 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 6, no. 2, 113-119, 2019 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2019.62.113.119 © 2019 by the authors; licensee asian online journal publishing group impact of audit committee characteristics on voluntary disclosures: evidence from pakistan rida a. ghaffar sheikh1 abdullah2 muhammad hashim shah3 ( corresponding author) 1,2paf, karachi institute of economics and technology, pakistan. 3southwest jiaotong university, china. abstract this paper examines the effect of characteristics of audit committee on voluntary disclosure levels. this topic has been given much importance by the researchers, because independent audit plays crucial role in protecting minority shareholder’s interest. the study uses a sample of one hundred fifty companies which are listed on pakistan stock exchange. studying this sample is tremendously important because of several reasons. regulatory bodies of pakistan are pushing companies to implement the code of corporate governance. we have used multiple regression analysis technique to analyze the effect of characteristics of audit committee on voluntary disclosure. the scores of voluntary disclosure has been considered as dependent variable and independence of audit committee, committee member’s financial expertise, committee meetings frequency and committee size were used as independent variables. a checklist of 64 discretionary items was adapted to measure the voluntary disclosure in-lined with the existing literature. we have considered firm’s size, its profitability and leverage as control variables. the results suggest that size and independence of audit committee members have statistically significant effect on voluntary disclosure while, other independent variables do not have any significant effect. the existing literature reports different findings for these variables. policy makers may further strengthen disclosure framework, which may be helpful in meeting the expectation of investors using the findings of this study. keywords: voluntary disclosure, audit committee independence, shareholders’ rights size of audit committee members, audit committee independence, listed companies of pakistan. jel classification: m42; m41. citation | rida a. ghaffar sheikh; abdullah; muhammad hashim shah (2019). impact of audit committee characteristics on voluntary disclosures: evidence from pakistan. asian journal of economics and empirical research, 6(2): 113-119. history: received: 14 june 2019 revised: 22 july 2019 accepted: 26 august 2019 published: 11 october 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 114 2. literature review and hypotheses development ................................................................................................................... 114 3. data and methodology ................................................................................................................................................................. 115 4. results and discussions ................................................................................................................................................................ 116 5. conclusion ....................................................................................................................................................................................... 118 references ............................................................................................................................................................................................ 118 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.62.113.119&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1057 https://orcid.org/0000-0002-5507-6091 https://orcid.org/0000-0001-8400-5295 https://orcid.org/0000-0001-6223-8979 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1057 https://orcid.org/0000-0002-5507-6091 https://orcid.org/0000-0001-8400-5295 https://orcid.org/0000-0001-6223-8979 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1057 https://orcid.org/0000-0002-5507-6091 https://orcid.org/0000-0001-8400-5295 https://orcid.org/0000-0001-6223-8979 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1057 https://orcid.org/0000-0002-5507-6091 https://orcid.org/0000-0001-8400-5295 https://orcid.org/0000-0001-6223-8979 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1057 https://orcid.org/0000-0002-5507-6091 https://orcid.org/0000-0001-8400-5295 https://orcid.org/0000-0001-6223-8979 asian journal of economics and empirical research, 2019, 6(2): 113-119 114 © 2019 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the existing literature by examining the effect of characteristics of audit committee on voluntary disclosure levels. 1. introduction the famous financial scandals of the world have urged researchers, academicians and policy makers to focus on corporate governance and voluntary disclosure. among many others, parmalat, worldcom and ahold from italy, usa and netherlands respectively, gained much popularity. the reliability of financial reporting became questionable after these scandals. corporate governance and voluntary disclosure plays crucial role in protecting minority shareholder’s interest therefore, these domains got attention recently. voluntary disclosure increases firm value by decreasing the information gap between managers and stakeholders which enhances the confidence and trust (akhtaruddin and haron, 2010). researchers are showing interest in evaluating the company’s disclosure (financial and non-financial), especially the information that is not required by the law (akhtaruddin and haron, 2010). the confidence of security analysts on firms enhances with the increase in voluntary disclosure by firm. since, they have influence on general public’s investment decision therefore, increase in their trust would result in the increase of investors’ confidence (samaha et al., 2015). firms usually choose annual reports for disclosing information voluntarily. audit committee is considered as an essential part of corporate governance as it force firm’s management to meet the expectation of shareholders. madi et al. (2014) suggest that audit committee is crucial in improving internal control and disclosure practices. audit committee helps in presenting the transparent financial reports with better disclosure which enhances shareholder’s confidence (allegrini and greco, 2011). audit committee efficiently increases the information level, which a firm discloses. we examine a sample consisting of 150 firms listed on psx (pakistan stock exchange). studying this sample is tremendously important. there are two reasons behind selection of this sample. firstly, it would contribute to the literature available on emerging markets or developing nations. as researchers have ignored the developing nations while studying the voluntary disclosure and characteristics of audit committee (pucheta-martínez and de fuentes, 2007); (greco, 2011); (samaha and abdallah, 2012). few researchers have studied developing counties like malaysia (akhtaruddin and haron, 2010); (madi et al., 2014) and egypt (samaha et al., 2015). therefore, studying this sample would contribute in understanding the level of voluntary disclosure and audit committee in emerging or developing economies. secondly, to the best of our knowledge, this type of study has never been conducted in pakistan. therefore, this study is crucially important in order to understand the relationship of characteristics of audit committee and level of voluntary disclosure in developing countries like pakistan. regulatory bodies of pakistan revisited their regulations after the abovementioned scandals. these regulations aim to enhance the level of transparency and trustworthiness of firm’s financial reporting. recently, they made strict regulations regarding audit committee independence, which may help in reducing the influence of management on the audit committees. pakistani companies are ineffective in disclosing information voluntarily which may be useful by investors and other stakeholders (lone et al., 2016). we have contributed to the literature of emerging and developing markets in several ways. firstly, we failed to find any regulation of secp about the financial expertise of audit committee members therefore, very few financial experts have been included in audit committees. it is therefore, recommended that secp and other regulatory bodies should restrict listed firms to include financial experts in audit committees. secondly, our results suggest that the size of audit committee and its independence significantly and positively affect voluntary disclosure which is in-lined with the existing literature on developed economies. thirdly, our results suggest that leverage, size and profitability affect voluntary disclosure positively which means large and profitable firms disclose superior level of information. this paper comprises of five sections; section 1 introduces the paper. the proceeding section briefly reviews the existing literature along with hypothesis development. we discussed the methodology in the proceeding section. section 4 discusses the results and finally section 5 concludes the whole study with recommendations for future researchers. 2. literature review and hypotheses development the theoretical framework has been developed using the agency theory, the capital need theory and signaling theory. principal agent relationship is defined as an agreement in which principal, appoints an agent who perform tasks according to the interest and instructions of the principal. agent has to make decision in order to perform tasks given by principal. bosse and phillips (2016) argue that agency relationship leads to problem of information asymmetry; as agent (manager) has more access to information than principal (shareholder). voluntary disclosure may be helpful in satisfying the concerns of shareholders that management is striving to achieve their wealth maximization goals. researchers have explained the voluntary disclosure in financial and non-financial reporting using the signaling theory (ross, 1977). organizations publish additional information which is not required by regulatory bodies, in order to give positive signals to their investors enhancing favorable reputation (verrecchia, 1983). organizations use voluntary disclosure as a signaling mean and disclose additional information to strengthen the trust of investors (zijl et al., 2017). (chung and kallapur, 2003) suggest that establishment of audit committee may be helpful in improving disclosure by reducing information asymmetry. companies seek external finances to support their capital requirements. the capital need theory suggests that companies get finances at lower cost, which discloses information voluntarily (choi, 1973). it has been argued that the organizations’ cost of capital includes the risk premium, which investors would require as they are not doubtful about the disclosed information. cost of capital may be reduced by voluntary disclosure as investors and analysts may understand the organization’s true economic prospects. therefore, literature suggests a positive relationship between cost of capital and voluntary (persons, 2009); (francis et al., 2008); (healy and palepu, 2001). asian journal of economics and empirical research, 2019, 6(2): 113-119 115 © 2019 by the authors; licensee asian online journal publishing group it has been made mandatory for the listed companies of pakistan by secp that audit committee must have at least four members consisting of three non-executive directors and one independent director. it has been suggested by the theory of resource dependency that large audit committees would be more efficient compared to the small ones. the increase in number of committee members would bring diversified skills, expertise and experiences. the confidence of stakeholders of the company may be enhanced through large audit committee consisting of members having diversified experience and expertise. it has been observed that companies having large audit committees pay lesser for debt financing (abbott et al., 2004). linda et al. (2011) suggest that the size of audit committee have a positive relationship with voluntary disclosure in financial sector companies in indonesia. persons (2009) also suggested the same relationship between both variables. building on these studies, we developed the following hypothesis to test whether audit committee size has an impact on voluntary disclosure: h1: audit committee size positively affects the level of voluntary disclosure. literature suggests that increase in the meetings of audit committee members improves the effectiveness of committee. menon and williams (1994) suggest that inactive audit committee may not be able to evaluate the management in an effective manner. it is believed that an audit committee is considered more active, if members are meeting frequently (stewart and munro, 2007). meeting at least once in a quarter has been made mandatory by scep for committee members. menon and williams (1994); raghunandan et al. (1998); beasley et al. (2000) and suggest that the more the audit committee members meet, the better they monitor, control the company which may improves the transparency of financial and non-financial reporting of the company. beasley et al. (2000) suggest that audit committees make mistakes in company’s financial reporting which do not meet frequently compare to audit committees which meet frequently. building on these studies, we have developed the following hypothesis. h2: frequency of audit committee meetings positively affects the level of voluntary disclosure. literature suggests that independence of audit committee is among the key factors which makes the audit committee effective. therefore, companies include members who are not involved in management to ensure the independence. independent member should possess no personal as well as economic relationship with the organization in order to work independently and objectively (goodwin and yeo, 2001); (bédard and gendron, 2010). therefore, management may have fewer chances to disclose less information which benefit them (allegrini and greco, 2011). akhtaruddin and haron (2010) suggest that independence of audit committee positively affects voluntary disclosures. due to its importance, the corporate governance act for listed companies, pakistan (2017) states that chairman of the board and audit committee must be separate person and audit committee chairman must be independent director. contrarily, beasley et al. (2000) suggested that number of independent members and the fraudulency level of firm have a negative relationship. it has been suggested by earlier research that disclosure quality is not affected by the inclusion of independent members in an audit committee. building on these studies, we developed a following hypothesis: h3: independence of audit committee positively affects voluntary disclosure. audit committee members have to assist board of directors so, it is vital for them to have adequate level of financial expertise so that they may be able to provide the true insight of the company’s affairs. the code of corporate governance of pakistan does not require listed companies to hire members who have adequate level of financial expertise. agrawal and chadha (2005) suggested that the chances of mistakes in the financial statements would be reduced, if the internal auditor have adequate level of financial knowledge. internal auditor having financial knowledge, may be able to identify the concealed deceptions happening in the company (krishnan and lee, 2009). therefore, we developed the following hypothesis: h4: financial expertise of audit committee member positively affect level of voluntary disclosure. there are numerous studies conducted on audit committee and its characteristics. this topic has a long history. researchers examined audit committee role and its characteristics, studying different data sets of under-developed, developing and developed nations. on the contrary, researchers have started focusing on voluntary disclosure in the recent past. still researchers focus remained on the developed countries (pucheta-martínez and de fuentes, 2007); (greco, 2011); (samaha and abdallah, 2012). few researchers have studied malaysia (akhtaruddin and haron, 2010); (madi et al., 2014) and egypt (samaha et al., 2015). to the best of our knowledge, this study has never been conducted in pakistan. therefore, this study is crucially important in understanding the relationship of voluntary disclosure and characteristics of audit committee. 3. data and methodology we have used dataset of 150 non-financial firms which are listed on pakistan stock exchange. we have used annual reports to extract the data for the year 2017. it is believed that annual report of a firm best portrays the overall information disclosure compare to websites, newspaper etc. (botosan, 1997); (allegrini and greco, 2011). we have not included financial firms in our sample, as their disclosure requirement and accounting standards are different. we have employed multiple regression technique to analyze the impact of characteristics of audit committee and voluntary disclosure. following is a regression equation we have used in our study: vds = β0 + β1aind + β2afe + β3amet + β4asiz + β6fsiz + β7prof + β8lev + ε where, vds is voluntary disclosure score. aind is audit committee independence. afe is financial expertise of audit committee members. amet is frequency of audit committee meeting. asiz is size of the audit committee. fsiz is size of the firm. prof is profitability. lev is leverage. researchers have used two methods to estimate the voluntary disclosure level of firm. the first approach which has been used to estimate the level of voluntary disclosure is to determine the amount of deliberate disclosure by asian journal of economics and empirical research, 2019, 6(2): 113-119 116 © 2019 by the authors; licensee asian online journal publishing group reading annual report (samaha et al., 2015); (botosan, 1997); (madi et al., 2014); (allegrini and greco, 2011). the second approach to estimate the voluntary disclosure level is through earnings forecast (allegrini and greco, 2011); (karamanou and vafeas, 2005). we estimated voluntary disclosure through annual report analysis. allegrini and greco (2011) argued that important source of information disclosure is annual report. therefore, we have estimated the voluntary disclosure using annual reports. a checklist of 64 discretionary items has been adapted from akhtaruddin and haron (2010) and used to estimate voluntary disclosure level. the list includes general information, governance, monetary information, strategy, csr information and graphical information. we have given every item either 1 (if it is disclosed) or 0 (if it is not disclosed). we then divided the total score of each company by 64 (total items) to get the percentage, representing voluntary disclosure level. independence of audit committee is measured by calculating the percentage of independent members present in committee. financial expertise represents the total committee members having educational background of finance. frequency of audit committee meetings is the measured by the number of meetings held in a year. following the existing literature we have used size of firm, its profitability and leverage as control variables (akhtaruddin and haron, 2010); (allegrini and greco, 2011); (samaha et al., 2015); (madi et al., 2014). large firms are believed to disclose superior level of information (cooke, 1989a); (hossain et al., 1995); (wallace et al., 1994). it is believed that firms having dependency on debt publish excessive information to decrease the cost of debt and to show their ability to repay their obligations (cooke, 1989b). firm size is measured by taking log of total assets. we have used roa to measure the profitability of firm. we have used debt ratio to measure the leverage of firm. 4. results and discussions table 1 presents the descriptive statistics of our data set. the minimum value of deliberate disclosure is 10% and maximum estimate is 68%. the mean of size of audit committee is 4.13, which suggests that on an average, audit committees of sample firms consist on 4 members. descriptive statistics suggest that minimum and maximum members of audit committee is 3 and 6 respectively. the average meetings held in a year is 4, which satisfies the guidelines provided by secp. 4.1. descriptive statistics table-1. descriptive analysis. variables mean min max std. vds 0.473 0.10 0.68 0.121 asiz 4.133 3.00 6.00 0.932 amet 4.08 2.00 5.00 0.485 aind 0.260 0.20 0.33 0.050 afe 0.140 0.00 0.33 0.134 lev 0.508 0.20 0.83 0.197 fsiz 1.705 0.90 2.80 0.440 prof 0.099 0.00 0.21 0.523 notes: the descriptive statistics has been presented in this table. vdc, voluntary disclosure score of sample firms, asiz, audit committee size measured by total audit members; amet, audit committee meetings measured by the total numbers of meetings held in a year. aind, audit committee independence measured by the percentage of independent members. afe level of members' financial expertise measured by proportion of financial experts in committee. lev, firms' level of leverage measured by debt ratio. fsiz, size of firm measured by log of total assets. prof, firm's profitability, measured by return on assets. the audit committee independence varies from 20% to 33% having an average of 26%. descriptive statistics reveal that only 14% audit committee members have financial expertise. table-2. cronbach's alpha. no of items 8 cronbach's alpha based on standardized item 0.812 cronbach's alpha 0.811 the crobach’s alpha was used to ascertain the internal reliability of the items used in the dependent variable. table 2 suggest that cronbach’s alpha is 0.811, which confirms that the dependent variable has acceptable internal consistency. the reliability of checklist used in this study has already been verified by ferguson et al. (2002) and kee and pillay (2003). 4.2. multiple regression analysis the results of multiple regression has been presented in table 3. results suggest that the audit committee size is significant and positive with voluntary disclosure. this finding is in-lined with madi et al. (2014); dhaliwal et al. (2010) and persons (2009). increasing the number of members in the committee means inclusion of more skills and expertise to committee that would improve the efficiency of committee (persons, 2009). secp already implemented the requirement of inclusion of at least 4 members in a committee. further to this restriction, committee should also consisting of at least 1 independent director and 3 non-executive directors. table 3 suggests a positive and significant association between independence of audit committee and the level of voluntary disclosure. this finding is in-lined with the findings of fama and jensen (1983); madi et al. (2014); akhtaruddin and haron (2010) and persons (2009). this has been already witnessed by earlier researchers that an audit committee with more independent members, would be able to make decisions without any influence, resulting in fair financial reporting (persons, 2009). asian journal of economics and empirical research, 2019, 6(2): 113-119 117 © 2019 by the authors; licensee asian online journal publishing group table-3. multiple regression results. variable coefficient t-test p-value (constant) -2.516 0.013** asiz 0.492 7.308 0.000*** amet -0.027 -0.411 0.682 aind 0.305 4.426 0.000*** afe -0.085 -1.309 0.193 lev 0.207 2.958 0.004* fsiz 0.368 5.257 0.000*** prof 0.407 5.480 0.000*** r2 0.443 adjusted r2 0.415 f 16.113 sig. 0.000 notes: regression results has been presented in this table. *, ** and *** indicate the level of statistical significance at the 10%, 5% and 1% respectively. vdc, voluntary disclosure score of sample firms, asiz, audit committee size measured by total audit members; amet, audit committee meetings measured by the total numbers of meetings held in a year. aind, audit committee independence measured by the percentage of independent members. afe level of members' financial expertise measured by proportion of financial experts in committee. lev, firms' level of leverage measured by debt ratio. fsiz, size of firm measured by log of total assets. prof, firm's profitability, measured by return on assets. we find insignificant relationship between firms’ level of voluntary disclosure and frequency of meetings. literature witnessed mixed findings regarding this relationship. menon and williams (1994); collier and gregory (1999); méndez and garcía (2007); o’sullivan et al. (2008) and madi et al. (2014) concluded similar results. contrarily, beasley et al. (2000) and vafeas (2005) suggested a significant relationship between firms’ level of voluntary disclosure and frequency of meetings. it may be insignificant in case of pakistan as it has been made mandatory by secp that an audit committee must be meeting at least 4 times in a year. we failed to find significant relation between committee members’ financial expertise and firms’ level of voluntary disclosure. this result is in-lined with persons (2009) and madi et al. (2014). contrarily, agrawal and chadha (2005); krishnan and lee (2009); akhtaruddin and haron (2010) suggested a positive relationship for these variables. it has already been established in the descriptive statistics section that few audit committees have financial experts for our sample. secp do not provide any guideline to include financial experts in audit committee. therefore, listed companies of pakistan are not paying attention to it yet. table 3 also suggests that profitability, leverage and size of firm has a positive relationship with voluntary disclosure. this means that larger and more profitable firms disclose superior level of information. it has been observed that firms with relatively high debt disclose excessive information to reduce the monitoring cost. these finding is in-lined with madi et al. (2014); camfferman and cooke (2002); meek et al. (1995); hossain et al. (1995) and cooke (1989a;1989b). table-4. robustness test. models for robustness test variable model 1 model 2 model 3 model 4 (constant) 0.013 0.125 0.016 0.025 asiz 0.492 0.504 0.495 0.501 0.000*** 0.000*** 0.000*** 0.000*** amet -0.027 0.005 -0.025 -0.023 0.682 0.943 0.710 0.692 aind 0.305 0.250 0.311 0.317 0.000*** 0.001** 0.000*** 0.000*** afe -0.085 -0.047 -0.060 -0.098 0.193 0.503 0.347 0.146 lev 0.207 0.303 0.216 0.004** 0.170 0.000*** fsiz 0.368 0.383 0.374 0.000*** 0.000*** 0.000*** prof 0.407 0.109 0.410 0.000*** 0.000*** 0.000*** fsize2 0.268 0.001** lev2 0.210 0.002** prof2 0.314 0.000*** notes: the results for robustness analysis are presented in this table. model 1 is the basic model whereas models 2, 3 and 4 are developed to check the robustness. *, ** and *** indicate statistical significance at the 10%, 5% and 1% respectively. vdc, voluntary disclosure score of sample firms, asiz, audit committee size measured by total audit members; amet, audit committee meetings measured by the total numbers of meetings held in a year. aind, audit committee independence measured by the percentage of independent members. afe level of members' financial expertise measured by proportion of financial experts in committee. lev, firms' level of leverage measured by debt ratio. fsiz, size of firm measured by log of total assets. prof, firm's profitability, measured by return on equity. fsiz2, firm size as log of total sales; lev2, leverage of the firms defined as ratio of debt over equity; prof2, profitability refers to return on equity. constant value is shown in front of every variable whereas, second row show its p-value. asian journal of economics and empirical research, 2019, 6(2): 113-119 118 © 2019 by the authors; licensee asian online journal publishing group it is clear from the above discussion that our hypotheses 1 and 3 are ascertained, as our results suggested a positive relationship for size of audit committee, its independence with firms’ level of voluntary disclosure. however, we failed to accept hypothesis 2 and 4 as we do not observe significant relationship between frequency of meetings, inclusion of financial experts in a committee with firm’s level of voluntary disclosure. 4.3. robustness analysis to crosscheck the results, we have changed the measurement of control variables. we have replaced the liabilities to assets ratio with debt over equity, which is another proxy to measure leverage of firm. we have also replaced roa with roe, which measures the profitability of firm. lastly, we have replaced log of assets to log of revenue, which measures size of firm. the results of robustness models are presented in table 4. the actual results are generated through model 1, which is our basic model. model 2, 3 and 4 have been used to verify the results generated though model 1. we have used model 2, 3 and 4 as robustness test to cross check the effects. we have changed the measurements of size, leverage and profitability in model 2, 3 and 4 respectively. table 4 suggests that the results are consistent even after changing the measurement of several variables except for leverage in one case. 5. conclusion this study tried to investigate the impact of audit committee characteristics on firms’ voluntary disclosure. literature suggests that audit committee has influence on firm’s voluntary disclosure. the sample chosen for this study was 150 companies, listed on pakistan stock exchange (psx). annual reports were used to extract the required data and used multiple regression technique to analyze the data set. the results suggest that size of audit committee and its independence level have positive and significant effects on firm’s voluntary disclosure. we failed to find significant effects of committee members’ financial expertise and meetings frequency on voluntary disclosure of firm. the results also suggest more information disclosure is common in larger and profitable firms. we also observe that firms with larger debt tend to disclose superior level of information compare to firms with lower leverage. authors suggest policy makers and secp to revisit their policies regarding audit committees of listed companies of pakistan. it should be made mandatory by secp to include financial experts in the audit committee for all listed companies of pakistan which may enhance its efficiency and tend to improve reporting quality of firm. policy makers may restrict listed companies to make audit committee according to its size. scep has already made guidelines regarding independence of audit committee but they should keep revisiting it in order to further strengthening the independence of audit committee. managers may establish strong and independent audit committees to enhance the confidence of investors. there are several limitations of this study. we have included 150 firms in our sample because of time constraints. this study has used only one year data, variations in voluntary disclosure over the 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practices. south african journal of business management, 48(3): 73-85.available at: https://doi.org/10.4102/sajbm.v48i3.37. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 1 asian journal of economics and empirical research vol. 5, no. 1, 1-18, 2018 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2018.51.1.18 foreign direct investment inflows and labor productivity in pakistan: a sectorwise panel cointegration analysis ayesha serfraz1 1doctoral student at university of hamburg, germany. assistant professor at university of the punjab, lahore, pakistan abstract this study empirically analyzes the effects of sector-wise fdi inflows on respective sector-wise labor productivity for a panel of seven major sectors of pakistan‘s economy covering time period of 1997-2016. for empirical analysis, sector-wise fdi inflows has been used as an independent variable while sector-wise labor productivity is a dependent variable. initial tests conclude that lsdv fixed effects model is the most appropriate test for the data being used for empirical analysis. further tests confirm the existence of a long-run cointegration between these two variables. wald test shows that a uni-directional short-run causality exists, running from sectorwise labor productivity to sector-wise fdi inflows. pair-wise granger-causality test further shows that the effects of fdi inflows are not limited to one sector, rather there is an evidence of spillover effect from one sector to an-other. all empirical tests conclude that sector-wise fdi inflows positively affect sector-wise labor productivity in case of pakistan. keywords: sector-wise fdi inflows, sectors-wise labor productivity, panel cointegration, spillovers, pakistan. jel classification: f21, j01, c10. citation | ayesha serfraz (2018). foreign direct investment inflows and labor productivity in pakistan: a sector-wise panel cointegration analysis. asian journal of economics and empirical research, 5(1): 1-18. history: received: 11 january 2018 revised: 24 january 2018 accepted: 26 january 2018 published: 30 january 2018 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ......................................................................................................................................................................................... 2 2. literature review ............................................................................................................................................................................... 3 3. empirical analysis .............................................................................................................................................................................. 7 4. interpretation of empirical results ............................................................................................................................................. 17 5. conclusion and policy recommendations .................................................................................................................................. 17 references .............................................................................................................................................................................................. 17 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2018.51.1.18&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://orcid.org/0000-0001-8954-2858 https://orcid.org/0000-0001-8954-2858 asian journal of economics and empirical research, 2018, 5(1): 1-18 2 1. introduction it is generally accepted by researchers that foreign direct investment (fdi) inflows cause positive impact on recipient country by way of boosting economic growth through transfer of better technology, knowledge and skills, training, education opportunities and many more. further as added by kurtishi-kastrati (2013) fdi inflows lead to capacity building of labor and entrepreneurs. in addition, it leads to an improvement in social conditions. johnson (2005) adds that fdi helps in growth of international trade by flow of goods and capital from one part of the world to the other part. this invariably takes place through mncs and thus fdi has become an important factor in the process of globalization. regarding labor productivity, particularly in developing economies, recent debates have resulted in different answers. in some countries fdi inflows do increase labor productivity by providing more technical knowhow especially in case of mncs which are responsible for providing better training, resulting in an increase in wages and that in turn raises standard of living and thus causes an enhancement in labor productivity. this relationship has been discussed theoretically and tested empirically in the recent paper by the same author i.e., serfraz (2017). on the other hand, labor productivity may fall due to replacement of labor by capital in the form of high technology, especially in case of labor abundant countries, since absorptive capacity of labor serves as a hurdle. mncs cause wage differentials by hiring the already better trained labor and refining their skills by providing higher training. also education plays a very important role in increasing labor productivity. although role of mncs results in unequal distribution of income and misallocation of resources, but the afore-mentioned advantages cannot be ignored. the extent of productivity growth caused by fdi varies from country to country. therefore it would be incorrect to claim that fdi inflows do not increase productivity at all. it does increase productivity and growth but not at a uniform level. pakistan has also benefitted from fdi inflows and presently, it is attracting higher amount of fdi due to liberalization policies. the advantages have been observed in the form of technology transfer, increase in labor productivity, reducing saving-investment gap etc. if the research is narrowed down to analyze the impact of fdi inflows on individual sectors rather than economy as a whole, many studies have argued that fdi inflows benefit individual sectors though not every sector equally. it may be due to the biasedness of foreign investors caused by ease of doing business in a particular sector as compared to the other. mostly industrial and services sectors attract more fdi inflows as compared to other sectors like agriculture because these two sectors hire more educated and skilled people viz a viz labor force employed in agriculture sector. consequently it becomes easy for foreign investors to train the already skilled labor. overall economic growth of any country is a measure of its level of development but sectoral growth cannot be ignored since sectors of any country are its building blocks and play a vital role in increasing economic growth. according to pakistan bureau of statistics1, the three main sectors of pakistan‘s economy are agriculture, industry and services. but these sectors are further divided into sub-sectors like food, mining, trade, transport, construction etc. majority of discussion related to sectors is confined to these three main sectors. moreover the relationship between sector-wise fdi inflows with reference to growth of respective sectors does not focus on sector-wise labor productivity. regarding growth, it has been established in literature that sector-wise fdi inflows increase sector-wise growth especially related to industrial sector. pakistan needs to introduce more investment friendly policies, particularly for foreign investors, to increase fdi since more fdi inflows will not only increase the growth of individual sectors but also the overall growth of economy. many authors (detailed discussion available in literature review) have suggested the same for other developing countries. at the same time, there are controversies related to the impact of fdi inflows on various sectors. there is a lot of discussion about sector-wise fdi inflows and economic growth but not much has been discussed about sector specific labor productivity. whether, sector-wise fdi inflows increase respective sectorwise labor productivity or not, this is the main innovative point of the present study and is actually an addition to the present knowledge on the subject. this paper is an extension of the previous research carried out by the same author, i.e. serfraz (2017) in which an empirical analysis has been conducted to analyze short run and long run causality between fdi inflows and labor productivity in pakistan. now the main focus is to find out the relationship between sector-wise fdi inflows and related labor productivity for seven major sectors of pakistan‘s economy. a panel of seven sectors has been taken along-with sector specific labor productivity to empirically analyze the relationship. sector-wise fdi inflows and sector-wise labor productivity data has been used. panel unit root tests have been applied. since panel data tests can be applied as fixed effects, random effects or pooled lsdv model, the empirical part first proves that which test and static panel data model is suitable for the data being used to carry out empirical analysis. after getting confirmed results about type of static panel data model, panel cointegration tests have been conducted. therefore, this study does not directly jump to the type of model to be used, but all initial tests have been presented in empirical section and conclusion is drawn on the basis of results. also empirical section throws light on characteristics of panel data models and as to what are their advantages and disadvantages. the seven sectors used in this study are: 1agriculture 2manufacturing and mining 3construction 4electricity and gas distribution 5transport 6trade 7others (financing, real estate, business services, extra territorial and other public and private services). 1 http://www.pbs.gov.pk/content/what-are-major-sectors-economy-pakistan http://www.pbs.gov.pk/content/what-are-major-sectors-economy-pakistan asian journal of economics and empirical research, 2018, 5(1): 1-18 3 for this purpose the data from 1997-2016 has been used. data prior to 1997 has not been estimated, therefore this puts a limitation on the study. for each sector, fdi inflows have been estimated along-with the labor specific to the sector. the details of data are also mentioned in coming chapters of the paper. this paper is divided into four main sections. section 1 explains the introduction and objective of study. section 2 throws light on literature review with sub-sections dealing with available literature, both national and international studies, relating to the topic under discussion. also, it highlights the gaps in existing body of knowledge and contribution made by present study. detailed empirical analysis has been presented in section 3 with sub-sections explaining different steps, empirical tests and their interpretations. last section concludes the study along-with policy recommendations. 1.1. contribution and objective of the study after establishing a positive relationship between fdi inflows and labor productivity in case of pakistan in the previous paper (serfraz, 2017) this study, instead of analyzing fdi‘s impact on the growth of different sectors of pakistan‘s economy, aims at examining the sector-wise fdi inflow and its effect on respective sector-wise labor productivity in pakistan. for this purpose, seven major sectors have been taken along-with the data of labor force hired in those particular sectors. whereas majority of the studies have concentrated on the relationship between sector-wise fdi inflows and growth, the unique contribution of this study in the existing literature is that it analyzes the relationship between each sector‘s fdi inflows and its corresponding impact on labor productivity. furthermore, this study is one of the very few studies which has investigated the relationship between fdi and respective labor productivity of ‗seven‘ major sectors of pakistan‘s economy for empirical analysis instead of empirically analyzing ‗growth‘ of two or three sectors. the reason behind taking these seven sectors and not more, is due to the limitation on availability of data. those sectors have been included for which data is available for all the years (1997-2016). 2. literature review literature review is divided into three sections. section 1 deals with the relevant literature on the topic available in international studies. also the established relationships of individual sectors will be discussed in detail since the available literature has used different sectors for analyzing the relationship. in section 2, studies related to pakistan will be analyzed. section 3 sums up the literature explaining the gaps which will be filled by the present study. 2.1. international studies maathai and sahoo (2008) carried out an empirical analysis to examine the effects of fdi inflows to nine major sectors of india using panel cointegration approach covering time period from 1991-92 to 2004-05. their empirical findings suggested a positive impact of fdi inflows on output, labor productivity and exports on drugs and pharmaceuticals sectors. in case of transport and metallurgical sectors, fdi inflows and labor productivity revealed a positive cointegration whereas fdi inflows did not show a positive impact on labor-intensive sectors like transport and chemicals due to backwardness of labor. their overall conclusion showed a negative impact on labor productivity and an increase in fdi inflows did not reveal any positive impact on indian economy at the sectoral level both in terms of output and labor productivity. dürnel (2012) empirically investigated the effects of fdi inflows on ten individual sectors of turkish economy. using panel cointegration and granger-causality test for the time period of 2000-2009, the study concluded that fdi inflows seemed to benefit growth rate mostly in the manufacturing, electricity, gas and water, wholesale and retail trade sectors. the essential findings of the study suggested that foreign direct investment contributed towards overall growth rate of turkish economy. the results indicated that though all the sectors were not benefitting from fdi inflows equally but, it was found that fdi inflows increased labor productivity which resulted in an increase in sectoral growth at different levels and to various extents. bang et al. (2007) carried out an empirical analysis to study the impact of fdi inflows on economic growth of china and vietnam, using sectoral data of china from 1997-2004 and 1995-2003 for vietnam. the results revealed that though fdi directly showed a significant and positive effect on economic growth as well as through its interaction with labor productivity in both countries, but, the impact was not evenly distributed across sectors. in both the countries, the industrial sector seemed to be the only sector to consistently benefit from fdi inflows as compared to other sectors. according to alam et al. (2008) eastern european countries and former soviet union have observed high economic growth in recent years due to increased level of investment. according to the author, productivity growth is the most important factor for increasing overall economic growth. an increase in productivity leads to an increase in profits and consequent investment. resultantly, wages grow upwards, leading to an increase in standard of living which enhances labor productivity. as a result, the sectors which receive higher investment also have more productive labor force. author focuses on three main sectors of economy, i.e., agriculture, manufacturing and services. the allocation of resources to relevant sectors directly affects sector-wise productivity and the labor attached to that sector. due to increase in investment in a particular sector leads to transfer of labor from less productive sector (agriculture) towards more productive sectors (manufacturing and services). at the same time, labor moving to more productive sectors also showed an increase in productivity relevant to that sector. from this study it can be inferred that labor productivity cannot be determined in isolation, rather sectoral productivity and labor productivity are related and dependent on each other. same conclusion has been derived in a study conducted by mallick (2015). author carried out an empirical analysis for examining the structural changes and effects of globalization in the form of fdi inflows and economic integration, on labor productivity growth in brics countries using shift-share analysis, dynamic panel data method and input-output tables covering the time period of 1990-91 to 2011-12. the empirical findings suggested a high labor productivity growth in brics due to globalization and economic integration policies. fdi inflows asian journal of economics and empirical research, 2018, 5(1): 1-18 4 resulted in a two way causality, i.e., fdi inflows affect labor productivity and in turn labor productivity increases sectoral growth resulting in reallocation of labor towards more productive sectors. in addition, the results also suggested that due to fdi inflows, labor is shifting to non-agriculture sectors in case of india and china, and towards services sector in brazil, russia and south africa. ilboudo (2014) tested the hypothesis that solow residual or tfp can be targeted to increase sectoral growth for mining sector of chile. highlighting the importance, author mentions that the mining sector of chile is one of the most important sectors of chilean economy and almost one-third of government income comes from copper exports. using cobb-douglas production function, the study revealed a long run relationship between fdi inflows and labor productivity for mining sector of chile. vu and noy (2009) conducted an empirical study using sector-wise data for a group of six member countries of oecd. they analyzed the relationship between sector-specific impacts of fdi on growth in developed economies. using cross-country regression, they found that the impact of fdi inflows may be positive or negative depending on direct impact on economy or through an increase in labor productivity. also different results were obtained across countries and sectors. for some sectors, there was a positive relation and for others it was negative; real estate and financial sector showed a negative but significant effect. only mining and quarrying showed positive and significant results. in the end, they suggested that fdi in certain sectors is more productive and has high labor productivity and the level of productivity differs across sectors. msuya (2007) examined the impact of fdi inflows on agricultural sector of tanzania. the qualitative study by author suggests that the crops produced by small farmers organized in small holders set-ups attract more fdi as compared to others. labor productivity depends on many macroeconomic variables including investment regulatory frameworks, policies that promote macroeconomic stability, and improved physical infrastructure. in addition author recommended that creation of ‗strong bonds‘ between small holders and investors through more integration, would help in attracting more fdi inflows to agricultural sector but this should be extended to developing strong institutions in all sectors. this would lead to more fdi inflows which would further increase the productivity and reduction in poverty. moving on to industrial sector, fillat and woerz (2011) conducted an empirical analysis for examining the impact of fdi on output and productivity using industrial level data for a panel of 35 oecd, asian and eastern european countries. their study concluded that fdi inflows lead to higher labor productivity and output in industrial sector of ‗catching-up‘ or developing countries as compared to developed countries but the productivity differs across industries. therefore such policies must be devised which can attract more fdi especially in those industries where labor is more productive as it would lead to a higher output. bijsterbosch and kolasa (2010) carried out an empirical analysis for investigating the effect of fdi inflows on productivity by using industrial level data of central and eastern european countries. their findings suggested that fdi leads to increase in productivity both at country and industrial sector level but it depends on area and absorptive capacity. if labor is more efficient and productive, the absorptive capacity results in more benefits from fdi inflows. they also found the evidence that level of labor productivity or human capital is positively associated with a larger impact of fdi though labor productivity levels have throughout remained depressed outside the euro area as compared to the euro area. in the year 2006, the output of industry was almost one-third of the euro area. the productivity level in services sector was almost half of the euro area while the pattern varied across the countries in the sector of construction. azeroual (2016) undertook an empirical analysis for examining the impacts of fdi inflows from france and spain on the tfp of manufacturing sector of morocco. author used gmm system in dynamic panels for a subset of 22 branches of this sector between 1985 and 2012 and found that the impact varied depending on the source from which the fdi originated. the impact on tfp from french fdi was negative, and significant, in medium and high level technology industries while the impact of spanish fdi was significantly positive. the negative impact of french fdi could be attributed to (i) productivity gap between moroccan and french companies due to high difference in labor productivity and efficiency (ii) the investment rate and control on technology transfer in the hands of french investors. fdi from spain seemed significant and positive on tfp though the positive impact was weak. french participation, being mostly concentrated in medium and high technology sectors, ranging between 30 percent of foreign ownership, and sometimes going above 70 percent in the case of automotive industry and transport equipment manufacturing. morrar and gallouj (2016) in their empirical study examined the main factors which contribute to growth in services sector of palestine. the results of panel data analysis suggested a positive and significant effect of fdi on the labor productivity growth while capital intensive service sectors exercised greater influence on labor productivity growth. other public services like retail trade, the sale and repair of motor vehicles and land transport are on weaker growth trajectory. the political instability adds fuel to the fire by further affecting the productivity growth of services sector. the author recommends that government should concentrate on policies which create new jobs for those thousands who lost their jobs inside israel along-with increasing productivity of its unskilled workers. alam et al. (2013) conducted an empirical analysis to examine the causality between economic growth, fdi inflows and labor productivity using a panel of 19 oecd member countries for the time period of 1980-2009. the results suggested the evidence of causality but after 1995, the policies favored in shifting fdi inflows towards manufacturing and services sectors where technological spillovers were high due to higher labor productivity in these sectors which resulted in both short run and long run causality. mallick (2013) argues that due to globalization, advancement in technology and factor of competition, the demand for productive labor is increasing since skilled and productive labor in every economic sector leads to an overall economic growth. for empirically analyzing this relationship, author conducted an analysis using panel estimation on data extracted from oecd and wdi covering time period from 1990-91 to 2011-12. the results of multiple regression also suggested that the indicators of globalization like fdi inflows and openness of economy have positive and significant impact on labor productivity both in individual sectors and economy as a whole. asian journal of economics and empirical research, 2018, 5(1): 1-18 5 kirti and prasad (2016) studied the impact of fdi inflows on indian economy taking both sectoral analysis and combined effect together. the ols estimation results revealed that fdi has both positive and negative effects on sectors and economy. they found that fdi leads to unemployment due to the use of capital intensive technology which replaces labor. regarding sector-wise analysis, they suggested that if capital intensive technology is used in agricultural sector (most backward sector of economy), this will lead to an increase in output based on high labor productivity due to spillover effects from technology transfer. however, manufacturing and services sectors are attracting more fdi due to high labor productivity in the respective sectors. thangavelu et al. (2015) analyzed the impacts of trade on labor productivity of services sector for five asean countries—indonesia, malaysia, the philippines, singapore, and thailand. they used fixed effects and gmm estimators for the time period of 1990-2005. four subsectors have been used for empirical analysis, i.e., (i) wholesale, retail, and hotel; (ii) transport, storage, and communications; (iii) finance, insurance, and real estate; and (iv) community, social, and personal sectors. the results show that the more exposure to exports leads to an increase in labor productivity in all these five countries. furthermore, higher fdi inflows lead to increase in productivity and output of services sector which then provides inputs for manufacturing sector in the region. therefore author suggests that such policies must be adopted which would lead to more openness and exposure to foreign investment for the advancement of services sector since it supports manufacturing sector as well. their results also highlight that increase in labor productivity and mobility of skilled labor will lead to an increase in services sector to the overall growth of both domestic and regional economies. thuy (2007) investigated the effects of fdi inflows on industrial sector of vietnam using industry level panel data for 29 industrial sectors during the periods of 1995-1999 and 2000-2002. the author also made an attempt to estimate the extent to which fdi inflows generate spillover effects on industrial sector. the empirical results revealed that fdi inflows lead to reduction in government budget deficit, increased exports and employment opportunities and have a positive impact on industrial growth and productivity. the results also indicate that fdi inflows lead to an increase in industrial labor productivity in the form of spillover effects. contessi and weinberger (2009) in their study analyzed the empirical literature on the studies analyzing the relationship between fdi, productivity and growth. their main emphasis was on studies that used aggregate data and focused on finding the answers of two questions: is there evidence of a positive relationship between foreign direct investment and national growth? and does the output of the ―multinational sectors‖ exhibit higher labor productivity? according to authors, the available literature provides ambiguous results but majority of studies have concluded that mncs and fdi inflows lead to increase in labor productivity, wages and employment. these results are specifically true if compared with domestic firms who do not have enough resources to provide better opportunities to domestic labor, fdi not only increases labor productivity but also makes use of human capital by providing more employment opportunities and higher wage rate which leads to sectoral and overall economic growth. this section of literature review has some important implications. first, all studies agree that fdi inflows and openness lead to increase in labor productivity and sectoral growth. also an important point to highlight is that, not all sectors enjoy same level of benefits. in most of the studies, agricultural sector has been given less importance due to its backwardness and low return. industrial and services sectors show better performance and attract more fdi because of higher return as well as availability of skilled and productive labor force working in these sectors. basically there is a bi-directional causality. fdi leads to increase in sectoral productivity along-with the increase in labor productivity of respective sectors which in turn attracts more fdi inflows. 2.2. studies related to pakistan this section reviews studies relevant to pakistan, including studies relating to asian countries or a panel of such countries inclusive of pakistan, though majority of the studies focus on impact of fdi inflows on sectoral growth rather than sectoral labor productivity. ullah et al. (2012) empirically analyzed the role of fdi inflows using data of agriculture and industrial sectors of pakistan for the time period of 1979-2009. services sector was also incorporated as an independent variable in the equations of agricultural and industrial sectors. the results of two stage least square (2sls) suggested a negative impact on agriculture sector and a positive impact on industrial sector. their results also suggested that an increase in growth rate of agriculture and industrial sector leads to a higher growth of services sector. consequently employment increases which causes an inclination towards attaining more education. this facilitates availability of increased number of educated and skilled workers which leads to enhancement in labor productivity both at sectoral and macro level. as a result, economic growth picks up. khan and khan (2011) are of the view that although pakistan has great potential for attracting fdi inflows, but it has not been successful in attracting sufficient amounts due to ineffective institutional framework, poor law and order situation and low labor productivity. their empirical analysis basically focuses on testing the impact of sector-wise fdi inflows on growth and output using data of pakistan from 1981-2008. the panel cointegration and grangercausality results suggested that although sectoral fdi inflow increases output and growth of three major sectors i.e., agriculture, industry and services but it is not satisfactory due to above mentioned factors. kasi and zafar (2016) examined the productivity and spillover effects of fdi inflows in four member countries of saarc including bangladesh, india, nepal and pakistan for the period of 1990-2013. authors used 3 main sectors for analysis, i.e., primary, manufacturing and services and applied fully modified least square technique. according to their results, although fdi inflows have positive and significant impact on productivity of all sectors but the effect varies across sectors. they found that maximum productivity effect of fdi is found in services sector through spillover effects where fdi plays an important role and increases labor productivity through technology, training and education. majority of studies argue that pakistan has high potential for attracting fdi inflows but there are many factors which are acting as a hurdle and low labor productivity is one of the most important factors. this is applicable not only at sectoral level but as a whole, as khan (2011) states, asian journal of economics and empirical research, 2018, 5(1): 1-18 6 ‘on the whole, pakistan has a lot of potential to attract foreign investment. although the rising trend of fdi in various sectors reflects the success of policy; however, fdi inflows are considerably hindered by institutional weakness, corruption, ineffective legal institutions, political uncertainty, poor laws, weak regulatory systems, deteriorating law and order situation, labour productivity and unsustainable international political relations.’ (page 20) sahoo (2006) carried out empirical analysis to examine the impact of fdi inflows and its determinants on growth of five south asia countries including india, pakistan, bangladesh, sri lanka and nepal. according to the author, since these countries have been following liberalization policies to attract fdi, all benefitted from fdi but pakistan is at the bottom of the list. fdi inflows in south asian countries is basically concentrated in manufacturing and services sectors. the panel cointegration analysis suggested that market size, labor for growth, infrastructure index and trade openness are main determinants of fdi inflows in these countries. regarding low benefits from fdi inflows to pakistan, author points out that major reason is poor labor laws which result in low labor productivity even in those sectors which are attracting high fdi inflows. in addition, pakistan has a ‗decent‘ fdi policy but low labor productivity is acting as a hurdle in both attracting and benefitting from fdi inflows. suleman and amin (2015) in their study examined the impact of sectoral fdi inflows on industrial growth of pakistan. they used cobb-douglas production function for three sectors of pakistan‘s economy including manufacturing, construction, mining and quarrying by using panel cointegration analysis covering the time period of 1997-2011. their empirical results suggested that sectoral fdi, capital and labor productivity affect industrial growth of pakistan both positively and significantly. authors recommended that such policies should be devised which provide better standard of living, reduce poverty and unemployment in order to increase labor productivity. regarding fdi inflows and tfp in pakistan (adnan et al., 2017) used johansen cointegration analysis and found a positive and significant impact of fdi in pakistan during long run time period. domestic factor of production or labor is affected due to low productivity. their findings suggest that labor needs more attention in the form of increase in education expenditure, better standard of living and high productive capacity. here authors started with tfp in pakistan but ended up at labor productivity since its abundance and importance cannot be ignored. park and shin (2012) studied services sector of 12 major asian economies including pakistan. authors mainly focused on examining that whether services sector can become new engine of growth for developing asia based on high labor productivity in services sector. authors added that since services sector had already contributed to asian economies in past, the panel cointegration analysis suggested that services sector (as compared to other sectors) has future potential to increase gdp growth of these countries since fdi inflows to services sector is positively affecting the labor productivity of this sector, consequently employment opportunities are increasing. in addition, it was found that labor productivity in services sector is increasing at a high rate in asian economies, and in case of pakistan the performance of services sector is on higher trajectory due to which it has become the strongest sector of the economy since the labor productivity has direct and positive relationship with fdi inflows to this sector. slimane et al. (2013) empirically examined the direct and indirect impact of fdi inflows on food security for 63 developing economies including pakistan. for empirical analysis, they used cobb-douglas agriculture production function and covered the time period from 1995-2009. their empirical results did not suggest a direct significant effect of sectoral fdi on food security but a significant and positive indirect impact was found for fdi in agriculture and secondary sector through the growth of agriculture production but it did not show any impact on mining. negative effects in tertiary sector were observed through fdi inflows. their results also suggested that secondary sector benefitted through high employment and wage rate which increased labor productivity. spillover effects were observed in agriculture food security and labor productivity through transfer of technology and knowledge spillovers. yusuf (2013) discussed whether chinese fdi would accelerate pakistan‘s growth and argued that chinese fdi would have positive impacts if china began off-shoring more of its labor-intensive manufacturing activities, pakistan‘s textile, leather, white goods and auto industries. pakistan has been facing problems in benefitting from fdi inflows due to technological backwardness and low labor productivity. although there is a high potential since it has large number of urban centers but poor investment policies and low factor productivity are main hindrances. labor laws need to be implemented so that technological spillovers can be enjoyed in manufacturing and export producing sectors. labor productivity in growth increasing sectors needs attention since pakistan can gain more from fdi inflows if proper investment is made in modern sectors specially manufacturing and export producing industries. this section of literature shows that undoubtedly policy makers and researchers have consensus that in general fdi inflows increase labor productivity. moreover agriculture sector is the most backward sector compared to manufacturing and services sectors. yet the discussion mainly concentrates on sector-wise fdi inflows and sectoral growth or overall growth instead of labor productivity of each sector. the empirical part of this paper is aimed at concentrating on the impact of sector-wise fdi on respective sector-wise labor productivity. some important figures related to country-wise and sector-wise fdi inflows to pakistan have been shown in following tables: asian journal of economics and empirical research, 2018, 5(1): 1-18 7 table-1. country wise fdi inflows ($ million) source: board of investment, pakistan http://boi.gov.pk/foreigninvestmentinpakistan.aspx 22.6% increase in net fdi in july-may, 2016-17 as compared to july-may, 2015-16. note: pakistan‘s fiscal year runs from 1st july till 30th june. the figures in brackets are in negative. table-2. sector wise fdi inflows ($ million) source: board of investment, pakistan http://boi.gov.pk/foreigninvestmentinpakistan.aspx 22.6% increase in net fdi in july-may, 2016-17 as compared to july-may, 2015-16. note: pakistan‘s fiscal year runs from 1st july till 30th june. the figures in brackets are in negative. 2.3. summary of literature review and gaps to be filled by present study numerous studies (national and international) have been discussed in literature review. the international literature has thrown light on the relationship between sector-wise fdi inflows and sector-wise labor productivity concluding that sector-wise fdi inflows do increase sector-wise labor productivity especially in case of manufacturing and services sectors. generally they are in the form of technology transfer, innovation, r & d and increase in labor productivity but agriculture and related sectors show either no impact or negative because of backwardness and low labor productivity. in case of pakistan, most of the studies have emphasized on ‗growth‘ instead of labor productivity. moreover, the literature has also given a hint that spillovers may exist, i.e., fdi inflows to one sector may lead to an increase in labor productivity in one or more sectors like in case of developing economies such as pakistan, agricultural output affects industrial output or productivity providing inputs for industrial sector (textile sector is the main sector which is affected by agricultural output). this study aims to fill the gap by empirically analyzing the impact of sector-wise fdi inflows on sector-wise labor productivity. it also tests the spillover effects empirically through grangercausality test. 3. empirical analysis the empirical part is divided into three sections. section 1 deals with data details, empirical model and hypothesis. section 2 shows result of unit root tests. section 3 is a detailed analysis of panel data models. all panel data models have been applied in order to know that which static panel model suits best to the data being used for this study. the purpose of detailed analysis is to substantiate the relevance of the model applicable for empirical analysis rather than jumping directly to the empirical model itself. also, the empirical rationale is shown as to which test is pragmatic and what assumptions it holds. in the end, section 4 shows pair-wise granger-causality test to see the spillover effects from one sector to another. section 5 provides a complete interpretation of empirical results. section1 1.1) data details and sources  data for fdi inflows has been extracted from world development indicators (wdi), world bank. unit= current bop us dollars country 200708 200809 200910 201011 201112 201213 201314 201415 201516 2016-17 (jul-may) usa 1,309.3 869.9 468.3 238.1 227.7 227.1 212.1 208.9 40.5 40.8 uk 460.2 263.4 294.6 207.1 205.8 633.0 157.0 169.6 138.4 54.2 u.a.e 589.2 178.1 242.7 284.2 36.6 22.5 (47.1) 218.8 138.6 51.2 japan 131.2 74.3 26.8 3.2 29.7 30.1 30.1 71.1 35.2 42.0 hong kong 339.8 156.1 9.9 125.6 80.3 242.6 228.5 136.2 119.5 10.1 switzerland 169.3 227.3 170.6 110.5 127.1 149.0 209.8 3.2 53.4 15.9 saudi arabia 46.2 (92.3) (133.8) 6.5 (79.9) 3.2 (40.1) (64.8) 24.0 1.9 germany 69.6 76.9 53.0 21.2 27.2 5.5 (5.7) (20.3) (11.6) (6.1) korea (south) 1.2 2.3 2.3 7.7 25.4 25.8 24.4 14.3 (2.3) 7.3 norway 274.9 101.1 0.4 (48.0) (275.0) (258.4) (21.6) 2.7 172.5 (12.6) china 13.7 (101.4) (3.6) 47.4 126.1 90.6 695.8 256.8 626.2 878.8 others 2,005.2 1,964.2 1,019.6 631.3 289.7 285.5 255.4 (73.6) 566.8 944.5 total including pvt. proceeds 5,409.8 3,719.9 2,150.8 1,634.8 820.7 1,456.5 1,698.6 922.9 1,901.2 2,028.0 privatisation proceeds 133.2 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 fdi excluding pvt. proceeds 5,276.6 3,719.9 2,150.8 1,634.8 820.7 1,456.5 1,698.6 922.9 1,901.2 2,028.0 sectors 200708 200809 200910 201011 201112 201213 201314 201415 201516 2016-17 (jul may) oil & gas 634.8 775.0 740.6 512.2 629.4 559.6 502.0 299.0 248.9 135.6 financial business 1,864.9 707.4 163.0 310.1 64.4 314.2 192.8 256.4 289.0 62.8 textiles 30.1 36.9 27.8 25.3 29.8 10.0 (0.2) 43.9 20.0 14.1 trade 175.9 166.6 117.0 53.0 25.3 5.7 (3.2) 50.0 26.8 28.1 construction 89.0 93.4 101.6 61.1 72.1 46.0 28.8 53.5 36.8 418.2 power 70.3 130.6 (120.6) 155.8 (84.9) 28.4 71.4 219.3 751.3 548.0 chemicals 79.3 74.3 112.1 30.5 96.3 71.6 94.9 55.3 88.5 10.6 transport 74.2 93.2 132.0 104.6 18.7 44.1 2.7 6.2 70.1 38.1 communication (it&telecom) 1,626.8 879.1 291.0 (34.1) (312.6) (385.7) 434.2 45.1 236.8 20.0 others 764.5 763.4 586.3 416.3 282.2 765.5 375.2 105.8) 133.0 752.5 total including pvt. proceeds 5,409.8 3,719.9 2,150.8 1,634.8 820.7 1,456.5 1,698.6 922.9 1901.2 2,028.0 privatisation proceeds 133.2 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 fdi excluding pvt. proceeds 5,276.6 3,719.9 2,150.8 1,634.8 820.7 1,456.5 1,698.6 922.9 1901.2 2,028.0 http://boi.gov.pk/foreigninvestmentinpakistan.aspx http://boi.gov.pk/foreigninvestmentinpakistan.aspx asian journal of economics and empirical research, 2018, 5(1): 1-18 8  data for sector-wise fdi inflows has been taken from handbook of statistics on pakistan, chapters 1-2, state bank of pakistan and pakistan economic survey (various issues). unit=percentage  data for sector-wise fdi inflows has been constructed by carrying out various steps. it is represented as value added per hour for each sector. data for total labor force is taken from wdi. distribution of employed persons of 10 years and above by major industries has been taken from pakistan economic survey 201415 and 2015-16 (chapter 12). units = value added per hour (million dollars)  data for sector-wise fdi inflows has been taken from board of investment (boi), pakistan. units = million dollars following abbreviations have been used for presenting data fdi =fdi inflows lprod =labor productivity agri =agriculture manuf = manufacturing const = construction e & g = electricity and gas trans = transport trade = trade others = others following abbreviations have been used for presenting empirical tests llu = levin, lin & chu. ips = im, pearon & shin. lsdv = least square dummy variable. 1.2) model and hypothesis model: sector-wise fdi inflows increase sector-wise lprod hypothesis: relationship between sector-wise fdi inflows and sector-wise lprod for this purpose panel models have been applied using seven sectors and their respective labor productivity of pakistan covering time period of 1997-2016. in all cases lprod is the dependent variable and inflow is the independent variable since the aim is to check whether fdi inflows to each sector increase respective labor productivity or not. 1.3) empirical equation: ( ) ℇ it where ℇ it = error term (to check robustness of results, the model has also been tested other way round) in case of wald test and granger-causality test, variables get automatically inter-changed to check bidirectional causality. also, granger-causality test has been applied to empirically check the spillover effects. the empirical section does not directly jump to panel model, rather all initial steps have been conducted and presented to confirm the reliability of the model for panel data. all tests are applied in eviews 9.0. section2 2.1) panel unit root tests first step in any empirical study is to check the stationarity status of data. depending on that, further tests are applied. initially all series have been presented in graphical form and then results are presented in tabular form. for this purpose, two famous tests are applied for checking unit root, i.e. llc and ips. results and interpretation are presented in table-3. graph-1. sector-wise labor productivity asian journal of economics and empirical research, 2018, 5(1): 1-18 9 graph-2. sector-wise fdi inflows table-3. panel unit root tests method levin, lin & chu im, pesaran and shin (ips) order of integration variables at level at first difference at level at first difference intercept trend & intercept intercept trend & intercept intercept trend & intercept intercept trend & intercept lprod 2.11491 (0.9828) 1.52993* (0.0630) 7.07647*** (0.0000) 5.74151*** (0.0000) 3.18318 (0.9999) 1.46509* (0.0714) 7.70225*** (0.0000) 6.25492*** (0.0000) i(1) inflow 1.34872 (0.0887) 0.1607 (0.5652) 4.42893*** (0.0000) 3.91451*** (0.0000) 2.31312* (0.0104) -0.95487 (0.1698) 5.75636*** (0.0000) 4.77672*** (0.0000) i(1) values in parenthesis represent probability values. *significant at 10% ** significant at 5% *** signiant at 1% levin et al. (2002) has a null hypothesis of unit root which assumes a common unit root whereas, im et al. (2003) also has the same null hypothesis but this test assumes individual unit root process. according to both tests, series are co-integrated of order 1, i.e., they become stationary at first difference (taking all significance level) which is a necessary condition for cointegration test. before applying panel cointegration test, it is required to check that which kind of static panel data model is appropriate. section-3 3.1) panel data models three basic panel data models have been applied one by one along-with interpretations. (i) pooled ols table-4. pooled ols (empirical results) dependent variable: lprod method: panel least squares assumption: all sectors are same (no individuality) sample: 1997 2016 periods included: 20 cross-sections included: 7 total panel (balanced) observations: 140 variable coefficient std. error t-statistic prob. c 3102.485 327.0495 9.486287 0.0000 inflow 9.191757 1.698498 5.411699 0.0000 r-squared 0.175068 mean dependent var 4083.403 adjusted r-squared 0.169090 s.d. dependent var 3533.585 s.e. of regression 3221.013 akaike info criterion 19.00696 sum squared resid 1.43e+09 schwarz criterion 19.04899 log likelihood -1328.487 hannan-quinn criter. 19.02404 f-statistic 29.28648 durbin-watson stat 0.335267 prob(f-statistic) 0.000000 decision: inflow is significant but the assumption of no individuality cannot be accepted although results are significant, yet this test is not preferred since it pools all seven sectors and denies the individuality. asian journal of economics and empirical research, 2018, 5(1): 1-18 10 (ii) pooled ols vs fixed effects (f-test) now testing that which test is appropriate, fixed effect or pooled regression model? also, is there any requirement for testing a model with heterogeneity? for this purpose, dummy variables are used to estimate fixed effect model. since the panel consists of 7 sectors, 7dummy variables are created. the equation to be estimated is lprod=c(1)+c(2)*inflow+c(3)*d1+c(4)*d2+c(5)*d3 +c(6)*d4+c(7)*d5+c(8)*d6+c(9)*d7 where lprod (sector-wise labor productivity) is the dependent variable and inflow (sector-wise fdi inflow) is the independent variable. c(1) is the co-efficient of constant c(2) is the co-efficient of inflow c(3), c(4), c(5), c(6), c(7), c(8) and c(9) are co-efficient of dummy1, dummy2, dummy3, dummy4, dummy5, dummy 6 and dummy7 respectively. the null and alternative hypothesis of panel least square model are: null: pooled regression model is appropriate (all dummy variables are zero) alternative: fixed effect model is more appropriate (all dummy variables are not zero) to check whether all dummy variables are zero or not, wald test is used. table-5. results of wald test (f-statistic) wald test: f-statistic based test test statistic value df probability f-statistic 32.31158 (7, 131) 0.0000 chi-square 226.1811 7 0.0000 null hypothesis: c(3)=c(4)=c(5)=c(6)=c(7)=c(8)=c(9)=0 null hypothesis summary: normalized restriction (= 0) value std. err. c(3) -8072.629 2159.858 c(4) -5910.032 2175.133 c(5) -9262.234 2077.298 c(6) 22.57162 2055.820 c(7) -3533.529 2175.990 c(8) -6024.004 2173.176 c(9) -5055.283 2171.676 since the probability value is almost zero, null hypothesis is rejected and alternative is accepted, i.e., fixed effect model is appropriate according to f-statistic model. (iii) pooled least-square dummy variable model table-6. results of pooled lsdv model (fixed effect) dependent variable: lprod method: panel least squares sample: 1997 2016 periods included: 20 cross-sections included: 7 total panel (balanced) observations: 140 lprod=c(1)+c(2)*inflow+c(3)*d1+c(4)*d2+c(5)*d3+c(6)*d4+c(7) *d5+c(8)*d6+c(9)*d7 coefficient std. error t-statistic prob. c(1) 9317.984 2139.559 4.355097 0.0000 c(2) 1.595601 1.378895 1.157159 0.2493 c(3) -8072.629 2159.858 -3.737574 0.0003 c(4) -5910.032 2175.133 -2.717090 0.0075 c(5) -9262.234 2077.298 -4.458790 0.0000 c(6) 22.57162 2055.820 0.010979 0.9913 c(7) -3533.529 2175.990 -1.623872 0.1068 c(8) -6024.004 2173.176 -2.771982 0.0064 c(9) -5055.283 2171.676 -2.327826 0.0215 r-squared 0.697447 mean dependent var 4083.403 adjusted r-squared 0.678971 s.d. dependent var 3533.585 s.e. of regression 2002.109 akaike info criterion 18.10392 sum squared resid 5.25e+08 schwarz criterion 18.29302 log likelihood -1258.274 hannan-quinn criter. 18.18076 f-statistic 37.74779 durbin-watson stat 0.551877 prob(f-statistic) 0.000000 since lprod is the dependent variable, the co-efficient of independent variable (inflow), which is c(2) must be same for fixed effect model estimation. the highlighted values in red show that in all tests the value of inflow co-efficient is same, which shows that it is fixed effect model. (iv) fixed effects or random effects now the question is that which test is more appropriate? to find out, hausman test is applied. asian journal of economics and empirical research, 2018, 5(1): 1-18 11 table-7. results of hausman test correlated random effects hausman test test cross-section random effects test summary chi-sq. statistic chi-sq. d.f. prob. cross-section random 4.017557 1 0.0450 cross-section random effects test comparisons: variable fixed random var(diff.) prob inflow 1.596216 2.007554 0.042115 0.0450 prob. value is significant at 10 percent level, therefore it can be concluded that fixed effect model is more appropriate. decision: both hausman test and f-statistic suggest that fixed effect model is appropriate. 3.2. panel cointegration tests table-8. results of panel cointegration test pedroni test with individual intercepts pedroni residual cointegration test series: lprod inflow sample: 1997 2016 included observations: 140 cross-sections included: 7 null hypothesis (h0): no cointegration between variables. alternative hypothesis (h1): cointegration between variable. automatic lag length selection based on sic with a max lag of 3 newey-west automatic bandwidth selection and bartlett kernel alternative hypothesis: common ar coefs. (within-dimension) weighted test type statistic prob. statistic prob. panel v-statistic -0.590388 0.7225 -1.295781 0.9025 panel rho-statistic 0.542161 0.7061 1.556694 0.9402 panel pp-statistic 0.788221 0.7847 1.942475 0.9740 panel adf-statistic 0.779412 0.7821 3.131847 0.9991 alternative hypothesis: individual ar coefs. (between-dimension) test type test type statistic prob. group rho-statistic 2.789980 0.9974 group pp-statistic 3.911325 1.0000 group adf-statistic 4.684392 1.0000 decision: accept h0 (no cointegration) pedroni test with individual intercepts and trend (this is the heading of above table) *significant at 10% ** significant at 5% *** signiant at 1% pedroni residual cointegration test series: lprod inflow sample: 1997 2016 included observations: 140 cross-sections included: 7 null hypothesis (h0): no cointegration between variables. alternative hypothesis (h1): cointegration between variables. automatic lag length selection based on sic with a max lag of 3 newey-west automatic bandwidth selection and bartlett kernel alternative hypothesis: common ar coefs. (within-dimension) weighted test type statistic prob. statistic prob. panel v-statistic 0.266400 0.3950 2.707674 0.0034** panel rho-statistic -1.576706 0.0574* -0.640072 0.2611 panel pp-statistic -2.851450 0.0022** -2.012096 0.0221* panel adf-statistic -2.909437 0.0018** -2.386335 0.0085** alternative hypothesis: individual ar coefs. (between-dimension) test type statistic prob. group rho-statistic 0.616731 0.7313 group pp-statistic -1.219229 0.1114 group adf-statistic -1.810697 0.0351* decision: accept h1 (there is cointegration) the results indicate that there is long run cointegration between sector-wise labor productivity and sectorwise fdi inflows when test is carried out using both trend and intercept. out of total 11 outcomes, 7 are significant, therefore, it is concluded that there is a strong evidence of cointegration. for cross check, now applying fisher cointegration test. asian journal of economics and empirical research, 2018, 5(1): 1-18 12 table-9. johansen fisher panel cointegration test  johansen fisher panel cointegration test (empirical results) series: lprod inflow sample: 1997 2016 included observations: 140 trend assumption: linear deterministic trend (restricted) lags interval (in first differences): 1 1 unrestricted cointegration rank test (trace and maximum eigenvalue) hypothesized fisher stat.* fisher stat.* no. of ce(s) (from trace test) prob. (from max-eigen test) prob. none 25.46 0.0303 27.92 0.0146 at most 1 9.371 0.8066 9.371 0.8066 * probabilities are computed using asymptotic chi-square distribution. individual cross section results trace test max-eign test cross section statistics prob.** statistics prob.** hypothesis of no cointegration agri 23.2648 0.1020 15.9062 0.1493 manuf 17.3666 0.3881 14.6940 0.2108 const 21.7021 0.1515 16.9830 0.1080 e&g 27.6196 0.0300 24.4816 0.0083 trans 25.8957 0.0497 16.7830 0.1149 trade 14.5430 0.6126 7.7133 0.8463 others 15.4050 0.5410 13.1481 0.3162 hypothesis of at most 1 cointegration relationship agri 7.3587 0.3086 7.3587 0.3086 manuf 2.6726 0.9130 2.6726 0.9130 const 4.7191 0.6371 4.7191 0.6371 e&g 3.1380 0.8597 3.1380 0.8597 trans 9.1128 0.1735 9.1128 0.1735 trade 6.8297 0.3626 6.8297 0.3626 others 2.2569 0.9508 2.2569 0.9508 **mackinnon (1990) p-values fisher test has a null hypothesis that there is no co-integrated equation (the two variables are not cointegrated). in case of none, both trace test and max eigen value test reject the null hypothesis. at the most one hypothesis has high probability values (more than 5%) for both trace co-integrated and max eigen value test which leads to the conclusion that there is cointegration between two variables (sector wise labor productivity and sector wise fdi inflows are) 3.3. panel vector error correction model although the basic model deals with lprod being a dependent variable but for robustness of test, separate vecm and system equation model are estimated taking inflow as a dependent variable. table-10. results of panel vector error correction model (vecm)  when lprod is dependent vector error correction estimates sample (adjusted): 2000 2016 standard errors in ( ) & t-statistics in [ ] cointegrating eq: cointeq1 lprod(-1) 1.000000 inflow(-1) -74.83640 (20.8250) [-3.59359] c 4203.830 error correction: d(lprod) d(inflow) cointeq1 -0.039096 (0.01282) [-3.05035] 0.001254 (0.00110) [ 1.14450] d(lprod(-1)) -0.245484 (0.08641) [-2.84080] -0.008062 (0.00739) [-1.09094] d(lprod(-2)) -0.355847 (0.08495) [-4.18900] -0.005610 (0.00726) [-0.77221] d(inflow(-1)) -3.756347 (1.44851) [-2.59324] -0.471644 (0.12388) [-3.80729] d(inflow(-2)) 0.216792 (1.39912) [ 0.15495] -0.307120 (0.11965) [-2.56672] asian journal of economics and empirical research, 2018, 5(1): 1-18 13 c 351.5799 (121.786) [ 2.88687] 12.99057 (10.4153) [ 1.24726] r-squared 0.243475 0.210100 adj. r-squared 0.210001 0.175149 sum sq. resids 1.88e+08 1376352. s.e. equation 1290.479 110.3635 f-statistic 7.273447 6.011222 log likelihood -1018.145 -725.5252 akaike aic 17.21252 12.29454 schwarz sc 17.35264 12.43466 mean dependent 231.6261 8.627731 s.d. dependent 1451.903 121.5172 determinant resid covariance (dof adj.) 1.96e+10 determinant resid covariance 1.76e+10 log likelihood -1741.524 akaike information criterion 29.50460 schwarz criterion 29.83155 the estimates of vecm also confirm a long run relationship between the variable under discussion. but the probability values are not available, for which system equation model is required. since lprod is the dependent variable, the first model is the main model of interest. vecm doesn‘t show probability values, therefore, construction of system equation model is required to get probability values. table-11. results of system equation model  taking lprod as dependent variable *significant at 10% **significant at 5%, *** signiant at 1% estimation method: panel least squares sample: 2000 2016 included observations: 119 total system (balanced) observations 238 equation: d(lprod) = c(1)*( lprod(-1) 74.8363953179*inflow(-1) + 4203.8300597 ) + c(2)*d(lprod(-1)) + c(3)*d(lprod(-2)) + c(4) *d(inflow(-1)) + c(5)*d(inflow(-2)) + c(6) coefficient std. error t-statistic prob. c(1) -0.039096 0.012817 -3.050354 0.0026** c(2) -0.245484 0.086414 -2.840799 0.0049** c(3) -0.355847 0.084948 -4.188996 0.0000** c(4) -3.756347 1.448514 -2.593242 0.0101* c(5) 0.216792 1.399120 0.154949 0.8770 c(6) 351.5799 121.7859 2.886868 0.0043** c(7) 0.001254 0.001096 1.144501 0.2536 c(8) -0.008062 0.007390 -1.090941 0.2765 c(9) -0.005610 0.007265 -0.772207 0.4408 c(10) -0.471644 0.123879 -3.807294 0.0002** c(11) -0.307120 0.119655 -2.566724 0.0109** c(12) 12.99057 10.41530 1.247258 0.2136 determinant residual covariance 1.76e+10 observations: 119 r-squared 0.243475 mean dependent var 231.6261 adjusted r-squared 0.210001 s.d. dependent var 1451.903 s.e. of regression 1290.479 sum squared resid 1.88e+08 durbin-watson stat 2.162215 equation: d(inflow) = c(7)*( lprod(-1) 74.8363953179*inflow(-1) + 4203.8300597 ) + c(8)*d(lprod(-1)) + c(9)*d(lprod(-2)) + c(10) *d(inflow(-1)) + c(11)*d(inflow(-2)) + c(12) observations: 119 r-squared adjusted r-squared 0.210100 0.175149 mean dependent var s.d. dependent var 8.627731 121.5172 s.e. of regression durbin-watson stat 110.3635 1.828057 sum squared resid 1376352. c(1) = error correction term or speed of adjustment towards long run equilibrium since c(1) is negative and significant, it can be concluded that there is a long run causality running from independent variable (sector-wise fdi inflows) to dependent variable (sector-wise labor productivity). or in simple words, an increase in sector specific fdi inflows leads to an increase in labor productivity working in that specific sector. this model explains long run causality which has already been established.  when inflow is a dependent variable asian journal of economics and empirical research, 2018, 5(1): 1-18 14 table-12. results of panel vector error correction model (vecm) vector error correction estimates sample (adjusted): 2000 2016 included observations: 119 after adjustments standard errors in ( ) & t-statistics in [ ] cointegrating eq: cointeq1 inflow(-1) 1.000000 -0.013362 (0.01282) lprod(-1) [-1.04245] c -56.17360 error correction: d(inflow) d(lprod) -0.093882 2.925767 (0.08203) (0.95916) cointeq1 [-1.14450] [ 3.05035] -0.471644 -3.756347 (0.12388) (1.44851) d(inflow(-1)) [-3.80729] [-2.59324] -0.307120 0.216792 (0.11965) (1.39912) d(inflow(-2)) [-2.56672] [ 0.15495] -0.008062 -0.245484 (0.00739) (0.08641) d(lprod(-1)) [-1.09094] [-2.84080] -0.005610 -0.355847 (0.00726) (0.08495) d(lprod(-2)) [-0.77221] [-4.18900] 12.99057 351.5799 (10.4153) (121.786) c [ 1.24726] [ 2.88687] r-squared 0.210100 0.243475 adj. r-squared 0.175149 0.210001 sum sq. resids 1376352. 1.88e+08 s.e. equation 110.3635 1290.479 f-statistic 6.011222 7.273447 log likelihood -725.5252 -1018.145 akaike aic 12.29454 17.21252 schwarz sc 12.43466 17.35264 mean dependent 8.627731 231.6261 s.d. dependent 121.5172 1451.903 determinant resid covariance (dof adj.) 1.96e+10 determinant resid covariance 1.76e+10 log likelihood -1741.524 akaike information criterion 29.50460 schwarz criterion 29.83155 again constructing system equation model for obtaining probability values. table-13. results of system equation model estimation method: least squares sample: 2000 2016 included observations: 119 total system (balanced) observations 238 equation: d(inflow) = c(1)*( inflow(-1) 0.0133624821954*lprod(-1) 56.1736043251 ) + c(2)*d(inflow(-1)) + c(3)*d(inflow(-2)) + c(4) *d(lprod(-1)) + c(5)*d(lprod(-2)) + c(6) coefficient std. error t-statistic prob. c(1) -0.093882 0.082028 -1.144501 0.2536 c(2) -0.471644 0.123879 -3.807294 0.0002** c(3) -0.307120 0.119655 -2.566724 0.0109* c(4) -0.008062 0.007390 -1.090941 0.2765 c(5) -0.005610 0.007265 -0.772207 0.4408 c(6) 12.99057 10.41530 1.247258 0.2136 c(7) 2.925767 0.959157 3.050354 0.0026** c(8) -3.756347 1.448514 -2.593242 0.0101* c(9) 0.216792 1.399120 0.154949 0.8770 c(10) -0.245484 0.086414 -2.840799 0.0049** c(11) -0.355847 0.084948 -4.188996 0.0000*** c(12) 351.5799 121.7859 2.886868 0.0043 determinant residual covariance 1.76e+10 observations: 119 r-squared 0.210100 mean dependent var 8.627731 adjusted r-squared 0.175149 s.d. dependent var 121.5172 s.e. of regression 110.3635 sum squared resid 1376352. asian journal of economics and empirical research, 2018, 5(1): 1-18 15 durbin-watson stat 1.828057 equation: d(lprod) = c(7)*( inflow(-1) 0.0133624821954*lprod(-1) 56.1736043251 ) + c(8)*d(inflow(-1)) + c(9)*d(inflow(-2)) + c(10) *d(lprod(-1)) + c(11)*d(lprod(-2)) + c(12) observations: 119 r-squared 0.243475 mean dependent var 231.6261 adjusted r-squared 0.210001 s.d. dependent var 1451.903 s.e. of regression 1290.479 sum squared resid 1.88e+08 durbin-watson stat 2.162215 *significant at 10% **significant at 5%, *** signiant at 1% c(1) = error correction term or speed of adjustment towards long run equilibrium since c(1) is negative though insignificant , it cannot be concluded that there is a long run causality running from dependent variable (sector-wise fdi inflows) to independent variable (sector-wise labor productivity). therefore there is one way causality which is the main model i.e., sector –wise labor productivity is affected by sector-wise fdi inflows. now checking short run causality through wald test. 3.4. wald test  when lprod is dependent table-14. results of panel wald test (estimating short-run causality) c(4)= coefficient of inflow (-1) c(5)= coefficient of inflow (-2) null hypothesis states that c(4)=c(5)=0 which means that c(4) and c(5), jointly are zero. wald test: test statistic value df probability chi-square 9.551606 2 0.0084 null hypothesis: c(4)=c(5)=0 null hypothesis summary: normalized restriction (= 0) value std. err. c(4) -3.756347 1.448514 c(5) 0.216792 1.399120 restrictions are linear in coefficients since the probability is less than 5 percent, null hypothesis can be rejected. there exists a short run causality from independent variable (sector-wise fdi inflows) to dependent variable (sector-wise labor productivity)  when inflow is a dependent variable c(10)= coefficient of lprod (-1) c(11)= coefficient of lprod (-2) null hypothesis states that c(10)=c(11)=0 which means that c(10) and c(11), jointly are zero. table-15. results of panel wald test (estimating short-run causality) wald test: test statistic value df probability chi-square 21.79722 2 0.0000 null hypothesis: c(10)=c(11)=0 null hypothesis summary: normalized restriction (= 0) value std. err. c(10) -0.245484 0.086414 c(11) -0.355847 0.084948 restrictions are linear in coefficients in this case too, as the probability is less than 5 percent, null hypothesis can be rejected. there exists a short run causality from independent variable (sector-wise labor productivity) to dependent variable (sector-wise fdiinflows). the overall conclusion suggested by the empirical analysis proves that random effect or lsdv model is the most appropriate model for the data. unit root tests suggest that all variables become stationary at first difference i.e., i (1). pedroni and fisher panel cointegration models show that there exists a long run cointegration between variables. the same is supported by vecm. system equation model shows that the independent variable has a long run causality on dependent variable, whereas, wald test provides a strong evidence of short run causality between independent and dependent variables. section4 this section deals with an extended segment of empirical part based on spillover effects suggested in literature review. some studies have suggested that there exists spillover effects in the form of one sector affecting the other; both in case of fdi inflows and labor productivity. for empirically testing spillover effects, pair-wise grangercausality test is applied. this part also adds further to the innovative contribution of the present study. test has been carried out both at level and at first difference. asian journal of economics and empirical research, 2018, 5(1): 1-18 16 table-16. pair wise granger-causality test at level direction of causality f-statistic prob. strength of causality agri_lprod → agri_inflow 6.80832 0.0095** strong causality cons_lprod →agri_inflow 16.9054 0.0002** strong causality elect_gas_lprod →agri_inflow 4.15488 0.0403* weak causality manu_inflow →agri_inflow 4.03740 0.0433* weak causality manu_lprod →agri_inflow 5.91312 0.0149* weak causality others_inflow →agri_inflow 7.42717 0.0071** strong causality others_lprod →agri_inflow 8.85650 .0037** strong causality trade_lprod →agri_inflow 3.80538 0.0500* weak causality agri_inflow →trade_lprod 3.14026 0.0772* weak causality trans_lprod →agri_inflow 3.80538 0.0500* weak causality agri_inflow →trans_lprod 3.14026 0.0772* weak causality agri_lprod →cons_inflow 2.84937 0.0942* weak causality agri_lprod →cons_lprod 4.24308 0.0382* weak causality elect_gas_inflow →agri_lprod 2.96506 0.0869* weak causality manu_inflow →agri_lprod 3.59211 0.0573* weak causality agri_lprod →manu_inflow 2.85021 0.0941* weak causality manu_lprod →agri_lprod 2.77625 0.0991* weak causality agri_lprod →manu_lprod 4.10974 0.0414* weak causality others_inflow →agri_lprod 7.18636 0.0079** strong causality trade_lprod →agri_lprod 4.11145 0.0413* weak causality trans_lprod →agri_lprod 4.11145 0.0413* weak causality cons_inflow →cons_lprod 3.21053 0.0736* weak causality cons_inflow →elect_gas_inflow 7.52173 0.0068** strong causality cons_inflow →manu_inflow 3.23694 0.0723* weak causality cons_inflow →manu_lprod 3.72899 0.0525* weak causality cons_inflow →others_inflow 4.44847 0.0337* weak causality others_lprod →cons_inflow 9.90378 0.0024** strong causality manu_inflow →cons_lprod 5.16748 0.0223* weak causality others_lprod →cons_lprod 9.94203 0.0024** weak causality trade_lprod →cons_lprod 11.9232 0.0011** strong causality trans_lprod →cons_lprod 11.9232 0.0011** strong causality elect_gas_inflow →elect_gas_lprod 9.45353 0.0029** strong causality manu_inflow →elect_gas_inflow 4.26847 0.0376* weak causality elect_gas_inflow →trade_inflow 3.88697 0.0475* weak causality elect_gas_inflow →trans_inflow 3.88697 0.0475* weak causality elect_gas_lprod →others_inflow 2.87770 0.0923* weak causality manu_inflow →others_inflow 8.17106 0.0050** strong causality manu_inflow →trade_inflow 3.31218 0.0688* weak causality others_lprod →manu_lprod 4.75293 0.0282* weak causality trade_lprod →manu_lprod 7.16874 0.0080** strong causality trans_lprod →manu_lprod 7.16874 0.0080** strong causality others_inflow →others_lprod 4.86832 0.0264* weak causality trade_inflow →trade_lprod 3.45733 0.0625* weak causality trade_inflow →trans_lprod 3.45733 0.0625* weak causality trans_inflow →trade_lprod 3.45733 0.0625* weak causality trans_inflow →trans_lprod 3.45733 0.0625* weak causality *significant at 10% **significant at 5%, *** signiant at 1% test has been conducted using 2 lags and 18 observations. strong or weak causality is based on level of significance. 5% and 1% level represent strong causality where as 10% represents weak causality. table-17. pair wise granger-causality test at first difference direction of causality f-statistic prob. strength of causality dcons_lprod →dagri_inflow 4.61474 0.0326* weak causality delect_gas_lprod →dagri_inflow 3.44244 0.0658* weak causality dagri_inflow →dmanu_lprod 8.54178 0.0049** strong causality dothers_inflow →dagri_inflow 9.27609 0.0037** strong causality dtrade_inflow →dagri_inflow 3.14080 0.0800* weak causality dagri_inflow →dtrade_lpord 4.13372 0.0431* weak causality dtrans_inflow →dagri_inflow 3.14080 0.0800* weak causality dagri_inflow →dtrans_lprod 4.13372 0.0431* weak causality dothers_inflow →dagri_lprod 4.29300 0.0392* weak causality dcons_inflow →dmanu_inflow 7.53099 0.0076** strong causality dcons_inflow →dmanu_lprod 3.38722 0.0682* weak causality dothers_lprod →dcons_inflow 8.40304 0.0052** strong causality delect_gas →dcons_lprod 3.67455 0.0569* weak causality dmanu_inflow →dcons_lprod 4.27188 0.0397* weak causality asian journal of economics and empirical research, 2018, 5(1): 1-18 17 *significant at 10% **significant at 5%, *** signiant at 1% dothers_lprod →dcons_lprod 4.13602 0.0430* weak causality dtrade_lpord →dcons_lprod 9.54526 0.0033** strong causality dtrans_lprod →dcons_lprod 9.545 6 0.0033** strong causality delect_gas →delect_gas_lprod 3.56908 0.0608* weak causality dmanu_inflow →delect_gas 3.61941 0.0589* weak causality dmanu_inflow →delect_gas_lprod 4.64914 0.0320* weak causality dmanu_lprod →delect_gas_lprod 5.937 6 0.0161* weak causality dmanu_inflow →dothers_inflow 2.93467 0.0917* weak causality dtrade_lpord →dmanu_lprod 3.13544 0.0803* weak causality dtrans_lprod →dmanu_lprod 3.13544 0.0803* weak causality test has been conducted using 2 lags and 18 observations d represents difference strong or weak causality is based on level of significance. 5% and 1% level represent strong causality where as 10% represents weak causality. granger-causality test suggests existence of spillover effects both in case of labor productivity and fdi inflows. 4. interpretation of empirical results according to panel unit root tests, all series become stationary at first difference having same order of integration, i.e., i(1). panel data models reveal that the most appropriate model is fixed effects models (lsdv). same order of integration leads to application of cointegration tests for checking long run relationship. for this purpose, pedroni test and johansen fisher panel cointegration tests are applied. evidence of cointegration leads to application of panel vector error correction model. for testing short-run relationship, wald test is applied which shows that a uni-directional short-run causality exists running from sector-wise labor productivity to sector-wise fdi inflows. the pair-wise granger-causality test shows a broader picture, i.e., there exist spillover effects both in case of fdi inflows and labor productivity in all sectors, although in some cases, there is weak causality, yet it cannot be ignored. 5. conclusion and policy recommendations in this study, an empirical analysis has been carried out to analyze the relationship between sector-wise fdi inflows and respective sector-wise labor productivity in case of pakistan. a panel of seven major sectors of economy has been made for which the results confirm that sector-wise fdi inflows increase respective sector-wise labor productivity. moreover, the evidence of spillover effects from one sector to another have been found through granger-causality test. amongst the three sectors, agriculture is the most backward sector while industrial and services sectors (including their sub-sectors) attract more fdi inflows and consequently labor productivity of these sectors also increases on account of technology transfer, innovation and r & d. however in comparison to industrial and services sectors, agriculture sector, on account of its inherent weaknesses caused by continuous fragmentation of land holdings, non-adoption of modern technologies due to lack of resources as well as awareness, does not attract substantial fdi and consequently remains deprived of higher labor productivity despite this sector‘s contribution of more than 21 percent to national gdp and 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http://dx.doi.org/10.3917/jie.019.0179 http://www.finance.gov.pk/survey/chapters_16/02_agriculture.pdf https://scholar.google.com/scholar?hl=en&q=the%20impact%20of%20sectoral%20foreign%20direct%20investment%20on%20industrial%20economic%20growth%20of%20pakistan https://scholar.google.com/scholar?hl=en&q=foreign%20direct%20investment%20and%20sectoral%20growth%20of%20pakistan%20economy:%20evidence%20from%20agricultural%20and%20industrial%20sector%20(1979%20to%202009) http://dx.doi.org/10.5897/ajbm11.2499 http://dx.doi.org/10.5897/ajbm11.2499 https://scholar.google.com/scholar?hl=en&q=sectoral%20analysis%20of%20foreign%20direct%20investment%20and%20growth%20in%20the%20developed%20countries https://scholar.google.com/scholar?hl=en&q=can%20chinese%20fdi%20accelerate%20pakistan’s%20growth? 79 asian journal of economics and empirical research vol. 5, no. 1, 79-86, 2018 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2018.51.79.86 determinants of technical efficiency of small scale sunflower oil processing firms in tanzania: one stage stochastic frontier approach anastasia r. njiku1 ganka d. nyamsogoro2  ( corresponding author) 1,2school of business, mzumbe university, tanzania abstract sunflower oil processing firms have recently captured the attention of many scholars due to their contributions along the value chain. despite their contributions, 75% of them operate under capacity with steadily declining technical efficiency. this paper estimates the technical efficiency of sunflower oil processing firms in tanzania and the factors contributing to their inefficiency. we used firm-level average production data for three years from 2013 to 2015 collected from a sample of 219 sunflower oil processing firms. data were analyzed using one stage stochastic production frontier with inefficiency effect model under the maximum likelihood estimate (mle) technique. we found that capital and materials input factors of production contributed statistically significantly to the output of the firms under the study. in the same way, firm age, location, ownership type, age and education of the owner were found significant determinants of technical efficiency in sunflower oil processing firms in tanzania. the findings in this paper imply that there is a need to adopt efficiency-enhancing measures including replacement of existing old machines since inefficiency increases with age; affordable industrial locations for easy accessibility and support services; and promotion of proper entrepreneurial education to owners. keywords: determinants, technical efficiency, small-scale sunflower oil processing, stochastic frontier analysis, maximum likelihood estimate. jel classification: c10; c40; c58; d22; d24; l25. citation | anastasia r. njiku; ganka d. nyamsogoro (2018). determinants of technical efficiency of small scale sunflower oil processing firms in tanzania: one stage stochastic frontier approach. asian journal of economics and empirical research, 5(1): 79-86. history: received: 28 june 2018 revised: 30 july 2018 accepted: 9 august 2018 published: 15 august 2018 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 80 2. literature review ............................................................................................................................................................................ 80 3. methodology ..................................................................................................................................................................................... 82 4. empirical results and discussion ................................................................................................................................................ 83 5. conclusion and policy implication ............................................................................................................................................... 85 references .............................................................................................................................................................................................. 85 http://asianonlinejournals.com/index.php/ajeer/article/view/247 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2018.51.79.86&domain=pdf&date_stamp=2017-01-14 https://orcid.org/0000-0003-3850-4733 https://orcid.org/0000-0002-4947-1749 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2018, 5(1): 79-86 80 1. introduction the agro-processing firms have captured the attention of many scholars due to their contributions along the value chain through expansion of forwarding and backward linkages in the economy (undp | united nations development program, 2012; ekblom, 2016). they particularly increase incomes, improve the living standards and create jobs (undp, 2012; ekblom, 2016). they also generate higher added value for agricultural commodities by converting raw material from agricultural farm to intermediate inputs or readily consumed products (yodfiatfinda, 2012). sunflower oil processing firms are ones of emerging agro-processing industries in tanzania with great potentials in providing nutritious and cholesterol free oil in both rural and urban areas (ekblom, 2016). despite the remarkable potentials, the processed sunflower oil is inadequate to cover the increasing gap of oil demand stimulated by population growth, township creation, increased awareness and improved standards of living (haggblade et al., 2010). as a result, tanzania continues to be a net importer of oil to cater for existing high demand. it is currently reported that 75% of sunflower oil processing firms operate under capacity with steadily declining technical efficiency in tanzania (tisimia, 2014). additionally, most sunflower oil processing firms are mainly of small-scale, they often sell their products locally along highways as their products are of a low standard in suiting international market (mpeta, 2015). moreover, there is limited empirical evidence in the academic literature on determinants of technical efficiency in sunflower oil processing firms. this is because of most of the previous studies on technical efficiency focused on other manufacturing sub-sector other than sunflower (admassie and matambalya, 2002; wu et al., 2006; niringiye et al., 2010; charoenrat, 2012). in addition, previous studies on technical efficiency generalized their findings while efficiency is relative and specific to firm group and country (ahmed et al., 2010). the applicability and generalization of their findings are questionable to other countries and sectors due to contextual differences in infrastructure, cultural, general economic environment and digital divide of which sunflower oil processing firms in tanzania is of no exception. from the production theory point of view, firms are not fully efficient in maximizing outputs from factors of production hence low level of production is attained with varying efficiency levels among them. there exists a large gap between actual and expected production output level of sunflower oil. this is because of losses which might be due to random errors out of the control of the firm and possibly inefficiency use of the firm’ resources. in the same vein, the resource-based theory of the firm assumes that resources are always applied in the best way by the firm for the superior performance, ignoring how this is actually done. this claim of the theory has remained at the conceptual level as few empirical studies (faruq and david, 2010; ahmed and ahmed, 2013) are based on different manufacturing subsectors other than sunflower processing firms. as a result, there is inadequate knowledge about the postulation to small-scale firms, particularly sunflower oil processing firms in tanzania. this paper therefore, estimated the technical efficiency levels and their determinants to identify how well the firms utilize their scarce resources to maximize output focusing on sunflower oil agro-processing firms in tanzania. 2. literature review the conception of technical efficiency has been explained by many scholars in various fields and sub-sectors in different ways, but the main idea is centred on the input-output relationship. it is either when the maximum quantity of output is obtained for a given set of inputs or when the minimum quantity of inputs is used to produce a given output level (debru, 1951; koopmans, 1951) and farrell (1957); kumbhakar and lovell (2000); coelli et al. (2005); charoenrat (2012) and ngeh (2014). in this paper, technical efficiency has been considered as the ability of the firm to produce maximum quantity of output measured as the ration of unit produced in litres (output) to a set of inputs capital, labour and material given a production technology. the input-output relationship has been grounded from production theory which assumes full technical efficiency while specifying the production function of firms, but in reality, a gap exists between theoretical assumption of full technical efficiency and empirical reality. it represents the level of achievement by the firm in utilizing the available inputs resources (capital, labour, and material) for maximum outputs. although the importance of efficient use of resources has long been recognized by firms, the actual output is less than what is postulated by the production function. they perform at their best practice (a frontier) which is used to emphasize the idea of the maximality of the firm reflecting the current state of technology in the industry. frontier defines the best combination of inputs that can be used to produce a maximum output. for this case, firms that operate on the frontier are considered technically efficient and those beneath the frontier are technically inefficient. these differences might be due to technical inefficiencies or some unanticipated exogenous shocks outside the control of the firm. the resource-based theory of the firm perceives organizations as bundles of resources which are combined to create organizational capabilities for superior performance (barney, 1991). in this light, we believe that effective utilization of input resources (capital, labour and materials) of the firm for maximum output depends on skills and capabilities possessed through firm-specific factors like size, age, location, experience, age and education of the owner, ownership type and training of employees. most of the previous studies on technical efficiency used capital, labour, and material as input factors of production and found statistically significant contribution on the output of the firm, measured in annual sales turnover (admassie and matambalya, 2002; memon and tahir, 2011). however, the sales turnover of the firm is the function of many factors like price, advertisement and other marketing issues, thus it is not directly related to the technical efficiency of the firm. contrary to previous studies, this study used the unit processed of sunflower oil as a proxy measure of output with similar input factors of production (capital, labour, and material) to determine the technical efficiency level in sunflower oil processing firms. the levels of technical efficiency of sunflower oil processing firms anticipated will indicate whether there would be losses in oil production that could be attributed to inefficiencies due to differences in firm-specific factors or not. next section presents some firm-specific factors that may affect technical efficiency as reported in previous studies. asian journal of economics and empirical research, 2018, 5(1): 79-86 81 2.1. firm-specific factors and technical efficiency of the firm 2.1.1. firm size theoretically, firm size influences technical efficiency. the theory of the passive learning model of firm dynamics by jovanovic (1982) predicts that larger firms are more efficient than smaller ones due to more acquired competence and experience in management. empirically, the firm size is found previously to have a significant and positive relationship with firms’ technical efficiency (admassie and matambalya, 2002; amornkitvikai and harvie, 2011; charoenrat and harvie, 2013). on the other hand, le and harvie (2010) found a significant and negative relationship of firm size with firms' technical efficiency. there are still mixed results depending on countries and sectors analyzed. in this study, we investigate the influence of firm size on the technical efficiency of small scale sunflower oil processing firm (sssopf). 2.1.2. firm age firm age is believed to influence technical efficiency. older firms are considered more efficient than younger ones due to gained experience from past operations. empirically, a positive relationship between age and technical efficiency is noted due to learning acquired through production experience (admassie and matambalya, 2002; batra and tan, 2003; amornkitvikai and harvie, 2011). in contrary, firm age was reported being negatively related to technical efficiency (le and harvie, 2010). for example, niringiye et al. (2010) pointed out that, young firms are more proactive, flexible and aggressive compared to old firms. this study was meant to establish the applicability of these findings in sssopf. 2.1.3. ownership structure ownership type especially sole proprietorship and partnership are reported previously to have a positive relationship with the firm’s technical efficiency (ha, 2006; liao et al., 2010). however, government and state-owned firms were found negatively associated with the firm technical efficiency (le and harvie, 2010; charoenrat, 2012). regardless of the positive and negative association found previously, scholars failed to recommend the most suitable and efficient type of ownership. where do these findings stand on sssopf? this study was meant to bridge this knowledge gap. 2.1.4. location of the firm different locations may affect the technical efficiency of the firm due to transport costs, infrastructure, spillover effects and natural resources (niringiye et al., 2010). firms located in the urban area perform better than those in rural areas (charoenrat, 2012). this is because they are likely to have greater market and credit facilities access, higher managerial training and greater market opportunities. these views are supported empirically in the previous studies. for example, le and harvie (2010) revealed that firms located in urban centres had lower technical efficiency compared to the ones in rural areas. tran et al. (2008) likewise found that firms located in metropolitan areas are more technically efficient than their counterparts located in less developed areas. since there is a noted inconclusive result on the influence of firm location on technical efficiency. this study determines the influence that location may have on technical efficiency. 2.1.5. age of the owner it is believed that, as the person grows older, his/her sense of obligations also gains maturity and resultantly the individuals in the high age group possess more performance (khan et al., 2013). this is theoretically supported by the decremental theory of aging which establishes the relationship between age and performance (giniger et al., 1983). older owners of the firm are therefore expected to display more technical efficiency in their firms than younger ones. empirically, age is positively and significantly related to work performance in other sectors than sunflower oil processing firms (amangala, 2013; met and ali, 2014). on the other hand, birren and schaie (2001) did not find the significant positive relationship between age and work performance. though conflicting results are previously found in other sectors, age was also considered as a variable of interest in this study. 2.1.6. experience of the owner it is believed that owners with high working experience perform better than the ones with low/no working experience something applicable also in sunflower oil processing firms. as one acquire more work experience, s/he acquires more skills, techniques, and methods, that improve performance capabilities (katozai, 2005; nsubuga, 2009). this means that an increase in work experience results in higher job knowledge and task performance. literature also reports that the performance of individuals differs from culture to culture and country to country depending upon the knowledge and experience of the firm owner (ibid). experience of the owner was also considered as one of the factors that could influence the technical efficiency of sunflower oil processing firms. 2.1.7. education level of the owner an education level of the owner is expected to influence the technical efficiency of the firm including sunflower oil processing firms. when an owner increases his/her education level, s/he gains more stock of human knowledge which consequently increases efficiency. this is even supported previously by jude (2007) who revealed that education of an individual plays a significant role in improving the efficiency of the firm by aiding adoption of requisite technologies. thus, we considered that the education level of the owner influence technical efficiency in sunflower oil processing firms. 2.1.8. training of the employees firms with well-trained work-force are likely to be more efficient because of their greater capability in absorbing and effectively utilizing new technology (admassie and matambalya, 2002; zahid and morkhtar, 2007; asian journal of economics and empirical research, 2018, 5(1): 79-86 82 amornkitvikai and harvie, 2011; charoenrat, 2012). could this be the case in sssopf? this study investigated the influence of training employees on the technical efficiency of sunflower oil processing firms. 3. methodology 3.1. study area dodoma and singida regions were purposely selected as the study area to represent a major central agricultural corridor and processing potential of sunflower oil in tanzania. the highest produced amount of sunflower seeds in this area led to the predominance of processing firms along dar-es-salaam to lake zones and arusha highways. however, they are of small-scale and 75% of them operate under capacity despite their big number utilizing only 29% of their installed capacity (tisimia, 2014). the selection of dodoma and singida region was also guided by a study by mpeta (2015) which revealed that the technical efficiency of sunflower seeds producers and processors in this area is inconclusive with steadily declining technical efficiency. 3.2. data a set of primary cross-sectional firm‐level average data was collected from 2013 to 2015 for 219 sunflower oil processing firms by using a questionnaire. the owner-managers were purposely selected and interviewed on important data particularly on the quantity produced on litres, price per litre, a quantity of raw materials used and the price per bag, average daily wages for labour and the number of personnel in their respective firms as they deal with the business daily. 3.3. model specification one stage stochastic production frontier with inefficiency effect model under a maximum likelihood estimate (mle) technique was used in estimating both technical efficiency and their determinants for sunflower oil processing firms simultaneously (battese and coelli, 1995). the mle approach chooses those values of the parameters of the likelihood function that maximize the probability of observing the most precise estimates sample values of the random variables. it is more suitable for efficiency analysis in a developing country like tanzania where there are serious issues with data quality and accuracy. small-scale firms do not keep records and thus data are based on estimates. the model decomposed error term into inefficiency and measurement errors for the purpose. importantly, a series of hypothesis tests were conducted to specify the model that fit the data well either cobbdouglas or translog, the distribution of one-sided error term, whether half normal or exponential and the presence or absence of inefficiency by using the generalized likelihood ratio statistic (lr) given by: where ln{l(ho)} and ln{l(h1)} are the values of the log-likelihood function under the null (ho) and alternative (h1) hypotheses. the results of lr values computed from equation (1) above were compared with critical values from kodde and palm (1986) table for valid and reliable model decision. this suggested that cobb douglas production function fit the data well and thus we fail to reject the null hypothesis, a frontier is cobb-douglas. thus, cobb douglas stochastic frontier functions being a suitable production function, its operational model has been specified as: where yi = total output of sunflower oil originally captured in liters, transformed into ln x1 = total capital invested originally captured in tshs, transformed into ln x2 = total materials used originally in tshs, transformed into ln x3 = labour cost used originally in tshs, transformed into ln vi = random error term with normal distribution n (0, σ2) ui = a nonnegative random variable called technical inefficiency associated with the processing firm ln = the natural logarithm β0 – β1 = coefficients to be estimated the deviation from the actual maximum output (ui) in equation 2 above became the measure of inefficiency, which is the point of interest for this empirical work. it is measured as the function of firm-specific factors as specified in the operational equation below. where ui = the inefficiency term z1 = firm age measured in number of years since the establishment z2 = firm size measured in number of employees z3 = ownership type dummy whether sole proprietor (1) or partnership (0) z4 = experience measured in years (prior and current industrial work experience) z5 = education of the owner in a number of schooling years. z6 = location of the firm dummy whether in singida (1) or dodoma (0) z7 = training of employees whether trained (1) or not trained (0) z8= age of the owner in years α0 -8 = estimated inefficiency model coefficients. parameters in equation (2) and (3) were jointly estimated in a single stage under maximum likelihood estimate technique, indicating the frontier model for the contribution of input to output (a measure of technical efficiency) of the firm and the inefficiency model for inefficiency factors simultaneously. asian journal of economics and empirical research, 2018, 5(1): 79-86 83 4. empirical results and discussion prior to the main findings of the study, the lr summary results of the hypothesis tested on the selection of suitable production function whether cob douglas or translog, the distribution of one-sided error term whether half normal or exponential and presence or absence of inefficiency in sunflower oil processing firms are presented in table 1 below. table-1. log-likelihood test for underlying hypothesis null hypothesis df λ critical values decision 1. h0: βij=0 (frontier is cobb douglas) 6 10. 014 11. 911 do not reject 2. h0: μ = 0. (half normal) 1 6. 034 3. 841 rejected 3. h0: γ = 0, γ = δ0 = δ1 =.... = δ6 = 0 (no inefficiency effect) 6 38. 982 11. 911 rejected source: researcher, 2018 the results on table 1 indicate that hypothesis 1 was not rejected to mean that cobb douglas production function fits the data well. hypothesis 2 was rejected to imply that inefficiency effect is stochastic with an exponential distribution. finally, hypothesis 3 was also rejected to imply the presence of inefficiency in sunflower oil processing firms. 4.1. determinants of technical efficiency table 2 shows the parameters of the stochastic frontier and inefficiency effect model simultaneously estimated under the maximum likelihood estimate (mle) technique. the upper part represents the frontier model parameters revealing the contribution of inputs (capital, labour, and material) to the output of the firms while the lower part indicates the inefficiency model parameters for inefficiency/efficiency factors respectively. table-2. maximum likelihood estimates of the parameters for both stochastic production frontier and inefficiency effect model. log unit produced parameter coefficient std. err z p>|z| frontier model constant 4. 563 2. 252 2. 03 0. 043 ** log capital 0. 792 0. 048 16. 60 0. 001** log materials 0. 126 0. 052 2. 43 0. 015** log labour 0. 179 0. 128 1. 39 0. 164 technical eff. scores mean 0. 529 mini 0. 032 max 0. 792 inefficiency model constant -31. 061 15. 007 2. 07 0. 038** location(singida) -9. 438 4. 708 -2. 00 0. 045** firm size α2 0. 279 0. 441 0. 63 0. 527 firm age α3 2. 205 1. 024 2. 15 0. 032** experience α4 0. 235 0. 361 -0. 65 0. 514 ownership(sole proprietor) -11. 399 5. 692 -2. 001 0. 047** education level -11. 420 5. 584 -2. 04 0. 041** training of employees(trained) 48. 56217 867. 727 -0. 06 0. 955 age of owner 0. 309 0. 150 2. 06 0. 039** #observations 219 wald chi2(4) 11. 48 prob. > chi2 0. 0094 log-likelihood -294. 882 variance parameters σu2 0. 889 λ 0. 769 γ 0. 744 source: researcher, 2018 ** significant at 5% level 4.1.1. frontier model the results in table 2 above indicate that capital contributes positively and significantly to the output of the firms at 5% while material contributes negatively but significantly. a positive direction of capital implies that it is an important determinant of the output in sunflower oil processing firms. an increase in capital will result in an increase in output level by 0. 792%. on the other hand, a negative coefficient of material implies over commitment of materials by sunflower oil processing firms in the production. an increase in material will result in a decrease in output. that is, in where there is inefficiency, firms with more materials perform poorly in output. this is due to seasonality nature of harvested seeds revealed from the field. sunflower seeds are reserved to the farmers before even ready for harvest and purchased during harvesting season regardless of their quality. we also found that sunflower oil processing firms operate at a mean technical efficiency of about 53 % ranges from a minimum of 3. 2 % to a maximum of 79. 2 %. this implies that there is an opportunity for firms to increase their current level of output by 47 % on average at the same level of inputs and technology. additionally, the estimated variance parameters represented by sigma squared (σu2), lambda (λ) and gamma (γ) as indicated in table 2 support the presence of inefficiency. the value of the sigma square (σu2), is large of 0. 88 significantly different from zero to imply goodness of fit and correctness of the distributional form assumed for the composite error term. this is supported by the greater value of lambda (λ) of 0. 769 indicating the dominant share of the one-sided error term, u. also, the quite large value of gamma (γ) of about 0. 744 justifies that a greater part asian journal of economics and empirical research, 2018, 5(1): 79-86 84 of the residual variation in output among small-scale sunflower oil processing firm is associated with the firm inefficiency rather than measurement errors. thus, the dominance of the one-sided error component in the model means further that, the average production function (ordinary least square, ols) is inadequate in representing the data. 4.1.2. inefficiency model conversely, a negative sign on the inefficiency effect model parameter means that the variables reduce inefficiency while the reverse is true for a positive sign. the results in table 2 above indicate that location of the firm, ownership type and education level of the owner related negatively while firm age and age of the owner related positively but significantly to the inefficiency model for sunflower oil processing firms as explained below: 4.1.2.1. location of the firm location of the firm contributes negatively and significantly to the inefficiency of sunflower oil processing to imply that technical inefficiency decreases with the location of the firm. since the location was captured as dummy 1 for a sunflower oil processing firm operating in singida and 0 for those located in dodoma. keeping dodoma as a reference category, the negative sign with location implies that sunflower oil processing firms located in singida are more likely to reduce inefficiency as compared to those in dodoma. this is due to the high production of sunflower seeds across districts. this is in line with tanzania edible oils actors association [teosa] (2012) ranking. one of the reason could be the existence of improved infrastructure and transport networks connecting districts for easy access and transport of raw materials and availability of electricity and water supplies to facilitate processing of sunflower oil as well. likewise, these firms have greater access to labour, information and communication technology infrastructure. these study findings are in line with the study by tran et al. (2008); le and harvie (2010) and charoenrat (2012). 4.1.2.2. ownership type the legal ownership of the firm was captured as dummy 1 for sole proprietorship and 0 for partnership, thus as compared to the partnership, sole proprietorship revealed a negative and significant relationship with the technical inefficiency of sunflower oil processing to imply that inefficiency of sunflower oil processing firms’ decreases with being a sole proprietor. although a partnership type of ownership, have the benefits of allowing the owner to draw on resources and expertise of co-partners, share risk and management skills and solve barriers to doing business collectively but a sole proprietor has a complete control within the parameters of the law and decision-making power over a business, which is crucial for small-scale firms. the findings are in line with the study by ha (2006). 4.1.2.3. education level of the owner the education level of the owner revealed a negative and statistically significant relationship with the inefficiency effect model as theoretically expected. this means that technical inefficiency in sunflower oil processing firms decreases with the education level of the owner. this implies further that one additional year of schooling enhances the technical efficiency of the sunflower oil processor to great extent. in the same way, education level enhances the stock of human knowledge which consequently increases efficiency. this finding is in line with the study by jude (2007) on technical efficiency of rice producers in uganda which revealed that education of an individual plays a significant role in improving the efficiency of the firm by aiding adoption of requisite technologies. well educated owners are expected to make rational decisions that improve efficiency. most of the sunflower oil firms are owner managed with highly centralized decision-making power thus education of the owners positively influence the efficiency of the firm independently of the workforce capabilities. 4.1.2.4. firm age the results indicate that firm age is positively and statistically significantly related to technical inefficiency in sunflower oil processing firms. this implies that inefficiency in sunflower oil processing firms increases with the age of the firm. therefore, older processing firms are less efficient than younger firms. older firms may have more experience but this can be offset by greater indifference through possession of older machinery as most of them own single refined machines rather than double refined ones. it becomes too expensive for them to fragment the old machines, for instance, single refined for a double refined one and hence efficiency decreases. old firms may not be willing to try new innovation and technology due to financial constraints. the findings of this study conform to the findings by le and harvie (2010); niringiye et al. (2010) and amornkitvikai and harvie (2011) on the technical efficiency of other manufacturing firms while contrasting with the study findings by admassie and matambalya (2002); batra and tan (2003); amornkitvikai and harvie (2011). this might be due to differences in the nature of the firms involved in the study. 4.1.2.5. age of the owner the age of the owner was included to control the age difference and found to be positively and statistically significantly related to the technical inefficiency in sunflower oil processing firms. this implies that inefficiency in sunflower oil processing firms increases with the age of the owner. this can be contributed by poor mobility and low production motives despite their greater practical problem-solving ability. in other words, they grow older and get past their productive age. also their flexibility and willingness to make fundamental strategic changes of business directions diminishes. these results are also consistent with studies in other sectors conducted in tanzania (hawassi, 2006; isaga, 2012; tundui, 2012). however, the experience of the owner, firm size and training of employees were not statistically significant determinants of technical efficiency but had a negative sign with inefficiency model. asian journal of economics and empirical research, 2018, 5(1): 79-86 85 5. conclusion and policy implication this study examined the determinants of technical efficiency among small-scale sunflower oil processing firms in tanzania using a one-stage stochastic production frontier based on cob-douglas function under mle. it was revealed that sunflower oil processing firms operate at the mean technical efficiency of about 53% with capital and materials input contributing significantly to the output. this implies that nearly 47 percent technical potentialities are not achieved, which means an opportunity that the level of sunflower oil can be improved under the same inputs and technology. location of the firm, education level of the owners, ownership type, firm age, and age of the owner are significant determinants of technical efficiency in sunflower oil processing firms in tanzania. efficiencyenhancing measures can, therefore, be considered to bring a considerable gain in oil processing, particularly affordable industrial location areas may be designed to cluster sunflower oil processing according to their size for easy accessibility and support services, sole proprietorship form of ownership may be encouraged through credit empowerment with accessible and affordable loans to individuals due to collateral issues. likewise, improvement of the capability of owner-managers through adult education, seminars, and training given their level of education they possess may also be thought. entrepreneurial awareness may be natured from primary to higher level curricular for young and middle-aged since they have been identified as an investment group. lastly, since an increase in the age of firms leads to a 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https://scholar.google.com/scholar?hl=en&q=firm%20size%20and%20technical%20efficiency%20in%20east%20african%20manufacturing%20firms https://scholar.google.com/scholar?hl=en&q=firm%20efficiency%20in%20a%20transitional%20economy:%20evidencefrom%20vietnam http://dx.doi.org/10.1111/j.1467-8381.2008.00268.x https://scholar.google.com/scholar?hl=en&q=examining%20retailing%20performance%20via%20financial%20index 147 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 2, 147-152, 2020 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2020.72.147.152 © 2020 by the authors; licensee asian online journal publishing group impacts of human resource management on the financial performance of vietnam joint stock commercial bank for industry and trade van dung ha1 quoc buu nguyen 2 hai nam tran3 ( corresponding author) 1,2,3banking university ho chi minh city, vietnam. abstract the aim of this paper is to investigate impacts of human resource management on financial performance of vietnam joint stock commercial bank for industry and trade (vietinbank). the study employs both qualitative and quantitative methods for analysis. qualitative method is used to finalize the questionnaire while quantitative method is used to test the research hypotheses via measurement scales, descriptive analysis, efa analysis, correlation coefficients, and linear regression model. the data is collected from 250 employees working at different branches of vietinbank in vietnam. the results show that these 7 factors: selection, training, job description, performance appraisal, compensation system, career planning, employee participation have significant impacts on the financial performance of vietinbank. keywords: human resources, financial performance, scales, hypotheses, training, commercial banks. jel classification: j2; o15; j24. citation | van dung ha; quoc buu nguyen; hai nam tran (2020). impacts of human resource management on the financial performance of vietnam joint stock commercial bank for industry and trade. asian journal of economics and empirical research, 7(2): 147-152. history: received: 23 march 2020 revised: 27 april 2020 accepted: 29 may 2020 published: 25 june 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 148 2. literature review and research design ................................................................................................................................... 148 3. methodology ................................................................................................................................................................................... 149 4. research results ............................................................................................................................................................................ 149 5. conclusion ....................................................................................................................................................................................... 151 references ............................................................................................................................................................................................ 151 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.72.147.152&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1777 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1777 asian journal of economics and empirical research, 2020, 7(2): 147-152 148 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to existing literature by investigating the impacts of human resource management on financial performance of vietnam joint stock commercial bank for industry and trade. 1. introduction banking industry has played an important role in supporting national as well as global economic growth. in vietnam, the banking system, at the discretion of the government, has helped the country achieve its goal of growth, macroeconomic stability, and inflation control by flexible utilization of different monetary policy tools during tough economic times. in particular, from mid-2012 up to now, the macro economy of vietnam has been gradually stabilized with a steady decrease of consumer price index (cpi) towards the control level. however, in early years of the period, the economic growth encountered many obstacles such as decreased demand, high inventories, and slow economic growth. at that moment the banking industry prioritized developing and immensely implementing flexible solutions to support the growth of the economy. noticeably, interest rates have been reduced to increase firm’s access to capital sources. in addition, a series of credit programs and policies, which contribute to the economic development and social security have been effectively operated. up to now, the system of commercial banks in vietnam has developed on a large scale, and become a key source of capital in the economy. by 2015, the commercial banking sector accounted for a very large proportion with total assets of 75% out of those in the whole financial system, in which, its total outstanding credit was up to 4,656 trillion vnd, equal to 111% of gdp. with such a large scale, bank credits are considered as the main capital source of the economy, accounting for 40-45% of the total investment capital. in the overall success of the industry, state-owned commercial banks have performed a key role in leading the whole sector in implementing the policies of the government and the industry. by the end of 2015, the state-owned commercial banks sector consist of 4 banks (agribank, bidv, vietinbank, vietcombank) accounting for 45% of total assets, 50.2% of total outstanding loans and 46.3% of mobilized capital of the whole system. over the period of 2011-2015, state-owned banks made a major contribution to the growth with an average growth rate of total assets at 13.8% per year, higher than that of the whole system at 10.3% per year, and particularly the credit grew at 17.1% per year compared to 13.5% per year of the banking industry. vietnam joint stock commercial bank for industry and trade (vietinbank) was established in 1988 and it is a state-owned commercial bank. the bank has a wide network of 155 branches, 09 member companies, 03 nonbusiness units and more than 1,000 transaction offices in 63 provinces/cities nationwide. also, vietinbank is the first and only the bank, which has branches in europe: two branches in frankfurt and berlin germany. at the same time, vietinbank has been present in vientiane – laos, and is actively promoting the opening of representative offices and branches in many other countries such as myanmar, england, poland, czech republic, etc. therefore, human resource management must be taken into account as an essential part of the bank's operational management. given that insight, this paper is conducted to evaluate how human resource management has affected financial performance of vietinbank. 2. literature review and research design 2.1. literature review human resources are defined as people within organizations, which should be studied in discrete aspects. in the narrow sense, they involve groups of working-age population with full physical and mental working capacity, thus equivalent to labor sources. in the broad sense, they involve those who are full 15 years of age or older. human resources are generally considered in two dimensions, quantity and quality, so human resource development is related to both of them. however, at present, nationally and globally, the quality of human resources is the top concern so it is the main focus of human resource development activities. human resource development is the process of improving the quality and efficiency of exploiting human resources. morrison (1996) proposed a model of human resource management (hrm) that included 6 components: (1) philosophy of hrm; (2) recruitment; (3) job description; (4) socialization; (5) training; (6) assessment and rewards. in particular, the philosophy of hrm is a system of policies, points of view, assessments as well as beliefs of administrators about their employees; socialization means that employees are empowered to participate in the planning and decision making process of their organization's general activities. guest (1997) proposed a model of hrm consisting of 7 components: (1) selection; (2) training; (3) appraisal; (4) rewards; (5) job design; (6) involvement; (7) status and security. according to pfeffer (1998) there were 7 components in hrm: (1) ensuring job security; (2) recruiting new employees; (3) building autonomous and decentralized teams in decision making; (4) setting high salary in relation to results; (5) expanding training; (6) reducing position gaps and barriers such as pay gap; (7) encouraging to share information and financial results within the organization. according to the research model of marwat, m., and ramay (2011) on hrm and employee performance, hrm include 07 components: selection; training; performance appraisal; career planning; compensation; employee participation; job description. qureshi, ramay, and marwat (2007)surveyed the impacts of factors: selection, training, performance appraisal system, compensation system, and employee participation on organizational performance. the results showed that among these factors, only the selection, training, and employee participation factors had positive impacts on organizational performance. consistent with these findings, singh (2004) found that there was a positive relationship between several human resource management such as recruitment, performance evaluation, training, and compensation system and employee engagement with company performance. among these factors, only training and compensation systems have a positive impact on performance of the company and its market. also, wan, ong, and kok (2002) examined the relationship between hrm and organizational performance. the former have created a positive effect on the later. calculation results through a regression method suggested that effective asian journal of economics and empirical research, 2020, 7(2): 147-152 149 © 2020 by the authors; licensee asian online journal publishing group implementation of key hrm enhance organizational performance. on the other hand, companies concerned about improving employees' performance should stress the need for empowerment and training. according to qureshi, akbar, khan, sheikh, and hijazi (2010) 7 factors of human resource management have effects on financial performance of banks including selection, training, job description, performance appraisal, compensation system, job planning, and employee engagement. 2.2. research model this study identifies different elements of human resource management that affect the financial performance of vietnam joint stock commercial bank for industry and trade (vietinbank). based on the model of qureshi et al. (2010) the research paper has selected the following factors: selection, training, job description, performance appraisal, compensation system, job planning, and employee participation. the expected signs of coefficients or the directions of impacts are also shown in the proposed model in figure 1. figure-1. proposed research model. 3. methodology the quantitative method employs the interview techniques by emails and questionnaires. the sample of 250 employees is randomly selected in vietinbank’s system. the collected data is processed by the software spss 20, then cronbach's alpha test will be used for assessments on the reliability of scales, also barlett and kmo tests are adopted for exploring factor analysis (efa). meanwhile, regression analysis will be used to measure the impacts of human resource management. 4. research results 4.1. cronbach's alpha analysis after the first cronbach's alpha analysis, the results in table 1 show that cronbach's alpha equal to 0.588. however, the correlation value of the total variable of fp4 and fp5 are -0,116; 0.060 less than 0.3 (invalid for the reliability analysis). therefore, the author removes the fp4 and fp5 variables of the financial performance factor and performs the second reliability test. after that, the researcher obtains a cronbach's alpha coefficient of 0.817 (greater than 0.6, valid for the reliability analysis) and all correlation coefficients of variables are greater than 0.3. therefore, the variables fp1, fp2, fp3 which belong to the financial performance group are suitable to be included in the next analysis step. table-1. cronbach's alpha analysis results. factor before analyzing cronbach's alpha after analyzing cronbach's alpha number of variables at first coefficient cronbach's alpha number of variables selection 4 0.936 4 training 6 .926 4 (remove t5, t6) job description 4 0.830 3 (remove jd4) performance appraisal 7 0.825 5 (remove pa6, pa7) compensation system 5 0.925 4 (remove cs5) career planning 7 0.829 4 (remove cp5, cp6, cp7) employee participation 3 0.764 3 financial performance 5 0.817 3 (remove fp4, fp5) after the analysis and evaluation of the reliability of the scales, it is concluded that 41 scales (including variables of dependent and independent factors) are all eligible, except for the t5, t6 (of training factors), jd4 (of job description factor), pa6, pa7 (of performance appraisal factors), cs5 (of compensation system factors), cp5, cp6, cp7 (of career planning factors), fp4, fp5 (of financial performance factors). all of the remaining scales (30 scales) are, therefore, included in the analysis of the following sections. asian journal of economics and empirical research, 2020, 7(2): 147-152 150 © 2020 by the authors; licensee asian online journal publishing group 4.2. results of exploratory factor analysis (efa) 4.2.1. exploratory factor analysis of independent variables all 28 variables belonging to independent factors that satisfied cronbach's alpha reliability analysis are included in the exploratory factor analysis (efa). the efa's mission is to explore the structure of the factors affecting financial performance through 7 factors: s (selection), t (training), jd (job description), pa (performance appraisal), cs (compensation system), cp (career planning), and ep (employee participation). after ensuring proper implementation of the efa process, these factors will be tested for data cleaning. performing the efa analysis for a total of 28 variables of the independent factors affecting financial performance, the study obtains the following results in table 2. table-2. kmo test of variables with independent factors. criteria value kmo 0.643 bartlett's test of sphericity approx. chi-square 6720.983 df 351 sig. 0.000 after the factor analysis of variables of independent factors, the paper obtains kmo coefficient = 0.643 with sig. = 0.000. this result shows the appropriateness of exploratory factor. the chi-square statistic of bartlett's test is 6,720.983 with significant level of 0.000. at the same time, the analysis of variance shows that the average variance extracted reaches 75.038%, this value is quite high. so it could be said that 75.038% of variation is explained by 7 factors, from which the scales are built and accepted. the stopping point when extracting factors from the seventh factor group with eigenvalue value is 1.361, greater than 1 (which ensures the inclusion of variables of these factors into the following analysis steps. variables are classified into 7 groups of factors). table-3. rotated component matrix. component 1 2 3 4 5 6 7 s3 0.974 s4 0.974 s1 0.974 s2 0.691 t3 0.974 t2 0.969 t4 0.949 t1 0.710 cs3 0.931 cs4 0.929 cs2 0.849 cs1 0.800 pa3 0.860 pa4 0.834 pa2 0.779 pa1 0.743 pa5 0.609 cp3 0.855 cp2 0.804 cp4 0.801 cp1 0.760 jd3 0.885 jd2 0.858 jd1 0.814 ep1 0.832 ep2 0.778 ep3 0.706 the rotated component matrix results (in table 3) indicate the number of coefficients. they all met the requirements (the factor loadings are greater than 0.5) and are arranged into 7 separate groups of factors, including s (selection), t (training), jd (job description), pa (performance appraisal), cs (compensation system), cp (career planning), ep (employee participation). 4.2.2. efa of financial performance the scales of financial performance are built to survey financial performance. it included 3 variables fp1, fp2, fp3 which are put into the efa factor analysis. table-4. efa analysis results. criteria value kmo 0.710 bartlett's test of sphericity approx. chi-square 268.807 df 3 sig. 0.000 asian journal of economics and empirical research, 2020, 7(2): 147-152 151 © 2020 by the authors; licensee asian online journal publishing group the table 4 indicates that the kmo is 0.710. this result shows the appropriateness of exploratory factor. the chi-square statistic of bartlett's test is worth 268.807 with significance = 0.000. the kmo test result, therefore, is proven to be completely statistically significant at the level of 5%. along with that, the factor loadings of the component variables fp1, fp2, fp3 are respectively 0.850; 0.883; 0.841 (all greater than 0.5), which implied that the component variables of the factor financial performance are valid for the data analysis. in general, the efa of financial performance confirms appropriateness of dependent variable so that the paper could perform a regression analysis, in which the factor financial performance is assigned as a dependent variable. 4.3. regression analysis this regression analysis aimed to determine the degree of influence of independent factors on fp factor (financial performance). the results from linear regression indicate that the total significant value of independent factors is less than 5%, which means that these 7 factors: s (selection), t (training), jd (job description), pa (performance appraisal), cs (compensation system), cp (career planning), ep (employee participation) significantly affect financial performance. consequently, the regression equation (according to the non-standardized coefficient) of the model showing the effects of s (selection), t (training), jd (job description), pa (performance appraisal), cs (compensation system), cp (career planning), ep (employee participation) is presented as follows: fp = -0.754 + 0.150*s + 0.205*t + 0.120*jd + 0.078*pa +0.135*cs + 0.110*cp + 0.350*ep + ei the most influential factor on the financial performance is the employee participation (the beta is 0.350). the higher employee participation is, the better is finance performance (one additional unit of the ep leads to an increase of 0.350 units of the fp). the second large is t (the beta is 0.205). the fp increased 0.205 units for every increase of one unit in the t. the next one is the s factor, then come cs, jd, cp, and pa. based on the standardized beta, the level of impact of independent factors on financial performance is given in table 5. table-5. degree of impact of factors. factor level of impact (1strongest ) employee participation 1 training 2 selection 3 compensation system 4 job description 5 career planning 6 performance appraisal 7 it could be seen that, as for vietnam joint stock commercial bank for industry and trade, the level of impact, in order from high to low is as follows: employee participation, training, selection, compensation system, job description, career planning, and performance appraisal. 5. conclusion based on the previous research and theories related to analyzing the impact of human resource management on financial performance, the researcher synthesized and proposed a research model including independent factors: s (selection), t (training), jd (job description), pa (performance appraisal), cs (compensation scheme), cp (career planning), and ep (employee participation) while fp (financial performance) is the dependent variable. the paper conducts qualitative research to correct and supplement errors if any and then proceeded to create a survey form and undertook an official investigation to collect opinions of employees at vietinbank's branches. after that, a review of the collected questionnaires to see whether they are appropriate or not is held, and followed by a statistical process in the shape of a preliminary step towards the analysis. with the collected database, the author ran the spss software to produce information statistics of the surveyed individual subjects as well as performed the main task of analyzing and evaluating the impact of human resource management on the financial performance of vietnam joint stock commercial bank for industry and trade. after presenting the fundamental theories about human resources, human resource management and especially domestic and foreign studies in detecting and analyzing influence factors of human resource management on improving financial performance, the researcher proposed 7 main factors of human resource management affecting fp (financial efficiency), namely: s (selection), t (training), jd (job description), pa (performance appraisal), cs (compensation system), cp (career planning), ep (employee participation). the researcher then conducted an analysis to evaluate the reliability of the scales. the results showed that 41 analyzed scales (including the scales of dependent and independent factors) all met the requirements, except for the scales t5, t6 (training factors), jd4 (job description factor), pa6 and pa7 (performance appraisal factors), cs5 (compensation system factor), cp5, cp6, cp7 (career planning factors), fp4, fp5 (financial performance factors). these invalid scales are removed from the next analysis. the results of factor analysis showed that all variables belonging to independent factors met the analysis requirements (the factor loadings are greater than 0.5). the total of 28 component factors are arranged into 7 separate groups of independent variables, namely, s, t, jd, pa, cs, cp, and ep. the results of the linear regression model showed that all 7 independent variables have positive impacts on financial performance of vietinbank. it means that the effects of independent variables on financial performance of vietinbank are as expectation. references guest, d. e. 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(2002). strategic human resource management and organizational performance in singapore. compensation & benefits review, 34(4), 33-42.available at: https://doi.org/10.1177/0886368702034004006. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. http://www.academia.edu/770358/impact_of_human_resource_management_hrm_practices_on_employees_performance http://www.academia.edu/770358/impact_of_human_resource_management_hrm_practices_on_employees_performance 183 asian journal of economics and empirical research vol. 5, no. 2, 183-190, 2018 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2018.52.183.190 impact of population, gdp and energy consumption on carbon emissions: evidence from pakistan using an analytic tool ipat abdul mansoor1  baserat sultana2 ( corresponding author) 1department of economics, university of wah, pakistan 2university of wah, pakistan abstract this study examines the relationship between co2 emission, economic growth, population and energy consumption in pakistan during period of 1975-2016. the study evaluates ipat (impact of co2 x population x affluence x technology) hypothesis where co2 emission is influence by high population growth, economic growth, and technology. the study use ardl bounds testing approach to estimate short and long run elasticities. the results confirm that population growth and energy demand both increase the co2 emission, while the relationship between gdp and co2 emissions is negative in long-run, because the development of new low-carbon technologies enables a country to reach the same production level but at lower co2 emissions, that improve the air quality indicator in a country. the results conclude that ipat hypothesis is verified in pakistan economy. where population growth influenced the environmental quality, the government should have to control high mass population growth by increasing family planning expenditure in a country. the renewable energy resources are further policy implication that is desirable to reduced energy associated emission in a country. keywords: population, gdp, energy, co2, ipat. jel classification: o14; o33; o44. citation | abdul mansoor; baserat sultana (2018). impact of population, gdp and energy consumption on carbon emissions: evidence from pakistan using an analytic tool ipat. asian journal of economics and empirical research, 5(2): 183-190. history: received: 10 july 2018 revised: 16 august 2018 accepted: 24 september 2018 published: 29 october 2018 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 184 2. literature review .......................................................................................................................................................................... 184 3. research methodology ................................................................................................................................................................. 185 4. results and discussions ................................................................................................................................................................ 187 5. conclusion ....................................................................................................................................................................................... 189 references ............................................................................................................................................................................................ 189 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2018.52.183.190&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/258 https://orcid.org/0000-0002-0221-3718 https://orcid.org/0000-0001-7769-3798 http://asianonlinejournals.com/index.php/ajeer/article/view/258 https://orcid.org/0000-0002-0221-3718 https://orcid.org/0000-0001-7769-3798 http://asianonlinejournals.com/index.php/ajeer/article/view/258 https://orcid.org/0000-0002-0221-3718 https://orcid.org/0000-0001-7769-3798 http://asianonlinejournals.com/index.php/ajeer/article/view/258 https://orcid.org/0000-0002-0221-3718 https://orcid.org/0000-0001-7769-3798 asian journal of economics and empirical research, 2018, 5(2): 183-190 184 1. introduction global warming and global climate changes recently has become most important issue worldwide. greenhouse gasses are increasing day by day. the worse effect of these gasses is usually faced by developing countries. co2 is one of the major sources of greenhouse gasses. it could become cause of enhancing the overall earth‟s temperature. a study conducted by intergovernmental panel in 2007 on the changing of climate, according to that report within next 100 years, the average global temperature would be increase. this report threatens that additional increase in the temperature would hamper the eco system and this could be cause of rise sea level that would be harmful for those people who are living in coastal areas. co2 emission directly affect the quality of water and land which will leads to further increase in the intensity and frequency of extreme flood, water uncertainty, high temperature, soil degradation etc. responsible for global warming, which will affect socio sustainability of country, naqvi and rehm (2014). the kyoto protocol is an international treaty which extends the 1992 united nations framework convention on climate change (unccc) that commits state parties to reduce greenhouse gas emission. the purpose of kyoto protocol is to minimize the risk of extreme events that are caused by change in climate by reduction the emissions level of ghgs... there are two main objectives of kyoto protocol. first one is policy approach that improvement in consumption of energy and carbon sinks, in also includes improvements in sustainable forms of agriculture sector with respect to climate change. (b) second approach is quantitative approach that is very much important for developed countries in order to minimize the quantity of emission. that includes include that it is necessary for developed countries to reduce their emissions by 5% on average. according to kyoto protocol the renewable energy is one of the major key solutions of global climate change, tiwari (2011). the developing country such as pakistan growing very quickly and on a fast track of modernization with the speedy economic development, as well as rise in income level, urbanization and other socio-economic drivers, so lifestyle of people in pakistan have changed remarkably. there is a heavy investment on infrastructure, heavy production leads to creating emission of co2 and become an important cause of environment degradation. in order to have of sustainable economic development there should be taken some steps to stop or control the co2 emission. this paper is an investigation on the driving force of co2 emission (such as, gdp per capita, energy consumption and population) in pakistan. population, it is a factor that leads to environment degradation. population size is closely associated with some source of emissions, i.e. increase in population causes to increase in consumption, which have to fulfill by increase in production. production activities also produce leftover waste product, called „residuals, which may be led to pollution and degradation of the natural resources. dietz and rosa and yark, rosa and dietz focus on co2 emission by using ipat model. they find the elasticity between them is close to unity i.e.-e 1% increase in population approximately leads to 1% increase in co2 emission. but according to the theory of “julien siemon and simon kuznets” who said that “increase in population can create more genius and there may be technology advancement.” however, a man is co2 emitter and resource consumer, so population is directly related to environment degradation. ehrlich agreed that population not exhausted resources and change points as environment degradation start, so emission is the function of population in the context of natural resources. affluence, it is economic activity per person. it can be taken as life style and gdp per capita which is one of the key factors contributing of co2 emission. a very close and strong relationship between economic development and environment quality has been widely taken into consideration. according to “environment kuznets curve hypothesis”, there is an existence of inverted u-shaped relationship between environment degradation and economic development. this hypothesis was first advanced by famous economist simon kuznets in 1950s and 60s. in order to consider sustainable development, it is very important to find relationship that is in the form of a ushape curve, which means that simon kuznets found that in the initial stage of economic development, the environmental degradation increase with increase in per capita income, and after a specific level, any further increase in per capita income decrease the environmental degradation. energy consumption is also a source of enhancing the temperature of earth through the emission of gas by use of fossil fuels, menyah and wolde-rufael (2010). as burning of fossil fuel is a major contributor to pollution. in pakistan, more than 98% non-renewable (fossil fuels) energy is consuming, which is a big cause of pollution, which may be led to environment disaster, sheikh (2010). to organize our analysis, we employ the ipat model (i= p x a x t) to evaluate the significance of factors that contributes to co2 emission... where i = impact on co2, p = population, a = affluence (gdp) and t = technology (energy consumption). ipat model is very easy to understand, widely utilize framework for addressing the driving forces of environmental change, chertow and lombardi (2005). this study chose the ipat model because this model is able to correctly identify the relationship between the factors that are drivers of co2 and quality of environment. according to the results of a study conducted in pakistan, 1% increase in energy consumption and population will lead to an increase in co2 emission per capita by 0.005% and 9.70% respectively (naqvi and rehm, 2014). in the light of above discussion, it is concluded that this issue of environment degradation needs to take into consideration. for this it is necessary to find out the real driving factors of environment degradation and have to estimate the impacts of all them. by apply the new technology ardl we can find more significant and accurate results. 2. literature review mikayilov et al. (2018) conducted a study to examine the relationship between economic growth and co2 emission in azerbaijan. data is taken on time series basis over the period 1992-2013. a co-integration analysis is conducted, and results show a positive relationship between economic growth and emission in long run. nilrit et al. (2017) highlight the impact of urbanization and energy consumption on carbon dioxide emission in the economy of thailand. data is taken from 1971 to 2010. there results found positive impacts of energy consumption and technology on co2 emission in long run as well as in short run in thailand, while urbanization is not strongly correlated with co2 emission and environmental issues. asian journal of economics and empirical research, 2018, 5(2): 183-190 185 zaman et al. (2015) investigate the major drivers effecting long run and short run co2 emission on the bases of time series data from 1980-2011 is taken for study by using the multivariate cointegration approach the results indicate that there is significant negative short run relationship between economic growth and co2 emission i.e.-e by introducing low co-emission technologies relationship between economic growth and co2 emission is also negative in long run. yeh and liao (2017) pointed out the impact of economic growth and population on emission of co2 in developing countries. time series data is taken 1990-2014 in taiwan. an analytical tool of stochastic impacts by regression on population, affluence and technology was employed and results suggested two models that gave prediction about the impact of co2 emission caused by population and economic growth by the year 2025. aye and edoja (2017) examined the impact of economic growth the impact of economic growth on emission of co2. the study found positive effect of economic growth on co2 emission, which means that increase in economic growth leads to increase in co2 emission. mikayilov et al. (2018) study the relationship between energy consumption gdp and population on transportation pollution in azerbaijan. time series data from 1990-2014 is taken to examine the impacts. results suggested that‟s there is also positive relationship between population and emission from transportation in azerbaijan, while gdp also have a positive but insignificant relationship with pollution from transportation. yang and zhao (2014) study is based on highlighting the impacts of energy consumption, population density, and gdp and trade openness on emission of co2 in the context of india. ardl is applied and result shows a short rum and long run relationship between dependent and independent variables. between all independent variables, population is most strongly influencing factor of emission of carbon dioxide. kais and hammami (2015) examined the influence of energy consumption and co2 on economic growth. panel data of 58 countries was taken for this study by using simultaneous equation model results shows the increase in energy consumption leads to increase in economic growth and increase in co2 decrease the economic growth. naqvi and rehm (2014) highlight the link among co2 per capita, energy consumption, gdp per capita and population growth in pakistan‟s economy. ardl technique was employed and data is taken from 1970 to 2010 that is of 41 years. the econometric result shows that energy consumption, population growth and gdp per capita have long run positive relationship. as they found that 1% increase in population, energy consumption and gdp per capita will increase the emission of co2 0.46%, 9.70% and 0.005% respectively. al-mulali and sab (2012) analyze the relationship between energy consumption on economic development. panel data of 19 countries was taken over the period of 19802008. result shows positive relationship between energy consumption and economic development. tiwari (2011) conducted a study to addressing the energy consumption and economic growth as major drivers of co2 in the economy of india. by using granger approach in var framework. their finding shows increase in co2 emission would increase in energy consumption and capital but increase the population and gdp per capita; on the other hand, energy consumption has positive relationship with co2 emission and gdp, and negatively correlated with capital and population. essien (2011) analyzed relationship between gdp and co2 emission for nigeria. rigorous econometrics was employed and employed, and results suggest that co2 and gdp have a strong relationship and elasticity between co2 emission and income is increasing day by day. according to them there is an existence of environmental kuznets curve with a reasonable u-shape turning point. apergis and payne (2009) examined the relationship between energy consumption co2 emission the relationship between energy consumption co2 emission and output in france. data is taken from 1971 to 2004.the found that there is positive relationship between co2 and energy consumption. liu (2005) examined the impact of gdp on co2 emission. according to results there is a negative relationship between income and co2 emission. according to these previous findings, it is concluded that in some country‟s relationship between gdp and co2 emission is positive; while in some other countries it is negative. it is also observed that in some countries the relationship between gdp and co2 emission is different in different time period, as in some countries the relationship is negative in short run while in long run it is positive, that create a ushape curve, which proves holding of environment kuznets curve hypothesis. on the other side, the result regarding the impacts of population and energy consumption on co2 emission is almost similar in all above mentioned studies. as energy consumption and population density both have a positive relationship with co2 emission. our study is conducted to check the relationship between these variables in the context of pakistan economy. 3. research methodology as discussed above, the “ipat” has been employed as a tool to describe the impact on environment (i) due to size of population (p), affluence (a) and technology (t). this study employ‟s a time series data of pakistan from 1972 to 2016. in this study, we attempted to select the co2 emission as the dependent variable, and on the other hand population, gross domestic product, and energy consumption are explanatory variables. data of these variables is taken from the world development indicators (wdi) publish by world bank development indicators (2017). in this study auto, regressive distributive lag model is applied to get the efficient results. ardl is basically a standard least squares regression that involves the lags of independent and dependent variables. as it is introduced by the pesaran et al. (2001). before applying auto regressive distributive lag model there are some preconditions that must be fulfill. the conditions are mentioned below. all the including variables are nonstationary at i (0) and i (1) level. no variable is non-stationary at i (2) process, we never apply ardl if any variable is non-stationary at i (2). economic analysis suggested the long run relationship between variables due to constant means and variance. but sometime means and variances change with the time due to this it would not give a satisfactory result. so, in this situation ardl co-integration and bond co-integration technique is applied. ardl is not required that all the variables are nonstationary at i (0) but it handle i (0), i (1) or both at a time. by using f-statistics it also tells the short term and long-term relationship among the variables. if the value of fstatistics is greater than the critical asian journal of economics and empirical research, 2018, 5(2): 183-190 186 value of upper bond, then it shows the long run relationship among the variables or if the value of f-statistics is smaller than the critical value of lower bond than relationship between variables is short term. the advantage of this model is that it can handle the multiple vectors. although ardl is not applied when variable have i (2). in the case of forecasting it is very necessary to follow the basic conditions of ardl. if these conditions are not fulfilling, then the model is miss-specified and unrealistic with its implication on forecasting and policy (nkoro and uko, 2016). 3.1. methodology this study employs ardl to estimate the relationship between the co2 emissions, energy consumption population and economic growth. this model is going in a specific following manner first we check the optimal lags then further we check the short run and long run relationship among the variable. and finally check the stability and model convergence. 3.2. econometric model based on the ipat, model proposed to describe impact on carbon dioxide emission (i) in pakistan, with the selected variables such as population (p), gross domestic production (a), energy consumption (t), co2 = β0 + β1pop + β2 enr + β3gdp + ε where co2 shows the co2 emissions (kg per 2010 us$ of gdp) , pop shows the population growth and enr shows the energy use kg of oil equivalent per capita , gdp shows the gdp per capita (constant 2010 us$) , β0 represent the intercept and ε shows the error term. 3.3. unit root tests it is already discussed that ardl can estimate those variables that have no unit root at i (0) and i(1) or both, means variables that are stationary at level or 1st difference can only be estimated. but if variables are stationary or have no unit root at i (2) then it is not able to apply ardl (pesaran et al., 2001) because it breaks the assumption of bound testing. in order to check the unit root, we apply the augmented dickey-fuller test (adf) in which null hypothesis is that there is a unit root and alternative is there is no unit root. augmented dickey-fuller statistic includes the negative numbers. in a case if the value of tstate is negative then there is a large chance to reject the null hypothesis at any level of significance. it may be 10% or 5% (march 2009). ∆yt= α + βt+γyt-1 + δ1∆yt-1 in this equation α shows the intercept, β shows the slope, p is the lag order by employing the restriction that is α=0 and β=1 corresponding the modeling of random walk. we have the following two approaches, first one is to check the t-value of coefficient and other is to check the information criteria that are akaike information criterion, hannan-quinn information criterion and bayesian information criterion. unit root also implies that null hypothesis is that γ=0 and alternative is γ<0. dft = γ/ s.e (γ) if the value of t-statistic is calculated from the above equation, then compare it with the critical value of dickeyfuller test. if the value of t-state is less than the critical value, h0 is rejected it means that there is no unit root. 3.4. shortand long-run elasticity’s model: ∆co2t = α0 + ∑ 1i ∆logco22t-i +∑ 2i∆loggdp2t-i +∑ 3i∆logpopt-i +∑ 4i∆logenrt-i + λ2logco2t-i+ λ3loggdpt-i + λ4logpopt-i + λ5logenrt-i+ εt in the above equation ∆ shows the difference while α0 shows the intercept, εt shows the error term and co2, pop, enr and gdp are the variables that are explain above. in this equation σ indicates the error correlation dynamic. hence in the last part of this equation λ is showing the long run relationship among the independent variables with the dependent variables. equation also combines the changes in the variables with time to time. the model estimates the (p+1)k number of regressions to check the optimal lag length of every variable, p shows the optimal lag length of the kth variables that are used to estimate the equation. this lag length approach is based on the akaike information criterion (aic) and schwarz bayesian criterion (sbc). while bound testing approach is based on the f-statistic and wald statistic. the null hypothesis in this approach is there is no long run association among the variables. in the bound test approach if the value of f-statistic is great then the upper bound then it is concluded that there is a long run association among the variables and h0 is rejected and if the value of f-statistic is smeller then the lower bound then concluded that there is no long run correlation among variables and h0 in this case accepted, and if the value lies between the upper and lower bound then results are inconclusive (pesaran et al., 2001). 3.5. stability after knowing the long run association next step is to check the stability that is error correction model (ecm). model: ∆co2t = α0 + ∑ 1i ∆logco22t-i +∑ 2i∆loggdp2t-i +∑ 3i∆logpopt-i +∑ 4i∆logenrt-i + λ2logco2t-i+ λ3loggdpt-i + λ4logpopt-i + λ5logenrt-i + ηectt-1 + εt in this equation η represents the speed of growth to reach the level of equilibrium in different period of time or ectt-i is the error correction term that estimate from the short and long run model. asian journal of economics and empirical research, 2018, 5(2): 183-190 187 4. results and discussions 4.1. heteroskedasticity heteroskedasticity test: breusch-pagan-godfrey f-statistic 0.112404 prob. f(3,39) 0.9523 obs*r-squared 0.368610 prob. chi-square(3) 0.9466 scaled explained ss 0.187996 prob. chi-square(3) 0.9795 the result of heteroskedasticity confirmed that the model has a constant variance, as f-statistic is less that the tabulated value and it is insignificant at 5% critical value. 4.2. serial correlation the result of serial correlation confirmed that there is no such problem of autocorrelation, as f-statistic is less that the tabulated value and it is insignificant at 5% critical value. breusch-godfrey serial correlation lm test: 4.3. estimation of unit root test unit root level 1st difference variables t-statistic critical value prob. t-statistic critical value prob. co2 0.602461 1% 4.205004 5% 3.526609 10% 3.194611 0.9993 6.334922 1% 4.25004 5% 3.526609 10% 3.194611 0.000 enr 0.187422 1% 4.192337 5% 3.520787 10% 3.191277 0.9972 -5.195279 1% 3.600987 5% -2.935001 10% 2.605836 0.0001 gdp -1.565053 1% 4.198503 5% 3.523623 10% 3.192902 0.7894 4.241582 1% -3.600987 5% -2.935001 10% -2.605836 0.0017 pop 0.133768 1% 4.205004 5% 3.526609 10% 3.194611 0.9966 6.444889 1% 4.205004 5% 3.526609 10% -3.194611 0.000 the result shows that co2 ,energy consumption, gdp and population are no stationary at level. the unit root test for co2 emission, gdp, population and energy consumption confirmed that the series are differenced stationary, as the t-statistics is greater than the tabulated value of 1% critical confidence, hence it is generally concluded that the variables series has an order of integration is one, i.e., i(1) series. in simple words, whole after taking 1st difference all four-variable become stationary. hence, we may conclude that all the variable is order of integration at one. this is good justification to use ardl test to estimate short and long run. 4.4. bound test null hypothesis: no long-run relationships exist test statistic value k f-statistic 4.714005 3 critical value bounds significance lower bound upper bound 10% 2.72 3.77 5% 3.23 4.35 2.5% 3.69 4.89 1% 4.29 5.61 the results of bound test confirmed that the f-statistics value fall above the upper bound at 5%, hence it is confirmed that the model exhibit the long-run relationship between the variables. so, we reject the null hypothesis. the results show that, in pakistan economy the short-run, energy consumption has a positive relationship with co2 emissions with an estimated elasticity value of 1.117%, which reveal that the relationship between the variables is more elastic in nature. the similar type of result is found in the long-run, where the elasticity estimates of energy demand is 1.605%. f-statistic 0.351282 prob. f(2,37) 0.7061 obs*r-squared 0.801278 prob. chi-square(2) 0.6699 asian journal of economics and empirical research, 2018, 5(2): 183-190 188 4.5. ardl it is clear that the impact of energy consumption on co2 emissions is greater in the long-run followed by the short-run. the result is linked with the previous studies of nilrit et al. (2017),ohlan (2015) and hammami and saidi (2015) where it confirmed that higher energy demand largely increases co2 emissions in different economic settings. the impact of per capita gdp on co2 emissions is negative, as if there is 1% increase in gdp, co2 emissions decreases by -0.441% in the short-run and -0.634% in the long-run. because increase in gdp enable a country to reach the same production level at lower co2 emission by development of new low-carbon technology. the result confirmed that higher economic growth substantially decreases high mass carbon emissions from the country, hence it is imperative to sustained economic growth in the long-run. the result is linked with the previous studies of zaman et al. (2015), hassan and nosheen (2018). where it confirmed that in pakistan economy gdp support to reduce environmental degradation. the impact of population growth on co2 emissions is positive, which confirmed that high population growth put a burden on environment in the form of high mass co2 emissions, hence it is desirable to limit the population by family planning process in a country. the result is linked with the previous studies of naqvi and rehm (2014), bulut et al. (2017) and yeh and liao (2017) where it could find that high population growth cumbersome the environment and largely deteriorate the environmental sustainability agenda across countries. the error correction term confirmed the model convergence, as its coefficient value is about -0.695, which reveals that the speed of adjustment towards the equilibrium is stable over a period of time. 4.6. cusum the result of cusum test confirmed that the model is stable over a period of time, as the model value is fall inside the two doted lines, which confirmed the model significance at 5% critical values. -20 -15 -10 -5 0 5 10 15 20 5 10 15 20 25 30 35 40 cusum 5% significance ardl co-integrating and long run form dependent variable: co2 selected model: ardl(1, 0, 0, 0) co-integrating form variable coefficient std. error t-statistic prob. d(lnenr) 0.169476 6.591459 0.0000 d(lngdp) -0.441647 0.076746 -5.754643 0.0000 d(lnpop) 0.164995 0.048700 3.387982 0.0017 cointeq(-1) -0.695863 0.115106 -6.045387 0.0000 long run coefficients variable coefficient std. error t-statistic prob. lnenr 1.605337 0.143797 11.163926 0.0000 lngdp -0.634675 0.082541 -7.689203 0.0000 lnpop 0.237108 0.074005 3.203950 0.0028 c -5.850696 0.573378 -10.203911 0.0000 note: r-square: 0.953522 asian journal of economics and empirical research, 2018, 5(2): 183-190 189 4.7. cusum sum of square the result of cusum square test confirmed that the model is stable over a period of time, as the model value is fall inside the two doted lines, which confirmed the model significance at 5% critical values. -0.4 -0.2 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 5 10 15 20 25 30 35 40 cusum of squares 5% significance 5. conclusion this study evaluated ipat hypothesis in pakistan economy by using a time series data from 1972-2016. this study initiated to assess united nation‟s sustainable development goals for environmental conservation in a given country. the results show that energy consumption and population growth both are the chief factors that delimit the sustainable development goal in a country. the per capita income decreases co2 emission which implies that country‟s economic growth helpful to reduce high mass co2 emission in a country . the government should have to use cleaner production technology, sustainable instruments, renewable energy mix and sustainable production for delimiting the hazardous material in the atmosphere. references al-mulali, u. and c.n.b.c. sab, 2012. the impact of energy consumption and co2 emission on the economic growth and financial development in the sub saharan african countries. energy, 39(1): 180-186. available at: https://doi.org/10.1016/j.energy.2012.01.032. apergis, n. and j.e. payne, 2009. co2 emissions, energy usage, and output in central america. energy policy, 37(8): 3282-3286. available at: https://doi.org/10.1016/j.enpol.2009.03.048. aye, g.c. and p.e. edoja, 2017. effect of economic growth on co2 emission in developing countries: evidence from a dynamic panel 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growth on carbon emissions in taiwan using an analytic tool stirpat. sustainable environment research, 27(1): 41-48. available at: https://doi.org/10.1016/j.serj.2016.10.00. zaman, k., s.a. hassan and s. gul, 2015. the relationship between growth-inequality-poverty triangle and environmental degradation: unveiling the reality. arab economics and business journal, 10(1): 57-71. available at: https://doi.org/10.1016/j.aebj.2014.05.007. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 201 © 2018 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 5, no. 2, 201-208, 2018 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2018.52.201.208 © 2018 by the authors; licensee asian online journal publishing group a comparative analysis based on economic factors of students emigration from south asia yasir khan1  taimoor hassan2 wang ming yi3 rahimullah gulzar4 ( corresponding author) 1ph.d. school of economics & management, southeast university nanjing 211189, china 2phd. school of economics and management, nanjing university of science and technology, china 3school of international trade and economics, shandong university of finance and economics, shandong, china 4school of engineering management, southeast university nanjing pr china abstract economic instability and higher unemployment significantly increased the number of students migration from all over the world, particularly south asian countries in the last decade. growing number of international student migration to abroad for higher education and search for better economic opportunity. this study will determine the economic impact of students‘ emigration from south asian countries particularly pakistan, india, and bangladesh. a comparative analysis of the three border sharing countries have shown the long-term economic and political instability and a result of an economic and financial collapse in 2008, and also discuss how such an environment has affected student emigration from south asia. this study is quantitative research using questioners as a tool to collect primary data, from the large sample size of 300 south asian students studying in chinses universities in china. this research work is based on two factors, 1) the deterioration of economic factors in pakistan, india, and bangladesh have changed the students‘ perception to migrate abroad; 2) the study also reflected that majority of pakistani, indian and bangladeshi students want to stay in the host country. the findings indicated that all the related variables have significantly positive, economic instability, higher unemployment, lower salary, political instability, and lower quality education system. the logit-probit regression models with these variables could predict the higher value of the variance in the overall student migration to abroad. findings are relevant for academic institutions and government agencies interested in international education, student migration behavior, comparative data as well as strategic policies. keywords: south asia, international students, economic factors, comparative analysis, migration, probit-logit regression. citation | yasir khan; taimoor hassan; wang mingyi; rahimullah gulzar (2018). a comparative analysis based on economic factors of students emigration from south asia. asian journal of economics and empirical research, 5(2): 201-208. history: received: 16 august 2018 revised: 19 september 2018 accepted: 22 october 2018 published: 26 november 2018 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: all authors contributed to the conception and design of the study. funding: this research was financially supported by the social science foundation project no.: 15bjy120. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 202 2. literature review .......................................................................................................................................................................... 203 3. research methodology ................................................................................................................................................................. 204 4. result and discussion ................................................................................................................................................................... 206 5. conclusion ....................................................................................................................................................................................... 207 references ............................................................................................................................................................................................ 208 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2018.52.201.208&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/260 https://orcid.org/0000-0002-9391-1772 https://orcid.org/0000-0003-3512-3847 https://orcid.org/0000-0001-9311-8275 http://asianonlinejournals.com/index.php/ajeer/article/view/260 https://orcid.org/0000-0002-9391-1772 https://orcid.org/0000-0003-3512-3847 https://orcid.org/0000-0001-9311-8275 http://asianonlinejournals.com/index.php/ajeer/article/view/260 https://orcid.org/0000-0002-9391-1772 https://orcid.org/0000-0003-3512-3847 https://orcid.org/0000-0001-9311-8275 http://asianonlinejournals.com/index.php/ajeer/article/view/260 https://orcid.org/0000-0002-9391-1772 https://orcid.org/0000-0003-3512-3847 https://orcid.org/0000-0001-9311-8275 http://asianonlinejournals.com/index.php/ajeer/article/view/260 https://orcid.org/0000-0002-9391-1772 https://orcid.org/0000-0003-3512-3847 https://orcid.org/0000-0001-9311-8275 asian journal of economics and empirical research, 2018, 5(2): 201-208 202 © 2018 by the authors; licensee asian online journal publishing group 1. introduction the past few years student emigration from pakistan, bangladesh, and india have been significantly increased. this research work analyzes the reasons for students‘ emigration from pakistan and their possible consequences on pakistan economy. the brain drains from pakistan particularly for higher education has been increased. the deterioration of economic factors increased the emigration outflow from pakistan. the results reflect that unemployment and lower gdp rate have significantly increased in the past few years which enforce pakistani student to migrate to other countries. the consequences of student migration of the are assessed analyzing migration theories. economist stresses that reasons leading to migration are sustained by and motivated three main types of influences: demand-pull factors in the destination place; supply-push factors in the origin place; network factors that link destination and origin places. the migration flow changing due to the deterioration of economic factors. unemployment significantly increased and was more critical in countries such as pakistan, india, and bangladesh. therefore, in these south asian nations, the immigration is reduced and emigration has started to increase. countries with a good economic position such as china, japan, south korea, singapore, and malaysia experienced an higher number of students inward mobility for the short-term. the aim of student migration to is to increase their income and improve their well-being by mobility to other nations where earnings are significantly higher. there are over 4 million globally mobile tertiary education students, and this number is set to increase. for most countries, this remains the major form of internationalization, whether focused on international student recruitment, scholarships or mobility programs. find out about current and future global patterns, trends, national strategies, motivations, targets, and institutional strategies. ―international students appear to have significant positive impacts on host institutions and countries as well as on host economies. acknowledging the potential benefits international students can bring on board, we found that china, canada, australia, and the u.k. are prompt in understanding the big-picture impact of international students. in the u.s. context, except for nafsa‘s annual economic impact report, voices on the benefits of international students to the national economy and institutional welfare are yet to be heard. we pay on prior mobility and emigration of students in pakistan, india, and bangladesh in this paper (guruz, 2011). generally, the mobility of students gives an opportunity to improve their knowledge in other foreign educational institutions of a different country during their studies. akulavicius and grundey (2011) enabling students can learn different approaches that expand their horizon and improving their potential opportunities for a future job especially in a time of economic downturn and higher international competition (akulavicius and grundey, 2011). moreover, international student mobility has been a top priority of the international institutions and the most of the countries aim to attract international students because it involves several benefits such as extra income, higher labor market participation and economic growth. migration processes were analyzed recently by cekanavičius and kasnauskienė (2009); reher and requena (2009). 1.1. quantifying short-term costs our major assessment of the economic short-term costs of international students was informed by a review of the literature on the costs and benefits of immigration. based on this we identified the following short-term costs:  consumption of public services: the most typically cited cost of immigration is the additional consumption of public services (health, education, police, fire, transport, waste removal etc).  increased congestion: increased congestion can impose costs on other residents. one example would be increased traffic congestion which, by increasing journey times, can impact upon local business productivity and hence gdp. immigration has also had the effect of increasing house and rental prices (as the supply of housing tends to be fairly fixed in the short-term) but for this report, we will assume that this simply generates a transfer of resources between owners and tenants with no net impact on gdp.  reduced social capital: some authors have argued that immigration can reduce the level of ―social capital‖ in an economy by reducing social cohesion. tertiary education institutions, universities in particular, have always encouraged international co-operation and free flow between countries of staff, students and ideas. they have appreciated that science and scholarship do not recognize national boundaries and that progress in research will be facilitated by effective international sharing of ideas and discoveries the need to promote such co-operation is even greater today than in the past. national economies generally are becoming increasingly interdependent, while each year new technological advances in http://www.nafsa.org/explore_international_education/impact/data_and_statistics/the_international_student_economic_value_tool/ asian journal of economics and empirical research, 2018, 5(2): 201-208 203 © 2018 by the authors; licensee asian online journal publishing group communication and transport mean that nations generally are in closer contact with one another. added to this is the realization that many areas of scientific, technological and medical research are becoming increasingly expensive, and that facilitating mobility of professional personnel is, on balance, likely to advantage rather than disadvantage most countries socially, culturally and economically. ―indeed‖, ―academic free trade may be more important than any other kind‖. curiosity still motivates a number of students to seek study abroad, but in the latter half of the twentieth century, international education has increasingly become tied to the development of global markets and worldwide economic restructuring. the internationalization of tertiary education is expanding and as the production of wealth increasingly becomes based on knowledge rather than manual labor or mechanization, it can be expected that the exploitation of international ―knowledge-markets‖ will assume even greater importance. the number of students enrolled outside their country of citizenship has increased from 0.8 million in 1975 to 4.1 million in 2010 worldwide. this growth has greatly accelerated over the past decade or so with an average annual increase of 7.1 percent, ―mirroring the globalization of economies and societies‖ (oecd, 2010; oecd, 2012). there is little or no evidence to suggest that growth in international student mobility is likely to abate in the near future. furthermore, in promoting student mobility, governments finance in one form or another various education co-operative effort. many governments expend a proportion of their international aid in the form of overseas fellowships and scholarships. (by so doing, of course, they recoup some of the international aid via overseas student financial expenditure at the host institutions.) many cultural treaties between nations contain an explicit provision for exchange of academic staff and students, and several government ministries of education have created formal programmers to further the international activities of their respective education systems. governments promote international co-operative schemes not merely for the cultural and academic enhancement of students and staff who participate in them. governments are becoming increasingly concerned that they occupy for economic and political purposes an advantageous position in the international knowledge-market. these are clearly motivating factors behind australia‘s prominent role in international education. australia is recognized as a world leader with respect to promoting the mobility of international tertiary education students. although a small country in terms of population, china ranks third in terms of its worldwide share (5.9 percent) of international students. while the united states has the largest share of international students at around 18 percent, it‘s overall market share until quite recently has significantly declined following the events of 9/11. in terms of the percentage of tertiary education students who are international, 2. literature review the student emigrations are huge particular form south asian nations, pakistan, india, and bangladesh due to deteriorations of economic factors. the migration process was currently analyzed by sakienė (2011). increase international migration flows that are very selective nations and regions, have been almost known everywhere since the 1980s cushing and poot (2004). economic factors have been increasingly determents by this situation. thus, constantly lack of employment in many countries significantly increase the percentage of seasonal works, has encouraged emigration to countries with less unemployment cattaneo (2008); martinoia (2009). economic factors have a major impact on migration. from the economics point of view, international migration must be studied very carefully sumption (2011). migration reasons the most analyzed authors faggian and mccann (2006); tigau (2013); mihi-ramirez and kumpikaite (2014). such major factors, economic, political, demographical, geographical and others, analyzing factors which attract students and worker migrate to other countries, they are called demand-pull factors in the destination place. economic factors attracted people by one or more factors faggian and mccann (2006); kumpikaite and zickute (2012); mihi-ramirez and kumpikaite (2014). better availability of employment, higher income, lower taxes, economic stability, political stability, religious tolerance, better education facilities, better weather, better medical and other social facilities, better behavior among people, law and order situation and family reasons. higher unemployment can increase emigration kumpikaite and zickute (2012). when the advantage of these factors more than cost, then the process of migration starts (mixon, 1992). our analysis of these factors is based on empirical study. table-1. demand-push factors and demandpull factors. rank push-factors (native places) pull-factors (foreign destination) 1 low wage rate high wage rate 2 lower (gdp) per capita higher gdp (per capita income) 3 higher unemployment rate high demand of labor 4 relatively high taxes relatively low taxes 5 relatively high consumer prices (cpi) relatively low consumer price index (cpi) 6 political instability strong political system 7 low quality education system quality education system looking for reasons of migration the most analyzed authors (mixon, 1992) depict such main factors: 1) political, 2) economical, 3) demographic, 4) geographical, and 5) others. when analyzing factors, which attract people to migrate to another country, they are called demand-pull factors in the destination area. people are attraced to places of destination by one or more factors (mixon, 1992; mihi-ramirez and kumpikaite-valiuniene, 2013) as higher incomes, lower taxes, better availability of employment, better weather, political stability, better education facilities, better medical and other social facilities, national prestige, better behavior among people, religious tolerance and family reasons. our empirical study is based an analysis of these factors for students. asian journal of economics and empirical research, 2018, 5(2): 201-208 204 © 2018 by the authors; licensee asian online journal publishing group farquharson et al. (2019) suggested the migration of highly-skilled and educated student has not been studied extensively. however, further research on migration outcomes particularly for international students who study outside their home country for any degree level is lacking. while considerable migration research exists, few studies observe the subsequent migration behavior of foreign graduates as it pertains to the united states. the number of international students‘ inflows entering the to china for educational purposes has increased considerably in the last ten years, as well as their degree levels attained prior to entrance. academic mobility increases pertinent questions regarding the causes and effects of such a significant demographic movement of highly-skilled individuals. the broad phenomenon of student mobility departing their country of origin, gaining a higher level of skill or education abroad, and not returning home, has created such concepts, well-known in educational circles, as ―brain drain.‖ this pattern of movement highlights several issues for consideration. this research work builds the collective set of comparative data is useful for higher education in companies invested and promoting their stay or back to home as well as offering significant directions for future research. this research paper will consider possible impactions for political and educational organization as well as the current academic institutions, may be impacted by the findings of this study. furthermore, on a broader scale, this study offers relevant implications and findings for educational institutions interested in the development of reciprocal international influence and government policymakers responsible for immigrations regulations and international students‘ trends. 3. research methodology 3.1. regression analysis logistic regression works very similar to linear regression, but with a binomial response variable. the greatest advantage when compared to mantel-haenszel or is the fact that you can use continuous explanatory variables and it is easier to handle more than two explanatory variables simultaneously. although apparently trivial, this last characteristic is essential when we are interested in the impact of various explanatory variables on the response variable. if we look at multiple explanatory variables independently, we ignore the covariance among variables and are subjected to confounding effects, as was demonstrated in the example above when the effect of treatment on death probability was partially hidden by the effect of age. a logistic regression will model the chance of an outcome based on individual characteristics. because chance is a ratio, what will be actually modeled is the logarithm of the chance given by: where π indicates the probability of an event (e.g., death in the previous example), and βi are the regression coefficients associated with the reference group and the xi explanatory variables. at this point, an important concept must to be highlighted. the reference group, represented by β0, is constituted by those individuals presenting the reference level of each and every variable x1...m. to illustrate, considering our previous example, these are the individuals older aged that received standard treatment. later, we will discuss how to set the reference level. probit regression is a special type of the generalized linear models. here, the bivariate outcome yy has a bernoulli distribution with parameter pp (success probability p ∈ (0,1) p ∈ (0,1)). recall that ey=p. the probit link function probit (ey) = φ−1(p) = φ−1(p[y=1]) is used to transform the expectation of this 0/1 dependent variable. then, the probit of the mean is modelled as a linear combination of the covariates (regressors) xx, i.e., we have a linear predictor probit (ey) = xβ. where β is a vector of unknow parameters. the maximum likelihood-based approach is used for the parameter estimation, where a version of the irls algorithm is applied (newton, raphson method, fisher‘s scoring method). predicated probability can be obtained by the inverse probit (i.e., standard normal cdf) transformation. asian journal of economics and empirical research, 2018, 5(2): 201-208 205 © 2018 by the authors; licensee asian online journal publishing group pˆ[yi=1] = φ(xi,∙βˆ). the result indicated that pakistan has the higher unemployment rate since 2005 comparatively with india and bangladesh. higher unemployment rate significantly increased the number of pakistani, indian and bangladeshi students. the number of unemployment among youth also increased in these three countries. the unemployment in pakistan suddenly increased since 2007 and it has been higher than the european average from that time (see table 1). simultaneously the long-term unemployment and the employment of the highest studies level in india and bangladesh have also continued to rise over the same period far above the south-asian average. pakistan is a leader for unemployment for youth in south-asian as well. the fastest-growing unemployment was observed in india, bangladesh, and nepal. however, the unemployment of young people decreased in bangladesh from 2011, at the same time when in pakistan it was still growing and reached more than 50 percent. table-2. unemployment rates in the percentage of active population pakistan, india and bangladesh. unemployment active population in % 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 pakistan 7.69 6.09 5.09 4.98 5.46 5.55 5.94 6.5 6.23 4.05 5.90 india 4.4 4.33 3.72 4.15 3.91 3.55 3.54 3.62 3.57 3.53 3.49 bangladesh 4.3 4.5 4 3 5.0 4.5 4.5 4.5 4.3 4.2 4.1 unemployment of youth in % 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 pakistan 12.02 8.75 7.75 7.86 8.83 9.02 10.92 10.98 11.30 10.63 10.93 india 9.89 9.90 8.83 9.97 9.60 10.13 10.24 10.61 10.54 10.12 9.83 bangladesh 8.65 8.50 7.30 7.84 9.82 8.57 8.67 8.77 8.96 10.03 10.27 source: international labor organization (ilo), imf, bangladesh bureau of statistics, fred the last decade economic recession and the fall of gdp per capita increase the migration flow from pakistan, india, and bangladesh. such a situation encourages students‘ migration outflow from their country (see figure 2). the three countries gdp per capita is less than two thousand us dollars which means the growth rate of these three countries are significantly slower. the weak economic situation makes the country less attractive. the gross domestic product (gdp) per capita allows showing the international level of development. consequently, it is widely acknowledged that a higher development could a prerequisite for a reduction of the extent of migration (mixon, 1992). the gross domestic product (gdp) is one of the primary indicators used to gauge the health of a country's economy. it represents the total dollar value of all goods and services produced over a specific time period, often referred to as the size of the economy. usually, gdp is expressed as a comparison to the previous quarter or year. for example, if the q3 2017 gdp of a country is up 3%, the economy of that country has grown by 3% over the third quarter. while quarterly growth rates are a periodic measure of how the economy is faring, annual gdp figures are often considered the benchmark for the size of the economy. fig-1. gross domestic product per capita source: international monterey fund (imf) source: international monterey fund one of the main economic factors that affect the flow of migration is wage (table. 3). lower wage rate is one of the key factors for student emigration. student intention to migrate for education where wage rate is high. thus, with high unemployment emigration increases and vice versa. but in spite of the wide believe there is no evidence of higher immigration causes higher unemployment (heid and larch, 2012). furthermore, a reduction of long-term unemployed could mean a higher productivity and lower emigration. likewise, the unemployment of the highest education employees demonstrates whether the labor market is demanding for educated labor, which is related to youth emigration and the worst consequences for the country's economy (glinskiene and petuskiene, 2011). inflation is the long-term rise in the prices of goods and services caused by the devaluation of currency fig 2. while there are advantages to inflation which i will discuss later in this article, i want to first focus on some of the negative aspects of inflation. inflationary problems arise when we experience unexpected inflation which is not adequately matched by a rise in people‘s incomes. if incomes do not increase along with the prices of goods, everyone‘s purchasing power has been effectively reduced, which can turn to lead to a slowing or stagnant economy. moreover, excessive inflation can also wreak havoc on retirement savings as it reduces the purchasing power of the money that savers and investors have squirreled away. https://www.investopedia.com/terms/g/gdp.asp https://www.investopedia.com/terms/i/indicator.asp https://www.moneycrashers.com/how-good-is-your-retirement-plan/ asian journal of economics and empirical research, 2018, 5(2): 201-208 206 © 2018 by the authors; licensee asian online journal publishing group table-3. other economic indicators among pakistan, india, bangladesh, 2005-2015 minimum average daily wage rate 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 pakistan 37.90 37.40 37.59 36.20 37 36.40 37.59 337.90 37.59 38.09 38.70 india 15.69 15.30 16.60 17.70 17.29 18.20 20.10 20.10 19.70 19.60 19.70 bangladesh 31.79 33.23 34.70 36 36.79 37.5 38.79 40.09 41.09 42.09 43.40 consumer prices index 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 pakistan 55.31 59.69 64.23 77.26 87.81 100 111.91 122.75 132.19 141.70 145.30 india 65.82 69.87 74.32 80.35 89.28 100 108.85 118.99 131.97 140.75 147.65 bangladesh 69.15 73.83 80.55 87.72 92.48 100 110.70 117.58 126.44 135.28 143.66 wage and salaried workers, total (% of total employment) source: world bank moreover, the variable, purchasing power parity of the country of origin (ppp), was hypothesized to be positively related to migration outcomes, this study showed no significance in their correlation. in other words, the study showed no relation to the objective economic differences of a student‘s country of origin and their choice of residence after graduation. great value lies in this finding. it serves to correct assumptions about any particular student‘s migration outcome. figure-2. an inflation rate of the three countries in percentage source: federal reserve economic data. source: world bank 4. result and discussion in this study, statistical analyses were performed using spss version 18.0, employing probit-logit regression. for all analysis, probability values below 0.05 were considered statistically significant. probit-logit regression was performed to estimate which concerned variables may be related to the likelihood of foreign students ‗financial aid, employment, better education facilities, comparative lower taxes, in table 5. international students are vital to supporting china‘s innovation, bringing new opportunities, perspectives to our classrooms, and creating new connections between the global workforces. a large number of survey questioners were disturbed among the students from pakistan, india, and bangladesh studying in chinese universities. the students were asked about the causes of migration. their responses showed (see table 4). the mean score of employment is 3.35 while the standard deviation is 0.751. the mean score of high wage 3.42 while the standard deviation is 0.776. this indicating the mean is around the coefficient of high wage factor. the mean score of political and high consumer prices index are 3.65 and 3.41 while the standard deviation is 0.773 and 0.765. the average score mean of lower taxes and cultural factors are 3.35 and 3.31 while standard of deviation 0.761 and 0.752. finally, the mean score of economic stability and religious intolerance are 3.30 and 3.43 while the standard deviation is 0.856 and 0.574. all the variables are equally important for international students to move abroad. table-4. mean scores of international students‘ migration by economic factors. mean std dev. employment opportunity 3.35 0.751 high wages 3.42 0.776 political stability 3.65 0.773 high consumer price index 3.41 0.765 lower taxes 3.35 0.761 cultural 3.31 0.752 economic stability 3.30 0.856 religious intolerance 3.43 0.574 this study is empirical in nature and the results were based on an assessment of the respondents. for this purpose, a questionnaire was designed using a modified servqual model to measure the service quality of business schools in the public sector and how the quality of services will help to gain student satisfaction. questionnaire for this study was comprised of 45 questions, which are further subdivided into 6 constructs out of which; 5 constructs used to measure service quality and the 6th constructs used to measure the student satisfaction about the overall service quality of the business school. these constructs are tangibles (20 items), reputation (12 asian journal of economics and empirical research, 2018, 5(2): 201-208 207 © 2018 by the authors; licensee asian online journal publishing group items), cooperation and support (8 items), reliability (8 items) responsiveness (6 items) and student satisfaction (5 items). the responses were measured on a five-point likert scale (farquharson et al., 2019) for strongly satisfied and akulavicius and grundey (2011) for strongly dissatisfied. the population of this study comprises all student studying graduate and undergraduate level in 4 public sector universities in the city lahore. personal efforts were made to collect the data. this city is also known as a hub of educational institutions. a total of 550 questionnaires were distributed among students and a total 798 questionnaire were selected for the analysis and the remaining 49 questionnaires were rejected due to incomplete response. therefore, it represents a very good rate of 91% of the total population. the data was entered into spss 16.0 and amos 16.0 was used to develop a structural equation model to draw inferences. reliability of the data was checked using cronbach alpha which provides a value of 0.956 is more than the. table-5. the ordered logit and ordered-probit model. overall satisfaction ordered logit ordered probit coef. robust s.e z p > |z| coef. robust s.e z p > |z| financial aid 0.4221185 0.1457244 2.90 0.004*** 0.2659591 0.0822039 3.24 0.001*** employment opportunity 0.7057732 0.1541789 4.58 0.000*** 0.4152735 0.0830044 5.00 0.000*** high salaries 0.2526937 0.1443204 1.75 0.080** 0.1216005 0.0808547 1.50 0.073** 0.1040839 0.1470028 0.71 0.479 0.0848014 0.0838407 1.01 0.312 exploring new culture 0.2242361 0.1206783 1.86 0.063 ** 0.0950729 0.0671435 1.42 0.077** mutually benefited 0.2586725 0.1206783 1.60 0.109 0.1380521 0.0870535 1.59 0.113 promoting prosperity and development 0.3735674 0.1505924 2.48 0.013** 0.2217842 0.0831047 2.67 0.008*** bring economic stability 0.2773888 0.1292438 2.15 0.032*** 0.1374364 0.07202 1.91 0.056*** log likelihood number of obs. walid chi2(8) prob > chi 2 -332.08617 359 144.48 0.0000 log likelihood numb of obs. walid chi2(8) prob > chi2 -332.88523 359 142.88 0.0000 pseudo r2 0.1787 pseudo 0.1767 significance level at 1%, 5%, 10%, *, ***, *** the results indicating that international students who are studying in china are significantly satisfied by the built and road initiative which was first proposed by chinese president xi jinping in 2013. international students who are studying in china under the built and road initiative β = 0.433 while the p > 0.004 which is quite statistically significant. the variable employment opportunity under built and road initiative the β value is 0.705 while the p value is 0.00 which is indicating strongly statistically significant. the students were asked whether the built and road initiative is helpful for those nations who are less developed the response was β = 0.252 while the p value is 0.08 which is statistically significant. the final model showed international student migration to foreign countries and its related economic factors. employment opportunities, high wages, and economic stability are the key and important factors for international students. different statistical tools and methods were applied to obtain the outcomes. in the first model, the significance values are quite close to each other. all the values are statistically significant and correlated with each other. hence the students have shown their migration decision are associated with economic reasons in the most cases, such as bigger salary expectations and the higher opportunities to get a better job 5. conclusion the result showed the economic factors are the most important reasons in the case of academic student migration. the result also described that unemployment, wage are common reasons among these three nations pakistan, india and, bangladesh. more indian and bangladeshi students are attracted by higher consumer price index (table. 4). the result also indicated the lower wage rate also common in pakistani, indian and bangladeshi students. the study has re-examined previous researches and its results have shown the economic factors are the most important reasons in the case of academic migration for both studied groups of students. looking at these results we could conclude that perhaps most importantly, emigration should not be seen as a substitute for job creation at home. if students would have appropriate employment as a better possibility to get a job and bigger salary at home, most, people as well as, students would prefer to remain in their own country. these results are scientifically very important due to the evidence of previous research (faggian and mccann, 2006; ciarniene and kumpikaite, 2011). the influencing of demand-pull factors in the destination place that encouraging international students to migrate across countries. growing international student migration and competition are also important for international institutions and governments are also benefits because of international migration involve. these results are important for scientific due to the confirmation of previous researches about influences – demand-pull factors in the destination area that encourage the undergraduate students to migrate across countries. it is also important for scholars as a result of showing growing international competition and mobility and for the governments and international institutions because the benefits of international migration involve. these results are important for scientific due to the confirmation of previous researches (mixon, 1992; faggian and mccann, 2006; ciarniene and kumpikaite, 2011) about influences – demand-pull factors in the destination area that encourage the undergraduate students to migrate across countries. it is also important for scholars as a result showing growing international competition and mobility and for the governments and international institutions because the benefits of international migration involve. the results, however, were useful in designing the future research and for the comparison with other studies. these results—in demonstrating what factors were and were asian journal of economics and empirical research, 2018, 5(2): 201-208 208 © 2018 by the authors; licensee asian online journal publishing group not related to location upon graduation—provide relevant information for the institution to clearly communicate to its constituency and administration as to the correlated factors associated with the migration behavior of foreign students and tomorrow‘s international leaders. in addition, if an educational institution has a special initiative for international exchange and reciprocation, this study offers strategic information on capitalizing on achieving desired outcomes. fawcett (1985) determined as migration involves ―individual behavior with respect to movement across space,‖ the present research discussed migration for international study in particular. international migration is a complex engagement of personal motivations, economic prospects, geopolitical factors, and cultural transitions. in that process, this study offers important data adding to the current lack of research. foreign student migration, with its impact both on the host and home country as well as on the individual lives of migrants, is an area worthy of continued research. specifically, the discovery of the factors involved in why people move can prepare educational institutions in how to help their international students to transition during their temporary stay of study and plan for their future. references akulavicius, m. and d. grundey, 2011. managing mobility opportunities for doctoral students: the sase of lithuania. economics & sociology, 4(2): 98-111. available at: https://doi.org/10.14254/2071-789x.2011/4-2/9. cattaneo, c., 2008. the determinants of actual migration and the role of wages and unemployment in albania & 58; an empirical analysis. the european journal of comparative economics, 5(1): 3-32. cekanavičius, l. and g. kasnauskienė, 2009. too high or just right? cost-benefit approach to emigration question. engineering economics, 61(1): 28–36. ciarniene, r. and v. kumpikaite, 2011. international labour migration: students viewpoint. engineering economics, 22(5): 527-533. available at: https://doi.org/10.5755/j01.ee.22.5.971. cushing, b. and j. poot, 2004. crossing boundaries and borders: regional science advances in migration modelling. papers in regional science, 1(83): 317-338. available at: https://doi.org/10.1007/s10110-003-0188-5. faggian, a. and p. mccann, 2006. human capital flows and regional knowledge assets: a simultaneous equation approach. oxford economic papers, 58(3): 475-500. available at: https://doi.org/10.1093/oep/gpl010. farquharson, k., r. spaaij, s. gorman, r. jeanes, d. lusher and j. magee, 2019. managing racism on the field in australian junior sport. in relating worlds of racism. cham: palgrave macmillan. pp: 165-189. fawcett, j.t., 1985. migration psychology: new behavioral models. population and environment, 8(1-2): 5-14. available at: https://doi.org/10.1007/bf01263014. glinskiene, r. and e. petuskiene, 2011. the incentive of entrepreneurship as the force of country's economic development. economics & management, 16. guruz, k., 2011. higher education and international student mobility in the global knowledge economy. 2nd edn.: suny press. heid, b. and m. larch, 2012. migration, trade and unemployment. economics-the open-access, open-assessment e-journal, 6: 1-40. kumpikaite, v. and i. zickute, 2012. synergy of migration theories: theoretical insights. inzinerine ekonomika-engineering economics, 23(4): 387-394. available at: https://doi.org/10.5755/j01.ee.23.4.1240. martinoia, m., 2009. european integration, labour market dynamics and migration flows. european journal of comparative economics, 8(1): 97-127. mihi-ramirez, a. and v. kumpikaite-valiuniene, 2013. the migration flow in the context of deterioration of the economic factors. economics & management, 18(3): 479-484. available at: https://doi.org/10.5755/j01.em.18.3.3583. mihi-ramirez, a. and v. kumpikaite, 2014. economics reason of migration from point of view of students. procedia social and behavioral sciences, 109: 522-526. available at: https://doi.org/10.1016/j.sbspro.2013.12.500. mixon, j.f.g., 1992. factors affecting college student migration across states. international journal of manpower, 13(1): 25-32. available at: https://doi.org/10.1108/eum0000000000900. reher, d. and m. requena, 2009. the national immigrant survey of spain. a new data source for migration studies in europe. demographic research, 20(12): 253-278. available at: https://doi.org/10.4054/demres.2009.20.12. sakienė, h., 2011. analysis of unemployment regulation tools oriented towards labour supply in lithuania. management theory and studies for rural business and infrastructure development, 26(2): 227-233. sumption, d.g.p.a.m., 2011. available from competitivenessstrategies-2011.pdf. tigau, c., 2013. policies for high-skilled vs. low-skilled migration in north america. open journal of political science, 3(4): 158-166. available at: https://doi.org/10.4236/ojps.2013.34022. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 93 © 2019 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 6, no. 2, 93-100, 2019 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2019.62.93.100 © 2019 by the authors; licensee asian online journal publishing group monetary policy transmission channels and economic growth in nigeria iwedi marshal 1department of banking and finance, rivers state university, nigeria. abstract this study empirically analyzes monetary policy transmission channels and economic growth in nigeria using the vector auto regression model. time series data were used for the period of 56 years (1960 to 2016) and sourced from the central bank of nigeria statistical bulletin for various issues. the analyses show a good number of findings. firstly, the unit root test results shows that all the variables of transmission channels are non-stationary at level, but appear stationary at first difference. hence, the series are all integrated of order i (1). this of course authorized the study to proceed with the co-integration test which revealed that there is a long run relationship between monetary policy transmission channels and economic growth in nigeria. following the fact that the variables under study are co-integrated, the study went further to estimate the vector autoregressive model. the baseline result of the vector autoregressive model indicates that there exist a significant positive short run relationship between the channels of monetary policy transmission and macroeconomic output in nigeria. therefore, we conclude that interest rate and credit channels are critical channels for transmitting monetary policy impulses into the nigeria economy. based on this, the study recommends among others that the nigeria monetary authority should as a matter of policy encourage and emphasize the good management of the transmission channels and this should be vigorously pursued, as it has the ability to trigger growth of the nigeria economy. keywords: monetary policy, keynesians, monetarist, interest rate channel, credit channel, economic growth. jel classification: e52; e12; e59; e49; e60. citation | iwedi marshal (2019). monetary policy transmission channels and economic growth in nigeria. asian journal of economics and empirical research, 6(2): 93-100. history: received: 13 may 2019 revised: 18 june 2019 accepted: 29 july 2019 published: 5 september 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the authors confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 94 2. literature review ............................................................................................................................................................................ 94 3. model estimation and data ........................................................................................................................................................... 95 4. results and discussions .................................................................................................................................................................. 96 5. conclusion and recommendations ............................................................................................................................................... 99 reference.............................................................................................................................................................................................. 100 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.62.93.100&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/968 https://orcid.org/0000-0001-7529-2464 http://asianonlinejournals.com/index.php/ajeer/article/view/968 https://orcid.org/0000-0001-7529-2464 http://asianonlinejournals.com/index.php/ajeer/article/view/968 https://orcid.org/0000-0001-7529-2464 asian journal of economics and empirical research, 2019, 6(2): 93-100 94 © 2019 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to existing literature by examining monetary policy transmission channels and economic growth in nigeria. 1. introduction over the decades, the real effect of the transmission channels of monetary policy on the economy has been a contentious area of debate in the academic literature (bernanke and gertler, 1995). this is because the argument among scholars about the channel through which monetary policy actions can be transmitted into the economy to achieve some selected macroeconomic goals is still yet to be ascertained. some schools of thought believe and support the interest rate channel as the channel for transmitting monetary policy action while other scholars support and believe that the credit channel is the answer. the monetary policy transmission channel is the processes by which changes in monetary policy decision affect the rate of economic activity (taylor, 1995). however, it has been discovered that the monetary policy transmission works through various channels such as the exchange rate channel, the interest rate channel, the bank credit channel and the assets price channel to affect different markets, institutions, sectors at different speeds and intensities (cecchetti, 1999; mihov, 2001; ganev et al., 2002; kujis, 2002; elbourne et al., 2003; juks, 2004; nwosa and saibu, 2012; ishioro, 2013; ndekwe, 2013; hassan, 2015). despite the efforts and measures taken by the nation monetary authority (cbn) in recent times, the uncertain nature of the transmission mechanism and poor understanding of the system has remained a major challenge for monetary policy (uchendu, 2009). nigeria as an economy has adopted different monetary policy regimes with the view that the economy will response favorably, but the poor performance of the economy in recent times further suggests that the lofty objectives of monetary policy may have been negatively affected by the inadequate knowledge of the exact channel through which monetary actions transmits to the economy. in the light of the above, however, very limited empirical works of citable significance have studied transmission channels of monetary policy in nigeria using small data information and different methodologies; however the issue of investigating the true nature of the relationship between interest rate and credit channels of monetary policy transmission in nigeria is still empirically unstudied and published using large data information and a more sophisticated methodology. from the forgoing, one can easily and clearly identify a lots of research gaps to be bridged and hence the main thrust of this paper is to critically analyze the impact of monetary policy transmission channels on economic growth in nigeria using large data information from 1960 -2016. 2. literature review the review of literature is done in two sub-sections viz: theoretical framework and empirical review. 2.1. theoretical framework this paper is anchored on the economic belief of both the keynesians and the monetarists schools of thought. 2.1.1. keynesians theory the keynesians theorize the effects of monetary policy instrument on the money market, the investment goods market and the goods and services market. keynesian transmission mechanism states that, an increase in the money supply lowers the interest rate, which causes investment to rise and the ad curve to shift rightward thereby real gdp increasing and the unemployment rate dropping. graphically it is represented in figure 1 as follows: figure-1. keynesian transmission mechanism. source: jhingan (2011). 2.1.2. monetarist theory the monetarist transmission mechanism holds that an increase in money supply: increases in aggregate demand, which causes real gdp and price to increase with a fall in unemployment while a decrease in money supply leads to a decrease in aggregate demand, real gdp and prices with a rise in unemployment. graphically it represented as in figure 2. asian journal of economics and empirical research, 2019, 6(2): 93-100 95 © 2019 by the authors; licensee asian online journal publishing group figure-2. monetarist transmission mechanism. source: jhingan (2011). 2.2. empirical review to the best knowledge of the researcher, there were few numbers of available empirical works conducted concerning the transmission channels of monetary policy in the case of nigeria. for example, chuku (2009) carried out such a study in nigeria. the author used quarterly data from 1986q1-2008q4 and applies svar model in measuring the impact of monetary policy innovations in the country. his paper reveal that money supply (m2) as a quantity anchor has a moderate effect on both output and prices, while the monetary policy rate (mpr) and real effective exchange rate (reer) have neutral effect on output. also nwosa and saibu (2012) investigated the transmission mechanism of monetary policy impact on the output of different sectors of the nigerian economy. they however used the var methodology and found both the interest rate and exchange rate as the most effective channels of stimulating output growth of most of the sectors in the country. chimobi and uche (2010) employed the co-integration technique and causality test to examine the relationship between money and real economic variables in nigeria. their study reveals that no long run relationship between money and real economic variables. however, money supply was found to have a causal effect on both output and prices. in contrast, harcourt et al. (2011) adopting the techniques of vector error correction model (vecm) and co integration test, found that there is long run relationship among money supply, minimum rediscount rate and treasury bill rate in nigeria. the study also reveals that while minimum rediscount rate impacts on inflation at lag 2, money supply does not. fasanya et al. (2013) study show that inflation, exchange rate and external reserves constitutes the most effective tools of monetary policy that promote growth of the nigerian economy. ishioro (2013) study examines the channels of monetary transmission mechanism in nigeria. the study employed the granger causality test and the test shows that three channels of interest rate, exchange rate and the credit channels are functional in nigeria. ndekwe (2013) found that the credit channel in the financial market for the supply of credit to private sector gives the greatest effect in the way monetary policy is transmitted to the economy. he also realized that interest rate and exchange rate channels at the period 1981-2008 have weak effect on the real economy. also, more recently, ismail (2014) using the same techniques of co integration and vecm during the period of 1975-2010, also found co integrating relationship exists between the monetary policy variables and the real economic variable (rgdp) in nigeria. obafemi and ifere (2015) investigated the mixed evidence on the effectiveness of monetary policy transmission by exploring the quarterly data of the period 1970 to 2013, tested using the favar model with 53 variables. the results supported that interest rates and credit channels are the dominant and strongest channel of transmission of monetary shocks in nigeria. while the exchange rate, and stock channel shows weak impact in the transmission process. the study by omolade and ngalawa (2017) in nigeria employed structural variance decomposition approach (svar) to examine monetary policy transmission mechanism and manufacturing output growth in libya and nigeria. the authors document that exchange rate regime has some influences on the monetary policy transmission and its effectiveness on the manufacturing output growth in the two oil exporting countries. 3. model estimation and data the estimations are carried out on yearly data spanning 1960 to 2016. for nigeria, the data series cover interest rates channel (monetary policy rate, prime and maximum lending rates and deposit rate, and 90-day t-bills rate), for credit channel it includes credit to the core private sector, credit to the government, credit to smes and net domestic credit to the economy, while real gdp was used as the dependent variable in the model specifications. 3.1. model specification following the previous works of chileshe et al. (2014) we model the monetary policy transmission channels in nigeria as follow. the first model below is used to capture the interest rate channel while the next captures the credit channel. = ( ) (1) equation 2 presents the estimable version of equation 1. + (2) = + 0 0 ;,1    i n i ite (3) = ( ) (4) equation 5 presents the estimable version of equation 4. asian journal of economics and empirical research, 2019, 6(2): 93-100 96 © 2019 by the authors; licensee asian online journal publishing group we can rewrite the model of credit channel to have the estimable version in equation 5. + (5) = + 0 0 ;,1    i n i ite (6) where rgdp = real gross domestic product growth rate. mpr = monetary policy rate. mlr = maximum lending rate of deposit money banks. plr = prime lending rates of deposit money banks. tbr = treasury bills rates. dpr = deposit rate of deposit money banks. cps = credit private sector. cgo = credit to the government. ndc = net domestic credit to the economy. csm = credit to small and medium enterprises. = constant / intercept. = coefficients of independent variables.  it = error term. 4. results and discussions table-1.unit root test for interest rate channel variable. items d(rgdp) d(mpr) d(tbr) d(mlr) d(plr) d(dpr) adf statistics -7.727133 -9.717338 -8.278697 -9.721453 -11.72617 -8.611123 1% -3.555023 -3.555023 -3.555023 -3.555023 -3.555023 -3.555023 5% -2.915522 -2.915522 -2.915522 -2.915522 -2.915522 -2.915522 probability 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 source: e-view 9.0 output. table-2.unit root test for credit channel. items d(rgdp) d(cps) d(cgo) d(csm) d(ndc) adf statistics -7.727133 -6.479150 -12.16586 -9.453190 -13.03563 1% -3.555023 -3.555023 -3.555023 -3.555023 -3.555023 5% -2.915522 -2.915522 -2.915522 -2.915522 -2.915522 probability 0.0000 0.0000 0.0000 0.0000 0.0000 source: e-view 9.0 output. the study conducted stationarity test using the augmented dickey fuller (adf) test. the results are summarized and presented in table 1 and table 2 for each of the variables studied. from the table displaying the result it is obvious that all the interest rate channel variables and credit channel variables were non stationary at levels but appears stationary at first difference. hence, the series are all integrated of order i (1). this is evidence by the fact that the absolute values of the adf test statistics are all greater than the mackinnon critical values at 1% and 5% level of significance and thus the respective null hypotheses of non-stationarity are rejected, implying the absence of unit roots among the variables. table-3.vector autoregression results. items rgdp mpr tbr mlr plr dpr lag 1 0.601772 (0.14616) [ 4.11721] 1.362664 (1.49336) [0.91248] 0.227538 (1.00227) [ 0.22702] 0.341193 (0.66646) [ 0.51195] -0.056965 (0.61548) [-0.09255] 0.842714 (0.77346) [ 1.08954] lag 2 -0.229958 (0.14501) [-1.58577] 1.199856 (1.67295) [0.71721] 1.045003 (1.25611) [ 0.83194] 0.397281 (0.67848) [ 0.58554] -0.256329 (0.62775) [-0.40833] -0.739319 (0.74293) [-0.99513] constant 10.93097 (3.78523) [ 2.88779] 0.753832 (1.00051) [ 0.75345] 0.684720 (1.25215) [ 0.54683] 0.947191 (1.48579) [ 0.63750] 1.787844 (1.18116) [ 1.51363] 1.125876 (1.17772) [ 0.95598] r-squared 0.678640 adj. r-squared 0.529680 f-statistic prob log likelihood akaike aic schwarz sc durbin watson 13.50635 0.000087 -187.9030 7.305563 7.780023 2.078935 source: e-view 9.0 output. a cursory look at table 3, it can be seen from the result that the coefficient of monetary policy rate (mpr) was positively and not significant related to real gdp at lag 1 and 2. the mpr coefficient records a positive value of 1.362664 and 1.199856 with a t-value of 0.91248 and 0.71721 at lag 1 and 2 respectively. this implies that mpr is an important interest rate channel variable that explains future path of nigeria economic growth. asian journal of economics and empirical research, 2019, 6(2): 93-100 97 © 2019 by the authors; licensee asian online journal publishing group table-4.variance decomposition analysis for interest rate channel. variance decomposition of rgdp: period s.e. rgdp mpr tbr mlr plr dpr 1 8.434337 100.0000 0.000000 0.000000 0.000000 0.000000 0.000000 2 10.11961 96.95490 0.005617 0.071339 0.785662 0.392427 1.790055 3 10.43453 92.96489 0.923625 2.083647 1.190620 0.476967 2.360251 4 10.65481 89.17154 2.654280 3.571297 1.408247 0.913575 2.281065 5 10.79910 86.82970 4.562318 3.656825 1.429113 1.301516 2.220527 6 10.90015 85.25431 6.006015 3.590357 1.437480 1.513553 2.198282 7 10.98339 84.07429 7.190904 3.536191 1.425737 1.585936 2.186947 8 11.05811 83.03592 8.201333 3.517040 1.407892 1.680023 2.157788 9 11.12375 82.10323 8.997801 3.538194 1.392591 1.825263 2.142924 10 11.18126 81.27781 9.630680 3.572409 1.380743 1.994862 2.143495 variance decomposition of mpr: period s.e. rgdp mpr tbr mlr plr dpr 1 2.229357 0.962426 99.03757 0.000000 0.000000 0.000000 0.000000 2 3.201704 0.592556 77.24688 7.065998 0.107096 11.22560 3.761874 3 3.503843 1.352799 78.62124 6.027942 1.067849 9.762551 3.167618 4 3.878872 1.634242 80.01638 5.988309 0.935444 8.826729 2.598899 5 4.173937 1.700975 78.21249 5.786780 0.841475 10.49983 2.958450 6 4.373634 1.622943 77.38652 5.692269 0.863504 11.39263 3.042140 7 4.551176 1.542700 76.66719 5.666532 0.901950 12.13302 3.088602 8 4.701110 1.499726 76.18800 5.548143 0.989095 12.65834 3.116704 9 4.827150 1.485237 75.99217 5.384562 1.090249 12.96958 3.078205 10 4.935917 1.487787 75.91877 5.221370 1.198246 13.14594 3.027884 variance decomposition of tbr: period s.e. rgdp mpr tbr mlr plr dpr 1 2.790077 0.182549 74.08539 25.73206 0.000000 0.000000 0.000000 2 4.007012 0.198258 57.26735 31.32728 0.701355 4.650702 5.855063 3 4.328164 0.747484 60.77545 27.61258 1.836367 3.987794 5.040329 4 4.684304 0.926509 65.06314 24.05664 1.568509 3.822207 4.562996 5 4.963857 0.911704 65.08182 21.56190 1.623468 5.640063 5.181042 6 5.145441 0.853053 65.16276 20.11442 1.939184 6.563966 5.366618 7 5.304011 0.806471 65.33822 18.97537 2.247383 7.216091 5.416459 8 5.440150 0.782931 65.52014 18.04100 2.610468 7.636690 5.408772 9 5.555371 0.779243 65.78101 17.30545 2.970189 7.843952 5.320155 10 5.655542 0.786133 66.03663 16.71488 3.308435 7.932286 5.221640 variance decomposition of ldr: period s.e. rgdp mpr tbr mlr plr dpr 1 3.310672 0.240731 68.97141 0.468549 30.31931 0.000000 0.000000 2 4.221571 1.008619 60.77094 0.785295 20.81065 16.60810 0.016409 3 4.573026 1.057218 59.82039 3.191765 18.13566 17.37432 0.420651 4 5.185386 0.874255 55.87862 9.363598 15.11311 17.49793 1.272489 5 5.657975 0.783283 52.92377 11.31902 12.90277 19.89322 2.177947 6 5.962704 0.759949 52.22219 12.02319 11.66142 21.08746 2.245790 7 6.222071 0.805485 52.30239 12.41259 10.73198 21.58651 2.161037 8 6.448688 0.906820 52.71578 12.54829 10.00220 21.76207 2.064834 9 6.647557 1.015566 53.25193 12.55158 9.420467 21.79075 1.969709 10 6.824151 1.107376 53.77078 12.52034 8.944543 21.76533 1.891622 variance decomposition of plr: period s.e. rgdp mpr tbr mlr plr dpr 1 2.631887 0.244115 27.49415 0.887946 6.481833 64.89195 0.000000 2 3.138912 1.401136 31.44379 1.795441 7.392059 53.91792 4.049655 3 3.723156 1.271320 43.35407 4.578869 5.329843 42.58312 2.882774 4 4.223003 1.455586 46.94058 5.168531 4.333745 39.01658 3.084971 5 4.564896 1.524997 50.58178 5.230643 3.826601 36.06926 2.766712 6 4.872764 1.585287 53.16908 5.239486 3.444569 34.01944 2.542142 7 5.128340 1.644133 55.05052 5.185666 3.208963 32.49095 2.419771 8 5.347064 1.677008 56.54160 5.117042 3.032927 31.31165 2.319774 9 5.535099 1.695508 57.66590 5.040768 2.914516 30.42220 2.261114 10 5.696536 1.703037 58.56735 4.962703 2.834927 29.71028 2.221704 variance decomposition of dpr: period s.e. rgdp mpr tbr mlr plr dpr 1 2.624210 0.009943 48.58470 0.270150 2.005392 11.64658 37.48324 2 3.457687 0.135769 44.79117 1.646227 3.278928 23.98137 26.16654 3 3.877004 0.254214 45.59682 1.424333 6.583039 23.46897 22.67262 4 4.261912 0.210638 49.45005 1.223300 7.656603 21.38626 20.07315 5 4.603639 0.228123 51.73159 1.149316 8.690461 20.19295 18.00756 6 4.873761 0.276649 53.19055 1.385435 9.865343 18.91768 16.36434 7 5.101285 0.321693 54.50980 1.587383 10.72062 17.75040 15.11011 8 5.297389 0.352962 55.47291 1.780755 11.39475 16.80909 14.18953 9 5.463912 0.365877 56.09549 2.001014 11.98258 16.05494 13.50010 10 5.605358 0.367229 56.46151 2.232607 12.52078 15.44088 12.97699 cholesky ordering: rgdp mpr tbr mlr plr dpr source: e-view 9.0 output. on the other hand, coefficient for treasury bill rate (tbr) was positively and not significantly related to real gdp of nigeria at both lag 1 and 2. the tbr coefficient was positive with this value 0.227538 and 1.045003 with a t-value of 0.22702 and 0.83194 respectively at lag 1 and 2. again the coefficient of maximum lending rate of deposit money bank (mlr) shows a positive and not significant relationship to real gdp at lag 1 and 2 with the value of 0.341193 and 0.397281 and a t-value of 0.51195 and 0.58554 respectively. similarly, the coefficient asian journal of economics and empirical research, 2019, 6(2): 93-100 98 © 2019 by the authors; licensee asian online journal publishing group estimate for prime lending rate (plr) was negatively signed and not significantly linked to real gdp when lagged both in first and second period. the plr coefficient value was (-0.056965) with a t-value of (-0.09255) at lag 1 and the coefficient value of -0.256329 and t-value of -0.40833 at lag 2. finally, the parameter estimate for deposit rate (dpr) was positively signed and not significantly related to real gdp when lag at one period. the coefficient has a positive value of 0.842714 with a t-value of 1.08954 but turned negative and significant with the value of -0.739319 as coefficient and -0.995113 as the t-value at lag 2. however, a look at the var global statistic results shows that the observed degree of relationship between real economic output and the interest rate channels variables stood at an r squared of 0.783486. this implies that about 78 percent of the variations in growth of the nigeria economy were explained by changes in interest rate channel variables. this shows that the direct link from interest rate channel to growth of the nigeria economy has historically been strong. the results of the variance decomposition in table 4 shows that short run shock to rgdp accounted for 100% variation of fluctuation in rgdp (own shock) and 0% from other variables in that period. the result also showed that the variation in rgdp as accounted for by its own shock happens to be the highest and varies from 100% in the first period to 81.27% over the 10 period horizons. also in the short run i.e. period two, shock to rgdp account for 0.59% changes in fluctuations in monetary policy rate (mpr) and 1.49% in the long run that is the 10th period. about 99% of variation in fluctuations in mpr is as a result of own shock in the first period. also, in period two, a shock in rgdp account for 0.20% variations in fluctuation in tbr (treasury bill rate), while 10th period i.e. (long run), it account for 16.71% with 25.7% shocks as a result of own shock in the first period. rgdp shocks account for 0.24% variation of fluctuation in ldr in the short run and 1.11% in the long run with 30.3% being accounted for from own shock in the first period. similarly about 0.24% changes in fluctuations in ldr are accounted by real gdp shock in the first period and 1.70% at the long run while 64.9% being accounted for by its own shock. finally, for dpr it also account for 0.01% variation in fluctuations in the short run and 0.37% on the long run while for its own shock it recorded 37.5% and 12.9% for both short and long run respectively. table-5.vector autoregression estimates for credit channel. items rgdp cps cgo csm lag 1 0.690180 (0.14350) [ 4.80973] 0.459879 (0.00430) [ 1.21243] 0.000762 (0.00140) [ 2.54544] -0.082126 (0.33406) [-0.24584] lag 2 -0.209061 (0.14368) [-1.45503] -0.554997 (0.00015) [-1.75550] -0.000158 (0.00139) [-0.11419] -0.176417 (0.31351) [-0.56271] constant 6.812128 (3.20003) [ 2.12877] 3.663073 (1.61279) [ 2.27126] 144.7818 (349.812) [ 0.41388] 2.308926 (1.48328) [ 1.55663] r-squared 0.783486 adj. r-squared 0.667005 f-statistic prob log likelihood akaike aic schwarz sc durbin watson 13.50635 0.000290 -189.6974 7.298088 7.699555 2.035670 source: e-view 9.0 output. the var results of the relative statistics are summarized on table 5. it can be seen that the parameter estimate for growth in credit to the private sector (cps) has a short run positive and significant relationship with real gdp at lag 1. it turned negative at lag 2. the variable recorded a coefficient 0.459879 and -0.554997 with a probability and standard error of 0.00015 & 0.000430 at t-value of 1.75530 and 1.21243 respectively. similarly, the coefficient estimate for growth in credit to the government (cgo) also had short run positive relationship with real gdp. this is statistically significant at lag 1 but turned negative when it was lagged 2. cgo as a variable of the credit channel recorded a coefficient of 0.000762 and -0.000158 at both lag 1 and 2. the standard error stood at 0.00140 and 0.00139 with a t-statistics of 0.54544 and -0.24584 for both lag. also, the parameter estimate for growth in credit to smes (csm) has a negative short run relationship with real gdp when lagged at period 1 and 2. csm recorded a coefficient of -0.082126 and -0.176417, a standard error of 0.33406 and 0.31351 and a t-value of -0.24584 and -0.56271. however, the observed degree of relationship between the variables of credit channel and economic growth was quite high at an adjusted r squared of 0.667. by implication, about 67% of the variations in real gdp were explained by changes in credit channel variables. this demonstrates a good fit as indicated by the fstatistic of 13.506. the log likelihood ratio, akaike information criterion and schwarz bayesian criterion statistic all showed that the model has good forecasting power. thus the credit channel of monetary policy transmission mechanism has short run relationship with real gdp. therefore, the null hypothesis of no significant short run relationship cannot be accepted in place of the alternative hypothesis. the result of the variance decomposition analysis for credit channel as presented in table 6 shows that changes in the variation in real gdp accounted by its own shock seem to be the highest and changes from 100% within the first period to 85.96% over ten (10) period horizons. for growth in credit to the private sector (cps), the result also revealed that the variations in real gdp accounted for by credit channel variables are low and started from 0.000 in the first period for cps, cgo, csm and ndc to 2.15%, 0.18%, 0.45% and 1.29% in the second period to about 2.33%, 0.17%, 3.29%, and 1.20% in the fourth period than 2.90%, 0.19%, 7.12% and 3.68% and 2.90%, 0.20%, 7.23% and 3.71% in the ninth and tenth period horizon respectively. as regards credit to private sector (cps), the variance decomposition result shows that changes in cps accounted for by its own shock is the highest and changes from 99.7% in the period to 74.52% in third period to 73.73% in the tenth period. asian journal of economics and empirical research, 2019, 6(2): 93-100 99 © 2019 by the authors; licensee asian online journal publishing group table-6. variance decomposition analysis. variance decomposition of rgdp: period s.e. rgdp cps cgo csm ndc 1 8.513706 100.0000 0.000000 0.000000 0.000000 0.000000 2 10.62898 95.91622 2.153178 0.187866 0.453195 1.289540 3 10.97646 94.79788 2.093407 0.176474 1.722649 1.209589 4 11.10055 93.00190 2.333663 0.173248 3.289624 1.201567 5 11.27434 90.16023 2.763084 0.168374 4.918100 1.990212 6 11.41178 88.00253 2.918916 0.170454 6.003359 2.904743 7 11.48723 86.85575 2.930072 0.184259 6.613413 3.416508 8 11.52235 86.33435 2.916123 0.194995 6.942033 3.612495 9 11.53917 86.08811 2.907760 0.199433 7.123093 3.681599 10 11.54812 85.95792 2.904956 0.200790 7.228336 3.707998 variance decomposition of cps: period s.e. rgdp cps cgo csm ndc 1 4.290857 0.228812 99.77119 0.000000 0.000000 0.000000 2 5.606817 0.137677 86.00194 0.483241 0.716047 12.66109 3 6.408449 0.105563 76.36918 0.478326 1.007384 22.03955 4 6.675994 0.098216 74.52119 0.682125 0.953307 23.74516 5 6.792062 0.103760 74.02347 0.813357 0.926071 24.13334 6 6.847893 0.116362 73.89031 0.849597 0.946119 24.19761 7 6.878504 0.128779 73.82853 0.861388 0.993735 24.18757 8 6.895708 0.137957 73.78851 0.866216 1.051314 24.15601 9 6.905732 0.144124 73.75700 0.868142 1.108895 24.12184 10 6.911874 0.148307 73.73036 0.868699 1.160189 24.09244 variance decomposition of cgo: period s.e. rgdp cps cgo csm ndc 1 930.6796 0.046527 0.279977 99.67350 0.000000 0.000000 2 944.7250 0.064122 0.765088 96.73188 0.009046 2.429863 3 949.6329 0.114879 0.983879 96.02844 0.447603 2.425198 4 951.3423 0.170898 1.190525 95.68415 0.517420 2.437010 5 952.0526 0.180696 1.253276 95.54227 0.588060 2.435696 6 952.5048 0.183216 1.286119 95.45211 0.642363 2.436196 7 952.8129 0.184456 1.303185 95.39059 0.686941 2.434831 8 953.0378 0.185532 1.315494 95.34564 0.719145 2.434184 9 953.1952 0.186436 1.324494 95.31418 0.741167 2.433727 10 953.3040 0.187099 1.330946 95.29241 0.756209 2.433333 variance decomposition of csm: period s.e. rgdp cps cgo csm ndc 1 3.946292 0.009126 4.732927 1.051240 94.20671 0.000000 2 4.837075 2.245935 9.670467 0.930410 85.65812 1.495064 3 5.541914 2.699962 10.81289 0.711073 81.40366 4.372413 4 5.906846 2.948474 12.67108 0.632347 79.79468 3.953413 5 6.137277 2.988809 13.51381 0.587202 79.13922 3.770962 6 6.290370 2.985850 14.03121 0.559595 78.77341 3.649936 7 6.393698 2.980258 14.35869 0.542005 78.53396 3.585087 8 6.464403 2.977546 14.59224 0.530361 78.35885 3.541006 9 6.512655 2.977040 14.76261 0.522621 78.22946 3.508269 10 6.545651 2.977037 14.88470 0.517451 78.13653 3.484277 variance decomposition of ndc: period s.e. rgdp cps cgo csm ndc 1 48.71597 0.077010 10.60329 2.451312 8.633990 78.23439 2 49.10961 0.754033 10.44652 2.960539 8.771397 77.06751 3 49.51701 0.852704 10.42489 3.304459 8.930783 76.48717 4 49.57541 0.860854 10.45235 3.300195 9.042889 76.34371 5 49.63941 0.858643 10.50200 3.293769 9.098248 76.24734 6 49.68093 0.857266 10.51992 3.290099 9.138086 76.19463 7 49.70097 0.856608 10.52374 3.289081 9.158034 76.17254 8 49.70973 0.856411 10.52373 3.288937 9.168294 76.16263 9 49.71324 0.856382 10.52325 3.288918 9.173466 76.15799 10 49.71480 0.856379 10.52287 3.288879 9.176207 76.15567 cholesky ordering: rgdp cps cgo csm ndc source: e-view 9.0 output. 5. conclusion and recommendations from the results, we conclude that the interest rate channel and the credit channel are significant channels for transmitting monetary policy actions in nigeria. this is not a surprising outcome due to the fact that these channels significantly influences and promote growth of the economy. a good understanding of these channels through which monetary policy actions can be transmitted into the economy is very critical for a wide range of macroeconomic policy formulation and implementation. for instance in stabilizing macroeconomic output and prices, which monetary policy instrument can be put to work in the case of business cycle and high inflationary pressure, which monetary policy instruments are appropriate to tackle it. these and more other pertinent policy asian journal of economics and empirical research, 2019, 6(2): 93-100 100 © 2019 by the authors; licensee asian online journal publishing group question should be examined in developing economies like nigeria. based on this, some very pertinent recommendations were offered from the empirical findings of this study as follows: i nigeria monetary authority should persistently adopt the use of changes in its monetary policy rate (mpr) as a policy strategy to effects changes in the credit supply and its accessibility by the productive sector of the economy. with such measures, the economy we experience changes in the credit market and the institutions. as it is through this mechanism, that the interest rate and credit channels would impact on the economy positively. ii in periods of perceived down-turn in economic activity, the cbn should employ the expansionary monetary policy tool of lowering the mpr to stimulate the credit channel, it supply and accessibility with the view of stimulating output growth, enhance employment generation and to better the general wellbeing of the economy without losing sight of its commitment to sustaining confidence in the monetary and financial system. iii to trigger growth through the credit channel, managers of the nigeria economy should improve on financial regulatory reform while the country judicial system should be strengthen. as these reforms can help in tightening the credit worthiness of the potential borrowers on one hand and the volume of nonperforming loans reduce on the other hand as well as enhancing the bank asset quality which in turn fortify the credit channel of monetary policy transmission mechanism in nigeria. reference bernanke, b.s. and m. gertler, 1995. inside the black box: the credit channel of monetary policy transmission. journal of economic perspectives, 9(4): 27-48.available at: https://doi.org/10.1257/jep.9.4.27. cecchetti, s.g., 1999. legal structure, financial structure and the monetary policy transmission mechanism. national bureau of economic research, working paper, no 7151. chileshe, p., f.z. mbao, b. mwanza, l. mwansa, t. rasmussen and p. zgambo, 2014. monetary policy transmission mechanism in zambia. bank of zambia working paper no 01. chimobi, o.p. and u.c. uche, 2010. money, price and output: a causality test for nigeria. american journal of scientific research, 8(1): 7887. chuku, c.a., 2009. measuring the effects of monetary policy innovations in nigeria: a structural vector autoregressive (svar) approach. available from 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studies and research, eastern mediterranean university gazimağusa, north cyprus. ishioro, b.o., 2013. monetary transmission mechanism in nigeria: a causality test. mediterranean journal of social sciences, 4(13): 377388.available at: https://doi.org/10.5901/mjss.2013.v4n13p377. ismail, o., 2014. does monetary policy influence economic growth in nigeria? international journal of economic and finance management, 12(1): 1–32. jhingan, m.l., 2011. monetary economics. 7th edn., delhi: vrinda publications limited. juks, r., 2004. monetary policy transmission mechanisms: a theoretical and empirical overview: the monetary transmission mechanism in the baltic states, tallinn. available from http://eestipank.info/pub/en/dokumendid/publikatsioonid/seeriad/muuduuringud/2004/2.pdf?objid=533623. kujis, l., 2002. monetary policy transmission mechanism and inflation in the slovak republic. imf working paper, no 80. mihov, i., 2001. monetary policy implementation and transmission in the european monetary union. economic policy review, 31(1): 371406. ndekwe, e.c., 2013. an analysis of the monetary policy transmission mechanism and the real economy in nigeria. central bank of nigeria occasional paper no 43. nwosa, p.i. and m.o. saibu, 2012. the monetary transmission mechanism in nigeria: a sectorial output analysis,’ international journal of economics and finance, 4(1): 204-212.available at: https://doi.org/10.5539/ijef.v4n1p204. obafemi, f. and e. ifere, 2015. monetary policy transmission mechanism in nigeria: a favar approach. international journal of economics and finance, 7(8): 93-103.available at: https://doi.org/10.5539/ijef.v7n8p229. omolade, a. and h. ngalawa, 2017. monetary policy transmission mechanism and growth of the manufacturing sectors in libya and nigeria. journal of entrepreneurship, business and economics, 5(1): 67-107. taylor, j.b., 1995. the monetary transmission mechanism: an empirical framework. journal of economic perspectives, 9(4): 11-26.available at: https://doi.org/10.1257/jep.9.4.11. uchendu, o., 2009. monetary policy management in nigeria in the context of uncertainty. bullion, central bank of nigeria, 33(3): 1-6. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 136 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 2, 136-146, 2020 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2020.72.136.146 © 2020 by the authors; licensee asian online journal publishing group the impact of capital inflows on economic growth in nigeria: empirical evidence from wavelet coherence technique tomiwa sunday adebayo cyprus international university, nicosia mersin, turkey. abstract the study explores the interaction between capital inflows and economic growth in nigeria using data between 1981 and 2018. this study utilized the ardl techniques to catch the short and long-run dynamics among variables utilized, and the granger causality test was utilized to ascertain the direction of causality. furthermore, the wavelet coherence, a recent and more powerful technique was deployed to verify the co-movement and causality among the variables. findings from the ardl techniques depict; (i) there is cointegration among the variables in the long-run; (ii) gross capital formation impact economic growth positively (iii) foreign aid and fdi inflows have an insignificant impact on economic growth. the granger causality test reveals; (i) feedback causality between gross capital formation and economic growth; (ii) unidirectional causality was found running from fdi inflows and foreign aid to economic growth. the wavelet coherence provides supportive evidence for the ardl and granger causality test. based on these findings, recommendations were suggested. keywords: gross capital formation, foreign aid, fdi inflows, economic growth, wavelet coherence technique, granger causality. jel classification: b17; b23; b22. citation | tomiwa sunday adebayo (2020). the impact of capital inflows on economic growth in nigeria: empirical evidence from wavelet coherence technique. asian journal of economics and empirical research, 7(2): 136-146. history: received: 20 march 2020 revised: 22 april 2020 accepted: 25 may 2020 published: 15 june 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 137 2. literature review .......................................................................................................................................................................... 137 3. data, model, and methodology .................................................................................................................................................. 139 4. empirical findings ........................................................................................................................................................................ 142 5. conclusion and policy direction ................................................................................................................................................ 145 references ............................................................................................................................................................................................ 145 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.72.136.146&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1736 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1736 asian journal of economics and empirical research, 2020, 7(2): 136-146 137 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature in the context of nigeria, using the two-gap growth theory, this paper tends to construct growth and development. though, the two-gap growth theory has been deployed by various researchers to propose economic growth and development, however, none of the studies have utilized the wavelet coherence technique to investigate the dynamics between capital inflows and gdp economic growth in the case of nigeria. therefore, this research addresses such gaps. this technique is utilized in econophysics to investigate the causality between economic variables. furthermore, it was also utilized as a robustness check for the granger causality test and ardl long and short-run dynamics. 1. introduction from the onset of worldwide recognition and growth, nations have recognized that capital inflows from more advanced and wealthier economies to smaller developing economies remain important for the accomplishment and fulfillment of domestic goals to strengthen their citizenship and nation-building. foreign capital inflows like foreign aid and fdi inflows bring in enormous amounts of foreign currency to developing countries which help in sustaining the balance of payment. unctad (2015) reports that western donors have given around us$4.14 trillion, which is seven times the gdp of nigeria, in aid to emerging economies. these inflows are supported by ngos and other charity bodies, as well as the so-called new donor nations. yet poverty stays widespread in several developing economies that receive the aid and impoverishment lingers. with over thirty various mineral resources, nigeria is seen as a resource-rich country with resources including gold, iron ore, coal and limestone. in the wake of the global financial crises between 2008 and 2009, the banking sector effectively recapitalized and increased regulation. economic growth in nigeria has since been powered by the development of agriculture, telecommunication, and services. economic diversification and steady growth have not transcribed into a significant drop in poverty level; with more than 62% of the over 200 million people experiencing severe poverty. notwithstanding its deep foundations, oil-rich nigeria has been crippled by an insufficient supply of power, inadequate infrastructure, setbacks in passing regulatory amendments, an outdated land system registration, strict trade policies, an unstable regulatory climate, a sluggish and unreliable justice system, instability and pervasive corruption. new investment in oil and gas has been hampered by regulation and security risks in nigeria with a continuous fall in output until 2012 with little recovery in 2017. due to a fall in the price of oil and output, nigeria falls into recession in 2016 coupled with worsening infrastructure in oil and gas, foreign exchange restrictions, niger-delta insurgency and economic policies. nigeria witnesses gdp growth, as output stabilizes due to the oil price increase in 2017. nigeria is the third destination for fdi inflows in africa behind egypt and ethiopia (unctad, 2019). in 2018, fdi totaled us$1.9billion compare to us$3.5billion in the previous year in nigeria (world bank, 2020). in nigeria, the major investing nations include the united kingdom, the netherlands, the usa, france, and china. these countries are lured into nigeria due to an advantageous taxation system, low labor cost, availability of resources and a partially privatized economy. likewise, political turmoil, high tax burden, insecurity majorly in the northern part of the country and corruption are restricting fdi inflows in nigeria. not to mention, nigeria has continually received foreign aid from various donors such as the world bank, united kingdom, china, japan, the united states, and european union, etc. nigeria receives a grant of $3billion from the united states government between 2010 and 2015. in 2018, nigeria received aid totaled us$3.3billion (world bank, 2020). although these statistics illustrate an enhancement in the gdp growth, but does these statistics mirror the true picture of living standards of nigerians? the vigor of these indicators influencing the growth is far from factuality (kolawole, 2013). in this perspective, the two-gap theory proposes that the investment-saving gap can be closed by fdi inflows while foreign aid can close the foreign exchange gap. hence, the shortcomings of foreign exchange and savings gaps can be closed by foreign aid and foreign direct investment respectively. though numerous studies have explored capital inflows and growth interactions, they only explore the interaction of foreign aid and foreign direct investment separately on gdp growth. the next section discusses the theoretical and empirical review. the model, data, and methodology are discussed in the third section. the fourth section analyse the empirical findings which is followed by the concluding and policy recommendations section. 2. literature review 2.1. the two-gap framework the concept underneath the two-gap economic growth tactic is that savings and foreign exchange gaps are two distinct and separate limitations in developing economies to realizing their preferred growth rate. the nature of the accounting procedures is followed by the two distinct gaps: investment-savings (i-s) and the import-export (m-x) gaps. it is generally acknowledged that if a country's investment is more than savings, there will be a balance of payment deficit. likewise, if a nation import surpasses its exports, it creates a trade deficit. as stated by chaehery and strout (1956) for a nation to achieve it targeted growth rate, the gap between investment-savings and import-export can be closed by capital inflows. as adelman and chenery (1966) stated, saving gap will arise when savings is less than the domestic investment needed to attain the desired growth rate of the economy. capital inflows can be deployed to breach the saving gap to attain the desired growth rate in the economy. the same analogy goes for the import-export gap. hence, if the import is more than export, a foreign-exchange gap will surface which can be closed by capital inflows. the national income accounting identities can be utilized to depict these gaps by employing aggregate expenditure equals aggregate output approach. …………………………..………. (1) in equation 1, national expenditure is depicted by e, income is depicted by i, the output is represented by y, imports is illustrated by m, x mirrors exports, f stands for net capital inflows. saving constraints will surface in the economy when the saving gap is more than the foreign exchange gap. likewise, the foreign exchange constraint will surface in the economy when the savings gap is less than the foreign exchange gap. foreign aid needed in each gap would be dissimilar since the gaps are disparate and independent. asian journal of economics and empirical research, 2020, 7(2): 136-146 138 © 2020 by the authors; licensee asian online journal publishing group basically, if local investors (through domestic commercial banks) obtain access to the global financial market, the foreign exchange and savings gaps could be resolved by the financing domestic (excess) investment out of the savings from developed economies that is, through capital inflow. according to bender and löwenstein (2005) foreign aid, portfolio investment by foreigners, and foreign direct investment are examples of capital inflows. ………………………………………….……………… (2) …………………………..............……….…………… (3) savings and foreign exchange gaps is depicted by equation 2 and 3. thus, the foreign capital inflows comprise of both foreign aid (oda) and foreign direct investment (fdi) as depicted in equation 4. ………………………………………… ……… (4) most economic reasoning for conferring special opportunities to lure fdi is predicated on the assumption that fdi close the gap between rich and impoverished countries besides generating technology transfers and spillovers. theoretically, gdp growth is impacted by fdi in several ways. the solow neoclassical growth model proposes that economic growth is improved by fdi by incorporating the capital stock. the solow view is accepted by several studies that propose that domestically owned production is less productive compared to foreign-owned production (haddad & harrison, 1993). this perspective, which is premised on the studies of rivera-batiz and romer (1991) and grossman and helpman (1991) buttresses the theoretical assumption in the literature. this strategy also attempts to relate fdi flows with global trade, changes in technology, and growth relationships (driffield & jones, 2013; romer, 1990). yet, out of 25 studies, only six countries observed fdi and gdp growth interaction to be positive (görg & greenaway, 2004). this effect reflects a scenario labeled as 'stylized fact' by herzer and klasen (2008). utilizing vietnam as a case study, nguyen (2020) explored the interaction between fdi inflows and international trade (export and import) on gdp growth utilizing data spanning between 2000 and 2018. the result obtained illustrates positive interaction between gdp growth, and export and import. yusoff (2014) examined the interaction between export, foreign direct investment, government expenditure, and gdp growth in malaysia employing the vecm and toda yamamoto causality test. findings show that export, fdi inflows, and government expenditure influence growth positively. additionally, one-way causality was found running from fdi inflows, exports, and government expenditure to gdp growth. in pakistan ali, ahmad, and sadiq (2019) investigated the fdi-growth nexus utilizing ardl approach to cointegration and utilizing timeseries data between 1975 and 2015. findings from this study reflect a negative link between gdp growth and fdi inflows. furthermore, in the short-run and long-run, economic growth is impacted positively by trade openness. the impact of fdi inflows on economic growth of seychelles was examined by yusheng, agyapong, bentummicah, and aboagye (2019) utilizing yearly data between 1985 and 2018, and deploying ordinary least square to establish this relationship. the investigators proved a positive and significant link between fdi inflows and gdp growth. olofin, aiyegbusi, and adebayo (2019) analyzed the link between fdi inflows and economic growth in nigeria using fmols to demonstrate this interaction and employing time series data. the result portrays that net trade and human capital, and fdi inflows, have a positive relationship with gdp growth while imports impact growth negatively. okoro, nzotta, and alajekwu (2019) used yearly data covering 32 years (1986-2016) to investigate the interaction between capital inflows and gdp growth in nigeria. the johansen and ols techniques were used to verify these dynamics. findings through the johannsen cointegration show that there is cointegration among the variables employed in the long run while the ols mirrors that both fdi inflows, and remittances impact growth positively. however, external debt and foreign aid have an insignificant link with gdp growth. abhyankar and tudekar (2020) explored the determinants of growth in india utilizing time-series data from 1980 and 2018, and multiple regression techniques. the investigators discovered a positive and significant link between fdi inflows, gross domestic savings, gross capital formation, and economic growth. 2.2. aid-growth relationship foreign assistance reaches a nation in the form of private capital and/or public capital. nevertheless, public foreign assistance is far more crucial for speeding up growth in the economy than private foreign capital. developing economies financial desires are so high that private foreign investment will only partly address the financing issue. for example, social spending such as education, medical services and public health is not financed by private foreign investment. although indirectly adding to the economic efficiency and competitiveness of the economy. overall, these initiatives do not produce direct benefits and could thus be funded by grants from industrialized economies and international agencies. foreign aid, therefore, enables industrialisation, in constructing overhead economic capital, and in generating greater chances for employment. nevertheless, as griffin and enos (1970) stated foreign aid contributes to a decrease in domestic savings whereas papanek (1973) demonstrates that in some nations, foreign aid promotes savings such that increase in foreign aid will lead to increase in investment, though in some other nations it dissuades savings and increase in foreign aid inflow contributes to decrease in investment. it is also conceived that aid opponents take the position that, this is a form of wealth transfer through sending money specifically to wealthy people in the developing world through poor people in wealthier nations (papanek, 1973). economic growth is not influence by foreign assistance, though there is a conditional impact when associated with a 'balanced' monetary and fiscal policy climate as shown by burnside and dollar (2000) and easterly, levine, and roodman (2004). additionally, bauer (1976) claimed that foreign assistance had damaging effects on beneficiary nations. sabra (2016) examined the determinants of growth in selected mena economies and considered foreign aid to impact growth and savings negatively, though positive and significant link was found between foreign aid and consumption. employing the two-gap theory, kolawole (2013) investigated the aid-growth nexus in nigeria utilizing data covering 31 years (1980-2011). the ardl techniques were utilized, and the author observed a negative link between fdi inflows and gdp growth whereas no significant interaction was found between foreign aid and economic growth. furthermore, investment influence economic growth positively and the granger causality test shows that both foreign aid and fdi inflows does not cause economic growth in nigeria. utilizing sub-saharan africa (ssa) as a case study, mah and yoon (2020) investigated the aid-growth nexus using data between 1994 and 2015. aid was divided into loan and grant, and the investigators observed that grant has a positive and significant link with growth while loan has negative and asian journal of economics and empirical research, 2020, 7(2): 136-146 139 © 2020 by the authors; licensee asian online journal publishing group significant interaction with growth. furthermore, both investment and education have positive and significant interactions with growth. onyibor, bah, and tomiwa (2018) explored aid-growth interaction among the five poorest nations in the world utilizing data between 1985 and 2015. findings from the ardl techniques show that foreign aid impact growth significantly during the period of study. furthermore, there is evidence of a positive and significant link between investment in burundi and congo in the long run. babalola, mohd, ehigiamusoe, and onikola (2019) looked into the dynamics among foreign aid, foreign trade and economic growth in nigeria by utilizing yearly data between 1980 and 2015 and utilizing the error correction model (ecm) to explore both the short and long-run interactions. the authors found that all the variables are cointegrated in the long-run and both fdi inflows and foreign aid positively and significantly influence growth in the long run. with the core objective to critically explore the gdp growth determinants in lower-middle-income countries and utilizing random effect model to verify this relationship, wadud (2017) observed that current account balance, fdi inflows, investment, and remittance have positive interaction with gdp growth while exports, imports, and inflation have an insignificant link with gdp growth. 3. data, model, and methodology 3.1. data and model to investigate the interaction between gdp growth (y) which is the dependent variable and gross capital formation (gcf), foreign aid (oda) and fdi inflows (fdi) which represent the independent variables, this paper utilized yearly data spanning between 1981 and 2018. these secondary data were gathered from the world bank (wb), and central bank of nigeria (cbn). the trends of the key variables are portrayed in figure 1, 2, and 3 respectively. figure-1. gdp growth between 1981 & 2018. source: world bank (2020). figure-2. fdi between 1981 & 2018. source: cbn (2020). asian journal of economics and empirical research, 2020, 7(2): 136-146 140 © 2020 by the authors; licensee asian online journal publishing group figure-3. oda between 1981 & 2018. source: world bank (2020). table-1. descriptive statistics. source wb cbn wb wb variables code y gcf fdi oda mean 3.0019 10.593 9.1618 8.6193 median 2.9505 10.551 9.2008 8.4365 maximum 3.5082 11.167 9.9465 10.058 minimum 2.4317 10.091 8.2768 7.5011 std. dev. 0.3192 0.2745 0.5067 0.7045 skewness 0.0621 0.1308 -0.0123 0.1473 kurtosis 1.5735 1.9564 1.7467 1.9730 jarque-bera 3.2463 1.8324 2.4878 1.8071 probability 0.1972 0.4000 0.2882 0.4051 observations 38 378 38 38 note: wb, & cbn represents world bank & central bank of nigeria respectively. brief information about the variables utilized is described by the table 1. the skewness and kurtosis values must not be greater than 1 and 3 respectively to mirrors normal distribution. based on the yardstick for normal distribution, all the variables utilized depicts characteristics of normal distribution. furthermore, the probability of the jarque–bera illustrates that all indicators utilized mirror normal distribution. 3.2. econometric methodology this paper utilized the two-gap framework to explore the long and short-run dynamics between gdp growth, and gross capital formation, fdi inflows and foreign aid. the natural logarithm of the variables utilized was taken. this is performed to reduce skewness and deviation (barro, 1991). the first thing is to formulate the economic function which is illustrated in equation 5; ……………………………………….……….… (5) this is followed by formulating the study’s economic model below; ..........… (6) after formulating the economic model, the study formulates the econometric model as depicted in the equation 7 below; . … (7) in equation 8 above, y represents economic growth, gcf denotes gross capital formation, fdi stands for foreign direct investment and oda represents foreign aid. 3.2.1. ardl approach the two-step created by engle and granger (1987) approach was generally utilized in parameter estimation in cointegration procedures. the ardl model created by pesaran and shin (1998) merged two phase-procedures between engle and granger in a single step in an attempt to investigate the path of causation between variables. the cointegration by johansen (1988) and johansen and juselius (1990) is less superior to the ardl technique. while the traditional method of cointegration measures long-run interactions within the framework of an equation system, the ardl method utilizes one reduced form equation (pesaran & shin, 1998). the method also generates reliable predictions of long-run interactions and appropriates t-statistics (inder, 1993). moreover, the ardl method will not necessitate pre-testing of the parameters, suggesting that the test is feasible unless the fundamental regression is i(0), or i(1), or mix of both. the simplicity of the approach makes it different from the other approaches since in most instances the time series data are integrated of the same order. furthermore, the ardl method eliminates the substantial number of requirements needed by traditional cointegration testing. any of which include the amount (if any) of dependent and independent variables to be used in the framework, the variations in the order of variables being implemented, and the treatment of deterministic components and the number of lags. the findings of traditional cointegration experiments are usually susceptible to the process and numerous alternate options available in the calculation procedure (pesaran & shin, 1998). nevertheless, behind the ardl asian journal of economics and empirical research, 2020, 7(2): 136-146 141 © 2020 by the authors; licensee asian online journal publishing group approach, various optimum lags can be used with minimal sample data, making it appropriate for this analysis. the ardl method is consequently, as stated by ghatak and siddiki (2001) a more statistically meaningful method for evaluating the cointegration relationship in small samples. ∑ ∑ ∑ ∑ in equation 8, the first difference operator is illustrated by δ, mirrors constant term, are short-run elasticities concerning the exogenous variables, ardl model lag order is represented by ί, an error correction term is represented by , stands for the error disturbance and time is depicted by t. also, the robustness of the ardl cointegration was checked utilizing the fmols and dols. 3.2.2. granger causality test the interaction between the variables is determined by the ardl approach however, the causality direction of variables can't be determined by the ardl approach. thus, granger (1969) suggested a causality approach to ascertain the casualty direction between variables. the general form of the granger causality is depicted by equation 9 & 10. ∑ ∑ ∑ ∑ in equayion 9 and 10, the lag length is indicated by t, and k, and and μ, represents their error terms which is presumed to be distinct (white noise) from each other. the granger causality test is very simple to conduct and use. 3.2.3. wavelet approach the wavelet techniques created by goupillaud, grossmann, and morlet (1984) was utilized to investigate comovement between gdp growth, foreign aid, fdi inflows, and gross capital formation in nigeria. onedimensional time data decomposition into the bidimensional time-frequency represents the leading innovation of wavelet techniques. this enables capturing the long-run and short-run causality between the economic growth and the exogenous variables in the current study. a multi-scale framework of disintegration yields a standard structure for demonstrating frequency-dependent activity for examining the linkage between economic growth and the exogenous variables in nigeria. non-stationarity represents the major attribute of most variables utilized in economic or finance based research. additionally, if it is discovered that the time series data have a structural break(s), time-domain causality tests with parameters fixed will suffer. the wavelet ( ) is part of the morlet wavelet family in this study, equation 11 illustrates the morlet equation. the main parameters of the wavelet are, (f) which indicates frequency, and (k) which stands for location or time. whereas the underlying feature of the k parameter is the exact location of a wavelet in time, the frequency parameter regulates the deformed wavelet for localizing different frequencies. according to gokmenoglu, kirikkaleli, and eren (2019) by converting the equation of the wavelet, it is possible to generate first. the equation 12 depicted below for this transition is: √ ( ) as a function of k and f given time series data p(t), the continuous wavelet can be constructed from as follows: ∫ √ ( ̅̅ ̅̅ ̅̅ ̅ ) in equation 13, the preceding equation, the reconstructed actual time series p(t) with the respective coefficient is depicted as follows; ∫ *∫ | | + as illustrated in equation 14, the wavelet power spectrum (wps) is used to catch instability and to get a deep understanding of the time series variables. | | in equation 15, the wavelet coherence method's key novelty is that the methodology helps the current research to imagine some correlation between gdp growth and other independent variables in causalities based on merged time-frequency. the time-series cross wavelet transform (cwt) is depicted equation 16: ̅̅ ̅̅ ̅̅ ̅̅ ̅̅ ̅ in equation 16, wp(k,f) stands for the cwt of p(t) and q(t), and the value of squared wtc is denoted by wq(k,f). . the is illustrated in equation 17 asian journal of economics and empirical research, 2020, 7(2): 136-146 142 © 2020 by the authors; licensee asian online journal publishing group | ( )| ( | | ) ( | | ) in equation 17, zero (0) correlation between two series will surface if the gets closer to 0 whereas correlation will show whenever is close to 1, which spherical thick black line illustrates and also indicated by warmer color (red). although, the values did not show the sign of the interaction. hence, torrence and compo (1998) suggests a method that can detect wavelet coherence by using variations by deferrals in two timeseries wavering signals. wavelet coherence at the different level is depicted in the equation 18 as follows; ( { ( )} { ( )} ) wherein l and o represent an imaginary operator and a real component operator as illustrated in equation 18 4. empirical findings 4.1. unit root test unit root tests are applied to the gdp growth and the other exogenous variables to assess the order of integration by utilizing adf, pp, and kpss unit root tests. the indicators under investigation are presumed to contain no structural breaks when implementing the specified tests. the outcomes of those tests are depicted in table 2. furthermore, taking into account that variables could have structural breaks, the zivot-andrews (za) unit root test that can sense one structural break, and lee strazicich (lm) unit test that can detect two structural breaks were utilized. table-2. unit root test. variables adf (k &t) decision pp (k & t) decision kpss (k & t) decision y -4.50* i(1)* -4.47* i(1)* 0.16** i(0)** gcf -3.49** i(1)** -3.68*** i(0)*** 0.19** i(0)** oda -5.50* i(1)* -5.56* i(1)* 0.14*** i(0)** fdi -9.82* i(1)* -9.92* i(1)* 0.182** i(0)** note: *, ** & *** signifies 1%, 5%, & 10% level of significance. k. and k. & t indicate constants and constant and trend. table-3. unit root with structural break (s). variables za (k & t) decision lm decision y -6.70* {2004} i(1)* -5.05* {2007} [2013] i(1)* gcf -5.12** {2007} i(1)** -7.69* {2004} [2010] i(1)* oda -6.14* {2007} i(1)* -8.02* {2002} [2006] i(1)* fdi -11.21* {1999} i(1)* -11.04* {1991} [1994] i(1)* note: *, ** & *** signifies 1%, 5%, & 10% level of significance. k. and k. & t indicate constants and constant and trend. {}, & [] signifies first and second break respectively. in tables 2 and 3 respectively, it can be observed that all the variables have a structural shift respectively. it is also disclosed that findings of unit root with structural breaks are unidentical to those without structural breaks. based on the results of the zivot-andrews and lee strazicich unit root test, the null hypothesis of a unit root at their level cannot be dismissed at significance level of 5%. it can therefore be assumed that structural breaks tend to influence on the behavior of the unit root and that the series is incorporated in a mixed order i.e. i (0) and i(1). 4.2. ardl bounds test table-4. bounds test. arld cointegration test function y =f(gcf fdi, oda) lag structure 1, 4, 3, 4 f-stat 6.64* lower bound upper bound 10% 2.45 3.52 5% 2.86 4.01 1% 3.74 5.06 note: ∗ stands for 1% significance levels. the long-run cointegration among the variables is portrayed in the table 4 utilizing the ardl bounds test. the ardl bounds test portrays evidence of cointegration among the variables. the following thing is to investigate the long-run interaction between the dependent and the independent variables after the long-run cointegration is confirmed. asian journal of economics and empirical research, 2020, 7(2): 136-146 143 © 2020 by the authors; licensee asian online journal publishing group 4.3. ardl long-run and short-run result table-5. ardl long run estimate. regressors coefficient std-error t-stat prob long-run coefficients of the ardl (1, 4, 3, 4) model of y y 0.339477 0.154388 2.198848 0.039** gcf 0.948410 0.093140 10.18265 0.0000* fdi 0.026304 0.027111 0.970227 0.3430 oda -0.023287 0.028403 -0.819858 0.4215 c -6.657110 1.599162 -4.162874 0.0004 r2 0.997828 f-statistic 302.7490 adj-r2 0.995078 prob(f-stat) 0.00000 ecm representation of the ardl (1, 4, 3, 4) model of y δgcf 0.948410 0.073377 12.92524 0.0000* δfdi -0.072824 0.025997 -2.801238 0.0107** δoda 0.086250 0.022975 3.754041 0.0012* ecm(-) -0.660523 0.119885 -5.509619 0.0000 note: *, & **, stands for 1%, 5%, level of significance. table-6. robust check. panel m: fmols estimate regressors coefficient std-error t-stat prob y 0.289407 0.068127 4.248074 0.0008* gcf 0.944189 0.061856 15.26425 0.0000* fdi 0.028919 0.018130 1.595111 0.1264 oda -0.020862 0.018782 -1.110747 0.2799 c -6.343023 1.128117 -5.622664 0.0000 panel n: dols estimate regressors coefficient std-error t-stat prob y 0.339477 0.147866 2.295836 0.0321** gcf 0.948410 0.089205 10.63179 0.0000* fdi 0.040860 0.027330 1.495027 0.1498 oda -0.023287 0.027203 -0.856021 0.4016 c -6.657110 1.531605 -4.346492 0.0003 note: *, & **, stands for 1%, 5%, level of significance. to examine the long and short run dynamics between economic growth and the other exogenous variables, the ardl techniques was deployed. the study further utilized the fmols and dols to verify the result of the ardl long-run interaction. the fmols and the dols provide a supportive evidence for ardl long-run result. the findings from the ardl long run estimation in table 5 shows; (i) 0.94% increase in gdp growth is as a result of a 1% rise in gcf keeping other factors constant. this finding aligns with the work of kolawole (2013); mah and yoon (2020); onyibor et al. (2018) and adebayo (2020); (ii) no significant relation was found between fdi and gdp growth. this outcome complies with herzer and klasen (2008); kolawole (2013) and görg and greenaway (2004) but does not agree with the study of abhyankar and tudekar (2020) and olofin et al. (2019); and (iii) the link between foreign aid and gdp growth is insignificant. this outcome aligns with the view of burnside and dollar (2000) and easterly et al. (2004) but does not comply with the study of babalola et al. (2019) and mah and yoon (2020). furthermore, in the short run, ecm is statistically significant with the appropriate sign (-0.66) which illustrates that shocks in the short run can be adjusted back to equilibrium by 66% each year. 4.4. diagnostic test to ensure whether this model is good or not suffering from any form of misspecification, various diagnostic tests were employed. table 7 depicts the diagnostic tests utilized. table-7. diagnostic tests. diagnostic tests f-stat (p-value) normality test (t) 1.59(0.45) breusch-pagan-godfrey test (0) 0.50 (0.90) breusch–godfrey lm test (m) 1.57 (0.17) ramsey test (y) 0.33 (0.57) 4.4.1. stability test to determine the stability of the model, the cusum, and cusm of square are employed. figures 4, and 5 below depict the outcome of the cusum, and cusm of square at 5% significance level. asian journal of economics and empirical research, 2020, 7(2): 136-146 144 © 2020 by the authors; licensee asian online journal publishing group -15 -10 -5 0 5 10 15 98 00 02 04 06 08 10 12 14 16 18 cusum 5% significance -0.4 -0.2 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 98 00 02 04 06 08 10 12 14 16 18 cusum of squares 5% significance figure-4. cusum. figure-5. cusum of square. 4.5. granger causality test though, the ardl approach ascertains the interaction between variables, however, it can’t determine the causality direction. hence, the causality test proposed by granger (1969) was deployed in the present study to capture the direction of causality. table-8. causality test. direction of causality f-stat p-value decision granger causality y  gcf 8.21385 0.0014* reject ho gcf  y 3.41818 0.0456** reject ho y  fdi 0.01342 0.9867 do not reject ho fdi  y 6.89090 0.0033* reject ho y oda 1.69658 0.1999 do not reject ho oda y 4.70292 0.0165** reject ho note:  stands for direction of the direction of causality, *, ** and *** mirror significance at 1%, & 5% levels, correspondingly. optimal lag for the model has been selected using sc information criteria (lag=2). the findings from the granger causality in table 6 above depicts; (i) feedback causality between gross capital formation and gdp growth; (ii) unidirectional causality was found running from fdi inflows; and (iii) one-way causality running from foreign aid to economic growth. these findings show that employed variables are vital determinant of growth in nigeria. 4.6. wavelet coherence result to explore the co-movement between economic growth and gross capital formation, fdi inflows and foreign aid in nigeria. the wavelet approach result is utilized to explain this question. the time is depicted by the x-axis. the frequency is illustrated by the y-axis. the cone-shaped grey line depicts the cone of influence in figures 6, 7 and 8 whereas 5% level of significance is depicted by the black contour shape tested against ar(1). in the figures 6, 7 and 8, zero dependency is illustrated by cold (blue) between two-time series variables while high dependency is illustrated by warmer red (hot) color. table-9. wavelet interpretation table. arrows direction interpretation rightward arrows positive correlation between variables leftward arrows negative correlation between variables rightward and up or leftward down second variable cause first variable leftward and up, or rightward and down the first variable cause second variable figure-6. wtc between y & gcf. figure-7. wtc between y & oda. asian journal of economics and empirical research, 2020, 7(2): 136-146 145 © 2020 by the authors; licensee asian online journal publishing group figure-8. wtc between y & fdi. the wavelet coherence between economic growth and gross capital formation is depicted in figure 6. the rightward arrow depicts a positive correlation between economic growth and gross capital formation. furthermore, rightward and up arrows at the thick black contour signifies there is a feedback causality between gdp growth and gross capital formation between 1982, and 1985, between 1990 and 2010, and 2013 and 2017. the wtc between gdp growth and foreign aid is illustrated in figure 7. the leftward arrows between 1983, and 1987 mirrors a negative correlation between gdp growth and foreign aid. no significant interaction was found between gdp growth and foreign aid between 1990 and 2012. however, a positive correlation was found between gdp growth and foreign aid between 2013 and 2016. also the rightward up and leftward down denotes foreign aid cause gdp growth can be rejected at a significant level of 5% between 1983 and 1987, between 2013 and 2016. this finding provides supportive evidence for the granger causality test. the wtc between economic growth and fdi inflows is depicted by figure 8. the leftward arrows illustrate a negative correlation between economic growth and fdi inflows between 1987 and 1997. additionally, leftward and down arrows signify that fdi inflows does not cause gdp growth can be rejected at 5% significant level. this result complies with the granger causality result. 5. conclusion and policy direction although several studies have been conducted exploring the impact of capital inflows on economic growth in emerging and developed economies, however, the time-frequency dependency of economic growth in the viewpoint of gross capital formation, foreign direct investment, and foreign aid is explored for the first time utilizing time series data between 1981 and 2018. therefore, this study addresses the gaps in the literature in regards to nigeria. the study utilized the ardl approaches to catch the short and long-run dynamics among variables utilized, and the granger causality test was utilized to ascertain the direction of causality. in addition, the wavelet coherence technique, a recent technique in econometrics was utilized to capture correlation and causality dynamics in the short and long run at various scales. findings from the ardl techniques depict; (i) there is evidence of cointegration among the variables in the long run; (ii) gross capital formation impart economic growth significantly; (ii) foreign aid and fdi inflows have an insignificant impact on economic growth. the granger causality test discloses; (i) feedback causality between gross capital formation and economic growth; (iii) unidirectional causality was found running from fdi inflows; and (iii) one-way causality running from foreign aid to gdp growth. these findings show that employed variables are a vital determinant of growth in nigeria. the wavelet coherence approach provides further supportive evidence for the ardl, and granger causality test. the study suggests; (i) favorable incentives that will lure more fdi inflows cotangent on sound macroeconomic policy environment should be implemented by the government; (ii) for foreign aid to be effective in nigeria, sound macroeconomic policy environment must be put of ground. although the empirical analysis of this paper is solid by utilizing ardl, granger causality and the recent wavelet coherence technique, further studies should be conducted in several nations using different techniques and more variables. references abhyankar, a., & tudekar, a. 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(2014). foreign direct investment, exports, education, and growth in malaysia. global business and economics review, 16(2), 111-122.available at: https://doi.org/10.1504/gber.2014.060180. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 242 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 2, 242-250, 2020 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2020.72.242.250 © 2020 by the authors; licensee asian online journal publishing group energy consumption, economic growth, and environmental degradation in oecd countries dong kyun kim pacific university, usa. abstract the world is governed by the issues of environmental degradation, climate control, pollutant emissions and other such phenomena due to the increasing dilapidation of environmental resources. for a while now, the focus has been on the production of green technologies, clean energy solutions and the development of a sustainable module that will aid in the restoration and protection of the environment. in this scenario, the dependence on consumption patterns of energy, economic growth (eg), and environmental degradation (ed) have become the focus of many researchers and policymakers. the organization for economic co-operation and development (oecd) countries are understandably characterized as the fastest developing nations of the world. however, literature evaluating the influence of energy consumption (ec) and economic growth (eg) on environmental degradation has presented conflicting results. this study aims to solve this conflict by presenting a panel dataset comprised of 35 oecd between 2000–2014. the generalized method of moments panel vector autoregression (gmm-pvar) has been used to estimate the impact and causal relationship between the variables. the results of the study indicate that eg and consumption patterns of energy are vital for the improvement of the environmental performance of the firms. in contrast to other empirical literature, this study finds that the economic development of the country or countries and the patterns of consumption have started to coagulate with set environmental performance parameters. environmental policies, consumption patterns and plans for eg are all being aligned in oecd countries. the results of this study are robust, as different methods for the evaluation have been used. keywords: gmm-pvar, granger causality, oecd. citation | dong kyun kim (2020). energy consumption, economic growth, and environmental degradation in oecd countries. asian journal of economics and empirical research, 7(2): 242-250. history: received: 9 july 2020 revised: 13 august 2020 accepted: 16 september 2020 published: 29 september 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. background ..................................................................................................................................................................................... 243 2. literature review .......................................................................................................................................................................... 244 3. energy consumption and environmental degradation ......................................................................................................... 244 4. economic growth and environmental degradation .............................................................................................................. 244 5. method ............................................................................................................................................................................................. 245 6. generalized method of moments panel vector autoregression ......................................................................................... 246 7. panel granger casualty test ...................................................................................................................................................... 246 8. analysis ............................................................................................................................................................................................ 246 9. discussion and conclusion ........................................................................................................................................................... 249 references ............................................................................................................................................................................................ 249 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.72.242.250&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/2193 asian journal of economics and empirical research, 2020, 7(2): 242-250 243 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to existing literature by empirically testing the association among energy consumption, economic growth, and environmental degradation in 35 oecd between 2000–2014. 1. background there somehow exists a positive relationship between energy consumption (ec) and economic growth (eg), as an increase in one variable results in an increase in the rate of another variable in oecd countries (kahouli, 2019). however, environmental degradation (ed), such as the pollution of land or water, results in a decreasing eg of a country, as well as effects such as the consumption of carbon dioxide gas, air pollutants, the consumption of fish and crops, and changes in land-use, which add to the degradation of the environment (zafar, shahbaz, sinha, sengupta, & qin, 2020). although ed results in an increase in income per capita up to a certain threshold, the eg of a country affects its performance level with regard to the environment, as the pure eg of a country increases the level of ed if a country is unable to change their structures in terms of their technology and economy (destek & sinha, 2020). the environmental situation and ed has been considerably gaining attention from academic practitioners over the past few decades (destek & sinha, 2020). it has been noted by different researchers and analysts that, even now, an environmental performance and ed gap exists in different european countries, as several nations and regions have consume a lot of energy in the past few decades (raza, shah, & sharif, 2019). mbarek, saidi, and rahman (2018) have suggested that, in order to respond to the limitations and gaps in the current literature, the contextual variables and factors impacting the overall environmental situation need to be identified and investigated in detail, as research efforts on ed and the ecological effects of eg are sparse; therefore, studies needs to be carried out on the environmental situation in oecd nations (gorus & aydin, 2019). zafar, saud, and hou (2019) have identified the impact of social factors, balsalobre-lorente, driha, shahbaz, and sinha (2020) have examined the impact of humidity and organisms, and bekhet, matar, and yasmin (2017) have investigated the impact of biotic and biotic factors. thus, the overall and detailed understanding of ec and eg factors from the perspective of ecological changes are significant. in order to respond to such restrictions in the academic research, the present paper investigates the impact of several ec and eg factors from the perspective of oecd countries through a unique and effective integration of variables using modern statistical methods and techniques. to the knowledge of the analyst, this is the first and unique study of its kind. the graph below indicates the percentage of ec in certain sectors in oecd countries. figure 1. energy consumption by sector in oecd countries the main purpose of the present research thesis is to empirically investigate the overall impact of ec factors on the ed of oecd regions, and the second major aim of this paper is to analyze the exclusive impact of the eg of different oecd countries on the degree of ed and related concepts and situations. moreover, the current research paper also investigates the correlation between eg and ec and how this nexus further affects the environment in oecd regions. in line with the above objectives, the given study poses the following research questions: what is the total impact of ec on ed in oecd states, and how does the eg of several states affect ed and related factors. like all studies and empirical findings, this effort has profound advantages and insights in both theory and practice. practically, the findings of this study are beneficial for academic scholars and experts, as well as policymakers who have to promote educational ecological models for different industries and sectors that consume energy and other hazardous materials, in order for more industries and sectors to be encouraged to use and adopt environmental regulations (amir & chaudhry, 2019). such research concerned with ecological concepts can build significant and favorable perceptions of environmental development in societies, as well as navigating the society of different oecd states towards improvement. theoretically, the overall results and outcomes of this paper contribute to the current framework of information by analyzing the underlying process through computing the influence of ec and eg on the ed of certain states. furthermore, this paper adds to the current body of research in several ways, as most of the previous research efforts only used carbon dioxide releases as intermediaries for ecological damage. in contrast, the present study uses a country’s ecological footprint (ef) and ecological performance index (epi) to represent several types of environmental pollution. the remainder of the research is organized as follows: section two presents the practices and concepts of epi and ef calculations; section three provides information on the overall methodological design used by the analyst for data collection; section four presents all empirical and observed findings; and section five concludes the paper and presents the implications and limitations of the study, as well as providing suggestions for future research. asian journal of economics and empirical research, 2020, 7(2): 242-250 244 © 2020 by the authors; licensee asian online journal publishing group 2. literature review according to this theory, ed and damage is the disintegration of the earth and deterioration of conditions as a result of the consumption of energy and other resources such as air, soil, and water (majeed & luni, 2019). according to majeed and mumtaz (2017), ed is generally characterized as any modifications or destruction to nature’s turf that is seen to be undesirable and pernicious. this theory also states that ecological destruction and its effects are largely generated by the unification of substantial and growing human activities, such as ec, (oktavilia & firmansyah) continuously increasing economic growth and wealth per capita, and the effects of resource destruction and technological procedures and practices. according to alvarado and toledo (2017), ed is the destruction of ecological conditions through the depletion of assets such as minerals and soil, which leads to the complete deterioration of ecosystems and habitat destruction. specifically, this theory states that ed only happens when the earth’s natural resources are depleted for economic activities and growth. ed is one of the largest issues and threats that is considered in global activities today. this theory and model characterizes ed as the decline of the limit of the earth to achieve environmental and economic destinations and requirements. according to alvarado, ponce, criollo, córdova, and khan (2018), ed can occur in a number of ways; initially, environments are harmed and fundamental resources are exhausted for economic and fiscal goals, and then the overall environment is considered to be disrupted and harmed. however, certain significant methods and procedures have been adopted to prevent this, including common protection efforts and environmental asset protection practices. moreover, this theory demonstrates that excessive ec is the major cause of ed because excessive ec is a condition whereby the use of assets has surpassed the capacity of the entire ecosystem. according to ogundipe, obi, and ogundipe (2020), this is generally measured using ef, which is a resource management concept used to compare the individual needs of ecosystems with the volume of ecosystems that can be renewed (usman, olanipekun, iorember, & abugoodman, 2020). 3. energy consumption and environmental degradation according to raza et al. (2019), all energy assets have some influence on the environment; fossil fuels such as oil, natural gas, and coal do substantially more damage than renewable energy sources, mainly through air and water pollution that can damage an individual’s health. according to sinha, shahbaz, and balsalobre (2017), habitat and wildlife loss, land use, and global warming (gw) increases. renewable assets, on the other hand, such as hydropower, solar, biomass, wind, and geothermal, also have direct environmental impacts and influences — some of which are favorable (sekrafi & sghaier, 2018). according to sharif and raza (2016), the right dimension and degree of environmental impacts varies depending on certain technological processes, geographic locations, and several other variables and factors. in oecd nations, the environmental impact of energy harvesting and consumption is diverse. recently, sharif et al. (2020) illustrated that, in recent years, there has been a trend towards the improved commercialization of several renewable energy assets. in a real sense, the consumption of fossil fuel predominantly leads to gw and climate change. although certain changes are being made in several states and regions of oecd, biodiesel consumption is still the main source of ed in oecd nations, according to ahmad et al. (2020); mbarek et al. (2018), the environmental influence of biodiesel involves the releasing of greenhouse gases, energy usage, and certain other types of pollution. according to recent statistics by oecd nations and the british department of energy, substituting 100% of biodiesel used for petroleum purposes in buses minimized the lifecycle consumption of petroleum by 95%. thus, biodiesel minimized the net release of co2 by 77.45%, compared to petroleum diesel. coal mining and burning are other major sources of ed in oecd regions. the environmental impact of electricity generation is significant in oecd regions because modern societies use large amounts of electrical power. therefore, based on the entire above discussion, the study proposes the following hypothesis: h1: ec directly and positively relates to ed in several states. 4. economic growth and environmental degradation ed is the deterioration of the environment through the exhaustion of resources such as water, air and soil, pollution, habitat destruction, the destruction of the ecosystem, pollution, and the disintegration of the earth’s resources. ed is either a consequence or driver of disasters, which causes a reduction in the capacity of the environment to meet ecological or social needs. over usage or the excessive consumption of natural resources may result in ed, which is essentially the reduction in the earth’s capacity to meet social and ecological objectives. this act of degradation and the associated decay of ecosystems and their invaluable services means that the advantages or benefits that humans obtain are a driving force of deforestation, landslides, and the removal of mangroves. eg plays a major role in improving facilities and meeting basic human needs, as well as providing lifestyle improvements, luxuries and leisure activates. construction is improved and the demands and priorities of life change (adu and denkyirah, 2018). this is because of the fact that humans around the globe have become accustomed to luxuries, modern vehicles, and the availability of all the latest technical objects, electronic items, and facilities. growing industries have become a constant source of ed, as meeting needs and demands has led to the establishment of mega factories, which has become a major reason for deforestation and environmental pollution. according to saidi and hammami (2017), countries with a better economy have become accustomed to using certain machines and electric equipment that make their life easier; however, this creates global problems such as environmental issues. eg indicates that a country is achieving milestones and making progress in the field of industry, agriculture and business. however, this cycle of progress brings satisfaction and an urge to go beyond certain limits by obtaining technical and electrical accessories. developed economic countries also make plans to experiment with scientific ideas, which also causes environmental degradation. it is also very alarming that the population of the world is increasing rapidly (rahman, 2020; usman, alola, & sarkodie, 2020). this rise in population means that certain resources will be in demand in order to maintain a good standard of life, such as new homes, schools, vehicles, and demands for the luxuries of life. this all creates a negative impact, as the consumption of natural resources increases and there is currently no replacement process. according to balsalobre-lorente, shahbaz, roubaud, and farhani (2018), it is very clear that eg creates chances for ed, as they have access to every asian journal of economics and empirical research, 2020, 7(2): 242-250 245 © 2020 by the authors; licensee asian online journal publishing group resource to use as their own. this situation creates a complicated scenario, as eg signifies the positive development of the economy; however, it also causes issues that influence the environment and create ed; thus, the link between eg and ed is very clear. the circumstances created under eg are not interrelated and positive with the condition of the environment. thus, the above discussion leads to the development of the following hypothesis: h2: there is a direct and positive relationship between eg and ed. 5. method in the present research, we examined a sample of thirty-five oecd countries between the years 2000 to 2014. this research makes use of two empirical models to determine the relationship between the consumption of energy, the growth of economy and the degradation of the environment. the study uses gdp, co2 emissions or environmental indexes (epi and ef), and ec. two different models have been used in the study to evaluate the significant relationship between consumption, growth and degradation patterns in the economies of oecd countries. the first model uses the inputs on gdp, co2 emissions, and ec, and the second model includes the variables of ef, gdp, and ec. the subsequent units of the variables are ec per capita equivalent of a kilogram of oil, co2 emissions (measured in metric tons per capita), and the variable gdp (measured in millions, constant 2011 international usd $). with regard to the variable of an environmental index, the epi data has been collected from sources from the yale center for economical law & policy and the ef data has been pulled from the global footprint network. figure 1 presents the variables that were used in the research. the figure presents a scatter diagram of the highlighted variables, focusing on the basic relationships. furthermore, the green and red lines show the parametric and non-parametric interconnections between the examined variables. in order to properly understand the connections between gdp, epi, ec, ef, and co2 emissions, the full outcomes are shown in figure 1. the density plot of the variables represents the distribution of every variable over the entire time period. we can see the difference between the different patterns of all variables used in this study. for example, co2 emissions had a positive impact on gdp, but a negative impact on epi and ef. if we look at the density distribution plot of co2 emissions, it shows a bimodal distribution. this distribution is explained by two clear points in the approximated density function. these findings indicate that, within the sample, there are two clear categories of countries in terms of co2 levels. the overall image implies a deeper examination of the discovered connections between the variables that were employed in the study. it has been observed from the results that the mean value of epi varies between the period of 2011 to 2014. the main reason behind this change is that the calculations from 2011 onwards were created using the new environmental trend index, epi. this new epi includes the environmental policies of countries. data were obtained from the millennium development goal seven and the earth summit, which took place in rio in 1992 (hsu, lloyd, & emerson, 2013). figure-2. scatterplot matrix asian journal of economics and empirical research, 2020, 7(2): 242-250 246 © 2020 by the authors; licensee asian online journal publishing group 6. generalized method of moments panel vector autoregression as this study applied the gmm-pvar methodology, the panel data has to be stationary. for this reason, the study used panel data tests developed by im, pesaran, and shin (2003) and pesaran (2007). the assumption is that the variables will be stationary either at level or at the first difference so that the model for the gmm-pvar method can be designed. the model is expressed as follows: 𝑥𝑖𝑡 = (𝐿𝑛 − ∑ 𝐴1 𝑃 𝑙=1 )𝑛𝑖 + ∑ 𝐴𝑙𝑥𝑖,𝑡−1 𝑝 𝑙=1 + 𝑍𝑥𝑖,𝑡 + 𝑉𝑓𝑖𝑡 + 𝑢𝑖𝑡 (1) in the above equation, the term 𝑥𝑖𝑡 is the main endogenous variable on the time t, the variable 𝑥𝑖,𝑡−1expresses the presence of a lagged constituent in the endogenous variable, the term 𝐿𝑛 signifies the nxn matrix, and the variables a, z and v have been used as parameters for homogeneity. the term f is used to display the vector of exclusive exogenous variates. the term u denotes the error term that is assumed to be independent. the method proposes the use of two processes for the estimation of fixed effects, where the first difference allows for the fixation of the problems imposed by the fixed effects. however, these issues can be omitted by using the gmm method. in particular, if the transformation matrix is used and applied on the converted covariates and lagged estimators, the variables can be used as coefficients for the instrumental regressors by applying the gmm estimator. 7. panel granger casualty test the granger casualty test was adopted by the author after the estimation of coefficients of variables and the long-term relationships between them. the basic purpose of these tests is to find out the existence and direction of any causal relationship between variables (dumitrescu & hurlin, 2012). these tests are generally performed for each cross section of the data in order to generate results in the form of test statistics. this test is also based on the process of a null and alternate hypothesis that indicates the absence and presence of casual relationships, respectively. a general equation for this test can be given as follows: 𝑥𝑡 = ∑ 𝑎𝑖 ∞ 𝑖=1 𝑥(𝑡 − 𝑖) + 𝑐1 + 𝜇1(𝑡) 𝑥𝑡 = ∑ 𝑎𝑖 ∞ 𝑖=1 𝑥(𝑡 − 𝑖) + ∑ 𝑏𝑗 ∞ 𝑗=1 𝑦(𝑡 − 𝑗) + 𝑐2 + 𝜇2(𝑡) 8. analysis first, we evaluated the stationary aspect of the covariates involved in the study for both models used. table 2 shows the stationarity of the variables. the two-panel unit root test indicates that all variables (gdp), (epi), (ef), (co2) releases, and (ec) are integrated of order one. more precise data in table 1 describes the results of the stationarity test; however, when we examine the results derived from the panel unit root test, the outcomes appear to be stationary in the first variation. table 1. stationarity test ec gdp co2 ef epi level t-bar 1.022 0.863 0.862 1.123 2.512 pesaran p-value 0.212 0.202 0.283 0.213 0.01 im t-bar 3.913 3.622 3.522 5.433 8.001 p-value 0.06 0.07 0.04 0.04 0.02 first difference pesaran t-bar -8.267 -4.538 -2.679 -2.651 -7.783 p-value 0.01 0.01 0.052 0.05 0.01 im t-bar pvalue -14.832 -11.479 -12.234 -15.025 -15.123 0 0 0 0 0 the outcomes obtained from the gmm-pvar analysis are stated in table 2. there is a substantial and positive impact of ec and gdp on the release of co2. this strongly indicates that economic development leads to an increase in air pollution in countries in the oecd region. the range of effects depend on the connection between the increased demand for natural resources in economic development. this is due to rising levels of air contamination. hence, through the production of air pollution and waste, environmental deprivation is the primary outcome of extensive production. table 2. gmm-pvar model 1 ec (t-1) gdp (t-1) co2 (t-1) ec(t) 0.052 (0.007) 0.033 (0.173) 0.053 (0.233) gdp(t) 0.032 (0.123) 0.711 (0.035) 0.141 (0.171) co2(t) 0.088 (0.05) 0.098 (0.05) 0.913 (0.05) model 2 ec (t-1) gdp (t-1) ef (t-1) ec(t) 0.021 (0.01) 0.062 (0.247) 0.332 (0.391) gdp(t) 0.061 (0.143) 0.155 (0.03) 0.053 (0.253) ef(t) 0.037 (0.05) 0.086 (0.05) 0.162 (0.032) asian journal of economics and empirical research, 2020, 7(2): 242-250 247 © 2020 by the authors; licensee asian online journal publishing group moreover, the considerable impact of ec on co2 emissions is an indication that most oecd countries are largely dependent on fossil fuel energy sources such as coal and oil. as per world development indicators data, in 2013, the total ec rate of oecd countries highlighted a share of 80.5% fossil fuel consumption. our results have been confirmed by different other studies. the findings derived from model 2 (covered by gdp, ef, and ec variables) show a considerable connection between ec, gdp and ef. they also show a positive connection between gdp, ef and ec. these results indicate that high ec levels and economic progress lead to an increased environmental burden on oecd countries. it can also be seen that increasing economic events developed from production activities require additional natural reserves, such as land, water, soil, and energy. similarly, an increased demand for energy precedes increased levels of ef because of the growing demand for the supply of energy, which then leads to elevated levels of co2 emissions. in the next step of the analysis, we tested the stability of each of the pvar models used in the study (figure 3). figure 3. pvar models undeniably, our results verify the fact that the stability of the variables in both models lie within the boundary of the circle. following this process, we calculated orthogonalized impulse response function (oirf) graphs for every model we used (figures 4 to 6). these graphs described the reactive shocks for each of the dependent variables to the three endogenous variables evaluated over a period of two years. the confidence bands are explained with the help of the blue zone, and the red lines denote the responses. when we analyzed the connection between ec and gdp, the results revealed that ec positively reacts to the variable of gdp shocks in the first model. similarly, in the second model, the responses were stable and positive. in the opposite relationship, the findings indicated that the variable of gdp positively responds to ec shocks in the first model; however, the impact is validated to a greater extent in the second model, as it reaches zero. with regard to the connection between pollutants and gdp, gdp presented a positive response to co2 shocks. additionally, a positive but weak response was detected between ef shocks and gdp; however, gdp did not show any response to epi shocks. according to the findings, the responses of gdp are more evident in co2 emissions, compared to the environmental indices (epi and ef). figure 4. reactive shocks asian journal of economics and empirical research, 2020, 7(2): 242-250 248 © 2020 by the authors; licensee asian online journal publishing group figure 5. reactive shocks figure 6. reactive shocks finally, to further check the connections between the variables, we used the panel granger causality test. the findings of the panel granger causality test are listed in table 3. this method of causality uses two tests to evaluate causal associations (dumitrescu & hurlin, 2012). in particular, the findings of the z test and the z-bar were found to be nearly identical. the findings indicated a bidirectional causality between the pair’s ec and gdp, as well as three other variables (epi, co2 emissions, and ef). table 3. panel granger causality z-wald z-bar z-wald z-bar z-wald z-bar z-wald z-bar zwald z-bar ec – – 6.175*** 12.036*** 5.229*** 8.993*** 5.733*** 9.811*** 3.102** 1.882* gdp co2 2.721* 5.852*** 2.016* 11.346*** – 10.423*** – 23.854*** 2.279* – 0.422 – 2.977** – 2.015* – 2.112* – 1.266 – ef 4.808*** 7.243*** 8.046*** 16.362*** – – – – – – epi 4.746*** 6.655*** 2.902*** 2.122* – – – – – – asian journal of economics and empirical research, 2020, 7(2): 242-250 249 © 2020 by the authors; licensee asian online journal publishing group 9. discussion and conclusion this research uses estimations from the gmm-pvar method to explore the causal relationships between eg, co2 emissions, ec, and environmental indices (epi or ef). this methodology was applied to a panel of thirty-five oecd countries between 2000 and 2014. furthermore, the study estimated the interconnections between variables using the panel granger causality test. the findings obtained from the pvar-gmm test indicate a considerable positive impact on gdp and ec on the overall quality of environmental statistics (co2 emissions, ef and epi). growing economic developments following industrial development and manufacturing produces more co2 emissions and creates extra pressure on the environment. rising levels of epi indicate that a shift in countries' eg will affect economic performance. across the observed time period, it became evident that oecd countries regularly changed their ec models by moving towards renewable energy resources. moreover, findings from the panel causality tests validated a bidirectional relationship between all variables except for the following pairs: co2 and gdp and epi and gdp. in these instances, we discovered encouraging support for unidirectional causality shifting from gdp to the other two statistics. the results of the present study are supported by similar studies (le, 2019; ozcan, tzeremes, & tzeremes, 2020; phrakhruopatnontakitti, watthanabut, & jermsittiparsert, 2020). the study by phrakhruopatnontakitti et al. (2020) evaluated causal associations between the emissions of pollutants, ec patterns, and economic output using panel data that considered four asean countries. pollutant emissions and environmental degradation is uncharacteristically high in the asean region. the results of the study indicated that, in the long-term, energy consumption patterns were significantly correlated with co2 emissions. in the short-term, changes in emission patterns were also found to be significant. the study by cai, sam, and chang (2018) evaluated causal associations between consumption patterns of clean energy, eg and co2 emissions. the study used an ardl bounds methodology to analyze the ec and pollutant emission patterns of g7 countries. the results of the causality analysis shows the presence of unidirectional causality between clean ec patterns and gdp per capita. these studies support the findings of this study, showing that economic degradation can be supplemented by limiting environmental pollutants. the route towards ecological improvements can be indicated as countries' benchmark for collaboration instead of a tradeoff between economic development and the natural environment. the major focus of policies related to sustainable economic progress is the foundation of an integrated working program between trade and industry expansion and the atmosphere. the findings generated by this study suggest the necessity of a collaborative relationship between the natural environment and economic advancement goals in oecd countries. this is because many oecd economies are causing harm to their economy through their energy patterns and their environmental strategies. the results from the estimations of the gmmpvar model outlined the significant and positive impact of eg and ec on the indicators used for the quality of the environment. the economic activities of countries are increasing due to industrialization, which produces strong emissions of pollutants, which cause harm to the environment. theis study also has some limitations and policy implications. the main focus of the study was oecd countries and their environmental sustainability. this domain has been the focus of researchers for some time now; however, the application of models like the pvar-gmm to evaluate such associations has been limited. thus, contributions to the existing literature have been made. the policymakers of institutions responsible for pollutant emissions can evaluate the results of this study and formulate policies to make the environment safer and reduce degradation. the time frame of this study was constrained, as the original dataset measured eg and degradation for only 14 years. moreover, the data was only employed in the oecd region. thus, future researchers should focus on increasing the sample size and diversifying the sample by including other regions, in order for the results to be more generalized. references adu, d. t., & denkyirah, e. k. 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(2020). how renewable energy consumption contribute to environmental quality? the role of education in oecd countries. journal of cleaner production, 122149. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 59 © 2019 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 6, no. 1, 59-69, 2019 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2019.61.59.69 © 2019 by the authors; licensee asian online journal publishing group factors affecting the bank credit accessibility of rural households in vietnam tran long giang1 hoang thi thanh hang2 ( corresponding author) 1,2banking university of ho chi minh city, vietnam abstract the research identifies and measures factors affecting the bank credit accessibility using heckman (1979). the research uses data from dataset of vietnam household living standard survey (vhlss) in 2014 and 2016 to eliminate the shock due to the global economic crisis in 2008-2009 making the estimate unsustainable. the results show that among the factors that can affect the bank credit accessibility considered in the first stage of heckman model, there are six factors that significantly and statistically affect the bank credit accessibility of rural households. these factors include the household’s average income, householder’s age, ethnic group, marital status, previous loan period and members of the farmers associations. the estimate results obtained from the second stage of heckman model on the possibility to receive loans of rural households in vietnam indicates seven factors affecting the value of loans received from bank credit institutions are the household’s average income, householder’s age, ethnic group, marital status, previous loan period and members of the farmers associations. keywords: credit accessibility, rural households, loan, banks citation | tran long giang; hoang thi thanh hang (2019). factors affecting the bank credit accessibility of rural households in vietnam. asian journal of economics and empirical research, 6(1): 59-69. history: received: 24 december 2018 revised: 29 january 2019 accepted: 4 march 2019 published: 20 may 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 60 2. theoretical basis and experimental researches ....................................................................................................................... 60 3. research methods and data .......................................................................................................................................................... 64 4. research results .............................................................................................................................................................................. 64 5. conclusion and recommendation ................................................................................................................................................ 68 references .............................................................................................................................................................................................. 69 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.61.59.69&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/267 http://asianonlinejournals.com/index.php/ajeer/article/view/267 asian journal of economics and empirical research, 2019, 6(1): 59-69 60 © 2019 by the authors; licensee asian online journal publishing group 1. introduction according to the report of the general statistics office in 2016, the proportion of people living in rural areas of vietnam accounts for about 68%, equivalent to 61.2 million people. therefore, the rural issues are particularly paid attention in vietnam in recent years. however, rural households face many difficulties in accessing bank credits. currently, there are several researches on the factors affecting the credit accessibility with different methods, times of research and scopes of research. some of them show that the householder’s educational level, income, purpose of borrowing, land area and collaterals affect the credit accessibility of rural households (nguyen and pham, 2010). others state that organizations and unions such as farmers associations and women's unions play an important role in the credit accessibility of rural households in vietnam, economic and development group (2010). in this research, the selected times of research are 2014 and 2016 and a scale of samples include 598 households in 61 provinces/cities to eliminate the shock caused by the economic crisis in 2008 affecting the sustainability of estimated coefficients. therefore, identification and measurement of the factors affecting the bank credit accessibility and proposal thereon of implications for the bank credit accessibility are necessary. 2. theoretical basis and experimental researches 2.1. theoretical basis 2.1.1. asymmetric information and the opposite choice according to the most basic economic theory that is market equilibrium, in which if demand exceeds supply, the price will rise and vice versa. decrease of demand and/or increase of supply should be made until supply and demand equal a new equilibrium price. therefore, credit supply and demand decisions depend on interest rates. however, according to stiglitz and weiss (1981) the theory of interest rate-based credit supply and demand cannot explain the behavior of lenders and borrowers since the borrowers do not rely on market interest rates only while lenders must depend on the borrowers' information to make loan decisions. according to stiglitz and weiss (1981) for credit markets, opposite option is also a consequence of asymmetric information, which means potential borrowers with more risks often seek loans and have rights to select, in which the distinction between low-risk and high-risk borrowers is reflected in interest rates. however, raising interest rates to compensate for high credit risk costs may push low-risk borrowers out of the market. as a result, lenders approve the high-risk projects only. asymmetric information also leads to moral hazards or dependence, in which borrowers are no longer motivated to try or act as reasonably as before the occurrence of transactions as lenders must suffer a part of risks. consequently, borrowers cannot pay their debts. in general, decisions on credit issue and credit amount depend on the information obtained by lenders from borrowers. thus, not all people wishing to borrow can access to credit. 2.1.2. factors affecting the credit accessibility in the countries with underdeveloped financial systems, poor households have more limited credit accessibility than the wealthy ones. according to claessens and feijen (2007) there are three main causes that hinder the credit accessibility of poor households: the generally unstable institutional and economic environment; unsuitable supply and demand; the influence of special benefits, according to rajan and zingales (2003). recently, accessibility to financial services is recognized as an important aspect of development. increasing the accessibility to finance requires the efforts of the government and financial institutions. based on that, claessens and feijen (2007) proposed nine policy recommendations: increase the scale of financial institutions and the financial system in general to benefit from economies through scale; use existing networks to expand the scope of access; improve credit infrastructure; minimize as much as possible the government regulation; enhance competition in the financial system; promote comprehensive access to financial services; introduce products creatively and in the best practices to meet customer needs; collect data and expand scope; conduct further researches and analysis of financial access. 2.2. experimental researches 2.2.1. researches in the world ololade and olagunju (2013) analyzed the factors affecting the credit accessibility of rural households in oyo, nigeria, using primary data through questionnaires collected from 210 observations. based on descriptive statistics results and logistic models, the research showed that gender, marital status, guarantee and high interest rate are important factors affecting the credit accessibility of rural households. mwangi and sichei (2011) used a polynomial probit model to look for factors affecting the credit accessibility of individuals residing in kenya based on kenya's national finaccess survey in 2006 and 2009. the results showed that the household size reduces the accessibility to loans from banks and accumulated savings and credit associations (ascas) but promotes borrowing from agricultural product buyers. the geographical distance between households and credit providers has a negative impact on the credit accessibility. in contrast, age, educational level and income are factors that increase the credit accessibility. in particular, age affects the credit accessibility in an inverted u shape, which means that the closer age of retirement is, the more increasing the decrease of accessibility is. kiplimo et al. (2015) determined the factors affecting the credit accessibility of rural households in kenya. logistic regression results indicated that the factors including educational level, occupation and access to agricultural extension services have a positive and statistical significant impact on the credit accessibility. however, the total income of a household and the geographical distance between such household and the credit provider have a negative impact on the credit accessibility. asian journal of economics and empirical research, 2019, 6(1): 59-69 61 © 2019 by the authors; licensee asian online journal publishing group 2.2.2. researches in vietnam in vietnam, there have been some researches on factors affecting the credit accessibility in different research periods and scopes of research. nevertheless, the research results are not highly consensus among each other. + the research carried out by nguyen and pham (2010) investigating factors affecting the formal credit accessibility of rural households nearly hanoi suburbs showed that age and social status of householder, informal credit and loan procedures are important factors affecting the formal credit accessibility of rural households here. at the same time, it indicated that the borrowed credit capital is affected by factors such as educational level of the householder, household income, purpose of borrowing, land area and collaterals. + the development economics research group (derg) used heckman's sample selection model and instrumental variable estimation (ive) based on the data from survey of accessibility to resources of vietnamese households in 2006, 2008 and 2010. the results showed that the credit accessibility in vietnamese rural areas is not subject to many credit barriers. it is evidenced by that the difference among characteristics of the households without credits and households with credits is negligible in aspects of income, educational level, marital status, ethnic group and land property. in addition, organizations and unions such as the farmers associations and women's unions play an important role in the credit accessibility of vietnamese rural households in relation to agricultural, non-agricultural and investment loans. nguyen (2007) analyzed factors affecting the credit accessibility and borrowing behavior in vietnam's rural credit market in the period 1993-1998. by using tobit, probit and heckman models, the research also proved that the credit accessibility in the rural areas is low. evidence pointing out important factors affecting the credit accessibility of households are educational level, health conditions, fixed assets held and distance from the location where households are residing to the bank branches. nguyen et al. (2016) studied factors affecting the formal credit accessibility of households raising black tiger shrimps in cau ngang district, tra vinh province. through their descriptive statistical analysis, this research group pointed out that the purpose of formal credit borrowing by the households raising black tiger shrimps in the research location is to expand their production scale. using the tobit model based on primary data collected in september 2015 from 245 rural households with or without formal credit loans, evidence showed that shrimp raising area, interest, borrowing procedures, social position of households and the need to expand production scale are important factors affecting the loan amount issued to rural households raising black tiger shrimps in cau ngang district, tra vinh province. in particular, the shrimp raising area has the greatest impact on the loan amount issued to rural households raising black tiger shrimps. using logistic and ordinary least square (ols) regression models, tran and huynh (2013) analyzed factors affecting the formal credit accessibility of rural households in an giang province. the research used primary data through random surveys and interviews with 150 households in december 2010 in 3 districts of an giang province including chau phu, phu tan and cho moi. the results explained that the percentage of households approved to borrow is 24% less than the credit demand or limit. based on the logistic model estimation analysis, the probability of credit limit of rural households is affected by some factors including (i) educational level; (ii) occupation of the householder; (iii) residential land area; (iv) asset value of household; (v) use of commercial credit. additionally, the ols multivariate regression analysis results reflected that the formal credit capital is affected by the following factors: (i) social relations of the householder; (ii) purpose of borrowing; (iii) asset value; (iv) household income. bui and truong (2014) investigated the formal credit capital accessibility of households raising shrimps based on primary data collected from 242 households through interviews in 10 communes of 3 districts that have large shrimp raising areas in tra vinh province. evidence indicated that 5 factors positively impacting on the formal credit capital accessibility of households raising shrimps are (i) household income; (ii) occupational duration (production experience); (iii) loan interest rate of the household; (iv) number of borrowing transactions with credit institutions of the household; (v) number of local credit institutions. on the other hand, the distance from the place where the household is residing to the district center is considered as a negative factor affecting the formal credit capital accessibility of households raising shrimps in tra vinh province. to identify the factors affecting the formal credit capital accessibility of households raising pigs in o mon district, can tho city, vuong and dang (2015) used the probit regression model based on primary data through direct interviews with 223 households raising pigs in the research area. the research pointed out the factors that have a significant impact on the formal credit capital accessibility are: (i) gender of the householder; (ii) educational level of the householder; (iii) age of the householder; (iv) social position of the household; (v) household income. based on the primary data collected from 919 households through interviews, phan (2013) analyzed the factors affecting the formal and informal credit accessibility of rural households in 13 provinces in the mekong delta. using conditional mixed process (cmp) developed by roodman (2009) probit estimation, tobit estimation and heckman's two-stage regression models, the evidence showed that 3 factors having important influence to informal loans include land ownership, official interest rates and loan terms. for microcredit accessibility, 6 significant factors indicated from the research are: (i) employee working at local authorities; (ii) member of lending group; (iii) poor household book; (iv) educational level; (v) skilled labor; and (vi) inter-commune roads. furthermore, the research also provided evidence of interaction among credit markets, in particular, the amount of informal credit loans has a positive impact on the accessibility to microcredit programs. 2.2.3. research model from the researches, we summarize and describe the variables in the model as table 1: asian journal of economics and empirical research, 2019, 6(1): 59-69 62 © 2019 by the authors; licensee asian online journal publishing group table-1. the variables in the model. variables symbols calculation source bank credit accessibility foac (m8c7) euqal to 1 in case of borrowing from the social policies bank and agribank. personal characteristics age of household units age (m1ac5) the age of household by years mwangi and sichei (2011), dinh and dong (2015), nguyen and pham (2010), vuong and dang (2015) sex of household head sex (m1ac2) the gender dummy receives 1 if the head of household is male. the gender dummy receives 0 if the head of household is female. ololade and olagunju (2013), dinh and dong (2015), vuong and dang (2015) ethnicity eth (dantoc) ethnic dumy variable equals to 1 if ethnic group is kinh. ethnic dumy variable equals to 0 if it is another ethnic group. dinh and dong (2015) marital status sta (m1ac8) marriage dummy variable equals to 1 if the households have couples. marriage dummy variable equals to 0 if other cases. ololade and olagunju (2013) education status of head of houshold edu (m2ac2a) educational dummy variables equal to 1 if it has no qualification”; 2 if it is primary; 3 if it is secondary school; 4 if it is high school; 5 if it is college; 6 if it is university; 7 if others . assogba et al. (2017), nguyen and pham (2010), dinh and dong (2015) demographic characteristics of households household size size (tsnguoi) total members of households assogba et al. (2017), , dinh and dong (2015) percentage of dependents dep the percentage of childern under 16 years old, the elder above 60 years old in total households dinh and dong (2015) financial characteristics average income tthubq narural logarit of annual household income from all sources unit: thousands dong kiplimo et al. (2015) individual fin inf (m4dc2_01/m4dc2_06) individual financing value equals 1 if the household receives sponsorships from relatives, 0 if not dinh and dong (2015) saving sav (m8c3b) dummy variables on saving receives 1 if households have saving account. it receives 0 if houeholds does not have saving account dinh and dong (2015) credit characteristics borrowed time loantime time for unpaid loan unit: year. loan value loanv (m8c9) loan value unit: thousands dong. amount to pay loan fee (m8c10) amount to pay for loan unit: thousands dong official loan interest rate loaninterest interest rate loan by month unit: %. assogba et al. (2017), ololade and olagunju (2013), bui and truong (2014) loan purpose on loan application tar0 (m8c13) dummy loan purpose equals 1 if the loan for agricultural activities includes "other crops", "livestock", "forestry", "fishery", "rice cultivation"; 0 if the loan for non-agricultural activities includes "education and training", "medical expenses", "nonagricultural activities", "land purchase", "purchase of other assets", tran and huynh (2013) asian journal of economics and empirical research, 2019, 6(1): 59-69 63 © 2019 by the authors; licensee asian online journal publishing group "repayment of other loans", "construction / purchase of houses", "other operating costs" and "other" the actual purpose is to use the loan range tar1 (m8c14) dummy variable for the actual purpose of using the loan equals 1 if the loan for agricultural activities includes "other crops", "livestock", "forestry", "fishery", "rice cultivation"; 0 if the loan for non-agricultural activities includes "education and training", "medical expenses", "nonagricultural activities", "land purchase", "purchase of other assets", "repayment of other loans", "construction / purchase of houses", "other operating costs" and "others". dinh and dong (2015) mortgage property col (m8c15) equals 1 if there is a mortgage; equal 0 if there is no mortgage. diagne (1999) amount owed unpay (m8c12) total debt unit: thousands dong other factors natural shock nasock (m4b1b) natural shock dummy variables such as natural disasters and epidemics, equals 1 if receiving effects from these factors and receive 0 if it does not have effects. dinh and dong (2015) member of farmers association agrc (m1ac15a) recevie 1 if you are members of farmer’s union, 0 if you are not mebers of farmers’ uninion. assogba et al. (2017) member of women’s union womec (m1ac15b) receive 1 if you are members of women’s union, 0 if you are not members. assogba et al. (2017) party member party (m1ac15c) equal 1 if they are party members, 0 they are not party members. assogba et al. (2017) member of veterans association veterc (m1ac15d) receive 1 if it belongs to member of veterans association, 0 if it does not belong to member of veterans association assogba et al. (2017) source: author’s synthesis analysis. asian journal of economics and empirical research, 2019, 6(1): 59-69 64 © 2019 by the authors; licensee asian online journal publishing group 3. research methods and data 3.1. research methods to measure factors affecting the bank credit accessibility of rural households in vietnam, heckman two-stage method (heckman, 1979) was used in this research. in particular, the bank credit accessibility of rural households is assessed through two criteria: (i) the possibility to receive bank credit with the control group that are households cannot access bank credits; (ii) the total amount borrowed by the rural households. the first stage of heckman method is to use the probability unit model to estimate the possibility to receive loans of rural households. the specific model is as equation 1: ( ) 1 ( ) 1 x p f x e           (1) to make an estimate, the model (1) is needed to convert to a linear form as equation 2: i i i ifoac x     (2) in which, foac is the possibility to receive bank credit of the ith household. foac equals 1 if the household can receive a bank credit and equals 0 in the opposite case; x are control variables that may affect the possibility to receive bank credit of the household including personal characteristics (age, gender, ethnic group, marital status, educational status), demographic characteristics (household size, percentage of dependent persons), financial characteristics of the household (average income, personal funding, savings, unpaid loan value), member of associations (farmers associations, women's unions, householder as a communist party member, veterans association), natural shocks;  is interference. the second stage in the heckman two-stage model is to estimate the bank credit limits received by the households by the ordinary least square (ols) method. the regression model is as equation 3: i i i iloanv x     (3) in which, loanv is the total amount borrowed by the ith household; x are control variables that can affect the loan value of the household including personal characteristics (age, gender, ethnic group, marital status, educational status of the householder), demographic characteristics (household size, percentage of dependent persons), financial characteristics of the household (average income, personal funding, savings, unpaid loan value, borrowing durations of unpaid loans), credit characteristics (official loan interest rate, loan term, total collateral value, with guarantor, amount payable for loan, purpose of loan as per the application for borrowing, actual use of loans, mortgage of assets), member of associations (farmers association, women's unions, householder as a communist party member, veterans association), natural shocks;  is interference. 3.2. research data this research uses secondary data from dataset of vietnam household living standard survey in 2014 and 2016 to eliminate the shock due to the global economic crisis in 2008-2009 making the estimate unsustainable. the survey scope of this dataset is 61 provinces and cities implemented by the general statistics office from 2002 to 2016 in which the surveyed subjects are households, members of households and communes/wards. the survey applies the direct interview method through questionnaires in which the surveyors visit the householder and related members in the household. at the household level, some characteristics collected include demographic items, household income, household expenditure, educational level, heath status, employment status, assets and properties, participation in poverty and alleviation programs, etc. at the commune/ward level, some aspects collected are socio-economic infrastructure and economic situation. 4. research results 4.1. descriptive statistics the statistical results showed that the average credit capital borrowed by each rural household was about vnd 48 million in 2014 and vnd 55 million in 2016. the largest loan values in 2014 and 2016 were respectively vnd 1.25 billion and vnd 1 billion. the average monthly interest rate was 0.87% and 0.70% in 2014 and 2016, respectively. the average previous borrowing duration in 2014 was almost twice that in 2016. the amount payable for loan in 2016 was less than that in 2014. average income per capita of the households in 2016 was improved in comparison to that in 2014, table 2. in general, the households continue to significantly depend on informal credit sources including farmers 'association, veterans association, women's unions, traders, especially friends, relatives, etc. moreover, if the purposes of borrowing are divided by applications for borrowing and actual use of loans in agricultural and nonagricultural activities, no significant difference in the proportion between the two types of borrowing purposes appears. this implies that about 50% of rural households borrow for agriculture, the remaining about 50% borrow for education and training, medical examination and treatment, land purchase, repayment for other loans, house building/purchase. a notable point here is the actual use of loans for agricultural activities is even lower than the purpose of loans according to applications for borrowing. asian journal of economics and empirical research, 2019, 6(1): 59-69 65 © 2019 by the authors; licensee asian online journal publishing group table-2. descriptive statistics results. variables marked average standard deviation lowest highest 2014 2016 2014 2016 2014 2016 2014 2016 credit accessibility foac 0.81 0.83 0.40 0.37 0 0 1 1 average income avgincome 1855.15 2226.03 1674.02 2712.57 224 357 17159 57146 total income income 87723.37 99909.87 81902.95 89489.91 10447 10999 1029550 1371510 householder’s age age 46.80 47.80 11.76 11.58 19 21 89 91 householder’s gender sex 0.81 0.79 0.39 0.41 0 0 1 1 ethnic group eth 0.75 0.73 0.44 0.44 0 0 1 1 marital status sta 0.85 0.84 0.35 0.36 0 0 1 1 householder’s education status edu 2.66 2.66 1.50 1.47 1 1 7 7 household size size 4.17 4.04 1.47 1.48 1 1 10 10 percentage of dependent persons dep 0.37 0.37 0.25 0.26 0 0 1 1 personal funding inf 0.84 0.85 0.37 0.36 0 0 1 1 savings sav 0.02 0.02 0.12 0.14 0 0 1 1 previous borrowing duration loantime 4.26 2.75 2.14 2.65 2 .25 17.58333 20.41667 loan value loanv 47664.28 55012.31 97139.68 99102.06 890 500 1250000 1000000 amount loan payment fee 34.78 33.70 250.65 222.19 0 0 5000 3000 official loan interest rate loaninterest 0.87 0.70 1.42 0.90 0 0 12.5 10 purpose of loan as per application for borrowing tar0n 0.54 0.51 0.50 0.50 0 0 1 1 actual use of loan tar1n 0.44 0.41 0.50 0.49 0 9 1 1 mortgage of assets col 0.35 0.38 0.48 0.49 0 0 1 1 unpaid amount unpay 46310.68 50707.68 99071.25 92548.86 890 0 1250000 1000000 nature shock nasock 0.84 0.84 0.37 0.37 0 0 1 1 member of farmers association agrc 0.45 0.44 0.50 0.50 0 0 1 1 member of women’s union womec 0.11 0.11 0.32 0.32 0 0 1 1 party member party 0.07 0.07 0.25 0.26 0 0 1 1 member of veterans association veterc 0.10 0.09 0.31 0.28 0 0 1 1 source: calculated by the author based on vhlss 2014 and vhlss 2016 dataset. an important feature of households receiving loans is often that such household is a member a certain organization such as farmer's associations, women's unions, etc. according to statistics data, more than 38.63% of households obtaining loans from bank credits are members of the farmers association. this rate is higher than the proportion of households in which there is a member joining in the women's unions, farmers associations, as a member of party and veterans association in the sample table 3. table-3. participated characteristic of household association under credit access. characteristic of household access to credit bank access to informal credit access to credit bank access to informal credit 2014 2014 2016 2016 member of farmers association yes 38.63% 6.52% 39.30% 4.52% no 42.14% 12.71% 44.15% 12.04% member of women’s union yes 8.19% 3.01% 9.20% 2.17% no 72.58% 16.22% 74.25% 14.38% party member yes 6.02% 0.84% 6.52% 0.50% no 74.75% 18.39% 76.92% 16.05% member of veterans association yes 8.36% 2.01% 7.36% 1.17% no 72.41% 17.22% 76.09% 15.38% source: calculated by the author based on vhlss 2014 and vhlss 2016 dataset 4.2. correlation analysis the research analyzes experimental results on determinants of bank credit accessibility of rural households in vietnam. firstly, the author considers households with major loans obtained from bank credit institutions and informal credits, thereby analyzes which characteristics determine the bank credit accessibility. then, the difference in the size of loans received by the households is analyzed. before selecting variables in the research model, the author uses the results from the correlation matrix to eliminate the multicollinearity among them. the results show that most correlation coefficients are less than 0.8 in all the models researched, except for the variable representing the unpaid loan value in heckman two-stage model. therefore, this variable is excluded from the research model asian journal of economics and empirical research, 2019, 6(1): 59-69 66 © 2019 by the authors; licensee asian online journal publishing group 4.3. regression results in this research, the research samples are not selected in a random way, the use of regression techniques would thus give deviated parameter estimates. in order to analyze the types of credit households access and the impact of credit accessibility on household income, we control that, in fact, households accessing credits are self-selected ones. these households may have characteristics related to the fact that they also have credit loans. to control this deviation when estimating parameters using standard regression techniques, the research uses heckman's sample selection model (heckman, 1979). this model requires estimation to be done through two stages, also known as heckman two-stage model. in particular, the first stage is to analyze the determinants of bank or informal credit accessibility of households using the probit model. these determinants are controlled in the regression in the second stage to estimate household income by including the ratio of the probability density function to the inverse mills ratio from the probit model in the first stage. table-4. results of analysis of the first stage heckman model on the ability of rural households to access bank credit. variables symbols 2014 2016 coefficient coefficient average income avgincome 0.1924162* (0.1150844) -0.1830993* (0.1158562) householder’s age age 0.0118241** (0.0059941) 0.0100962* (0.0062873) householder’s gender sex -0.2363856 (0.2607638) 0.056564 (0.2404464) ethnicity eth -0.4341966** (0.175618) -0.1341527 (0.1721352) marital status sta 0.674162*** (0.2317677) 0.2899067 (0.2271619) education status of head of household edu -0.0299758 (0.0408896) -0.0072173 (0.0451158) household size size 0.0489896 (0.0484098) 0.0612807 (0.0490915) percentage of dependents dep -0.2069048 (0.2553241) -0.3183561 (0.2645414) individual financing inf -0.1362114 (0.179475) -0.0630081 (0.1870923) saving sav 0.1122132 (0.5754466) 0.0641152 (0.4420232) unpaid amount unpay -1.92e-06*** (6.83e-07) -1.24e-06** (6.73e-07) natural shock nasock 0.1168149 (0.16935) 0.0348077 (0.1721933) member of farmers association agrc 0.2877241** (0.1342664) 0.3890931*** (0.1434584) member of women’s union womec -0.1039865 (0.2662187) 0.1353885 (0.2667266) party member party 0.2803205 (0.3026963) 0.610192* (0.3350208) member of veterans association veterc -0.3000168 (0.2240461) -0.1578418 (0.2607071) constant _cons -1.133473 (0.9349581) 1.489394 (0.9891055) note: (*), (**) and (***) are statistically significant at 10%, 5% and 1% respectively. source: calculated by the author based on vhlss 2014 and vhlss 2016 dataset. among the factors that can affect the credit accessibility considered in the first stage of heckman model, there are six factors that have significant and statistically significant effects on the bank credit capital accessibility of rural households. they include average income of the household, age of the householder, ethnic group, marital status, previous borrowing duration, member of farmers associations and party member (table 4). firstly, the average income of the household has a remarkably positive and statistically significant effect on the bank credit capital accessibility of households at 10%. households with a higher average annual income have higher accessibility to bank credit capital than to informal credit capital. this conclusion is similar to tran and huynh (2013), bui and truong (2014), nguyen and pham (2010), vuong and dang (2015), mwangi and sichei (2011) but contrary to kiplimo et al. (2015). secondly, the estimation results show that age of the householder has a positive impact on the bank credit capital accessibility of households at significant rates of 5% (2014) and 10% (2016). this implies that the older the householder is, the higher the probability of accessing bank credit capital is. this finding is supported by nguyen and pham (2010), vuong and dang (2015) and mwangi and sichei (2011). thirdly, the bank credit accessibility is also increased for households classified in kinh ethnic group. data show that the ethnic group factor has a remarkably positive and statistically significant impact at 5% in 2014, which is, however, not statistically significant in 2016. this is perfectly reasonable since kinh people households often live in the delta so it is easy for them to access bank credit institutions. meanwhile, households of other ethnic groups often live in remote areas with difficult transportation, so it is difficult for them to access bank credit institutions. moreover, ethnic minority households face many difficulties in production, have low skills and educational levels, and are multi-child and backward families, which hence create many barriers to access to the formal capital. this conclusion contrasts with development economics research group (derg). fourthly, the research results indicate that the marital status of the householder is an important factor asian journal of economics and empirical research, 2019, 6(1): 59-69 67 © 2019 by the authors; licensee asian online journal publishing group significantly impacting on the bank credit accessibility of rural households at a statistically significant rate of 1% in 2014 which is, however, not significant in 2016. this means that a householder who is currently married has a higher accessibility to bank credit than to the informal credit. this finding is not supported by the development economics research group (derg), duy et al. (2012) as well as ololade and olagunju (2013). fifthly, the duration of unpaid loans also reduces the bank credit accessibility of rural households in vietnam. this result has statistical significance rates of 1% (2014) and 5% (2016). this finding implies that the longer the debts owed to households are, the more decreasing their possibility to receive the formal loan capital is. this is an important finding that previous researches have not yet shown. finally, that households are currently members of farmers associations has an important meaning in the decisions to issue loans from bank credit institutions, which has a statistical significance rates of 5% and 10% in 2014 and 2016, respectively. for householders who are party members, their reputation also has a positive effect on their bank credit accessibility in 2016. however, if the households are members of women's unions or veterans associations, there is no statistical significance regarding the impact on their bank credit accessibility. this result is consented by assogba et al. (2017), tran and huynh (2013) and the development economics research group (derg) when thinking that organizations and unions like the farmers associations play an important role in the credit accessibility of vietnamese rural households in connection with agricultural, non-agricultural and investment loans. table 5 presents the estimation results of heckman two-stage model on the possibility to receive loans of rural households in vietnam. the results show that there are 18 factors that affect the value of loans received from bank credit institutions including average income of the household, age of the householder, gender of the householder, ethnic group, marital status, educational status of the householder, household size, percentage of dependent persons, personal funding, savings, purpose of loan according to application for borrowing, mortgage of assets, natural shock, previous borrowing duration and members of associations and unions. table-5. results of heckman model analysis of the second step on the ability of rural households to access bank credit. variables symbols 2014 2016 coeficient coeficient average income avgincome 73649.6*** (2601.12) -67017.78*** (4726.173) householder’s age age 4132.494*** (165.016) 4118.629*** (220.0773) householder’s gender sex -87452.24*** (6413.622) 38572.18*** (7154.788) ethnicity eth -139839.4*** (4766.728) -50314.83*** (4712.804) marital status sta 273940.4*** (8523.094) 134770.6*** (7654.039) education status of head of household edu -9616.384*** (986.8537) 568.6621 (1208.606) household size size 18312.25*** (1049.948) 27264.61*** (1477.458) percentage of dependents dep -78477.19*** (6239.476) -132654.2*** (8557.581) individual financing inf -43027.84*** (3818.201) -17069.21*** (4940.635) savings sav 48638.26*** (10767.17) 55074.53*** (12755.77) borrowed time loantime -772.9602 (682.6477) -1178.365* (680.6268) fee of loan fee 7.022414 (5.063817) 9.431843 (7.350401) loan interest loaninterest 16.54856 (954.1035) 590.087 (2238.083) purpose of loan in the application form tar0n -12535.81** (4870.354) -9727.456* (5875.016) the actual purpose of loan tar1n 6229.27 (4800.941) -2026.826 (5765.248) collateral col 15481.43*** (3151.804) 26878.8*** (4084.574) natural shock nasock 51087.76*** (4355.186) 23880.68*** (5294.871) member of farmers association agrc 102098.6*** (3860.518) 159453.7*** (6395.516) member of women’s union womec -47029.69*** (6761.327) 66861.14*** (8245.986) party member party 86252.55*** (6212.679) 203678.5*** (10141.56) member of veterans association veterc -115005.1*** (5578.39) -67691.25*** (7140.371) lambda 962010.9*** (23292.64) 1201355*** (38324.22) constant _cons -1125626*** (30100.51) -261218.6 (27134.05) note: (*), (**) and (***) are statistically significant at 10%, 5% and 1% respectively. source: calculated by the author based on vhlss 2014 and vhlss 2016 dataset. asian journal of economics and empirical research, 2019, 6(1): 59-69 68 © 2019 by the authors; licensee asian online journal publishing group firstly, the average incomes of households have a remarkably positive and statistically significant effect on the value of the loans they receive from the bank credit institutions at 10%. households with higher average annual incomes have higher accessibility to bank credit capital than to informal credit capital. this conclusion is similar to nguyen and pham (2010), tran and huynh (2013), bui and truong (2014), vuong and dang (2015), mwangi and sichei (2011) but contrary to the development economics research group (derg). second, the estimation results explain that ages of the householders have a positive impact on the value of the loans they receive from bank credit institutions at a significant rate of 5%. this implies that the older the householder is, the higher the probability of receiving bank credit capital than informal credit capital is. this finding is supported by nguyen and pham (2010), vuong and dang (2015) and mwangi and sichei (2011). thirdly, the value of loans received from bank credit institutions is also increased for households of kinh ethnic group. evidence shows that kinh people households are often more favorable in getting more loans from bank credit institutions. this conclusion contrasts with the development economics research group (derg) when considering that the difference among ethnic group-related characteristics of households is not a barrier to credit accessibility. fourthly, the findings in table 5 also indicate that marital status of the householders is a key factor that has a significant effect on the value of the loans received from the bank credit institutions by rural households at a statistically significant rate of 1%. this implies that the householders who are currently married have higher possibility to receive loans from bank credit institutions than from informal credits. this finding is also not similar to the development economics research group (derg), duy et al. (2012) as well as ololade and olagunju (2013). fifthly, the duration of unpaid loans also reduces the value of loans received from bank credit institutions by rural households at a statistically significant rate of 1%. this finding implies that the longer the debts owed to households are, the more decreasing the value of loans received from bank credit institutions is. this is in line with the credit rating criteria of vietnamese banks. sixthly, that households are currently members of associations and unions including farmers associations, women’s unions, householders as a party member and veterans associations has a positive effect on the value of loans received from bank credit institutions by rural households. this shows that received loans are tended to higher thanks to participation in social activities and prestige of the householders. this result is agreed by assogba et al. (2017), tran and huynh (2013) and the development economics research group (derg). finally, other factors significantly affecting the value of loans received from bank credit institutions include gender of the householder, educational status of the householder, household size, percentage of dependent persons, personal funding, savings, purpose of loan according to application for borrowing, mortgage of assets and natural shock. in summary, based on the results obtained from the heckman two-stage model, the research shows factors including average income of household, age of householder, ethnic group, marital status, duration of unpaid loans and member of farmers association, the householder as a party member have a significant influence on the bank credit accessibility. in contrast, the evidence have not yet shown the factors including gender of householder, educational status of householder, household size, percentage of dependent persons, personal funding, savings, members of women's union or veterans association impact on the bank credit accessibility. 5. conclusion and recommendation 5.1. rural households firstly, improve credit accessibility of rural households in vietnam. in fact, credit information accessibility of rural households is limited. the main reason is that education level, resident's living standards, access to information and equal rights are still low compared to urban areas. therefore, communication channels need to be disseminated widely to improve bank credit accessibility for rural households. local authorities at all levels need to establish a department / committee equipped with sufficient criteria on facilities and resources with intensive skills to update credit information for local people. the provision of information to the people must be diversified in different forms such as local radio stations listing at offices, and distributing leaflets together with other administrative procedures. secondly, encourage households to join mass organizations. most households in rural areas face many barriers in accessing to credit, such as low education levels, low income, high number of dependents, limited time for social activities. due to livelihood activities, geographical distance, ... affecting credit accessiblity. participation in local mass organizations such as women's union, farmers 'association, veterans' association, etc. will help people have more conditions in sharing information, creating close relationships among households. mass organizations are also channels to connect with banks, state agencies, etc. thus updating the information fully and promptly on the credit market. thirdly, support households to complete land ownership certificates. most rural households have the biggest asset is land. however, the number of rural households granted land ownership certificates is still low compared to urban households. therefore, the government should have policies to encourage households, especially in rural areas, to obtain land ownership certificates, creating favorable conditions for households to access credit. 5.2. banks firstly, improve lending process and procedures for rural households. in fact, rural households borrow directly with a complicated loan process at banks. therefore, to improve households' access to bank credit, banks need to simplify procedures and streamline lending processes for rural households so they can access to credit easily and fastly. on the other hand, banks need to understand the production activities of each of their customers, especially agriculture forestry fishery production because each type of production will affect the process of loan. therefore, expand credit and loan conditions accordingly, facilitate borrowers to access credit and pay interest. moreover, although collateral is one of the lending conditions, banks should not see collateral as a decisive factor in lending. secondly, deploy lending to production households through mass organizations. banks need to cooperate with mass organizations in lending activities because of the reduction of human resource costs that are often lacking in asian journal of economics and empirical research, 2019, 6(1): 59-69 69 © 2019 by the authors; licensee asian online journal publishing group rural areas to disburse and monitor. furthermore, mass organizations hold get information about households and can provide more information to consult banks in loan profile reviews. lending through mass organizations also contributed to improving the knowledge and skills of bankers in taking care of borrowers, closely observing the status of production and business of farmers as well as propagating policies, credit information for farmers. thirdly, strengthen the promotion of images and brand of banks. in order to improve access to bank credit, banks need to promote communication activities for rural households. 5.3. government firstly, promoting the implementation of credit policies for rural area development. the government needs to continue to adjust the loan structure of commercial banks to prioritize medium and long-term loans. secondly, complete procedures for granting land ownership certificates. the government implement a longterm stable allocation of land for rural households, and accelerate the process of granting land ownership certificates so that farmers could have enough assets to secure bank mortgages. this is one of the main barriers to access bank credit of rural households today. thirdly, there are sanctions to limit the forms of access to black credit, high-interest loans. references assogba, p.n., s.e.h. kokoye, r.n. yegbemey, j.a. djenontin, z. tassou, j. pardoe and j.a. yabi, 2017. determinants of credit access by smallholder farmers in north-east benin. journal of development and agricultural economics, 9(8): 210-216. bui, v.t. and t.p.t. truong, 2014. analysis of the formal credit capital access: the case of shrimp farmers in tra vinh province. science journal of can tho university, 32: 1-6. claessens, s. and e. feijen, 2007. financial sector development and the millennium development goals (no. 89). world bank publications. diagne, a., 1999. determinants of household access to and participation in formal and informal credit markets in malawi. fcnd discussion paper no. 67. dinh, p.h. and d. dong, 2015. the impact of formal credit on household incomes in vietnam. journal of economic development, 26(2): 6582. duy, v.q., m. d’haese, j. lemba and l. d’haese, 2012. determinants of household access to formal credit in the rural areas of the mekong delta, vietnam. african and asian studies, 11(3): 261-287.available at: https://doi.org/10.1163/15692108-12341234. economic and development group, 2010. the availability and effectiveness of rural credit in vietnam: investigation evidence access to household resources in vietnam 2006-2008-2010. copenhagen university (uoc) agriculture and rural development program (ard). heckman, j.j., 1979. sample selection bias as a specification error. econometrica: journal of the econometric society, 47(1): 153161.available at: https://doi.org/10.2307/1912352. kiplimo, j.c., e. ngenoh, w. koech and j.k. bett, 2015. determinants of access to credit financial services by smallholder farmers in kenya. journal of development and agricultural economics, 7(9): 303-313. mwangi, i.w. and m.m. sichei, 2011. determinants of access to credit by individuals in kenya: a comparative analysis of the kenya national finaccess surveys of 2006 and 2009. european journal of business and management, 3(3): 206-227. nguyen, c.h., 2007. access to credit and borrowing behaviour of rural households in a transition economy. 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https://doi.org/10.1016/s0304-405x(03)00125-9. roodman, d., 2009. cmp: stata module to implement conditional (recursive) mixed process estimator. statistical software components s456882, boston college department of economics. stiglitz, j.e. and a. weiss, 1981. credit rationing in markets with imperfect information. the american economic review, 71(3): 393-410. tran, a.k. and t.t. huynh, 2013. factors affecting the access to formal credit by households in an giang province. science journal of can tho university, 27: 17-24. vuong, q.d. and h.t. dang, 2015. analysis of factors affecting pig farmers' ability to access official credit in o mon and can tho districts. science journal of can tho university, 36: 42-51. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 139 asian journal of economics and empirical research vol. 5, no. 2, 139-146, 2018 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2018.52.139.146 how the gcc economic crises effect labor migration: evidence from pakistan yasir khan1  wang mingyi2 ( corresponding author) 1ph.d. scholar school of economics and management southeast university 211198 china 2ph.d. professor school of international economics and trade, shandong university of finance & economics, china abstract migrant workers have participated in promoting economic growth and prosperity and the generation of wealth in countries of destination. the gulf cooperation council (gcc) which is comprised of six countries such as saudi arabia, uae, qatar, kuwait, bahrain, and oman have been historically and traditionally job market for pakistani workers. labor migration and its relationship to economic growth and employment have received increasing attention because of increasing demand for labor, higher salaries, economic and political stability. using a case study, we focus on the impact and relationship of labor migration with macroeconomic indicators such as gross domestic product (gdp), unemployment, and inflation rate. limited employment opportunities, the weak economy, and political instability are the factors leading labor migration from pakistan. consequently, the government of pakistan considered labor migration primarily as an employment sector and encourage labor migration to solve economic problems in the country. we analyze the impact of labor migration on (gdp), inflation rate and unemployment in pakistan with the help of time series data from 1971-2016. the result to have showed a positive and significant relationship between labor migration and gdp, while a negative but significant relationship with unemployment. on the other hand, there is no relationship between labor migration and inflation rate. we found that the gcc economic crises actually caused significant influence on labor migration in the case of pakistan. keywords: foreign direct investment (fdi), pakistan, gcc, gdp, unemployment, inflation rate, vecm. citation | yasir khan; wang mingyi (2018). how the gcc economic crises effect labor migration: evidence from pakistan. asian journal of economics and empirical research, 5(2): 139-146. history: received: 29 june 2018 revised: 13 august 2018 accepted: 4 september 2018 published: 21 september 2018 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 140 2. literature review .......................................................................................................................................................................... 141 3. empirical analysis ......................................................................................................................................................................... 142 4. result and discussion ................................................................................................................................................................... 143 5. conclusion ....................................................................................................................................................................................... 145 references ............................................................................................................................................................................................ 145 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2018.52.139.146&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/253 http://asianonlinejournals.com/index.php/ajeer/article/view/253 asian journal of economics and empirical research, 2018, 5(2): 139-146 140 1. introduction labor migration is an integral part of pakistan economy. over the past four decades, there are 8 million pakistanis migrated abroad through the formal channel for employment. the labor migration level from pakistan reached a new peak after 2011. in the five-year plan from 2011-2015, more than 3 million pakistani labor lift the country for overseas employment. the migrant workers have significantly contributed to pakistan’s development through the remittances of their earnings. moreover, labor migration is benefited for pakistani labor in terms of learning new skills and knowledge through other social assets they required while working overseas. labor form the poor to the rich countries have been a significant component of international economic relations to an extent it affects political debate in the developing nations. awad (2009) indicates that the demand for migrant workers in some major regions of destination, such as the gulf cooperation council (gcc) countries, has not significantly diminished. this may be due to their still positive financial situations, in turn made possible by reserves accumulated in recent years because of high oil prices. the major component to drive labor is international wage differences such moments, vast migration and labor mobility as a heterogeneous factor have also been the reason for capital formation, unemployment, wage inequality. labor migration also helps the process of development of poor economies have to do with the expansion of physical, human and capital stock. many classical models determined that in the short-run is to be paid higher wages in order to be attracted to a certain country. on the other hand, in the long-run would cause to equalize wages across nations. according to keynesian, analyzing that capital was likely to move in the same direction as labor and in effect would intensify and perpetuate the disequilibrium between the gaining and losing areas. jonathan addelton (the gulf migration and pakistan) had determined that a combination of economic and culture motives was responsible for mobility for mobility of labor from south asia to gulf prior to the 20th century. two phases of pakistani labor migration to the gulf describes that the third phase of migration which began around 1970 built on an already existing set of family and cultural links. the major destination for pakistani labor is united arab emirates (uae), saudi arabia, kuwait, bahrain, and europe. khan et al. (2018) found the long-run relationship between foreign direct investment (fdi) and economic growth using time series data for pakistan form 1978-2016. koser (2010) most gcc countries report declines in economic growth, this is mainly due to decreasing oil prices after soaring oil-prices in 2008. figure-1. number of overseas labor from pakistan. source: national bureau of statistics pakistan, international labor organization figure 1 reveals a strong and positive relationship between the overall economic growth of pakistan and the growth of overseas migration among pakistani labor. azam (1995) found that sending remittances of pakistani labor remarkably supported pakistan economy. manpower export to eh middle east began on a large scale in early 1975. noman (1991) revealed that remittances from the middle east increased dramatically over the past decades. international migration considered as an ever-growing phenomenon that has important development implications for both sending and receiving countries. halfacree (2004) stress that a range of non-economic macro-scale variables could be also influence migration. for sending country labor migration and the resulting remittances lead to increase incomes and poverty reduction, promote economic development and improved health and educational outcomes. fassmann and hintermann (1998) suggest that determining the potential for migration is a complicated issue and especially due to political sensitivities, need a rigorous research approach. many developing nations are also major recipients of international migrants, they face challenges of integration of immigrants, job competition between migrant and native workers, and fiscal costs associated with the provision of social services to the migrants. remittances have been found to have an income stabilizing effect at both macroeconomic levels and at the household level. asian journal of economics and empirical research, 2018, 5(2): 139-146 141 table-1. economic push and full factors of migration push factor (native places) pull factor (foreign destinations) high unemployment rate high demand of labor relatively low wages high income level per capita (gdp) relatively low-income level per capita (gdp) high wages relative high taxes relative low taxes relative high consumer price index (cpi) relative low consumer price index (cpi) low investment high investment source: ministry of trade and commerce pakistan mixon (1992) revealed that the process of migration starts when the benefits of these factors exceed costs. kumpikaite and zickute (2012) analyzed when the percentage of unemployment increases, emigration increase and vice versa. glinskienė and petuškienė (2009) higher productivity and lower emigration could mean a reduction of long-term unemployment. sending more labor migrants to other countries could decrease unemployment and increase the country economic growth by sending remittances. sjaastad (1962) analyzed that migration can be understood an investment decision to realize differential outcomes on human capital in terms of different economic spaces. figure-2. unemployment rate in pakistan in percent source: national bureau of statistics pakistan 2. literature review labor migration from pakistan has been increased significantly in the last two decades. labor from pakistan has contributed hugely to the country economy by sending remittances. kumpikaite and zickute (2012) the minimum wage rate influences significantly change the migration process. valiūnienė (2016) found that one of the most important factors are better employment possibilities with better wages. otoiu et al. (2014) the process of migration is not new by itself and is studied by many research scholars. migration is a phenomenon that has major societal, regional, national, and transactional consequences. chiswick et al. (2005) found highly-skilled immigrants and for immigrants from countries where skills are readily transferable to the host. in the case of high-skilled migrants, the countries with different labor markets, the mobility from one country to another is more likely to involve downward mobility, but as with highly skilled labor migrants, as location-specific human capital is obtained, upward mobility is possible. mixon (1992) found that the gross domestic product (gdp) per capita allows comparing the international level of development. therefore, it is significantly acknowledged that a higher development could a prerequisite for a reduction of the extent of migration. meyer and shera (2017) suggested that the impact of remittances on economic growth increase the gdp of 6 high remittances receiving countries (albania, bulgaria, macedonia, moldova, romania and bosnia herzegovina during the period of 1993-2013 using panel data. suggest that pakistan need to improve and develop the production technology of primary and secondary goods to high tech products and industries where international growth is concentered. hirose (1994) found that labor migration and direct investment are becoming the focus of attention and careful analysis due to rapid changes in the economic changes. phongpaichit (1990); root (1994) determined that fdi has a positive impact on exports the reason is that overseas investors and firms taking of abundant and inexpensive factor of production of the host nation which economizes unit cost and thus increases its exports. hailu (2010) analyzed the relationship between fdi and trade (export, import) of african countries for the time period 1980-2007. the relationship between fdi and import is found out positive and significant. firpo et al. (2011); ottaviano et al. (2013) indicates that international trade appears to be a decisive factor. in particularly, typically held by middle-skill workers are increasingly offshored. davidson et al. (2008) found that the roles of efficiency in employment search, they concluded the rate of employment destruction and the ratio of employee turnover in the determination of comparative advantage. moore and ranjan (2005) determine that how trade liberalization in a skill-abundant country can reduce the unemployment of skilled workers and increase the unemployment of unskilled workers. felbermayr et al. (2011) found that incorporate search of unemployment in a one sector model with firm heterogeneity to understand the implications of a bilateral reduction in trade cost on unemployment. braun and scheffel (2007) revealed that growing international outsourcing reduce the union wage premium of low skilled workers. asian journal of economics and empirical research, 2018, 5(2): 139-146 142 artuç and mclaren (2015) found that labor can move across wage difference at a cost. this factor of migration is common and an idiosyncratic component. krugman (1991) determents that migrants not only follow markets potential, they also affect market potential. mundell (1961); kenen (1969); hughes and mccormick (1994) revealed that labor in extreme high unemployment region can move to low unemployment region, for the purpose to reducing aggregate unemployment and accelerating adjustments to asymmetric regional shocks. todaro (1969) his research mostly focused on economic inequalities and macroeconomic trends. he suggests that the new classical approach stress differences in wage and unemployment at the regional and international level. otrachshenko and popova (2014) found that the perception to migrate is indeed affected by macroeconomic factors. combining the impact of life satisfaction and macroeconomic factors reveals a greater propensity to migrate among individuals from the central and eastern european countries. 2.1. labor migration from pakistan labor migration from pakistan is not a new topic. the surge in labor migration for overseas employment has brought deep changes in the socio-economic fabric of the country. although the labor migration phenomenon has emerged as an alternative livelihood opportunity for many pakistani households. with such a huge working-age population in pakistan, an increasing number of workers have moved to other countries for employment; after india, pakistan annually sends abroad the second-largest grouping of workers in south asia, mainly to the gulf region. table-2. distribution (%) of pakistani workers, by country of destination, 1971–2015 courtiers no. of workers % share saudi arabia 432 5183 50.3 united arab emirates 283 2941 32.9 oman 644 047 7.5 kuwait 181 441 2.1 bahrain 142 420 1.7 qatar 123 639 1.4 iraq 70 719 0.8 libya 81 145 0.9 republic of korea 15 431 0.2 malaysia 66 417 0.8 italy 28 033 0.3 united states 4 739 0.1 united kingdom 12 142 0.1 rest of the world 70 568 0.1 total 8 598 865 100.0 source: bureau of statistics pakistan pakistan relies heavily on labor migration as an avenue for reducing both unemployment and poverty. migration is recognized as a central dimension of globalization, touching almost all countries around the world as points of origin, transit or destination for migrants or even all three at once. since the mid-1970s when dramatically rising oil prices led to an economic boom in the oil-rich countries of the gulf region, large-scale temporary and circular foreign worker migration has accommodated the associated labor needs. pakistani workers have been a large presence in that movement as well as in the flow to other new opportunities in the world, particularly the united kingdom, north america and europe. over the past four decades, more than 8 million pakistanis moved abroad through the formal channel for employment. migration from pakistan reached a new peak after 2011. in the five-year period from 2011 to 2015, more than 3 million people left the country for foreign-based jobs. 3. empirical analysis labor migration = a11 + β11 total gdp growth (annual %) + β12 unemployment + β13 inflation rate (1) gdp growth (annual %) = a21 + β21 labor migration + β22unemployment + β23 inflation rate (2) unemployment = a31 + labor migration + β32 gdp growth (annual %) + β33 inflation rate (3) inflation rate = a31 + labor migration + β32 gdp growth (annual %) + β33 unemployment (4) 3.1. vector error correction model ∆y1,t = βy0 + βy1∆yt-1 + βyp ∆yt-p + γy1∆t-1 λyp∆xt-1 ( yt-1 α0 α1xt-1) + vt y ∆x1,t = βx0 + βx1∆yt-1 + βxp ∆yt-p + γx1∆t-1 – λxp∆xt-1 ( yt-1 α0 α1xt-1) + vt y where yt = α0 + α1x1 is the long-run cointegrating relationship between the two variables and λy and λx are the error-correction parameters that measure how y and x react to deviations from long-run equilibrium. when we apply the vec model to more than two variables, we must consider the possibility that more than one cointegrating relationship exists among the variables. for example, if x, y, and z all tend to be equal in the long run, then xt = yt and yt = zt (or, equivalently, xt = zt) would be two cointegrating relationships. to deal with this situation we need to generalize the procedure for testing for cointegrating relationships to allow more than one cointegrating equation, and we need a model that allows multiple error-correction terms in each equation. asian journal of economics and empirical research, 2018, 5(2): 139-146 143 3.2. labor mobility labor mobility describes as the consists of changes in the location of workers both across physical space (geographical mobility) to find jobs (occupational mobility). geographical mobility can be further subdivided into two categories, long-distance mobility and short-term mobility. a study in pakistan showed that such economic indicators such as unemployment rate, lower wages, lack of education and skill knowledge have the biggest influence on emigration. 4. result and discussion first of all, we concluded the summary statistics of all the variables which comprise of labor migration, gross domestic product (gdp), unemployment, and inflation rate. the data were obtained by world bank indicators database for the period of 1978-2016. all the variables are in real terms and are expressed in us dollars. the summary statistics for the all the variables are indicating that the data is equally distributed. the mean for labor migration is 11.68 while coefficient β is 1.16. the mean of gross domestic product (gdp) is 6.61 while the coefficient of β is 0.28. on the other hand, the mean value for inflation rate and unemployment are 2.05 and 1.14 while the value of coefficient β is 0.55 and 0.46 respectively. the study also indicating the jerque-bera test for labor migration, gdp, inflation rate, and unemployment is greater than 0.1 suggests the data are equally distributed. skewness test shows the probability for labor migration, gdp, inflation rate and unemployment are near to zero, while kurtosis test should be close to 3. median is described as the central value of series data while the maximum is the highest in a given set of data and minimum is the smallest or lowest value of the data. finally, the standard deviation is the dispersion of data around the mean and is denoted by sigma. table-3. summery statistics migration gdp inflation unemployment mean 11.6862 6.6145 2.0551 1.4189 median 11.7592 6.6778 2.0597 1.4539 maximum 13.7606 7.0746 3.2832 2.112 minimum 8.1701 6.1176 0.9319 0.5128 std. dev 1.1666 0.2853 0.5560 0.4698 skewness -0.9846 -0.2504 0.048 -0.5506 kurtosis 4.7762 1.9132 2.6303 2.2356 jerque-bera 13.6866 2.6847 0.2739 3.3695 probability 0.0013 0.2612 0.8719 0.1854 sum 585.8813 297.65 92.4831 63.8524 sum sq. dev. 59.8854 3.5816 13.6047 9.7151 source: ministry of trade and commerce pakistan, world bank 4.1. unit root test first of all, we use the augmented dickey-fuller test, 1979 to check whether the variables are stationary or not. for this hypothesis, the null hypothesis is that the series does not have to the unit root issue. on the other hand, it is important that all variables are stationary before testing hypothesis. we supposed that alternative hypothesis is that series do have a unit root problem. in our study, at the start all the variables having an issue of a unit root at a level, but we examined at first difference, all variables convert into a stationary hence null hypothesis is accepted as series does not have a unit root problem. table 4. johensen cointegration test suggests that the t-statistics for labor migration, gdp, inflation rate and unemployment are greater than critical value at 5%. therefore, we choose vector error correction model on the basis of johansen cointegration test. table-4. unit root test at level at first difference variable t-statistic prob* t-statistic prob* emigration 2.23 0.99 -4.36 0.000 gdp 4.47 1.000 -2.91 0.004 inflation rate -0.76 0.37 -6.93 0.000 unemployment 0.59 0.83 -9.31 0.000 source: ministry of trade and commerce pakistan, world bank table-5. johansen cointegration test hypothesized no. of ce(s) eigenvalue trace statistic 0.05 critical value prob.** none * 0.560787 69.55244 40.17493 0.0000 at most 1 0.439724 35.81882 24.27596 0.0012 at most 2 0.211323 12.06644 12.32090 0.0551 at most 3 0.055316 2.333097 4.129906 0.1495 source: ministry of trade and commerce pakistan, world bank cusum graph shows the results of mean and variance of coefficient stability. in the study. we examined that variance of the coefficient is stable as the mean is within the straight bound lines. therefore, all our models are perfect and stable. asian journal of economics and empirical research, 2018, 5(2): 139-146 144 fig-3. stability coefficient cusum test 4.2. vector error correction model granger and newbold (1974) was first introduced the vector error correction model. many researchers use a vector error correction model for long-run and short-run effects of one-time series on another. we found long runrelationship between labor migration, gdp, and unemployment. in the long-run error correction estimation, the results indicating that the response variable labor migration has a positive and significant relationship with gdp. the coefficient of gdp is 4.60 while the value of variance is 2.80. on the other hand, the response variable labor migration has a negative but significant relationship with explanatory variable unemployment. there is a long-run relationship between labor migration, gdp, and unemployment. the result indicates the no relationship between labor migration and inflation rate. moreover, the r2 value of labor migration is 0.42, gdp, inflation rate and unemployment 0.37, 0.17, 0.34 and adjusted r2 value is o.23, 0.18, -0.08 and 0.14. it indicates that the residual plots are quite close to the regression line. the f-statistics value is 2.30, 1.92, 0.66, and 1.72 respectively, while log-likelihood value is 1.67, 109.5, 15.68, and 5.85. table-6. vector error correction estimation error correction d(migration d(gdp) d(inflation d(unemployment cointeq1 -0.251795 (0.08604) [-2.92655] 0.013516 (0.00541) [ 2.49948] 0.195774 (0.13428) [ 1.45796] 0.062290 (0.07729) [ 0.80593] d(migration(-1)) 0.348140 (0.15330) [ 2.27099] -0.004273 (0.00963) [-0.44352] -0.068935 (0.23925) [-0.28813] 0.039836 (0.13771) [ 0.28928] d(migration(-2)) -0.021404 (0.16778) [-0.12757] -0.012430 (0.01055) [-1.17874] 0.088644 (0.26186) [ 0.33852] 0.205316 (0.15072) [ 1.36220] d(gdp(-1)) 4.604680 (2.80760) [ 1.64007] 0.037503 (0.17645) [ 0.21253] 3.314130 (4.38181) [ 0.75634] -1.970112 (2.52212) [-0.78113] d(gdp(-2)) 0.238470 (2.52743) [ 0.09435] 0.109484 (0.15885) [ 0.68925] -1.403545 (3.94455) [-0.35582] -2.576992 (2.27044) [-1.13502] d(inflation_rate(1)) -0.385043 (0.11848) [-3.24974] 0.018734 (0.00745) [ 2.51578] 0.027983 (0.18492) [ 0.15133] 0.041865 (0.10644) [ 0.39334] d(inflation_rate(2)) -0.182183 (0.15069) [-1.20900] 0.004652 (0.00947) [ 0.49123] 0.028071 (0.23518) [ 0.11936] -0.130043 (0.13537) [-0.96067] d(unemployment(-1)) -0.067374 (0.19526) [-0.34506] 0.003516 (0.01227) [ 0.28651] -0.271336 (0.30474) [-0.89040] -0.434038 (0.17540) [-2.47453] d(unemployment(-2)) -0.169617 (0.17771) [-0.95448] -0.007783 (0.01117) [-0.69683] -0.027770 (0.27734) [-0.10013] -0.068383 (0.15964) [-0.42837] c -0.046285 (0.09910) [-0.46707] 0.020094 (0.00623) [ 3.22630] -0.043503 (0.15466) [-0.28128] 0.115014 (0.08902) [ 1.29201] r-squared 0.416728 0.374442 0.171959 0.347625 adj. r-squared 0.235712 0.180303 -0.085019 0.145164 sum sq. resids 2.095461 0.008277 5.104055 1.690979 s.e. equation 0.268807 0.016894 0.419526 0.241474 f-statistic 2.302168 1.928731 0.669158 1.716997 log likelihood 1.675260 109.5891 -15.68484 5.857349 akaike aic 0.426910 -5.107135 1.317171 0.212444 schwarz sc 0.853464 -4.680581 1.743726 0.638998 mean dependent 0.089606 0.021303 -0.006926 0.027955 s.d. dependent 0.307477 0.018660 0.402754 0.261173 source: ministry of trade and commerce pakistan asian journal of economics and empirical research, 2018, 5(2): 139-146 145 4.4. simple regression model historically, when labor migration outflow increasing unemployment decreasing. our study found that the response variable labour migration has a positive relationship which indicating labor migration increases unemployment. the reason is that a higher number of pakistani labor in the gulf region were deported due to consistently oil decline prices. the economic crises significantly affected pakistani labor losses their jobs and deport from the arab countries simple regression model shows the relationship and significance value of the variables. we found that gdp has a positive and significant relationship with the response variable labor migration. when labor migration outflow increase gdp will increase in the form of labor-sending remittances. on the other hand, the response variable labor migration has a negative but statistically significant relationship with explanatory variable unemployment. it indicates when labor migration outflow increases the unemployment will decrease and vice versa. moreover, we did not find any relationship between labor migration and inflation rate. table-7. simple regression model variable coefficient std. error t-statistic prob. gdp 1.550808 0.116755 13.28257 0.000*** inflation_rate 0.112327 0.222581 0.504657 0.6164 unemployment 0.849929 0.304895 2.787614 0.007*** source: ministry of trade and commerce pakistan 5. conclusion this paper has focused on how labor migration gives effect to economic development in emergent ones as sending nations from the viewpoint of the human capital. we analyzed the impact of labor migration on (gdp) and unemployment and determined the factors causing labor emigrants. the results of the regression analysis based on the relationship between labor migration, (gdp) and unemployment. we found that labor migration has a positive and significant relationship with gdp while a negative but statistically significant relationship with unemployment. on the other hand, there is no relationship between labor migration and inflation rate. the outcomes suggested that when the labor migration increases the gdp will increase vice versa. alternatively, based on the previous literature when the labor migration increases the ratio of unemployment decreases. but in our study, we found a positive relationship between explanatory variable labor migration and unemployment. this result suggests to us that a significant number of pakistani workers have been deported from the gulf cooperation council (gcc) countries due to economic crises. our analysis shows a strong consistent correlation between labor migration and gdp. overall, the conclusion of our paper approach comprises of macroeconomic development indicators such as unemployment, inflation rate, gross domestic product (gdp) and labor migration. based on the result of table 5. we have stated that the relationship between labor migration, (gdp) and unemployment was clearly proved at all levels. references artuç, e. and j. mclaren, 2015. trade policy and wage inequality: a structural analysis with occupational and sectoral mobili ty. journal of international economics, 97(2): 278-294.available at: https://doi.org/10.1016/j.jinteco.2015.06.001. awad, i., 2009. the global economic crisis and migrant workers: impact and response (no. 433612). international labour organization. azam, f.-i., 1995. emigration dynamics in pakistan. 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2020 by the authors; licensee asian online journal publishing group voluntary environmental regulations and firm innovation in china shaojie zhang zhongnan university of economics and law, wuhan, china. abstract the world is fighting the issue of increasing levels of pollution and the detrimental effects of the ecological imprints of the business industry. pollution and other environmental issues are causing the environment to deteriorate; however, this has also led to an increased interest in the protection of the environment. the porter hypothesis has stimulated a long debate on whether organizational regulations can lead to changes in a firm‟s innovation. building on these theories, this study evaluates the effect of voluntary environmental regulations (vers) on the innovation of chinese firms. for this purpose, the study uses a dichotomous dependent variable. the proxy variables used for evaluating the innovative performance of firms are the average investments made for research and development (r&d) activities, which are evaluated on the basis of investments made and the decision to invest in innovation activities. vers were evaluated using applications for the iso 14000 certification. the study uses firm level variables to answer the research questions, as well as control variables such as firm size, profitability, degree of competition, and high technology industry. the results of the estimations reveal that the impact of environmental regulations (ers) is positive and significant in terms of the innovation output of the firms under consideration. moreover, the results also highlight the fact that large firms with high levels of profitability and a presence in the technology sector are more adept at introducing innovative activities. the study also provides some policy implications. keywords: gmm; pols; environmental regulations; innovation. citation | shaojie zhang (2020). voluntary environmental regulations and firm innovation in china. asian journal of economics and empirical research, 7(2): 171-177. history: received: 14 may 2020 revised: 19 june 2020 accepted: 21 july 2020 published: 17 august 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. research background .................................................................................................................................................................... 172 2. literature review .......................................................................................................................................................................... 172 3. methodology ................................................................................................................................................................................... 173 4. results .............................................................................................................................................................................................. 174 5. discussion and conclusion ........................................................................................................................................................... 176 6. policy implication and limitations ............................................................................................................................................ 176 references ............................................................................................................................................................................................ 176 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.72.171.177&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/2026 http://asianonlinejournals.com/index.php/ajeer/article/view/2026 asian journal of economics and empirical research, 2020, 7(2): 171-177 172 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to existing literature by analyzing the overall impact of vers on the fi performance and presentation in the case of china. 1. research background a well-designed set of environmental regulations (ers) leads to the stimulation of innovative activities (wang & shen, 2016). chinese organizations with well-designed ers are able to use innovative technology, techniques, and tools to reduce their costs. there is a lack of competitive advantage in chinese firms where the incorporation of such regulations has not taken place (wang, wu, & zhang, 2018). the voluntary commitments of an organization are generally voluntary ers (vers) that help to control pollution and conduct other activities that are concerned with protecting the environment. these ers result in increased costs for the regulators and organizations, and they are limited due to the conflict between pollution and the development of the economy. the impact of ers on firm innovation (fi) varies according to the environment and marketplace. the phenomenon of innovation and er has been gaining considerable positive attention from academic experts and scholars over the past few decades (you, zhang, & yuan, 2019). however, it can be said that, even now, business performance is influenced by innovation gaps and other limitations. the number of firms operating successful business practices (jiang, wang, & li, 2018); pan, ai, li, pan, and yan (2019) suggest that, in order to address limitations and performance gaps, a firm‟s context and other factors affecting innovation performance need to be evaluated and examined in detail. studies on fi performance and related concepts are sparse and limited, which is why research efforts need to be conducted on developing firms and organizations (liu, li, & yin, 2018); soto-acosta, popa, and palacios-marqués, 2017), in order to test the impact of social factors, zehir and özsahin (2008); zehir and özsahin (2008); zehir and özşahin (2008) and analyze the impact of environmental factors on fi performance and presentation. naranjo-gil (2009) completed research on synthesized and empirically evaluated experiences and outcomes of ers, proposing further investigation and evaluation into these factors and variables through cross-nation and single-nation analysis. thus, the forecasting of environmental restrictions and rules from the perspective of fi is significant. this research has profound and constructive benefits in practice, as well as in theory. theoretically, the results and findings of this research contribute to the current body of data and information on the above variables through an evaluation of the underlying process of identifying the impact of vers on fi performance. practically, the outcomes of the current paper prove to be beneficial for academic experts and practitioners, as well as the policymakers who promote and design supportive frameworks for businesses and firms in china. this paper also contributes to the porter hypothesis by supporting analysis on whether or not ver has a favorable impact on fi and overall operational performance. based on the above discussion, the current study has the following aims:  to analyze the overall impact of vers on the fi performance and presentation, primarily based on an organizational level survey concerning iso certification and rules in china.  to understand and evaluate the relationship between ver and fi through porter's hypothesis, which is entirely based on whether or not environmental rules and regulations can effectively influence organizational innovation. the rest of the paper is organized as follows: in the second section, a detailed and supportive review of the literature is presented; the third section provides the related hypotheses; the fourth section presents the collected data and the methods used to collect data from different firms and organizations; the fifth section reports all results and the robustness evaluation; and finally, the sixth section summarizes the study‟s outcomes and limitations, as well as highlighting future study directions. 2. literature review it has been postulated that strict and exacting ers and rules can play a direct role in inducing efficiency and encouraging innovative practices that help organizations to improve and enhance their commercial competitiveness (lanoie, patry, & lajeunesse, 2008). this hypothesis was originally formulated in 1995 by michael porter, a famous economist who studied the environmental performance of firms (ambec, cohen, elgie, & lanoie, 2013). according to rubashkina, galeotti, and verdolini (2015), this hypothesis strongly suggested that harsh ers and restrictions trigger the discovery and introduction of cleaner and more environmentally friendly technologies, technological procedures, and environmental enhancements. the overall effect on innovation, through the development of production processes, is that goods delivered by firms are more efficient and the firms themselves have a more innovative performance (murty & kumar, 2003). furthermore, the cost savings that can be made are essential to overcompensate for the innovation and compliance costs that are produced by new rules and regulations. as an initial benefit, firms can exploit their innovation and its related activities by learning about curve impacts or patenting, in order to achieve a leading and significant competitive image, compared to firms in nations where er and restrictions were enforced much later. this hypothesis has been applied to various studies and research; according to ambec and barla (2002), firms that adopt a cost leadership strategy and have a relatively small product and goods portfolio will fare better than firms that compete over brand differentiation that have a significant number of chemicals that require er (rennings & rammer, 2011). in light of this hypothesis, several studies and research papers found that stricter and harsher er stimulates innovation that directly affects a firm‟s overall innovation (rexhäuser & rammer, 2014). there have been mixed results with regard to whether stricter rules improve a firm‟s business and whether regulations on market-based concepts, such as needs and prohibitions, have a direct impact. moreover, economic and business theories or models recommend that market-based strategies could be more effective and significant, although different suggestions and evidence exist. for example, research on oecd nations showed no evidence that a tightening of environmental rules and policy has a permanent impact on productivity, regardless of the extent of rules. after considering the empirical proof provided in the above asian journal of economics and empirical research, 2020, 7(2): 171-177 173 © 2020 by the authors; licensee asian online journal publishing group hypothesis, it can be concluded that stricter ers can have a direct and significant influence on the innovative processes and activities carried by the firm. conventional er and laws that are often described as command and management regulations play a significant role in managing and minimizing pollution (jiang et al., 2018). however, critics argue that conventional ers enhance the overall expenses of both organizations and regulators (bu., qiao, & liu, 2020). on the one hand, the capability and willingness of local governments to enforce er are being questioned, as er and policies play a role in major disputes between economic growth and environmental deterioration. for the moment, the overall execution of ers and policies is often influenced by exploitation and corruption. on the other hand, some organizations who have undertaken these regulations have, to a degree, bypassed governmental ers in order to reduce their costs. when this proves to be a challenge, organizations and small businesses spend more on emission minimization and pollution management. consequently, organizations have to minimize their budgets for other processes, such as the production of goods and other management practices. typically, it tends to be the largely innovative processes that are prominent in this technique (ren, li, yuan, li, & chen, 2018). conventional ers may lead to an insignificant level of efficiency and hinder the firm‟s innovative processes and strategies, which could lead to long-term consequences (zhuge, freeman, & higgins, 2020). moreover, according to demirel, iatridis, and kesidou (2018), conventional er and other policies are part of a collective process that consists of rules to protect the environment in the region or country (fang, liu, & gao, 2019). one set of regulations have a direct impact on environmental legal issues, which mainly focus on the management of certain natural resources, such as minerals, fisheries, and forests. although other aspects, such as the environmental influence assessment, may not fit perfectly into either category, they are nonetheless significant aspects of the ers that directly affect fi performance. according to feng and chen (2018), air quality regulations are a fundamental component of ers which govern the air pollutants emitted into the atmosphere by different firms. as described by ball, burt, de vries, and maceachern (2018), a specialized subset of air quality regulation controls the air quality in cities and residential areas. air quality regulations are typically designed and developed to protect the health of individuals by limiting and/or eliminating pollutants emitted by firms. several other initiatives have been developed to respond to broader environmental issues, such as limitations on chemicals used by firms in processes that directly affect the ozone layer and the creation of emissions trading programs to respond to climate change. regulatory processes predominantly include determining and categorizing air pollutant factors, in order to limit firms‟ emission levels by incorporating innovative steps and dictating suitable modifications and innovative technologies. water quality regulations are another important component of er, as they control the release of pollutants by firms into water resources, including surface water, water stores, and groundwater (zhou & feng, 2017). efforts to regulate water quality may include determining and categorizing water pollutants released by different firms, dictating suitable pollutant concentrations in water resources, and limiting pollutant emissions from firms. chemical safety regulations are another type of er that governs the use of chemicals, particularly man-made chemicals in modern applications and innovative practices (wibisana. & dewaranu, 2017). in contrast with media-oriented ers, chemical management regulations seek to control the potential pollutants themselves; such regulatory efforts generally include banning certain chemicals in consumer goods and regulating certain chemicals used by firms in their processes. in order to overcome the drawbacks of conventional ers, cohen and tubb (2018) have suggested that a suitable er framework would encourage and prompt innovation, thereby enhancing the overall competitiveness of the firm. sc filho, romano, de almeida, and sousa-aguiar (2019) further demonstrate the fact that a suitable framework of ers can prompt innovation and offset certain compliance expenditures. this is generally referred to as the innovation or modernization offset impact. 2.1. literature review for china china is in the process of economic development. however, it has been observed that china‟s gdp growth has declined in recent years. china‟s consumption of energy and environmental pollution has played a critical role in this trend. during the years between 1978–2011, the usage and consumption of energy sources were continually and considerably increasing in china; at the same time, the gdp growth of china also increased (guohui & yunfeng, 2012). the major reason behind this increase in gdp was china‟s energy usage. based on such positive and encouraging results, china placed an emphasis on controlling environmental pollution by introducing certain rules and regulations with regard to the environment. the initial methodology employed was the introduction of control procedures, such as policies that determine the standard of emissions. however, these policies proved ineffective at the time, as they led to greater costs and lower profits. after the failure of such policies, the government of china introduced policies related to the market (holz, 2014; zhao, zhao, zeng, & zhang, 2015). some examples include the “regulation enforcement of export companies' environmental protection”, the “national environmental protection „12th five-year‟ plan”, and the “environment quality standard”. 3. methodology this study is being carried out in order to evaluate the performance of organizations and their response to vers. data were collected to evaluate the corporate social responsibility (csr) practices of chinese organizations. the study used a csr survey developed in 2006 that characterized the performance of 1268 chinese enterprises and considered their annual reviews, which contain financial data from large organizations, as selected by the national bureau of statistics (nbs) of china. a total of twelve cities were chosen for the study and the application of a random sampling technique resulted in a total 120 firms from each city being selected for the study. the cities were selected on the basis of their development and other geographical constraints. the selected cities are beijing, changchun, zibo, hangzhou, chongqing, shijiazhuang, dandong, shunde, chifeng, shiyan, xi‟an, and wujiang. the sample was subjected to preliminary analysis in order to detect missing values and outliers. after the removal of outliers, the final sample consisted of an unbalanced panel of 1040 firms during the period 2001–2008. the main outcome variable in this study was the innovation of the firm. for this purpose, a dichotomous variable was designed. the first proxy variable used to evaluate the innovation of firms was the average investment asian journal of economics and empirical research, 2020, 7(2): 171-177 174 © 2020 by the authors; licensee asian online journal publishing group made for research and development (r&d) activities. this variable is referred to as ard and is defined as the ratio of total expenditures made for r&d in one financial year to the firm‟s sales income. in cases where an investment for innovation or r&d was made during a given year, the variable assumed the value of 0. the second variable designed to evaluate innovative input activities of organizations was a dummy variable, drd. this variable was used to evaluate the organizations‟ decision on whether or not to make an r&d investment. in cases where an investment is made, this variable assumed the value of 1; if not, it assumed the value of 0. the key explanatory variable in this study was the iso 14000 certification. a dummy variable was designed to evaluate the impact of voluntary regulation on firms when they have registered for or attained an iso certification. the measures of the certification were expected to have a significant impact on the evaluation of innovation activities of the organizations. in cases in which the organization has the certification, the variable assumed the value of 1. the study also introduced key control variables in order to accurately evaluate the extent of innovation and voluntary regulations. the control variables were used to evaluate features of the organizations that were under consideration. one of the evaluated characteristics was organization size, which was defined as the logarithm of the total number of people employed. previous literature has not evaluated the impact of organizational size on innovative activities (becheikh, landry, & amara, 2006; stock., greis, & fischer, 2002). the profit of the organization is also evaluated, which was defined as the ratio of annual profit before taxation to revenue generated by sales. this variable was anticipated to have a positive impact on the innovation of firms because there is evidence to suggest a close relationship between firm profitability and innovation (ukpabio, siyanbola, & studies, 2017). the competition of firms was also evaluated using the dummy variables of low and high. these variables assumed the value of 1 in cases in which a firm‟s premium product line faces market competition, whether it be low or high; if not, a value of 0 was assumed. theoretically, innovation is more probable in organizations that are characterized by high levels of technology. therefore, a dummy variable measuring whether or not the firm belongs to a high technology industry was also introduced in the study (verdu, tamayo, & ruiz-moreno, 2012). the primary aim of this study was to evaluate whether vers impact the advancement of innovation in firms. for this purpose, the following model has been developed to estimate regression: (1) in this equation, the term y is used to represent the innovation of the firm, iso is the independent variable, size, rate and degree are used to represent the firm size, profit rate and the degree of competition faced by the firm, and the term xi is used to represent the fixed dummy variable that accounts for the industry in which the firm belongs. the chosen firms in the sample have made investments in innovation in any of the selected years. the variable ard cannot assume a negative value; therefore, the method adopted for evaluation was the pols model and the tobit regression, which can easily forecast the size and probability of an investment in any given year. when using the drd variable in the evaluation of r&d innovation, the probit and pols models were used. the probit model is commonly used by researchers for binary regressions (bu et al., 2020). the impact of government-imposed ers was calculated and compared using the analytics on voluntary regulations. moreover, a gmm estimation was performed to measure the robustness of the results. 4. results before beginning the analysis and estimation, the variables were subjected to a correlation analysis in order to evaluate multicollinearity. the results of the correlation analysis are displayed in table 1. the correlation coefficients of most of the variables lie in the moderate range, i.e. less than 0.4. therefore, the problem of multicollinearity isn‟t found in the dataset. table 1. correlation analysis. variable ard drd iso size rate fierce low high-tech ard 1 drd 0.378 1 iso 0.045 0.12 1 size 0.036 0.154 0.271 1 rate 0.028 0.053 0.045 0.082 1 fierce 0.006 0.036 0.074 0.055 0.003 1 low 0.023 0.041 0.026 0.112 0.025 0.222 1 hightech 0.070 0.095 0.066 0.106 0.021 0.02 0.003 1 table 2 displays the estimations for equation 1. the pols, probit and tobit models were used to evaluate the impact of the voluntary regulations on the innovation of the firm. models 1 and 2 represent the estimations of the impact of the iso certification on investments made for r&d using the tobit and the pols model. the calculated coefficients for iso in both models were 0.0366 and 0.222; they are both positive and significant at a level of five percent. these results indicate that the voluntary registration has a positive and significant impact on the innovation of the firms. models 3 and 4 used the dummy variable drd in order to evaluate the relationship between fi and the voluntary regulations. the estimations and evaluations for the assessment were calculated on the basis of the probit and the pols model and the coefficients for iso were significant and positive. the coefficient values were 0.0873 and 1.502 and significant at the level of one percent. these results support the hypothesis (h1), which stated that the acceptance and implementation of vers has a significant and positive effect on the overall innovation of a firm. the control variables were also evaluated in order to study the impact of the firm‟s characteristics on its level of innovation. the control variables of size and profit rate were found to be significant. the variable firm size was significant and positive in models 2, 3 and 4, whereas the variable profit rate was found to be significant in models 3 and 4. these results indicate that larger firms have more exposure and a asian journal of economics and empirical research, 2020, 7(2): 171-177 175 © 2020 by the authors; licensee asian online journal publishing group higher chance of performing well and being more profitable; moreover, the more profitable the firm is, the more it will be inclined to invest in r&d activities. the coefficients for market competition were insignificant, which showed that there is no relation between innovation activities and the competition faced by firms. the coefficient for high technology was significant in models 1 and 2, which showed that firms that are either equipped with technology or are operating in the technology industry are more likely to invest in innovation activities. table 2. estimation of coefficients. variable pols (1)_ tobit (2) pols (3) probit (4) iso 0.0366** 0.222** 0.0873*** 1.502*** -0.0182 -0.0929 -0.031 -0.285 size 0.00312 0.0708** 0.0479*** 0.389*** -0.00489 -0.0329 -0.00556 -0.0934 rate 0.0116 0.34 0.156*** 1.253* -0.0438 -0.214 -0.0481 -0.682 fierce 0.000211 0.0838 0.0166 0.287 -0.0143 -0.107 -0.0148 -0.27 low 0.0517 0.862 0.139*** 2.242 -0.052 -0.613 -0.0549 -1.852 high-tech 0.0576*** 0.101 0.0552** 0.185 -0.0226 -0.105 -0.0247 -0.338 r-squared 0.021 0.086 note: ***, **, and * represent statistically significant levels of 1%, 5%, and 10%, respectively. the firms were subject to regulations imposed by the government, irrespective of whether they implement the voluntary regulations or not, so the analysis also considers the impact of government-imposed regulations in order to see which has a more significant impact on the innovation of the firm. table 3 presents the results of the analysis. for the purpose of evaluating the impact of government-imposed regulations, a new variable was introduced into the models. the variable er was used to assess the severity of the government regulations imposed to improve environmental efficiency. the variable er has been defined as the number of investigations made by the government per year. models 5 and 6 evaluate the impact of government regulations and voluntary regulations through a consideration of the dependent variable ard; while in models 7 and 8, the dummy variable drd is used. table 3. estimation of coefficients keeping control variables variable pols (5) tobit (6) pols (7) probit (8) iso 0.0386** 0.227** 0.102*** 1.583*** -0.0189 -0.0949 -0.0229 -0.313 size 0.0032 0.0751** 0.0471*** 0.391*** -0.0052 -0.0345 -0.00572 -0.0958 rate 0.0211 0.428* 0.177*** 1.595** -0.0467 -0.234 -0.0524 -0.771 fierce 0.00218 0.0287 0.00038 0.0659 -0.0152 -0.12 -0.0179 -0.308 low 0.0567 0.7 0.174*** 2.446 -0.0523 -0.598 -0.0575 -1.776 high-tech 0.0825*** 0.117 0.0827*** 0.0268 -0.0225 -0.113 -0.0248 -0.372 er 0.000234 0.000111 0.000721 0.0122 -0.000599 -0.00377 -0.000646 -0.0276 constant 0.042 2.226*** 0.225*** 9.328*** -0.0339 -0.224 -0.0372 -0.631 r-squared 0.027 0.097 note: ***, **, and * represent statistically significant levels of 1%, 5%, and 10%, respectively. table 4. gmm estimations variable gmm (9) gmm (10) iso 0.0435** 0.121*** -0.0223 -0.0232 size 0.00253 0.0446*** -0.00501 -0.00553 rate 0.00935 0.162*** -0.0449 -0.059 fierce 0.000474 0.0172 -0.0146 -0.0168 low 0.0513 0.156*** -0.052 -0.0567 high-tech 0.0574*** 0.0553** -0.0226 -0.0246 constant 0.0352 0.217*** -0.0332 -0.0331 r-squared 0.022 0.077 ar1 0.56 0.91 ar2 0.73 0.23 sargan test 0.66 0.44 note: ***, **, and * represent statistically significant levels of 1%, 5%, and 10%, respectively. the iso 14000 certification was found to be significant in all four models, which is in line with the estimations displayed in table 2. however, the effects of governmental environment regulations are insignificant in all four asian journal of economics and empirical research, 2020, 7(2): 171-177 176 © 2020 by the authors; licensee asian online journal publishing group models, demonstrating that the implementation of vers have a greater impact on the innovation performance of firms. the effects of the control variables are the same as evaluated in table 3. the gmm estimation was performed to consider the effects of vers in instances when they are lagged. the results are presented in table 4. the lagged phase one data for the iso 14000 certification was used. models 9 and 10 report significant values in the coefficients of voluntary regulations. the values are positive and significant, which indicates the robustness of the results when a lagged effect is considered to be present. in order to evaluate the robustness of the model, the serial correlation was analyzed using autoregressive tests, and the sargan test was used to evaluate the over-estimation or inclusion of extra variables in the model. it can be seen from the results that such an issue does not prevail and, therefore, the results are deemed to be efficient. 5. discussion and conclusion recently, studies evaluating the effects of voluntary, government-imposed, and supervised ers and their impact on performance indicators such as profitability, environmental performance, and innovative activities have been increasing. this discussion is developing because of the global issue of increasing levels of pollution. the concentration of pollution in china is significant due to the presence of heavy industries; as a result, literature evaluating ers has increased (bigliardi, bertolini, doran, & ryan, 2012; li, tang, & zhang, 2020; tang, 2015; you et al., 2019). there is a varying evidence relating to the impact of ers on innovation activities in chinese firms. this study explored the relationship between vers and the innovation of firms using data on the implementation and application of the iso 14000 certification. the results of the study show that the implementation of vers have a significant impact on the innovation of firms. the study by liu et al. (2018) evaluated the impact of different ers on the consumption of energy using a least squares method. the study found that supervised and economical regulations reduce consumption patterns of energy. the study by fang, gao, and lai (2020) evaluated the impact of ers on organizational innovation in china. this study evaluated the impact of supervised regulations from the government on the innovation of firms. in order to do so, the researchers analyzed government-monitored firms to understand the impact of fi in china. it was found that china‟s distinctive and monitored program significantly influenced fi. moreover, financial constraints, financial conditions, and firm size were found to be important characteristics in the evaluation of the performance of the firms. implementing effective ers in firms is one way of considering global ecological impacts through improved green practices. liu, xie, and ealth (2020) evaluated the impact of ers and their impact on the efficiency and competitiveness of the domestic chinese manufacturing sector. the competitiveness of export functions and value-added products were also considered. the researchers used the porter hypothesis to evaluate the impact of the regulations on the effectiveness of the export sector. the results of this study point to the presence of an internal heterogeneity in the industry. moreover, technological competitiveness and political regulations were found to have a significant impact on the relationship between innovation and regulation. the objective of the present study was to evaluate the impact of vers on fi. for this purpose, pols, probit, and tobit models were used to evaluate the impact of vers on the innovation of the firms. the study used the adoption or application of the iso 14000 to measure voluntary regulations, and a dichotomous dependent variable was designed. the results of the estimations showed a clear and significant impact of vers on the stimulation of innovation activities in chinese firms. moreover, in order to validate the findings, the study introduced government-imposed regulations and vers into the same model. the results indicate that the impact of the voluntary regulations is more significant, putting the firms in a more likely position to ensure innovative activities. furthermore, the presence of lagged variables was accounted for, as the gmm estimation provided significant results on voluntary regulations and proved the robustness of the results. 6. policy implication and limitations the findings of the study emphasize the importance of vers on the innovation of firms. moreover, policy procedures in developing countries need to focus on the importance of the voluntary adoption of ers so that emissions can be reduced, and innovation can be stimulated. the limitations of the study are that it focuses on general innovation indicators, due to limited data. thus, future researchers should focus on evaluating innovation using direct and more robust indicators. references ambec, s., & barla, p. 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(2020). regulation and innovation: examining outcomes in chinese pollution control policy areas. economic modelling, 89(c), 19-31.available at: https://doi.org/10.1016/j.econmod.2019.09.041. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. http://www.ualberta.ca/-econphd/ruotao_tang_jmp.pdf http://www.ualberta.ca/-econphd/ruotao_tang_jmp.pdf 147 asian journal of economics and empirical research vol. 5, no. 2, 147-154, 2018 issn (e) 2409-2622 / issn (p) 2518-010x doi: 10.20448/journal.501.2018.52.147.154 analyzing the savings-investment trend in a panel of g-7 countries abdul mansoor1  baserat sultana2 romana saeed3 ( corresponding author) 1,2,3department of economics, university of wah, pakistan abstract this study examined the relationship between savings and investment in the g-7 countries for the period of 1970 to 2015. the stationary analysis of the data has been done by adopting the panel levin, lin & chu, breitung, pesaran & shin, adf-fisher & pp-fisher criteria while the long run relationship has been tested by employing the pedroni residual test of co-integration. the results neglected the existence of a long run correlation between saving and investment in g-7 countries. further, joint causality between the savings and investment has also been tested using the fixed effect var model. wald test explains that the two consecutive lags i.e. s (-1) and s (-2) of savings is jointly causing savings in the current year in the g7 countries. while the same two lags of investment i.e. i (-1) and i (-2) does not jointly granger cause savings in the g7 economies. the results are in line with feldstein and horioka (1980) that there is a stable and significant association between the increasing rates of savings and investment in the short run while this relationship weaken in the long run. keywords: savings, investment, panel co-integration, panel var, g-7 countries. jel classification: e21; e22. citation | abdul mansoor; baserat sultana; romana saeed (2018). analyzing the savings-investment trend in a panel of g-7 countries. asian journal of economics and empirical research, 5(2): 147-154. history: received: 13 june 2018 revised: 30 july 2018 accepted: 18 august 2018 published: 27 september 2018 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 148 2. review of literature ...................................................................................................................................................................... 148 3. econometric methodology .......................................................................................................................................................... 149 4. result and discussions ................................................................................................................................................................. 150 5. conclusion 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journal of economics and empirical research, 2018, 5(2): 147-154 148 1. introduction all economists support the equality between savings and investment but their ideas differ from each other in a way of how the balance between savings and investment will occur. the discussion over this issue is spread over a long range of time starting from the classical theory of full employment. classicals are of the view that equality between savings and investment will bring about by the rate of interest. classicals documented a positive response of investment towards the interest rate and inversely proportional to the savings in the economy. keynesian are somehow think differently upon this issue. keynes theory support the equilibrium of savings and investment via income adjustments in the economy. secondly keynes also suggests that the interest rate not only effect the investment level but also the savings pattern of the people of the country. the most important point of the keynesian theory is that the full employment in the economy is rare to find rather there is urge of suitable policy implications that will bring about equilibrium in the economy. therefore, the saving-investment patterns must be investigated in order to brought them down to equality at the best. the takeoff point for the researcher on the association between savings and investment is based on feldstein and horioka (1980) who documented a direct relationship between the increasing rate of saving and investment as a measure of capital mobility . according to their study if capital is assumed to be perfectly mobile, then domestic savings would raise out the returns in the capital market and by the same way capital market would carter the domestic investment needs. can such results be replicated for other historic data and countries? to sort out this study intends to investigate the saving-investment relationship in a cross panel of 17 oecd countries. this theory generates a voluminous literature over the last couple of decades. this theory is tested by a series of researchers (see (schmidt, 2003; narayan, 2005; de vita and kyaw, 2009)) one of the important feature of the extant literature that savinginvestment nexus is investigated for developing countries and only few studies e.g. abbott and vita (2003) and baranov and kohler (2018) investigate this issue for developed countries. this study differs from the previous studies in two aspects. first this study examines the saving investment nexus in the panel of developed economies of the globe and this group encircles france, germany, italy, japan us, uk and canada. this chunk of country interestingly shows a relative balance pattern of saving and investment as per the statistics of world bank. the saving arte to gdp in the panel of g7 countries is 20.159% while that of investment to gdp ratio is 20.118% (world bank group, 2015). this balance growth rates of savings and investment compels us to reexamined the theory of feldstein and horioka (1980); feldstein (1982). secondly, this study is a comparative analysis of cross country sample of developed nations. as developed nations are very sensitive to any change in the policy variable by the central authority, tesar (1991). the early literature suggests the importance of savings and investment nexus in the stability of any economy; however, it is not obvious. several problems with approach highlights that the high level correlation between saving and investment is some time shows non consistency with the integrated financial markets. in order to view this idea we try to reinvestigate the co relationship between saving and investment in the relative stable economies of the globe e.g. the group of g-7 countries. saving economic growth and investment have a very close relationship. they analyze the open economy structure of new zealand and found that foreign and domestic saving enhances the way of growth and the desired investment. it was found that there is a close link between saving, investment and growth in a small economy of new zealand. the country managed to reach to foreign capital in efficient way and able to meet the needs of investment, claus and thomas (2001). feldstein-horioka technique of measuring financial condition of the economy through capital mobility is a puzzle as it has created many problems in the economy as suggested by tsoukis and alyousha (2001). they found that savings and investment has a positive relationship in australia and united kingdom but it is in opposite direction in germany. the concept savings identity or the investment savings identity is a conception in macro economics stating that the specific quantity which saved in any economic system will be the quantity invested in new physical, machinery and new inventories etc. the diagrams presented in appendix of this study shows the correlation between the said variables i.e. saving and investment for the g-7 economies like canada, germany, france, italy, japan, united kingdom and united states of america respectively. 2. review of literature relatively a few studies have been carried out to analyze the panel data of the countries to estimate the behavior of savings-investment relationship. some notable contribution in this regard. schmidt (2003) studied the short and long run relationship between saving and investment by using feldstein-horioka (fh) test for twelve countries over a long period of time using time series and cross sectional data since 1850. he found that the internal mobility of capital largely vary within different countries. the selected countries showed that during the period of war or time of great depression the internal mobility of capital was very low. pelgrin and schich (2014) analyzed the association between saving and investment to over view the level of investment at international level. they found that in the long run capital mobility passes through the lines of closed attachment although that is slow but not restricted. they also workout the short run estimates of these variables through panel error correction technique for 20 organization for economic co-operation & development (oecd) countries over the time period of 1960 to 1999. it was documented that short run variables when turns to long run variables follows a solvency constraint. lewis (1955) while explaining a hypothetical growth model found the linkages among the investment and saving with the help of accumulation of capital. in the light of harrod (1939) and domar (1946) model the growth rate of output in an economy has direct relationship with savings and investment. while the exogenous growth model of solow (1956) and swan (1956) which attempts to enlighten the long run economic growth with the help of accumulation of capital, productivity and technological progress has confirmed that saving has no significant impact on the growth of an economy in the long run. according to romer (1986); lucas (1988) and barro (1990) physical capital increase the economic growth in the long period. so, all theories regarding growth and development concludes that savings and investment can play a vital role in prop up and enhancing the economic growth in an economy. asian journal of economics and empirical research, 2018, 5(2): 147-154 149 esso and yaya (2010) analyzed the panel data for the saving investment nexus in seven developing economies i.e. benin, burkina faso, côte d‘ivoire, mali, niger, senegal and togo west african economic and monetary union (uemoa). they found that saving only active in three economies i.e. benin, côte d‘ivoire and burkina faso. two different approaches pesaran bounds co integration approach and toda-yamamoto granger causality test were used in their analysis. saving, investment and economic growth have a close relation with each other it was studied by jangili (2011) who analyzed the data for the period spread over 1950-2008 for india. he found the long-run association between saving and investment in india. further they documented that in india investment mainly comes through the channel of household saving. india is also lagging a bit in the field of innovation and technology so there is no significant role of technology in the economy of india. augmented dickey fuller (adf) test was used for the stationary of the data while co-integration johansen-juselius technique was used to check the long run correlation in the variables. for causality vector error correction model (vecm) and vector autoregressive distribution model (var) has been used. onafowara et al. (2011) found the correlation between saving and investment in eight advance european countries. they used autoregressive distributed lag model (ardl) for the co-integration. they used unrestricted error correction model (ecm) and vector autoregressive distributive model for the analysis of data. they found that in denmark, germany and luxemburg there is long run causality exist between saving and investment. in these economies investment granger causes saving and hence government expenditures should be minimized. while those economies where the saving granger cause investment; tax should be controlled and people should be given tax relief in order to attract them towards savings. adebola and dahalan (2012) analyzed the saving and investment relationship for tunisia using feldstein and horioka technique. they used longitudinal time series data for the time span between 1970 and 2009. zivotandrews unit root test was used for the stationary of the data. bound test was used for co integration among these variables while granger causality was also used for casualty. it was found that there is low level relationship exists between savings and investment in tunisia. bibi et al. (2012) concluded that investment is not determined by domestic saving in pakistan they used time series data for the period of 1970-2009 through adf and johnson co integration technique. investment was taken as a function of domestic saving while undertaking the johansen‘s maximum likelihood test. it was documented that savings and investment has no long-run relationship in pakistan economy. ogbokor and musilika (2014) studied about the relationship of saving and investment for namibia. they documented that there is no significant relationship exists between the potential savings and investment in namibia neither in the long nor in the short run. augmented dickey fuller unit root test was used for testing the stationary. johansen test of co-integration and granger causality test is employed for the joint causality of the variables. it is suggested that by increasing government expenditures and reduction in taxation cultures can put economy on right direction. ucan (2014) analyzed the role of investment in g7 countries taking panel data for the period of 1994-2010. in developing and developed countries the intend of increasing the volume of capital is to enhance international trade, motivate economic growth and capital inflows. for empirical analysis panel unit root tests, kao and pedroni residual test of co-integration has been employed. he found that saving was used in terms of recession in advance countries while in developing countries it was used for imports of the goods. 3. econometric methodology the present study is secondary in nature. in this study the behavior of savings and investment for the g7 countries has been investigated by considering a sample period of 1970-2014. panel data is taken from the world development index (wdi) data base listed in the data bank of world bank. augmented dickey fuller (adf) test has been applied in order to check the stationary, which summarized the results of levin et al. (2002); breitung (2005); im et al. (2003) and fisher chi-square, adf and pp-fisher chi-square employed by kao (1999) and kao and chiang (2000) the unit root can be written as follows; where are the cross units which observed over the time period the it symbolized the exogenous variable in the model, is the autoregressive coefficients and error term is assumed to be jointly autonomous distinctive error term. further if shows the existence of weak stationary but if |  | then sit is likely to have a unit root. for the purpose of testing of co-integration among the variables pedroni (1999;2000;2004) has been employed. pedroni consider the panel co integration as: for ; where γ and χ are supposed to be integrated of order one. while the parameters assumed  i and  it are individual and trend effects which may be assumed as zero if needed. pedroni consider the two alternative hypothesis, for homogeneous alternative (  ) for all i, which under pedroni terminology called within dimension and the heterogeneous alternative ( )for all i, which under pedroni terminology called between dimension. the results of pedroni test of co-integration recommends the study for testing of vector autoregressive model (var) developed by johansen (1988) performed using an estimated var object. the vector autoregressive model (var) is a stochastic phenomenon that is employed to highlight the significant linear relationships among various time series or panel repressors. all variables employed in the var modeling are based on their respective lag  itiititiit iss  1 asian journal of economics and empirical research, 2018, 5(2): 147-154 150 values, lag values of other explanatory variables along with the random error term of the model. this model does not need any sort of theoretical support about the force that is causing the changes to the variables. sims (1980) documented the var model as a robust model that is theory free method to estimate the economic relationships. var model adopted in this study is given as follows; where y t is the  vector of non-stationary (i) variables  t is the vector of deterministic variables and  t is the vector of innovations. this var model may be rewritten as:        tpt p i iitt yyy 1 1  t where ∏ = (i -  p i ia 1 )    p ij ji a 1 and ―i‖ is an identity matrix. if all the variables are integrated of order 1 i.e. non stationary of same order, than ∆yt are stationary. the estimated coefficients of equation (2) are consistent if the assumption that variables are cointegrated, are not violated, and then xt 1 is also stationary or integrated of order zero. 4. result and discussions in order to discuss the results let‘s have a bird‘s eye view of the overall glimpse of the saving-investment trends in the group of g-7 countries. figure-1. trend in saving and investment in canada developed by authors using data given in world development indicators (wdi) figure-2. trend in saving and investment in france (developed by authors using data given in world development indicators (wdi) figure-3. trend in saving and investment in germany (developed by authors using data given in world development indicators (wdi) asian journal of economics and empirical research, 2018, 5(2): 147-154 151 figure-4. trend in saving and investment in italy (developed by authors using data given in world development indicators (wdi) figure-5. trend in saving and investment in japan (developed by authors using data given in world development indicators (wdi) figure-6. trend in saving and investment in united kingdom (developed by authors using data given in world development indicators (wdi) figure-7. trend in saving and investment in usa source: (developed by authors using data given in world development indicators (wdi) the graphs show the trends savings and investments in the g-7 countries over the selected time period in this study. both of the variables are taken in us billion dollars. the diagrams show a gradual upward movement in saving and investment ratio for all the g-7 countries. figure 1, depicts the overall investment ratio tends to increase more than saving in canada. similar trend is shown in figure 2, regarding saving and investment ratio that increases over time in france. saving and investment increase in germany much more than any european country over the course of time as shown in figure 3. in italy saving and investment are comparatively low than other g-7 countries. this can be picture out from figure 4; japan among all the g-7 countries has a higher ratio of investment as compared to savings. according to figure 5, therefore, there is a slight disequilibrium in japanese economy as per theory of keynes. a stable and solid increase in saving and in investment has found in uk economy. figure 6, depicts the high trend of investment compared with savings in uk while in figure 7, saving and investment is very much high in united states as compared to other g-7 countries where investment ratios are asian journal of economics and empirical research, 2018, 5(2): 147-154 152 much more as compared to savings. if we give a bird‘s eye view to the overall picture, savings has declined as compared to investment in the economies of canada, france, italy, uk and usa. the problem of unit root is considered to be the most common issue of panel and time series data sets. as we employed the panel data in our study so it is essential to prior confirm the presence of stationary in the present sample of the data in the study. we have used various testing criteria to figure out the footprints of a unit root in the data. the results summary is documented in table 1. table-1. results of panel unit root test for investment methods at-level with intercept at-first difference with intercept t-stat prob.** t-stat prob.** levin, lin & chu 0.95146 0.8293 -14.9612 0.000 pesaran & shin 3.23985 0.9994 -12.9758 0.000 adf-fisher 3.13474 0.9988 157.956 0.000 pp-fisher 3.00477 0.9991 161.971 0.000 author‘s calculations using e.views-9 table-2. summary of the panel unit root test for savings methods at-level with intercept at-first difference with intercept t-stat prob.** t-stat prob.** levin, lin & chu 0.75299 0.7743 -12.3223 0.000 pesaran & shin 3.02128 0.9987 -13.2885 0.000 adf-fisher 2.95694 0.9991 162.263 0.000 pp-fisher 2.87474 0.9993 170.211 0.000 ‗**‘ shows significance at 5 % significance level table 1 and table 2 shows the results of panel unit root tests. the results are assessed at level and at 1st difference for both savings and investment. using panel unit root tests, intercept has been considered as a bench mark with automatic selection criterion of lags in order to test the presence of stationary issue in the data set. table 1 and table 2 confirm that the data regarding investment and savings for the g-7 countries is non stationary (presence of a unit root) at level while this issue is solved after taking its first difference. as the corresponding probability values of all the test statistic i.e. levin, lin & chu, pesaran & shin, adf-fisher and pp-fisher are more than 5% and hence the results shows that the data is non stationary at level therefore, in order to remove the unit root we take the corresponding first and second differences of the variable. while the probability values regarding all tests are significant at first difference. this means that the data is stationary at its first difference. table 3 of the study shows the results of pedroni residual of panel co-integration test considering no deterministic trend as a bench mark. table 3 possess the corresponding statistic value and corresponding probabilities. furthermore, we employed various test methods such as panel v-statistic, panel rho statistic, panel pp-statistic, panel adf statistic, group rho statistic, group pp statistic and group adf statistic and having eleven statistic values with the corresponding probability values. all these seven methodologies possess eleven outcomes. out of eleven outcomes only five corresponding probability values are significant which less than 5% level of significance is while six are not significant, and hence, their corresponding probabilities are more than 5% level of significance. in this scenario majority must be guaranteed hence there is no considerable co-integration among the explanatory variables. on the basis of this we cannot reject the null hypothesis; rather we accept the null hypothesis that there is no co integration among the variables included in this study. table-3. pedroni residual co-integration test with no deterministic trend methods statistic p-value weighted statistic p-value within dimension panel v statistic 8.067432 0.0000 3.332678 0.0004 panel φ (rho) statistic -8.409846 0.0000 -1.213517 0.1125 panel pp statistic -6.315322 0.0000 -0.626820 0.2654 panel adf statistic -6.378627 0.0000 -0.867836 0.1927 author‘s calculations using e.views-9 as the decision of pedroni residual panel test of co-integration negated the presence of cointegration among the variables so research forwarded for the testing of panel vector auto regressive (var) model. panel var model could be the panel random effect model and panel fixed effect model and then the results of haussmann test statistic could suggest the significance of the model. table-4. result of panel var fixed effect model variable coefficient std. error t-statistic prob. c (c1) 27.66372 7.800737 3.546296 0.0005 savings (-1) (c2) 1.037031 0.066330 15.63436 0.0000 savings (-2) (c3) -0.078763 0.075481 -1.043481 0.2976 investment (-1) (c4) -0.014355 0.064911 -0.221150 0.8251 investment (-2) (c5) 0.037763 0.058953 0.640570 0.5223 author‘s calculations using e.views-9 table 4 shows the results of panel var fixed effect model. from the result, the joint causality is checked among the variables along with their lags i.e. savings (-1), savings (-2), investment (-1) and investment (-2) as shown in table 4. the coefficients of the variables are denoted by (c1), (c2), (c3), (c4) and c (5) respectively. in asian journal of economics and empirical research, 2018, 5(2): 147-154 153 other words we are going to check either the first and second lags of saving and investment can cause the dependent variable or not? to answer this question wald test criterion is applied and the results are shown in table 5. table-5. result of wald test of joint causality c (2) = c (3) =0 test statistic value prob. f-statistic 236.9681 0.0000 chi square 473.9362 0.0000 author‘s calculations using e.views-9 table-6. summary results of wald test of joint causality c (4) =c (5) =0 test statistic value prob. f-statistic 0.275679 0.7579 chi square 0.551357 0.7991 author‘s calculations using e.views-9 the outcome of the wald test shown by table 5 explains that the joint causality is running from savings (-1) and savings (-2) towards saving in the current year. less than 5% corresponding probability value of f-statistic rejects the null hypothesis which means that c (2) =c (3) are not equal to zero. it means that savings (-1) and savings (-2) jointly can cause savings in the current year in the g7 countries. table 6 documents the results about the joint causality running from investment (-1) and investment (-2) towards the investment in the current period. it means that the trend of saving and investment in the g7 economies has a strong association with the previous year trends of savings and investment. more than 5% corresponding probability value of f-statistic can‘t reject the null hypothesis. which means that investment (-1) and investment (-2) does not jointly granger cause savings in the g7 nations. 5. conclusion this paper endeavors to employ the panel data co-integration tests in order to test the long run association among the savings and investment in the g-7 countries from the period over 1970 to 2015. panel unit root test confirms that savings and investment of g-7 countries are non-stationary at level and stationary at its first difference. the empirical results of pedroni residual test of co-integration suggest that that there is no cointegration among the savings and investment in the g-7 countries. as the decision of pedroni residual panel test of co-integration negated the presence of co-integration among the savings and investment in the g-7 countries so the study further employed the testing of panel var model. furthermore the joint causality among the savings and investment has also been tested using fixed effect var model. wald test statistic explains that the lags of savings jointly can granger cause savings of current period in the g7 countries. while the lags of investment do not jointly granger causes savings in the g7 nations. the results of the study lead to the results that saving and investment have no long run relationship with each other in the said economies. these results are in-line with the results documented by ramakrishna and rao (2012), who documented that there is no long run relationship among the savings and investment in ethiopia and other industrial countries. the fundamental reason for the absence of long run equilibrium relationship among the savings and investment in the economies of g-7 countries is that savings has declined overtime. it is the need of the time that plans of investment should be modified in such a way that it could encourage employment and it may help out to dropping down the inflationary figures in the economy. the pattern of savings should be encouraged after introducing some sort of incentives such as relief in the income tax and higher bank deposit rates should be realize. the plans of investment should be modified in such a way that it may encourage employment and it may help out to drop down the inflationary rate in these countries. the pattern of savings should be modified in such a way that the people are encouraged towards savings and also utilize these funds in the form of investment by adopting the keynesian theory of savings and investment, in which the 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authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 6, no. 1, 85-92, 2019 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2019.61.85.92 © 2019 by the authors; licensee asian online journal publishing group determinants of liquidity and its relationship with profitability – the case of macedonian banking sector gockov gjorgji1 hristovski goran2 ( corresponding author) 1associate professor, university “ss. cyril and methodius”, faculty of economic – skopje, republic of north macedonia, 1000 skopje, republic of macedonia. 2graduated employee, university “ss. cyril and methodius”, faculty of economic – skopje, republic of north macedonia, 1000 skopje, republic of macedonia. abstract this paper deals with the liquidity and profitability of the macedonian banking sector and attempts to identify the determinants of liquidity mainly focusing on the relationship between profitability and liquidity. first, we analyzed the level of liquidity and profitability and we found that the macedonian banking system is characterized by high liquidity and relatively high profitability compared with the banking systems of the countries in the region and the more developed economies. furthermore, the paper examines the determinants of liquidity. the empirical analysis is carried out through the use of the dynamic panel analysis based on the generalized method of moments (gmm) methodology on a dataset of overall banking sector operating in macedonia in the period from 2007 to 2017. the study uses seven factors as potential determinants of banks liquidity, five of them are internal banks variables (lagged value of liquidity, bank profitability, size of the bank, capital adequacy and non-performing loans) while two of them are macroeconomic variables (gdp growth rate and central bank reference interest rate). the study showed that profitability is one of the most important factors influencing liquidity in the macedonian banks. the other determinants with important positive effects on liquidity are lagged value of liquidity, non-performing loans and central bank interest rate but, to a somewhat lower extent. on the other hand, only the size of the bank is significantly inversely associated with bank liquidity. the capital adequacy and gdp growth rate are not statistically significant factors of macedonian banks liquidity. keywords: liquidity, profitability, determinants, macedonian commercial banks, panel data analysis, gmm model. jel classification: g21; c33; e52. citation | gockov gjorgji; hristovski goran (2019). determinants of liquidity and its relationship with profitability – the case of macedonian banking sector. asian journal of economics and empirical research, 6(1): 85-92. history: received: 11 april 2019 revised: 20 may 2019 accepted: 25 june 2019 published: 15 august 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 86 2. review of the empirical literature .............................................................................................................................................. 86 3. liquidity and profitability in the macedonian banking sector – some stylized facts .................................................... 87 4. data and methodology ................................................................................................................................................................... 88 5. research results .............................................................................................................................................................................. 90 6. conclusions ....................................................................................................................................................................................... 91 references .............................................................................................................................................................................................. 91 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.61.85.92&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://www.asianonlinejournals.com/index.php/ajeer/article/view/921 https://orcid.org/0000-0002-1780-6129 https://orcid.org/0000-0001-7890-7460 http://www.asianonlinejournals.com/index.php/ajeer/article/view/921 https://orcid.org/0000-0002-1780-6129 https://orcid.org/0000-0001-7890-7460 http://www.asianonlinejournals.com/index.php/ajeer/article/view/921 https://orcid.org/0000-0002-1780-6129 https://orcid.org/0000-0001-7890-7460 http://www.asianonlinejournals.com/index.php/ajeer/article/view/921 https://orcid.org/0000-0002-1780-6129 https://orcid.org/0000-0001-7890-7460 asian journal of economics and empirical research, 2019, 6(1): 85-92 86 © 2019 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the existing literature by identifying the determinants of liquidity and focusing on the relationship between profitability and liquidity. 1. introduction liquidity and profitability are two important principles in modern banking nowadays. banks work with other funds deposits of the public (primarily of natural persons) and they have an obligation to repay those funds in accordance with the agreed terms and conditions. it is understandable that banks do not keep these funds however they invest them throughout giving loans, buying securities, fixed assets, depositing in other banks, etc. liquidity is the ability of a bank to fund increases in assets and meet obligations as they come due, without incurring unacceptable losses (basel committee, 2008). the most liquid assets available to the banks are the cash they have and the funds they have on their accounts at the central bank. these assets are called super-liquid assets or primary reserve. all other assets that banks have at their disposal are with a lower degree of liquidity, depending on the time and costs needed for their conversion. the principle of profitability requires the bank to allocate the funds in financial instruments with a higher rate of return. the bank's profitability analysis is mainly performed by return on assets (roa) and return on equity (roe) indicators. regardless of the accepted strategy for liquidity-profitability, each bank attempts to achieve satisfying yield rate, bearing in mind to not jeopardize its liquidity. profitability and liquidity as performance indicators are very important to the major stakeholders: shareholders, creditors, and tax authorities. the shareholders are interested in the profitability of banks because it determines their returns on investment. depositors are concerned with the liquidity position of their banks because it determines the ability to respond to their withdrawal needs, which are normally on-demand or on short notice as the case may be. the tax authorities are interested in the profitability of the banks in order to determine the appropriate tax obligation (olagunju et al., 2011). the contradictory nature of liquidity and profitability can be explained by intuitive reasoning. in that sense, a bank operating with high liquidity, in the process tying down investable funds, may have a low insolvency risk, but followed by low profitability. conversely, a bank operating at a low liquidity level, thus freeing investible funds, may encounter with high insolvency risk, but the potential for higher profitability. the aim of this paper is to analyze the level of liquidity and level of profitability of macedonian banks by comparative quantitative analysis with several selected countries in the region and germany, which should serve as a benchmark for drawing conclusions about the level of liquidity and profitability in our banking system. besides comparative analysis, additionally, the paper tries to test various determinants of variable liquidity in the macedonian banking sector including profitability as one of the independent variables. various determinant variables can be grouped into two groups: internal and external factors. internal factors consist of the lagged value of liquidity, profitability, capital adequacy, the share of non-performing loans, and bank size. external factors consist of, gross domestic product (gdp) growth and interest rate of central bank bills (cbb). throughout testing various determinants of variable liquidity in macedonia, the results of this study are expected to provide information about the impact of the available variety of variables toward the bank liquidity. another benefit of this research is to add empirical evidence on the determinants of bank liquidity in the macedonian banking sector, especially how profitability is correlated with and influencing the liquidity. also, the empirical evidence can be used as a source of knowledge, bearing in mind the lack of studies that provide empirical evidence related to the bank liquidity – profitability correlation and determinants of banks liquidity in the macedonian banking sector. the rest of the paper is organized as follows: section 2 provides an overview of the empirical literature, section 3 describes some stylized facts about liquidity and profitability in the macedonian banking sector, section 4 describes data and methodological issues, while section 5 discusses the empirical findings. the final section concludes. 2. review of the empirical literature this section provides a brief review of empirical literature that explores the determinants of banking sector liquidity, the used statistical methods, and in particular the relationship between liquidity and profitability. vodova (2011) investigated the determinants of check bank’s liquidity using panel data regression. she found that capital adequacy, non-performing loans and lending interest rates (including interbank transaction) had a positive effect on bank liquidity, while inflation rate, business cycle and financial crisis had a negative influence on liquidity. the same author using panel data regression for the banks in poland (vodova, 2012) and hungary (vodová, 2013) found similar results but taking into consideration specific characteristics of individual markets. also, horváth et al. (2014) studied a sample of czech banks between 2000 and 2010, using a dynamic general method of moments (gmm). they observed a negative relationship between the creation of liquidity and bank capital, showing that higher capital requirement according basel iii reforms reduces liquidity creation, but the creation of high liquidity can reduce bank solvency. contrary to these conclusions, berger and bouwman (2009) analyzing us bank’s data for the period 1993-2003 found a positive relationship between liquidity and bank capital, using regressions run with both time fixed effects and bank fixed effects. regarding the determinants of the bank’s liquidity in romania, munteanu (2012) performed a study analyzing panel data of 27 banks in romania, during the period from 2002 to 2010, through a multiple regression model. analyzing the crises period separately (2008-2010) the author found that z-score, as an indicator for bank stability, has a significant influence on bank liquidity in the crisis years. moreover, results indicated that liquidity is negatively affected by capital adequacy, asset quality, and interbank funding, whereas, it is positively related to cost to income ratio, funding cost, credit risk rate and inflation. additionally, roman and sargu (2015) analyzed the impact of bank-specific factors on commercial banks liquidity in central eastern european (cee) countries. they analyzed data from financial statements of the banks in seven cee countries for the period 2004-2011 using ordinary least square (ols) regression. the results highlighted the negative impact that the depreciation of the loans portfolio had on the overall liquidity of the analyzed banks. another empirical research for cee commercial bank’s liquidity was conducted by trenca et al. (2012). they analyzed 30 banks from cee countries for the period asian journal of economics and empirical research, 2019, 6(1): 85-92 87 © 2019 by the authors; licensee asian online journal publishing group 2001-2011 using general method of moments (gmm). using four liquidity ratios and analyzing three bankspecific factors and ten macroeconomic factors they found that bank’s liquidity is significantly affected by the following factors: capital, total assets, lending interest rate, interest rate spread, credit flow to the private sector, private debt, and current account balance. regarding the relationship between liquidity and profitability, molyneux and thornton (1992) examined the determinants of bank’s performance in a pooled sample of eighteen european countries in the period 1986-1989 using simple linear regression. their results showed that the ratio of liquid assets to total assets is negatively related to return on assets (roa). the same negative relationship was also supported by guru et al. (1999) who considered a linear model to analyze the determinants of commercial bank’s profitability in malaysia. they stressed out that liquid assets are often associated with lower returns and thus high levels of liquid assets would be expected to be associated with lower profitability. in addition, barth et al. (2003) examined the impact of the structure, the scope and the independence of bank supervision on the bank profitability. they employed a sample of 2300 banks from 55 countries, using regression analysis and found that liquidity ratio has a negative and highly significant relationship with the profitability (roa). on the other hand, bourke (1989) analyzing the internal and external determinants of bank profitability in europe, north america and australia using generalized least squares (gls), found a significant positive relationship between liquidity ratio and banks’ profitability. furthermore, the same positive significant coefficient between profitability and liquidity was found by lartey et al. (2013) analyzing the banks listed on the ghana stock exchange for the period 20052010, using linear model. also, singh and sharma (2016) analyzing data of 59 indian banks for period from 2000 to 2013 and using fixed effect and random effect showed that profitability measured by roa, as well as capital adequacy, deposits and inflation have a statistically significant positive impact on bank’s liquidity. interesting conclusions about this relationship are given by the former governor of the fed, who points out that profitability is better in banks that hold liquid assets, but there is a point in which further increase in liquid assets reduces the bank’s profitability, bernanke (2008). 3. liquidity and profitability in the macedonian banking sector – some stylized facts in recent years the macedonian banking system is characterized by high liquidity and relatively satisfying profitability. structural surplus of liquidity, which is present in the macedonian banking system for more than 15 years, determines the design of the central bank’s monetary policy. hence, the main instrument of national bank of the republic of north macedonia is central bank bills auction, an instrument used to withdrawn instead to create liquidity in the banking system. this is totally opposite from the practice of the largest number of central banks, especially the practice of the central banks of developed countries, where usually the main instruments are those that create liquidity in the banking system, which provides greater efficiency in the transmission mechanism of the monetary policy. high liquidity in the macedonian banking sector is confirmed with a comparative quantitative analysis of the ratio of liquidity. figure 1 shows the share of the super-liquid assets in the total assets of the banking systems of selected countries for the period from 2003 to 2016. the highest value of this indicator is in macedonia, with an average value of around 14%, which is higher than croatia (with an average value of 13%) and significantly higher compared to slovenia (average value of 4%) and germany with an average value of 1.5%. in general, this indicator has lower values in the banking systems of developed countries, due to more rational and more efficient liquidity management. dynamically analyzed, the macedonian banking system especially after the global financial crisis accomplished high values of this liquidity indicator. unlike croatia and slovenia, which faced liquidity reduction during the financial crisis, the banking sector in macedonia maintained its high liquidity value and did not face any consequences. in recent years, almost all developed economies have tendency of increasing the liquidity in the banking systems under the pressure of the tightened liquidity requirements in accordance with the international basel standards for supervision. figure-1. liquidity in the banking systems of selected countries (in %). source: nbrm, world bank, imf, central banks of the analyzed countries. apart from high liquidity, the macedonian banking sector is characterized by relatively satisfying profitability. figure 2 presents data on profitability in the banking systems of several selected countries, measured through the return of average assets (roaa) for the period from 2003 to 2016. data shows that macedonia has the highest profitability in the analyzed period, with an average roaa of 1.4%, followed by croatia, with an average of 1.1%. asian journal of economics and empirical research, 2019, 6(1): 85-92 88 © 2019 by the authors; licensee asian online journal publishing group figure-2. profitability in the banking systems of selected countries (roaa, in %) source: nbrm, world bank, imf, central banks of the analyzed countries in addition to the relatively high values, the roaa in the macedonian banking system is characterized by relatively stable values (the standard deviation in the analyzed period is 0.5). also it is evident that the macedonian banking system was least affected by the global financial crisis, with a relatively small and short decrease in the roaa. unlike the macedonian banking system, the banking systems of other countries were much more affected by the crisis, recording more significant reductions in their profitability, even losses in some years. hence, the profitability rate is permanently higher in less developed countries (macedonia, croatia) compared to the banking systems of more developed economies (germany). the state of high liquidity and at the same time satisfying profitability is contrary to numerous theoretical and empirical researches that indicate the conflicting and negative relationship between these two important principles of banking operations. as it shows in this section in the case of the macedonian banking system, high liquidity does not limit its profitability. this is especially noticeable in the period before the crisis (2003-2007), when the increase in liquidity did not cause a decrease in profitability, but also after the crisis when high liquidity was followed by increasing profitability. one of the explanatory factors for this situation is the relatively high net interest margin, due to the higher difference between active and passive interest rates (interest margin). as it shows in figure 3, contrary from the macedonian banking system, in croatia and slovenia, especially in germany, the profitability of the banking sector is a result of the high volume of interest-bearing assets (loans, securities), while the difference between active and passive interest rates are significantly lower. this comes from the greater operating efficiency, but also from competitiveness within the banking systems in those countries. in other words, high-interest rates, when global interest rates are at historically lowest levels, indicates weaker efficiency and competitiveness in the macedonian banking system, as well as the non-elasticity of credit demand. figure-3. net interest margin and interest rate margin (in %). source: nbrm, world bank, central banks of the analyzed countries. in the last few years, there has been a tendency of reorientation of macedonian banks towards more substantial lending to households. therefore, net interest income from households as registered a significant increase and is promoted as the main source of profitability of macedonian banks. this is due to significantly reduced expenditures to households (due to reduced passive interest rates), with simultaneously increased interest income (due to increasing lending and proportionally lower decline in the active interest rates). 4. data and methodology in this section, an empirical study is based on panel data set covering 14 banks (out of 15) operating in republic of north macedonia over the period from 2007 to 2017. the data sources are balance sheets and income statements from annual reports, audit reports and financial statements of macedonian banks published on their official websites and the central bank database. determinants of a bank's liquidity are grouped into two groups: internal factors and external factors. bank specific variables are used as internal determinants of liquidity and macroeconomic variables are used as external determinants of liquidity. in that sense, five internal variables, asian journal of economics and empirical research, 2019, 6(1): 85-92 89 © 2019 by the authors; licensee asian online journal publishing group including the lagged value of liquidity and two external variables are used as independent variables. each measurement of internal and external variables as well as the expected effect on liquidity is given in table 1. table-1. description of variables. variables notation measurement expected impact dependent variable: la liquid assets/total assets / liquidity independent variables: la-1 liquid assets/total assets(-1) positive lagged value of liquidity profitability roa net income/total assets positive/negative equity cap equity/total assets positive/negative log total assets_ proxy for size of bank log ta natural logarithm of total assets positive/negative non-performing loans npl non-performing loans/total assets positive growth of gross domestic product gdp_gr annual growth rate of gdp (%) positive/negative central bank bills interest rate cbb_ir central bank bills interest rate (%) positive source: author’s compilation. the studies that assess the determinants of the liquidity of banks are presented by a large array of methodologies. economic relationships which are included in this paper are dynamic in their nature, and their current behavior depends on their past behavior. therefore, a dynamic panel model was required. the dynamic nature of the model disenables using standard ordinary least squares (ols) estimators, which might be biased and inconsistent due to the correlation between the unobserved panel-level effects and the lagged dependent variable (hasanovic and latic, 2017). thus, the use of panel data with fixed or random effects does not solve econometric problems inherent in dynamic models. in order to overcome a problem of endogenеity that makes biased results and unobserved heterogeneity between banks that cannot be accurately measured, arellano and bond (1991) proposed a new generalized method of moments (gmm) estimator for dynamic panel model (difference gmm). their proposal was to include additional instruments in the dynamic panel model and to use the different transformation. later, arellano and bover (1995) and blundell and bond (1998) proposed an improvement of the arellano and bond estimator by imposing additional restrictions to the initial conditions, which allow the introduction of more instruments in order to improve efficiency. it combines the first difference in equations with equation at the level in which the variables are instrumented by their first differences. it builds a system of two equations (system gmm), the original and transformed one. according to roodman (2006) difference and system gmm estimators can be seen as a part of a broader historical trend in econometric practice toward estimators that make fewer assumptions about underlying data – generating process and use more complex techniques to isolate useful information. they are designed for panel analysis, and embody the following assumption about the data–generating process: 1) “small t, large n” panels, meaning few time periods and many individuals; 2) a linear functional relationship; 3) a single left-hand-side variable that is dynamic, depending on its own past realizations; 4) independent variables that are not strictly exogenous, meaning correlated with past and possibly current realizations of the error; 5) fixed individual effects and 6) heteroskedasticity and autocorrelation within individuals, but not across them. according to bond (2002) the unit root property makes the difference gmm estimator biased, while system gmm produces more precise results. this study uses system gmm. the general model to be estimated is of the following linear form: is a dependent variable which is bank liquidity of bank 𝑖 at time 𝑡, with 𝑖 = 1, … , 𝑁,𝑡 = 1, … , 𝑇., is a constant, δi denotes fixed effects in bank 𝑖 , is lagged value of the dependent variable, is a vector of internal explanatory variables for bank 𝑖 in the time 𝑡, is a vector of external explanatory variables for bank 𝑖 in the time 𝑡, are coefficient which represents the slope of variables, is the error term which follows n (0,1), where is the unobserved bank-specific time-invariant effect, while is a disturbance term which is independent across banks. to test the multicollinearity we estimate the relationships between the independent variables used in the model. correlations between the potential determinants of banks liquidity are shown in table 2. all coefficients are inferior to 80%, so there is no problem of multicollinearity (kennedy, 1985). table-2. test of multicollinearity. roa cap log_ta npl gdp_gr cbb_ir roa 1.0000 cap -0.4500 1.0000 log_ta 0.6127 -0.5968 1.0000 npl -0.5323 0.5723 -0.4685 1.0000 gdp_gr 0.1459 0.1340 -0.0913 -0.0599 1.0000 cbb_ir -0.1714 0.3020 -0.1966 0.0896 -0.0408 1.0000 another useful test for detecting multicollinearity is variance inflation factors (vif). if a vif is greater than 10, there is a high multicollinearity and the variation will seem larger and the factor will appear to be more influential than it is. if vif is closer to 1, then the model is much stronger, as the factors are not impacted by asian journal of economics and empirical research, 2019, 6(1): 85-92 90 © 2019 by the authors; licensee asian online journal publishing group correlation with other factors. table 3 shows that vif for independent variables are very low which indicates that the model is not facing multicollenearity problem. table-3. variance inflation factors (vif). variable vif 1/vif cap 2.08 0.480959 log_ta 2.07 0.483898 roa 1.94 0.516299 npl 1.78 0.561386 cbb_ir 1.13 0.883675 gdp_gr 1.12 0.892791 5. research results the results of testing the effect of various determinants of liquidity with the system gmm are shown in table 4. based on the results of the test it can be seen that the system gmm with lag (3, 3) gives good results. hansen test shows that the model has been feasible, p ( = 0,427, so we cannot reject null hypothesis that all the restrictions of over-identification are valid. also, arellano-bond test for autocorrelation in first differences is greater than 5% (ar (2) = 0.092), which indicates that the errors term are not serially correlated. table-4. panel-data estimation, results. explanatory variables system gmm, lag(3,3) cons 0.14213404** (0.000) la-1 0.55420281*** (0.100) roa 0.38348227* (0.700) cap 0.0175876 (0.040) log_ta -0.00652671** (0.079) npl 0.25927951* (0.183) gdp_gr 0.00227096 (0.021) cbb_ir 0.00334537** (0.020) number of observation 140 number of instruments 21 arellano-bond test for ar(1) in first differences: z = -2.49 pr > z = 0.013 arellano-bond test for ar(2) in first differences: z = -1.68 pr > z = 0.092 hansen test of overid. restrictions. chi2(13) = 13.27 prob > chi2 = 0.427 ***statistically significant at 1% level. **statistically significant at 5% level. *statistically significant at 10% level. based on the analysis results, explanatory power of the model is very high. the results of the analysis show that only capital adequacy (cap) and gdp growth rate (gdp_gr) are not statistically significant at level of 1%, 5% and 10%. it means that macedonian banking sector display small sensitivity to economic circle, indicating that macedonian banks are not affected by the risk of insolvency which arose from economic downturns. this could be due to the relatively high regulations as well as the conservative nature of macedonian banks behavior. the positive sign of cap is consistent with the assumption that a bank with sufficient capital adequacy should be liquid as well. the positive sign of gdp_gr might signal that companies and households with higher profits and income during expansionary phases prefer to rely more on internal sources of finance and intend to reduce their debt level and vice versa. the significant coefficient of lagged dependent variable proves the dynamic model. the lag of liquidity has a positive impact on the current level of liquidity. it is consistent with our expectations as we assumed that banks tend to maintain higher levels of liquidity from the past into forthcoming period. the relation between profitability and liquidity in this model is statistically positively significant at 10% level. significant positive effect of profitability on liquidity shows that profitability is one of sources of liquidity creation. the greater the profitability of a bank is, the greater the ability of bank to meet the liquidity needs is. this is partly due to the structural surplus of banks liquidity that determines the central bank to pay interest for banks funds placement in central bank bills. additionally, the monetary strategy of macedonian central bank is based on pegged exchange rate, so the interest rates of cb bills are unconventionally high and the positive relationship between these two indicators is becoming inevitable. another explanatory variable which has statistically significant influence on the liquidity is the size of bank, measured by logarithm of total bank assets. this relation is statistically significant at 5% level of significance. the impact of the size of the bank on its liquidity is negatively, so liquidity is decreasing with the sizing of the bank. in macedonian banking system, with excess liquidity, this relation occurs because of more effective liquidity management among big banks and high concentration in banking system especially a large portion of deposits are located in a few big banks balance sheets. however, this relation is too ambitious and it could be useful for further studies to estimate determinants of liquidity separately for small, medium-sized and large banks. asian journal of economics and empirical research, 2019, 6(1): 85-92 91 © 2019 by the authors; licensee asian online journal publishing group share of non-performing loans to total loans in this study was used as asset quality. the greater the ratio is means the worse quality of the assets owned by a bank is and conversely, the lower the ratio is, the better quality of a bank’s assets is. influence of asset quality on liquidity in this study shows a positive significant relationship at 10% level of significance. it means that a bank with higher npls is more cautious about investing and it rather keeps more funds in the account as the excess liquidity. the results also showed a positive statistically significant impact of the interest rate of central bank bills (cbb) on bank liquidity, at 5% level of significance. so, when central bank decides to raise interest rates on cbb, the market responds that condition by shifting some of its assets into central bank account (cb bills) and the ratio of liquidity assets to total assets becomes more significant. it is also a signal to commercial banks to increase their interest rates, active and passive ones and normally demand for bank loans is decreasing, while deposit accounts become more attractive because of the interest gained. hence, in the macedonian banking sector the higher the interest rate of central bank bills is, the greater the share of liquidity asset to total assets is. 6. conclusions the main objective of the study was to identify the bank-specific and macro-economic factors that can affect macedonian banks liquidity mainly focusing on the relationship between profitability and liquidity. according to the review on empirical literature and liquidity and its determinants area theories, the current study chosen and investigated the impact of five bank-specific and two macro-economic factors on the liquidity of the macedonian commercial banks over the period of 2007 to 2017. the bank-specific factors that were used in this study include variables such as profitability, non-performing loans, capital adequacy, bank size, and lagged value of liquidity. on the other hand, the two macroeconomic conditions indicator variables employed in this study were real gdp growth and central bank reference interest rate. one of the main features of the macedonian banking system is the existence of structural excess of liquidity. surplus liquidity, simply put, means that commercial banks persistently hold excess reserves. in other words, banks continuously have more deposits than the credits they provide and therefore keep large liquid instruments on the assets side. structural surplus of liquidity, which is present in macedonian banking system for more than 15 years, determines the design of the central bank’s monetary policy because commercial banks do not need to borrow from the central bank. hence, the main instrument of national bank of the republic of north macedonia is central bank bills auction, an instrument used to withdrawn instead to create liquidity in the banking system. apart from high liquidity confirmed through quantitative comparative analysis, the macedonian banking sector is characterized by relatively high profitability. the comparative analysis shows that the macedonian banking sector has the highest profitability, calculated through the return of average assets (roaa). this means that in the case of macedonian banking system, high liquidity does not limit its profitability. one of the explanatory factors for this situation is the relatively high net interest margin, due to the higher difference between active and passive interest rates indicating weaker efficiency and competitiveness as well as non-elasticity of credit demand in the macedonian banking system. furthermore, this paper examined the determinants of liquidity of the macedonian banking sector using the dynamic panel analysis based on the generalized method of moments (gmm) methodology. the results showed that bank liquidity increases with higher lagged of liquidity, higher bank profitability, higher monetary policy interest rates and a higher share of non-performing loans. it is very important to mention that our model shows that profitability is one of the significant sources of bank’s liquidity creation pointing out that banks not only are comfortable in the commodity of high amount of cash and funds placed at account in national bank of the republic of north macedonia, simultaneously they аre achieving a relatively high net profits. on the other hand, only the size of the bank is significantly inversely associated with bank liquidity confirming that bigger banks use more effective liquidity management compared to smaller banks. we also found that capital adequacy and gdp growth rate have no statistically significant effect on the liquidity of macedonian commercial banks meaning that macedonian banking sector displays small sensitivity to economic circle. this confirms the relatively high regulations as well as the conservative nature of macedonian banks behavior. references arellano, m. and s. bond, 1991. some tests of specification for panel data: monte carlo evidence and an application to employment equations. the review of economic studies, 58(2): 277-297.available at: ttps://doi.org/10.2307/2297968. arellano, m. and o. bover, 1995. another look at the instrumental variable estimation of error-components models. journal of econometrics, 68(1): 29-51.available at: https://doi.org/10.1016/0304-4076(94)01642-d. barth, j.r., d.e. nolle, t. phumiwasana and g. yago, 2003. a cross-country analysis of the bank supervisory framework and bank performance. financial markets, institutions & instruments, 12(2): 67-120.available at: https://doi.org/10.1111/1468-0416.t01-200001. basel committee, 2008. principles for sound liquidity risk management and supervision. basel: bis. berger, a.n. and c.h. 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author of the article. 36 © 2019 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 6, no. 1, 36-44, 2019 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2019.61.36.44 © 2018 by the authors; licensee asian online journal publishing group analysis of domestic versus foreign banks efficiency in pakistan muhammad afzal1 shelah ejaz2 shoaib ahmad3 ( corresponding author) 1,2department of economics, preston university, islamabad-pakistan 3department of management sciences, preston university, islamabad-pakistan abstract banking sector reforms were introduced in 1972 in the light of many contemporary issues observed in the banking industry. the nationalization of banks in 1974 improved the financialӏ sector in many ways. the efficiency of the sector was compromised due to politicalӏ influence; over-branching and overstaffing that affected the banking industry. in 1990s many reforms were made in the banking sector to address the problems that existed in the nationalized banking system. the public sector’s ownership of commercial banks had created lot of problems (political intervention in credit allocation, loan recovery and deterioration in services quality). this study evaluated the efficiency of domestic and foreign banks for the period 2010-2016. dea was used to explore the scale, technical, pure technical and scale efficiency of the domestic and foreign banks. the ӏeast efficient banks are bank alfalah, nationaӏ bank, askari bank and standard chartered in terms of scale efficiency. technicalӏ efficiency scores demonstrate that aӏӏied bank, askari bank, nationalӏ bank, standard chartered bank and bank alfalah did not perform efficiently whereas other banks of the sample did well. pure technicalӏ efficiency scores under both orientations reveal that in 2010 and 2015, aӏӏ banks showed a perfect pure technicalӏ efficiency score of 1.00. both domestic and foreign banks performance is mixed. domestic banks are not less efficient in terms of all efficiencies than foreign banks. both banks need attention to managerialӏ aspects and efficient utilization of technology in their operations. sound macroeconomic policies may also help in improving the efficiency of banks. keywords: dea, efficiency, technical, pure technical, scale efficiency, domestic banks, foreign banks, pakistan. jel classification: c60, c61. citation | muhammad afzal; shelah ejaz; shoaib ahmad (2019). analysis of domestic versus foreign banks efficiency in pakistan. asian journal of economics and empirical research, 6(1): 36-44. history: received: 29 october 2018 revised: 21 november 2018 accepted: 3 january 2019 published: 25 january 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 37 2. history of pakistan banking sector ............................................................................................................................................. 37 3. significance of the study ................................................................................................................................................................ 38 4. literature review ............................................................................................................................................................................ 38 5. foreign bank entry in domestic markets .................................................................................................................................. 39 6. methodology ..................................................................................................................................................................................... 39 7. measurement of efficiency ............................................................................................................................................................ 40 8. dea modeӏ ........................................................................................................................................................................................ 40 9. data .................................................................................................................................................................................................... 40 10. efficiency evaluation with output orientation ...................................................................................................................... 41 11. efficiency scores with input orientation ................................................................................................................................. 42 12. conclusions ..................................................................................................................................................................................... 42 references .............................................................................................................................................................................................. 43 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.61.36.44&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/264 http://asianonlinejournals.com/index.php/ajeer/article/view/264 asian journal of economics and empirical research, 2019, 6(1): 36-44 37 © 2019 by the authors; licensee asian online journal publishing group 1. introduction banking sector of any economy lies at the heart of the financial development. many studies in the literature on the intermediation role of banks reveal the pivotal role that banks play in the development of an economy. almost all countries of the world including pakistan have a modest banking sector. studies show that growth of banks contributes to financialӏ development. to enhance the efficiency of the banking sector several countries initiated reforms in 1980s. pakistan did the same in 1990s. many developments were made in the banking sector of pakistan that included privatization of large banks, increase in private domestic banks, enhancement of automation and technologicalӏ services of banks, banks services in rural areas etc. efficiency refers to the optimum utilization of inputs and production of maximum possible output. there are different types of efficiencies (technical, cost, allocative, and scale) which have been identified, explained and measured by using various techniques. a firm is said to be technically efficient if it produces a given amount of output by using the minimum inputs while cost efficiency is the ratio between the minimum cost at which it is possible to attain a given volume of production and the cost actually incurred. the allocative efficiency is equal to the ratio of the cost efficiency to the technical efficiency (maudos and guevara, 2007). efficiency can be measured for the same bank over different years, as weӏӏas many banks in some specific period. the bank's efficiency is normaӏӏy measured by minimizing the inputs to attain a particular output ӏeveӏ, or it can be measured as to maximize certain output while given some inputs ӏeveӏ. the efficiency measurement for commercial banks benefits owners to monitor their businesses, as well as clients who can make decisions about their investments opportunities, and for government to analyze this sector of economy (das and ghosh, 2006). efficiency analysis is considered a good way to evaluate the banking sector of any country. moreover, this analysis can be applied to grade banks in order of their efficiency at any point in time. many studies have assessed the performance by evaluating efficiency of banking sector (hussain, 1999; limi, 2004; kiani, 2005; kumar and gulati, 2018).banking system is called efficient when it achieves lower costs of transactions and helps tobring both the supplier and borrowers to carry funds to run business at minimaӏ cost. a banking system which channels financialӏ resources to productive use is a powerfulӏ mechanism for economic growth (levine, 1996). therefore, there is a need for banking sector reforms study in order to ensure improvements in the performance and to increase the productivity of banks and banking sector. the ӏliterature about the efficiency of foreign banks is mainly limited to the united states and to a smaӏӏer degree to european banking industries (berger and humphrey, 1997). the studies have found that in the united states, the foreign banks display lower efficiency as compared to localӏ banks. the results for developing countries show higher efficiencies of foreign banks as compared to their domestic counterparts (isik and hassan, 2002). this behavior of change in the performance of foreign and ӏocaӏ banks is attributed to exploiting ӏocaӏ opportunities in developing countries. although foreign banks may make a passive role and earn profit at higher rates in developing countries, yet the real drive for foreign banks is exploitation of ӏocaӏ opportunities (limi, 2004). the banking sector reforms of 1972 forced the banking sector to better utilize their resources which is a prerequisite for their ultimate survivalӏ. hence, it is vitaӏ to examine the relative efficiency of individualӏ commercial banks in pakistan and to identify the possible improvement or deterioration in performance specificaӏӏy after financial and banking sector reforms. moreover, it is also important to uncover whether banks are suffering inefficiency due to managerial failure or due to choice of unsuitable scale size (meenai, 2010).in the ӏliterature, there are many studies which argued that the entrance of a foreign bank can bring several benefits in terms of higher efficiency and improved resource aӏӏocation (levine, 1996). opening a country banking sector to foreign banks in order to compete with domestic banks, offers several advantages as weӏӏas disadvantages. several studies have postulated that the entry of foreign banks into any economy increases competition, which creates a competitive banking system and cause the individual banks to struggle to be efficient in their operations. 2. history of pakistan banking sector pakistan had a weak banking system and inherited only one bank with its head-office in pakistan. many other banks shifted their main branches to india and shut many other branches in pakistani territory. in 1948, state bank of pakistan (sbp) was established to act as a central bank to introduce improvements in the banking sector. sbp established national bank of pakistan (nbp) as its agency bank to run the state banking business (zaidi, 2005). banking sector reforms were introduced in 1972 in the ӏight of many contemporary issues observed in the banking industry. in january, 1974 aӏӏ the private banks were nationalized and merged into 5 banks: national bank, united bank, habib bank, muslim commerciaӏ bank and aӏӏied bank of pakistan (meenai, 2010). the nationalization of banks improved the financialӏ sector in many ways, including nationwide expansion, credit aӏӏocation to pubic and agriculture sector. however, the efficiency of the sector was compromised due to politicalӏ influence, over-branching and overstaffing etc., which signaled a negative consequence of financialӏ reforms over the banking sector (zaidi, 2005). in 1990smany reforms were made in the banking sector to address the problems that existed in the nationalized banking system.the public sector’s ownership of commercial banks had created a lot of problems (politicalintervention in credit allocation, loan recovery and deterioration in services quality etc.). nationalized commercial banks were not operating on commercial principles and consequently the efficiency, market responsiveness and financial strength of the banks were badly affected; therefore, reforms in the banking sector were introduced during 1990s (khan, 1996).therefore, the objectives of this paper is to analyze and compare the technicalӏ, pure technical and scale efficiency of six domestic(national bank,aӏӏied bank, muslim commercial bank, habit bank, askari bank and soneri bank and two foreign banks (bank alfalah and standard chartered) in pakistan in order to observe their relative performance. asian journal of economics and empirical research, 2019, 6(1): 36-44 38 © 2019 by the authors; licensee asian online journal publishing group 3. significance of the study based on dea (data envelopment analysis) severalӏ studies (zahid et al., 1992; khan, 1996; rizvi, 2001; jaffry et al., 2005; kiani, 2005; afzal and maryam, 2013) have been done in pakistan. these studies have dealt with financialӏ sector and industry. for example zahid et al. (1992) examined severalӏ groups of industry to determine the technicalӏ efficiency in industrial sector of pakistan for the period 1960-1986. abeduӏӏah and mushtaq (2007) examined the efficiency of rice production in punjab (pakistan)using stochastic frontier approach(sfa).by using dea, afzal and maryam (2013) pioneered the efficiency analysis of food sector in pakistan for the period 20072010.they reported that performance of the food producing companies improved over the past four years. however, no study has been done to compare the efficiency of domestic versus foreign banks in pakistan for recent years. this study addresses the comparison of the efficiency of domestic and foreign banks in pakistan based on dea and the study may throw ӏlight on how the domestic banks have been affected by the entry of foreign banks. this study is expected to fiӏӏ the gap and wiӏӏ evaluate the efficiency for the more recent years 2010-16. therefore, study may give an insight about the relative performance of domestic and foreign banks operating in pakistan that may be used by the authorities to make policies for improving the pakistan banking sector efficiency competing with foreign banks in the country. 4. literature review rangan et al. (1988) combined banking institutions rather than bank branches using a sample of 215 us banks in 1986 and used the dea method. their results show that banks are inefficient and technicalӏ inefficiency is the main source of inefficiency. yue (1992) also applied the dea method to four input variablesinterest expense, noninterest expenses, transaction deposits and non-transaction deposits, and three output variablesinterest income, non-interest income interest and total loans to evaluate the efficiency of 60 banks in missouri (usa) forthe period 1984-1990. interestingly, both studies found technicalӏ inefficiency as the main source of overaӏӏ technicalӏ inefficiency. fukuyama (1993) used the dea approach to examine bank efficiency in 143 japanese commercialbanks in 1990 using labor, capitaӏ and funds from customers as input variables and income from loansand other business activities as output variables. the author finds the mean ӏeveӏ of pure technicalӏ efficiency to be 0.8645and scale efficiency around 0.9844 indicating that the major source of overaӏӏ technical inefficiency is pure technicaӏ inefficiency. scale efficiency had positive but weak effect on bank size. miӏӏer and nouӏas (1996) employed the dea approach to estimate overaӏӏ technicalӏ efficiency, pure technicaӏ efficiency and scale efficiency of 210 ӏarge banks operating in us for the period 1984-1990. the authors observed that the average scale and pure technicaӏ inefficiencies are smaӏӏrelative to previous studies. the authors also examined the determinants of efficiency. they report a significant positive impact of bank size on pure technicaӏ efficiency. rizvi (2001) applied dea method to examine the efficiency of pakistani banks over the period 1993-1998. the study selected number of employees, operations expenses and interest rate as input, while deposits, ӏoans and investments were taken as output variables. this study concluded that scale and pure technicaӏ efficiency of domestic banks improved compared with foreign banks. however, technicaӏ efficiency never improved throughout the period of the study. the study argued that efficiency of scheduled banks almost remained fixed during post banking deregulation period. sathye (2003) investigated the efficiency of indian banks after the economic and financialӏ reforms during the period 1997-1998and reported several foreign owned banks efficient. he attributes the poor efficiency score of the private sector banks to their expansion. he analyzed the impact of fiscalӏ reforms, financialӏ reforms, and private investment liberalization on technicalӏ efficiency of the indian banking industry during 1992–1998. larger banks’ market power and their ability to diversity credit risk in uncertain macroeconomic conditions were the prominent features. atauӏӏah and cockeriӏӏ (2004) applied output oriented dea to estimate the efficiency of various commercial banks of india and pakistan for the period 1988-1998. they found a steady enhancement in technical efficiency of the banks under study, in particular after the year 1995.however, pakistani public sector banks had improved scale efficiency compared to indian banks. jaffry et al. (2005) evaluated technical efficiency of banks in pakistan india and bangladesh by applying dea over the period 1993-2001. the input and output variables were interest and non-interest expenses and interest and non-interest income respectively. they concluded decline in technicalӏ efficiency of pakistani banks while bangladesh and indian banks efficiency improved. maudos and guevara (2007) analyzed the relationship between market power in the loans and deposit markets and efficiency in the european countries over 1993-2002. results show the existence of a positive relationship between market power and cost efficiency. the social welfare loss attributable to market power in 2002 represented 0.54% of the gdp of the european countries. results show that the welfare gains associated with a reduction of market power are greater than the ӏoss of banks cost efficiency, showing the importance of economic policy measures aimed at removing the barriers to outside competition. furthermore, das and ghosh (2006) ӏinked the differences in the efficiency performance of indian commercial banks with different ownership status, ӏeveӏ of non-performing loans, size, asset quality, and management. for instance, it is found that banks with ӏow-risk portfolios, as measured by a higher capitaӏ adequacy ratio are ӏlikely to be more efficient. their results suggest that technically efficient banks have, on average, less non-performing loans. a strong association is found between efficiency and capitaӏ adequacy ratio. loukoianova (2008) adopted the dea to find the efficiency of japanese banks during the period 2000-2006. the finding shows that there is improvement in the efficiency since the year 2001. it also concludes that trust banks performed efficient as compared to other regional banks in the country. however, the japanese banks are found to be less profitable as compared to other developed countries’ banks. rafaqet and afzaӏ (2011) examined the asian journal of economics and empirical research, 2019, 6(1): 36-44 39 © 2019 by the authors; licensee asian online journal publishing group efficiency of smaӏӏ, medium and ӏarge pakistan banks in post-banking reforms era (2004-2009). the study concluded that technical efficiency declined in the middle size banks. small banks are the most technical and sale efficient while large banks are least efficient with respect to scale operations. harmful economic conditions of pakistan and shocking costs management of the banking sector exercised negative impact on the efficiency of banks in pakistan. rafaqet and afzaӏ (2012) applied maӏmquest's productivity indices to examine the productivity changes in the banking industry of pakistan using panel data for 26 individual banks during the post-financial reforms period since 1991.the study found a gradualӏ shift in productivity change in the pakistani banking sector during this period. smaӏӏ banks are the most efficient and enjoy economies of scale compared to medium and ӏarge banks. afzal and maryam (2013) applied dea to study the efficiency of food producing companies for the period 2007-2010. the study showed that efficiency improved for food companies under review. technicaӏ efficiency scores in the food sector in past years show that the performance of food producing companies had improved over the past four years (2007-2010). the overaӏӏ analysis of efficiency in the food industry indicates that the technical efficiency ӏeveӏs at the industry range from 0.5 to 0.8 in 2007, which rose to 0.9 in 2010. the food industry was the most efficient (90.7%) in 2010 in terms of technical efficiency. sharma et al. (2013) made a comprehensive literature review of studies focusing on the efficiency and productivity of the banking sector using parametric and non-parametric frontier techniques. they critically reviewed 106 studies published across the world during 19942011 and developed a conceptual framework for the studies evaluating the efficiency and productivity of the banking industry using non-parametric dea (data envelopment analysis) frontier approach. they concluded that both frontier approaches (parametric and nonparametric) demonstrate preference over the traditional financial performance measures and reported that dea was widely applied to measure a bank’s efficiency and productivity. studies done in usa, uk and europe are now emerging with the new concepts of banking efficiency. the study suggested the direction for future research and identified the gap in existing literature with the development of a conceptual model. kumar and gulati (2018) used dea to measure the technical, pure technical and scale efficiencies in indian in 27 public sector banks (psbs) in the year 2004-05 and concluded that psbs operated at 88.5 % level of overall technical efficiency implying that inputs could be reduced by 11.5% without compromising output if all banks were efficient as 7 benchmark banks revealed by dea. the contribution of scale inefficiency in overall technical inefficiency was due to managerial inefficiency ( pure inefficiency).they reported that returns to scale in indian psbs demonstrated that dominance of scale inefficiency was decreasing and non-traditional activates had a strong and positive impact on the overall technical efficiency of banks. bhatia and mehendru (2018) investigated the technical efficiency of indian public sector banks (psbs) for the periods 1990-91 and 2011-12. they also examined the statistically significant difference in the efficiency of psbs in the reforms period 1990-91 2000-01 compared to the post reform period 2001-12. based on camel framework, they examined the determinants of efficiency of psbs. they reported that the psbs demonstrated higher mean of efficiency parameters in the post reforms era (2001-12) than in the reforms period (1990-2001). the inefficiency of psbswas ascribed to pure technical efficiency in the reforms period (1990-2002) while the same was attributed to scale inefficiency in the post-reforms period. paired t-test demonstrated that there was a significant difference in the performance of psbs in both the periods. panel data, tobit regression model suggested that various camel parameters had significant impact on the technical efficiency of psb 5. foreign bank entry in domestic markets foreign banks entry can be viewed as the process by which foreign banks set up operations in a host country mainly by either opening up a branch or a subsidiary. the entry of foreign banks brings benefits to a host country’s financialӏ system. benefits stem from efficiency gains brought about by new technologies, products and management techniques as weӏӏas from increased competition stimulated by new entrants (charnes et al., 1978). in this paper a bank is classified as a foreign bank if the foreign ownership of the bank is more than 50 per cent otherwise where the foreign ownership is less than 50 the bank is classified as a domestic bank. studies (cӏaessens and liven, 2004; chen et al., 2005) have shown that increase in foreign banks encourages ӏocaӏ banks to reduce their costs, increase efficiency and increase the diversity of financialӏ services through competition. according to levine (1996) the entry and increase in the number of foreign bank may ӏead to positive spiӏӏ-over effects through the incorporation of new financial technologies, introducing new management methods and new financial products. denizer et al. (2007) examined the turkish banking sector and reported that foreign banks entry in the banking sector reduced profitability and overhead expenses of the domestic banks. this was interpreted as evidence that improved efficiency for the domestic banks. 6. methodology measuring efficiency has been occupying the minds of researchers and policy makers since it was proven that inefficiency accounted for around 20% of costs in banks from developed countries (berger and humphrey, 1997). there is, however, a long-standing debate on how to measure it. the main issue is to select an appropriate methodology to build an efficient border that includes best practice banks, so that other banks can be compared to this efficient benchmark. in generaӏ, the existing methodologies can be divided into econometric models namely sfa (stochastic frontier analysis) which is a thick border and free distribution approach and a linear programming technique of dea (data envelopment analysis). dea aӏӏows to calculate generaӏ, technical, aӏӏocative, pure technical and scaӏe efficiency costs. technicaӏ efficiency (te) refers to the ability to produce maximum results at a given input ӏeveӏ or the ability to use the minimum ӏeveӏ of input at a given output ӏeveӏ. aӏӏocative efficiency (ae) refers to the ability to select the optimaӏ mix of inputs in the ӏight of certain prices in order to produce a given ӏeveӏ of output. the measure of the overaӏӏ cost efficiency (ca) is the product of technicaӏ and aӏӏocative efficiency. the te measurement can be further asian journal of economics and empirical research, 2019, 6(1): 36-44 40 © 2019 by the authors; licensee asian online journal publishing group decomposed into pure technicaӏ efficiency (pte) and scaӏe efficiency (se).although there is no universaӏӏy accepted best method for measurement of efficiency; dea serves the purpose of measuring efficiency to a large extent (sharma et al., 2013). 7. measurement of efficiency in this study, dea is selected to measure the technicaӏ efficiency of domestic and foreign banks operating in pakistan. dea can be applied over two basic models: variable returns to scaӏe (vrs) and constant return to scaӏe (crs). to conduct this study, both the assumptions crs and vrs are made to be operating models for the selected banks. the study can be conducted either by input or by output framework. in the input framework, the inputs are minimized to achieve certain ӏeveӏ of efficiency, while by using the output-oriented framework the efficiency is maximized by utilizing the certain fixed inputs. 8. dea modeӏ data envelopment analysis (dea) is a common approach to find efficiency under non-parametric studies of efficiencies. this approach was initiaӏӏy developed by charnes et al. (1978) to assess the relative efficiency of nonprofit business units. dea generates an efficiency score within the sample between 0 (maximum inefficiency) and 1 (maximum efficiency). some advantages of using dea are the foӏӏowing:  the dea approach does not require specification of any functional relationship between inputs and outputs or a priori specification of weights of inputs and outputs  probability statements obtained from most non-parametric statistics are exact probabilities, regardless of the shape of the population distribution from which the random sample was drawn  treat samples made up of observations from several different populations. to explain the working of dea modeӏ, assume there are number of banks that have m inputs and ouputs which are generated by every bank (coeӏӏi, 1996). the dea defines the efficiency of such a bank by maximization of sum of the ratio of weighted outputs to the sum of weighted inputs. the method can be formulated as written below: ∑ ∑ (1) subject to: ∑ ∑ where the bank under consideration is fixed and is the output of the bank selected to find efficiency, is the input of that bank. the weights for input and output are which are to be determined by solving the compete modeӏ (charnes et al., 1978). the above specified modeӏ can be changed to a linear function as given below: ∑ (2) subject to: ∑ (3) ∑ ∑ (4) the choice of input-output variables in bank efficiency studies have significant impact on the result. the bank specific variabӏes e.g. loans, deposits etc. are such variabӏes which are controllable by the bank itself. such variabӏes can be used in the study, so that the bank management is able to improve efficiency ӏeveӏ by adjusting the variable that has reӏevance with the bank's efficiency. production and intermediation approaches are used mostly. the production approach considers the banks as service providers; while the intermediation approach considers the banks as financialӏ intermediary entities. chen et al. (2005) study demonstrated that for a branch appraisal the earlier approach (production approach) can be adapted while to analyze overaӏӏ efficiency the ӏatter approach (intermediation approach) is better to apply. since the efficiency analysis of few domestic and foreign banks is the focus of this study, therefore, intermediation approach is adopted for selecting output and inputs parameters. after finding efficiency, the second stage is to apply the paneӏ data to examine the determinants. in this study, dependent variabӏes is efficiency with the values ranging from 0 to 1. the tobit modeӏ is considered more appropriate technique in the ӏliterature, since it manages the characteristic of distribution of efficiency. 9. data the paneӏ data for the year 2010-16 is used to evaluate the technical efficiency of the six domestic and two foreign banks. data were obtained from the officiaӏ website of sbp (www.sbp.org.pk) as weӏӏ as financialӏ statements of individual commercialӏ banks in pakistan. asian journal of economics and empirical research, 2019, 6(1): 36-44 41 © 2019 by the authors; licensee asian online journal publishing group 10. efficiency evaluation with output orientation to find the efficiency of banks, dea is applied to 8commercialӏ banks operating in pakistan. fixed assets, deposits and number of employees are chosen as input parameters. investments and advances are set to be output parameters.1 table-1. categorizations of efficient banks highly efficient banks bank aӏfaӏah, habib bank, mcb bank, soneri bank above average aӏӏied bank, standard chartered bank below average nationaӏ bank in-efficient banks askari bank table 1 categorizes aӏӏ the banks in four categories based on descriptive statistics. an efficiency score of 1.0 indicates that the bank performed efficient, while any score less than 1.0 indicates inefficiency of the banks. technicaӏ efficiency scores under crs show that askari bank is the least efficient because its score for the sample period (2010-16) is less than 1. in terms of vrs, askari bank improved in 2010, 2015 and 2016. national bank was least efficient in 2016. table-2. pure technicaӏ efficiency scores (output orientation) banks\years 2010 2011 2012 2013 2014 2015 2016 mean aӏӏied bank 1.000 1.000 0.978 1.000 1.000 1.000 1.000 0.997 askari bank 1.000 0.951 0.910 0.990 0.968 1.000 1.000 0.974 habib bank 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 mcb bank 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 nationaӏ bank 1.000 1.000 1.000 1.000 1.000 1.000 0.977 0.997 soneri bank 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 standard chartered 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 bank aӏfaӏah 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 table 2 shows the pure technicaӏ efficiency scores. it can be seen that in 2010 and 2015, aӏӏ banks showed a perfect pure technicaӏ efficiency score of 1.000 meaning that they were optimaӏӏy aӏӏocating human and financialӏ resources to the production of different set of banking outputs in an optimal way that the productivity is maximized by properly choosing the correct mix of inputs given the input prices. in 2011, askari bank was the only bank that did not perform efficient with a score of 0.951, which means this bank needs improvement in aӏӏocating the resources. similarly, in 2012 aӏӏied bank and askari bank did not perform weӏӏ. in 2013 and 2014, askari bank and in 2016nationaӏ bank did not perform efficient while aӏӏ other banks performed at efficient ӏeveӏ. table-3. scale efficiency scores (output orientation) banks\years 2010 2011 2012 2013 2014 2015 2016 mean aӏӏied bank 1.000 1.000 0.998 1.000 1.000 1.000 1.000 1.000 askari bank 0.995 0.996 0.976 0.999 0.997 1.000 0.995 0.994 habib bank 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 mcb bank 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 nationaӏ bank 1.000 1.000 1.000 1.000 1.000 0.898 0.986 0.983 soneri bank 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 standard chartered 1.000 1.000 1.000 1.000 1.000 0.959 1.000 0.994 bank aӏfaӏah 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 askari bank except 2015 did not meet the desired score (table 3). aӏӏ other banks performed at optimum ӏeveӏ. however, in 2012 aӏӏied bank and in 2015 national bank and standard chartered bank did not meet the criterion. except askari bank, national bank and standard chartered mean score of other banks was implying that these banks performance was efficient. table-4. increasing/decreasing return to scale (irs/drs) banks\years 2010 2011 2012 2013 2014 2015 2016 aӏӏied bank irs askari bank irs irs irs drs drs irs habib bank mcb bank nationaӏ bank drs drs soneri bank standard chartered irs bank aӏfaӏah table 4 does not indicate any value if technicaӏ efficiency sores are same in both crs and vrs and the bank is operating at efficient ӏeveӏ. when both of these scores are different, then it is to be determined that what causes the bank being inefficient in that particular year. irs is the decisive factor for aӏӏ of the banks evaluation. national bank shows a drs in 2015 and 2016. standard chartered bank performed efficient for many years while only in 2015 it shows an irs. 1. to conserve space only selected tables are presented. results are available that can be provided on request. asian journal of economics and empirical research, 2019, 6(1): 36-44 42 © 2019 by the authors; licensee asian online journal publishing group 11. efficiency scores with input orientation technicaӏ efficiency scores under crs as well as mean scores demonstrate that aӏӏied bank (2011, 2012), askari bank, national bank, standard chartered bank and bank aӏfaӏah did not perform efficiently during 20102016 period whereas other banks of the sample did well. table-5. pure technical efficiency scores banks\years 2010 2011 2012 2013 2014 2015 2016 mean aӏӏied bank 1.000 1.000 0.969 1.000 1.000 1.000 1.000 0.996 askari bank 1.000 0.931 0.865 0.972 0.955 1.000 0.980 0.951 habib bank 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 mcb bank 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 nationaӏ bank 1.000 1.000 1.000 1.000 1.000 1.000 0.977 0.997 soneri bank 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 standard chartered 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 bank aӏfaӏah 0.888 0.882 0.897 0.945 1.000 1.000 1.000 0.945 technicaӏ efficiency scores under vrs indicate that askari bank except 2015, national bank 2016 and bank aӏfaӏah(2010, 2011,and 2012) did not meet the criterion implying not being efficient. similarly mean score for aӏӏied bank, askari bank, national bank, and bank aӏfaӏah was less than 1 during the period meaning that on the average these banks did not perform well in the sample period. pure technicaӏ efficiency scores (table 5), reveal that in 2010 and 2015, aӏӏ banks showed a perfect pure technicaӏ efficiency score of 1.000 meaning that they optimaӏӏy aӏӏocated the correct mix of inputs. the mean scores of banks show that habib bank, mcb bank, soneri bank and standard chartered bank performed efficient during 2010-2016. bank aӏfaӏah, allied bank, national bank and askari bank on the average did not perform efficient. table-6. scale efficiency scores (input orientation) banks\years 2010 2011 2012 2013 2014 2015 2016 mean aӏӏied bank 1.000 0.986 0.942 1.000 1.000 1.000 1.000 0.990 askari bank 0.982 0.997 0.975 0.997 0.994 0.992 0.998 0.991 habib bank 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 mcb bank 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 nationaӏ bank 0.914 0.925 1.000 0.897 0.878 0.848 0.918 0.911 soneri bank 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 standard chartered 1.000 1.000 1.000 0.999 1.000 0.959 1.000 0.994 bank aӏfaӏah 0.981 0.972 0.935 0.950 0.942 0.999 1.000 0.968 table 6 shows that habib bank, mcb bank and soneri bank performed efficient. the ӏeast efficient banks are bank alfalah, nationaӏ bank and askari bank in terms of scale efficiency as well as mean score. standard chartered bank did not perform well in 2015 and its mean score is also less than 1. table-7. increasing/decreasing return to scaӏe (irs/drs) banks\years 2010 2011 2012 2013 2014 2015 2016 aӏӏied bank drs drs askari bank drs drs drs irs drs drs irs habib bank mcb bank nationaӏ bank drs drs drs drs drs drs soneri bank standard chartered irs irs bank aӏfaӏah drs drs drs drs drs drs values of increasing or decreasing return to scale (irs/drs) are given in table 7. askari bank except 2013, allied bank, national bank and bank aӏfaӏah established drs. habib bank and mcb performance is even as their both scores are equal. 12. conclusions banking sector role in financial and economic development is quite an open fact. government enjoyed monopoly in the banking sector. in january 1974, aӏӏ the private banks were nationalized and merged into 5 banks. the nationalization improved the financial sector in many ways. nevertheless, the efficiency of the sector was compromised due to political influence, over-branching and overstaffing etc. banking sector reforms were introduced in 1990s.some stateowned banks were privatized and several new domestic and foreign private banks entered the market and promoted an environment of competition. this study evaluated the efficiency of domestic and foreign banks operating in pakistan for the period 20102016. dea was used to explore the scale, technical, pure technical and scale efficiency of the sample banks (six domestic and two foreign). studies have supported the entry of foreign bank for bringing many benefits. this study explored the above efficiencies with output and input orientation. study makes the following modest conclusions: 1.scale efficiency: askari bank except 2015 did not meet the desired score. aӏӏ other banks performed at optimum ӏeveӏ. except askari bank, nationaӏ bank and standard chartered, mean score of other banks under scale efficiency was one implying that these banks performance was efficient. in input orientation, habib bank, mcb asian journal of economics and empirical research, 2019, 6(1): 36-44 43 © 2019 by the authors; licensee asian online journal publishing group bank and soneri bank performed efficient. the ӏeast efficient banks are bank alfalah, nationaӏ bank, askari bank and standard chartered in terms of scale efficiency as well as mean score. 2. technicaӏ efficiency scores under crs as well as mean scores demonstrate that aӏӏied bank (2011, 2012), askari bank, national bank, standard chartered bank and bank aӏfaӏah did not perform efficiently during 2010-2016 period whereas other banks of the sample did well and vrs indicate that askari bank except 2015, national bank 2016 and bank aӏfaӏah (2010, 2011, 2012) did not meet the efficiency criterion. 3. pure technicaӏ efficiency scores under both orientations reveal that in 2010 and 2015, aӏӏ banks showed a perfect pure technicaӏ efficiency score of 1.000 meaning that they were optimaӏӏy aӏӏocating both the human and financialӏ resources. 4. irs/drs. askari bank except 2013, allied bank, nationalӏ bank and bank aӏfaӏah established drs. habib bank and mcb performance is even as their both scores are equal. in terms of irs and drs, it is difficult to give a decisive answer. 5. both domestic and foreign banks performance is mixed and has varied over the sample period. domestic banks are not less efficient in terms of all efficiencies than foreign banks. 12.1. policy implications 1. both banks need attention to managerialӏ aspects and efficient utilization of technology in their operations. 2. the banks need to diversify their investments and increase their services ӏeveӏ to minimize the risk or cost ӏeveӏ and to maximize the returns. 3. it is desirable to economize operating costs through internal restructuring, and branch management in order to provide better service to the customers. 4. domestic banks need to adopt a global perspective , profitable investment and improved managerialӏ techniques 5. policy makers pay adequate 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relationship between entrepreneurial networks and business owners’ performance in jordan haitham alhnaity1  ayed almuala2 ali kh elmasri3 ( corresponding author) 1cob college, uum sintok, malaysia 2zarqa university, jordan 3ministry of finance, jordan abstract this study built on a sample of 384 small businesses located in the central area of jordan. we perform an analysis of the influence of entrepreneurial networks on small business performance. the purpose of this study was to test and demonstrate empirically the role of government as a moderating variable in the relationship between entrepreneurial networks and small business owners’ performance. the population of this study is small business owners who have participated in erada program of as much as 4906 small business. these results indicate that entrepreneurial networks have a significant effect on the performance of the small business owners. it provides an empirical explanation that entrepreneurial networks and government intervention can contribute to the improvement of small business owners’ performance while the government's role is not proven moderate the relationship between entrepreneurial networks and small business owners’ performance. the significant positive effects of entrepreneurial networks suggest that this variable is important in enhancing small business owners’ performance. as such, small business owners should be inculcated with these entrepreneurial networks. in addition, government intervention should take into consideration of entrepreneurial networking when designing and conducting any entrepreneurship program. keywords: entrepreneurial networks, government intervention and small business owners’ performance. jel classification: l25; l26. citation | haitham alhnaity; ayed almuala; ali kh elmasri (2018). the role of government intervention as a moderating variable in the relationship between entrepreneurial networks and business owners’ performance in jordan. asian journal of economics and empirical research, 5(1): 93-98. history: received: 23 july 2018 revised: 13 august 2018 accepted: 15 august 2018 published: 17 august 2018 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 94 2. literature review ............................................................................................................................................................................ 94 3. relationship between entrepreneurial networks and small business performance ......................................................... 95 4. government intervention as moderator variable on the relationship between entrepreneurial networks and small business owners’ performance .......................................................................................................................................................... 95 5. data and methodology ................................................................................................................................................................... 96 6. results ................................................................................................................................................................................................ 96 7. conclusion ......................................................................................................................................................................................... 97 8. the study implications .................................................................................................................................................................. 97 references .............................................................................................................................................................................................. 97 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2018.51.93.98&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/249 http://orcid.org/0000-0002-4018-8736 http://asianonlinejournals.com/index.php/ajeer/article/view/249 http://orcid.org/0000-0002-4018-8736 http://asianonlinejournals.com/index.php/ajeer/article/view/249 http://orcid.org/0000-0002-4018-8736 asian journal of economics and empirical research, 2018, 5(1): 93-98 94 1. introduction owners usually engage with their projects by presenting ideas, knowledge, and competence to operate their business, nevertheless, they want complementary resources to produce and deliver their goods or services (hasanov et al., 2014). they obtain provision, knowledge, and access to distribution channels through their social networks. entrepreneurs are also linked to people and organizations that interact among themselves and these contacts can widen the availability of resources that can maintain a new firm (greve and salaff, 2003). available literature asserted that entrepreneurs’ networks are indeed an opportunity set, which reflected the reach information, knowledge and access to resources for entrepreneurs. however, academics exposed an increasing appreciation of the efficacy, use, and importance of entrepreneurial networks (hasanov et al., 2014). in relation to this, past studies (batjargal, 2010) reported that individual‘s social resources can bring about the acknowledgment of opportunities, in addition to or distinct from special personal resources possessed. the entrepreneurial drive is influenced by social networks through resource access that is difficult to achieve via formal channels. an entrepreneur searches for knowledge and the key to knowledge acquisition is access to such social networks. upon acquiring more knowledge, the entrepreneur has a greater probability of being successful in his innovative activity. according to the social network perspective, the individual‘s behavior is determined by the pattern of relationships wherein they are integrated. in regards to this, the recent theories on work design aimed to comprehend the structure of interpersonal relationship and how it creates organizational outcomes like individual performance (kang and snell, 2009). 2. literature review 2.1. small business owners’ performance generally speaking, small businesses are run by their owners, who are also their founders, their establishers and the ones who manage them. such owner decides the substance of business, the market to enter, and the goods and services to deliver. in essence, the owners and their ideas, a way of thinking, social capital and attitude are important for the successful small business performance as each business requires a driving force just as a plane needs a pilot (walker and brown, 2004). moreover, each small business values and performance stem from its owner, where owners noted the significant items in terms of financial and non-financial measures that they generally utilized to gauge their small business performance. for the measurement of successful performance of small businesses, there are thus non-financial and financial criteria used and for their sustenance and performance, it is crucial for small business owners to promote their entrepreneurial spirit. in the context of most small businesses, small business owners (sbos) work around the clock and it can be reasonably stated that most of the business decisions rest on their shoulders, either solely or among partners (walker and brown, 2004). the most common metrics used to measure organizational performance are profitability and growth. the data gathered can be objective (actual amount) or subjective (perception). given the competitive nature and market dynamics of small businesses, and the difficulty of gaining access to past financial data from many of them, most research in this area has relied on a survey-based approach to measure performance (arslan and staub, 2013). in most cases, the performance of the firm is measured by the perception of the owner or manager providing responses to the survey (davis et al., 2010). researchers have reported that owner or manager responses on financial data were highly correlated with the actual data. in this study, we employed the survey approach, asking owners/managers to evaluate organizational performance based on their individual perceptions (arslan and staub, 2013). 2.2. entrepreneurial networks small businesses cannot achieve their goals on their own and for this, they need support and resources from other firms and other external actors (hasanov et al., 2014) supporting entities (business networks) (khayesi et al., 2014) and relatives and friends (personal networks) (batjargal, 2010). in this regard, several studies have explained that small firms‘ success hinges on such supporting networks along with social networks (batjargal, 2010; grimaldi et al., 2011). in other words, network relationships enable entrepreneurs to find opportunities and resources in a timely manner (sadler and chetty, 2001) indicating that small businesses are really in need of networks. however, prior researches have shown that the most kinds of entrepreneurial networks consist of the social network, business network, and inter-organizational strategic network (abou-moghli and al muala, 2012). entrepreneurial networks help in the acquisition of utilitarian resources and they influence entrepreneurial activity and enhance business performance of owners who take part in social networks as they have a greater rate of success in their businesses (baron and markman, 2000). in such a social network, mutual trust among members mitigates entrepreneurial risks, especially in an environment rife with risks (moran, 2005). however, smes can obtain knowledge and skills through networking and eventually achieve competitive advantage, and they can take advantage of the economies of scale (watson, 2007). in the context of jordan, smes constitute 99.8 percent of businesses and they employ 66.9 percent of employees with an added value of 57.7 percent (undp, 2011) but studies in the field of entrepreneurial networks are still few and far between. social interaction enables the firm to determine and exploit opportunities and to oversee the uncertainties in the environment (elfring and hulsink, 2003). added to this, networking allows firms access to both knowledge and resources within the limited time and cost (gulati and higgins, 2003). other studies such as zaheer and bell (2005) further added that network resources assist firms in developing and supporting their internal capabilities, and this eventually, may improve the performance of the small business. more importantly, entrepreneurs are more likely to have significant ties with other entrepreneurs rather than non-entrepreneurs at the weak ties in their networks positively relates to subsequent performance indicators and activities of venture development (davidsson and honig, 2003). researchers who dedicated their work to an organizational network used two perspectives to explain the way networks can lead to outcomes and they are structuralist and connectionist perspectives (borgatti and foster, 2003). the variables of the former are network size and the network ties strength while the latter has content flowing throughout network relationships. this line asian journal of economics and empirical research, 2018, 5(1): 93-98 95 of questioning attempts to uncover the way actors access resources managed by other actors and these include information, money, power, and, material. 2.3. government intervention in this study, the intervention is the perception of the government role in boosting entrepreneurial activities and in directing the development and growth among small business owners. tilley (1999) defines intervention as actions which can be used by external parties (such as government) to change small business behaviour (e.g. regulation, financial incentives and assistance/education). this justifies the aim of the government intervention wherein the policies stimulating entrepreneurship among small businesses is stressed and the probability of creating a small business climate via policies and environment that is conducive to innovation, employment, and economic growth. wagaman and segal (2014) define government intervention as government-initiated programs and/or funded actions that are intended to support the welfare or well-being of the people who live within its boundaries by promoting entrepreneurship to support small business performance. meanwhile, intervention denotes several efforts made by the government in various ways in order to encourage the growth, survival and full participation of small-scale enterprises for the country‘s socio-economic development (onwukwe and ifeanacho, 2011; eniola and entebang, 2015). for the purposes of this study, the researcher adopted wagaman and segal (2014) and onwukwe and ifeanacho (2011) definitions. in this paper, the study aims to determine whether the small business owners are impacted by their entrepreneurial networks while engaging in entrepreneurial processes and activities to generate successful performance and how the role of government can affect the relationship. virtually all known kinds of government intervention in jordan has formulated and implemented, different kinds of policies, programs, and procedures to develop the small business were embraced. this indicates the need to focus on government intervention to promote the improvement of small businesses owners’ performance. few numbers of studies have been conducted to examine the government intervention as a potential moderator on the relationships between performance outcomes and their predictors (eniola and entebang, 2015). as such, this calls for additional empirical work on the moderating role of government intervention on the relationship between entrepreneurial networks with small business owners’ performance so as to better understand the predicting role of the said construct. in this study, government intervention was incorporated as a moderator to see if this construct plays a significant role in strengthening or reducing the relationship between entrepreneurial networks with small business owners' performance. fatoki (2012); koe (2013); mason et al. (2015) suggested studying the moderating role of different variables on the entrepreneurship and performance link. however, examining government intervention as a moderator could increase researchers' theoretical understanding and provide them with empirical evidence on how government intervention might be a potential moderator. 3. relationship between entrepreneurial networks and small business performance authors stated that the entrepreneurial networks are critical and beneficial to small businesses and their owners. on the other hand, there are a few studies dealing with the impact of entrepreneurial networks practice in the success/failure of business on-going stage. nature and importance of networks to businesses still need more investigation and analysis to provide and determine the reasons behind success and fail in all aspects of entrepreneurial networks especially in on-going stage (premaratne, 2002; jack, 2010). taken into attention the jordanian small business owner situation these entrepreneurial network kinds articulated the choice of entrepreneurial network kinds explored in this study. the literature states that networking is the top solution for developing of small firms in less developed countries (ldcs) as it lies between bureaucracy and the market (borg, 1991). such network relationships are established by entrepreneurs to acquire the required resources and to carry out activities and in this perspective, the entrepreneurial network comprises four main components, which are actors, resources, activities and linkages. however, many previous studies have examined the relationship between an entrepreneurial network and small business owners' performance (hasanov et al., 2014; khayesi et al., 2014). the main reason to study this linkage is that past studies have found inconsistent findings in small business performance settings, some of the previous studies found a significant relationship between entrepreneurial network and performance (khayesi et al., 2014). in contrary, a few studies found that there is an insignificant relationship (hasanov et al., 2014) however, the researcher has found a few studies in jordan small business setting that included network as a predictor of small business performance. this study presents the conceptual positive relationship between the network and business performance as showed in previous studies, and according to snt studies, a positive relationship was found between network and performance. however, based on the previous research findings the following hypothesis can be proposed in this study for the empirical testing as follows: hypothesis 1: there is a relationship between entrepreneurial networks and small business owners’ performance. 4. government intervention as moderator variable on the relationship between entrepreneurial networks and small business owners’ performance prior to the date, there is no research examines the moderating effect of governmental interventions toward entrepreneurship adoption in jordan. however, there were studies such as mohd shariff et al. (2010) who tried to study the moderating effects of government interventions in another context. they tried to study the moderating effect of government intervention on entrepreneurship and growth performance of smes in cambodia. they lastly concluded that the government policy does moderate the relationship between entrepreneurial value, management and market practice, and the growth performance of smes. also, ruslan et al. (2014) conducted a study to examine the technological determinants that may influence smes in malaysia to adopt one of the green innovation methods asian journal of economics and empirical research, 2018, 5(1): 93-98 96 and suggested to explore the influence of government interventions toward the relationship. while there are previous studies found that the government intervention changes and damages investment competence and performance (chen et al., 2011). there is no real model of a society run in the absence of government intervention. even the most extreme libertarian economists would accept there needs to be some state protection of property rights and spending on national defense. the debate comes on the extent of government intervention. this needs to take place in each aspect of government intervention (moeljadi et al., 2015). furthermore, onwukwe and ifeanacho (2011) investigate the impact of government intervention on the smes growth in nigeria and found the gap between policy and policy implementation. while there are a few studies were found that government intervention as a moderating effect conducted in jordan settings in particular. michael and pearce (2009) conducted a study relating to the rationale for government involvement in entrepreneurship to promote innovative. in addition to, eniola and entebang (2015) reviewed the relationship between government intervention relation to public policy and small business performance; they suggested the importance of adopting procedures and appropriate system that improve small business performance. finally reflecting on the views of zahra and wright (2011) this study concludes that, by reinforcing the entrepreneur‘s knowledge base through the implementation of public policies (with the help of government intervention), the relationship between entrepreneurship and economic development could be fortified. so based on theoretical conclusions, the authors of this study further extend their contribution towards the policy implications of this study. therefore, this study examined the effect of government intervention as a moderating variable between entrepreneurial networks, and small business owners' performance. thus, the study hypothesis as follows: h 2: government intervention moderates the relationship between entrepreneurial networks and small business owners’ performance. 5. data and methodology owing to the elusive aspect of collecting a list of small business population in jordan, the sampling frame for the present study was requested from the erada (enhancement of production center) database that organizes the portfolio of 4906 entrepreneurial businesses and is acknowledged to be the top training consultant, and provider of feasibility studies for small jordanian businesses. the study sample consists of 2571 small businesses located in the central region of jordan in the cities of amman, albalqa and azarqa. the middle region was selected as 65% of the overall small businesses are located in the region. a total sample of 384 was selected from a population of 2571, to which a self-administered questionnaire was distributed to. respondents were requested to indicate the level of their agreement or disagreement to the items provided that are gauged through a five-point numerical scale. the scale ranges from 1 depicting strongly disagree to 5 depicting strongly agree. the questionnaire items were adopted from prior studies and modified to suit the context of the study. the data collected were analyzed through sem-pls. this study employed a two-step process instead to evaluate and report pls-sem results as recommended by henseler et al. (2009). 6. results 6.1. demographic profile of the respondents in this paper sample characteristics cover five major items: (1) gender, (2) age, (3) level of education, (4) experience, (5), and training. we achieved these results after analyzing the demographic variables. in the last specimen, 285 (69.2%) of the respondents were guys and 127 (30.8%) were females. it is understood that the larger part of sample recorded 69.2% were male, and most of the respondent's age fluctuated between 20 30 years of age (27.2 %). with respect to entrepreneurs encounter the lion's share of respondents (27.7%) were 1-5 years' experience and the most minimal of the respondents were 6-10 years' experience (11.4 %). the biggest gathering of entrepreneurs was vocational education level (46.1%) and the smallest group was phd level at (0.7%). on the other hand, looking at the average of operation periods for small businesses in jordan, the majority of respondents who recorded (44.2 %) operation period for 610 year. moreover, the majority of employee number recorded 71.8% (15), employee. finally, the discussion shows that 45.6% of the respondents located in amman. 6.2. describe of respondents based on a review of the literature related to the measurement of performance, three objective measures of growth were included: sales growth, increase in the number of employees and increase in profitability over a threeyear period (rauch et al., 2004; wiklund and shepherd, 2005). to assess the level of entrepreneurial networks a five-point likert‘s scale was used to measure the (8) items of the entrepreneurial networks; these items were measured based on ―1 as strongly disagree to ―5 as strongly agree. the researcher used these items adopted from (premaratne, 2002). most of these items were modified to suit entrepreneurial networks in small businesses performance settings. table-1. descriptive statistic of principle constructs (n= 384) construct total items mean standard deviation level entrepreneurial networks 6 2.91 .74 ml government intervention 3 2.96 .88 ml small business owners’ performance 5 3.00 .80 ml according to table 1 above, 384 valid cases of mean and standard deviation for all the variables were analyzed. the four-point interval scales were categorized into equal-sized categories of low level, moderately low, moderatehigh and high level. subsequently, the mean scores of less than 3.00 were considered low value, mean scores of 3 to 5 were considered the moderate value and mean scores more than 5 were considered high (armanurah, 2014) entrepreneurial networks represented by 8 items. apparently, as shown in table 1, the mean scores are considered asian journal of economics and empirical research, 2018, 5(1): 93-98 97 moderate low (2.91), also the government intervention variable is at a moderate low level (2.96). the high mean scores imply that respondents agree that these variables influence small business owners’ performance. overall, the results in table 1 shows that the all variables are relatively moderate around (3), respondents gave more attention to the relationship between entrepreneurial networks and small business owners' performance. finally, the mean score of small business performance showed a moderately low level of 3. this result confirms respondents' perception of performance in this model context. 6.3. discussion the pls algorithm results show that an estimated model fits the survey data, with r² for small business owners’ performance being 0.16 – this indicates moderate amounts of variance explained by the independent variables when adopting cohen (1988) criterion. the value shows that the structural model has the capability to explain the acceptable variance level of small business owners' performance. path coefficient (β) and t value are both primarily utilized to test the proposed hypotheses in pls (henseler et al., 2009; hair et al., 2014). after the generation of the path coefficients, each path coefficient can be evaluated in terms of its significance through the bootstrapping method that computes t-values. on the whole, the statistical tests were assessed at the significance level of 5% through the use of two-tailed ttests as the entire hypotheses were proposed in a two-directional manner. the structural model estimates results are listed in table 2. table-2. path coefficients and significant level of structure model construct β t statistics p value entrepreneurial networks eno – sbp 0.196 2.906 0.003 government intervention (eno)—(gi) — (sbp) 0.542 1.155 0.24 the path coefficients of the relationship among constructs are displayed, wherein the path form entrepreneurial networks to small business owners’ performance is positive and insignificant at (β= 0.196; p < 0.01). this reveals that as entrepreneurial networks increases, the performance increased with it and therefore, h1 is supported. a similar finding was obtained for government intervention in the interaction effect, the result of the pls indicates that the estimated model fits the data well, wherein the r² for small business performance was found to be 0.171, which indicates moderate variance explained by the independent variables. furthermore, table 3 reveals that the research model was capable of explaining 17.1% of the total variance in small business performance, indicating that exogenous variables (entrepreneurial networks and government intervention) jointly explain 17.1% of the dependent variable (small business owners’ performance). table-3. variance explained in the endogenous latent variables latent variable variance explained r2 small business owners’ performance %17.1 a positive relationship was found between entrepreneurial networks and small business owners’ performance that decreases when government intervention is high, but the interaction was insignificant at (standardized β= 0.542, p > 0.10), negating the presence of a moderating effect. and as such h2 is not supported. 7. conclusion as the firm operates in a social context that may significantly impact its behavior and performance. however, a social network wherein the firm is integrated into also comprises resources and capabilities that can be considered as critical success factors for the firm. the relational and structural integration of the networks is significant drivers of firm performance. furthermore, networks consist of a combination of strong and weak ties that can boost the economic performance of the owners. as such, managers and academicians are expanding efforts to understand the effects of networking on the performance of the firm. most theoretical and empirical work dedicated to networks in entrepreneurship sought to explain the way networks impact the process of entrepreneurship and the way they result in superior firm outcomes, and the way entrepreneurial process and outcomes impact the network development as time passes. 8. the study implications the study‘s conceptual framework was developed on the 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http://dx.doi.org/10.1016/j.jbusvent.2004.01.001 https://scholar.google.com/scholar?hl=en&q=benefiting%20from%20network%20position:%20firm%20capabilities,%20structural%20holes,%20and%20performance http://dx.doi.org/10.1002/smj.482 https://scholar.google.com/scholar?hl=en&q=entrepreneurship's%20next%20act http://dx.doi.org/10.5465/amp.2010.0149 http://dx.doi.org/10.5465/amp.2010.0149 197 © 2019 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 6, no. 2, 197-204, 2019 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2019.62.197.204 © 2019 by the authors; licensee asian online journal publishing group macroeconomic effect of foreign aid joseph olarewaju afolabi1 justine tochukwu nwanekwere2 ( corresponding author) 1,2nigerian institute of social and economic research, nigeria. abstract the study examines the linear and non-linear macroeconomic effect of foreign aid in nigeria between 1970 and 2017. the macroeconomic variables considered include real gdp per capital growth, investment, real interest rate and consumer price index. it adopts the linear and nonlinear ardl estimation techniques. the linear regression results show foreign aid to have no significant effect on welfare, measured by rgdppc in the short-run and long-run. on investment however, foreign aid exerts significant positive influence both in the short-run and long-run and the impact of foreign aid on real interest rate and consumer price index is felt more in the longrun, than in the short-run. looking into the asymmetry relationship, it was found that increase in aid significantly reduces welfare in nigeria and decrease in aid significantly increases welfare and both positive and negative changes in aid have no significant effect on investment. real interest rate is unaffected by increase in aid, but significantly affected by decrease in aid. consumer price index is significantly affected by both positive and negative change in aid in short run and long run. keywords: foreign aids, macroeconomics, long-run, short-run ardl, nardl. jel classification: c13, f35, f41, o11. citation | joseph olarewaju afolabi; justine tochukwu nwanekwere (2019). macroeconomic effect of foreign aid. asian journal of economics and empirical research, 6(2): 197-204. history: received: 3 september 2019 revised: 7 october 2019 accepted: 11 november 2019 published: 20 december 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 198 2. literature review .......................................................................................................................................................................... 198 3. methodology ................................................................................................................................................................................... 199 4. empirical findings ........................................................................................................................................................................ 201 5. conclusion ....................................................................................................................................................................................... 203 references ............................................................................................................................................................................................ 203 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.62.197.204&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1175 https://orcid.org/0000-0002-7752-1459 https://orcid.org/0000-0001-7677-9098 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1175 https://orcid.org/0000-0002-7752-1459 https://orcid.org/0000-0001-7677-9098 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1175 https://orcid.org/0000-0002-7752-1459 https://orcid.org/0000-0001-7677-9098 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1175 https://orcid.org/0000-0002-7752-1459 https://orcid.org/0000-0001-7677-9098 asian journal of economics and empirical research, 2019, 6(2): 197-204 198 © 2019 by the authors; licensee asian online journal publishing group contribution of this paper to the literature the study contributes to the existing literature by examining the linear and non-linear macroeconomic effect of foreign aid in nigeria between 1970 and 2017. 1. introduction foreign aid and intervention is becoming more popular than ever in the wake of the sustainable development goals (sdgs) targeted at 2030, especially to developing countries. some arguments have been made for foreign aid as indispensable for developing countries, particularly at the early stage of development. rostow, in his five stages of development theory argues implicitly that poor countries cannot take-off to development without help from advanced countries in the form of aid and assistance. burnside and dollar (2000) corroborate this that financial constraint in developing countries may hamper their potential capacity for desired growth, thus, foreign aid and assistance may be away out of the fiscal impasse. however, in the case of nigeria, available statistics does not support this claim. nigeria within 1970 and 1990 had enjoyed official development assistance (oda) in the range of $10.62 million and $118.88 million. by 2010, nigeria received a sum in total of $846.04 million, and $1, 742.68 million in 2017 (organization for economic corporation and development (oecd), 2019). despite these large sums received in the form of aids and assistance from advanced countries, nigeria still wallows in poverty and perpetually experiences economic downturn. in 2018, nigeria records the highest number (about 91.8 million) of extremely poor people in the world, it records negative growth of real gdp per capital for 2015, 2016 and 2017 (wdi, 2018) and unemployment rate stood at 21.3% (nbs, 2018). in a bid to ameliorate the demeaning economic situation, the government of nigeria has embarked on various journeys to advance countries seeking one form of aid or the other. report has it that the president of nigeria, since 2015 has spent 404 days in 33 different countries, across four continents (punch newspaper, 2019). other than the available statistics indicting foreign aids against development in nigeria, empirical investigations into this issue have produced a mixed result. while findings from the works of burnside and dollar (2000); chauvet and ehrhart (2018); harb and hall (2018) present that foreign aid positively motivate growth and development, evidences from works of djankov et al. (2008) claim that foreign aid has a negative effect on institution and development in general. in fact, they assert that foreign aid is a bigger curse than oil in developing countries. sachs and warner (2001) link foreign aid with natural resources, claiming that they share common characteristics; they can both be appropriated by corrupt politicians without having to resort to less profitable measure like taxation. feeny and de silva (2012) explained that macroeconomic impact of official development assistance depends on how these are channeled to the development activities. they pointed out factors like good governance, socio-political condition of the country as germane to the effectiveness of foreign aid on macroeconomic variables. but beyond these empirical results is an underlying conspiracy theory that aids from advance countries come with ulterior motives. that in most cases, these aids and assistance comes with political conditionality which allows the donor country to profit from their donations to the developing countries. in fact, perkins (2004) in his confession of an economic hit-man claimed that, those aids are meant to subject the developing countries to the bidding of the donor countries. after all, he who plays the piper dictates the tune. empirically understanding the macroeconomic impact of foreign aid in nigeria is very important because this will help the government evaluate their stance on foreign aid. if it is found to have positive impact on macroeconomic variables, the government would encourage foreign aid and seek a better use to it, but if is found deleterious, the government should discourage it no matter how tempting, and look for better ways of achieving macroeconomic objectives. therefore, this paper seeks to empirically investigate the macroeconomic impact of foreign aid in nigeria between 1970 and 2017. this paper is unique because, to the best of knowledge, it is the first paper to looks at the short-run and longrun symmetric and asymmetric impact of foreign aid on macroeconomic variables like real gdp per capita growth, investment, inflation and interest rate at disaggregate level. although, scholars like djankov et al. (2008) (on 108 countries) and harb and hall (2018) (0n 25 developing countries) examined the asymmetry effect of aids, their studies focus on aids at panel level, making it difficult to assess the individual effect of aid on the countries assessed. 2. literature review theoretical trajectories have tried to explain the linkage between foreign aid and macroeconomic performance, but this study focuses on the dual-gap theory. though the gap theory is old and unpopular in academic literature, it is still relevant and widely used by policymakers today (elphas, 2009; philip, 2012). the dual-gap model was developed by chenery and strout (1966) based on the harrod–domar growth model. the model identified two gaps that are peculiar to developing countries which support official development assistance (oda) as the necessary option. poor countries are always faced with low savings and foreign exchange constraints which create a gap that is filled with foreign aid (philip, 2012). a savings gap arises when the domestic savings is less than what is required for investment to achieve the targeted growth rate. similarly, a foreign exchange gap occurs when the net receipts of exports of a country falls short of the foreign exchange requirements (jhingan, 2004). the model assumed that growth was constrained by the insufficiency of capital despite the excess labor supply. capital availability depends on the level of savings which could be supplemented through foreign aid, thus increasing investment and leading to growth. also, growth is constrained by the shortfall of capital goods for investment in developing countries. insufficient export earnings necessary for the importation of capital goods create a foreign exchange gap which can be filled with foreign aid1. the empirical findings on this issue show that the macroeconomic effective of foreign aid remains a controversial issue in macroeconomics debate. studies by hansen and tarp (2000); hermes and lensink (2001); morrissey (2001); mcgillivray (2003) and mcgillivray et al. (2005) have tried to investigate the progress made in the literature on the macroeconomic effect 1 see chenery and strout (1966); mckinnon (1964) and chenery and bruno (1962) for the full structure of the model. asian journal of economics and empirical research, 2019, 6(2): 197-204 199 © 2019 by the authors; licensee asian online journal publishing group of foreign aid over time. mcgillivray et al. (2005) examined the foreign aid-growth controversy for the past 50 years. guillaumont and wagner (2014) and quibria (2014) had more comprehensive recent reviews on the macroeconomic effectiveness of foreign aid on poor countries with high recipient of foreign aid. two opposing groups have emerged in the debate concerning the effectiveness of foreign aid on macroeconomic variables. on the one hand, some scholars have argued that foreign aid has no positive macroeconomic effect on the economy; hence has caused more harm to poor countries over time (burnside and dollar, 2000; moyo, 2010; easterly, 2014). according to this view, official aid promotes dependency, creates room for corruption, and encourages currency overvaluation, among recipient countries (sebastian, 2014). on the other hand, scholars like sachs (2005;2009) and stiglitz (2002); doucouliagos and paldam (2008) argued that foreign aid can help boost macroeconomic performance of poor countries. according to these scholars, increase in foreign aid, especially special interventions, could be effective in reducing poverty and improving living standard. albiman (2016) investigated the impact of foreign aid on economic growth in tanzania, using dynamic ordinary least square (dols) with data from 1976 to 2014. he found that foreign aid has negative impact on economic growth. also, the further revealed that there is no causal relationship between foreign aid and economic growth in short run. similar study was conducted by philip (2012) in sierra leone, adopting ardl model and johansen maximum likelihood. the study revealed that foreign aid has a significant impact on economic growth in the country. the study further showed that aid is more effective during the post-war period than the pre-war period. hence, the impact of aid on the economy may change with time. another study by girijasankar (2008) examined the effectiveness of foreign aid on macroeconomic performance in the six poorest and highly aid dependent african countries (central african republic, malawi, mali, niger, sierra leone and togo). the study used cointegration analysis and the found that a long run relationship exists between per-capita real gdp, aid as a percentage of gdp, investment as a percentage of gdp and openness. however, the long run effect of foreign aid on growth was found to be negative for most of these countries (girijasankar, 2008). elphas (2009) examined the effects of foreign aid on investment, macroeconomic policy environment and economic growth in kenya from 1966 to 2010. it employed the ardl estimation technique and found that foreign aid had a positive effect on public investment and economic growth. in addition, the lagged effects of foreign aid are positively related with public investment and economic growth after one year and negatively thereafter (elphas, 2009). herzer and morrissey (2011) investigated the long-run aid effectiveness on macroeconomic variables using data from 59 developing countries over the period 1971 to 2003. their study argued that the effect of aid on economic growth depends on the trade-off a country chooses to make. furthermore, they found that aid has a direct positive effect on the economy through financing investment, but could have an indirect negative effect on aggregate productivity (herzer and morrissey, 2011). a panel study on 20 sub-saharan african countries by salisu and ogwumike (2010) using ols and tsls, concluded that foreign aid is effective in countries with sound macroeconomic policy environment. however, quibria (2014) and rajan and subramanian (2011) argued contrarily that there is no clear relation between more aid and faster growth, irrespective of better macroeconomic policy environment and stronger institutions. 3. methodology the study adopts the auto-regressive distributive lag (ardl) model and the non-linear auto-regressive distributive lag (nardl) to investigate the linear and non-linear relationship between the various series of interest. the ardl method was developed by pesaran et al. (2001) and suggests it can estimate both short run and long run relationships among the series in a model in one step simultaneously. it is adjudged efficient in establishing linear relationships between variables of mixed order of stationarity, usually, i(0) and i(1) series, but cannot accommodate i(2) variables. in other to confirm the existence of a long run relationship, pesaran et al. (2001) presented a bound test approach to testing for cointegration in the model. the model is said to be cointegrated when the f-statistics from the bound test exceeds the upper bound limit of the test. also, the error correction mechanism component of the model which shows the speed of adjustment of any disequilibrium in the model is expected to be negative, less than one and statistically significant. the linear ardl model, given variable x and y is given bellow: = ∑ + ∑ + (1) re-specifying the model, we have: = + + ∑ + ∑ + (2) = ∑ + ∑ + (3) equation 1 expresses the relationship between x and y in ardl form. ardl expresses dependent variable (y) as a function of its lag and lags of other independent variables (x). equation 2 extends equation 1 to capture the short-run and long-run relationships between the variables. represent the long-run parameters, while k, measure the short run relationship in the model. equation 3 simplifies equation 2 such that = + ( ) , based on the assumption that in the long-run, and = . captures the error term in the model. while pesaran et al. (2001) developed ardl to capture short-run and long-run linear relationships among series, shin et al. (2014) modified the model to reflect non-linearity in relationship among variables, siting that, often time, relationship among variables are not linear. thus, non-linear ardl was introduced to capture both short run and long run asymmetries, without compromising the merit of standard ardl model. the model measures both the positive and negative relationship in a model, by identifying the positive and negative effect. given variable x, it can be decomposed into positive and negative as follow: = ∑ = ∑ ( ) (4) = ∑ = ∑ ( ) (5) asian journal of economics and empirical research, 2019, 6(2): 197-204 200 © 2019 by the authors; licensee asian online journal publishing group equation 4 and 5 shows the decomposition of variable x into negative changes and positive changes. represents positive changes in x and denotes negative changes in x. from equation 4 the maximum value between is considered as positive changes in x and in equation 5, the minimum value between is taken to be negative changes in x. is the partial sum of positive changes in x and is the partial sum of negative changes in x. hence, a non – linear ardl model is specified as follow, given variable x and y: = + ∑ + ∑ + ∑ + + + (6) equation 6 shows the specification of the ardl model in non-linear form to accommodate the effect positive and negative changes of x on y. and symbolize the positive and negative changes of x in the model. 3.1. model specification in other to achieve the objectives of this paper, we specify four models to capture the asymmetry and nonasymmetry effect of foreign aid on selected macroeconomic variables. the models are specified as follow: rgdp = f (foreign aid, external debt, real interest rate, exchange rate) (7) investment = f (foreign aid, real interest rate, exchange rate) (8) real interest rate = f(foreign aid, money supply, exchange rate) (9) consumer price index = f(foreign aid, external debt, rgdp per capital, money supply) (10) equation 7, 8, 9 and 10 is specified to capture the effect of foreign aid on selected macroeconomic variables. equation 7 expresses national output (rgdp) as a function of external debt, real interest rate and exchange rate, equation 8 functioned investment as a function of foreign aid, real interest rate and exchange rate, 9 specifies real interest rate as a function of foreign aid, money supply and exchange rate, while 10 shows consumer price index to be a function of foreign aid, external debt, rgdp per capita and money supply. re-paramatizing the model for linear ardl; = + + + + + ∑ + ∑ +∑ ∑ + ∑ (11) = + + + + ∑ + ∑ + ∑ + ∑ (12) = + + + + ∑ + ∑ +∑ ∑ + (13) = + + + + + ∑ + ∑ +∑ ∑ + ∑ (14) equation 10 to 14 represent the re-parametized form of model 7 to 10 in linear ardl form, expressing the dependent variables (rgdp, investment, real interest rate and consumer price index) as a function of their lag values (dependent variables) and the lag values of the independent variables. parameters , capture the short-run linear relationships, while parameters , , and are long-run linear parameters. re-paramatizing the model for non-linear ardl; = + + + + ∑ + ∑ + ∑ ∑ ∑ + ∑ (15) = + + + ∑ + ∑ + ∑ ∑ + ∑ (16) = + + + + + ∑ + ∑ + ∑ ∑ ∑ + ∑ (17) = + + + ∑ + ∑ + ∑ ∑ + ∑ (18) equation 15 to 18 represent the re-specification of model 7 to 10 in a non-linear ardl form to capture the non-linear relationships in the model. the variable with + and – capture the effect of positive and negative changes in foreign aid on each of the dependent variable. parameters capture the short-run non-linear relationships, while parameters j are long-run non-linear parameters. 3.2. data the data for the study were sourced from oecd (2019) and wdi (2018). the variables include; foreign aid: this is measured by the sum of the official development assistance (oda) received in nigeria. the oda is the total aid flow that is accrued to a country in a given year. this data was sourced from the oecd (2019). asian journal of economics and empirical research, 2019, 6(2): 197-204 201 © 2019 by the authors; licensee asian online journal publishing group investment: this is measured by gross fixed capital formation (gfcf). gfcf measures the net increase in tangible asset within a given period. the net increase in tangible asset interprets investment less disposal and does not include capital consumption or land purchased. the data was sourced from wdi (2018). real gdp: this is measured by the total value of all goods produced and services rendered at a constant price within nigeria over a given period, usually a year. the data was sourced from wdi (2018). real interest rate: this measure the real cost of capital. it is the cost of borrowing after adjusting for inflationary effect. the data was sourced from wdi (2018). exchange rate: this measure the average rate at which naira exchanges for dollar in a year. the data was sourced from wdi (2018). external debt: this measures the total borrowings of the government in dollars within a given period, usually a year. the data was sourced from wdi (2018). consumer price index (cpi): this measures the average changes overtime in consumer baskets of goods and services. the data was sourced from wdi (2018). money supply (ms): this measures the total volume of money in circulation in local currency. this is defined in terms of broad money. that is, local money in circulation plus demand deposit, savings and fixed deposit. 4. empirical findings table-1. summary of unit root test result. augmented dicky-fuller (adf) phillips-perron (pp) variables level first difference level first difference i(d) exchr -0.2603 -4.3106*** 0.1646 -4.3044*** i(1) extdebt -1.998 -4.4840*** -1.7153 -4.3695*** i(1) gdpg -5.5724*** -5.5745*** i(0) grant -4.7357*** -3.9300** i(0) rgdppc -5.5676*** -5.5714*** i(0) rintr ms -6.2604*** -3.6804** -6.2155*** -2.0668 -3.5988** i(0) i(0)/i(1) note: nb: ***, **, and *, represent significance levels at 1%, 5% and 10%, respectively. table 1, shows that the variables are stationary in mixed order of i(0) and i(1). this informs us of the nature and degree of predictability of the variables in the model. this informs the conduct of bound test as prescribed by pesaran et al. (2001) to check for the existence of long run relationship between the variables. this is presented in table 2. table-2. bound test. bound test test statistic value k model 1 f-statistic 6.015389 4 model 2 f-statistic 11.08556 4 model 3 f-statistic 12.34779 4 model 4 f-statistic 32.47732 4 critical value bounds significance i0 bound i1 bound 10% 2.45 3.52 5% 2.86 4.01 2.50% 3.25 4.49 1% 3.74 5.06 from table 2, the bound test confirms the existence of long run relationship between in the models. i0 represent the lower bound and i1, the upper bound. as explained by pesaran et al. (2001) long run relationships exist in a model if the f-statistic exceeds the upper bound of the bound test result. the models are bounded and exhibit long run relationships. from the result obtained in table 3, the effect of grant on rgdppc is insignificant in both short run and long run. it shows an estimated negative coefficient of -0.0005 and -0.0007 in the short run and long run respectively, but these coefficients are insignificant. real interest rate is shown to have significant positive impact on rgdppc in the short and long run, while exchange rate has a significant negative effect on rgdppc in the short run and no significant effect in the long run. on investment, grant is shown to have a significant and positive impact in the short and long run. it shows that for every 1$ grant, it leads to approximately 0.0008 ngn and 0.0016 ngn increase in investment in nigeria in the short run and long run respectively. also, real interest rate exerts a positive and significant effect on investment in both short and long run. exchange rate have only negative and significant effect in the long run, in the short run, the effect is insignificant. on consumer price index, grant has no significant effect in the short run, but exerts a significant and positive effect in the long run. the result shows that a 1$ increase in grant leads to approximately 0.0088 ngn increase in consumer basket of commodity in the long run in nigeria. other significant variables influencing cpi in the model include money supply and exchange rate. asian journal of economics and empirical research, 2019, 6(2): 197-204 202 © 2019 by the authors; licensee asian online journal publishing group table-3. symmetry results. variables model 1 rgdppc model 2 investment model 3 cpi model 4 rintr d(foreign aid) -0.0005 (0.4033) 0.0008** (0.013) 0.0002 (0.5227) 0.0005 (0.5529) d(extdebt) 0.0000 (0.2253) 0.0000*** (0.0075) d(rintr) 0.1954*** (0.0006) 0.1032* (0.1084) d(exchr) -0.1341*** (0.0066) 0.05093 (0.1533) 0.0450 (0.2019) d(ms) 0.0000* (0.0921) 3.5045*** (0.0000) d(rgdppc) 0.428276 (0.1442) foreign aid -0.0007 (0.4071) 0.0016** (0.0219) 0.0088** (0.0214) 0.0027** (0.0306) extdebt 0.0000 (0.9143) 0.0000 (0.0024) rintr 0.6223*** (0.0016) 0.6132** (0.0314) ms 0.0000*** (0.0001) 1.2454*** (0.0007) rgdppc 0.133452 (0.7520) exchr -0.02143 (0.3918) -0.2491*** (0.0000) 0.2531*** (0.0000) c 3.9037 (0.1119) 45.2202*** (0.0000) -0.2454 (0.7182) -30.1712*** (0.0000) r-squared 0.65 0.97 0.99 0.86 cointeq(-1) normality test serial correlation test heteroscedasticity test ramsey test -0.7667 (0.81) (0.44) (0.34) 0.19 -0.4911 (0.01) (0.43) (0.58) 0.49 -0.362 (0.31) (0.65) (0.65) 0.49 -1.0347 (0.01) 0.06 (0.84) (0.36) note: nb: ***, **, and *, represent significance levels at 1%, 5% and 10%, respectively. the figures in parenthesis are p-value. table-4. asymmetry results. variables rgdppc model 5 investment model 6 rintr model 7 cpi model 8 d(foreign aid-positive) -0.0028** (0.0229) 0.0009 (0.6054) 0.0013 (0.3721) 0.0016*** (0.0002) d(foreign aidnegative) -0.0269** (0.0325) -0.0098 (0.3618) -0.0090** (0.0163) -0.0126*** (0.0028) d(extdebt) 0.0000** (0.0209) 0.0000 (0.2684) d(rintr) 0.2046*** (0.0015) 0.1149 (0.7511) d(exchr) -0.1421** (0.0186) 0.0847 (0.1886) 0.1585*** (0.0024) d(ms) 0.2887 (0.8370) 2.8845*** (0.0000) 0.0000 (0.3960) d(rgdppc) 0.4836* (0.077) foreign aid _pos -0.0097 (0.5939) 0.0019 (0.6212) -0.0076** (0.0599) -0.0140*** (0.0001) foreign aid _neg -0.0098 (0.6156) 0.0025 (0.5698) -0.0095** (0.0295) -0.0156*** (0.0001) extdebt 0.0000 (0.5817) 0.0000 (0.2252) rintr 0.5774** (0.0131) 0.2084** (0.0478) ms 0.7119 (0.3690) -0.0259 (0.9634) 0.0000*** (0.0000) rgdppc 0.3515 (0.4437) exchr 0.08348* (0.0627) -0.0415 (0.1912) 0.2155*** (0.0000) c 5.05315 (0.1173) -4.54594 (0.5892) -8.6560 (0.4283) -1.0744*** (0.0001) r-squared 0.81 0.99 0.97 0.99 note: nb: ***, **, and *, represent significance levels at 1%, 5% and 10%, respectively. the figures in parenthesis are p-value. results grant has no significant effect on real interest rate in the short run, but in the long run, it has a significant positive impact on real interest rate. this might not be unconnected with the positive effect of grant on cpi. increase in cpi increases inflation rate, and increase in inflation with a given nominal interest rate reduces asian journal of economics and empirical research, 2019, 6(2): 197-204 203 © 2019 by the authors; licensee asian online journal publishing group real interest rate. other factors that significantly influence real interest rate in the model include external debt, exchange rate and money supply. from table 4, in the short-run, the non-linear model reveals a significant and indirect relationship between an increase in grant and rgdppc in nigeria. it shows that a $1 increase in grant reduces rgdppc by 0.0028ngn. conversely, a $1 decrease in grant increases significantly rgdppc by 0.0269. the negative sign with the coefficient (i.e. -0.0229) indicates a negative relationship between a unit decrease in grant and rgdppc. in the long-run however, both positive and negative changes in grant have no significant effect on rgdppc. on investment, for short-run, the result shows that both positive and negative changes in grant exert positive but insignificant effect on investment, however, the magnitude of the effect of negative change in grant (0.0098) exceeds that of positive change (0.0009). the long-run non-linear estimates provide similar result. the real interest rate model shows in the short-run a positive change in grant has no significant effect on real interest rate; however, a negative change in grant significantly increases real interest rate by 0.009%. in the long run however, a positive change in grant significantly reduces real interest rate by 0.0076%, while a negative change in grant significantly increases real interest rate by 0.0095%. model 8 presents both positive and negative changes in grant significantly positively affect cpi in the short run. in the long run however, a positive change in grant significantly reduces cpi by 0.0140 units and a negative change in grant increases cpi by 0.0156 units. 5. conclusion the study examines short-run and long-run linear and non-linear effect of foreign aid on gross domestic product per capita, investment, real interest rate and consumer price index. the linear regression results show foreign aid to have no significant effect on welfare, measured by rgdppc in the short-run and long-run. on investment however, foreign aid exerts significant positive influence both in the short-run and long-run and the impact of foreign aid on real interest rate and consumer price index is felt more in the long-run, than in the shortrun. the non-linear result on the other hand presents an interest result. increase in aid significantly reduces welfare in nigeria and decrease in aid significantly increases welfare and both positive and negative changes in aid have no significant effect on investment. real interest rate is unaffected by increase in aid, but significantly affected by decrease in aid. consumer price index is significantly affected by both positive and negative change in aid in short run and long run. from these findings, it is clear that foreign aids do more harm than good to nigerian economy. these findings are in consonant with the findings of sachs and warner (2001) and djankov et al. (2008). it is therefore recommended that instead in seeking for foreign assistance for growth, nigerian government should look inward to raise revenue needed for developmental projects. the government could implement an effective and efficient tax system to raise more revenue, cut down unnecessary recurrent government expenditure by closing down redundant ministry and parastatals and privatizing inefficient government establishment and even pursue the economic diversification. if foreign aid is however inevitable, then such fund should be properly managed by establishing strong institutions to administer the aids and the conditions to such aids should be critically examined. references albiman, m., 2016. what are the impact of foreign aid to the economic growth? time series analysis with new evidence from tanzania. business and economics journal, 7(3): 1-7.available at: https://doi.org/10.4172/2151-6219.1000237. burnside, c. and d. dollar, 2000. aid, policies, and growth. american 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article. 19 asian journal of economics and empirical research vol. 5, no. 1, 19-28, 2018 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2018.51.19.28 monetary policy rule and its performance under inflation targeting in thailand hiroyuki taguchi1  mesa wanasilp2 ( corresponding author) 1,2saitama university, japan abstract this article reviews the thailand monetary policy rule and its performance under the adoption of inflation targeting regime since 2000. the study estimates the policy reaction function to see if the inflation targeting has been linked with an inflation-responsive monetary policy rule, and investigates whether the monetary policy rule would actually have its transmission effect on inflation, through tracing the impulse responses of inflation rate to monetary policy shocks. the main findings are as follows. the estimation outcomes of the policy reaction function show that the thailand monetary policy rule is characterized as an inflationand exchange-rateresponsive rule with forward-looking manner, which is countercyclical against inflation in the long run, but is accompanied with slow adjustment toward a target policy rate. the impulse response analyses imply that the thailand monetary policy has only a marginal transmission effect on inflation probably due to the slow adjustment of policy rate. keywords: monetary policy rule, inflation targeting, the bank of thailand. jel classification: e52, e58, o53. citation | hiroyuki taguchi; mesa wanasilp (2018). monetary policy rule and its performance under inflation targeting in thailand. asian journal of economics and empirical research, 5(1): 19-28. history: received: 13 january 2018 revised: 24 january 2018 accepted: 26 january 2018 published: 30 january 2018 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 20 2. development of monetary policy framework in thailand .................................................................................................... 21 3. literature review and contributions .......................................................................................................................................... 22 4. empirical analyses .......................................................................................................................................................................... 22 5. concluding remarks ....................................................................................................................................................................... 27 references .............................................................................................................................................................................................. 28 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2018.51.19.28&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://orcid.org/0000-0002-6426-772x https://orcid.org/orcid-search/quick-search?searchquery=mesa wanasilp https://orcid.org/0000-0002-6426-772x https://orcid.org/orcid-search/quick-search?searchquery=mesa wanasilp https://orcid.org/0000-0002-6426-772x https://orcid.org/orcid-search/quick-search?searchquery=mesa wanasilp asian journal of economics and empirical research, 2018, 5(1): 19-28 20 1. introduction the bank of thailand has adopted “inflation targeting” as its monetary policy framework since may 2000.1 the background behind introducing inflation targeting lies in the currency crisis named “tom yum goong crisis” in july 1997. in this crisis thailand abandoned pegged currency regime and switched to floating exchange rate system. then it became necessary for the authority to identify a new policy anchor with a main objective of maintaining price stability. as mishkin (2000) argued, inflation targeting has become an alternative nominal anchor to stabilize inflation instead of pegged currency regime. the question then arises on how we can evaluate the inflation target that has been operated for around two decades since its adoption in thailand. in general, there seems to be a consensus in academic literature and policy discussions that inflation targeting has so far been successful to stabilize inflation in advanced economies with their long histories of its adoption since the 1990s (e.g. (mishkin and posen, 1998; mishkin and schmidt-hebbel, 2007)). as far as emerging market economies including thailand are concerned, however, there have been rather less evidence to support the performance of inflation targeting due to their relatively shorter histories of its adoption and to some difficulties in its management. the difficulties that emerging market economies have faced in operating their inflation targeting might come from exchange rate fluctuations for the following senses. first, inflation targeting can work well only when monetary autonomy is secured under floating exchange rate regime with capital mobility. emerging market economies have, however, the problem of a “fear of floating”, as suggested by calvo and reinhart (2002). it comes from a lack of confidence in currency value, especially given that their external debt is primarily denominated in us dollars. their efforts to avoid exchange rate volatility prevent their monetary authorities from concentrating fully on inflation targeting. second, as eichengreen (2002) argued, exchange rate fluctuation itself has large influence on domestic prices through the “pass-through” effect in small, open economies. it makes it difficult for the monetary authorities to control inflation and to perform inflation targeting well. there is, however, a counterargument against the pass-through effect on inflation targeting. gagnon and ihrig (2004) argued that an inflation targeting framework reduces the pass-through effect, in the sense that domestic agents are less inclined to change prices in response to a given exchange rate shock under the strong commitment of the monetary authority to price stability. another possible difficulty for inflation targeting management in emerging market economies is the lack of credibility of the central bank capacity. it might come from arbitrary policy reactions accompanied with unreliable inflation forecasting by the central bank as well as the economic uncertainty and volatility. as long as agents do not believe that the monetary authority will be successful in achieving the inflation target, it will be difficult for inflation targeting to have any significant impact on the expectations and behavior of the private sector with respect to wage and pricing contracts. as eichengreen (2002) emphasized, the lack of credibility would thus lessen inflation targeting performance. some studies, among the limited literature, have assessed inflation targeting in emerging market economies as “conditional” success. for example, mishkin (2000;2004) argued that the success of inflation targeting could not be solely attributed to the actions of the central bank, and that supportive policies such as the absence of large fiscal deficits and rigorous regulation and supervision of the financial sector were crucial to its success. lin and ye (2009) also noted that the performance of inflation targeting could be affected by a country’s characteristics such as the government’s fiscal position, the central bank’s desire to limit movements of the exchange rate and its willingness to meet the preconditions of policy adoption. ito and hayashi (2004) presented the following two recommendations on inflation targeting management, considering the characteristics of emerging market economies: 1) emerging market countries should set an inflation with target central rate slightly higher and with a target range slightly wider than a typical advanced country; (2) small, open economies may pursue both an inflation target range and an implicit basket band in exchange rate regime, as both targets are expressed in a range (the targets work as the source of stability in expectations, while the ranges allow some flexibility). thailand is not an exception in facing the aforementioned difficulties and conditional success in inflation targeting operation as one of emerging market economies. this article, in this context, reviews the monetary policy rule and its performance under inflation targeting framework focusing on thailand. the study first estimates the policy reaction function to see if the adoption of inflation targeting has been linked with a monetary policy rule emphasizing on inflation stabilization. the study then investigates further whether the monetary policy rule would actually have its transmission effect on inflation, through tracing the impulse responses of inflation rate to monetary policy shocks in vector autoregressive (var) and structural var (svar) models. the rest of the paper is structured as follows. section 2 describes the historical development of monetary policy framework in thailand. section 3 reviews previous studies on the assessment of thailand monetary policies and clarifies this paper’s contribution. section 4 conducts the empirical analyses, describing the data, the methodology, and the estimation results and their interpretations. section 4 summarizes and concludes. 1 the essence of inflation targeting framework was clearly described in bernanke and mishkin (1997) and bernanke, laubach, mishkin and posen (1999) for instance. asian journal of economics and empirical research, 2018, 5(1): 19-28 21 2. development of monetary policy framework in thailand this section first describes the short history of the monetary policy framework after the second world war in thailand, and then reviews the progress in inflation targeting setting since may 2000.2 the long-term development of the monetary policy framework in thailand can be divided into the following three periods. the first is the period of pegged exchange rate regime from the second world war to june 1997. under this regime, the value of local currency named “bath” was pegged either to gold, a major currency, or a basket of currencies. the second is the period of monetary targeting regime from july 1997 to may 2000. after the adoption of the floating exchange rate system on july 2, 1997, under the financial assistance program by the international monetary fund (imf) during the crisis time, the bank of thailand targeted domestic money supply in such a way that the bank set the daily and quarterly monetary base targets to stabilize financial markets. the third is the period of inflation targeting regime from may 2000 to present. since the relationship between money supply and output growth became less stable over time after the financial crisis, the bank adopted inflation targeting instead of monetary targeting in may 2000, together with the exit of the imf program. at the same time, the bank introduced the policy rate as an operational instrument for managing inflation targeting, so that the policy rate can affect real economy through transmission channels. the bank of japan has upgraded the framework of inflation targeting since its adoption in the following way (the process is displayed in figure 1). at the initial stage from may 2000 to august 2009, the core-inflation targetrange at between 0.0-3.5 percent was set based on the income ability of various groups of people and on the consistency with inflation of thailand’s trading partners for keeping price competitiveness. the “core” inflation is expressed by the year-on-year percentage change in the consumer price index (cpi) that excludes fresh food and energy prices. the rationale for excluding these prices is that they are highly volatile in the short run as a result of factors beyond the control of monetary policy. the range target helps cushion temporary economic shocks and minimize the need for the authority to adjust monetary policy stances frequently. the core inflation rate had been assessed by not monthly but quarterly average to avoid the indicator’s volatility. figure-1. progress in inflation targeting framework source: author’s description based on the website of the bank of thailand the second stage from september 2009 to january 2015 narrowed the target range from 0.0-3.5 percent to 0.53.0 percent. the lower bound of the range was adjusted upwards by 0.5 percent to reduce the probability of deflation, while the upper bound was lowered by the same amount to signal no change in the overall monetary policy stance. at the current phase from january 2015 to present, the new target has been set for the annual average of headline inflation to be at 2.5 percent with a tolerance band of ± 1.5 percent. the rationale of adopting “headline” inflation instead of “core” inflation is that the headline inflation is better in reflecting more accurately the change in the cost of living, since it captures changes in prices of all goods and services in the cpi basket. changing from the target range of 0.5-3.0 percent to point target at 2.5 percent with a band of ± 1.5 percent gives a clearer policy signal to the public. the point target helps anchor long term inflation expectation more effectively, while the tolerate band provides some flexibility to absorb temporary shocks. giving the forward-looking nature of monetary 2 the description of this section is based on the website of the bank of thailand. see: https://www.bot.or.th/english/monetarypolicy/monetpolicyknowledge/pages/default.aspx asian journal of economics and empirical research, 2018, 5(1): 19-28 22 policy, the time horizon for targeting has expanded from quarterly to annual average which is better attuned with the 1-2 year time lag before the monetary policy gains its policy impact on the economy. 3. literature review and contributions this section reviews previous studies on the assessment of thailand monetary policy and clarifies this paper’s contributions. we confine the reviews to the empirical studies with the sample data covering the period after 2005, namely the period enough to assess the inflation targeting of thailand that was initiated in may 2000. the number of the reviewed articles would, therefore, be quite limited. the literature can be classified into the studies of monetary policy rule and those of policy transmission effect on inflation. regarding the literature on monetary policy rule in thailand, hsing (2009) simply estimated monetary policy reaction functions for thailand with the sample period from the first quarter of 1993 to the second quarter of 2007 as well as for indonesia, malaysia and the philippines, and verified the existence of inflation-responsive rule in the contemporaneous manner. this study, however, focused only on the comparison of rules among four economies above, and did not imply any linkage with inflation targeting framework. taguchi and kato (2011) tried to evaluate the inflation targeting implementation for thailand by examining its monetary policy rule with the sample period from the second quarter of 2000 to the fourth quarter of 2009, together with the cases for indonesia, korea and the philippines. by estimating a policy reaction function, the study identified the inflation-responsive but backwardlooking monetary policy rule for thailand. as the more recent study, lueangwilai (2012) also analyzed monetary policy implementation under the inflation targeting in thailand during the period from june 2000 to june 2011, by applying the bayesian maximum likelihood estimation to a small, open economy model. the study considered exchange rate movement as a determinant factor of the policy rule and took into account the various types of the rule in the time horizon: contemporaneous, backward-looking and forward-looking. its main finding was that the contemporaneous rule responding to inflation and exchange rate movement well characterized the policy rate set by the bank of thailand. as for the studies of policy transmission effect on inflation, taguchi and kato (2011) again, by confirming the inflation-responsive but backward-looking monetary policy rule under the inflation targeting in thailand, investigated its policy effect on inflation during the same period from the second quarter of 2000 to the fourth quarter of 2009, and could not find any significant impulse response of inflation rate to a monetary policy shock. as the more recent studies for thailand, phiromswad (2015) and arwatchanakarn (2017) examined monetary policy transmission mechanism by using structural var model, and found a policy channel to price level and output, respectively. since the sample period of phiromswad (2015) is from the first quarter of 1999 to the fourth quarter of 2011 and the one of arwatchanakarn (2017) is from the third quarter of 1997 to the fourth quarter of 2014, however, their studies are not necessarily linked with the adoption of inflation targeting framework in thailand. this study contributes to the reviewed literature above on the assessment of thailand monetary policy as follows. first, this study updates the assessment of thailand monetary policy with a focus on its inflation targeting by extending the sample period from the second quarter of 2000 (the starting time of inflation targeting) to the second quarter of 2017. in particular, covering the period after 2015 as the analytical sample is significant enough to evaluate the inflation targeting, since the bank of thailand transformed its framework in january 2015 from the range target of 0.5-3.0 percent to the point target at 2.5 percent with a band of ± 1.5 percent to provide a clearer policy signal to the public as mentioned in section 2. any of studies in the aforementioned literature did not cover this critical period for assessing the inflation targeting. second, this study combines the analysis of monetary policy rule with the one of its transmission effect to provide a comprehensive evaluation for the inflation targeting. in the reviewed literature, it was only taguchi and kato (2011) that combined two kinds of analyses, whereas the other studies dealt with them separately. in this sense, the major role of this study is to update (taguchi and kato, 2011) by including the new phase of the inflation targeting in thailand as the sample period. 4. empirical analyses this section conducts the empirical analyses in order to examine the monetary policy rule and its performance under inflation targeting framework focusing on thailand. for examining the monetary policy rule, the study estimates the policy reaction function to see if the adoption of inflation targeting has been linked with an inflationresponsive monetary policy rule. the study then investigates further whether the monetary policy rule would actually have its transmission effect on inflation, through tracing the impulse responses of inflation rate to monetary policy shocks in var and svar models. the analyses here sample the quarterly data running from the second quarter of 2000 to the second quarter of 2017 during which the bank of thailand has operated the inflation targeting and has also upgraded it. the source of all the data used for the subsequent estimations is the international financial statistics (ifs) of the international monetary fund (imf).3 the analytical indicators are selected as follows: “central bank policy rate” for policy interest rate (denoted by por); “consumer prices index (2010=100)” for price index, which is transformed into its year-on-year change rate as inflation rate for the estimation (π); “gross domestic product (gdp), volume, seasonally adjusted (2010=100)” for gdp, which is further processed into gdp gap (gap) by subtracting from the gdp a hodrick-prescott-filter of that series as a proxy of potential gdp level; and “national currency per us dollar, period average” for exchange rate, which is expressed as its year-on-year change rate (exr). the combination between policy interest rate and the other variables of inflation rate, gdp gap and exchange rate, are simply displayed in figure 2. this observation itself does not tell us clear correlations and causalities in any combinations, and so should be statistically tested in the more sophisticated ways in the later sections. 3 the data are retrieved from the website: http://www.imf.org/en/data. asian journal of economics and empirical research, 2018, 5(1): 19-28 23 table-1. unit root test note: ***, ** denote the rejection of null hypothesis at the 99% and 95% level of significance. sources: ifs of imf before conducting the estimations below, we investigate the stationary property of the data for each variable, by employing the ng-perron unit root test4 on the null hypothesis that each variable has a unit root in the test equation including “intercept”. this test constructs four test statistics: modified forms of phillips and perron (1988) statistics (mza, mzt), the bhargava (1986) statistic (msb), and the point optimal statistic (mpt). table 1 reports the test results for the data for all the indicators, i.e., policy interest rate (por) for its level data; and inflation rate (π), gdp gap (gap) and exchange rate (exr) for their level and first difference data. the test rejected a unit root in all the data at the conventional level of significance by more than 95 percent, thereby their data showing stationary property. thus their data are justified to be used for the subsequent estimations. figure-2. observation of analytical indicators source: ifs of imf 4.1. policy reaction function the policy reaction function is one of the useful analytical tools to describe a monetary policy rule in practices managed by a central bank. its standard specification is that a central bank adjusts the nominal policy interest rate in response to the gaps between expected inflation and output, and their respective targets. it can be interpreted as a more generalized rule of the taylor rule (see taylor (1993)) – the simple backward-looking reaction function. the estimable policy reaction functions were presented for the first time by clarida and gertler (1997) for bundesbank monetary policy, clarida et al. (1998a) for the us monetary policy, and clarida et al. (1998b) for monetary policies of two sets countries: the g3 (germany, japan, and the us) and the e3 (uk, france, and italy). 4 ng and perron (2001) introduced a new unit root test, which used detrended data and a lag selection procedure that improved on previous methods. mza mzt msb mpt por -11.200 ** -2.361 ** 0.210 ** 2.206 ** π -33.932 *** -4.107 *** 0.121 *** 0.756 *** gap -18.766 *** -3.063 *** 0.163 *** 1.305 *** exr -31.299 *** -3.947 *** 0.126 *** 0.807 *** mza mzt msb mpt d(π) -52.474 *** -5.089 *** 0.096 *** 0.548 *** d(gap) -33.291 *** -4.063 *** 0.122 *** 0.786 *** d(exr) -16.941 *** -2.894 *** 0.170 *** 1.506 *** -4.0 -2.0 0.0 2.0 4.0 6.0 8.0 10.0 20 00 q 2 20 00 q 4 20 01 q 2 20 01 q 4 20 02 q 2 20 02 q 4 20 03 q 2 20 03 q 4 20 04 q 2 20 04 q 4 20 05 q 2 20 05 q 4 20 06 q 2 20 06 q 4 20 07 q 2 20 07 q 4 20 08 q 2 20 08 q 4 20 09 q 2 20 09 q 4 20 10 q 2 20 10 q 4 20 11 q 2 20 11 q 4 20 12 q 2 20 12 q 4 20 13 q 2 20 13 q 4 20 14 q 2 20 14 q 4 20 15 q 2 20 15 q 4 20 16 q 2 20 16 q 4 20 17 q 2 por (policy interest rate) π (inflation rate) -10.0 -8.0 -6.0 -4.0 -2.0 0.0 2.0 4.0 6.0 20 00 q 2 20 00 q 4 20 01 q 2 20 01 q 4 20 02 q 2 20 02 q 4 20 03 q 2 20 03 q 4 20 04 q 2 20 04 q 4 20 05 q 2 20 05 q 4 20 06 q 2 20 06 q 4 20 07 q 2 20 07 q 4 20 08 q 2 20 08 q 4 20 09 q 2 20 09 q 4 20 10 q 2 20 10 q 4 20 11 q 2 20 11 q 4 20 12 q 2 20 12 q 4 20 13 q 2 20 13 q 4 20 14 q 2 20 14 q 4 20 15 q 2 20 15 q 4 20 16 q 2 20 16 q 4 20 17 q 2 por (policy interest rate) gap (gdp gap) -15.0 -10.0 -5.0 0.0 5.0 10.0 15.0 20.0 20 00 q 2 20 00 q 4 20 01 q 2 20 01 q 4 20 02 q 2 20 02 q 4 20 03 q 2 20 03 q 4 20 04 q 2 20 04 q 4 20 05 q 2 20 05 q 4 20 06 q 2 20 06 q 4 20 07 q 2 20 07 q 4 20 08 q 2 20 08 q 4 20 09 q 2 20 09 q 4 20 10 q 2 20 10 q 4 20 11 q 2 20 11 q 4 20 12 q 2 20 12 q 4 20 13 q 2 20 13 q 4 20 14 q 2 20 14 q 4 20 15 q 2 20 15 q 4 20 16 q 2 20 16 q 4 20 17 q 2 por (policy interest rate) exr (exchange rate) asian journal of economics and empirical research, 2018, 5(1): 19-28 24 among them, clarida et al. (1998b) demonstrated the most comprehensive estimation of policy reaction functions. for estimating the g3 monetary policy rules, they took the forward-looking specification as the baseline and the backward-looking function as the alternative for their comparison, and they found that the g3 pursued forwardlooking rules, responding to anticipated inflation as opposed to lagged inflation. as for the e3 estimation, they added such explanatory terms as german interest rate and exchange rate in their functions, to examine how the constraints of the european monetary system that collapsed in late 1992 influenced the e3 monetary policy rules. this study applies the methodology of clarida et al. (1998b) to estimate the policy reaction function for thailand during the second period from quarter of 2000 to the second quarter of 2017. the analysis employs both of forward-looking and backward-looking specifications for the estimation, since emerging market economies including thailand may face the difficulties in forecasting inflation rate as eichengreen (2002) suggested. in fact, the previous studies such as taguchi and kato (2011) and lueangwilai (2012) identified backward-looking and contemporaneous rules for the thailand monetary policy. the analysis also includes the exchange rate term as one of the monetary policy determinants, since emerging market economies including thailand may fall into a “fear of floating” as calvo and reinhart (2002) suggested. the original policy reaction function presented by clarida et al. (1998b) is shown as the following equation (1). ̅ ( [ | ] ) ( [ | ] ) (1) where is a target for the nominal short-term interest rate; ̅ is the long-run equilibrium nominal interest rate; is the inflation rate at the period t+n; is the real output, and are respective bliss points for inflation and real output; e is the expectation operator; and ω is the information available to the central bank at the time when it sets the interest rate. equation (1) can be rewritten for empirical specification by defining ̅ and , and by replacing the unobserved forecast variables with realized variables as follows. (2) where is a linear combination of the forecast errors of inflation and real output. then the equation (2) is modified in accordance with our analytical concerns into the forward-looking specification in equation (3) and the backward-looking specification in equation (4) and the equation (3) and (4) also include the exchange rate term, exr, as follows. n =1,2,3 and 4 (3) n =0,1,2 and 3 (4) the equation (3) and (4) are further modified for obtaining estimable equations since the central bank tends to conduct smooth changes in its policy interest rate in their practices. by assuming that the actual rate partially adjusts to the target as ( ) where ρ is the degree of smoothing with 0 < ρ < 1 and υ is the disturbance term, equations (3) and (4) can be further rewritten into equation (5) and (6) as follows. ( ) ( ) ( ) ( ) (5) ( ) ( ) ( ) ( ) (6) for the technique to estimate the parameter vector [α, β, γ, δ, ρ], we adopt generalized method of moments, since the equations above entail endogeneity problem in that the policy interest rate may also affect explanatory variables. the instrumental set includes oneand two-quarter lagged values of inflation rate π, gdp gap gap, and exchange rate exr, in the estimation equation (5) and (6). the j-statistic implies that these instrumental variables are valid in the sense that the over-identifying restrictions cannot be rejected in the models above except for the case of (see table 2). table 2 reports the estimation outcomes of policy reaction functions in two kinds of specifications: the forwardlooking specification in the equation (5) and the backward-looking specification in the equation (6). based on the estimated short-term coefficients in the equations of (5) and (6) the long-term coefficients are worked out in the equations of (3) and (4) which are displayed in the lower part of each table. when we focus on the long-term coefficients, the cases of and are excluded from their calculations, since the degree of smoothing ρ is beyond unity, which is against our expectation. it is in the cases of and that the coefficient of inflation β is positively discernable at the conventional significant level. we herein identify the case of , the forward-looking specification with one quarter ahead, as the most suitable specification for the thailand policy reaction function, since the inflation coefficient has the higher significance by more than 99 percent and its magnitude is large enough to exceed unity by 1.966. in that case, we also confirm the significance at 95 percent level in the coefficient of exchange rate δ, but not in the coefficient of gdp gap. asian journal of economics and empirical research, 2018, 5(1): 19-28 25 table-2. policy reaction functions note: ***, **, * denote the rejection of null hypothesis at the 99%,95% and 90% level of significance. sources: ifs of imf we interpret the estimation results above as follows. first, the bank of thailand appears to have adopted the inflation-responsive and forward-looking (one quarter ahead) monetary policy rule under its inflation targeting framework. this finding is much different from the previous studies such as taguchi and kato (2011) and lueangwilai (2012) that identified backward-looking and contemporaneous rules for thailand monetary policy. the difference might come from the fact that this study’s estimation covers the period after 2015 when the bank of thailand has upgraded its inflation targeting framework by transforming it from range target to point target to provide a clearer policy signal to the public as mentioned in section 2. second, the thailand inflation-responsive rule is countercyclical enough to affect real interest rate, since the magnitude of the response to inflation is more than unity. this countercyclical rule seems to be similar to those of advanced economies; the magnitude of the bank of thailand in this study, 1.966, is comparable to those of the bundesbank (1.31), the bank of japan (2.04) and the federal reserve system in usa (1.79). this study’s magnitude is also consistent with that of the previous study, for instance, 1.969 in taguchi and kato (2011). third, the thailand monetary policy rule is also responsive to exchange rate movement. it might reflect the fact that the bank of thailand has still taken a role to avoid the excess of volatility of the value of the baht, particularly resulting from speculative capital flow, through the intervention in foreign exchange market, even under the inflation targeting regime.5 the exchange-rate responsive rule seems to be related to the problem of “fear of floating” in emerging market economies including thailand. this rule is also consistent with the one that lueangwilai (2012) described as responding to inflation and exchange rate movement. lastly, it should be noted that the adjustment speed of a policy interest rate toward its target rate in the operation of the bank of thailand is slower than those in central banks in advanced economies. the smoothing speed ρ for thailand is 0.927 in “quarterly” base, whereas the “monthly” smoothing speed is 0.91 for the bundesbank; 0.93 for the bank of japan, and 0.92 for the federal reserve system, respectively. the thailand adjustment speed is, thus, about one-third of those in the g3 countries. to sum up, the thailand monetary policy rule under the inflation targeting is characterized as an inflationand exchange-rateresponsive rule with forward-looking manner (one quarter ahead), which is countercyclical against inflation in the long run, but is accompanied with slow adjustment toward a target policy rate. 5 the description of this sentence is based on the website of the bank of thailand. see: https://www.bot.or.th/english/monetarypolicy/monetpolicyknowledge/pages/exchangerate.aspx forward-looking πt+1 πt+2 πt+3 πt+4 (1-ρ )*α -0.121 (-0.745) -0.456 (-1.569) -0.423 (-1.197) 0.688 (0.983) (1-ρ)*β 0.143 *** (3.820) 0.080 * (1.904) 0.077 * (1.914) -0.044 (-1.338) (1-ρ)*γ 0.001 (0.044) 0.053 (0.644) 0.110 (1.428) 0.118 (1.441) (1-ρ)*δ 0.017 ** (2.392) 0.014 (1.104) 0.015 (1.327) -0.006 (-0.304) ρ 0.927 *** (12.051) 1.150 *** (10.094) 1.138 *** (8.180) 0.721 *** (2.728) j-statistics 2.802 (0.246) 2.359 (0.307) 2.935 (0.230) 4.622 * (0.099) long-term coefficients α -1.667 2.470 β 1.966 *** -0.160 γ 0.027 0.426 δ 0.246 ** -0.023 backward-looking πt πt-1 πt-2 πt-3 (1-ρ )*α 0.043 (0.195) 0.107 (0.698) 0.267 * (1.795) 0.555 ** (2.204) (1-ρ)*β 0.089 ** (2.270) 0.033 (0.897) 0.050 (0.945) 0.081 (1.574) (1-ρ)*γ -0.010 (-0.269) 0.029 (0.520) 0.068 (1.453) 0.153 ** (2.094) (1-ρ)*δ 0.009 (1.049) 0.003 (0.386) 0.003 (0.311) 0.006 (0.474) ρ 0.900 *** (7.125) 0.922 *** (12.467) 0.834 *** (8.894) 0.689 *** (4.743) j-statistics 2.555 (0.278) 2.201 (0.332) 2.562 (0.227) 0.453 (0.797) long-term coefficients α 0.440 1.387 1.612 * 1.789 ** β 0.895 ** 0.430 0.302 0.262 γ -0.107 0.380 0.415 0.493 ** δ 0.092 0.050 0.020 0.020 https://www.bot.or.th/english/monetarypolicy/monetpolicyknowledge/pages/exchangerate.aspx asian journal of economics and empirical research, 2018, 5(1): 19-28 26 4.2. policy transmission effect on inflation this section examines whether the thailand monetary policy rule would actually have its transmission effect on inflation, through tracing the impulse responses of inflation rate to monetary policy shocks in var and structural var (svar) models. the ordinary var model was traditionally used for examining the effects of monetary policy shocks, for instance, by christiano et al. (1996). it was also applied to investigating economic impacts of the thailand monetary policy shocks (e.g., taguchi and kato (2011)). then, the var model has been developed into the svar model under the assumption that the concerned variables should be contemporaneously and dynamically interdependent. the svar has become more popular than the ordinary var, since theoretical and empirical grounds can be incorporated for imposing the restrictions on the model. christiano et al. (1999) for instance, applied the svar to examining the effects of monetary policy shocks, and phiromswad (2015) and arwatchanakarn (2017) also utilized the svar for the analyses of thailand monetary policy. this study adopts the same four variables as in the policy reaction function for the model construction: policy interest rate (por), inflation rate (π), gdp gap (gap) and exchange rate (exr), since the variables here should be consistent with those used in the policy reaction function so that the implementation and performance of the thailand inflation targeting can be simultaneously examined. the variables in this study are confined to the four indicators above, also because the purpose of this study is not to deal directly with the transmission channels and mechanisms inside of the thailand monetary markets. the study also uses the modified version of variables through first difference except for policy interest rate: d(π), d(gap) and d(exr), in order to investigate a “marginal” effect of monetary policy shocks we start to specify an equation for the ordinary var estimation in the following way. (7) where is a column vector of the endogenous variables with year t, i.e., ( ) for examining an ordinary policy transmission effect, and ( ( ) ( ) ( )) for examining a marginal transmission effect; is a constant vector; is a coefficient matrix; is a vector of the lagged endogenous variables; and is a vector of the random error terms in the system. the lag length (-1) is selected by the schwarz information criterion with maximum lag being equal to (-2) under the limited number of observations from the second quarter of 2000 to the second quarter of 2017. based on the var model estimation above, we examine the impulse responses of inflation rate to the shock of policy interest rate in terms of ordinary and marginal transmission effects. in examining the impulse response, the structural policy shock should be identified by applying the svar model under the assumption of the contemporaneous relationship among the sampled four variables. for that purpose, there are several approaches to impose the restrictions to identify structural shocks: short-run restriction and long-run restriction. this study, as in christiano et al. (1999) adopts the short-run restriction by assuming the existence of time-lag for policy reaction so that policy rate can keep a recursive linkage with inflation rate, gdp gap and exchange rate. the impulse responses of inflation to the structural shock of policy rate under the svar are also presented together with the ordinary impulse responses. table 3 and figure 3 respectively report the estimation outcomes of var model and the impulse responses of inflation rate to the ordinary and structural shocks of policy rate with 95 percent error bands over a 8-quarter horizon, in terms of ordinary and marginal transmission effects. according to the ordinary transmission effect, inflation rate does not respond significantly to the policy-rate shock in the var model, and it responds even positively to the structural shock of policy-rate during the initial four quarters under the svar model. as for the marginal transmission effect, inflation rate responds negatively to the policy-rate shock from the beginning quarter in the var model and from the fifth quarter in the svar model. the results of impulse response analyses, therefore, imply that the thailand monetary policy under inflation targeting has only a marginal transmission effect on inflation. it might be probably because the thailand monetary policy rule is accompanied with slow adjustment toward a target policy rate, although the rule is found to be inflation-responsive, forward-looking and countercyclical against inflation. table-3. var model estimation [ordinary transmission effect] por π gap exr por (-1 ) 0.823 *** (15.049) -0.186 (-1.034) 0.063 (0.268) -0.710 (-1.229) π (-1 ) 0.090 ** (3.116) 0.795 *** (8.322) -0.063 (-0.507) 0.337 (1.102) gap (-1 ) 0.011 (0.407) 0.114 (1.236) 0.456 *** (3.738) 0.155 (0.522) exr (-1 ) 0.003 (0.535) -0.042 * (-1.735) -0.040 (-1.252) 0.847 *** (10.829) c 0.210 * (1.881) 0.866 ** (2.349) -0.040 (-0.083) 0.772 (0.653) adj. r^2 0.883 0.676 0.225 0.682 asian journal of economics and empirical research, 2018, 5(1): 19-28 27 [marginal transmission effect] note: ***, **, * denote the rejection of null hypothesis at the 99%,95% and 90% level of significance. sources: ifs of imf figure-3. impulse responses note: the dotted lines denote a 95 percent error band over 8-year horizons. source: ifs of imf 5. concluding remarks this article reviewed the thailand monetary policy rule and its performance under the adoption of inflation targeting regime since 2000. the study estimated the policy reaction function to see if the inflation targeting has been linked with an inflation-responsive monetary policy rule, and investigated whether the monetary policy rule would actually have its transmission effect on inflation, through tracing the impulse responses of inflation rate to monetary policy shocks in vector autoregressive (var) and structural var models. the study contributed to the literature by updating the assessment of the thailand monetary policy through covering the period after 2015, when the bank of thailand has upgraded its inflation targeting framework by transforming it from range target to point target to provide a clearer policy signal to the public. the main findings were as follows. first, the estimation outcomes of the policy reaction function showed that the thailand monetary policy rule under the inflation targeting is characterized as an inflationand exchange-rate responsive rule with forward-looking manner. the identified progress in the thailand monetary policy toward forward-looking rule might reflect the upgrading in the inflation targeting regime from range target to point target since 2015. second, the estimation results also demonstrated that the thailand monetary policy rule is countercyclical against inflation in the long run, but is accompanied with slow adjustment toward a target policy por d(π) d (gap ) d (exr ) por (-1 ) 0.949 *** (22.942) -0.262 ** (-1.981) -0.144 (-0.717) 0.089 (0.199) d (π )(-1 ) 0.121 *** (3.439) 0.371 *** (3.277) 0.199 (1.161) -0.142 (-0.372) d (gap )(-1 ) 0.007 (0.288) 0.039 (0.461) -0.329 ** (-2.528) 0.098 (0.339) d (exr )(-1 ) 0.000 (0.014) -0.045 (-1.208) -0.068 (-1.187) 0.323 ** (2.529) c 0.118 (1.127) 0.588 * (1.744) 0.325 (0.636) -0.289 (-0.254) adj. r^2 0.886 0.195 0.050 0.042 asian journal of economics and empirical research, 2018, 5(1): 19-28 28 rate. third, the results from the impulse response analyses suggested that the thailand monetary policy under the inflation targeting has only a marginal transmission effect on inflation probably due to the slow adjustment of policy rate. references arwatchanakarn, p., 2017. structural vector autoregressive analysis of monetary policy in thailand. sociology study, 7(3): 133–145. view at google scholar | view at publisher bernanke, b.s., t. laubach, f.s. mishkin and a.s. posen, 1999. inflation targeting: lessons from the international experience. princeton: princeton university press. bernanke, b.s. and f.s. mishkin, 1997. 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responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://scholar.google.com/scholar?hl=en&q=structural%20vector%20autoregressive%20analysis%20of%20monetary%20policy%20in%20thailand https://scholar.google.com/scholar?hl=en&q=structural%20vector%20autoregressive%20analysis%20of%20monetary%20policy%20in%20thailand http://dx.doi.org/10.17265/2159-5526/2017.03.002 https://scholar.google.com/scholar?hl=en&q=inflation%20targeting:%20a%20new%20framework%20for%20monetary%20policy? https://scholar.google.com/scholar?hl=en&q=on%20the%20theory%20of%20testing%20for%20unit%20roots%20in%20observed%20time%20series https://scholar.google.com/scholar?hl=en&q=on%20the%20theory%20of%20testing%20for%20unit%20roots%20in%20observed%20time%20series http://dx.doi.org/10.2307/2297634 https://scholar.google.com/scholar?hl=en&q=fear%20of%20floating 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research vol. 4, no. 2, 106-120, 2017 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2017.42.106.120 106 why are the performances of business groups different? a case study of formosa plastics group and far eastern group yu-wei lan1  dan lin2 lu lin3 ( corresponding author) 1,2department of banking and finance, takming university of science and technology, taiwan 3department of public finance and taxation, takming university of science and technology, taiwan abstract this study examines the difference in performances of two business groups, formosa plastics group and far eastern group, under the impact of financial tsunami (2007.10.29~2017.8.10). the aim of this study is to help investors understand the operating model of business groups and use the herding effect to enhance the trading performance in financial markets. the empirical evidence shows that for the formosa plastics group, the news impact curve (based on egarch model) including the leading company is flatter when the news impact is less than zero (that is, negative news impact) than the news impact curve excluding the leading company. in contrast, the news impact curve of the far eastern group is steeper when the leading company is included. moreover, when the leading company is included as an endogeneous variable in the model as a filter for the program trading simulation, results show that investors can profit from the formosa plastics group. therefore, business groups that include the leading company have lower risks. it is beneficial to the stability of the market trading by incorporating the leverage effect of the leading company in business groups. on the contrary, the leading company of the far eastern group does not have such an effect. the absolute profits and the increment of performance are both lower than that of the formosa plastics group. the results suggest that the diversification strategy of far eastern group is worse than the vertical integration strategy of the formosa plastics group. the implication is that investors should carefully choose the business group for investment if they are to utilize the herding effect in investment. keywords: family business, egarch, herd effect, granger causality test, symmetric trading. citation | yu-wei lan; dan lin; lu lin (2017). why are the performances of business groups different? a case study of formosa plastics group and far eastern group. asian journal of economics and empirical research, 4(2): 106-120. history: received: 18 october 2017 revised: 8 november 2017 accepted: 13 november 2017 published: 16 november 2017 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 107 2. literature review .......................................................................................................................................................................... 107 3. research methods .......................................................................................................................................................................... 108 4. data .................................................................................................................................................................................................. 110 5. empirical results of the formosa plastics group .................................................................................................................. 110 6. empirical results of the far eastern group ............................................................................................................................ 115 7. conclusion and discussion on investment strategies ............................................................................................................ 119 references ............................................................................................................................................................................................ 119 appendixes .......................................................................................................................................................................................... 120 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://orcid.org/orcid-search/quick-search?searchquery=yu-wei lan https://orcid.org/orcid-search/quick-search?searchquery=dan lin https://orcid.org/orcid-search/quick-search?searchquery=lu lin https://orcid.org/orcid-search/quick-search?searchquery=yu-wei lan https://orcid.org/orcid-search/quick-search?searchquery=dan lin https://orcid.org/orcid-search/quick-search?searchquery=lu lin https://orcid.org/orcid-search/quick-search?searchquery=yu-wei lan https://orcid.org/orcid-search/quick-search?searchquery=dan lin https://orcid.org/orcid-search/quick-search?searchquery=lu lin https://orcid.org/orcid-search/quick-search?searchquery=yu-wei lan https://orcid.org/orcid-search/quick-search?searchquery=dan lin https://orcid.org/orcid-search/quick-search?searchquery=lu lin asian journal of economics and empirical research, 2017, 4(2): 106-120 107 1. introduction all business groups around the world are formed based on independent companies. businesses that have certain resources (such as entrepreneurial skills and technical skills) are likely to profit from other businesses. alternatively, businesses can lower the risks through diversifications. when there is a lack of basic infrastructure or weak social economic and legal systems, the cost of transactions between buyers and sellers can be expensive. it may be cheaper and more efficient to trade within the business group. some business groups may even use this method to monopolize the market. therefore, some business groups attempt to diversify by connecting several unrelated businesses through formal stock holdings or informal family networks. some other business groups operate by focusing on their industry through vertical integrations.1 two issues arisen from this complex organizational style. the first treats business groups as a diversified entity and analyzed the relationship between this feature, industrial organization and financing problems. business groups can control their related enterprises through internal trading and capital. currently, 40% of the top 500 companies around the world are controlled by families. families tend to use pyramid holdings to maintain their controls. finkelstein (1992) finds that family members have higher commitments to their businesses and pay attention to the businesses‟ long-term developments. by extending their tenure to consolidate their power, the transaction costs in business management can be lowered. johannisson and huse (2000) also support the view that the cohesion of the founder to the enterprise can help increase the operating efficiency of the family business group. the second issue is raised by the corporate governance survey of shleifer and vishny (1997) and the following work by la porta et al. (1997;1998). la porta et al. (1999) examine the top 20 companies around 27 countries and find that the ultimate holders of business groups will expropriate small shareholders and hollowed out the companies through pyramid holdings. jain and kini (2000) argue that if there are too many family members on the board of directors, this is likely to limit the resource network of the companies. baek and kang (2004) also find that controlling shareholders of business groups often use internal trading and asset restructuring to transfer the companies‟ resources to become their property. therefore, understanding this complex operating model is a great challenge to investors. the aim of this research is to directly examine the stock performance of business groups in order to search for better investment opportunities. the prime job is then to understand the relationship between the operating strategy of business groups and their stock performance. the formosa plastics group was first established in 1954 as a plastics company. after more than 50 years of hard work, the formosa plastics group now have more than hundreds of related enterprises including formosa plastics, nan ya, formosa chemicals & fibre, formosa petrochemicals, formosa ha tinh steel and etc. these companies are spread out in taiwan, usa, china, vietnam, philippine, and indonesia. the group is also committed to education and medical care by establishing a hospital and universities. the formosa plastics group is the largest private company in taiwan. to follow the spirit of a separation of ownership and control, the founders of formosa plastics group established an administration centre which is for the group‟s family members and an executive centre which is led by a professional manager. this structure was executed in june 2017.2 the second business group examined in this study is the far eastern group, which was first established in 1937 in china. the company started its textile business in 1953 in taiwan. it then diversified to other businesses such as petrochemical energy, cement building materials, department store retailing, financial services, land & sea transportation, communication networks, and tourism hotels. the business group has more than 200 related companies. of which, eight companies are listed in taiwan, and one company, asia cement, is listed in hong kong. far eastern group is the third largest business group in taiwan and is a model of diversified companies in taiwan.3 in 2014, the total market values of formosa plastics group and far eastern group were $2680.8 billion and $679 billion, respectively. however, in july 2017, the market value of formosa plastics group increased to $3032.6 billion while the market value of far eastern group decreased to $572.3 billion. one common feature of the business group is the cross holdings between related businesses. therefore, if the performance of related companies changes, the investment profits of the whole business group will be affected. when the benefit of vertical integration gradually reveals, the after tax net profits of formosa plastics group increased by 43.11% in 2016. in contrast, as the economy becomes more volatile, diversified operations will encounter greater challenges. hence, the after tax net profits of far eastern group reduced by 19.44% in 2016.4 therefore, this study proposes a program trading investment strategy based on behavioral finance theory to help individual investors trade the stocks of family businesses. the organization of the paper is as follows. section 2 is the literature review. section 3 discusses the granger causality, egarch model and the estimation method for program trading. section 4 describes that data source. section 5 and 6 presents that empirical results and analyses for the formosa plastics group and the far eastern group, respectively. finally, the conclusion is presented in the last section. 2. literature review both researches by bachelier (1900) and samulson (1965) argue that the stock prices are unpredictable. fama (1965) also suggests that the trend in stock price is random. fama (1970) then proposes an efficient market 1according to khanna and yishay (2015). diversification is measured by two-digit isic industry classifications. the degree of vertical integration of a business group (x, y) is measured by the degree of investment in each other‟s businesses. the petrochemical system of formosa plastics group basically mimicked japan‟s regional petrochemical industry connection model of isard (1951). in taiwan tsai (1997). based on the investment input, the correlation coefficients of petrochemical industry businesses are 7.72 for formosa plastics group and 6.71 for far eastern group (see appendix 1). as for the degree of diversification, as this study does not use individual company‟s data, there is no need to calculate the weighted entropy index of palepu (1985). the formosa plastics group has nine companies across four industries (0.44) and the far eastern group has eight companies across seven industries (0.87). therefore, comparing the two business groups, this study defines the former as having a vertical integration and the later as having a diversification. 2 refer to united daily news (2017-05-18), “family members of formosa plastics group withdraw from executive centre from june.” https://udn.com/news/story/11142/2471011. unique business weekly (issue 1011) (2017-10-23), “profits tracing by formosa plastics group”. 3refer to http://www.feg.com.tw/tw/business/important.aspx and https://zh.wikipedia.org/ 4refer to wealth magazine (2017-07-27), “why does the difference in market values of the two biggest business groups grow larger? vertical integration of formosa plastics group versus the diversification of far eastern group.” http://www.wealth.com.tw https://udn.com/news/story/11142/2471011 http://www.feg.com.tw/tw/business/important.aspx http://www.wealth.com.tw/ asian journal of economics and empirical research, 2017, 4(2): 106-120 108 hypothesis (emh) by suggesting that all participating investors in the market are rational, are aimed to maximize their utility and are able to make unbiased estimates based on all available information. as the stock prices follow random walks and investors arbitrage, no abnormal profits exist in the market. more and more evidence reveal market anomalies after 1980s, showing “limited rational behavior” as suggested by behavioral finance. shiller (1981) finds that the results of nyse listed companies are completely differently from sharp‟s asset pricing model. the return of higher risk stocks is lower than the theoretical prediction. the volatility of stock prices cannot be predicted by the discounted present value of premium. banz (1981) finds that the monthly returns of 50 smallest market cap companies are 1% higher than the returns of 50 largest market cap companies. lakonishok and smidt (1988) also find season effect in us stock markets and cadsby (1989) reports calendar effect in canadian stock market. as for the herding behavior, shiller (1979) finds over reaction in speculative asset prices. investors often trade based on noise trading and have positive feedback behavior. economists propose reasons from the perspectives of information asymmetry, reputation, return and limited rational behavior. from the information cascade point of view, bikhchandani et al. (1992) argue that when investors omit private information and simply mimic others, this has great impacts on the markets and is likely to cause a domino effect. scharfstein and stein (1990) from the reputation viewpoint suggest that by mimicking other managers‟ investment portfolio, managers can save the cost of information search. they can also shirk responsibility and have less regrets if making investment losses. maug and naik (2013) from the return viewpoint argue that due to moral hazard and inverse selection, having optimal contracts between managers and the owner that link remuneration with performance is the best solution. managers are encouraged to collect information and therefore avoid moral hazard. also, we can separate good and bad fund managers and avoid inverse selections. therefore, fund managers tend to have herd behavior. the empirical evidence by lakonishok et al. (1992) shows herding behavior among fund managers when they trade small companies‟ stocks. froot et al. (1993) also find herding behavior among financial analysts as they use similar information sources, economic models, investment portfolios and hedging strategies. christie and huang (1995) examine the measures for herding effect, stock market returns and dispersion in investment portfolio returns. they find that the smaller the dispersion, the more prominent the herding effect. wermers (1999) studies the herding behavior of mutual funds between 1975 and 1994 and finds that herding behavior of mutual funds is rational as it can fasten the absorption of information in stock prices and help stabilize the market. however, kim and wei (2002) examine the herding behavior of qfiis in korea and find that it can increase volatilities in the emerging markets. moreover, alanyali et al. (2013) find a positive relationship between the numbers of issues mentioned in financial times and daily trading volume. this shows a close relation between changes in financial markets and financial news. cipriani and guarino (2014) builds a herding information model and shows that the herding behavior is rational when there is information uncertainty. herding behavior also typically happens on certain days. on average, there is a 2% of herding buyers and 4% of herding sellers. balcilar and demirer (2015) examine turkish investors and find that apart from industrial departments, us and market related factors cause a transformation in the market, causing herding behavior in all market departments. furthermore, since the financial tsunami in 2007, exchange traded funds (etfs) become a popular passive investment tool among retail and professional investors due to its low transaction costs. however, ben-david et al. (2017) find that although etfs can help with price discovery, they can inject non-fundamental volatility to market prices and affect the correlation structure of returns. during the events of market stress, etfs will affect the liquidity of the underlying portfolios and are likely to cause a herding effect of a sudden drop in markets. taiwan 50 etf (0050), issued in 2005, is currently the largest etf in terms of size ($58.6 billion) in taiwan. taiwan mid 100 (0051) was issued in 2007. the fund size is $380 million. this study uses 0050 and 0051 as filters in the experiments to examine the herding behavior of following large business groups. this research studies the herding behavior from the business group viewpoint. past studies typically measure the degree of dispersion. in contrast, this study proposes a new testing method by utilizing quantitative models and optimal program trading to test the following two hypotheses. the first hypothesis is that including the price information of leading company should lower the impact of selling news on investors. the first hypothesis is tested in two steps with an attempt to find a stabilized investment strategy for trading family business groups‟ stocks. the second hypothesis tests if the trading performance can be enhanced using technical analyzes by including the leading company of the family business group. the second hypothesis can also indirectly prove the existence of herding behavior in business groups. 3. research methods 3.1. theoretical models and estimation methods of var and granger causality the traditional test of herding effect measures the degree of dispersion. however, this method requires internal trading data. due the data collection problem, this study uses econometric methods to examine herding effect, the testing methods are as follows: (1) examining if unit roots exist; (2) testing if the model has co-integration; (3) testing the causal relationship between variables in the model; (4) using the variable that has the strongest causal relationship as the leading company and using program trading experiments to test if the herding effect exists. engle and granger (1987) suggest that one important function of var model is to use co-integration relationship as a restriction in var model to examine long-term dynamic relationships between variables in the model. later, johansen and juselius (1988) and johansen (1991) propose a co-integration test for multi-variables, var(p), which is outlined below: tptpttt uyyycy   ...2211 ………… (1) where ' 1 )...( nttt yyy  and hypothesize )1(~ iyt . after transformation, var(p) in equation (1) can be represented as the following: uyyyycy ptptpttt   112211 ... ……………. (2) asian journal of economics and empirical research, 2017, 4(2): 106-120 109 where ,...1,...1 pii ii  and pi  ...1 in equation (2), apart from pty  , all other variables are stationary. therefore, similar to var(1), the compressed matrix  before vector pty  can be used to test the co-integration relationship between variables. if the rank of coefficient matrix  is nrrk  , then there exists an adjacency matrix ( rn )  and  . as their ranks are both r, this means ' and ptt  ' is stationary with )0(~' it pt .  is a co-integrated parameter matrix that reflects the long-term relationship between variables.  is an adjusted coefficient matrix that reflects the shortterm imbalance adjustment of this period‟s variable from last period. one method of co-integration test proposed by johansen is the trace test, which can be calculated as follows: )1(* 1    n ri ir lntlr  ..............................(3) where i is the eigenvalue of a certain matrix arisen from the testing process. the second method is to use the maximum eigenvalue test, which can is calculated as follows: )1(*max rlntlr  ................................(4) where i is the maximum eigenvalue. based on the feature of time series (with or without trend and linearity or secondary type) and the form of cointegration equation (ce) and var, johansen co-integration test can be checked one by one.5 3.2. theoretical model and estimation method of egarch past research often uses garch models to test stock market volatility. however, as many time series data in the financial market do not have normal distribution or do not meet the traditional requirement of homoscedasticity and have fat tails and volatility cluster, bollerslev (1986) builds a garch model based on arch. it has become a common method of testing the volatility in stock market returns. the econometrists continue to modify the garch model. nelson (1991) then proposes an egarch model. compared to garch models which have restrictions on coefficients, egarch (1, 1) can give more appropriate conditional variance and better reflect the volatility in market returns. the egarch model is provided below: mean equation: yt = xt + ut ................................(5) conditional variance: ................................(6) moreover, to test the effect on investors when the leading company‟s stock price is or is not included, this paper adopts the method used in lan et al. (2014;2017) and tests for the difference in  coefficients. the t statistics can be calculated as follows: 2 2 2 1 2 1 12 ˆˆ /)( nn t    ................................(7) where 21, are the  coefficient for including (or excluding) the leading company‟s stock prices. ̂ 2 1 and ̂ 2 2 are the covariance of . n1 and n2 represent the sample size. if the latter is greater than the former and there is a significant difference in coefficients, this suggests that excluding the leading company‟s stock price information in investors‟ investment decisions, investors worry more about their future cash flow risks. therefore, the results provide support for hypothesis 1. that is, including the stock price information of the leading company can lower the leverage effect and reduce the impact of selling news on investors. 3.3. experimental design and estimation method two main research methods in behavioral finance are structural equation modeling (sem) and experimental methods. as the former requires a carefully designed questionnaire and a large scale of survey to find a suitable theoretical model, this study adopts the experimental method and uses a simulation program in multicharts to develop a model for following the leading company‟s stock prices. specifically, for the formosa plastics group, the leading company of model 1 is formosa advanced technologies and the leading company of model 2 is nan ya printed circuit board. data1 is the price of individual stocks; data2 is the price of 0050; data 3 is the stock price of leading company (i.e., formosa advanced technologies for model 1 and nan ya printed circuit board for model 2).6 as for the far eastern group, the leading company of model 1 is u-ming marine and the leading company of model 2 is far eastern department stores. similarly, data1 is the price of individual stocks; data2 is the price of 0050; data 3 is the stock price of leading company (i.e., u-ming marine for model 1 and far eastern department stores for model 2). then, this study follows the method in williams (1999) adds in filters and adopts the rsi technical trading strategy in lan et al. (2014;2017) which is based on the closing price and the breakthrough by the 20-day moving average. specifically, a “system buy” requires the following three conditions to be met and they are: (1) today‟s closing price of data2 is higher than 20-day moving average price of data2; (2) today‟s closing price of data1 is higher than the 20-day moving average price of data1; and (3) the rsi of today‟s stock prices is higher than the best buying point‟s rsi. on the contrary, a “system sell” requires three conditions to be met and they are: (1) today‟s closing price of data2 is lower than 20-day moving average price of data2; (2) today‟s closing price of 5due to page limit, the detail discussions are not provided here. 6the choice of leading company is based on granger causality test results. asian journal of economics and empirical research, 2017, 4(2): 106-120 110 data1 is lower than the 20-day moving average price of data1; and (3) the rsi of today‟s stock prices is lower than the best selling point‟s rsi. this study uses the optimized trading program to find the optimal number of days in moving average. the position is closed out if the profit is greater than 500 points or the loss is greater than 100 points. based on the results from simulated experiments, we can test for hypothesis 2; that is, incorporating the leading company of the business group in the technical analysis can enhance the trading performance in the stock market. this, at the same time, indirectly proves the existence of herding behavior. 4. data based on the classifications provided in tej database, nine publicly listed companies of the formosa plastics group (including formosa plastics (1301), na ya plastics (1303), formosa petrochemical (6505), formosa chemicals & fibre (1326), formosa taffeta (1434), nanya technology (2408), nan ya printed circuit board (8046) and formosa advanced technologies (8131) and formosa sumco technology (3532)) and taiwan 50 etf (0050) are included as filters. that is, this study has 10 sample set of time series data. the sample period covers from 10 december 2007 to 10 august 2017; that is, a total of 2393 daily sample data.7 as for the far eastern group, eight publicly listed companies (including asia cement (1102), far eastern new century (1402), everest textile (1460), oriental union chemical (1710), u-ming marine (2606), far eastern international bank (2845), far eastern department stores (2903), far estone telecommunications (4904)) and taiwan 50 etf (0050) are included as filters. that is, nine sample sets of time series data are investigated. the sample period covers from 29 october 2007, the peak before financial tsunami, to 10 august 2017; that is, a total of 2423 daily sample data. all the data mentioned above are obtained from tej database and multicharts daily stock price database. to ensure that integrity of the model, the experiments are carried out in two stages. for the formosa plastics group, the first stage covers the period from 2007.12.10~2014.12.29 (which is the end of qe). the second stage covers the period from 2007.12.10~2017.8.10. as for the far eastern group, only the starting date differs, where the sample period starts on 29 october 2007. the method of testing the far eastern group is the same as the formosa plastics group. the parameters used in the second stage of simulation are based on the optimal parameters from the first stage. the trading cost in simulated models is assumed to be about 1% of the 200-day moving average of the underlying company‟s stock prices. transaction fees and slippage are not considered in the experiments. 5. empirical results of the formosa plastics group 5.1. granger causality test of formosa plastics group 5.1.1. unit root test of model variables to ensure the validity of empirical results, we need to ensure the stationarity of the series by testing the var model and choosing the minimal aic value. the results of formosa plastics group are as follows. including the intercept and trend (2.7044(0)) does not reject the null hypothesis. that is, the variables are not stationary, have fat tails that are often observed in financial data, and have autocorrelations. therefore, i(0) is not stationary. after taking a difference (.46.4714(0)), the null hypothesis is rejected and i(1) is stationary (table 1). therefore, we can proceed with var and johansen co-integration test. table-1. unit root test of var model variables of formosa plastics group original value first order difference variables / model intercept and trend intercept and trend a1301 -2.7044(0) -3.4905(1)** -2.5880(1) -3.6787(0)** -2.3178(0) -3.2634(1)*** -3.3609(0)*** -4.2184(0) ** -2.8096(1) -2.8347(0) -46.4714(0)* -44.9050(0)* -45.5030(0)* -50.9778(0)* -47.7780(0)* -44.5537(0)* -50.3610(0)* -47.3754(0)* -47.5000(0)* -48.7114(0)* a1303 a1326 a1434 a2408 a3532 a6505 a8046 a8131 a50 note: *，**，*** shows significance level at 1%, 5% and 10%. the number inside the bracket represents the number of lagging periods. (0) shows that when the lag period is 0, it has the minimal aic. sample code is as provided in section 4. 5.1.2. lag period test of the model in order to proceed with the var model estimation, lagging periods must be tested first. the results show that the aic and fpe of the formosa plastics group are at their minimum when the data are lagged 8 periods (table 2). this study also tests the maximum likelihood proposed by johansen and juselius (1990) to examine the cointegration relationships between multi-variables. the model has five co-integration equations (table 3). therefore, we can conduct the granger causality test. 7as formosa sumco technology (3532) was listed on 10 december 2007, the sample period for formosa plastics group started on that day. quang viet enterprise (4438) was excluded from the formosa plastics group‟s sample as the data of quang viet enterprise was available after 10 december 2007. asian journal of economics and empirical research, 2017, 4(2): 106-120 111 table-2. lag period estimation of formosa plastics group‟s var model lag logl lr fpe aic sc hq 0 -61799.68 na 1.29e+10 51.65874 51.68289 51.66753 1 -34712.05 53926.22 2.063684 29.10326 29.36897* 29.19994 7 -33026.5 2440.603 0.833097 28.19599 29.911 28.82000* 8 -32926.22 193.7792 0.832969* 28.19575* 30.15231 28.90766 11 -32689.69 126.8364* 0.878709 28.2488 30.93001 29.22437 12 -32640.19 94.00331 0.916767 28.29101 31.21377 29.35447 table-3. co-integration estimation results of johansen model for formosa plastics group trace max-eigen no. of ce(s) eigenvalue statistic critical value(0.05) prob. statistic critical value(0.05) prob. none * 0.1982 1955.79 219.40 0 528.53 61.03 0.0001 at most 1* 0.1573 1427.26 179.51 0 409.64 54.97 0.0001 at most 2* 0.1373 1017.62 143.67 0.0001 353.32 48.88 0.0001 at most 3* 0.1278 664.30 111.78 0.0001 327.14 42.77 0.0001 at most 4* 0.1125 337.16 83.94 0 285.54 36.63 0.0001 at most 5 0.0096 51.62 60.06 0.2101 23.00 30.44 0.315 5.1.3. granger causality test as the relationships between variables are not clear based on economic theories, in this case we can use the var model to examine the dynamic relationships between variables. specifically, we assume that the variables are related to each other and regress the variables in the current period with their lag periods. to investigate the investment behavior of formosa plastics group, we include the trading information of nine companies and taiwan 50 etf in the var model and conduct granger causality test. the results show that when lagging eight periods, formosa advanced technologies (8 times), nan ya printed circuit board (5 times) and taiwan 50 etf (4 times) are the top three that have the highest number of granger cause of other companies. in other words, the investment behavior of the other eight companies of the formosa plastics group all refuse to reject the data of taiwan 50 etf and formosa advanced technologies. therefore, the data of taiwan 50 etf and formosa advanced technologies can be treated as endogeneous variables (table 4). the data of taiwan 50 etf and formosa advanced technologies are the granger cause of other companies and cause herding trading behavior in other companies. table-4. granger causality test of formosa plastics group dependent variable: d(a1301) dependent variable: a1434 dependent variable: a6505 dependent variable: d(p50) excluded chi-sq prob. excluded chi-sq prob. excluded chi-sq prob. excluded chi-sq prob. a1303 19.34 0.01 d(a1301) 10.68 0.22 d(a1301) 6.79 0.56 d(a1301) 14.23 0.08 d(a1326) 26.43 0.00 a1303 20.98 0.01 a1303 12.62 0.13 a1303 11.35 0.18 a1434 14.14 0.08 d(a1326) 5.44 0.71 d(a1326) 8.41 0.39 d(a1326) 5.19 0.74 d(a2408) 2.65 0.95 d(a2408) 7.11 0.52 a1434 7.93 0.44 a1434 16.39 0.04 a3532 18.61 0.02 a3532 11.01 0.20 d(a2408) 4.28 0.83 d(a2408) 1.71 0.99 a6505 13.05 0.11 a6505 10.31 0.24 a3532 9.44 0.31 a3532 38.55 0.00 a8046 21.89 0.01 a8046 11.13 0.19 a8046 5.20 0.74 a6505 4.54 0.81 d(a8131) 20.93 0.01 d(a8131) 14.87 0.06 d(a8131) 20.16 0.01 a8046 12.45 0.13 d(p50) 14.04 0.08 d(p50) 22.66 0.00 d(p50) 7.79 0.45 d(a8131) 22.96 0.00 all 140.86 0.00 all 118.33 0.00 all 102.73 0.01 all 130.16 0.00 dependent variable: a1303 dependent variable: d(a2408) dependent variable: a8046 dependent variable: d(a8131) excluded chi-sq prob. excluded chi-sq prob. excluded chi-sq prob. excluded chi-sq prob. d(a1301) 10.49 0.23 d(a1301) 4.20 0.84 d(a1301) 17.84 0.02 d(a1301) 19.14 0.01 d(a1326) 9.95 0.27 a1303 6.96 0.54 a1303 12.15 0.14 a1303 6.57 0.58 a1434 9.78 0.28 d(a1326) 1.36 0.99 d(a1326) 9.45 0.31 d(a1326) 5.87 0.66 d(a2408) 2.78 0.95 a1434 8.81 0.36 a1434 8.28 0.41 a1434 10.08 0.26 a3532 13.20 0.11 a3532 1.48 0.99 d(a2408) 2.44 0.96 d(a2408) 1.10 1.00 a6505 11.30 0.19 a6505 1.13 1.00 a3532 82.27 0.00 a3532 33.59 0.00 a8046 14.31 0.07 a8046 7.05 0.53 a6505 7.48 0.49 a6505 4.31 0.83 d(a8131) 23.09 0.00 d(a8131) 4.97 0.76 d(a8131) 25.88 0.00 a8046 19.40 0.01 d(p50) 18.24 0.02 d(p50) 4.03 0.85 d(p50) 15.02 0.06 d(p50) 21.89 0.01 all 124.28 0.00 all 38.79 1.00 all 185.72 0.00 all 137.11 0.00 dependent variable: d(a1326) dependent variable: a3532 excluded chi-sq prob. excluded chi-sq prob. d(a1301) 6.67 0.57 d(a1301) 9.15 0.33 a1303 12.98 0.11 a1303 11.62 0.17 a1434 12.34 0.14 d(a1326) 4.47 0.81 d(a2408) 7.09 0.53 a1434 11.87 0.16 a3532 9.66 0.29 d(a2408) 5.08 0.75 a6505 16.45 0.04 a6505 9.96 0.27 a8046 16.10 0.04 a8046 54.20 0.00 d(a8131) 18.33 0.02 d(a8131) 3841.38 0.00 d(p50) 10.24 0.25 d(p50) 70.84 0.00 all 112.94 0.00 all 4186.39 0.00 note: prob. means probability. chi-sq is the χ2 statistics. sample code is the same as table 1. d means taking the first difference. asian journal of economics and empirical research, 2017, 4(2): 106-120 112 5.2. granger causality test of na ya plastic, taiwan 50 etf and formosa advanced technologies 5.2.1. lag period test in this section, we use na ya plastic, taiwan 50 etf and formosa advanced technologies as examples and carry out the var model estimation. we need to first test the lagging period and the results show that the aic and fpe of na ya plastic, taiwan 50 etf and formosa advanced technologies are at their minimum when lagging two periods (table 5). therefore, this model is estimated using a lag period of two. also, based on the maximum likelihood estimation proposed by johansen and juselius (1990) we test the co-integration relationship between multi-variables. the model has two co-integrated equations (table 6). table-5. lag period estimation of var model of na ya plastic, taiwan 50 etf and formosa advanced technologies lag logl lr fpe aic sc hq 0 -13756.69 na 19.81256 11.49995 11.50719 11.50258 1 -7645.846 12201.25 0.120823 6.400206 6.429192* 6.410753 2 -7622.395 46.76492 0.119373* 6.388128* 6.438854 6.406585* 6 -7592.430 18.20995* 0.119977 6.393171 6.530855 6.443268 table-6. co-integration estimation results of johansen model for na ya plastic, taiwan 50 etf and formosa advanced technologies trace max-eigen no. of ce(s) eigenvalue statistic critical value(0.05) prob. statistic critical value(0.05) prob. none * 0.4051 2252.31 24.28 1 1242.90 17.80 1 at most 1 * 0.3440 1009.41 12.32 0.0001 1008.88 11.22 0.0001 at most 2 0.0002 0.54 4.13 0.5261 0.54 4.13 0.5261 5.2.2. granger causality test three variables, na ya plastic, taiwan 50 etf and formosa advanced technologies, are included in the var model and conducted the granger causality test. results show that when lagging two periods, apart from taiwan 50 etf which is not the granger cause of na ya plastic, na ya plastic, taiwan 50 etf and formosa advanced technologies are granger cause of each other and can be treated as endogenous variables (table 7). in other words, the three variables refuse to reject the data of each other and we can proceed with the investment simulation in the next stage. table-7. granger causality relationships between na ya plastic, taiwan 50 etf and formosa advanced technologies a1303 p50 a8131 a1303 2.1692 (0.338) 8.8867 (0.0118) p50 11.6966 (0.0029) 13.1406 (0.0014) a8131 4.4544 (0.0178) 26.7587 (0.0000) note: sample codes are the same as provided in table 1. 5.3. estimation of egarch model’s coefficient and news impact response 5.3.1. estimation results of egarch model (excluding formosa advanced technologies) the values of  (0.0679),  (0.9941),  (0.0452) of the model (excluding formosa advanced technologies) are all significant at the 1% level and are all positive. this suggests the existence of asymmetric volatility. the volatility caused by good news (0.1131) is greater than the impact of bad news on the logarithm of conditional variance (0.022 times) (table 8). table-8. estimation results of egarch model (excluding formosa advanced technologies) variable coefficient std. error z-statistic prob. a1303 0.000142 0.001566 0.090982 0.9275 d(a1326) 0.503892 0.010579 47.63353 0 a1434 -0.00074 0.003351 -0.2206 0.8254 d(a2408) -0.01361 0.014484 -0.93948 0.3475 a3532 -0.00103 0.000507 -2.03818 0.0415 a6505 0.00073 0.000785 0.929408 0.3527 a8046 0.000188 0.000287 0.655265 0.5123 d(p50) 0.47616 0.023113 20.60105 0 variance equation c(9) -0.05348 0.006881 -7.77239 0 c(10) 0.067979 0.008613 7.892741 0 c(11) 0.045297 0.0076 5.959912 0 c(12) 0.994168 0.001492 666.2372 0 r-squared 0.526442 akaike info criterion 2.325313 log likelihood -2770.24 schwarz criterion 2.354299 then, this study draws the news impact curve based on the egarch model (excluding formosa advanced technologies) (figure 1). in order to see the difference between figure 1 and figure 2 more easily, the figure includes kernel density at the frame of the figures. the kernel density is a non-parametric way to estimate the asian journal of economics and empirical research, 2017, 4(2): 106-120 113 probability density function of a random variable and can be presented by a non-continuous bar graph. the kernel density of series x at point x can be estimated by: )( 1 )( 1     n i i h xx k nh xf ……………………………… (8) where n is the sample size, h is the width based on silverman (1986) and k is the kernel function. the epanechnikov density form is given by: )1()1( 4 3 2   i where i is the index function; when 1 , 1 is chosen, or otherwise 0. figure 1 shows that when the news impact is less than 0 (i.e., when encountering negative news), the curve is flatter. in contrast, the news impact curve is steeper when having positive news. this is likely due to the integration strategy and company policy within the formosa plastics group, which strengthen the function of the business group‟s headquarter.8 therefore, the effect of negative news on stock prices is weakened. figure-1. news impact curve of formosa plastics group (excluding formosa advanced technologies) 5.3.2. estimation results of egarch model (including formosa advanced technologies) the coefficients of this model (including formosa advanced technologies) are all significant at the 1% level without adding any restrictions. the values of α (0.0661), β (0.9943) and γ (0.0460) are all positive. the value of α + γ is proportional to its sensitivity. when having good news, the impact on the logarithm of conditional variance can be presented as: 0.0661 + 0.0460 = 0.1121 times; when having bad news, the impact on the logarithm of conditional variance can be presented as: 0.0661 + 0.0460*(-1) = 0.0201 times. this suggests that investors do not have greater psychological reactions to bad news (table 9). table-9. estimation results of egarch model (including formosa advanced technologies) variable coefficient std. error z-statistic prob. a1303 4.47e-05 0.001562 0.028636 0.9772 d(a1326) 0.504051 0.010627 47.42908 0 a1434 -0.00063 0.0033 -0.18953 0.8497 d(a2408) -0.01376 0.014311 -0.96156 0.3363 a3532 -0.00104 0.000495 -2.09259 0.0364 a6505 0.000754 0.000763 0.987339 0.3235 a8046 0.000203 0.00028 0.723959 0.4691 d(a8131) 0.018598 0.022756 0.817257 0.4138 d(p50) 0.465813 0.025222 18.46823 0 variance equation c(10) -0.05208 0.00679 -7.67018 0 c(11) 0.066172 0.008509 7.7765 0 c(12) 0.046068 0.007513 6.131406 0 c(13) 0.994309 0.00147 676.2493 0 r-squared 0.526034 akaike info criterion 2.325885 log likelihood -2769.92 schwarz criterion 2.357287 based on the egarch model results, including formosa advanced technologies, the news impact curve is drawn and shown in figure 2. the figure also shows that when the news impact is less than 0 (i.e., when encountering negative news), the curve is flatter. in contrast, the news impact curve is steeper when having positive news. however, compared with figure 1 (which excludes formosa advanced technologies), the curve is even flatter when formosa advanced technologies is included. this suggests that including formosa advanced technologies can lower the risks and the β of the model (0.99) is close to 1; that is, it is slowly stabilize. therefore, the effect of negative news on stock prices is weakened. 8refer to wealth magazine (issue 531, 2017.06.15), “things that the headquarter of the business groups do.” https://www.wealth.com.tw https://www.wealth.com.tw/ asian journal of economics and empirical research, 2017, 4(2): 106-120 114 figure-2. news impact curve of formosa plastics group (including formosa advanced technologies) as the γ coefficients are positive no matter the leading company‟s stock prices are included or not, very little difference in figures can be observed in figures. therefore, this study further test for the difference in γ coefficients. the t statistic is 3.52 (appendix 2), suggesting a significant difference in γ coefficients of formosa advanced technologies. investor sentiment is calmer when formosa advanced technologies is included. 5.4. comparison of formosa plastics group’s investment performance the model adopts the stock prices of leading company, taiwan 50 etf and other stocks. that is, data1 is the price of individual stocks; data2 is the price of 0050 etf; data3 is the price of leading company, where formosa advanced technologies is used in model 1 and nan ya printed circuit board is used in model 2. the results show that in model 1, the returns increase in the second stage for six companies (table 10-1). if the investment portfolio includes the eight companies in the formosa plastics group, the investment is profitable. the profits increase from $353.66 in the first stage to $357.86 in the second stage, showing an increase of 12.49%. the results show that this program trading is profitable. however, the performance of formosa plastics group is worse than the whole market by 16.01%. this is probably because the peak in taiwan‟s stock market is mainly caused by iphone‟s supply chain companies. table-10.1. investment returns of model 1, including formosa advanced technologies as the leading company (unit: $, times, %) company code 2007.12.10-2014.12.29 2007.12.10-2017.8.10 changes in profits total profits net profit no. of transactions winning probability net profit no. of transactions winning probability a1301 26.56 1 -100 35.88 3 100 9.32 44.2 a1303 25 1 100 25 1 100 0 a6505 14.1 5 80 27.64 9 64 13.54 a1326 48.36 4 75 48.36 4 75 0 a1434 14.34 1 100 14.68 2 100 0.34 a2408 44.6 4 100 59.7 6 100 15.1 a8406 128.7 5 80 132.07 6 83 3.37 a3532 52.0 6 83 54.53 8 75 2.53 note: the first stage covers the period 2007.12.10~2014.12.29. the second stage covers the period 2007.12.10~2017.8.10. changes in profits cover the period 2014.10.29~2017.8.10. the results of model 2 show that four companies in model 2 increase the returns in the second stage. the portfolio formed by eight companies in the formosa plastics group is also profitable (table 10-2). the profit in the first stage is $192.76 and increases by $28.35 (14.7%) in the second stage. the results are better than that in model 1. however, when the profit of $353.66 in model 1 is used as the denominator, the increase is only 8.01%, which is worse than the 12.49% in model 1. therefore, the model with formosa advanced technologies as the leading company is better than the model with nan ya printed circuit board as the leading company. the results of formosa plastics group also provide support for hypothesis 1 and 2. that is, including the stock price data of the leading company can lower the impact of negative news. in addition, after choosing the leading company of the business group, we can use technical analysis to enhance the trading performance in the stock market and we indirectly prove the existence of herding behavior. table-10.2. investment returns of model 2, including nan ya printed circuit board as the leading company (unit: $, times, %) company code 2007.12.10-2014.10.29 2007.12.10-2017.8.10 changes in profits total profits net profit no. of transactions winning probability net profit no. of transactions winning probability a1301 26.81 1 100 48.67 2 100 21.86 28.35 a1303 27.46 1 100 27.46 1 100 0 a6505 11.9 1 100 11.9 1 100 0 a1326 34.54 6 83 40.92 8 75 6.38 a1434 12.23 1 100 12.23 1 100 0 a2408 27.98 2 100 28.68 3 100 0.7 a8131 24.79 4 75 26.55 5 80 1.76 a3532 27.05 6 83 24.7 11 63 -2.35 asian journal of economics and empirical research, 2017, 4(2): 106-120 115 6. empirical results of the far eastern group 6.1. granger causality test of the far eastern group 6.1.1. unit root test of model variables of far eastern group to ensure the validity of empirical results, we check the stationarity of the series by testing the var model and choosing the minimal aic value. taking asia cement as an example, the results reject the null hypothesis when the intercept and trend (2.9108(0)) are included. that is, the variable is stationary. therefore, we can proceed with var and granger causality test. other variables are found to have fat tails and autocorrelation. that is, i(1) is not stationary. after taking a difference, the null hypotheses are rejected (table 11) and i(0) is stationary. table-11. unit root test of var model variables of far eastern group original value first order difference variables / model intercept and trend intercept and trend a1102 -2.9108(0)** -2.9712(0) -3.2906(0)** -2.3558(0) -3.3800(1)** -2.2999(0) -2.3971(1) -2.7583(0) -2.8347(0) -30.8949(2)* -37.5003(0)* -46.5832(0)* -47.3465(0)* -43.2681(0)* -47.5449(0)* -40.2399(0)* -36.7305(1)* -48.7114(0)* a1402 a1460 a1710 a2606 a2845 a2903 a4904 a50 note: *，**，*** shows significance level at 1%, 5% and 10%. the number inside the bracket represents the number of lagging periods. (0) shows that when the lag period is 0, it has the minimal aic. sample code is as provided in section 4. 6.1.2. lag-period co-integration test of far eastern group’s var model before proceeding with the var model estimation, lag periods need be tested. the results show that the aic and fpe of the far eastern group are at their minimum when the data are lagged two periods (table 12). therefore, the model is tested with two lagging periods. this study also tests the maximum likelihood proposed by johansen and juselius (1990) to examine the co-integration relationships between multi-variables. the model has five co-integration equations (table 13). therefore, we can conduct the granger causality test. table-12. lag period estimation of far eastern group‟s var model lag logl lr fpe aic sc hq 0 -40212.81 na 2399.206 33.32379 33.34537 33.33164 1 -16202.17 47822.35 5.89e-06 13.49807 13.71390* 13.57657* 2 -16048.74 304.4466 5.54e-06* 13.43806* 13.84814 13.5872 8 -15648.49 141.4467* 5.95e-06 13.50911 15.08466 14.08213 table-13. johansen co-integration test results trace max-eigen no. of ce(s) eigenvalue statistic critical value(0.05) prob. statistic critical value(0.05) prob. none * 0.4489 5824.35 179.51 0 1442.06 54.97 1.00 at most 1 * 0.3966 4382.29 143.67 0 1222.33 48.88 1.00 at most 2 * 0.3769 3159.96 111.78 1 1144.92 42.77 1.00 at most 3 * 0.3561 2015.04 83.94 1 1065.23 36.63 1.00 at most 4 * 0.3151 949.81 60.06 0.0001 915.82 30.44 0.00 at most 5 0.0087 33.98 40.17 0.1826 21.20 24.16 0.12 note: * means below the 5% level and rejects h0. 6.1.3. granger causality test of the far eastern group in order to examine the investment behavior of far eastern group, we include the trading information of eight companies and taiwan 50 etf in the var model and conduct granger causality test. the results show that when lagging two periods, u-ming marine (2606) (5times), taiwan 50 etf and far eastern department stores (2903) (4times) have the highest and second highest number of granger causes. in other words, the investment behavior of the other eight companies of the far eastern group all refuse to reject the data of taiwan 50 etf and u-ming marine. that is, they are treated as endogeneous variables (table 14). therefore, the data of taiwan 50 etf and u-ming marine are the granger cause of other companies and cause herding trading behavior in other companies. 6.2. granger causality test of asia cement, taiwan 50 etf, and u-ming marine 6.2.1. lag period test in this section, we use asia cement, taiwan 50 etf and u-ming marine as examples to carry out the var model estimation. we need to first test the lagging periods. the results show that the aic, fpe and lr of asia cement, taiwan 50 etf and u-ming marine are at their minimum when lagging 10 periods (table 15). therefore, this model is estimated using a lag period of 10. also, based the maximum likelihood estimation proposed by johansen and juselius (1990) we test the co-integration relationship between multi-variables. the model has one co-integrated equations (table 16). asian journal of economics and empirical research, 2017, 4(2): 106-120 116 table-14. granger causality test of far eastern group dependent variable: p2606 dependent variable: d(p1402) dependent variable: d(p2903) excluded chi-sq prob. excluded chi-sq prob. excluded chi-sq prob. p1102 4.55 0.10 p2606 4.77 0.09 p2606 17.28 0.00 p1460 2.22 0.33 p1102 0.76 0.68 p1102 13.08 0.00 p50 7.59 0.02 p1460 2.85 0.24 p1460 0.76 0.69 d(p1402) 4.10 0.13 p50 9.67 0.01 p50 3.41 0.18 d(p1710) 0.67 0.71 d(p1710) 2.94 0.23 d(p1402) 34.79 0.00 d(p2845) 8.11 0.02 d(p2845) 2.42 0.30 d(p1710) 0.17 0.92 d(p2903) 3.11 0.21 d(p2903) 28.97 0.00 d(p2845) 1.82 0.40 d(p4904) 1.36 0.51 d(p4904) 6.50 0.04 d(p4904) 3.35 0.19 all 32.28 0.01 all 64.06 0.00 all 206.51 0.00 dependent variable: p1102 dependent variable: d(p1710) dependent variable: d(p4904) excluded chi-sq prob. excluded chi-sq prob. excluded chi-sq prob. p2606 37.31 0.00 p2606 15.54 0.00 p2606 0.30 0.86 p1460 1.20 0.55 p1102 2.08 0.35 p1102 1.30 0.52 p50 1.79 0.41 p1460 1.27 0.53 p1460 1.24 0.54 d(p1402) 27.23 0.00 p50 3.83 0.15 p50 3.98 0.14 d(p1710) 5.45 0.07 d(p1402) 0.14 0.93 d(p1402) 0.49 0.78 d(p2845) 1.37 0.50 d(p2845) 1.72 0.42 d(p1710) 0.14 0.93 d(p2903) 18.80 0.00 d(p2903) 2.64 0.27 d(p2845) 4.64 0.10 d(p4904) 2.07 0.36 d(p4904) 0.41 0.81 d(p2903) 0.32 0.85 all 107.58 0.00 all 45.11 0.00 all 20.74 0.19 dependent variable: p1460 dependent variable: d(p2845) dependent variable: p50 excluded chi-sq prob. excluded chi-sq prob. excluded chi-sq prob. p2606 5.12 0.08 p2606 2.30 0.32 p2606 0.59 0.74 p1102 3.76 0.15 p1102 1.55 0.46 p1102 1.46 0.48 p50 5.51 0.06 p1460 0.31 0.86 p1460 1.49 0.47 d(p1402) 0.97 0.61 p50 6.43 0.04 d(p1402) 10.79 0.00 d(p1710) 1.50 0.47 d(p1402) 0.18 0.91 d(p1710) 5.87 0.05 d(p2845) 3.04 0.22 d(p1710) 4.14 0.13 d(p2845) 4.33 0.12 d(p2903) 2.06 0.36 d(p2903) 11.73 0.00 d(p2903) 7.91 0.02 d(p4904) 0.94 0.62 d(p4904) 0.80 0.67 d(p4904) 1.26 0.53 all 26.89 0.04 all 46.19 0.00 all 40.04 0.00 note: prob. means probability. chi-sq is the χ2 statistics. sample code is the same as table 1. d means taking the first difference. table-15. lag period estimation of var model of asia cement, taiwan 50 etf (p50), and u-ming marine lag logl lr fpe aic sc hq 1 -7737.154 24911.57 0.181921 6.809450 6.839662 6.820471 2 -7683.505 106.9673 0.174922 6.770216 6.823086* 6.789502 3 -7656.867 53.04309 0.172232 6.754716 6.830246 6.782268* 10 -7587.266 21.63717* 0.171236* 6.748916* 6.983057 6.834326 12 -7575.269 14.37891 0.172143 6.754191 7.033650 6.856132 table-16. johansen co-integration test results trace max-eigen no. of ce(s) eigenvalue statistic critical value(0.05) prob. statistic critical value(0.05) prob. none * 0.4489 5824.35 179.51 0 1442.06 54.97 1.00 at most 1 0.3966 4382.29 143.67 0 1222.33 48.88 1.00 6.2.2. granger causality test we include three variables, asia cement, taiwan 50 etf and u-ming marine, in the var model and conduct the granger causality test. the results show that when lagging 10 periods, except that u-ming marine is not the granger cause of taiwan 50 etf, all other variables are granger cause of each other and can be treated as endogenous variables (table 17). in other words, the three variables refuse to reject the data of each other and we can proceed with the investment simulation in the next stage. table-17. granger causality relationships between asia cement, taiwan 50 etf, and u-ming marine p1102 p50 p2606 p1102 22.3095 (0.0136) 52.0642 (0.0000) p50 23.1639 (0.0102) 12.7971 (0.2352) p2606 43.1905 (0.0000) 36.1488 (0.0001) note: sample codes are the same as that presented in table 14. 6.3. coefficients estimation of egarch model 6.3.1. estimation results of egarch model (excluding u-ming marine) using log(var), the values of  (1.2459) and  (0.9363) of the model (excluding u-ming marine) are both significant at the 1% level. as for γ (0.0822), it is positive and significant at the 10% level. this shows the existence of asymmetric volatility. the volatility caused by good news (1.3282) is greater than the volatility caused by bad news (1.1637) (table 18). the news impact curve of far eastern group excluding u-ming marine is presented in figure 3. asian journal of economics and empirical research, 2017, 4(2): 106-120 117 table-18. estimation results of egarch model (excluding u-ming marine) variable coefficient std. error z-statistic prob. log(garch) 0.253939 0.013727 18.49924 0 p1460 -1.37272 0.003421 -401.274 0 p50 0.855594 0.000819 1044.124 0 d(p1402) -0.01974 0.029651 -0.66584 0.5055 d(p1710) -0.07774 0.017068 -4.55488 0 d(p2845) 0.012349 0.037818 0.326538 0.744 d(p2903) 0.123528 0.024697 5.001772 0 d(p4904) -0.01338 0.013625 -0.98203 0.3261 variance equation c(9) -1.0055 0.039416 -25.51 0 c(10) 1.245943 0.06153 20.24945 0 c(11) 0.082286 0.045586 1.805092 0.0711 c(12) 0.934208 0.016346 57.15351 0 r-squared -0.11256 akaike info criterion 5.347462 log likelihood -6463.78 schwarz criterion 5.376161 figure-3. news impact curve of far eastern group (excluding u-ming marine) 6.3.2. estimation results of egarch model (including u-ming marine) using the log(var) method,  (=1.0893),  (=0.5299), and  (=-0.1797) of this model (including u-ming marine) are all significant at the 1% level. the results shows that due to leverage effect negative news have greater impacts on investors‟ psychological reactions. the leverage effect of positive news can be presented as: 0.9090=(1.0893-0.1797). the leverage effect of negative news can be presented as: 1.2690=1.0893-0.1797*(-1) (table 19). the  of the model including u-ming marine is smaller than that of the model excluding u-ming marine. this suggests that the model stabilizes more quickly. the news impact curve of the far eastern group, including u-ming marine, is presented in figure 4. table-19. estimation results of egarch model (including u-ming marine) variable coefficient std. error z-statistic prob. log(garch) -1.99369 0.000332 -6010.5 0 p1102 1.408301 4.92e-05 28652.68 0 p1460 -3.35942 0.000292 -11514.9 0 p50 0.746751 8.08e-05 9237.694 0 d(p1402) -0.40108 0.002449 -163.802 0 d(p1710) 0.296476 0.002707 109.5347 0 d(p2845) -0.15351 0.003334 -46.0395 0 d(p2903) -0.38407 0.000308 -1247.76 0 d(p4904) 0.100932 0.003646 27.68309 0 variance equation c(10) 0.076418 0.000226 337.6941 0 c(11) 1.089367 0.000739 1473.486 0 c(12) -0.17974 0.000256 -701.306 0 c(13) 0.529939 0.000348 1521.322 0 r-squared 0.75463 akaike info criterion 6.527433 log likelihood -7891.72 schwarz criterion 6.558523 asian journal of economics and empirical research, 2017, 4(2): 106-120 118 figure-4. news impact curve of far eastern group (including u-ming marine) figure 3 and 4 shows that returns and risks are significantly different depending on weather u-ming marine is included. this study also tests for the differences in γ coefficients. the t statistic is 105.16, suggesting significant differences in γ. the results show investor sentiment is calmer when excluding u-ming marine. 6.4. comparison of far eastern group’s investment performance the model adopts the stock prices of leading company, taiwan 50 etf and other stocks. that is, data1 is the price of individual stocks; data2 is the price of 0050 etf; data3 is the price of leading company, where u-ming marine is used in model 1 and far eastern department stores is used in model 2. the results show that in model 1, only two companies have an increase in investment returns in the second stage. if the investment portfolio includes the eight companies in far eastern group, the investment is profitable (table 20-1). the profit in the first stage is $132.18 but it decreases to $129.41 in the second stage, showing a fall of 0.0209%. therefore, this program trading is not profitable. table-20.1. investment returns of model 1, including u-ming marine as the leading company (unit: $, times, %) company code 2007.10.29-2014.10.29 2007.10.29-2017.8.10 changes in profits total profits net profit no. of transactions winning probability net profit no. of transactions winning probability a1102 17.7 7 100 13.99 7 85 -3.71 -2.77 a1402 18.12 4 100 19.7 5 100 1.58 a1460 12.24 3 100 13.13 4 100 0.89 a1710 21.35 15 66 20.2 20 55 -1.15 a2606 0 a2845 4.18 11 72 3.8 13 61 -0.38 a2903 28.56 4 100 28.56 4 100 0 a4904 30.03 2 100 30.03 2 100 0 note: the first stage covers the period 2007.10.29~2014.10.29. the second stage covers the period 2007.10.29~2017.8.10. changes in profits cover the period 2014.10.29~2017.8.10. the results of model 2 show that only one company (u-ming marine) has an increase in investment returns in the second stage. the portfolio formed by eight companies in the far eastern group as a whole is profitable (table 20-2). the profit of the investment portfolio in the first stage is $141.29 and increases by $12.07 (8.54%) in the second stage. the findings suggest that model 2 with far eastern department stores as the leading company is better than model 1 with u-ming marine as the leading company. however, when u-ming marine is excluded from model 2, it becomes unprofitable. therefore, the results from far eastern group do not support hypothesis 1 or 2. specifically, the leading company of the far eastern group is not useful for enhancing the profits. the program trading simulation results also suggest that the diversification strategy of the far eastern group is not as good as the vertical integration strategy of the formosa plastics group. therefore, when investors are choosing a business group for investing based on herding effect, they should choose carefully.9 table-20.2. investment returns of model 2, including far eastern department stores as the leading company (unit: $, times, %) company code 2007.10.29-2014.10.29 2007.10.29-2017.8.10 changes in profits total profits net profit no. of transactions winning probability net profit no. of transactions winning probability a1102 26.89 2 100 26.89 2 30 0 12.07 a1402 18.52 9 66 15.83 11 63 -2.69 a1460 11.11 1 100 11.11 1 100 0 a1710 17.36 3 100 17.36 3 100 0 a2606 56.83 3 100 72.77 4 100 15.94 a2845 4.04 6 50 4.04 6 50 0 a2903 0 0 0 a4904 6.54 2 100 5.36 3 66 -1.18 9this study has tried using taiwan mid 100 in the model instead of taiwan 50. however, the sum of α (1.4335) and γ (0.4867) is greater than 1, suggesting that this model is not stationary. the program trading simulation also leads to similar conclusion. therefore, due to page limit, the test results are not provided here. asian journal of economics and empirical research, 2017, 4(2): 106-120 119 7. conclusion and discussion on investment strategies the aim of this study is to examine the difference in operating performance for two family business groups, formosa plastics group and far eastern group, after the impact of financial tsunami (2007.10.29~2017.08.10). this research helps investors understand the operating model of business groups and learn how to use the herding effect of business groups to enhance their trading performance in financial markets. the results show that for the formosa plastics group, the news impact curve (based on egarch model) including the leading company is flatter than when the news impact curve excludes the leading company. in contrast, the news impact curve of the far eastern group is steeper when the leading company is included. moreover, when the leading company is include as an endogeneous variable in the model as a filter for the program trading simulation, the net profits for the first stage (2007.10.29~2014.12.29) and the second stage (2007.10.29~2017.08.10) are 12.49% and -0.02%, respectively. therefore, this program trading of the formosa plastics group can lead to trading profits. in sum, business groups that include the leading company have lower risks. it is also beneficial to the stability of the market trading by incorporating the leverage effect of the leading company in business groups. the results show 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far eastern group unit: $, %, „000 million business group code company name year establish industry classification (correlation coefficient*) stock price (2017.8.10) net profits (2016) eps (2016) market value (7.21) stock holdings (%) board chairman formosa plastics group 1301 formosa plastics 1954 plastics (6.78) 92.6 394 6.19 5825 36 lin jian nan 1303 na ya plastics 1958 plastics (6.78) 75.4 484 6.16 5932 43 wu jia zhao 1326 formosa chemicals & fibre 1965 plastics (6.78) 91.5 438 7.5 5322 47 wang wen yuan 1434 formosa taffeta 1973 textile (6.76) 29.7 35 2.07 535 37 wang wen yuan 2408 nanya technology 1995 electronic (7.32) 60.5 237 8.67 1740 33 wu jia zhao 3532 formosa sumco technology 1995 electronic (7.32) 88.5 7 0.94 691 29 lin jian nan 6505 formosa petrochemical 1992 oil and electricity (13.16) 103.5 758 7.95 10002 76 chen bao lang 8046 nan ya printed circuit board 1997 electronic (7.32) 23.35 -7 -1.07 158 67 wu jia zhao 8131 formosa advanced technologies 1990 electronic (7.32) 27.2 10 2.31 121 66 wang wen yuan far eastern group 1102 asia cement 1957 cement (14.8) 26.55 39 1.26 889 22 xu xu dong 1402 far eastern new century 1954 textile (6.76) 24.35 63 1.26 1314 24 xu xu dong 1460 everest textile 1988 textile (6.76) 26.1 5 1.2 77 25 xi jia yi 1710 oriental union chemical 1975 chemical (7.61) 26.1 -6 -0.63 255 43 xu xu dong 2606 u-ming marine 1968 shipping (6.13) 32.8 -8 -1.04 270 39 xu xu dong 2845 far eastern international bank 1992 finance (4.64) 9.93 32 1.04 309 42 hou jin ying 2903 far eastern department stores 1967 department store (3.43) 15.1 11 0.81 215 40 xu xu dong 4904 far estone telecommunications 1997 telecommunication (3.62) 73.3 114 3.5 2395 38 xu xu dong note: *including forward and backward correlation coefficient (http://www.dgbas.gov.tw/lp.asp?ctnode=2340&ctunit=1088&basedsd=7&mp=1) appendix-2. test for difference in  coefficients of egarch model formosa plastics group far eastern group γ coefficient std dev. t γ coefficient std dev. t including leading company 0.046068 0.0075 3.52 -0.1797 0.0003 105.16 excluding leading company 0.045297 0.0076 0.0823 0.0456 asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://scholar.google.com/scholar?hl=en&q=conditional%20heteroskedasticity%20in%20asset%20returns:%20a%20new%20approach http://dx.doi.org/10.2307/2938260 http://dx.doi.org/10.2307/2938260 https://scholar.google.com/scholar?hl=en&q=diversification%20strategy,%20profit%20performance%20and%20the%20entropy%20measure https://scholar.google.com/scholar?hl=en&q=diversification%20strategy,%20profit%20performance%20and%20the%20entropy%20measure http://dx.doi.org/10.1002/smj.4250060305 https://scholar.google.com/scholar?hl=en&q=proof%20that%20properly%20anticipated%20prices%20fluctuate%20randomly https://scholar.google.com/scholar?hl=en&q=herd%20behavior%20and%20investment https://scholar.google.com/scholar?hl=en&q=the%20volatility%20of%20long-term%20interest%20rates%20and%20expectations%20models%20of%20the%20term%20structure http://dx.doi.org/10.1086/260832 https://scholar.google.com/scholar?hl=en&q=the%20use%20of%20volatility%20measures%20in%20assessing%20market%20efficiency http://dx.doi.org/10.2307/2327010 http://dx.doi.org/10.2307/2327010 https://scholar.google.com/scholar?hl=en&q=a%20survey%20of%20corporate%20governance http://dx.doi.org/10.1111/j.1540-6261.1997.tb04820.x https://scholar.google.com/scholar?hl=en&q=mutual%20fund%20herding%20and%20the%20impact%20on%20stock%20prices http://dx.doi.org/10.1111/0022-1082.00118 http://www.dgbas.gov.tw/lp.asp?ctnode=2340&ctunit=1088&basedsd=7&mp=1 16 © 2019 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 6, no. 1, 16-26, 2019 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2019.61.16.26 © 2019 by the authors; licensee asian online journal publishing group business cycles and financial frictions under money growth rule wondemhunegn ezezew melesse1 1university of gondar, gondar, ethiopia abstract in the last few years, macroeconomic modeling has emphasized the role of credit market frictions in magnifying and transmitting nominal and real disturbances and their implication for macro-prudential policy design. in this paper, i construct a modest new keynesian general equilibrium model with active banking sector. in this set-up, the financial sector interacts with the real side of the economy via firm balance sheet and bank capital conditions and through their impact on investment and production decisions. i rely on the financial accelerator mechanism due to bernanke et al. (1999) and combine it with a bank capital channel as demonstrated by aguiar and drumond (2007). the resulting model is calibrated from the perspective of a low-income economy reflecting the existence of relatively high investment adjustment cost, strong fiscal dominance, and underdeveloped financial and capital markets. the main objective of this exercise is to see whether the financial accelerator mechanism documented under interest-rate-rule based simulations could be replicated under a situation where the central bank uses money growth rule in stabilizing the national economy. the findings are broadly consistent with previous studies that demonstrated stronger role for credit market imperfections in amplifying and propagating monetary policy shocks. keywords: financial frictions, monetary policy transmission, money growth rule, dsge model, calibration. jel classification: e30, e44 citation | wondemhunegn ezezew melesse (2019). business cycles and financial frictions under money growth rule. asian journal of economics and empirical research, 6(1): 16-26. history: received: 22 october 2018 revised: 16 november 2018 accepted: 31 december 2018 published: 18 january 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 17 2. literature review ............................................................................................................................................................................ 17 3. model .................................................................................................................................................................................................. 19 4. results and discussion ................................................................................................................................................................... 23 5. conclusion and policy implications ............................................................................................................................................. 25 references .............................................................................................................................................................................................. 25 appendix ................................................................................................................................................................................................ 26 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.61.16.26&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/262 https://orcid.org/0000-0001-8762-3881 http://asianonlinejournals.com/index.php/ajeer/article/view/262 https://orcid.org/0000-0001-8762-3881 http://asianonlinejournals.com/index.php/ajeer/article/view/262 https://orcid.org/0000-0001-8762-3881 asian journal of economics and empirical research, 2019, 6(1): 16-26 17 © 2019 by the authors; licensee asian online journal publishing group 1. introduction over the past few years, applied research has attached due emphasis to the explicit role of the financial sector in amplifying and propagating disturbances into the real economy. the financial crisis that broke out in 2007 has spurred a wide range of investigations into the importance of banking and financial activities in shaping business cycle fluctuations. previously, economic thinking was widely influenced by the modigliani-miller (mm) principle in which financial structure was irrelevant for both banking and non-banking business funding considerations. as a result, it did not matter whether a firm financed its investment opportunities by issuing bonds (debt) or shares (equity) and the market valuation of the firm would be deemed independent of its capital structure. however, the mm hypothesis rests on numerous suspicious assumptions that are incompatible with empirical evidence. some of those assumptions include absence of distortive taxation, symmetric distribution of information among transaction parties, efficient goods and financial markets, and zero bankruptcy costs. since financial markets are perfect, there is no wedge between lending and borrowing rates, and in fact, there is no need for financial intermediaries as businesses can directly source their external funds from households. the mm principle, therefore, would rule out the monetary policy transmission aspects of bank asset and liability management as well as the effects of leverage ratio on business investment choices. theory and empirical regularities show that agency problems such as moral hazard and information asymmetry play a huge role in influencing access to credit and, therefore, the balance sheet structure of entrepreneurial firms, especially small and micro enterprises (smes). stiglitz and weiss (1981) have shown how existence of agency problems could generate credit rationing in which among observationally identical applicants some are offered credit and others are rejected. thus applicants who are denied credit would not be able to get external funds even if they were willing to accept a higher interest rate than the one prevailing in the market or post more collateral than was required of eligible borrowers. under such circumstances, banks would reconcile the supply of available funds with demand for credit not by raising the lending rate or demanding more collateral but by restricting the number of borrowers via rationing. thus, downsized balance sheets reduce the banks‘ capacity to offer additional loans and lower debt-to-equity ratio incentivizes banks to minimize the variability of their portfolio. if this logic is operational, banks are willing to sacrifice more profits on [potentially] successful loan advancements by increasing screening and monitoring of loan applicants (agur, 2010). one important force behind the screening and filtering barriers erected by lenders is that agency problems can operate through the size of the borrowing firm.1 size can affect the capital structure of the firm because of the role of scale economies in reducing asymmetric information, degree of risk exposure, the extent of transaction costs, and access to market facilities. smaller firms receive less capital or pay higher rates as it is relatively more expensive for them to solve informational problems with their potential creditors. this implies that the effect of size on financing structure should be more pronounced among start-ups as new firms are more information-wise dense than their established counterparts. moreover, to the extent that firm size is inversely correlated with risk, bankruptcy costs, and market barriers, this would discourage smaller firms from accessing outside financing options. consequently, in light of these frictions and imperfections, the capital structure of firms and financial intermediaries could be vastly different from the one predicted by the mm principle. size is particularly relevant in the context of low income countries where small and micro enterprises (smes) have great potential in terms of employment creation as well as in their contribution to gdp but face significant barriers against access to finance.2 the world bank report on small and micro enterprise financing in ethiopia (world bank, 2015) confirms this observation. the report shows that in both manufacturing and service sectors, job creation is higher among established and older firms than under young businesses, suggesting a lack of competitiveness and innovation in the private sector. the retail and service sectors were also more important than manufacturing in job creation and employment. regarding financial constraints, the report indicates small firms struggle the most in getting access to credit, smaller and young firms are more likely to be rejected for a loan or a line of credit, and that smes are discouraged or willingly distance themselves from applying for loans due to prohibitive collateral requirements. the report also identifies a ‗missing link‘ in which small firms are disproportionately affected compared with micro, medium, and large enterprises.3 the main objective of this paper is to see whether the financial accelerator mechanism documented under interest-rate-rule based simulations could be replicated under a situation where the central bank uses money growth rule in stabilizing the national economy. the findings are broadly consistent with previous studies that demonstrated stronger role for credit market imperfections in amplifying and propagating monetary policy shocks. 2. literature review despite their popularity as the workhorse for monetary policy scenario analysis, standard new keynesian general equilibrium models had devoted insignificant role to financial market frictions in magnifying and driving macroeconomic volatility.4 these models replicate business cycle properties only with heavy reliance on extensive and persistent shocks whose existence cannot easily be verified and explained (brázdik et al., 2012). in this paper, we introduce explicit roles for both business and financial market rigidities that facilitates the amplification and propagation of real and nominal shocks affecting the economy.5 as noted by markovic (2006) we can identify between two distinct categories of modeling frameworks featuring financial market imperfections. the first category includes bank balance sheet models that emphasize the supply side aspects of financial markets such as bank balance sheet status. the second group focuses on corporate 1see cassar (2004) for more detail on financing issues affecting business start-ups. additionally, owner characteristics (level of education or experience), asset structure or collateral, legal organization (presence or absence of limited liability) and other factors can shape financing structure. 2for instance, under the five-year growth and transformation plan (gtp), the government of ethiopia recognized the industrial potential embedded in smes and it planned to generate more than 3 million jobs between 2010/11 and 2014/15,a goal which was realized by more than threefold by the end of july 2015. 3according to this report only 1.9 percent of small firms have loan or line of credit while the corresponding figures for micro, medium and large firms are 6, 20.5, 35.5 percent, respectively. 4 for instance, influential papers like clarida, gali and gertler (1999). do not consider financial frictions at all in their new keynesian models 5 see also vousinas (2013) on the financial-real economy linkage. asian journal of economics and empirical research, 2019, 6(1): 16-26 18 © 2019 by the authors; licensee asian online journal publishing group or business balance sheet conditions like the financial accelerator mechanism influencing firm net worth. while most of the literature has so far concentrated solely on the demand side, we also consider interaction with the supply side to account for frictions arising from banking and financial markets. on the demand side, bernanke et al. (1989) and bernanke et al. (1999) constitute the foundation by incorporating information asymmetry in credit markets as a source of agency costs influencing investmentspending behavior among firms. this link is particularly strong when the economy is stuck below its capacity. in recession, for instance, demand shortfall negatively affects revenue and consequently firm profit and equity6 fall substantially. the attendant increase in leverage ratio (or decrease in net worth) aggravates the already existent agency problem and creditors respond by raising the finance premium on their loans. the higher external financial premium reduces the demand for capital investment which, in turn, further undermines the net worth position and survivability of the firm. this self-reinforcing mechanism is known as the ―financial accelerator‖ and illustrates the pro-cyclical nature of adverse changes in business net worth and their impact on the ability of firms to access external funding opportunities. the financial accelerator principle implicitly assumes that producers can get unlimited amount of funding at the prevailing lending rate subject to the strength of their balance sheet structures (banks demand no guarantee that the loan be repaid in full). in this setting, the external risk premium only affects their capacity to borrow without facing the possibility of credit rationing or some other quantitative restrictions imposed by lenders. kiyotaki and moore (1997) consider collateral constraints that facilitate the magnification of business cycle volatility and persistence as a result of dynamic association between credit prices and quantities. in the past, the vast majority of the literature focused its attention on credit market imperfections affecting firms while the role of banking was understated or totally ignored. incorporating the financial sector permits an important role for the supply side of the credit market by activating banks‘ liquidity and capital structures, which creates a two-way bridge between banking services and the broader non-financial economic activity. consequently, introducing an active banking sector creates a double-agency-cost problem between banks and their shareholders on the one hand and between borrowers and creditors on the other.7 heuvel (2002); markovic (2006); aguiar and drumond (2007); christensen and dib (2008) and dib (2010) among others, have rationalized how capital sufficiency regulations imply a breakdown of the modigliani-miller principle: the bank‘s credit supply policy is a function of its capital structure, lending opportunities, and market interest rates. for instance, a sharp fall in bank capital—from cancellation of large non-performing loans or other adverse shocks—will force the bank to reduce the supply of credit because of regulatory capital requirement or the punitive cost of attracting new capital. a similar argument can be deployed regarding the role of insufficient bank liquidity in amplifying tight monetary policy measures and other negative shocks affecting the broader economy. as emphasized byaguiar and drumond (2007) the discussion on the importance of bank equity in business cycle fluctuations is relevant in view of the implementation of the basel capital accords (the first in 1988/1992, the second in 2004, and the third motivated by the 2007 financial crisis and yet to be implemented). this series of international standards establishes the basis for a host of central banks and other regulatory authorities to make sure that commercial banks have adequate capital to weather individual and aggregate risks stemming from within and outside the financial system. by imposing risk and capital measurement and management requirements, such standards can influence bank credit offer and investment decisions: if a bank finds itself exposed to large outstanding risky loans, it will be required to increase its capital to avoid total collapse, and this should reduce lending to the wider economy. the cost of bank capital can be an important factor for the smooth operation of credit providers. markovic (2006) identifies three key bank capital channels that cause a variation in the expected return and thus a variation in the cost of bank capital: 1) the default risk channel due to the possibility of banks defaulting on their capital. this channel is active in equilibrium and its strength is, in turn, a function of firms defaulting on bank loans 2) the adjustment cost channel which rests on the existence of information asymmetry between depository institutions/banks and their investors/shareholders, and the associated monetary cost necessary to minimize this asymmetry. if this channel is real, raising fresh capital is costly, as this would send a bad signal to potential investors about the financial conditions of the target bank. as a result, prospective investors would buy bank shares only after incurring search costs (costs involved in checking the health of specific banks) 3) the capital/equity loss channel works via existing shareholders‘ expectation of future bank losses. during recession, shareholders anticipate that in the future there will be a decline in the value of their bank capital. thus, the higher the expected erosion in bank equity, the stronger the capital loss channel will be. on the empirical front, there have been numerous studies accentuating the significant role of the financial sector in intensifying and propagating the effects of adverse shocks affecting the economy. fukunaga (2002) built upon the bernanke et al. (1999) framework to develop a dynamic general equilibrium model calibrated to the japanese economy. the model features a micro-financial contractual problem involving companies/borrowers and financial intermediaries/banks. retailers are included to introduce inertia in the price setting process with the objective of providing room for monetary non-neutrality in the short run. moreover, capital producers and government (fiscal and monetary sectors) are included. in this decentralized, rational-expectation-equilibriummodel economy, three sources of unanticipated shocks are considered: technology (total factor productivity), monetary and demand (exogenous fiscal expenditure). the results suggest, among other things, that tight monetary policy stance (negative shock) is followed by a decline in corporate investment, net worth, and demand for capital as a result of a rise in the external financial risk premium. this fall in investment is much deeper and more persistent in the model with financial accelerator than the one without credit market frictions. in addition to the net worth channel, demand-side financial imperfections have also been identified to originate from collateral constraints. brzoza-brzezina et al. (2010)8 compare the relative significance of the two channels in 6throughout the discourse, i use net worth, equity and capital interchangably both in the context of bank and business balance sheets. 7 this agency problem has two dimensions: moral hazard (when one agent--the bank--cannot without cost verify the intention, activity or action of another agent--the borrower) and adverse selection (when one agent has access to private information). 8 they also introduce a banking sector in both versions of frictions even though analyzing the impact of shocks emanating from the banking system is not their main objective. asian journal of economics and empirical research, 2019, 6(1): 16-26 19 © 2019 by the authors; licensee asian online journal publishing group an extended medium scale new keynesian model calibrated to the polish economy. they compare the collateral constraint framework of kiyotaki and moore (1997) with the external finance premium setup of carlstrom and fuerst (1997) and bernanke et al. (1999). they rely on business cycle accounting, moment matching, and impulse response analyses to see the qualitative and quantitative performance of the two models. their results indicate that both models with financial frictions add volatility to the baseline new keynesian framework, with the external finance premium showing significantly stronger internal propagation mechanism than its collateral constraint counterpart. in terms of business cycle accounting, they find superior performance of the models with financial frictions to the baseline specification, with the model under collateral constraint offering moments closely resembling those filtered from actual data. recently, there have been growing tendencies to model banking activity as a potential source of economic fluctuations. for instance, meh and moran (2010) using a general equilibrium framework, show that bank capital can be an important channel for the transmission of shocks in view of moral hazard problems between banks and investors that provide funds. other works emphasizing the role of bank balance sheets in intensifying and transmitting exogenous shocks include gertler and karadi (2011) and hafstead and smith (2012) among others. though much of the focus has been on bank equity, there have been efforts to incorporate the importance of liquidity under a general equilibrium framework. this might involve assigning roles to interbank markets as in carrera and vega (2012) or studying the impact of reserve requirements as in areosa and coelho (2013). the vast majority of studies on financial market imperfections are devoted to advanced industrial economies and to some extent to emerging blocks while there appears to be scant interest in low-income countries, especially those in sub-saharan africa. one contribution is by babilla (2014) who uses a mix of calibration and bayesian estimation of a modified small open dynamic stochastic general equilibrium model for the west african economic and monetary union (waemu). the paper evaluates the effectiveness of bank lending channel in the propagation of monetary policy measures within a currency union where financial intermediation is dominated by oligopolistic banks. consistent with the evidence for advanced and emerging countries, the paper finds that including financial market distortions improves the performance of the model. this paper relates to the works of markovic (2006); aguiar and drumond (2007); christensen and dib (2008) by allowing interaction between the balance sheet structures of the corporate and banking sectors. the bernanke et al. (1999) model of financial accelerator mechanism is augmented to accommodate distortions arising from credit suppliers. this way, a double-agency-cost problem is emphasized to capture the effects of information and moral hazard costs between banks and borrowers on one side and between banks and their shareholders on the other. it is assumed that banks mobilize funding by issuing shares to and collecting deposits from households. the household preference for liquidity determines the relative costs of banking finance through equity issuance and deposit mobilization. the rest of the paper has been structured as follows. section 3 outlines the model followed by the presentation of calibration and simulation exercise in section 4. section 5 concludes. 3. model the model setup features standard elements in new keynesian general equilibrium models augmented with financial frictions. the household sector makes consumption, labor supply and saving decisions. they use their savings to make deposits and/or buy shares in banks. entrepreneurs rely on bank credit to purchase investment capital and combine it with hired worker to produce wholesale goods. the banks mobilize household resources in the form of deposits and equity and make loans to businesses/entrepreneurs. 3.1. entrepreneurs every period the entrepreneur purchases the required capital stock which will be combined with labor to produce goods the next period. thus, at time t entrepreneur j purchases homogenous capital for use at t+1, 1 j tk  . the return to capital is affected by both systemic risk and risk that is specific to the firm. the ex-post gross return on capital for firm j is 1 1 j k t tr   , where 1 j t  is an idiosyncratic shock specific to firm j‘s return and 1 k tr is the ex post aggregate return to capital. the idiosyncratic disturbance ( )j is independently and identically distributed both across entrepreneurs and over time, with a continuous and once-differentiable cumulative distribution function (c.d.f), ( )f  , over a non-negative support, and with expected value equal to unity. entrepreneur j enters next period with net worth 1 j tn  which complements borrowed funds for the purchase of 1 j tk  . the borrowed money finances the difference between the total capital expenditure and own funds (net worth) and is equal to 1 1 1 j j j t t t tl qk n    , where tq is the unit price of capital in period t. each entrepreneur signs a credit contract with a bank which demands a required rate of return on lending between t and t+1, 1 f tr . this arrangement reflects an agency problem due to asymmetric information between the bank and the entrepreneur. this implies that only the borrower can without incurring costs observe the return of the project. the financial contract is designed to minimize the expected agency cost. as popularized by bernanke et al. (1999) this gives rise to a costly state verification (csv) problem, in which the lending bank must incur monitoring and supervision costs in order to know the actual performance of the borrower‘s project. we assume this monitoring cost is equal a fraction  of the realized gross return of the entrepreneur‘s capital: 1 1 1, j k j t t t tr qk     where 0 1  . neither the bank nor the entrepreneur knows the idiosyncratic disturbance 1 j t  prior to the investment decision. that is both capital expenditure and the credit contract are established before the realization of the shock specific to the borrower. once the investment project has been installed, the bank can observe the random shock but only after incurring monetary costs. asian journal of economics and empirical research, 2019, 6(1): 16-26 20 © 2019 by the authors; licensee asian online journal publishing group given 1 j t tq k  , 1 j tl  , and 1 k tr , the optimal contract is characterized by a gross non-default loan rate , 1 j tz  , and a cut-off 1 j t  , such that, if 1 1 j j t t   , the borrower pays the lender the amount 1 1 1 j k j t t t tr qk    and keeps the residual value 1 1 1 1( ) .j j k j t t t t tr qk     that is, 1 j t  is defined by: 1 1 1 1 j k j j t t t t t tr qk z l     (1) if 1 1 j j t t   , the borrower receives nothing, while the bank monitors the borrower and receives 1 1 1(1 ) j k j t t t tr qk     . in equilibrium, the contractual arrangement ensures that the lender gets an expected gross return on the loan equal to the required return: 1 1 1 1 1 1 1 1 1 1 0 (1 ( )]z (1 ) ( ) ( ), j tj i j j k j f j j t t t t t t t t t t tf l r q k f d r q k n                     (2a) where ( )f  is the probability density function (p.d.f) of  . combining equation (1) with equation (2a) yields the following expression:  1 1 1 1 1 1 1 1 1 0 [1 ( )] (1 ) ( ) ( ) j tj j j k j f j j t t t t t t t t tf f d r k r q k n                     (2b) expanding the expression within the parenthesis on the left hand side of equation (2b) we can define the share of income going to the lender ( ( ) ) and the residual amount to the entrepreneur ( ( ) ): 1 1 1 1 1 1 0 0 ( ) ( ) [1 ( )] ( ) ( ) j j t tj j j j t t t tf f d f d                           thus the optimal financial contract involves maximizing the profit share of the entrepreneur subject to the lender resource constraint discussed previously: 1 1 1 1, [1 ( )](1 r )(lev 1) max 1 t t k t t t t f tlev e r           (2c) s.t. 1 1 1 1 [ ( ) ( )](1 r )(1 lev ) 1 k t t t t tf t lev r              where 1 1 1 t t t t t q k n lev n      . bernanke et al. (1999) have demonstrated that the lender‘s expected return is maximized at a unique interior point 1 j t  , * 1 j t  , and the equilibrium is characterized by 1 j t  always being below * 1 j t  . as a result, the possibility of equilibrium under credit rationing is not considered and the creditor‘s expected return is always increasing in 1 j t  . denoting the expected discounted return to capital by the ratio, 1 1 ( )k t t f t e r r   , if this ratio exceeds unity, the first order conditions of the contracting problem produces the following relationship between 1 1 j t t j t q k n   and the expected return to capital: 1 1 1 1 ( )j k t t t t j f t t q k e r n r           , (3) where (.) 0  and (.) 0  . this implies that the entrepreneur incurs capital expenditures that are proportional to their net worth, with a proportionality factor that is positively correlated with the expected return to capital. thus the probability of default should fall with a rise in the discounted return to capital. the decline in the specter of bankruptcy enables the firm to take on more loans and expand its operation. however, future default costs rise with the leverage ratio and this limits the ability of borrowers to expand investments indefinitely. reformulating the preceding relationship in aggregated form (over firms) we get: 1 1 1 1 ( ) , k t t t t f t t q k e r n r           (4) where 1tk  represents the aggregate stock of capital bought by all entrepreneurial firms at time t, and 1tn  is their aggregate equity or net worth. 1 1 1 1 ( ) , k t t t t f t t e r q k r n            (5) where (.) is increasing in 1 1 t t t q k n   for 1 1t t tn q k  . consequently, in equilibrium, the expected discounted return to capital, 1 1 ( )k t t f t e r r   , evolves inversely with the volume of capital expenditure financed by the firms‘ net asian journal of economics and empirical research, 2019, 6(1): 16-26 21 © 2019 by the authors; licensee asian online journal publishing group worth. 1 1 ( )k t t f t e r r   is what has been referred to as external finance premium in bernanke et al. (1999) faced by entrepreneurs. 3.1.1. entrepreneurial net worth entrepreneurs build their net worth based on accumulated retained earnings from past capital investments and wage compensation from supplying labor. as a technical requirement, we allow entrepreneurs to start with some net worth to begin their operations. moreover, we assume that the fraction of the population who are entrepreneurs remains constant over time: in every period the number of firms entering the market is equal to the number of firms going out of the market. let tv be the entrepreneurs‘ total net worth accumulated from business operations, then normalizing the entrepreneurial work hour to unity we have: 1 e t t tn v w   (6) where e tw captures the wage income to entrepreneurs and  is the chance that the specific entrepreneur survives to the next period. to rule out the possibility that firms build sufficient net worth to be fully self financed, we assume that those firms are active for finite horizons. note the equilibrium value of tv can be cast as a function of the variables from the financial contract as: 1 1 1( ) ( ) ,k f k t t t t t t t t t t tv r q k r q k n r q k        (7) where 1( ) k t t t tr q k   represent the total default monitoring costs and 0 ( ) ( ) . t j t t f d        equations (6) and (7) indicate that the net worth of firms is influenced by their earnings net of interest expenses to the bankers. entrepreneurs that exit from the market in period t are not allowed to purchase capital and simply consume their residual equity (1 ) tv : (1 )e t tc v  , (8) where e tc is the total consumption of entrepreneurs that exit from the market. 3.2. banks in our model economy, the financial industry is dominated by banks which function by mobilizing household funds and extending loans to entrepreneurial firms. in bernanke et al. (1999) banks are only intermediaries and their operation is totally insulated from aggregate risk or whatever risk they face is diversified away. in our approach, for simplicity, lenders are exempt from exogenous reserve requirement, but must satisfy a risk-based capital requirement imposed by the regulatory regime. it is presumed that banks are the sole business entities that issue equity which rests on households‘ willingness and ability to hold capital in addition to deposits. the asset side of the bank balance sheet reveals not just loans to entrepreneurs, but also short term treasury securities. the debt instruments have zero weight in the risk-based capital assessment as they entail no risk (the fiscal sector is assumed not to default on its obligations). a special characteristic feature of banks concerns the facility necessary to monitor and supervise the activities of borrowers. households—who are the major bank shareholders—lack this facility and delegate the responsibility of monitoring to banks, which grapple with the costly state verification problem described previously. under such arrangements, each bank does not enjoy any bargaining advantage. in other words, the banks operate in a perfectly competitive environment and obtain zero profit in the long run as entry and exit are totally unregulated. the banks problem involves:   1 1 1 1 1 1 1 1 1 1 1 1 , , , max ( ) t t t t f d s t t t t t t t t t s d b l r l r b r d e r s               s.t. 1 1 1 1t t t tl b d s      (9) 1 1 _t t s del k l    (10) where 0 _ 1del k  is the exogenous capital adequacy ratio. equations (9) and (10) specify the bank balance sheet constraint and the regulatory capital requirement, respectively. moreover, 1 1 1 1, , ,andt t t tl b d s    denote, respectively, the loan advancement, purchase of treasury securities, deposit collection and equity issuance by banks between periods t and t+1; while 1 1 1 1, , ,andf d s t t t t tr r r e r    represent the required gross real rate of return on loans; the gross real rate of return on treasury securities; the gross real rate of return on deposits; and the expected gross real rate of return on bank equity—in the same order. notice that 1 f tr differs from the non-default lending rate, 1tz  . the difference arises from the possibility of entrepreneurs getting bankrupt--default on their loans—and the attendant monitoring costs which are reflected in 1 f tr . in addition, while the other rates of return are known in advance in period t, the rate of return on equity, 1 s t te r  , is uncertain and depends on the realization of the state of the economy at t+1. asian journal of economics and empirical research, 2019, 6(1): 16-26 22 © 2019 by the authors; licensee asian online journal publishing group under binding bank capital requirement, 1 1 _t t s del k l    , the first order conditions9 of the admissible solution of the bank‘s maximization problem are: 1 1 d t tr r  (11) 1 1 1(1 _ ) _ ( )f s t t t tr del k r del ke r     (12) these conditions illustrate that with binding minimum capital threshold, the required rate of return on lending is a weighted average of the rate of return on deposits and the expected rate of return on bank equity. thus, we have significant departure from the bernanke et al. (1999) framework where the required rate of return on lending equals the riskless/deposit rate. 3.2.1. return on capital the exogenous regulatory capital requirement entails that the bank must maintain a level of equity which amounts to _del k times the volume of total loan advancement. the supply of credit is therefore financed by a combination of bank equity and deposits mobilized from households, who allocate their savings between these financial instruments. the relative ease of using deposits for liquidity services and the riskless rate associated with them establishes a spread vis-à-vis the rate of return on bank capital, that is, 1 1 s d t t te r r  . moreover, we assume that the real rate of return on physical and bank capital is the same: 1 1 s k t t t te r e r  (13) the interpretation of (13) is that even if entrepreneurs are the only investors in physical capital, households would demand the same expected rate of return on both physical and bank capital if they were to make capital expenditures. thus, equation (13) represents a no-arbitrage condition as physical and bank capital provide no liquidity services and their returns are exposed to the same systemic risk. 3.2.2. capital producers in this section we integrate the optimal financial contract signed in a partial equilibrium setting into new keynesian general equilibrium framework. capital producers buy final investment goods ti from retailers and transform them using existing capital to generate new capital stock. investment decisions are subject to quadratic adjustment costs. the inclusion of such costs induces volatility of entrepreneurial net worth and bank capital via the variability of the price of capital. we assume that capital producers deploy a linear technology and choose the level of investment spending to maximize profits subject to adjustment costs: 2 q,i max 2 k t t t t t t t i k q i i k k              (14) where tq is the real price of capital while ,q ik and  are parameters capturing the degree of adjustment cost and depreciation of capital, respectively. the optimization problem gives rise to the following first order condition: .1 t t q ik t i q k           (15) notice that the higher the value of ,q ik , the higher the volatility of the price of capital. setting this parameter to zero entails a constant price of capital equal to unity. the law of motion for the aggregate capital stock in the economy is evolves according to: 1 (1 )t t tk i k    (16) 3.3. production by entrepreneurs entrepreneurial firms rely on bank loans to supplement their net worth in the purchase of capital goods. they combine the purchased capital with hired labor to produce wholesale goods which they sell at nominal marginal cost in perfectly competitive markets. only households and entrepreneurs are employed by the firm as bankers are assumed to be insignificant fraction of the labor force. the firm uses constant returns to scale cobb-douglas production technology: 11[( ) ( ) ]k kh e t t t t ty ak h h   (17) where 0 1k  is the capital share in aggregate output; 1( ) ( )h e t th h  is total labor supply with h th and e th indicating the work hours of households and entrepreneurs, respectively.  is the fraction of work hours provided by households. finally, the demand for capital must satisfy the following condition for the expected return on capital: , 1 1 1 (1 )k t tk t t t mp q e r q            (18) 3.4. retailers retailers are included to generate inertia in the price setting schedule. they are monopolistic firms that set their prices in a staggered fashion due to calvo (1983). in each period, a random fraction 1  ( [0,1]  ) of firms 9 the complete set of first order conditions is available from the author upon request. asian journal of economics and empirical research, 2019, 6(1): 16-26 23 © 2019 by the authors; licensee asian online journal publishing group adjust their prices optimally. the remaining fraction,  , are assumed to follow an adjustment process that exploits indexation of current prices to inflation in the previous period: 1 2 (j) p ( )i t t t t t p p j p            (19) denoting the price level that the optimizing firm chooses in each period by tp , the aggregate price level in the domestic economy evolves according to the pricing rule: 1 1 1 1 1 1 2 (1 ) t t t t t p p p p p                            (20a) or 2 1 1(1 )( )t t t tp p        (20b) those optimizing firms that are able to adjust their prices in the current period will choose tp in such a way as to maximize the present discounted sum of future streams of profits subject to the sequence of demand constraints for household and residual government consumption:      , 0 max t j n t j t j h t t j p j q y p mc       (21) subject to  t t j t j t t j p y c g p             where n t jmc  is the nominal marginal cost while j t t je  is the effective stochastic discount factor that considers the fact that firms have a 1  provability of being able to reset their prices in each period. 3.5. households the economy is inhabited by an infinitely lived forward looking representative household. the household engages in key economic decisions that involve labor supply, consumption, and saving. the typical household has the opportunity to allocate its savings between riskless deposits ( td ) and risky equity investment ( ts ) offered by banks, which offer expected returns of 1 d tr and 1 s tr , respectively. the maximization problem of the typical household is: 1 1 1 1 1 0, , , ( ) max 1 1 1 t t t t h j t t t jc n d s c d h                        s.t. 1 1 h h d s t t t t t t t t t t tc d s t w h r d r s        (22) where  is the subjective discount rate,  is the inter-temporal elasticity of substitution (same for both consumption and deposit demand),  is the inverse elasticity of labor supply; h th captures the number of hours worked, h tw is the hourly household real wage rate, tt is tax expense, t is the dividend receipts, tc denotes the real composite consumption index of home produced goods and services. 4. results and discussion 4.1. calibration the quarterly business bankruptcy rate is set to 0.0075 based on the international development research centre (idrc) survey results which report an annual 3 per cent business discontinuance rate for ethiopia. the loan monitoring cost is fixed at 0.12 as in bernanke et al. (1999). the fraction of entrepreneurs who survive to the next period is assumed to be 97 percent. these values suggest a steady state leverage ratio of 1.932, an annual external finance premium of 200 basis points, and an elasticity of external finance premium to leverage ratio of 0.041. based on these values and choosing a value of 1.01 for the quarterly gross risk-free rate, we get a quarterly gross return on capital equal to 1.0157 and a quarterly gross bank financing cost of 1.0107. see appendix a for the complete list of parameters and their definition. asian journal of economics and empirical research, 2019, 6(1): 16-26 24 © 2019 by the authors; licensee asian online journal publishing group 4.2. simulation results figure-1. impulse response to monetary policy shock with financial frictions (solid line) and without financial frictions (dotted line) source: (author‘s own simulation results) figure 1 shows the relative responses of selected endogenous variables to a one-off quarterly monetary policy shock equal to 0.05 standard deviation applied under money growth rule. it is clear that the results are significantly different for the two models. in the model with financial distortions, unexpected increase in the policy rate lifts the cost of raising fresh capital for financial intermediaries which they translate into higher external premium for loan applicants. by contrast, when the role of frictions is switched off, there is no difference among the policy rate, the required rate of return on bank loans, and the rate of return on equity investment. this is summarized by the flat impulse response of the external finance premium. consistent with conventional empirical evidence, monetary tightening is accompanied by a decline in inflation, output, consumption, investment, and asset prices. but the degree of contraction is deeper and more persistent in the model where supply and demand side financial market imperfections have been considered. these results are broadly in line with previous findings that include markovic (2006); aguiar and drumond (2007) and zhang (2009) that found unanticipated monetary shocks are amplified and propagated much more strongly with double agency cost problems in the financial markets. figure-2. impulse responses of output and inflation under interest rate (dotted) and money growth (solid) rules (source: author‘s own simulation results) source: (author‘s own simulation results) asian journal of economics and empirical research, 2019, 6(1): 16-26 25 © 2019 by the authors; licensee asian online journal publishing group the next task is to see if previous findings under taylor based rules could be quantitatively any different from those under money growth rule. figure 2 presents the responses of output and inflation to shocks under alternative monetary policy regimes. the qualitative aspects of the results are more or less preserved. for instance, monetary policy tightening (a rise in the policy rate or a fall in money supply) leads to noticeable reduction in output and inflation while improvement in factor productivity boosts production and eases upward pressure on price changes. increased fiscal intervention also expands output under both monetary policy rules. however, the effects of a rise in public expenditure on inflation clearly depend on the operational instrument deployed by the central bank. when the monetary authority sticks to an interest rate rule, increased government borrowing feeds into higher inflation. but under money growth rule expanded fiscal activism results in a decline in inflation in the first few quarters. to the extent that the output effect of a fiscal stimulus is more persistent, the money growth rule contributes to a fall in price changes in the immediate short run perhaps reflecting delayed effects of fiscal policy due to, say, the low velocity of money in developing economies such as ethiopia. over all, the model with money growth rule generates qualitatively similar results as those which employ interest rate rules (markovic, 2006; aguiar and drumond, 2007; zhang, 2009). 4.3. sensitivity check a common challenge when using dsge models is the so called ―parameter bifurcation problem‖—the observation that changing parameter values a little leads to considerable change in the impulse response of endogenous variables. it is impractical to verify the sensitivity of these responses to changes in the value of every parameter. however, given the objective this paper, i tried to evaluate how sensitive the results are to variations in the values of policy parameters in the central bank money growth reaction function rule. the impulse response functions were generally stable both qualitatively and quantitatively to such small changes in the values of the parameters in the monetary policy rule. 5. conclusion and policy implications in the last few years, macroeconomic modeling has emphasized the role of credit market frictions in magnifying and transmitting nominal and real disturbances and their implication for macro-prudential policy design. in this chapter, we construct a medium-size small new keynesian general equilibrium model with active banking sector. in this set-up, the financial sector interacts with the real side of the economy via firm balance sheet and bank capital conditions and their impact on investment and production decisions. we rely on the financial accelerator mechanism due to bernanke et al. (1999) and combine it with a bank capital channel as demonstrated by aguiar and drumond (2007). we calibrate the resulting model from the perspective of a low income economy reflecting the existence of relatively high investment adjustment cost, strong fiscal dominance, and underdeveloped financial and capital markets where the central bank uses money growth in stabilizing the national economy. the findings are broadly consistent with previous studies that demonstrated stronger role for credit market imperfections in amplifying and propagating monetary policy shocks. while most studies assume an interest feedback rule to capture the behavior of monetary authorities, we rely on a money growth rule to adapt to the dominant policy practice in low income economies. it is interesting that in our model the interaction of corporate and bank balance sheets generates similar results as those which employ interest rate rules (markovic, 2006; zhang, 2009; agur, 2010) for instance). the policy implication of this result is particularly relevant in low income countries where small and fragile firms face very high external finance premium. with little or no net worth to post as collateral, these firms often have to pay above market rates on small loans obtained from banks and microfinance institutions. even though adding a default premium on poor borrowers makes perfect financial sense, it creates a kind of self-fulfilling prophesy where the higher lending rate undermines the ability of the poor borrower to start and operate profitable projects. a clear market failure is present in the loan market for poor households, which justifies well-designed and targeted intervention that facilitates the creation and provision of special loans to struggling businesses. the world has long recognized the importance of arranging concessional loans at lower rates and with grace periods for poor countries. and poor countries eligible for such programs have made effective use of this arrangement in reducing poverty and creating employment for their citizens. a similar logic should apply at the micro level to rectify credit market failures for the penniless. references aguiar, a. and i. drumond, 2007. business cycle and bank capital: monetary policy transmission under the basel accords. fep working paper series no. 242. agur, i., 2010. capital requirements and credit rationing. dnb working paper no. 257. areosa, w.d. and c.a. coelho, 2013. using a dsge model to assess the macroeconomic effects of reserve requirements in brazil. central bank of brazil working paper series no. 303: 1-28. babilla, t.k., 2014. bank lending channel of monetary policy transmission in waemu: a dsge modeling approach. working paper of conference on economic development in africa, st. caherine's college, oxford. bernanke, b., m. gertler and s. gilchrist, 1989. the financial accelerator and the flight to quality. the review of economics and statistics, 78(1): 1-15. bernanke, b.s., m. gertler and s. gilchrist, 1999. the financial accelerator in a quantitative business cycle framework. handbook of macroeconomics, 1: 1341-1393. available at: https://doi.org/10.1016/s1574-0048(99)10034-x. brázdik, f., m. hlaváček and a. maršál, 2012. survey of research on financial sector modeling within dsge models: what central banks can learn from it. finance and credit -czech journal of economics and finance, 62(3): 252–277. brzoza-brzezina, m., m. kolasa and k. makarski, 2010. the anatomy of standard dsge models with financial frictions. national bank of poland disucssion paper. calvo, g.a., 1983. staggered prices in a utility-maximizing framework. journal of monetary economics, 12(3): 383-398. available at: https://doi.org/10.1016/0304-3932(83)90060-0. carlstrom, c.t. and t.s. fuerst, 1997. agency costs, net worth, and business fluctuations: a computable general equilibrium analysis. the american economic review, 87(5): 893-910. carrera, c. and h. vega, 2012. interbank market and macroprudential tools in a dsge model. central reserve bank of peru working paper series no.014: 1-46. asian journal of economics and empirical research, 2019, 6(1): 16-26 26 © 2019 by the authors; licensee asian online journal publishing group cassar, g., 2004. the financing of business start-ups. journal of business venturing, 19(2): 261-283. available at: https://doi.org/10.1016/s0883-9026(03)00029-6. christensen, i. and a. dib, 2008. the financial accelerator in an estimated new keynesian model. review of economic dynamics, 11(1): 155178. available at: https://doi.org/10.1016/j.red.2007.04.006. clarida, r., j. gali and m. gertler, 1999. the science of monetary policy: a new keynesian perspective. journal of economic literature, 37(4): 1661-1707. dib, a., 2010. banks, credit market frictions, and business cycles. bank of canada working paper series no.24: 1-48. fukunaga, i., 2002. financial accelerator effects in japan‘s business cycles. bank of japan working paper series no. 02-6. gertler, m. and p. karadi, 2011. a model of unconventional monetary policy. journal of monetary economics, 58(1): 17-34. hafstead, m. and j. smith, 2012. financial shocks, bank intermediation, and monetary policy in a dsge model. stanford university economic research working paper. heuvel, v.d.s.j., 2002. does bank capital matter for monetary transmission? economic policy review, 8(1): 259-265. kiyotaki, n. and j. moore, 1997. credit cycles. journal of political economy, 105(2): 211-248. markovic, b., 2006. bank capital channels in the monetary transmission mechanism. bank of england working paper no. 313. meh, c.a. and k. moran, 2010. the role of bank capital in the propagation of shocks. journal of economic dynamics and control, 34(3): 555-576. available at: https://doi.org/10.1016/j.jedc.2009.10.009. stiglitz, j.e. and a. weiss, 1981. credit rationing in markets with imperfect information. the american economic review, 71(3): 393-410. vousinas, g.l., 2013. the transmission channels between financial sector and real economy in light of the current financial crisis a critical survey of the literature. modern economy, 4(4): 248-256. available at: https://doi.org/10.4236/me.2013.44028. world bank, 2015. sme finance in ethiopia: addressing the missing middle challenge. washington, dc: world bank group. zhang, l., 2009. bank capital regulation, lending channel and business cycles. deutsche bundesbank working paper series no. 33/2009: 156. appendix appendix-a. parameter definitions and values parameter description value β subjective discount factor 0.98 central bank weight attached to inflation gap 1 central bank weight attached to output 0.11 i interest semi-elasticity 0.0035 θ calvo price rigidity 0.75 money growth rate smoothening/persistence 0.8 ar coefficient for each exogenous process 0.8 1/σ inverse elasticity of inter-temporal substitution 1/3 φ inverse elasticity of labor supply 4 v elasticity of external premium with respect to leverage 0.041 ,q ik sensitivity of price of capital to the investment-capital ratio 0.5 δ capital depreciation rate 0.025 steady state gross return on entrepreneurial project 1.0157 steady state cost of raising funds by lender 1.0107 r steady state deposit/riskless rate 1.01 k/n steady state leverage ratio 1.932 y/n steady state output net worth ratio 0.2383 mp_k steady state marginal product of capital 0.0407 del_k exogenous capital requirement ratio 0.12 c/d steady state consumption-deposit ratio 0.22  capital share in production 0.3 (1 )  fraction of labor supplied by households 0.693 (1 )(1 )  fraction of labor supplied by entrepreneurs 0.007 mc steady state gross cost mark up 1.1 μ loan monitoring cost 0.12 γ business survival rate 0.97  steady state profit division parameter 0.4805 ( )f  quarterly business bankruptcy rate 0.0075 i/y steady state ratio of investment to gdp 0.18 c/y steady state ratio of consumption to gdp 0.60 g/y steady state ratio of public spending to gdp 0.22 asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 148 © 2019 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 6, no. 2, 148-168, 2019 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2019.62.148.168 © 2019 by the authors; licensee asian online journal publishing group firm survival through semi-exits: the case of indian registered manufacturing priyambada gupta assistant professor at sri guru nanak dev khalsa college, university of delhi, department of economics, india. abstract the paper examines the extent to which product line change as a strategy improves the performance of firms across two manufacturing sectors over a period from 2008-2017. durability and technology are the two dimensions chosen to identify the sectors. hence, the paper studies electronic industry and food industry firms as the former are science-based, high-tech firms, whereas, the latter is a traditional manufacturing according to the pavitt’s taxonomy. additionally, food products are known to be less durable than the electronic and electrical products. the paper analyzes the data using a cross-section difference-in-differences estimation to study the difference in average performance since the strategy is not an exogenous treatment but relies on firm-specific characteristics. in appendix 2 results from a hypothetical case is presented in which it shows how the average performance across the two sectors adopting the strategy differs had the strategy been completely exogenous. the results hint towards an overwhelming improvement in the performance for electronic industry firms showing a change in product line as compared to food industry firms not adopting the strategy. even though it is vital in enhancing the efficiency in firms which is shown both theoretically and empirically still only a few firms adopt the strategy in the indian market. the paper tries to find reasons for the same by using certain case studies and see how product line change may not be an ideal strategy to undertake despite its role in allocating resources efficiently. keywords: industrial organization, firm survival, product line change, durable and technology intensive firms, difference-in differences estimation method, rct, propensity score matching. jel classification: l00; l63; l66. citation | priyambada gupta (2019). firm survival through semiexits: the case of indian registered manufacturing. asian journal of economics and empirical research, 6(2): 148-168. history: received: 8 august 2019 revised: 12 september 2019 accepted: 16 october 2019 published: 2 december 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 149 2. review of literature ...................................................................................................................................................................... 152 3. research methodology and data................................................................................................................................................ 154 4. results and discussions ................................................................................................................................................................ 157 5. conclusion ....................................................................................................................................................................................... 160 references ............................................................................................................................................................................................ 161 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.62.148.168&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1134 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1134 asian journal of economics and empirical research, 2019, 6(2): 148-168 149 © 2019 by the authors; licensee asian online journal publishing group contribution of this paper to the literature the paper contributes to the existing literature by examining the extent to which product line change as a strategy improves the performance of firms across two manufacturing sectors over a period from 20082017 in india. 1. introduction the manufacturing sector is one of the most crucial drivers of economic growth for any economy, and henceforth the development of a high-quality manufacturing sector has been the strategy of rich nations over the last several hundred years to develop national wealth and power. it has been the fuel for the growth of the five largest economies of the world, namely the us, china, japan, germany & united kingdom. it leads to rapid modernization and provided millions of skilled and unskilled jobs directly or indirectly. it has played an indispensable role in moving millions of workers from the agriculture sector to the industries in the east asian countries, thus improving the living standards of the population. manufacturing plays a fundamental role in the indian economy. the gross value added (gva) for the manufacturing sector at constant prices grew at a cagr of 4.34 percent during the fiscal year 2012 and 2018 (annual national income published by the goi). value-added as a percentage of gdp by the manufacturing sector was reported at 15 percent in 2017 (world bank data). manufacturing plays a crucial role in job creation. the sector added an estimated 89,000 jobs in the second quarter of 2017-18 in india (labour bureau’s quarterly report on employment scenario) and absorbed 12 percent of the labour force. it is well analyzed in the literature that india's growth has been fueled by the service sector which has shown the characteristic of ‘jobless growth.’ with over 5 million new entrants in the labour market each year (world development indicators), the focus of policymakers is now shifting towards the manufacturing sector which has a high potential to absorb the increasing labour force. the government has instituted national manufacturing policy in 2011 which plans to boost manufacturing by raising its contribution to gdp to 25 percent and create 100 million new jobs by 2022. according to this policy, every job created in manufacturing creates two-three jobs additionally in the related activities. prime minister narendra modi led government launched ‘make in india’ campaign in september 2014 to transform india into a manufacturing hub. for the initiatives of the government to boost an environment to enhance business and create jobs to be successful, the survival of the firms in the industry plays a pivotal role. there are problems if a firm is forced to shut operations before its natural life cycle which includes an introduction phase, growth, maturity and then finally a decline arising because of exhausted demand or competition. india’s industrial activity has been highly regulated which has posed a constraint on its development. liberalization policies were adopted in 1991, but india still ranks very low in terms of providing an enabling nature for its business environment and unnecessary regulatory burdens are imposed on businesses and investors even now. 1.1. firm survival strategies a change in the product line is one of the strategies for survival by firms facing tight competition from the rivals. this route to survive is not well studied in the literature. we call this kind of a change in product line a semi-exit, undertaken by firms for restructuring their operations and survive in the industry. in joseph schumpeter’s creative destruction innovation is the force that sustained growth in the economy, entry by an innovative entrepreneur destroys the established firms, and the process continues when there is another breakthrough in technological innovation. there is a substantial gain in total output with this redistribution of production from low performing to the high performing firms within the industry. but these models do not consider the reallocation of the product lines within the firms in a multiproduct setup. various other restructuring strategies were adopted by the indian private corporate sector. an important method of restructuring was in the form of mergers and acquisitions (m&a). some of india’s most famous business groups like tata, birla, goenka, piramal, and modi engaged in the acquisition of profitmaking companies in the 1980s. section 72-a of the income tax act was introduced which encouraged the merger of sick firms with healthy firms by offering tax and other fiscal benefits to the acquiring firm. therefore, some m&as were also undertaken for this purpose. the recent merger of idea cellular ltd and vodafone india ltd can also be seen as a strategy for survival after the entry of reliance jio in 2016 disrupted the telecom sector in india. outsourcing can also help firms survive and remain viable, particularly during an economic crisis. apart from services, manufacturing firms also outsource the production of some specific components, for example, automobile parts. a study by kar and dutta showed the evidence of outsourcing by approximately 70 percent of the india manufacturing firms and found that outsourcing unambiguously increase the productivity of the firms (kar and dutta, 2018). firms can also survive and thrive by a building nexus between the business and the political class and involving in rent-seeking activities called crony capitalism. government helps the firms to survive by providing subsidies and trade protections, even if these efforts increase inefficiencies in the economy. on the other hand, the other strategies mentioned are self-selected conscious survival strategies by the firms which are not rent-seeking and enhance the efficiency by employing resources to their use. insolvency and bankruptcy code was passed in 2016, to make the process of doing business a little less cumbersome, it tries to minimize the time and cost in attaining liquidation. bankruptcy is a complete exit by a firm from the industry. although m&as have been a crucial element of corporate strategy all over the world for several decades, research has not been able to provide compelling evidence on whether they enhance efficiency. there is a growing debate on the effects of m&as on firms on a global level (bedi, 2010). indian firms do not show much evidence of a large number of mergers and acquisitions. m&a proposals could also end up under the scanner of competition regulators. outsourcing as a survival strategy is also debatable. it is done for various purposes like cost reduction, taking advantage of cheap labour or low taxes. production typically gets outsourced to a contract manufacturer that produces goods under the label of another firm. the original company can gain in flexibility as it does not have to asian journal of economics and empirical research, 2019, 6(2): 148-168 150 © 2019 by the authors; licensee asian online journal publishing group invest in capital if there is an increase in demand and can request the contract manufacturer for the increased quantity which has a higher production capacity. the central theme of this thesis is to study the patterns of product line change as a survival strategy in the indian manufacturing firms. durability and technology are the two dimensions chosen to identify two different sectors and firms therein to study the strategy. durable goods are the goods that last for a longer duration with no easy wear and tear, most importantly these goods give utility over a longer period rather than being utilized for one-time use. industries differ in the degree of durability of the end product. for instance, industry manufacturing food products and beverages are less durable as compared to the industries producing textiles or basic metals. the second dimension is technology which keeps on changing and the firms producing such goods have to keep reinventing their products to survive the competition. we control for differences in the technological environment using pavitt’s taxonomy. pavitt (1984) taxonomy helps to capture some fundamental differences in the characteristics of the innovation process such as its nature and direction of change that distinguish firms operating in different industrial sectors. it consists of four categories of industrial firms; supplier dominated, scale intensive, specialized suppliers, and science-based. 1.2. importance of product line change for durable goods industries because of the feature of durability, the firms producing such goods create a self-created competition in addition to the outside competition. they foreclose the chunk of the market they have already served as the consumers keep these good for a longer duration depending upon the durability of that good. this feature changes the kind of competition these firms face and also their strategies to sustain it. planned obsolescence which artificially reduces the life of these good is one of the ill strategies used by the producers, but they face limitations in using this because of the outside competition and also it affects their reputation (bulow, 1986). the firms producing such goods adopt excess momentum in product introduction as compared to excess inertia to revive the demand for their products in the market. they create a condition under which the consumers find the new product essential. software which is introduced over time as a different version of the previous one can be seen as an example. 1.3. importance of product line change for technology intensive industries the one sure thing about innovation is, that it is about to change. introduction of new products which use better technologies alter the existing patterns in the market. these patterns are evident in the daily market situations1. technology opens up opportunities for a company to redeploy its assets and rethink its strategy. technological innovation can lead to dramatic cost reduction which can significantly change the old rules of competition. firms can add value to their products that will permit a change in competition on the basis of product differentiation. to cope up with changing environment firms to survive in the industry should transform their products to embody the new technology in them. we can claim that for such firms making changes in the products is quite essential. for instance, the electronics industry has an extensive scope of technological innovations. firms in the industry producing mobile phones are launching newer versions of the mobile almost every year. these goods are being continuously replaced with latest and improved versions. 1.4. importance of product line change as a survival strategy we will motivate this idea by using two case studiesfirst, that of eastman kodak company which completely revolutionized how photography was done and the other of intel corporation which had a strategic business exit and survived. durable goods industries cannot be isolated from the technological intensive industries as in these two examples both the goods are durables but differ in their technological intensity. microprocessors can be considered to be more technological intensive as compared to film cameras. 1. eastman kodak company founded by george eastman and henry strong in 1882 was the biggest name in the photography industry. they started with being the king of the industry to being bankrupt in 2012; they still exist today but in a very different form. before kodak, taking a photograph was a tedious procedure and was mainly done by professionals. it was done using glass plates installed in the back of the camera on which light was focused through the lens. it had to be kept away from all the sources of light and treated with chemicals. the photographer had to carry a pile of glass plates while going out for capturing pictures (leggat, 1995). kodak’s major advancement was the chemically coated film that replaced the delicate glass plates. kodak rollfilm camera was made to become an integral part of one’s life. kodak moment as they called became a synonym for a photograph. this was achieved through various ad campaigns which transformed the way people looked at photographs (munir and phillips, 2005). in 1976 they had an 85% market share in cameras and 90% market share in films. by the 1990s there was a rise in digital cameras. in 1975 steve sasson, an engineer working for kodak invented the first digital camera, they also received a patent for it. but the problem was they did not focus on the digital cameras enough (anthony, 2016). in 2005 the leader in the digital market in the us was still kodak, but this time their share was only 22.1% with significant competitors like canon and sony. they were reluctant to change their product line as they knew everything about films; they had created it and had more than 100 years of experience in it. also, they made money through films rather than the sale of cameras. they ignored the fact that digital cameras are the future. later cameras merged with mobile phones and rather than getting pictures printed people preferred posting it on the social media. their market share fell considerably. they tried to make a switch to different products like printers, but it was not very successful as there were already established firms like hp. this led to their bankruptcy in 2012. they are now back but not in the same way as they were, their revenues are considerably low. 1reliance jio offered free hd voice services through volte enabled handsets which should be connected to 4g networks. entry of jio shut wireless operations of small operators. like aircel and reliance communication. bharti airtel acquired telenor and tata tele-services. vodafone and idea cellular merged. the focus of companies has now shifted from the number of users to more data usage per sim, as a strategy to survive. for instance, airtel is boosting its offering by tying up with video platforms such as amazon prime, netflix and zee5; whereas jio is looking forward to producing in-house content bhatia, j., 2016. reliance jio: predatory pricing or predatory behaviour? economic and political weekly, 51(39). asian journal of economics and empirical research, 2019, 6(2): 148-168 151 © 2019 by the authors; licensee asian online journal publishing group this story of kodak hints at the fact that a miss in the understanding of product switching can lead to the downfall of a massively profitable venture. the other example comes from intel corporation’s surviving strategy. 2. burgelman studied the processes leading intel corporation to transform itself from a memory company into a microcomputer company (burgelman, 1994). intel established as the leader in semiconductor memories in 1969. it introduced dram in 1970 for the first time in the world market and was very successful in the dram industry in the early to mid of the 1970s. drams replaced the magnetic cores as the standard technology used to store instructions and data in the computer. dram sales accounted for 90% of intel’s sales revenue. intel’s drams were the world’s largest selling semiconductor product and were seen as the technological driver for intel. the company allocated ample resources for its fast-growing dram business. important competitive products introduced in drams like texas instruments and mostek were the early entrants. mostek introduced products which increased the user-friendliness in drams. there was a reduction in the usefulness of intel’s memory systems operations. japanese companies also entered with the intention to dominate and led to stiff price competition and aggressive capacity. because of the migration of the semiconductor companies in the us it was becoming increasingly difficult to profit from intellectual value added in drams. with the maturity of dram industry consumers started demanding drams in bulk with reasonable reliability and price. this shift favoured texas instruments and japanese more than intel. intel struggled to maintain a competitive advantage. intel’s market share fell from 82.9% to 1.3% in a period from 1974 to 1984. intel had developed microprocessors as an unplanned new technology as part of a contract with japanese calculator company. by the mid-1980s intel made a shift from the semiconductor memories to microprocessors and exited the dram business completely in november 1984. the aforementioned stories are very similar; both the companies were world leaders and had the highest market shares. the situation turned around when they faced intense competition or changing market situations. the difference lies in the way the two firms responded. intel strategically moved out of the drams business; they moved out of the product in which they had patents. on the other hand, kodak was attached to the film business and did not foresee the changing market pattern, ultimately leading to the death of the company. intel’s semi-exit prevented its permanent exit from the industry. 1.4.1. product line change and the possibility of firm survival product line changes can be used as a conscious or an unconscious strategy by the firms. as a conscious strategy, product line change can be reflective of various other factors and not just as a survival strategy. organizations can establish new markets and technologies by introducing new products (burgelman, 1991). firms can use this strategy in order to attract new customers. when a company wants to increase its customer base or expand its reach to different geographical areas, it has to add new product lines or new varieties to its existing product lines to attract the demands from different segments of the market (brown and eisenhardt, 1995). a firm can also add products to its mix of existing products to utilize the excess production capacity. it can also be used as a strategy to build a reputation, by introducing high price prestigious products or low price prestigious goods to serve low-income groups. as an unconscious strategy, product line change can be reflective of the case whereby a firm in order to survive merges its operations with other firms. even if the firm does not lose its identity, it might have to adopt the product line of the other firm. we have to be careful in considering a product line change by a firm only as a conscious survival strategy. the conscience of the firm cannot be reflected in the data. therefore, throughout the study, we maintain the assumption that if a firm’s identity is intact and it survives after a product line change, it was undertaken as a conscious strategy for survival. we ignore the firms which do not survive after a product line change as data can only be found for the surviving firms. 1.5. research objectives for our study, we focus on a product line change as a survival strategy what we call as a semi-exit for the indian manufacturing firms. we try to see how the product line change differs across industries varying in durability and technology intensity. in our best knowledge, this link with product line change in indian manufacturing firms has not been studied. we make a hypothesis that durable good firms will be required more in comparison to the non-durable goods firms to keep changing their product lines in the changing business environment to survive in the industry. also, the industries which are more technological intensive use the route of a product line change to survive. as mentioned earlier we maintain the assumption that if a firm’s identity is not changed and it changes its product line, it is using this route as a conscious strategy for survival. 1.5.1. research question we address the following key research questions: central research question: what is the pattern of semi-exits through product line change across products for india? sub-questions: (i) how does this pattern work out within an industry? (ii) how does it work out across industries varying by durability? (iii) how does it work out across industries varying with technology? asian journal of economics and empirical research, 2019, 6(2): 148-168 152 © 2019 by the authors; licensee asian online journal publishing group 2. review of literature 2.1. theoretical papers 2.1.1. economic distress and firm dynamics a firm is economically distressed when it has negative or low current operating profitability and little opportunity to recover (lemmon et al., 2009). this limits its long-term probability of recovery and economic value creation. in comparison, financially distressed firms have temporary difficulties of repaying their debt. while they may be profitable at present, a high leverage may lead to distress (platt and platt, 2006). recovery of economically distressed firms needs a restructuring of their operations as well as strategy whereas firms in financial distress may survive after restructuring only their balance sheet. agarwal and gort (2002) analyze the determinants of the probability of firm survival other than the random shocks. there is considerable literature developed on life cycle of industry and firms and their effect on survival (caves, 1998). models of product life cycle are well established. systematic changes occur as a market evolves to maturity which affects the survival probability. for instance, in the early years there are ample of technological opportunities but with maturity of the product market, these opportunities decline and moves towards product refinement and cost reduction. then the shift starts taking place towards imitation. competition in the market is intensified because of these changes. there are cross-industry variations in terms of intensiveness in technology. the more technologically intensive an industry, higher is the rate of obsolescence. this adversely affects the survival rate of the firms. in the model of industry dynamics, hopenhayn (1992) gives a cutoff level of productivity below which the firms exit the industry. with increase in the fixed cost this cutoff level increases which affects the survival decision. age of the firm also matters in shaping the growth structure of the firms, in the learning-by-doing process given by arrow (1971) older firms are advantaged with respect to their younger counterparts in terms of efficiency which determine their possibility of growth. in the jovanovic (1982) model of passive learning, younger firms grow faster than their older counterparts as in the early years of firm’s life they do not clearly know their level of productivity so they experiment more, so the rates of growth are greater as the updating is stronger. active learning framework of ericson and pakes (1995) predicts firms will stop investing after reaching a certain level of efficiency. organizations adapt and reinvent themselves in the changing market and technological conditions through the channel of product creation (schoonhoven et al., 1990). it also improves market share and firm survival (banbury and mitchell, 1995). study by katila and ahuja (2002) through their findings in the global robotics industry show how organizations differ in the way they utilize their existing knowledge and also how they explore new knowledge, which will affect the rate at which the products are reintroduced within an organization and in a way their survival. 2.1.2. competition with durable goods the market structure changes with durable goods, as the consumer who has bought the good today is not likely to buy it tomorrow. because of this feature of durable goods, a durable goods monopolist becomes his own competition. waldman (1993) shows that if a monopolist markets his product by selling rather than leasing, then in many settings he will have an incentive to practice planned obsolescence i.e., he will introduce new products that make old units obsolete at a very high rate. for instance, automobile manufacturers introduce annual style changes into their new model cars or textbook publishers periodically bring out revised editions of their popular books. the reason is that, the firm will not internalize how its current behavior affects the value of units previously sold while deciding whether to introduce the new product. bulow in his 1986 paper showed that a monopolist in order to sell more in the second period may build a level of durability into its output that is below the socially optimal amount. a monopolist has a considerable power in the market. monopoly distortion results from his pricing structure. for the market behavior in the durable goods monopoly, two conjectures have been made. these two are contradicting in nature and depends on the basic assumptions about the market (fehr and kuhn, 1995). coase conjecture: developed by ronald coase in 1972; a monopolist selling durable goods in a market where re-selling is not possible facing consumers with different valuations will have to sell at a low price if he wants to do intertemporal price discrimination. the monopolist faces a price competition with himself over several periods. if the highest valuation buyer has enough patience he can give a credible threat of waiting unless price falls. future price expectations are embedded in the price at which consumers are willing to buy in any given period. therefore in the limit when the period between price adjustments converges to zero, the producer of durable goods loses all his monopoly power. pacman conjecture: it is in contrast with coase conjecture and holds that monopolist selling durable goods have complete control over their market power and extract total surplus.bagnoli et al. (1989) theorized that if consumers follow ‘get-it-while-you-can’ strategy i.e. if they buy a good as soon as its price dipped below a specific level, monopolist can set very high prices initially and then gradually reduce his prices eating his way down the demand curve. in this way he can extract the entire surplus. coasian outcome is a unique subgame perfect equilibrium if the buyers are patient enough in models where demand is continuous and with smallest unit of account. and it is pacman strategy which is a unique subgame perfect equilibrium if the sellers are more patient in markets with finite number of buyers and a continuous price space (fehr and kuhn, 1995). they also show that qualitative features of the equilibrium outcome are strikingly similar for oligopolistic market structure. durable good monopolist faces a different problem from the producers of non-durable goods because the sale of their products creates a second hand market (bulow, 1982). this market is not directly controlled by the monopolist. this problem can be tackled if the monopolist rents his good rather than selling it. this idea was formalized by bulow (1982) and stokey (1981). by renting rather than selling the problem of intertemporal credibility can be avoided. leasing may pose hazards for the consumers if the monopolist can discriminate between them on the basis of past consumption patterns to seek higher rents which reduce current period’s consumption. oliver and tirole (1988) proved that if the two parties sign a long term leasing contract, the market organization is same as that of selling without commitment. asian journal of economics and empirical research, 2019, 6(2): 148-168 153 © 2019 by the authors; licensee asian online journal publishing group it is evident from the literature that a durable good monopolist can survive by using strategies like planned obsolescence (waldman, 1993) renting rather than selling (bulow, 1982); (stokey, 1981) or signing long term contracts with the buyers (oliver and tirole, 1988). firms can also earn extra revenues by controlling the market of second-hand goods (bulow, 1982). another important strategy can be how organizations adapt and reinvent themselves in the changing market and technological conditions through the channel of product creation (schoonhoven et al., 1990). firms may change their product line when they find that growth in demand generation is declining and then may find new avenues which maybe related to the previous product or unrelated to invest into. this is an important strategy especially for the duable goods seller because of the nature of the good as in comparison to the firms producing less durable goods as they do not face an additional problem of low pace of demand regeneration. 2.1.3. product line change and network effects farrell and saloner (1985) theorized the effect of installed base of durable goods on the desirability of innovation. there is a possibility of excess inertia: a socially excessive reluctance by the agents to switch to a superior technology in the presence of important network externalities. all the users do not have the same opportunities at the same time, so when there is an unexpected change in technology, the new users have options not available to the old users. the old users remain somewhat committed to the previous technology, and it takes time for the network of the new technology to grow. failure of dvorak keyboard is an example of this. dvorak keyboard became available when qwerty keyboard was in use (david, 1985). since existing users were reluctant to shift to the new technology, the new users also did not find it profitable to make the switch, even if that was more efficient. on the contrary there is also a possibility of excess momentum: inefficient adoption of the new technology, supposing the new technology offers the adopter an advantage over the existing technology. once he adopts, the new technology becomes even more attractive to the new and existing users. the unique nash equilibrium then is to adopt the new technology. the size of the existing installed base critically determines the adoption and can act as a potential barrier to entry. strategies such as ‘premature announcements’ or ‘predatory preannouncement’ could undo the effect of installed base by creating an incentive for the new users to become a part of the existing base if they can wait. it increases the network of the new capacity once it is adopted and also the base of the existing technology reduces by the number of users who wait. when the users are firms, their eagerness to switch will depend on the condition of its equipment currently in use, whether or not they need replacement. and it will also depend on how the rival firms are switching to the new technology. the firms may be reluctant to switch (excess inertia), too eager to switch (excess momentum) or switch efficiently. this is an empirical question and depends on the rigidities faced by firms in product introduction. therefore, high-tech firms have an additional incentive to reinvent themselves in the related product or may even change the product basket as a survival strategy if the other firms are transforming products at a very fast pace. 2.2. empirical papers 2.2.1. product line change in the us a model of multi-product firm and product switching by bernard et al. (2010) is a natural extension of the standard model of industry dynamics which is trying to capture a broad range of models which feature product selection. the model focuses on the factors peculiar to firm-product pairing i.e., interaction between the idiosyncratic shocks to the productivity of firms and the demand of the product. for instance, an idiosyncratic shock to the firm productivity might increase the profitability of all the products a firm produces or firm-specific shocks involving changes in relative demand or supply like changing fashion or technology which affects a particular product produced by firms. they analyzed product switching in the us manufacturing firms in the period from 1987-1997 and found that one-half of the firms alter their mix of products every five years. it also induced huge changes in the firm scope as the empirical evidence showed that on an average 40 percent of the firms, added products outside their industries. there was also an evidence of a positive correlation between product adding and dropping. they showed that multi-product firms have higher measured revenue-based productivity as compared to single product firms. this difference can be understood in terms of the ability of a more productive firm to cover the fixed costs of multiple products. product creation and destruction are crucial for long-run growth models and for understanding fluctuations in the business cycle. there is not enough empirical analysis to study its overall implications. broda and weinstein (2007) studied a large sector of the u.s. economy and found evidence of net creation (creation-destruction) being strongly pro-cyclical and driven primarily by pro-cyclical creation rather than counter-cyclical destruction. they studied the impact of true product creation and destruction on consumer price index (cpi) which is effectively more pronounced than what is theorized as these are fixed-goods price indices and do not take into account the quality improvement of the new goods on consumer welfare. 2.2.2. product line change in india on similar lines, a paper by goldberg et al. (2008) analyzed multi-product firms and product turnover in india during the period of market reforms. developing country differs in the way resources are allocated in the industries which affect the efficiency of allocation as the firms operate in different regulatory environments (tybout, 2000). indian firms faced constraints in the form of license raj and industrial dispute act (1947) which heavily regulated the private sector. reforms were introduced in 1991 which liberalized trade. indian multi-product firms similar to the us firms were found to be larger and more productive as compared to the single product firms. they found evidence of a lack of product shedding in the indian firms, which shows that creative destruction was not happening in the ’90s despite major reforms during this period. they divided the firm activity into four categories; asian journal of economics and empirical research, 2019, 6(2): 148-168 154 © 2019 by the authors; licensee asian online journal publishing group add only, drop only, both add and drop and no activity. data showed that for a five-year average, 72 percent of the firms did not change their product line. out of the firms changing their products, 22 percent of the firms only added products. one possible explanation is the high sunk costs incurred by the firms that wanted to expand production during the time of restrictive policies like industrial licensing. once incurred firms were reluctant to withdraw production even when the products became unprofitable. on the contrary, it might also reflect growth in the indian economy. because of wealth inequality, there can always be a demand for older products. goldberg et al. (2008) also showed that while product shedding is an important channel through which firms adjust their output in the united states, its contribution to changes in output in india is negligible. theory suggests that lower trade costs lead firms to reduce their extensive trade margin by dropping their relatively unproductive products. the least productive domestic firms exit and all firms reduce product scope. this leads to productivity growth within and across firms and in the aggregate, but indian firms do not show this pattern. in conclusion, product churning was found to be substantially lower among the indian firms and had been almost driven almost entirely by product additions rather than the shedding of existing product lines. 2.3. contribution to the literature we contribute to the existing literature by bringing to light that there is a significance of product line change for firms producing durable and technologically intensive goods and this strategy may improve their performance and act as survival strategy. the problem of firms producing durable goods and technologically intensive goods has been studied theoretically in the literature and how it changes competition in the market. this thesis will contribute to our understanding of this issue in the context of india. 3. research methodology and data in order to assess product line change by firms varying in the level of durability and technological intensiveness of the products we use difference-in-differences (dd) estimation method. section 3.1 explains the general dd framework and 3.1.1 explains how we use dd estimation method in our analysis. the source used for extracting data is elaborated in section 3.2. we use the statistical analysis to find if the data reveals a difference in the outcome of firms changing a product line versus those firms which are not. since the data does not provide micro level information of products produced by a firm we also do case studies to show different patterns and effects of the strategy. in appendix 1, we show an alternative result assuming a scenario in which product line change is an exogenous strategy for firms and find the difference in the means for the two sets of firms using average treatment effect on the treated by propensity score matching. 3.1. difference-in-difference estimation difference-in-differences (dd) is a statistical technique that attempts to study the causal effects of programs when the program is not applied as a randomized control trial. the simplest set up is when the outcomes are observed for two groups; treatment and control, and two periods; before and after the program. the treatment group is exposed to the program in the second period whereas the control group is not exposed to it in either period. without a random assignment, we cannot be sure whether the difference between the two groups is due to the program or some unobservable factors. to find the causal effect of the program, the average gain of the control groups, i.e., the difference between the average outcome before and after the program is subtracted from the average gain of the treatment group. this removes the bias that could arise in the treatment group as a result of a time trend as the comparison is made over time and also the bias in the second-period comparison of the two groups that could arise due to permanent differences within the groups. quality of the evaluation depends on how well we can estimate the counterfactual (angrist and pischke, 2008), (wing et al., 2018). 3.1.1. regression framework for two groups and two periods where t denotes the two periods (t=pre, post) and s denotes the two groups (s= control, treatment). is the dummy for observations in the post period; it does not have subscript s as time period does not vary across groups. is the dummy for treatment group i.e. =1[s=treatment], it captures the time-invariant group differences. is the dummy for treatment group in the post period i.e. =1[s=treatment & t=post]. is the dependent variable. denotes controls and is the error. coefficient is of interest and can be denoted as the following (wooldridge, 2012). ̂ [( ̅ ̅ ) ̅ ̅ ] the expected value of the dependent variable given the controls is given by: | we explain the coefficients through table 1 given below (wooldridge, 2012) and describe the two equivalent ways of finding the dd estimate. table-1. coefficients of dd estismation. variables = 1 (post) = 0 (pre) difference = 1 (treatment) = 0 (control) difference source: wooldridge (2012). asian journal of economics and empirical research, 2019, 6(2): 148-168 155 © 2019 by the authors; licensee asian online journal publishing group the values in the cell are expected values from the regression function. the dd estimate can be computed in two ways: 1. horizontal and then vertical: first horizontal difference is the difference across time in the treatment group i.e. and the second horizontal difference is the difference across time in the control group i.e. . 2. vertical and then horizontal: first vertical difference is the difference in the treatment and control group variables in the period after the program is implemented i.e. and the second vertical difference is the difference in the two groups in the period before the program was implemented i.e. the dd estimate is d . can be partially due to the program but can also be influenced by exogenous time trends which might not be present before the program but only after it. to control for such exogenous trends we take a control group in which the program does not take place, data is collected during the same periods and the second difference is obtained. if we can assume that what happens in the control group can be reflective of the trend in the treatment group then can be taken as an approximation of it. difference-in-differences ( is computed to reflect the pure effect of the program net of exogenous trends on the outcome variable. similarly can be seen as a sum of the program effects and factors which are different between the two groups which have nothing to do with the program, if we can make an assumption that these factors were the same even when the program was not implemented then can be taken as an approximation of those factors to obtain the net effect of the program on the outcome variable. difference-in-differences is computed as ( . the two dd estimates are algebraically the same. regression formulation facilitates the estimation of the parameters and their standard errors. it is easy to add controls in the regression framework. the key assumption behind dd is that in the absence of the program, the average change in the outcome variable would have been the same for both the groups; this assumption is called parallel trend assumption. it is the most critical assumption for the internal validity of the model. one can use visual inspection to see whether it holds (angrist and pischke, 2008). the trend lines for the two groups need not coincide with each other but should be parallel over time. 3.1.2. dd for product line change although, we have mentioned the set-up in terms of two groups and two time periods, the idea of dd is more general. additional groups and periods can be added. subscript s denotes two states which could represent for instance different demographic groups. instead of time, we might categorize data by different cohorts or characteristics (angrist and pischke, 2008). in our analysis we use the dd estimation method in a slightly different way. in this analysis treatment is in terms of a conscious strategy of a firm in which it changes its product line in the period 2008-2017. a treatment is an exogenous variable whereas in our methodology the strategy of product line change is an endogenous variable, therefore we are using a dd model. it is a planned strategy of a firm which depends on various factors like the market conditions, firm’s financial status and the risk taking ability of the top management (burgelman, 1991). we analyze this strategy across two industries differing in the level of durability and technology. the two industries chosen are electronics and food. we define a change in product line change as it is defined in goldberg et al. (2008) paper. they have divided firm activity into four mutually exclusive groups: add products, drop products, both add drop and no activity. a product is added if it is produced in period t but not in period t-1. a product is dropped if it was produced in period t-1 but not in period t. so a firm is said to change the product line if it is involved in any of the first three activities whereas no activity means that firm is keeping the product basket same. therefore, in our analysis we say that a firm has changed its product line if it either adds product, drops product or both and add and drop products over a period of 10 years i.e., from 2008-2017, whereas it is said to not change product line if there is no change in the product basket for the same period. product line changes are observed for the main products. the main product of a firm is that product from which the company gets more than half of its revenue. but we observe the activity for products from which the company gets at least ten percent of its revenue. more patterns of product line change are possible, for instance product reintroduction. a firm may discontinue a product, introduce other products and might then later resort to the same product discontinuing the new products if it finds it is not profitable. we have mostly observed the first three patterns in the data. decadal time is assumed to be a sufficiently long time period for a firm to adjust its product line. firms which have not adjusted their product line within 2008-2017 may or may not have chosen this strategy outside the period in consideration. both the sets of firms maybe additionally using other strategies for survival during this time but we would like to study product line changes in exclusion. we define the two groups as the two industries; electronic and food. definition of product and industry is based on cmie’s internal product classification. an industry is defined at a 2-digit nic code and product at 4 or 5 digit classifications. an electronic industry firm is expected to produce goods which are more durable than the goods produced by food industry firm. for instance, television, mobile phones, cables, printers, control valves, dvd players etc. are more durable than goods like tea, coffee, butter, milk, chocolate confectionary etc. produced by the latter. technologically also the goods differ. according to pavitt (1984) electronic industry firms are science-based, high-tech firms which rely on r&d, whereas, food industry firms are supplier dominated which includes firms from traditional manufacturing. we therefore compare the firms changing and not changing product line within 20082017 and the comparison is done across two industries differing in the two dimensions mentioned using electronic and food industry. to be consistent with the dd terminology, in this analysis treatment and control groups are electronic and food industry firms respectively. instead of the two time periods we might categorize data by different cohorts or characteristics (angrist and pischke, 2008) therefore we define the cohort ‘pre’ as the outcome variable observed for those firms which have not taken up the strategy within 2008-2017. we call it pre because they may or may not asian journal of economics and empirical research, 2019, 6(2): 148-168 156 © 2019 by the authors; licensee asian online journal publishing group have used this strategy before 2008, but not in 2008-2017, and ‘post’ is the outcome variables for firms which have changed product line after 2008. 3.1.3. definition of variables 3.1.3.1. dependent variable the dependent variable is the log of the value of gross sales for a firm averaged for 10 years from 2008-2017. a sale is as an act of transferring a product or service in return for cash or other non-cash consideration. value of sales includes regular income generated by a firm from sales of identifiable goods and non-financial services. it includes the sale of scrap, raw materials, and stores, income from job-work done, repairs and maintenance, construction and utilities. sales and not the number of products produced by a firm are considered for two reasons. first, it allows comparison under a common unit for multiproduct firms. second, price is also an important consideration for a firm to discontinue or introduce a product. value of sales captures both the quantity effects and the value effects. 3.1.4. measurement of dependent variable for each firm, we find the average sales value for the 10 years, i.e., for years 2008-2017. we also check if the mean is an appropriate measure of central tendency by finding the standard deviation for each firm for the sales values over this period. we then calculate the coefficient of variation for each firm which is a ratio of standard deviation and means. we find that the coefficient of standard deviation is less than 1 for each firm, i.e., mean is greater than the standard deviation which implies that mean contains much information of the data. since all the values are uniformly bounded below 1, we can therefore, do the regression at the means. sales values are large numbers; we use the log transformation of the sales value to remove the problem of heteroscedasticity by reducing the scale effect of the number. the analysis can also be done using panel data, but due to time constraint we are restricting to cross-section analysis. we represent the time series of a variable for a firm by an average of the values for the years 2008-2017 assuming it to be a reasonable representative because of the reasons mentioned above. 3.1.5. independent variables and controls we include the dummy for electronics and food industry that takes value one if firm belongs to electronic industry and zero if it belongs to food industry. this dummy would capture the industry specific features determining the performance. dummy for post and pre firms is that takes value one if a firm changes product line within 2008-2017 and zero if it does not. our variable of interest is the interaction dummy which takes value one if a firm belongs to electronic industry and changes product line and zero otherwise. it would give an estimate of the difference between the average sales value of electronic industry firms changing product line and food industry firms not changing product line. 3.1.6. controls we control for firm characteristics such as age [age] and size of endowments [average total assets] which explain variations in the probability of survival (agarwal and gort, 2002). age of the firm relates to knowledge that a fir acquires that leads to cost reductions, and product improvements. and the endowments affect how a firm is inherently suited for profitable production. additionally, we control for costs of sales and manufacturing [average cost of manufac. and sales]. as the costs differ in the two industries, it will affect the decision of product line change for the firms in different industries. 3.1.7. variable measurement age of the firm is measured as the current year minus the year of incorporation. average size of endowment is measured as the book value of total assets of a firm averaged for 2008-2017. total assets are a common proxy for size (balcaen et al., 2011). cost of sales is the cost involved in manufacturing and selling a product during a year. it is different from the cost of goods sold. cost of goods includes only the direct costs for production of goods and ignores the cost of selling and distribution. average cost of sales is used which is the average of cost of sales for year 2008-2017. we define the dd model as: where, is a dummy for firms changing product line in the period 2008-2017 and is the dummy for electronic industry firms. captures the interaction effect. the outcome variable is i.e. the natural log of average sales value for firms, averaged for years 2008-2017. is the error. ̂ [( ̅ ̅ ) ̅ ̅ ] the first and the second parentheses show the difference between firms changing product line and not changing product line. the difference is across the two industries varying in durability and technology of the products produced. hence this is a difference-in-differences analysis. we try to capture the differential impact of product line changes controlling for technology and durability of products on the average sales value. 3.2. data we compile the data from database, collected by centre for monitoring the indian economy (cmie). it is a database of the financial performance of companies delivering data for over 40,000 indian companies including listed companies, unlisted public companies and private companies of all sizes and ownership groups. it is the only database in our knowledge that records detailed annual information of the product mix of a firm. by the 1956 companies act, firms are mandated to disclose the information about capacities, sales and production at the asian journal of economics and empirical research, 2019, 6(2): 148-168 157 © 2019 by the authors; licensee asian online journal publishing group product level. prowess database compiles this data and hence allows us to track whether the firm has changed its product line over the period 2008-2017. we categorize a firm as electronic and food industry by matching the nic product code at digit classification 4 and 5 given by prowess for the products of a firm with the nic 2008 industry code. in case of a multi-industry firm, the categorization is done according to the code of the main product of the firm or the product from which the firm earns the highest revenue. for each firm we collect data on sales value which includes industrial sales and income from non-financial services. industrial sales includes the sale of goods and income from activities associated with sales like sale of scrap, raw materials and stores, income from job-work done, and income from repairs & maintenance, construction and utilities. it includes fiscal benefits received by a firm. the other variables are cost of sales and manufacturing, age of firm, total assets of firms, profit ratios like pbidta/total income, pat/net worth. all these values are collected for years 2008-2017. 4. results and discussions for descriptive statistics, we make the calculations using the compiled dataset and tabulate the values separately for the firms belonging to electronic and food industry, similarly for the set of firms which adopt a product line change within 2008-2017 and the set of firms that do not. we also tabulate the mean of different industry-specific features for the two groups and test the difference in means using wilcoxon rank sum test. descriptive statistics and the results from means test are given in appendix 1. in section 4.1 we give the estimates of dd analysis. since the data does not capture micro-level changes that take place within a firm, we take some case studies to discuss the effects of product line change in section 4.2. in appendix 2, we show an alternative result by assuming product line change is an exogenous strategy of the firm to show how sales value would react to the strategy across the two sets of firms. this is a big assumption and is difficult to fulfill therefore we use this result only to indicate what could happen had the assumption held true. we find the average treatment effect on the treated by using propensity score matching for the two industries separately and report the results in appendix 2. 4.1. difference-in-differences estimation parallel trend assumption is the most crucial of the assumptions mentioned for the internal validity of dd model. figure 4 appendix 3 shows a plot of average sales value against years for the two industries for the firms not showing change in product line. figure 5 appendix 3 shows the same plot for the log of average sales values against years. from the figures we can infer that there is an upwards trend for both electronic and food industry firms. the electronic industry besides having an upwards trend is also affected by business cycle fluctuations more than food industry. the trend lines for the two industries for firms which have not undergone a product line change are not exactly parallel but still show similar patterns. while we do not find exact evidence for the parallel trend assumption, we do not find evidence to reject it either. we work with it in our analysis that follows, and in our future exploration with panel data, we shall formally test for it. 4.1.1. dd estimates dd equation is given by: table-2. estimates of dd model. variables model 1 model 2 model 3 -0.068 (0.444) -0.124 (0.370) -0.748 (0.334) -0.875** (0.343) -1.344*** (0.283) -1.021** (0.299) 0.866 (0.603) 1.112** (0.505) 0.968** (0.476) age -0.251*** (0.006) -0.234*** (0.005) average total assets -0.001*** (0.0001) 0.0006*** (0.0002) average cost of manufac. and sales 0.0012*** (0.000039) constant 6.905*** (0.249) 7.401*** (0.299) 7.061*** (0.281) no.of obs = 229 f(3,225) = 2.930 prob > f = 0.034 = 0.037 no.of obs = 229 f(5,223) = 17.06 prob > f = 0.000 = 0.352 no.of obs = 229 f(3,225) = 14.74 prob > f = 0.000 = 0.431 4.1.2. inference table 2 shows the estimates of dd model. in model 2 after controlling for age and size of the firms the parameter of interest i.e. the coefficient of the interaction term , is positive and is statistically significant at 5 percent level of significance. since the dependent variable is in log terms the coefficient of 1.112 means that controlling for age and size of firms on an average, the average sales value for electronic industry firms which are changing product line is approximately 111 percent higher than the food industry firms which do not change product line. in model 3, when there is an additional control for average cost of manufacturing and sales the coefficient of 0.968 means that controlling for costs, size and age, on an average the average sales value for electronic industry firms which are changing product line is 96.8 percent higher than food industry firms which do not change product line. the coefficient is significant at 5 percent level of significance. in the first model, the coefficient is significant but it is not statistically significant. other coefficients are also of interest. for instance the coefficient for is -1.344 which means after controlling for age and size of firms, on an average the average sales value for electronic industry firms not asian journal of economics and empirical research, 2019, 6(2): 148-168 158 © 2019 by the authors; licensee asian online journal publishing group changing product line is approximately 134 percent lower than food industry firms not changing a product line. the coefficient is significant at 1 percent level of significance. the sign is as expected; because of the nature of products in electronic industry, the firms not changing product line are performing badly than firms not changing product line in food industry firms. the coefficient for the other models can be interpreted in the same way. the sign of is also according to the expectation though not significant. negative sign implies that the firm changing product lines in the food industry are performing lower than the firms not changing product line; because of the nature of the product, consumers demand the good more often, therefore the firms need not reinvent themselves in order to survive. from the empirical evidence we can infer that product line change is playing an important role for firms as a strategy. even though the data masks a lot of micro level changes happening within a firm still we can find evidence when we measure the strategy of changing product lines through the impact on average sales of a positive performance of firms involved in changing product line and the change is more pronounced in electronic industry firms. still not many firms are using this as a strategy for survival; the probable reasons of this are discussed in section 4.2. 4.2. case studies through the cases, we want to bring in light the various patterns of product line changes showing up in the firms and how the sales performance of the firms reacted to such changes. we say that a firm has changed the product line if it adds product, drops product or both add and drop products in the period from 2008 to 2017 from which it accrues at least 10 percent of its sales value. we first try to understand why this strategy might not be popular amongst firms and also show under what conditions keeping the product basket same be a feasible strategy. we also find evidence of manufacturing firms turning into service providers which is another kind of product line change where firms enter into a different domain of business to survive. at the end, we indicate the presence of complementarities amongst different goods of a firm and the potential repercussions to reputation by changing the products which is an additional cost of product line change. the first case is of wrigley india pvt. ltd., a food industry firm that had produced bubble gums, chewing gums, lollipops, and toffees from 2005-2011. from 2012-2015 continuing with the same product line it also produced pharmaceutical products and prepared food products accounting for almost 13 percent of its sales revenue in 2012 and 19 percent of the sales revenue in 2014. in 2016 it discontinued the added products and continued the previous line. data on cost of sales and manufacturing reveals that the cost increased by 21 percent from 2011 to 2012 when it introduced the new products and fell by almost 4 percent in 2016 when the new products were discontinued. the cost had been relatively stable and high in the period from 2012-2015. the cost of raw materials, advertisements and marketing as percent of sales increased by about 35 percent, 3.5 percent and 7.5 percent respectively in 2013-14. these measures showed a slight decline in the period 2016-17 when the added products were discontinued. these findings hint at the additional cost burdens of product line change for a firm. though, the added products add to the revenues, the firm also has to incur huge cost to produce and sell the product. a similar pattern has also been observed with nippon audiotronix pvt. ltd which is an electronics industry firm. data shows that the firm had produced the same basket of goods from 2000-2011. after 2012 it had added various products in different years. the cost of sales and manufacturing rose by 25 percent in that year and remained high after that. the cost of raw materials, advertisements and marketing as percent of sales increased by about 6 percent, 1 percent and 2 percent in 2011-2012. data from other firms also reveals a similar pattern. product line change; one of the survival strategies of firms is an expensive strategy. introducing new products and laying product line requires capital and expertise which the firm has to acquire and additional cost in terms of raw materials, advertisement and marketing. these cases show the costs when a firm adds a product, but cost can also be associated with dropping a product line. goldberg et al. (2008) show that indian firms are not dropping products whereas it is an important strategy for the us firms. the change in product lines is almost driven by product addition than dropping. the plaussible reason for this could be that the management is reluctant to drop a product once the sunk cost has been paid even if the product is not profitable. therefore, there are costs associated with both product addition and dropping because of which firms do not use this strategy very often. the following two examples are of two electronic industry firms which have not changed the product line in period 2008-2017. for the first firm, the profit measures have reduced significantly and have become negative whereas for the second firm it has never sharply reduced and remained positive throughout the period. from these examples, we want to bring in light the fact that the market situation under which a firm operates matters for getting benefits from product lines. if a firm has control over the supply in the market, it need not alter its products and can survive and thrive even without product line change. the first example is of samtel color ltd., it had produced color tv picture tubes from 1980-1999, from 20002007 along with the tv tubes it produced black and white and colored electron guns, it discontinued black and white guns by 2008 and produced colored guns and tv tubes in the period 2008-2017. even though the firm had introduced changes outside the period 2008-2017 but since it has kept the product line same in this period we keep it under category-2, i.e., firm not changing product line. form figure 1 we can see that the profit measures have considerably reduced in the period 2008-2017. interestingly, the values were positive before 2008, when the firm has shown changes in the product basket. asian journal of economics and empirical research, 2019, 6(2): 148-168 159 © 2019 by the authors; licensee asian online journal publishing group figure-1. profit measures of samtel pvt. ltd. (1995-2016). contrary to the previous example, bharat dynamics ltd. also a firm in electronic industry is a government of india enterprise and has produced first generation anti-tank missile and missile system; defense communication equipment since 1989 and has never undertaken a product line change. pbidta/total income and pat/total income shows a very different trend from samtel color ltd. from figure 2 we find that profit measures have both declined and rose within 1995-2016 but have not shown significantly negative values as in the case of the previous example despite keeping product line same throughout. hence, the position of a firm in the industry and its control over supply really matters. the first example in which a private firm is competing with other firms is showing negative profits by keeping product line same whereas, in the second example, where the firm has a semi-monopoly, product line change is not required. this indicates that product line change may help firms to survive in cases it is facing competition in the market but is not an important strategy for firms which have control over the supply. also we should note that we cannot generalize the findings from these examples for the industry as a whole. these are particular examples to motivate certain points which one must consider for product line changes. figure-2. profit measures of bharat dynamics ltd. (1995-2016). there must be firms which change their product lines and still fail as they are not able to either sell the product or have no expertise in the new product. since the dataset contains only those firms which still exist, i.e., they are still surviving; we cannot capture those firms which have exited the market because of product line change. hence our analysis has a survival bias which cannot be removed as the data set does not have information on firms which do not exist now. whether firms barely survive through a product line change or survive and thrive depends on the firm and industry-specific conditions. product line change being an expensive strategy poses an additional burden on a firm’s expenses in the form of advertisement, research and development, laying new product line, etc. firms also adopt various other strategies which are not given much attention in the literature. for instance, esha media research ltd. an electronic industry manufacturing firm produced ultra sound scanners from 19962010. since the sales revenue from the product continuously fell, the firm moved out of the given product line to market research & public opinion polling and earned revenue only from these operations. figure 3 shows the sales revenue of the firm from 1996-2014, the sales value continuously fell from 1996-2010 and increased from 2011 when the firm moved into market research services. this is also an example of product line change where a firm moves from manufacturing to services to survive. other examples can also be found, for instance, satva jewelers and design ltd. moved out of manufacturing into the fund based financial services and renting services, but the sales figure had been low throughout. asian journal of economics and empirical research, 2019, 6(2): 148-168 160 © 2019 by the authors; licensee asian online journal publishing group figure-2. sales value of esha media research ltd. (1996-2014). from these cases, we can see that product line change is not an ultimate strategy of survival but is important as well as an expensive strategy. firms may or may not do well by keeping product line the same which depends on the market competition and the nature of products a firm produces. there are also other kinds of product line changes where the firm gives up manufacturing and moves into services. there exists complementarity in the products a firm produces. for instance, the food safety and standards authority of india banned maggi in june 2015, a flagship product of nestle india, due to the presence of lead above the permissible limit. their market share reduced from 80 percent to 0 percent within a month. the ban on the product also harmed the sales of the company’s other products like infant milk food as the customers may have lost confidence in the company. the growth in sales of infant baby products was a little higher than 13 percent in 201314 whereas, it was only 0.9 percent post ban in 2015-16. the company did not give up the product but tried to bring it back to maintain its reputation in the market. after the maggi noodles were back in the market, the growth in sales of infant milk food also improved to 2.3 percent in 2016-17. hence adding and dropping products is not only expensive in terms of an additional financial requirement but also the complementarities associated with different products of a company. when a firm drops a product, customers may not find the firm to be reliable and the demand might fall. these cases point out towards the costs associated with product line changes potentially because of which there is not much evidence of this strategy found in the indian firms. 5. conclusion in this work we presented that product line change through which a firm adjusts its basket of goods to eliminate products which are not profitable or adding products which have the possibility of earning high profits is a crucial strategy for any firm. it allocates resources efficiently which is of paramount importance for the economy as a whole. we studied this strategy for the manufacturing industry of india focusing on electronic and food industry firms as they have some specific characteristics. the former produces goods which are durable and technologically intensive and the latter produces goods which are less durable and technologically less intensive. linking the literature on product line changes and competition under durable and technologically intensive goods, we understood that the strategy would be beneficial more for firms producing such goods. this is precisely what we have found from the empirical analysis. controlling for age, the average size of firms and the average cost of sales and manufacturing, the average value of sales for electronic industry firms which are changing product line is approximately 96.8 percent higher than the food industry firms which do not change product line. through the difference-in-differences technique, we have tried to capture the two differences; the first difference is related to the difference in firms changing the product line and not changing the product line and second for firms producing durable and technologically intensive goods and those which are not. we also tried to find an alternative result shown in appendix 2, which depends in the assumption of product line change being an exogenous strategy of the firm. the result is in line with what we hypothesis from the literature. for firms with similar average total assets, the average cost of sales and manufacturing, average pbidta/total income and average pat/net worth which is also the return on equity, the electronic industry firms which are changing product line are earning 82.6 percent more on an average than the firms which are not. for the food industry firms, on the other hand, these firms do worse though the result does not come out to be statistically significant. the result shows that this strategy is more useful for electronic industry firms. although the reliability of the result is questionable since the assumption on which it depends is difficult to fulfill. we have also seen that this strategy is not very popular amongst firms, the reason for which is that changing a product line is an expensive affair. laying a product line requires enormous costs; not only monetary but the cost in terms of forming links with other firms, creating demand, gaining the expertise in product formation which includes training staff and managers. the cost may also include repercussions on reputation, where customers may lose faith in a company which frequently changes its products and brands. therefore, the sunk costs of new product introduction and dropping are high. hence it is not surprising that firms that did pay these high sunk costs are reluctant to withdraw products, even if the products turned out to be less profitable. there might also be a situation where a firm wants to change its product basket but is not able to undertake the change due to insufficient capital and lack of credit. also from the data, we have seen that changing the product basket is not the only strategy. manufacturing firms may even turn into service providers or invest in other firms which are profitable to survive. survival strategies are specific to each firm which depends on the market situation. once we understand the bottlenecks, we can improve upon it so that firms not just survive, but survive and thrive. it is not only beneficial for a particular firm but is profitable for the economy as a whole. asian journal of economics and empirical research, 2019, 6(2): 148-168 161 © 2019 by the authors; licensee asian online journal publishing group 5.1. future work since many firms have changed their product lines just before the year 2008 and have not shown changes within 2008-2017, it is critical to shift the period window, let’s say from 2005-2015 and analyze the results 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and category-2 firms industry wise. variables electronic ind. food ind. total category-1 38 37 75 category-2 78 76 154 total 116 113 229 we find that the proportion of firms changing product line in both the industries is almost the same (around 32 percent). the electronic industry firms are not using the strategy more often than the food industry firms which is contrary to our understanding from the literature. the plausible reason of this could be the rigidities in product reintroduction or lack of capital or risk appetite of the firms in the industry. we discuss these further using case studies in section 4.4. given below are the various industry-specific features and cost characterizations for electronic industry, food industry, category-1 and category-2 firms. 1.1. hhi index and cr-4 herfindahl-hirschman index (hhi) and concentration ratio (cr) are measures of market concentration. hhi is calculated by summing the squares of market shares of firms within an industry. it ranges from 0-10,000. cr-4 is calculated by summing the percentage of market share of top 4 firms in the industry. table 4 shows the market share of each firm calculated by dividing average sales value for period 2008-2017 of a firm by total average sales value for all firms. table-4. hhi index and cr-4. variables electronic ind. food ind. category-1 category-2 hhi index 782.825 385.576 423.885 486.487 cr-4 (%) 38.91 31.65 30.31 36.46 the us department of justice considers a market with hhi from 0-1500 a competitive market, hhi of 15002500 as moderately concentrated and hhi of more than 2500 as highly concentrated. cr between 0-50 percent indicates low concentration market. through both the measures both electronics and food industry are nearly perfectly competitive. same holds for category-1 and category-2 firms. 1.2. values in the descriptive statistics for all the descriptive statistics given below, we provide the values of the maximum and minimum of the given variables, mean, and the average standard deviation. we calculate the mean by first calculating the average for each firm for the given variable and then average those values for firms lying in the four sets. similarly, we find the average standard deviation by first finding the standard deviation of the individual firm for the given variable and then averaging those values for firms lying in the four sets which are electronic industry, food industry, category-1, and category-2 firms. 1.3. average sales value from table 5 we can see that average standard deviation is less than the mean for all the four sets. though, the average sales value for food industry firms is higher than electronic industry firms, the value of average standard deviation is higher for the former. average sales value is higher for category-2 firms. table-5. descriptive statistics of average sales value (2008-2017) (inr million). variables electronic ind. food ind. category-1 category-2 maximum 88487.28 54733.54 29443.52 88487.28 minimum 0.54 2 0.54 2 mean 3204.26 4394.13 3669.45 3850.79 av.std.deviation 1357.64 2014.54 1685.19 1680.13 1.4. average total assets from table 6 we infer that there is not much noise in the data as mean is higher than the standard deviation for all the four sets. average total assets for electronic industry firms are higher than that for food industry firms whereas for category-2 firms are higher than that for category-1 firms. table-6. descriptive statistics of average total assets (2008-2017) (inr million). variables electronic ind. food ind. category-1 category-2 maximum 61613.92 30213.62 18482.52 61613.92 minimum 00 3.7 12.49 3.7 4.8 mean 4134.847 2756.246 3171.425 3592.475 av.std.deviation 1708.289 1038.016 1113.811 1505.989 asian journal of economics and empirical research, 2019, 6(2): 148-168 163 © 2019 by the authors; licensee asian online journal publishing group 1.5. cost of manufacturing and sales we can see from table 7 that the mean of average cost of sales and manufacturing for category-1 and category-2 is almost the same. surprisingly, the mean of average costs is more for food industry than electronic industry firms, though the standard deviation is higher for the latter. table-7. descriptive statistics of cost of manufacturing and sales (2008-2017) (inr million). variables electronic ind. food ind. category-1 category-2 maximum 75502.750 50322.920 28897.650 75502.750 minimum 0.467 1.8334 0.4667 1.834 mean 3047.635 4302.982 3613.107 3693.374 av.std.deviation 1188.012 1789.983 1468.975 1492.885 1.6. compensation to employees (coe) as a percent of a firm’s sales revenue and change in stock the ratio analyzes the expense on compensation to employees (coe) as a percent of a firm’s sales revenue. table 8 raises some concerns as the mean values are less than the standard deviation for all the four sets which indicates that there is some noise in the data. it also questions the variability in the returns employees receive in different industries. table-8. descriptive statistics of coe as a percent of sales and change in stock (2008-2017) (%). variables electronic ind. food ind. category-1 category-2 maximum 1371.971 1230.308 1230.308 1371.971 minimum -94.2862 -11.89047 -11.89047 -94.2862 mean 47.082 25.63903 43.73634 32.97736 av.std.deviation 62.91 33.885 74.948 35.774 1.7. cost of raw material, stores and spares as a percent of sales and change in stock table 9 gives descriptive statistics of raw material, stores and spares as a percent of sales and change in stock. this data reflects how much of sales revenue are utilized in the absorption of its costs incurred on raw materials, stores and spares. it is part of variable cost of a company. these costs on average are more for category-1 firms as compared to category-2 firms. one plausible reason is that changing product line requires additional cost in terms of purchasing new raw materials and required materials, though the standard deviation is also very high for the former indicating a large noise in the data. counterintuitively, the average costs are higher for food than electronic industry firms. again, the standard deviation is also high implying that the data is spread out. we test the difference in the means in the next section. table-9. descriptive statistics of raw material, stores and spares as a percent of sales and change in stock (2008-2017) (%). variables electronic ind. food ind. category-1 category-2 maximum 1428.031 3778.233 3778.233 1428.031 minimum -311.6334 0 0 -311.633 mean 60.006 106.0497 134.655 57.436 av.std.deviation 51.714 112.876 173.832 37.120 2. means test we test whether the difference in the means for variables of average size, expenditure on advertisement, compensation to employees, and raw material, and profit measures like pbidta and pat are significant using mann-whitney u test, sometimes called wilcoxon rank-sum test or mann-whitney-wilcoxon test. it is a nonparametric test used to test whether two independent samples are derived from same population. it does not require the assumption of normal distribution and is nearly as efficient as the t-test on normal distribution. the null and two-sided research hypotheses for the nonparametric test are stated as follows: : the two populations are equal. : the two populations are not equal i.e. the population distributions are different in some way, center, spread and/or shape. rejecting null hypothesis is interpreted to mean that one of the populations tend to have larger scores than the other. as we have seen from the descriptive statistics that the measures of different variables have shown large noise and high skewness, the amount of information that the mean contains is questionable. we find the statistical significance in the means in the following section. 2.1. size of the firm size here is defined as the three-year average of the total income and total assets of a firm. average size is larger for electronic industry though the difference is not statistically significant. table 10 shows average size of category-1 firms is slightly higher though the difference is not statistically significant and table 11 shows that average size of category-1 firms is slightly higher and the difference in the two distributions is significant at 10 percent level of significance2. for all the statistics hereafter the value for individual firm is found by averaging the values from years 2008 to 2017 unless otherwise. 2 *** = p < 0.01; significant at 1 percent, ** = p < 0.05; significant at 5 percent, * = p < 0.10; significant at 10 percent. we use this notification for the entire analysis. asian journal of economics and empirical research, 2019, 6(2): 148-168 164 © 2019 by the authors; licensee asian online journal publishing group table-10. mean of size of firm (industry-wise). variables size (inr million) z, p-value inference electronic 3367.560 z = -1.170 prob > |z| = 0.242 is not rejected. difference in the means is not statistically significant food 3129.373 table-11. mean of size of firm (category-wise). variables size (inr million) z, p-value inference category-1 3259.975 z = -1.756 prob > |z| = 0.079* is rejected at 10%. difference in the means is statistically significant category-2 3245.181 2.2. advertising expense as a percent of sales and change in stock the ratio serves as an indicator of a company’s profitability, by analyzing the magnitude of the company’s sales revenue spent on advertising cost. table 12 shows that for firms in food industry, average advertising cost is higher than electronic industry firms. in table 13 it is shown that the same ratio for category-2 firms is higher than for category-1 firm, even though both are not statistically different from each other. table-12. mean of advertisement cost of firm (industry-wise). variables adv./sales+ stocks (%) p-value inference electronic 0.320 z = -0.478 prob > |z| = 0.633 is not rejected. difference in the means is not statistically significant food 1.092 table-13. mean of advertisement cost of firm (category-wise). variables adv./sales+ stocks (%) p-value inference category-1 0.444 z = -0.869 prob > |z| = 0.385 is not rejected. difference in the means is not statistically significant category-2 0.827 2.3. compensation to employees as a percent of sales and change in stock from table 14 it can be seen that coe as a percent of sales is higher for electronic industry firms and the null hypothesis of no difference in population is rejected at 1 percent level of significance. whereas for category-1 firms it is higher but the two sets of distributions are not statistically different from each other seen in table 15. table-14. mean of compensation to employees of firm (industry-wise). variables coe/sales+ stocks (%) z, p-value inference electronic 47.082 z = 4.001 prob > |z| = 0.000*** is rejected at 1%. difference in the means is statistically significant food 25.639 table-15. descriptive statistics of compensation to employees of firm (category-wise). variables coe/sales+ stocks (%) z, p-value inference category-1 43.736 z =0.706 prob > |z| = 0.480 is not rejected. difference in the means is not statistically significant category-2 32.977 2.4. raw material, stores and spares as a percent of sales and change in stock table 16 and table 17 respectively show that for electronic industry firms the ratio is higher and the difference between the two groups is significant at 5 percent level of significance whereas for category 1 and 2 the difference is not significant. table-16. mean of raw material, stores and spares cost of firm (industry-wise). variables raw/sales+ stocks (%) z, p-value inference electronic 49.870 z = -2.102 prob > |z| = 0.036* is rejected at 5%. difference in the means is statistically significant food 54.232 table-17. mean of raw material, stores and spares cost of firm (category-wise). variables raw/sales+ stocks (%) p-value inference category-1 50.910 z = 0.012 prob > |z| = 0.991 is not rejected. difference in the means is not statistically significant category-2 52.564 2.5. pat as a percent of net worth pat is profit after tax. pat/net worth is a measure of returns over investment. this measure is commonly known as return on equity (roe). net worth is the sum of funds provided by equity shareholders and accumulated reserves of a firm. higher the ratio, the more efficient the management is in utilizing its equity base. average of asian journal of economics and empirical research, 2019, 6(2): 148-168 165 © 2019 by the authors; licensee asian online journal publishing group roe is higher for electronic industry firms and category-1 firms. both the results are statistically insignificant and are given in table 18 and table 19 respectively. table-18. mean of reo of firms (industry-wise). variables pat/net worth (%) z, p-value inference electronic 1.317 z = -1.079 prob > |z| = 0.281 is not rejected. difference in the means is not statistically significant food -0.967 table-19. mean of reo of firms (category-wise). variables pat/net worth (%) z, p-value inference category-1 4.516 z = 0.662 prob > |z| = 0.508 is not rejected. difference in the means is not statistically significant category-2 -2.025 2.6. pbidta as a percent of total income this is a ratio of profitability of total income of a firm. pbidta is profits before depreciation, interest, tax and amortization. it is a measure of operating profits. higher pbidta as a percentage of total income indicates that a company is generating good profits from its day-to-day business operations. as indicated from table 20 pbidta/total income measure for electronic industry firms is very less as compared to food industry firms and the difference statistically significant at 1 percent level of significance. difference for firms in category 1 and 2 is not statistically significant which is given in table 21. table-20. mean of pbidta/total income of firms (industry-wise). variables pbidta/total income (%) z, p-value inference electronic -3.682 z = 3.597 prob > |z| = 0.000*** is rejected at 1%. difference in the means is statistically significant food 7.839 table-21. mean of pbidta/total income of firms (category-wise). variables pat/net worth (%) z, p-value inference category-1 10.716 z = -0.321 prob > |z| = 0.748 is not rejected. difference in the means is not statistically significant category-2 -2.240 appendix 2 the strategy of a product line change is not an exogenous strategy and depends on a firm’s characteristics therefore we have used difference-in-differences analysis. in this section we represent an alternative result by assuming that the strategy of product line change was like an exogenous treatment. this is a big assumption which is difficult to fulfill hence we give the results in the appendix just to show how the average sales value differ between firms changing product line and firms not changing product line for the two industries separately. we first explain the average treatment effect using propensity score matching and then report the results. propensity score matching propensity score matching (psm) is a statistical matching technique popularly used to estimate causal treatment effects. it applies to all situations where we define a treatment and can form two groups; one with treated individuals and the other with untreated individuals (caliendo and kopeinig, 2005). one would like to know the difference in the outcome of treated without the treatment. let the dummy for a binary treatment be denoted by for individual i, be equal to one if the individual receives a treatment and zero otherwise. the potential outcome for each individual can be denoted by ( . the treatment effect is then ( for each individual. the problem arises because both the outcomes are not observable for each individual. therefore we cannot find individual treatment effect and have to work on average treatment effect. another measure of interest is the average treatment effect on the treated. this is defined as: atet = e (treatment| t=1) = e [z (1) |t=1] e [z (0) |t=1] the problem in finding atet is that (e[z(0) |t=1]) is not observable. substituting the missing value by the average outcome of untreated individuals is not a good idea as in non-experimental studies the conditions under which the decision of treatment is taken may also influence the potential outcome. hence the two groups may possibly be different even in the absence of the treatment. this is called ‘self-selection bias’. one strategy is to compare the outcome of those individuals in the group who have similar covariates which influence the outcome. for instance, if age affects both treatment selection and outcome, one would compare individuals of similar age in both groups. as variables are added to the matching process, it becomes more complex to find exact matches. psm provides a way to balance covariates across treatment and control groups and better approximate the counterfactual for treated individuals. it solves the problem by compressing the relevant factors into a single score. we find the propensity scores which is the probability for an individual to participate in the treatment given the covariates i.e. p(t=1|x) = p(x), it is one of the balancing scores (rosenbaum and rubin, 1983). individuals with similar propensity scores are then compared across treatment and comparison groups. assumptions: asian journal of economics and empirical research, 2019, 6(2): 148-168 166 © 2019 by the authors; licensee asian online journal publishing group one assumption is conditional independence assumption (cia) which requires that potential outcome be independent of treatment given the propensity scores. other assumption called the common support assumption (csa) requires that an individual with same x have a positive probability of being a participant or non-participant. given cia and csa, propensity score estimator for atet can be written as: | { | | psm estimator is the mean difference in outcomes over the common support, weighted by the propensity scores of individuals who are participating. variables which simultaneously determine participation decision and outcome variables should be chosen as covariates. variables should either be fixed over time or measured before participation to ensure that the covariates are not influenced by participation. for the implementation of atet it is important to check the overlap and region of common support between the control and the treatment group. in our analysis we find the average treatment effect on the treated (atet) using propensity scores. we conduct the exercise for electronic and food industry firms separately and report the results below. result we have the presence of category-1 and category-2 firms in both food and electronic industry. we find the atet by propensity score matching for both the industries separately. we would be interested to know what their average sales value would be had they not changed the product line, since we do not have that value we find the average sales value of the untreated firms which are similar to the treated firms in terms of average of total assets, average of cost of sales and manufacturing, pbidta/total income and pat/net worth which is also the return on equity of a firm. since the data on these covariates for firms were missing for most of the years from 2000-2007, we use the average values from year 2008-2017. also from descriptive statistics it can be seen that category-1 and category-2 firms do not statistically differ for average pbidta/total income and pat/net worth. figure 6 and 7 appendix 3 show the graph for before matching and after matching of the covariates for electronic industry firms and figure 8 and 9 appendix 3 show the same for food industry firms. the result for electronic and food industries are as follows: table-22. atet for electronic industry firm. variables coefficient robust std. error z p > |z| [95% confidence interval] (treated vs untreated) 0.862 0.446 1.93 0.053* -0.125 1.736 table-23. atet for food industry firm. variables coefficient robust std. error z p > |z| [95% confidence interval] (treated vs untreated) -0.415 0.309 -1.34 0.180 -1.021 0.191 from table 22 it can be inferred that treated firms are earning 82.6 percent more than the untreated firms of similar covariates and the result is significant at 10 percent level of significance. for the food industry firms on the other hand the treated firms do worse on average though the result is not statistically significant which is given in table 23. thus we can claim that product line change is an important strategy for electronic industry firms. there can be various reasons for this but an important reason is the characteristic of the products the industry produces. the goods are more durable and are technologically intensive. technology keeps on changing, so it is crucial for these firms to reinvent themselves. also since the consumers keep the goods for a relatively longer period of time, the firms face an additional self-created competition. it is important note that the inference from the result maybe questionable because of the big assumption. this analysis only hints at the situation in which product line change is an exogenous treatment for firms. appendix 3 figure-4. average sales value for electronic and food industry firms not changing the product line (2008-2016). asian journal of economics and empirical research, 2019, 6(2): 148-168 167 © 2019 by the authors; licensee asian online journal publishing group figure-3. log of average sales value for electronic and food industry firms not changing the product line (2008-2016). figure-4. graph for propensity scores before matching for electronic industry firm. figure-5. graph for propensity scores after matching for electronic industry firm. figure-8. graph for propensity scores before matching for food industry firm. asian journal of economics and empirical research, 2019, 6(2): 148-168 168 © 2019 by the authors; licensee asian online journal publishing group figure-9. graph for propensity scores after matching for food industry firm. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 130 © 2019 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 6, no. 2, 130-139, 2019 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2019.62.130.139 © 2019 by the authors; licensee asian online journal publishing group health expenditure, health outcomes and economic growth in nigeria joshua adeyemi ogunjimi1 adedeji oluwatosin adebayo2 ( corresponding author) 1,2department of economics, university of ibadan, nigeria. abstract this study examined the relationship among health expenditure, health outcomes and economic growth in nigeria for the period between 1981 and 2017. this study adopted the todayamamoto causality framework to examine these relationships. the augmented dickey fuller unit root test was used to check for maximum order of integration of the variables used in the study and the result was one while the autoregressive distributed lag (ardl) bounds test approach to cointegration was used to investigate if a long-run relationship exists among the macroeconomic variables used in the study and the result was in the affirmative. the results of the toda-yamamoto causality tests showed a unidirectional causality running from health expenditure to infant mortality while there is no causality between real gdp and infant mortality; a unidirectional causal relationship running from health expenditure and real gdp to life expectancy and maternal mortality; and a unidirectional causal relationship running from real gdp to health expenditure. this study therefore recommended that the nigerian government should make concerted efforts geared towards increasing the health expenditure at least to meet up with the who‟s recommendation that all countries should allocate at least 13 per cent of their annual budget to the health sector for effective funding as this would bring desired health outcomes and employ the use of modern technology and the services of professional health personnel should be sought to combat the high incidence of maternal and infant mortality in the health sector in nigeria. keywords: health expenditure, life expectancy, infant mortality, maternal mortality, toda-yamamoto causality test, nigeria. citation | joshua adeyemi ogunjimi; adedeji oluwatosin adebayo (2019). health expenditure, health outcomes and economic growth in nigeria. asian journal of economics and empirical research, 6(2): 130-139. history: received: 22 july 2019 revised: 26 august 2019 accepted: 1 october 2019 published: 31 october 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 131 2. health expenditure, health outcomes and real gdp profile in nigeria ......................................................................... 132 3. literature review .......................................................................................................................................................................... 133 4. methodology, model specification and empirical analysis ................................................................................................. 134 5. conclusion and policy implications ........................................................................................................................................... 138 references ............................................................................................................................................................................................ 138 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.62.130.139&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1088 http://orcid.org/0000-0002-5162-3326 https://orcid.org/0000-0001-5019-1253 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1088 http://orcid.org/0000-0002-5162-3326 https://orcid.org/0000-0001-5019-1253 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1088 http://orcid.org/0000-0002-5162-3326 https://orcid.org/0000-0001-5019-1253 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1088 http://orcid.org/0000-0002-5162-3326 https://orcid.org/0000-0001-5019-1253 asian journal of economics and empirical research, 2019, 6(2): 130-139 131 © 2019 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this paper contributes to the extant literature by examining the relationship among health expenditure, health outcomes and economic growth in nigeria in a trivariate framework. 1. introduction the state of health of the population of a country is a major factor driving productivity as only a healthy labour force can make meaningful contributions to production and growth of national output. as is the case in a typical production function, the quantity / level of inputs has a corresponding effect on the quantity / level of output depending on the scale of production and returns to scale. hence, this make the health of the citizens of a country imperative and as such adequate provision for health should be one of the primary goals of government as it has a positive impact on economic growth, one of the macroeconomic goals of every government. similarly, the health of the population is influenced by both the type of health system and of their resources. the relationship between resources and outcomes helps one to effectively assess how functional the health system of a country is. a country has a health system with a better performance than another country, if, for the same level of resources, it generates better health outcomes, or if it generates the same outcomes but with fewer resources (elola et al., 1995). health systems are financed either through taxes, in the case of healthcare services owned by the state (national health services), or through income-related social contributions (social security systems) (elola et al., 1995). the contribution of social security to the sustenance of the finance of the health system is phenomenal in countries with high income per capita. it is one of the major duties of every government to provide funds for the provision of social welfare of which health care is an integral part. thus, government devotes public fund to the provision of health care services in a bid to improving the health of the citizenry so as to enable them make significant contributions to economic growth and development in the country. it is believed that an increase in budgetary allocation to social services should enhance service delivery but this is not the case in nigeria. in many developing countries, budget misappropriation and/or mismanagement is one of the primary causes of ineffective public spending (world bank, 1998). for instance, many health indicators show that nigeria ranks low in health status despite the increasing budgetary allocation to the health sector. unaids, in 2016, ranked nigeria as the second largest country with the prevalence of hiv/aids in the world. in 2017, central intelligence agency (cia) also ranked nigeria as the eighth country with the highest infant mortality rate (69.8 per 1000 live birth) in the world. furthermore, the united nations department of economic and social affairs (un desa) says nigeria‟s life expectancy stands at 52.29 years, the 194th in the world. this statistics is indicative of the fact that the expenditure on health is not enough to develop the health system of nigeria or appropriate policies are not put in place to improve the health system of the country. the cost of health is on the high side and in a bid to bridge the huge health funding gap by governments to its citizens, especially in developing and underdeveloped countries, the who recommended that countries should allocate at least 13 per cent of their annual budget to the health sector for effective funding. all member countries, including nigeria signed towards the recommendation. also, an abuja declaration, signed in 2001 by all member countries of the african union, including nigeria, who in fact was the host of the high powered meeting, recommended that for the continent to be at par with other nations of the world in terms of healthcare provision, 15 per cent of their annual budget, at the least, be allocated to the health sector. however, the budgetary allocation to the health sector (government health expenditure) has been below par over time implying that a large percentage of healthcare services will be funded from out-of-pocket which majority of nigerians cannot afford. the nigerian economy is highly import-dependent not only on goods but also on services to the extent that her political office holders as well as the rich import medical services either by employing the services of foreign medical experts to nigeria or travelling abroad for medical check-up and/or treatment thereby enriching foreign nations at the expense of the domestic economy. for instance, the present president of nigeria, muhammadu buhari, went on medical vacation in early 2017 for over 50 days after which he went for another medical vacation for a staggering 103 days in may, 2017. this attitude by the president, other politicians and the rich alike shows that they do not believe in the services rendered by resident medical practitioners as most of the equipment and machines used in nigerian are outdated and cannot measure up to what obtains in developed countries of the world. consequently, there is an increase in brain-drain as competent medical personnel migrate to developed countries of the world, where sophisticated medical equipment and machines are available, to enhance their productivity and keep up with the pace of development in the medicine. consequently, this reduces the labour force in the health sector thereby reducing the sector‟s contribution to gdp and the aggregate national output at large. several policies and institution frameworks have been instituted to improve the performance of the nigerian health sector overtime. these policies include: national population policy of 1988, national population policy for sustainable development of 2004 and the national population policy of 2006. the institutional frameworks include: the national population commission (npc), the national planning commission and the federal ministry of health which comprises of four agencies whose activities directly or indirectly affect the demographic structure of nigeria namely: the national primary health care development agency (nphcda), the national health insurance scheme (nhis), the nigerian institute of medical research (nimr) and the national agency for food and drug administration and control (nafdac). however, these efforts of the government have not yielded the desired results given the maladies bedeviling the nigerian health sector. the literature is replete with studies on the issues relating to public health expenditure and health outcomes in different countries of the world (kim and lane, 2013) (17 oecd countries); (novignon et al., 2012) (44 sub-sahara african countries); anyanwu and erhijakpor (2007) (47 african countries); (elola et al., 1995) (17 western european countries); (novignon and lawanson, 2016) (45 sub-saharan african countries); (kulkarni, 2016) (brics countries); (deluna and peralta, 2014) (philippines), (day and tousignant, 2005) (canada); (becchetti et al., 2015) (european countries); (jaba et al., 2014) (175 world countries); (ogungbenle et al., 2013) (nigeria); (edeme et al., 2017) (nigeria); among other]. while some studies jaba et al. (2014); and ogungbenle et al. (2013) focused on the impact of health expenditure on life expectancy, some focused on the relationship between public asian journal of economics and empirical research, 2019, 6(2): 130-139 132 © 2019 by the authors; licensee asian online journal publishing group health expenditure and mortality rate which are the only a small fraction of the overall health indicators/outcomes of an economy. hence, the literature contains only a few studies on the empirical examination of the relationship between public health expenditure and health outcomes using only about two health indicator as a proxy for health outcome. this study will take a panoramic view of the health outcomes/indicators of an average household in the nigerian economy by examining the relationship between public health expenditure and three major health outcomes (life expectancy, infant mortality, and maternal mortality) in nigeria and also extend the analysis to investigating the impact of these health outcomes on the growth of the nigerian economy. another novelty of this study lies in the fact that it employs the use of the toda-yamamoto causality test to examine the relationship among health expenditure, health outcomes and economic growth, a technique that is particularly rare in the extant literature. it is against this background that this study will empirically investigate the relationship between health expenditure and health outcomes as well as the impact of health outcomes on economic growth in nigeria for the period between 1981 and 2016. it also checks for the direction of causal relationship of these macroeconomic variables. the rest of this paper is structured in the following manner: section 2 discusses the trend analysis of key variables; section 3 comprises the review of related studies; section 4 contains the methodology, model specification and empirical analysis; and section 5 concludes the study. 2. health expenditure, health outcomes and real gdp profile in nigeria figure 1 presents the profile of government expenditure on health and the corresponding health outcomes as well as the real gdp of nigeria. a cursory look at figure 1 reveals that government expenditure on health fluctuated for most the period under review even though there was a significant increase in it during the period. it grew steadily from n0.80 billion in 1981 to n0.62 billion in 1991, plummeted the following year to n0.15 billion and grew sharply to n3.87 billion in 1993 after which it fluctuated but stood at n16.64 billion in 1999. however, it is noteworthy that it grew markedly by about 134 percent from n99.1 billion in 2010 to n231.8 billion in 2011 from when it plummeted and stood at n202.36 billion in 2016. on the other hand, the share of health expenditure in total government expenditure stabilized at 1.74 percent from 1981 to 1986 but fell sharply to 0.26 percent in 1987 from when it rose to stand between 2.3 – 3.7 percent from 1993 – 2000. moreover, it grew to 4 and 5 percent in 2001 and 2002 respectively. the highest share of health expenditure in total government expenditure was in 2011 when it stood at 6.99 percent which falls short of the who recommendation as well as 2001 abuja declaration of the african union that countries should allocate at least 13 per cent of their annual budget to the health sector for effective funding. this indicates that nigeria falls below par in the expected expenditure on health. in addition, it is obvious that real gdp grew steadily almost throughout the period under review except for a few years (1982-1984 and 2016). the nigerian economy plunged into economic crises during these periods and the bretton woods institutions, in a bid to salvage the nigerian economy in the 1980s, introduced the structural adjustment programmes (sap) to nigeria which later aggravated the economic crises it was meant to solve. also, the nigerian economy plunged into a recession in recently (2016) when her real gdp fell from n69023 billion in 2015 to n67931 billion in 2016. figure 1 also shows that infant mortality rate stood at 125.4 per 1,000 live births in 1981 but declined to 124 per 1,000 live births in 1983 and increased steadily to 126.2 in 1989 and 1990. however, it plummeted in 126 per 1,000 live births in 1991 from when it decreased steadily until it reached a double figure of 99.8 per 1,000 live births in 2004 and stood at 81.1 and 66.9 per 1,000 live births in 2010 and 2016 respectively. this downward trend could be linked to the advancement in medical science. in the same vein, maternal mortality rate stood at 362.41 per 1,000 female adults in 1981 and it fluctuated from then till 1993 when it stood at 363.8 per 1,000 female adults. it however increased steadily to 393.53 per 1,000 female adults in 2002 but declined from then until it reached 359.82 and 333.03 per 1,000 female adults in 2010 and 2016 respectively. this indicates that the effort of the nigerian government in combating maternal mortality is yielding the desired fruit. additionally, life expectancy at birth in nigeria stood at 45.62 years in 1981 increased steadily to 46.13 in 1985. it however declined to 45.84 years in 1993 and 1994 but increase in 1995 to 48.25 years and has since then maintained an upward trend till it reached 48.25 years, 50.85 years and 53.43 years in 2005, 2010 and 2016 respectively. figure 1 reveals that life expectancy at birth is relatively stable throughout the period under review. it is also apparent that infant mortality as well as maternal mortality rose for some time but declined gradually for most part of the period under review. on the other hand, real gdp maintained an upward trend almost throughout the period under review while government health expenditure had some spikes and also grew for most part of the period under review but fell in 2016 when nigeria plunged into a recession. this suggests that the recession in nigeria in 2016 reduced government expenditure on health. asian journal of economics and empirical research, 2019, 6(2): 130-139 133 © 2019 by the authors; licensee asian online journal publishing group figure-1. trends of health expenditure, health outcomes and real gdp in nigeria. source: cbnsb (2017) and wdi (2018). 3. literature review there is a plethora of time-series and panel studies examining the nexus among health expenditure, health outcomes and economic growth. for instance, dormont et al. (2007) adopted the pooled ols, fixed effect and random effect models to examine the relationships between health spending, medical innovation, health status, growth and welfare and found that health spending triggers technological progress, which is a potential source of better outcomes in terms of longevity and quality of life, a direct source of growth for the bio-tech industries and an indirect source of growth through improved of human capital. the latter contributes to gdp per capita through two main channels: higher participation of the population in the labour force and higher labour productivity levels. in turn, income growth induces an increase in health expenditure, as richer countries tend to spend a higher share of their income on health. becchetti et al. (2015) investigated the impact of health expenditure on health outcomes on a large sample of europeans aged above 50 using individual and regional-level data. the results showed that health expenditure to gdp and health expenditure per capita have a negative and significant impact on changes in the number of chronic diseases. it also showed that health expenditure produces heterogeneous effects on health outcomes, being more relevant for the elders, females, the overweight/obese, the below-median income group and for the less-educated vis-à-vis their complementary samples. after controlling for real per capita income, literacy level, and female participation in the labour market, boachie and ramu (2015) adopted the ols and newey-west estimation techniques and found evidence that the declining or falling infant mortality rate in ghana has been influenced by public health spending among other factors. kulkarni (2016) used the panel data regression with fixed effects model to examine the differences in the health care systems of brazil, india, china, russian federation and south africa, the emerging economies of brics. the results show a positive relation between health outcome and the gdp per capita, adult literacy rate, and out-ofpocket expenditure; environmental pollution has a negative relation with health outcomes; and age dependency ratio and public health expenditure also show a positive elasticity with infant mortality rate. kim and lane (2013) analyzed the relationship between public health expenditure and national health outcomes among developed countries. the findings showed a negative relationship between government health expenditure and infant mortality rate, and a positive relationship between government health expenditure and life expectancy at birth. jaba et al. (2014) analyzed the relationship between the dynamics of the inputs and the outputs of health care systems and found that there is a significant relationship between health expenditures and life expectancy and that country effects are significant and show the existence of important differences among the countries. in their study, deluna and peralta (2014) examined the relationship among public health expenditures, income and health outcomes in the philippines. the results showed that infant mortality rate is inversely related to health expenditure per capita and gdp per capita. in their study on the dynamic analysis of the relationship among health spending, health outcomes and per capita income in canada, day and tousignant (2005) employed the vector autoregression (var) model and the generalized impulse response function estimation technique and found evidence of a weak statistically significant relationship between per capita health spending, health outcomes, and per capita gdp. gani (2009) examined the relationship between per capita public health expenditure and three measures of health outcomes for seven pacific island countries. the result provided strong evidence that per capita health expenditure is an important factor in determining health outcomes. the empirical results also provide strong evidence that per capita incomes and immunization are additional core factors that determine health outcomes. novignon and lawanson (2016) sought to understand the relationship between child health outcomes and health spending while investigating lagged effects. the results show a positive and significant relationship between health expenditure and child health outcomes. public health expenditure was found to be relatively more significant than private expenditure. novignon et al. (2012) employed the fixed and random effects panel data regression model estimation techniques to assess the effect of health care expenditure on population health status and to examine the effect by public and private expenditure sources. the results show that health care expenditure significantly influences health status through improving life expectancy at birth, reducing death and infant mortality rates. both public and private health care spending showed strong positive association with health status asian journal of economics and empirical research, 2019, 6(2): 130-139 134 © 2019 by the authors; licensee asian online journal publishing group even though public health care spending had relatively higher impact. edeme et al. (2017) investigated the effect of public health expenditure on health outcomes in nigeria and found that an increase in public health expenditure improves life expectancy and reduces infant mortality rates. anyanwu and erhijakpor (2007) employed the robust ordinary least squares (rols) model and robust two-stage least squares (r2sls) techniques to provide econometric evidence linking african countries‟ per capita total as well as government health expenditures and per capita income to infant mortality and under-five mortality. health expenditures have a statistically significant effect on infant mortality and under-five mortality. in addition, both infant and under-five mortality are positively and significantly associated with sub-saharan africa while the reverse is true for north africa. piabuo and tieguhong (2017) conducted a comparative analysis on the impact of health expenditure between countries in the cemac sub-region and five other african countries that achieved the abuja declaration. the results showed that health expenditure has a positive and significant effect on economic growth in both samples. in addition, a long-run relationship also exists between health expenditure and economic growth for both groups of countries. matthew et al. (2015) adopted the vector error correction model to examine government spending on health and its effect on health outcomes in nigeria and found that public spending on health has a significant relationship with health outcomes in nigeria and that environmental factors such as carbon dioxide emissions affects individuals‟ health. similarly, nwanosike et al. (2015) employed the ordinary least square estimation technique to investigate the progressive implication of malaria incidence and malaria spending on nigeria health outcomes and found that increase in health expenditure and educational expenditure reduce malaria incidence. yaqub et al. (2012) used the ordinary least squares and the two-stage least squares estimation techniques to investigate how the effectiveness of public health expenditure is affected by governance in nigeria and found that public health expenditure has negative effect on infant mortality and under-5 mortalities when the governance indicators are included. maduka et al. (2006) examined the relationship among government health expenditure, health outcomes and economic growth in nigeria using the using toda and yamamoto causality approach. the results revealed that government health expenditures indirectly influence economic growth through health outcomes such as mortality rate and life expectancy. in their empirical analysis of the relationship existing among life expectancy, public health spending and economic growth in nigeria, ogungbenle et al. (2013) found that there is no bi-directional causality between life expectancy and public health spending in nigeria neither is a bi-directional causality between life expectancy and economic growth in nigeria over the years. however, the study confirmed that there is bi-directional causality between public health spending and economic growth in nigeria. hooda (2014) examined the impact of different decentralized governance measures on infant and child mortality rates of rural india across states and in improving the efficacy of rural health spending. the result showed that states with high fiscal and political decentralisation have more significant impact in reducing the infant mortality compared to states having high fiscal but low political decentralisation, indicating efficacy of fiscal decentralisation increases with political decentralisation. 4. methodology, model specification and empirical analysis 4.1. methodology and model specification this study assesses the relationship among health expenditure, health outcomes and economic growth in nigeria for the period between 1981 and 2016 using the toda-yamamoto causality test. the aim is to examine how health expenditure influences health outcome and economic growth; how health outcomes influence health outcome and economic growth; and how economic growth influences health expenditure and health outcome. whereas government expenditure on health is used as a proxy for health expenditure, real gdp growth is used as proxy for economic growth and the variables of health outcomes for this study include: life expectancy, infant mortality and maternal mortality. data for the period between 1981 and 2017 on infant mortality, life expectancy and maternal mortality are sourced from world development indicators (2018) while data on health expenditure and real gdp are sourced from central bank of nigeria statistical bulletin (2017) following wolde-rufael (2005) and maduka et al. (2016) this study employs the granger non-causality test, a toda–yamamoto procedure that is applicable regardless of whether a series is i(0), i(1), or i(2), non-cointegrated or cointegrated of any order. this implies that it avoids the potential bias associated with unit root and cointegration tests. as pointed out by clarke and mirza (2006) pre-tests for unit root and cointegration might suffer from size distortion, which often implies the use of an inaccurate model for the non-causality test. to obviate some of these problems, the toda-yamamoto test, based on augmented var modeling, introduced a wald test statistic that asymptotically has a chi-square distribution irrespective of the order of integration or cointegration properties of the variables. the toda–yamamoto approach fits a standard vector autoregression and a vector error correction model on levels of the variables (not on their first differences) and therefore makes allowances for the long-run information often ignored in systems that require first differencing and pre-whitening (clarke and mirza, 2006). the approach employs a modified wald test (mwald) for restrictions on the parameters of the var (k), where k is the lag length of the system. the basic idea of the toda-yamamoto approach is to artificially augment the correct order, k, by the maximal order of integration, say dmax. once this is done, a (k + dmax) the order of var is estimated and the coefficients of the last lagged dmax vectors are ignored. based on the foregoing and following the specification of maduka et al. (2016) the relationship between health expenditure, health outcomes and economic growth are represented mathematically as follows: lexp = f (hexp, rgdp) (1) ifm = f (hexp, rgdp) (2) mmt = f (hexp, rgdp) (3) rdgp = f (hexp, lexp, ifm, mmt, ftr) (4) hexp = f (rgdp, lexp, ifm, mmt, ftr) (5) the econometric representations of the above mathematical equations are as follow: lexp = α0 + α1hexp + α2rgdp + 𝜺1 (6) asian journal of economics and empirical research, 2019, 6(2): 130-139 135 © 2019 by the authors; licensee asian online journal publishing group ifm = β0 + β1hexp + β2rgdp + 𝜺2 (7) mmt = δ0 + δ1hexp + δ2rgdp) + 𝜺3 (8) rdgp = ϑ0 + ϑ1hexp + ϑ2lexp + ϑ3ifm + ϑ4mmt + ϑ5ftr + 𝜺5 (9) hexp = σ0 + σ1rgdp + σ2lexp + σ3ifm + σ4mmt + σ5ftr + 𝜺6 (10) the toda and yamamoto (1995) version of the above specified models representing the nexus among health expenditure, health outcomes and economic growth are in the following var system: ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ where: lexp = life expectancy. ifm = infant mortality. mmt = maternal mortality rate. hexp = health expenditure. rgdp = real gross domestic product (proxy for economic growth). α, β, δ, θ, ϑ and σ = coefficients of the independent variables. γit = white noise stochastic error term. 4.2. empirical analysis 4.2.1. preliminary analysis 4.2.1.1. descriptive statistics table 1 presents the descriptive characteristics of the macroeconomic variables used in this study. the average value of health expenditure, infant mortality, life expectancy, maternal mortality rate and real gdp are n58.85 billion, 105.78 per 1000 live births, 47.91 years, 364.95 per 1000 female adults and n32749.95 billion respectively. this suggests that maternal mortality rate is still very high in nigeria and infant mortality is as well relatively high indicating that more women than children die in the course of child birth. this suggests that there is a dire need to upgrade the child delivery facilities in the country to lower the incidence of maternal and infant mortality. the mean values of health expenditure and real gdp also show that the percentage of government expenditure on health is extremely low and this could be the reason for the high maternal and infant mortality rate in nigeria. furthermore, the probability values of the jarque-bera statistic of each variable show that the all the variables are normally distributed given the probability value of the jarque-bera statistic. in addition, for a series to be said to be normally distributed, the value of skewness should be zero or not be statistically different from zero. accordingly, all the variables except health expenditure meet this condition thus giving further credence to the assertion of normal distribution. further, all the variables employed in this study are platykurtic except health expenditure which is leptokurtic given its kurtosis value. the result also shows that all the variables have a very high standard deviation signifying a high deviation from their respective mean values. table-1. descriptive statistics. statistics hexp ifm lexp mmt rgdp mean 58.85 105.78 47.91 364.95 32749.95 median 15.22 115.20 46.13 360.32 22449.41 maximum 257.72 126.20 53.72 393.74 69023.93 minimum 0.04 65.50 45.64 331.45 13779.26 std. dev. 82.51 21.58 2.67 15.54 18889.20 skewness 1.26 0.61 0.97 0.14 0.80 kurtosis 3.10 1.81 2.40 2.68 2.14 jarque-bera 9.79 4.46 6.37 0.27 5.10 probability 0.1075 0.1074 0.1414 0.8749 0.1781 sum 2177.54 3913.70 1772.74 13502.97 1211748.00 observations 37 37 37 37 37 where hexp = health expenditure; ifm = infant mortality; lexp = life expectancy; mmt = maternal mortality rate; and rgdp = real gross domestic product. (11) (12) (13) (14) (15) asian journal of economics and empirical research, 2019, 6(2): 130-139 136 © 2019 by the authors; licensee asian online journal publishing group 4.2.1.2. unit root test routinely, the time-series properties of macroeconomic variables need to be ascertained when carrying out time-series analysis so as to guard against obtaining spurious results. the appropriate test for checking these timeseries properties is unit root test. it tests the null hypothesis of the presence of unit root as against the alternative hypothesis of the absence of unit root. the decision rule is that the null hypothesis will be rejected and be alternative hypothesis accepted should the computed t-statistic be greater than the test critical values in absolute terms or the probability value be less than 0.1; it will be accepted and be alternative hypothesis rejected should the computed t-statistic be less than the test critical values in absolute terms or its probability value be greater than 0.1 or 10 per cent significance level. this study employs the augmented dickey-fuller (adf) unit root test method to check the order of integration of the macroeconomic variables of this study and the results are presented in table 2. the results show that infant mortality and life expectancy are stationary at level [i(0)] while health expenditure, maternal mortality rate and real gdp are stationary at first difference [i(1)]. this result shows that the macroeconomic variables employed in this study are a combination of i(0) and i(1) series or are integrated of different orders. this condition makes the ardl bounds test approach to cointegration appropriate for investigating the long-run relationship among these variable. table-2. unit root test results. augmented dickey fuller (adf) variables level first difference i(d) hexp -1.27c -2.94a** i(1) ifm -4.58*b i(0) lexp -3.67*b i(0) mmt -0.96a -3.78b* i(1) rgdp -1.86b -5.45b* i(1) note: *, ** and *** represent statistical significance at 1%, 5% and 10% level respectively; „a‟ denotes model with constant and „b‟ is for model with trend and constant and trend. i(0) and i(1) indicate stationarity at level and first difference respectively. 4.2.1.3. ardl bounds test approach to cointegration in line with the result of the unit root test, cointegration test will be carried out using ardl bounds test approach to cointegration. the choice of this approach is premised on the fact that our variables are integrated of different orders [(i(0) and i(1)], thus negating the use of engle-granger and johansen cointegration test approach. pesaran and shin (1999) and pesaran et al. (2001) developed the ardl cointegration approach which has three major advantages over other traditional cointegration approaches. firstly, the ardl framework does not require that all the variables under study be of the same order of integration; it accommodates series which are i(0) or i(1) or both. secondly, it is relatively more efficient using small sample sizes. thirdly, the ardl framework obtains unbiased estimates of the long-run model. the rule of ardl bounds test of cointegration states that the null hypothesis should be rejected if the value of the computed f-statistic is greater than the upper bounds value and accepted if the f-statistic is less than the lower bounds value. the ardl cointegration test will be said to be inconclusive should the computed f-statistic fall within the lower and upper bound. accordingly, table 3 shows that the computed f-statistic (4.54) falls above the upper bound critical value at 5 and 10 percent level of significance. this implies that there is a long-run relationship among health expenditure, infant mortality, life expectancy, maternal mortality rate and real gdp. table-3. ardl bounds test result. significance level critical value computed f-statistics lower (i0) bound upper (i0) bound 1% 3.74 5.06 5% 2.86 4.01 4.54 10% 2.45 3.52 the bounds critical values for k=5are obtained from narayan (2005) case iii for 40 observations. 4.2.2. result of toda-yamamoto granger causality test this study employs the toda-yamamoto granger causality approach examine the direction of causal relationship among health expenditure, health outcomes and economic growth in nigeria. before carrying out the toda-yamamoto granger causality test, it is needful to estimate the highest order of integration (dmax) in the system which is derived from the result of the unit root test. a cursory look at the unit root test result in table 2 reveals that the maximum order of integration is one which implies that there will be an additional one lag to the var models. the next step after ascertaining the maximum order of integration is to determine the optimal lag length of the var model which is determined using the following criterions: sequential modified lr test statistic (lr), final prediction error (fpe), akaike information criterion (aic), schwarz information criterion (sc) as well as the hannan quinn (hq) information criterion. accordingly, the result of the var optimal lag length selection criteria is presented in table 4. it is obvious that the various information criteria unanimously suggested the selection of a maximum lag length of 3 for each variable thus, the var model with lag length 3 will be estimated. asian journal of economics and empirical research, 2019, 6(2): 130-139 137 © 2019 by the authors; licensee asian online journal publishing group table-4. var lag length selection criteria. endogenous variables: hexp ifm lexp mmt rdgp lag logl lr fpe aic sc hq 0 106.1440 na 1.01e-09 -6.525417 -6.294128 -6.450023 1 389.6865 457.3267 5.89e-17 -23.20558 -21.81785 -22.75322 2 451.8915 80.26451 6.13e-18 -25.60590 -23.06173 -24.77657 3 504.8231 51.22415* 1.49e-18* -27.40794* -23.70733* -26.20164* 4 585.4645 52.02672 1.03e-19 -30.99771 -26.14066 -29.41443 where * indicates lag order selected by the criterion, lr = sequential modified lr test statistic (each test at 5% level), fpe = final prediction error, aic = akaike information criterion, sc = schwarz information criterion and hq = hannan-quinn information criterion. the results of toda-yamamoto causality estimated by the modified wald test are presented in table 5. the results show that the test follows the chi-square distribution with 3 degrees of freedom which is in accordance with optimal lag length. the results of the toda-yamamoto causality test reveal that the null hypothesis that health expenditure does not granger causes infant mortality is rejected thus, health expenditure granger causes infant mortality in nigeria while infant mortality does not granger cause health expenditure suggesting that there is a unidirectional causal relationship running from health expenditure to infant mortality. this result is plausible and in line with a priori expectation. it suggests that the health expenditure in nigeria has been able to achieve a desired result (reduction in infant mortality) and that the effort of government and other stakeholder in the heath sector have not been in vain. this result is also consistent with findings by novignon et al. (2012); kulkarni (2016); edeme et al. (2017). also, real gdp does not granger cause infant mortality neither does infant mortality granger cause real gdp indicating that there is no causality between real gdp and infant mortality in nigeria. moreover, the result shows that health expenditure granger causes life expectancy while life expectancy does not granger cause health expenditure indicating that there is a unidirectional causality running from health expenditure to life expectancy. this suggests that health expenditure by the government has been able to improve the life expectancy at birth in nigeria and that government‟s effort at improving the health sector of the nigerian economy is yielding the desired result. this result in line with a priori expectation and parallels the findings of maduka et al. (2006); kim and lane (2013); jaba et al. (2014) but negates the findings of ogungbenle et al. (2013). similarly, real gdp granger causes life expectancy while life expectancy does not granger cause real gdp thus, indicating that there is a unidirectional causal relationship running from real gdp to life expectancy. this result is against the findings of ogungbenle et al. (2013) who found a bidirectional causality running from real gdp to life expectancy and vice versa. besides, there is a unidirectional causal relationship between health expenditure and maternal mortality rate in nigeria as causality runs from health expenditure to maternal mortality rate but not the other way round. this result implies that health expenditure in nigeria has been able to weakly combat maternal mortality given the probability value that is very close to 10 percent. similarly, whereas real gdp granger causes maternal mortality, maternal mortality does not granger cause real gdp in nigeria thus, suggesting a unidirectional causality running from real gdp to maternal mortality. this result is plausible and in line with a priori expectations as it implies that as the economy grows, maternal mortality rate reduces. this is the case in most developed economies and it can be attributed to the improvement in technology that has led to the invention of modern machines with which to preserve lives. more so, health expenditure does not granger cause real gdp but real gdp granger causes health expenditure in nigeria suggesting that a there is a unidirectional causality running from real gdp to health expenditure in nigeria. this suggests that economic growth is capable of increasing health expenditure or economic growth is capable of influencing the amount the government will spend on the health sector in nigeria. this result is plausible and is in line with theoretical expectation. summarily, health expenditure has a significant causal relationship with infant mortality, maternal mortality and life expectancy in nigeria. in the same vein, real gdp has a significant causal relationship with maternal mortality and life expectancy in nigeria. these results indicate that health expenditure has a significant causal relationship with health outcomes in nigeria and the direction of relationship is unidirectional such that causality runs from health expenditure and health outcomes. this implies that the little efforts of the government in funding the health sector of the nigerian economy are gradually yielding the desired fruit. on the other hand, real gdp causes/influences health outcomes in nigeria and not the other way round. a unidirectional causality runs from real gdp to health outcomes in nigeria. finally, the result shows that it is real gdp that granger causes health expenditure and not the other way round. table-5. toda-yamamoto causality (modified wald) test results. null hypotheses chi-sq df prob. direction of causality hexp does not granger cause ifm 1.59 3 0.0136 unidirectional hexp  ifm ifm does not granger cause hexp 0.81 3 0.8145 rgdp does not granger cause ifm 1.27 3 0.7358 no causality ifm does not granger cause rgdp 2.29 3 0.5147 hexp does not granger cause lexp 7.53 3 0.0568 unidirectional hexp  lexp lexp does not granger cause hexp 3.39 3 0.3353 rgdp does not granger cause lexp 20.16 3 0.0002 unidirectional rgdp  lexp lexp does not granger cause rgdp 1.06 3 0.7860 hexp does not granger cause mmt 13.62 3 0.0035 unidirectional hexp  mmt mmt does not granger cause hexp 0.67 3 0.8797 rgdp does not granger cause mmt 5.03 3 0.0142 unidirectional rdgp  mmt mmt does not granger cause rgdp 0.10 3 0.9918 hexp does not granger cause rgdp 2.40 3 0.4944 unidirectional rdgp  hexp rgdp does not granger cause hexp 11.49 3 0.0093 asian journal of economics and empirical research, 2019, 6(2): 130-139 138 © 2019 by the authors; licensee asian online journal publishing group 4.2.3. diagnostic / post-estimation test before this result can be appropriate for policy formulation and/or prescription, it is needful to verify that the estimates of the chosen multivariate model are reliable. this will require diagnostic checks / post-estimation tests. the most relevant post-estimation test for multivariate models is the serial correlation test (using the lm test). it is carried out to test the presence of serial correlation in the estimated model thus, the null hypothesis of the serial correlation test is: “no serial correlation at lag order h.” the null hypothesis will be accepted if the probability value is greater than 10 percent and rejected of the probability value is less than 10 percent. accordingly, table 6 presents the result of the serial correlation lm test and it shows that the probability values of the lm-stat for each lag is greater than 10 percent thus, the null hypothesis of no serial correlation will be accepted indicating that the estimates of the model and its results are reliable for policy prescription. table-6. diagnostic test. var residual serial correlation lm tests null hypothesis: no serial correlation at lag order h lags lm-stat prob. 1 30.88705 0.2236 2 25.91344 0.4122 3 32.48781 0.1444 4 19.47508 0.7738 5 15.79846 0.8241 5. conclusion and policy implications the relationship between health expenditure, health outcomes and economic growth remains inconclusive in the extant literature hence, it is needful to ascertain these relationships so as to make evidence-based decision that would ameliorate the situation of the health sector of nigeria. given the high rate of infant and maternal mortality, the low life expectancy in nigeria as well as the meagre budgetary allocation to the health sector of the nigerian economy, it became imperative to examine the link between health expenditure, health outcomes and economic growth to actually see there is a causal relationship among these key macroeconomic variables in nigeria. hence, this study was carried out to examine the causal relationship as well as the direction of causality among health expenditure, health outcomes (infant mortality, life expectancy and maternal mortality) and economic growth in nigeria using the ardl bounds test approach to cointegration and the toda and yamamoto (1995) causality test. sequel to the empirical findings of this study, this study concludes that health expenditure and economic growth play key roles in determining the health outcomes in nigeria. specifically, causality runs from health expenditure to infant mortality, maternal mortality and life expectancy while causality runs from economic growth to life expectancy and maternal mortality. on the other hand, this study concludes that a unidirectional causal relationship exists between economic growth and health outcomes in nigeria indicating that causality runs from economic growth to health expenditure. the implications of these findings for the nigerian economy are hereby discussed. first, the non-causality between economic growth and infant mortality suggests that economic growth and infant mortality does not cause nor affect each other thus, that the government and the stakeholders in the health sector should endeavour to adopt technologies that would lower the incidence of infant mortality in nigeria. lastly, the unidirectional causality between health expenditure and economic growth as against the bidirectional causality found by ogungbenle et al. (2013) suggests that the government need to formulate and implement policies that will stimulate economic growth which will in turn influence health expenditure, thereby instigating the desired health outcomes. second, the unidirectional causality running from economic growth to health expenditure suggests that health expenditure does not cause economic growth thus, downplaying the contribution of the health sector of the nigerian economy to aggregate output. this implies that while government spends on health sector, it should focus on the impact of health expenditure on health outcomes rather than economic growth. it also suggests that health expenditure does not have a direct but indirect effect on economic growth as it goes through health outcomes to influence economic growth. references anyanwu, j.c. and a.e.o. erhijakpor, 2007. health expenditures and health outcomes in africa. african development bank, economic research working paper series. no. 91. becchetti, l., p. conzo and 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891903.available at: https://doi.org/10.1016/j.jpolmod.2005.06.003. world bank, 1998. world development report 1998, washington, dc. world development indicators, 2018. world bank, washington, d.c. available from: https://data.worldbank.org/country/nigeria. yaqub, j.o., t.v. ojapinwa and r.o. yussuff, 2012. public health expenditure and health outcome in nigeria: the impact of governance. european scientific journal, 8(13): 181-201. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 29 asian journal of economics and empirical research vol. 5, no. 1, 29-35, 2018 issn(e) 2409-2622 / issn(p)2518-010x doi: 10.20448/journal.501.2018.51.29.35 export and economic growth in saudi arabia: the granger causality test saif sallam alhakimi1 1associate professor of international economics, university of bisha, saudi arabia, and university of hodeida, yemen abstract an export-led growth strategy aims to encourage producers to export their goods through various economic and governmental policies. this study was carried out with the primary objective of investigating the relationship between exports and economic growth in the kingdom of saudi arabia (hereafter referred to as the ksa), specifically by examining the causality between exports and ksa’s economic growth. there are four main propositions for the relationship between exports and economic growth: export-led growth (elg), growth-driven exports (gde), and feedback relationships between exports and economic growth. to complete this study, samples were used based on 37 years of annual data. the study also employed a unit root test, a co-integration test, and the granger causality test to observe the causal relationship between exports and economic growth. data were collected for exports, which were expressed according to export growth. economic growth, meanwhile, was measured according to gross domestic product (gdp) per capita and expressed in terms of us dollars. the result of this study found that gdp per capita significantly influenced exports, while exports did not affect gdp. keywords: growth, export, co-integration, error-correction, causality. jel classification: 04. citation | saifsallam alhakimi (2018). export and economic growth in saudi arabia: the granger causality test. asian journal of economics and empirical research, 5(1): 29-35. history: received: 5 march 2018 revised: 27 march 2018 accepted: 2 april 2018 published: 4 april 2018 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 30 2. literature review ............................................................................................................................................................................ 31 4. results ................................................................................................................................................................................................ 32 5. conclusion and remarks ................................................................................................................................................................ 33 references .............................................................................................................................................................................................. 34 appendices ............................................................................................................................................................................................. 34 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2018.51.29.35&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://orcid.org/0000-0002-2905-7145 https://orcid.org/0000-0002-2905-7145 asian journal of economics and empirical research, 2018, 5(1): 29-35 30 1. introduction export is a function of international trade where goods produced in one country are shipped to another country for sale or trade. sales from exports contribute to a nation’s gross domestic product and play an important role in a developed economy. a popular debate among economists has focused on the relationship between export growth and economic growth, because a successful macro-economic strategy leads to a better quality of life for people. as a consequence, rapid gpd growth has become an important objective for many countries, including the ksa. an important question immediately confuses this objective, however: does the promotion of exports lead to greater economic growth or vice versa? the export of goods and services is an important source of foreign income, and this can relieve the pressure on budgetary expenses and create new employment opportunities. an export-led growth strategy therefore aims to encourage producers to find export markets for their goods through various economic and governmental policies. this study addresses the above question by examining the causality between exports and the ksa’s economic growth. the reminder of this paper proceeds as follows: section 2 covers the literature review. section 3 introduces an experimental study. section 4 reports the empirical results. section 5 conclusion and remarks. 1.1. overview of exports in the ksa based on the un cometrade database (2016) the ksa’s main exports are mineral fuels, oils, and distillation products (76% of total exports); plastics and articles derived thereof (7.5%); organic chemicals (5.1%); ships, boats, and other floating structures (1.2%); aluminum and articles derived thereof (1%); and machinery, nuclear reactors, and boilers (0.85%). the ksa also exports oil, inorganic chemicals, precious metals, isotopes, non-railway vehicles, and other products. its main export markets are the united arab emirates (14% of total exports), china (12%), india (6.3%), singapore (4.9 %), egypt (4.1%), turkey (3.6%), qatar (3.3%), kuwait (3.3%), belgium (3.2%), bahrain (3.1%), the united states (3.1%), jordan (3.1%), and malaysia (2.8%). other exports include south korea, pakistan, oman, italy, vietnam, japan, spain, thailand, algeria, the united kingdom, and yemen. 1.2. the trend for the ksa’s export flows figure-1. export flows for the ksa (2008-2 016) source: uncd (2016) figure 1 shows the export levels of the ksa between 2008 and 2016. in 2008, annual exports started to decrease until 2009, when they started slowly increasing again. in 2010, export growth accelerated until the end of q1 2012, when exports broadly plateaued. by the end of q2 2014, exports declined rapidly until the beginning of 2016, when a moderate recovery began. 1.3. overview of the ksa’s gross domestic product (gdp) figure-2. annual gdp growth for the (2008-2016) source: uncd (2016) figure 2 shows how the ksa’s gdp growth has experienced a downward trend since 2010, with there being some fluctuations between 2102 and 2016. this is essentially due to two factors: a sharp fall in the price of oil and fluctuations in oil exports. this reflects the narrow dependence of the ksa’s economy on oil production and the absence of a diversified economy. asian journal of economics and empirical research, 2018, 5(1): 29-35 31 annual data for the exchange rate, gross domestic product, and exports were collected from the world bank’s database for the 1980–2016 period. 2. literature review this study was conducted with the main objective of investigating the relationship between exports and economic growth in ksa. more specifically, it aims to:  determine the long-term relationship between exports and economic growth in the ksa;  examine the short-term relationship between exports and economic growth in the ksa; and  test the causality patterns between exports and economic growth in the ksa. the relationship between exports and economic growth in the ksa is still fraught with controversy and divergent views. this research seeks to address this issue by verifying the causal link between these two factors. classical economic theory emphasizes the issue of comparative advantage and its relevance as a basis for international trade, such as when one country specializes in the production of certain goods where it has a comparative advantage over other countries. in addition, classical trade theory emphasizes transportation as a tool to facilitate commodity movements and develop exports among nations. this has led to improved productivity and greater economic gains thanks to economies of scale (doraisami, 1996; deme, 2002; mahadevan, 2009; ozturk and acaravci, 2010). furthermore, trade exchange contributes to the transfer of knowledge, skills, and the localization of technology, which in turn leads to a) product development and enhanced competitiveness, b) more foreign exchange to purchase imports and buy equipment for local production. it should be noted that these benefits cannot be achieved without an economic and political environment that supports economic growth that balances exports and imports with high productivity and advanced competitiveness in the global market. a study by mehrara and firouzjaee (2011) suggests that export growth will boost gdp through the improvement of human capital, workforce skills, and technology. according to this study, estimating the export demand equations helps in obtaining the relative price and income elasticity, which has important implications for export-led growth policies. therefore, the greater the income elasticity of the export demand, the more that exports will generate growth (bahmani-oskoee et al., 1991). this will also increase the price elasticity and make exports more competitive in the international market (kumar and pacheco, 2012). furthermore, khan et al. (2012) examine the long-run correlation among the economic growth, exports, and imports of pakistan using time series data for the 1972–2009 period. they apply the engle and granger (1987) causality test and co-integration via a vecm method in their study. the results show the existence of a long-term correlation between exports, imports, and economic growth in pakistan. in conclusion, most previous studies apply co-integration and granger causality methods in order to examine the influence of exports on economic growth in developed and developing countries. only a few studies have used alternative models such as the toda-yamamoto granger, ardl, and sims causality approaches. all empirical studies use a unit root test to find the stationarity of the time series data in level and first difference. in addition, the augmented dickey-fuller test is another well-known approached applied in past studies. this research will help identify factors that influence economic growth, namely the effect of export growth. as a consequence, this study may aid the ksa’s government by shedding some light on the effect of export growth changes in the ksa. the result of this study will establish whether changes in exports have significant consequences for the economic growth of the country. this will contribute to the body of knowledge and help policy formulation. in addition, the study will show the relationship between exports and economic growth. ultimately, we will be able to estimate whether export growth is appropriate for boosting the economic growth of a developed or developing country. the research will also act as a reference and guideline for future research. this study is concerned with the relationship between exports and economic growth, so 37 years of economic data for the 1980–2016 period was studied. it aims to establish whether exports have an effect on economic growth or whether economic growth drives export growth. 3. experimental study in completing this study, samples were used based on 37 years of annual data. data were collected for exports and expressed as a measure of export growth, while economic growth was measured by the gross domestic product (gdp) per capita. all variables are expressed in terms of usd (us dollars). this data were obtained from world bank and imf sources. the methods applied to analyze the datawere a unit root test, johansen co-integration, and the granger causality test. johansen co-integration was used to discover the relationship between exports and economic growth over the long term, while the granger causality test was used to observe the causality relationship between exports and economic growth. first, however, the unit root test was applied to determine the stationarity of the series at level and first difference by using the augmented dickey-fuller test (adf). finally, the eviews econometric software was used to analyze all data and interpret the findings. the collected raw data had to be transformed into information that could help answer the research question and identify the relationship between exports and economic growth. 3.1. statistical method of analysis many economic variables are non-stationary, so a unit root test, namely the augmented dickey-fuller test, was used to analyze the data and ensure stationarity. following this, the johansen and juselius (1988) was used to determine the long-term relationship among the variables. finally, the famous granger causality test was applied to examine the causality relationship between exports and economic growth, specifically to identify whether exports affect economic growth or if economic growth drives the demand for more exports in the economy. this study employed empirical analysis to examine the effects of exports on economic growth. annual data for the 1980–2016 period were used for all variables in the ksa. the estimating equation for this study was: asian journal of economics and empirical research, 2018, 5(1): 29-35 32 gdpt= β0 + β1expt +εt where gdpt is the gross domestic product for period t, and expt is the total exports for period t. in order to avoid autocorrelation, the equation must use the log for all variables. this was so the percentage of change for independent variables could be seen when the independent variables changed by around 1%. in addition, εtis the error term. lngdpt= β0 + β1lnexpt +εt 3.1.1. unit root test in econometrics, many variables are non-stationary, so to ensure that the data were stationary, a unit root test was performed before the co-integration test. this test was also applied to avoid any spurious regression. for this study, the augmented dickey-fuller (adf) test was used. both tests were used to check the robustness of the results. the adf test was based on the following regression model, which comprises running a regression of the first in the series against the series lagged once, the sum of lagged difference term, a constant, and a time trend. ∑ (1) where, }, ∆ is the differencing operator, t is the time trend, p is the number of lagged terms, and is the error term as white noise. { }is the set of parameters to be estimated. the hypotheses for the adf unit root test were: : δ = 0 (unit root/ non stationary) (2) : δ≠ 0 (no unit root/ stationary) (3) the unit hypothesis of the adf can be rejected if it is found to be negative and significantly different from zero. on the other hand, if we fail to reject , the variable is non-stationary and also has a unit root in the variable. 3.1.2. co-integration test a co-integration test was used in this study to examine the long-term relationship between the variables. consider the following levels of var, with xt defined as the log of exports. ∑ (4) if the variables in xt are i (1), the var in equation (4) is non-stationary. if no co-integration exists, statistical inference is not possible with the usual tests. given this condition, the difference of the series should be determined, and a first difference var of the form should be estimated. ∑ (5) integration vectors give rise to the stationary variables. if this is the case, the var in eq. (5) can be written as: ∑ (6) in eq. (6), π is a rank r matrix that can be divided into (7) where α is a 3 × r loading matrix and β is a 3× r matrix of co-integrating vectors, with r being the number of co-integration vectors. following the johansen procedure (ighodaro, 2010) the number of co-integration vectors was tested by using the co-integrated var shown in eq. (6). 3.1.3. granger causality test the granger causality test was employed to examine the causal relationship between the two variables. if the p values of the variable y significantly contribute to forecasting the value of another variable x, then y has a granger causal relationship with x and vice versa. the test was based on the equation below. ∑ ∑ (8) ∑ ∑ (9) where ytand xt are the tested variables, µt and ɛtare the error terms, and t representsthe time period, and z and i are the number of lags. the null hypothesis is that = i = 0 for all i, while the alternative hypothesis is that ≠ 0 and i ≠ 0 for at the least some i. if the is significant, but iis not significant, then x is granger causal to y. if both coefficients are significant, however, the causality runs both ways. 4. results 4.1. unit root test results in order to examine the stationary properties of the export and gdp variables, the augmented dickey-fuller test produced the results shown in table 4.1. these results are separated into the level and first difference under constant and constant with trend. table-4. unit root test results intercept intercept + trend level first difference level first difference export -1.947212 (0.3079 ) -4.526633 (0.0009) -2.190321 (0.4804 ) -4.460786 (0.0058) gross domestic product (gdp) 0.521838 (0.9852) -4.050588 (0.0034) -4.441637 (0.0061 ) -4.441637 (0.0061) note: ***, ** and * indicates the rejection of the null hypothesis of non-stationary at 1%, 5%, and 10% significance level, respectively. for the export variable, the results revealed that under the intercept, it is non-stationary at level and stationary at the first difference. for level, the probability is 0.6256 and the t-statistic is -1.2788, which is not significant. meanwhile, for the first difference, the probability is 0.0010 and the t-statistic is -4.6372, which is a asian journal of economics and empirical research, 2018, 5(1): 29-35 33 significance level of 1%. under the intercept and trend, it is also clear that level is not significant with a probability of 0.9688 and a t-statistic of -0.6347. meanwhile, exports at the first difference is stationary with a significance level of 10% (p-value= 0.0804, t-statistic = -3.3510). as for the gdp variable, this is also non-stationary at level with a probability of 0.7600 and a t-statistic of 0.9416. in contrast, for the first difference under intercept, it is stationary at a significance level of 1% with a probability of 0.0024 and a t-statistic of -4.2784. under the intercept and trend, meanwhile, the results show it is nonstationary at level with a probability of 0.9093 and a t-statistic of -1.1134. at the first difference it is stationary, however, with a probability of 0.0110 and a t-statistic of -4.2826, showing a significance level of 5%. 4.2. co-integration test results the main focus of this study was to assess how exports and gdp relate to each other in the long term, if such a relationship exists. the unit root test revealed that both variables are non-stationary at level under intercept and intercept with trend, as well as that both are stationary at first difference under both intercept and intercept with trend. therefore, in order to identify the relationship between exports and gdp, a co-integration test was performed. table-4.1.results of the co-integration test rank max-eigen statistic critical value (eigen) at 5% trace statistic critical value (trace) at 5% r = 0 14.90479 14.26460 18.06819 15.49471 r ≤ 1 3.163398 3.841466 3.163398 3.841466 note: ***, ** and * donate significance at the 1%, 5% and 10% level, respectively. the results of the co-integration test are given in table 4.2. these show that both the maximum eigen statistic and the trace statistic are present in the ksa’s economy at the 5% level for both two variables. this means that a long-term equilibrium relationship does exist between exports and gdp. for the null hypothesis, the trace statistic is 60.5226, which is higher than the critical value (trace) of 15.4947 at a significance level of 5%. this clarifies that this equation has a long-term relationship between variables at a significance level of 5%. on the other hand, for the trace statistic based on rank r ≤ 1, the values are lower than the critical value (trace), which exceeds the significance level. at rank r ≤ 1, the trace statistic value is 3.4310, which is lower than the critical value (trace) of 3.8415 at a significance level of 5%. however, for the max-eigen statistic, the value at rank r = 0 is 57.0916, which is higher than the critical value (eigen) of 14.2646, showing a long-term relationship between variables at a 5% significance level. in addition, at rank r ≤ 1, the values are lower than the critical value (eigen), so much like for the trace statistic, this has also exceeded the significance level. at rank r ≤ 1, the max-eigen statistic value is 3.4310, which is lower than the critical value (eigen) of 3.8415 at a significance level of 5%. 4.3. pairwise granger causality test results since the co-integration test cannot be used to determine the direction of any relationship between the variables, a pairwise granger causality test was applied to determine whether the paired time series data has a correlation or not (i.e., whether there is a causal relationship between two variables). the correlation for the granger causality test was applied for all variables. when the f-statistic is lower than the f-critical, it means that there is no granger causality among the variables. the time series data were checked before running the causality test by applying the unit root and co-integration tests. table-4.2. results of the pairwise granger causality test null hypothesis obs. f-statistic prob. export does not granger cause gdp gdp does not granger cause export 36 0.09843 0.01713 0.7557 0.8967 note: ***, ** and * denote statistical significance at the 1%, 5% and 10% level, respectively the granger causality test results are shown in table 4.2, representing the pairwise granger causality among export and gdp. for the relationship between export and gdp, the results show that the export does not granger cause gdp, because the significance level is exceeded (p-value = 0.6630, fstatistic = 0.1944). in contrast, the results also show that gdp does granger cause export at a significance level of 5% (p-value = 0.0185, f-statistic = 6.3116). in summary, for the correlation between exports and real gdp, exports do not granger cause gdp but gdp does granger cause exports. 5. conclusion and remarks table-5. results of the hypothesis testing hypothesis statement of hypothesis results h1 exports influence gdp rejected h2 gdp influences exports accepted source: eviews 9 in conclusion, the hypotheses were accepted or rejected as described in table 5. the results revealed that gdp significantly influenced exports, so hypothesis h2 is accepted. however, exports do not have a significant effect on gdp, so hypothesis h1 is 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-2.612874 *mackinnon (1996) one-sided p-values. null hypothesis: ly has a unit root exogenous: constant lag length: 0 (automatic based on sic, maxlag=9) t-statistic prob.* augmented dickey-fuller test statistic 0.521838 0.9852 test critical values: 1% level -3.626784 5% level -2.945842 10% level -2.611531 *mackinnon (1996) one-sided p-values. null hypothesis: d(ly) has a unit root exogenous: constant lag length: 0 (automatic based on sic, maxlag=9) t-statistic prob.* augmented dickey-fuller test statistic -4.050588 0.0034 test critical values: 1% level -3.632900 5% level -2.948404 10% level -2.612874 *mackinnon (1996) one-sided p-values. https://scholar.google.com/scholar?hl=en&q=exports,%20growth%20and%20causality%20in%20ldcs:%20a%20re-examination http://dx.doi.org/10.1016/0304-3878(91)90044-v https://scholar.google.com/scholar?hl=en&q=an%20examination%20of%20the%20trade-led%20growth%20hypothesis%20in%20nigeria:%20a%20co-integration,%20causality,%20and%20impulse%20response%20analysis 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https://scholar.google.com/scholar?hl=en&q=numerical%20distribution%20functions%20of%20likelihood%20ratio%20tests%20for%20cointegration http://dx.doi.org/10.1002/(sici)1099-1255(199909/10)14:5%3c563::aid-jae530%3e3.3.co;2-i https://scholar.google.com/scholar?hl=en&q=numerical%20distribution%20functions%20for%20unit%20root%20and%20cointegration%20tests http://dx.doi.org/10.1002/(sici)1099-1255(199611)11:6%3c601::aid-jae417%3e3.0.co;2-t https://scholar.google.com/scholar?hl=en&q=the%20sustainability%20of%20export-led%20growth:%20the%20singaporean%20experience http://dx.doi.org/10.1353/jda.0.0034 https://scholar.google.com/scholar?hl=en&q=granger%20causality%20relationship%20between%20export%20growth%20and%20gdp%20growth%20in%20developing%20countries:%20panel%20cointegration%20approach https://scholar.google.com/scholar?hl=en&q=testing%20the%20export-led%20growth%20hypothesis:%20empirical%20evidence%20from%20turkey http://dx.doi.org/10.1353/jda.0.0079 asian journal of economics and empirical research, 2018, 5(1): 29-35 35 appendix b: johansen co-integration test results date: 10/08/17 time: 12:47 sample (adjusted): 1989 2016 included observations: 28 after adjustments trend assumption: linear deterministic trend series: dlex dly lags interval (in first differences): 1 to 7 unrestricted cointegration rank test (trace) hypothesized trace 0.05 no. of ce(s) eigenvalue statistic critical value prob.** none * 0.412756 18.06819 15.49471 0.0200 at most 1 0.106830 3.163398 3.841466 0.0753 trace test indicates 1 cointegratingeqn(s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level **mackinnon et al. (1999) p-values unrestricted cointegration rank test (maximum eigenvalue) hypothesized max-eigen 0.05 no. of ce(s) eigenvalue statistic critical value prob.** none * 0.412756 14.90479 14.26460 0.0396 at most 1 0.106830 3.163398 3.841466 0.0753 max-eigenvalue test indicates 1 cointegratingeqn(s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level **mackinnon et al. (1999) p-values unrestricted cointegrating coefficients (normalized by b'*s11*b=i): dlex dly -15.14379 0.170214 15.92390 -8.804196 unrestricted adjustment coefficients (alpha): d(dlex) -0.028861 -0.020891 d(dly) -0.046087 -0.010213 1 cointegrating equation(s): log likelihood 89.00399 normalized cointegrating coefficients (standard error in parentheses) dlex dly 1.000000 -0.011240 (0.13515) adjustment coefficients (standard error in parentheses) d(dlex) 0.437072 (0.31738) d(dly) 0.697930 (0.27643) appendix c: granger causality test results pairwise granger causality tests date: 10/08/17 time: 12:45 sample: 1980 2016 lags: 1 null hypothesis: obs f-statistic prob. ly does not granger cause lex 36 0.09843 0.7557 lex does not granger cause ly 0.01713 0.8967 asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 46 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 1, 46-63, 2020 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2020.71.46.63 © 2020 by the authors; licensee asian online journal publishing group causes of current account fluctuations in west african monetary union amadou woury diallo phd student in economics, university of dakar, senegal. abstract this study analyzes the sources of current account fluctuations in the west african monetary union (waemu) economies over the period from 1980 to 2017. it is part of the inter-temporal approach which considers that the dynamics of the current account of a country is influenced by global shocks and transient or permanent domestic shocks. thus, we developed a three-variable structural autoregressive vector model. this is the international real interest rate that represents the aggregate shock, the ratio of current account to gross domestic product which is the proxy for transient domestic shocks, and the ratio of net output to gross domestic product to measure impact of permanent shocks to the current account. from the theoretical model, structural shocks are identified by applying the long-term restrictions imposed by the inter-temporal approach in the analysis of current account dynamics. the study leads to three major results: 1) current account fluctuations within waemu are explained by transient domestic shocks, 2) net product fluctuations are due to permanent domestic shocks, 3) global or exogenous shocks have a modest contribution to current account fluctuations, but their effects on net income are still significant, especially in the long run. keywords: current account, inter-temporal approach, svar, global shocks, transient shocks, permanent shocks, waemu. jel classification: f32; f41. citation | amadou woury diallo (2020). causes of current account fluctuations in west african monetary union. asian journal of economics and empirical research, 7(1): 46-63. history: received: 25 november 2019 revised: 8 january 2020 accepted: 12 february 2020 published: 24 march 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 47 2. literature review ............................................................................................................................................................................ 48 3. stylized facts .................................................................................................................................................................................... 49 4. methodology ..................................................................................................................................................................................... 50 5. results and interpretation of results .......................................................................................................................................... 51 6. conclusion ......................................................................................................................................................................................... 55 references .............................................................................................................................................................................................. 56 appendix ................................................................................................................................................................................................ 56 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.71.46.63&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1431 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1431 asian journal of economics and empirical research, 2020, 7(1): 46-63 47 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to existing literature by analyzing the sources of current account fluctuations in the west african monetary union (waemu) economies over the period from 1980 to 2017. 1. introduction after its creation in the early 1960s, the west african monetary union (wamu) benefited from a favorable international environment, particularly with high commodity prices, the basis of its economies exports. thus, the zone has recorded good macroeconomic performance with significant economic growth and controlled inflation. these good macroeconomic performances will lead to the implementation of proactive economic policies to substitute for imports by the states at the industrial level during the decade 1970-1980. which industrial policies have been financed by external indebtedness (nubukpo, 2013). but in the early 1980s, the waemu economies will have to deal with exogenous shocks, such as falling commodity prices. thus, difficulties have emerged in terms of public finances with unsustainable debt and budget and current account deficits. these deficits were particularly marked during the 1970-1980 decade, mainly because of the fall in commodity prices on the world market (plane, 1988). since then, the current accounts of the member countries of the west african economic and monetary union (waemu) are systematically in deficit and the good performances of the zone in terms of economic growth registered in recent years, do not seem to reduce the deficits that keeps growing. in 2017, for example, while economic growth was more than 6% (west african economies central bank statistics) for the third year in a row, the overall current account deficit of the union reached 6.8% of gdp, its highest level since 2008; year of the global economic and financial crisis. thus, despite the good macroeconomic performance recorded, waemu still faces a widening of external deficits which accentuate its financing constraints (alby, 2018). the worsening of the current account deficits in the union leads countries to use indebtedness to finance their public investment programs. this is also fueling the burden of the public debt and increasing budget deficits. fiscal and current imbalances put pressure on international foreign exchange reserves and put the economies at risk of a sharp adjustment. according to the international monetary fund (2018) the waemu countries incurred a loss of 993 billion cfa francs on their foreign exchange reserves during the year 2016, thus raised the debate on a necessary devaluation of the common currency. if the scenario of a devaluation of the cfa franc was then avoided and the deficit was made up, it is thanks to the foreign capital flows resulting in particular from the issues of eurobonds by the two big states of the zone, ivory coast and senegal. but the exposure of waemu countries to the international financial market calls for close monitoring of budget and current account deficits for at least two reasons. first, an accumulation of current account deficits in a context of low resource mobilization capacities exposes countries to a spiral of debt with almost unbearable debt interest charges, as was the case in the late 1980s. second, economies of the union would then depend on the conditions of credit on the international market and a hardening of these would strongly affect their external stability. thus, a decline in growth in developed countries and the tightening of international financial market conditions, which would be linked to the nature of the monetary policies that will be conducted in the united states and in europe particularly, raise the risk of a sudden stop of foreign capital flows. this would create a serious threat to the stability of the waemu economies. indeed, an accentuation of current deficits, combined with a scarcity of foreign capital, will lead to a deficit in the overall balance of payments and ultimately to a decrease in foreign exchange reserves. in order to avoid a payments crisis, countries could be forced to carry out brutal adjustment policies as it happened with the devaluation of the cfa franc in 1994. given such risks to external stability of economies, it is important to look at the causes of current account fluctuations in waemu to those deficit drivers and possibly the search for resorption policies. the objective of this study is to locate the origin of current account fluctuations in waemu. thus, it tries to answer the questions to know: what are the causes of fluctuations of current accounts in waemu? are they external or internal to the economic activity of the countries? the study is conducted as part of the inter-temporal current account approach developed by sachs (1981) and buiter (1981). following this approach, the current account is used by economic agents to smooth their consumption against income shocks. so its movements come from the factors underlying individual consumption decisions. to find the causes of empirical current account fluctuations, we will use an identification scheme in an autoregressive vector model (var) as proposed by sims (1982) and blanchard and quah (1989). this method makes it possible to distinguish specific shocks from global shocks that are supposed to influence the dynamics of the current account in accordance with the inter-temporal approach. the analysis of impulse response functions (irf) will be used to identify the nature of shocks that have a significant influence on the dynamics of the current account. in addition, with the decomposition of the variance of the errors, we will be able to check to what extent the exogenous and endogenous shocks contribute in the movements of the current accounts in waemu. this will ultimately provide information on empirical sources of current account fluctuations. such information is crucial for the conduct of states economic policies. indeed, if external shocks are preponderant then the room for maneuver of national or regional economic policies will be very limited. on the other hand, insofar as current account fluctuations are explained by domestic shocks, policies to reduce or even eliminate deficits would be quite conceivable. despite the importance of this topic that treats the external stability of west african economies; few studies have been done on this. our study tries to repair this lag of studies on current account deficits in the case of waemu. in this sense, this one contributes to understand the main shocks that drive the current account fluctuations in waemu. the study is organized into four sections. the first section presents a review of the literature on studies of sources of current account fluctuations using the inter-temporal approach. the second section provides a descriptive analysis of the evolution of current accounts of waemu countries from 1980 to 2017. the analysis methodology is the subject of the third section that deals with the theoretical model and the specification of the empirical model. finally, the fourth section deals with the empirical analysis of sources of fluctuations in the current account in waemu. the presentation and the analysis of the results make up this last section. asian journal of economics and empirical research, 2020, 7(1): 46-63 48 © 2020 by the authors; licensee asian online journal publishing group 2. literature review this section provides both the theoretical and empirical review of the literature. the inter-temporal current account approach highlights the effects of real factors such as productivity, government spending or international real interest rates on the current account balance. within the context of analysis, the current account balance results from inter-temporal savings and investment decisions by economic agents. buiter (1981); sachs (1981); obstfeld (1982) and svensson and razin (1983) developed the first inter-temporal current account models. to formally define the current account, the inter-temporal approach starts from the accounting identity that establishes the equality between the national income and the overall expenditure of the country. national income is the sum of domestic production (y) and factor income paid by the rest of the world equal to interest earned on foreign assets (rat). while spending includes government spending (gt), investment (it) and private consumption (ct) expenditure. (1) yt is the national production. ct the private consumption. gt the public expenses. it investment. at the net foreign assets and r the constant real interest rate. the current account balance corresponds to the change in net foreign assets (a), but is also equal to the difference between national income and total expenditure or absorption. (2) as defined in equation 2, the current account balance depends not only on actual flows of goods but also on international capital flows. the integration of capital movements in the current account dynamics is thus a major innovation of the inter-temporal approach compared to so-called absorption and elasticity approaches of international trade. indeed, these approaches reduce the balance of current transactions to the trade balance and neglect the movement of capital (razin, 1993). hence, the factors that determine the dynamics of the current account are those that also underlie individual savings decisions in the economy. from equation 1, changes in the current account balance ( ) can be written as follows (razin, 1993): ( ) (3) where r is the market discount factor (see obstfeld and rogoff (1994)) : ∏ ( ) (4) equation 3 points up the different shocks that can affect the balance of current transactions. these shocks may be exogenous or domestic and country-specific (glick & rogoff, 1992; obstfeld & rogoff, 1995). the impact of these shocks on the current account differs according to their nature. after its theoretical statement in the early 1980s, the inter-temporal approach of the current account has been the subject of several empirical studies. the explicative power of current account dynamics by the inter-temporal model has been tested in several studies (ghosh, 1995; otto, 1992). all these pioneering studies used the present value model to check the validity of the conclusions of the inter-temporal current account approach. the results of these studies differ on the power of the inter-temporal model to explain the dynamics of the current account. subsequent studies, however, have relied on the restrictions imposed by the inter-temporal model to empirically evaluate the sources of current account fluctuations through an autoregressive vector model. thus, the role of transitory shocks in the dynamics of the current account has been pointed up by campa and gavilan (2006) in the framework of the european union. the authors tested the validity of the inter-temporal current account model for these economies. based on quarterly data, the study rejected the model for finland, germany and ireland. on the other hand, it concluded that the model correctly traced the evolution of the current accounts of countries such as belgium, france, italy, netherlands, portugal and spain. in addition, the authors have shown that current account fluctuations are determined by the two shocks of relative price changes and expectations of future income, the relative importance of which varies by country. relative price movements account for the majority of current account fluctuations in italy and the netherlands, while future income expectations are responsible for fluctuations in the current accounts of belgium, portugal and spain. the preponderance of transient productivity shocks over global and permanent shocks was also found by kano (2003). the author develops a three-variable structural autoregressive vector (svar) model to explain current account fluctuations in canada and the united kingdom. the study identifies three types of shocks: transient specific shocks, permanent specific shocks and global shocks. the latter are represented by the world real interest rate, while the changes in net output and the ratio of the current account to the net domestic output are the respective proxies of the transitory and permanent specific shocks. the results of the study show that shocks transitory specificities are at the origin of current account movements and therefore explain most of its fluctuations. however, the role of these shocks in the variations of the net domestic product remains very limited. in addition, bussiere, karadimitropoulou, and leon-ledesma (2017) underlined that temporary domestic shocks explain for a large proportion, the current account fluctuations in the case of the g-6 economies. other studies have found that global shocks predominate in sources of current account fluctuations. indeed, in contrast, to the theoretical predictions of the inter-temporal approach, hoffmann (2013) points out that china's current account surpluses are explained by global shocks. dunne and makanza (2016) have also found that current account is affected by global monetary shocks in the case of south africa. the weak role played by transitory domestic shocks in the current account fluctuations of the g6 economies was also found in the study by karadimitropoulou and ledesma (2014). the authors use a structural var model with four variables. in addition to changes in net output, current account ratio to gross domestic product and international interest rate, the study takes into account the real exchange rate. four shocks are highlighted: external supply shocks, domestic and permanent net production shocks, preference shocks and transitory and specific production shocks. the authors reach three major conclusions. the first is that the present value model of asian journal of economics and empirical research, 2020, 7(1): 46-63 49 © 2020 by the authors; licensee asian online journal publishing group the current account is accepted for all countries except for france. the second major result of the study is that external and preferential supply shocks determine current account fluctuations. finally, the last result of this study points out that the current account response to transient domestic shocks is less important than it has been in previous studies. pioneering studies of current account dynamics through the inter-temporal approach develop a "present value model" to test the validity of the restrictions induced by the approach. however, the most recent studies on the current account adopting the inter-temporal approach directly integrate the restrictions imposed by a constrained autoregressive vector model. studies that incorporated these formal limitations of the approach into a constrained autoregressive vector model attempted to explain the origin of current account and net output fluctuations. we can note that the approach seems more suited to small open economies than to industrialized countries. indeed, the standard intertemporal current account model fails to explain observed current account with persistent changes in consumption (shibata, 2018). however, capital movements, the inclusion of which in the study of current account dynamics remains the major innovation of the inter-temporal approach compared to traditional approaches, are less important in developing countries. both of these limitations could undermine the scope of the approach's contributions in the study of current account dynamics. 3. stylized facts in this section, we analyze the evolution of the balance of the current accounts of the countries of the union such as the balance of payments national account except guinea bissau. the withdrawal of guinea bissau from the sample is explained by the lack of available data on the variables considered, covering the study period from 1980 to 2017. current account balances in waemu countries are systematically in deficit over the entire period except for a few years when some countries recorded a surplus see figure 1. figure-1. evolution of the ratio current account to gdp. thus, we can identify three sub-periods in the evolution of waemu countries' current account balances. the first sub-period corresponds to the 1980-1990 decade. this is marked by a significant level of current account deficits in waemu countries. in fact, starting in 1980, there is a widening of the deficits of the different countries. this is due to soaring prices of energy products following the oil shocks of 1973 and 1979. this has a double deficit effect on the current account. on the one hand, rising energy prices will exacerbate the bill for hydrocarbon imports. there is a deterioration in the trade balance of countries that are all net importers. on the other hand, to comply with their internal growth constraint, countries are required to borrow to finance the current account deficit. as a result, government debt and the interest payments it generates will increase. since these interests are partly paid by export earnings, the current account deficit of countries is widening. but this period is also marked by the deterioration of the terms of trade of the primary products which constitute the basis of the exports of the waemu economies. this situation seriously undermines the public finances of the countries of the zone until the beginning of the 1990s and will inevitably lead to the devaluation of the single currency. the second phase of waemu current account developments is between the mid-1990s and the early 2000s. this period corresponds to the 50% devaluation of the common currency of the eight waemu countries, the fcfa, towards the french franc that was the currency of linking (and the euro since its entry into force in 1998). it is marked by moderate movements in countries current account balances around the equilibrium. indeed, after the devaluation, the situation of current payments in the union, which recorded surpluses in 1994, improved. however, this surplus soon gave way to the return of deficits as early as the following year, even though their level remains less important. this sudden return to deficits after the mechanical surpluses recorded with the devaluation could be explained by "the combined effect of the contraction of foreign trade (-33.3 billion fcfa), of the mechanical increase of the interest charge on the debt foreign exchange (+6 billion fcfa) and the amount of net outflows for unrequited transfers of private origin (+23.5 billion cfa) ".1 finally, the last sub-period starts from 2002, the countries record a clear improvement of their current deficits. however, starting in 2006, deficits started to rise again and reached a new peak in 2008. this new period of large current account deficits coincided with the economic and financial crisis that hit the world towards the end of the decade 2000-2010. since the waemu countries are net importers of most food and energy products, the rise in world prices caused by the crisis increases the import bill and aggravates the trade deficit. this upward trend in current account deficits is still continuing despite the stability or even the decline in certain commodity prices. 1 bernard (1995). asian journal of economics and empirical research, 2020, 7(1): 46-63 50 © 2020 by the authors; licensee asian online journal publishing group thus, the analysis of the evolution of the current account can be conducted taking into account that of these two scales. this would make it possible to establish a link between the evolution of the current account in relation to that of the trade balance on the one hand and the savings-investment balance on the other hand. the trade balance is equal to the difference between the value of exports and imports recorded in the balance of payments for each year. 4. methodology to analyze the sources of current account fluctuations in waemu following the inter-temporal approach, we use an autoregressive vector model that directly integrates the long-term restrictions imposed by this approach. 4.1. the theoretical model our model for analyzing sources of current account fluctuations in waemu is inspired by the work of kano (2003). we consider a small open economy with a representative agent whose life is infinite. let (ct) be the consumption of the representative agent at period t and u (ct) be its utility function at time t. this is defined as follows: ( ) ∑ ( ) (4) (et) is the operator of the mathematical expectation of information available at time (t). let at, yt, it and gt respectively be external assets, production, investment and government expenditures. the representative agent maximizes its utility equation 4 under the following budget constraint: ( ) ( ) the first order and transversality conditions are given by equations 6 and 7: ( ) [( ) ( )] (6) with ( ). condition (7) states that the present value of the country's net foreign assets tends to 0. in other words, over an infinite time horizon, the economy uses all the resources available to it. rt is the discount factor of the market at period t, for the consumption horizon t + i, it is defined as follows in equation 8: { ( ( )) ⁄ ( ) let’s note, net production. taking into account the consumer budget constraint equation 5 and using the condition of transversality equation 7, we have the ex-ante inter-temporal budgetary constraint of the consumer: ∑ ( ) ∑ ( ) from the equation 9 of the inter-temporal budget constraint and the transversality condition in equation 7, we can define the approximate solution of the ratio of the current account to the net output as follows (see kano (2003)): ̀ [( ) ]∑ ̀ ∑ ( ) equation 10 is the linearized log version of the current account ratio on net output. it highlights the role of the current account in smoothing the consumption of private agents through its relationship with three factors. the first factor is the international interest rate. a variation of the latter has an impact on the interest payments on the debt. but the nature of this impact depends on the net external position of the economy in question. if the economy is debtor, which is the case of several developing countries, particularly those of waemu, a rise in the world interest rate (r) results in an increase in the interest payable to the rest of the world. the consumer anticipates the payment of this additional interest through a new tax. from then on, he will smooth his consumption according to his level of wealth. this changes the ratio of the current account to the net output. the second factor affecting the ratio of current account to net output is related to inter-temporal substitution and wealth effects. in fact, by varying, the international interest rate forces the representative agent to deviate consumption from its initial trajectory. so, on the one hand, there is an inter-temporal substitution effect between consumption and savings and, on the other hand, a net enrichment effect. as a result, the current account to net production ratio is also changed. finally, the third factor expresses the smoothing of consumption by the representative agent following a modification of its expectations on the growth of net output. if in his expectations he foresees a rise in income, the representative agent increases his consumption to the detriment of savings. on the other hand, if he foresees a fall in income, the consumer sets up precautionary savings while giving up certain expenses. the current account balance of the country then depends on the income expectations of the consumer. thus, in anticipation of an increase in income, the agent consumes more; the current account reacts and becomes deficit. the opposite effect should be observed in the context of expectations of a fall in income by the representative consumer. these three factors explain the role of the current account, which reflects consumer behavior in their savings and investment choices. 4.2. the empirical model according to the inter-temporal approach, the current account balance of a small open economy is not influenced by global shocks but rather by domestic shocks. but the impact of these domestic shocks also depends on their persistence. this leads to the modeling of the current account, imposing restrictions on a structural autoregressive vector (kano, 2003). asian journal of economics and empirical research, 2020, 7(1): 46-63 51 © 2020 by the authors; licensee asian online journal publishing group to do this, we develop a three-variable structural autoregressive vector model (savm) that is the ratio of current account to gdp (ca_gdp), net output (np) and the real international interest rate (tiri). there is the vector of ( ). from these three variables, we identify three types of structural shocks: the global shock through the global real interest rate, the permanent specific shock that relates to net output and the transient specific shock represented by the ratio of the current account to gdp. these shocks are specified as follows: ( ) so we can specify the var model in its reduced form: ( ) (11) in equation 11 above, b is a triangular matrix whose diagonal elements are all equal to unity, γ (l) is the delay operator, xt is the variable vector and εt is the vector of structural shocks. we can therefore express the svar model in its matrix form: [ ] [ ( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) ] [ ] since the model has three variables (k = 3), we must impose at least three constraints ( ) so that identify it. the pattern of model identification is based on the orthogonality of the international interest rate to domestic shocks on the one hand and the absence of a long-term response from net output to domestic shocks on the other. the orthogonality of the international interest rate stems from the assumption of a small open economy that faces an interest rate set in the international financial market and on which domestic shocks have no impact. by imposing the constraints mentioned above, we have: the small open economy assumption means that it has no influence on the international real interest rate, so: ( ) ( ) the transient shock has no effect on long-term net output, resulting in: : ( ) finally, by putting l = 1, our long-term matrix is written: [ ( ) ( ) ( ) ( ) ( ) ( ) ] from this empirical specification, we can now analyze the sources of current account fluctuations in waemu. 5. results and interpretation of results in this part, we proceed to the estimation of the structural var model and the analysis of the results. but before doing so, we present the data used for the empirical analysis and perform the unit root tests to verify the stationarity of the variables. 5.1. data and stationarity tests the estimation of the empirical model must be preceded by the study of the stationarity of the variables. indeed, the use of var modeling assumes that the series are not cointegrated, but integrated into a first difference. otherwise, an error correction vector would have been more appropriate. thus, the representation of time series figure 2 in the appendix shows the presence of a trend and a certain volatility for most of them. this suggests that they are not stationary at level. to be sure, we performed the formal tests of stationarity and cointegration table 8 in the appendix. the results of the johannsen cointegration test conducted on the time series show that they are not cointegrated to a level. on the other hand, the unit root tests lead to the conclusion that all the series are stationary in first difference, so are integrated of order one (i (1)). as a result, our variables lend themselves to autoregressive vector modeling. therefore, we can proceed to estimate the structural var. in addition, the data used in this study were all converted into quarterly frequency from annual values. for this purpose, methods such as the proportionality of denton (1971) allow the conversion of annual data into quarterly frequency. this method consists in generating from the calculated annual ratios, quarterly ratios whose average must be equal to the annual ratio for each year. the implementation was done by concatenation on the r software. the data come from the international financial statistics of the international monetary fund (imf) for the series used to calculate the real world interest rate and the national accounts of the countries available on the basis of the west african economies central bank, economic and financial data for internal variables. the methodology used to construct the various variables is presented in appendix (appendix: construction of variables). from this empirical specification, we can now analyze the sources of current account fluctuations in waemu. 5.2. analysis of results the interpretation of the structural var estimation results is done in two parts. it is the first analysis of the impulse response functions (irf) presented in figure 3 in appendix that will inform us about the positive or negative nature of the response of a given variable to a structural shock. then we will analyze the decomposition of the residual variances table 9 in appendix of the endogenous variables. this analysis makes it possible to measure the contribution of the various structural shocks to the fluctuations of the endogenous variables. however, a number of standard statistical tests have been applied to the estimated structural var models to verify their robustness. these include autocorrelation tests, normality and homokedasticity of estimation errors. the results of these tests confirm the consistency of the different models. thus, the residuals of estimation errors are not autocorrelated, they are normally distributed and homokedastic. therefore, the results can be the asian journal of economics and empirical research, 2020, 7(1): 46-63 52 © 2020 by the authors; licensee asian online journal publishing group subject of economic analysis and interpretation. the model estimation is done in two steps. the first one is the estimation of the simple var model. the simple var model estimated, we proceed the selection of the appropriate lag that will be the same for the svar. for this, we begun with 8 lags for all countries. based on different criteria (aic, fpe, hq and sc), we selected the appropriate lag. then, for all countries, the criteria confirm 8 lags. that is consistent with the length of the data that is not so long. the second step is the estimation of the structural var. the results of svar estimation on eviews 9, are in tables 1 to 7 for each country. table-1. benin. table-2. burkina faso. structural var estimates model: ae = bu where e[uu']=i restriction type: long-run pattern matrix long-run response pattern: c(1) 0 0 c(2) c(4) 0 c(3) c(5) c(6) coefficient std. error z-statistic prob. c(1) 0.645069 0.076022 8.485281 0.0000 c(2) 0.005128 0.000627 8.178976 0.0000 c(3) -29.46430 3.639108 -8.096574 0.0000 c(4) 0.001002 0.000118 8.485281 0.0000 c(5) -5.453202 0.878927 -6.204387 0.0000 c(6) 3.597462 0.423965 8.485281 0.0000 log likelihood 270.6404 estimated a matrix: 1.000000 0.000000 0.000000 0.000000 1.000000 0.000000 0.000000 0.000000 1.000000 estimated b matrix: 0.022019 0.050265 0.000526 -6.92e-05 1.53e-05 9.89e-06 0.718459 -0.186569 1.912017 . table-3. ivory coast. structural var estimates model: ae = bu where e[uu']=i restriction type: long-run pattern matrix long-run response pattern: c(1) 0 0 c(2) c(4) 0 c(3) c(5) c(6) coefficient std. error z-statistic prob. c(1) 0.599540 0.070656 8.485281 0.0000 c(2) -0.002083 0.000466 -4.473220 0.0000 c(3) 6.160029 1.680145 3.666367 0.0002 c(4) 0.002374 0.000280 8.485281 0.0000 c(5) -6.932327 1.276088 -5.432484 0.0000 c(6) 5.881652 0.693159 8.485281 0.0000 log likelihood 146.9524 estimated a matrix: 1.000000 0.000000 0.000000 0.000000 1.000000 0.000000 0.000000 0.000000 1.000000 estimated b matrix: 0.261405 0.426400 0.273126 -9.53e-05 0.000220 8.17e-05 -0.347248 -0.591264 2.062596 structural var estimates model: ae = bu where e[uu']=i restriction type: long-run pattern matrix long-run response pattern: c(1) 0 0 c(2) c(4) 0 c(3) c(5) c(6) coefficient std. error z-statistic prob. c(1) 0.592227 0.069795 8.485281 0.0000 c(2) 0.002779 0.001030 2.698684 0.0070 c(3) -9.829070 2.953150 -3.328334 0.0009 c(4) 0.005857 0.000690 8.485281 0.0000 c(5) -16.16480 1.936518 -8.347354 0.0000 c(6) 2.086451 0.245891 8.485281 0.0000 log likelihood 182.6129 asian journal of economics and empirical research, 2020, 7(1): 46-63 53 © 2020 by the authors; licensee asian online journal publishing group table-4. mali. structural var estimates model: ae = bu where e[uu']=i restriction type: long-run pattern matrix long-run response pattern: c(1) 0 0 c(2) c(4) 0 c(3) c(5) c(6) coefficient std. error z-statistic prob. c(1) 0.233255 0.027489 8.485281 0.0000 c(2) -0.002005 0.001164 -1.723294 0.0848 c(3) -2.988173 1.510846 -1.977815 0.0479 c(4) 0.006837 0.000806 8.485281 0.0000 c(5) -7.870244 1.139452 -6.907045 0.0000 c(6) 3.971175 0.468007 8.485281 0.0000 log likelihood 150.4089 estimated a matrix: 1.000000 0.000000 0.000000 0.000000 1.000000 0.000000 0.000000 0.000000 1.000000 estimated b matrix: 0.102250 0.085829 0.119475 -0.000321 0.000461 8.85e-05 -0.675467 -1.059857 1.805503 table-5. niger. table-6. senegal. structural var estimates model: ae = bu where e[uu']=i restriction type: long-run pattern matrix long-run response pattern: c(1) 0 0 c(2) c(4) 0 c(3) c(5) c(6) coefficient std. error z-statistic prob. c(1) 0.134091 0.015803 8.485281 0.0000 c(2) -0.005949 0.000982 -6.058407 0.0000 c(3) 14.65886 2.727122 5.375210 0.0000 c(4) 0.004125 0.000486 8.485281 0.0000 c(5) -12.41677 1.520325 -8.167185 0.0000 estimated a matrix: 1.000000 0.000000 0.000000 0.000000 1.000000 0.000000 0.000000 0.000000 1.000000 estimated b matrix: 0.261607 0.042895 0.111769 -7.14e-05 0.000134 6.39e-05 0.159668 -1.172665 1.622546 structural var estimates model: ae = bu where e[uu']=i restriction type: long-run pattern matrix long-run response pattern: c(1) 0 0 c(2) c(4) 0 c(3) c(5) c(6) coefficient std. error z-statistic prob. c(1) 0.607951 0.071648 8.485281 0.0000 c(2) 0.003046 0.000362 8.404493 0.0000 c(3) -34.46490 4.179422 -8.246333 0.0000 c(4) 0.000299 3.53e-05 8.485281 0.0000 c(5) -3.506690 0.893949 -3.922695 0.0001 c(6) 4.756132 0.560516 8.485281 0.0000 log likelihood 283.7102 estimated a matrix: 1.000000 0.000000 0.000000 0.000000 1.000000 0.000000 0.000000 0.000000 1.000000 estimated b matrix: 0.005900 0.041085 0.001756 -5.98e-05 3.84e-06 1.91e-05 1.448429 -0.065400 1.698540 asian journal of economics and empirical research, 2020, 7(1): 46-63 54 © 2020 by the authors; licensee asian online journal publishing group c(6) 2.474230 0.291591 8.485281 0.0000 log likelihood 267.7569 estimated a matrix: 1.000000 0.000000 0.000000 0.000000 1.000000 0.000000 0.000000 0.000000 1.000000 estimated b matrix: 0.004875 0.017399 0.004402 -0.000208 0.000113 -1.78e-05 -0.180897 -0.946494 1.775149 table-7. togo structural var estimates model: ae = bu where e[uu']=i restriction type: long-run pattern matrix long-run response pattern: c(1) 0 0 c(2) c(4) 0 c(3) c(5) c(6) coefficient std. error z-statistic prob. c(1) 0.414974 0.048905 8.485281 0.0000 c(2) 0.007850 0.001048 7.493661 0.0000 c(3) -45.48492 5.953699 -7.639775 0.0000 c(4) -0.002948 0.000347 -8.485281 0.0000 c(5) 15.31136 1.859042 8.236156 0.0000 c(6) 2.682997 0.316194 8.485281 0.0000 log likelihood 244.3602 estimated a matrix: 1.000000 0.000000 0.000000 0.000000 1.000000 0.000000 0.000000 0.000000 1.000000 estimated b matrix: 0.044472 -0.050939 0.005758 0.000112 7.22e-05 9.13e-06 -0.201110 -0.373628 1.780004 after the svar estimation, by applying structural decomposition of blanchard and quah (1989) we then obtained the impulse responses of different variables to the structural shocks and we performed a variance decomposition analysis. 5.2.1. impulse responses analysis the analysis of impulse response functions focuses on the current account responses to global, permanent and transient shocks and those of net output to these shocks. thus, the observation of the shape of the impulse response functions figure 3 in the appendix shows for all countries that the current account response to shock on the international interest rate is almost zero. in other words, based on the impulse response functions, we can say that the global shock has almost no impact on the current account of the waemu countries. this result is consistent with the theoretical predictions of the inter-temporal approach, which states the absence of a current account response to the global shock in a small open economy. this has also been empirically established by recent studies such as gross (2001) and especially kuo (2015) in the context of east asian economies. the current account response to the permanent shock remains very low for all waemu countries except senegal. thus, according to the assumptions of the inter-temporal approach, the permanent shock on net production does not contribute to the fluctuations of the current account of these countries except for senegal. for the latter we find an important response of the current account to the permanent shock. with regard to specific transitory shocks, there is an immediate and significant current account response to these shocks for all the countries of the union. so we can say, based on impulse response functions that current account transactions respond to transitory specific shocks across all economies. in other words, transitory specific shocks are the dominant factor in the current account fluctuations of the waemu economies. this result confirms the fundamental assumption of the inter-temporal approach and corresponds to that found by other studies in particular, gregory and head (1999) for the g7 economies, kano (2003) in the framework of canada and the united kingdom and kuo (2015) with regard to east asian countries. the analysis of impulse response functions also focuses on the responses of net output to global, specific and permanent shocks. indeed, one of the strong conclusions of the intertemporal approach is that the shocks that determine the dynamics of the current account are identical to those that affect the changes in net output (kuo, 2015). therefore, we also analyze the reactions of net output to different structural shocks. thus, the impulse response functions of net output to the global shock of the real interest rate show a very limited impact of this for most countries. this is the case for net production in benin, burkina faso, mali and togo, which react only slightly to the global shock. however, there is a negative impact of the global shock on the net production of ivory coast, niger and senegal. thus, even if it is not the predominant factor, the global shock has an influence on the net output of all waemu countries. as for permanent domestic shocks, they appear to be the driving force behind fluctuations in net output in waemu economies. indeed, the impulse response functions show a strong reaction of this aggregate to permanent shocks. as a result, the permanent shock appears to be the main source of fluctuations in net output in the waemu economies. asian journal of economics and empirical research, 2020, 7(1): 46-63 55 © 2020 by the authors; licensee asian online journal publishing group finally, depending on the scale of responses, transitory domestic shocks appear to have no impact on net output. indeed, the response of this aggregate to transitory specific shocks is very low or almost nil for all countries. the analysis of the impulse response functions makes three important remarks. the first is that the global shock would have a very small short-term impact on both the current account and the net output for all waemu countries. however, in the long run, it appears to be dominant in the explanation of movements in net output within the economies studied. the second remark is that the driving forces of the current account and the net production of the countries of the union are not identical. indeed, the current account reacts weakly to permanent shocks and very significantly to transient shocks, which are the driving force. while changes in net output are largely explained by permanent shocks, where transient domestic shocks have a negligible impact. the fact that the sources of fluctuations in the current account and net output are not identical is a "puzzle" from the point of view of the inter-temporal approach. in fact, it predicts that the shocks that affect current account movements are those that also determine changes in net output. kano (2003) produced a similar result for canada and the united kingdom. we must complete this analysis of the impulse response functions (irf) by that of the decomposition of the variance of the estimates errors which will make it possible to measure the contribution of each type of structural shocks to the fluctuations of the current account and the net output of the union. 5.2.2. analysis of variance decomposition the decomposition of the variance of current account and net output allows us to measure the contribution of different structural shocks to their fluctuations. in general, as we have pointed out with the analysis of impulse response functions, it appears that permanent and specific domestic shocks are the determinants of the respective changes in net output and current account within the economies of waemu. thus, for explanations of the variance of the current account to gdp ratio, we note that transient domestic shocks contribute 90% in the short term and 80% in the long term with the exception of mali and togo. for both countries, the contribution of transitional shocks to current account variance is about 55% and 70% in the short term, compared to 30% for permanent shocks respectively. in the long term, transient shocks explain 50 to 60% of current account variations in these two countries, compared to 40% for permanent shocks. thus, according to the result of the analysis of the impulse response functions, transient domestic shocks are the main cause of current account fluctuations in waemu. as for the variance in net output, it is largely due to permanent domestic shocks. however, global shocks also play an important role in fluctuations in net output, especially in the long run. the contribution of permanent shocks to fluctuations in net output thus runs around 70% in the short term compared to 30% due to global shocks and less than 50% in the long term in the variations in countries' net output. we note that outside countries such as mali and niger where the impact of permanent shocks on net output endures in the long run, it is rather the movements in the real world interest rate that account for most of the variance long-term net production. in sum, the analysis of the variance of the net output and the current account ratio on gdp confirms the remarks resulting from the one made at the level of the impulse response functions. thus, transient domestic shocks account for the majority of current account fluctuations in the waemu economies. while fluctuations in net output originate in domestic permanent shocks, although for a number of countries the real world interest rate plays a major role in the long run. 6. conclusion the objective of this study is to analyze the main shocks that lead the fluctuations of the current account within the framework of waemu whose countries have systematically recorded deficits since the 80s. the study was conducted according to the inter-temporal approach current account. which approach defines the current account as the difference between domestic savings and investment. this, therefore, bases its analysis of the movements of the current account on the savings and consumption decisions of households in the countries concerned. in addition, the inter-temporal approach allows international capital movements to be accounted for in explaining sources of current account fluctuations, in contrast to traditional macroeconomic models that reduce the current balance to the trade balance. thus, the empirical analysis of the sources of current account fluctuations in waemu countries was based on an autoregressive vector model. it is a structural vector autoregressive model with three types of shocks whose contribution to current account fluctuations has been underlined by the different previous studies carried out under the inter-temporal approach (obstfeld & rogoff, 1994; razin, 1993). these shocks are either domestic and permanent, domestic and transient, or exogenous. transient and permanent domestic shocks are respectively approximated by the ratio of the current account to the gross domestic product and the ratio of net output to gross domestic product. exogenous shocks are represented by changes in the real international interest rate. the estimation of the model was made on data covering the period 1980-2017 and seven of the eight waemu countries. the empirical results obtained from the analysis of the impulse response functions and the decomposition of the variances make it possible to make the following remarks. in waemu, domestic shocks are the main sources of current account and net output fluctuations due to the low participation of countries in international trade and in keeping with their status as small open economies. thus, transient shocks determine the fluctuations of the current account while the impact of permanent and global shocks on this aggregate is almost weak. this result is consistent with the predictions of the inter-temporal approach, which states that fluctuations in the current account of a small open economy are caused by transient domestic shocks. as for net output, its fluctuations can be explained by permanent domestic shocks in the short term. nevertheless, in the long run, changes in the real international interest rate are the main cause of fluctuations in net output. the other conclusion that we can draw from these results is that the shocks that determine the fluctuations of the current account and the net production are not identical under waemu. what constitutes a "puzzle" from the asian journal of economics and empirical research, 2020, 7(1): 46-63 56 © 2020 by the authors; licensee asian online journal publishing group point of view of the inter-temporal approach. but this same observation was made by kano (2003) in canada and the united kingdom, where current account fluctuations would be explained by transient domestic shocks but which would have a limited influence on changes in net income. in view of the empirical results, the improvement of the level of current deficits in the waemu requires the control of domestic transient shocks. however, this study has some limitations. first, other sources of current account variations such as supply and preference shocks could have been incorporated and would have improved the model results. however, the availability of data covering the entire study period was lacking. secondly, the study only gives an indication of the origin of current account fluctuations, but does not specifically identify the imbalance factors in the specific context of waemu. thus, it would be particularly important to supplement it with another study that would seek to identify precisely the current account deficit factors in waemu. if so, it will be interesting to look for current account adjustment policies within the union based on the deficit factors that would be identified. references alby, s. (2018). cfa franc: new stress test. conjoncture 2018, economic-research.bnpparibas.com., france. 2-10. bernard, c. (1995). devaluation of the fcfa and balance of current payments. bordeaux iv, france: center for development economics, montesquieu university. blanchard, o. j., & quah, d. (1989). the dynamic effects of aggregate demand and supply disturbances. the american economic review, 79(4), 653-673. buiter, w. h. (1981). time preference and international lending and borrowing in an overlapping-generations model. journal of political economy, 89(4), 769-797. available at: https://doi.org/10.1086/261002. bussiere, m., karadimitropoulou, a., & leon-ledesma, m. a. (2017). current account dynamics and the real exchange rate: disentangling the evidence: school of economics, university of east anglia, norwich, uk. campa, j. m., & gavilan, a. (2006). current accounts in the euro area: an intertemporal approach. bank of spain, working document no. 0638. denton, f. t. (1971). adjustment of monthly or quarterly series to annual totals: an approach based on quadratic minimization. journal of the american statistical association, 66(333), 99-102. available at: https://doi.org/10.1080/01621459.1971.10482227. dunne, j. p., & makanza, c. s. (2016). current account dynamics and monetary policy transmission in south africa. school of economics discussion paper series, no. 2016-02. school of economics, university of cape town. ghosh, a. r. (1995). international capital mobility amongst the major industrialised countries: too little or too much? the economic journal, 105(428), 107-128. available at: https://doi.org/10.2307/2235322. glick, r., & rogoff, k. (1992). global versus country-specific productivity shocks and the current account dynamics. journal of monetary economics, 35, 159-193. gregory, a. w., & head, a. c. (1999). common and country specific fluctuations in productivity, investment and the current account. journal of monetary economics, 44(3), 423-451. available at: https://doi.org/10.1016/s0304-3932(99)00035-5. gross, d. (2001). country-specific and global shocks in business cycles. center for financial studies, germany, working paper n°2001/11. hoffmann, m. (2013). what drives china's current account? journal of international money and finance, 32, 856-883. available at: ttps://doi.org/10.1016/j.jimonfin.2012.07.005. international monetary fund. (2018). n°2018/106. kano, t. (2003). a structural var approach to the intertemporal model of the current account. bank of canada, working paper 2003-42. karadimitropoulou, a., & ledesma, l. m. a. (2014). what are the sources of current accounts fluctuations in the g6 countries? retrieved from http://www.researchgate.net/publication/26041281. kuo, c.-y. (2015). is an intertemporal model of the current account valid for east asian countries? evidence from structural var. journal of business economics and management, 16(6), 1085-1108. available at: https://doi.org/10.3846/16111699.2014.964304. nubukpo, k. (2013). fifty west african monetary union: what have we learned? financial economy review, 2013/2 (no 110), 145-164. obstfeld, m. (1982). aggregate spending and the terms of trade: is there a laursen-metzler effect? nber working paper series, wp n°686. obstfeld, m., & rogoff, k. (1994). the intertemporal approach to the current account. nber working paper series, wp n°4893. obstfeld, m., & rogoff, k. (1995). exchange rate dynamics redux. nber working paper series, wp n°4693. otto, g. (1992). testing a present-value model of the current account: evidence from us and canadian time series. journal of international money and finance, 11(5), 414-430. available at: https://doi.org/10.1016/0261-5606(92)90009-m. plane, p. (1988). the factors of imbalances in current payments in the west african monetary union (1970-1983). journal of political economy, 98(1), 111-126. razin, a. (1993). the dynamic-optimizing approach to the current account: theory and evidence. nber working paper series, wp n°4334. sachs, j. (1981). the current account in the macroeconomic adjustment process. scandinavian journal of economics, 84(2), 47-59. shibata, a. (2018). current account dynamics under information rigidity and imperfect capital mobility. esri discussion papers series n°344. sims, c. a. (1982). policy analysis with econometric models. brookings papers on economic activity, 13(1), 107-164. svensson, l. e., & razin, a. (1983). the terms of trade and the current account: the harberger-laursen-metzler effect. journal of political economy, 91(1), 97-125. available at: https://doi.org/10.1086/261130. appendix construction of the variables: the data used in this study come from the national accounts of the various countries with respect to internal variables and imf international financial statistics (ifs) for the global interest rate. they have been converted to quarterly frequency from annual data. the international interest rate was constructed using fisher's formula. in other words, we have calculated the real international interest rate by subtracting the current year's inflation rate from the nominal interest rate of the us treasury in the short term. the calculation of the inflation rate was done by differentiating between the price index of the current year and that of the previous year. or formally: . where rt is the nominal interest rate of the us treasury. as far as net output is concerned, it is calculated as the difference between government expenditures, which is equal to the sum of gross fixed capital formation and gross domestic product stock changes. finally, the current account to gdp ratio was made by comparing the current account of the balance of payments to the nominal gross domestic product. the different sets of internal variables thus constructed are divided by the gdp deflator to make them real and then by the total population to conform to the representative agent hypothesis. asian journal of economics and empirical research, 2020, 7(1): 46-63 57 © 2020 by the authors; licensee asian online journal publishing group table-8. cointegration and unit root tests. cointegration unit root 1. benin method statistic prob.** levin, lin & chu t* -8.66795 0.0000 adf fisher chi-square 106.997 0.0000 pp fisher chi-square 36.4052 0.0000 2. burkina trace statistic 0.05 critical value prob.** 24.05039 29.79707 0.1983 11.08654 15.49471 0.2062 0.131401 3.841466 0.7170 method statistic prob.** levin, lin & chu t* -8.66795 0.0000 adf fisher chi-square 106.997 0.0000 pp fisher chi-square 36.4052 0.0000 3. ivoiry coast trace statistic 0.05 critical value prob.** 24.05039 29.79707 0.1983 11.08654 15.49471 0.2062 0.131401 3.841466 0.7170 method statistic prob.** levin, lin & chu t* -7.86340 0.0000 adf fisher chi-square 100.246 0.0000 pp fisher chi-square 36.0654 0.0000 trace statistic 0.05 critical value prob.** 23.02538 29.79707 0.2448 11.04674 15.49471 0.2086 0.515201 3.841466 0.4729 4. mali method statistic prob.** levin, lin & chu t* -7.81523 0.0000 adf fisher chi-square 99.8537 0.0000 pp fisher chi-square 36.1389 0.0000 5. niger trace statistic 0.05 critical value prob.** 27.45871 29.79707 0.0909 10.47776 15.49471 0.2458 0.414641 3.841466 0.5196 method statistic prob.** levin, lin & chu t* -9.67559 0.0000 adf fisher chi-square 108.702 0.0000 pp fisher chi-square 34.9706 0.0000 trace statistic 0.05 critical value prob.** 21.92632 24.27596 0.0962 10.59920 12.32090 0.0955 0.001012 4.129906 0.9809 6. senegal method statistic prob.** levin, lin & chu t* -3.33082 0.0004 adf fisher chi-square 19.6868 0.0031 pp fisher chi-square 20.6309 0.0021 trace statistic 0.05 critical value prob.** 71.55394 29.79707 0.0000 6.439892 15.49471 0.6435 2.283239 3.841466 0.1308 7. togo method statistic prob.** levin, lin & chu t* -9.34575 0.0000 adf fisher chisquare 108.628 0.0000 pp fisher chi-square 35.0009 0.0000 trace statistic 0.05 critical value prob.** 25.35363 29.79707 0.1492 10.52497 15.49471 0.2425 1.239252 3.841466 0.2656 asian journal of economics and empirical research, 2020, 7(1): 46-63 58 © 2020 by the authors; licensee asian online journal publishing group figure-2. representation of constructed series. asian journal of economics and empirical research, 2020, 7(1): 46-63 59 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research, 2020, 7(1): 46-63 60 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research, 2020, 7(1): 46-63 61 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research, 2020, 7(1): 46-63 62 © 2020 by the authors; licensee asian online journal publishing group figure-3. impulse response functions. table-9. decomposition of variance. 1. benin variance decomposition of np period s.e. gs ps ts 2 15.52636 46.04610 53.73720 0.216700 10 51.05503 39.78096 59.98271 0.236329 20 53.39300 49.55462 50.13471 0.310673 variance decomposition of ca/gdp period s.e. gs ps ts 2 0.000654 2.089481 3.871050 94.03947 10 0.003504 4.973667 7.616084 87.41025 20 0.004136 4.846890 9.435648 85.71746 2. burkina faso variance decomposition of np period s.e. gs ps ts 2 0.000654 46.04610 53.73720 0.216700 10 0.003504 39.78096 59.98271 0.236329 20 0.004136 49.55462 50.13471 0.310673 variance decomposition of ca/gdp period s.e. gs ps ts 2 2.864577 2.089481 3.871050 94.03947 10 9.826025 4.973667 7.616084 87.41025 20 10.43378 4.846890 9.435648 85.71746 asian journal of economics and empirical research, 2020, 7(1): 46-63 63 © 2020 by the authors; licensee asian online journal publishing group 3. ivory coast variance decomposition of np : period s.e. gs ps ts 2 0.002815 22.11021 62.44739 15.44240 10 0.018687 49.10754 44.64797 6.244490 20 0.024034 53.47749 42.24102 4.281496 variance decomposition of ca/gdp: period s.e. gs ps ts 2 2.800633 0.108973 0.646038 99.24499 10 9.048979 0.750810 2.229074 97.02012 20 10.17510 5.891720 10.75330 83.35498 4. mali variance decomposition of np period s.e. gs ps ts 2 0.001123 22.19861 77.03416 0.767231 10 0.006174 12.67797 86.53404 0.787990 20 0.008857 6.715274 92.43548 0.849245 variance decomposition of ca/gdp period s.e. gs ps ts 2 2.721849 24.96734 19.29179 55.74087 10 9.653075 22.40393 27.00905 50.58702 20 10.35607 21.83825 28.75692 49.40483 5. niger variance decomposition of np period s.e. gs ps ts 2 16.95850 13.94728 85.88413 0.168584 10 52.80131 11.03605 88.84648 0.117468 20 54.89289 11.46929 88.20483 0.325880 variance decomposition of ca/gdp period s.e. gs ps ts 2 0.000480 0.342190 2.610384 97.04743 10 0.002258 0.367420 5.132755 94.49982 20 0.002353 0.558828 4.894546 94.54663 6. senegal variance decomposition of np period s.e. gs ps ts 2 16.8147 31.2605 50.4522 18.2874 10 52.7192 49.5352 40.3773 10.0876 20 54.2568 47.6553 45.1056 7.23911 variance decomposition of ca/gdp period s.e. gs ps ts 2 0.001537 2.525292 3.488888 93.98582 10 0.008359 7.266887 7.293134 85.43998 20 0.010518 10.53994 10.12012 79.33994 7.togo variance decomposition of np period s.e. gs ps ts 2 15.92043 1.070528 56.60889 42.32058 10 52.01419 4.195602 74.40748 21.39691 20 53.77925 20.25914 65.82229 13.91857 variance decomposition of ca/gdp period s.e. gs ps ts 2 0.000689 1.561382 27.78531 70.65331 10 0.003890 1.759554 30.48307 67.75738 20 0.005449 1.751188 31.71975 66.52906 note: gs: global shock. ps: permanent shock. ts: transitory shock. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 120 © 2019 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 6, no. 2, 120-129, 2019 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2019.62.120.129 © 2019 by the authors; licensee asian online journal publishing group influence of excessive expenditure of the government in perspective of interest rate and money circulation which in turn affects the growing process in pakistan zia-urrahman department of economics, preston university, pakistan. abstract in this study an attempt was made to investigate the affiliation among the excessive expenditure, interest rate, inflation, money supply and growing rate. for this purpose, time series data comprises 1976 to 2018 were collected from the handbook and world development indicator. the analyses show a good number of findings. firstly, the unit root test results show that all the variables are stationary at level, except inflation but appear stationary at first difference. however, za test pronounces structural break in the data with a different time period. this of course leads the study to determine the short and long-term association among the variables. the vector error correction and johansen cointegration reveals the short and long-run relationship exists among the variables. while excessive expenditure and the money circulation have one-way granger causality with the growth rate. moreover, the diagnostic and stability tests describe that model specification, auto correlation and model are normal. even impulse response pronounces that all the variables would have a positive influence on the growth rate in the future. based on this, the study recommends that government should not create the atmosphere of the crowding out. no doubt interest rate favors the economy, but government should also manage its expenditure. keywords: money circulation, expenditures, interest rate, granger causality, impulse response and growth rate. jel classification: e12; e43; e51; e62. citation | zia-ur-rahman (2019). influence of excessive expenditure of the government in perspective of interest rate and money circulation which in turn affects the growing process in pakistan. asian journal of economics and empirical research, 6(2): 120-129. history: received: 18 june 2019 revised: 24 july 2019 accepted: 28 august 2019 published: 11 october 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 121 2. literature review .......................................................................................................................................................................... 121 3. theoretical framework and data .............................................................................................................................................. 123 4. results and discussion ................................................................................................................................................................. 123 5. conclusion and suggestions ........................................................................................................................................................ 128 reference.............................................................................................................................................................................................. 128 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.62.120.129&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1058 https://orcid.org/0000-0002-3985-2679 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1058 https://orcid.org/0000-0002-3985-2679 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1058 https://orcid.org/0000-0002-3985-2679 asian journal of economics and empirical research, 2019, 6(2): 120-129 121 © 2019 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the existing literature by analyzing the monetary policy incorporated with one fiscal factor which leads the economy towards the prosperity. 1. introduction earning and spending of the government play a pivotal role in the growth process either it is developed country or the emerging economy. and when expenditure level goes up in context to the earnings creates a situation named excessive expenditure which is very bad for the economy. and also creates shock wave which hits the economy one after the another, destabilize the economy, deficiency of funds, the rise of interest rate which in turn influenced the growing process (kirchner, 2007; tabar et al., 2016). keynesian economists are in the favor of government intervention to resolve the market imbalance by increasing the government expenditure or money supply to assist the economy from recession. meanwhile, keynesian rely on the interest rate, use shocks to influence the growing process. on the other hand, classical economist says that all the resources are fully utilized so there in no room for government intervention (saymeh and orabi, 2013). to fulfill expenditure, up rises in taxation reduce the profit of the firm and discourages new investment which in turn reduce the demand of the loanable funds and reduce the interest rates. while money supply is the total amount of the money in circulation and liquid instruments in a specific time period. money supply is further break down in money supply one, money supply two and money supply three. this study utilizes the m2. the money supply is reflected to be measured, to regulate the interest rate and also affects the economy. keynesian model consists of three factors, consumption, investment and government expenditure like y = c + i + g. however, in the study is perspective of g which represents the government expenditure. when government expands its spending, then it creates the same effect produced by the investment because the government may be increasing some sort of public expenditure like energy, sanitation etc. which in turn increase the productivity further promotes the inflationary phenomena (feldstein, 1982; eisner, 1992; tabar et al., 2016) along with excessive expenditure. in recent past pakistan encourages and sponsored rigorous enhancement in the growth rate, expenditure, interest rate, money supply and the inflation. consequently, pakistan has to face many ups and down in the flow of all the factors, great fluctuation can be seen after 2004 which declines the growth rate even growth rate turns smooth with the passage of time. so, figure 1 demonstrates an overall picture of macro factors which are present to enhance the growth rate. figure-1. overview of the factors. source: economic survey. this study is different from the past work on many bases because it incorporated the structural break in the data which was missing in the literature. and utilizes the granger causality which factor granger causes the other factor in what direction (uni-direction/bi-directional). also illustrates the fluctuating behavior of the variables which generates a shock wave to destabilize the growth rate in the future. eventually, predict the trend, pattern or the behavior either it responds positively or negatively. however, the rest of the paper comprises the literature review, methodology, result and discussion and the conclusion with the policy suggestions. 2. literature review money in circulation, interest rate and excessive expenditure are the pivotal variables of the monetary and fiscal policy and also play very important role in the development either it is developing country or the developing country. muñoz et al. (1985) states that excessive budget expenditure and current anticipated deficit have effects on the production but in the long term. munoz concluded these results on the basis of multi regression equation for the american economy, while employing the interest rate and excessive expenditure. nwaogwugwu and evans (2016) confirms the crowding out the phenomena in the usa economy. and also states that excessive expenditure and interest rate are connected, and also capture a direct association between interest rate and excessive expenditure if one goes up second variable also goes up. while hubbard (2012) says that if the 1 percent increase of debt of the asian journal of economics and empirical research, 2019, 6(2): 120-129 122 © 2019 by the authors; licensee asian online journal publishing group government increases it will also increase the interest rate. hubbard explore the connection on the basis of vector auto regression technique and also confirms the muñoz et al. (1985) findings. burney et al. (1989) while utilizing the ordinary least square method, state that if the government borrowed to fulfill the capital requirement it directly influenced the interest rate. to overcome the problem of excessive expenditure, government should be used the monetary factor like money supply to counter the hurdle of excessive expenditure (aqeel et al., 2000). the major factor of excessive expenditure is the crowding out of the non-public investment because it has long term association with interest rate, however gdp and an increase in prices are influenced by the interest rate positively (herbert and saher, 2010). the fluctuation in excessive expenditure casing interest rate in the south africa, but spending does not cause the treasury bills while treasury bills and interest rate are interlinked. the excessive expenditure changes the interest rate, which indirectly influenced the investment (gupta and uwilingiye, 2008). while ramey (2011) determines the excessive expenditure is causing interest rate and needs to be controlled. in the perspective of neoclassical framework, kameda (2008) states that the nexus between interest rate and excessive expenditure in japan economy. and also explore the excessive expenditure has more influenced on the interest rate in the context to the government debt. while in the perspective of pakistan economy, in different time period the researches try to capture the interlink between interest rate and excessive expenditure. and found that the causes of all major economic problems in pakistan are due to the interest rate and excessive spending. the decades of 70, 80, 90 & 00 provides enough evidence to confirm that the problematic factor is the excessive expenditure. and there is also a short as well as long term correlation among the interest rate, current deficit and excessive expenditure. however, the ricardian equivalence hypothesis does not hold in the pakistan economy, because interest rate, public debt and excessive expenditure are correlated in the long term (waqas and awan, 2012). the excessive expenditure directly affects the interest rate (rangarajan and srivastava, 2005). moreover, chakraborty (2012) conducted a study to capture the association between excessive expenditure and interest rate, which leads a situation of the crowding out. while, purusothaman (2013) since 1970 it is noted that in the nigerian economy, excessive expenditure is correlated with interest rate in the short term as well as in the long term. in other worlds keynesian views, on the government spending and interest rate holds in the nigerian economy. while, keeping in the view of co-integration of interest rate and excessive expenditure, it is advised that a monetary policy and fiscal policy mix would be employed to stabilize the investment and the interest rate in the nigerian economy. under the consideration of “loanable fund theory” bonga-bonga (2012) and noula (2012) are on the same page. they state, the influence of tremors in the budget deficit, like an increase in the nonproductive spending on nominal interest rates in south africa, suggested that a policy combination of fiscal and monetary is the crucial for investor to attain a friendly interest rate in the economy. however, in the context of pakistan, haque and montiel (1994); burney et al. (1989) to explore the classical opinion on the said factors, the scholars employed a number of variables and retreat with interest and don’t investigate any association between excessive expenditure and interest. under the consideration of these possibilities, mukhtar and zakaria (2008) analyze and found that excessive expenditure has no influence on interest rate and therefore the recardian equivalence do hold in pakistan. harmonizing with haque and montiel (1994); burney et al. (1989). even there is turn in the work of mukhtar and zakaria (2008) i.e. gdp ratio was determining the substantial effect and also confirm the granger causality and found the interlinked of excessive spending with the interest rate. therefore, confirming the keynesian believed of crowding out, suggesting to curtail deficit and non-productive spending. and they totally ignore the impact of shocks in the context of pakistan. the excessive expenditure has important and proportional effect on money supply which in turn affects the inflation, in iran this phenomenon was observed by the samimi and jamshid (2011). and the research ignores the impact of choosing factors on the overall economy. while in turkey it is found that consist accumulation of debt and excessive expenditure does not cause an increase in siegnorage in another world money is affected by them. and smooth the way to increase the interest rate, which leads the situation of crowding out. so, it is suggested to adopt a policy mix instead of monetary or fiscal one. according to the ihsan and anjum (2013) consumer price index and interest rate have a positively connected with the growth, while inflation has no effect on growth rate. both denied the tight monetary policy because when central bank of pakistan raise the currency circulation all sectors improve consequently, means that there is an overall enhancement in the growing ratio. due to above mentioned reason the role of money supply as a tool to control the inflation was questionable and new inflation controller and stabilizer factors are required. abou (2014) states that money supply is utilized to control the effects of gdp developing ratio and be a collaboration of central bank and government so fiscal policy must be well planned and prepared. but on the other side, adefeso and mobolaji (2010) spending of the government paly a very important role in the developmental process in the economy, but is also promoting the inflationary pressure and increase the liquidity in the economy. so, in the context of cyprus, the government should control its current expenditure and focus on the developmental expenditure to stimulate the growth and economy has no interference for excessive money supply in the short run. idris et al. (2016) examination declares that a continuously up-rise in the price of goods which indirectly reduce the purchasing power of the public that’s why firstly goods become rare, but with the passage of time availability of goods increases due to the decrease in purchasing power. while kewal (2012) says the increase in the price level will declines the real income of the society. santosa (2017) also agrees with both researcher’s findings moreover, santosa says that the price rise in the goods is more than the increase in the wage rate, that’s why the level of economy in society declines. in the context of an above literature review it is concluded that the argument is not convincing on the relation of excessive expenditure and interest rate. as ari (2012) and kirchner (2007) explore that the connection of said variables keeps on changing and one cannot depend on the past findings to make policy to counter current problems. that’s why this study utilizes the fluctuating approach to capture the influence of shock on explained variables in the perspective of the current situation. which assist to develop economic model for further studies. asian journal of economics and empirical research, 2019, 6(2): 120-129 123 © 2019 by the authors; licensee asian online journal publishing group 3. theoretical framework and data 3.1. theoretical framework the study of sims (1986) elaborates that gdp, nominal interest rate and excessive expenditure have a contemporaneous influenced by the circulation of the money. generally expressed in the equation 1. t 0 1 t n tay y     (1) multiplying both sides with a-1 1 1 1 t   0 1 t n ty a a x a         (2) the equation can be written as t 0 1 t n ty b b x    (3) while t t t t ty (gdp , ni ,ee ,ms ) (4) in equation 1 a, β0 and β1 are the coefficient and the equation 4 elaborates the yt. according to the keynesian the interest rate negatively influences the gdp, due to increase in the interest rate, the investor is discouraged and hence he is no more interested in the investment which in turn decrease the productivity of the economy. further, they say that expending the government expenditure progressively influenced the economy, but for a while after some time the effect of deficit takes over the positivity. keynesian says, when there is an increase in the money supply it will negatively affect the nominal interest rate, means that the interest rate will fall and this decrease is considered to be favorable to borrow, so in this sense money supply is considered to be a policy variable to control and maintain the favorable interest rate for the economy. moreover, the effect of increase in money supply negatively influenced by the nominal interest, meaning that a decrease in the interest rate is more favorable to borrow that’s why here money supply is considered as a policy factor to control and maintain the suitable interest rate. schabert (2005) in the framework of “new keynesian model” explores that the targets of interest ratio can be achieved, if the circulation of money is non-destabilizing. and circulation of the money should be amplified along with the increase in the gross domestic product so that it can fluctuate the interest rate. while the interest rate is affected by the excessive expenditure and this effect is also depends on the lower tax ratio. in other words, anticipated fiscal deficit affects the interest rate. according to the jillani and asim (2010) growth rate is affected by the nominal interest rate and money supply and karapetyan and harutyunyan (2013) suggest that excessive expenditure influence the gdp growth rate this can be expressed as in equation 5. gdp = ƒ(ni, ms, ee ) (5) but the relation “i” not deterministic as given above, there are also observant of the reverse causality. there are also cases of causality between money supply, nominal interest rate and excessive expenditure. while muelbauer and nunziata (2001) observes that nominal interest rates affect the economy. while reforming the jillani and asim (2010) and karapetyan and harutyunyan (2013) model we design a new one as expressed in the equation 6. gr = ƒ(xp, ir, m2, inf) (6) where gr stands for the growth rate, xp for the excessive expenditures, ir for the interest rate, m2 for the money supply/money circulation and inf for the inflation prevailing in the economy. 3.2. data the time series data of all the variables such as excessive government expenditure (xp), interest rate (ir), money in circulation (m2), inflation (inf) and gross domestic product proxy for the growth rate (gr) are collected from the handbook of statistics, world development indicator and the international financial statistics comprises on the 1978 to 2018. 4. results and discussion to find out the basic features of the data, descriptive analyses are utilized. table 1 illustrates the overview of all the factors included in this study for the period 1978–2017. which shows that the average growth rate in pakistan is the million dollars 1.48 which lies between the 2.08 to 0.01 and expenditure is the -0.58 million dollars, while the average value of ir, m2 and inf were 1,87, 0.14 and 1.91 respectively. table-1. descriptive review of the variables. factors mean median maximum minimum std. dev. skewne kurtosis jar-bera ln gr 1.48 1.53 2.08 0.01 0.46 -1.12 4.45 11.33 ln xp -0.58 -0.59 1.94 -3.50 1.61 0.05 1.95 1.73 ln ir 1.87 1.90 2.63 0.64 0.47 -0.44 2.60 1.47 ln m2 0.14 0.22 2.40 -2.40 1.53 -0.02 1.87 2.00 ln inf 1.91 2.00 2.63 0.92 0.46 -0.41 2.06 2.47 source: author(s) calculation. while, standard deviation shows the dispersion of the data along the equilibrium line indirectly demonstrated the normality. and figure 2 illustrates the periodic increase from 1978 to 2018. asian journal of economics and empirical research, 2019, 6(2): 120-129 124 © 2019 by the authors; licensee asian online journal publishing group 0 2 4 6 8 10 1980 1985 1990 1995 2000 2005 2010 2015 g ro w th r at e (p ro xy g ro ss d om es tic p ro du ct ) 0 2 4 6 8 1980 1985 1990 1995 2000 2005 2010 2015 e xc es si ve e xp en di tu re ( x p) -10 -5 0 5 10 15 1980 1985 1990 1995 2000 2005 2010 2015 in te re st r at e (i r ) 0 2 4 6 8 10 12 1980 1985 1990 1995 2000 2005 2010 2015 m on ey c ir cu la tio n (m 2) 0 4 8 12 16 20 24 1980 1985 1990 1995 2000 2005 2010 2015 in fl at io n r at e (i nf ) figure-2. trend of the data. source: author(s) calculation. whenever the time series data are utilized, it is necessary to make the data stationery i.e. prerequisite condition. otherwise the results will be non-reliable. the results of adf and pp test along with the za test are listed in the table 2. table-2. adf test, pp test & za test. variable adf test pp test lags integration order za test t-stat prob t-stat prob t-stat break point gr -9.40 0.00 -18.26 0.00 1 i(0) -5.63 1993 xp -4.46 0.00 -4.83 0.00 1 i(0) -4.99 2012 ir -9.42 0.00 -5.78 0.00 1 i(0) -4.04 1988 m2 1.84 0.00 -2.7 0.01 1 i(0) -2.95 2006 inf -7.865 0.00 -4.72 0.00 1 i(1) -3.71 2008 source: author(s) calculations. the outcome states that all the concerning factors are stationary with a same integration order i(0), except the inflation i(1), meaning that they have zero mean and constant variance. however, the za test elaborates the structural break in the data. such as money circulation has broken in the data in the year 2006, inflation in the 2008, growth rate in the year 1993 and the government excessive expenditure has the structural break in the year 2012. after a careful inquiry of the stationarity, the johansen co-integration test was performed. here point to be noted that lag value plays an important role and also affect the freedom if numbers of lag values are more than the requirement. therefore, to determine the suitable number of lag values lag length criteria was applied. the results are listed in the table 3. table-3. lag length criteria. lag logl lr fpe aic sc hq 0 -1342.195 na 4.28e+24 70.90498 71.12045 70.98164 1 -1173.692 283.7936* 2.27e+21* 63.35222* 64.64505* 63.81220* source: author(s) calculations. the aic selection criteria are in the favor of one lag and it also explains the goodness of fit. however, conventional methods are not able to investigate and discriminate the true long-run relation and spurious regression because stochastic trend prevails in the data. therefore, this study utilizes the johansen (1988) approach for multiple equations to observe the true long-run affiliation. it is expected that this study may have more than one co-integrating equation because model includes more than two variables. for instance, if there are n variables in the model, there can be n−1 co-integrating vectors. the results of trace and max-eigen presented in the table 4 and 5. asian journal of economics and empirical research, 2019, 6(2): 120-129 125 © 2019 by the authors; licensee asian online journal publishing group table-4. trace value. null hypothesis alternative hypothesis eigenvalue trace statistic 5% critical value prob.** hypothesized no. of ce(s) n0: n = 0 a1: n ≤ 1 0.75 121.69 69.81 0.00 none * n1: n ≤ 1 a1: n ≤ 2 0.65 70.14 47.85 0.00 at most 1* n1: n ≤ 2 a1: n ≤ 3 0.29 29.79 29.79 0.04 at most 2* n1: n ≤ 3 a1: n ≤ 4 0.17 15.49 15.49 0.02 at most 3* source: author(s) calculations. table-5. maximum eigen value. null hypothesis alternative hypothesis eigenvalue max-eigen statistic 5% critical value prob.** hypothesized no. of ce(s) n0: n = 0 a1: n ≤ 1 0.75 51.54 33.87 0.00 none * n1: n ≤ 1 a1: n ≤ 2 0.65 39.74 27.58 0.00 at most 1* n1: n ≤ 2 a1: n ≤ 3 0.29 22.13 15.26 0.04 at most 2* n1: n ≤ 3 a1: n ≤ 4 0.17 6.96 3.84 0.00 at most 3* source: author(s) calculations. the results show that there are four co-integrating equations respectively to their trace statistic value are greater than 5% critical value. the results of the johansen co-integration rank test (max eigenvalue) are given in table 5. the results of the max-eigen statistic confirm four co-integrating vectors as max-eigen statistic value is greater than 5% critical value. the johansen co-integration test confirms that all the variables are co-integrated in the long-run and having long-run relationship. the study employs the vector error correction model to determine the short-term association. this approach also examines the speed of adjustment i.e. how much time, an explained variable requires to converge the equilibrium after generating fluctuation in the series by some other factor. the analysis is represented in table 6. table-6. vector error correction model. error correction d(gdp) d(exp) d(m2) d(ir) d(inf) cointeq1 -0.283 (0.244) [-1.160] -0.039 (0.034) [-1.137] 0.018 (0.004) [4.56] 0.002 (0.533) [0.004] -0.884 (0.343) [-2.578] source: author(s) calculations. the equation states that gross domestic product and government excessive expenditure converge towards the equilibrium in 1.16 years and 1.13 years’ time respectively, while interest rate sharply adjust with the equilibrium, inflation take a time of 2.57 year and m2 on the other hand takes about 4.5 years’ time to attain stabilization in the economy. moreover, the p-value was determined (prob 0.04) which is in the favors so we are interested to capture the cumulative influence of all the co-efficient, the study will employ the wald test, which is utilized to analyze the significance of the explanatory variables in the model. the result is listed in the table 7. table-7. wald test estimations. test stat value df p value f-statistic 6.19 (1,24) 0.02 source: author’s calculation. the results states that explanatory variable in the model are significant and cumulatively affect the dependent factor. the most important thing is to find out the granger causality, either variables granger causes each other and in what direction. the results are presented in the table 8. table-8. granger causality. null hypothesis: f-statistic prob. conclusion ln xp does not granger cause ln gr 3.62108 0.0645 uni-direction ln gr does not granger cause ln xp 0.13905 0.7112 ln ir does not granger cause ln gr 0.40674 0.5285 ln gr does not granger cause ln ir 0.07877 0.7809 ln m2 does not granger cause ln gr 4.40419 0.0424 uni-direction ln gr does not granger cause ln m2 3.03599 0.0893 ln inf does not granger cause ln gr 0.65798 0.4222 ln gr does not granger cause ln inf 0.94644 0.3366 ln ir does not granger cause ln xp 1.79935 0.1899 ln xp does not granger cause ln ir 1.14659 0.2928 ln m2 does not granger cause ln xp 6.11029 0.0179 uni-direction ln xp does not granger cause ln m2 2.38683 0.1304 ln inf does not granger cause ln xp 0.30884 0.5816 ln xp does not granger cause ln inf 0.41445 0.5235 ln m2 does not granger cause ln ir 0.88714 0.3538 ln ir does not granger cause ln m2 0.00136 0.9708 ln inf does not granger cause ln ir 0.00035 0.9852 ln ir does not granger cause ln inf 0.01891 0.8916 ln inf does not granger cause ln m2 0.00355 0.9528 ln m2 does not granger cause ln inf 0.25128 0.6192 source: author(s) calculation. asian journal of economics and empirical research, 2019, 6(2): 120-129 126 © 2019 by the authors; licensee asian online journal publishing group the results elaborate that xp granger cause the gr with the direction from xp towards the gr, m2 granger cause the gr with the direction from m2 towards the gr and m2 granger cause the xp with the direction from m2 towards the xp. all have the one-way causality from xp to gr, m2 to gr and m2 to xp. in order to examine the reliability and stability of the model, the study employ the six residual diagnostic tests. results of diagnostic tests are presented in table 9. the autoregressive conditional heteroskedasticity (arch) (engle, 1982) and breusch–godfrey serial correlation lm (breusch, 1978; godfrey, 1978) tests conclude that the results of ardl model are free from problems of heteroscedasticity and serial correlation as in both cases, probability value is greater than 0.05. here, the null hypotheses of homoscedasticity and no serial correlation are accepted. the ramsey reset test (ramsey, 1969) confirmed that the model was correctly specified as this test probability value is greater than 0.05. the jarque and bera (1987) test was applied to check that the residual terms are normally distributed or not. the null hypothesis of normal distribution was accepted as probability value is greater than 0.05. table-9. diagnostic tests. arch test 2x statistics degree of freedom prob 1 0.34 breuschgodfrey serial correlation lm test 2x statistics degree of freedom prob 1 0.67 ramsey reset test f statistics degree of freedom prob 16.62 (1,39) 0.15 jarque-bera test f statistics degree of freedom prob 1.24 (2.34) 0.69 source: author(s) calculation. figure 3 and 4 shows the cusum and the cusumsq tests of parameter stability, respectively. the straight line represents the critical bound at 5% significance level. the null hypothesis of stable parameters is accepted against the alternative hypothesis of unstable parameters as the plots of cusum and cusumsq statistic fall within the 5% significance level. this confirms that the short-run and long-run parameters of the model are stable and reliable. -12 -8 -4 0 4 8 12 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 cusum 5% significance figure-3. cusum. source: author(s) calculation. -0.4 0.0 0.4 0.8 1.2 1.6 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 cusum of squares 5% significance figure-4. cusum q. source: author(s) calculation. asian journal of economics and empirical research, 2019, 6(2): 120-129 127 © 2019 by the authors; licensee asian online journal publishing group now study employs the vector auto-regressive (var), which was presented by sims (1980) to determine the vigorous and fluctuating interlink among the variables. the var model explores the hidden information in the data and economist use it to conduct some type of experiments to change the direction of the variable in the economy and also to re-arrange the policy factors. the results are presented in table 10. table-10. vector auto-regressive result. variables gr xp inf m2 ir gr (1) 0.012 (0.19) [-0.06] 0.002 (0.019) [0.483] -0.029 (0.169) [-0.176] -0.008 (0.028) [-0.295] 0.140 (0.149) [-0.940] source: author’s calculation. it is very problematic directly, to explore the estimations i.e. impulse response function (irf) is there to explain the results. although this method shows that all the variable inflation, excessive expenditure, growth rate, interest rate and the money in circulation are connected with each other. the irf elaborates that when a fluctuation is produced by changing the level of a variable in the economy, then it creates a shock wave which pass through the whole and every sector of the economy and have some type of influence on growing process. this shock not only divert the course of a variable in the present atmosphere, but also influence the other factors in the economy in the future. moreover, irf measures the response generated by some external disturbance i.e. interest rate, money in circulation, inflation and excessive expenditure. the results of irf are listed in figure 5. -.1 .0 .1 .2 .3 .4 .5 1 2 3 4 5 6 7 8 9 10 r es p o n se o f l n g r t o l n x p -.1 .0 .1 .2 .3 .4 .5 1 2 3 4 5 6 7 8 9 10 r es p o n se o f l n g r t o l n i r -.1 .0 .1 .2 .3 .4 .5 1 2 3 4 5 6 7 8 9 10 r es p o n se o f l n g r t o l n m 2 -.1 .0 .1 .2 .3 .4 .5 1 2 3 4 5 6 7 8 9 10 r es p o n se o f l n g r t o l n i n f response to cholesky one s.d. (d.f. adjusted) innovations ± 2 s.e. figure-5. impulse response function. source: author(s) calculation. the estimations state that when a contemporaneous shock of excessive expenditure is given to the growth rate, initially the growth rate would increase till second period, then starts to move towards the equilibrium and become closer and closer with every passing year until attaining equilibrium in the fifth period. simply we can say that when government fluctuate the level of its spending, then growth rate starts to move positively, after some time growth starts to increase and would attain the equilibrium in the long term. when a standard deviation shock of interest rate is given to the growth rate, initially growth rate increase with increasing rate till the 3rd year after that starts to decrease with decrease rate and attain equilibrium in the 7th year and moves along with the equilibrium line. in other words, when the government changes the level of interest ratio, then the growth rate of the economy increased positively throughout the time frame. while money supply fluctuates then it creates a shock wave which hits the economy. then the growth rate initially responds positively, then moves away from the equilibrium in the negative direction till 2nd year after that growth ratio increase with the increasing rate in such a way that every year it becomes closer and closer towards the equilibrium state. and in the case of inflation, contemporaneous shock wave which is generated by the inflation. growth rate initially responds positively and the moves below the equilibrium, but closely and after that, remain there closer and closer towards the equilibrium state. let’s compare the finding of his work to the findings of the other authors from the world, 110 economies from the world have experiencing the co-relation of output and the money circulating (money supply), however in the perspective of this paper pakistan is also included in the 110 economies of the world (herwartz and reimers, 2006). pakistan is facing the impact on interest rate on excessive expenditure is negative just as the sweden, greece, nigeria, india and america while resembling with the germany, india and japan in the context of gdp and interest rate (waqas and awan, 2012; purusothaman, 2013). asian journal of economics and empirical research, 2019, 6(2): 120-129 128 © 2019 by the authors; licensee asian online journal publishing group 5. conclusion and suggestions every economy of the world is facing the problem of inflation, interest rate, money supply and excessive expenditures, which in turn influence the growth rate, either it is developed or the emerging one. the difference is that the influence of these factors in the emerging economy is strong as compared to the developed countries. the objective of the study is to investigate that excessive expenditure of the government affects the interest rate and circulation of the money which in turn influence the growing process. for this purpose, time series data comprises on 1976 to 2018 were collected from handbook of statistics and the world development indicator. to determine the zero mean and constant variance adf and pp test were employed and to capture the data break in the variables za test was utilized. and confirms the stationery in the data incorporated with data break in different time periods. however, to determine the short and long-term association among the interest rate, inflation, growing rate, excessive expenditure and money supply, vecm and johansen cointegration test were used. the results of vecm and johansen cointegration elaborate that all the concerning variables are connected with each other in the short as well as in the long term along with the zero mean and constant variance while having a structural break in the data with different time frame. moreover, the study also determines that the explanatory variables are significant, the model is stable, residual is free from auto-correlation and the model is normal. however, to capture the fluctuation study utilizes the impulse response function. the result depicts that if a shock of excessive government expenditure, inflation, money circulation and interest rate are given to the growth rate then the response of growth rate in the case of expenditure and interest rate would be positive while in the case of the money circulation and the inflation would be negative in the future. there are some suggestions. the government should control its expenditure which in turn increases the level of interest rate in the economy. the interest rate is the key to attract the capital outside the economy, but government should not create the atmosphere of crowding out. when an expenditure is increased no doubt, gdp increased, but inflation and interest rate also increase, so government adopts the strategy which tries to maintain the favorable level of both inflation and interest rate. reference abou, m.s., 2014. testing the 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liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 8 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 1, 8-14, 2020 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2020.71.8.14 © 2020 by the authors; licensee asian online journal publishing group impact of financial inclusion on inclusive growth: an empirical study of nigeria joseph olarewaju afolabi financial inclusion and inclusive growth in nigeria. abstract the study investigates the effect of financial inclusion on inclusive growth in nigeria covering the periods of 1981 to 2017. it adopts the auto-regressive distributed lag (ardl) model, using annual series from cbn statistical bulletin and world development indicators (wdi). the variables adopted include; rural loan, number of bank branches, money supply-gdp ratio, private sector credit to gdp ratio and gdp per capita. the study found financial inclusion, in the form of rural loan, number of bank branches and level of liquidity have a positive and significant effect on inclusive growth in the short and long run, while interest rate impede inclusive growth. the study recommends more and improved financial services be made available to rural dwellers and the economy in general to help them participate and contribute more to national productivity. however, these financial services should be carefully monitored to make sure they are used productively. this should help reduce inequality in the country and put the country in a path of inclusive growth. keywords: financial inclusion, inclusive growth, short-run, long-run ardl, sustainable growth and development. jel classification: e44; g19; g29; p43. citation | joseph olarewaju afolabi (2020). impact of financial inclusion on inclusive growth: an empirical study of nigeria. asian journal of economics and empirical research, 7(1): 8-14. history: received: 12 november 2019 revised: 16 december 2019 accepted: 20 january 2020 published: 4 february 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ......................................................................................................................................................................................... 9 2. literature review ............................................................................................................................................................................... 9 3. data sources and variables description ..................................................................................................................................... 10 4. methodology ..................................................................................................................................................................................... 10 5. results and interpretations of results ........................................................................................................................................ 11 6. conclusion and recommendation ................................................................................................................................................ 13 references .............................................................................................................................................................................................. 13 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.71.8.14&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/1282 https://orcid.org/0000-0002-7752-1459 http://asianonlinejournals.com/index.php/ajeer/article/view/1282 https://orcid.org/0000-0002-7752-1459 http://asianonlinejournals.com/index.php/ajeer/article/view/1282 https://orcid.org/0000-0002-7752-1459 asian journal of economics and empirical research, 2020, 7(1): 8-14 9 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the existing literature by investigating the effect of financial inclusion on inclusive growth in nigeria covering the periods of 1981 to 2017. 1. introduction the attention of the world is gradually shifting from growth and development to 1sustainable growth and development. this was made clear by the sustainable development goals of the united nation targeted at 2030 (undp, 2015). one of the advocated ways of achieving sustainable growth and development is inclusive growth (berg and ostry, 2011). inclusive growth, although, defined nebulously by various bodies such as undp2, oecd3, adb4 among other, all have a common ground. that is, inclusive growth should ameliorate poverty, inequality and benefit the most marginalized in the society (chang, 2014). despite the fact that this violates an already established okun’s law (okun, 1975) a lot of theoretical and empirical arguments have been made for inclusive growth (grammy and assane, 2006; ganelli and aoyagi, 2015; undp, 2015). some scholars have argued for financial inclusion as a potent antidote to the absence of inclusive growth (demirgüç-kunt and klapper, 2012; beck and cull, 2015). while financial inclusion is expressed as the effectual delivery of financial services at an affordable cost to vast cross-section of the disadvantaged and low-income groups who tend to be excluded (kelkar, 2009) financial exclusion is the in ability to access a suitable financial service (bayero, 2015). bayero (2015) laments financial exclusion not only stops people from eluding poverty, it can also lead to people falling deeper into the cycle of poverty. corrado and corrado (2017) made a case that financial inclusion can be an important tool in driving economies on a sustainable growth trajectory by empowering people to tap into a wider set of economic opportunities. shrivastava and satam (2015) had earlier noted that financial inclusion can contribute to greater socioeconomic equality by reducing poverty and enabling the development of financial services and infrastructure. conversely, some have argued to the contrary (robinson, 1952; miller, 1998). empirically understanding the role of financial inclusion on inclusive growth is germane to this period. globalization and technological changes have further widened the gap between the rich and the poor over the last decade in both advanced and developing countries, and this threaten social and political stability as well economic development (ganelli and aoyagi, 2015). in nigeria particularly, where this paper is focused, three (3) in every five (5) nigerian live in poverty, and on the average, over 60% live in poverty (stear business, 2017). the nigerian economy has grown without the enabling environment for equal opportunities for the general population, which has resulted in persistent inequalities across generations and region (sb, 2017) and this has long-term implication for sustainable economic growth and national unity. understanding the role of financial inclusion on inclusive growth will help shape future policy-oriented research and if it is found to be insignificant, then it will mitigate the intensity of research in this area. from the literature reviewed, most studies focused on the role of financial inclusion on growth in nigeria, while to the best of my knowledge, only odeleye and olusoji (2018) have worked on the topic and captured inclusive growth, using the real gross domestic product (rgdp) as a proxy for inclusive growth. this study therefore seeks to investigate the short-run and long-run role of financial inclusion on inclusive growth in nigeria from 1981 to 2017, using real gpd per capital growth rate to capture inclusive growth. while real gdp focuses on production that is bought and sold at constant price in the market, real gdp per capita growth captures improvement in wellbeing or standard of living of the people on the average. 2. literature review this section review both theoretical and empirical literature linking financial innovation with inclusive growth. levine (2005) stressed that the links between finance and income distribution is independently important for understanding the process of economic growth and development because income distribution affects saving decision, resources allocation, incentives to innovate and public policy. literature on this issue has provided conflicting prognosis. scholars like galor and zeira (1993); aghion and bolton (1997) claim the impact of financial development is disproportionate, because of information asymmetry and non-availability of collateral of the poor, which they refer to as credit constraint. this will consequently restrict the poor from exploiting investment opportunities and their contribution to national output. but, rajan and zingales (2003); morck et al. (2005) argue that financial development needs not to restrict growth. that, a well-functioning financial system minimizes financial exclusion and makes financial services available to the larger proportion of the population, rather than making it available only to some sections of the population. they posit that if this is done, financial development may encourage entrepreneurship, industrial growth and engender development. some scholars, on other hand claim there is a non-linear relationship between finance and development. greenwood and jovanovic (1990) present for example an inverted u-curve of financial development and inequality. he made a case that at the early stage of development, only few get access to finance and that it is the process of economic development that financial inclusion is achieved. the empirical findings relating to this study are presented below; abor et al. (2018) conducted a study on financial inclusion and inclusive growth in ghana, using a survey large sample of household. they adopted unrelated probit and instrumental variable to test their study and reported that financial inclusion significantly reduces the probability of household becoming poor and increase the per capita household consumption. otiwu et al. (2018) while investigating the influence of financial inclusion on growth in nigeria, using the ordinary least square (ols) techniques found that the growth and development of nigeria is significantly dependent on financial inclusion, claiming that the financially excluded citizens possess untapped and unexplored valuable potentials that will contribute immensely to national prosperity. similarly, odeleye and olusoji (2018) empirically examined financial inclusion and inclusive growth in nigeria, using the ols, and their 1 this is growth and development that attempts to improve the living conditions of humans, however, in a manner that preserves natural resources and the environment for future generations. 2 united nation development project. 3 organisation for economic cooperation and development. 4 asia development bank. asian journal of economics and empirical research, 2020, 7(1): 8-14 10 © 2020 by the authors; licensee asian online journal publishing group study validate the finance led hypothesis and establish a case that financial inclusion is germane for inclusive growth in the country. nwafor and yomi (2018) into the nexus between financial inclusion and economic growth in nigeria, adopted two-stage least square regression and discover that financial inclusion influence significantly economic growth and that financial industry intermediation has not influenced financial inclusion. dixit and ghosh (2013) look into financial inclusion for inclusive growth in india, using secondary data and analysis of hierarchical grouping cluster, found that states with the highest financial inclusion accounts for high gdp per capita. luintel et al. (2016) invested financial development, structure and growth, using a dynamic ols, covering 69 countries (33 high income and 36 middle and low income) found financial structure to be irrelevant for economic growth. harley et al. (2017) examined the role of financial inclusion on growth and poverty reduction in developing countries, using panel data analysis and found that bank branches significantly improves growth and reduces poverty. okoye et al. (2017) still on nigeria conducted a study on financial inclusion and economic growth and development in nigeria, and found that credit delivery to private sector has not significantly supported economic growth, but financial inclusion ameliorates poverty in nigeria through rural credit scheme. cabeza-garcia et al. (2019) examined female financial inclusion and its impact on inclusive economic development, using instrumental variable analysis for 91 countries and found evidence attesting to the fact that greater financial inclusion for woman has a positive economic impact on inclusive growth. similarly, adegbite and machette (2020) considered bridging the financial inclusion gender gap in small holder agriculture in nigeria, using mixed method review discovered financial inclusion in a small holder agriculture through targeted strategies like digital financial inclusion and gender responsive agricultural finance motivation would not only advance effort at closing the financial inclusion gender gap but would also reposition the country in attaining sustainable development outcome. in summary, the theoretical literature present that while some argue that it is finance that facilitates inclusiveness, others argue that it is development that facilitates financial inclusion. the empirical literature on the other hand mostly makes a case for the effectiveness of financial inclusion on inclusive growth. although, most studies in nigeria focus on financial inclusion and economic growth, except for the work of odeleye and olusoji (2018) on nigeria, and the study captures inclusive growth using the real gdp. real gdp, however is not a good representation of inclusiveness, as it only account for the value of national output at a constant price and not individual contribution to national output. 3. data sources and variables description the data for the study were sourced from the central bank statistical bulletin (2018) and world bank development indicators (wdi) (2018). the study covers the period 1981 to 2017. the variables adopted for the study were; real gdp per capita (gdppc): the data on this variable was sourced from the wdi, 2018. it is the annual average of real output in local currency. it is adopted to capture inclusive growth, as it measures the increase in the contribution of the average citizen to national output in real term. private sector credit to gdp ratio (pscgdp): this is the ratio of credit to private sector to the domestic national output. it is one of the variables adopted to caption financial inclusion as it shows the magnitude of credit available to private sector for business activities. the data is sourced from cbn bulletin, 2018. money supply to gdp ratio (m2gdp): this is the ratio of the total liquidity in the economy to national output. it adopted to capture the level of liquidity in the economy within the period of study. the data for the variable is sourced from cbn statistical bulletin, 2018. rural loan (ruralloan): this is total credit facilities available to rural dwellers over the period of study. it is one of the variables adopted to capture financial inclusion in the model. the data is sourced from the cbn statistical bulletin, 2018. this is measured in million naira bank branches (banb): this represents the total number of bank branches available to carry out financial services over the period of study. the data is sourced from the cbn statistical bulletin, 2018. maximum lending rate (maxlendingrate): this represent the retail interest rate charged by financial institution on financial services. the data is sourced from the cbn statistical bulletin, 2018. 4. methodology this paper adopts the auto-regressive distributive lag (ardl) model. the model was developed by pasaran and shin (1999) and adjudged efficient in capturing relationships among variables of different order of integration, that is, estimating a model with a mixture of i(0) and i(1) variables. it has the advantages of being just a singleequation model, making it simple to interpret and implement, also, different variables can be assigned different lag length and they enter the mode (pesaran et al., 2001). because of its ability to accommodate and estimate variables of different order of integration (i.e. mixture of i(0) and i(1)), it can estimate efficiently both short-run and long-run relationships in a given model. the ardl as specified by pasaran and shin (1999) is presented below, using two variables x and y; = ∑ + ∑ + (1) re-specifying the model, we have; = + + ∑ + ∑ + (2) = ∑ + ∑ + (3) where, = + ( ) . this is based on the assumption that in the long-run, and = equation 1 above shows the baseline ardl model expressing the dependent variable ( ) as a function of its lag ( (ar) and the lag of the dependent variables ( (dl). equation 2 simplifies the model to reflect the short-run and long-run relationships between the dependent variable and the independent variables, where parameters are the long-run parameters, and are short-run parameters. for equation 3, = asian journal of economics and empirical research, 2020, 7(1): 8-14 11 © 2020 by the authors; licensee asian online journal publishing group + ( ) . this is based on the assumption that in the long-run, there is convergence such that and = . re-parametizing, using equation 3 with the variables for the study; + ∑ +∑ +∑ +∑ + ∑ + ∑ (4) for equation 4, , measures the long-run relationships, , is the parameter that measures the short-run relationship between the previous value of gdppc and the current value, , measures the short-run relationship between pscgdp and gdppc, , measures the short-run relationship be m2gdp and pdgpc, measures the shortrun relationship between ruralloan and gdppc, , measures the short-run relationship between banb and gdppc and , the relationship between maxlendingrate and gdppc. 5. results and interpretations of results pre-estimation tests: the study conducted stationerity tests using the augumented dickey fuller (adf) and the philips – perron (pp) test. the tests allow us to examine the behavior of the series overtime. it makes us understand the predictability or otherwise of the variables. the bound test was also conducted to establish whether or not there is a long-run relationship among the variables. these tests are presented below; table-1. descriptive statistics. descriptives gdppc ruralloan pscgdp maxlendingrate banb m2gdp mean 261597.6 65139.31 10.87491 21.62588 3083.622 14.05582 median 227565.9 11158.6 8.207608 21.3375 2385 12.65026 maximum 385227.6 988587.9 20.7733 36.09 5803 21.30726 minimum 198919.5 35.9 5.91727 10 848 9.151674 std. dev. 65042.05 198555.8 5.337531 5.977104 1660.038 3.879041 skewness 0.739389 3.92476 0.969189 -0.01567 0.51466 0.678641 kurtosis 1.986059 17.17534 2.138632 2.936644 1.788553 1.971016 jarque-bera 4.956247 404.7728 6.936369 0.007703 3.895951 4.472415 probability 0.083901 0 0.031174 0.996156 0.142562 0.106863 sum 9679112 2410154 402.3715 800.1576 114094 520.0652 sum sq. dev. 1.52e+11 1.42e+12 1025.613 1286.128 99206175 541.6905 observations 37 37 37 37 37 37 table 1 shows the descriptive characteristics of the series in the model. nigeria records a gdppc of ngn 261,597.6 annually on the average, with a minimum of ngn198,919.5 and maximum of ngn 385, 227.6. it therefore means that an average nigerian contributes about ngn21,799.8 to national output monthly. rural loan is measured in millions and reveals an average loan of ngn 65 billion is given to rural dwellers, with a minimum of ngn35 billions and maximum of ngn111 billion. in other word, rural dwellers receive loan to the tone of ngn5.42 billion on a monthly basis. the private sector credit to gdp ratio (pscgdp) measures 10.9 percent per annum, with a minimum of 8.2 percent and maximum of 20.8 percent. this indicates only about 10 percent of gdp is given to private sector as credit on the average per annum in the country. the maximum lending rate (maxlendingrate) ranges between 10 percent and 36 percent, with an average of 21.6 percent per annum while the number of bank branches (banb) falls within the range of 848 and 5803, with a mean value of 3084. given a population of about 200 million in the country, it therefore means that 3084 bank branches provide for the financial services need of about 200 million people in the country. the ration of money supply to gdp ratio (m2gdp) ranges between 9 and 21 percent with an average value of 14 percent. it indicates about 14 percent of annual gdp constitute the level of liquidity in the economy. given the kurtosis and jargue-bera statistics, all variables in the model are normally distributed except for rural loan and private sector credit to gdp ratio. table-2. unit root test. adf pp variables levels first difference levels first difference i(d) lgdppc -1.4924 -3.7667** -3.1497 -3.6813** i(1) lruralloan -3.7292 -3.5472** i(0) lpscgdp -2.0248 -5.4874*** -1.9841 -8.4825*** i(1) lmaxlendingrate -2.8931 -6.0614*** -2.8156 -7.885*** i(1) lbanb -3.3583* -2.2303 -4.6739*** i(0)/i(1) lm2gdp -2.4986 -5.68*** -2.6023 -5.9522*** i(1) ***, **, *, signify significance level at 1%, 5% and 10% respectively. table 2 shows the unit root test results tests using adf and pp. these results indicate the series are stationary in mixed order. while lbanb and lruralloan are stationary at levels (i(0)), other variables as lpscgdp, lruraldeposit, lgdppc and lm2gdp are stationary at first difference (i(1)). the stationarity behavior of the series informs the conduct of the bound test to find out if a long-run relationship exists among the variables. the bound test is presented below; asian journal of economics and empirical research, 2020, 7(1): 8-14 12 © 2020 by the authors; licensee asian online journal publishing group table-3. bound test. critical value bounds test statistic value k significance i0 bound i1 bound f-statistic 18.8158 5 10% 2.26 3.35 5% 2.62 3.79 2.50% 2.96 4.18 1% 3.41 4.68 from table 3 above, i0 bound represents short-run relationship and i1, long-run relationship. a long-run relationship exists if the f-statistic exceeds the i1 bound at any significant level, and otherwise if below i0 bound. if the f-statistic falls in between the i0 bound and i1 bound, the relationship is unclear. however, if the variables are stationary in mixed order of i(0) and i(1), and the co-integrating equation (cointeq(-1)) component of the estimate, using ardl method of estimation is negative, less than one and statistically significant, the long-run relationship among the variables can be justified. from the result obtained above, there exist along-run relationships among the variables as the f-statistics exceeds critical values at all levels. table-4. short run estimation result. variable coefficient std. error t-statistic prob. d(lruralloan) 0.0016 0.0040 0.4096 0.7031 d(lpscgdp) -0.3911*** 0.0643 -6.0790 0.0037 d(lmaxlendingrate) 0.1430** 0.0377 3.7981 0.0191 d(lbanb) 0.1695** 0.0473 3.5828 0.0231 d(lm2gdp) 0.5865*** 0.1086 5.4015 0.0057 cointeq(-1) -0.6675*** 0.0826 -8.0786 0.0013 r-squared 0.9900 adjusted r-squared 0.9900 f-stat 603.81(0.000) from table 4, the results reveal financial inclusion indices in the form of bank branches, money supply to gdp ratio and rural loans are likely to influence changes in real output per head positively. it shows a one percent increase in m2gdp is likely to increase significantly gdppc by 0.59 percent. this could mean that the level of liquidity in an economy contributes positively to national output, justifying keynes (1936) postulation that when there are slacks in the economy, increase in liquidity propels more output. gddpc responds positively to a percent increase in banb by 0.16% and a percent increase in rural loan is likely to improve gdppc by 0.002 percent. both bank branches (banb) and rural loan (ruralloan) are indices for financial inclusion and explains the importance on financial inclusion in facilitating inclusive growth. this result corroborates the assertion of demirgüç-kunt and klapper (2012) and beck and cull (2015) that financial inclusion is a potent antidote to absence of inclusive growth and the findings of corrado and corrado (2017) that financial inclusion can be an important tool in driving economies on sustainable growth trajectory by empowering people to tap into a wider set of economic opportunities. the maximum lending rate is shown to positively influence inclusive growth in the short-run invalidating the classical postulations of a negatively relationship between interest rate and investment, and consequently output and validating keynesian assertion that the main drivers of investment and growth is not necessarily low interest rate but investor confidence and aggregate demand level. the adjusted r-squared which measures the weight of the independents variables on the dependent variables shows 99 percent of changes in gdppc are captured by the explanatory variables (in rural loan, number of bank branches, private sector credit to gdp ratio, money supply to gdp ratio and the maximum lending rate) and the f-stat depicts the variables are jointly significant. the coint eq(-1) reveals that for every disequilibrium, about 66 percent of such disequilibrium is corrected each year. table-5. long run estimation result. variable coefficient std. error t-statistic prob. lruralloan 0.1106*** 0.0181 6.0984 0.0037 lpscgdp -1.2075*** 0.2171 -5.5622 0.0051 lmaxlendingrate -0.6778*** 0.0854 -7.9417 0.0014 lbanb 0.5294*** 0.1047 5.0543 0.0072 lm2gdp 1.8307*** 0.2534 7.2234 0.0019 c 7.3230*** 0.6141 11.9251 0.0003 cointeq = lgdppcn (0.1106*lruralloan -1.2075*lpscgdp -0.6778 *lmaxlendingrate + 0.5294*lbanb + 1.8307*lm2gdp + 7.3230). table 5 presents the long run effect of financial inclusion on inclusive growth in nigeria. it reveals financial inclusion have a statistically significant effect of inclusive growth, while interest rate affects inclusive growth negatively. gddpc is likely to increase by about 0.12%, for every one percent increase in rural loan, meaning, for every ngn1 given out as loan to rural dwellers, gdp per capita increases by about n0.12kobo. for number of bank branches (banb), a one percent increase in the number of banks available to render financial services, increases gdp per capita by 0.53%. it could be inferred that for every one additional bank branch, gdp per capita increases by ngn0.53kobo. also, a percent increase in liquidity level in the form of m2gdp ratio increase gdp per capital by about 1.83 percent, indicating that for every ngn1 increase in liquidity, gdp per capital would increase by about ngn1.83 kobo. contrary to the relationship between maximum lending rate and gdp per capital in the short-run, a negative relationship is found between maximum lending rate and gdp per capital in the long-run. it is shown that a one percent increase in maximum lending rate would likely reduce gdp per capita by about 0.68 percent. post estimation test: the study conducted post-estimation test on the estimated model in the form of normality test, heteroscedasticity test and serial correlation test and ramsey test. the tests show that the asian journal of economics and empirical research, 2020, 7(1): 8-14 13 © 2020 by the authors; licensee asian online journal publishing group variables in model are normally distributed, no heteroscedasticity in the model, no serial correlation and there is parameter stability in the model. these results are presented below; table-6. post estimation test. post estimation test test f-stat prob serial correlation 3.6792 0.2137 heteroscedasticity 2.9746 0.1488 ramsey 0.0092 0.9296 jarque-bera normality 0.5799 0.7483 from table 6, the null hypothesis is that there is no serial correlation, no heteroscedasticity, the variables are normally distributed and there is parameter stability in the model. from the results obtained (f-stat and prob), the null hypothesis is to be accepted. we can therefore conclude that the estimated model is void of serial correlation, no heteroscedasticity, there is parameter stability in the model and the series are normally distributed. 6. conclusion and recommendation the empirical investigation into financial inclusion and inclusive growth provides an interesting result. it shows that financial inclusion does have both short-run and long-run positive effect on inclusive growth in nigeria. the finding shows high interest rate impede inclusive growth, but number of bank branches, level of liquidity in the economy, loans to rural dweller facilitate a more inclusive growth in the economy. this study therefore, recommends that more and improved financial services be made available at a reasonable cost to rural dwellers and the economy as a whole at a reasonably low interest rate so as to help them participate and contribute to national productivity. however, these financial services should be carefully monitored to make sure they are used productively as loan to private sector is revealed to affect inclusive growth negatively. this will help reduce inequality in the country and put the country in a path of inclusive growth. references abor, j.y., m. amidu and h. issahaku, 2018. mobile telephony, financial inclusion and inclusive growth. journal of african 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nigerian economic data. available from https://datacatalog.worldbank.org/dataset/world-development-indicators. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. asian journal of economics and empirical research 60 asian journal of economics and empirical research vol. 5, no. 1, 60-64, 2018 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2018.51.60.64 a link between oil price and stock market index: the case of three countries maya katenova1 zhanat syzdykov2 ( corresponding author) 1,2kimep university kazakhstan, kazakhstan abstract this study empirically explores the causal relationship between the stock market development and oil price in russia, uk and kazakhstan. with this aim, the data between 2000 and 2017 was used. this data was obtained from bloomberg. the data includes index kase, rts index, ftse index and oil price. in order to find out the dependence between oil price and indexes of united kingdom, russian federation and kazakhstan (ftse 100 index, rts index and index kase respectively) it was necessary to collect the data first of all. for the analysis it was decided to choose, as variables, the prices and trade volumes of chosen instruments. as it was mentioned previously, i looked through the 17-year period starting from january 1st, 2000 lasting january 1st, 2018. monthly data was retrieved from bloomberg. the purpose of the empirical analysis is to determine what kind of relationship, if any, exists between oil price and such stock indices as kase index, rts index and ftse index. this study investigates the interaction between the oil price and three indices. quite an interesting fact is that there are no any significant relationships between oil price and indexes studied. among all indices studied, index kase is the most dependent on oil prices. the least dependent index is ftse index. it is important to understand that every country has its own research environment and special features, which also could be researched independently. taking into consideration the importance of oil export earnings to the growth profile of the kazakhstani economy, higher oil export revenues would result in the growth of index kase. majority of companies listed in kazakhstani index are export oriented. thus, the study can serve as a promising avenue for further research. for example, for kazakhstan, some new research indicators can be added, such as weight of export and import. keywords: stock market index, oil price, russia, uk, kazakhstan. jel classification: stock market, oil price, ftse, rts, kase index. citation | maya katenova; zhanat syzdykov (2018). a link between oil price and stock market index: the case of three countries. asian journal of economics and empirical research, 5(1): 60-64. history: received: 31 may 2018 revised: 3 july 2018 accepted: 9 july 2018 published: 12 july 2018 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 61 2. literature review ............................................................................................................................................................................ 61 3. methodology ..................................................................................................................................................................................... 61 4. conclusion ......................................................................................................................................................................................... 63 references .............................................................................................................................................................................................. 64 bibliography .......................................................................................................................................................................................... 64 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2018.51.60.64&domain=pdf&date_stamp=2017-01-14 https://orcid.org/orcid-search/quick-search?searchquery=maya%20katenova https://orcid.org/orcid-search/quick-search?searchquery=zhanat%20syzdykov http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2018, 5(1): 60-64 61 1. introduction the main aim of the economic development of the country is to increase overall wealth, become stronger and achieve to be a respected player in the world arena. one of the ways to improve efficiency is to develop strong financial market. this research paper is going to look for the links between oil price and stock market index: in united kingdom, russian federation and kazakhstan. due to the high volatility of oil prices in recent years, the economy of some oil-producing countries has been on the verge of a crisis. in the list of such countries were russian federation and kazakhstan, who had faced the devaluation of national currencies right after the oil price fall. thus it would be interesting to look through the influence of such fluctuations on the economy of the countries. so, second objective which is going to be observed in this paper is the dependence of stock market index on oil price. it is expected that fluctuations in the price of oil affect the economy of developing and developed countries on different scales. this is happening due to the different industrialization levels. every country which has a financial market typically has its own stock market index, which consists from stocks of local companies from the most developed and perspective industries. thus, stock market index could be considered as a reflection of the economic condition of the country at a certain period of time. the indices of the uk, russian federation and kazakhstan include companies from 40, 14 and 5 industries respectively. due to this fact, third research question of this paper is going to observe the impact of the industrialization on the developing and developed countries. countries chosen for the research have their own indices, which serve as a measurement of stock market development at a certain point of the time: “kase index” for kazakhstan, “ftse 100” for uk and “rts” for russian federation. the youngest among all three is kase index, which emerged in the year 2000, thus this year is going to be considered as the starting point of the research. in order to find out the answers for these questions, historical monthly data (from year 2000 until 2017) of the stock market indexes of london stock exchange (index ftse 100), kazakhstani stock exchange (index kase) and russian trading system (index rts) is going to be observed. indexes prices, trade volume and returns will be compared with the data of generic oil in order to find out a dependence of expected market condition (historical) and exact market condition (actual). expected results of this thesis are going to be useful for the further research, especially if the answers for the research questions would be positive. 2. literature review many experts all over the world recognize the importance of oil price on the economy. different studies had examined various aspects of oil price and macroeconomic relationship for different countries. according to brown and yicel (2002) oil price definitely influence macroeconomic variables, such as, for instance, output, prices, gdp and unemployment. according to huang et al. (1996) oil stock price can be linked with the stock market with the usage of equity pricing model. at any point of time, price of equity can be equated to the discounted pv of the future net earnings. so, oil price shocks could be immediately reflected in the prices, which means that increase in oil price can reduce future net earnings and hence stock price is expected to be negatively correlated with the oil price shocks. analogically, most of the published literature on the topic documented a negative relationship between oil price and stock market activities chen (2010); masih et al. (2011); basher et al. (2012). however, there are articles, which still argue with this position. arouri et al. (2011) explored the linear and nonlinear long-term relationships between oil prices and stock prices. authors wanted to define, whether changes in oil price equally affect changes in a stock prices. the investigation was made on the basis of the post-1997 asian financial crisis: from january 01, 1998, to november 13, 2008. arouri et al. (2011) made a set of tests, which showed the existence of significant asymmetric cointegrating relationships between oil prices and several european stocks. abhyankar et al. (2013) presented the information on the link between stock market and oil price on the basis of japan. due to the fact that japan in not a country which produces oil, and forced to import it at a price which is set by the seller, an increase in oil price should theoretically have a negative consequence on the economy of japan. however, authors concluded, that “oil price shocks that arise from changes in aggregate global demand are positively correlated to returns on the japanese stock market”. which means, that an increase in oil price sufficiently increase the performance of japanese stock market. 3. methodology in order to find out the dependence between oil price and indexes of united kingdom, russian federation and kazakhstan (ftse 100 index, rts index and index kase respectively) it was necessary to collect the data first of all. for the analysis it was decided to choose, as variables, the prices and trade volumes of chosen instruments. as it was mentioned previously, i looked through the 17-year period starting from january 1st, 2000 lasting january 1st, 2018. monthly data was retrieved from bloomberg. two standard procedures of unit root test namely the augmented dickey fuller (adf) and phillips-perron (pp) tests are employed. tjtjtt ytrendyy    2110 (1) the augmented dickey fuller test (adf) is one of the most common unit roots tests for stationarity. the null hypothesis for this test is that there is a unit root, which means that the data is non stationary. alternative hypothesis states that the data is nonstationary. finally, the least squares method (ls) is employed. according to charnes et al. (1976) the method of least squares is a standard approach in regression analysis to approximate the solution of over determined systems. "least squares" means that the overall solution minimizes the sum of the squares of the residuals made in the results of every single equation. this study empirically explores the causal relationship between the stock market development and oil price in russia, uk and kazakhstan. with this aim, the data between 2000 and 2017 was used. this data was obtained from bloomberg. http://www.statisticshowto.com/probability-and-statistics/null-hypothesis/ asian journal of economics and empirical research, 2018, 5(1): 60-64 62 the data includes index kase, rts index, ftse index and oil price. table-1. unit root test unit root and stationarity adf (1%) adf (5%) pp (1%) pp (5%) critical values -3.48 -2.88 -3.48 -2.88 kase index 1.29 1.28 ftse index -1.19 -1.22 rts index -1.55 1.57 oil price -1.99 -1.94 1.45 1.48 source: unit root test from e-views as it was mentioned previously, first of all, it was necessary to make the data appropriate for further research. it can be observed from the table 1, that according to the adf and pp models we fail to reject the null hypothesis, which states that the data has unit root and is stationary, because it lies between the critical values -3,48 and -2,88 for both tests with 1% and 5% probabilities respectively. table-2. unit root test unit root test adf (1%) adf (5%) pp (1%) pp (5%) critical values 3.48 -2.88 -3,48 -2,88 kase index -6.87 -6.91 ftse index -9.96 -9.89 rts index -11.35 -11.42 oil price 10.45 10.51 11.24 11.28 source: unit root test from e-views table 2 reflects the results after we transform all-time series into natural logarithm values. as a result, according to the adf and pp models we can reject the null hypothesis, and state that the data doesn’t have unit root and is stationary, because it lies above the critical values -3, 48 and -2, 88 for both tests with 1% and 5% probabilities respectively. that means that the data become appropriate for further research, and with the usage of this results i can look through the correlation between kase index, ftse index, rts index and oil price. the results of the test could be observed in the table 4. there are 204 monthly observations, which cover a ten-year period of time starting in january 2000 and finishing in december 2017. first of all, oil price was employed. such indices as kase index, rts index and ftse index were employed in the study. the purpose of the empirical analysis is to determine what kind of relationship, if any, exists between oil price and such stock indices as kase index, rts index and ftse index. the least square method (ls) was applied to check relationship between dependent variables index kase = 8701191134.38 + 1957110.94384*oil price obtained coefficient has an expected “plus” sign, which implies positive influence on assets. the regression results show that change of oil price by one unit will lead to increase of the kase index value by 1957110.94 units. table-3. index kase and oil price dependent variable: index kase method: least squares date: 01/25/2018 time: 10:15 sample: 2000m01 2017m12 included observations: 204 coefficient std. error t-statistic prob. oil price 1957111. 602827.6 3.246551 0.0018 c 8.70e+09 7.10e+08 12.26016 0.0000 r-squared 0.130868 mean dependent var 1.08e+10 adjusted r-squared 0.118452 s.d. dependent var 2.54e+09 s.e. of regression 2.38e+09 akaike info criterion 46.05018 sum squared resid 3.98e+20 schwarz criterion 46.11342 log likelihood -1655.806 hannan-quinn criter. 46.07536 f-statistic 10.54010 durbin-watson stat 0.089219 prob (f-statistic) 0.000194 source: ordinary least squares from e-views the regression above has the right functional form that confirms f-statistic coefficient (10.54010) with small p-value (0.000194). at the same time, r-squared, this measures the proportion of the variation in the dependent variable – index kase accounted for by the explanatory variable oil price, equals to 0.130868. it means that regression model describes insignificantly than 13% of the pattern in the oil price. in other words, 1% increase in oil price leads to 13% increase in index kase. the regression also has positive autocorrelation in residuals according to durbin-watson statistic (0.089219). residuals of the regression have no normal distribution with kurtosis 3.0 and skewness -1.11. although the obtained coefficient is statistically significant in keeping with large t-statistic 3.246551 and small p-value, it cannot be reliable because of autocorrelation in residuals. the next step in the study was to analyze the relationship between oil price and rts index. asian journal of economics and empirical research, 2018, 5(1): 60-64 63 table-4. rts index and oil price dependent variable: rts index method: least squares date: 01/25/18 time: 10:18 sample: 2000m01 2017m12 included observations: 204 coefficient std. error t-statistic prob. oil price 3628495. 492928.0 7.361105 0.0000 c 79023539 1.48e+09 0.053532 0.9575 r-squared 0.107654 mean dependent var 1.08e+10 adjusted r-squared 0.1028276 s.d. dependent var 2.54e+09 s.e. of regression 1.92e+09 akaike info criterion 45.61715 sum squared resid 2.58e+20 schwarz criterion 45.68040 log likelihood -1640.218 hannan-quinn criter. 45.64233 f-statistic 54.18587 durbin-watson stat 0.880701 prob(f-statistic) 0.000000 source: ordinary least squares from e-views the results of the second regression are fully consistent with the results of the first one, 1% increase in oil price leads to 10,7% increase in rts index. the regression has right functional form with large f-statistic – 54.1859 and small p-value (0.000000). the coefficient of determination r2 equals 10.7654%. the value of this coefficient characterizes the fraction of variance in the dependent variable rts index that can be explained by regression, i.e. of the independent variable, which is oil price. accordingly, the value of 1 – r2 characterizes the proportion of variance of assets, caused by the influence of all the others taken into account in the econometric model. the regression also has got positive autocorrelation of residuals that confirms small durbin – watson statistics (0.880701). therefore, we cannot fully rely on the results of the regression. table-5. ftse index and oil price dependent variable: ftse index method: least squares date: 01/25/18 time: 10:21 sample: 2000m01 2017m12 included observations: 204 coefficient std. error t-statistic prob. gdp -893447.6 185428.0 -4.818299 0.0000 c 1.74e+09 2.18e+08 7.984789 0.0000 r-squared 0.049056 mean dependent var 7.77e+08 adjusted r-squared 0.038328 s.d. dependent var 8.41e+08 s.e. of regression 7.34e+08 akaike info criterion 43.69225 sum squared resid 3.77e+19 schwarz criterion 43.75549 log likelihood -1570.921 hannan-quinn criter. 43.71743 f-statistic 23.21601 durbin-watson stat 0.278177 prob(f-statistic) 0.000008 source: ordinary least squares from e-views the same conclusion can be done by looking at the last regression, where the durbin – watson statistic will be considered. this coefficient clearly shows the presence of positive autocorrelation of the disturbance terms. the last regression model reveals the relationship between oil price and ftse index. in this case, all coefficients show full statistical insignificance of the model. coefficient of determinations r2 is only 0.049056 which means that the regression describes only four percent of the phenomenon. 1% increase on oil price leads to 4,9% increase in ftse 100. f-statistic confirmed wrong functional form of the regression model and durbin watson statistic showed the presence of positive autocorrelation among disturbance terms. ftse index has lower dependence in comparison with index kase and rts index. 4. conclusion this study investigates the interaction between the oil price and three indices. quite an interesting fact is that there are no any significant relationships between oil price and indexes studied. among all indices studied, index kase is the most dependent on oil prices. the least dependent index is ftse index. it is important to understand that every country has its own research environment and special features, which also could be researched independently. taking into consideration the importance of oil export earnings to the growth profile of the kazakhstani economy, higher oil export revenues would result in the growth of index kase. majority of companies listed in kazakhstani index are export oriented. thus, the study can serve as a promising avenue for further research. for example, for kazakhstan, some new research indicators can be added, such as weight of export and import. moreover, after the devaluation of national currency in 2015, national bank of kazakhstan applied free floating exchange rate, which allows the legislator to control some economic components. for example, national bank of kazakhstan can artificially keep foreign exchange rate of national currency at a preditermined rate by trading tenge. this fact also might affect the results of my research due to the fact that such interventions also help to keep the preditermined inflation rate. when it comes to the russian federation, the results of my research are the most unexpected. oil and gas companies compose nearly half of the rts stock index, however according to the research, 1 % change in oil price affect only 10,7% change in the rts index. it can be considered, that there are also some environmental issues in the case. for example, further it can be checked how the anti-russian economic sanctions influences on the stock market and oil and gas industry. asian journal of economics and empirical research, 2018, 5(1): 60-64 64 when it comes to the ftse 100, it is still can be considered as one of the most stable and reliable economic indicator. however, it is still unclear in terms of ftse index and some internal and external shocks. monetary stability does not necessarily lead to financial market stability and the study did not explore the reason of british financial market stability. not only new indicators can be added, such as balance of trade data, export, import, inflation or gdp, but also some new oil extracting countries could be compared, such as mexico, brazil, iraq, iran and etc. moreover, as it can be observed from the literature review, there is a lot of different tests, methods and analysis’s, (for example var or garch) which also can be used in order to look though the impact of oil price and economy of the countries. so this paper may serve as a promising avenue for the further research. references abhyankar, a., b. xu and j. wang, 2013. oil price shocks and the stock market: evidence from japan. energy journal, 34(2): 199-222. view at google scholar arouri, m.e.h., p. foulquier and j. fouquau, 2011. oil prices and stock markets in europe: a sector perspective. recherches économiques de louvain/louvain economic review, 77(1): 5-30. view at google scholar | view at publisher basher, s.a., a.a. haug and p. sadorsky, 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publishing group asian journal of economics and empirical research vol. 6, no. 2, 186-196, 2019 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2019.62.186.196 © 2019 by the authors; licensee asian online journal publishing group dynamics of demographic structure and economic growth in nigeria joshua adeyemi ogunjimi1 dauda olarotimi oladipupo2 1,2department of economics, university of ibadan, nigeria. ( corresponding author) abstract this study evaluated the impact of demographic structure on nigeria‟s economic growth over the period between 1981 and 2016. employing the autoregressive distributed lag (ardl) framework and granger causality test, this study confirms the existence of a long-run relationship between the dependent and independent variables. the results showed that aged population has a negative impact on economic growth while children population and labour force stimulate growth of the nigerian economy thereby supporting the existence of the demographic dividend hypothesis. on the other hand, whereas a bidirectional relationship exists between aged population and economic growth in nigeria and a unidirectional causality runs from children population and labour force to real gdp, economic growth engenders gross fixed capital formation (investment) and school enrolment. hence, this study concludes that aged population, children population, labour force, gross fixed capital formation and secondary school enrolment constitute important determinants of economic growth in nigeria. therefore, this study recommends that the nigerian government provide incentives and platforms which will encourage old people to engage in productive activities and to continually develop human capital of the children and labour force as it would increase the effectiveness of labour and have growthenhancing effects on the nigerian economy. keywords: demographic structure, demographic dividend, ardl, granger causality, nigeria. jel classification: c22; j11; o47. citation | joshua adeyemi ogunjimi; dauda olarotimi oladipupo (2019). dynamics of demographic structure and economic growth in nigeria. asian journal of economics and empirical research, 6(2): 186-196. history: received: 20 august 2019 revised: 25 september 2019 accepted: 28 october 2019 published: 10 december 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 187 2. demographic structure and real gdp profile in nigeria .................................................................................................... 188 3. literature review .......................................................................................................................................................................... 189 4. methodology and empirical analysis ........................................................................................................................................ 190 5. conclusion and policy recommendations ................................................................................................................................ 195 references ............................................................................................................................................................................................ 195 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.62.186.196&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1151 http://orcid.org/0000-0002-5162-3326 http://orcid.org/0000-0001-7019-1533 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1151 http://orcid.org/0000-0002-5162-3326 http://orcid.org/0000-0001-7019-1533 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1151 http://orcid.org/0000-0002-5162-3326 http://orcid.org/0000-0001-7019-1533 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1151 http://orcid.org/0000-0002-5162-3326 http://orcid.org/0000-0001-7019-1533 asian journal of economics and empirical research, 2019, 6(2): 186-196 187 © 2019 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this paper contributes to the extant literature by providing detailed and comprehensive analysis of the impact of the demographic structure of nigeria on her economy by examining the extent to which each age structure influence aggregate output in the nigerian economy. 1. introduction every economy of the world aims to achieve the macroeconomics goals of price stability, economy growth, full employment, favourable balance of payment and improved standard of living, among others. the demographic structure of an economy plays a crucial role in the achievement of these macroeconomic goals. it can be disaggregated into dependent and independent (labour force) population. the dependent population is the population below and above the working age while the independent population is those in the labour force. theoretically, a country with more dependent population is expected to experience slow or negative economic growth while a country with high labour force tends to record positive growth as there are more than enough hands to improve the productivity of the economy (bloom et al., 2000; bloom and finlay, 2009). in other words, economic growth in a country is related to an increase in the share of its working-age population, a phenomenon referred to as “demographic dividend.” according to world development indicator (2018) the population of nigeria stood at approximately 45 million people in 1981 but has grew markedly by about 322 percent to approximately 190 million people in 2017. however, this positive population growth had not been optimally harnessed for economic growth and development in the country as the population upsurge appears to be more of a curse than blessing. the surge in population has increased the pressure on the few available social amenities (roads, houses, water, schools and hospitals, among others) in the country thereby leading to their dilapidation or complete destruction; crime rate and other social vices have also been on the increase especially in major cities in the country; and cost of living is on the increase while standard of living dwindles on regular basis. these make it increasingly difficult for the nigerian government to adequately provide quality social services to her citizens as every effort to do this is being frustrated. in a bid to effectively manage population growth in nigeria, policy-makers came up with different population policies overtime. they include: the national population policy of 1988, the national population policy for sustainable development of 2004 and the national population policy of 2006 whose goals are to improve the standards of living and the quality of life of nigerians; to promote the health and welfare of nigerians; to achieve lower population growth rates; to achieve even distribution of rural-urban population; and to prevent the causes and spread of hiv/aids pandemics in nigeria. there are also a number of institutions and agencies charged with the responsibility of managing nigeria‟s population. they include the national population commission (npc), national planning commission, the federal ministry of health, the national primary health care development agency (nphcda), the national health insurance scheme (nhis), and the national agency for food and drug administration and control (nafdac), among others. despite these legal and institutional frameworks, the population policies implemented over time seem not to have achieved the desired results. in addition, the persistent increase in the number of children who hawk, beg and do all kinds of menial jobs for survival is worrisome. there are two likely reasons for this malady: inadequate income or increase in dependency ratio or both. firstly, it could mean that the income of those on whom they should depend for a living is not enough to cater for them thus, they resort to fending for themselves. secondly, it could imply that the number of the dependent population increased at a rate higher than that of the labour force. the latter indicates a change in the demographic structure of the economy which obviously has implications for economic growth. the inability of employment opportunities to match the high population growth has led to widespread poverty, high rate of unemployment, high crime rate, and has also retarded and slowed down the economy of nigeria. in the first three quarters of 2016, nigeria experienced a fall in its aggregate national output and it was declared to be in recession. the recession had debilitating effects on the economy as inflation in the country was on the high side; governments, especially state governments, were unable to pay the salaries of their workers; a general fall in the standard of living accompanied by a very high cost of living; massive emigration of citizens to other countries of the world; tremendous increase in crime rate, terrorism, kidnapping and other social vices, and massive lay-off of workers in almost every industry in the country, among others. all these might not be unconnected from the demographic structure of the country hence, it is needful to assess the relationship between nigeria‟s demographic structure and her economic growth. the literature is awash with several studies on the issues relating population growth, demographic structure and economic growth in different countries of the world: india (prskawetz et al., 2007) china (wei and hao, 2010; zhang et al., 2014; gao and shao, 2016) ethiopia (wako, 2012) developing countries (ven and smits, 2011; atanda et al., 2012) and nigeria (eniang, 1977; bloom et al., 2007; bloom et al., 2010; nwosu et al., 2014; tartiyus et al., 2015; adenola and saibu, 2017). however, a critical review of the related studies in nigeria shows that most of the authors used data of the total population of nigeria to investigate the link between population and economic growth rather than total labour force (the working population of the economy) who are directly involved in the productive activities in the economy. on the other hand, they could have disaggregated population into different demographic structure so as to check for the individual contribution of each age group to productivity to aid comparison, a gap this study seeks to fill. the novelty of this study is its provision of a detailed and comprehensive analysis of the impact of the demographic structure of nigeria on her economy. it also seeks to contribute its quota to the existing literature, thereby expanding the frontier of knowledge on the relationship between demographic structure and economic growth in nigeria as it provides a basis for further research and also serve as a reference tool to other researchers who would work on related topic. it is against this background that this study seeks to answer the following research questions: (i) does the demographic dividend hypothesis hold in nigeria? (ii) is there is a long-run relationship between nigeria‟s asian journal of economics and empirical research, 2019, 6(2): 186-196 188 © 2019 by the authors; licensee asian online journal publishing group demographic structure and her economic growth? and (iii) which age structure has the most significant impact on economic growth in nigeria. the rest of this paper is structured as follows: section 2 encompasses stylized facts on demographic structure and output performance of the nigerian economy; section 3 contains literature review; the crux of section 4 is methodology and empirical analysis; and section 5 concludes the study by making policy recommendations. 2. demographic structure and real gdp profile in nigeria figure 1 reveals that the total labour force population (15-64 years) is greater than the children population (014 years) and the aged (65 years and above) both individually and collectively. the sum of the children and aged population gives the dependent population which depends on the labour force for their survival. when the number of the independent population (labour force) exceeds the dependent population, it is good for the economy but when it is otherwise, it retards growth. accordingly, figure 1 shows that the independent population exceeds the dependent population throughout the period under review which is good for the economy as it puts less pressure on the productive population (labour force). the dependency ratio is computed as the ratio of the dependent population (sum of the children and aged population) to the labour force. it is used to measure the pressure on the productive population. if the ratio is less than one, it shows that the dependent population is less than labour force and there is no pressure on the labour force; if it is greater that than one, it indicates that the dependent population exceeds the labour force thus mounting more pressure on them; and if the ratio is one, it implies that the dependent population is equal to the labour force. figure 1 shows that the dependency ratio stood above 86 per cent throughout the period under review. it reached an unprecedented height of 93 per cent in 1987, a year after the implementation of the structural adjustment programme (sap) of the world bank and international monetary fund (imf). however, it plummeted in subsequent years and was stable at about 87 per cent between 2000 and 2005 from when it began to rise steadily to 88 per cent in 2016. figure 2 shows the trend of the total male and female population of nigeria from 1981 to 2016. it reveals that both male and female population experienced significant increase overtime and they have a positive relationship even though it is apparent that there is arguably no significant difference between the male population and female population throughout the period under review. figure-1. dependent and independent population in nigeria (1981-2016). source: wdi (2018). asian journal of economics and empirical research, 2019, 6(2): 186-196 189 © 2019 by the authors; licensee asian online journal publishing group figure-2. total male and female population in nigeria (1981-2016). source: wdi (2018). figure 3 shows the trend of real gdp and demographic structure of nigeria from 1981 to 2016. it reveals that, like population, real gdp grew steadily throughout the period under review except for a few years, the most recent being 2016 when the nigerian economy plunged into a recession. the trend of real gdp implies that the nigerian economy experienced both positive and negative economic growth overtime. the upward trend which characterised the different demographic structure throughout the period under review implies an upward trend in the total population as the sum of the children population (0-14 years), labour force (15-64 years) and aged population (65 years and above) gives total population. thus, it can arguably be said that real gdp and population has positive relationship as they both moved in the same direction for most of the period under review. this implies that population could be a one of the drivers of economic growth in nigeria. figure-3. trend of real gdp and demographic structure of nigeria (1981-2016). source: wdi (2018). 3. literature review there are several studies on the relationship between demographic structure/population and economic growth in nigeria and other countries of the world. most of these studies were motivated by the explosion in population witnessed in different countries of the world especially in countries like china and india. empirical studies were carried out to examine how population change affects economic growth both in developed and developing asian journal of economics and empirical research, 2019, 6(2): 186-196 190 © 2019 by the authors; licensee asian online journal publishing group economies. most of the empirical findings concluded that population growth especially in labour force engenders economic growth. in their study on the chinese economy, gao and shao (2016) analysed the impact of population transition in china provinces on economic growth. the result supports the demographic dividend hypothesis. the findings of zhang et al. (2014) also support the demographic dividend hypothesis and revealed that the evolution of age structure accounts for about one-fifth of gdp per capita growth where a change in the internal demographic composition of the labour force accounts for over 50 percent. it was also found that the dynamics of age structure across provinces accounts for over one-eighth of the persistent inter-provincial income inequality. also, bloom et al. (2007) opined that increases in the proportion of the working age population can yield a demographic dividend that enhances the rate of economic growth. song (2013) found a negative influence of young population growth on economic growth but supports the demographic dividend hypothesis. this suggests that the favourable demographic structure accounts for the rapid growth of the asian economies. mason et al. (2008) quipped that longer life, lower fertility, and population aging all raise the demand for wealth to provide for old age consumption. similarly, by incorporating age structure dynamics into the growth equation and applying it to china‟s provincial-level data, wei and hao (2010) examined the economic implications of demographic change in china. they found that demographic structure changes, specifically a decline in fertility rate, have helped fuel the growth of the chinese economy. the channel through which demographic change affects income growth is primarily through its impact on steady state income levels and it is more evident in provinces where market forces operate. the result also showed a significant feedback effect between demographic behaviours (birth rates, life expectancy and marriage age) and economic growth. furthermore, joe et al. (2015) examined the impact of changing population age structure on performance of the chinese and indian economy. they found that unlike china, the slow pace of decline in birth rate had adverse effects on india's savings and growth potential, together with the magnitude and timing of her first demographic dividend. they further argued that high domestic savings and investments in the demographic dividend phase are crucial in neutralizing the adverse effects of population ageing and to foster sustainable growth. eniang (1977) averred that rapid population growth places an economy at a disadvantage for a two major reasons. first, it retards capital formation and second, it skews the demographic structure such that there is an increase in the low skilled and unskilled labour in the labour force. wako (2012) assessed the causal relationship between demographic factors and economic development in ethiopia. the results revealed a negative long run relationship between per capita income and population growth and a positive relationship between the former and growth of workers with bidirectional causality in both cases. similarly, brunow and hirte (2006) examined the relationship between age structure and regional economic growth and found evidence in favour of a strong positive impact of population age structure on real gdp per capita growth where the labour force below 45 years exerts the strongest positive impact. the result also supports the learning effects as it was found that a region with a relatively high share of individuals between 45 and 74 years have a relatively better performance than the average of its country whereas a high share of the young labour force have no significant impact. bloom et al. (2010) examined the prospects for economic growth in nigeria from a demographic change and human capital perspective. they found that nigeria has a substantial demographic opportunity on the horizon however, she lacks policy options with which to harness her demographic transition into indefinite sustained growth and unemployment, low job productivity, and low levels of human capital are highlighted as the major roadblocks to achieving these benefits. in the same vein, tartiyus et al. (2015) evaluated the impact of population growth on economic growth in nigeria. the result revealed a positive relationship between economic growth and population, fertility and export growth and an inverse relationship between economic growth and life expectancy as well as crude death rate. wongboonsin and phiromswad (2017) found that demographic structure affects economic growth differently in developed and developing economies. for developed countries, they found that an increase in the share of middle-aged workers has a positive effect on economic growth through institutions, investment and education channels. on the other hand, an increase in the share of the senior population has a negative effect on economic growth through institutions and investment channels. for developing countries, they found (but with weak evidence) that an increase in the share of young workers has a negative effect on economic growth through investment, financial market development and trade channels. aidi et al. (2016) found that fertility rate, mortality rate and net-migration are inversely related to economic growth in nigeria. similarly, nwosu et al. (2014) found that population growth has a significant impact on economic growth; and there is a unidirectional causality running from population growth to economic growth. akokuwebe and okunola (2015) argued that demographic dividend can be harnessed for the development of especially rural areas in transitional countries like nigeria. adenola and saibu (2017) examined the relationship between demographic change and economic growth in nigeria. they found that population has a positive but insignificant relationship with nigeria‟s economic growth. 4. methodology and empirical analysis 4.1. methodology since this study makes use of time series secondary data, preliminary tests of stationarity such as unit root test was conducted on each variable in the model. the unit root test would be carried out using augmented dickey fuller (adf) and phillips perron (pp) methods to determine the level of stationarity of the variables so as to guard against spurious regression. the autoregressive distributed lag (ardl) bounds test approach to cointegration would be conducted to determine the existence of long-run relationship between the dependent and explanatory variables. the choice of the ardl bounds test approach to cointegration is premised on the fact that it accommodates series that are stationary at levels [i(0)], first difference [i(1)] or both [i(0) and i(1)]. thereafter, i would proceed to the estimation of the dynamic (short-run and long run) relationships between the dependent and explanatory variables of the ardl models and further investigate the impacts of demographic asian journal of economics and empirical research, 2019, 6(2): 186-196 191 © 2019 by the authors; licensee asian online journal publishing group structure on economic growth in nigeria. then, diagnostic test would be carried out to check for the robustness of the model and see that the models do not violate any of the assumptions of the classical linear regression model (clrm). the granger causality test would also be run to check the direction of causality of the macroeconomic variables in the model. data for this study are sourced from world development indicator, 2018 edition, for the period between 1981 and 2016. 4.2. model specification this study analyses the impact of demographic structure on economic growth in nigeria for the period between 1981 and 2016. for the purpose of a comprehensive analysis and to investigate the contribution of age group to economic growth, demographic structure (labour) will be disaggregated into: labour force (15-64 years) and dependent population [children population (0-14 years) and the aged population (65 years and above)]. furthermore, gross fixed capital formation (gfcf) will be used as a proxy for capital while secondary school enrolment (sse) will be used to proxy technology. based on the foregoing and the theoretical framework employed in this study, the mathematical model for this study can be presented as: rgdp = f (gfcf, cpop, labf, apop, sse) (1) equation 1 suggests that economic growth is a function of gross fixed capita formation, children population, labour force, aged population and secondary school enrolment. to aid interpretation of the results in proportionate terms using elasticities, the variables are expressed in natural logarithm. thus, the econometric models can be specified as follows: lrgdpt = α0 + α1lgfcft + α2lcpopt + α3llabft + α4lapopt + α2lsset + ɛt (2) where: lrgdp = log of real gross domestic product (proxy for economic growth). lgfcf = log of gross fixed capital formation (proxy for capital). lcpop = log of children population. llabf = log of labour force. lapop = log of aged population. lsse = log of secondary school enrolment (proxy for technology). ɛt = disturbance term. the ardl representation of equation 2 is specified as: ∑ ∑ ∑ ∑ ∑ ∑ equation 3 is derived from equation 2 and the interpretation of each variable remains the same while δ denotes the first difference operator, α0 is the drift component, and ɛt is the error term. 4.3. preliminary analysis 4.3.1. descriptive statistics table 1 presents the descriptive characteristics of the macroeconomic variables used in this study. the average value of log of real gdp, log of aged population, log of children population, log of labour force, log of gross fixed capital formation and log of secondary school enrolment are 25.97, 15.02, 17.77, 17.95, 23.96, 3.41 respectively. this suggests that labour force dominates the population of nigeria as it is greater that both the aged and children population indicating that the dependency ratio in nigeria is less than 1 thus, economic growth will be engendered. furthermore, the skewness, kurtosis and probability values of the jarque-bera statistic show that all the macroeconomic variables incorporated in this study are normally distributed. also, the standard deviation of each variable is very low. table-1. descriptive statistics. statistics lrgdp lapop lcpop llabf lgfcf lsse mean 25.97 15.02 17.77 17.95 23.96 3.41 median 25.73 15.03 17.76 17.96 23.65 3.30 maximum 26.86 15.45 18.22 18.41 24.98 4.03 minimum 25.34 14.57 17.33 17.50 23.21 2.84 std. dev. 0.51 0.25 0.26 0.28 0.60 0.27 skewness 0.59 -0.06 0.06 -0.01 0.53 0.57 kurtosis 1.76 1.94 1.89 1.76 1.69 2.62 jarque-bera 4.41 1.71 1.87 2.29 4.26 2.14 probability 0.11 0.43 0.39 0.32 0.12 0.34 sum 934.95 540.66 639.83 646.20 862.72 122.89 sum sq. dev. 9.02 2.25 2.40 2.70 12.51 2.63 observations 36 36 36 36 36 36 where lrdgp =log of real gdp, lapop=log of aged population, lcpop=log of children population, llbaf=log of labour force, lgfcf=log of gross fixed capital formation and lsse=log of secondary school enrolment 4.3.2. unit root test routinely, the time-series properties of macroeconomic variables need to be ascertained when carrying out time-series analysis so as to guard against obtaining spurious results. the appropriate test for checking these timeseries properties is unit root test. it tests the null hypothesis of the presence of unit root as against the alternative asian journal of economics and empirical research, 2019, 6(2): 186-196 192 © 2019 by the authors; licensee asian online journal publishing group hypothesis of the absence of unit root. the decision rule is that the null hypothesis will be rejected and be alternative hypothesis accepted should the computed t-statistic be greater than the test critical values in absolute terms or the probability value be less than 0.1; it will be accepted and be alternative hypothesis rejected should the computed t-statistic be less than the test critical values in absolute terms or its probability value be greater than 0.1 or 10 per cent significance level. this study employs the augmented dickey-fuller (adf) and phillip perron (pp) unit root tests to check the order of integration of the macroeconomic variables of this study and the results are presented in table 2 the results of augmented dickey-fuller (adf) show that all the variables are stationary at first difference [i(1)] except log of children population that is stationary at level [i(0)]. similarly, the phillips-perron results show only log of gross fixed capital formation is stationary at level [i(0)] while all other variables are stationary at first difference [i(1)]. the unit root results show that the macroeconomic variables employed in this study are a combination of i(0) and i(1) series or are integrated of different orders. this condition makes the ardl bounds test approach to cointegration appropriate for investigating the long-run relationship among these variable. table-2. unit root test results. augmented dickey fuller (adf) phillips-perron (pp) level first difference i(d) level first difference i(d) lapop -2.82b -3.59b** i(1) -2.49b -3.61a** i(1) lcpop -19.36b* i(0) -1.43b -3.46b** i(1) lgfcf -2.09b -3.26a** i(1) -3.68b** i(0) llabf -1.71b -5.01a* i(1) -2.70b -3.02a** i(1) lrgdp -2.28b -4.66b* i(1) -2.70b -3.02a** i(1) lsse -2.20b -6.28b* i(1) -2.42b -6.42a* i(1) note: *, ** and *** represent statistical significance at 1%, 5% and 10% level respectively; „a‟ denotes model with constant and „b‟ is for model with trend and constant and trend. i(0) and i(1) indicate stationarity at level and first difference respectively. 4.3.3. ardl bounds test approach to cointegration following the unit root tests results, cointegration test is carried out using the ardl bounds test approach. this is because this techniques accommodates the series that are integrated of different orders [(i(0) and i(1)] unlike the engle-granger and johansen cointegration test which accommodate only series that are stationary at first difference [i(1)]. it tests the null hypothesis of “no long-run relationship” where the decision rule is that the null hypothesis be rejected should the value of the computed f-statistic exceed the upper bound and not rejected should it fall below the lower bound. however, the bounds test will be inconclusive should the computed f-statistic fall between the lower and upper bound. accordingly, table 3 presents the result of the ardl bounds test and revealed that the result is adjudged inconclusive because the computed f-statistic (3.76) falls between the lower bound and the upper bound critical value at 5 percent level of significance. this implies that the long run relationship among the variables (dependent and independent) is unascertained. hence, it is needful to proceed to estimating the short-run and long-run ardl model. table-3. ardl bounds test result. significance level critical value computed f-statistics lower (i0) bound upper (i0) bound 1% 3.41 4.68 5% 2.62 3.79 3.76 10% 2.26 3.35 the bounds critical values for k=5are obtained from narayan (2005) case iii for 40 observations. 4.4. presentation and interpretation of the result 4.4.1. analysis of the short-run ardl model results table 4 present the results of the estimated short-run ardl model. firstly, the coefficient of the error correction term follows a priori expectation as it is negative, less than one in absolute value and statistically significant at 1 per cent significance level. this suggests that there is actually a long run relationship among the variables in the model as against the bounds test result that adjudged it inconclusive thus, the error correction term confirms the existence of a long-run relationship among the variables. the error correction term shows the speed of adjustment of the dependent variable from a short-run disequilibrium in the previous period to its longrun equilibrium in the current period. accordingly, the coefficient of the error correction term (-0.85) suggests that the speed of adjustment from a short-run deviation such as population explosion is quite fast as about 85 percent of the disequilibrium in real gdp resulting from the shock in the previous period will converge to the long-run equilibrium in the current period. in addition, the coefficient of the first period lag of log of real gdp and its associated probability value show that the expectations about real gdp growth in nigeria is adaptive in nature because the previous value of real gdp constitutes an important determinant of its present value. furthermore, the result shows that aged population is inversely related to economic growth in nigeria such that an increase in aged population by 1 percent will, on the average, slow down the economic growth by about 4.32 percent. this result is plausible and is in line with a priori expectation. economic theory classifies the aged together with children as dependents who rely on the working population for their survival. hence, rather than increase productivity and output, they contribute to its decline. this result parallels the findings of wei and hao (2010); gao and shao (2016) and wongboonsin and phiromswad (2017). it also implies that aged population is one of the determinants of economic growth in nigeria. in addition, the result shows that children population has a positive and significant relationship with economic growth. specifically, an increase in child population by 1 percent will, on the average, stimulate economic growth asian journal of economics and empirical research, 2019, 6(2): 186-196 193 © 2019 by the authors; licensee asian online journal publishing group by 4.04 percent. this result is in sharp contrast with a priori expectation and with the findings of wei and hao (2010) and gao and shao (2016). however, this result depicts the true picture of nigeria. nigeria is a country where child abuse is prevalent and children are left to fend for themselves. oftentimes, children of school age are found hawking and trading on highways during school hours. this could be traced to the high poverty rate and unemployment rate in the country which has made it extremely difficult for parents to provide for their wards. this result implies that the contribution of these children to productive and commercial activities in nigeria is significant. the result also shows that labour force has a significant (at 10 percent significance level) positive relationship with economic growth thus confirming the existence of demographic dividend in nigeria. specifically, the result show that an increase in labour force by 1 percent will lead to approximately 1.21 percent increase in economic growth. this implies that the nigerian economy responds sharply to changes in labour force thus suggesting that labour-intensive production must be engendered for nigeria to experience more economic growth. this result parallels economic theory and the findings of brunow and hirte (2006); wei and hao (2010); ven and smits (2011); gao and shao (2016), song (2013); akokuwebe and okunola (2015); zhang et al. (2014) and wongboonsin and phiromswad (2017). in sum, of the three age groups in this study, aged population has the greatest influence on economic growth in nigeria albeit negative. this could be attributed its high growth rate in relation with other age groups. moreover, in line with a priori expectation, the coefficient of gross fixed capital formation has a positive sign indicating a significant positive relationship with economic growth in nigeria. specifically, the nigerian economy will grow by approximately 0.15 percent if gross fixed capital formation increases by 1 percent. this suggests that capital is an important driver of economic growth in nigeria although its influence on economic growth is not as great as that of labour force. this suggests that for the nigerian economy to experience sustainable and inclusive economic growth, there is a need to combat unemployment and create conducive environment where investment in both capital and labour will thrive. in addition, school enrolment has a significant positive relationship with economic growth such that an increase in school enrolment by 1 percent will, on the average, lead to an increase in economic growth by 0.24 percent. this result is plausible and in line with theoretical expectation. it suggests that education is an important determinant of economic growth in nigeria thus investing in education will further stimulate the growth of the nigerian economy. table-4. short-run estimates. variable coefficient t-statistic prob. d(lrgdp(-1)) 0.353405 2.362436 0.0259 d(lapop) -4.326803 -3.269020 0.0030 d(lcpop) 4.042570 2.460311 0.0208 d(lgfcf) 0.147738 3.169403 0.0039 d(llabf) 1.210393 1.796499 0.0840 d(lsse) 0.242220 2.097318 0.0458 ecm(-1) -0.853035 -5.905293 0.0000 ecm = lrgdp (-5.0722*lapop + 4.7390*lcpop + 0.1732*lgfcf + 1.4189*llabf + 0.2840*lsse -12.6817) r-squared 0.9943 f-statistic 648.52 (0.0000) adjusted r-squared 0.9928 durbin-watson stat 1.8795 on the other hand, the adjusted r-squared result (0.992) indicates that about 99 percent of the variation in the real gdp can be explained by aged population, children population, labour force, gross fixed capital formation and school enrolment. this implies that this model has a very high explanatory power and could be used for policy prescription. in the same vein, the probability value of the f-statistic shows that aged population, children population, labour force, gross fixed capital formation and school enrolment jointly influence economic growth in nigeria. it is noteworthy that all the explanatory variables are individually significant in influencing economic growth in nigeria so, their joint significance is not surprising. moreover, the value of the durbin-watson statistic shows the absence of autocorrelation in this model. 4.4.2. analysis of the estimated long-run model results table 5 presents the long-run result of the estimated ardl model. as is the case in the short run model, a significant negative relationship exists between aged population and economic growth in nigeria in the long run such that economic growth will plummets by approximately 5.07 percent if aged population increases by 1 percent. this shows that degree of responsiveness of economic growth in nigeria to a change in aged population is very high. this result is plausible and in consonance with economic theory which posits that demographic dividends tend to decline as dependent population increases. interestingly, the influence aged population has on economic growth in the long-run is greater than in the short-run. on the other hand, the result shows that children population has a positive effect on economic growth in nigeria in the long run. in particular, economic growth will increase by approximately 4.74 percent if children population increased by 1 percent. this finding contrast theoretical postulation but typically depicts the case of nigeria. similar to the coefficient of the aged population, the coefficient of children population shows that children population influences economic growth more in the long-run than the short-run. moreover, a significant positive relationship was found to exist between labour force and economic growth in nigeria in the long run thus justifying the existence of demographic dividends in nigeria. in particular, economic growth will be stimulated by about 1.41 percent should labour force increase by 1 percent. this shows the importance of labour force in engendering economic growth in nigeria in the long-run. in other words, it suggests that labour force constitutes an important determinant of long-run economic growth in nigeria. interestingly, the impact of labour force on economic growth in the long-run outweighs its short-run impact. asian journal of economics and empirical research, 2019, 6(2): 186-196 194 © 2019 by the authors; licensee asian online journal publishing group similarly, the coefficients of gross fixed capital formation and school enrolment are positive indicating that they have a positive relationship with economic growth in nigeria in the long run. specifically, an increase in gross fixed capital formation and school enrolment by 1 percent will stimulate economic growth in nigeria by approximately 0.17 percent and 0.28 percent respectively. this result complies with theoretical expectations as well as empirical findings which posit that capital and technology (education) are important drivers of long-run economic growth. summarily, the long run results show that aged population, children population, labour force, gross fixed capital formation and school enrolment all influence long-run economic growth in nigeria. in other words, aged population, children population, labour force, gross fixed capital formation and school enrolment constitute important determinants of long-run economic growth in nigeria. table-5. long run estimates. variable coefficient t-statistic prob. lapop -5.072246 -3.524753 0.0016 lcpop 4.739044 2.693865 0.0122 lgfcf 0.173191 4.282360 0.0002 llabf 1.418926 1.729186 0.0956 lsse 0.283951 2.232652 0.0344 c -12.681700 -2.763046 0.0104 table 6 presents the results diagnostic (post-estimation) tests carried out to check the appropriateness of the model for policy formulation. it is a standard practice that before the empirical results of a study can be adjudged valid for policy formulation, diagnostic tests need to be carried out to ensure that the estimated model conform to or does not violate the assumptions of the classical linear regression model (clrm). specifically, the diagnostic tests include: test for normality, serial correlation, heteroscedasticity and correct specification form. the null hypotheses are: the errors are normally distributed, there is no serial correlation, errors are heteroscedastic and the model is correctly specified respectively. the decision rule is that if the probability value of each test is less than 5 per cent level of significance, the null hypothesis will be rejected but accepted if more than 5 per cent significance level. accordingly, the probability of all the diagnostic tests are more than 5 per cent hence, all the null hypotheses will be accepted. this suggests that the estimated model fulfils all the assumptions of clrm in that the model is correctly specified and its errors are normally distributed, homoscedastic and free from serial correlation. intuitively, this indicates that the results and findings of this study are appropriate for policy formulation and prescription. table-6. diagnostic tests. diagnostic tests test statistics jarque-bera normality test 0.371288 (0.8306) breusch-godfrey serial correlation lm test 0.325323(0.8499) heteroscedasticity test (arch) 2.672393(0.1021) ramsey reset test 4.080526( 0.0542) n.b: probability values are in parenthesis. 4.4.3. analysis of the granger causality test results granger-causality test is carried out in this study to further establish the existence of relationship between demographic structures and economic growth in nigeria. the granger-causality test is designed to determine the direction of causal relationship between macroeconomic variables. there are basically three kinds of relationship outlined by this test: bidirectional, unidirectional and neutral, relationship. bidirectional relationship exists when the two variables in question granger-causes each other; unidirectional relationship exists when the one of the two variables in question granger-causes the other; and a neutral directional relationship exists when none of the two variables in question granger-causes each other. the granger-causality test tests the null hypothesis of no granger-causality between two variables. the decision rule is that if the probability value of each test is less than 10 per cent level of significance, the null hypothesis will be rejected but accepted if more than 10 per cent significance level. the granger-causality test results are presented in table 7 accordingly, the results show that there is a bidirectional relationship between aged population and economic growth in nigeria indicating that aged population influences economic growth and vice versa. on the other hand, children population and labour force have a unidirectional causal relationship with economic growth in nigeria. the nature of the relationship suggests causality runs from children population and labour force to economic growth. in addition, there is a unidirectional causal relationship running from gross fixed capital formation and school enrolment to economic growth in nigeria. this suggests that when the nigerian economy grows, it engenders a surge in gross fixed capital formation (investment) and school enrolment. this result is plausible in that it reveals that investment as well as education will thrive when an economy experiences growth. in sum, these results give further credence to the results of the estimated ardl model. asian journal of economics and empirical research, 2019, 6(2): 186-196 195 © 2019 by the authors; licensee asian online journal publishing group table-7. pairwise granger causality tests. null hypothesis: obs f-statistic prob. lapop does not granger cause lrgdp 34 3.11520 0.0595 lrgdp does not granger cause lapop 7.27334 0.0028 lcpop does not granger cause lrgdp 34 7.03853 0.0032 lrgdp does not granger cause lcpop 0.94494 0.4003 llabf does not granger cause lrgdp 34 4.71573 0.0169 lrgdp does not granger cause llabf 0.55807 0.5783 lgfcf does not granger cause lrgdp 34 2.33080 0.1152 lrgdp does not granger cause lgfcf 14.7269 0.0000 lsse does not granger cause lrgdp 34 1.40277 0.2621 lrgdp does not granger cause lsse 6.89288 0.0036 5. conclusion and policy recommendations the effects of demographic structure on economic growth cannot be overemphasized thus, researchers from different parts of the world have made efforts at discovering these effects. given the high rate of poverty and unemployment in nigeria, it became imperative to examine the link between demographic structure and economic growth to actually see if demographic structure has a role to play in determining economic growth in nigeria. hence, this study was carried out to examine the effects of demographic structure on economic growth in nigeria using the ardl framework to estimate the specified short-run and long-run equation. sequel to the empirical findings of this study, this study concludes that demographic structure plays a pivotal role in the performance of the nigerian economy. specifically, aged population has a negative impact on economic growth while children population as well as labour force stimulates the growth of the nigerian economy both in the short-run and long-run. however, their impacts are greater in the long-run than the short-run. it was also found that gross fixed capital formation and school enrolment are important drivers of economic growth in nigeria. on the other hand, this study concludes that whereas a bidirectional relationship exists between aged population and economic growth in nigeria and a unidirectional causality runs from children population and labour force to real gdp, economic growth engenders gross fixed capital formation (investment) and school enrolment. hence, this study concludes that aged population, children population, labour force, gross fixed capital formation and secondary school enrolment constitute important determinants of economic growth in nigeria. the implications of these findings for the nigerian economy are hereby discussed. first, the negative impact of aged population on economic growth suggests that the increase in the population of old people is one of the variables responsible for the slow growth of the nigerian economy as they do not engage in productive activities any longer therefore, government can provide incentive and platforms which will encourage old people to engage in productive activities and make adequate provisions to cater for them at this stage of their lives. second, the positive impact children population, school enrolment and labour force has on economic growth in nigeria suggests that there is need to continually develop human capital as it would increase the effectiveness of labour which will have growth-enhancing effects on the nigerian economy. references adenola, f. and o.m. saibu, 2017. does population change matter for long run economic growth in nigeria? international journal of development and sustainability, 12(6): 1955-1965. aidi, h.o., c. emecheta and i.m. ngwudiobu, 2016. population dynamics and economic growth in nigeria. journal of economics and sustainable development, 7(15): 16-24. akokuwebe, m.e. and r.a. okunola, 2015. demographic transition and rural development in nigeria. developing country studie, 5(6): 90102. atanda, a.a., s.b. aminu and o.y. alimi, 2012. the role of population on economic growth and development: evidence from developing countries. munich personal repec archive (mpra) paper no. 37966. 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https://doi.org/10.1016/j.jce.2014.07.002. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 193 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 2, 193-206, 2020 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2020.72.193.206 © 2020 by the authors; licensee asian online journal publishing group influence of environmental degradation and economic growth on co2 emissions: evidence from developing countries rabnawaz khan1 yusheng kong2 jin xinxin3 ( corresponding author) 1school of finance and economics, jiangsu university, zhenjiang, jiangsu, zhenjiang, people’s republic of china. 2professor, dean in the school of finance and economics, jiangsu university, zhenjiang, people’s republic of china. 3school of literature and language, jiangsu university, zhenjiang, jiangsu, zhenjiang, people’s republic of china. abstract china is working to revive the ancient on the silk road trade routes from asia to europe and promote the corporation of energy production with trade under its transactional megaproject the belt and road (bri) initiative. we investigate the relationship between energy consumption and economic growth of regions in this paper along with bri using panel data for 55 countries during the period of 1970-2015. by assessing vector error correction model (vecm), fully changed ordinary least squares (fmols) and dynamic ordinary least squares regression (dols) with first generation test. the statistical finding there is evidence from long-run bidirectional causalities among co2 emissions, energy use per capita, gdp per capita, manufacturing industries and fossil fuel energy consumption. hence, there is unidirectional short-run causality running from gdp to renewable energy in south asia bri listed countries and bidirectional causality between consumption of energy and gdp per capita in the long run east asia (australia, brunei, indonesia, malaysia, myanmar, vietnam), europe & central asia (azerbaijan, kazakhstan. russian, turkmenistan, uzbekistan) and middle east & north africa (bahrain. egypt, iran, iraq, kuwait, oman, qatar, uae, yemen). the results confirm the renewable energy and fossil energy consumption and manufacturing industries. these outcomes suggest significant provision in the economies and trade of china with different countries in the belt and road regions. keywords: co2 emission, economic growth, regional classification, belt road initiative (bri). jel classification: f43, f64, o11, q32. citation | rabnawaz khan; yusheng kong; jin xinxin (2020). influence of environmental degradation and economic growth on co2 emissions: evidence from developing countries. asian journal of economics and empirical research, 7(2): 193-206. history: received: 28 may 2020 revised: 3 july 2020 accepted: 5 august 2020 published: 17 august 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 194 2. literature review .......................................................................................................................................................................... 195 3. data and methodology ................................................................................................................................................................. 195 4. result ................................................................................................................................................................................................ 198 5. conclusions ..................................................................................................................................................................................... 205 references ............................................................................................................................................................................................ 205 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.72.193.206&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/2029 http://asianonlinejournals.com/index.php/ajeer/article/view/2029 asian journal of economics and empirical research, 2020, 7(2): 193-206 194 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study is unique based on economic growth, likewise the prior research is not investigated the dynamic link between developing countries energy-consumption and economic growth. investigating economic growth and co2 emissions by manufacturing industries. moreover, the innovation of this study is indicated that there is evidence from long−run bidirectional causalities among co2 emission, energy-use per capita, per-capita of gdp, industrialization and remnant fuel energy-consumption. 1. introduction china’s belt and road initiative (bri), start emergent strategies and provides coincidental to build trade between south asian countries and europe, aims to build trade and infrastructure by one silk road and coordinate with african countries, the trade road has it a roadblock in seven countries and later join other countries. in pakistan, the china is developing baluchistan province, and an estimated $63 billion will invest in china-pakistan economic corridor (cpec), developing airports, highway and beijing aims to link landlocked with a western region to gwadar. this game changer does not influence; it will change the level of consumption and need for goods. although environment effects on bri listed countries and developing strategies will boost economy but influence on environment by pollution. the wide variety of chinese products capture a major part of the pakistani local market and resulted in closing down many industries while others are struggling to survive. hence the fuel emission indicated by the fuel import, percentage of merchandise export employs that highest fuel rate was 17.40% in 2013 (bank, 2013) in china and 35.14% in pakistan same year. figure 1. the problem of energy security and climate have drawn increasing attention in worldwide and international energy agency (iea) have declared through global energy demand. the growth is projected to slow until 2040, and total energy need will increase 30% by china and india. the transport sector, as a main energy consumer sector and sources of greenhouse (ghg) emission, its concern for sustainable development, in 2015 there was 24% co2 emission occurred by fuel consumption (liu., zhao, liu, & hao, 2018); (mirza & kanwal, 2017). the 79% developed countries are responsible for enormous co2 emission and two fifth pollution (60% co2) emission responsible countries are china and usa. these top polluters countries are accountable for a huge global warming, and 11 billion tons co2 it records emission in the china with 1.36 billion population in the period of 2013. the usa is one of the top developed. figure-1. fuel consumption. source: tm.val.fuel.zs. un. country and co2 emission from only gaseous fuel consumption is only 1.43 million kt, that account for 21.72% of all over the world co2 emission in 2014 and china, russia, iran and japan were 48.97% with 6.6 millions of fuel gaseous. the export and infrastructure of china is promoting economic trade and great important to climate change and energy consumption (zhang, liao, & hao, 2018). i vow the president of china to keep resolving climate projects. the global warming has already showed a massive change in climate cause of huge production, infrastructure, cement and steel extensive fossil energy consumption and turn to engender of co2 emission (zhao, zhang, & shao, 2016). as a result, the environment quality will improve and we accept alternative development as a real solution for lower carbon emissions. some developing countries have enormous renewable resources and there is a large gap in the development level of energy between developing to developed countries (schwerhoff & sy, 2017). noteworthy that, china-pakistan economic corridor (cpec) could serve as affective and slushy platform of economic development not only pakistan and china, other relevant countries their economy in a different level. the more significant aim is to share co2 emissions and reduce it by different projects. this study is unique because of economic growth, likewise the prior research papers have investigated the dynamic link between developing countries’ energy consumption and economic growth (ito, 2017; kong & khan, 2019; liu. et al., 2018; tian, bai, jia, liu, & shi, 2019). the prior investigations have not showed the regional effects by states likes, 12 east asia (ea), 4 south asia (sa), 26 south asia countries (sec) and 13 middle east and north africa (mena). the logical structure of this paper highlights the relationship between energy and economic growth of regions and causes of co2 emissions by development change. this study promotes the use of renewable vitalities that constantly replenished not directly diminish. environmental degradation and economic growth cause air contamination in the regions and produce a huge flow of co2 emissions for developing countries. when countries burn fossil fuels like petroleum gas, coal, carbon dioxide and other gases released into environments so these emission trap heat to the earth and the sea https://economictimes.indiatimes.com/news/international/world-news/chinas-bri-initiative-hits-roadblock-in-7-countries-report/articleshow/63771550.cms https://economictimes.indiatimes.com/news/international/world-news/chinas-bri-initiative-hits-roadblock-in-7-countries-report/articleshow/63771550.cms https://www.cgdev.org/media/who-caused-climate-change-historically https://www.businessinsider.com/these-6-countries-are-responsible-for-60-of-co2-emissions-2014-12 https://www.businessinsider.com/these-6-countries-are-responsible-for-60-of-co2-emissions-2014-12 https://data.worldbank.org/indicator/tm.val.fuel.zs.un https://knoema.com/atlas/topics/environment/emissions/co2-emissions-from-gaseous-fuel-consumption?action=export&gadget=tranking-container. https://knoema.com/atlas/topics/environment/emissions/co2-emissions-from-gaseous-fuel-consumption?action=export&gadget=tranking-container. http://fortune.com/2017/05/15/china-xi-jinping-belt-road-summit-protectionism/ http://fortune.com/2017/05/15/china-xi-jinping-belt-road-summit-protectionism/ https://www.sciencedirect.com/topics/earth-and-planetary-sciences/global-warming https://www.sciencedirect.com/topics/earth-and-planetary-sciences/global-warming https://www.sciencedirect.com/topics/earth-and-planetary-sciences/energy-consumption https://www.sciencedirect.com/topics/earth-and-planetary-sciences/energy-consumption https://www.sciencedirect.com/topics/earth-and-planetary-sciences/environmental-quality https://www.sciencedirect.com/topics/earth-and-planetary-sciences/environmental-quality https://www.sciencedirect.com/topics/earth-and-planetary-sciences/carbon-emission https://www.sciencedirect.com/topics/earth-and-planetary-sciences/carbon-emission https://www.sciencedirect.com/topics/earth-and-planetary-sciences/renewable-resource https://www.sciencedirect.com/topics/earth-and-planetary-sciences/renewable-resource http://www.cpecinfo.com/cpec-news-detail?id=mtc4nw== asian journal of economics and empirical research, 2020, 7(2): 193-206 195 © 2020 by the authors; licensee asian online journal publishing group levels have led to a higher cause of the earth’s rising temperature, extreme storms that stem from a changing climate. the literature, dataset estimation, results and conclusion and recommendations in sections 2, 3, 4 and 5. 2. literature review in 1970, the oil and energy crisis has examined and energy consumption count as a paired factor of labor, capital production in the economic growth (korppoo & kokorin, 2017; ozcan, 2013; solow., 1974). the empirical analysis emphasis by granger causality test between energy and economic growth and classifies the econometric method based on variable selection and data sets. the early mainstream study has been classified and determined the facts of energy and industrial development regarding gdp and per capita of gdp (soytas, sari, & ewing, 2007). table-1. literature review of economic growth and co2 emission. study datasets econometric techniques period outcomes liu and hao (2018) 69 countries vector error correction model (vecm), fully modified ols (fmols) and dynamic ols (dols) approaches, 1970 and 2013. the nexuses of the energy consumption and economic developments vary across different subgroups. for the entire group, there is evidence of long−run bidirectional causalities among carbon emissions, energy use, industry value added and gdp per capita cheng et al. (2017) g6 countries error-correctionbased granger causality 1990– 2012. that economic growth can indeed cause increases in energy consumption hao, wang, zhu, and ye (2018) oecd countries the vector errors correction model (vecm) 19952010 causal relationship from rural gdp to rural investment and bilateral causal relationship between rural gdp and rural energy consumption in the short run. zhang et al. (2018) 30 individual chinese provinces ardl 1970 empirical evidence suggests the existence of energy consumption per capita in some provinces. kahia, ben aïssa, and charfeddine (2016) data of 429 observations for 13 mena noecs. panel errorcorrection model 1980 to 2012 long run causality for the two samples. mirza and kanwal (2017) pakistan ardl approach 2014 dynamic causality between energy consumption, economic growth and co2 emission. kohler (2013) south african ardl approach, engel granger method. 19602009 per capita has significant long positively effect in level of co2. find bidirectional causality between in income per capita and foreign trade. pao and fu (2013) the annual data for brazil’s real gdp, capital, labour and different types of energy consumptions the vector error correction models reveal a unidirectional causality 1980– 2010 that brazil is an energy-independent economy and that economic growth is crucial in providing the necessary resources for sustainable development. countries have the different economic characteristic that may have the different direction of causality with different policies, here the study explore the relationship between emission and the growth in individual countries table 1 and how the fuel import (% merchandise import) effects this project in different angles. the infrastructure of pakistan divers on modern strengthen and transportation networks, with many and determined projects. cpec project becomes operational when chinese cargo transported overland of gwader port for onward africa and west asia by maritime shipment. 3. data and methodology 3.1. sample and variables the data period covers 1970-2015 for a panel comprising the 55 countries. the one belt one road showed seven components of economic growth (6 economics and 1 merchant silk road), the economic corridor was consisting with 6 countries with the name of cpec in 2013. table 2 is an explanatory variable definition with a source of data used for analysis. we use henceforth part of preceding studies in the pragmatic analysis figure 2. we conduct the sources of the database from the base (2015) and databases (2015) data. in the terms of total primary energy supply (tpes), re represent renewable energy (re) including the primary energy equivalent of hydro (excluding pumped storage), solar, geo-thermic, tide and wave sources. https://www.sciencedirect.com/topics/engineering/energy-utilization https://www.sciencedirect.com/topics/engineering/energy-utilization https://www.sciencedirect.com/topics/engineering/causality https://www.sciencedirect.com/topics/engineering/sustainable-development http://www.gwadarport.gov.pk/ http://www.gwadarport.gov.pk/ https://en.wikipedia.org/wiki/china%e2%80%93pakistan_economic_corridor https://en.wikipedia.org/wiki/china%e2%80%93pakistan_economic_corridor asian journal of economics and empirical research, 2020, 7(2): 193-206 196 © 2020 by the authors; licensee asian online journal publishing group while cmic and ffe influence the infrastructure of this mega project, high manufacturing and export development creating negative aspects on environments by co2. per capita increase the wealth also increases co2 emissions in different development sectors. it shows table 3 the mean of indicators with a standard deviation. figure-2. region distribution of countries. sources: east asia (ea), south asia countries (sec), europe & central asia (e&ca), middle east & north africa (mena). east asia (ea), south asia countries (sec), europe & central asia (e&ca), middle east & north africa (mena) in this empirical method, in what we follow, we test all explanatory variables in panel data, in case of nonstationary, we investigate the long run prevailing cointegration relationship and investigate their magnitude by long-run stationary. the panel cointegration test with panel unit root test applied on all variables, which allow the serial correlation among a cross section i.e. the so-called 2nd generation test. therefore, it is essential to estimate the stationary of each explanatory variable by a unit root test. the reliability of variables ensure by four unit root test (levin, lin, & chu, 2002) which include ips augmented test used by cross-sectional (im, 2003; levin et al., 2002; pesaran, 2007) used for panel unit root test and so far panel co-integration estimated error-correction by westerlund (2007). table-2. variables description for the analysis. variables definition unit measurement time frame availability data sources re renewable energy 1000 toe (tonne of oil equivalent) 1960-2017 oecd c co2 emission metric tons per capita 1960-2014 world bank (en.atm.co2e. pc) ep energy use per capita kilograms of oil equivalent per capita 1960-2015 world bank (eg.use.pcap.kg.oe) iva industry value added % of gdp 1994-2016 world bank (nv.ind.totl. zs) gdpc gdp per capita growth constant 2010 us$ 1960-2017 world bank (ny.gdp.pcap. kd) cmic co emissions from manufacturing industries and construction % of total fuel combustion 1960-2014 world bank (en.co2.manf. zs) ffe fossil fuel energy consumption % of total 1960-2015 world bank (eg.use.comm.fo.zs) table 4 shows unit root test on a level. in the level case, we cannot reject the null hypothesis, except for the gdp per capita growth, co2 emission, arm import trend, commercial service export, and inflation gdp deflator. table 5 shows padroni residual co-integration test with newey-west automatic bandwidth. 3.2. econometric methods whether or not the panel data processes are stationary specifies in the regression's selection model, if the panel data process is non-stationary, the conformist ols estimation method would lead and solve a spurious problem in regression. show the dependent variable where regressed on to get . equation. [1] is shows the dependent variable where regressed on to get and effect showed by null hypothesis and deterministic trend is . ∑ (2) the equation. [2] shows a dependent variable in 1st order lag, also i s a vector that contains all explanatory variable. is the autoregressive coefficient and variable is equal to − . meanwhile, the null hypothesis , is equal to zero, and there is a parameter of a unit root. when an is negative, so it shows that we reject the null hypothesis, implying a stationary in panel data? the panel data requires stationary or cointegration in regression. the residual of spurious regression of non-stationary examine by co-integration test in https://data.oecd.org/energy/renewable-energy.htm asian journal of economics and empirical research, 2020, 7(2): 193-206 197 © 2020 by the authors; licensee asian online journal publishing group explanatory variables. equation. [3] show the dependent variable where regressed on to get . the individual effect showed by null hypothesis and deterministic trend is . the null hypothesis , is not cointegration, the residual value will be l(1) process, if the variables are cointegrated, the residual value of the alternative hypothesis is l(0) process. (3) renewable energy, we followed the approach of cai, che, zhu, zhao, and xie (2018); hussain, arif, and aslam (2017); liu and hao (2018); waite (2017); younas et al. (2016); (yu & lu, 2018) the long-run relationship between renewable energy, co2 emission, energy use per capita, industry value added, gdp per capita growth, co emissions from manufacturing industries and construction and fossil we give fuel energy consumption: where re shows the renewable energy and i=1,….,55 and t=1970,….,2015 reveal the country and time, respectively whereas renewable energy, which we take from the source of energy per capita, industry value added, gdp growth level, manufacturing industries, and fossil fuel consumption. shows the fixed effects of country and − are the long-run parameter of elasticities, related with each explanatory variable of this panel data. kao (1999) and pedroni (2001) tests based on two-step method implemented for data analysis in this paper. this theoretical test based on the vector error correction model, the kao test approach showed with the padroni test, includes cross section intercepts and homogenous coefficient of variables. the johansen fisher panel (wu, zhu, & zhu, 2018). the long-run dynamic estimation exist among the variable after the cointegration test. the relationship leads to long-run correlation in cointegration and variables endogeneity problems, which may cause ols estimation in asymptotic bias. this paper adopts the dynamic ordinary least square (dols) and panel fully changed ordinary least squares (fmols), which are unbiased asymptotic estimators developed by pedroni (2001) the long-run correlation problems and endogeneity solve by fmols estimator a non-parametric term of correlation. the associated t-statistics constructed with panel fmols in equation 4 where indicate the conventional (fmols) estimator is indicating in equation (5a and 5b): ∑ ∑ the dols panel method augments the lead and lagged difference of the repressors in the cointegration equation, which helps to eliminate serial correlation and the asymptotic endogeneity from the individual model. equation 6 shows panel dols regression to get the dols estimator. the long-run dynamic involves lead (ki) and lags (ki). equation 7 shows dols regression with long run and equation 8 shows the dynamic link of cointegration. if the long-run cointegration relationship exists among the variables, we can establish the vector error correction model to investigate by the two-step procedure of engle and granger (1987) causalities. ∑ ∑ ∑ ∑ ∑ ∑ ∑ as a bounded var with cointegration relationship, the vec model handling the endogenous variable to the long-run equilibrium while allowing the short-run variable. the dynamic panel vec model by the following equation [9] to [16] where the first difference operator showed with , the intercept of individual effects denoted with , the optimal lag length denoted with q by schwarz information criterion (sc), the error correction term derived from the long-run correlation and specify serial uncorrelated error term. in the panel vector error correction model (vcm), short-and long-run causality among the variable treated by granger causalities. the direction of causality shows the significance of the coefficient in the equation. the direction of causality in the equation shows the significance of the coefficient. it represents the dynamic error correction model below: ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ https://pdfs.semanticscholar.org/99c2/fdecbced56a09ace2950da5cd7d0bdd617b7.pdf https://pdfs.semanticscholar.org/99c2/fdecbced56a09ace2950da5cd7d0bdd617b7.pdf asian journal of economics and empirical research, 2020, 7(2): 193-206 198 © 2020 by the authors; licensee asian online journal publishing group ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ ∑ the direction of causality by the significance of the coefficient in the equation. the δ denotes the short-run casualty of the change coefficient. the long-run causality. 4. result 4.1. descriptive statistics and unit root figure 3 explored the value of a box plot element, the median is 95% of confidence with a fixed width, lower and upper whisker. re lower whisker shows minimum far outliers in lower whisker ffe, ep and gdpc, register the highest mean value with nearest neighbor fit line and it concluded that all predictor with renewable energy integrated with the countries along belt and road. figure 4 states dispersal has computed in renewable energy (re), the middle east and north africa are embarking, that will require more than $200 billion in investment on a massive program to develop renewable energy and sustain socio-economic development of the region, with ripple effects of renewables development throughout society by economic growth. figure 5 showed the residual sign of renewable energy in different countries by regions. figure-3. categorical means of countries by boxplot. http://helioscsp.com/mena-plans-200bn-investment-in-renewable-energy/ https://www.irena.org/mena https://www.mei.edu/publications/middle-east-hub-chinas-modern-silk-road asian journal of economics and empirical research, 2020, 7(2): 193-206 199 © 2020 by the authors; licensee asian online journal publishing group table 4 shows the panel unit root test of the llc, ips, adf, pp, and hadri in individual and trend intercept, both in level and 1st difference, and an order to remove inconvenience, stationary test rendering to cross-sectional in 1st generation unit root test table 5 with a common root, afterward, table 6 we computed the cointegration test by pedroni, kao from engle-granger based and fisher performed before empirical valuation of fmols and dols. figure-4. dispersal of states. table-3. descriptive statistics. variables mean median max min sta.dev. obs re 8.198 2.050 89.596 0.000 12.455 1551 c 6.428 4.403 67.106 0.016 7.712 1551 ep 2307.542 1571.034 21959.440 86.879 2495.740 1551 iva 33.776 30.555 213.690 6.064 15.729 1551 gdpc 11387.490 4781.851 113682.000 237.814 15294.990 1551 cmic 19.659 18.639 56.604 0.000 10.476 1551 ffe 78.096 86.045 100.000 1.654 23.276 1551 4.2. panel regression analysis the endogenous explanatory variables do not contain any past value of variables in the static model, the term of error serially and mutual independent, therefore need to construct the dynamic model in form of endogenous lagged variables and serially correlated error (gourieroux & monfort, 1997) . the dynamic model can construct for the endogenous variables in form of lagged and dols and vecm estimations the lag of dependent variables are present as explanatory variables of the regression equation; therefore, the dynamic relationship shows the dynamic model. figure-5. residual indication of renewable energy. in fact, these methods have become mainstream dynamic approaches of relevant studies (emirmahmutoglu & kose, 2011; herrerias, joyeux, & girardin, 2013; liddle & lung, 2013; nazlioglu & karul, 2017). it should account for the dynamic relationship between the variables for when analyzing different individual variables. 1st variation of time matters in investigating the granger causality among variables. 2nd the lagged effects of the policy or past information have a direct impact on changes of variables. 3rd the relationship among variables differ in long-run and short-run, which requires long and short-run estimations dynamic. asian journal of economics and empirical research, 2020, 7(2): 193-206 200 © 2020 by the authors; licensee asian online journal publishing group table-4. unit root of individual variables (level). individual intercept individual intercept and trend variable les cr individual root hadri cr individual root hadri llc ips adf pp llc breitung ips adf pp re -45.080*** -14.656*** 277.840*** 319.731*** 8.521*** -41.624*** -1.614*** -11.936*** 474.523*** 262.236*** 8.89*** c 3.794 3.368 112.996 174.445*** 14.834*** -0.059 6.723 0.135 146.777*** 223.552*** 14.865*** ep 0.810 -1.926*** 246.709*** 170.106*** 22.294*** -8.443*** 7.479 -4.857*** 487.042*** 508.001*** 17.986*** iva -3.237*** -2.356*** 130.172** 148.074*** 16.551*** 1.608 1.533 1.143 93.607 100.323 14.221*** gdpc 7.899 10.047 65.194* 44.285 28.143*** 2.296* 5.101 3.532 105.382* 88.320 12.065*** cmic -4.590*** -2.781*** 165.828*** 198.960*** 20.745*** -0.893 0.579 -0.661 138.003*** 161.444*** 13.219*** ffe -23.219*** -6.324*** 143.533*** 173.255*** 27.012*** -41.316*** 5.086 -7.893*** 380.635*** 396.642*** 16.267*** note: *** specifies the significance levels at 1% ** specifies the significance levels at 5% * specifies the significance levels at 10%. table-5. padroni residual co-integration test. individual intercept individual intercept and individual trend no intercept or trend statistic weighted statistics statistic weighted statistics statistic weighted statistics panel v-statistic 0.008* -3.086* -1.631* -5.501 0.070* -3.046* panel rho-statistic 1.96* 2.228* 3.348* 5.065 2.174* 1.214* panel pp-statistic -4.021*** -6.899*** -4.824*** -6.202*** -2.898*** -6.858*** panel adf-statistic -0.389* -4.415*** -1.056* -5.302*** -0.424* -3.354*** alternative hypothesis: individual ar coefs. (between-dimension) individual intercept individual intercept and individual trend no intercept or trend roup rho-statistic 5.809 7.890 4.518 group rho-statistic -13.954*** -12.480*** -12.698*** group rho-statistic -9.239*** -8.119*** -4.733*** note: specified with lag ength 1 with newey-west automatic bandwidth (bartlett kernel). kao residual co-integration (t-statistics) are -8.199*** (adf), 16.393 (residual variance) and 10.111 (hac variance). asian journal of economics and empirical research, 2020, 7(2): 193-206 201 © 2020 by the authors; licensee asian online journal publishing group table-6. johansen fisher panel co-integration test. note: the variable’s definition stated in table 2 *** specifies the significance levels at 1% ** specifies the significance levels at 5% * specifies the significance levels at 10%. the cointegration regression: fully modified ols (fmols) and dynamic ols (dols), emphasized by the maximum likelihood approach (johansen, 1991). the nonstationary estimation specified the basic cointegration method in the triangular system of equation, the linear trend specification by a trend variable assumption. fully changed ols uses a semi-parametric correction to eliminate the problem caused by the long run correlation between the stochastic repressors and the integration equation. hence, asymptotically unbiased by fmols and fully efficient mixture normal asymptotic allowing for standard wald test using asymptotic statistically chi-square inference. table 6 shows panel (fmols) liner trend specification, the cointegration regression estimate using by differenced data in an additional trend. the pool panel method specifies the long run variance computed by bartlett in the andrews automatic bandwidth method. table 7 showed an individual coefficient of fully modified ordinary least squares (fmols) & dynamic ordinary least squares regression (dols) has computed with (@trend) specification. the bartlett and andrew automatic in long run covariance individually categorize countries by different regions. the ordinary least squares coefficient covariance using an estimation of the long run variance of fmols & dols residual in different regions and use a sandwich-style hav (newley-west) covariance. the individual coefficient examined the trend coefficient for each cross-section in individual regions. the vector error correction (vec) model explore seven variables, the cointegration equation (coineq), re statistically significant coefficient related at -6.86 in cointegration term, the coefficient relating to error correction term (ecm), its negative at 2.49% table 8 implies that previous year errors will be correct in the following year at the change rate of 2.49%, the other difference operator it represents short-run coefficients, the co-integration equation or ect capture the long-run equilibrium, it signified conversion to long-run equilibrium at -0.024, therefore show convergent to long run equilibrium so it analyzing that that in the short run relationship there is no significant coefficients in re except ep ( lag -1). the short-run coefficient of is significant showing that short-run will exhibit reduction it’s on by self because its log representation every order relationship and transept are not significant. the contribution of c, ep, iva, gdpc, cmic, and ffe is strongly exogenous, and it implies that they have a very weak influence on predicting re. the long-run period influence of re on itself is the further remove while the influence of predictor variables is increasing as further remove, it means predictor are exhibiting strong endogenous influence on re on a remove, strong endogenous influence while re exhibiting weak endogenous influence on itself. in ffe the short run re focus arrow variance, while c is 0.71% figure 6 of focus arrow variance in ffe, both variables re and c are exhibiting strong exogeneity, and they have a weak influence on predicting ffe short-run, we show that ffe is 98.53% as we go in future the influence of predictor variables (increasing) are very strong while the influence of ffe is decreasing the further removed. figure 7 east asia countries except for australia, japan, and newzeland is a positive effect in high economic growth regime but forming negative effect on co2 emission. these countries with weak infrastructure and limited financial resources will struggle to adapt and sustain their economic growth in the face of a changing climate, like singapore showed high economic growth with less co2 emission and brunei showed emission from the above median line, india and china need to binding emission limit cause of climate catastrophe in asia also in several decades to occur in developing countries.[1] the united arab emirates and qatar (2nd highest ecological footprint globally) are increasing co2 emission in the middle east, and romania gradually decreased by 14.6% from fossil fuel combustion in 2012, turkmenistan increased co2 emission from 19 to 100 million from 1997 to 2016 with the 10.20% annual rate, hungary and ukraine are slightly going down in europe and central asia. intercept in ce and var intercept and trend in ce-no trend in var no. of ce(s) (from trace test) (from max-eigen test) (from trace test) (from maxeigen test) none 890.7*** 857.2*** 985.1*** 542.1*** at most 1 995.8*** 649.4*** 1505*** 2358*** at most 2 697.4*** 608.4*** 820.5*** 600*** at most 3 581.5*** 434.5*** 547.9*** 3481*** at most 4 424*** 309.9*** 498*** 375.6*** at most 5 209.7*** 176.8*** 356.3*** 282.6*** at most 6 155.4*** 155.4*** 148.7*** 148.7*** https://knoema.com/atlas/australia/co2-emissions-per-capita https://tradingeconomics.com/japan/gdp-per-capita https://climatepositions.com/climate-change-performance-australia-vs-new-zealand/ https://www.cogentoa.com/article/10.1080/23322039.2017.1379239 https://www.cogentoa.com/article/10.1080/23322039.2017.1379239 https://futureoflife.org/2016/08/05/developing-countries-cant-afford-climate-change/ https://futureoflife.org/2016/08/05/developing-countries-cant-afford-climate-change/ https://www.nccs.gov.sg/climate-change-and-singapore/national-circumstances/singapore's-emissions-profile https://en.actualitix.com/country/brn/brunei-darussalam-co2-emissions.php https://www.masterresource.org/climate-policy/india-co2-emissions-to-triple-by-2030/ https://www.masterresource.org/climate-policy/india-co2-emissions-to-triple-by-2030/ https://countryeconomy.com/energy-and-environment/co2-emissions/united-arab-emirates https://dohanews.co/global-report-warns-qatars-consumption-resources-unsustainble/ https://www.romania-insider.com/romania-sees-14-6-fall-in-co2-emissions-from-energy-use https://knoema.com/atlas/turkmenistan/topics/energy/total-energy/carbon-dioxide-emissions https://www.indexmundi.com/facts/hungary/co2-emissions https://knoema.com/atlas/ukraine/co2-emissions-per-capita asian journal of economics and empirical research, 2020, 7(2): 193-206 202 © 2020 by the authors; licensee asian online journal publishing group table-7. individual coefficient by regions. east asia fmols dols south. a fmols dols europe fmols dols middle.e fmols dols australia -27.27 (-0.43) -0.21(0.67) bangladesh 2.79 (.24) 7.22(0.17) albania 1.03 (-0.20) -14.82(-0.15) bahrain -177.27 (0.01) brunei darussalam -16.83 (-0.06) india 4.70 (.19) 8.72(0.19) armenia -19.47(0.28) -31.42(0.21) egypt -136.18 (-0.62) -170.43(-1.09) china 5.73 (-0.27) 13.97(-0.36) nepal -2.46 (-0.04) -1.57(-0.02) azerbaijan -6.20 (0.51) 25.01(-1.02) iran -165.92 (0.28) -216.18(0.20) indonesia 5.79 (-0.16) 12.98(-0.16) pakistan 2.36 (0.13) 5.95(0.07) belarus -6.42 (-0.10) -54.67(0.18) iraq -171.60 (0.75) -217.02(0.47) japan -37.16 (-0.15) bosnia h. -11.65(0.09) israel -168.00 (0.21) malaysia 29.12 (-0.88) 33.36(-0.62) bulgaria -16.63 (0.29) -26.16(0.06) jordan -164.51 (0.04) -220.36(0.12) myanmar 34.70 (-0.79) cyprus -13.90 (0.23) -35.46(-0.33) kuwait new zealand -19.59 (-0.28) 5.90(0.07) czech p -11.47 (0.12) lebanon -161.52 (0.24) philippines -1.55 (-0.03) 3.97(-0.10) estonia -0.11 (-0.00) oman -164.39(0.19) singapore -8.41 (-0.86) 7.05(0.13) georgia -9.74 (0.06) -42.83(0.63) qatar thailand -1.41 (-0.13) 1.11(0.09) greece -12.16 (0.18) saudi -169.26(0.47) -233.74(0.64) vietnam -0.35 (0.11) 11.67(-0.79) hungary -11.44 (0.10) uae -177.09(0.22) -261.56(1.15) kazakhstan -17.24 (0.76) 5.54(-0.40) yemen -116.61(-1.0) -91.83(-2.93) latvia -6.68 (0.03) lithuania -4.418 (-0.06) macedonia, -19.17(0.34) -33.16(0.28) montenegro -4.880 (-0.00) poland -12.74(0.11) romania -8.23 (-0.01) -28.86(0.01) russian f -10.27 (0.45) -92.43(3.38) serbia -8.71 (0.39) slovak r -10.91 (0.09) slovenia -12.87 (0.20) turkey -8.82(-0.031) -25.68(-0.24) turkmenistan ukraine -17.52(0.37) -32.50(0.30) uzbekistan -22.57 (0.95) 86.74(-4.69) asian journal of economics and empirical research, 2020, 7(2): 193-206 203 © 2020 by the authors; licensee asian online journal publishing group table-8. panel causality results of all countries. note: *** specifies the significance levels at 1% ** specifies the significance levels at 5% * specifies the significance levels at 10%. countries dependent variable independent variables long run short run ecm conteq all countries 2.949*** -0.287* 12.110*** 2.305** 1.768** -1.185* -6.863*** -0.024 2.692*** -1.256* 3.769*** 4.331*** -0.577* 1.080* 11.885*** -0.924* -2.267*** 0.401* -4.119*** 2.642*** 2.409*** -7.648 10.884*** 2.803*** -1.198* 5.168*** 0.346* 3.499*** -0.3113*** 2.800*** 5.900*** -4.732*** 6.284*** 0.646* 0.293* -0.569 1.805** -0.784* 3.088*** 1.025* 0.729* -0.449* 2.407*** -0.630* 0.858* 2.194*** 3.092*** 0.492* -0.841* 0.310*** east asia 5.614*** -0.126* 2.174*** 5.482*** 0.761* -0.227* 0.363*** 0.000 6.461*** 0.289* 1.903*** 0.065* -1.755** -0.176* -2.211*** -0.909* -0.304* 1.262* 0.060* -3.087*** 0.213* 4.200*** 3.424*** 1.873** 0.785* 2.219** -1.478* 1.509* 4.430*** 7.265*** -0.841* -0.397* 2.594*** 3.20*** -0.691* 5.551* -0.295* -1.209* -2.692*** -1.350* 3.638*** -0.256* -1.462*** -0.196* -0.195* 0.053* 1.663** -0.780* -0.685* -0.7199*** south asia -1.359* 1.591* 0.441* -0.181* 1.179* -2.548*** -3.922*** -0.130 -1.233* 5.333*** 1.608* 4.753*** -0.430* 2.262*** 0.129*** 1.815** 5.110*** -2.685*** 3.844*** 1.300* 4.259*** 0.624* 0.416* 1.639* -3.136*** 0.798* -3.082*** 1.277* -1.800*** 0.870* -0.496* 1.062* -3.586*** 0.189* -0.405* 3.533* -2.641*** 1.664** 3.929*** 1.188* -7.829*** -0.561* 3.332* -2.641*** 1.664** 3.929*** 1.188* -7.829 -0.561* -0.358*** europe 0.036* -0.323* 3.968*** -0.810* -0.580* 2.021*** -0.117*** -0.000 0.249* 33.200*** 3.368*** 2.246*** -1.141* 0.313* 3.602*** -0.571* 32.046*** -1.767** 1.830** 2.974*** -0.128* 1.931* 5.035*** 3.944*** -1.858** 0.226* 1.293* 2.086*** 4.853*** -0.636* 1.853** 2.457*** 0.392* -1.785** 1.772** -1.032 -0.675* -1.595* 2.874*** 1.005* -1.828** 0.816* 0.386*** 1.752** 1.083* 0.353* 2.416*** 1.712** 1.712** 2.086*** middle east 0.168* 0.876* 8.147*** 0.686* 0.249* 1.534* -5.003*** -0.113 -1.572* -2.652*** 3.723*** 2.766*** -1.233* 0.426* 6.883*** 0.153* -3.915*** -0.930* -2.083*** 2.384*** 0.282* -4.547* 7.107*** 1.840** -1.775** 2.085*** 2.166*** -0.845* -0.757*** 0.064* 3.214*** -1.593* 3.778*** -1.212* 0.103* 0.604 -0.184* 0.378* 3.620*** 3.569*** -0.802* 0.024* 2.100*** 1.365* 0.265* 0.349* -0.880* 0.077* -0.109* 0.351*** asian journal of economics and empirical research, 2020, 7(2): 193-206 204 © 2020 by the authors; licensee asian online journal publishing group figure-6. variance decomposition (cholesky). figure-7. distribution of region. asian journal of economics and empirical research, 2020, 7(2): 193-206 205 © 2020 by the authors; licensee asian online journal publishing group 5. conclusions the mega project belt and road is a precisely re-presenting economic corporation, and it is a huge plan of development of 4 regions. in the 21stcentury it connected with the maritime silk road from the china to europe via central asia and then rapidly in-touch with other states as well for pure economic corridor. this paper panel data analysis implies that economic growth of 55 countries and their influence on energy consumption, renewable energy, manufacturing industry and construction with industry value added, fossil fuel and gdp per capita. the regional individualities of countries are different within bri on behave economic contribution, the policies and recommendation of energy discussed separately in regions. it shows ea countries’ positive and high economic growth, and there is a causality running from gdp per capita, industry value added and renewable energy. in addition, chinese enterprises have undertaken over 3,100 projects in belt and road likes nuclear, hydraulic and biomass and also the country region-specific factors should be carefully finding the energy development approach for renewable energy such as hydropower projects in south asia. regarding south asia-countries, the relationship between renewable energy consumption and economic growth is not the signification, there are causality running from gdp and likes india have created a negative impact on global warming. the united arab emirates (uae) and oman is less causality running from gdp and energy consumption is not significant in europe and the central east. the middle east & north africa (me&na) region has undergone a significant transformation because of economic development and increase diversification of energy sources in an economic factor like belt and road project. the result implies that most import sources of economic development are traditional fossil energy rather than renewable energy and the global energy demand growing by an average 1% per year from 2010 and through 2040. the most important source of energy meet future demand growth is natural gas expected to largest absolute economic growth, and it became a key fuel in meeting future. bri project may also reduce transit risk of energy sources by pakistan via the iran-pakistan pipeline in middle east and import natural gas to western china through pakistan and maintaining oil and gas pipelines and other transport routes. construction of cross-valueadded industries, power supply network, power-transmission routes can further promote 55 country’s economy in bri project. besides, in addition, the relationship got from the empirical study could investigate from a theoretical framework could help us understand and provide policymakers to a more comprehensive and wide-ranging adjust relevant policies. references bank, w. 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(2016). decoupling co2 emissions and industrial growth in china over 1993–2013: the role of investment. energy economics, 60, 275-292.available at: https://doi.org/10.1016/j.eneco.2016.10.008. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 1 © 2021 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 8, no. 1, 1-9, 2021 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2021.81.1.9 © 2021 by the authors; licensee asian online journal publishing group sustainability in asean countries: the role of financial development in climate change vikniswari vija kumaran1 siti nurul munawwarah2 mohd khairi ismail3 ( corresponding author) 1faculty of business and finance, universiti tunku abdul rahman (utar), malaysia. 2school of finance and accounting, taylor’s university, malaysia. email : sitinurul.munawwarah@gmail.com tel : 019-2410638 3faculty of business & management, universiti teknologi mara (uitm), malaysia. abstract higher financial development and economic growth leads to higher production and consumption of a nation. this is because when a country is developed, the demand for infrastructure will increase which could significantly affect the country’s environment. the main aim of this paper is to explore the link between energy efficiency, sustainable economic growth, population and financial development in five asean countries (malaysia, thailand, indonesia, philippines and vietnam). panel data analysis was employed and the results show that financial development, economic growth, population and renewable energy are important factors in influencing climate change. based on the results, increasing financial development, higher energy use, high population and increasing economic growth will generate more co2 emissions and contribute to climate change. thus, there are several policies suggested to balance the relationship between financial development and carbon emission levels, which should be considered and implemented by governments and policy makers in order to improve the environmental quality in asean countries. in conclusion, in the five selected asean countries, financial growth plays an important role in highlighting climate change issues. many past studies have focused on the impacts of renewable energy consumption, population, economic growth and foreign direct investment on climate change. this study narrows the gap that exists in the literature by focusing on financial development, which is able to foster vigorous economic growth, especially in asean countries. overall, the results from the fixed effects estimates show that financial development is a significant factor and has a positive contribution towards climate change. keywords: sustainable development, economic growth, asean, financial development, co2 emissions, climate change. jel classification: q01, r11, o57, o16, q53, q54 citation | vikniswari vija kumaran; siti nurul munawwarah; mohd khairi ismail (2021). sustainability in asean countries: the role of financial development in climate change. asian journal of economics and empirical research 8(1): 1-9. history: received: 3 november 2020 revised: 7 december 2020 accepted: 30 december 2020 published: 14 january 2021 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study, that no vital features of the study have been omitted, and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction ......................................................................................................................................................................................... 2 2. literature review ............................................................................................................................................................................... 2 3. methodology ........................................................................................................................................................................................ 4 4. results ................................................................................................................................................................................................... 5 5. conclusion ............................................................................................................................................................................................ 7 references ................................................................................................................................................................................................. 8 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2021.81.1.9&domain=pdf&date_stamp=2017-01-14 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2021.81.1.9&domain=pdf&date_stamp=2017-01-14 mailto:sitinurul.munawwarah@gmail.com http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/2569 https://orcid.org/0000-0002-0540-9193 https://orcid.org/0000-0001-8561-9264 https://orcid.org/0000-0002-2004-3337 asian journal of economics and empirical research, 2021, 8(1): 1-9 2 © 2021 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to existing literature by examining the link between energy efficiency, sustainable economic growth, population, and financial development in five asean countries. 1. introduction developing an economy includes growing the financial sector through developing and increasing institutions, instruments and markets that support huge investments, which will, in turn, lead to poverty reduction. financial development facilitates the availability of information on potential successful investments and efficient resource allocation. in addition, expanding financial access cultivates complex productivity in the sector by introducing systemic reform through creativity and welfare benefits for the economy as a whole. financial development can be described as the development of the size, efficiency and stability of the financial markets, along with the growth of access to financial markets, which can have multiple economic benefits (guru & yadav, 2019). regarding macroeconomic factors, such as foreign direct investment (fdi), population and economic growth, studies have shown that they can also contribute to climate change. this is because most of the asean countries are still developing and they will attempt to enhance their economic condition by increasing development activities, such as deforestation, that will contribute to environmental degradation. the impact of climate change is a major concern for asean countries. a report by the intergovernmental panel on climate change (ipcc) in 2014 stated that the human influence on climate is obvious. over the last century, the emission of greenhouse gases in southeast asia has become the highest in history. the average temperature trends in southeast asia have been increasing by 0.1–0.3°c per decade over the last five decades (asean cooperation environment, 2017). the countries in southeast asia are the most vulnerable in the world to the impacts of climate change. malaysia, thailand, indonesia, vietnam, myanmar, the philippines and cambodia are forecasted with the rankings, which show that these seven out of the twenty southeast asian countries are more susceptible to the impacts of climate change (asean state of climate change report, 2021). according to the global climate risk index 2019, thailand and vietnam were listed in the top ten countries most affected by extreme weather in 2017. this shows the seriousness of climate change in the asean region. the effects of climate change include the increase in the rate of occurrence of heat waves, droughts and extreme rainfall, and an increase in sea levels, floods and tropical cyclones. regarding renewable energy, yu (2019) states that the asean region is lagging behind other regions in the development of environmental, social and corporate governance (esg) infrastructure, especially renewable energy. in asean, vietnam and the philippines have not put much effort into the development of esg so far. according to chen, wang, & zhong (2019), renewable energy consumption and carbon dioxide emissions have a negative relationship. however, asean countries have the lowest renewable energy consumption among indonesia, the philippines and thailand (vikniswari, ridzuan, khan, abdullah, & mohamad, 2019b). therefore, asean countries are encouraged to develop its esg infrastructure. the problem of environmental degradation has become worrying in the asean region. hence, there is an urgent necessity to carry out a study to identify the significant determinants that contribute to climate change so that actions can be taken in the hope of a better environment in the future. this study was carried out to determine the factors affecting climate change in five asean countries— malaysia, thailand, indonesia, the philippines and vietnam. these five countries are considered to be developing countries. the period of this study ranges from 2006 to 2015. the environmental kuznets curve (ekc) hypothesis is used to explain the environmental changes in response to a country’s change in income. according to dinda (2004), based on the ekc, the environment changes faster in developing countries. the data used in this study is based on the climate change issues and data availability for the selected countries. factors such as foreign direct investment (fdi), population, economic growth and renewable energy have been studied before as major determinants that contribute to climate change. however, there are only a few studies that explore the impact of financial development on climate change in developing countries, making it a necessary area to investigate. according to sadorsky (2010), financial development will stimulate foreign direct investment (fdi). this means that more investors from overseas will invest in a country. for instance, foreign investors may build factories for the production of their goods. thus, a deeper investigation is necessary so we must extend the model by adding a variable such as financial development. this will be the gap variable of this research due to limited available literature. 2. literature review in environmental kuznets curve (ekc) applications, carbon dioxide emissions are the most applied emissions (tutulmaz, 2015). the ekc hypothesis postulates that there is a positive relationship between economic growth and environmental degradation as the country is developing, which means that a country is willing to sacrifice their environment in order to raise their standards of living from initial low levels. yet, the hypothesis assumes that a country will prioritize their environmental quality after achieving successful development. therefore, the ekc hypothesis has an inverted u-shaped curve when pollution indicators are plotted against income per capita (dinda, 2004). by analyzing the data from 31 developing countries from 1970 to 2013, aye & edoja (2017) found a negative relationship between economic growth and carbon dioxide emissions in low regimes and a positive relationship in high regimes. the low regime refers to the levels of gdp per capita below 4,686 usd, where environmental degradation decreases with economic growth while vice versa in high regime with gdp per capita above 4,686 usd. in this case, the ekc hypothesis is not valid, and the results are supported by aslanidis & iranzo (2009) and ahmed, rehman, & ozturk (2017), among others. their results suggest that when a country is in its early stage of development, its service sector emits less carbon dioxide compared to its manufacturing sector. the rise in gdp of a country will tend to produce more carbon dioxide due to the expansion of the manufacturing industry. also, a country will face an economic boom period while the gdp is increasing, so people with more income will increase their dependency on electrical appliances and transportation, leading to higher consumption of energy and higher pollution levels. nowadays, china is the largest developing country and has a very high gdp, asian journal of economics and empirical research, 2021, 8(1): 1-9 3 © 2021 by the authors; licensee asian online journal publishing group hence many studies have been done to investigate the relationship between economic growth and carbon dioxide emissions in china. wang, hao, & yao (2017) used gdp as the threshold for the panel smooth transition regression (pstr) model, and the results suggest that the influence of gdp on carbon dioxide emissions show the characteristic of coincident double thresholds. additionally, a pull effect was exerted by gdp on carbon dioxide emissions while the gdp is gradually rising. however, the pull effect on carbon dioxide emissions becomes weaker as the gdp continues to rise or even exceeds the threshold parameter. this is consistent with the study by aye & edoja (2017). however, the result is different from others because the turning point at which carbon dioxide emissions start to decrease is not found when the gdp is high, as claimed by aye & edoja (2017). based on monasterolo (2020), the financial systems could help achieve the global climate targets by aligning investments with sustainability. however, investors are largely exposed to carbon-intensive assets that could become stranded, thus delaying the low-carbon transition and bringing new sources of risk for financial stability, i.e., climate-related financial risks. abbasi & riaz (2016) indicated that there is a long-run and positive relationship between co2 emissions and financial development in pakistan by using an augmented var model. their findings revealed that financial development and trade openness do not help to reduce the environmental degradation effects and lead to further environmental destruction. venmans, ellis, & nachtigall (2020) explored the world bank's position in defining and stimulating international markets for carbon. adopting the viewpoint of public preference, they argued that their participation can be viewed as an answer to the common objective of reputational and financial benefits. a booming, privately driven carbon market followed during this time, often competing with, rather than catalyzing, private activities. however, because transparency is limited in relation to its operations, thereby reducing reputational risk, these operations may not meet the quality standards, especially with regard to additionality, which is required for carbon markets to be an efficient mechanism for mitigating climate change. sawyer (2020) discusses the essence of the new era of financialization, detailing the changes that are especially important to the environment emergency in the financial sector and its ties with the real sector. the relationship between financial sector growth ('financial development') and economic growth is reviewed, and the importance of recent empirical results for the financial sector's role in addressing climate emergencies is established. it is also argued that the policy response to climate emergencies and environmental degradation should be integrated into an industrial strategy. xiong, tu, & ju (2017) investigated the regional differences in the effects of financial development on co2 emissions in china by using panel data. the study indicated that some parts of china that are well-developed could help to reduce emissions with more financial development. however, there is an inverse relationship in which financial development tends to increase the emissions of co2 in china in the areas that are less developed, and this situation further leads to harmful environmental degradation. according to yaw (2017), the state of the environment has gathered the attention of the world for more than a decade. issues such as depletion of the ozone layer, the rise in global temperature and altered rainfall patterns are not new anymore; we now know that these issues began a long time ago and new information is being gathered continuously. the change in global climate is known as the world most conspicuous threat to children’s health. what makes it worse is that no country is spared. all countries, regardless of whether they are highor lowincome countries, are experiencing the effects of climate change. the worst scenario of climate change would be future children inheriting an untenable world that lacks vital ecological resources to support them. however, the use of renewable energy is one of the ways to reduce the effects of climate change. renewable energy, such as solar power, hydropower and biomass are commonly used in malaysia. malaysia is asean’s biggest user of solar power and is ranked sixth on the global list of top solar photovoltaics (pv) employers. it is one of the asean countries to make it to the top ten alongside vietnam (irena, 2019). according to irena (2019), the philippines is known as asean’s largest employer of wind energy. one example to prove that renewable energy is indeed very helpful in reducing the effects of climate change is that petroliam nasional berhad (petronas) is considering investing in renewable energy on a commercial scale. the study by chen et al. (2019) regarding the relationship between renewable energy consumption and co2 emissions shows that there is a negative relationship between both variables. they found that, in the long run, the increasing use of renewable energy is able to reduce carbon emissions. the addition of the renewable energy variable is able to support the inverted u-shaped ekc hypothesis. the study by cheng, ren, wang, & yan (2019) shows similar results, that renewable energy is useful in reducing carbon emissions. their study, which focuses on briics countries (brazil, russia, india, indonesia, china and south africa), shows that renewable energy production in briics had increased from 19.72 terawatt-hours (twh) to 300.67 twh. the drastic usage of renewable energy is able to reduce the effect of co2 emission. additionally, dong, sun, & hochman (2017) mentioned that renewable energy consumption is crucial to reducing carbon emissions, and their results also showed that renewable energy will have a significantly negative impact on co2 emissions. moreover, based on vikniswari et al. (2019a), the heavy reliance on non-renewable energy incurred scarcity and severe environmental destruction. demographic changes, such as size of population, urbanization and household structure, have positive impacts on carbon dioxide emissions (o'neill et al., 2012). the authors also mentioned that the emission of carbon dioxide reacts proportionately to the changes of population size. both ageing and urbanization also have significant relationships with carbon dioxide emissions but it is less proportional compared to population size. cohen (2015) mentioned that an increase in population causes an increase in the production of plant and animal foods. the production of these foods has significant impacts on the atmospheric concentration of greenhouse gases, which include carbon dioxide, methane and nitrous oxide. however, population growth and carbon dioxide emissions do not have a long term equilibrium relationship (knapp & mookerjee, 1996). based on their findings, carbon dioxide emissions and population lack cointegration, which means that population is not the sole factor in the cause of climate change. sulaiman & abdul-rahim (2018) found that population growth does influence carbon dioxide in the short run but it does not have a great impact on climate change in the long run. they used the vector error correction model granger causality approach to determine the causality relationship of population growth and carbon dioxide emissions in both the short run and the long run. asian journal of economics and empirical research, 2021, 8(1): 1-9 4 © 2021 by the authors; licensee asian online journal publishing group 3. methodology in this study, co2 emissions will represent climate change, and the selected independent variables include financial development, foreign direct investment, economic growth, renewable energy consumption and population. annual data from 2006 to 2015 were collected from five asean countries—malaysia, the philippines, vietnam, indonesia and thailand. the type of data applied in this study is panel data. the basic model below in equation 1 was extracted from the research by dietz & rosa (1997) based on the environmental kuznets theory (ekc). co2 i𝑡 = β0 + 𝛽1 rei𝑡 + 𝛽2 egit + β3 poi𝑡 + εi𝑡 (1) where, co2 = carbon dioxide emissions re = renewable energy eg = economic growth po = population β0 = y-intercept 𝑡 = year εi𝑡 = white noise error term. equation 1 has been extended by including financial development, as shown in equation 2. the proxy for this variable is domestic credit to the private sector. the following model consists of four independent variables, which are population, renewable energy, economic growth and financial development. co2 i𝑡 = β0 + 𝛽1 rei𝑡 + 𝛽2 egit + β3 poi𝑡 + 𝛽4 fdi𝑡 + εi𝑡 (2) where, co2 = carbon dioxide emissions re = renewable energy eg = economic growth po = population fd = financial development β0 = y-intercept i = malaysia, thailand, indonesia, philippines, vietnam 𝑡 = year 2006, 2007, …, 2015 εi𝑡 = white noise error term. a panel unit root test will be used to conduct the preliminary analysis. this test shows the stationary conditions of the variables. then, the levin–lin–chu (llc) test is used to check the stationarity of each variable. last, but not least, the pooled ordinary least squares (pols), fixed effects model (fem) and random effects model (rem) are used for the estimation. a likelihood ratio test is conducted in order to choose between the pols and rem. while for for comparison between rem and fem, the hausman test was used. diagnostic checking will also be conducted to check for the existence of econometric problems. 3.1. panel unit root test a unit root test is used to look for stationarity in the time series. times series data is said to be stationary when there is a shift in time that does not lead to a change in the shape of distribution. one of the major factors contributing to non-stationarity is a unit root. if a times series contains a unit root, it tends to display a systematic pattern that is unpredictable. with panel unit root tests, the results can be used to determine whether a time series variable is non-stationary (random walk and unit root) or contains a unit root. in this test, the null hypothesis will be generally defined as a unit root being present in the time series variable, while the alternative hypothesis will be stationarity, explosive root or trend stationarity existing in time series variables. this depends on the type of unit root test being utilized in the study. there are different types of panel unit root tests: the levin, lin and chu (llc) test; the im, pesaran and shin (ips) test; the breitung test, and the hadri test to investigate the common unit root process, while the fisher–pp and fisher–adf tests examine the individual unit root process. the nonstationarity of the variables needs to be verified to fulfil the classical linear regression model assumptions, which require constant variance in the econometric model. with constant variances, the ordinary least squares (ols) method can be utilized to obtain accurate results so the estimators will be efficient, the hypothesis testing is valid, and t-statistics and p-values in the model will be reliable. for this study, the levin–lin–chu test was employed. according to levin, lin, & chu (2002), this test is used to generalize the model that allows for the heterogeneity of individual deterministic effects and the heterogeneous serial correlation structure of error terms by assuming the same first order autoregressive coefficients. the power of this test is the probability of rejecting null when it is false and the null hypothesis is a unit root. the llc test is based on the augmented dickey–fuller (adf) regression model, as shown in equation 3. ∆𝑦𝑖 = 𝛼0𝑖 + 𝑥0𝑖 + 𝑥1𝑖𝑡 + 𝜀𝑖𝑡 (3) where, 𝑖 = 1,2,……, n; t = 1,2,…,t. the hypothesis of the llc test is calculated as follows: h0: 𝑥𝑖 = 𝑥 = 0 (each time series contains a unit root). h1: 𝑥𝑖 = 𝑥 < 0 (each time series is stationary). based on equation 3, when an individual effect (𝑥0𝑖) and a time trend (𝑥1𝑖𝑡 ) are incorporated, the parameter of the lagged dependent variable is restricted to homogeneity in every unit in the panel model. thus, the deterministic components are a significant source of heterogeneity. moreover, the llc test assumption states that both 𝑖 and t will move towards infinity but t will increase at a higher rate. the required condition of the llc test is √𝑁𝑇 𝑇 = 0, and the sufficient conditions are 𝑁𝑇 𝑇 = 0 and 𝑁𝑇 𝑇 = 𝑘. the sample size suggested in the panel unit root test ranges from 10 to 250. the unit root test is appropriate when t is large or small but n is large (levin et al., 2002). if t is very small, the test is undersized and has low power. the llc test also has another limitation as it is asian journal of economics and empirical research, 2021, 8(1): 1-9 5 © 2021 by the authors; licensee asian online journal publishing group highly dependent on the assumption of independence across individuals. hence, this test is not suitable to apply in a cross-sectional correlation. 3.2. pooled ordinary least squares (pols) the pols estimation is simply an ols technique that runs on panel data, which is the combination of time series data and individual data. all specific, individual effects are completely ignored, which leads to a violation of basic assumptions, such as the orthogonality of the error term. pols consist of few assumptions. it can be assumed that the regression coefficient is the indifferences among countries while pooling all observations together. second, the error term of the model is assumed to be normally distributed, which means that it is not correlated with the independent variables. another assumption is that the error term must have a mean of zero with constant variance. also, the independent variables are assumed to be fixed in repeated sampling in the model. the last assumption is that all the independent variables in the model are exogenous. 3.3. fixed effects model (fem) the fem is a statistical model where the parameters of the model have fixed or non-random quantities. the term ‘fixed effects’ refers to the different intercepts across the subjects, yet each of the interceptions do not change their characteristics over time and they are not correlated with the characteristics of other individuals. it is known to be time invariant. the error terms and constants of each unique individual must not be correlated with each other, otherwise the fixed effect will be considered as inappropriate. referring to mushtaq & siddiqui (2017), the effect of variables that fluctuate occasionally can be studied through the fem. in order to use the fem, it needs to fulfil the assumptions of the classical linear regression model. however, there are some side effects of using the fem. its usage will eliminate a lot of degrees of freedom and will result in unstable estimation results, and it cannot be used to determine the time-invariance caused by the dependent variable in the model (torres-reyna, 2007). 3.4. random effects model (rem) the rem is also known as the error component model and it has become the most common method for synthesizing a set of effect sizes. it allows a model to have its own fixed interception value. this model assumes that the intercept value is randomly drawn from the population. in this research, the rem assumes that all the variables are time-invariant. furthermore, rem is normally used for the estimation of dummy variables, such as gender, preference and age, by using the least squares dummy variable model. the rem is able to detect the difference in true effect size. the individual effect is assumed to have no correlation with any regressor and estimates the error variance specific to a group. this is why the rem is more efficient than the fem if the assumption holds. 3.5. likelihood ratio (lr) test the likelihood ratio (lr) test was first introduced by neyman and pearson in 1928. lehmann (2006) stated that this test can be used to compare the maximum likelihood by using hypothesis testing. this test is also used to assess the goodness of fit of two statistical models – the pols and fem models. it can also be used when the test statistics of the estimated model are larger than the critical values of the model. therefore, the pols is preferable if the null hypothesis is not rejected, and vice versa. 3.6. hausman specification test the hausman specification test (also known as the durbin–wu–hausman test) is applied to investigate and detect endogenous regressors in a regression model. sometimes, the predictor variables, referred to as independent variables, are determined by other variables in the system to calculate their values. according to one of the assumptions of the ordinary least squares (ols) method, there must be no correlation between an endogenous regressor and the error term (hausman, 1978). when a model contains endogenous regressors, it will cause the hypothesis testing to be invalid and the t-statistics and p-values will be unreliable, thus providing spurious and misleading results. in this test, the null hypothesis will be that the rem is better than the fem, while the alternative hypothesis will be that the fem is better than the rem. the decision rule for this test will be to reject the null hypothesis when the probability value of the hausman test is less than the significance level, otherwise, do not reject the null hypothesis. the general formula applied in the hausman specification test is shown below: h= (β̂fem−β̂rem) [(β̂fem) −var (β̂rem)] −1 (β̂fem−βf̂em) 3.7. diagnostic checking there are a few important tests to be carried out to verify the specification of this study’s model, including a normality test, a variance inflation factor test, the breusch–godfrey serial correlation lm test, and the breusch– pagan–godfrey test. 4. results 4.1. panel unit root test the analysis starts by conducting a panel unit root test for all variables using the levin–lin–chu test. rejection of null hypothesis indicates that the variable is non-stationary. table 1 summarizes the outcome of the test at level for all variables. asian journal of economics and empirical research, 2021, 8(1): 1-9 6 © 2021 by the authors; licensee asian online journal publishing group table 1. levin–lin–chu test results. variable individual effects, level form individual effects, individual linear trends, level form lnco2 -4.32587*** (0.0000***) -0.47591 (0.3171) lnfd -1.39951* (0.0808*) -6.11484*** (0.0000***) lngdp -4.56744*** (0.0000***) -1.16224 (0.1226) lnpop -6.48760*** (0.0000***) -8.65327*** (0.0000***) lnre -1.57471* (0.0577*) -1.38442* (0.0831*) note: the asterisks, * and ***, indicate rejection of null hypothesis at the 10% and 1% levels of significance, respectively. this study employs a panel data model estimation to estimate the individual and time series effects for every variable, including the dependent variable, carbon dioxide emissions and the four independent variables (population, renewable energy consumption, gdp and financial development). the panel data estimation models employed are the pooled ordinary least squares model, the fixed effects model and the random effects model in order to identify the significant variables related to climate change. table 2. panel data estimation. variable pols fem rem c 3.865291*** (0.342253) 1.724597*** (0.315924) 8.257759*** (0.409223) lnfd 0.083682*** (0.026831) 0.232376*** (0.049677) -0.128164*** (0.020650) lnpop -0.503724*** (0.030668) 1.078312*** (0.249804) -0128164*** (0.029968) lngdp 0.498562*** (0.025629) 0.203110*** (0.033711) 0.188024*** (0.029373) lnre 0.232258*** (0.014188) 0.638006*** (0.072915) 0.291502*** (0.007901) r-squared adjusted r-squared 0.988400 0.987369 0.997869 0.997454 0.997372 0.996424 note: ***, indicates rejection of null hypothesis at the 1% levels of significance. table 2 depicts the results for the pols, rem and fem estimations. the pols r-squared is 0.9884, which means that 98.84% of the total variation in carbon emissions is explained by the total variation in the independent variables. from the results, all of the explanatory variables are significant at the 1% level of significance. table 2 contains the results for the fem model estimation, and we can see that the r-squared for model 2 is 0.9979, which means that 99.79% of the total variation in co2 emissions can be explained by the total variation in the explanatory variables. the independent variables (financial development, population, gdp and renewable energy consumption) are all significant at the 1% significance level. thus, all of the explanatory variables are significant at the 0.01% significance level (the standard errors are in parentheses). 4.2. model comparison table 3 depicts the results of the likelihood ratio test and the hausman test. by referring to the likelihood ratio test results, the null hypothesis was rejected at 1%, 5% and 10% because it has a probability of 0.0000, which is less than 0.01, 0.05 and 0.1. hence, the fixed effects model is preferable compared to the pooled ols model. after conducting the hausman test, the result showed a probability of 0.0000, which indicates that the null hypothesis will be rejected. this is because the probability of 0.0000 is less than the 1%, 5% and 10% significance levels. therefore, the fixed effects model is also preferable compared to the random effects model. then, a comparison between the expected sign of each independent variable in this study and the actual sign from the fem result was conducted. first, the actual sign from the result shows that there is a positive sign between the relationship of financial development and climate change, which is in line with the expected sign in this research. this means that financial development increases the carbon emissions in the asean countries and contributes to climate change. this finding is also supported by previous studies (abbasi & riaz, 2016; boutabba, 2014; sadorsky, 2010), which concluded that financial development has a significant and positive impact on co2 emissions. when a country has better developed financial systems and institutions, it can help to attract overseas investors, which will improve a country’s financial and economic development. however, industrialization will cater for the heavy production of goods and services. this will lead to environmental degradation and more carbon will be emitted due to intense use of fossil fuels and waste produced from factories, which will further contribute to the causes of climate change. the relationship between population and carbon emissions is positive and significant, indicated by the results of the fem. it follows the expectation of this study in which population has a positive impact towards carbon emission. this relationship is supported by the majority of the previous studies in which it was concluded that size of population will lead to an increase in the level of carbon emissions. according to stephenson, newman, & mayhew (2010), rapid growth in population will deplete more key resources, such as water and fossil fuels. this means that there will be higher consumption of, and demand for, natural resources, and may cause the mismanagement of energy resources. demographic changes, such as size of population and urbanization, have positive impacts on co2 emissions as the emissions react proportionately to the changes in population size (o'neill et al., 2012). asian journal of economics and empirical research, 2021, 8(1): 1-9 7 © 2021 by the authors; licensee asian online journal publishing group gdp was also found to have a significant and positive relationship with climate change in this study. this finding is aligned with the expectation that there is a positive relationship between co2 emissions and gdp. this is due to the fact that a highly productive country often has greater economic growth activities, which becomes one of the factors of rapid industrialization. in particular, when a country has greater economic development, it also has a greater level of industrialization, which increases the level of carbon emissions contributing to climate change. moreover, renewable energy consumption was discovered to have a positive relationship with carbon emissions. however, this finding contradicts the expected sign in this study, that renewable energy consumption should have a negative impact on carbon emissions. this means that renewable energy does not contribute to the reduction of carbon emissions. insufficient financial incentives provided by governments is also one of the reasons for the slow development of renewable energy technology (apergis, 2010). it is quite difficult for asean countries to fund r&d development for renewable energy as they are still developing. table 3. model comparison. lr test hausman test test statistic 84.728593*** 35.632729*** decision making null hypothesis is rejected null hypothesis is rejected conclusion fem is more appropriate compared to pols fem is more appropriate compared to rem note: ***, indicates rejection of null hypothesis at the 1% levels of significance. 4.3. diagnostic checking 4.3.1. detection of multicollinearity multicollinearity problems happen when more than one explanatory variable is found to have high correlation within the regression model. the symptoms of multicollinearity are high standard errors, low significance levels, and extremely high r2 values. table 4. covariance matrix. variable lnfd lnpop lngdp lnre vif lnfd 0.0007 0.0002 0.0002 0.0001 2.0718 lnpop 0.0002 0.0009 0.0006 -0.0002 3.2298 lngdp 0.0002 0.0006 0.0007 -0.0002 2.9151 lnre 0.0001 -0.0002 -0.0002 0.0002 2.8282 the covariance matrix results in table 4 depicts that there is no strong correlation between the independent variables. also, the variance inflation factor (vif) shows that there is no serious multicollinearity problem because the vif values for all of the variables are less than ten for all three models. as there is no serious multicollinearity problem, the variables are verified and can be used to conduct the regression analysis. 4.3.2. normality, heteroscedasticity and autocorrelation table 5 displays the outcomes of the serial correlation, heteroscedasticity and normality distribution tests. first, the lagrange multiplier (lm) test is used to prove whether a model is serial correlated by determining its pvalue. the result shows that the model is free from autocorrelation problems because the p-values of the chi-square distribution for these models are greater than the 1% significance level. hence, the null hypothesis is not rejected and there is no autocorrelation. this proves that they are consistent and unbiased. the outcome of the breusch– pagan–godfrey test shows that the probability of 0.1825 is greater than the 1%, 5%, and 10% levels of significance. thus, the null hypothesis is not rejected, and this indicates that the model is free from heteroscedasticity problems (homoscedasticity). the result of the normality test (0.3923) is higher than the 1%, 5% and 10% levels of significance, which shows that the error term of the model is normally distributed. in short, the model is free from diagnostic problems. table 5. diagnostic checking results. model diagnostic checking: lm test 23.5956*** (0.0146) breusch–pagan–godfrey test 6.2322* (0.1825) normality test 1.8716*** (0.3923) notes: the p-values are written in parentheses; * and *** denote rejection at the 10% and 1% significance levels, respectively. 5. conclusion overall, the main objective was to examine the significant factors that contribute to climate change in selected asean countries from 2006 to 2015. as such, the pooled ordinary least squares (pols) method was applied, along with unit root, hausman, likelihood ratio and diagnostic checking tests. by employing panel data analysis, it was found that the fixed effects model (fem) is preferable, and the results show that all independent variables, including financial development, are found to have a significant and positive effect on climate change. however, renewable energy consumption is found to be inconsistent with the expected sign. according to adams & nsiah (2019), this might be due to the intermittent nature of its output and inadequate storage technology for renewable energy, which is in line with the context of developing asean countries. in order to prevent the damaging effect of financial development on the environment, governments in asean countries should develop financial markets by allocating and using the funds for projects which will introduce lowasian journal of economics and empirical research, 2021, 8(1): 1-9 8 © 2021 by the authors; licensee asian online journal publishing group carbon and clean energy technologies. this should increase the motivation of firms to lower their carbon emissions. for instance, local governments should direct their central bank to monitor the allocation of financial resources of each bank. then, the banks should monitor the enterprises after financial resources are allocated to ensure that credit is not being used at the cost of environmental quality. if an enterprise is involved in any activity that contributes to environmental degradation, the authorities should penalize those who default by placing slightly higher interest rates on loans and issuing fines as punishments. additionally, the governments should also motivate the banking sector to invest in businesses that utilize renewable energy with the purpose of achieving a sustainable environment. in particular, the banking industry should allocate financial resources to r&d for developing new energy efficient technologies. the banking sector could also use part of the financial resources to buy patents for these technologies in order to earn a profit as part of their income while working toward reducing environmental degradation. the adoption of renewable energy solutions that work with energy efficiency strategies will help to reduce carbon emissions by over 90% (irena, 2019). according to irena, the power systems generated by renewable energy can function more efficiently while supporting sustained economic growth. there are many forms of renewable energy, such as bioenergy, hydropower, and geothermal, ocean, solar and wind energy. ultimately, the electricity sector needs to be totally decarbonized for the energy transition, which can be achieved by making good use of renewable energy, increasing energy efficiency and adjusting power systems to be more flexible. the industrial sector is one of the largest carbon emitters, but the attention given to policies is not enough. steps should be taken by the government, such as offering financial incentives (i.e., grants, tax credits) and setting renewable portfolio standards (i.e., setting a renewable heat quota), among others. 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[accessed july 24, 2019]. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. http://dss.princeton.edu/training 169 © 2019 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 6, no. 2, 169-179, 2019 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2019.62.169.179 © 2019 by the authors; licensee asian online journal publishing group a re-examination of the relationship between foreign flows and economic growth in lldcs: dynamic fixed effects (dfe) faruq umar, quadri innovation and technology policy department (itpd), nigerian institute of social and economic research (niser), ibadan, nigeria. abstract there are 32 landlocked developing countries (lldcs) across four major continents of the world. these countries are mostly low-income or lower middle-income developing economies and suffer from a number of challenges especially, dwindling economic growth. the main objective of the study therefore, is to re-examine how economic growth in lldcs can be influenced with the aids of foreign flows such as foreign direct investment (fdi), foreign portfolio investment (fpi) and official development assistance (oda). the study made use of a sample of 19 member-states due to data limitation in order to evaluate the impact of foreign flows on economic growth using ardl panel approach with the dynamic fixed effect (dfe) as the baseline estimation techniques during the period of 1995 to 2017. our finding reveals that in the long-run, net fdi and net oda have impacts on the economic growth in lldcs but net fpi shows no any discernible impacts on gdp growth in lldcs. keywords: landlocked developing countries (lldcs), co-integration, dynamic fixed effect (dfe), economic growth, fdi, fpi, oda. jel classification: f4; c23; f21; f35; f24; f29. citation | faruq umar, quadri (2019). a re-examination of the relationship between foreign flows and economic growth in lldcs: dynamic fixed effects (dfe). asian journal of economics and empirical research, 6(2): 169-179. history: received: 13 august 2019 revised: 17 september 2019 accepted: 21 october 2019 published: 2 december 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 170 2. review of the literature ............................................................................................................................................................... 171 3. methodology and data ................................................................................................................................................................. 173 4. data presentation and empirical results ................................................................................................................................. 173 5. conclusion ....................................................................................................................................................................................... 177 references ............................................................................................................................................................................................ 178 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.62.169.179&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1135 https://orcid.org/0000-0001-8264-1212 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1135 https://orcid.org/0000-0001-8264-1212 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1135 https://orcid.org/0000-0001-8264-1212 asian journal of economics and empirical research, 2019, 6(2): 169-179 170 © 2019 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the existing literature by examining how economic growth in lldcs can be influenced with the aids of foreign flows such as foreign direct investment (fdi), foreign portfolio investment (fpi) and official development assistance (oda). 1. introduction in the developing countries, flows of foreign capital in their various forms have become the alternative source to deficits in domestic saving as well as dwindling foreign exchange earnings to meet demand for investments and other financial obligations. these foreign flows in their different forms viz-a-viz; foreign direct investment, foreign portfolio investment, official development assistance, foreign remittances, as well as external debts, have varying degrees of macroeconomic impacts on the economic growth and development of the destination countries. bearing on this importance of foreign capital flows into the developing economies of the world, quite a few anecdotal research work have examined the causality between foreign capital flows and economic growth at a single-country level as well as cross-countries. a number of empirical research work on the efficacy of international capital influx have tried to examine whether these capital flows in its various forms have achieved its main targets of enhancing ordinary consumers’ welfare and economic growth of developing economies such as that of these landlocked developing countries (lldcs). there are plethora of evidences in the literature that when researchers examined the basic reason behind foreign capital influx, improvement in the level of welfare and accelerated growth in the economy, divergent findings are often reported by researchers depending on the adopted methodology. for instance, a number of work adopting the cost-benefit approach at the micro-level often arrive at the findings that foreign capital flows have been effective in achieving its fundamental objectives. in contrast, the macro-level approach, namely cross-country regression analyses, are oftentimes not definite and conclusive. this contradiction, according to mosley (1986) is dubbed the “micro-macro paradox. in another dichotomy, the findings of these studies have shown a diverse opinions (ilhan, 2007). however, according to agbloyor et al. (2014); durham (2004); akinlo (2004) and adekunle and sulimon (2018) there are some researchers who opined that foreign capital flows are likely to accelerate growth in the economies only if these developing countries possess the necessary requisites viz-a-viz a conducive political atmosphere, sophisticated infrastructural facilities, improved technology, stock of human capital rather than mere population size as well as a well-functioning and deepened financial system; to absorb and make efficient utilization of these flows. on the other hand, some other authors have discovered that foreign flows impacted differently across several constituents of the flows orji et al. (2014). meanwhile, the contradiction in the findings of these two classes of authors is perhaps, according to obiechina and ukeje (2013) attributable to relative volatility between portfolio flows and fdi flows. generally speaking, adekunle and sulimon (2018) assert that fluctuation of capital flows does not occur predominantly at the preceding period of economic recession but during and accompanying periods of the economic turmoil. besides, fluctuation of foreign flows is a rife phenomenon associated with developing economies with no strong and competent financial structures to make effective use of the flows during financial crunch. the essence of foreign capital flows to the growth trajectory of the emerging economies remains an issue of fierce argument among economists as well as international policy makers. foreign capital flows in its variants remain an essential thematic issue in international economics discuss given its implications on the amelioration of absolute and relative poverty in developing countries. mixed findings have been discovered from previous databased researches on foreign capital flows and economic growth. gomanee et al. (2003); dalgaard et al. (2004) and karras (2006) for example, discovered a positive relation between economic growth and foreign capital flows; while burnside and dollar (2000) and bräutigam and knack (2004) on the other hand, reported a negative relation between foreign capital flows and growth. according to mosley et al. (1987) and boone (1996) capital flows has no effects on growth of the economy. it is worth note that burnside and dollar (2000) arrived at the submission that foreign capital flows has positive impacts on growth. meanwhile, the relevance of their conclusion is only to economies with effective trade policies as well as fiscal and monetary policies. thus, the key objective of this research paper is to re-evaluate of the existing relations between foreign flows and economic growth in the landlocked developing countries (lldcs). the paper endeavors to provide answers to the following research questions viz-a-viz: what is the impact of foreign direct investment (fdi) on economic growth in the lldcs? does foreign portfolio investments (fpi) significantly affect economic growth in the lldcs? and finally, how has official development assistance (oda) accelerated growth in the lldcs’ economies? methodologically, this paper tries to be distinct from a number of other research works in its adoption of autoregressive distributed lag (ardl) within the panel framework which seems to have not be exhaustively used to investigate the effects of foreign flows on economic growth. a number of research work such as akinlo (2004); kolawole (2013); jibir and abdu (2017); obiechina and ukeje (2013); ugwuegbe et al. (2016) have adopted ecm or vecm as appropriate to gauge the effects of foreign capital flows on economic growth. the studies highlighted above only centered on nigeria as their area of study. it is equally observed that many of the work used only foreign direct investment (fdi) as the representative of capital flows, but for ugwuegbe et al. (2016) who used external borrowing and official development assistance (oda) in lieu of foreign direct investment (fdi). many other authors have adopted methodological frameworks such as ordinary least squares (ols), three-stage least squares (3sls), vector auto-regression (var) and toda-yamamoto (t-y) causality test. also some surveys such as nyeadi et al. (2014); adeleke (2014) and shen (2010) adopted cross-country analyses, with nyeadi et al. (2014) diagnosing each country under separate analysis while adeleke (2014) and shen (2010) investigating the economies in a panel framework and estimated pooled ols, fixed-effects and random-effects models for their studies just to arrive at reliable and valid analyses. this introductory section of the study is centered on background to the study. follows by section 2 which focuses on the literature review that takes a look at some theoretical underpinnings and empirical findings. sections 3 and 4 discuss the methodology and empirical results respectively. finally, the concluding part of the paper is the focus of section 5. asian journal of economics and empirical research, 2019, 6(2): 169-179 171 © 2019 by the authors; licensee asian online journal publishing group 2. review of the literature the two-gap model of foreign aids, according to chenery and strout (1966), is centered on the essence of attracting foreign flows, most importantly foreign aids, to bridge the two gaps of savings and foreign exchange. they opined that the first gap, savings, is the shortage of domestic savings over domestic investment opportunities thereby making investments to be constrained by the available foreign exchange. the second gap on the other hand; foreign exchange gap occurs when a country’s foreign exchange supply via its import demand and outflows of capital investment exceeds its export supply and inflows of capital investment from its trading partners. the harrod-domar growth model equally supports the two-gap model of chenery and strout (1966) by propounding that economies with excess investment requirements relative to domestic savings would possibly bridge the socalled investment-savings gap by pursuing foreign capital in form of foreign aids or foreign private investment (todaro and smith, 2012). the harroddomar growth model posits a positive relations between economic growth and savings but a negative relations between output growth and capital-output ratio. meanwhile according to the solow growth model, in the short-run, closed economies associated with higher savings rate, ceteris paribus, grow faster than those with lower savings rates and tend to diverge from lower income levels per person. but for an open economies, the model asserts that as capital flows from industrial countries with increased capital-labor intensity and lower returns on investment to poor countries with lower capital-labor intensity and higher returns on investment, the economies undergo output convergence at superior levels of incomes (todaro and smith, 2012). another interesting part of endogenous growth models is their ability to analyze abnormal foreign influx of capital that widens income gap between the industrialized and poor nations. the opportunity of higher investments’ returns associated with non-industrialized economies due to lower capitallabor intensity, according to todaro and smith (2012) are denied by discouraging rate of substituting investments in human resources (health and education), infrastructural facilities as well as research and development (r&d). hence, contrary to the neoclassical growth models, models of endogenous growth propose an operational function for public policy in catalyzing economic growth via comprehensive investments in the formation of human capital and the impetus for foreign investments in technical knowhow-driven industries, such as telecommunications and artificial intelligence (ai). 2.1. empirical findings from the developing economies in his study of the causal relations between economic growth and trade openness and financial development in nigeria; chimobi (2010) divided the financial variables into three sub-classes of variables which are private credit, money supply and direct credit. he used time series data ranging from 1970 to 2005. testing the stationary of the variables, the augmented dickey fuller (adf) test was adopted and his findings revealed that all the variables were i(1). that is, they were all stationary after first difference. for the long run equilibrium, no co-integration was found among the variables and the granger causality test shows that there is no causal relations between the explanatory variables and economic growth. surprisingly, he found that economic growth affects financial development and trade openness in nigeria. foreign direct investments (fdi), in line with gray (2003) are seen as an origin of useful technologies and skills in the long term. at the tail end of the 2008 financial crunch, he discovered that fdi emerged as an essential variable imparting on indonesia’s economic growth. gray investigated fdi with how its flows was of great assistance in indonesian economy. development projects in indonesia were found to be uncertain for businessmen and a number of challenges were equally discovered between governments at various levels in indonesia. in his study, ouattara (2006) looks at the impacts of foreign capital supply on fundamental fiscal variables in senegal. he made used of information ranging from the period of 1970 to 2000 and his attention was majorly on the causalities between capital flows and debts. he came up with the following three findings. in the first instance, he discovered that roughly 41%, the largest part of capital flows, are used in debts financing in senegal while 20% of the state’s revenue are committed to debt servicing. secondly, he discovered that the foreign capital supply has statistically insignificant impacts on domestic expenditures, and finally, domestic expenditure was significant negative affected by debt servicing. he therefore, concludes that a decrease in debt should be a more potent policy instrument to receiving more loans. in a panel study of seven countries in the east asia, mandilaras and popper (2009) take a look at foreign capital flows. their main objective was to determine the factors that have influence on net capital outflows. their evaluation include the effect of openness of financial sector on external capital flows as well as the relations between domestic and foreign capital flows in the these countries. they found that domestic capital sector serve as a perfect yardstick in measuring the changes in aggregate capital supplies in the seven chosen countries. they equally discovered that lack of closeness of the capital sector is vital in explaining aggregate capital flows in the seven east asian countries. surprisingly, the us macroeconomic fundamentals were found to be significant determinants of the gdp growth in these countries. addison et al. (2005) observe projections in formal capital flows to africa for the period between 1960 and 2002. the authors discovered a significant decrease in foreign flows to these economies in the last few years which has greatly led to a rise in the magnitude of poverty in africa and economy of the region as a whole has suffered. they discovered that the shortage in capital flows would make the achievement of the mdgs much harder if not impossible. and then concludes that foreign capital flows do in real sense accelerate economic growth and also leads to a reduction in impoverishment. in addition, foreign capital flows directly affects public sector aggregates, enhancing increased public expenditure and reduction in domestic borrowings. to achieve mgds, it is crystal clear that advantages of sources of innovation for financial deepening and widening combining with development capital supply must be taken. hoang et al. (2010) adopted panel data ranging from 1995 to 2006 to examine the effects of fdi on economic growth rates in vietnam. they found that fdi has significant impact on economic growth in vietnam and that a 1 per cent rise in fdi will expand economic growth by 0.012 per cent. hoang et al. (2010) discover that effects of fdi is only positive on the stock of human capital after a given threshold level. they thus, concluded that only at this point can a country tap the advantages embedded in fdi. asian journal of economics and empirical research, 2019, 6(2): 169-179 172 © 2019 by the authors; licensee asian online journal publishing group 2.2. empirical findings from the developed economies in portugal, andraz et al. (2009) used a 3-stage approach with data ranging from 1977 to 2004 to find that fdi inflows and economic growth have a bi-directional causality. the main aim of their study was to observe grangercausality between the macroeconomic variables of gdp, fdi and export. they thus, discovered that fdi was significant in short run and granger-caused aggregate real exports. it is equally found that fdi is one of the economic fundamentals that impact on growth of gdp in portugal. meanwhile, real export do not influence increment in gdp while increase in fdi impacts total capital formation in portugal. therefore, they conclude that increased capacity of total output and foreign competitiveness would increase the rates at which economy grows. adhikary (2011) reports that the relations between capital formation and economic growth, trade openness, foreign direct investment (fdi) appears to be positive. karras (2006) looked into the relations between foreign aid and growth of gdp per capita with datasets ranging from 1960 to 1997 for a sample of 71 non-industrial economies in quest for aid and opined that a positive and statistically significant impact originates from foreign aid to economic growth. gomanee et al. (2005) directly examined the channels by which aid impacted on economic growth. in their paper they made use of a sample of 25 sub-saharan african countries from 1970 to 1997 and then arrived at the conclusion that foreign aid has a significant positive impact on economic growth in these economies. investment was discovered as the most effective transmission mechanism and that poor growth profile in africa need not be completely attributed to aid ineffectiveness. quartey (2005) utilized huge volume of data to examine the methods of innovations to make financial aid effectual in ghana and concludes that the state and its development partners must propose a better and well-coordinated plan to make multi-donor budgetary support successful. he also recommended that the state should work towards reducing its volume of debt to avoid using the bulky of these aids for debt servicing. according to burnside and dollar (2000) the connections between aid, state policy, and economic growth showed that foreign aid has little or no significant impact on the economies with weak economic policies but a positive impacts on growth in non-industrial countries with strong fiscal, monetary and trade policies. 2.3. the challenge of economic transformation of lldcs there are 32 landlocked developing countries (lldcs) distributed across four continents as shown in table 1 below. these countries are majorly low-income or lower middle-income developing economies and suffer from a number of challenges especially, dwindling economic growth. these economic growth challenges of lldcs are compounded by the constraints of lack of entrance to the sea, geographical remoteness, and poor physical infrastructure. as rightly captured by a recent statement on the plight of lldcs, though lldcs are diverse with respect to economic systems, natural resource endowment and levels of development, these common set of challenges impose on them rising transaction and transport costs which make attainment of global economic competitiveness an arduous task. the high transaction and transport costs restricts trade, make manufacturing in lldcs more expensive thereby preventing real sector investments required for structural economic transformation, and hinders the regular productivity improvements that move countries up in the global value chains. table-1. list of landlocked developing countries by regions. africa asia europe south america botswana mali afghanistan mongolia armenia bolivia burkina faso niger bhutan nepal azerbaijan paraguay burundi rwanda kazakhstan tajikistan moldova central africa republic south sudan kyrgyzstan turkmenistan north macedonia chad eswatini lao pdr uzbekistan ethiopia uganda lesotho zambia malawi zimbabwe source: un-ohrlls. lldcs also exhibit major challenges in the area of information and communication technologies (icts) infrastructure, which remain relatively less developed in spite of its crucial role as a driver of network relationships for trade facilitation and integration into the global economy. icts are especially important for overcoming the constraints due to remoteness by facilitating access to information on global markets for producers and consumers; and they also promote technology transfer required for productivity growth and unlocking the economic potentials of the lldcs. the challenge of land-locked compel most lldcs to depend on their neighboring transit countries to access international market. this kind of reliance is classified into four in the literature: reliance on neighbors’ infrastructure; dependence on sound cross-border political relations; reliance on neighbors’ peace and stability; and dependence on neighbors’ administrative practices. many of these landlocked developing countries are besides, highly commodity dependent, and their export is majorly heavy and low value goods which often lead to high transport costs. primary goods dominated over 50 per cent of the exports of 27 out of the 32 lldcs in 2011–2013. this implying that non-industrial and semi-processed commodities contributed roughly 75 per cent of the aggregate goods and services exported out of the lldcs economies as whole. in the same timeframe, 84.7 per cent is the average proportion of exports contributed by primary goods in the lldcs. the vulnerability of lldcs due to geographical remoteness and dependency thus hinders the economic transformation and results in different sets of crises and priorities in each of the countries. moreover, the locational challenges of lldcs are usually made complex due to weak transit-transport infrastructure, poor customs operations, and over-reliance on exports of non-industrial commodities (rothstein, 2015). asian journal of economics and empirical research, 2019, 6(2): 169-179 173 © 2019 by the authors; licensee asian online journal publishing group in view of the foregoing constraints on economic transformation in lldcs, the united nations recognized that the achievement of the global development goals of eradicating poverty, inclusive growth, and environmental sustainability would be impossible in lldcs without a joint action by the international community to address the challenge of land-locked. 3. methodology and data in this research work, non-primary data are strictly used. it relied on annual time series data from 19 selected countries out of the 32 lldcs due to data constraints and they were solely collected from the world bank, wdi (2018). the variables selected for the study include net foreign direct investment, net portfolio investment and net official development assistance as the explanatory variables while the explained variable is real gdp per capita. 3.1. specification of model in line with the cross-country regression analysis provided by hansen and tarp (2000) a single-equation regression is deemed fit to achieve the research objectives because of its frequent use in the literature. it is imperative to know that for in short panels, homogeneity of slope coefficients and stationary are assumed. however, for long panels, the assumption of stationary and homogeneity of coefficient of the slopes are often not appropriate. hence, the consideration of both non-stationary and heterogeneity when dealing with long panels. according to pesaran and smith (1995) and pesaran et al. (1999) a panel data representation of the time series autoregressive distributed lag (ardl) model is required to account for any potential non-stationary in the model. (1) where is the group-specific effect; is the number of groups; is the number of periods; pcgit represents per capita gdp growth rate, odait denotes official development assistance relative to gdp, fdiit is foreign direct investment relative to gdp and fpiit is net foreign portfolio investment relative to gdp, τt represents time period effects. we can re-write the model in a way that permits for the determination of both long run and short run estimates as follows: (2) 1, , ; 1, , . 1, , ; 0,1, , . i n t t k p j q         3.2. method of panel co-integration adopting method of panel co-integration is substantiated by considerations that include magnitude and features of the data utilized. the traditional panel techniques of random effect (re) and fixed effect (fe) is considered most appropriate for microeconomic datasets such as surveys with small t and large n. meanwhile, spurious result is often generated with the analysis of panel data with t > n because the behavioral properties of the data tends to be close to the of a time series. this spuriousness arises while dealing with macroeconomic data in the nature of this research work, for the fact that macroeconomic variables are often non-stationary. dealing with difficulties that often result from gathering of observations over time, baltagi (2008) proffers two alternatives: non-homogeneous regressions for each individual to bypass the homogeneity of the parameters that would result from a single regression and; the adoption of time series processes to panels to deal with nonstationary and co-integrations within the variables of interest. panel co-integration is noteworthy as an extension of time series analysis to panel data with large time (t). according to pedroni (2000); the panel co-integration technique offers both the short and long run estimates and also has power to pool long run equilibrium involved in panels, by permitting short run dynamics and fixed effect to be non-homogeneous across the panels. the procedures can be summarized as follows: the unit root test is conducted for pre-estimation investigation. if series were discovered to be integrated of non-zero order, then there comes a need to run a co-integration test to determine the possibility of co-integrations among the selected variables. lastly, if a long-run relations (cointegrated) is established among variables, there is need to determine the equilibrium coefficients in the long run. like the short panels, there are essentially three estimators developed to estimate dynamic models with long panels. they are: mean group (mg) estimator, pooled mean group (pmg) estimator and the dynamic fixed effect (dfe) estimator. 4. data presentation and empirical results 4.1. descriptive analysis of the data the statistical characteristics of the data including the mean, standard deviation, minimum and maximum values, at levels are depicted in this section of the paper. the descriptive statistics is to show a behavioral trend of our data and analyzed according to the sampled countries as shown in table 2. 1, , ; 1, , . 1, , ; 0,1, , . i n t t k p j q         asian journal of economics and empirical research, 2019, 6(2): 169-179 174 © 2019 by the authors; licensee asian online journal publishing group table-2. descriptive statistics. s/n country statistics gdp fdi fpi oda 1 armenia mean 2567.219 5.153161 -4.00e+07 93.16771 st. dev 1092.019 2.643053 1.55e+08 30.2292 min 1043.541 1.100209 -6.89e+08 53.06903 max 4198.795 11.66114 8.68e+07 181.9921 2 azerbaijan mean 3749.033 16.47968 -2.35e+08 24.06721 st. dev 1964.774 14.8073 6.53e+08 17.84348 min 1234.997 2.464374 -2.67e+09 -7.52166 max 6072.586 55.0759 3.47e+08 91.82452 3 bolivia mean 1859.194 4.574412 7.33e+07 76.34275 st. dev 313.2728 3.704279 4.27e+08 14.57843 min 1493.418 -2.49888 -9.80e+08 49.69431 max 2490.956 12.19663 9.32e+08 106.4882 4 botswana mean 6114.811 3.245471 3.25e+08 62.06506 st. dev 1101.978 2.193433 4.04e+08 74.1784 min 4525.769 0.558883 -5.34e+08 16.17276 max 7864.253 8.93102 1.23e+09 377.472 5 burkinafaso mean 525.2079 1.101836 2.54e+08 51.03386 st. dev 96.1554 1.193713 2.24e+08 14.93857 min 361.1214 0.020826 -1.20e+08 15.48767 max 685.7575 4.103598 5.25e+08 71.57341 6 eswatini mean 3804.115 2.150596 -6.86e+06 59.7954 st. dev 668.9482 2.837498 3.28e+07 36.19737 min 2938.889 -2.73891 -1.16e+08 13.05902 max 4838.844 9.684826 4.59e+07 132.3987 7 kahzakhstan mean 7395.097 7.740143 1.82e+09 11.15542 st. dev 2619.301 3.467813 5.75e+09 5.3366 min 3738.469 2.893193 -8.47e+09 3.278675 max 10867.74 13.01286 1.74e+10 21.57075 8 krygkhstan mean 798.6478 5.290868 7.45e+06 65.70728 st. dev 163.8211 4.223879 2.83e+07 23.74736 min 535.044 -1.39184 -2.71e+07 37.21322 max 1070.369 17.13123 1.29e+08 129.2602 9 lesotho mean 1042.135 7.938632 1.23e+06 61.52298 st. dev 247.8001 10.14474 3.48e+06 39.17914 min 739.0457 0.402577 -3.91e+06 15.68031 max 1436.15 30.38665 1.46e+07 158.0808 10 macedonia mean 4032.104 3.903113 -6.12e+07 94.56051 st. dev 754.9118 2.874941 1.85e+08 28.17629 min 3056.985 0.202774 -6.50e+08 39.73272 max 5256.711 12.65813 2.09e+08 136.8014 11 malawi mean 429.7709 3.196528 -7.90e+07 53.55073 st. dev 55.31789 3.180963 1.24e+08 14.8628 min 361.0435 -0.1474 -3.95e+08 32.41855 max 512.6456 10.15434 3.97e+06 85.76388 12 mali mean 647.946 2.529665 -9.65e+05 57.40963 st. dev 76.11271 1.650835 1.37e+08 17.43609 min 496.6702 -0.31655 -3.71e+08 26.31357 max 764.1692 6.351123 4.55e+08 84.95876 13 moldova mean 1732.854 4.865271 -6.08e+06 4.568708 st. dev 468.4432 3.114204 6.66e+07 5.181362 min 1135.818 1.174877 -2.34e+08 -0.0493 max 2578.498 12.17908 1.40e+08 16.6291 14 mongolia mean 2457.067 8.052962 -2.60e+08 109.0906 st. dev 913.7001 14.76001 4.98e+08 36.70459 min 1459.118 -37.1548 -2.30e+09 78.82101 max 3996.144 43.91211 1.61e+08 245.3353 15 niger mean 347.6648 4.568708 -1.79e+07 36.13407 st. dev 22.87198 5.181362 4.64e+07 10.3722 asian journal of economics and empirical research, 2019, 6(2): 169-179 175 © 2019 by the authors; licensee asian online journal publishing group min 322.7779 -0.0493 -1.39e+08 17.13371 max 393.6621 16.6291 3.02e+07 55.85703 16 paraguay mean 4089.306 1.2551 -1.51e+08 15.46453 st. dev 561.1228 0.86059 3.09e+08 6.029084 min 3406.233 -0.75019 -1.30e+09 3.89317 max 5272.576 3.692033 9.00e+06 29.16989 17 tajikhstan mean 644.2494 3.971965 -1.79e+08 34.41881 st. dev 212.5096 3.549803 2.35e+08 13.3113 min 366.9354 0.616866 -6.27e+08 11.28918 max 1024.859 13.10218 1.19e+06 57.5405 18 uganda mean 536.4975 3.629608 -2.68e+07 43.16339 st. dev 118.0268 1.294726 1.50e+08 9.188309 min 362.1812 2.001792 -2.59e+08 26.47565 max 694.2895 6.479821 4.42e+08 58.94764 19 zambia mean 1250.653 5.362081 -1.75e+08 79.18317 st. dev 292.6578 1.853939 3.91e+08 36.42707 min 909.5834 2.547893 -1.22e+09 35.28615 max 1658.823 9.418112 2.40e+08 223.2338 note: for the fpi, a 3-year moving average technique was used to generate the missing values. 4.2. correlation analysis table 3 below reveals the strength of partial relations linking the four macroeconomic variables under study. it shows a strong positive relationship between gdp fdi, and lpi, but a negative relationship between gdp and oda. and there is no likelihood of multicoliearity based on the magnitude of the partial correlations. thus, these correlations validate the choice of these macroeconomic fundamentals in the study. table-3. correlation analysis. gdp fdi fpi oda gdp 1 fdi 0.0386 1 fpi 0.20000 0.0279 1 oda -0.0525 0.0181 -0.0861 1 source: author’s computation. 4.3. analysis of panel unit root determining the stationary of the selected variables is the first step in in using the available data in achieving the objectives of our study. **significance at 5% and ***significance at 1% 4.4. panel unit root there are number of techniques in panel data analysis used in the literature in determining the order of integration of a given dataset. levin et al. (2002) came up with a modified version of the augmented dickey-fuller (adf) unit root test known as levin et al. (2002) (llc) unit-root test: δxit = ϕitψit + ρxit-1 + σψij δxi,t-j + εt (3) where in equation 3, ϕit includes separate deterministic components like fixed effect, trend, or a mixture of fixed effects and trend; ρ the autoregressive parameter; ξit the error terms; with lag order n. however, the levin-lin-chu test presumes ρ constant the panel unts but this often experience power degeneration (breitung, 2001). im et al. (2003) further develop the levin-lin-chu test by letting ρ to vary over the panel units: δxit = ϕitψit + ρixit-1 + σψij δxi,t-j + εt (4) a new test that rectifies the occurring biasedness in the utilization of levin et al. (2002) or im et al. (2003) unitroot test was later developed by breitung (2001). the difference in magnitude between panel units (n) and periods (t) or the choice an individual deterministic trend in llc and ips often leads to this biasedness. besides, as proposes by choi (2001) the fisher test adopts the time series augmented dick-fuller (adf) and phillips-perron (pp) tests as a framework in panel analysis. the fisher test combines p-value from the unit root test of each series, in lieu of taking the individual test statistics average as proposed by im et al. (2003). the hadri (2000) unit root test is premised on the lagrangian multiplier and uses residuals derived from individual ordinary least squared regression on deterministic components to compute the statistics. while llc, breitung, ips and fisher test the null hypothesis that each series is non stationary across individuals (h0: ρi=0) against the alternative that at least table-4. unit root test. variables llc ips hadri breitung remarks t*-stat z-value z-stat t-stat level 1st diff. level 1st diff. level 1st diff. level 1st diff. gdp -2.254 -3.398*** 5.803 -7.761*** 57.758*** 5.850*** 10.313 -5.094*** i(1) fdi -4.501*** -9.148*** -5.703*** -11.533*** 12.293*** -2.832 -4.835*** -12.595*** i(0) fpi -2.489 -9.082 -6.844*** -12.539*** 0.641 -3.155 -5.295*** -10.093*** i(0) oda -0.005 -6.196*** -2.387*** -11.371*** 13.096*** -2.434 -3.554*** -7.532*** i(1) asian journal of economics and empirical research, 2019, 6(2): 169-179 176 © 2019 by the authors; licensee asian online journal publishing group one individual in the series is stationary (h1: ρi < 0), the hadri test assumes the opposite (null hypothesis: no unit root against the alternative that some or all series are non-stationary). in addition, the llc, breitung and hadri tests are based on homogeneity in the unit root process (ρi=ρ across panels), while the ips and fisher tests assume the autoregressive coefficient to be heterogeneous. as depicted in table 4, there is clear evidence of stationary of the variables. the llc, ips and breitung tests do not reject the null hypothesis of non-stationary of gross domestic product at level but they rejected it after first difference. while hadri rejected the null hypothesis at both level and first difference. thus, concluding that gdp is i(1) variable that is stationary after first difference. for foreign direct investment (fdi), the llc, ips and breitung tests do reject the null hypothesis of non-stationary at both level and first difference. while hadri rejected the null hypothesis at both level. thus, concluding that gdp is i(0) variable that is stationary at level. in addition, for foreign direct investment (fpi), the ips and breitung tests do reject the null hypothesis of nonstationary of fpi at both level and after first difference. while the llc and hadri do not reject the null hypothesis at both level and first difference. thus, concluding that fpi is an i(0) variable. finally, for oversee development assistance (oda), the llc, ips and breitung tests reject the null hypothesis of non-stationary of oversee development assistance (oda) after first difference. while hadri also rejected the null hypothesis at level. hence, confirming that oda is i(1). therefore, no i(2) variable is used in the study. 4.5. co-integration tests the discovery of an i(1) variable in the series calls for a need to examine the presence of long-run equilibrium among the selected variables. the pedroni (2000) panel and group statistics is used in determining any long-run equilibrium in our model. pedroni panel tests is centered on the null hypothesis of no co-integration versus the alternative hypothesis of co-integration among the variables. co-integration tests are dependent on the within dimension analysis, and statistics are estimated independently by summing numerators and denominators along series. there are four constituents of the panel statistics: a panel-v statistic, a panel-rho, panel-pp and panel adf statistics which is similar to phillips-perron ρ statistics, phillipsperon t-statistics and augmented dickey-fuller tstatistics in uni-variate time series, respectively. pedroni group statistics are based on the between dimension approach. the three computable statistics are group-rho, group-pp and group-adf statistics. table-5. pedroni test of co-integration. test stats panel group v -3.502 rho 2.646 4.282 t 1.711 2.439 adf 5.204 7.198 table 5 displays the outcomes of the co-integration results. in the pedroni tests, the schwarz information criterion (sic) with the option of individual intercept with no trend is used to ascertain the appropriate lag length. evidence of a long-run relations exists among the variables. all the four test components reject the null hypothesis of no co-integration but only for the t-statistic. this simply implies that an equilibrium exist among the variables in the long run and it is evident that there is co-movement among the series in the long run, and the difference among them is stationary. based on its power, the panel tests appear to be better than the group tests and thus affirm the increasing in efficiency due to pooling of data. 4.6. estimation and discussion of results this section of the research paper is devoted to the estimation and discussion of results. establishing the empirical relations between the variables is next having discovered that the variables are co-integrated. the study’s baseline estimator the dynamic fixed effect (dfe) is used in conjunction with the gmm, and the pooled mean group (pmg) estimators to obtain the short-run parameter estimates as well as determining the relevance of the findings because each of these estimators has its peculiar merit and arriving at the resulting parameters differently. generalized method of moment needs that a specific number of moment conditions were set for the model. these moment conditions are functions of the model parameters and the data, such that their expectation is zero at the parameters' true values. the gmm method then minimizes a certain norm of the sample averages of the moment conditions. the gmm estimator is more efficient when t < n (roodman, 2009). to estimate dynamic models with long panels the following estimators mean group (mg) estimator, pooled mean group (pmg) estimator and the dynamic fixed effects are used in the literature. the mg estimator by pesaran and smith (1995) has to do with estimating n time-series regressions and taking the average of the coefficients. using this estimator, the intercepts, slope coefficients, and error variances are all allowed to differ across groups. the pmg estimator by pesaran et al. (1997;1999) on the other hand, jointly use both pooling and averaging of coefficients. it permits the intercept, short-run coefficients, and error variances to differ across the groups like the mg estimator but constrains the long-run coefficients to be the same across groups. lastly the dfe estimator, like the pmg estimator, constraints the parameters of the co-integrating matrix to be the same across all panels. this estimator equally restricts the speed of adjustment parameter and the short-run parameters to be the same. results of the estimation with that of benchmark models are displayed in table 6. the dfe provides evidence that foreign flows have impacts on gross domestic product (gdp) in landlocked developing countries (lldcs). the results as presented in table 6 shows that net foreign direct investment (fdi), net foreign portfolio investment (fpi) and net official development assistance (oda) have positive but not significant effects on economic growth at both 1% and 5% level of significance. in the short-run, the dynamic fixed effect (dfe) estimation technique shows that the negative sign of error correction term shows the overlapping of the series to equilibrium in the long-run. the parameter of the ecmt–1 is found to be (-0.006) for short-run model which https://en.wikipedia.org/wiki/expected_value https://en.wikipedia.org/wiki/norm_(mathematics) asian journal of economics and empirical research, 2019, 6(2): 169-179 177 © 2019 by the authors; licensee asian online journal publishing group implies that variation from short-run in real gdp per capita is rectified by 0.6% every year in the long-run and it is significant at 10% level. meanwhile, the dfe estimator asserts that in the long-run, oda is the most effective instrument of growth out of the three chosen variables of foreign flows. the slope parameter of net oda (1.42) reveals that 1% rise in net (oda) would raise the real gdp per capita by 1.41%. net fdi with positive influence on economic growth of the landlocked developing countries is the second significant inflow variable in the analysis. with the parameter of net fdi of 1.134 implies that real gdp per capita increases by 1.13% for every 1% increase in net (fdi). this result is partly corroborated by the findings of shafiq and ahmad (2016); pattillo et al. (2002) and bornschier et al. (1978). finally, the coefficient of net fpi of 3.26e-10 implies that for net foreign portfolio investment to have appreciable impacts on economic growth of these economies, billions of dollars in net investment is required. that is, for a unit increase in real gross domestic product, 10 billion units of net fpi is needed. succinctly, the three estimators used in the robustness tests provide reliable evidence to conclude that foreign flows contribute to growth in the economies of landlocked developing countries (lldcs). using the hausman test for making a choice between the estimates of the pmg and dfe, the coefficient (0.999) is found to be insignificant at the 5% level. thus, the analysis is hinged on the dfe estimates, as dynamic fixed effect perform better than the pooled mean group as well as the gmm used as a measure of robustness. table-6. estimation/robustness. variable gmm dynamic fixed effects pooled mean group d.(log(gdp) d.(log(gdp) d.(log(gdp) short run error corr -0.00558 (-0.70***) -0.00091 (.00076) d.(log fdi) 0.0050 (0.00226) -0.00179 (-0.69) 0.00257 (.00446) d.(fpi) 4.96e-13 (8.32e-13) 4.02e-13 (0.26) 2.26e-11 (2.37e-11) d.(log oda) 0.0129 (0.0131) 0.00077 (0.14) 2.13e-05*** (.00893) l.d(log gdp) 0.9455*** (51.74) constant 0.03656 (0.66) -0.00438 (.0378) ar(1) -2.59*** ar(2) -1.23 instruments 227 hausman 0.9998 long run log fdi 1.134 (1.666041) 3.522 (5.592216) fpi 1.93e-10 (3.26e-10) -6.01e-11 (6.11e-10) log oda 1.406 (1.909339) 12.505 (19.76189) standard errors in parentheses. ***, ** and * is statistically different from zero at 1%, 5% and 10% significance level, respectively. 5. conclusion this paper has evaluated the impact of foreign flows or what is also known as foreign capital flows on economic growth in the landlocked developing countries with a sample of 19 out of the 32 member-states due to limitation of data using ardl panel approach with the dynamic fixed effect (dfe) as the baseline estimator for the period of 1995 to 2017. the findings show that a long-run effect of net foreign direct investment, net official development assistance on economic growth but the net portfolio investment have no any discernible effects on economic growth in the lldcs. examining the subject matter from the perspective of lldcs due to their geographical peculiarity is part of this paper’s contribution to the literature. in order to foster economic growth and strengthening these economies on the right trajectory, it is hope that the study’s recommendations are given the required attention. aggressive pursuit of foreign direct investment and official development assistance would be useful in fostering economic growth in these countries since they show positive though, insignificant impacts on economic growth in the long-run while the impact of portfolio investment is found to be highly negligible on the real gdp per capita. the negative sign of error correction term implies the overlapping of the dynamics model at the steady-state in the long-run. the parameter value of the error correction reveals that the rate at which the model attains the steadystate is highly significant. the findings are pointers for policymakers at both national (government and private investors) and international (donors, foreign investors etc) levels to develop appropriate models that would facilitate economic utilization of the available foreign flows and to minimize the negative impact of over reliance on external debt as well as foreign aids through sound and robust macroeconomic policies usually, trade and industrial policies in conjunction with fiscal and monetary policies. to achieve sustainable economic growth that is the yearnings of the united nations and other stakeholders, the governments at all levels should provide conducive business environment and institutional framework to attract foreign flows, particularly, fdi and oda to enhance economic growth in the landlocked developing countries (lldcs). asian journal of economics and empirical research, 2019, 6(2): 169-179 178 © 2019 by the authors; 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https://doi.org/10.6007/ijarbss/v6-i4/2087. wdi, 2018. world development indicator. washington dc: the world bank group. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 1 © 2019 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 6, no. 1, 1-15, 2019 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2019.61.1.15 © 2019 by the authors; licensee asian online journal publishing group an empirical examination on trade openness and economic growth nexus in africa cosmas s. mbogela1 1mzumbe university business school, box 6 mzumbe, tanzania abstract african countries have experienced disparities in the growth of their economies. the literature provides different propositions on the causality of economic growth which has given rise to debates on the alternative course that countries need to pursue to enhance their respective growths economically. the paper has therefore examined the effects of trade openness on economic growth for the african countries. in order to analyse the link between trade openness and economic growth by using the growth model, the instrumental variables and two stage least squares (2sls) for panel data models approach is employed. later an examination of the direction and strength of causality is conducted by using such techniques as johansen cointergration test and short run granger causality test. the paper uses data from the world bank database. a sample size consists of 49 african countries with a sample period of 20 years. empirical results reveal that of all the variables that were included in the growth model, gross capital formation revealed a great impact on economic growth for african economies, followed by openness and then fdi flows. a test of granger causality for individual countries so as to explain the economic disparities, reveals that majority of the african countries (in the sample) supports the export led growth hypothesis. implications are that the export led hypothesis would be much more advantageous for the african countries if it would not only result into increased real incomes but also economic structural transformations. keywords: trade openness, economic growth, export driven growth, growth driven exports. jel classification: e23, f10, f13. citation | cosmas s. mbogela (2019). an empirical examination on trade openness and economic growth nexus in africa. asian journal of economics and empirical research, 6(1): 1-15. history: received: 18 september 2018 revised: 26 october 2018 accepted: 30 november 2018 published: 24 december 2018 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ......................................................................................................................................................................................... 2 2. channels through which trade openness affect economic growth ....................................................................................... 3 3. growth model specification ............................................................................................................................................................ 4 4. further examination on the nature of relationships and the direction of causality ........................................................ 7 5. conclusions ........................................................................................................................................................................................13 references ...............................................................................................................................................................................................13 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.61.1.15&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/261 https://orcid.org/0000-0003-3124-0122 http://asianonlinejournals.com/index.php/ajeer/article/view/261 https://orcid.org/0000-0003-3124-0122 http://asianonlinejournals.com/index.php/ajeer/article/view/261 https://orcid.org/0000-0003-3124-0122 asian journal of economics and empirical research, 2019, 6(1): 1-15 2 © 2019 by the authors; licensee asian online journal publishing group 1. introduction there has been much debates on the examination of the relationship between trade openness and economic growth in the theoretical and empirical literature (dollar and kraay, 2001; ekanayake et al., 2003; karras, 2003; yanikkaya, 2003; awokuse, 2008; nannicini and billmeier, 2011; seetanah et al., 2012; mercan et al., 2013; menyah et al., 2014; huchet-bourdon et al., 2018). the reason is obvious that economies would want to establish the direction of causality so that they can focus their priorities on the part that causes the other. this is a crucial aspect, particularly to policy makers, who would need to decide if they should encourage trade openness to speed up their economic growth or the other way round; focus on enhancing economic growth that in turn would promote the degree at which they trade internationally (harrison, 1996; kónya, 2006). the literature provides four possible propositions on the direction of causality on the two phenomena. the export led growth hypothesis (elg), which is supported by most of the studies, provides that more exports results into higher economic growth rates (onafowora and owoye, 1998; rodriguez and rodrik, 2001; din, 2004; hassan and islam, 2005). this hypothesis is complemented by the import led growth hypothesis (ilg) as suggested by awokuse (2008). coining the two hypotheses together results into country‘s aggregate trade hence trade openness. most of the researchers supporting this hypothesis attribute positive effects of trade openness to economic growth. in a sense, this claims that openness enhances productivity in the economy through export promotion, importation of high quality technologies, as it is a prerequisite for the production of higher quality and competitive products and services. besides, high quality technology has positive effects on labour productivity and capital efficiency (kónya, 2006). in support of this proposition are studies such as harrison (1996) and rodriguez and rodrik (2001) who examined the association between openness and economic growth and found a positive correlation between the two and in particular, the causality running from trade openness to economic growth. same conclusion is observed from studies like that of din (2004) examining the elg hypothesis in south asian region countries, he found that there exists a long-run causality in bangladesh and pakistan with short run causality in some other southern asia countries. in addition, the study by hassan and islam (2005) finds a long-run uni-directional equilibrium relationship running from trade openness and economic growth. the study by onafowora and owoye (1998) who used vector error correlation model (vecm) in order to facilitate the dynamic analysis of the interactions among the variables, found that trade policies and exports have significant positive effects on the real output growth in sub sahara african countries. consequently, this imply that outward orientation strategy might benefit sub saharan african countries in terms of stimulating their economic growth, though it also requires suitable domestic policies that discourage import substitution strategies. another hypothesis is the opposite of the above, the growth-driven export (gde). this hypothesis predicts that trade flows are induced by the level of economic growth of a country. higher trade volumes are expected to be associated with the economies with higher levels of gdp per capita. studies of awokuse (2008) suggest that the export –led growth may be misleading while the import–led growth as well as the causality running from income levels leading to increased export volumes hypothesis is having relatively stronger empirical evidence. however, there is a also an importance of realising the importance of ilg, because ignoring imports which is a source of inputs for the production of imports as well as technological knowledge is misleading. furthermore, there is a hypothesis that postulates the bi-directional causality, which means the causation runs from both sides. empirical examples of studies supporting this hypothesis include (ekanayake et al., 2003) who found a bi-directional causality between export growth and economic growth for both developed and developing countries. examining the long run relationship between fdi, trade openness and economic growth (klasra, 2011) observed a bi-directional causality between openness and economic growth in pakistan. some other studies include dollar and kraay (2001) in their study of 137 countries concluded that openness brings about enhanced and faster economic growth as well as reduction in poverty in poor countries. the last hypothesis postulates that there is no relationship between trade openness and economic growth. examples are the study by sarkar (2008) who examined the relationship between openness and economic growth and found that there is no positive long term relationship between the two variables particularly in the less developed countries. however, some other researchers show that higher trade openness brings about different outcomes to different countries depending on the level of development. it has strong positive impacts on real income for developed countries with high incomes while having detrimental impacts to low income countries (kim, 2011). this view is also supported by studies done by krugman and venables (1995); caner and hansen (2004). the contention is that, low-income economies benefit from trade liberalization but only if the opening up to international trade is carried out alongside with policy and institutional reforms toward investment, production efficiency, and financial development (kim, 2011). for this reason there is much in the literature that confirms the existence of the relationships that exists between economic growth and trade openness. the most appealing argument in the literature is that which claims a positive effect of openness on economic growth. david (2007) finds that raising trade openness by 10 per cent permanently increases real growth rate of gdp per capita by 0.5 per cent. it can be argued that developing countries to include african economies, tend to benefit more from this because of the fact that trade openness promotes transfer of technology from developed countries, which implies a positive spill over effect on world income distribution. even the recent chinese rapid economic growth is attributed to the country‘s increasing degree of opening up to international trade (marelli and signorelli, 2011). moreover, the literature acknowledge that economies characterized with higher degrees of trade openness tend to grow faster than those with lower levels of openness (din. et al., 2003) because trade openness enhances growth in a country‘s gdp per capita. manole and spatareanu (2010) reveals that countries (developing and developed) with less trade protectionism have higher growth of gdp per capita. an empirical research by edwards (1993) reveals that a higher level of a country‘s openness is associated with a higher level of economic growth, because among others a country open to international trade improve product quality and efficiency in production due to competition from foreign companies (grossman and helpman, 1991; aizenman and noy, 2003). importing industries can also import technology and knowledge, where exporting sectors in turn can learn from this and improve their competitive position. asian journal of economics and empirical research, 2019, 6(1): 1-15 3 © 2019 by the authors; licensee asian online journal publishing group is it growth led exports or export led growth for african countries? despite the fact that literature vindicates that openness to international trade (especially exports) has an influence to economic growth, we see mixed results (huchet-bourdon et al., 2018) there are studies that support both negative and positive impact, with scanty literature from africa. this paper complements the literature by providing new insights on the relationship that exists between trade openness and economic growth for the african countries. the empirical results from this paper can be instrumental for african countries to analyse their trade policies and economic growth trends. the remainder of the paper is organized as follows; next is the review of literature especially the channels through which outward orientation can affect economic growth. section 3 provides a growth model specification. section 4 provides an empirical examination of the nature and direction of the relationship between trade openness and economic growth. section 5 concludes. 2. channels through which trade openness affect economic growth the literature presents three channels from economics that provide the nexus between trade openness and economic growth, to include government policy, domestic allocation and distribution and technology transfer (rose, 2002). on the other hand, based on the neo-classical model of international trade (david, 2007) offers three channels including gains from exchange, specialization and economies of scale. both consumers and producers will gain from trade openness due to increased imports of primary and intermediate inputs that will be at lower prices (gains from exchange). moreover, by opening up borders, firms will direct resources away from the previously protected sectors to those that add more value to an economy and those that have a competitive advantage hence utilizing resources more diligently to increase outputs (gains from specialization). on the firm level, firms that will survive competition after liberalizing the economy, realises an increase in output and achieve lower average total costs. this enhances their efficient use of resources, which lead to higher output (gains from economies of scale). revisiting the channels by rose (2002) the first channel is the government policy. higher degree of openness compels countries to pursue good quality microeconomic policies so as to create favourable environments for inhibiting capital flights and being in line with the international and inter regional agreements. since good policies create a stable microeconomic environment, these countries are expected to positively affect their economic growth for they not only eliminate price uncertainty in their economies but also moderate public deficit and debt levels. eventually this enhances the capacity of the domestic firms to compete internationally (rose, 2002). furthermore, open economies tend to have less price distortions because in economic theory, free trade facilitates price convergence of tradable goods across countries. the presence of trade restrictions generates price distortions that shift productions between economies leading to production processes that are not based on comparative advantage, hence consumers end up paying higher prices on goods and services (david, 2007). since price distortions have adverse effects on factor accumulation and growth, open economies are then expected to enjoy positive effects on their economic growth by having less price distortions. trade openness is positively related to domestic rate of physical investment. investments enhance factor accumulations which is a major factor in economic development, specifically for developing economies moving from low economic growth equilibrium to a path of sustained industrialization (rose, 2002). the most common channel is through technological transmission. knowledge spillages are a driving force for sustained and long run economic growth. trade openness can affect growth and convergence through technology transmissions, because open economies are more exposed to a worldwide stock of productivity-enhancing knowledge (falvey et al., 2002; rose, 2002). the literature asserts that national policies that reduces the degree to which an economy is intergraded to external trade strengthens the undersupply of innovation in that respective economy (grossman and helpman, 1991). innovation is central to any improvement in total factor productivity in any economy. madsen finds that empirically that 93 per cent of the total factor productivity in the 1990‘s for the oecd countries has been solely due to knowledge spill over through imports. in fact even the total factor productivity convergence among these countries over the period 1870 to 2004 has been associated with knowledge spill over through international trade (madsen, 2007). learning from east asian growth miracle, trade openness enhances direct imports of high– tech goods as well as greater interactions with the sources of innovations through high international communications and mobility among economies. this has a positive advantage as it is easier for domestic producers in open economies to imitate foreign technologies in their productive process. this alone translates into economic growth as it boosts the capacities of the developing economies to compete with more advanced economies in the global market. it also lead to great transformations in the product composition of output and exports, developing countries will transform from relying heavily on agriculture to heavy industries as well as high-tech goods. open economies are better positioned to gain economically through efficient resource allocation. efficient allocation of resources is associated with enhanced investments, productivity and growth (kandiero and chitiga, 2006). in the long run such economic environment is likely to attract fdis which is vital channel to economic growth. and, since trade is positively related to fdi inflows, countries that desire to increase their fdi inflows levels should enhance their trade levels (asiedu, 2006; marelli and signorelli, 2011). this is because trade and fdi are interrelated, as in most cases fdi is export oriented (marelli and signorelli, 2011). thus, trade openness signals investors that a particular country is committed to stable and market oriented economic policies. investors will see the possibility of importing intermediate goods for initiating new projects, be able to repatriate their profits as well as exporting the produced goods. with more fdi inflows, host economies obtain required financing resources for infrastructure development and rehabilitation of their economies. moreover, arguing in line with endogenous and neo classical growth models, fdi is positively associated with economic growth (babatunde, 2011). with the fdi inflows, host countries benefit as they are being provoked to be competitive and to obtain new technologies, managerial expertise, marketing capabilities, which improve their human capital. market competition enhances efficiency in the economy by reducing the degree of monopoly power that dominates most of the less open economies. fdi also enhances employment levels, managerial skills, diffuses technologies and fosters innovations in the economy (asiedu, 2002; kandiero and chitiga, 2006; adhikary, 2011). likewise quoting kandiero and chitiga (2006) fdi inflows ―stimulate capital accumulation through adding to asian journal of economics and empirical research, 2019, 6(1): 1-15 4 © 2019 by the authors; licensee asian online journal publishing group domestic savings and raising the recipient economy‘s efficiency through improving resource allocation, deepening domestic financial markets and reducing local capital costs‖ with all these, countries strengthen their supply-side capabilities for producing and selling goods and services, which lead to their economic growth. moreover, with fdi host economies increase the volume and efficiency of their physical investment, which eventually promotes economic growth through aggregate expenditure and increased fixed capital stock. this is because fixed investments in part depend not only on the internal saving rate but also on the foreign investments through fdi (adhikary, 2011; marelli and signorelli, 2011). trade openness enhances export volumes that can be used to pay for an increased value of imports, which in most cases leads to a positive net value of exports. this results into higher local savings and higher accumulation of foreign exchange reserves which can be invested for further earnings (marelli and signorelli, 2011). it is also good to note that private and public capital stock formation depends on fixed investment, which as noted earlier is largely supported by a high saving rate and foreign investment. the neo-classical growth model suggest that developing countries with lower initial level of capital stock tend to have higher marginal rate of returns (productivity) and growth rates if adequate capital stock is injected. this is because when additional capital is injected in the form of long term investment the marginal productivity of investment is increased in the short-run and this increased productivity have a long run positive effects on economic growth (adhikary, 2011). moreover, in line with transaction theory (i.e. a low transaction cost environment generates financial incentives because of higher return on investment) trade openness tends to influence the flows of international capital in terms of risk-return relationship. investors will feel interested in committing long-term investment in a country with lower tariff and non-tariff barriers on investment and allows repatriating capitals and profits (adhikary, 2011). it is however, good to note that openness can also result from the level of economic growth of a country; among others frankel and romer (1999) have argued that economies experiencing rapid economic growth resulting from reasons other than openness are in a better chance to engage in the international trade. 3. growth model specification the paper establishes the causality relationships that exist between trade openness and economic growth in african countries, particularly sub saharan africa. the variables of interest here are therefore mainly trade openness and gdp per capita. however, it is inevitable to examine the relationships in a growth model before testing for short run and long run relationships. based on the marelli and signorelli (2011) study, the growth model to be used for this study is a function of trade openness, foreign direct investment, the workforce (population aged 15 to 64 as a percentage of total population), human capital development, initial conditions and gross capital formation. thus the resultant general growth model is; yit= β0+β1 eit + β2toit + β3xi+εit (1.1) where y represents economic growth; e are the control variables that affect economic growth in country i at time t (for this study are initial conditions, the workforce, foreign direct investment ratio, gross capital formation and human capital development). to refers to a measure of level of trade openness; xi stands for country fixed effects; and εit is an error term. however, economic growth modelling has two potential problems of inconsistency, the omitted variable bias and the endogeneity problem. the former arises when country specific effects are wrongly assumed uncorrelated with the other explanatory variables mainly because of the dynamic nature of the growth models. on the other hand, the latter problem may arise due to a failure to control for endogeneity, which might result into inconsistent estimation results (tsangarides, 2001). in this case, it means that the ordinary linear regression cannot be used because the zero conditional mean assumption does not hold. in econometrics perspective, three main circumstances may result into the violation of this assumption, the endogeneity, omitted variable bias and the issue of errors in variables (i.e. measurement error in the explanatory variables). to avoid all these potential problems, the model for this paper is estimated by using the instrumental variables and two stage least squares (2sls) for panel data models. this is done through two estimators, the fixed effects estimator and random effect estimator. with the 2sls, we first conduct a one stage estimation that include all the variables in the model, and then thereafter a further examination is done by instrumenting the trade openness variables in a 2sls approach. after obtaining the regression results, we examine the direction and strength of causality between the two variables as well as assessing the short run and long run relationships that exists between trade openness and economic growth. in the latter, unit root tests are conducted to check whether the panel data are stationary. 3.1. data and variables this paper used the standard measure of trade openness is used (the sum of exports and imports as a proportion of gdp). gdp per capita growth (annual percentage) is the widely used proxy for economic growth in the literature (dowrick and golley, 2004; bajwa and siddiqi, 2011) and is therefore used to measure the economic growth of the sample of countries under consideration. the data are averaged in five years to reduce the noise in the data. since the data are averaged in five years, the initial condition variable is measured by log of real gdp per capita in the first year of the five-year period under each observation (cinyabuguma and putterman, 2011). the secondary school enrolment ratio is used as a proxy for human capital development, which measures the quality of labour (seetanah, 2009; seetanah, 2011). the foreign direct investment flows and the gross capital formation variables are in percentage of gdp. the workforce variable is proxied by the ratio of population workforce (aged 15-64) as a percentage of the total population. this is considered as the most active population cadre in any economy. all the data are from the world bank database. data are collected for 49 countries, which represent the sample size, and the sample period covering from 1989 to 2008 inclusive (that is 20 years). the selection of countries for the sample is based on the criteria that, only those countries with full data in almost all the sample period are included. table 1 provides an account and description as well as the data sources for all the variables that will be used in this paper. asian journal of economics and empirical research, 2019, 6(1): 1-15 5 © 2019 by the authors; licensee asian online journal publishing group all the data were then organised in a panel data form and are averaged in four five-year‘ time periods so as to reduce the noise in data. besides, this helps to remove any business cycle effects in the dataset as well as to simplify the empirical analysis. panel data analysis is used because it can exploit both the time series, cross sectional dimensions of data, and has proved to provide more efficient estimations of parameters by considering wider sources of variation. what's more, the use panel data avails a richer set of information to exploit the relationships between the dependent and independent variables. the variable initial conditions are converted into natural logarithm before its usage in order to ensure that the data is normally distributed and properly skewed. the rest of the data are in percentages, hence, there was no need for logarithmic transformations. 3.2. growth model estimations results in order to analyse the link between trade openness and economic growth by using the growth model, the instrumental variables and two stage least squares for panel data models approach is employed. the two stage least squares method with instrumental variables is employed because some of the covariates in the model (1.1) are endogenous (i.e. trade openness).this approach provides five different options of estimators with their variation being based on the way they treat the country individual effects. these options include the two gls randomeffects (g2sls and ec2sls) model, the between-effects (be2sls) model, the fixed effects estimator (fe2sls) and the first differenced estimator (fd2sls) which take away individual effects by fitting the model in first differences. this paper opts for the random effect and fixed effect estimators, but we conduct these estimators in two stages. table-1. variable description and sources of data variable description of a variable source gdp per capita growth (annual %) this is a dependent variable. annual percentage growth rate of gdp per capita based on constant 2005 u.s. dollars. gdp per capita is gross domestic product divided by midyear population. world bank database. trade openness measures aggregate trade (sum of exports and imports of goods and services) as a ratio of gdp. world bank database. initial conditions a measure of gdp per capita in the first year of each ―five year period average‖ as used in this study. world bank database. gross capital formation (% gdp) the variable consists of outlays on additions to the fixed assets of the economy plus net changes in the level of inventories. fixed assets include land improvements; plant, machinery, and equipment purchases; and the construction of roads, railways, and the like, including schools, offices, hospitals, private residential dwellings, and commercial and industrial buildings. inventories are stocks of goods held by firms to meet temporary or unexpected fluctuations in production or sales, and 'work in progress.' world bank database. human capital development (% of gross enrolment) measures secondary school enrolment as a ratio of total enrolment, regardless of age, to the population of the age group that officially corresponds to the level of education shown. secondary education completes the provision of basic education that began at the primary level, and aims at laying the foundations for lifelong learning and human development, by offering more subjector skill-oriented instruction using more specialized teachers. world bank database. workforce (population aged 15-64 as a percentage of total) used as a measure of a country's active population as a ratio of total population. total population between the ages 15 to 64 is the number of people who could potentially be economically active. population is based on the de facto definition of population, which counts all residents regardless of legal status or citizenship-except for refugees not permanently settled in the country of asylum, who are generally considered part of the population of the country of origin. world bank database. foreign direct investment, net inflows(%gdp) fdi measures the sum of equity capital, reinvestment of earnings, other long-term capital, and short-term capital as shown in the balance of payments. this series shows net inflows (new investment inflows less disinvestment) in the reporting economy from foreign investors, and is divided by gdp. world bank database. source: author‘s compilation (2015) the first stage is to do regression while treating all the variables as if they were exogenous by using the one stage within estimator and the generalised least square. subsequently, in the second stage of the regression, the trade openness is instrumented using the primary variables (i.e. log of economic location, log of gdp per capita, trade policy and log of population). the resultant equations are presented in the specifications below; asian journal of economics and empirical research, 2019, 6(1): 1-15 6 © 2019 by the authors; licensee asian online journal publishing group gdp per capita growthit = β0+β1log(initial conditionsit)+ β2(gross capital formation(%gdp) it)+ β3(human capital development (% total enrollment)it)+ β4(workforce (population aged 15-64%total)it)+ β5 log (openness it)+ β6(fdi ratioit) +εit (1.2) gdp per capita growthit = β0+β1log(initial conditionsit)+ β2(gross capital formation(%gdp)it)+ β3(human capital development (% total enrollment)it)+ β4(workforce (population aged 15-64%total)it)+ β5(fdi ratioit)+ β6[log(openness it )= β7 log(gdp per capitait)+ β8log (economic locationit)+ β9log(populationit)+ β10log(areait)+ β11trade policyit + β12agriculture (%gdp) + β13mining(%gdp) ] +εit (1.3) where; openness it represents trade openness, i is the ith cross-section unit and t is the time of observation, β represents the coefficients of the variables and εit is the error term. table-2. analysis of the economic growth of sub sahara africa one stage estimator (xtreg) instrumented 2sls (xtivreg) modelling technique: fixed effects random effects fixed effects random effects lninitial conditions 1.03 0.20 0.88 0.21 (0.98) (0.28) (1.00) (0.28) workforce 0.24 0.07* 0.23 0.06* (0.19) (0.03) (0.19) (0.04) human capital (% of total) 0.01 0.01 0.01 0.01 (0.03) (0.01) (0.03) (0.01) gross capital formation (%gdp) 0.17*** 0.14*** 0.18*** 0.16*** (0.06) (0.03) (0.06) (0.04) fdi flows (%gdp) 0.05 0.15*** 0.06 0.13* (0.09) (0.06) (0.09) (0.06) trade openness 0.02 0.01* 0.05 0.02* (0.01) (0.00) (0.03) ( 0.01) hausman test 5.82 (0.44) 5.72 (0. 45) r-square 0.26 0.52 0.28 0.48 no. of observations 196 196 196 196 no of panel groups 49 49 49 49 note: the dependent variable for these regression results is the gdp per capita growth. ***, **, * denotes significance level at 1%, 5% and 10% respectively. standard errors are in parentheses. table 2 presents the results for the specifications of the equations 1.2 and 1.3. the hausman test has been applied to decide on the two models, the fixed effects and the random effects. it is a test that tests the null hypothesis that the coefficients estimated by the efficient random effects estimator are the same as the ones estimated by the consistent fixed effects estimator. in this case the results shows that they are (that is insignificant, because the p-value, prob>chi2 larger than the critical value .05) because the prob>chi2 is 0.44 and 0.45 for one stage and instrumented 2sls respectively. therefore, for this specification, the hausman test results in both cases do not reject the null hypothesis which means that the unique errors are not correlated with the regressors, hence the individual effects can adequately be modelled by a random effects model. in both cases, gross capital formation and trade openness variables are highly significant, gross capital formation being highly significant (at 1% level) and trade openness is significant at 10% in all cases. the fdi and the workforce variables are statistically significant in both cases under the random effect estimator. the workforce variable is only significant with the random effect estimator both in the first stage regression and in the instrumented g2sls. this is consistent to the assertion that it is through a skilled workforce in the economy that foreign direct investment can have a positive effect on the economic growth (borensztein et al., 1998). the foreign direct investment (as percentage of gdp), is also highly statistically significant with the random effect model in the one stage estimation. all coefficients for these variables take their expected positive signs implying a positive effect on african economic growth (alfaro et al., 2004). the variable initial condition shows relatively lower coefficients and in both cases, it is not statistically significant, which suggests that the variable has lower influence on the economic growth. likewise, the quality of human capital variables is not significant in all stages of both estimators. however, they take the expected signs in all four cases. fdi flows variable is not significant with the fixed effect estimator in both stages, in the same way the workforce variable is also not statistically significant, though all take the expected positive signs. the r-square value shows that the explanatory variables together explain approximately 27% deviations in economic growth in model under the fixed effect estimator while it is approximately 50 per cent with the generalised least square estimator. the estimated coefficients on trade openness are positively and significant at 10per cent, indicating that an increase in the trade openness by one percent is associated with an increase in the economic growth of the african countries by 0.02 per cent. from the variables included in the growth model, the statistical results for both equations indicates that gross capital formation has more impact on economic growth for the african economies, followed by the level of openness and then fdi flows and the workforce (population aged 15-64) as a percentage of the total population. table 3 presents the alternative estimation using the instrumental variables and two stage least squares for panel data models using the ―first‖ option. this option reports the variables in the model as well as the excluded instruments so that it is possible to examine the correlation of the instruments to the endogenous variable (i.e. trade openness). the first stage regression results above suggest that three of the seven excluded instruments are correlated with trade openness at different levels, the agriculture ratio is highly correlated followed by log of gdp per capita and mining ratio. asian journal of economics and empirical research, 2019, 6(1): 1-15 7 © 2019 by the authors; licensee asian online journal publishing group table-3. using the ‗xtivreg‘ with a first option modelling technique: first stage g2sls regression g2sls random effect iv regression initial conditions 0.06** (0.02) 0.21 (0.28) openness 0.02* (0.01) workforce (population. aged 15-64 % total) 0.03 (0.26) 0.06* (0.03) human capital (% of total) 0.14 (0.10) 0.01 (0.01) gross capital formation (%gdp) -0.53** (0.26) 0.16*** (0.04) fdi flows (%gdp) 1.63*** (0.40) 0.13** (0.06) lngdpper capita -0.09 (0.11) lnpopulation -0.21* (0.11) lnarea -0.01 (0.02) lneconomic location 0.07 (0.11) tradepolicy 0.01 (0.02) agriculture (% gdp) -0.58*** (0.17) mining (% gdp) 0.31* (0.18) no. of observation 196 196 no. of panel groups 49 49 note: the dependent variable for these regression results is the gdp per capita growth. ***, **, * denotes significance level at 1%, 5% and 10% respectively. standard errors are in parentheses. the openness variable is instrumented by lngdp per capita, lneconomic location, lnpopulation, lnarea, trade policy, agriculture (%gdp) and mining(%gdp). the exceptions are the log of population and log of economic location and log of area. however it can be noted that conditioning on other variables included in the model, trade openness seem to play a relatively less role in determining the economic growth of the african countries. the rest of the variables present the same picture as discussed in table 2 except for the initial conditions variable. these estimation results on the log of initial conditions shows that the variable is statistically significant and have relatively higher coefficients, implying a significant impact on economic growth in african countries. in any case the regression results indicate that trade openness and economic growth has positive relationship. though the level of statistical significance is not that promising, still a positive relationship guarantees policy makers in the african countries that any effort to boost up trade levels in their economies will have desirable positive impacts on their economic growth rates. 4. further examination on the nature of relationships and the direction of causality this part examines the existence of either uni or bi-directional causality between trade openness and economic growth. for this examination the extended sample period is used, from the previously used 1989 to 2008 now the sample period is 1980 to 2011. the reason being the variables that are of interest do not have missing values as it was the case with some of the variables in the previous dataset. the first step is to test the data to detect if they have any unit root, to ensure that they are stationary. this will ensure appropriate model specification and an avoidance of arriving at misleading results (onafowora and owoye, 1998). only after establishing that the data for the variables are not stationary at level is when cointegration tests can be done. if the data for both variables are stationary this could mean that they are also cointegrated and therefore the necessity of running the short run causality tests to establish the direction of causality. the granger causality test is conducted to establish the causality direction, the test aims at determining as to whether the variables have a unidirectional or bi directional causality. 4.1. unit root tests for panel data to conduct these tests the panel unit root tests are employed, which are essentially multiple series tests that have been applied to the panel data structures. the intention of testing for unit root aims at checking whether the data have their mean around zero. there are various tests for testing the unit root in a dataset ranging from the levin et al. (2002); breitung (2001); im et al. (2003) and fisher type tests by choi (2001). the study conducted all these tests to check for stationarity in the data. despite the fact that the entire test gave same results, table 4 reports only two unit root tests (im, pesaran and shin and fisher type). these tests allow heterogeneity, in the sense that they allow for different autoregressive (ar) structure for all of the series in the panel. under this group, there are im, pesaran, shin (ips tbar tests) by im et al. (2003) and fisher-type by choi (2001). these tests are both referred to as unit root tests with individual unit root processes, they has as the null hypothesis that all the panels have a unit root (choi, 2001; breitung, 2002; levin et al., 2002; im et al., 2003). asian journal of economics and empirical research, 2019, 6(1): 1-15 8 © 2019 by the authors; licensee asian online journal publishing group the choice of these two tests is also based on the nature of data, while their counterparts assume panels of data are balanced and therefore cannot be applied in a situation of unbalanced panel data, im, pesaran and shin and fisher type tests have proved to work perfectly with the unbalanced data panels, though there cannot be gaps in a panel. they are therefore chosen because the panel dataset in use involves a large number of african countries which in most cases does not have all the data for the whole sample period. these tests also have been recommended as performing well in combining individual unit root tests applied on each time series when the panel data that are heterogeneous and non-stationary are used. they thus derive the panel specific unit root from combining of individual unit root tests. the fisher type tests are devised for finite n as well as infinite n; they assume that each individual panel has different types of non-stochastic and stochastic component; and that the time series span are different for each of the panels. both test settings, assume that the alternative hypothesis is that some of the panels have a unit root while other panels does not. under the fisher type tests settings, the main idea is to combine p-values from the unit root tests applied to each panel. for ips t-bar test is a t-bar statistic based on the augmented dickey-fuller statistic (dickey and fuller, 1979) the test statistic is computed by the sample mean of the individual unit root tests for each panel. therefore, while both tests combine information based on individual unit root tests, the crucial difference between the two is that the ips test is based on combining the test statistics while the fisher-type test is based on combining the significance levels of the individual tests (maddala and wu, 1999). the framework consider a sample of n cross sections (i.e. countries) observed over t time periods (1980 -2011). the stochastic process, yit , is generated by the first-order autoregressive process: yit= (1 øi)µi + øiyi,t-1 + εit , i =1,…n, t =1,…,t, (1.4) where; initial values, yi0, are given. the interest is in testing the null hypothesis of unit roots øi= 1 for all i. the equation (1.4) above can be expressed as; dyit = αi +βiyi,t-1 +εit, (1.5) where; αi= (1 øi)µi, , βi= (1 øi)anddyit = yityi,t-1 table-4. panel unit root tests results 1980 -2011(by using im, pesaran and shin test, and fisher type test). ips fisher adf fisher pp conclusion intercept intercept and trend intercept intercept and trend intercept intercept and trend openness -2.55*** (0.00) -4.21*** (0.00) 159.37*** (0.00) 194.15*** (0.00) 145.49*** (0.00) 169.87*** (0.00) i(0) gdppp growth -21.31*** (0.00) -22.04*** (0.00) 735.05*** (0.00) 757.76*** (0.00) 910.26*** (0.00) 1461.92*** (0.00) i(0) fdi (% gdp) -10.68*** (0.00) -10.19*** (0.00) 375.87*** (0.00) 354.04*** (0.00) 390.34*** (0.00) 346.52*** (0.00) i(0) gross capital formation (% gdp) -4.45*** (0.00) -3.39*** (0.00) 212.81*** (0.00) 230.04*** (0.00) 189.93*** (0.00) 162.08*** (0.00) i(0) quality of human capital (% of total) -9.62 *** (0.00) -6.92*** (0.00) 299.92*** (0.00) 239.51*** (0.00) 332.39*** (0.00) 336.37*** (0.00) i(0) workforce (aged 15 -64 % total population) -3.15*** (0.00) 14.03 (1.00) 184.15*** (0.00) 58.68 (1.00) 110.92 (0.51) 16.05 (1.00) i(0) notes: * rejects the null of a unit root at the 10% significance level, ** rejects the null of a unit root at the 5% significance level, *** rejects the null of a unit root at the 1% significance level. probabilities in parentheses. the null hypothesis of the unit roots then becomes; h0 : βi=0 for all i (1.6) against the alternatives that allows for some of the cross section in the panel to have unit roots (i.e. at least one is stationary), h1: βi<0 , i=1,2,…,n1, βi = 0, i = n1 + 1, n1 +2, ..., n. (1.7) the formulation of this alternative hypothesis allows βi to differ across cross sections, hence allowing for heterogeneity. table 4 presents the results for the unit root test for all the variables of interest in both level and in first difference. the table presents only two unit root tests, but it is good to note as mentioned earlier that the test was done using all the unit root tests mentioned above. the results for all the tests were the same, that is, all the variables were stationary at level. therefore, this shows that despite the choice of the two tests, the data are proved to behave in the same way with the other unit root tests as well. the results show that for all variables both ips and fisher type tests for unit roots reject the null hypothesis of non-stationary at level. for that reason, the tests results do reject the null hypothesis of non-stationary at level with both individual effect and individual linear trend effects. by the fact that both variables are rejecting the null hypothesis at the order of i(0), it means that trade openness and economic growth (as measured by gdp per capita) are integrated to the order of one i(0). since they are integrated of the same order, it also means that they are cointegrated as well. asian journal of economics and empirical research, 2019, 6(1): 1-15 9 © 2019 by the authors; licensee asian online journal publishing group 4.2. panel granger causality test so far, the relationships that exist between the variables have been established; however the existing relationship does not prove anything on the causality or direction of influence. a common sense logic of causality may start from the axiom that, time always forge ahead, never backward (koop, 2000). thus, since a certain event a happened before event b, one can conclude fallaciously that there is a possibility that event a caused the happening of event b (i.e. past events can cause the current events). but sometimes both the variables a and b fail to granger cause each other, in this case they are said to be independent variables. there is also a possibility that a granger causes b, meanwhile b granger causes a (this is referred to as bi-directional causality). under granger causality, if variable a (granger) causes variable b, then changes in a must precede changes in b. hence when regressing b on other variables (including the past values of b) if the lagged values of a are included and they improves the prediction of b, then it can be concluded that a (granger) causes b. similar case will be for the case where b (granger) causes a. the main idea under this test is to predict the existence and direction of causality; whether it is running from trade openness to gdp per capita or from gdp per capita to trade openness, or runs from both directions (bi directional). this is known as bilateral causality as there are only two variables under consideration, in case where more than two variables are involved, hence multivariable causation, the relevant technique would be the vector autoregression (var). granger causality test involves the estimation of the following pair of regressions: ∑ ∑ (1.8) ∑ ∑ (1.9) where; index i refers to the country (i = 1,..., n), t to the time period (t=1,..., t) and l to the lag. , represents the white noise errors that may be correlated for a given country but not across countries. it is also assumed that yt and xt are stationary or cointegrated and in this case at first difference of gdp per capita and trade openness respectively. with respect to this method, in country i there is one way granger causality running from x to y if in the first equation not all ‘s are zero but in the second all ‘s (regression coefficients) are zero, there is one way granger causality from y to x if in the first equation all ‘s (autoregressive coefficients)are zero but in the second not all ‘s are zero, there is two way granger causality between y and x if neither all ‘s nor all ‘s, are zero, and there is no granger causality between y and x if all ‘s and ‘s are zero. the evaluation of the null hypothesis that x does not granger cause y can be done by estimating an equation in which y is regressed on lagged values of y and the lagged values of an additional variable x. to reject the null hypothesis that x does not granger cause y (i.e. concluding that x granger cause y), one or more of the lagged values of x must be significant. despite the fact that granger causality tool has been considered to be imperfect, it is, yet a standard and helpful tool for assessing the causality relationship between two variables. the most reported weakness of the panel granger tests despite their advantages is the inappropriate assumption of causal homogeneity. of course, this is true for most of the panel data analysis, the flaw of making inferences on causal relationships in all individual cross section units while it sometimes exists in only some of the individual cross sections. this may as well be true on the other way round, rejecting the existence of causality for the whole group of cross section individuals while actually there exists some causal relationships in some of the individual cross sections in the panel. however, it is also good to note that the outcome of the granger test is sensitive to the number of lags introduced in the regression model. this is because too few or too many lags are problematic, too few lags means some important variables are omitted hence specification error that leads to biasness in the retained regression coefficients, leading to erroneous conclusions. likewise too many lags leads to specification error indicating wasteful observations, hence increasing the standard errors of the estimated coefficients leading to false conclusions (konya 2006).the results in the table 5 are based on the lag of 2, however whatever lag that could be chosen between 1 to 10 gives the same results in terms of significance and the nature of causality. table-5. short run causality test by granger dependent variables source of causation (independent variables) trade openness gdp per capita growth f – statistic (pvalue) trade openness 8.21*** (0.00) gdp per capita growth 0.03 (0.97) note: the values in the parenthesis are the probability of rejecting the null of non-causality. * rejects the null of non-causality at the 10% significance level; and, ** rejects the null of non-causality at the 5% significance level. the short-run causality tests by using granger reveal that there exists a high statistical significant unidirectional short run causal relationship between trade openness and gdp per capita growth. the direction of causality runs from economic growth to trade openness indicating that economic growth induces trade flows in africa. this implies that african countries could boost their trade openness ratios by enhancing their economic development. the results supports growth led hypothesis for the african countries. the results above do not give the detailed granger causality for the variables for each individual african country. it is inevitable to have a look on the detailed individual african countries considering the fact that most of these countries significantly differ from one another, so they could have different economic growth experiences and hence the causality directions between trade openness and economic growth. factors such as civil wars in some of these countries, different extent of foreign aid they receive, the differences in climatic conditions, and differences in natural resources endowments, among others, explains for the economic disparities among african countries. asian journal of economics and empirical research, 2019, 6(1): 1-15 10 © 2019 by the authors; licensee asian online journal publishing group however for this to be done requires a cross section data analysis rather than the previously used panel dataset. the sample size is altered as four countries (djibouti, libya, somalia and eritrea) were removed from the sample due to many gaps in the data as a result of which the granger causality test could not workout. it is expected that testing for granger causality for each country in the sample will also help to explain the differences between countries. table 6 shows mixed results for the different african countries. table-6. granger causality wald tests for individual african countries (lags 5) null hypothesis f-statistic probability algeria‘s lagged values of trade openness does not granger cause gdp per capita growth 0.8011 0.5641 algeria‘s lagged values of gdp per capita growth does not granger cause trade openness 1.6771 0.1940 angola‘s lagged values of trade openness does not granger cause gdp per capita growth 2.5879 0.0944 angola‘s lagged values of gdp per capita growth does not granger cause trade openness 4.9693 0.0149 benin‘s lagged values of trade openness does not granger cause gdp per capita growth 2.0173 0.1276 benin‘s lagged values of gdp per capita growth does not granger cause trade openness 1.5083 0.2393 botswana‘s lagged values of trade openness does not granger cause gdp per capita growth 2.8533 0.0493 botswana‘s lagged values of gdp per capita growth does not granger cause trade openness 3.4521 0.0256 burkina faso‘s lagged values of trade openness does not granger cause gdp per capita growth 2.877 0.0480 burkina faso‘s lagged values of gdp per capita growth does not granger cause trade openness 0.33131 0.8538 burundi‘s lagged values of trade openness does not granger cause gdp per capita growth 1.1316 0.3794 burundi‘s lagged values of gdp per capita growth does not granger cause trade openness 0.10774 0.9892 cameroon‘s lagged values of trade openness does not granger cause gdp per capita growth 3.3337 0.0264 cameroon‘s lagged values of gdp per capita growth does not granger cause trade openness 0.62039 0.6861 central africa republic‘s lagged values of trade openness does not granger cause gdp per capita growth 1.6074 0.2095 central africa republic‘s lagged values of gdp per capita growth does not granger cause trade openness 2.3836 0.0840 chad‘s lagged values of trade openness does not granger cause gdp per capita growth 4.4836 0.0079 chad‘s lagged values of gdp per capita growth does not granger cause trade openness 0.15731 0.9750 congo‘s lagged values of trade openness does not granger cause gdp per capita growth 2.4155 0.0765 congo‘s lagged values of gdp per capita growth does not granger cause trade openness 0.83672 0.5408 cote d‘ivoire‘s lagged values of trade openness does not granger cause gdp per capita growth 8.2656 0.0003 cote d‘ivoire‘s lagged values of gdp per capita growth does not granger cause trade openness 0.47718 0.7885 d.r.c‘s lagged values of trade openness does not granger cause gdp per capita growth 0.56938 0.7225 d.r.c‘s lagged values of gdp per capita growth does not granger cause trade openness 0.32143 0.8935 djibouti‘s lagged values of trade openness does not granger cause gdp per capita growth 2.9518 0.0693 djibouti‘s lagged values of gdp per capita growth does not granger cause trade openness 0.53504 0.5917 egypt‘s lagged values of trade openness does not granger cause gdp per capita growth 3.429 0.0237 egypt‘s lagged values of gdp per capita growth not granger cause trade openness 0.5152 0.7614 equatorial guinea‘s lagged values of trade openness does not granger cause gdp per capita growth 8.0177 0.0004 equatorial guinea‘s lagged values of gdp per capita growth does not granger cause trade openness 4.3112 0.0094 eritrea‘s lagged values of trade openness does not granger cause gdp per capita growth 7.083 0.0008 asian journal of economics and empirical research, 2019, 6(1): 1-15 11 © 2019 by the authors; licensee asian online journal publishing group eritrea‘s lagged values of gdp per capita growth does not granger cause trade openness 0.61825 0.6876 ethiopia‘s lagged values of trade openness does not granger cause gdp per capita growth 5.8085 0.0023 ethiopia‘s lagged values of gdp per capita growth does not granger cause trade openness 0.89956 0.5025 gabon‘s lagged values of trade openness does not granger cause gdp per capita growth 8.8078 0.0011 gabon‘s lagged values of gdp per capita growth does not granger cause trade openness 0.58228 0.5655 gambia‘s lagged values of trade openness does not granger cause gdp per capita growth 1.7701 0.1699 gambia‘s lagged values of gdp per capita growth does not granger cause trade openness 0.45545 0.8039 ghana‘s lagged values of trade openness does not granger cause gdp per capita growth 0.71634 0.4976 ghana‘s lagged values of gdp per capita growth does not granger cause trade openness 3.7343 0.0370 guinea‘s lagged values of trade openness does not granger cause gdp per capita growth 1.5138 0.2349 guinea‘s lagged values of gdp per capita growth does not granger cause trade openness 3.4525 0.0231 guinea bissau‘s lagged values of trade openness does not granger cause gdp per capita growth 3.2331 0.0551 guinea bissau‘s lagged values of gdp per capita growth does not granger cause trade openness 0.28378 0.7552 kenya‘s lagged values of trade openness does not granger cause gdp per capita growth 0.53149 0.7497 kenya‘s lagged values of gdp per capita growth does not granger cause trade openness 2.9601 0.0402 lesotho‘s lagged values of trade openness does not granger cause gdp per capita growth 1.3394 0.2927 lesotho‘s lagged values of gdp per capita growth does not granger cause trade openness 0.92489 0.4877 liberia‘s lagged values of trade openness does not granger cause gdp per capita growth 0.51435 0.7620 liberia‘s lagged values of gdp per capita growth does not granger cause trade openness 0.20799 0.9548 libya‘s lagged values of trade openness does not granger cause gdp per capita growth 2.8313 0.0765 libya‘s lagged values of gdp per capita growth does not granger cause trade openness 0.23857 0.7894 madagascar‘s lagged values of trade openness does not granger cause gdp per capita growth 0.62897 0.6800 madagascar‘s lagged values of gdp per capita growth does not granger cause trade openness 0.6291 0.6799 malawi‘s lagged values of trade openness does not granger cause gdp per capita growth 2.5274 0.0986 malawi‘s lagged values of gdp per capita growth does not granger cause trade openness 3.0928 0.0617 mauritania‘s lagged values of trade openness does not granger cause gdp per capita growth 1.294 0.3099 mauritania‘s lagged values of gdp per capita growth does not granger cause trade openness 1.4456 0.2560 mauritius‘s lagged values of trade openness does not granger cause gdp per capita growth 2.5067 0.0686 mauritius‘s lagged values of gdp per capita growth does not granger cause trade openness 2.275 0.0907 morocco‘s lagged values of trade openness does not granger cause gdp per capita growth 3.7011 0.0380 morocco‘s lagged values of gdp per capita growth does not granger cause trade openness 0.55158 0.5824 mozambique‘s lagged values of trade openness does not granger cause gdp per capita growth 0.96555 0.4646 mozambique‘s lagged values of gdp per capita growth does not granger cause trade openness 0.5234 0.7555 namibia‘s lagged values of trade openness does not granger cause gdp per capita growth 6.4002 0.0053 namibia‘s lagged values of gdp per capita growth does not granger cause trade openness 0.69089 0.5098 asian journal of economics and empirical research, 2019, 6(1): 1-15 12 © 2019 by the authors; licensee asian online journal publishing group niger‘s lagged values of trade openness does not granger cause gdp per capita growth 4.4979 0.0078 niger‘s lagged values of gdp per capita growth does not granger cause trade openness 2.5816 0.0627 nigeria‘s lagged values of trade openness does not granger cause gdp per capita growth 4.1374 0.0112 nigeria‘s lagged values of gdp per capita growth does not granger cause trade openness 0.10042 0.9908 rwanda‘s lagged values of trade openness does not granger cause gdp per capita growth 3.2247 0.0298 rwanda‘s lagged values of gdp per capita growth not granger cause trade openness 6.0261 0.0019 senegal‘s lagged values of trade openness does not granger cause gdp per capita growth 2.3085 0.0871 senegal‘s lagged values of gdp per capita growth does not granger cause trade openness 1.6112 0.2077 seychelles‘ s lagged values of trade openness does not granger cause gdp per capita growth 1.2395 0.3318 seychelles‘ lagged values of gdp per capita growth does not granger cause trade openness 7.5168 0.0006 sierra leone‘s lagged values of trade openness does not granger cause gdp per capita growth 2.3715 0.0807 sierra leone‘s lagged values of gdp per capita growth does not granger cause trade openness 0.95221 0.4721 sudan‘s lagged values of trade openness does not granger cause gdp per capita growth 1.0108 0.4399 sudan‘s lagged values of gdp per capita growth does not granger cause trade openness 1.0854 0.4016 tanzania‘s lagged values of trade openness does not granger cause gdp per capita growth 3.939 0.0137 tanzania‘s lagged values of gdp per capita growth does not granger cause trade openness 1.0992 0.3949 togo‘s lagged values of trade openness does not granger cause gdp per capita growth 0.80132 0.4591 togo‘s lagged values of gdp per capita growth does not granger cause trade openness 0.45999 0.6361 tunisia‘s lagged values of trade openness does not granger cause gdp per capita growth 1.4625 0.2506 tunisia‘s lagged values of gdp per capita growth does not granger cause trade openness 5.0319 0.0047 uganda‘s lagged values of trade openness does not granger cause gdp per capita growth 5.1588 0.0047 uganda‘s lagged values of gdp per capita growth does not granger cause trade openness 0.94342 0.4584 zambia‘s lagged values of trade openness does not granger cause gdp per capita growth 3.9071 0.0323 zambia‘s lagged values of gdp per capita growth does not granger cause trade openness 0.04414 0.9569 zimbabwe‘s lagged values of trade openness does not granger cause gdp per capita growth 5.7073 0.0025 zimbabwe‘s lagged values of gdp per capita growth does not granger cause trade openness 4.8202 0.0057 source: stata output (2015) in fact the dominant hypothesis for the 34.8 per cent of the african countries in the sample is the export led growth hypothesis. this group is a composition of 16 countries (burkina faso, cameroon, chad, and cot d‘ivoire, egypt, eritrea, ethiopia, gabon, guinea bissau, morocco, namibia, niger, nigeria, tanzania, uganda and zambia). several studies have recommended this hypothesis than any other particularly for the developing countries like most of the african countries. this is based on the fact that with the export promotion hypothesis african countries can expand their limited domestic markets by making use of the international markets through exports of their products (chow, 1987). however the export led hypothesis would be much more advantageous for the african countries if it would not only result into increased in real incomes but also if it would result into economic structural transformation of these economies. this is important because in order for these countries to achieve sustained economic growths, promotion of trade openness presupposes a well-established set of institutions and investment strategies. the importance of having well established domestic institutions and investments strategies lies on the fact that the world has been facing several international economic problems. one of which is the increasing protectionism especially for developed countries which has effects on the developing countries trying to open up their economies. studies show that the collapse of the world trade (by us$43 billion) during the 2008 crisis was as a result of increased tariffs on asian journal of economics and empirical research, 2019, 6(1): 1-15 13 © 2019 by the authors; licensee asian online journal publishing group major imported products in russia, china, argentina and turkey. it was also due to higher antidumping duties in the united states and the eu (kee et al., 2013). most of these economies impose restrictions on the free flow of trade on the grounds of national welfare, while they are advocated by and greatly for the benefit of small minority of producers in the economy at the expense of mostly silent majority of consumers (salvatore, 1998). it is even more challenging with the tendency of the world to break up in three major blocks, a north american block (i.e. us, canada and mexico), a european trading block and asian trading block. with these tendency towards protectionism by developed economies and the creation of blocks, poor african economies are left hanging, even in their efforts to adopt openness strategies so as to boost their economies proves futile. there is also an excessive volatility of exchange rates as a challenge facing international economics. the pattern of international trade and specialisation is greatly affected by large fluctuations of national currencies as well as persistent exchange rates disequilibrium. besides it causes the instability in global international financial conditions. for unstable economies with feeble domestic financial and institutional system like the african economies, opening up to the world market may be disastrous leading a country into experiencing disadvantages of openness. granger causality results in table 6 also indicate that 13.0 per cent of the african economies in the sample show preference of growth led hypothesis. countries in this group include angola, ghana, guinea, kenya, seychelles and tunisia; whereas only 8.7 per cent indicates a bi directional causality between trade openness and economic growth. for these countries the implication is that trade openness and economic growth are mutually beneficial and reinforce each other (chow, 1987; klasra, 2011). the results also indicate a large number of countries with no conclusive implication for causality direction. for these countries which represent 43.5 percent of the sample, the implication could be that the adoption of other strategies other than export led or growth led hypothesis might result into economic growth (sarkar, 2008). 5. conclusions this paper has examined the effects of trade openness on economic growth for the african countries; this has been done by use of growth models and later granger causality analysis. from the variables included in the growth model, the statistical results indicates that gross capital formation has more impact on economic growth for the african economies, followed by the level of openness and then fdi flows and the workforce (population aged 1564) as a percentage of the total population. moreover, the regression results indicate that trade openness and economic growth has positive relationship. though the level of statistical significance is not that promising, still a positive relationship guarantees policy makers in the african countries that any effort to boost up trade levels in their economies will have desirable positive impacts on their economic growth rates. these relationships are confirmed by granger causality test to be uni-directional, running from economic growth to trade openness. however this is for the african countries as a whole because individual countries granger causality tests indicate mixed results. the policy implications of these results to policy makers is that comparatively permanent economic growth shocks induce larger long-run trade openness level responses, than the effect of permanent trade openness shocks on long-run economic growth. therefore concentrating on enhancing policies that induce permanent economic growth may bring about the large positive long run trade openness changes for the african countries. in a way these conclusions supports the growth-driven export hypothesis discussed earlier in this paper. however as some of the individual countries granger causality wald tests indicates, there are also cases where the causality runs from trade openness to economic growth. the implication of which is that economies should seek for adoption of outward oriented policies for them to achieve economic growth. however this has not been straight forward for many african countries. deriving positive impacts from the integrating in the world economy, policy makers in african countries need to understand the effects of globalisation having in mind the set-up of their own countries. this is because globalisation has proved to oppose the notion of ‗one size fits all’. african countries need to know how to manage the openness strategies they adopt so as to maximize the benefits of outward oriented strategies in the same time minimising the risks. this is in line with the argument by rodriguez and rodrik (2000) who argues that openness has potential benefits, but for these benefits to be realised the beneficiaries need to have quality and well established complementary policies and institutions. proper 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ajageer, 2012. stock market development and economic growth: evidence from least developed countries. berlin: college of technology and economics. tsangarides, c.g., 2001. on cross-country growth and convergence: evidence from african and oecd countries. journal of african economies, 10(4): 355-389. available at: https://doi.org/10.1093/jae/10.4.355. yanikkaya, h., 2003. trade openness and economic growth: a cross-country empirical investigation. journal of development economics, 72(1): 57-89. available at: https://doi.org/10.1016/s0304-3878(03)00068-3. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. asian journal of economics and empirical research vol. 4, no. 2, 121-131, 2017 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2017.42.121.131 121 the role of services in total productivity growth of indian manufacturing firms: a firm level analysis since 2000 sonia mukherjee1 1consultant, ministry of finance, new delhi, india abstract services were considered non-tradable in the initial stages (in the mid-eighties). however, with the advent of information communication and technology (ict) and other modern services, services have become increasingly tradable day by day. since, the eighties, there had been a rapid expansion of the indian service sector, surpassing the agriculture and manufacturing sector. with the expansion, important services like communication, financial, transport, insurance, research and development, business services, legal services and other professional services etc. were on high demand in the manufacturing sector. absence of such important services would act as a bottleneck in major investment projects of a manufacturing firm. specialized services obtained from the external agency would help the firm to focus on its non-core activities and improve its productivity growth and competitiveness. against this backdrop, the study mainly examines the role of services in enhancing the productivity growth of the indian manufacturing firms since 2000. the firm level data was collected from prowess database. the study was done at the aggregate and disaggregated level. the results conclude that services have been playing a positive role in enhancing the productivity growth of the manufacturing sector and also for the industry group like textile group, machinery group etc. however, for the electronics group services did not play a significant role so far. keywords: services, total factor productivity, indian manufacturing firms. jel classification: d24, l80, l60. citation | sonia mukherjee (2017). the role of services in total productivity growth of indian manufacturing firms: a firm level analysis since 2000. asian journal of economics and empirical research, 4(2): 121-131. history: received: 12 september 2017 revised: 20 november 2017 accepted: 27 november 2017 published: 4 december 2017 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 122 2. literature review .......................................................................................................................................................................... 123 3. methodology, and data sources ................................................................................................................................................. 125 4. description of explanatory variables ....................................................................................................................................... 126 5. econometric results ..................................................................................................................................................................... 127 6. regression results for some individual group of manufacturing firms .......................................................................... 128 7. conclusion ....................................................................................................................................................................................... 130 references ............................................................................................................................................................................................ 130 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://orcid.org/orcid-search/quick-search?searchquery=sonia%20mukherjee https://orcid.org/orcid-search/quick-search?searchquery=sonia%20mukherjee asian journal of economics and empirical research, 2017, 4(2): 121-131 122 1. introduction the term “economic growth” has generally been associated with an increase in the share of services in the gross domestic product, investment and employment (fisher, 1935; clarke, 1940; kuznet, 1957; chenery, 1960; fuch, 1968). the rising share of services along with economic growth was first noted by clark in the1940s. clark attributed this rise of the services to demand side factors. different types of explanations had been provided by fisher (1935); kuznet (1957) to the phenomenon of increase in services associated with the economic growth. a variety of explanations and reasons have been forwarded to explain this structural change of rise in services. the main reasons forwarded and provided include high-income elasticity of demand for final product services1, slower productivity growth in services which makes contracting services from external sources more efficient and cheaper than producing them within the firm. most of the developing economies have undergone a significant structural shift in the last few decades. the shift was depicted through a significant decline in the share of agriculture in the total value-added and gross domestic product (gdp) and a rapid increase in the share of the manufacturing followed by the service sector. normally, this is the trend, where the primary sector witnesses a decline to be picked up by the manufacturing followed by service sector in the long run. china, for instance, had witnessed the phenomenon of agricultural sector declining followed by rise in the manufacturing sector followed by the service sector. compared to this trend, india‟s structural transformation was a bit different. followed by a decline in the primary sector (agriculture), the share of manufacturing did not increase in the value-added or gdp. it remained more or less constant at 15 percent and the service sector surpassed both the sectors and became the main contributor in value-added and gdp share. presently, share of the service share stands to be around fifty five to sixty in total gdp share. cross country analyses have confirmed the fact that as the share of services increases in the aggregate output, it leads to an increase in the per capita income, and the intensity of use of services in the manufacturing sector goes up (francois and reinert, 1996). this has become true in the context of the indian economy. the indian manufacturing firms are now readily purchasing services from external specialized bodies or agencies. this is due to the fact that the competitiveness of the manufacturing firms depend on the low cost availability of efficient producer services (francois and hoekman, 2010). according to bhagwati (1984) a part of the rise in the use of services by the manufacturing firms is due to splintering i.e. outsourcing of indirect production activities and the remaining demand for higher usage of services are attributable to structural changes in the manufacturing industries (francois and reinert, 1996). in the earlier period, i.e. seventies and eighties, the indian manufacturing firms produced a variety of services in their in-house set-up. a separate department for each types of services were operational and no outsourcing of services were done. separate sections or department existed within the firm. separate departments such as insurance, repair and maintenance, legal services, audit, expenses, consultancy, and others were operational. the manufacturing firm had to incur a fixed cost on all these departments. however, these costs which were found to be higher when compared to the cost charged by external service providers. a higher marginal cost of in-house production of services compelled the manufacturing firms to seek assistance of service providers who were not only specialized but also cheaper. with the increase in the share of services in the gdp share, the phenomenon of outsourcing, sub-contracting and purchasing of services from specialized service providers increased manifold. the expansion of the services provided a greater opportunity to the indian manufacturing firms to purchase a wider range of services, instead of producing them in-house. some notable services outsourced are business services, marketing, selling and distribution, legal, audit, insurance, financial, communication, transport and others professional services. the various types of services has the competence to improve the firm‟s performance through productivity growth. for example, through intensive usage of business services, especially information-technology enabled services (ites), a firm can have an up-to date knowledge about the market and knowledge about their clients. business process outsourcing are a part of the ites. similarly, with better telecommunication services, a manufacturing firm can communicate and better coordinate with their clients and suppliers. this will further enable the firm to loose valuable time and staff in the process. auditors are kept to examine and investigate the important documents, records, for financial or other purposes. consultants are hired by the manufacturing firms to consult on different important matters of the firm. marketing and advertising are important to increase the sales and performance in the market. lastly, banking and financial service, are a vital form of service without which the firm may fail to exploit its productivity-enhancing investment opportunities. financial constraints severely act as bottlenecks for future projects. all these services are expected to enhance the operational efficiency of the firm in terms of productivity growth. through use of these diversified services, it will also add to the total value of the firms‟ produce and help in cutting down the operating costs. following, a firm may focus on its core competencies and improve its productivity significantly. the outsourcing of services through a specialized and efficient provider will help the firm to save costs in the long run. and further, the usage of higher quality services can help the firm to increase its competitiveness and efficiency in times of stiffer competition and globalization. competitiveness of the manufacturing firms also depends on the availability of low cost high efficiency producer services (francois and hoekman, 2010). hence, the manufacturing firms are contracting out more services which are efficient rather than producing then within the inhouse (pilat and wölfl, 2005). therefore these changes taking place is resulting in an increase in the demand for services as intermediate goods2. 1 there is an overlap between the output of the service industries and final product services but the former term mainly implies and includes purchase of services for intermediate activities by the firms such as repair, and maintenance, other business services etc. 2 two different methods have been chosen to explain the inter-relationship between the service sector and the manufacturing sector. one set of studies argue that the demand for the producer services grow with development and this expansion is linked to growth in round-about production and the associated conversion of the local markets into national markets (e.g. francois (1990); greenfield (1966); kataozian (1970). as against this, bhagwati (1984) emphasized „splintering‟ or „outsourcing‟ of indirect production activities as a possible source for apparent growth in producer services. he put forward different ways in which technical and structural change define a continuous process during which services splinter-off goods and goods splinter-off services. he argued that services that splinter-off from goods are technically progressive and possibly capital intensive since these services arise due to specialization, which reflects economies of scale. but the services that are left after the goods-from services splintering process are mostly technically unprogressive and labor intensive. asian journal of economics and empirical research, 2017, 4(2): 121-131 123 services are widely used by people day to day in all spheres of their day-today life. services are have also become increasingly tradable due to greater mobility of labor and technological advancement over time. this has increased the scope of specialization in production and trade. the competitiveness and productivity of the manufacturing firms (both domestic companies and exporters) crucially depends on the availability, cost and quality of crucial services like producer services such as finance, transport and telecommunications. lack of the essential producer services reflected in the transport bottlenecks, availability of low quality telecommunication services and absence of efficient financial services can impede the proper functioning of the firms. hence, against this backdrop, the paper intends to study the role of services in enhancing the performance of the manufacturing firms in terms of productivity. presently, the manufacturing firms have started taking advantage of the best outside vendors available in market and focus on the core business. this has helped the firm to build its core competencies and serve customer according to their needs. all these factors motivates us to study the role of services for growth of manufacturing firm. 2. literature review a number of studies had been done on the use of services, its role and how they assist in improving the performance of the firm. some studies are theoretical in nature and some are empirical in nature. this section summarizes some of the prominent studies done on services. 2.1. country level studies services are heterogeneous and span over a wide range of economic activities. conceptually, this diversity marks a fundamental function that many services perform in relation to the overall economic growth: they are inputs into the production process. one dimension of this “input function” is that service facilitates transaction through space (transport, telecommunications) or time (financial services) (melvin, 1989). there are a number of theoretical papers providing good number of arguments that liberalization of the barriers against foreign providers of services tends to increase the productivity of the manufacturing sector, agricultural sector and that of the services sectors productivity too. the most important papers are papers by markusen (1989); francois (1990a;1990b); markusen and venables (1998) and markusen et al. (2005). the key ideas behind all these papers are that the providers of services increase the productivity of the users of services in manufacturing, agriculture and in the service sectors themselves. the term generally used by the economists known as “total factor productivity”. multinational providers of services are especially important in increasing the total factor productivity because they bring technology or expertise to the local production process. theory suggests that new domestic firms will typically increase their total factor productivity. this will be done via access to a diverse set of service suppliers allowing the firms to use the services that most closely match as per their requirements. but the liberalization of the barriers against the foreign suppliers of services are required to be done as foreign services suppliers are a crucial source of new services, and the services which they are likely to offer are more likely to be different from the domestic service providers, thereby adding more to the productivity of those users whose production processes fit more naturally to the specialized services of foreign services suppliers. markusen (1989) developed a model of trade in differentiated intermediate inputs along the lines proposed by ethier. the model consisted of two countries having a competitive sector (y) and a sector (x) which produce a composite good from intermediate inputs or services (s). the composite good was produced with the help of increasing returns to scale and were complementary in nature. the results concluded that allowing trade in specialized inputs was superior to allowing trade in final goods. free trade in inputs/ services were found to be pareto superior to free trade in goods from the world point of view. markusen et al. (2005) concluded that foreign producer services such as managerial and engineering consulting can provide substantial benefits of specialized knowledge that could be costly in terms of both time and money for domestic firms to develop on their own. the study was built on a monopolistic competition models of intermediate producer services to assess the importance of liberalization of restraints on foreign providers of producer services. some three key assumptions were made. first, a larger variety of producer services lower the adjusted costs of these services for downstream industries; second, producer services were produced under conditions of increasing returns to scale (faini, 1984) and third, key inputs to producer services (e.g. foreign personnel) were affected by very different barriers than trade in goods. the results concluded that real wage of domestic skilled labor increased the liberalization of policies against the foreign service providers. also, the presence of foreign firms in the domestic market increased the real wage of domestic skilled workers. the additional foreign firms present lowered the cost of the intermediate service product in final goods production and increased the relative importance of the final good sector which used the services intensively. results also indicated that foreign services were partial equilibrium substitutes for domestic skilled labor and service trade could provide crucial inputs which might reverse the comparative advantage in final goods. francois (1990a) in his study noted that the growth of the intermediation services was an important determinant of overall economic growth because they allowed specialization to occur. the reason was as firms increased their size and specialized more labor, more activity was needed to be devoted. the activity was mainly in the form of coordination and organizing core business activities and companies. the additional activity was partly outsourced to an external service providers. the producer services that were demanded and supplied played an important distinct role in coordinating the production processes. further, they were needed to generate more differentiated goods and realize the scale economies. the associated organizational innovations and expansion of logistics (network) services yield productivity gains that in turn affected economy wide growth performance. lastly, the greater the variety and quality of services, the larger the reduction in (real) price associated with greater specialization in services (outsourcing), the greater the impact on productivity(welfare) of firms(households) that buy services. at the aggregate level, eschenbach and hoekman (2006) examined the impact of service sector policy reforms on the growth performance of the 24 transition economies from the year 1990 till 2004. ordinary least squares asian journal of economics and empirical research, 2017, 4(2): 121-131 124 (ols) method with country specific fixed effects regression and controlling for a number of standard explanatory variables was used as a methodology. the results concluded that the measures of service sector reform was statistically significant in explaining the growth of the sample of twenty four countries. king and levine (1993a) postulated that the financial services have the potential to affect the growth through enhanced capital accumulation and technical innovation. the study controlled for factors affecting the long run growth and constructed an additional measures of financial sector development such as the ratio of liabilities of the financial system to gdp and the ratio of gross claims on the private sector to gdp. the additional measures used in the regression analysis concluded that they were statistically significant. lastly, financial sector development in the sixties were found to be a significant predictor of the economic growth. mattoo et al. (2006) in their study had three objectives in mind. the first objective was to explain the impact of liberalization of the services sector and how that differed from the liberalization in the goods sector. the second objective was to measure the openness3 for the country‟s services regime. the third objective was to test whether the openness of the policy regime in services had an impact on the long run economic growth of the country or not. a simple regression method was applied for a sample consisting of sixty countries from 1990 till 1999. after controlling for other determinants of growth, the study found that the countries more open to telecom and financial services sectors grew up to 1.5 percentage points faster than the countries with closed regimes. 2.2. firm-level studies after studying the role of services at the country level, a few firm level studies dealing with the role of services in enhancing the manufacturing firm‟s performance are examined below. employing a rich panel of firm data set, arnold et al. (2011) analyzed the far reaching reforms of service industries based on firm-level data for the period 1998 to 2003. the main objective was to establish a positive link between the extent of policy reform in service industries and productivity of the manufacturing sectors using necessary service inputs. a rich set of firm-level data was collected from amadeus, a commercial database for the czech companies. subsequently, the total factor productivity (tfp) was estimated for all the manufacturing firms using an ordinary least squares and semi-parametric estimation by ollay and pakes (1996). a national inputoutput matrix was used to obtain the reliance of manufacturing sectors on the service inputs. the results demonstrated a positive correlation between liberalization in service sectors and the productivity of manufacturing firm‟s relying on foreign providers in services. results also confirmed a positive and statistically significant association between the overall index of policy reforms and downstream productivity. arnold et al. (2008) studied the relationship between the availability of services and the productivity of the african manufacturing firms in details. the world bank enterprise surveys was used as a main data source. it contained unique measures of the performance of communications, electricity and financial services. the study exploited the variation in the service performance at the sub-regional level and the results concluded a positive association between the performance of the manufacturing firms and the indicators of the availability of services in the region. shepotylo and vakhitov (2012) examined the impact of service liberalization on productivity for ukrainian firms. the study used a data set of over 40 thousand firms in ukraine from 2001 to 2007. a firm specific index was constructed to see the amount of service intensity and usage by the manufacturing firms. the study extended their methodology by applying a newly developed methodology of de loeker (2011). the study concluded that a one standard deviation increase in the service sector liberalization led to a nine percent increase in the total factor productivity. siegel and griliches (1992) examined the relationship between the manufacturing productivity growth and outsourcing of services from the year 1979 till 1986. the outsourcing of the services was measured in terms of average ratio of the purchased services within the manufacturing to the manufacturing output between the timeperiod 1977 till 1982. the results revealed a weak correlation between the latter measure and manufacturing productivity growth. raa and wolff (2001) examined the recovery of the standard total factor productivity growth in manufacturing during the period 1977-87. the main speculation of their study was the fact, that whether the recovery of the manufacturing productivity growth was mainly due to the outsourcing of services or not. a consolidated framework initiated by the leontief (1967) was employed. the data sources used for this study was mainly collected from the us-85 order input-output tables for 1947, 1958, 1967, 1987, 1996 in the dual use table format. the results concluded that outsourcing of services were partly responsible for the recovery of the conventional total factor productivity growth in manufacturing growth during the 1980s. 2.3. indian firm level studies not many studies in the indian context have verified the interrelationship between the role of services and manufacturing productivity growth. however, a few notable studies do exist. they are as follows: banga and goldar (2004) examined the role of services to the output growth and productivity in the indian manufacturing industries using the klems production function framework. two main data sets were used. one dataset was used at an aggregated level, i.e. for 41 major industry groups (comprising the organized manufacturing sector) for the time-period starting from 1980-81 to 1990-00 and the other data set at a more disaggregated level covering the 148 three digit industries for the period 1980-81 to 1997-98. the study constructed a multifactor total factor productivity index for the forty one major industry groups for the period 1980-81 to 1999-2000, with and without incorporating services. thereafter, the total factor productivity index was regressed on a set of explanatory variables such as export intensity, import intensity and others including the services variable. the coefficient of the services variable turned to be positive and statistically significant at the one percent level. following this, the tfp equation was again re-estimated after dropping some of the explanatory variables. in all 3 the measures of openness were constructed for the two services sectors individually such as telecommunication and financial services. asian journal of economics and empirical research, 2017, 4(2): 121-131 125 the cases, the services variable was found to be significant at one percent level. further, the findings also suggested the growing usage of the services contributing to a better performance in the nineties as compared to the eighties. arnold et al. (2010) examined india‟s policy reforms in services. the liberalization measures used in their study were segregated into several indexes like banking, telecommunications, transport, and insurance services. all these indexes were used for focusing on the policy reforms in the services sectors. arnold addressed three main questions. first, had the service reforms in the present times contributed more towards the manufacturing productivity? second, whether some manufacturers benefitted more as compared to the other firms in terms of intensive usage of services? and lastly, did the reform in the services had a bigger impact in comparison to the other reforms? the manufacturing sector‟s reliance on inputs from each service sector was based on the national input-output table. the results concluded that the service reforms had made a significant impact on the manufacturing firm‟s total productivity. the aggregate effect of the service liberalization was an increase in productivity of 11.7 percent for the domestic firms and 13.2 percent for the foreign firms for a one-standard deviation increase in the liberalization index. hansda (2001) found a strong relationship between the services sector and the manufacturing sector in india. the study mainly addressed two issues. firstly, the sustainability of the services and secondly, the services-led growth of the indian economy. these two issues was addressed in terms of their inter-sectoral linkages as emanating from the input-output tables (1993-94) for both the disaggregated level consisting of 115 activities and aggregated level containing 10 constructed national accounts categories. the findings concluded that at the disaggregated level, the indian economy was found to be predominantly services-intensive with fifty five percent activities directly service –intensive. 3. methodology, and data sources 3.1. levinsohn and petrin (2003) (lp) methodology before describing the methodology, we start by describing the variables which have been used in the levinsohn petrin methodology. value-added: the total value added of the firms has been calculated by taking the total sales of firms minus the value of materials minus the value of total services minus the value of energy inputs. thereafter, it is deflated using a suitable wholesale price index4 for every individual manufacturing group of firms and real value-added is obtained for all the manufacturing firms. labor: cmie prowess, “annual financial statement” did not have sufficient data for total laborers/employees. the database containing the number of employees were extremely thin and missing. hence, to construct the variable “total labor”, data on total emoluments and number of person days were obtained from the annual survey of industries (asi) and the total wage rate was obtained. henceforth, we took the data on “total wages and salaries” from cmie, prowess and divided it by the wage rate (calculated from asi) to get the total number of employees or laborers. capital: total gross fixed capital asset is collected from cmie prowess was taken to construct the capital variable. for this purpose, the total gross fixed capital asset was divided with an “implicit deflator”, i.e. the gross fixed capital stock, obtained from the national accounts statistics, central statistical organization, and the variable “total capital” in real terms was obtained. in the above equation, all the components of the value-added are expressed in real terms is the dependent variables. both capital and labor inputs (expressed in real terms) are included as independent variables. after the variable creation, the total factor productivity (tfp) needed in the study was estimated using the lp methodology. a number of steps was done. to control for the unobserved and unexpected productivity shocks, a proxy was required to be taken. henceforth, energy variable was used as a proxy to capture the unexpected productivity shocks. the value of the energy was obtained from the cmie prowess, “annual financial statements” in terms of “power, fuel and water expenses”. but energy was given in current prices. hence, it was converted in real terms as the other variables, using a suitable energy deflator. therefore, a price index or deflator of energy was constructed using annual survey of industries (asi) data. for this purpose, data on the relative expenditures of the manufacturing firms on coal, petroleum products, and electricity were collected and compiled. a weighted average was created for the three indexes, coal, petroleum, and electricity. thereafter a price index for coal, petroleum products and electricity was calculated from the wpi series. following this, the price index of each of them is divided by the relative weighted average of each of the three indices, coal, petroleum and electricity. the relative price index obtained for the three indexes separately is added and a composite price index is formed for energy. in the last step, the energy variable obtained from cmie was divided with relative price index and energy in real terms is obtained. and thereafter in the estimation process, the energy (in real terms) is used as a proxy to control for the productivity shocks similarly as done by the earlier works by banga and goldar (2004) and mary et al. (2002). in recent years, a greater amount of attention has been paid on the measurement of total factor productivity. the estimation of the production function by using of ordinary least squares (ols) does not always give consistent results and tends to give biased estimate of the explanatory variables taken for the study. also, there are a number of effects such as firms, industries, time, and other effects which are not always observable. these unobservable effects are known to the firm but not to the researcher or academician. and these unobservable might influence the usage of inputs used in the production process and fail to address the endogeneity issue. the results obtained would therefore be inconsistent and unbiased. to solve these issues, semi-parametric methods such as levinsohn and petrin (2003) had been used in a good number of studies. in our first hypothesis, we will be using the lp methodology to estimate the firm level 4 the wholesale price index has been obtained from the office of the economic advisor, government of india, ministry of commerce and industry, dipp. the wpi had a different base year prior to 2004-05. hence, we had shifted the wpi to a common base year for obtaining a suitable price-index for each firm. asian journal of economics and empirical research, 2017, 4(2): 121-131 126 production function. the lp method uses energy as the proxy for controlling unobservable productivity shocks. the detailed estimation is as follows: we assume a production function of the form: yt = β0 + βkkt + βllt+βeet + ωt+ μt………………………………………………………(1) where, yt, kt, lt, and et are log of output, capital stock, labor input and energy of the manufacturing firm respectively. we represents the productivity of the firm and μt stands for the measurement error in output, which is totally uncorrelated with the input choices. to control for the unobservable productivity shock, we take energy as the proxy to take care of the endogeneity problem. lp assumes that firm‟s energy demand function as et = et (wt ,kt) is monotonically increasing in productivity given its capital stock. this allows inversion of energy demand function as wt = wt (et , kt). thus the unobservable productivity term (wt) depends solely on two observed inputs, et and kt. rewriting equation (2) gives us, yt = βllt +βmmt+ ψ(kt , et) + μt……………………………………………………….(2) the estimation of the production function is carried out in two stages. the first stage involves the estimation of the above equation where conditional moments e (yt /kt et), e(l/kt et) are estimated. first moment condition identifies βk by assuming that capital stock does not respond to the innovation in productivity, i.e. e (μt + ξt / kt )= 0; second moment condition identifies b by using the fact that last period‟s energy choice should be uncorrelated with innovation in productivity this period, the final estimation requires several steps5. the value of the static is computed for each of these samples and the distribution of estimates so generated provides bootstrap approximation to the sampling distribution of the statistics. using the estimated coefficients of production function, we estimate ln tfpijt =lnyijtύllnlijtύklnkijtύeeijt………………………………………………………(3) after obtaining the tfp, we examine the role of services as an independent variable on the total factor productivity (tfp) for aggregate manufacturing firms and also for sub-groups of industries like textiles, food, beverages, & tobacco etc separately. the regression equation to be estimated is using the random effect6, fixed effect7 and industry effect. the random model for the study is given below: yijt= βxijt + αi +μijt +ξijt…………………………………………………………………….(4) where, yijt is the dependent variable where, i is the firm, j is the industry and t is the time. α is the unknown intercept of a firm. xijt represents the independent variables such as services, import intensity, size, exports, and age etc. β is the coefficients for the explanatory variables. μijt,is the error term in the equation. ξijt is the omitted term. the rationale behind the random effects, is that, the variation across entities is assumed to be random and uncorrelated with the predictor or independent variables included in the model. it is generally believed that the difference across the firms have an influence on the dependent variable. hence, the logic for using random effects model. the fixed effect equation for the study is given below yijt= β1xijt + αi +μijt, ………………………………………………..……………………….(5) where, yijt is the dependent variable where, i is the firm, j is the industry and t is the time. αi (i=1,…..,n) is the unknown intercept for each firm (firm specific intercepts). xijt represents the independent variables such as services, import intensity, size, exports, and age etc. β1 is the coefficients for the explanatory variables. μijt,is the error term in the equation. where, yijt is the tfp. the total factor productivity tends to vary across the indian manufacturing firms over the time. the term xijt represents the independent variables such as services (s), import intensity (im), size (si), exports (ex) , and ownership dummy (ow) etc. s denotes the real value of services used by the manufacturing firms. for the purpose of normalization, s is being divided by q (total output of firms). if the use of services as an input is favorable and have a positive contribution towards the manufacturing firms‟ performance in terms of total factor productivity than it should have a positive coefficient of s/q. 4. description of explanatory variables the description of four explanatory variables used in the study are as follows. s denotes the real value of services used by the manufacturing firms. for the purpose of normalization, s is being divided by q (total output of firms). if the use of services as an input is favorable and have a positive contribution towards the manufacturing firms‟ performance in terms of total factor productivity than it should have a positive coefficient of s/q. 5 refer to levinsohn and petrin (2003) for detailed discussion. 6 random effects (re) assumes that the firm‟s error term is not correlated with the predictor and allows for time-invariant variables to play a role as explanatory variables. in re, specification of the individual characteristics is required. 7 the fixed effect (fe) model controls for all time-invariant differences between the individuals. the estimated coefficient of the fe model cannot be biased because of the time-invariant characteristics. asian journal of economics and empirical research, 2017, 4(2): 121-131 127 export dummy: the export dummy is used to examine whether the firms who have an export propensity of more 5% are the ones who have contributed positively towards total productivity growth of manufacturing firms or not. im denotes the imported raw materials, stores and parts divided by total raw materials. it is expected that the use of raw materials contribute positively towards the total factor productivity of the manufacturing firms. si denotes the size of the firms. the size was computed by taking logarithm of sales. it is expected firms with a bigger size will contribute positively to the total factor productivity. lastly, ow1 denotes the ownership dummy. the ownership dummies used in the study are mainly of two types. the first ownership dummy ow1 is taken to see whether the group or the non-group firms are contributing more towards the total factor productivity growth. for group firms, the dummy is taken to be 1 and for non-group firms, the value is taken to be zero. a similar regression analysis is also performed upon a private group of firms. the second ownership dummy variable taken to be ow2. this dummy is taken to see whether the private (indian) or the private (foreign firms) are contributing more towards the tfp growth of the indian manufacturing firms. for private (foreign) firms, the dummy value is taken to be 1 and for private (indian) firms the dummy value is taken to be zero. the above equations (4) and (5) are estimated through both the random effect model and fixed effects models. this is done for both the aggregate group of manufacturing firms and disaggregated group of manufacturing firms. apart from the above two models, another regression analysis was done by using the industry fixed effects. 5. econometric results 5.1. regression results for the contribution of services towards the productivity growth of the aggregate manufacturing firms since 2000 table 1 clearly shows that the service coefficient have positively contributed to the tfp growth in case of the aggregate manufacturing firms. the other factors which have also positively contributed to the productivity growth are export dummy variable, import intensity, size, experience and ownership dummy variable. the export (e/q) variable is also found to be positive and significant in improving the tfp growth of the aggregate manufacturing firms. the exporting firms taken here for the analysis were those whose were exporting at a rate more than 5 percent. they were found to be more productive and efficient as compared to the non-exporting firms. the size (si) variable defined as logarithm of sales was also found to be positive and significant. the logic behind this is that the larger and medium size firms contribute more to the productivity as compared to the small-sized firms. larger and medium firms have more access to advanced technology, skills and expertise. hence, all these factors combined contributes to the positive impact of size on the tfp of the manufacturing firms. the import intensity variable (im) was found to have a positive impact on the tfp at the aggregate level. the rationale here is that, as the indian manufacturing firms imports the essential raw materials in the form of tools, machinery and other essential equipment‟s, it contributes to the value –addition of the firm. hence, the productivity of the firm rises as a result of higher value-addition. the experience (exp) variable also contributed positively to the tfp growth of the aggregate manufacturing firms. it is usually seen that the higher the experience, the more it becomes positively associated with the tfp of the firms. in other words, the more experience a firm acquires, the more it will contribute towards its productivity growth in the coming years. lastly, ownership dummy (ow1) variable is also found to have a positive impact on the tfp of the indian manufacturing firms. the group firms like tata, mahindra & mahindra and other group firms performed better as compared to the non-group firms in terms of productivity. the results are summarized in the table 1. table-1. role of services in improving the tfp of the aggregate indian manufacturing firms (taking ownership dummy, ow1) panel fixed effect panel random effect panel random effect with robust standard error pooled ols with industry fixed effects explanatory variables coefficients ‘t’ statistics coefficients ‘t’ statistics coefficients ‘t’ statistics coefficients ‘t’ statistics s/q .25 (17.36)* .26 (17.34)* .26 (2.51)** .20 (15.06)* ex .069 (7.43)* .072 (7.59)* .07 (7.09)* .03 (4.24)* im .0003 (3.25)* .0003 (3.39)* .0003 (4.12)* .0003 (3.86)* si 1.09 (352.36)* 1.07 (350.37)* 1.07 (295.65)* 1.09 (356.85)* exp .028 (4.71)* .029 (4.81)* .029 (4.81)* .01 (3.44)* ow1 .21 (21.53)* .24 (24.35)* .24 (23.05)* .13 (14.53)* no. of observations 37703 37703 37703 37704 overall r2 0.80 0.80 0.80 .85 * significant at 1% level of significance, ** significant at 5% level of significance. estimates in the first three column allows for firm fixed effects. estimate in the last column allows for industry-fixed effect. table 2 show a similar kind of results. here to check for the robustness of the ownership dummy, we have taken the group of private firms, i.e. not belonging to the business group, which comprised mainly the private indian firms and private foreign firms operating in the indian manufacturing sector. we use the symbol ow2 to represent the private dummy variable. the private indian dummy variable was assumed to be 0 and the private foreign variable was assumed to be one. the results show that services have played a significant role. the other variable‟s playing a vital role are experience, exports, and im etc. lastly, the private dummy variable ow2, revealed that the private foreign firms were more productive in boosting the productivity growth as compared to asian journal of economics and empirical research, 2017, 4(2): 121-131 128 the indian private firms. all the variables taken for the analysis had played an important role in enhancing the tfp of the indian manufacturing firm since the year 2000 onwards. the results are shown in table 2. table-2. contribution of services on the total factor productivity of the indian manufacturing since 2000 onwards panel fixed effect panel random effect panel random effect with robust standard error pooled ols with industry fixed effects explanatory variables coefficients ‘t’ statistics coefficients ‘t’ statistics coefficients ‘t’ statistics coefficients ‘t’ statistics s/q 1.12 (22.50)* 1.14 (22.84)* 1.14 (10.53)* .74 (15.91)* ex .08 (7.15)* .08 (7.19)* .08 (6.94)* .05 (4.51)* im .002 (4.73)* .002 (4.78)* .002 (2.49)** .003 (7.36)* si 1.01 (238.94)* .99 (241.76)* .99 (212.11)* 1.02 (254.97)* exp .02 (3.47)* .02 (16.11)* .02 (3.57)* .02 (3.55)* ow2 .29 (14.89)* .32 (16.11)* .32 (16.74)* .21 (10.63)* no. of observations 24473 24773 24773 24473 overall r2 .74 .74 .74 .80 * statistically significant at one percent, **statistically significant at 5 percent. estimates in the first three column allows for firm fixed effects. estimate in the last column allows for industry-fixed effect. 6. regression results for some individual group of manufacturing firms 6.1. regression results for chemical group of firms for the analysis of the chemical group of firms, variables such as services, im, and ex were found to play a positive and significant role in influencing the tfp growth of the manufacturing firms in case of random effect. the results are given in table 3a. table-3a. contribution of services towards total factor productivity of the chemical group of firms (ow1); dependent variable is l(tfp ) random effects fixed effects random effects with robust standard error explanatory variables coefficients ‘t’ statistics coefficients ‘t’ statistics coefficients ‘t’ statistics s/q .25 (2.45)** .10 (1.06) .25 (1.03) ex .02 (1.02) .02 (1.13) .02 (0.99) im .04 (1.02) .05 (1.11) .04 (0.78) si 1.11 (125.65)* 1.14 (127.40)* 1.11 (110.88)* exp .10 (6.29)* .10 (6.33)* .10 (6.23)* ow1 .25 (9.04)* .21 (7.97)* .25 (9.07)* number of observations 4199 4199 4199 r2 .84 .84 .84 * statistically significant at one percent, ** statistically significant at five percent, t values in the parentheses for the analysis below, we took a small number of firms, that is, private firms as compared to group firms in the earlier case. the difference with the earlier analysis is that here we have taken the private firms such as indian and foreign, as the ownership dummy variable. the results show that variables such as services, experience, size, exports, imports intensity and ownership dummy have contributed positively in the case of the private firms. the results are shown in table 3b. table-3b. contribution of services towards total factor productivity of the chemical firms (ow2); dependent variable is ltfp random effects fixed effects random effects with robust standard error explanatory variables coefficients ‘t’ statistics coefficients ‘t’ statistics coefficients ‘t’ statistics s/q .68(5.82)* .60 (5.00)* .68 (4.84)* ex .07(2.28)** .07 (2.25)** .07 (2.25)** im .16 (2.88)* .16 (2.84)* .16 (2.14)** si 1.09 (84.82)* 1.02 (83.10)* 1.00 (74.29)* exp .11 (5.88)* .11 (5.95)* .11(5.86)* ow2 .20 (4.09)* .15 (3.16)* .20 (4.66)* number of observations 2608 2608 2608 r2 .79 .79 .79 * statistically significant at one percent, ** statistically significant at five percent, t values in the parentheses. asian journal of economics and empirical research, 2017, 4(2): 121-131 129 6.2. regression results for the machinery group of firms for the machinery group of firms, services have made a positive contribution in improving the productivity growth. the other variables enhancing the productivity growth are si, im, ex and exp respectively. lastly, the group firms had performed better in enhancing the productivity as compared to the non-group firms. the results are summarized in table 4a. table-4a. contribution of services towards total factor productivity growth of the machinery group of firms; dependent variable: ln (total factor productivity) random effects fixed effects random effects with robust standard error explanatory variables coefficients ‘t’ statistics coefficients ‘t’ statistics coefficients ‘t’ statistics s/q .13 (.85) -.14 (-0.90) .13 (0.28) ex .14 (4.46)* .15 (4.64)* .14 (4.14)* im .005 (2.96)* .005 (2.67)* .005 (19.64)* si 1.03 (109.76)* 1.05 (110.36)* 1.03 (99.97)* exp .04 (2.13)** .04 (2.24)** .04 (2.05)** ow1 .14 (4.26)* .11 (3.41)* .14 (4.23)* number of observations 2346 2346 2346 r2 .86 .86 .86 * statistically significant at 1 percent, ** statistically significant at 5 percent. in the case of private firms, with ow2 as ownership dummy, the variables such as s/q, im, si and exports (ex) have made a positive contribution towards productivity growth. the results are given in table 4b. table-4b. contribution of services towards total factor productivity growth of the machinery group of firms (ow2); dependent variable: ln (tfp) random effects fixed effects random effects with robust standard error explanatory variables coefficients ‘t’ statistics coefficients ‘t’ statistics coefficients ‘t’ statistics s/q .73 (3.88)* .52 (2.72)* .73 (2.38)** ex .17 (3.99)* .18 (4.20)* .17 (3.83)* im .005 (2.55)* .004 (2.30)** .005 (17.82)* si 1.01 (71.47)* 1.02 (71.53)* 1.01 (67.70)* exp -0.009 (-0.38) -.006 (-0.26) -.009 (-0.36) ow2 .08 (1.84) .05 (1.11) .08 (1.89) number of observations 1488 1488 1488 r2 .82 .82 .82 * statistically significant at 1 percent, **statistically significant at 5 percent 6.3. regression results for the electronics group of firms in case of the electronics group, the services have not played an important role in improving the productivity growth. the variables enhancing productivity growth were im, si and ow1 respectively. the results are shown in table 5a below. table-5a. contribution of services towards total factor productivity growth of the electronics group of firms (ow1), dependent variable: ln (tfp) random effects fixed effects random effects with robust standard error explanatory variables coefficients ‘t’ statistics coefficients ‘t’ statistics coefficients ‘t’ statistics s/q -.04 (-.24) -.15 (-0.95) -.16 (-.36) ex .003 (0.12) .006 (0.21) .003 (0.22) im .21 (4.75)* .23 (5.14)* .22 (6.15)* si 1.00 (103.96)* 1.01 (103.39)* 1.02 (54.56)* exp .03 (1.55) .03 (1.59) .03 (1.61) ow1 .18 (5.75)* .15 (4.97)* .19 (5.69)* number of observations 3095 3095 3095 r2 .81 .81 .81 * statistically significant at 1 percent, ** statistically significant at 5 percent asian journal of economics and empirical research, 2017, 4(2): 121-131 130 table-5b. contribution of services towards total factor productivity growth of the electronics group of firms (ow2); dependent variable: ln (tfp) random effects fixed effects random effects with robust standard error explanatory variables coefficients ‘t’ statistics coefficients ‘t’ statistics coefficients ‘t’ statistics s/q .18 (0.97) .13 (.68) .16 (.78) ex .03 (.87) .03 (0.92) .04 (0.91) im .24 (4.16)* .25 (4.33)* .27 (4.55)* si .91 (75.24)* .92 (73.18)* .93 (74.11)* exp .05 (2.32)* .04 (2.14)* .05 (2.01)* ow2 .06 (1.33) .04 (0.89) .05 (1.11) number of observations 1976 1976 1976 r2 .78 .78 .78 * statistically significant at one percent, t values in the parentheses the above results indicate the private firms belonging to the electronics group with ownership dummy ow2 have contributed positively towards the productivity growth. the other variables including services have played a positive as well as significant role in improving productivity. 7. conclusion to test and examine the proposition, that services are playing a positive role in improving the productivity growth for indian manufacturing firms, an econometric analysis, using fixed and random effects was conducted. the results clearly showed that services are playing a positive role for improving the productivity growth of the indian manufacturing firms since 2000. the econometric analysis was done separately at the aggregate indian manufacturing firms as well as the disaggregated level. overall, the results were similar with an exceptional case for the electronics group. an unbalanced data-set collected from prowess database was used for this purpose. but before proceeding towards the econometric analysis and estimation, the data-set was cleaned. the outliers detected were removed. there were also problems of missing values. but in spite of all these problems, around 3500 firms were found and the services variable was calculated by compiling all expenses incurred by the manufacturing firms on different heads such as professional services, business services, legal services, it services, banking and financial services, insurance and transport services, marketing, selling and distribution etc. the expenses of the manufacturing firms towards these services gave us a brief idea how much these services were used by the different manufacturing groups. after construction of the service variable, we regressed the services variable and the other variables such as exp, ex, si, im, and ow on the tfp of the manufacturing firms. the analysis was done separately for both for aggregate and individual sub-groups. the results were found to be positive for aggregate group of 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(ed), output measurement in the service sector. il: university of chicago press. pp: 429-458. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://scholar.google.com/scholar?hl=en&q=the%20role%20of%20services%20in%20the%20structure%20of%20production%20and%20trade;%20stylized%20facts%20from%20a%20cross-country%20analysis http://www.oecd.org/sti/ind/2090561.pdf https://scholar.google.com/scholar?hl=en&q=the%20development%20of%20the%20service%20sector:%20a%20new%20approach http://dx.doi.org/10.1093/oxfordjournals.oep.a041171 https://scholar.google.com/scholar?hl=en&q=an%20alternative%20to%20aggregation%20in%20input-output%20analysis%20and%20national%20accounts http://dx.doi.org/10.2307/1926651 https://scholar.google.com/scholar?hl=en&q=estimating%20production%20function%20using%20inputs%20to%20control%20for%20unobservables http://dx.doi.org/10.1111/1467-937x.00246 http://elibrary.worldbank.org/doi/pdf/10.1596/1813-9450-2413 https://scholar.google.com/scholar?hl=en&q=trade%20in%20producer%20services%20and%20in%20other%20specialized%20intermediate%20inputs%20and%20differentiated%20final%20goods https://scholar.google.com/scholar?hl=en&q=multinational%20firms%20and%20new%20trade%20theory https://scholar.google.com/scholar?hl=en&q=multinational%20firms%20and%20new%20trade%20theory http://dx.doi.org/10.1016/s0022-1996(97)00052-4 http://www.nber.org/papers/w8894 http://dx.doi.org/10.11130/jei.2006.21.1.64 https://scholar.google.com/scholar?hl=en&q=trade%20in%20producer%20services:%20a%20hecksher%20ohlin%20approach https://scholar.google.com/scholar?hl=en&q=trade%20in%20producer%20services:%20a%20hecksher%20ohlin%20approach http://dx.doi.org/10.1086/261648 http://dx.doi.org/10.2307/2171831 https://scholar.google.com/scholar?hl=en&q=outsourcing%20of%20services%20and%20the%20productivity%20recovery%20in%20the%20united%20states%20manufacturing%20in%20the%201980s%20and%20the%201990s 173 asian journal of economics and empirical research vol. 5, no. 2, 173-182, 2018 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2018.52.173.182 an empirical analysis of the taylor rule and its application to monetary policy: a case for the united kingdom and euro area keshab bhattarai1  matthew carter2 ( corresponding author) 1,2the business school, university of hull, cottingham road, hull, hu6 7rx, united kingdom abstract this paper analyses the taylor rule and its application to monetary policy in the united kingdom and euro area. the analysis uses a linear regression on quarterly economic data from 1993q1 to 2017q4 for the united kingdom and 2000q1 to 2016q4 for the euro area. the results show that the taylor rule does not fully describe the monetary policy actions made by the bank of england and european central bank over the period analysed; and, that both central banks engage in a significant level of interest rate smoothing. the results also suggest that the taylor rule does not provide the rationale for quantitative easing within the two regions and that interest rates should be higher than they currently are. keywords: interest rate rule, taylor rule, monetary policy, united kingdom, euro area. jel classification: e43; e47. citation | keshab bhattarai; matthew carter (2018). an empirical analysis of the taylor rule and its application to monetary policy: a case for the united kingdom and euro area. asian journal of economics and empirical research, 5(2): 173-182. history: received: 3 july 2018 revised: 7 august 2018 accepted: 11 september 2018 published: 29 october 2018 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 174 2 the taylor rule .............................................................................................................................................................................. 174 3. data .................................................................................................................................................................................................. 175 4. models .............................................................................................................................................................................................. 175 5. analysis of results ......................................................................................................................................................................... 176 6. conclusion ....................................................................................................................................................................................... 178 references ............................................................................................................................................................................................ 178 appendices ........................................................................................................................................................................................... 179 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2018.52.173.182&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/257 https://orcid.org/0000-0002-5398-984x http://asianonlinejournals.com/index.php/ajeer/article/view/257 https://orcid.org/0000-0002-5398-984x http://asianonlinejournals.com/index.php/ajeer/article/view/257 https://orcid.org/0000-0002-5398-984x asian journal of economics and empirical research, 2018, 5(2): 173-182 174 1. introduction following the financial crisis there was a substantial shift in monetary policy. central banks first responded by cutting interest rates to the zero lower bound. at the zero lower bound, conventional monetary policy fails to stimulate the economy and thus, central banks responded by implementing unconventional policies such as quantitative easing (loide, 2014; filardo and nakajima, 2018). over a decade since the financial crisis, monetary policy is yet to return to the norm; interest rates throughout developed nations remain close to the zero lower bound and central banks are still engaged in monetary policy. several economists have argued that this extended period of low interest rates and unconventional monetary policy has failed to spur economic growth and instead hurt savers and lead to the formation of asset bubbles. thus, it is useful to revisit the application of the taylor rule throughout these abnormal times for monetary policy. by doing so, this paper aims to determine whether the taylor rule adequately describes the monetary policy actions made by the bank of england and european central bank throughout the period analysed. more specifically, this paper will aim to determine whether or not the taylor rule advocates the extended period of unconventional monetary policy in these two regions. 2 the taylor rule the original taylor (1993) rule is a simple interest rate determination rule that approximates the responsiveness of the interest rate to the output gap and inflation gap (castro, 2008). the original rule proposed by taylor (1993) takes the following form: r = p + .5y + .5(p – 2) + 2 where: r = the nominal interest rate; y = the percentage deviation of real gdp from a target; p = the rate of inflation from the previous four quarters. the first constant that is inside the term (p – 2) is the federal reserve’s target rate of inflation. the second constant is the assumed natural interest rate. the rule states that if gdp exceeds potential gdp, or the level of inflation exceeds a target (assumed to be 2%) that the interest rate should increase. despite finding significant support for the taylor rule in describing the actions of the federal reserve, taylor (1993) noted that a central bank should not strictly follow an interest determination rule and instead use them as a guideline. there is a significant level of support for the existence of a taylor rule in previous literature. taylor and davradakis (2006); cukierman and muscatelli (2008) found evidence that the bank of england followed a nonlinear taylor rule. cukierman and muscatelli (2008) and kulikauskas (2014) found similar evidence for the european central bank. maza and sanchez-robles (2013) found that the taylor rule perfectly fit the monetary policy actions of the european central bank between 1999 to 2002 and 2007 to 2009. lee et al. (2013) found that there were sizeable shifts in the bank of england's monetary policy following the financial crisis. haug and nesse (2016) found that monetary policy had been either too strict or neutral for the euro area following the financial crisis. similarly, alcidi et al. (2016) found that monetary policy was too loose until 2008 and then too tight in 2009 and 2010. figure-1. a comparison of the bank rate and marginal lending facility source: bank of england (2018),federal reserve economic data (2018). figure-2. inflation rates for the united kingdom and euro area source: office of national statistics (2018), ecb statistical data warehouse (2018) asian journal of economics and empirical research, 2018, 5(2): 173-182 175 figure-3. gdp for the united kingdom (millions of pounds) source: ons (2016). figure-4. gdp for the euro area (millions of euros) source: ecbsdw (2018) nikolsko-rzhevskyy and papell (2012) found that the taylor rule did not prescribe negative interest rates and thus did not provide the rationale for quantitative easing following the financial crisis. woodford (2001) suggested that the taylor rule could be improved by incorporating the historical behavior of the variables in the rule. coibion and yuriy (2011) and driffill and rotondi (2007) attempted to account for interest rate smoothing by adding a lagged interest rate variable to the original taylor rule. both found that the coefficient of the lagged variable tended to be large and significant. 3. data this paper analyses quarterly economic data from 1993q1 to 2017q4 for the united kingdom and 2000q1 to 2016q4 for the euro area. the period analysed for the euro area is shorter as the european central bank has only conducted monetary policy since 1999 (gonzález-páramo, 2005). interest rate time-series of the official bank rate and the marginal lending facility are used to estimate the taylor rule throughout this analysis and are shown in figure 3. the data for the official bank rate and marginal lending facility are collected from the bank of england (2018) website and fred (2018) respectively. as figure 3 shows, interest rates have varied substantially over the period analysed. however, since the financial crisis, interest rates in both the united kingdom and euro area have remained close to the zero lower bound as central banks try to stimulate the economy. figures 2, 3 and 4 show the inflation rate and the level of gdp in the united kingdom and euro area which are used alongside the respective interest rates to estimate the taylor rule throughout the analysis. figure 2 shows the volatility of the inflation rate, especially throughout the financial crisis. in addition, there is a clear dip in figure 3 and 4 which represent the reduction in gdp following the financial crisis. this paper uses cpi as the measure of inflation. the inflation rate data and gdp data are collected from the ons (2018) for the united kingdom and the ecbsdw (2018) for the euro area. both gdp time-series are chain linked to account for the effects of inflation (ons, 2016). 4. models this paper will estimate two models for the united kingdom and euro area. the first, the original (taylor, 1993) rule, can be constructed using three equations. the first states the output gap (yt–yt *) as a function of the deviation of the previous periods interest rate from the target rate (it-1 – i*). this relationship is negative as a higher interest rate decreases investment and spending thus causing the economy to contract such that: yt – yt * = -d(it-1 – i*t) d > 0 where yt and yt * are the actual and potential levels of output; it-1 is the previous periods interest rate and i*t is the target interest rate. asian journal of economics and empirical research, 2018, 5(2): 173-182 176 the second equation, the expectations-augmented phillips curve, shows how price levels respond to a change in aggregate supply and is given by: πt = πt * + c(yt-1 – y* t-1) c > 0 where πt and πt * are the actual and target rates of inflation; yt and yt * are the actual and potential levels of output in the previous period. the taylor rule can be derived by combining these equations such that: it = it* + a(yt–yt *) + b(πt–πt *) a > 0; b > 0 where it is the interest rate; (yt–yt *) is the output gap; (πt–πt *) is the inflation gap ; it* is the natural interest rate and a and b are parameters and both are positive constants. this model shows how policymakers should increase the interest rate if the output level raises above the potential or the inflation rate rises above the target (bhattarai, 2008). based on coibion and yuriy (2011) and driffill and rotondi (2007) results we will estimate a second model to account for interest rate smoothing. the taylor rule that was derived previously will be modified to incorporate a lagged interest rate variable such that: it = it* + a(yt–yt *) + b(πt–πt *) + it-1 a > 0; b > 0 where it-1 is the previous periods interest rate; all other constants and variables are the same as mentioned previously. 5. analysis of results the estimated taylor rules for both the united kingdom (r2 = 0.37) and euro area (r2 = 0.47) had a weak fit to the data. this is expected as the interest rate in an economy is influenced by more than just the output gap and inflation gap (bhattarai, 2008). the part of interest setting that is not accounted for by the interest rate or output gap could be explained by these other variables (loide, 2014). as noted by coibion and yuriy (2011); driffill and rotondi (2007) and loide (2014) the weak fit could also be explained by interest rate smoothing. the relationship between the interest rate and output gap for the united kingdom (1) and euro area (2) are as follows: it = 0.04 + 0.16(yt–yt *) + 1.24(πt–πt *) (1) (p value) (7.2x10-25) (0.07) (1.4x10-11); r2 = 0.37 it = 2.89 + 7.76(yt–yt *) + 1.17(πt–πt *) (2) (p value) (7.66x10-28) (0.33) (5.4x10-28); r2 = 0.47 the interest rate rises with the output gap and inflation gap for both the united kingdom and euro area, which is expected based on the literature. in both models, the inflation gap was highly statistically significant at p < 0.001 however, the output gap was statistically insignificant. this result in line with loide (2014) who also found that the output gap was insignificant to their model. moreover, as primary objectives both the bank of england and european central banks are to maintain price stability; it is expected that they would place more emphasis on the inflation gap when setting monetary policies. figure-5. official bank rate, predicted taylor rate & confidence bands source: authors’ interest rate model. figure-6. marginal lending facility, predicted taylor rate & confidence bands source: authors’ interest rate model. asian journal of economics and empirical research, 2018, 5(2): 173-182 177 figure-7. official bank rate, lagged taylor rate and confidence bands source: authors’ interest rate model. figure-8. marginal lending facility, lagged taylor rate & confidence band source: authors’ interest rate model. the coefficients of the inflation gap were similar for both the bank of england and the european central bank, which shows the central banks place a similar emphasis on the inflation gap when setting interest rates. when the inflation gap rose by one, both central banks respond by increasing the interest rate by more than one. like bhattarai (2008) we also find that the interest rate for the united kingdom is more responsive to the inflation gap than the output gap. the results from the estimation of the second model that attempts to account for interest rate smoothing returned the following interest rate rule for the united kingdom (3) and euro area (4): it = -0.0004 0.05 (yt–yt *) – 0.004(πt–πt *) + 0.99it-1 (3) (p value) (0.58) (0.77) (0.16) (4.39x10-91); r2 = 0.98 it = 0.077 + 2.56 (yt–yt *) + 0.05(πt–πt *) + 0.95it-1 (4) (p value) (0.47) (0.40) (0.24) (6.89x10-40); r2 = 0.96 the estimated rule for both the united kingdom (r2 = 0.98) and euro area (r2 = 0.96) had a strong fit to the data. despite this, the output gap and inflation gap in both equations are statistically insignificant. moreover, the output gap and inflation gap in equation 3 have a negative coefficient which does not make economic sense; the interest rate should rise with the inflation gap and output gap, not fall (bhattarai, 2018). the results are similar to those of coibion and yuriy (2011) who found that the "coefficients on lagged interest rate are around 0.90 and are statistically significant at conventional levels". the significance of the lagged interest rate and insignificance of both the output gap and inflation gap in equations 3 and 4 suggest that both the bank of england and european central bank smooth interest rates. the original taylor rule poorly forecasts both the official bank rate and the marginal lending facility in the period analysed as shown in figures 5 and 6. the accuracy of the forecasts were significantly improved when accounting for interest rate smoothing as shown in figures 7 and 8. over the period analysed, the taylor rate is a lot more volatile in comparison to the bank rate and the marginal lending facility which is comparable to the results of coibion and yuriy (2011). unlike the interest rates set by central banks, the taylor rule advocates for interest rate changes in each of the periods analysed. this emphasises (taylor, 1993) point that it would be unrealistic for monetary policy to strictly adhere to the taylor rule as it would not be reasonable for a central bank to frequently change interest rates. the taylor rules estimated do not predict negative interest rates over the period analysed for either the united kingdom or the euro area. thus, like nikolsko-rzhevskyy and papell (2012) our results do not provide the rationale for quantitative easing in the years following the financial crisis. despite this, both the bank of england and european central bank engaged in large asset repurchase programs following the financial crisis. several economists have argued that this, coupled with an extended period of zero interest rate policy, lead to the asian journal of economics and empirical research, 2018, 5(2): 173-182 178 formation of asset bubbles within the economy. however, this would require further exploration which is outside the scope of this paper. 6. conclusion the results show that the original taylor rule poorly explains monetary policy in both the united kingdom and euro area. the addition of a one-period lagged interest rate significantly improved the fit of the model to the data, suggesting that central banks smooth interest rates over time. the forecasted taylor rates show that the bank of england's and european central banks monetary policy was too loose leading up to and following the financial crisis. moreover, the forecasted rates to not prescribe the rationale for quantitative easing in either region. in conclusion, the taylor rule continues to be a useful tool for both academics and policymakers alike. the volatility of the taylor rule emphasises (taylor, 1993) point that policymakers should use the rule as a guideline and not strictly adhere to it. nevertheless, the rule has some important implications for how central banks conduct monetary policy in the future. references alcidi, c., m. busse and d. gros, 2016. is there a need for additional monetary stimulus? insights from the original taylor rule. no. 11492. centre for european policy studies, 2016. bank of england, 2018. the interest rate. official bank rate historical data. available from https://www.bankofengland.co.uk/monetarypolicy/the-interest-rate-bank-rate [accessed 06/01/2018]. bhattarai, 2018. advanced macroeconomics. uk: university of hull. bhattarai, k., 2008. an empirical study of interest rate determination rules. applied financial economics, 18(4): 327-343. available at: https://doi.org/10.1080/09603100500447560. castro, v., 2008. are central banks following a linear or nonlinear (augmented) taylor rule? 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papers no 691). fred, 2018. euro area gdp. available from https://fred.stlouisfed.org/series/clvmeurscab1gqea19 [accessed 19/03/2018]. gonzález-páramo, j., 2005. the european central bank’s monetary policy in an international context: principles and challenges. available from https://www.ecb.europa.eu/press/key/date/2005/html/sp050623.en.html [accessed 23/03/2017]. haug, s. and m. nesse, 2016. taylor rules and monetary policy in the eurozone. master’s thesis. norwegian school of economics. kulikauskas, d., 2014. nonlinear taylor rule for the european central bank. economics bulletin, 34(3): 1798-1804. lee, k., n. olekalns and k. shields, 2013. meta taylor rules for the uk and australia; accommodating regime uncertainty in monetary policy analysis using model averaging methods. the manchester school, 3(81): 28-53. available at: https://doi.org/10.1111/manc.12000. loide, g., 2014. the taylor rule as a benchmark for ecb interest rate setting. master’s thesis. tallinn school of economics and business administration. maza, a. and b. sanchez-robles, 2013. the european central bank monetary policy and the taylor rule, 1999-2009 the monetary policy of the central european bank and the rule of taylor, 1999-2009. world economic review, 32: 179-193. nikolsko-rzhevskyy, a. and d. papell, 2012. taylor’s rule versus taylor rules. international finance, 16(1): 71-93. office of national statistics, 2018. gross domestic product. gdp: chained volume measures: seasonally adjusted £m. available from https://www.ons.gov.uk/economy/grossdomesticproductgdp [accessed 06/01/2018]. ons, 2016. chain-linking methods used within the uk national accounts. available from https://www.ons.gov.uk/economy/nationalaccounts/uksectoraccounts/methodologies/chainlinkingmethodsusedwithintheuknatio nalaccounts [accessed 07/01/2018]. ons, 2018. inflation and price indices. cpih annual rate. available from https://www.ons.gov.uk/economy/inflationandpriceindices [accessed 06/01/2018]. taylor, j., 1993. discretion versus policy rules in practice. carnegie-rochester conference series on public policy, 39: 195-214. taylor, m.p. and e. davradakis, 2006. interest rate setting and inflation targeting: evidence of a nonlinear taylor rule for the united kingdom. studies in nonlinear dynamics & econometrics, 10(4): 1-20. available at: https://doi.org/10.2202/1558-3708.1359. woodford, m., 2001. the taylor rule and optimal monetary policy. american economic review, 91(2): 232-237. available at: https://doi.org/10.1257/aer.91.2.232. http://www.bankofengland.co.uk/monetary-policy/the-interest-rate-bank-rate http://www.bankofengland.co.uk/monetary-policy/the-interest-rate-bank-rate http://sdw.ecb.europa.eu/ http://www.ecb.europa.eu/press/key/date/2005/html/sp050623.en.html http://www.ons.gov.uk/economy/grossdomesticproductgdp http://www.ons.gov.uk/economy/nationalaccounts/uksectoraccounts/methodologies/chainlinkingmethodsusedwithintheuknationalaccounts http://www.ons.gov.uk/economy/nationalaccounts/uksectoraccounts/methodologies/chainlinkingmethodsusedwithintheuknationalaccounts http://www.ons.gov.uk/economy/inflationandpriceindices asian journal of economics and empirical research, 2018, 5(2): 173-182 179 appendices appendix 1 – data used united kingdom year official bank rate lagged bank rate inflation gap output gap taylor rate lagged taylor rate 1989-1 12.88% 12.88% 3.00% 0.02041386 8.14% 12.59% 1989-2 13.75% 12.88% 3.30% 0.02637319 8.61% 12.57% 1989-3 13.81% 13.75% 3.10% 0.04155653 8.60% 13.44% 1989-4 14.88% 13.81% 3.50% 0.05014553 9.24% 13.48% 1990-1 14.88% 14.88% 3.90% 0.02616712 9.35% 14.53% 1990-2 14.88% 14.88% 4.70% 0.03265785 10.45% 14.49% 1990-3 14.88% 14.88% 5.60% 0.03361574 11.58% 14.45% 1990-4 13.88% 14.88% 5.90% 0.03452015 11.97% 14.43% 1991-1 13.00% 13.88% 5.00% 0.01369227 10.52% 13.49% 1991-2 11.63% 13.00% 6.40% 0.01882321 12.34% 12.55% 1991-3 10.61% 11.63% 5.70% 0.00838792 11.30% 11.23% 1991-4 10.38% 10.61% 5.00% 0.00504432 10.38% 10.25% 1992-1 10.38% 10.38% 5.00% -0.0245736 9.90% 10.03% 1992-2 9.88% 10.38% 2.30% -0.0257854 6.52% 10.16% 1992-3 10.38% 9.88% 1.30% -0.0280686 5.24% 9.71% 1992-4 7.38% 10.38% 0.70% -0.0264659 4.52% 10.23% 1993-1 5.88% 7.38% 0.40% -0.0526212 3.73% 7.28% 1993-2 5.88% 5.88% 0.40% -0.0538531 3.71% 5.79% 1993-3 5.88% 5.88% 0.80% -0.0474738 4.31% 5.77% 1993-4 5.38% 5.88% 0.40% -0.0404622 3.92% 5.79% 1994-1 5.13% 5.38% 0.50% -0.0586057 3.76% 5.29% 1994-2 5.13% 5.13% 0.00% -0.0535331 3.21% 5.07% 1994-3 5.63% 5.13% -0.30% -0.0455212 2.97% 5.08% 1994-4 6.13% 5.63% -0.20% -0.0387289 3.20% 5.57% 1995-1 6.63% 6.13% 0.50% -0.0515787 3.87% 6.03% 1995-2 6.63% 6.63% 0.40% -0.0400405 3.93% 6.53% 1995-3 6.63% 6.63% 0.80% -0.0287551 4.61% 6.51% 1995-4 6.38% 6.63% 0.90% -0.0230882 4.82% 6.50% 1996-1 6.03% 6.38% 0.70% -0.0439461 4.24% 6.27% 1996-2 5.69% 6.03% 0.40% -0.0403429 3.92% 5.94% 1996-3 5.69% 5.69% 0.30% -0.0305549 3.96% 5.60% 1996-4 5.94% 5.69% 0.50% -0.0276956 4.25% 5.59% 1997-1 5.94% 5.94% -0.10% -0.042282 3.27% 5.87% 1997-2 6.63% 5.94% -0.40% -0.0391345 2.95% 5.89% 1997-3 6.88% 6.63% -0.10% -0.0323802 3.43% 6.55% 1997-4 7.25% 6.88% -0.20% -0.023007 3.46% 6.80% 1998-1 7.25% 7.25% -0.40% -0.0317384 3.07% 7.18% 1998-2 7.25% 7.25% -0.20% -0.021078 3.49% 7.17% 1998-3 7.25% 7.25% -0.60% -0.0151367 3.08% 7.19% 1998-4 6.75% 7.25% -0.60% -0.0029516 3.28% 7.18% 1999-1 5.75% 6.75% -0.40% -0.0199983 3.26% 6.68% 1999-2 5.13% 5.75% -0.60% -0.0141542 3.10% 5.70% 1999-3 5.25% 5.13% -0.80% -0.0068663 2.97% 5.08% 1999-4 5.50% 5.25% -0.90% 0.00349916 3.01% 5.21% 2000-1 5.88% 5.50% -1.20% -0.0125693 2.38% 5.48% 2000-2 5.88% 5.88% -1.40% -0.0118747 2.14% 5.86% 2000-3 5.88% 5.88% -1.20% 0.00551846 2.67% 5.84% 2000-4 5.88% 5.88% -1.00% 0.01957437 3.14% 5.83% 2001-1 5.75% 5.88% -1.10% 0.00726313 2.82% 5.84% 2001-2 5.38% 5.75% -0.50% 0.01442447 3.68% 5.68% 2001-3 4.88% 5.38% -0.50% 0.01738216 3.73% 5.31% 2001-4 4.25% 4.88% -1.00% 0.01947702 3.14% 4.83% 2002-1 4.00% 4.25% -0.50% 0.00840409 3.59% 4.19% 2002-2 4.00% 4.00% -1.10% 0.01664342 2.97% 3.97% 2002-3 4.00% 4.00% -1.00% 0.02305946 3.20% 3.96% 2002-4 4.00% 4.00% -0.50% 0.0263434 3.87% 3.94% 2003-1 3.75% 4.00% -0.50% 0.01045874 3.62% 3.95% 2003-2 3.75% 3.75% -0.70% 0.01760398 3.49% 3.70% asian journal of economics and empirical research, 2018, 5(2): 173-182 180 2003-3 3.50% 3.75% -0.60% 0.02562235 3.74% 3.70% 2003-4 3.75% 3.50% -0.70% 0.03502976 3.77% 3.45% 2004-1 4.00% 3.75% -0.70% 0.02094635 3.54% 3.70% 2004-2 4.38% 4.00% -0.60% 0.02996588 3.81% 3.94% 2004-3 4.75% 4.38% -0.70% 0.03989003 3.84% 4.32% 2004-4 4.75% 4.75% -0.60% 0.0476402 4.09% 4.68% 2005-1 4.75% 4.75% -0.30% 0.03293418 4.23% 4.67% 2005-2 4.75% 4.75% 0.00% 0.0371452 4.67% 4.66% 2005-3 4.50% 4.75% 0.40% 0.03944807 5.21% 4.64% 2005-4 4.50% 4.50% 0.10% 0.04307123 4.89% 4.40% 2006-1 4.50% 4.50% -0.10% 0.03201837 4.46% 4.41% 2006-2 4.50% 4.50% 0.30% 0.04289975 5.14% 4.39% 2006-3 4.75% 4.50% 0.40% 0.05340497 5.43% 4.38% 2006-4 5.00% 4.75% 0.70% 0.06796726 6.04% 4.61% 2007-1 5.25% 5.00% 0.90% 0.0514821 6.02% 4.86% 2007-2 5.50% 5.25% 0.60% 0.0535055 5.68% 5.12% 2007-3 5.75% 5.50% -0.20% 0.05429788 4.70% 5.40% 2007-4 5.50% 5.75% 0.10% 0.05793939 5.13% 5.63% 2008-1 5.25% 5.50% 0.40% 0.04816291 5.35% 5.38% 2008-2 5.00% 5.25% 1.40% 0.05529619 6.70% 5.08% 2008-3 4.50% 5.00% 2.80% 0.06189576 8.55% 4.76% 2008-4 2.50% 4.50% 1.90% 0.0699027 7.56% 4.31% 2009-1 1.50% 2.50% 1.00% 0.05420973 6.19% 2.37% 2009-2 0.50% 1.50% 0.10% 0.04742543 4.96% 1.42% 2009-3 0.50% 0.50% -0.50% 0.03128546 3.95% 0.46% 2009-4 0.50% 0.50% 0.10% 0.00928011 4.35% 0.44% 2010-1 0.50% 0.50% 1.30% -0.0249093 5.29% 0.40% 2010-2 0.50% 0.50% 1.50% -0.0271643 5.51% 0.39% 2010-3 0.50% 0.50% 1.10% -0.0256135 5.03% 0.41% 2010-4 0.50% 0.50% 1.40% -0.0229499 5.45% 0.40% 2011-1 0.50% 0.50% 2.10% -0.0353414 6.12% 0.37% 2011-2 0.50% 0.50% 2.40% -0.0263831 6.64% 0.35% 2011-3 0.50% 0.50% 2.70% -0.0217527 7.09% 0.34% 2011-4 0.50% 0.50% 2.60% -0.0210309 6.97% 0.34% 2012-1 0.50% 0.50% 1.50% -0.0326248 5.42% 0.40% 2012-2 0.50% 0.50% 0.80% -0.0311448 4.57% 0.43% 2012-3 0.50% 0.50% 0.40% -0.027346 4.13% 0.45% 2012-4 0.50% 0.50% 0.70% -0.0254473 4.54% 0.43% 2013-1 0.50% 0.50% 0.80% -0.036151 4.49% 0.43% 2013-2 0.50% 0.50% 0.70% -0.0372187 4.35% 0.44% 2013-3 0.50% 0.50% 0.70% -0.0257741 4.53% 0.43% 2013-4 0.50% 0.50% 0.10% -0.0272256 3.76% 0.46% 2014-1 0.50% 0.50% -0.30% -0.0377201 3.09% 0.48% 2014-2 0.50% 0.50% -0.30% -0.0323288 3.18% 0.48% 2014-3 0.50% 0.50% -0.50% -0.0238611 3.07% 0.49% 2014-4 0.50% 0.50% -1.10% -0.0186855 2.40% 0.51% 2015-1 0.50% 0.50% -1.90% -0.0267115 1.28% 0.55% 2015-2 0.50% 0.50% -2.00% -0.0182179 1.29% 0.55% 2015-3 0.50% 0.50% -2.00% -0.0106353 1.41% 0.55% 2015-4 0.50% 0.50% -1.90% -0.0030519 1.66% 0.54% 2016-1 0.50% 0.50% -1.70% -0.0159405 1.70% 0.54% 2016-2 0.50% 0.50% -1.60% -0.0102088 1.92% 0.53% 2016-3 0.25% 0.50% -1.30% -0.006052 2.36% 0.52% 2016-4 0.25% 0.25% -0.80% 0.00117998 3.10% 0.24% 2017-1 0.25% 0.25% 0.10% -0.0127535 3.99% 0.21% 2017-2 0.25% 0.25% 0.70% -0.0080059 4.82% 0.18% 2017-3 0.25% 0.25% 0.80% -0.0026108 5.03% 0.17% 2017-4 0.50% 0.25% 1.00% 0.00484444 5.40% 0.16% asian journal of economics and empirical research, 2018, 5(2): 173-182 181 euro area year marginal lending facility lagged mlf inflation gap output gap taylor rate lagged taylor rate 2000-1 4.50 4.50 -0.07 -0.03 3.36 4.29 2000-2 5.25 4.50 -0.13 -0.02 3.46 4.32 2000-3 5.50 5.25 0.17 -0.02 3.53 5.04 2000-4 5.75 5.50 0.47 -0.01 3.59 5.30 2001-1 5.75 5.75 0.07 -0.01 3.56 5.53 2001-2 5.50 5.75 0.90 -0.01 3.54 5.54 2001-3 4.75 5.50 0.33 -0.01 3.49 5.30 2001-4 4.25 4.75 0.13 -0.01 3.44 4.59 2002-1 4.25 4.25 0.53 -0.02 3.24 4.09 2002-2 4.25 4.25 0.13 -0.01 3.19 4.10 2002-3 4.25 4.25 0.10 -0.01 3.14 4.11 2002-4 3.75 4.25 0.30 -0.01 3.06 4.11 2003-1 3.50 3.75 0.30 -0.02 2.79 3.59 2003-2 3.00 3.50 -0.03 -0.02 2.73 3.36 2003-3 3.00 3.00 0.00 -0.01 2.74 2.90 2003-4 3.00 3.00 0.07 -0.01 2.80 2.92 2004-1 3.00 3.00 -0.30 -0.01 2.85 2.91 2004-2 3.00 3.00 0.30 0.00 2.93 2.93 2004-3 3.00 3.00 0.27 0.00 3.00 2.94 2004-4 3.00 3.00 0.30 0.00 3.09 2.95 2005-1 3.00 3.00 0.07 -0.01 3.14 2.93 2005-2 3.00 3.00 0.03 0.00 3.26 2.95 2005-3 3.00 3.00 0.30 0.01 3.37 2.98 2005-4 3.25 3.00 0.33 0.01 3.48 3.00 2006-1 3.50 3.25 0.33 0.01 3.56 3.24 2006-2 3.75 3.50 0.47 0.02 3.67 3.50 2006-3 4.25 3.75 0.17 0.03 3.73 3.76 2006-4 4.50 4.25 -0.20 0.04 3.80 4.26 2007-1 4.75 4.50 -0.17 0.04 3.39 4.48 2007-2 5.00 4.75 -0.10 0.05 3.51 4.73 2007-3 5.00 5.00 -0.13 0.05 3.74 4.99 2007-4 5.00 5.00 0.90 0.06 4.08 5.02 2008-1 5.00 5.00 1.37 0.05 5.61 5.08 2008-2 5.00 5.00 1.67 0.05 5.64 5.07 2008-3 5.25 5.00 1.83 0.04 5.32 5.04 2008-4 3.00 5.25 0.30 0.02 4.55 5.20 2009-1 2.50 3.00 -1.03 -0.01 1.59 2.84 2009-2 1.75 2.50 -1.83 -0.02 0.91 2.33 2009-3 1.75 1.75 -2.40 -0.01 0.60 1.62 2009-4 1.75 1.75 -1.57 -0.01 0.63 1.63 2010-1 1.75 1.75 -0.87 -0.01 1.59 1.66 2010-2 1.75 1.75 -0.40 0.00 2.01 1.71 2010-3 1.75 1.75 -0.27 0.00 2.44 1.73 2010-4 1.75 1.75 0.00 0.01 2.91 1.77 2011-1 1.75 1.75 0.47 0.01 3.89 1.81 2011-2 2.00 1.75 0.73 0.00 4.18 1.82 2011-3 2.25 2.00 0.70 0.01 4.31 2.06 2011-4 1.75 2.25 0.93 0.00 4.24 2.29 2012-1 1.75 1.75 0.70 -0.01 3.57 1.76 2012-2 1.75 1.75 0.47 -0.01 3.31 1.74 2012-3 1.50 1.75 0.53 -0.01 3.04 1.73 2012-4 1.50 1.50 0.30 -0.02 2.74 1.46 2013-1 1.50 1.50 -0.13 -0.03 2.30 1.41 2013-2 1.00 1.50 -0.60 -0.03 2.04 1.42 2013-3 1.00 1.00 -0.67 -0.02 1.77 0.94 2013-4 0.75 1.00 -1.20 -0.02 1.50 0.94 2014-1 0.75 0.75 -1.33 -0.02 1.00 0.67 2014-2 0.40 0.75 -1.43 -0.02 0.78 0.66 2014-3 0.30 0.40 -1.63 -0.02 0.63 0.33 2014-4 0.30 0.30 -1.83 -0.01 0.56 0.25 2015-1 0.30 0.30 -2.33 -0.02 0.59 0.25 2015-2 0.30 0.30 -1.83 -0.01 0.58 0.25 2015-3 0.30 0.30 -1.93 -0.01 0.61 0.27 2015-4 0.30 0.30 -1.87 0.00 0.66 0.28 2016-1 0.25 0.30 -1.97 -0.01 0.67 0.27 asian journal of economics and empirical research, 2018, 5(2): 173-182 182 2016-2 0.25 0.25 -2.07 0.00 0.76 0.24 2016-3 0.25 0.25 -1.73 0.00 0.88 0.25 2016-4 0.25 0.25 -1.27 0.01 1.03 0.27 2017-1 0.25 -0.23 0.00 2017-2 0.00 -0.47 0.01 2017-3 0.00 -0.57 0.02 2017-4 0.00 -0.57 0.02 appendix 2 – table of results table-1. united kingdom model one: united kingdom natural rate output gap inflation gap 0.04 0.16 1.24 (13.3; 7.2x10-25; 0.003) (1.8; 0.07; 0.09) (7.5; 1.4x10-11; 0.17) values in parentheses (t-stat; p-value; standard error) r2: 0.37; adjusted r2: 0.36; significance f: 32.60(6.67x10-12) source: authors’ estimations table-2. united kingdom – including lagged interest rate variables (it-1) model two: united kingdom (lagged values of interest rate) natural rate output gap inflation gap it-1 -0.00044 -0.047 -0.0042 0.99 (-0.55; 0.58; 0.0008) (-0.29; 0.77; 0.014) (-1.41; 0.16; 0.033) (65.6; 4.39x10-91; 0.015) values in parentheses (t-stat; p-value; standard error) r2: 0.98; adjusted r2: 0.98; f value: 2281.41(3.2x10-100) source: authors’ estimations table-3. euro area model one: euro area natural ate output gap inflation gap 2.89 7.76 1.17 (18.0; 7.66x10-28; 0.16) (0.97; 0.33; 7.95) (6.66; 5.4x10-28; 0.17) values in parentheses (t-stat; p-value; standard error) r2: 0.47; adjusted r2: 0.45; f value: 30.09(4.01x10-10) source: authors’ estimations table-4. euro area – including lagged interest rate variable (it-1) model two: euro area (lagged values of interest rate) natural rate output gap inflation gap it-1 0.08 2.57 0.05 0.95 (0.72; 0.47; 0.10) (0.85; 0.40; 2.21) (1.16; 0.24; 0.06) (28.87; 6.89x10-40; 0.03) values in parentheses (t-stat; p-value; standard error) r2: 0.96; adjusted r2: 0.96 f value: 539.90(0.004) source: authors’ estimations asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 112 asian journal of economics and empirical research vol. 5, no. 2, 112-120, 2018 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2018.52.112.120 does financial and trade liberalization drive private investment in pakistan? qazi muhammad adnan hye1  wee-yeap lau2 ( corresponding author) 1 adjunct faculty, mohammad ali jinnah university, karachi, pakistan 2faculty of economics and administration university of malaya, malaysia abstract there is evidence in economic growth literature that private investment enhances economic growth of developing countries. recent economic growth policies in pakistan has concentrated more on encouraging private sector investment through the liberalization of the financial and trade sectors. however, previous studies have ignored the impact of trade and financial liberalization on private investment. this study investigates the shortand long-run impact of financial and trade liberalization on private investment in pakistan. using the data from 1971– 2014 on the ardl bounds testing approach to cointegration, our result suggests that: first, per capita real private income, public investment, and financial liberalization are positively related to private investment in the long run; second, real interest rate and trade openness are negatively related to private investment in the long run; and finally, the short-run results indicate that capital account liberalization and financial openness are positively associated with private savings. keywords: financial and trade liberalization, private savings, ardl, pakistan jel classification: e21; f43; f60. citation | qazi muhammad adnan hye; wee-yeap lau (2018). does financial and trade liberalization drive private investment in pakistan? asian journal of economics and empirical research, 5(2): 112-120. history: received: 23 march 2018 revised: 1 august 2018 accepted: 15 august 2018 published: 10 september 2018 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 113 2. financial and trade reforms ...................................................................................................................................................... 114 3. theoretical framework ................................................................................................................................................................ 114 4. estimation methodology and construction of variables ...................................................................................................... 116 5. estimation results ......................................................................................................................................................................... 117 6. conclusion ....................................................................................................................................................................................... 119 references ............................................................................................................................................................................................ 119 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2018.52.112.120&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/251 http://asianonlinejournals.com/index.php/ajeer/article/view/251 asian journal of economics and empirical research, 2018, 5(2): 112-120 113 1. introduction according to the neoclassical framework of the repressed financial systems, firms do not get an unlimited supply of credit. the neoclassical framework assumes that perfectly competitive markets prevail. stiglitz and weiss (1981) state developing countries frequently face credit restraints due to market imperfections such as unequal information. the imperfect credit market stops firms from acquiring enough borrowing. this type of restraint generally discourages the investment activities. the study of ang and mckibbin (2007) test the influence of financial deregulation on private investment in the case of malaysia. they suggest that an appropriate mix of financial liberalization and repression strategies effective in stimulating private investment. neo-structuralist van wijnbergen (1982) and taylor (1983) state that lower tax collection and higher government borrowing can cause financial systems to reduce credit flow to the private sector. the official financial systems focus on reserve requirements that show leakage in the intermediation process. the neo-structuralists claim that unorganized markets perform more efficiently in intermediating savers and investors. stiglitz (1994a) claims that restraint interest rate may increase savings in the financial system with the existence of good governance. he explains that depositor may observe the restriction as a strategy of stability in the financial system; the saver may be keen to keep their savings in the form of bank deposits. thus, there is a possibility of more resources for investment in the absence of perfect capital mobility. razin et al. (2002) argue that openness may have non-traditional links with investment level and its cyclical behaviour. discrete “jump” in the level of investment in the stage of trade liberalization is plausible due to a discrete change in the terms of trade which can considerably boost aggregate investment. however, trade openness could also lead to boom-bust cycles in investment or create multiple-equilibrium. sizable gain from globalization can be accrued from investment-boom equilibrium. conversely, benefits, if any from investment-bust equilibrium is either small or negative. openness can disrupt an economy. hellmann et al. (2000) use a dynamic model to show that capital can be recycled in a prudent manner to overcome the problem of moral hazard. through a combination of capital requirement and deposit rate controls, banks can be incentivized in a pareto-optimal manner. the line of direct credit commonly allows controlled distribution of credit to priority areas such as agriculture and industry. they point out that without such interferences, banks normally will not supply fund to activities with low yields.1 greene and villanueva (1991) use 1975-87 data to examine the influence of macroeconomic variables on private investment in 23 developing countries2 and find that real growth of gdp, level of gdp per capita, and the rate of public sector investment are positively related to private investment; but real interest rates, domestic inflation, debt-service ratio, and the ratio of debt to gdp affect private investment negatively. on the other hand, private investment expenditure is positively related to domestic credit and net capital inflow to the private sector in the developing countries (zebib and muoghalu, 1997). henry (2000) includes stock market liberalization3 in a private investment model and finds that the former causes private investment booms in 11 developing countries. in the case of developing countries,4 salahuddin et al. (2009) find a positive impact of the growth rate of per capita real gdp, domestic savings, trade openness, foreign aid, private sector credit and institutional development on private investment; but the negative effect of foreign debt servicing on private investment. however, he finds no significant effect of the inflation rate, lending rate, human capital and population growth on investment. he highlights the importance of efficient allocation of local resources; reduce reliance on foreign debt; increase trade openness, and institutional development and higher per capita real gdp growth to boost private/gross investment. using data from developing countries,5 spatafora and luca (2012) find that private capital inflows and domestic credit positively causes private investment. the global pricing of risk and domestic borrowing costs, increase through their impact on net capital inflows and domestic credit. however, neither more domestic credit nor superior institutional quality increases the degree to which capital inflows related to domestic investment. in the transitional economies, the impact of economic freedom, economic growth, savings, and financial development are positively related to private investment (dang, 2012). jenkins (1998) estimates private investment for zimbabwe, and find that the impact of gross profits is positive, but that of external debt6 is negative on the private capital formation. achy (2005) documents that financial development indicators and financial liberalization index are negatively related with private investment in the five mena countries.7 akkina and celebi (2002) examine the impacts of financial repression and financial liberalization on private fixed investment in turkey. they find that the financial repression and liberalization programs do not show any positive effect on private investment despite implementation of liberalization measures in 1983. acosta and loza (2005) examine the impact of the short and long-run factors affecting private investment in argentina. they conclude that exchange rate and trade liberalization are determinants of short-term investment. in the long term, the capital accumulation, fiscal sustainability, financial development and credit market are important determinants of private investment. they establish the positive impact of financial liberalization on domestic savings, private 1mckinnon–shaw thesis supports the elimination of directed credit programs that shift investment projects with possibly higher returns. 2 the 23 countries are argentina, bolivia, brazil, chile, colombia, costa rica, ecuador, guatemala, india, kenya, the republic of korea, mexico, pakistan, peru, the philippines, singapore, sri lanka, thailand, tunisia, turkey, uruguay, venezuela, and zimbabwe. 3stock market liberalization measured by dummy variable equals "1" for the liberalization period. 4 albania, algeria, bangladesh, chad, egypt, ethiopia, indonesia, iran, jordan, malaysia, mali, mauritania, morocco, niger, oman, pakistan, saudi arabia, senegal, syria, tunisia, and turkey. 5albania, algeria, angola, argentina, armenia, azerbaijan, bangladesh, belarus, belize, benin, bolivia, botswana, brazil, bulgaria, burkina faso, burundi, cambodia, cameroon, cape verde, central african republic, chad, chile, china, colombia, comoros, congo dem. rep.,congorep., costa rica, côte d'ivoire, croatia, dominica, dominican republic, ecuador, egypt, el salvador, eritrea, ethiopia, fiji, gabon, gambia, georgia, ghana, guatemala, guinea, guineabissau, guyana, haiti, jamaica, honduras, india, indonesia, iran, jordan, kazakhstan, kenya, kyrgyz, republic, lao pdr, latvia, moldova, lebanon, lesotho, macedonia, madagascar, malawi, malaysia, mali, mozambique, mauritania, mauritius, mexico, morocco, nepal, nicaragua, niger, nigeria, pakistan panama, papua new guinea, paraguay, peru, philippines, poland, romania, russian federation, rwanda, senegal, seychelles, sierra leone, south africa, sri lanka, st. lucia, st. vincent and the grenadines, sudan, swaziland, syrian arab republic, tanzania, thailand, togo, tunisia, turkey, uganda, ukraine, uruguay, uzbekistan ,vanuatu venezuela, vietnam, yemen zambia, zimbabwe. 6 increase in external debt enhances uncertainty, so negative impact on private investment. 7list of countries i.e. egypt, jordan, morocco, tunisia, and turkey. asian journal of economics and empirical research, 2018, 5(2): 112-120 114 investment and per capita gdp growth and negative impact on public investment. their results indicate that financial liberalization substituting from public to private investment, which can enhance economic growth. the positive interest rate helpful for generating higher savings and investment in nepal (shrestha and chowdhury, 2007). moreover, in the case of thailand, jongwanich and kohpaiboon (2008) conclude that in the short run output growth, real private credit, and the existences of spare capacity are the main determinants of private investment. in addition, in the long run, output growth, real exchange rate (rer) and investment costs determine private investment. the export-led growth phenomenon shows the positive and statistically significant coefficient of rer. the government investment also can endorse long-term private investment, but its influences are comparatively lower than other variables. in the case of india and malaysia, ang (2009) shows that credit control policy negatively causes private capital formation in both countries. the interest rate control positively impacts on private investment in both countries. however, high reserve and liquidity requirements negatively affect private investment in india, and positively in malaysia. spatafora and luca (2012) examine the effect of trade liberalization on private investment in fiji. they conclude a positive association between the two. there are a few studies on investment in pakistan. for example, sakr (1993) shows that private investment positively correlates with gdp growth; credit extended to the private sector, and government investment. the private sector output, net capital inflows into the private sector, the total sources of funds, change in bank credit and past capital stock is positively linked with private investment rates in pakistan (majeed and khan, 2008). moreover, the indirect tax, debt servicing and interest rate are negatively linked with private investment. also, the gdp, domestic savings, subsidies, and government development expenditures (psdp) are positively related to private investment (haroon and nasr, 2011). saghir and khan (2012) examine the determinants of public and private investment. they find that government investment negatively affects private investment, but aid positively relates to government investment in the long run. in the case of pakistan, several studies have estimated the private investment function. but they have ignored to check the impact of trade and financial liberalization on private investment. this study uses the renowned databases of trade and financial liberalization such as abiad et al. (2010)8, chinn and ito (2006)9, lane and milesiferretti (2007)10, and wacziarg and welch (2008)11 in order to estimate the private investment model by using the ardl approach to cointegration. the rest of the study is structured as follows. section 2 represents the financial and trade reforms. section 3 represents the theoretical framework. section 4 describes estimation methodology and construction of variables. sections 5 report the empirical results, and the last section concludes the study. 2. financial and trade reforms in order to increase the efficiency of the market, financial and trade liberalization was started in the late 1980's by pakistan policymakers. the privatization of national bank was introduced to improve the efficiency of the banking sector. the interest rate was liberalized by removing limits on maximum lending rates of banks and nbfis12 in march 1995. as part of liberalization of the financial sector in 1991, the pak rupee (currency) was made convertible in july 1994 under the imf article viii. the stock market plays an important role in resource allocation and providing investment opportunities. of the three stock exchanges in pakistan (karachi, lahore, and islamabad), karachi stock exchange (kse), of which was established in 1947, dominates all others. the lahore stock exchange (lse) and the islamabad stock exchange (ise) were set up in 1974 and 1997 respectively. in trade reforms, the tariff rate was reduced and restrictions on imports of non-capital good removed. the maximum tariff rate on imports levied was 25% in 2005. import substitution strategies, shaped previously, had an anti-export bias in the allocation of resources which added to inefficiency. so, import substitution was exchanged by export promotion. in order to invite foreign direct investment, if not all, most economic sectors were opened for 100% foreign ownership. the key objective of the reforms was to attain self-reliance, build up the industrial base, root out inefficiency, improve the exports and reduce the trade deficit. 3. theoretical framework the dynamics of private investment are based on the neo-classical model of jorgenson (1967). we consider essential features of developing countries. in the neoclassical investment model, firms' maximize the utility of a consumption stream emphasizing on the production function which connects the flow of output to the flow of labour and capital services (jorgenson, 1967). through the acquisition of investment goods, firms supply capital services. the capital demand is consequently a derived demand. in the cobb-douglas production function (equation 3.1) the anticipated capital stock can be positively related to output planned/level of production ( ) and negatively to the anticipated rental cost of capital as follows: (3.1) where is the distribution parameter. there are three components that determine the cost of capital, (equation 3.1). they are the interest rate, the firm's receive opportunity cost if it traded the capital goods, and capitalized the earnings and respectively indicate the nominal bank lending rate and the price of capital 8database of financial reforms. 9de jure indicator of capital account liberalization. 10de facto indicator of capital account liberalization. 11de jure indicator of trade liberalization in the studies. 12for trade-related mode of financing. asian journal of economics and empirical research, 2018, 5(2): 112-120 115 goods. the depreciation of the capital goods is the second component, which is measured by where is the rate of depreciation. the gain/loss from anticipated deviations in the price of capital is given by: where is the anticipated fluctuation in the price of capital goods. these terms are deflated by general price (p) level in order to convert in real terms. (3.2) in equation 3.3 the gross private investment is represented by: (3.3) equation 3.3 indicates that the gross private investment is the collection of net and replacement components. the actual capital stock does reach the anticipated level in the short term. thus, equation (3.3) is a function of lagged investment and adjustment coefficient as in equation (3.4). [ ] (3.4) in equation 3.4 represents the adjustment coefficient, and refers to the lag operator, (e.g. ). in the long run, firms invest to get their anticipated capital stock to the anticipated investment, as specified by a distributed lag of the changes in desired capital stock as follows: ∑ (3.5) substituting the desired capital stock from equation (3.1) into equation (3.5) we find that private investment is a function of the cost of capital, output, and adjustment coefficient; ∑ (3.6) according to theoretical literature, is generally a function of economic aspects that influence the capacity of private stockholders to attain the anticipated level of investment. jorgenson investment model considers a perfect financial market where an unrestricted supply of capital available for firms. under this outline, the capital user cost is a vital determinant of private investment. within this context, attention has usually been focused on the implication of investment tax credit and depreciation rules on the cost of capital. on the other hand, the firms unable to access an unlimited supply of credit in financially repressed systems, while the neoclassical model assumes a competitive market. stiglitz and weiss (1981) point to the credit restraints due to market imperfection such as asymmetric information and agency problems in developing countries. thus, credit restraints discourage investment projects, in general. in the seminal work on financial liberalization, mckinnon (1973) and shaw (1973) explain the problem of financial repression in the developing countries and offer a new model in the policy of financial liberalization. they define that financial repression policies were the main reason of low investment and poor economic performance of developing countries in the 1960s. in the controlled financial market, the funds can be allocated based on the willingness of policymakers, so both quantitative and qualitative investment suffered. their theories suggest that loan issued at an artificially low-interest rate, directed credit programs, and high reserve requirements are major distortions in the financial systems. these can be prevented by efficient resource allocation via the reduction in savings and capital accumulation. consequently, they support financial liberalization policies, which is referred to as the process of elimination of financial repression in order to motivate private investment and economic growth. in contrast, the neo-structuralists suggest that it is not necessary for financial liberalization to lead investment because the formal financial systems are subject to reserve requirements, which contain a leakage in the intermediation process, the neo-structuralists claim that unorganized markets do better in intermediating process between savers and investors van wijnbergen (1982) and taylor (1983). the control on interest rate may increase savings in the existence of supremacy of financial systems (stiglitz, 1994b). the neo-structuralists agree with mckinnon–shaw school of thought on the reserve requirement because it may cause leakage in the intermediation process (fry, 1988). on the other hand, courakis (1984) shows that higher reserve requirements increase deposit rate and thus the size of loanable funds, under the assumption that the demand for loanable funds is not perfectly inelastic. schwarz (1992) argues that directed credit programs boost investment in the targeted sectors and thus adds to gains. furthermore, the financial openness may assist the domestic financial system, thus there will be a more efficient allocation of capital, more investment and higher economic growth in the country (levine, 2001). lahiri (2001) argues that capital mobility can be destabilizing in the sense that it increases the chance of multiple equilibria. bhagwati (1998); rodrik (1998) and stiglitz (2000) show that financial openness is not necessarily welfare augmenting in the presence of distortions such as trade barriers, weak institutions, macroeconomic imbalances or information asymmetries. thus, it appears that the impact of financial sector policies on private investment is theoretically ambiguous. baldwin (1989) explores the effect of trade policy on capital accumulation (human, knowledge, and physical). he suggests that medium-run growth or accumulation works through savings and investment. trade liberalization increases the efficiency of resource allocation; and the possibility of consumption and investment in the static model (francois et al., 1999). trade liberalization is vital for increased productivity, employment creation, and wages as they relate to the higher level of private investment (krueger, 1978). asian journal of economics and empirical research, 2018, 5(2): 112-120 116 in the developing countries, public investment can complement private investment by collaborating in the area of infrastructure (sundararajan and thakur, 1980). higher productivity of capital increases the overall resource availability by stimulating output. contrariwise, public investment can crowd out private investment if the public sector directly competes with the private sector in the production of goods (blejer and khan, 1984). in line with the above theoretical discussion, we propose the following general form of an empirical model of long-run private investment function: (3.7) the estimable function is as follows: (3.8) where refers to natural logarithm and represent the coefficient of respective variables to be estimated. the i, ppi, rir, pi, and li respectively, represent a real private investment, per capita real private income, real interest rate (user cost of capital), real private investment, and liberalization indicators (i.e. financial liberalization index, capital account liberalization index, financial openness and trade liberalization indicators). the refers to the error term. 4. estimation methodology and construction of variables this study employs the augmented dickey-fuller (adf) unit root test to determine the level of stationary because if the regressions run on non-stationary time series, they will produce the spurious result. the adf unit root test is constructed on the following regression. tpttttt zzzzz     .......... x 2211 ' t10 (4.1) where zt refers a time series, ∆ represents the first difference operator, ' tx consists of an optional exogenous variable, t shows a pure white noise error term,  and  show the estimated parameters. the unit root null hypothesis is that  = 0 and alongside the alternative hypothesis using the orthodox test. the null hypothesis of a unit root does not follow the conventional student‟s t-distribution (dickey and fuller, 1979). according to different test and sample sizes, they have developed asymptotic outcomes and simulate the critical level. further, mackinnon (1996) develops a larger set of simulations than those tabulated by dickey and fuller. this study employs the mackinnon (1996) critical value to determine the level of integration order by applying adf. 4.1. ardl co-integration approach many co-integration methods are available in the empirical literature. starting from the classical approach to residual based co-integration tests of engle and granger (1987) multivariate tests of johansen (1991; 1995); banerjee et al. (1998) ecm test, among others. in current empirical investigations, the autoregressive distributed lag (ardl) approaches to co-integration is widely used. because it is preferable to use when variables are integrated at the different order, i(0), i(1) or combination of the both (pesaran et al., 2001). the ardl approach to co-integration is based on assessing a simple unrestricted error-correction model (uecm) which can be expressed as follows: i is a dependent variable, and ppi, rir, pi & li13 are the independent variables. tttt tt k j jt k j jt jt k oj k j k j jtjtt lnlilnpirir lnppilnililnpiln rirppilnilniln 1151413 1211 0 5 0 4 1 3 0 210 )( )()( )()()(                    (4.2) in the equation, 4.2 summation signs indicate the error correction dynamic whereas the term with s  shows the long run association. the long-run relationship test by using the f-test. the narayan (2005) critical values are used to determine cointegration through f-test. the null hypothesis of no co-integration  0: 543210 h is tested against the alternate of co-integration  0: 543210 h . if the calculated f-statistic exceeds the upper bound critical value, we formerly conclude the co-integration among the variables and the null hypothesis is rejected. the t-statistic is tested through 01  in eq. 3.2. the following long-run model is estimated, after the existence of the co-integration relationship. t j jtj j jtj j jtj j jtj j jtjt lilnpiln rirppilnilniln                   0 5 0 4 0 3 0 2 1 10 )()( )( )()()( 13 the li indicate the trade and financial liberation indicators. asian journal of economics and empirical research, 2018, 5(2): 112-120 117 the schwarz bayesian criterion (sbc) is used to determine the long run relationship. in the following way, error correction model (ecm) is derived from the ardl. tt j jtj j jtj j jtj j jtj j jtjt ecm lilnpilnrir ppilnilniln                      1 0 5 0 4 0 3 0 2 1 10 )()()( )()()( (4.3) where 1tecm is the error correction term, estimated as                   0 5 0 4 0 3 0 2 1 10 )()()()( )()( j jtj j jtj j jtj j jtj j jtjtt lilnpilnrirppiln ilnilnecm in equation 4.3 the coefficients represent the short-run dynamics of the model and indicating the speed of adjustment from short-run disequilibrium to long-run equilibrium. 4.2. the data sources and the definition of variables this study uses annual time series from1971-2014. the data is taken from world development indicators (url: http://data.worldbank.org/), state bank of pakistan and pakistan economic survey. 4.3. investment the real private investment and real public investment are in millions of us$. the real gdp, in constant prices, is taken from wdi, while the other savings and investment variables are from state bank of pakistan. these variables are in nominal terms and are adjusted by the gdp deflator. 4.4. real interest rate the real interest rate (rir) is the user cost of capital and lending interest rate adjusted for inflation (as used by the gdp deflator). 4.5. financial indicators the capital account liberalization index is taken from the chinn and ito, available at url: http://web.pdx.edu/~ito/chinn-ito_website.htm. the de facto indicator of financial openness uses a total stock of assets and liabilities as constructed by lane and milesi-ferretti (2007). the financial liberalization index used is developed by hye and lau (2017). 4.6. trade indicators to identify the trade liberalization date (de jure), we apply the procedure by wacziarg and welch (2008) and the trade openness variable is constructed by taking the ratio of export plus import to gdp. 4.7. private income we add private consumption and private saving to find aggregate private income and then adjusted by the gdp deflator. to obtain the real per capita private income, it is divided by population. 5. estimation results table-5.1 shows the adf unit root test results. the results indicate that all variables are integrated order one expect the capital account liberalization. table-5.1. adf unit root test results level 1st difference rir -0.987 ln(fo) -1.697 -2.697 note: ln shows the sign of natural logarithm, i to real private investment ppi stands for per capita real private income, rir stands for real interest rate, pi stands for real public investment (pi), fli stands for financial liberalization index, tli stands for trade liberalization index, k_open stands for capital account liberalization index, fo stands for financial openness index, to stands for trade openness (to). a; indicate 1% level of significance. b indicates a 5% level of significance. c indicates a 10% level of significance. http://data.worldbank.org/ http://web.pdx.edu/~ito/chinn-ito_website.htm asian journal of economics and empirical research, 2018, 5(2): 112-120 118 table-5.2. critical values for ardl modeling approach k = 4 0.10 0.05 0.01 i(0) i(1) 3.298 4.378 3.980 5.104 5.224 6.696 fiii 2.638 3.772 3.178 4.450 4.394 5.914 tv -3.13 -4.04 -3.41 -4.36 -3.96 -4.96 tiii -2.57 -3.66 -2.86 -3.99 -3.43 -4.60 notes: k is the number of regressors, represents the f-statistic of the model with unrestricted intercept and trend, represents the f-statistic of the model with unrestricted intercept and no trend. and are the t ratios for testing in equation (4.2) is respectively with and without deterministic linear trend. source: narayan (2005) for f-statistics and pesaran et al. (2001) for t-statistic. table-5.3. ardl co-integration analysis of private investment model models without deterministic trends with deterministic trends conclusion fiii tiii fv tv h0 rejected rejected rejected rejected rejected note: h0 indicates no cointegration. the optimum lag is selected by using the schwarz bayesian criterion. lag is the number of lags, represents the fstatistic of the model with unrestricted intercept and no trend. represents the f-statistic of the model with unrestricted intercept and trend. the and are the t ratios are respectively with and without a deterministic linear trend. „c‟ indicates that the statistic lies below the 0.10 lower bound „b‟ that it falls within the 0.10 bounds and a‟ that it lies above the 0.10 upper bound. table-5.4. long run coefficients of the private investment model 1 2 3 4 5 constant 2.327a -0.002 de jure de facto note: ln shows the sign of natural logarithm, ppi stands for per capita real private income, rir stands for real interest rate, pi stands for real public investment (pi), fli stands for financial liberalization index, tli stands for trade liberalization index, k_open stands for capital account liberalization index, fo stands for financial openness index, to stands for trade openness (to). a indicates 1% level of significance. b indicates 5% level of significance. c indicates 10% level of significance. table-5.5. short run coefficients of private investment model (1) (2) (3) (4) (5) intercept 0.014 0.743 de jure -0.021 de facto 0.011 ecm(-1) 0.547 0.647 0.611 note: ln shows the sign of natural logarithm, ppi stands for per capita real private income, rir stands for real interest rate, pi stands for real public investment (pi), fli stands for financial liberalization index, tli stands for trade liberalization index, k open stands for capital account liberalization index, foi stands for financial openness index, to stands for trade openness (to). a indicates 1% level of significance. b indicates 5% level of significance. c indicates 10% level of significance. asian journal of economics and empirical research, 2018, 5(2): 112-120 119 table 5.2 reports the results of tand f-statistics for the bounds tests.14 in term of the results, the null hypothesis of no co-integration for the private investment equation is rejected at the 10% level for five models. the long-run coefficient of the private investment model reported in table 5.4 indicates that private investment is positively related with real per capita private income which is in line with the predictions of the neoclassical model. a 1% increase in per capita real private income is expected to stimulate private investment by 1.088 to 2.327 percent. the finding that income/output is an important determinant of private investment is consistent with sakr (1993); shrestha and chowdhury (2007) and ang (2009). the elasticity of real interest rate with respect to private investment is -0.010 to 0.019 statistically significant suggesting little if any, evidence to support real interest rate (user cost of capital) as a useful determinant of private investment in pakistan. the public investment is positively related with the private investment which indicates a rise in government investment is associated with an increase in private sector investment. thus, the current effort made by the pakistan government to spend on infrastructure development may stimulate, rather than crowd out private capital formation. the coefficient of financial liberalization index is positively related with private investment, indicating that internal financial reforms (e.g., banking and stock market) stimulate private investment in pakistan. a 1% increase in lnfli increases private investment by 0.0855%. the expansion of banking service such as new banks and more branches which improve access to banking services and lowers the banking transaction cost. this happens due to increased competition and willingness of individuals to save, and thus make more fund available for investment. as for external financial liberalization, the estimates of the effect of capital account liberalization and financial openness on private investment in pakistan the coefficients are statistically insignificant. it is plausible that external financial liberalization is less effective in boosting private investment because of the less capital inflow. we find that trade liberalization is statistically insignificant. the trade openness is negatively related to private investment. a 1% increase in trade openness reduces private investment by 3.162%. in terms of the theory of trade liberalization, the effect on private investment through higher efficiency in resource allocation may not be achieved due to poor management. pakistan still is an exporter of raw material due to low investment and income in the export sector. the short run coefficients presented in table 5.5 show that the coefficient of real per capital private income is positive and the real interest rate is negatively associated with private investment. in addition, public investment is positively related with the private investment. financial liberalization index is found to play a positive role in stimulating private investment in the shortas well as the long run. based on the results, it appears that internal financial liberalization can help to promote private investment in pakistan. trade liberalization and trade openness are statistically insignificant in the short run. interestingly, the capital account liberalization and financial openness are positively related to the private investment of pakistan. the better-managed capital account attracts foreign direct investment due to the positive impact of external financial liberalization. the error correction term is negative and significant. it shows the speed of adjustment from short-run disequilibrium to long-run equilibrium. the results indicate that adjustment takes place at a speed of 33.9 to 91.5 percent per year. 6. conclusion this study empirically examines the impact of financial and trade liberalization on private investment in pakistan by employing the data from 1971to 2014. the ardl results indicate that the cointegration exists among variables and suggest that per capita real private income, public investment, and financial liberalization are positively related to private investment in the long run. these findings are as per our expectation as a percentage of increase in per capita private income is likely to be invested. moreover, public investment in power, water, roads, etc. through making the infrastructure available give impetus to private investments. similarly, financial liberalization i.e. liberalization of the banking sector and stock market increase investments by making investment opportunities available to investors. the real interest rate and trade openness are negatively related to private investment in the long run. the positive impact of trade liberalization on 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issn(p) 2518-010x doi: 10.20448/journal.501.2020.71.91.104 © 2020 by the authors; licensee asian online journal publishing group globalization and income inequality in mexico, indonesia, nigeria, and turkey: a dynamic gmm approach tolulope temilola osinubi1 philip akanni olomola2 ( corresponding author) 1,2department of economics, obafemi awolowo university, ile-ife, nigeria. abstract this study examines the effect of globalisation on income inequality in mexico, indonesia, nigeria, and turkey between 1980 and 2018, using economic, social, political, and overall globalisation as proposed by dreher., gaston, and martens (2008). the study employs a dynamic generalised method of moments. results show that economic globalisation significantly increases income inequality in mexico and turkey, but insignificantly reduces inequality in indonesia and nigeria. for social globalisation, inequality responds positively to it in all the mint countries, except in turkey. political globalisation adds to income inequality in mexico, but reduces inequality in nigeria and turkey. in indonesia, political globalisation exerts insignificant positive effect on inequality. overall globalisation increases income inequality in all the mint countries, except in indonesia. the study, therefore, concludes that the various dimensions of globalisation and overall globalisation are key drivers of income inequality in each of the mint countries, except in some few cases. keywords: economic globalization, social globalization, political globalization, overall globalisation, income inequality, kuznets’ hypothesis, dynamic gmm. jel classification: d31, f15, f41, 010, 057 citation | tolulope temilola osinubi; philip akanni olomola (2020). globalization and income inequality in mexico, indonesia, nigeria, and turkey: a dynamic gmm approach. asian journal of economics and empirical research, 7(1): 91-104. history: received: 14 january 2020 revised: 17 february 2020 accepted: 28 march 2020 published: 11 may 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 92 2. a brief review of the existing studies ....................................................................................................................................... 93 3. data description and methodology............................................................................................................................................. 94 4. results and discussion of findings.............................................................................................................................................. 96 5. concluding remarks ..................................................................................................................................................................... 102 references ............................................................................................................................................................................................ 102 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.71.91.104&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1616 https://orcid.org/0000-0002-5276-0365 https://orcid.org/0000-0003-0830-6832 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1616 https://orcid.org/0000-0002-5276-0365 https://orcid.org/0000-0003-0830-6832 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1616 https://orcid.org/0000-0002-5276-0365 https://orcid.org/0000-0003-0830-6832 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1616 https://orcid.org/0000-0002-5276-0365 https://orcid.org/0000-0003-0830-6832 asian journal of economics and empirical research, 2020, 7(1): 91-104 92 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature the study contributes to the existing knowledge by examining the effect of globalisation, using different dimensions of globalisationeconomic, social, and political globalisation, on income inequality in mexico, indonesia, nigeria, and turkey. 1. introduction globalisation came into existence to promote wealth among all countries of the world with the united states being the leader after world war ii. then, the united states introduced the north american free trade agreement (nafta) in 1993 to remove trade barriers and promote globalisation. consequently, most countries started following suit in the 20th century by investing in new forms of transportation (road, sea, rail, and air) and communication services (the use of internet and cell phones). this has helped in connecting billions of people around the globe. the process of globalisation, therefore, makes the whole world behaves as if it were a single market, with interdependent production, consuming similar goods, and responding to the same impulses. this means that the whole world is a global village and globalisation is meant to promote increased global output (williamson, 2015). globalisation is an interaction of national economies, through trade and financial integration. however, globalisation has its own positive and negative sides. the positive sides are an increase in global output, exposure to new ideas and products, global awareness, economies of scale in production, increased specialization, competition and efficiency, improved social developments, and human welfare (hassan, 2013). the negative sides include unemployment (orga, 2012) economic insecurity and income inequality (blinder, 2006; krugman, 2008; stiglitz, 2002; summers, 2006). income inequality is seen as one of the responses to globalisation. this is affirmed by williamson (2015) who argued that globalisation can influence income level and its distribution. income distribution describes the degree or the extent to which the total gross domestic product of a country is distributed among its population or the smoothness with which income is distributed among members of society. it is perfectly equal if members of the population earn the same amount of money and perfectly unequal if only one person earns all the money in the society. and, income is said to be more evenly distributed in the developed countries than in the developing countries. thus, income inequality is the extent to which incomes are unevenly distributed among the population of a given country (rye, 2016). according to kuznets (1955) income inequality is high in the developing countries due to their lower level of average per capita income and it is expected to be reversed once they become more economically developed and richer. as expected, as an economy integrates with other economies, income inequality may reduce, that is, a negative association between globalisation and inequality. evidence from the literature showed that globalisation alone cannot lower inequality but globalisation with the help of consistent and stable long-term economic policies (expansionary monetary and fiscal policies) to improve the level of growth, literacy level, government spending, reduce inflation and unemployment would go a long way in reducing inequality (lee, 2014; mihaylova, 2015). this implies that the effect of globalisation on income inequality is both direct and conditional. the mint countries, that is, mexico, indonesia, nigeria, and turkey, in recent times, have been observed to experience high level of income inequality even in the face of improved level of globalisation. these countries are popularized by jim o’neil of goldman sachs as emerging economies and are said to have their prospects and challenges (see olomola and osinubi (2018)). kof (2018) reports that the overall globalisation indices are 73, 63, 56, and 72 per cents, while the swiid (2018) shows that the levels of income inequality are 45.8, 43, 40.1 and 39.8 per cents for mexico, indonesia, nigeria, and turkey, respectively. and, a country has high-income inequality if the gini coefficient lies between 0.36 and 1.0. by implication, mexico has the highest level of income inequality in all the mint countries, while income inequality reduced from about 40 per cent in 2014 to about 39 per cent (swiid, 2018) in turkey but this does not take turkey off of the list of the world's worst inequality countries. income inequality, as one of the responses to globalisation, has gained so much prominence in the literature, and globalisation is said to affect income distribution and its level. previous studies (atif, srivastav, sauytbekova, & arachchige, 2012; baek & shi, 2016; kratou & goaied, 2016) argue that globalisation can either reduce (in developed countries) or spur (in developing countries) income inequality. the question that comes to mind is that why do mint countries still face the problem of income distribution despite their increased levels of globalisation and this calls for investigating the impact of globalisation on income inequality in each of the mint countries. this present study adds to the existing knowledge in the area of study because it uses different dimensions of globalisation (that is, economic, social, and political globalisation) and overall globalisation. most studies (baek & shi, 2016; bukhari & munir, 2016; jaumotte, lall, & papageorgiou, 2013; mihaylova, 2015) in the literature capture globalisation narrowly. meanwhile, the concept of globalisation is wide as it includes economic, social, cultural, religious, and political dimensions. it has been argued that each of these components of globalisation affects economic agents differently. then, using a generic measure of globalisation could mar the full impact of globalisation on the economy as well as on income inequality. for instance, these studies mentioned above used only one or two variables, that is, trade openness, foreign direct investment, financial integration, and technological globalisation as measures of globalisation and these are classified as economic globalisation according to dreher (2006). in the real sense, the process of globalisation covers social and political dimensions asides the economic component of globalisation used by previous studies. explicitly for social globalisation, the idea is that improvement in information and communication technologies through telephone traffic, transfers as a percentage of gdp, international tourism, internet users, trade-in newspapers and books will create job opportunities which will help in reducing income inequality. while, political globalisation, as a result of the number of embassies in the country, international treaties, and membership in international organizations which in turn help to provide job opportunities in the economy, will help in inequality reduction. this paper is structured as follows: next to this introductory aspect is the brief review of the existing studies as shown in section 2. section 3 handles the data description and methodology employed. section 4 asian journal of economics and empirical research, 2020, 7(1): 91-104 93 © 2020 by the authors; licensee asian online journal publishing group provides the empirical results with the discussion of findings. the paper ends with concluding remarks in section 5. 2. a brief review of the existing studies in recent times, rising inequality has been a major concern of development and there are many studies on globalisation-inequality nexus. looking at the relationship between globalisation and income equality since the former is known to be one of the causes of the latter. there have been so many debates as to which direction does globalisation affect income inequality. mills (2009) opines that globalisation is related to inequality with contrary views. some authors (alderson & nielsen, 2002; bergh & nilsson, 2010; wade, 2004) argue that globalisation, especially through trade openness or foreign direct investment or financial liberalisation, contributes to unequal income distribution within and between countries, as mostly seen in the developed countries. contrarily, some authors argue that globalisation helps to reduce inequality across and within economies, especially in developing countries (marjit, beladi, & chakrabarti, 2004). this implies that there are conflicting arguments based on the globalisation-inequality nexus, hence, evidence that globalisation has many roles to play in influencing inequality in an economy. there are exhaustive studies on the relationship between globalisation and income inequality in the literature. base on this, different measures of globalisation are used by these authors. among the measures used are trade openness, foreign direct investment (fdi), financial liberalisation, and technological globalisation. only a few studies (see dreher and gaston (2008)) employ all the three dimensions of globalisation-economic, social, and political globalisation. this review is coming from the three strands of findings in the literature since the nexus between globalisation and income inequality is contradictory. the first strand of the literature comes from the argument that the more an economy is integrated with other countries, the lower the level of income inequality. in other words, the authors establish that there is a negative relationship between globalisation and income inequality. this argument is in line with the findings of baiardi and morana (2018) in the euro area; baek and shi (2016) using trade intensity in 52 developing countries and financial integration in 26 developed countries; bukhari and munir (2016) with trade and technological globalisation in some selected asian countries; kratou and goaied (2016) in 66 developing countries; lim and mcnelis (2016) across 214 countries; trinh (2016) across vietnam’s provinces; mihaylova (2015) with fdi, level of education and economic growth, for 10 post-socialist countries from central and eastern europe; msweli (2015) in south africa; mugeni (2015) using a panel dataset of 153 developing and developed countries; asteriou, dimelis, and moudatsou (2014) in eu-27 countries using financial globalisation; farhan, azman-saini, and law (2014) in asean-5; herzer, hühne, and nunnenkamp (2014) in uruguay; salimi, akhoondzadeh, and arsalanbod (2014) in 30 developed and developing countries; deng and lin (2013) among 102 countries with insufficient human capital; jaumotte et al. (2013) with trade openness in 51 countries; wu and hsu (2012) in countries with improved absorptive capacity; david (2011) using trade openness for 27 brazillian states; faustino and vali (2011) using trade openness in oecd countries; figini and gorg (2011) in developed countries; herzer and nunnenkamp (2011) in the european countries; zhou, biswas, bowles, and saunders (2011) in 60 developed, transitional and developing countries; celik and basdas (2010) for both developed and developing countries; chintrakarn, herzer, and nunnenkamp (2010) in the united states; mills (2009) in developing countries; dreher and gaston (2008) in 123 countries; bhandari (2007) with wage income and capital income inequality in transitional countries in eastern europe and central asia; blinder (2006) in the united states; reuveny and li (2003) in 69 countries; beer and boswell (2002) using a cross-sectional analysis; alderson and nielsen (1999) in 88 countries; and spilimbergo, londoño, and székely (1999) in capital-rich countries. contrarily, the second strand of the literature shows that the process of globalisation causes income inequality to increase, thus, a positive association between the two variables. the following studies are in tandem with this submission, de haan and sturm (2017) for 121 countries; dorn, fuest, and potrafke (2017) using kof globalisation index across 140 developing and developed countries; nguyen (2017) in the united states; baek and shi (2016) using trade intensity in 26 developed countries and financial integration in 52 developing countries; bukhari and munir (2016) with financial globalisation in some selected asian countries; cabral, garcía-díaz, and mollick (2016) for 15 economies (mahesh, 2016) in brazil, russia, india, and china; liu, liu, and zhang (2016) for a panel of 23 chinese provinces; suanes (2016) in latin america; amjad (2015); asteriou et al. (2014); kutor (2014) in ghana; herzer et al. (2014) in bolivia, chile, and columbia; zulfiu-alili (2014) in macedonia; deng and lin (2013) among 102 countries with sufficient human capital; herzer. and nunnenkamp (2013); jaumotte et al. (2013) with financial globalisation in 51 countries in eu-27 countries using trade opennes; atif et al. (2012) in 68 developing countries; herzer and nunnenkamp (2012) for 21 countries; wu and hsu (2012) in countries with low absorptive capacity; david (2011) using fdi for 27 brazillian states figini and gorg (2011) in developing countries; halmos (2011) for eastern european countries; bergh and nilsson (2010) for 80 countries; celik and basdas (2010) for east asian countries; basu and guariglia (2007) on 119 developing countries; nunnenkamp, schweickert, and wiebelt (2007) in bolivia; mills (2009) in developed countries; kahai and simmons (2005) in developing countries; zhang and zhang (2003) in china; choi (2006) in asia, latin america and caribbean countries; mah (2002) in south korea; and spilimbergo et al. (1999) in labour-rich countries. the last strand of the literature reveals that globalisation has no significant effect on income inequality as shown in the studies of okatan (2011) among 92 selected developing countries; kahai and simmons (2005) in developed countries; sylwester (2005) in 29 developing countries; faustino and vali (2011) using fdi in oecd countries; bhandari (2007) in transitional countries in eastern europe and central asia; mah (2003) with fdi, in south korea; and milanovic (2005) with fdi in 88 countries. additionally, there are few studies on each of the mint countries. for instance, in mexico, herzer et al. (2014) show that globalisation (fdi) increases income inequality. the direct nexus supports the feenstra and hanson (1997) hypothesis which states that the process of globalisation worsens inequality. on the other hand, harrison and hanson (1999) using trade openness as a measure of globalisation show that states with a high level of globalisation experience a higher increase in incomes which translates to reduced inequality. borraz and lopezcordova (2007) find the same result that states that are closely related to other countries would experience more asian journal of economics and empirical research, 2020, 7(1): 91-104 94 © 2020 by the authors; licensee asian online journal publishing group equal distribution of incomes and lower inequality due to increasing wages for women compared to those that are not integrated with other countries. to corroborate this finding, jensen and rosas (2007) affirm that fdi reduces income inequality. in indonesia, agusalim and pohan (2018) confirm that globalisation (trade openness) helps in reducing inequality in the short run but otherwise in the long run, while lipsey and sjoholm (2001) argue that globalisation (fdi inflows) causes income inequality to rise. in nigeria, babatunde (2018) studies the effect of inward fdi on income inequality the shortand long-run symmetric results reveal that the lagged values of fdi tend to reduce the unequal distribution of income. looking at the short-run asymmetric result, the positive and negative fdi shocks reduce and increase income inequality, respectively. the long-run asymmetric results are found to be inconclusive. while, ogunyomi, daisi, and oluwashikemi (2013) study the effect of economic globalisation on income inequality and economic growth and the results show that economic globalisation increased inequality and reduces economic growth. the three tiers of government, provision of infrastructural facilities, and promotion of entrepreneurial capabilities in the non-oil sector to reduce inequality between the skilled and unskilled workers. lastly, in turkey, ucal, haug, and bilgin (2015) argue that globalisation (fdi) significantly reduces income inequality in both the short-and long-run. this is against the study of ucal, bilgin, and haug (2014) in turkey where fdi adds to income inequality. meanwhile, few of these studies test for the validity of kuznets’ hypothesis. among the studies that support this hypothesis are lee (2014) and bukhari and munir (2016) while mah (2003) and dreher and gaston (2008) reject the hypothesis. conclusively, evidence from the previous studies reveals than globalisation could either reduce or increase income inequality. also, the effect of globalisation on income inequality could be insignificant. however, none of the studies tests for the validity of kuznets’ hypothesis and examines the effect of overall globalisation and its dimensions on income inequality by studying the mint countries together. this current study intends to fill the gaps. 3. data description and methodology 3.1. data description data on economic growth, as measured by gdp per capita in constant us$ (gdppc), human capital, as proxied by secondary school enrolment rate (humc), population growth (pop), and inflation rate (inf) are gotten from wdi (2018) data on corruption, as captured by control of corruption, is sourced from international country risk guide (icrg, 2018); gini coefficient, as a measure of income inequality (yinq), is obtained from swiid (2018) and data on economic (egb), social (sgb), political (pgb) and overall globalisation (gbi) are gathered from konjunkturforschungsstelle globalisation index (kof, 2018). all the variables under consideration are time series which range between 1980 and 2018. notably, the study interpolates missing data points using a 4year moving average and the variables are in their natural logarithmic form to reduce non-normality. 3.2. methodology 3.2.1. theoretical framework the theoretical framework for this study stems from the traditional neoclassical trade theory. the simplest form of the neoclassical trade theory is the ricardo (1817) theory of comparative advantage. and, as time went by, the heckscher (1919); ohlin (1933) theory of comparative advantage was produced as an alternative to the ricardian model. according to the theory, reductions in trade barriers and trade costs would encourage convergence of factor prices and income levels. this is because the removal or reductions in trade restrictions would bring about specialization and factor accumulation that would be beneficial to all, irrespective of the initial economic condition of the country involved. another point of argument of the neoclassical theory is the claim that globalisation attracts domestic and foreign investment that increases the rate of capital accumulation and employment opportunities, thus reduces the level of income inequality. also, todaro and smith (2015) established that the process of globalisation improves greater access to foreign production ideas that will lead to technological progress. interestingly, even the modern trade theory, that is, hecksher-ohlin trade theory, is based on the neoclassical trade theory. the hecksher-ohlin trade theory assumes perfect competition and asserts that trade enhances people’s well-being as a result of distributing factors of production across all sectors of the economy. 3.2.2. model specification following the theoretical framework, the following model by jaumotte et al. (2013); lee (2014); mihaylova (2015) and baek and shi (2016) is adapted. the model states that income inequality is a function of globalisation and the model is shown in equation 1. ( , )t t tyinq f gb x (1) where tyinq : income inequality measure, that is, gini index. tgb : measure of globalization. tx : control variables however, to account for the various dimensions of globalisation, that is, economic, social and political globalisation, equation 1 is modified to include the various dimensions. this is because the process of globalisation is more than economic phenomena as captured in some studies but it includes the intensification of economic, political and social relations across international boundaries (fafowora, 1998). therefore, equation 1 can be re-written as: ( , , , )t t t t tyinq f egb sgb pgb x (2) where tegb : economic globalisation at time t. tsgb : social globalisation at time t. tpgb : political globalisation at time t. asian journal of economics and empirical research, 2020, 7(1): 91-104 95 © 2020 by the authors; licensee asian online journal publishing group from equation 2, income inequality is the endogenous variable, while globalisation and other control variables are the exogenous variables. the control variables used in this study include economic growth, human capital, population growth, inflation, and control of corruption. the choice of these variables is based on their significance in affecting the level of income inequality in each of the mint economies and also, on the fact that they have been found useful by other studies as discussed below. for economic growth, it is expected that improved economic growth should help in reducing income inequality. this calls for the inclusion of economic growth (that is, gdp per capita) into the model (baek & shi, 2016; im & mclaren, 2015; jaumotte et al., 2013; lee, 2014; mihaylova, 2015; rye, 2016). human capital is added because education is a key factor in human development as it provides widespread employment and income-earning opportunities for all (baek & shi, 2016; bukhari & munir, 2016; lee, 2014; mihaylova, 2015). also, population growth is included in the model following some studies like im and mclaren (2015); bukhari and munir (2016) and rye (2016) because a high population is detrimental to share of national resources and all the mint countries have a large population. the idea is that population growth adds to income inequality and slows down the prospects for a better life for those already born. to capture the macroeconomic stability of the economy, inflation is added to the model. inflation is therefore important in determining the relationship between globalisation and income inequality because a high inflation rate can reduce the purchasing power of the country's currency leading to high level of income inequality (see mihaylova (2015)). lastly, in examining the institutional impact on globalisation-inequality nexus, control of corruption is added to the model. also, corruption is included because all the mint countries scored badly in transparency international’s corruption perception index (2014) turkey ranked 64 out of 175, while the rest were closer to the other end of the scale (matsangou, 2015). corruption will eventually lead to an increase in the rate of unemployment and income inequality (see kahai and simmons (2005)). hence, to include all the control variables and to take care of the country-specific analysis, equation 2 is respecified as follows: ( , , , , , , , )it it it it it it it it ityinq f egb sgb pgb gdppc humc pop inf cor (3) ( , , , , , )it it it it it it ityinq f gbi gdppc humc pop inf cor (4) explicitly, equations 3 and 4 are stated below to include the stochastic form: it i i it i it i it i it i it i it i it i it ityinq egb sgb pgb gdppc humc pop inf cor                   (5) it i i t i t i t i t i t i t tyinq gbi gdppc humc pop inf cor               (6) note that, subscripts i and t capture the countries involved in this study (i.e. mexico, indonesia, nigeria, and turkey) and the period for the study (i.e.1980-2018), respectively. also, equation 5 is used to examine the relative effects of the dimensions of globalisation on income equality, while equation 6 determines the effect of overall globalisation on income inequality. where itgbi : overall globalisation index in each of the mint countries at time t. ityinq : gini coefficient in each of the mint countries at time t. itgdppc : gdp per capita in each of the mint countries at time t. ithumc : human capital in each of the mint countries at time t. itpop : population growth in each of the mint countries at time t. itinf : inflation rate in each of the mint countries at time t. itcor : control of corruption in each of the mint countries at time t. it : error term in each of the mint countries at time t. 3.2.3. estimation technique a dynamic generalised method of moments is employed to achieve the study objectives. this technique of estimation is preferred because of its strengths over other methods like descriptive statistics and ols. the gmm technique possesses four major strengths according to bond, hoeffler, and temple (2001) and wooldridge (2001) which are; it gives unbiased estimates when some variables are omitted, it generates consistent estimates with measurement error, it helps in solving the problem of endogeneity and non-normality in the data. a key econometric issue to be addressed is the potential issue of endogeneity that might arise among the variables of interest. the idea is that the exogenous variables can be endogenously determined, meaning that income inequality can influence globalisation. for instance, income inequality affects globalisation through credit market imperfections, indivisibilities in investment and lower gdp per capita that brings about political and social instability, lower investment, unproductive rent-seeking activities which will all affect the integration of an economy with others. this shows that globalisation cannot be strictly treated as an explanatory variable. to determine how income inequality responds to globalisation, equations 5 and 6 are modified using a dynamic gmm approach. the models are also used to test for the validity or otherwise of the kuznets’ inverted-u hypothesis in all the mint countries. to achieve this, the square of the level of growth (gdp per capita) is added to the models. according to lee (2014) and mihaylova (2015), globalisation is said to exert both direct and conditional effects on inequality and the conditional variables used following lee (2014) and mihaylova (2015) are levels of education and growth. to test for the conditional effect of globalisation, the interactive terms of overall globalisation index and level of education (humc) and level of growth (gdp) are used in the regression models. therefore, these are used to capture the interactive (joint or conditional) effects of globalisation and each of economic growth and education on income inequality as shown in equations 7 and 8. asian journal of economics and empirical research, 2020, 7(1): 91-104 96 © 2020 by the authors; licensee asian online journal publishing group 2 1 1 2it i i it i it i it i it i it i it i it i it i it i it it yinq yinq egb sgb pgb gdppc gdppc humc pop inf cor                         (7) 2 1 1 2 ( * ) ( * ) it i i it i it i it i it i it i it i it i it i it i it it yinq yinq gbi gdppc gdppc humc pop inf cor gbi gdppc gbi humc                         (8) 1ityinq  = previous value of income inequality in each of the mint countries at time t. for strong evidence of kuznets' inverted-u hypothesis, 1i and 2i must be significantly positive and negative, respectively, which implies that income inequality rises as an economy develops to some threshold level and thereafter, inequality starts to fall. 4. results and discussion of findings 4.1. descriptive statistics tables 1a-b display the descriptive statistics of the variables involved. the results show that all the variables in each of the mint countries are consistent because their mean values fall between the minimum and maximum values. specifically, the average values of yinq are 0.46, 0.38, 0.39, and 0.43 in mexico, indonesia, nigeria, and turkey, respectively, while the average values of gbi are 58.09, 53.92, 49.10, and 60.59, respectively. other values are reported in tables 1a-b. also, the standard deviation values reveal that the variables do not deviate from their mean values. table-1a. descriptive statistics of the variables for mexico and indonesia. country variable mean median max. value min. value std. dev. obs. mexico yinq 0.46 0.46 0.48 0.45 0.01 39 egb 47.15 48.34 60.86 31.89 9.17 39 sgb 54.72 53.83 67.75 40.38 10.18 39 pgb 72.41 73.25 94.81 58.09 9.10 39 gbi 58.09 58.08 74.33 44.79 9.16 39 gdppc 0.91 1.58 6.63 -7.98 3.28 39 humc 69.78 67.84 103.34 44.87 16.86 39 pop 1.69 1.61 2.41 1.22 0.34 39 inf 25.20 9.49 131.82 2.72 33.19 39 cor 2.54 2.50 3.42 1.81 0.50 39 indonesia yinq 0.38 0.37 0.43 0.36 0.03 39 egb 50.58 50.68 69.69 37.30 8.61 39 sgb 36.05 37.52 54.36 17.14 12.92 39 pgb 75.14 77.32 87.56 59.40 9.98 39 gbi 53.92 58.14 64.23 38.11 9.56 39 gdppc 3.50 3.92 7.32 -14.35 3.36 39 humc 57.39 54.43 90.60 26.45 18.06 39 pop 1.58 1.40 2.36 1.06 0.37 39 inf 9.50 7.82 58.45 2.88 8.87 39 cor 1.88 2.00 3.58 0.00 1.13 39 table-1b. descriptive statistics of variables for nigeria and turkey. country variable mean median max. value min. value std. dev. obs. nigeria yinq 0.39 0.39 0.41 0.36 0.01 39 egb 46.55 46.52 60.12 35.45 6.19 39 sgb 24.04 19.30 39.85 12.45 9.97 39 pgb 76.71 78.59 86.98 60.34 8.93 39 gbi 49.10 50.87 57.55 40.00 5.94 39 gdppc 0.68 1.20 30.36 -15.45 7.19 39 humc 33.37 28.28 72.28 13.67 15.17 39 pop 2.59 2.59 2.86 2.49 0.08 39 inf 19.25 12.88 72.84 5.38 17.05 39 cor 1.62 1.50 2.00 1.00 0.35 39 turkey yinq 0.43 0.43 0.46 0.39 0.02 39 egb 48.48 50.72 56.47 32.79 6.73 39 sgb 50.67 51.35 66.79 34.51 11.32 39 pgb 82.63 86.79 92.82 63.54 10.34 39 gbi 60.59 63.13 71.67 44.41 9.13 39 gdppc 2.90 3.77 9.47 -7.36 4.23 39 humc 71.40 71.69 119.65 37.56 23.89 39 pop 1.66 1.59 2.28 1.20 0.30 39 inf 40.22 37.61 105.22 6.25 30.74 39 cor 2.68 2.50 4.00 2.00 0.54 39 asian journal of economics and empirical research, 2020, 7(1): 91-104 97 © 2020 by the authors; licensee asian online journal publishing group table-2a. unit root tests (with intercept and trend) for mexico, indonesia, nigeria, and turkey. country variable adf test (with intercept and trend) pp test (with intercept and trend) kpss (with intercept and trend) level first difference order level first difference order level first difference order mexico egb -4.25** i(0) -2.59 -7.53** i(1) 0.08** i(0) humc -5.24** i(0) -1.96 -3.22* i(1) 0.10** i(0) cor -4.98** i(0) -4.95** i(0) gbi*humc -3.62** i(0) -1.71 -4.12** i(1) 0.09** i(0) nigeria gbi -1.94 -4.80** i(1) -2.13 -6.03** i(1) indonesia sgb 0.51 -3.56** i(1) -0.43 -6.87** i(1) pop -4.21** i(0) -1.52 -3.56** i(1) 0.16 0.14** i(1) inf -4.84** i(0) -4.77** i(0) turkey egb -2.37 -7.48** i(1) -2.26 -8.81** i(1) gbi -0.78 -6.58** i(1) -0.69 -6.91** i(1) pop -0.08 -6.03** i(1) -1.10 -6.03** i(1) critical values level first difference critical values level first difference critical values level first difference 5% -3.54 -3.56 5% -3.53 -3.54 5% 0.15 0.15 10% -3.20 -3.22 10% -3.20 --3.20 10% 0.12 0.12 note: ** and * represent 5 per cent and 10 per cent levels of significance, respectively. asian journal of economics and empirical research, 2020, 7(1): 91-104 98 © 2020 by the authors; licensee asian online journal publishing group table-2b. unit root tests (with intercept only) for mexico, indonesia, nigeria, and turkey. note: ** and * represent 5 per cent and 10 per cent levels of significance, respectively. table-2c. unit root tests (without intercept and trend) for mexico, indonesia, nigeria, and turkey. country variable adf test (without intercept and trend) pp test (without intercept and trend) level first difference order level first difference order yinq 0.23 -1.97** i(1) 0.68 -2.83** i(1) pgb 1.70 -5.00** i(1) 2.24 -4.97** i(1) mexico gbi 3.32 -5.06** i(1) -5.66 -5.06** i(1) gdppc 1.36 -6.24** i(1) 1.70 -6.25** i(1) pop -3.03** i(0) -2.15** i(0) gbi*gdppc -3.95 -2.48** i(1) 4.04 -4.55** i(1) yinq -1.14 -6.73** i(1) -1.46 -1.62** i(1) indonesia egb 0.52 -4.97** i(1) -1.79 -4.95** i(1) gdppc 5.80 -3.11** i(1) -5.80 -3.01** i(1) cor -1.31 -6.32** i(1) -1.52 -6.37** i(1) yinq -0.92 -1.83* i(1) -0.92 -2.07** i(1) egb -0.32 -6.22** i(1) -0.38 -6.45** i(1) sgb 0.86 -3.61** i(1) 1.11 -3.58** i(1) nigeria pgb 1.23 -7.25** i(1) 1.29 -7.14** i(1) gdppc 4.49 -4.47** i(1) 5.70 -4.65** i(1) humc 2.93 -3.85** i(1) 2.07 -3.77** i(1) cor -1.08 -3.98** i(1) -1.04 -3.91** i(1) gbi*humc 3.16 -4.35** i(1) 2.50 -4.33** i(1) yinq 0.66 -1.83* i(1) 0.31 -1.69* i(1) turkey gdppc 4.49 -4.47** i(1) 5.70 -4.65** i(1) inf -1.39 -6.04** i(1) -1.34 -6.05** i(1) critical values level first difference critical values level first difference critical values 5% -1.95 -1.95 5% -1.95 -1.95 5% 10% -1.61 -1.61 10% -1.61 -1.61 10% note: ** and * represent 5 per cent and 10 per cent levels of significance, respectively. 4.2. unit root test we next determine the stationarity of the variables of interest. time series are assumed not to be stationary and to avoid wrong conclusions, it is important to carry out a unit root test. to do this, the study uses augmented dickey-fuller (adf), phillips-perron (pp) and kwiatkowski-phillips-schmidt-shin (kpss) tests. the null hypothesis of non-stationary will be rejected if the test statistic from the adf and pp tests is greater than the critical value (in absolute term) at either 5 per cent or 10 per cent level of significance, while the null hypothesis of stationarity will be accepted if the test statistic from the kpss test is less than the critical value. the kpss test is involved to confirm the results of the adf and pp tests. importantly, the kpss test is only used for those variables, specifically for mexico's egb, humc, and gbi*humc, and indonesia's pop, where both adf and pp tests showed different orders of stationarity. therefore, the order of stationarity for such variables is based on the kpss test. however, the included variables use different equations for them to be stationary in all the mint countries. consequently, both adf and pp tests are carried out with intercept and trend, with intercept only and without intercept and trend while the kpss test is carried out with only intercept and trend as shown in tables 2a-c. as observed in tables 2a-c, all the variables are stationary at the first difference, that is, they are i(1) in all the mint countries, except mexico’s egb, humc, and gbi*humc; nigeria’s pop and inf; and turkey’s cor. country variable adf test (with intercept only) pp test (with intercept only) level first difference order level first difference order mexico sgb -0.31 -5.59** i(1) -0.38 -5.59** i(1) inf -1.26 -5.86** i(1) -1.16 -6.60** i(1) indonesia pgb -1.10 -2.95** i(1) -1.10 -7.36** i(1) gbi -1.85 -4.92** i(1) -1.85 -4.92** i(1) humc -2.12 -4.09** i(1) -1.88 -4.06** i(1) gbi*gdppc -1.37 -4.41** i(1) -1.27 -4.43 i(1) gbi*humc -2.51 -4.52** i(1) -2.51 -4.52** i(1) nigeria pop -5.34** i(0) -3.58** i(0) inf -3.44** i(0) -3.32** i(0) gbi*gdppc -0.42 -5.18** i(1) -0.33 -6.30** i(1) turkey sgb -0.87 -4.90** i(1) -0.86 -4.85** i(1) pgb -0.87 -4.65** i(1) -0.86 -4.85** i(1) humc -0.36 -6.21** i(1) -0.35 -6.21** i(1) cor -3.75** i(0) -2.96** i(0) gbi*gdppc -1.04 -5.94** i(1) -1.07 -5.94** i(1) gbi*humc -0.71 -6.30** i(1) -0.72 -6.30** i(1) critical values level first difference critical values level first difference critical values 5% -2.94 -2.94 5% -2.94 -2.94 5% 10% -2.61 -2.61 10% -2.61 -2.61 10% asian journal of economics and empirical research, 2020, 7(1): 91-104 99 © 2020 by the authors; licensee asian online journal publishing group 4.3. kuznets’ hypothesis and the relative effects of the components of globalisation on income inequality to start with, the results of the gmm estimates in tables 3 and 4 show that the estimated parameters are reliable and robust based on the diagnostic statistics. the probability values (p-value) of j-statistic being insignificant, in both tables, indicate the validity of the instrumental variables used. also, the instrumental ranks are higher than the number of the estimated parameters and the insignificant p-values of ar(2) show that there is no serial correlation in the differentiated residuals. table 3 shows that the previous value of income inequality increases its current value in each of the mint countries. this reflects the consequence of the past level of income inequality by increasing the present status of inequality in each of the mint countries. it also shows that the gini coefficient is a stable index for computing inequality over time. when examining the relative effects of the components of globalisation on income inequality, there is strong evidence of kuznets' hypothesis of an inverted ushaped association between economic growth and inequality in each of the mint countries as observed in table 3. the findings support the empirical evidence from the works of lee (2014); mihaylova (2015) and bukhari and munir (2016). the implication is that income inequality in mexico, indonesia, nigeria, and turkey will first increase as their economies reach a certain level, and thereafter inequality will start to decline as they become more economically developed and richer. economic globalisation affects income inequality positively and significantly in mexico and turkey at 5 per cent and 10 per cent level of significance, respectively, and this may be as a result of relative factor endowments and the levels of protection that emerged before the process of globalisation. this is in line with the earlier works of mahesh (2016); amjad (2015); lee (2014); ogunyomi et al. (2013); atif et al. (2012); bergh and nilsson (2010) and dreher and gaston (2008). in indonesia and nigeria, its effect is insignificant and this is consistent with the studies of dorn et al. (2017); faustino and vali (2011); sylwester (2005); dollar and kraay (2002) and mihaylova (2015). the positive impact in mexico confirms the evidence that the process of income convergence ended in 1985 as a result of trade liberalisation. thus, globalisation caused people living in northern mexico to become wealthier than those in southern mexico. while in turkey, it could be as a result of an increase in unemployment from the abandonment of economic development and industrialization with public investments. on the other hand, social globalisation has a significant and positive impact on income inequality in all the mint countries, except in turkey where the effect is negative and significant at 5 per cent significant level. the negative effect follows the findings of dreher and gaston (2008). the reason for the positive relationship could be credited to the fact that there are some weak policies, in terms of social reforms, threatening the rise of social globalisation in mexico, indonesia, and nigeria. but, the negative impact of social globalisation in turkey may be because turkey as one of the mint countries has the most strategic locations given its transcontinental status between asia and europe. the negative impact of political globalisation on income inequality in nigeria and turkey at 5 per cent level of significance is in line with the theoretical proposition, but inequality increases at 10 per cent significant level in mexico as a result of rising political globalisation (dreher & gaston, 2008). therefore, nigeria and turkey might be able to benefit from other countries in terms of international treaties and number of embassies in their economies which help to increase investment and job opportunities and thus, reduce income inequality, while mexico was unable to benefit from political globalisation in terms of rising inequality because mexico’s government is seen to be institutionally inclined towards dishonesty and failure or unwillingness to seriously deal with drug dealers. furthermore, level of education as captured by human capital, using secondary school enrolment rate, significantly affects inequality in all the mint countries at 5 per cent significance level, except in indonesia where its impact is positive and insignificant and this confirms the findings of asteriou et al. (2014). in mexico, the effect is inverse (bukhari & munir, 2016; macdonald & majeed, 2010; salimi et al., 2014; trinh, 2016; ucal et al., 2015) and this implies that as more people get educated, the level of income inequality will reduce because education will afford them good job opportunities. in other words, a higher level of education results in an increase in the supply of skilled labour force, which in turn, leads to a decrease in skilled wage premium, hence, lowering overall inequality (mihaylova, 2015). contrarily, the impact is direct in nigeria and turkey as against extant studies and this shows that the level of income inequality will continue to rise as people get higher education. for instance, in nigeria, employers now attach importance to the level of education in getting well-paid jobs rather than the minimum educational qualification required for the job. this is because the country has a situation of many people seeking for jobs. interestingly, population growth in all the mint countries is statistically significant at 5 per cent level and support the theoretical position that income inequality should increase as population increases, except nigeria that shows otherwise. in mexico, indonesia and turkey, an increase in population will reduce the prospects for a better life for those already born and also, reduces limited government revenues to provide basic amenities. this supports the empirical evidence from the works of trinh (2016) and macdonald and majeed (2010). in nigeria, the result shows that population growth is desirable and should help in reducing income inequality (amjad, 2015; david, 2011; ucal et al., 2015). this infers that population growth in a country like nigeria should not constitute a problem because it might cause consumer demand to increase leading to an increase in production and hence, might increase investment and employment opportunities that will help in reducing inequality. another interesting result is found for inflation rate and control of corruption as they affect income inequality significantly at a 5 per cent level. the inflation rate has a positive effect on income inequality in all the mint countries apart from indonesia where the impact is negative. the positive impact confirms the a priori expectation that is in line with the findings of trinh (2016); mihaylova (2015); salimi et al. (2014); faustino and vali (2011) and macdonald and majeed (2010). these studies confirm that rising inflation reduces real wages and disproportionately affects those in the bottom part of the income distribution, hence leading to high inequality. this is because inflation reduces a country's purchasing power and also hurts the poor more than the rich (easterly & fischer, 2001). whereas, the negative impact in indonesia could be attributed to the fact that, high inflation rate adds to economic growth by encouraging investment and employment opportunities because it serves as a source of increasing revenues to investors. this is based on the fact that the rich can pursue several investment options in order not to be affected by the negative effects of inflation. asian journal of economics and empirical research, 2020, 7(1): 91-104 100 © 2020 by the authors; licensee asian online journal publishing group relatedly, the level of corruption in nigeria and turkey show a negative relationship with inequality, while it shows a positive relationship with inequality in mexico and indonesia. the implication is that in nigeria and turkey, an increase in the level of corruption will reduce inequality. the inverse association is premised on the fact that corruption can cause higher economic growth if those resources gained by the public officers are used for public gains and this seems to also follow "second-best theory" that states that corruption would allow people to avoid regulations that can hinder their investment opportunities, thus enabling them to create more jobs that will help in reducing inequality (huntington, 1968; leff, 1964). this is not the case in mexico and indonesia where public officers always take the resources gained out of the country. in such a situation, corruption will add to inequality. in analysing the joint effects of globalisation in respect of levels of economic growth and education in table 4, the findings show that there is no evidence of kuznets' hypothesis of an inverted u-shaped association between economic growth and income inequality in all the mint countries, except in indonesia where the hypothesis is accepted. however, there is kuznets' evidence of a positive relationship between inequality and level of economic growth only in turkey (faustino & vali, 2011). the impact of overall globalisation on inequality is found to be positive and significant at 5 per cent in mexico, nigeria, and turkey, while the impact is significantly negative at 5 per cent also in indonesia. the positive relationship, which is in accordance with the studies of dorn et al. (2017); mahesh (2016); kutor (2014); atif et al. (2012); dreher and gaston (2008) and kahai and simmons (2005) could be as a result of relative factor endowments and level of protections put in place. the negative impact, which is in tandem with the studies of salimi et al. (2014) and zhou et al. (2011) in indonesia could be as a result of open economic policy and the favorable socio-political climate of indonesia. an interesting result is found for the level of education while using overall globalisation index in table 4 when compared with the various dimensions of globalisation in table 3. improved level of education implies that income inequality would fall in all the mint countries, except in turkey where inequality would continue to rise as the level of education improves at 5 per cent level of significance. meanwhile, the impact is observed to be statistically insignificant in mexico only (asteriou et al., 2014). this shows that indonesia and nigeria will experience a lower level of inequality due to the higher level of education and also when all the dimensions of globalisation are pooled together as an overall globalisation index. this negative result is consistent with the studies of bukhari and munir (2016); trinh (2016); ucal et al. (2015) and macdonald and majeed (2010) while the positive impact is against the a priori expectation. theoretically, the expectation is that human capital should reduce inequality but when faced with other challenges then it will show otherwise and this might be the case for turkey. for instance, in turkey, there are challenges (such as lack of infrastructures, shortage of teachers and schools, low teacher quality and inadequate funding) militating against the development of human capital (erdem, aydin, tasdan, & akin, 2011). also, an increase in population growth follows the a priori expectation by increasing income inequality in mexico and turkey at 5 per cent significant level and the result shows otherwise in indonesia (significant at 5 per cent level) and nigeria (insignificant). this means that in mexico and turkey, a high population slows down the prospects for a better life for those already born by preventing the government to use her limited resources to provide basic amenities, hence increased inequality. this is consistent with the studies of trinh (2016) and macdonald and majeed (2010). inequality tends to reduce due to the increase in population (see (amjad, 2015; ucal et al., 2015)) in indonesia. this is because there are an abundant labour pool and a very large domestic market for all types of manufactured goods and services that can fuel economic growth and attract more investment opportunities, leading to an increase in income-earning opportunities. the impact of inflation is found to be significant at the 5 per cent level in all the mint countries, except in mexico. in indonesia, a persistent rise in the prices of goods and services would amount to a lower level of inequality and this is against the theoretical expectation. on the other hand, the relationship between inflation and inequality in nigeria and turkey follows the a priori expectation and this is said to be in line with the studies of trinh (2016); mihaylova (2015) and salimi et al. (2014). thus, inflation in both countries widens the gap between the rich and the poor because it can reduce the purchasing power of their currencies. also, the negative impact of inflation on the poor is pronounced when an increase in price level does not change the wage level. this is because trade unions are weak and minimum wage laws fail to work properly, especially in nigeria. a cursory look at the control of corruption in all the mint countries reveals that an increase in corruption control (that is, a lower level of corruption) would reduce inequality in mexico and indonesia, and increase inequality in nigeria and turkey. the reason is not far-fetched as nigerian and turkish governments have been able to use the resources gained illegitimately for public gains, while in mexico and indonesia, a high level of corruption hinders investment opportunities, thus increased the level of inequality. specifically, the joint effect of overall globalisation and level of growth is found to reduce income inequality in all the mint countries, except in indonesia where its impact is positive, all at a 5 per cent level of significance see table 4. this indicates that the level of growth has a lot to do in reducing inequality as globalisation alone might not be able to reduce the level of income inequality (mihaylova, 2015; salimi et al., 2014). for instance, mexico sharing border with the united states has been able to improve her integration with other parts of the world including her level of economic growth which will help in reducing inequality. while in nigeria, globalisation with economic growth help in creating trade, investment and job opportunities, increasing specialization and efficiency, transferring technology, and developing human resource, thus reducing inequality. turkey is not left out as her level of globalisation along with economic growth plays an important role in reducing inequality as a result of her economic and social development performance, leading to increased employment and income-earning opportunities. contrarily, the interactive term of globalisation and level of growth does not reduce inequality in indonesia, as expected, and this is because the country is recently experiencing an economic slowdown with the same growth rate of gdppc since 2017. the above results show that overall globalisation and level of growth are substitute and should be pursued differently to experience a low level of income inequality in all the mint countries, except in indonesia where the two variables are complementary and should be pursued simultaneously to achieve a low level of income inequality. finally, a positive relationship is established between the joint effect of overall globalisation and the level of education and income inequality in indonesia and nigeria as shown in table 4. the positive impact in nigeria could be attributed to the fact that the positive impact of globalisation is more than the asian journal of economics and empirical research, 2020, 7(1): 91-104 101 © 2020 by the authors; licensee asian online journal publishing group negative impact of human capital, while there is a problem of how to standardize education in indonesia. the joint effect is negative in mexico (but not significant) and turkey and this follows some studies like mihaylova (2015) and macdonald and majeed (2010) which argue that globalisation with the help of high level of education would go a long way in reducing inequality as it will provide income-earning opportunities for those with a higher level of education. another inference from these results is that overall globalisation and level of education are complementary and should be used together to reduce income inequality in indonesia and nigeria, while the two variables are substitute in mexico and turkey, and should be pursued differently to experience a low level of income inequality. table-3. kuznets’ hypothesis, dimensions of globalisation, and income inequality in mexico, indonesia, nigeria, and turkey (1980-2018). exogenous variable endogenous variable: yinq mexico indonesia nigeria turkey yinq(-1) 0.75** (0.00) 0.88** (0.00) 0.98** (0.00) 0.76** (0.00) egb 0.03** (0.00) -0.01 (0.13) -0.0004 (0.87) 0.02* (0.09) sgb 0.05** (0.00) 0.05** (0.00) 0.01** (0.00) -0.06** (0.00) pgb 0.01* (0.09) 0.01 (0.77) -0.02** (0.01) -0.02** (0.03) gdppc 0.13** (0.02) 0.49** (0.00) 0.35** (0.01) 1.33** (0.00) gdppc2 -0.10** (0.01) -0.03** (0.01) -0.02** (0.01) -0.07** (0.00) humc -0.11** (0.00) 0.01 (0.31) 0.01** (0.00) 0.02** (0.00) pop 0.03** (0.00) 0.11** (0.00) -0.06** (0.04) 0.02** (0.00) inf 0.001** (0.00) -0.002** (0.00) 0.001** (0.00) 0.01** (0.00) cor -0.01* (0.01) -0.001 (0.58) 0.02** (0.00) 0.01** (0.00) inst. rank 36 31 31 37 j-stat. (prob.) 8.90 (0.89) 8.34 (0.88) 8.15 (0.89) 9.27 (0.95) ar(1) (0.08)* (0.50) (0.01)** (0.00)** ar(2) (0.48) (0.34) (0.70) (0.18) obs. 35 30 36 35 note: ** and * represent 5 per cent and 10 per cent levels of significance, respectively. intercept values are not reported. p-values are reported in parentheses. table-4. kuznets’ hypothesis, overall globalisation, and income inequality in mexico, indonesia, nigeria, and turkey (1980-2018). exogenous variable endogenous variable: yinq mexico indonesia nigeria turkey yinq(-1) 0.74** (0.00) 0.96** (0.00) 0.86** (0.00) 0.68** (0.00) gbi 2.49** (0.00) -3.38** (0.00) 0.36** (0.04) 4.00** (0.00) gdppc -3.09** (0.01) 2.67** (0.00) -0.04 (0.42) 0.33** (0.00) gdppc2 0.23** (0.01) -0.23** (0.00) 0.01** (0.03) 0.07** (0.00) humc 0.10 (0.44) -1.43** (0.00) -0.22** (0.00) 0.44** (0.00) pop 0.03** (0.00) -0.11** (0.01) -0.01 (0.55) 0.02** (0.00) inf 0.0001 (0.69) -0.003** (0.00) 0.001** (0.00) 0.003** (0.00) cor -0.01** (0.00) -0.003** (0.00) 0.02** (0.00) 0.01** (0.00) gbi*gdppc -0.25** (0.03) 0.24** (0.00) -0.06** (0.02) -0.40** (0.00) gbi*humc -0.04 (0.21) 0.36** (0.00) 0.06** (0.00) -0.11** (0.00) inst. rank 34 29 35 36 j-stat. (prob.) 8.91 (0.89) 6.86 (0.89) 8.88 (0.90) 8.73 (0.89) ar(1) (0.04)** (0.04)** (0.00)** (0.00)** ar(2) (0.19) (0.17) (0.48) (0.40) obs. 36 28 35 35 note: ** and * represent 5 per cent and 10 per cent levels of significance, respectively. intercept values are not reported. p-values are reported in parentheses. asian journal of economics and empirical research, 2020, 7(1): 91-104 102 © 2020 by the authors; licensee asian online journal publishing group 5. concluding remarks the study tests for the validity of kuznets’ hypothesis and examines the relative effects of the dimensions of globalisation and overall globalisation on income inequality between 1980 and 2018. the dynamic gmm results show that all the various dimensions of globalisation were important for kuznets’ hypothesis to be accepted in all the mint countries. this is because while using overall globalisation, there is no evidence of kuznets’ hypothesis in all the mint countries, except in indonesia. in mexico, all the dimensions of globalisation including overall globalisation increases income inequality. human capital with the various dimensions of globalisation increases income inequality, while with overall globalisation its effect is insignificant. population growth increases inequality, while the effect of inflation rate on inequality is positive with the various dimensions of globalisation and its effect is insignificant with overall globalisation. also, a high level of corruption increases income inequality in mexico. the joint effect of globalisation and economic growth reduces economic growth, while that of globalisation and the level of education is insignificant. the impacts of economic and political globalisation are insignificant in indonesia. meanwhile, social and overall globalisation increases and reduces income inequality, respectively. human capital, with the various dimensions of globalisation, insignificantly affects income inequality, while with overall globalisation its effect is negative, as expected. with the various dimensions of globalisation, an increase in population increases inequality, while with the overall globalisation, an increase in population reduces income inequality. inflation and the level of corruption reduce income inequality in indonesia. the joint effects of globalisation and each of economic growth and level of education increase income inequality in indonesia. in examining the nigerian economy, economic globalisation has a non-significant effect on income inequality, political globalisation reduces income inequality, and social globalisation and overall globalisation add to income inequality. with the various dimensions of globalisation, a high level of education increases income inequality, while with the overall globalisation, the effect of education on inequality is inverse. population growth reduces inequality with the various dimensions of globalisation but its effect is insignificant with overall globalisation. inflation and the level of corruption increases and reduces income inequality, respectively. the conditional effects of globalisation and each of economic growth and level of education reduces and increases income inequality, respectively. to end this, an increase in each of economic and overall globalisation increases income inequality, while social and political globalisation in turkey cause inequality to reduce. human capital, population growth, and inflation increase income inequality, while the level of corruption, the joint effects of globalisation and each economic growth and level of education reduce income inequality in turkey. it is recommended that all the mint countries need to put in place measures, such as economic, social, and political stability that will enable them to benefit from the globalisation process as these benefits might help in reducing income inequality. the government of the mint countries should not attach so much importance to certificates in accessing any job opportunity, especially in mexico and nigeria. however, human capital in all the mint countries can be improved through adequate investment in education to reduce income inequality. population growth should be reduced in all the mint countries in order not to limit the government resources in providing a better life for those already born. meanwhile, the nigerian government can achieve a high level of growth that can help in reducing inequality if they channel their high population towards improved productivity. also, if the resources in the nigerian economy are properly managed, then population growth should not add to income inequality. furthermore, the rate of inflation needs to be moderate and stable through such measures as a reduction in money supply, reduction in the budget deficit, total ban on the importation of certain items, especially when inflation is imported, and increase in the production of goods and services. specifically, the inflation rate in indonesia should be tied to the wage level since income inequality reduces as inflation rises. there is a need for transparency and accountability in government functions in mint countries, particularly in financial transactions. this can improve the level of globalisation, reduce inequality in each of the mint countries. precisely, a high level of corruption is observed to reduce income inequality in nigeria. if this is the case, there should be a way to see that the resources gained illegitimately are used for public gains in terms of investment and income-earning opportunities to income inequality. finally, other studies can examine the joint effect of each of the dimensions of globalisation with the levels of education and economic growth on income inequality as against the joint effects of overall globalisation with the levels of education and economic growth that this present study examines. in addition, future research can test for the validity of kuznets’ hypothesis in other groups of countries 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(2011). impact of globalization on income distribution inequality in 60 countries. global economy journal, 11(1), 1-16.available at: https://doi.org/10.2202/1524-5861.1628. zulfiu-alili, m. (2014). inward foreign direct investment and wage inequality in macedonia. eastern european economics, 52(5), 5686.available at: https://doi.org/10.1080/00128775.2014.1004265. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. http://www.theneweconomy.com/business/is-mint-the-next-bric http://www.theneweconomy.com/business/is-mint-the-next-bric 73 © 2021 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 8, no. 2, 73-80, 2021 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2021.82.73.80 © 2021 by the authors; licensee asian online journal publishing group analysis of the effect of private healthcare financing on poverty in nigeria: evidence from edo state olaniyi, o.1 abubakar idris2 ( corresponding author) 1department of economics, university of abuja, federal capital territory, abuja, nigeria. email: poolaniyi@yahoo.co.uk tel: 08039661576 2department of economics, edo state university, uzairue, edo state, nigeria. email: idrisbakr@yahoo.com tel: 08038220298. abstract poverty is one of the problems that challenges economies in africa. though it is a complex phenomenon which requires efforts by different experts to reduce or eliminate, conventional wisdom posits that “health is wealth”. health status is a component of human capital development which plays a fundamental role in the poverty and well-being of individuals and national economies. paradoxically, the cost of accessing quality health care is an important contributor to income poverty among low income households. thus, adequate healthcare financing mechanisms (public and private) are required to attain quality health outcomes. this study investigates the adequacy or otherwise of the current means of private healthcare financing in edo state in nigeria, and it employed the survey method and multinomial logistic regression technique. results revealed that the dominant means of private healthcare financing in edo state is “out-ofpocket” payments, which have a negative effect on the income of households. it therefore recommends the introduction of a more effective collective healthcare financing mechanism to mitigate the financial burden associated with out-of-pocket spending. also, funding should be provided for the research and development of locally manufactured drugs with high local content to enhance the availability and affordability of effective drugs. keywords: healthcare financing, health status, out-of-pocket payment, poverty, multinomial logistic, households. jel classification: c83; d14; e24; h51; i11; i12; i13. citation | olaniyi,o.; abubakar idris (2021). analysis of the effect of private healthcare financing on poverty in nigeria: evidence from edo state. asian journal of economics and empirical research, 8(2): 73-80. history: received: 20 july 2021 revised: 19 august 2021 accepted: 8 september 2021 published: 22 september 2021 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 74 2. literature review ............................................................................................................................................................................ 75 3. theoretical framework .................................................................................................................................................................. 75 4. results ................................................................................................................................................................................................ 77 5. summary of major findings .......................................................................................................................................................... 79 6. conclusion and policy recommendations .................................................................................................................................. 79 references .............................................................................................................................................................................................. 79 mailto:poolaniyi@yahoo.co.uk mailto:idrisbakr@yahoo.com http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.doi.org/10.20448/journal.501.2021.82.73.80 asian journal of economics and empirical research, 2021, 8(2): 73-80 74 © 2021 by the authors; licensee asian online journal publishing group contribution of this paper to the literature the study contributes to existing literature by establishing a nexus between poverty and the income effect of healthcare financing using multinomial logistic regression. this makes the study unique and significant in the context of health economics. 1. introduction healthcare financing is an issue that demands adequate attention given its pivotal role in the overall performance of national health systems, the wellbeing of individuals, and national economies. a national health system is the vehicle through which health care is provided to residents in an economy. it comprises various components in the health sector that interact to bring about a well-functioning system that responds in a balanced way to meet a population’s health needs. it functions to improve the health status of individuals, families and communities and protects the community against all forms of problems that may threaten health and income per capita. it requires the provision of infrastructure to facilitate the delivery of medical services, consultation and diagnostic services, care, medications, technology, and financing functions necessary to make them available when required. the compendium of u.s. health systems (2018) defines a health system as an organization that includes at least one hospital and at least one group of physicians that provides comprehensive care. these include primary and specialty care that are connected with each other through common ownership or joint management. also, the who (2018) described a well-functioning health system as that with adequate health infrastructure, modern health technologies, trained and motivated health workers, pharmaceutical industries backed by adequate funding, appropriate health plans, and evidence-based policies. since no resources can be mobilized for production without adequate financing, an efficient healthcare financing system is essential for a health system to satisfy the health-based needs of a country. such a system involves three interrelated parts: i) raising adequate funds for the health sector, ii) reducing financial barriers to access through prepayment and subsequent pooling of funds in preference to direct (out-of-pocket) private payments, iii) allocating the raised funds in a way that promotes efficiency and equity. growth in all these areas of healthcare financing determines whether health services exist and are affordable for everyone who needs it (uzochukwu et al., 2015). how a country finances and manages funds available for its healthcare system is a major means of reducing poverty associated with ill health. however, healthcare spending in nigeria is characterized by personal “out-ofpocket” spending, which constitutes a burden for poor households that make up 40.1% of the population (varrela, 2020). this has contributed to the low level of healthcare delivery, high health burden, and high rates of morbidity and mortality in the country. this study therefore investigates the appropriateness of the current method of private healthcare financing using evidence from edo state in nigeria. to the best of our knowledge, studies based on household surveys that measure the income effect of private “out-of-pocket” healthcare financing are limited. 1.1. conceptual issues healthcare financing is a branch of the healthcare system that is concerned with the mobilization, accumulation, and allocation of financial resources to cover the health needs of the providers, individually and collectively, in a country’s national health system. it helps patients and healthcare beneficiaries to pay for medical expenses in the short and long terms, and it involves both private and public healthcare financing mechanisms. in relation to private healthcare financing, the main concern is how it impacts the health status of the community by facilitating payments for healthcare services. public healthcare financing, on the other hand, involves public expenditures geared towards the provision of health facilities, such as building hospitals, providing the latest medical technologies, training and recruiting medical professionals (doctors, nurses, physicians), establishing pharmaceutical industries for the provision of drugs, and paying salaries of health workers. the volume of public healthcare financing is determined by a range of factors, such as the increase in population of the communities and their health status, initial investment in latest medical technologies, the level of health needs of the communities, and the availability of financial resources. several mechanisms are employed to mobilize resources for healthcare financing in nigeria, which include government budget sources, such as tax revenues (direct and indirect) and deficit financing. other sources include foreign donor funding, contributions from domestic philanthropic organizations/individuals, entrepreneurial spending, the national health insurance scheme, community-based health insurance schemes, and user fees. notwithstanding the diversity of the sources of funding, nigeria’s health system is characterized by inadequate availability of beds, high population to medical professional ratios, and poor health outcomes, such as low life expectancy, and high infant and maternal mortality rates. these may be attributed to grossly inadequate public investment in the health sector and poor health insurance coverage leading to extensive private out-of-pocket payments. according to aregbesola (2017), the average federal government health spending as a percentage of total government spending is 4% instead of the international benchmark of 15% of government spending for developing countries, and it is less than 1% of gdp. also, collection of user fees is low because of low capacity and lack of willingness and ability to pay for quality health services due to the high level of poverty as 40.1% of nigerians live below the poverty line (varrela, 2020). poverty, as noted earlier, has many dimensions, including lack of adequate income and lack of opportunities to procure or access basic necessities, such as food, clothing, shelter, health services and education. it is a pronounced deprivation in well-being due to the inability to acquire basic goods and services necessary for survival with dignity leading to lack of self-esteem and lack of self-actualization. these derivations may include inadequate health facilities and education, lack of clean water and sanitation, inadequate physical security, lack of voice, and insufficient capacity and opportunity to better one’s life. poverty is therefore a denial of choices and opportunities, and a violation of human dignity. it also means a lack of the basic capacity to participate effectively in society, not being able to attend school, being ill and not having a clinic to attend or money to procure quality health care, not having land on which to grow one’s own food, or a job to earn one’s living, and not having access to credit. also, asian journal of economics and empirical research, 2021, 8(2): 73-80 75 © 2021 by the authors; licensee asian online journal publishing group poverty may mean more than lack of private resources. if a village has no quality healthcare facilities, no amount of money may be enough to purchase effective and convenient health care within such a village. if a country’s healthcare system is weak, all the residents of that nation may not be able to access health care during lockdowns or war as was the case during the covid-19 global lockdowns. however, despite the breadth of its concerns, social scientists still find it practical to define poverty largely as lack of adequate income. hence, the poverty line is measured in monetary terms as a critically low income level below which a basic quality of life may not be sustained. an individual who has an availability of less than 137.4 thousand naira (roughly us$ 361) per year in nigeria is considered poor (varrela, 2020). the primary reason for this is that inadequate income is clear, measurable, and of immediate concern for individuals. another reason is that low incomes tend to correlate strongly with other concerns that are important but harder to measure. for example, those with the lowest health and social statuses tend to come from the bottom of the income distribution ladder, and lack of money also serves as a rough but quantifiable proxy for a host of deprivations (olusola, 2018). 2. literature review scheffler (2004) and bloom, sachs, collier, & udry (1998) stressed that ill health is one of the major causes of poverty hence the importance of universal access to quality health care to reduce poverty. according to soyibo (2005), a bidirectional causal relationship exists between health and economic growth. also, gyimah-brempong & wilson (2004) established the existence of a positive relation between investment in health and economic growth in both sub-saharan african and oecd countries. to measure the impact of health spending on national income growth in nigeria, obansa, idris, & benedict (2013) employed the vector autoregressive method and identified a causal relationship between public health spending and health outcomes. health is considered a fundamental commodity in the analyses of economic performance of individuals, and andrew, nigel, & paul (2012) observed that health spending is an investment in human capital that aids productivity and growth. acemoglu, johnson, & robinson (2003) also maintained that poor health conditions in africa determines the differences between the growth rates in africa and the average growth rates of other countries to a great extent. their study further identified three mechanisms through which health could impact the aggregate economic outcomes. these are (i) unhealthy people are less productive, (ii) poor health reduces life expectancy, and (iii) poor health may directly reduce human capital investment. thus, the human capital theory has identified spending on health as a component of human capital development which promotes health outcomes and thereby growth in national and per capita income levels. in addition, a poor national health system induces the outflow of medical tourism as high net worth households tend to solve their health problems abroad. this drains the nation’s foreign reserves and contributes to national debt. in nigeria, about one billion dollars is spent on medical tourism annually according to government sources (ayodele, 2016). thus, a poor national health system also affects economic development by diverting demand for healthcare services offshore, increasing mortality among those who cannot afford offshore healthcare services, and whenever overseas travel is impossible, the mortality among high net worth individuals also rises as was experienced in nigeria during the covid-19 lockdown. the quality of a national health system is therefore not only a challenge to the health status of a nation, it also adversely affects national income, aggregate demand, foreign exchange reserve and national security. 3. theoretical framework individual demand for a good health status is both a consumption and an investment as it promotes a person’s wellness and enhances their productivity and income, which enables them to avoid aspects of poverty associated with ill health. social demand for a healthy society, on the other hand, is mainly an investment demand as a healthy society has increased productivity, aggregate spending, and increases revenue for the government. thus, healthcare delivery is both a private and social good. however, the desirable level of social delivery may be higher than the level that could be sustained if health spending is mainly determined by poor people’s willingness to pay. this is because the immediate and direct impact of private “out-of-pocket” payments on poor and vulnerable households may further increase their vulnerability. however, this adversity could be mitigated with a sustainable healthcare financing mechanism, which would reduce private out-of-pocket payments. a healthy society has reduced absenteeism at work and school leading to higher productivity in the short and long runs. a higher level of productivity increases per capita income and the productivity of government revenue sources. these may raise subsequent levels of both private and public health spending and lead to a more efficient healthcare system that could reverse the direction of health tourism from outwards to inwards leading to an increase in employment and national productivity. however, if private out-of-pocket financing is the dominant mode of healthcare financing, the level of health outcomes achievable may not be up to the level required to achieve the optimum level of economic growth and development. figure 1 shows that healthcare financing may come from both private and public sources. adequate and sustainable healthcare financing may have a positive effect on productivity and increase per capita income and government revenue leading to enhanced capacity for higher private and public healthcare funding in the future. on the other hand, private out-of-pocket funding may adversely affect the personal income of vulnerable households leading to reduced capacity for sustained private healthcare financing. asian journal of economics and empirical research, 2021, 8(2): 73-80 76 © 2021 by the authors; licensee asian online journal publishing group figure 1. income effect of health care financing. this study is therefore anchored on investment theory whereby optimal health stock is attained when the marginal cost of health (mch) equals its marginal benefits (mbh). like capital stock, which depends on the cost of capital and depreciation rates, health stock depends on the cost of obtaining and maintaining good health (r+δ), where r represents of the cost of transport to access medical care, consultation/diagnosis fees, cost of medication, hospitalization, paying care givers and the cost of the time of unpaid care givers, while δ represents the additional cost of sustaining a healthy status in old age (depreciation cost). this study investigated the income effect of private healthcare financing in edo state. the income effect of healthcare financing is made a function of private out-of-pocket spending on health care, which includes cost of transport, consultation fees, cost of drugs and the financial burden of medical care using the number of residents with health insurance as a proxy. this is because the level of public funding and/or funding through an aggregative funding mechanism is inversely proportional to private out-of-pocket spending. for example, if an individual is covered by a health insurance program or the government provides free or subsidized drugs to patients, builds public hospitals and equips and staffs them adequately, out-of-pocket spending on drugs, transportation and consultations will reduce. therefore, ceteris paribus, high out-of-pocket spending on each of the cost elements is indicative of low levels of public and aggregative spending on those aspects of health care. 3.1. study area the survey was conducted in edo state, nigeria. edo state is located in the northern fringe of the south-south zone of nigeria and it shares borders with the kogi, ondo and delta states in the north central, southwest and south-south zones of the country, respectively. anambra state in the southeast zone is just across its boundary with the river niger. this proximity to four out of six zones of the federation and the presence of residents from across the country makes edo state fairly representative of the nation. the state is made up of four major ethnic groups – bini, esan, etsako and owan. edo state is regarded as the seventh largest nigerian state with a gross domestic product (gdp) of 11,888 million us dollars. it is therefore neither one of the richest nor poorest states in the nation. the population of the entire state is approximately five million based on the 2016 projected population figure by the national bureau of statistics (nigeria bureau of statistics, 2009). the study adequately covers the state as it sampled residents in six local governments: etsako west, etsako east, esan central, esan west, egor and oredo, i.e., two local government areas in each of the three senatorial zones of the state. 3.2. data collection and analysis methods the study used a survey method in which a structured questionnaire was randomly administered to a crosssection of households in edo state after subjecting the instrument to a pilot study to test its validity and reliability. descriptive and multinomial logistic regression techniques were used to analyze the effect of healthcare financing on the income of individual households in the state. the exponential function of the estimated parameters measured the responses of the probability impulse of direct (out-of-pocket) healthcare spending on the income of individual households. the study used primary data obtained from the questionnaires, which were administered from october to december 2018. 3.3. model specification the multinomial logistic regression model was employed for the estimation of the parameters because of its superiority in measuring dichotomous (binary) response variables. it is functionally specified as follows: 𝑙𝑛𝐷𝑆𝐻𝐼 = 𝑓(𝐴𝑆𝑇𝐻, 𝐴𝑆𝑂𝐷, 𝐶𝐷, 𝐸𝐻𝐼𝑆) (1) where: lndshi is the natural logarithm of the respondents’ perceptions on the income effect of private out-of-pocket healthcare financing, asth = the amount spent by respondents on transportation for each hospital visit, asod = the amount spent on medication by respondents, cd = the cost of consultation/medical diagnosis, ehis = enrollment in a health insurance program. the multinomial logistic regression model estimated is as follows: 𝑙𝑛ý = 𝛽0 + ∑𝛽1𝑋1 + 𝛽2𝑋2 + 𝛽3𝑋3 + 𝛽4𝑋4 + 𝑒𝑖 (2) asian journal of economics and empirical research, 2021, 8(2): 73-80 77 © 2021 by the authors; licensee asian online journal publishing group since a better health outcome leads to higher productivity and income, the explanatory variables are expected to positively impact the incomes of the respondents. however, given the prevailing high level of poverty in nigeria, the direct impact of out-of-pocket private expenditure on health care may be catastrophic for poor households and thereby negatively impact their income (idris & olaniyi, 2020). thus, x1,x2 , x3 and x4 may be positive, zero or negative; ei = the error term and is assumed to be normally distributed with a zero mean and constant variance, that is ei~n[0,1/nipi(1-pi)]. 4. results table 1 shows that 19 (5.5%) of the respondents spent n3,100–n4,000 on transportation to access hospital services, 44 (12.8%) of the respondents spent n2,100–n3,000 and 79 (23%) spent n1,100–n2,000. however, the majority of respondents, i.e., 181 (52.6%) spent between n100 and n1,000 on transportation to access hospital services. the variation in the amount spent is attributed to differences in distance to hospitals. thus, the longer the distance, the greater the financial burden for patients. building more hospitals closer to people’s homes will therefore reduce the transportation component of out-of-pocket spending on health care. table 1. distribution of the average amount spent on transportation to hospital. frequency percent valid percent cumulative percent valid unspecified 20 5.8 5.8 5.8 n3,100–n4,000 19 5.5 5.5 11.4 n2,100–n3,000 44 12.8 12.8 24.2 n1,100–n2,000 79 23.0 23.0 47.2 n100–n1,000 181 52.6 52.8 100.0 total 343 99.7 100.0 missing system 1 0.3 total 344 100.0 source: field survey, 2018. table 2 shows that ten (2.9%) of the respondents spent n16,000 or more monthly on medication, 20 (5.8%) of the respondents spent n11,000–n15,000, and 44 (12.8%) of the respondents spent n6,000–n10,000. also, the majority of the respondents, that is, 249 (72.4%) spent the least amount n1,000–n5,000 on medication monthly. the differences in the amount spent on medication could be associated with the gravity of the health challenges of patients as approximately 70% of health problems require only primary health care and drugs that are largely inexpensive. another reason is the availability of health insurance cover, such as the national health insurance scheme (nhis) or community-based health insurance scheme (cbhis), as enrollees of the nhis pay only 10% of the cost of drugs. table 2. respondents’ monthly spend on drugs. frequency percent valid percent cumulative percent valid unspecified 20 5.8 5.8 5.8 n16,000 and above 10 2.9 2.9 8.7 n11,000–n15,000 20 5.8 5.8 14.6 n6,000–n10,000 44 12.8 12.8 27.4 n1,000–n5,000 249 72.4 72.6 100.0 total 343 99.7 100.0 missing system 1 0.3 total 344 100.0 source: field survey, 2018. table 3 indicates the amounts spent by respondents on medical diagnostic services and consultations. it was revealed that 54 (15.7%) of the respondents spent about n8,100 or more per month on diagnostic services, while 109 (31.7%) spent n4,100–n6,000, 39 (11.3%) spent n2,100–n4,000, and 141 (41%) spent n1,000–n2,000. table 3. respondents’ monthly spend on diagnosis. frequency percent valid percent cumulative percent valid n8,100 and above 54 15.7 15.7 15.7 n4,100–n6,000 109 31.7 31.8 47.5 n2,100–n4,000 39 11.3 11.4 58.9 n1,000–n2,000 141 41.0 41.1 100.0 total 343 99.7 100.0 missing system 1 0.3 total 344 100.0 source: field survey, 2018. table 4 shows the distribution of respondents’ enrollment in any government health intervention programs, such as nhis or cbhis, in edo state. the results reveal that about 189 (54.9%) of the respondents have not enrolled in any government intervention programs to finance their healthcare services, while about 154 (44.8%) have enrolled in either nhis or cbhis. asian journal of economics and empirical research, 2021, 8(2): 73-80 78 © 2021 by the authors; licensee asian online journal publishing group table 4. distribution of respondents enrolled in a government health intervention program. frequency percent valid percent cumulative percent valid no 189 54.9 55.1 55.1 yes 154 44.8 44.9 100.0 total 343 99.7 100.0 missing system 1 0.3 total 344 100.0 note: the estimated multinomial logistic regression results are presented hereunder: lný = 4.434 + 0.458asth-0.626asod -0.404cdg0.687ehis table 5. summary of the estimated multinomial logistic results of the model. perception of the income effect of healthcare financing (dshi) (dependent) variable. b se wald exp(b) or sig. (p-value) constant 4.434 0.779 32.421 0.001* asth 0.458 0.139 10.818 1.581 0.001* asod -0.626 0.180 12.080 0.535 0.001* cd -0.404 0.101 15.931 0.668 0.001* ehis -0.687 0.150 20.987 0.503 0.001* summary stat. likelihood (x2) = 65.769, df = 4, p < 0.001 nagelkerke’s r2 = 0.234 (23.4%) note: * p < 0.05. similar to the ordinary least squares (ols), the summary statistics of the predictors in the model indicates that together they explain about 23.4% of the variance in the outcome as revealed by the nagelkerke pseudo-r2 (see table 5). however, in the logistic regression, especially when it involves dummy dependent variables, the value of the pseudo-r2 normally may come out low. this should not be overly emphasized, as noted by cox (1958) and cited in obansa (2011). gujarati (2004) also stressed that where the regressands are dichotomous, goodness of fit (r2) is not particularly meaningful. what is important are the signs of the coefficients and their statistical significance. the chi-square (x2) value of 65.769, df = 4, p < 0.01 revealed that, put together, all the variables have a significant effect on the income of the respondents. in addition, each of the independent variables is significant at the 5% level. with respect to the individual predictors, table 5 reveals that the parameter estimates of the amounts spent by respondents on transportation to access hospital services (asth) are β = 0.458, wald stat. =10.818 and p < 0.01, indicating that it is statistically significant at the 5% level. this implies that a unit change in asth leads to an increase of 0.458 units in income. this positive relationship may be attributed to the fact that residents get better after-hospital treatment. consequently, they become more productive and are able to earn more income as the cost of transportation is not a burden to most of them. the low cost of transportation to hospital (see table 1) eases access to medical care and enhances their health status, leading to higher productivity and higher income. however, the antilog of the parameter (asth) shown in table 5, row 3 column 5, the exp (b) or the odds ratio (or) reveals that respondents who visited hospital less frequently for medical care are 58.1% less likely to incur adverse effects on their income than those who needed hospital services more frequently. this shows that those who seek treatment less frequently are less likely to experience negative income effects than those who have to visit hospitals regularly for medical care. also, the estimates for the amount spent on medication (asod) are as follows: β = -0.626, wald stat. =12.080 and p < 0.01. this implies that a unit change in the amount spent on medication leads to a decrease in income of the respondents by about 0.63%, showing a negative relationship between income and the cost of medication. the odds ratio (or) exp(b) of 0.535 (46.5%), estimated as 0.465, showed that, on average, respondents who engage in more out-of-pocket spending on medications are 46.5% more likely to be vulnerable to the negative income effects of healthcare spending than those who spend less. since obtaining health care should ordinarily stimulate an increase in productivity and higher income, the negative income effect underscores the low income status of a large segment of the population and the catastrophic effect of private out-of-pocket spending on poor households (idris & olaniyi, 2020). the amount spent on medical consultation/diagnosis (cd) also has the following statistics: β= -0.404, wald stat.= 15.931 and p < 0.1. this implies that a unit change in cd leads to a decrease in income of the patients by 0.404 units of naira. this showed a negative relationship between the respondents’ income and the amount spent on medical diagnosis, which is significant at the 5% level. the estimated odds ratio (or) of 0.331 indicates that patients who spend more of their income on medical consultation/diagnosis are 33.3% more likely to have adverse income effects than respondents who spend less. the ehis variable statistics (β = 0.687, wald stat. = 20.987 and p < 0.01) measured the respondents’ perceptions on the burden of healthcare financing on patients who are not enrolled in any health intervention scheme. it indicates that healthcare financing is perceived to exert a 0.68% burden on the income of patients who are not enrolled in any health insurance scheme, and this is statistically significant at the 5% level. the odds ratio exp (b) denotes that patients who are not enrolled in any health insurance scheme are 49.7% more likely to perceive medical care financing as a burden. the behavior of asod, cd and ehis in the model supports the postulation that there is a statistically significant relationship between private out-of-pocket healthcare financing and an individual’s income. this finding is in line with those of scheffler (2004) and bloom et al. (1998), who state that ill health is a major cause of poverty. also in line with these findings is rosenthal (2001) asian journal of economics and empirical research, 2021, 8(2): 73-80 79 © 2021 by the authors; licensee asian online journal publishing group and kassalow (2001), who discovered that illness is the leading reason why families in china fall below the poverty line. 5. summary of major findings this study was motivated by the need to analyze the effect on income of private out-of-pocket spending on health care and how any perceived adverse effects on households could be remedied. acquiring a good national health status is the goal of every national health system and it entails both direct and indirect costs financed either by individuals (patients) or the public sector. individuals undertake healthcare financing or spending to improve their health status. this should increase an individual’s productivity leading to higher income, improved wellbeing and longer life expectancy. paradoxically, health spending could be a critical decision for low income households, especially for those without sufficient public support or insurance coverage, as out-of-pocket health financing among poor households may be catastrophic and lead to further impoverishment. the descriptive analysis of the study revealed that the majority of the households undertook out-of-pocket expenditure, as 189 (54.9%) of the respondents were not enrolled in any form of health insurance scheme at either national or state levels, and only 154 (44.8%) were enrolled. the case is even worse at the national level as less than 5% of nigerians, who are mainly federal government workers and their dependents, were covered by the nhis scheme as of june 2017 (aregbesola, 2017). thus, out-of-pocket health financing is the main source of private healthcare financing in edo state, which constitutes a financial burden for low income families. this study has established that health financing, especially direct out-of-pocket payments, is a major public health challenge for the majority of households in edo state who are low income earners. the cost of transportation to hospital did not constitute much of a problem, as the distance to hospital for the majority of respondents is relatively short. however, those who attend hospital less frequently have a less adverse effect on their income. this shows that eliminating the cost of transport to hospital will enhance the effect of healthcare delivery on income. this can be partly achieved by removing the cost of ambulance services at least for critically ill patients. the cost of drugs and medical diagnosis are negatively related to the respondents’ perceived income effect. this shows the need for increased public healthcare financing through research and development of drugs with high local content to reduce the cost of medication. in addition, the cost of medical diagnosis should be reduced by equipping public health facilities with diagnostic equipment so that services can be accessed at a lower cost. also, the parameter that measures enrollment in healthcare intervention programs show a low level of patronage of such programs, hence the negative impact which shows that healthcare financing is a burden to the majority of respondents. governments at both state and federal levels should therefore reorganize the healthcare intervention schemes to make them more user friendly and more efficient. this study also observed that the poor health outcomes of the national health system leads to the outflow of medical tourism, depletes available foreign exchange and, through the multiplier effect, reduces national productivity and the employment generation capacity of the economy. furthermore, the occurrences of death of high net worth individuals in the country during the covid-19 global lockdown that put foreign medical services out of their reach shows that a strong national health system is also a national security concern. 6. conclusion and policy recommendations in conclusion, the government should increase healthcare financing by allocating funds more efficiently among the various components of the national health system, such as the provision and distribution of primary, secondary and tertiary health facilities. also, investment in medical, pharmaceutical and pharmacological research should increase in order to produce drugs with high local content so that the cost of drugs can be reduced. in addition, professional hospital managers should be recruited to manage available resources efficiently to reduce the burden of healthcare financing. last, the health insurance schemes at the national and state levels should be made more attractive to encourage enrollment so that out-of-pocket healthcare spending can be reduced to a minimum. although the study is limited to the analysis of the income effect of out-of-pocket health spending in edo state, the findings can be extended to all of nigeria and other parts of africa where similar conditions prevail. we therefore suggest a national survey on the income effects of healthcare financing and its impact on poverty reduction in nigeria and other parts of africa. references acemoglu, d., johnson, s., & robinson, j. 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(2004). health expenditure and economic growth: an international perspective. tampa, florida: university of south florida. soyibo, a. (2005). health of economics and economics of health. paper presented at the selected papers for the 2005 nes annual conference. uzochukwu, b., ughasoro, m., etiaba, e., okwuosa, c., envuladu, e., & onwujekwe, o. (2015). health care financing in nigeria: implications for achieving universal health coverage. nigerian journal of clinical practice, 18(4), 437-444. available at: https://doi.org/10.4103/1119-3077.154196. varrela, s. (2020). poverty head count rate in nigeria 2019 by state, september, 4th, 2020. retrieved from: https://www.statista.com/statistics/1121438/poverty-headcount-rate-in-nigeria-by-state. who. (2018). health care financing: universal health coverage (uhc). retrieved from: https://www.who.int/health-topics. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. http://www.willamette.edu/ http://www.statista.com/statistics/1121438/poverty-headcount-rate-in-nigeria-by-state http://www.who.int/health-topics 251 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 2, 251-257, 2020 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2020.72.251.257 © 2020 by the authors; licensee asian online journal publishing group impact of prestigious indicators on sustainable growth of small and medium-sized enterprises in pakistan shoaib ali1 farooq azam2 hafiz muhammad naveed3 waqar abid4 ( corresponding author) 1school of management, jiangsu university, zhenjiang, china. 2faculty of commerce, hailey college of commerce, university of the punjab, lahore pakistan. 3school of finance and economics, jiangsu university, china. 4school of economics and finance, xi'an jiaotong university, p.r. china. abstract this study aims to examine the prestigious indicators influencing the sustainable growth of small and medium enterprises (sme’s) in pakistan. this research is comprised of primary data. the evidence for this analysis was collected through a standardized questionnaire. the study population structure is extracted from pakistan's punjab province. sample selection is performed employing a random sample technique. the set of questionnaires were 200 circulated but 25 inadequate questionnaires were excluded. the research employed descriptive statistics and the process of regression to evaluate significant indicators concerning pakistan's smes. the study findings demonstrate that the most imperative indicators associated with the sustainable growth of pakistan's sme’s are government funding, access to credit, and technology awareness turn out to have been vital indicators. furthermore, results revealed that pakistan sme’s are not riskfocused. the research findings may enable business owners to identify essential indicators that compete with a considerable function in their enterprise’s growth. the study indicates authorities should consider the results when implementing regulation that can give a sense which would be practicable for the sustainable growth of pakistan's smes. keywords: government funding, access to credit, technology awareness, small, medium enterprises, sustainable growth, pakistan. jel classification: h11, l32, o00, q01. citation | shoaib ali; farooq azam; hafiz muhammad naveed; waqar abid (2020). impact of prestigious indicators on small and medium-sized enterprises sustainable growth in pakistan. asian journal of economics and empirical research, 7(2): 251-257. history: received: 14 july 2020 revised: 18 august 2020 accepted: 21 september 2020 published: 2 october 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 252 2. theory and hypothesis development ....................................................................................................................................... 253 3. methodology ................................................................................................................................................................................... 255 4. results and discussions ................................................................................................................................................................ 255 5. conclusion ....................................................................................................................................................................................... 256 references ............................................................................................................................................................................................ 256 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.72.242.250&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/2197 https://orcid.org/0000-0002-3528-7422 https://orcid.org/0000-0003-2025-2734 https://orcid.org/0000-0002-7319-354x asian journal of economics and empirical research, 2020, 7(2): 251-257 252 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to existing literature by examining the prestigious indicators influencing the sustainable growth of small and medium enterprises (sme’s) in pakistan. 1. introduction the small-and-medium-sized enterprises (sme’s) business sector is an important part of any economy. the sme’s enterprise sector has made tremendous improvements to the financial and social quality of life-being of people worldwide and more specifically, emerging regions of the world in developing and underdeveloped economies. it has a substantial part of job creation and the main contributor to a country's gross domestic production, development, and exports (loewe et al., 2013). the sme’s sectors are effective in promoting entrepreneurial potential and also maintain grass-roots sustainable economic development, thus supporting the country's viable and sustainable growth. as well as, sme’s expansion can contribute to economic change and positive flexibility. in particular, in the instance of asia's developing economies especially, smes are contributing greater job opportunities (badar & rahman, 2015; harvie, 2010). sme’s provide employment opportunities for millions of underprivileged groups, as well as helping to improve skill rates for low-skilled or unskilled workers. sme's also facilitates society's upward growth by encouraging poor or oppressed communities including such women, the elderly, newcomers, cultural or racial communities, and the impaired to build their opportunities for economic participation. hence, smes serve as a valuable mechanism for reducing poverty and sustainable growth, but not entirely in developing and low-income economies (oecd & wbg, 2015). the growth and sustainability of smes are essential for the measure of the developing countries' development. sme’s are the growth drivers for developing countries. the substantial study was carried on the major importance of the sme’s. meanwhile, research on the problem and development of the sme’s sector in pakistan is slowing down away. the small and medium enterprises development authority (smeda) is a government body in pakistan that has worked to grow the sme’s infrastructure during the last years. many of sme's are not authorized with government departments and have no connection to get smeda funding or help. while smeda worked over all years, advancement against sme’s expansion but it was constrained. this research would provide support for the importance of smes and would examine the prestigious factors that lead to sme’s sustainable growth in pakistan. in pakistan, sme's have the ability in the expansion of the agriculture and food field, because they can make more effective use of sufficient resources and produce goods that are internationally appropriate which gives ground to export earnings. smes in pakistan face many difficulties, such as access to financial services, lack of technological understanding, and information technology training. these challenges raise the need for adequate assistance to sme’s sustainable growth (jamali, anka, & khooharo, 2010). the smeda worked in pakistan to encourage the sme’s, but primarily focused on upper-income sectors, as mostly pakistani sme’s are in the lowerincome sectors (kureshi, qureshi, & sajid, 2010). the smeda and small business finance corporations (sbfc) support to sme's in pakistan in accessing credit funding but insufficient government initiatives are inadequate and ineffective tax regulations are the main obstacles to the restricted growth (shah, mehmood, hashmi, shah, & shaikh, 2011a). some earlier studies critically evaluated the issues that influence the economic expansion of sme's in other emerging countries such as india and malaysia. the research applicable in pakistan and investigated the impacts of a few attributes in the overall assessment of the sustainability of smes in pakistan, through an individual level. several other studies have explored whether major contributing factors are suitable for enterprises, or if they are related to enterprise features. this study emphasizes the impact of prestigious indicators on sme’s sustainable growth in pakistan, and explores the indicators that lead to sustainable development. this research would convey the essence of emphasizing the factors which are influencing the growth of smes in pakistan. firstly, the study findings would make it convenient for policymakers to create a sustainable climate by policy development that will promote the growth of smes in pakistan. secondly, this is an opportunity to increase new knowledge regarding empirical information to pakistan's sme sector. however, this paper may help sme's owners to identify the effecting indicators of business development which can take effective action for the sustainable growth of pakistan. pakistan's sme’s are very valuable for its economic growth. due to restricted exposure and lack of knowledge, they don't get the help as they needed. research proof on the growth of smes is scarce and numerous studies on this field are still required. the decisionmakers must have a clear understanding of the issues that impact the growth of smes in pakistan. this research emphasizes on identifying the indicators affecting the sustainable growth of pakistan sme's. the current study further explores the impacts of learning, market growth challenges, and the implementation of new technologies in sme's growth. the figure 1 theoretical framework analysis is built based on reviewing important indicators that can promote sme’s sustainable growth in pakistan. it has proposed a market-oriented economy focused on a sustainable regulation and legal structure where industries can roam freely. throughout such a way, smes' component of pressure exposure will decline. learning how to handle associated with sme's practices. this will also lead to the growth of the enterprises and eventually promote the growth of smes through policy funding and support programs for access to credit and the adoption of technology awareness (chowdhury, 2007). the research is also applied to the system that contains marketing complications or challenges which need to be addressed for promoting smes internationally to raise bank deposits to concentrate on effective marketing. however, the main objective to examine prestigious indicators that influence the sustainable growth of smes in pakistan. asian journal of economics and empirical research, 2020, 7(2): 251-257 253 © 2020 by the authors; licensee asian online journal publishing group figure-1. theoretical framework. 2. theory and hypothesis development 2.1. sme’s sustainable growth sme’s are now becoming extremely aware of the effect of their public identity and their interaction with multistakeholders in reaction to regulatory growth and environmental intense oversight of sme’s activities regarding sustainability challenges (tonello, 2011). sme's is a substantial strength in economic growth and development, are shorter in volume and adaptable in the pattern, capable of responding quickly to market adjustments, meeting evergrowing and differentiated requirements for cultural utilization, and are still in pursuit of promoting the specialization-based collaboration of large-scale social output. in addition, sme's could continue driving the highspeed growth of the state and economy and perform a distinctive part in forming jobs, boosting marketplaces, alleviating poverty for people, and sustaining economic stability. however, to accomplish the rapid sustainable growth of smes, they need to evaluate those indicators that can significantly maintain and develop the growth of smes in pakistan. the role and development of smes in emerging country growth are key. as in pakistan sme’s companies make up a significant part of the market and makeup to 80 percent of employment. as competed with the largescale business area, the growth prospects of smes are greater (chowdhury, 2007). while pakistan’s smes do not make significant participation in gdp, but their function is very significant in contexts of job creation, the efficient use of scarce resources, the chance to afford export earnings, and the capacity to act as an entity for future entrepreneurs. hence, smes are valuable with quite a unique character as less financing, easy handling, fast produce, and instant adherence to changes in the business environment (jamali et al., 2010). 2.2. government funding smeda is already continued working for the advancement of the sme's sector in the last 15 years and it has not been able to create adequate economic growth. to encourage this field, government departments and other government bodies have to devise effective ways in form of loan or funding scheme programs which should go hand in hand with the smeda plan. there is a positive connection between government support for sme’s development (abrar-ul-haq, jali, & islam, 2015). furthermore, through promoting sme's practices, it would contribute to alleviating poverty and may also result in significant with foreign exchange earnings. although many pakistani smes has not paid much attention to having brought in sustainability practices in their industries, due to various their constrained resources. creating and implementing government regulations that help smes in designing appropriate structures will solve this issue. many studies have stressed that government funding is the key factor in pakistan's sme’s sustainable growth. h1: government funding is positively associated with sme’s sustainable growth. 2.3. business risk another component which impacts on sme's growth is indeed the risk element. overall risk (company as well as financial risk) could be an aspect along which there may be a funding disparity. the financial risks of a company (that also concentrates on the operations of a company), is the ambiguity of the company's return over its resources (trovato & alfò, 2006). in comparison, financial risks exist when a company uses borrowing (i.e., financial collateral). for these situations, the business takes extra obligation for servicing the debt that collects interest timely payments. the business's failure to pay interest charges or repayment of principal would fail that may proceed in foreclosure. ntakobajira (2013) argued that financial institutions continue to attribute a high risk to sme’s and are thus unable to allocate credit to small businesses. the loss statistics of small businesses are comparatively high due to the inadequate scale an underlying exposure to market volatility. even by their existence these businesses are still relatively stable and often neglect a financial status. furthermore, businesses and managerial failures, poorer quality governance, and an absence of sufficient accounting systems can negatively impact the transparency and quality of sme's information about their reimbursement potential. there is still a need to tackle business risk and improve sme’s growth in pakistan. h2: business risk is positively associated with sme’s sustainable growth. 2.4. technology awareness implementing advanced manufacturing technology may be an approach to resolve product demand by higher productivity. throughout this context processes such as increased performance per unit and reduction of inventory levels via higher operational volumes through the introduction of the overall amount have been established. increased production and timely delivery are important if businesses are to improve their performance efficiency. asian journal of economics and empirical research, 2020, 7(2): 251-257 254 © 2020 by the authors; licensee asian online journal publishing group this research also stated the probability of failures of technologies in pakistan's lack of experience, education, support, funding, and contribution to adoption (marri, gunasekaran, & sohag, 2007). the growth of smes will also be reinforced by numerous government development programs in obtaining access to financial and implementing new technology (chowdhury, 2007). services vendors should encourage the technology and dynamic challenges of sme's producing products and fair need for outside sources, i.e. promoting the transformation and use of suitable technology in smes which would lead to smes' sustainable growth. there is a relatively positive relation of technology advancement and sme’s (jamali et al., 2010). h3: technology awareness is positively associated with sme’s sustainable growth. 2.5. access to credit many smes businesses in pakistan are classified as microstructure and many smes employed less than 50 workers since they failed to expand their operational activities to boost their position as a stable business. the main reason behind this issue is the lack of access to credit organizations in pakistan (bano, 2008). the microfinance banking institutions are the most determined institution which works access to credit to sme's while the requirements and interest rate are not favorable to sme's. limited access to credit is a big issue for the sustainable growth of smes. the smeda or sbfc is the only inadequate source for access to credit provision. higher interest levels, heavy collateral criteria, and insufficient management are the key reasons for restricted access to credit (jamali et al., 2010). the key explanation for the restricted growth of smes is not only access to credit while an inflexible government taxation system is also a significant factor (shah, mehmood, hashmi, shah, & shaikh, 2011b). naqvi (2011) explained that large risk rates applied to smes have reflected in the high cost of borrowing for financial credit. h4: access to credit positively associated with sme’s sustainable growth. 2.6. complication of marketing the research survey in bangladesh as well discovered that financial system problems, government regulations, laws and legal facilitate, political, cultural, development, and skills are the major limitations to grow the sme’s, as well as the research, has recommended a mechanism to address these to boost up the sme’s growth. the research also proposed that corruption should be minimized to build a healthy atmosphere for smes to function and develop in a challenging economic environment (chowdhury, 2007). indonesia's research analysis has defined marketing know-how, technologies, qualified quality management, promoting federal regulations, adequate funds, and marketing complications or challenges as the key drivers fostering sme growth in indonesia. even the results of this research are relevant for many other developing economies since sme's are an invaluable source of growth for the economy of every developing economy as well as the outcomes will also support lawmakers develop policies that support the growth of the sme in their country (tambunan, 2011). h5: complications of marketing positively associated with sme’s sustainable growth. 2.7. learning and development the investigator has studied the disparity between manager attributes of low-performing and high-performing businesses through using safety metrics such as product sales. the findings revealed that schooling, community-tofamily transitions, behaviors that include electronic technology, and investment rates significantly impact the performance of the business. but the standard of learning is the most feasible ownership function that serves as encouraging pakistan's sme's element (bhutta, rana, & asad, 2008). learning and development skills about how to run the enterprises and entrepreneurial ventures would also contribute to the sme's growth (chowdhury, 2007). the business investors' analysis found that many people need the learning and skills to operate and lead the business. so, the absence of enterprise management expertise is a significant limitation in nigeria's sme’s growth (okpara, 2011). implementing technology often focuses on employees learning and development, so adequate learning and development are necessary to prevent employees' obstacles to creating new things for smes' growth. h6: learning and development are positively associated with sme’s sustainable growth. 2.8. managerial expertise pakistan's sme's are doing poorly and contingently regarding their potential operations. providing competition will lead to product quality control becoming effective both domestically and globally. there is a discrepancy between understanding of the quality managerial expertise in pakistan and their operation. the organizations that use quality control methods are positive about the efficacy of these methods. in addition, those who do not adopt are not involved in using these methods. thus, many pakistani smes have just not given great attention to attempting to bring managerial quality behaviors in their enterprises due to various their limited resources. constructing regulatory standards that help smes in improving quality structures and solves these issues. many other studies have emphasized that managerial expertise and federal funding is just the key element in pakistan's growth of sme’s (kureshi et al., 2010). h7: managerial expertise positively associated with sme’s sustainable growth. the research also showed that cognitive and interpersonal abilities (behavior about risk, creativity, and selfrule), leadership education and competencies (financial services and workforce management), as well as the immediate forces (funding exposure and government assistance), are crucial growth drivers for smes (benzing, chu, & kara, 2009). the corruption leading from close to zero-quality service and has also failed sme’s, though stressing that reduce training levels, lack of management understands exactly-how and learning result in big growth expense. therefore, lawmakers need to strike a rebalancing between the obstacles that sme’s face and the need to promote sme’s growth. smes in pakistan are confronting serious large obstacles and weak assistance. asian journal of economics and empirical research, 2020, 7(2): 251-257 255 © 2020 by the authors; licensee asian online journal publishing group 3. methodology 3.1. sample and data collection this study is conducted to evaluate our hypothesis with an empirical assessment. this research is contained in primary data. the tool used in this study is a questionnaire that is adapted from pakistan and indonesian studies (abrar-ul-haq., jali, & islam, 2015; indarti & langenberg, 2004). the questionnaire for this study includes numerous explanatory indicators which could contribute to sme’s sustainable growth in pakistan. the study population structure is extracted from pakistan's province punjab. sample selection is performed employing a random sample technique. the set of questionnaires were 200 circulated but 25 inadequate questionnaires were excluded. the final sample consisted of 175 effective questionnaires, which is participating in a 17.5 percent response rate. to settle the important indicators affecting the growth of sme’s in pakistan, spss statistics 21 is implied with regression. 3.2. questionnaire with variables table-1. variables development. variables abbreviation types questionnaire (likert scale 1-5) sme’s sustainable growth sg dependent sense of achievement with the net earnings growth; sense of achievement mostly with the time required to get to breakeven point; recognize the enterprise to be good; consider enterprise is up warding. government funding gf independent government funding is adequate; conveniently got enterprise license; there are no issues with government communication; does government actions have a beneficial effect on your enterprises. business risk br independent does enterprise take on added responsibility for risk of taking debt financing; enterprise’s failure to pay borrowing costs; more reliance on internal funds by companies, technology awareness ta independent sufficient installed technology to promote most other production methods; extant technology encourages creativity; conveniently maintainable extant technologies; modern technology to promote market innovative behavior is achievable; adopting modern technology is boosting output. access to credit ac independent previous capital is enough to keep and grow firm; if necessary, could easily provide additional capital; have affordable substitute sources of access to credit complication of marketing cm independent the network of channel distribution; business has market potential; marketing is not complicated and also well designed to discover new for markets. learning and development ld independent is professional training extremely important for enterprise growth; is formal learning development help sound decision-making; does formal education boost market comprehension. managerial expertise me independent management expertise abilities are essential for productive enterprise operation; have strong management expertise experience; have outstanding interpersonal capabilities; abilities in strategic thinking are quite essential to enterprise achievement. 4. results and discussions the inner reliability for the component is already verified for each build by measuring cronbach's alpha. the calculated estimates indicate the accuracy of the data internally. the cronbach’s values for government funding, business risk, technology awareness, access to marking, the complication of marketing, learning and development, managerial expertise is 0.69, 0.67, 0.71, 0.81, 0.75, 0.78, and 0.87 respectively. table-2. descriptive statistics and correlation matrix. variables mean sd sg gf br ta ac cm ld me sg 5.30 0.84 1 gf 4.25 0.81 .615** 1 br 3.66 0.79 .327** .436** 1 ta 3.29 0.73 .414** .426** .827** 1 ac 3.42 0.92 .317* .212* .567** .420** 1 cm 2.03 0.73 .128* .234 .124** .436** .344** 1 ld 2.90 0.82 .033 .262 .124 .215* .361* .177** 1 me 3.50 0.79 .435 .154* .126** .381** .237** .345* .241** 1 note: * correlation is significant at the 0.05 level (2-tailed). ** correlation is significant at the 0.01 level (2-tailed). demographic statistics revealed that 72 percent were male participants, but only 28 percent were female. their age was 25 percent between 25 and 35, 40 percent were between 35 and 45, 30 percent were between 45 and 55 and only 5 percent were above 55. the educational background indicates that graduation was attained by 35 percent of participants, post-graduation was attained by 15 percent and secondary level or secondary level by 50 percent. asian journal of economics and empirical research, 2020, 7(2): 251-257 256 © 2020 by the authors; licensee asian online journal publishing group addressed the average value of each variable and the standard deviation. correlations are measured to evaluate the variables which are dependent and explanatory. the results of the test demonstrate and explain in table 2. table-3. regression coefficients. variables coefficients t-value (constant) 0.186 1.090 gf 0.056* 1.023 ta 0.404* 10.72 ac 0.190** 8.312 cm 0.051* 2.918 ld 0.215* 1.430 me 0.085** 1.073 r =0.85 f = 159.26 p=0.00 note: * significant at the 0.01 level, ** significant at the 0.05 level. in table 3 the amount of constant is 0.186, which has a positive relationship with the predictor variable and it is empirically insignificant. while this study's r2 is 0.85 which indicates that the structure is important and explains a strong percentage of the hypothesis and the variability in predictor variables due to variables is about 85 percent. throughout this particular scenario, explanatory variables (government funding, business risk, technology awareness, access to credit, a complication of marketing, learning and development, managerial expertise) decide around 0.85 sme’s sustainable growth, as well as the corresponding portion, is influenced by other parameters that have not been addressed within that current research. the very initial hypothesis is agreed that government funding has a positive and important association with the sustainable growth of sme’s as the explanatory variable government funding coefficient value is 0.056. the second hypothesis (h2) that is business risk has been denied since the current research identified no meaningful association between sustainable growth of smes and fell out of model through employing step-wise regression testing. technology awareness (h3) is recognized, with a coefficient of 0.404. the p-value of the explanatory variable indicates that the association regarding technology awareness and the sustainable growth of smes is essential. the hypothesis (h4) explanatory variable access to credit is supported and its coefficient value is 0.190 and the outcome is important at a degree of importance which is 1 percent. hypothesis (h5) regarding explanatory variable complication of marketing and the coefficient value is 0.051 which is important at the point of importance which is 1 percent. the findings demonstrate a positive relationship between the complication of marketing and the sustainable growth of smes. learning and development with a coefficient value of 0.215 have a positive connection with the sustainable growth of smes. also agreed in the last hypothesis (h7) regarding managerial expertise and it represents a coefficient value of 0.085, which has a major impact on the sustainable growth of smes at a meaningful level. 5. conclusion sme’s are development drivers for emerging economies such as pakistan. sme’s make a significant contribution to job advancement which is attributing to poverty mitigation. this research explored components that influence sme’s in pakistan including government funding, business risk, technology awareness, access to credit, a complication of marketing, learning and development, and managerial expertise. the findings also endorsed that all indicators rather than business risk perform an important function in the growth of smes. business risk does not make a significant contribution well to the sustainable growth of smes in pakistan because they are not business risk likely to judgment. a non-risk-taker is due to issues with power, or although they do not use complicated production operations. government funding, access to credit, and technology awareness turn out to have been vital indicators contributing to sme’s growth. pakistani smes do not rely mostly on selling their goods or commodities in a challenging world of today. numerous sme’s owners are undereducated but the education system is presumed to have a major effect on the sustainable growth of smes. many enterprises tend to use their resources instead of pursuing certain replacements. pakistan's sme’s have tremendous opportunities and can be investigated and encouraged through pakistan. the government would accomplish it by implementing sme’s growth conferences or seminars to much more effectively inform participants about sme’s growth indicators. while most sme’s in pakistan are delighted about existing modest sales but therefore, not likely to expand their business. 5.1. future research potential studies upon that theme can determine by considering a bigger sample size because the findings of this study are restricted to punjab province. second, it is also important 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(2006). credit rationing and the financial structure of italian small and medium enterprises. journal of applied economics, 9(1), 167-184. available at: https://doi.org/10.1080/15140326.2006.12040643. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 99 asian journal of economics and empirical research vol. 5, no. 1, 99-111, 2018 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2018.51.99.111 interaction of monetary and macro-prudential policies: the case of jordancredit gap as an example rami obeid1  bassam awad2 1head of data analysis & management division, central bank of jordan, amman, jordan 2head of systemic risk & macro-prudential policy analysis division, central bank of jordan, amman, jordan ( corresponding author) abstract this study aims at investigating the extent of interaction between monetary policy and macroprudential policy in jordan during the period (2005-2015) using the vector error correction model (vecm) to check the presence of short-term and long-term impacts of the monetary policy tools in general on the accumulation of systemic risks in the banking system. systemic risk was measured using the credit gap. the results showed the existence of a statistically significant negative effect of deposit window rate and required reserve ratio on the accumulation of systemic risks, whereas the rediscount rate had a positive effect. keywords: macro-prudential policy, monetary policy, countercyclical capital buffer, credit gap. jel classification: e44; e52; e58; e61; g18. citation | rami obeid; bassam awad (2018). interaction of monetary and macro-prudential policies: the case of jordan credit gap as an example. asian journal of economics and empirical research, 5(1): 99-111. history: received: 18 july 2018 revised: 13 august 2018 accepted: 15 august 2018 published: 18 august 2018 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 100 2. research problem .......................................................................................................................................................................... 100 3. research questions ....................................................................................................................................................................... 100 4. importance of the research ......................................................................................................................................................... 100 5. research objectives ...................................................................................................................................................................... 100 6. research hypothesis ..................................................................................................................................................................... 100 7. literature review .......................................................................................................................................................................... 100 8. theoretical and empirical contribution of the paper ........................................................................................................... 101 9. macro-prudential policy............................................................................................................................................................... 101 10. systemic risk................................................................................................................................................................................ 102 11. financial stability ........................................................................................................................................................................ 103 12. macro-prudential policy instruments ..................................................................................................................................... 103 13. countercyclical capital buffer .................................................................................................................................................. 103 14. monetary policy and macro-prudential policy interaction................................................................................................ 104 15. monetary policy of the cbj....................................................................................................................................................... 105 16. the ratio of credit granted by banks to the private sector to gdp ............................................................................ 106 17. research methodology and econometric analysis .............................................................................................................. 107 18. estimating the econometric model ......................................................................................................................................... 110 19. conclusions and recommendations ......................................................................................................................................... 111 references ............................................................................................................................................................................................ 111 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2018.51.99.111&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/250 https://orcid.org/0000-0003-3829-5812 http://asianonlinejournals.com/index.php/ajeer/article/view/250 https://orcid.org/0000-0003-3829-5812 http://asianonlinejournals.com/index.php/ajeer/article/view/250 https://orcid.org/0000-0003-3829-5812 asian journal of economics and empirical research, 2018, 5(1): 99-111 100 1. introduction the last global financial crisis revealed the need for linking financial risks with economic risks through the socalled macro-prudential policy1. this policy aims at maintaining financial stability as an ultimate goal through identifying, monitoring and quantifying the systemic risks in the financial system as a whole (claessens et al., 2013). several studies, like claessens et al. (2013) stressed the necessity of coordinating monetary and macroprudential policies so that their objectives do not conflict. the interest of monetary authorities in the world in maintaining financial stability significantly increased after the conclusion of the global financial crisis through the newly emerged macro-prudential policy that was included to the duties of the monetary authorities in many world countries. the regulatory monetary authorities paid extra attention to the risks of the excessive credit expansion as it might lead to the accumulation of systemic risks. for example, the growth of household debt at higher rates than their income or net wealth might signal increases in credit risk for this sector, which in turn might adversely affect financial and economic stability. this entails on the banking sector to monitor the risks associated with the lending offered to the household sector. the expansion of credit to this sector must take into consideration these risks. the monetary authorities were made aware to the importance of continually monitoring and assessing systemic risks after the global financial crisis through the implementation of macro-prudential policy tools that alleviate the risks that the financial sector as a whole might be subjected to, and that enhance its capacity to withstand shocks. 2. research problem this study inspects the extent of the interaction between monetary policy and macro-prudential policy in jordan by examining the effect of the adjustments in monetary policy instruments on the accumulation of systemic risks in the banking system in jordan through realizing that adjusting monetary policy instruments do not lead to an increase in the credit gap,2 and, hence the accumulation of systemic risks in the banking system during the study period. 3. research questions the study tries to answer the following two questions: 1. has the use of monetary policy instruments led to the accumulation of systemic risk in the banking system during the study period? 2. do adjustments in monetary policy instruments lead to widening the credit gap in jordan? 4. importance of the research the importance of investigating the interaction of monetary policy with macro-prudential policy is due to the high interconnection between the two policies. if the monetary authority cut the interest rates on monetary policy instruments, the banks might react by cutting the interest rates imposed on credit facilities. this might consequently reduce the net interest margin in the banking system. in turn, this encourages the households to demand more borrowing and hence their indebtedness goes up excessively leading to accumulation of systemic risks possibly. the cut of the monetary policy interest rates might lead to increase in the value of assets fueled by the increasing demand on real estate loans that are offered at relatively lower costs (interest rates). the exaggerated real estate prices might create a financial crisis in case these prices decrease sharply by forces like economic downturns (beyer et al., 2017). 5. research objectives this paper aims at conforming to the regulatory authorities represented by the central banks the importance of coordination between monetary policy and macro-prudential policy changes in the monetary policy instruments interest rates might cause accumulation of systemic risks arising from excessive credit growth that is disproportionate to the growth in the real economy (gdp growth). this consequently might adversely affect the stability of both the financial system and the economic system. 6. research hypothesis the paper examines the following hypothesis: there is no effect of monetary policy instruments on the accumulation of systemic risks (the widening of credit gap) at 10.0% level of significance. 7. literature review there are several studies in the literature that researched the interaction between monetary policy and macroprudential policy. in general, the path of the investigation was through examining the effect of monetary policy on the accumulation of systemic risks. for example, goodhart et al. (2009) and illing (2006) found that the tight monetary policy might lead to an increase in default rates of borrowers from the banks, a decrease in bank's profitability rates and an increase in non-performing loans that collectively might cause an accumulation of systemic risk that might eventually cause a financial crisis (goodhart et al., 2009); (illing, 2006). dell'ariccia et al. (2010); borio and zhu (2012) and valencia (2014) inserted that the expansionary monetary policies might motivate banks to increase their risk appetite. in turn, they are encouraged to extend more credit at 1. the macro-prudential policy is defined as the policy under which systemic risk is identified, monitored and controlled to mitigate the accumulation of these risks and enhance the ability of the financial system to withstand shocks using a set of tools based on key indicators (central bank of jordan, 2012). 2the quarterly credit gap is calculated by dividing the amount of loans at the end of a given quarter by the annualized gdp – the value of gdp in the relevant quarter plus the gdp in the previous three quarters. the difference between this value (called actual credit to gdp ratio) and its long-term trend (extracted using the hodrick-prescott filter) is the credit gap asian journal of economics and empirical research, 2018, 5(1): 99-111 101 low interest rates. this might also be accompanied by insuficient assessment of their cleints' solvency before extending the credit. as a result, the systemic risk increases (dell'ariccia et al., 2010); (borio and zhu, 2012); (valencia, 2014). claessens et al. (2013) indicated that cutting interest rates on monetary policy instruments will make the banks cut their interest rates on the credit extended to their clients. consequently, the total size of credit facilities increases, leading to increase in asset prices and, hence, the accumulation of systemic risks (claessens et al., 2013). as for the credit gap determinants, the studies are small in this regard. this is mostly attributed to the fact that the credit gap concept came to attention after the recent global financial crisis. in this regard, the basel committee on banking supervision (bcbs) issued a guide in 2010 that includes an algorithm for calculating credit gap (basel committee on banking supervision, 2010). gersl and seidler (2012) surveyed the determinants of credit gap (as conceptualized by bcbs). they found that household consumption and per capita gdp both had a statistically significant positive effect on credit gap in the long run at 1.0% level of significance as the credit gap in the long-term rises with the rise in household's wealth and the increase in their consumption (gersl and seidler, 2012). similarly, the household consumption in the short run had a statistically significant positive effect on the credit gap at 5.0% level of significance. in contrast, inflation had a statistically significant negative effect on the gap at 10.0% level of significance. in light of the results of the econometric analysis, the study concluded that inflation and interest rates on monetary policy instruments are negatively related with credit gap. the decline in both the interest rates on monetary policy instruments and inflation rates result in lower interest rates on bank lending and, hence, higher demand for credit by households, leading eventually to widening in the credit gap (gersl and seidler, 2012). 8. theoretical and empirical contribution of the paper it is inevitable the importance of coordinating macro-prudential policy and monetary policy, especially since both policies, as it is mostly the case, are formulated by the monetary authority. the central bank of jordan is an example, the paper targets to enhance the capacity of cbj in evaluating the effect of monetary policy on credit gap in jordan, besides stressing the vital role of macro-prudential policy in curbing the buildup of systemic risk and the importance of policy coordination in general. and in particular, when credit grows excessively and disproportionately with the growth in the real economy leading to the accumulation of systemic risks and might create imbalances in the financial system and the economy as a whole. 9. macro-prudential policy there is a high degree of uncertainty when it comes to the concept of macro-prudential policy and its role in maintaining financial and monetary stability. this uncertainty includes its objectives, tools and management and implementation. there are varied opinions when it comes to the role of macro-prudential policy. for example, does the policy aim at protecting the banking and financial systems from the fluctuations in the economic cycle? if so, then the policy objective is maintaining financial stability. alternatively, does the macro-prudential policy aim at protecting the economy from the fluctuations in the financial cycle? if this is the case, then the macro-prudential policy is more oriented towards the macro-economy (akerlof et al., 2014). moreover, despite the presence of new supervisory authorities that are responsible for formulating and implementing the macro-prudential policy in both advanced and emerging economies, there are some ambiguities regarding the role of the policy, how to implement it and when it can be more effective (aikman et al., 2013). prior to the global financial crisis, there were no linkages (i.e. coordination) between the major economic policies (monetary and fiscal policies) and the micro-prudential policy (financial supervision). put differently, economic risks and financial risks were independent. economic policymaking does not take into consideration the financial risks that might emerge through the implementation of the policies, aiming solely at achieving price stability and maintaining sustainable economic growth. similarly, the micro-prudential policy (financial supervision) does not count for economic risks, targeting to achieve its own objective of maintaining the soundness of financial institutions on individual level only, but not collectively, therefore, the risk that the financial system as a whole might be vulnerable to and affected adversely by, the systemic risk, was not taken into consideration (figure 1). one of the lessons from the global financial crisis is that maintaining financial stability on the individual level of the institutions in the financial system is insufficient to maintain the stability of the financial system as the whole. figure-1. policies and objectives before the global financial crisis source: international monetary fund. asian journal of economics and empirical research, 2018, 5(1): 99-111 102 during the crisis, the financial positions of many financial institutions in the united states of america were relatively stable, but the bankruptcy of lehman brothers bank was followed by the collapse of other banks affected by the contagion risk. the crisis exacerbated further spread cross border from usa to hit the world so that the entire global financial system has been put to the test, which has adversely impacted the economies of countries outputting heavy losses for many years. in sum, the stability of both financial and economic systems can only be achieved if financial and economic risks are both taken into consideration when making economic and macroprudential policies decision. as a result of the global financial crisis, the supervisory authorities became aware of the vital importance of coordinating economic policies and micro prudential policies through the so-called macro-prudential policy that targets achieving and maintaining financial stability on the entire financial system’s level. this macro-prudential policy interlinks economic and financial risks to achieve its main objective (figure 2) through identifying, monitoring and controlling systemic risks using several tools that consider matching the developments in the financial system with the developments in the real economy. the macro-prudential policy curbs the ability of the financial system in extending credit through the activation of the appropriate macro-prudential instrument that is compatible with the stance of the economy. for example, during boost, the real estate prices might follow a fast and positive trend (put simply, real estate bubble) and can be therefore used as collaterals for loans, leading to increased demand for credit by individuals and households. during recessions, however, the situation is reversed, the real estate prices decrease sharply, leading to a decline in the value of the credit extended. the economic situation worsens even more as a result of the decline in the value of real estate asset as collateral for the credit extended and decline in the ability of households to repay their obligations. consequently, the bank sells the mortgages at lower prices than the value of the credit extended (as was with the global financial crisis). the macro-prudential policy mainly targets to control and supervise the ability of banks in extending excessive credit using the suitable instrument – during boost periods. thereby helps protect financial stability and economy from severe losses. figure-2. policies and objectives after the global financial crisis source: international monetary fund. the comparison of policies and objectives before and after the global financial crisis as shown in figure 1 and figure 2 respectively clearly shows the important role of macro-prudential policy. before the emergence of this policy, the micro-prudential policy was the actor in achieving its major goal of maintaining financial stability on the individual institutional level regardless of the economic policies in general and monetary policy in particular. similarly, the monetary policy directed toward achieving price stability and promoting economic activity regardless of the performance or stance of the micro-prudential policy. in the wake of the global financial crisis, decision makers in the regulatory authorities have alerted to the importance of balancing economic policies and micro-prudential policies so that these policies are linked. thus, the macro-prudential policy was developed to act as a link between micro-prudential policy and the economic policies. the objective of the macro-prudential policy is to achieve financial stability as an ultimate policy objective by using of some tools that take account of the prevailing conditions in both the financial and economic systems. in addition, the macro-prudential policy promotes the ability of financial and banking sectors to withstand economic and financial shocks that they may face at any time. under any circumstances, the macro-prudential policy needs support from the other economic policies in order to achieve its objectives. in this regard, the monetary policy must be conducted effectively (borio, 2012). 10. systemic risk one of the most important lessons that are learned from the global financial crisis that financial stability at the micro level of the banking system is insufficient to achieve financial stability at the macro level because of the socalled systemic risks that hit the whole financial system. the 2012 financial stability report published by the cbj defined systemic risks as the risks that affect the entire financial system (cbj, 2012). examples of systemic risks are: excessive credit growth that does not match the size of economic activity, in such a case, the credit is directed towards the nonproductive consumption sectors. for example, the banks' expansion of credit to the household sector might result in a slowdown in economic growth as a result of the increase in imports that negatively affects trade balance. asian journal of economics and empirical research, 2018, 5(1): 99-111 103 1. high exposure to assets (stocks and real estate) that witness a large increase, which might consequently lead to price bubbles. 2. high exposure of banks to the mostly nonproductive household sector at the expense of the productive corporate sector. bernanke defined systemic risk as "developments that threaten the stability of the financial system as a whole and consequently the broader economy, not just that of one or two institutions” (cbj, 2012). bank for international settlements, the international monetary fund and the financial stability board agreed on defining on defining systemic risk as “the risk of widespread disruption to the provision of financial services that is caused by an impairment of all or parts of the financial system, and which can cause serious negative consequences for the real economy” (fsb/imf/bis, 2009). in other words, systemic risks are costs or financial losses caused by that disruption reflected in either the financial sector or the real economy or both in case of occurrence of financial crisis. relying on the previous discussion, it can be concluded that systemic risk arises by the interaction of three forces: a financial shock, an interruption in the provision of financial services and the materialization of economic losses. 11. financial stability economists have put several definitions for financial stability. however, these definitions are similar in context despite different wordings. for example, laker (1999) indicated that in light of the fact that achieving financial stability is itself an objective, then “the objective of financial system stability could therefore be defined, in broad terms, as the avoidance of disruptions to the financial system that are likely to cause significant costs to real output” (laker, 1999); (alawode and al sadek, 2008). according to schinasi (2004) “financial stability is defined in terms of its ability to facilitate and enhance economic processes, manage risks, and absorb shocks. moreover, financial stability is considered a continuum: changeable over time …” (schinasi, 2004). he also pointed out that the financial system will stable if it promotes the performance of the economy and overcomes the financial imbalances arising from unexpected adverse events. in other words, financial stability is the case where the economic mechanisms of pricing and financial risk management (credit risk, liquidity risk, market risk, operating risk. etc.) are working in such a way as to contribute to the performance of the economy. in line with the previous discussion, it can be clearly concluded that the definition of financial stability is linked to the components and activities of the financial system. besides, the role of the monetary authority in achieving or maintaining financial stability is vital due to the fact that the monetary authority is usually the leader supervisory party on the banking and financial institutions. financial stability was defined by the cbj in its jfsr 2012 as the situation under which the financial system (that includes financial intermediaries like banks, markets stocks; derivatives and bonds, and market infrastructure like payment systems) is capable of withstanding shocks and adjusting imbalances without interrupting the financial intermediation process through facilitating the smooth flow of funds between savers and investors and, by doing so, help promote growth in economic activity (cbj, 2012). 12. macro-prudential policy instruments the macro-prudential supervision is defined as the supervision of financial institutions and their transactions on a macro level. therefore, the micro supervision on individual institutions is not part of the macro-prudential supervision mandate. the macro-prudential policy is defined as the policy under which systemic risk is identified, monitored and controlled to mitigate the accumulation of these risks and enhance the ability of the financial system to withstand shocks using a set of tools based on key indicators. the macro-prudential policy gained a special focus after the 2008 global financial crisis. based on the classification set by the committee on the global financial system with the bis, the macroprudential policy instruments are classified into three main categories, capital-based instruments, liquidity-based instruments and asset-side instruments. capital-based instruments include countercyclical capital buffers, sectorial capital requirements, and dynamic provisions; whereas liquidity-based instruments encompass net stable funding ratio and liquidity coverage ratio. asset-side instruments are loan-to-value ratio (ltv) and debt-to-income (dti) ratio. there is another classification of the macro-prudential policy instruments set by the imf. it divided the instruments into two main groups. one group is designed to mitigate systemic risk like the asset-side based tools. the other group of tools is designed to enhance the resilience of the financial system to withstand shocks like capital-based and liquidity-based tools. there are two determinants of the activation of deactivation of the macro-prudential policy instruments: 1. the appropriate timing for activating or deactivating the macro-prudential policy instruments. 2. the appropriate macro-prudential policy instrument(s). the financial cycle is considered a very important factor in determining the appropriate timing for operationalizing the macro-prudential policy instruments.3 at the boom stage of the financial cycle, the macroprudential policy instruments must be activated to curb the appetite of banks in offering credit to protect the economic and financial system from bearing severe losses in case dangers materialize. at the bust stage, the monetary policy instruments must be released to motivate the banks to provide credit to motivate the economy. 13. countercyclical capital buffer the proportionality of the growth of the credit granted to the private sector with the size of economic activity is one of the driving forces that ensure that credit is directed towards the productive economic sectors. this proportionality is abbreviated by the ratio of private credit to gdp. the importance of this ratio is that it measures 3financial cycle characterizes the behaviour of the credit-to-gdp ratio, quantity of credit, assets prices (real estate and stocks). akerlof, blanchard, romer and stigliz (2014). asian journal of economics and empirical research, 2018, 5(1): 99-111 104 systemic risks from a financial and economic perspective by examining the degree of harmony of two important macro indicators: (1) the credit granted to the private sector by banks and other financial institutions and (2) gdp. the bcbs released a guide to the relevant supervisory authorities entitled “guidance for national authorities operating the countercyclical capital buffer” (bcbs, 2010). the guidance details an algorithm for determining the amount of the countercyclical capital buffer that banks and financial institutions needed to maintain the proportionality of financial and real sectors trends. 1. collecting historical quarterly data of credit extended to the private sector by banks and other financial institutions and gdp. 2. calculating the credit-to-gdp ratio in period t. 3. estimating the trend of the ratio of private credit-to-gdp in period t using econometric software.4 4. calculating the credit-to-gdp gap. the credit-to-gdp ratio is compared to its long-term trend. if the credit-to-gdp ratio is significantly above its trend (i.e., there is a large positive gap), then this is an indication that credit may have grown excessively relative to gdp growth. in mathematical terminology, gap = (credit/gdp*100%)-trend. if this gap is greater than 10.0%, then the authorized entity mandates the banks to add a buffer to its capital equal to 2.5% of risk-weighted assets (rwa). moreover, if this gap is less than 2.0%, then the authorized entity does not mandate banks to make any additions. finally, if this gap ranges between these two limits (2.0%-10.0%), then the authorized entity mandates the banks to add a buffer to its capital equal that ranges between 0.0% and 2.5% of risk-weighted assets (rwa) based on the formula: ⁄ ( ). 14. monetary policy and macro-prudential policy interaction the coordination of macro-prudential and monetary policies is elements that must be considered when formulating a framework for macro-prudential policy since both policies aimed at achieving financial stability and affecting real economic variables. both macro-prudential policy and monetary policy to influence the price and quantity of credit in the economy, which in turn is likely to affect overall economic activity, the contradiction could take place with the implementation of these two policies. for example, using one or more monetary policy instruments targeting to cut down interest rates leads to an increase in the amount of credit in the economy. at the same time, the macroprudential policy while keeps an eye on credit growth might use some instruments to curb the growth of credit above desired limits (long-term trends) through the activation of one more macro-prudential policy instruments. similarly, real economic activity and interest rates influence systemic risk via their impact on the size of credit that is considered one of the most important factors that lead to the accumulation of systemic risk in the financial sector. moreover, both monetary and macro-prudential policymakers build their decisions in practice using similar data, pointing to potential interactions. for example, financial conditions such as lending conditions and credit size are important information sources for monetary policy and would of course constitute core inputs to macroprudential policymaking. on the other hand, the macro-prudential policymaker would also take the state of the business cycle and the stance of monetary policy into account in deciding the appropriate macro-prudential instruments. the paper of claessens et al. (2013) about “interaction of monetary and macro-prudential policies" stressed the importance of monetary and macro-prudential policies' coordination even though the task cannot be easily performed. the policy coordination will most likely have positive effects on enhancing financial stability since monetary policy helps in maintaining the balance in the economy, and the macro-prudential policy aims at addressing the imbalances in the financial system. the absence of coordination between the two policies might a failure of each of them in achieving its objective. the previous reveals the importance of both policies being managed by the monetary authorities. the existence of a single institutional framework reduces the possibility of conflicting independent policy decisions. price stability the ultimate goal of monetary policy does not guarantee economic stability in the absence of effective treatment of macro-financial risks that are within the tasks of macro-prudential policy. empirical evidence has shown that the instability in the financial system undermines the stability of the economy even if the inflation rate is maintained stable and low. the macro-prudential policy instruments are complementary to monetary policy instruments in countering the cyclical fluctuations of the economy. in this regard, some instruments of the macro-prudential policy (e.g., capital adequacy and loan-to-value (ltv) ratio) that do not only achieve the macro-prudential policy objectives, but also the objectives of monetary policy (federico et al., 2014); (tovar et al., 2012). therefore, policymakers paid more attention to the relationship between the two policies. as previously stated, monetary policy is primarily aimed at maintaining price stability; while the macroprudential policy is primarily aimed at maintaining financial stability. the relationship between monetary policy and macro-prudential policy is counterbalanced by the "side effects" resulting from each one of another. these interactions could enhance or downgrade the effectiveness of each policy in achieving its objectives (gerlach et al., 2009). for example, monetary policy instruments might encourage banks to expand credit in a period when the macro-prudential policy is aimed at controlling the leverage ratio. the activation of one of the macro-prudential policy instruments to reduce credit granted by banks to the private sector might lead to a contradiction in case of adopting an expansionary monetary policy aiming at promoting economic growth. in the existence of coordination between the two policies, they are supportive of each other. for example, the absence of reaction of economic variables to a deflationary monetary policy can be resolved by imposing a ceiling on the ltv ratio instrument of macro-prudential policy and thus controlling the banks' capacity to grant excessive credit (igan and kang, 2011). similarly, the absence of reaction of economic variables to an expansionary monetary policy can be resolved by cutting down on the limit of ltv ratio as an instrument of macro-prudential policy and thus enhancing the banks' capacity to grant more credit. any increase in banking risk arising from the 4 one of the most commonly used software in this kind of research is e-views that can be used to estimate trend using the hodrick-prescott (hp) filter. asian journal of economics and empirical research, 2018, 5(1): 99-111 105 expansionary monetary policy and the reduction of the ltv ratio can be controlled by raising capital requirements, liquidity or leverage. 15. monetary policy of the cbj the cbj continued to implement monetary policy to achieve monetary and financial stability in the kingdom, by continuing to follow economic conditions and various relevant variables and then using all the tools available at the appropriate time for achieving those goals. these tools are divided into main interest rates and open market operations. within the context of the cbj’s strategy of continuous development of its monetary policy tools to achieve its objectives in line with the economic and monetary conditions, it has established an operational framework of monetary policy and its tools to determine their effectiveness in achieving the objectives of monetary policy. because of the aforementioned revision, since 2012, the cbj continuously review and update the monetary policy operational framework and its tools. the most recent update granted the commercial banks and the cbj more flexibility in managing liquidity in line with financial and monetary conditions under the high volume of financing needs for jordan. 15.1. updating the monetary policy operational framework 15.1.1. temporary open market operations these operations are designed to enhance open-market operations to influence the size of the excess reserves and adjusting overnight interbank rates within the corridor system and targeting market interest rates at the desired level of monetary policy, by introducing the securities repurchase agreements for a week to a month through auctions conducted by the cbj. 15.1.2. outright open market operations this tool provided the cbj of the ability to access the money market as a seller and buyer of government securities and guaranteed pump or withdrawal liquidity in accordance with the requirements of economic activity, and to enhance the role of the secondary market dealing in bonds. 15.1.3. currency swap according to this tool, the cbj made several foreign currency swaps in jordanian dinars in response to requests by licensed banks to strengthen the dinar liquidity of banks. 15.1.4. corridor system where this system is used in the implementation of monetary policy, it aims at adjusting to influence the overnight interbank interest rate, which in turn affects interest rates in the market. the overnight deposit interest rate represents the floor of the system while the repurchase agreement interest rate represents the ceiling of the system. the repos are initiated by banks in case they needed liquidity with no limits for one night only. the interest rate on the overnight repos is the upper limit in the corridor system. whereas the overnight deposit window transactions are initiated by banks as well but their interest rates are the lower limit of the corridor system. figure 3 shows the trends of the overnight deposit window rate, the overnight repos rate (and the corresponding corridor system) and the overnight interbank loan rate, as might be realized from the figure that the overnight interbank interest rate moving between the overnight deposit interest rate and the repos rate. figure-3. overnight interbank interest rate, overnight deposit window interest rate and repos interest rate (2005-2015) source: statistical database, cbj. 15.1.5. cbj main rate at the beginning of 2015, cbj adopted this price as a main interest rate for managing the monetary policy. the cbj main rate was decided to range between 2.5% and 2.75% (expressed in terms of repos for one week). this action aims to give clear signals about the stance of monetary policy and orientation about the domestic and international economic monetary and economic conditions. asian journal of economics and empirical research, 2018, 5(1): 99-111 106 15.1.6. certificates of deposit (cds) to develop liquidity management tools to enhance the ability of banks to manage their liquidity efficiently and effectively, the cbj issued certificates of deposit with specific maturities and values in 2015 for the first time since 2008. this aims to attract part of the liquidity of banks through auctions within the range of pricing determined by the cbj in accordance with the terms of this tool. 15.2. traditional monetary policy instruments regarding the traditional monetary policy instruments, the cbj have manipulated these instruments several times in the past few years in the light of the conditions, developments, and challenges the jordanian economy faces as reflected on the trends in major macroeconomic variables like the stock of foreign reserves, current account deficit and inflation rates. other drivers for the policy instruments changes included enhancing a growthenhancing environment and availing of credit at reasonable costs for financing various economic activities. table 1 summarizes the main developments in rediscount rate and interest rates on overnight repurchase agreements and overnight deposit window, besides overnight interbank lending interest rate5 and required reserve ratio on bank deposits. table-1. monetary policy instruments rates (2005-2015) (%) year rediscount rate overnight repurchase agreements rate overnight deposit window rate weighted average of interbank overnight lending rate required reserve ratio on bank deposits 2005 6.50 7.50 4.50 4.63 8.00 2006 7.50 8.50 5.25 6.50 8.00 2007 7.00 6.75 4.75 5.15 8.00 2008 6.25 6.00 4.00 4.65 9.00 2009 4.75 4.50 2.50 2.65 7.00 2010 4.25 4.00 2.00 2.15 7.00 2011 4.50 4.25 2.25 2.92 7.00 2012 5.00 4.75 4.00 4.31 7.00 2013 4.50 4.25 3.50 3.79 7.00 2014 4.25 4.00 2.75 2.94 7.00 2015 3.75 3.50 1.50 1.96 7.00 source: cbj. 15.3. macro-prudential policy at the central bank of jordan the 2008 global financial crisis highlighted the importance of maintaining financial stability. the discussion of monetary and fiscal policies is no longer separated from policies related to policies targeting to control systemic risk. therefore, there is a vital need to focus on developing instruments for managing macro-prudential policy at central banks that consider the objective of maintaining financial stability on the macro level (arab monetary fund, 2017). 16. the ratio of credit granted by banks to the private sector to gdp the ratio of credit provided by the financial institutions to the private sector to gdp is a very important ratio that measures the consistency of the credit granted to the private sector with the pace of economic activity. in other words, this ratio can be visualized as an assessment of directing funding to the productive sector rather than concentrated in the consumption sectors and/or real estate and assets sector. the excessive lending to the later sectors might lead to jumps in asset prices and creating price bubbles that adversely affect economic and financial stability. the importance of this ratio was highlighted after the 2008 global financial crisis. economists in general and monetary authorities in specific were criticized for not linking economic indicators with financial indicators when building their projections about the risks of economic and financial crises in the future. the importance of this ratio is that it measures systemic risk from both economic and financial prospects through monitoring and analyzing the harmony and consistency of two important indicators: the credit granted by banks and other financial institutions to the private sector and the gross domestic product. the ratio is compared to its long-term trend. the difference between the two variables is called credit gap. systemic risks increase as the larger the difference of the ratio from its long-term trend (cbj, 2012). per basel iii guidelines, the banks must maintain a countercyclical capital buffer to counteract any possible adverse consequences of the fluctuations in economic and financial cycles. the buffer ranges between 0 and 2.5% of the risk-weighted assets of common-equity capital (cet1) that is applied gradually on a span of four years, given that minimum stable funding is available to banks, besides some minimum liquidity levels that enhance the capacity of banks in meeting their obligations toward their customers. the result of the analysis of the credit gap in jordan revealed that the gap was below 2.0%. it reached about 1.1% at the end of 2015. therefore, the countercyclical capital buffer tool of macro-prudential policy does need to be activated. therefore, the growth of credit granted to the private sector by the financial institutions is consistent with the growth in the real economy – the gdp. it worth mentioning that the gap exceeded 2.0% just before the 2008 global financial crisis, it ranged between 4.1% and 8.4% during the period (q4:2006-q3:2008). this means that during that period, there was a vital need for activating the countercyclical capital buffer tool of macro-prudential policy (assuming that it the tool was available during this period). this gives an important lesson that systemic risks can be clearly evaluated using the analysis of the credit gap. figure 4 depicts the actual credit-to-gdp ratio, its trend and credit gap for the period (2005-2015). 5the overnight interbank lending interest rate is not a monetary policy instrument but included in the discussion for its importance as being targeted and managed indirectly by monetary policy instruments. asian journal of economics and empirical research, 2018, 5(1): 99-111 107 figure-4. credit-to-gdp ratio, its trend and credit gap (2005-2015) (%) source: authors’ calculations using the cbj databases. 17. research methodology and econometric analysis 17.1. data sources and sample regarding the effect of monetary policy instruments on the credit gap for all the commercial banks working in jordan during the study period (19 banks), the study relied on the quarterly data obtained from the cbj's database published on its website. 17.2. the model used for measuring the effect of monetary policy instruments on systemic risk accumulation in the banking system regarding the model used to estimate the effect of monetary policy instruments on the accumulation of systemic risk in the banking system in jordan, it was as follows: where g: credit gap. it is the deviation of the actual ratio of credit granted by the commercial banks to the private sector to gdp from its long-term trend estimated using the hodrick-prescott (hp) filter. r: required reserve ratio. which is a percentage imposed on banks’ deposits and held at the monetary authority – usually the central bank without getting any interest returns. the goal of this ratio is providing the minimum liquidity requested by any commercial bank. the high this ratio, the lower the excess liquidity available at banks (if any) and, hence, the lower the credit available for granting loans. in contrast, the lower the required reserve ratio, the higher the excess liquidity at banks and the higher the amounts available for extending credit facilities. w: overnight deposit window rate. which is the rate paid on excess liquidity of banks, the commercial bank deposit this liquidity in the cbj for one night. the higher the interest rate paid by the cbj on the overnight deposit window, the more willing are banks to deposit their excess liquidity at the cbj instead of offering more loans to their clients, conversely, the lower the rate, the less willing and more reluctant the banks to deposit their excess liquidity using this window at the cbj. consequently, the excess liquidity is offered to the bank clients, it worth mentioning that the overnight deposit window rate mirrors the attractiveness of the jordanian dinar. d: the discount rate. also called rediscount rate, or bank rate, interest rate charged by the cbj for loans of reserve funds to commercial banks and other financial intermediaries. the banks may approach this path in order to obtain more funds for granting credit facilities. the higher the rate, the more reluctant banks to ask for loans, the lower the liquidity. the nature of the relationship between these independent variables and credit gap depends on their effect on credit (the numerator of the credit-to-gdp ratio) and gdp (the denominator of the credit-to-gdp ratio). for example, if the relationship between any of the independent variables in the previous equation (required reserve ratio, overnight deposit window rate and discount rate) and the credit gap is negative. this is attributed to the fact that cutting these rates increased credit more that the gdp. therefore, the lower these rates, the higher the liquidity levels at banks. consequently, they will offer more credit and hence possibly systemic risks might build up. put differently, both interest rates and economic activity affect systemic risk through their effect on asset prices and leverage at the bank (cbj, 2012). 17.3. econometric analysis before estimation 17.3.1. correlations the strength of the relationship among study independent variables are used to examine the presence of the problem of multicollinearity. this problem is considered severe in case the correlation coefficient between two independent variables exceeds 0.80 (obeid and adeinat, 2017). table 2 shows the correlation matrix for the model's variables, which are required reserve ratio, overnight deposit window rate and the discount rate. as appear from the table, all correlations in the matrix are accepted and less than 0.7. therefore, there is no need for testing multicollinearity using the vif test. asian journal of economics and empirical research, 2018, 5(1): 99-111 108 table-2. model's correlation matrix d w r 3.96.0 3.9630 1.0000 r 3.9696 1.0000 3.9630 w 1.0000 3.9696 3.96.0 d source: authors’ calculations 17.4. stationary test before analyzing the results of the econometric model, the stationarity of time series must be tested to examine the presence of unit root problem in any of the model variables. adf and pp test were conducted to test for stationarity and degree of cointegration. as many time series are non-stationary because of the presence of unit root in its structure. the unit root in time series means that the mean and the variance of the variable are not time invariant. the assumption of stationarity in time series that includes unit root in econometric models leads misleading statistical results – the so-called spurious regression. the analysis and econometric inference as well will be misleading and defective despite the high value of the coefficient of determination (r2) and t-statistic. adf and pp tests are the most commonly used tools for testing the stationarity of a time series and the determination of its degree of cointegration. table 3 shows the results of the two tests. as appears from the table, the independent variables of the model were level non-stationary but attained stationarity at taking the first difference, indicating a degree of cointegration of i(1). similarly, the dependent variable was level; nonstationary in the estimations that included no intercept and/or trend for both adf and pp tests. table-3. stationarity testing using adf & pp tests for the study variables level first-differences c c+t none c c+t none adf g -2.1602 -2.563 -2.0498** -5.6363*** -5.0630*** -5.7059*** r -2.2431 -3.0848 -0.5274 -7.9554*** -7.8556*** -8.0267*** w -0.4721 -3.1054 -0.6399 -4.2642*** -4.3858*** -4.2835*** d -0.6559 -3.1374 -0.364 -3.5679** -3.6891** -3.6025*** pp g -2.35 -2.6629 -2.2448** -5.6004*** -5.4984*** -5.6798*** r -2.13 -3.0816 -1.1373 -10.188*** -10.024*** -9.6433*** w -1.2639 -2.4733 -0.7148 -4.3662*** -4.5880*** -4.4055*** d -1.347 -3.1873 -0.428 -3.4734** -3.6947** -3.5221*** significant @ 1.0%***, 5.0%** and 10.0%* c: constant, t: trend 17.5. cointegration testing following the results of the stationarity testing for the model variables that indicated a first-difference stationarity, the test for cointegration of the model variables must be conducted. in case the test showed the presence of cointegration, the long-term relationship can be predicted. the most common method used for testing cointegration is johansen method. according to this test, the null hypothesis for the trace test is that the number of cointegration vectors is less than or equal r. the test helps determine the coefficient of the speed of adjustment. johansen method includes two tests: trace and maximum eigenvalue. table 4 lists the results of tests. as appears from the table, trace test shows that there exist at least three long-term relationships among the variables, whereas the maximum eigenvalue test shows that there exist at least two long-term relationships among the variables. consequently, the vecm can be used. table-4. cointegration of model variables using trace and maximum eigenvalue methods unrestricted cointegration rank test (trace) null hypothesis eigenvalue trace statistic 5% critical value prob. none * 0.6660 82.3496 47.8561 0.0000 at least 1 * 0.4555 39.5819 29.7971 0.0027 at least 2 * 0.2703 15.8761 15.4947 0.0438 at least 3 0.0878 3.5845 3.8415 0.0583 unrestricted cointegration rank test (maximum eigenvalue) null hypothesis eigenvalue max-eigen 5% critical value prob. statistic none * 0.6660 42.7678 27.5843 0.0003 at least 1 * 0.4555 23.7057 21.1316 0.0212 at least 2 0.2703 12.2917 14.2646 0.1002 at least 3 0.0878 3.5845 3.8415 0.0583 source: authors’ calculations based on the results of stationarity and cointegration tests, the paper uses the vector error correction model (vecm) to measure the impact of monetary policy instruments on credit gap in jordan. this test link between short-term and long-term changes for the variables used in the study during the adjustment process, until reaching the long-term balance. this model can be applied for small samples according to greene (2007) cointegration relationship is required (by johansen method) before applying this model. error correction method requires data that have the same degree of integration at level and differences in the same equation, the deviations from a longrun equilibrium are corrected gradually by the dynamics and partial adjustments in the short terms. in light of the results of the cointegration test, the long-term relationship can be checked using vecm. asian journal of economics and empirical research, 2018, 5(1): 99-111 109 regarding the calculation of the optimal number of lags (lag length selection), table 5 shows that the optimal number of lags for both models and using both aic and hqc is seven. however, when using the vecm model, one lag will be eliminated, maintaining six lags for the model. it is worth mentioning that the selection of optimal lag periods depends on the frequency of the used data. the number of lag periods is usually small for the annual data, and it gets bigger the more the data frequency. table-5. results of optimal lag length selection using akaike information criterion (aic) and hannan-quinn criterion (hqc) lag aic hq 0 -26.50 -26.44 1 -32.70 -32.39 2 -32.10 -31.55 3 -32.25 -31.45 4 -32.36 -31.31 5 -32.82 -31.54 6 -33.25 -31.72 7 -35.38 -33.60 source: authors’ calculations 17.6. stability test in order to investigate the existence of any structural changes in the model variables (or, alternatively, the presence of structural stability), this paper examined the stability of the long-term parameters together with the short-term movements for the model utilizing the cumulative sum (cusum) and cumulative sum squares (cusumsq) tests proposed by borensztein et al. (1998). these tests show any structural change in the data, in addition to clarifying stability and harmony between the long term and short-term parameters (borensztein et al., 1998). the existence of structural stability for the estimated parameters can be verified using graphical representation. if the plot of both tests cusum and cusumsq stay within the critical 5% level bounds, there is structural stability in the model. from figure 5 and figure 6 it can be realized that both plot of cusum and cusumsq stay within the critical bounds, thus we can confirm the long-term relationships among model variables at 5.0% level of significance, implying that there exists a harmony and stability in the model for the short-term and long-term results. figure-5. plot of cusum of the model source: authors’ calculations using the cbj databases. figure-6. plot of cusumsq of the model source: authors’ calculations using the cbj databases. 17.7. diagnostic testing table 6 shows the results of the diagnostic testing of the study model. the tests included heteroscedasticity (is present when the size of the error term differs across values of an independent variable), autocorrelation (the error terms are correlated with one another) using lm test, and normality of distribution using jarque-bera test. the table shows that the probability of the three tests is well above 5.0% implying that the model does not suffer from any of these distortions that impact the validity of analysis. asian journal of economics and empirical research, 2018, 5(1): 99-111 110 table-6. diagnostic testing of the vecm model chi-square 389.5853 residual heteroscedasticity test prob. 0.2321 lm-stat. 13.28028 residual autocorrelation lm test prob. 0.6522 jarque bera 0.27297 residual normality test prob. 0.8724 source: authors’ calculations 18. estimating the econometric model the results of the standard model estimation (table 7) show that there are two monetary policy instruments that have a negative effect on the credit gap in the model. they are the required reserve ratio and the overnight deposit window interest rate. the effect of the discount rate on the credit gap was positive. in detail, the results showed that there is a statistically significant negative effect of the required reserve ratio on credit gap at 1.0% level of significance, which clearly indicates that the reduction of the required reserve ratio by the cbj lead to the injection of liquidity into banks that in turn utilize it to extend more credit to their clients leading to accumulation of systemic risk in case the credit did not target the productive sectors. allocating more credit to consumption sectors (households) rather than to productive sectors (companies) may lead to a discrepancy between credit growth and gdp growth and, hence, widening the credit gap. the gap may widen further if consumption credit facilities lead to increase in imports, which in turn may increase the deficit in the trade balance, resulting in a slowdown in economic growth. as for the interest rate on the overnight deposit window, the negative effect of this variable on the credit gap was significant 1.0%. cutting the interest rate on the overnight deposit window by the cbj reduce the banks' desirability to deposit their surplus liquidity with the cbj. instead, they will seek other ways to utilize their surplus liquidity at higher returns. therefore, banks will increase the amount of credit extended, which will lead consequently to the accumulation of systemic risk and, hence, increase the credit gap in the same mechanism indicated previously about the effect of the required reserve ratio. finally, the effect of the discount rate on the credit gap was a significantly positive at 1.0%. the reduction of the discount rate by the cbj led to an increase in the credit but at a rate less than the increase in gdp, which resulted in a decrease in the credit gap. conversely, if the cbj raises the discount rate, this will decrease credit at lower rates than the decrease in gdp and hence widen the credit gap. using the results in table 7, the vecm model can be formulated to include long-term and short-term elasticity in addition to the error correction coefficient as follows: ( ) [ ] ( ) as shown in table 7, the error correction coefficient is statistically significant, which implies that this term helps explain the changes in the credit gap. it indicates that about 45.0% of the deviations of the credit gap from its long-term trend are corrected during a period not greater than three quarters. table-7. vecm model estimation long-term variable coefficient standard error t-statistics d(-1) -2.6575 0.8216 -3.2345 w(-1) 4.2426 0.5722 7.4147 r(-1) 5.6175 1.2327 4.5570 short-term coineq1 0.4514 0.1967 2.2947 d(g(-1)) 0.6640 0.4475 1.4837 d(g(-2)) 0.8133 0.4453 1.8266 d(g(-3)) 0.1300 0.2939 0.4424 d(g(-4)) -0.0315 0.3524 -0.0895 d(g(-5)) -0.1324 0.2401 -0.5514 d(g(-6)) -0.3096 0.2648 -1.1694 d(d(-1)) 1.3539 2.7609 0.4904 d(d(-2)) 2.0489 2.2091 0.9275 d(d(-3)) 2.8283 2.5793 1.0965 d(d(-4)) 0.5564 2.0371 0.2731 d(d(-5)) 0.2538 1.9016 0.1335 d(d(-6)) -0.1465 1.7128 -0.0855 d(w(-1)) -1.3687 1.5749 -0.8691 d(w(-2)) -1.6557 1.3864 -1.1942 d(w(-3)) -1.1623 1.6544 -0.7026 d(w(-4)) -1.7004 1.7874 -0.9514 d(w(-5)) 1.2195 1.6365 0.7452 d(w(-6)) -1.0555 1.8318 -0.5762 d(r(-1)) 0.7585 1.3887 0.5462 d(r(-2)) 0.3579 1.0341 0.3462 d(r(-3)) 0.0291 0.9272 0.0314 d(r(-4)) 2.1994 0.8368 2.6282 d(r(-5)) 0.2762 0.9147 0.3019 d(r(-6)) 0.2122 1.0380 0.2044 c -0.0068 0.0039 -1.7137 r2=0.77, adjusted r-squared=0.26, f-stat.= 1.500570 asian journal of economics and empirical research, 2018, 5(1): 99-111 111 the estimation results of the model revealed that there exists an inverse short-term and long-term relationship required reserve ratio and credit gap. the elasticity of the long-term relationship roughed 2.53, meaning that a 10.0% decline in the required reserve ratio, for example, leads to an increase in the credit gap by 25.3%, ceteris paribus. for the overnight deposit window, the results showed a negative effect on the credit gap, both in long and short terms. the elasticity of the long-term relationship roughed 1.91, meaning that a 10.0% decline in the overnight deposit window rate leads to an increase in the credit gap by 19.1%, ceteris paribus. finally, regarding the discount rate, the results showed a positive effect of the rate on the credit gap, both in long and short terms. the elasticity of the long-term relationship roughed 1.20, meaning that a 10.0% decline in the overnight deposit window rate leads to an increase in the credit gap by 12.0%, ceteris paribus. 19. conclusions and recommendations 19.1. conclusions this study investigated the interaction between monetary policy and macro-prudential policy using the vector error correction model to test the existence of an impact (short-term or long-term) of monetary policy instruments in general, and the overnight deposit window in particular, on the accumulation of systemic risk in the banking sector. the systemic risk was measured by credit gap as detailed in the main text. the results showed that there exists a statistically significant negative effect of both the required reserve ratio and overnight deposit window and a statistically significant positive effect of discount rate on the dependent variable credit gap. 19.2. recommendations 1the central bank of jordan should manipulate the monetary policy instruments prudently so that it takes into consideration their direct and indirect effect on the net interest margin and credit. 2the cbj should coordinate monetary policy and macro-prudential policy in order to clearly characterize the systemic risks and assess their impact on both economic and financial systemic. in particular, the impact of any monetary policy instrument must be clearly projected before manipulating that instrument. references aikman, d., a.g. haldane and s. kapadia, 2013. operationalising a 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licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 1, 36-45, 2020 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2020.71.36.45 © 2020 by the authors; licensee asian online journal publishing group the effect of mergers and acquisitions on bank performance in ghana alhassan musah1 mohammed abdulai2 hilda baffour3 ( corresponding author) 1school of business, dominion university college, accra, ghana. 2department of distance education, university of ghana, accra, ghana. 3kwame nkrumah university of science and technology, ghana. abstract the study examined the consequence of mergers and acquisition on bank performance in ghana. specifically, the study investigated the effect of mergers and acquisition on net profit margin, return on assets and return on equity of commercial banks in ghana. data from the annual reports of eight (8) commercial banks over a 10-year period (2009-2018) were collected and analysed by the use of descriptive statistics, correlation analysis, and regression analysis. the findings revealed a negative and significant association between mergers and acquisition and net profit margin. there existed a positive but statistically insignificant relationship between mergers and acquisition and return on assets of commercial banks in ghana. further, there was a negative but statistically insignificant relationship between mergers and acquisition and return on equity. the results, however, could not establish a conclusive evidence of the impact of mergers and acquisition on bank performance, implying that mergers and acquisition might not necessarily improve bank financial performance. keywords: merger and acquisition, profit margin, roa, roe, performance, banks. jel classification: g21, g34. citation | alhassan musah; mohammed abdulai; hilda baffour (2020). the effect of mergers and acquisitions on bank performance in ghana. asian journal of economics and empirical research, 7(1): 36-45. history: received: 22 november 2019 revised: 30 december 2019 accepted: 3 february 2020 published: 26 february 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 37 2. literature review ............................................................................................................................................................................ 38 3. methodology ..................................................................................................................................................................................... 40 4. discussion of findings .................................................................................................................................................................... 43 5. conclusion ......................................................................................................................................................................................... 44 references .............................................................................................................................................................................................. 44 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1356 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.71.36.45&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2020, 7(1): 36-45 37 © 2019 by the authors; licensee asian online journal publishing group contribution of this paper to the literature the study extends previous studies on the effect of mergers and acquisition on financial performance which focused on smaller samples and case studies to using a sample of all commercial banks that have been involved in mergers and acquisition in the last 10 years. the results therefore represent a more comprehensive study on how mergers and acquisition affect financial performance of commercial banks in ghana. 1. introduction mergers and acquisition falls under inorganic or artificial growth which has attracted attention all over the world and across all sectors (oduro and agyei, 2013). the objective of most mergers and acquisition is to propel growth and ultimately maximize shareholders’ growth (maama et al., 2017; mensah and onumah, 2017). several reasons have been given for corporations trying to grow using mergers and acquisition rather than through natural growth. it is estimated that as far as 2008, the global mergers and acquisition market was worth $3.280 billion, which was a reduction of 29% from the 2007 estimate (amewu, 2014). the high numbers in global mergers and acquisitions have also resulted in several academic literatures on the subject matter in various countries and industries (haleblian and finkelstein, 1999). saboo et al. (2017) argue that one of the biggest drivers of mergers and acquisition is the motivation to eliminate or reduce competition. it also helps to increase the size and operations of firms in order to enable them enjoy economies of scale, which could improve their performance in terms of profitability (harvey, 2015). according to harvey (2015) firms adopt mergers and acquisition as one of the most useful corporate strategies to help respond to changes in the business environment and globalization. zaremba and płotnicki (2016) see mergers and acquisition as part of corporate restructuring, which allows companies to re-establish or improve their competitive advantage in the industry. aggarwal and singh (2015) posits that corporate restructuring through mergers and acquisition is intended to skip some steps in the ladder of growth. one of the most profitable growth strategies a firm can adopt in today’s competitive environment is through mergers and acquisitions (cho et al., 2016). companies also use mergers and acquisition as a risk management strategy, which helps the company to diversify risk and enhance its value (agbloyor et al., 2012). additionally, mergers and acquisition helps company to gain market power and become dominant players in the industry they operate (amewu, 2014). some studies even argue that synergies and tax benefits are also important considerations in corporate mergers and acquisitions (harvey, 2015). mergers and acquisition could also be a means to improve managerial skills or technological enhancement and innovation, improve liquidity and eliminate inefficiencies (seidu, 2009). companies especially multinational companies can use acquisition as a means to enter new market or diversify their operations (harvey, 2015). in spite of the above, some researchers are of the view that mergers and acquisitions can bring negative consequences if the process is not properly managed (altunbaş and marqués-ibanez, 2008; joash and njangiru, 2015). it has been established in literature that not all mergers and acquisitions resulted in improvement of the fortunes of the acquirer and make them better. mergers and acquisitions in ghana have been a normal phenomenon in most industries involving both private sector business and public sector business (oduro and agyei, 2013). the earliest form of mergers and acquisition were driven by government’s privatization agenda, which saw most state-owned enterprises taken over or sold to private entities. in the last two decades, businesses in the private sector have also engaged in some form of mergers and acquisitions. in the telecommunication sector, vodafone acquired ghana telecom, airtel acquired zain, mtn acquired areeba and recently the merger between airtel and tigo to form airteltigo. in the insurance industry, provident insurance acquired old mutual, prudential plc acquired express life etc. in the food and beverage industry, there is the merger and acquisition between fan milk international and abaraaj food industries. in the pharmaceutical industry, dannex pharmaceutical company acquired starwin products and aryton drugs manufacturing limited. the highest number of mergers and acquisition in ghana perhaps can be found in the banking industry (barnor and adu-twumwaah, 2015; yeboah et al., 2015). studies shows that a significant part of these mergers and acquisitions in the ghanaian banking sector were driven largely on account of recapitalization where the bank of ghana asked commercial banks to increase their capital to a certain threshold (amewu, 2014; salami, 2015). however, some mergers and acquisitions were not directly linked to the recapitalization program as they already had the needed capital. the first of such mergers and acquisition was societe generale’s acquisition of social security bank in 1994 (salami, 2015). since then a number of acquisitions have taken place including, but not limited to ecobank ghana acquiring the trust bank, fortiz private equity’s acquisition of merchant bank ghana, access bank acquired intercontinental bank ghana, capital bank and ut bank were absorbed or acquired by gcb bank, fidelity bank acquired procredit, bank of africa acquired amalgamated bank ghana limited etc. what is not clear is whether all of these acquisitions have resulted in improvement in the performance of the acquired banks. what is clear, however, is that some acquisitions have increased the market share and power for some acquirers. a good example in this case is ecobank ghana, which became the largest bank after it completed the acquisition of the trust bank, a position which was held by gcb bank. some other leading banks in the country have also used mergers and to gain market control and boost their position in the industry ranking. apart from ecobank ghana that moved up the ranking in terms of size after it acquired the trust bank, fidelity bank ghana also moved up the ladder from second tier bank based on price water house coopers banking classification to first tier. the goal of most mergers and acquisition is to improve performance, reduce risk, tax considerations, synergies, improve economies of scale, eliminate competitions and enhance competitive advantage (barnor and adutwumwaah, 2015; harvey, 2015; maama et al., 2017). the ownership and capital structure of most banks have changed drastically as a result of mergers and acquisitions in recent times (barnor and adu-twumwaah, 2015). from the policy point of view, the focus of policy makers is usually how mergers and acquisitions in the banking sector can affect the conduct of monetary policy (maama et al., 2017). studies have shown that increase in banking concentration results is an increase in the interest rate on loans, which improves the performance of banks in such asian journal of economics and empirical research, 2020, 7(1): 36-45 38 © 2019 by the authors; licensee asian online journal publishing group markets (moctar and xiaofang, 2014). the increasing cases of mergers and acquisitions, especially in the ghanaian banking sector have also resulted in more academic literature on how these acquisitions and mergers are affecting various aspects of the acquirer-being its performance, market share, service quality, employee welfare etc (barnor and adu-twumwaah, 2015; harvey, 2015; salami, 2015; maama et al., 2017). even though a significant number of studies have examined the effect of mergers and acquisitions in the banking sector in ghana and its impact on performance, the findings from these studies are inconclusive or somehow contradictory. whereas, some of them found a positive relationship between mergers and acquisition and firm performance both in ghana and other parts of the world (gatsi and agbenu, 2006; moctar and xiaofang, 2014; aggarwal and singh, 2015; barnor and adutwumwaah, 2015; salami, 2015; yeboah et al., 2015; maama et al., 2017) others reported a negative association between mergers and acquisition and firm performance (beena, 2006; oduro and agyei, 2013; akhtar and iqbal, 2014). also, some of the studies were conducted in other sectors while the few on banks in ghana used case study approach, which limits the generalization of their findings. this study therefore addresses these discrepancies in literature by using a larger sample of banks to study the effect of mergers and acquisitions on performance. the study makes significant contributions to literature. as it extends previous studies on the subject in the ghanaian banking industry by examining the cause of mergers and acquisition as well as the processes adopted in these mergers and acquisitions in the banking industry in ghana. the results therefore provide a much robust evidence on the consequence of mergers and acquisitions in the banking sector in ghana. the results will also be useful to policy makers like the bank of ghana who has advocated for banks to merge and consolidate to become big enough to help reduce risk and improve their performance, and help clear doubts as to whether this policy direction is having positive impact on commercial banks that have merged or consolidated in ghana in the last decade. the results will also be useful to government of ghana in terms of regulating mergers and acquisitions in the ghanaian banking sector. in terms of practice, the findings will assist commercial banks in ghana to decide whether to use mergers and acquisition as a corporate strategy for growth or they should rely on natural growth. 2. literature review 2.1. the concept of mergers and acquisition moctar and xiaofang (2014) argue that mergers and acquisitions, especially in the financial sector is one of the features of globalization. this was accompanied by financial sector deregulations in developed countries like europe before developing countries in africa followed same. technological innovation, and in the case of europe the creation of single currency and the european monetary union were significant drivers for mergers and acquisitions (amihud et al., 2002; altunbaş and marqués-ibanez, 2008). it has been argued that the term mergers and acquisitions have mostly been used interchangeably in literature even though in reality there is some difference between the two concepts (moctar and xiaofang, 2014; maama et al., 2017). harvey (2015) defined a merger as a business combination involving two or more independent firms on almost similar terms under a joint ownership of the former two owners. moctar and xiaofang (2014) define a merger as simply the combination of two or more firms into one bigger organization. oduro and agyei (2013) in their study defined mergers as an arrangement where the assets of two separate entities come under the control of one, which still have all or substantially all the shareholders of the previous companies. gaughan (2002) see a merger as a business combination in which only one entity survives even though two entities will have pooled resources together. similarly, gupta (2012) also sees merger as an amalgamation of two firms where only one firm survives and the new firm assumes the assets and liabilities of the old firms. on the other hand, moctar and xiaofang (2014) defines acquisition as the purchase of one firm by another firm. they argue that the action of the purchase could be hostile or friendly as the case maybe but the significant part is that the acquirer takes control of the acquiree. selvam et al. (2009) holds a similar view as they see acquisition as simply the purchase of an entity by another entity and assuming all or a substantial part of the assets and liabilities of the acquitted entity. harvey (2015) defined acquisition as a situation where one entity buys all the shares or substantially all the shares in another company with ownership of the company vested in the acquirer company. the study further argues that whether a business combination is a merger or an acquisition, the outcome of the process is that only one firm survives which makes the two concepts almost similar. maama et al. (2017) posits that acquisitions are categorized as either hostile or friendly depending on the willingness of the acquiree to sell their shares or even whether the acquirer makes an offer to the target firm board before going public with the acquisition announcement. a number of companies have been acquired against the will of the original owners, which could be described as hostile takeover. a good example in ghana is the acquisition of hfc bank by republic bank where republic bank made an offer to two of the majority shareholders of hfc bank and acquired their shares to gain significant control against the will of the original owners of hfc bank. mergers and acquisitions can be classified as either vertical or horizontal and sometimes a conglomerate (gaughan, 2002; chen and findlay, 2003). horizontal mergers are where the acquiring firm buys another company in the same industry and level of business activity. chen and findlay (2003) reports that this type of acquisition has increased rapidly in the midst of globalization, increased competition and restructuring in many industries across the globe. a lot of the acquisitions in ghana, particularly the banking sector falls under horizontal mergers and acquisitions. vertical mergers and acquisition on the other hand are business combinations involving companies in different level in the value chain of an industry like a client-supplier relationship. this type of merger allows the acquiring firm to reduce business risk in either supply of raw materials or distribution systems or manage costs incurred in these services, thereby maximize profits (chen and findlay, 2003). the best example of this type of merger is the acquisition of benso oil palm plantation by unilever ghana who uses the products from benso as raw material in its production process. a conglomerate in the context of mergers and acquisition is a business combination involving unrelated businesses in terms of activity or industry of operations. these mergers and acquisition could also be domestic or even cross-border events. a number of acquisitions and mergers in ghana are foreign companies or even banks acquiring local ones and assuming their assets and liabilities. asian journal of economics and empirical research, 2020, 7(1): 36-45 39 © 2019 by the authors; licensee asian online journal publishing group 2.2. empirical review harvey (2015) examined the impact of mergers and acquisition on the performance of the acquiring firm using t-test analysis. the study used the merger between mobil oil ghana limited and total petroleum ghana limited. the main source of data for the study is secondary data. the results of the study revealed that the main reason for the acquisition was not profit maximizing but growth and shareholder value maximizing. agbloyor et al. (2012) examined the influence of financial markets on cross border mergers and acquisition in africa. the study used secondary data from 14 african countries ranging from 1993 to 2008. the study used panel data relying on feasible generalized least square for data analysis. the results of their study revealed that banking sector development promotes cross border mergers and acquisition. even though the study did not find string evidence relating stock market development to cross border mergers and acquisition it found that cross border mergers and acquisition promotes financial and stock market development in africa. maama et al. (2017) in their study examined the impact of business combination or consolidation on the financial performance of commercial banks in ghana. the study used a sample of two banks; ecobank ghana limited and access bank ghana limited. the study relied on secondary data from the financial statement of these banks using descriptive statistics and correlation as well as regression as statistical tool for analysis. the sample period covered the year 2009 to 2011 as pre-merger period and 2012 to 2015 as post-merger period. net profit margin and return on capital employed were the two variables that were used to represent firm performance. the results of the study revealed that mergers and acquisition led to more than 80% increase in net assets immediately after the acquisition. the results showed that there is growth in profit after the merger but at a decreasing rate. the regression results showed that mergers and acquisition had positive impact on the performance of the two banks. oduro and agyei (2013) examined the effect of mergers and acquisition on firm performance of listed firms in ghana. the study used a sample of five companies with data covering the period from 1999 to 2010. the results showed significant difference in profitability before and after the mergers and acquisition and showed evidence of decreasing profit after the merger and acquisition. the study established a negative and statistically significant association between mergers and acquisition and performance of listed firms in ghana. yeboah et al. (2015) examined the effect of mergers and acquisition on service quality using ecobank and access bank as case studies. the study used primary data from questionnaire and showed that mergers and acquisition had significant positive impact on service quality in the banking industry. barnor and adu-twumwaah (2015) explored the performance of commercial banks after mergers and acquisition. the study used data from ecobank ghana and ut financial services as case studies to examine the valuation methods adopted by the acquiring companies and how that affected the post-acquisition performance of the companies. the study found that firms that adopted a good valuation strategy and used the best available financing strategy for the merger and acquisition improved their corporate value and financial performance after the acquisition. moctar and xiaofang (2014) examined the effect of mergers and acquisition on performance of west african banks. using secondary data their study measured performance using liquidity ratios, and profitability ratios in the form of return on assets and return on equity whiles including one investment ration such as earnings per share. the study used a sample of four selected from ghana, nigeria and niger. the analysis showed that the liquidity of the banks improved both in the short term and long term after the mergers and acquisition. also, the profitability ratios and the investment ratio decreased in the early years of the mergers and acquisition but increased three years later. the study therefore concluded that mergers and acquisition has negative effect on performance in the short terms but positive effect in the long term. abdul-ramon and ayorinde (2012) in their study examined the impact of mergers and acquisition on selected banks in nigeria. their analysis of performance focused on gross margin, profit after tax and deposit profile or growth. the study purposively selected seven banks in nigeria for the study. the results of the analysis showed that there was significant improvement in performance of the banks in the post-merger period. the study did not use any complex statistical analysis but only relied on trend in profit growth and deposit growth. the major limitation of such analysis is that it failed to account for inflation and time value of money. it also did not examine profitability in relation to size by using return on assets and return on capital employed. koi-akrofi (2014) examined the motives for mergers and acquisitions in ghana using a sample of firms in the telecommunication industry. the study relied on secondary data from literature and reports on mergers and acquisitions in the telecommunication sector in ghana. the results of the study showed that the major motives of mergers and acquisition in ghana’s telecom sector are synergy, growth, improving market share and market competitiveness, creating wealth to shareholders and empire building for managers. adoma (2016) examined the impact of mergers and acquisition on firm performance in ghana using guinness brewery ghana limited as a case study. the study relied on both primary and secondary data to achieve the objectives of the study. the secondary data involved financial information for 2 years prior to the acquisition and five years after the acquisition. the study revealed that there was a consistent improvement in the financial performance of the company after the merger and acquisition. the key contributing factors for this improved financial performance were supply of raw materials, innovative marketing, employee commitment etc. they also reported that the merger process faced challenges in the area of the cost of the business combination, source of finance, regulatory compliance, integration of information technology systems among others. altunbaş and marqués-ibanez (2008) examined the effect of mergers and acquisition on bank performance in europe. the study relied mostly on secondary data on selected banks from different european countries and reported that banks merger and acquisition in europe resulted in improvement in return on capital. there was however a significant difference in performance for domestic mergers and cross border mergers. there was also evidence of integration challenges in the post-merger period in terms of costs and well as technological structures. joash and njangiru (2015) examined the impact of mergers and acquisition on financial performance of commercial banks in kenya. the study was conducted on merger and acquisition that have taken place in the kenyan banking sector between the period of 2000 and 2014 with a sample of 14 banks, which had all gone through mergers and acquisition. the results of the study showed that mergers and acquisition improved shareholder value asian journal of economics and empirical research, 2020, 7(1): 36-45 40 © 2019 by the authors; licensee asian online journal publishing group of the banks involved. the study also revealed that the driving motive behind most if the mergers and acquisition in kenya banking sector was to improve profitability. amewu (2014) studied the impact of mergers and acquisition on stock return before and during the financial crisis between 2006 and 2009. the study used secondary data collected from international websites such as reuters, bloomberg, etc. and reported a significant impact of mergers and acquisition announcement on share prices during the period or even before the period. akinbuli and kelilume (2013) examined the effect of mergers and acquisition on growth, profitability and efficiency of corporations in nigeria. the study used a survey of the financial sector in nigeria. the results showed that mergers and acquisition does not solve financial distress of companies. however, the study found that mergers and acquisition influenced profitability and growth in nigeria. on the other hand, operational efficiency suffers in the short run before normalizing subsequently in the long run. salami (2015) examined the impact of mergers and acquisition on the banking industry in ghana using societe generale as the case study. the study relied on a mixed approach using data from both primary and secondary sources. their results showed some improvement in financial performance of the bank after the acquisition. however, the results could not find any evidence of cost reduction in the post-acquisition period. 3. methodology the study relied on secondary data collected from the financial statement of commercial banks that have undergone mergers and acquisitions over the last ten years. data from the price water house coopers annual banking survey also served as another source of evidence, especially for the years that the study could not get the annual report for the respective banks. the sample frame includes gcb bank, ecobank ghana limited, fidelity bank ghana limited, access bank limited, bank of africa and universal merchant bank. the study period covered both pre-acquisition period and post-acquisition period. the study, however, excluded societe generale ghana because of lack of data for the bank prior to the acquisition. it also excluded new mergers and acquisition such as the absa group acquisition of barclays bank ghana limited as well as first atlantic bank because financial data for the pre and post-acquisition period were not available for these mergers and acquisitions. the empirical model developed for the study is similar to those used in previous studies to examine the effect of mergers and acquisition on bank performance in ghana (oduro and agyei, 2013; maama et al., 2017). the study used three empirical models which involves the use of three different measures of performance. the measures of bank performance used in the study include net profit margin (npm), return on assets (roa) and return on equity (roe). the empirical models are presented below; table-1. dependent and independent variables and their measurement. where variable meaning measurement npm net profit margin profit after tax divided by interest income multiplied by 100 roa return on assets profit before tax divided by total assets multiplied by 100 roe return on equity profit after tax divided by total equity multiplied by 100 ma mergers and acquisition dummy, 1 for post-acquisition and 0 for pre-acquisition period size firm size natural logarithm of total assets own foreign ownership dummy, 1 if bank is a foreign bank, 0 otherwise. 3.1. dependent and independent variables the study has three dependent variables, which were used to measure bank performance. these are net profit margin, return on assets and return on equity. return on assets and return equity are the two most popular performance ratios used in most studies (moctar and xiaofang, 2014; barnor and adu-twumwaah, 2015; salami, 2015). the independent variables in this study are mergers and acquisition (ma) which is measured as a dummy variable in line with previous studies (moctar and xiaofang, 2014; barnor and adu-twumwaah, 2015; salami, 2015; maama et al., 2017). 3.2. control variables control variable are other independent variables that can predict firm performance but are not the variable of interest for the study. the first control variable is firm size. researchers established that the size of commercial banks in ghana influence firm performance (maama et al., 2017; musah, 2017). these studies argue that bigger banks enjoy economies of scale and are able to undertake bigger transactions, which have lower risk and improve their performance. the second control variable is the age of the bank, which have also been cited as potential determinant of bank performance in ghana (maama et al., 2017). banks that have operated for a long time in ghana understand the industry-the risk profile of their clients and the macroeconomic environment, and are able to take steps that will improve their financial performance. the last control variable is foreign ownership, which have also been found to be a potential determinant of bank performance in ghana (musah, 2017). asian journal of economics and empirical research, 2020, 7(1): 36-45 41 © 2019 by the authors; licensee asian online journal publishing group 3.3. analysis and discussion of findings table-2. descriptive statistics. variables mean std. dev. min max net profit margin (npm) 0.2091 0.1822 -0.346 0.641 return on assets (roa) 0.0411 0.0752 0.073 0.372 return on equity (roe) 0.1481 0.2453 -1.095 0.664 mergers & acquisition (ma) 0.575 0.4975 0 1 firm size (size) 9.1578 0.4519 8.274 10.03 foreign ownership (own) 0.4875 0.5029 0 1 the results from table 2 above shows that on average the sampled banks are able to keep 21% of their interest income as profit after taking care of all major business operating expenses. majority of studies that examined the effect of mergers and acquisition on bank performance did have net profit margin as one of its variable. however, the 20% net profit margin appears very impressive given the competitive nature of the banking industry. the 20% net profit margin is higher than the result of harvey (2015) whose study reported a net profit margin average of 3%. the second variable (return on assets) showed a mean of about 4% over the study period with a minimum of negative 0.07 and maximum of 0.372. the results suggest that the banks sampled were only able to manage 4% returns on their entire assets over the study period. this figure is lower than the return of assets of 12% reported by harvey (2015) in mergers and acquisition and profitability based on total petroleum ghana. the return on equity revealed a mean score of 14.81% over the study period, suggesting that the sampled commercial banks are able to generate 14.81% returns on shareholders’ investments. the rate is however lower compared to that of the findings of oduro and agyei (2013) whose study reported a return on equity of 22% based on a sample of listed financial and non-financial firms on the ghana stock exchange. harvey (2015) also reported a much higher return on equity of 33% even though that study was not based on commercial banks in ghana. on the mergers and acquisition variable, the results suggest that 57.5% of the sample observation fall under the post-merger and acquisition period including the merger year itself. this is slightly higher that the findings of oduro and agyei (2013) who reported 51% as their mean score for mergers and acquisition using the same measurement approach. size of the banks which is measured as the natural logarithm of total assets ranges from 8.24 to 10.03 with a mean score of 9.15. this is similar to the findings of oduro and agyei (2013)who also reported a mean for natural logarithm of total assets of 8.27 and a maximum of 10.16. table 2 shows that 49% of the banks sampled were foreign banks and the rest local banks based on the sample observations. this is because majority of the mergers and acquisitions were in the form of foreign banks acquiring local banks. 3.4. correlation analysis between net profit margin and independent variable table 3 shows the results of a correlation matrix of the relationship between mergers and acquisition and net profit margin. table-3. correlation results for npm and other variables. variables npm ma size own npm 1.000 ma -0.1368 1.000 size 0.2265* 0.3081*** 1.000 own 0.0986 0.6361*** 0.0709 1.000 note: *** means significant at 1% significance level, ** means significant at 5% significance level and * means significant at 10% significance level). the results from table 3 above shows that there is a negative correlation between net profit margin and mergers and acquisition. the result however is statistically insignificant but can be interpreted to mean that mergers and acquisition reduces the net profit margins of commercial banks in ghana. the result is partly consistent with the findings of oduro and agyei (2013)who also reported a negative correlation between mergers and acquisition of bank performance. the results show a positive correlation between mergers and acquisition and net profit margin. the result is also statistically significant at 10% significance level. the results suggest that larger banks are able to maintain high net profit margin and as such are more cost-efficient compared to smaller banks. foreign ownership showed a positive correlation with net profit margin but statistically insignificant. 3.5. correlation analysis between return of assets and independent variable table-4. correlation between mergers and acquisition and return on assets. variable roa ma size own roa 1.000 ma 0.1568 1.000 size 0.5109*** 0.3081*** 1.000 own 0.0777 0.6361*** 0.0709 1.000 note: *** means significant at 1% significance level, ** means significant at 5% significance level and * means significant at 10% significance level). the result of the correlation analysis from table 4 above shows a positive correlation between mergers and acquisition and return on assets. the result however is statistically insignificant and also shows a weak correlation asian journal of economics and empirical research, 2020, 7(1): 36-45 42 © 2019 by the authors; licensee asian online journal publishing group between the two variables, suggesting that mergers and acquisition translates into improvement in return on assets even though such improvement is statistically insignificant. bank size exhibited a positive correlation with return on assets and the result is also statistically significant. similarly, foreign ownership showed a positive correlation with return on assets, but statistically insignificant. 3.6. correlation analysis between return of equity and independent variable the results of the correlation between mergers and acquisition and return on equity are presented in table 5 below. table-5. correlation results for roe and other independent variables. variable roe ma size own roe 1.000 ma 0.0014 1.000 size 0.3868*** 0.3081*** 1.000 own 0.0053 0.6361*** 0.0709 1.000 note: *** means significant at 1% significance level, ** means significant at 5% significance level and * means significant at 10% significance level). the correlation result shows a positive and weak correlation between mergers and acquisition and return on equity. the result is also statistically insignificant. this is inconsistent with the findings of oduro and agyei (2013) who reported a negative and significant association between mergers and acquisition and return on equity of listed firms in ghana. the correlation analysis presented for the three dependent variables shows conflicting results. whiles the first analysis showed that mergers and acquisition reduces net profit margin, the subsequent analysis did not find evidence of negative correlation. moreover, the correlation coefficients among the independent variables are all less than 0.8, suggesting that there is no evidence of multicollineraity. overall, the correlation analysis presents inconclusive results on the effect of mergers and acquisition on bank performance in ghana. 3.7. effect of mergers and acquisition on net profit margin table 6 shows the effect of mergers and acquisition on the net profit margin of the banks. the regression results showed an adjusted r-squared of 18% suggesting that the independent variable can only explain 18% of the variations in the dependent variable. the probability of the f-statistics is however significant at 10% significance level suggesting that to some extent the model is well fit. table-6. regression results on the effect of mergers and acquisition on npm. variable coefficient std.err z ma -0.1488** 0.0598 -2.49 size 0.1065** 0.0535 1.99 own 0.0816 0.0602 1.36 cont -0.7251 0.481 -1.51 overall r-squared 0.1795 wald chi2 (3) 7.01 probability>chi2 0.07 note: *** means significant at 1% significance level, ** means significant at 5% significance level and * means significant at 10% significance level). the results indicate that there is a statistically significant negative association between mergers and acquisition and net profit margin at 5% significance level, suggesting that mergers and acquisition is a significant determinant of net profit margin. the results imply that mergers and acquisition reduce net profit margin of commercial banks in ghana. bank size had a positive association between mergers and acquisition and net profit margin. the result is also statistically significant at 5% significance level and shows that bigger banks have higher net profit margin. the results further show that foreign ownership does not significantly influence net profit margin of commercial banks in ghana. 3.8. effect of mergers and acquisition on return on assets table 7 shows the effect of mergers and acquisition on the return on assets of the banks. the overall r-squared of 24% suggest that the independent variable can explain 24% of the variation in the dependent variable. the probability of the f-statistics is also statistically significant at 1% significance level, which suggest that the model is well-fit. table-7. regression results on the effect of mergers and acquisition on roa. variable coefficient std.err z ma 0.0087 0.0218 0.4 size 0.0745*** 0.0205 3.64 own -0.0164 0.0227 -0.72 cont -0.6391 0.1843 -3.47 overall r-squared 0.2426 wald chi2 (3) 18.84 probability>chi2 0.0003 note: *** means significant at 1% significance level, ** means significant at 5% significance level and * means significant at 10% significance level). asian journal of economics and empirical research, 2020, 7(1): 36-45 43 © 2019 by the authors; licensee asian online journal publishing group the results show that there is a positive relationship between mergers and acquisition and return on assets. the result is however statistically insignificant which suggest that mergers and acquisition is not a significant determinant of return on assets. thus, even though mergers and acquisition in the banking sector improves bank performance, such improvements are statistically insignificant. the results also show a positive and statistically significant association between bank size and return on assets, implying that larger banks are able to take on bigger risk of finance that allows them to maximize profit. furthermore, larger banks also enjoy economics of scale, which help to improve their profitability. the last control variable foreign ownership showed a positive association but statistically significant. 3.9. effect of mergers and acquisition on return on equity previous studies on mergers and acquisition and its effect on profitability have mostly used return on equity as a measure of performance as they focus more on the return on equity shareholder’s investments. the regression analysis showed an overall adjusted r-squared of 17%, which suggest that the independent variable can only explain 17% of the variations in the dependent variable. the probability of the f-statistic is statistically significant at 5% significance level. the results of the regression analysis for this variable are presented in table 8: table-8. regression results on the effect of mergers and acquisition on roe. variable coefficient std. err z ma -0.0898 0.0711 -1.26 size 0.2301*** 0.0899 2.84 own 0.0423 0.0558 0.76 cont -1.9285 0.7521 -2.56 overall r-squared 0.1702 wald chi2 (3) 9.13 probability>chi2 0.027 note: *** means significant at 1% significance level, ** means significant at 5% significance level and * means significant at 10% significance level). the results show that there is a negative relationship between mergers and acquisition and return on equity. the result is however statistically insignificant and shows that mergers and acquisitions in the ghanaian banking industry does not significantly influence return on equity. bank size is positively associated with return on equity. the result suggests that larger banks are able to generate more return to their shareholders as compared to smaller banks. finally, foreign ownership did not have any significant association with return on equity. 4. discussion of findings the regression analysis showed a negative association between mergers and acquisition and net profit margin. the result was also statistically significant and show mergers and acquisition have not improved bank costefficiency. the result is inconsistent with previous studies such as harvey (2015) who reported a positive but insignificant association between mergers and acquisition and net profit margin. however, the result is similar to the findings of salami (2015) who did not find any evidence of reduction in cost after merger and acquisition. the study result revealed that the banks’ cost increased above the increase in interest income in the post-acquisition period affecting the efficiency of the bank and eventually profitability. the result is also consistent with the findings of adu-darko and bruce-twum (2014) whose study reported a downward trend in all profitability measures. the result is however inconsistent with the findings of maama et al. (2017) who reported a positive and statistically significant relationship between mergers and acquisition and bank net profit margin. overall, the result suggests that mergers and acquisition in the ghanaian banking sector reduces net profit margin of the commercial banks involved. the result of the regression analysis showed a statistically insignificant positive relationship between mergers and acquisition and return on assets, suggesting that mergers and acquisition is not a significant determinant of banks return on assets. the result contradicts the findings of moctar and xiaofang (2014) who reported a negative effect of mergers and acquisition in the short run but positive effect in the long run based on a sample of commercial banks in west africa. the result is also contrary to the findings of abdul-ramon and ayorinde (2012) who reported improved financial performance of commercial banks post-merger and acquisition in nigeria. also, the result is inconsistent with the findings of maama et al. (2017) who reported positive impact of mergers and acquisition on bank profitability in ghana. the result is however consistent with the findings of akinbuli and kelilume (2013) who reported that mergers and acquisition does not significantly influence firm performance in nigeria. also, harvey (2015) reported that profitability results in the post-merger period of firms in ghana declined suggesting that mergers and acquisition does not improve financial performance of firms in ghana. the result is however also at variance with the findings of adu-darko and bruce-twum (2014) who reported a downward trend in profitability of firms used for their study, suggesting that mergers and acquisition does not improve firm performance. even though the ultimate goal of every merger and acquisition is to improve return to its shareholder or maximize shareholders value, the regression results revealed a negative association between mergers and acquisition and return on equity. this result is however not statistically significant and suggest that banks return on shareholders’ investment does not increase after a merger and acquisition, which is consistent with the findings of adu-darko and bruce-twum (2014) who reported a reduction in profitability of the case company in ghana used for their study, but inconsistent with the findings of moctar and xiaofang (2014) who reported that mergers and acquisition was negatively associated with bank profitability in the short run but positively associated with bank profitability in the long run. the result is also contrary to the findings of abdul-ramon and ayorinde (2012) who reported improved financial performance of the companies in the post-merger and acquisition period. furthermore, the result is at variance with the findings of oduro and agyei (2013) who found a negative and asian journal of economics and empirical research, 2020, 7(1): 36-45 44 © 2019 by the authors; licensee asian online journal publishing group statistically significant relationship between mergers and acquisition and return on equity of listed firms on the ghana stock exchange. the result is similar to the findings of barnor and adu-twumwaah (2015) who reported a decrease on return on equity after the mergers and acquisition by the banks in their study. the result is partly consistent and partly inconsistent with the findings of maama et al. (2017) where it was reported that even though there was a decline in return on capital employed by banks in the first three years after the merger and acquisition, there was a positive relationship between mergers and acquisition and bank profitability. the result contradicts the findings of joash and njangiru (2015) who found that mergers and acquisition in kenyan banking sector improved shareholder value. harvey (2015) on the other hand showed a decline in firm profitability including return on equity in the post-acquisition period, which is consistent with the findings of this study. the results also align with the findings of adu-darko and bruce-twum (2014) who found that profitability of commercial banks declined after mergers and acquisitions. overall, the results show inconclusive evidence on the consequence of mergers and acquisition on bank performance in ghana. the result shows a positive and statistically significant association between bank size and bank profitability. the result is consistent with the view that larger banks are able to take on bigger risk finance that allows them to maximize profit. furthermore, larger banks also enjoy economies of scale, which help to improve their profitability. 5. conclusion the study examined the consequence of mergers and acquisition on net profit margin, return on assets and return on equity. the results of the study with regards to the impact of mergers and acquisition on bank profitability are however inconclusive. the study showed a negative and significant association between mergers and acquisition and net profit margin and also found a positive but statistically insignificant relationship between mergers and acquisition and return on assets of commercial banks in ghana. the study further found a negative but statistically insignificant relationship between mergers and acquisition and return on equity. the results suggest that there is no conclusive evidence of the impact of mergers and acquisition on bank performance in ghana. the implication of the results is that mergers and acquisition might not necessarily improve bank financial performance. on the control variable, bank size showed a significant relationship with net profit margin, return on assets and return on equity. the results suggest that banks with larger sizes are able to take bigger financial transactions and reduce expenses and improve financial performance. this confirms the assertion that larger banks enjoy economies of scale and improved financial performance as compared to smaller banks. the results suggest increase cost of operations in the post-merger period as evidenced in the negative association between mergers and acquisition and net profit margin. the study therefore recommends that companies should adopt a comprehensive strategy to reduce cost in the post-merger and acquisition period in order to maximize profitability. the study further recommends that future research expand to include other aspects of bank 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issn(p)2518-010x doi: 10.20448/journal.501.2018.51.65.78 ceo’s emotional commitment level and its firm capital structure choice: decision tree analysis azouzi mohamed ali1  jarboui anis2 ( corresponding author) 1assistant professor in finance and accounting methods higher institute of business administration (isaas) university of sfax postal address: isaas, sfax-tunisia 2doctor and hdr financial and accounting associate professor of universities higher institute of business administration (isaas) university of sfax postal address: isaas, bp 1013 3018 sfax-tunisia abstract this research examines the determinants of firms‟ capital structure introducing a behavioral perspective that has received little attention in corporate finance literature. after discussing the theoretical linking between firm capital structure choice and the ceo‟s attitude and behavior, we are showing on empirical grounds the relationship between the manager‟s behavior toward the capital structure preferences and his cognitive commitment level. the article explains that the main cause of capital structure choice is ceo commitment level. we introduce an approach based on decision tree analysis technique with a series of semi-directive interviews. the originality of this research is guaranteed since it traits the behavioral corporate policy choice in emergent markets. in the best of knowledge this is the first study in the tunisian context that explores such area of research. results show that psychological dimension introduced in the capital structure analysis has enriched the pecking order theory (pot) and the static trade off theory (stt) ceo (ceo affective commitment) prefer to finance their projects primarily through internal capital, by debt in the second hand and finally by equity. keywords: emotional bias, ceo commitment level, corporate finance, capital structure choice, decision tree. jel classification: g3; g4; l1; l2. citation | azouzi mohamed ali; jarboui anis (2018). ceo‟s emotional commitment level and its firm capital structure choice: decision tree analysis. asian journal of economics and empirical research, 5(1): 65-78. history: received: 26 february 2018 revised: 17 july 2018 accepted: 24 july 2018 published: 31 july 2018 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 66 2. literature review and hypothesis ............................................................................................................................................... 66 3. research method ............................................................................................................................................................................. 69 4. empirical results ............................................................................................................................................................................. 73 5. conclusion ......................................................................................................................................................................................... 76 references .............................................................................................................................................................................................. 76 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2018.51.65.78&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/246 https://orcid.org/orcid-search/quick-search?searchquery=azouzi mohamed ali https://orcid.org/orcid-search/quick-search?searchquery=jarboui anis http://asianonlinejournals.com/index.php/ajeer/article/view/246 https://orcid.org/orcid-search/quick-search?searchquery=azouzi mohamed ali https://orcid.org/orcid-search/quick-search?searchquery=jarboui anis http://asianonlinejournals.com/index.php/ajeer/article/view/246 https://orcid.org/orcid-search/quick-search?searchquery=azouzi mohamed ali https://orcid.org/orcid-search/quick-search?searchquery=jarboui anis http://asianonlinejournals.com/index.php/ajeer/article/view/246 https://orcid.org/orcid-search/quick-search?searchquery=azouzi mohamed ali https://orcid.org/orcid-search/quick-search?searchquery=jarboui anis asian journal of economics and empirical research, 2018, 5(1): 65-78 66 1. introduction the main changes recorded in financial theory, including consideration conflicts of interest between agents, information asymmetries, the optional nature of financing, asset specificity have significantly closer approach theoretical reasoning actually observed in practice. theories of trade-off (static trade-off theory, stt) and pecking order (pecking order theory) are the theoretical corpus of reference addressed the issue of the structure financial position of the firm. the first (stt) based on a trade-off between costs ( explicit or implicit bankruptcy) and gains (values tax savings) debt-related to obtain an optimal financial structure maximizing the value of the firm. with against the second ignores the concept of optimal capital structure and argues that the choice of funding is through a hierarchical order. however, despite the contributions of these approaches to corporate finance several decisions are not understood. indeed, if we accept eg trade-off, the structures observed funding can be either without adjustment costs and structure with optimal ratios or goods with adjustment costs and poach the optimum ratios (ross, 1977; jalilvand and harris, 1984; mayers and majluf, 1984; titman and wessels, 1988; stulz, 1990; graham, 2000; booth et al., 2001). booth et al. (2001) argues the presence of a discrepancy between the theoretical predictions (stt and pot) analysis of the capital structure of companies and the distribution of this structure in reality. many contemporary researchers have emphasized the importance of leaders values and objectives in explaining corporate financing structure (barton and gordon, 1987; barton et al., 1989). indeed, the individual arguments are shortcuts influencing cognitive stance, making irrational and suboptimal under traditional financial theories. these biases have been identified and classified and include the follows: the representativeness bias, analog reasoning conservatism bias and confirmation, but also emotions such as loss aversion, optimism and overconfidence. in this sense, several authors have updated the old idea that emotions an adaptive role. emotions are necessary for the functioning of many of our faculties, such as memory, reasoning, decision-making. goleman et al. (2001) asserts that the emotional part of our brain is the basis of development of our thinking and, ultimately, our lives. it is this which explains our successes and our failures. graham (2000) says that insofar as our emotions or block amplify our ability to think and plan, learn to achieve a goal distant, solve problems, etc., they define the limits of our ability to use our innate mental abilities and therefore decide our future. the leader attitude, such as commitment, positively influences the ability to assess alternatives. according to baker et al. (2011) to contemporary organizations, it is not enough more to recruit and retain workers but they must also inspire and give them the ability to deploy the most of their skills in their duties. companies have therefore need people who are psychologically related to their work and their organization wishing invest more in their roles, in other words, today's businesses need workers engaged. it is therefore interesting to transpose the bias identified in behavioral finance study behavior of leaders faced with choices of financing and investment. this is the path taken by the current managerial optimism. assumptions neglect the existence of information asymmetries and conflicts of interests between the leaders shareholders and introduce behavioral biases leading executives to be engaged, optimistic or overly confident in their skills and future revenues firm. the presence of these biases we bring to the questioning of the effectiveness of decisions managerial (political financing) and the integration of behavioral dimension in explaining the policy of corporate finance. on this basis, the aim of our research is to integrate the behavioral dimension in the analysis of financing choices leaders: our goal is to show the effect of the managerial commitment to its choice of financing. 2. literature review and hypothesis individual reasoning with cognitive shortcuts that influence the position, irrational and non-optimal in terms of conventional financial theories making. these biases have been identified and classified and include the following terms: the representativeness bias, analog reasoning bias conservatism and confirmation, but also emotions such as loss aversion, optimism, overconfidence and emotional commitment. in this sense, many contemporary researchers have updated the old idea that emotions have an adaptive role. emotions are necessary for the functioning of many of our faculties, such as memory, reasoning, decision-making or social adjustment. research has frequently demonstrated the influence of affect on attitudes and behavior (garg et al., 2007). recent years have thus emphasized the predominant role of emotion as an enabler for decision making on the one hand and as one of the key regulators of behavior, on the other hand (philippot, 2007). the behavioral finance literature that examines the consequences of behavioral biases of managers has primarily focused on managerial loss aversion, optimism and overconfidence; traits that have been shown to be prevalent in managers (malmendier and tate, 2005;2008). in this paper, we extend the results of our study conducted in the tunisian context in 2012 (azouzi and jarboui, 2012).we examine an alternative explanation based on differences in managerial beliefs to shed light on some of the unexplained variation in capital structure decision. we examine the role of ceo behavioral characteristics (emotional commitment) in the design of capital structure choice. hence, in this section, the central objective consists in highlighting the type of relationship existing between emotional commitment and the capital structure choice : the first part consists in emotional commitment construct and the second part show relationship between emotional commitment and the capital structure choice. 2.1. emotional commitment concept (ec) 2.1.1. definition tsai (1999) defined organizational commitment as the identification with the organization and willingness to make extra efforts for the organization to achieve organizational goals (lee et al., 2014). robbins (2001) believed that organizational commitment is the level of loyalty to and identification with an organization, as well as the involvement in organizational activities (lee et al., 2014). asian journal of economics and empirical research, 2018, 5(1): 65-78 67 meyer and allen (1991) define commitment:" as a psychological state that characterizes the employee's relationship with the organization and has implications for the decision to continue or discontinuous membership in the organization "(meyer and allen, 1991). for these authors, if the commitment is a psychological state that reflects the relationship of employees in their organization, the concept now has several dimensions. their approach built the commitment to a multidimensional three components: a component "emotional", a component of "continuation" and a component "normative". in our study, is interested in the emotional commitment component. thus, meyer and allen (1991) define emotional commitment:" refers to identification and emotional attachment to the company". this type of commitment is interested in the will of the individual to adhere to what the organization stands for. the individual engaged emotionally, identifies, engages and is happy to be a member of the company for which he works (allen and meyer, 1990; meyer and allen, 1997). 2.1.2.commitment organizational model: three-component model of organizational commitment (tcm) (allen and meyer, 1996) there are currently at least three active approaches to measuring organizational commitment: the organizational commitment questionnaire by mowday et al. (1979) the identification/internalization typology by o'reilly and chatman (1986) and the three-component model of organizational commitment (tcm) by meyer and allen (1991;1997). among these approaches, the tcm is widely regarded as the most dominant model in organizational commitment research (mcdonald and makin, 2000; greenberg and baron, 2003; cohen, 2003;2007; bentein et al., 2005; solinger et al., 2008). allen and meyer (1990) argued that organizational commitment is a multiple construction and can be divided into personal emotions, costs and risks perceived and social relationships. organizational commitments can be decomposed into (1) affective commitment: the level of emotional attachments toward an organization; (2) continued commitment: perceived costs and risks regarding the departure from the organization; and (3) normative commitment: a moral commitment, the responsibility and obligation felt toward the organization.these dimensions describe the different ways of organizational commitment development and the implications for employees‟ behavior. affective commitment largely inspired by the work of porter et al. (1974) we chose to use the measuring instrument developed by allen and meyer (1990) to measure organizational commitment emotional guy. affective commitment involves three aspects: creation, emotion setting to the organization, identification and desire to maintain organizational membership. according to meyer and allen (1997) affective commitment is “the employee‟s emotional attachment to, identification with and involvement in the organization”. their model target how the individual feels committed to the location of the employing organization, taking into account the positive feelings of identification, attachment and involvement.they indicate that affective commitment is influenced by factors such as employment challenge, the role clarity, clarity of purpose and the purpose of the difficulty, responsiveness by management, peer cohesion, equity, self-importance, comments, participation and reliability. 2.1.3. emotional commitment, academic performance and social interactions the consequences of affective commitment on organizational behavior have a significant justification for interest in this concept. essentially because it is associated with favorable outcomes such as lower turnover rates and increased job performance and organizational citizenship behavior (meyer et al., 2002). among the various forms of commitment that have been studied, the affective dimension, which reflects employees‟ identification and involvement with the organization (meyer and allen, 1991) has been found to be the most strongly associated with work outcomes (meyer et al., 2002). studies that have focused on the consequences of organizational commitment demonstrates the importance for public and private organizations, employees highly engaged emotionally. meyer and allen (1997) reported that an employee strongly committed emotionally present greater motivation or a greater desire to contribute significantly to the organization. it will work with more zeal and will have a higher return. he will direct his attention to the performance aspects of his work that he considers valuable to the organization. he will receive a congruence between its objectives and those of his organization. rocha et al. (2008) say that organizational commitment not only has positive influences on organizations, but also beneficial to individual employee and the society as a whole. it benefits employees themselves in such a way that emotional and financial instability can be reduced by lower turnover rate.the achievement of in-role performance could be affected by employees‟ affective commitment to the organization (swailes, 2004). affective commitment is an employee‟s desire to stay as a member of the organization, an intention to make an effort for the organization, a belief in the values and norms of the organization (glazer and kruse, 2008) and emotional attachment to the organization. this affective commitment is a driving force that makes employees contribute to the improvement of the organization‟s performance (lee et al., 2014). 2.2. hypothesis 2.2.1. ceo's emotional commitment and internally generated resources choice the most common approach in the literature is undoubtedly emotional commitment, which is defined as the identification and emotional attachment of an employee to his company (meyer and allen, 1997). according to the literature, affective commitment would encourage positive attitudes and behaviors at work. as highlighted individuals emotionally committed to their business would be more willing to develop favorable towards it attitudes and to show willing to contribute voluntarily to the proper functioning. affective commitment is positively related to positive discretionary behaviors (shore and wayne, 1993; organ and ryan, 1995; allen and meyer, 1996). so any ceo engaged threatened by the risk of loss of social status seeking to value his work at the head of his company through effective financial choices. helliar et al. (2005) argue asian journal of economics and empirical research, 2018, 5(1): 65-78 68 that the loss showers leaders seek to avoid the most pessimistic. scenarios they do not would use the management tools risk to reduce the variance of cash flows but rather to avoid the worst scenarios pessimistic influencing the risk of bankruptcy or preventing the company to benefit profitable investment to value his work at the head of his company through effective financial choices. it therefore avoids choice of methods of risk financing (debt: bankruptcy risk and equity: takeover risk ) and preferred financing internal capital. somers and birnbaum (2000) state leaders committed both to their profession and their company appear more positive attitudes and behaviors for the organization, including better and a lower satisfaction and greater involvement in work propensity to leave the organization. these highly committed leaders opt for projects riskier investment (including investment innovation). this investment requires the risky choice to prefer self-financing in order to escape the risk premium required by providers of external capital. this implies the presence of a positive relationship between internally generated resources preferences and ceo emotional commitment level. kundi et al. (2007) show that the ceo emotional commitment level its encourages to undertake the efficiency choice.a committed leader seeks to avoid the adverse consequences of financial distress (loss of brand image on the market leaders ...). he prefers to finance its investments by internal capital at the expense of external financing modes (risky). girandola and michelik (2008) assume that the leaders strongly committed tend to be more optimistic. hilary and menzly (2006) added that financial analysts in situations of overconfidence and optimism (emotional commitment high level) tend to move away from the consensus predictions apart by delivering the reality of more than 10%. the same idea, always take an engaged leader that his company is undervalued by the market. the leader must take into account the risk and uncertainties regarding fluctuations in stock prices and takeovers. so it will save the maximum to be financed by the market (capital increase). h1: an engaged leader accepts a internally generated resources level greater than that debt (and / or equity). 2.2.2. ceo's emotional commitment and debt choice meyer et al. (2004) suggested that commitment level is part of the motivation. they showed that the ceo commitment level is positively correlated with its motivation. this committed leader (motivated) looking through strategic choices (including debt financing decision) report the performance of its business. thus, modeling financial decisions proposed by mayers and majluf (1984) how show the level of debt can be used to solve the problem of asymmetric information between leader and markets (investors). the leader chosen for debt project finance and performance reports (maximizes shareholder wealth in place and refuse the entry of new shareholders) of the firm that pushes analysts to reassess. de clercq et al. (2009) found that ceo's emotional commitment positively impacts start-up and venture performance. thus, the committed leader opts for debt to take advantage of its tax savings (the most successful companies are the most indebted is the static trade-off theory), create value for shareholders and to report its performance on the market leaders. chang et al. (2009) states that managers overestimate their power to reduce risks within the business. bertrand and sendhil (2003) point out that the reputation leaders can lead them to prefer to imitate the decisions of their predecessors efficient, ignoring the return on investment. this mimicry appears depending on the ceo commitment level, age and the uncertainty of its environment. indeed it is committed leader downpour in the reputation loss or employment chooses a distribution policy more generous than its predecessors dividends (azouzi and jarboui, 2012). it meets the expectations of its shareholders in terms of changes in the rate of dividend distribution. it uses the borrowing capacity of the company. they also underestimate bankruptcy probability and therefore issue a higher debt level. luthans and youssef (2007) show that organizational commitment is positively related with optimism. fairchild (2009) adds that optimistic leader (high emotional commitment level) overestimates the capacity of its business and underestimate the costs of financial distress. this evaluation bias (hopefully) makes him choose debt as a financing of these investment projects. thus, malmendier and tate (2005;2008); malmendier and tate (2015) find that the optimistic manager will give priority to self-financing, then debt and ultimately to the issuance of shares. thus, if the flow of the company is insufficient capacity, it is useful to resort to external financing. the optimistic leader always prefers debt (reported by debt) to the capital increase: the pecking order theory (azouzi and jarboui, 2012). humphreys et al. (2005) observed a positive correlation between ceo emotional intelligence and commitment level (carmeli, 2003; rosete and ciarrochi, 2005). siu (2009) indicates the presence of a positive correlation between emotional intelligence and effective decision-making. the author maintains a high level of emotional intelligence is positively associated with low suggestibility of behavioral biases. thus, emotion regulation refers to actual useful skills to cope with the necessary modifications and changes that take part in our societies (gendron, 2008). in other words, emotional intelligence allows the leader to generate and maintain enthusiasm, serenity optimism and commitment in the organization and cooperation and mutual trust. awareness and understanding of others' emotions allow him to gain the confidence of all stakeholders of the company. this emotional regulation facilitates the negotiations of contracts with third parties, reduced transaction costs and ensures speed. these conditions encourage the leaders to issue risky securities (azouzi and jarboui, 2014). the reduction of transaction costs impulse ceo access to extra debt. h2: a leader committed accept a level of debt more than rational 2.2.3. ceo's emotional commitment level and equity choice modern organizations expect their employees to be full of enthusiasm and show initiative at work, they want them to take responsibility for their own development, strive for high quality and performance, be energetic and dedicated to what they do. in other words, companies want their employees be engaged (bakker and leiter, 2010). other researchers state that employee engagement is the best tool in the company‟s efforts to gain competitive advantages and stay competitive (rashid et al., 2011). this implies that the leader is less emotionally engaged asian journal of economics and empirical research, 2018, 5(1): 65-78 69 downpour in the loss. it is in the position to effectively evaluate market reactions. he is aware of the financial situation of the company. it is not reluctant to issue shares to finance its investment projects. maslach et al. (2001) and may et al. (2004) suggested that leadership commitment affects the quality of work and their own experience to their work. it influences the growth and productivity of the organization. thus, committed leaders‟ benefits likely to use their emotions to enhance their job performance. in other words, the emotional engagement allows the leader to improve its relationship with its business partners whose creditors. this facilitates the negotiations of contracts, reduces agency costs, transaction costs and ensures the speed of operations. these conditions encourage the leaders to issue risky securities (including equity preferences). halov and heider (2004) defend the general idea that a strong asymmetric information about the risk of a company leads to adverse selection problem that leads companies to issue equity securities. thus, luthans and youssef (2007) show that organizational commitment is positively related with optimism. in other words, optimistic and committed leader underestimates the risk of its business. he believes that the risk can be reduced by proper use of their professional skills, which led him to choose means costly external financing (external equity). the increase in risk, as measured by the volatility of securities, led to an increase in share issues. these results are based on the assumption that differences in volatility capture differences asymmetric information about the variance of cash flows arising from a managerial commitment. this implies the presence of a positive relationship between equity preferences and ceo emotional commitment level. frank and goyal (2003) show a long-term relationship between levels of debt and capital. they confirm the impact of market conditions on financing choices. parfet (2000) adds that the ability of a company to provide stable and predictable performance is a sign of good management. so, any ceo emotional committed seeks to show that good management through its financing choices. it issues shares when prices are high and go into debt or redeem shares when prices are low to benefit from favorable market trends. faccio et al. (2001) the dividend payment is lower in east asia, where conflicts of interest between minority shareholders and controlling shareholders are severe, because the risk of expropriation is high because of the existence of such structures. in other words, a leader committed emotionally to manage its conflicts of interest between minority and majority shareholders. it is encouraged to minimize dividend payments. the presence of a restrictive dividend policy limit ceo preference of external financing choices (including equity ). h3: the use of the capital increase is more important for leaders committed 3. research method 3.1. data to note, the empirical tests are based on 100 non-financial tunisian firms during the 2010 fiscal year (28 are listed companies and 82 are non-listed companies, see table 1). all financial firms (including banks) outing to the fact that this business sector is regulated and likely to have fundamentally different cash flows and characteristics. firms with insufficient data regarding about emotional characteristics and the board of director‟s composition are also excluded. the board‟s compositions, as well as financial characteristics data, are gathered from the bvmt annual report. emotional and psychological characteristics are collected by means of an administered questionnaire. actually, the selected choice deals with some homogeneous individuals representing some tunisian ceo representatives of 100 firms (60 males, 35 females, 5 unreported), ranging in age from 25 to 58 (table 2). table-1.visited companies initial bvmt sample for 2010 50 financialfirms (22) other non financial firms 120 insufficient data to ceo emotional commitment (40) insufficient data to board of directors compositions (8) final sample 100 table-2. ceos‟ characteristics n percentages age 25-30 years 31-40 years 40-49 years over 50 years 5 20 35 40 5% 20% 35% 40% gender/sex males females unreported 60 35 5 60% 35% 5% degree baccalaureate bac + 2 bac + 4 das/hdss 15 20 30 35 15% 20% 30% 35% most questionnaires have been distributed by the method of door to door to ensure they are personally delivered to the person concerned; few among them have been mailed, for businesses located outside the greater tunis area. asian journal of economics and empirical research, 2018, 5(1): 65-78 70 it is worth noting, however, a broader sample that even if it had been envisaged to be studied and that more than 100 questionnaires had been distributed for this purpose, we would have received far fewer responses than expected (return rate 44.84 per cent: although the number of distributed questionnaires reached 223, the responses received did not exceeded 100 ceo). indeed, many of the adduced have refused to respond to our questions on the ground of several reasons, namely, that:  they are too busy and have no time to devote to research;  they generally do not pay any interest to the questionnaires submitted by students and would return them to their assistants or other staff for a response (this has been the case of our officer-centred research); and  they perceive that the questionnaire is a sort of „„control‟‟ damage to their private lives and that it is out of the question to answer. other encountered difficulties are mainly due to the administrative procedures and hierarchical procedures which linger questionnaires to the recoveries. fortunately, the leaders who had been so kind as to cooperate and help us formulate and set up our sample eventually composed of 100 private company leaders, belonging mostly to the industrial sector. 3.2. variables’ measurement the objective of this section is to determine the variables‟ measurement. 3.2.1. capital structure choice the purpose of this article is to show the impact of ceo emotional commitment on the firm capital structure choice (internally generated resources, debt level and choosing to issue new stocks). the appropriate measures in the literature to evaluate three methods of financing are azouzi and jarboui (2012): 3.2.3.1.internally generated resources (the cash flow) research within the framework of financial theory of investment, have resorted tomany measures of internal resources. cash flow represents the flow generated by the activity of any business, is one of the most appropriate (lehn and poulsen, 1989; molay, 2006; naoui et al., 2008; azouzi and jarboui, 2012). cf = net income + depreciation – dividend casch flow rate (rcf) = cf / total assets to show that the leader chosen or not internaly generated ressources, we can use the change in flow rate. a negative change indicates the use of internal resources. cash flow rate variation = rcfnrcfn-1 / rcfn-1 3.2.3.2. debt level we observe a variety of variables that measure the level of debt in the company.measures such as total debt service ratio has been selected by several authors (hovakimian et al., 2004). others have used the debt ratio in the medium and long term (myers, 2001). the debt ratio in the short term was also used by titman (1984). as part of our analysis we propose to use the debt ratio as a measure of this variable. it should be noted that this ratio is calculated by: leverage ratios (lev)= (total debt / total assets) this measure is also used by koh (2003); demaria and dufour (2007); jarboui and olivero (2008); benkraiem (2008); sahut and gharbi (2008) and azouzi and jarboui (2012). to show that the manager uses debt or not, we can use the change in debt ratio. a positive change indicates the use of debt. leverage ratios variation = levnlevn-1 / levn-1 3.2.3.3. equity level this variable is measured by the value of equity in the balance sheet of the company.to show that the leader chosen or not the capital increase, we can use the variationin the percentage of investment. a positive change indicates an increase of capital (azouzi and jarboui, 2012). level of capital invested (lci) = equity / total assets level of capital invested variation = lcinlcin-1 / lcin-1 the financial decision takes 7 follows:  1 if the manager chooses the internally generated resources: positive variation in the cash flow rate.  2 if the manager chooses debt: positive variation in the leverage ratio.  3 if the manager chooses the capital increase: positive variation in the level of invested capital.  4 if the manager chooses internally generated resources + debt : positive variation in the cash flow rate and debt ratios.  5 if the manager chooses internally generated resources + capital increase: positive variation in the cash flow rate and level of capita invested.  6 if the manager chooses debt + capital increase: positive variation in the leverage ratio and level of invested capital.  7 if the manager chooses internally generated resources + debt+ capital increase: positive variation in the cash flow rate, leverage ratio and level of invested capital. 3.2.2. emotional commitment to measure the ceo‟s commitment bias, we take the same steps as most of studies have using an adaptation of the original questionnaire elaborated by meyer and allen (1991) to evaluate organizational commitment (organizational commitment scale). this instrument is chosen because of its validity and its multidimensional asian journal of economics and empirical research, 2018, 5(1): 65-78 71 character shown by several researchers (meyer et al., 2002; azouzi and jarboui, 2013). the questionnaire includes statements such as: "i do not feel a full member of the company "and" i'll be very happy to finish my career in this business. the commitment bias takes the following two points (table 3): • 1 if the manager has a high level of this bias. •0 if not table-3. items used in the emotionnal commitment scale (8 items) items emotional commitment 50.750 % of total variance 1. i would be very happy to finish my career in my company 0.861 2. i like to discuss my firm with outsiders. 0.851 3. i feel the problems of my company like mine. 0.842 4. i think i could easily become attached to other organizations such as my firm -0.774 5. i do not feel a full member of my firm 0.715 6.i do not feel emotionally attached to my company 0.553 7.my firm at great personal meaning for me. 0.466 8. do not feel a strong sense of belonging to my firm 0.677 3.2.3. profitability more profitable firms have, ceteris paribus, more internally generated resources to fund new investments. if their managers follow a pecking order, they will be less likely to seek external financing (fama and french, 2002). thus, on average, these firms‟ leverage ratios will be lower. in trade-off models, on the other hand, this relationship is inverted. more profitable firms are less subject to bankruptcy risks. hence, their expected bankruptcy costs are reduced and they can make more use of the tax shields provided by debt, thus choosing a position of greater leverage. we will keep the ratio of return on assets roa to measure this variable (azouzi and jarboui, 2012;2014): roa= earnings before interest, tax, depreciation divided by total assets, lagged one year period 3.2.4. firm size studies suggest that the probability of bankruptcy is lower in larger firms and that, therefore, their debt capacity is higher than that of smaller ones, all else equal. on the other hand, fixed transaction costs can make new stock issues unattractive to small corporations, stimulating them to issue debt rajan and zingales (1998); hovakimian et al. (2004); azouzi and jarboui (2012;2014). indeed, most studies have applied total assets or turnover as a measure for firm size (bujadi and richardson, 1997). in this paper, it is measured through the log of the firm’s total assets (lnsize). 3.2.5. control variable 3.2.5.1. future investment opportunities it is argued that future profitable investment opportunities can influence corporate financing decisions in different ways. in the context of the pecking order theory, firms that have many investment opportunities and believe that their stocks (and risky bonds) are undervalued by the market, may choose a capital structure with less debt. if they maintained high debt ratios, they would be forced to distribute precious cash flows generated by their business and could face the need to issue undervalued securities to fund new projects. this could, in turn, induce underinvestment. a more static version of the pecking order model, on the other hand, predicts that firms with more future opportunities will be more levered, ceteris paribus, because they need more external financing and issuing debt is preferable to issuing new stock (graham, 2000; booth et al., 2001; naoui et al., 2008; azouzi and jarboui, 2012;2014). we will keep the tobin‟s q to measure this variable. the tobin‟s q estimated with the approximation formula proposed by chung and pruitt (1994): it it it it mvs d q a   mvs – market value of common and preferred shares; d – book value of debt, defined as current liabilities plus long-term debt plus inventories minus current assets; a – total assets. 3.2.5.2. board of directors to note, theories regarding the board of directors, along with prior empirical researches and various recommendations have suggested that some board characteristics have an influence on the quality of the financial report and on firms‟ performance. board characteristics are examined here:, independence (fama and jensen, 1983). the board‟s independence the different characteristics pertaining to the board‟s independence are measured by the following variable: bind is defined as the percentage of the board members who are simultaneously independent and non-executives which is equal to the number of outside directors divided by the total board members (forker, 1992; wright, 1996; haniffa and cooke, 2000; chtourou et al., 2001; azouzi and jarboui, 2012). bind = number of outside directors /total board members. table 4 presents the characteristics of boards of directors of the 100 tunisian companies included in our study. tunisian companies are run by independent boards, medium (seven directors) and not dominated by ceos. asian journal of economics and empirical research, 2018, 5(1): 65-78 72 table-4. board of directors‟ characteristics variables mean std min max n entire board 7.60 2.56 4 12 100 outside directors 2.62 1.11 1 4 100 affiliated directors 1.98 0.80 1 3 100 inside directors 3.360 1.34 1 5 100 ceo duality 0.26 0.44 0 1 100 for simplification purposes, the summary of each variable extent range in the model, its name as well as its expected impact on the firm assets specificity choice are depicted in table 5. table-5. operational definitions of variables class : phenomena : mesure : variables : predictions : endogens variables : capital structure choice internally generated resources (the cash flow) cf = net income + depreciation – dividend casch flow rate (rcf) = cf / total assets ) cash flow rate variation = rcfnrcfn-1 / rcfn-1 cf debt level leverage ratios (lev)= (total debt / total assets) leverage ratios variation = levnlevn-1 / levn-1 lev equity level level of capital invested (lci) = equity / total assets level of capital invested variation = lcinlcin-1 / lcin-1 eq exogenous variables : cf lev eq emotionnal commitment ceo identification with and involvement in a particular organization the questionnaire obtained score ec + + + profitability reports on the company's ability to meet its commitments roa= earnings before interest, tax, depreciation divided by total assets, lagged one year period pf + + firm size firms signaled performance ln (total assets) lnsize + + + controls variables: future investment opportunities indicates the productive capacity of the company it it it it mvs d q a   mvs – market value of common and preferred shares; d – book value of debt, defined as current liabilities plus longterm debt plus inventories minus current assets; a – total assets. fio + + board of directors the presence of independent members in the board number of outside directors /total board members. bind + + 3.3. decision tree methods a decision tree is a flowchart-like tree structure where each internal node (non-leaf node) denotes a test on an attribute, each branch represents an outcome of the test and each leaf node (terminal node) holds a class label. the topmost node in a tree is the root node. a decision tree is a decision-making device which assigns a probability to each of the possible choices based on the context of the decision: p (f / h), where f is an element of the future attributes (the set of choices) and h is a history (the context of the decision). this probability p(f / h) is determined by asking a sequence of questions ql q2 ... qn about the context, where the ith question asked is uniquely determined by the answers to the i 1 previous questions. each question asked by the decision tree is represented by a tree node and the possible answers to this question are associated with branches emanating from the node. each node defines a probability distribution on the space of possible decisions. a node at which the decision tree stops asking questions is a leaf node. the leaf nodes represent the unique states in the decision-making problem, i.e. all contexts which lead to the same leaf node have the same probability distribution for the decision (michae, 2006). classification is a data mining technique that asian journal of economics and empirical research, 2018, 5(1): 65-78 73 assigns items in a group to target class. the purpose of classification is to accurately envisage the target class for each case in the data. in our study we used the naive bayesian classification to explain ceo investment choice. the naive bays classifier is a simple probabilistic classifier based on applying bays theorem with strong independence assumptions which assumes all of the features are equally independent. it uses a bayesian algorithm for the total probability procedure, the principle is according to the probability that the text belongs to a category of prior probability, and the text would be assigned to the category of posterior probability. in simple terms, a naive bays classifier assumes that the presence (or absence) of a particular feature of a class is unrelated to the presence (or absence) of any other feature. 3.4. define attributes and values the first step in building a decision tree is to list the variables recursively, starting from the target variable to the causes. in this order we present the variables in the table below: table-6.the attributes and their values attributes type capital structure choice discret [1 ; 2 ;3 ] emotionnal commitment discret : yes/no profitability discret : yes/no firm size discret [1 ; 2 ; 3] future investment opportunities discret : yes/no board independence discret : yes/no 4. empirical results 4.1. graphical model analysis capital structure choice modality: [1.2.3.4.5.6.7] 1.internally generated resources 2.debt 3.equity 4.internally generated resources+ debt 5. internally generated resources +equity 6.debt+equity 7. internally generated resources+ debt+equity table-7. attribute statistic attribute probability % capital structure choice (csc) 100 internally generated resources 10 debt 9 equity 10 internally generated resources+ debt 14 internally generated resources +equity 18 debt + equity 48 internally generated resources+ debt+equity 21 emotional commitment (ec) 100 yes :1 55 no : 0 45 profitability (prof) 100 yes :1 54 no : 0 46 firm size (fsize) 100 small :1 66 medium : 2 26 big :3 8 future investment opportunities (fio) 100 yes :1 85 no : 0 15 board independency (bind) 100 yes :1 69 no : 0 31 note that the decision tree that has been built gives us information on the relevance of attributes about the target variable (firm capital structure choice): asian journal of economics and empirical research, 2018, 5(1): 65-78 74 the graphical model shows that the size is "is the first variable used; is called segmentation variable. this is the most relevant in the analysis of ceo capital structure preferences(p =0.21 for the choice of capital structure mode: internally generated resources+ debt+equity). as it is composed of three terms {small, medium, large}, so she produced three peaks children. the first edge (the first leg), left, on the second level, is produced from the "average" category of the variable "size". the resulting top cover 2 observation. it indicates the future investment opportunities (fio) {yes / no}. the frequency distribution shows that for a leader to medium size firm and future investment opportunities chosen capital structure mode 7 namely internally generated resources+ debt+equity a probability of 21.2%. the second ridge in the center corresponds to the "large" category of the segmentation variable "size"; the corresponding vertex cover 2 observation. it shows the profitability level of the company {yes/ no}. the frequency distribution shows that for a large company is performing selected one of the capital structure terms are: internally generated resources with a probability of 25%. the third ridge, right, is the "small" category of the segmentation variable "size"; the corresponding vertex cover 2 observation. it indicates the degree of independence of the board {yes / no}. the frequency distribution shows that, for the tunisian small businesses that their advice is independent, leaders prefer a combination of internally generated resources+ debt with a probability of 23.3%. let the third level of the tree to the left, we see that the variable future investment opportunities (fio)turns into a segmentation variable. as it is composed of two modality {yes / no}, we note the presence of two branches. thus, the first edge on the left, on the third level, is produced from the "no" category of the variable " future investment opportunities ". the resulting top cover 2 observation. it indicates the level of ceo emotional commitment {yes/ no}. the frequency distribution shows that the ceo prefer internally generated resources+ debt+equity with a probability of 26.7% due to their emotional commitment. the second part is produced from the modality "yes" to the variable " future investment opportunities ". the resulting top cover 2 observation. it indicates the level of ceo emotional commitment {yes / no}. the frequency distribution shows that the engaged prefer internally generated resources +equity with a probability of 29.%. still remain on the third level to the right of the tree, there is the variable of board independence as segmentation variable. as it is composed of two modality {yes / no}, we note the presence of two branches. thus, the first edge on the left, on the third level, is produced from the modality "yes" to the variable "independent counsel." the resulting top cover 2 observation. it indicates the firm profitability level {yes / no}. the frequency distribution shows that the leaders of profitable firm with independent advice and choose the internally generated resources+ debt with a probability of 25%. the second part is produced from the "no" category of the variable "independent board." the resulting top cover 2 observation. it indicates the level of profitability of the company {yes/ no}. the frequency distribution shows the least profitable companies that their advice is independent opting internally generated resources +equity to probability 28.6%. this process is repeated on each vertex of the tree until pure leaves. thus, the pure or pure tree leaf in our study corresponds to level 5. the right part of level 5 shows that companies, profitable firm, small size and independent advice to choose the debt and combination between debt+ equity with the following probabilities: 33.33% and 66.7% due to their leaders‟ emotional commitment high level. we also note that tunisian companies small, less profitability level and independent incentive leader to undertake internally generated resources+ debt to probability 50%. tunisian companies small, independency small level, profitable have emotionally committed leader. this emotional bias incited him to prefer internally generated resources+ debt and internally generated resources+ debt+equity with the following probabilities: 50% and 40%. tunisian companies small, independency small level, profitability small level prefer internally generated resources +equity and equity with the following probabilities: 50% and 66.7%. let the left of the pure tree parts, the results of our classification argue that tunisian emotionally engaged leaders in medium size firm, profitable, future investment opportunities and independent opt for internally generated resources +equity with a probability of 33.33%. they use debt + equity with a probability of 33.33% if the profitability of their firms is low. then these engaged leaders realize the equity with a probability of 40% when the level of board independence and corporate future investment opportunities levels are low. however, companies use debt with a probability of 40%. this choice is justified by the low level of emotionally engaged leaders despite high profitability of these firms. 4.2. cross validation analysis for measuring performance classification techniques the following parameters are taken. in classification techniques parameters to be examined are accuracy, sensitivity, precision, specificity and f-measure. classification accuracy accuracy is the percent of correct classifications. accuracy is the overall correctness of the model and is calculated as the sum of correct classifications divided by the total number of classifications. we note that this ratio is low for 7 classes of capital structure choice (13%). sensitivity sensitivity is a measure of the ability of a prediction model to select instances of a certain class from a data set. it is corresponds to the true positive rate. we note that the capital structure preferences of tunisian companies are divided into the following 4 conditions:  internally generated resources with a completion rate of 30%  internally generated resources +equity with a completion rate of 22.22%  debt+ equity with a completion rate of 5.56% and  internally generated resources+ debt+equity with a completion rate of 23.81% asian journal of economics and empirical research, 2018, 5(1): 65-78 75 table-8. cross validation analysis (csc). internally generated resources methods classification accuracy sensitivity specificity fmesure precision matthews correlation coefficient naive bayes 0.1300 0.3000 0.8333 0.2143 0.1667 0.1041 debt methods classification accuracy sensitivity specificity fmesure precision matthews correlation coefficient naive bayes 0.1300 0.0000 0.9670 n/a 0.0000 -0.0553 equity methods classification accuracy sensitivity specificity fmesure precision matthews correlation coefficient naive bayes 0.1300 0.0000 0.9222 n/a 0.0000 -0.0915 internally generated resources+ debt methods classification accuracy sensitivity specificity fmesure precision matthews correlation coefficient naive bayes 0.1300 0.0000 0.8488 n/a 0.0000 -0.1560 internally generated resources +equity methods classification accuracy sensitivity specificity fmesure precision matthews correlation coefficient naive bayes 0.1300 0.2222 0.7561 0.1905 0.1667 -0.0195 debt+ equity methods classification accuracy sensitivity specificity fmesure precision matthews correlation coefficient naive bayes 0.1300 0.0556 0.8780 0.0690 0.0909 -0.0815 internally generated resources+ debt+equity methods classification accuracy sensitivity specificity fmesure precision matthews correlation coefficient naive bayes 0.1300 0.2381 0.87595 0.2222 0.2083 -0.0023 specificity specificity measures the proportion of negatives who are correctly identified (e.g. the percentage of well people who are identified as not having the condition). in our study the specificity measures the percentage of companies that have not chosen the capital structure mode. we note that this percentage between 70% and 90%. this is explained by the tunisian leaders made that are not aware of the presence of these combination. fmesure it corresponds to the margin of error around the exact solution. we note that the capital structure preferences of tunisian companies are divided into the following 4 conditions with a low margin of error between 0.06 and 0.22:  internally generated resources with an error rate of 21.43%  internally generated resources +equity with an error rate of 19.05%  debt+ equity with an error rate of 6.90% and  internally generated resources+ debt+equity with an error rate of 22.22% we note that all the variables chosen for the analysis of ceo capital structure preferences (firm size, ceo emotional commitment, the investment opportunities, profitability and the board independence) explain that the following 4 capital structure choice categories namely: internally generated resources: this result affirms our theoretical prediction (h1): an engaged leader accepts a internally generated resources level greater than that debt (and / or equity): a committed leader seeks to avoid the adverse consequences of financial distress (loss of brand image on the market leaders ...). he prefers to finance its investments by internal capital at the expense of external financing modes (risky). internally generated resources +equity: this result confirms our hypothesis (h3): organizational commitment is positively related with optimism. in other words, optimistic and committed leader underestimates the risk of its business. he believes that the risk can be reduced by proper use of their professional skills, which led him to choose means costly external financing (external equity). the increase in risk, as measured by the volatility of securities, led to an increase in share issues. these results are based on the assumption that differences in volatility capture differences asymmetric information about the variance of cash flows arising from a managerial commitment. debt+ equity this result confirms our hypothesis (h2): organizational commitment is positively related with optimism. fairchild (2009) adds that optimistic leader (high emotional commitment level) overestimates the capacity of its business and underestimate the costs of financial distress. this evaluation bias (hopefully) makes him choose debt as a financing of these investment projects. thus, malmendier and tate (2005;2008); malmendier and tate (2015) find that the optimistic manager will give priority to self-financing, then debt and ultimately to the issuance of shares. thus, if the flow of the company is insufficient capacity, it is useful to resort to external financing. the optimistic leader always prefers debt (reported by debt) to the capital increase: the pecking order theory (azouzi and jarboui, 2012). internally generated resources+ debt+equity: this result confirms the pecking order theory: optimistic and committed leader underestimates the risk of its business. he believes that the risk can be reduced by proper use of their professional skills, which led him to choose means costly external financing (external equity). the increase in risk, as measured by the volatility of securities, led to an increase in share issues. these results are based on the assumption that differences in volatility capture differences asymmetric information about the variance of cash flows arising from a managerial commitment. thus, malmendier and tate (2005;2008); malmendier and tate (2015) find that the optimistic manager will give priority to self-financing, then debt and ultimately to the issuance of shares. asian journal of economics and empirical research, 2018, 5(1): 65-78 76 5. conclusion this research examines the determinants of firms 'capital structure choice introducing a behavioral perspective. theoretical analysis presented implications of managerial emotional commitment to explain his preference for financial decision. internally generated resources analysis by introducing managerial affective commitment enriched organizational financial theory: affective commitment is positively related to positive discretionary behaviors. so any ceo engaged threatened by the risk of loss of social status seeking to value his work at the head of his company through effective financial choices. he prefers to finance its investments by internal capital at the expense of external financing modes (risky). the managerial commitment analysis of debt preference suggested that commitment level is part of the motivation. they showed that the ceo commitment level is positively correlated with its motivation.this committed leader (motivated) looking through strategic choices (including debt financing decision) report the performance of its business. the leader chosen for debt project finance and performance reports (maximizes shareholder wealth in place and refuse the entry of new shareholders) of the firm that pushes analysts to reassess. the relationship between firm equity choice and ceo affective commitment show that optimistic and committed leader underestimates the risk of its business. he believes that the risk can be reduced by proper use of their professional skills, which led him to choose means costly external financing (external equity). the increase in risk, as measured by the volatility of securities, led to an increase in share issues. these results are based on the assumption that differences in volatility capture differences asymmetric information about the variance of cash flows arising from a managerial commitment. empirical analysis presenting survey ceo large private companies in tunisia. data analyses revealed ceo emotional commitment level importance in explaining his financial decision. the decision tree analysis of the relationship between ceo affective commitment level and investment policy confirm theoretical prediction. thus, decision tree cross validation analysis suggested that financial preferences of tunisian companies are divided into the following 4 conditions with a low margin of error between 0.06 and 0.22:  internally generated resources with an error rate of 21.43%  internally generated resources +equity with an error rate of 19.05%  debt+ equity with an error rate of 6.90% and  internally generated resources+ debt+equity with an error rate of 22.22% finally, this paper proposes a decision tree model for 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http://dx.doi.org/10.1111/j.1540-6261.1988.tb02585.x 39 © 2021 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 8, no. 1, 39-47, 2021 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2021.81.39.47 © 2021 by the authors; licensee asian online journal publishing group empirical analysis of external debt exposure to exchange rate risk in nigeria afamefuna a. eze1 stephen obinozie ogwu2 obehi destiny obozua3 chukwuemeka valentine okolo4 ( corresponding author) 1,2,3,4department of economics, university of nigeria, nsukka, nigeria. abstract this study investigates external debt exposure to exchange rate risk in nigeria. the secondary data used were sourced from the world bank development indicators for all the variables for the period from 1981 to 2019. by employing the augmented dickey–fuller unit root test and the ordinary least squares (ols) estimation technique, the study found that external debt service payment (extdsp), total payment on external debt (tpextd), and trade openness (trop) are significant, while external debt service payment (extdsp) and trade openness (trop) negatively impact the exchange rate (exchr). tpextd has a positive significant impact on exchr at a 5% level of significance. the rest of the explanatory variables – external debt stock (extds), gross domestic product growth rate (gdpgr) and real interest rate (rintr) – are all positive and insignificant at all levels of significance. the study, therefore, recommends that the government should take out concessional loans which have low-interest rates and are long-term in nature and as well encourage international trade with other countries. keywords: external debt, exchange rate risk, ols, unit root, model stability, international trade. jel classification: e3; e4; c15. citation | afamefuna a. eze; stephen obinozie ogwu; obehi destiny obozua; chukwuemeka valentine okolo (2021). empirical analysis of external debt exposure to exchange rate risk in nigeria. asian journal of economics and empirical research, 8(1): 39-47. history: received: 26 april 2021 revised: 28 may 2021 accepted: 18 june 2021 published: 14 july 2021 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interest. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 40 2. empirical review ............................................................................................................................................................................. 42 3. methodology ..................................................................................................................................................................................... 43 4. data analysis and interpretation ................................................................................................................................................. 44 5. diagnostic tests .............................................................................................................................................................................. 44 6. conclusion and recommendations ............................................................................................................................................... 46 references .............................................................................................................................................................................................. 46 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2021.81.39.47&domain=pdf&date_stamp=2017-01-14 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2021.81.39.47&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/3079 https://orcid.org/0000-0003-1163-372x https://orcid.org/0000-0002-3427-0426 https://orcid.org/0000-0002-6656-8497 https://orcid.org/0000-0003-3802-6305 asian journal of economics and empirical research, 2021, 8(1): 39-47 40 © 2021 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to existing literature by investigating external debt exposure to exchange rate risk in nigeria. 1. introduction in recent times, debt owed by countries worldwide has been in the news due to the increasing rate at which countries borrow from external and domestic sources. arguably, borrowing is not a bad idea if the borrowed funds are channeled into capital projects, such as railway construction, road construction, human capital development, and electricity generation. as a result, government revenue will increase in the near future because many taxpayers will be empowered due to the new infrastructure facilities put in place. from the revenue generated, the government can afford to repay the debt with interest because countries that borrow, especially from multilateral sources such as the international monetary fund (imf) and the world bank, are given time (often long-term) to pay back their debt. however, when borrowed funds are not used for investment purposes, the concept of debt financing will lead to an economic setback. as ijirshar, joseph, & godoo (2016) note, a country will be less prosperous if the loans obtained for investment projects are not adequately managed. they further note that only when the investment project's gains exceed the interest paid on the loans will the economy be better off. on an annual basis, the nigerian government uses fiscal policy to influence the country’s economy. for instance, if the nigerian government's planned expenditure exceeds its revenue collection for the fiscal period, the budget is a deficit. therefore, many economists argue in favor of budget deficit as they believe that tax cut increases aggregate demand, thereby increasing government revenue in the near future. in line with this reasoning, governments often borrow from domestic and external sources to fill the gap between revenue and expenditure. domestic borrowing differs from external borrowing in that the former is borrowed in local currency, whereas the latter is often in foreign currency, so there is a possibility that external debt influences the foreign exchange rate. as ezenwa (2012) notes, external debts are needed to cover the foreign exchange gap and the investment-savings gap to achieve economic growth. anyafo, cited in nwanne & eze (2015), stated that the public sector's debts can make foreign exchange resources available for financing imports, supplements foreign exchange earned from exportation of goods and services, increase capital formation, developmental aid programs as well as annual support budget and capital project implementation. he further stated, just as external debt increases national income, their servicing constitutes a major leakage as the loan repayment and the interest deplete foreign reserves which, in turn, affects the exchange rate. according to iyoboyi & muftau (2014), exchange rate is an essential endogenous element that impacts economic performance due to its impact on macroeconomic variables, such as outputs, imports, export prices, interest rates, and inflation. they went on to say that depending on the exchange rate system (fixed or floating) implemented in a country, it can be useful for balancing payment adjustments, managing crises linked with pressure for currency revaluation, fulfilling internal policy objectives, the ability to adapt to external shocks, maintaining foreign exchange reserves, driving investments, and handling speculation and levels of discipline in economic management. the preceding paragraphs show that the exchange rate's role in the nigerian economy's growth is critical. given this, the nigerian government should consider the relationship between external debt and the foreign exchange rate when formulating external debt policies. the debt management office (dmo) is a government agency established to manage the risk associated with public debt. during its 2018 annual report and statement of accounts, the dmo stated that the link between external debt and foreign exchange rate is now very clear; as the fraction of external debt to total debt increased to 32% as of december 31, 2018, from 27% as of december 31, 2017. it went on to say that the 5% increase, which coincided with a rise in the foreign currency rate, was due to debt portfolio restructuring in line with the debt management strategy's aims of achieving a 60:40 ratio for domestic debt stock to external debt stock. as a consequence, external debt from non-concessional sources increased in 2018 relative to 2017. as of december 31, 2017, the dmo data shows that external debt from concessional and non-concessional sources was 59.80% and 40.20%, respectively. in contrast, in 2018, the concessional debt dropped to 50.32%, while the nonconcessional debt increased to 49.68%. it was noted that the interest rate on concessional external debt is low relative to non-concessional debt. moreover, concessional loans are often long-term loans from multilateral and bilateral sources, such as the world bank, the international monetary fund, the african development bank, and the export-import bank of china, unlike non-concessional sources, such as the international capital market, where financial instruments are traded. regardless of the reasons why the dmo officials increased external debt relative to domestic debt, the data in the preceding paragraph shows that external loans from commercial sources with high-interest rates and less time to repay have increased relative to multilateral and bilateral sources, which are concessional (low interest rate and enough time to repay). therefore, the vital question that motivated this study is: what is the behavior of foreign exchange rate in nigeria in the face of increased external debt relative to domestic debt, especially now that the bulk of external debt is from commercial sources? answering this question has become essential following the realization that external debt affects exchange rate, as explained by dmo officials during the 2018 annual report and statement of accounts. according to the debt management office (dmo) (2018), eurobonds increased by us$4,868.35 million to us$10,868.35 million in 2018 from its previous year’s value of us$6,000.00 million, bringing the ratio of external commercial debt to 44.19% in 2018, compared to 33.33% in 2017. the growth in foreign debt stock is in keeping with nigeria's debt management plan, which strives to attain a 60:40 ratio between domestic and external debt, according to dmo officials. the largest currencies in nigeria's external debt stock are the us dollar (usd) and the special drawing right (sdr), which account for 63.81% and 34.55% of the currency composition, respectively (debt management office (dmo), 2018). this means that paying back external loans, especially loans obtained from commercial sources, will deplete our foreign reserve due to the scarcity of foreign currency. it is well known that macroeconomic stability depends on price stability, exchange rate stability, moderate inflation rate, etc. the danger inherent in the poor asian journal of economics and empirical research, 2021, 8(1): 39-47 41 © 2021 by the authors; licensee asian online journal publishing group management of external debt is that it affects vital variables, such as exchange rate, leading to poor macroeconomic performance. in light of nigeria's debt management plan, the goal of this study is to examine the risk associated with foreign exchange/currency rate in nigeria due to external debt stock and external debt service payment. this study departs from the studies conducted by nwanne & eze (2015) and many others in the sense that, at the time the study was undertaken, nigeria's debt management strategy was not in existence. therefore, there is a need to analyze the exchange rate behavior in recent times. this new strategy has increased external debt from commercial sources with high interest rates and short periods for the repayment of loans. 1.1. trend analysis on exchange rate, external debt stock, and external debt service payment in recent years some stylized facts on external debt stock, external debt service payment, and the exchange rate is provided in this section. the nigerian currency, the naira, has been depreciating in recent times and it now exchanges for fewer dollars. this unfavorable exchange rate has been attributed by many researchers and policymakers to a fall in crude oil prices. however, the diagrams below are insightful as they show a link between external debt stock, external debt service payments, and the exchange rate in nigeria. figure 1. recent trends in exchange rate and external debt stock. as figure 1 above shows, the ratio of external debt stock to gross domestic product (gdp) increased in 2016 relative to 2015. it also increased in subsequent years (18.20% in 2017 to 19.09% in 2018). this means that foreign resources entering nigeria are partly in the form of debt and not exclusively in exchange for goods and services. and because it takes time for foreign loans to impact the economy, the exchange rate has increased. when the percentage of external debt relative to gdp increases, it means that foreign resources entering the country in the form of debt have increased relative to the exchange of goods and services in the international market. this means that a drop in the export of goods and services decreases the demand for local currency, hence motivating a rise in the exchange rate in the last couple of years (₦168 in 2014, ₦197 in 2015, ₦307 in 2018, ₦379 in 2019), as shown by the central bank of nigeria's statistical bulletin. in the preceding section, it was shown that external debt from commercial sources has increased relative to multilateral and bilateral sources. this means that the bulk of the debt will be repaid within a short period. the diagram below shows debt repayment in 2017 and 2018. figure 2. public debt repayment in millions of us dollars. figure 2 above shows a wide gap between the repayment of debt in 2017 relative to 2018. this gap is attributed to an increase in interest payment. the debt management office (dmo) (2018) explained that the increase in interest payment by us$1,521.62 million, or 30.30%, reflects a repayment of 5.12% (five hundred million dollars) eurobonds, which was due for repayment in july 2018, and principal repayment of bilateral and multilateral debts. the short-term repayment of external debts from commercial sources is problematic because it will continuously drain foreign reserves and further weaken the strength of the naira, thereby raising the exchange rate. the risk associated with this development is the motivation for this study. there is a possibility that public debt will be unsustainable in the near future. moreover, the current strategy to stem the escalation of public debt will likely cause more harm than good. all indications suggest that increased external debt relative to domestic debt will weaken the naira even more. this will culminate into an unfavorable balance of trade, capital flight, high inflation rate, increased unemployment rate, and a general decline in gdp. the diagram below shows the percentage increase in external debt stock relative to total debt stock in recent years. asian journal of economics and empirical research, 2021, 8(1): 39-47 42 © 2021 by the authors; licensee asian online journal publishing group figure 3. % increase in external debt relative to total debt stock. figure 3 above confirms that the strategic plan has been implemented as the ratio of external debt relative to total debt has increased in the last couple of years. since total debt stock consists of domestic and external debts, the graph indicates that domestic debts have decreased relative to external debts. the focus of this study is to find out how this development affects the exchange rate in nigeria. in addition to the descriptive analysis in this section, a suitable data analysis method is adopted (see section four) to make recommendations that will address the possible problems of unfavorable debt policies and exchange rate risk. this paper is divided into five sections. the first is the preceding section in which the study is introduced, the second section is the literature review in which relevant literature is reviewed, section three contains the methodological framework fitted to the data used in the study, section four focuses on the discussion of the results, and section five exposes the diagnostic tests that validates the regression result for the study. finally, section six contains a summary, conclusion, and policy recommendation. 2. empirical review kouladoum (2018) studied the effect of foreign debt on the real exchange rate in chad from 1975 to 2014. using the generalized method of moments (gmm) estimation methodology, the results showed that foreign debt has a positive and significant effect on the real exchange rate at a 5% level of significance. furthermore, debt servicing has a major negative impact on the real economy. fida, khan, & sohail (2012) investigated pakistan's foreign debt and exchange rate volatility. quarterly data from 1983:q1 to 2008:q4 were tested using the autoregressive distributed lag (ardl) cointegration technique. the results show that the exchange rate and external debt variables have no long-run relationship. ijeoma (2013) used the ordinary least squares (ols) estimation approach on data from 1980 to 2010 to analyze the impact of debt on selected macroeconomic indicators in the nigerian economy. the findings show that nigeria's external debt stock has a positive and significant impact on the country's economic growth. furthermore, the findings show a statistically significant association between debt service payment and gross fixed capital formation (gfcf). liliana (2014) investigated the effect of foreign debt on romanian exchange rate volatility. external debt constituents were asked to agree to the econometric modeling of the ron/eur exchange rate using a statistical analysis. when the evolution of public and private external debt is taken into account, the results show that the evolution of the ron/eur exchange rate cannot be predicted. this may be attributed to the fluctuation of the exchange rate's unpredictability. draz & ahmad (2015) used data from nigeria and pakistan from 1965 to 2009 to examine the foreign debts and exchange rates of oil-producing and non-oil-producing countries using the ols process. according to the results, external debts have a statistically significant impact on the exchange rate of the pakistani rupee but not on global oil prices. ibi & aganyi (2015) investigated the effect of foreign debt on nigeria's economic growth. the study discovered that the causal relationship between external debt and economic growth is weak, and thus cannot be used to forecast either economic growth progress or decline using the vector autoregression (var) econometric model. as a result, fluctuations in gdp cannot be anticipated by changes in the economy. quilent (2015) looked at the effect of foreign public debt on kenyan exchange rate volatility. the ols technique was used to analyze time series data from 1993 to 2013. the foreign debt to gdp ratio was found to have a negative and large impact on exchange rate volatility, while the interest rate has a positive and large impact. inflation, gdp growth rate, and the money supply to gdp ratio all had no significant impact. finally, kenya's enormous and unsustainable external state debt was found to cause high real effective exchange rate (reer) volatility. the effect of foreign debt servicing and receipt on nigeria's exchange rate was studied by nwanne & eze (2015). using the ols method and the cointegration test on time series data from 1981 to 2013, the analysis discovered positive shortand long-run relationships between foreign debt receipts and external debt servicing with naira exchange rate fluctuations. although external debt receipts have a positive impact on the exchange rate, external public debt servicing has a negative impact, according to the report. similarly, saheed, sani, & idakwoji (2015) investigated the exchange rate impact of nigeria's public foreign debt. external debt, debt service payments, and foreign reserve all had a role in explaining currency rate changes in nigeria. the payment of debt service was found to have the greatest impact. iyoboyi & muftau (2014) empirically investigated the impact of exchange rate depreciation on nigeria's balance of payments from 1961 to 2012. using a multivariate vector error correction system, the researchers discovered a cointegrating relationship between the balance of payments, exchange rate, and other related variables. the results of the causal effect test also showed bidirectional causality between the balance of payment and the other variables. in addition, generalized impulse response functions were used in the study, and the results showed that a one standard deviation shift in the exchange rate reduces the positive balance of payments in the medium and long terms. the variance decomposition results show that major variations in nigeria's balance of payments are not due to changes in exchange rates. asian journal of economics and empirical research, 2021, 8(1): 39-47 43 © 2021 by the authors; licensee asian online journal publishing group more recently, ogbonna, ibenta, chris-ejiogu, & atsanan (2019) critically analyzed nigeria's public debt servicing and economic development from 1970 to 2017. the augmented dickey–fuller unit root test, johansen cointegration test, and vector error correction model were used in this analysis. according to the findings, total public debt services and the consumer price index have a negative and positive impact, respectively, on economic development. the outcome of the exchange rate, on the other hand, had a negative and insignificant effect on economic growth. the results of the cointegration test also showed the existence of a long-term relationship. adeniran, azeez, & aremu (2016) conducted a report on the impact of foreign borrowing on nigerian economic growth. the results of applying the ardl cointegration method to time series data from 1987 to 2018 indicate that external debt stock has a positive and significant impact on economic growth, while debt servicing has an adverse impact on growth both in the short and long runs. adamu & rasiah (2016) investigated the complex impact of external debt on nigerian economic development from 1970 to 2013. the ardl bounds test was used in this analysis, and the results indicate a cointegrating association between the variables. external debt has a negative long-term impact on economic growth, while the external debt sustainability index has positive shortand long-term impacts on economic growth. using the vector error correction model, adeniran et al. (2016) investigated the effect of external debt on economic growth in nigeria from 1980 to 2014. external debt has a negative and substantial effect on economic development, according to the empirical results of the impulse response study. the granger causality test also showed that real gdp and exchange rate have a one-way causal relationship between external debt service payment and real gdp. kharusi & ada (2018) looked into the relationship between government external borrowing and economic growth in oman. the ardl cointegration approach was used to analyze time series data from 1970 to 2015. according to the findings, external debt has a negative and significant effect on economic growth. ali & mustafa (2012) examined the longand short-term impacts of external debt on pakistan's economic growth from 1970 to 2010. according to empirical studies, external debt has a negative effect on economic growth. jebran, ali, hayat, & iqbal (2016) investigated the effect of public debt on pakistan's economic growth from 1972 to 2012. the study used the ardl bounds testing method to evaluate the long-run and short-run relationships between external debt and economic development. the findings showed both positive and significant relationships between external debt, gdp and gnp in the long and short terms. in the short term, debt servicing was found to have a negative impact on gdp and gnp. the effect of sri lanka's public debt on economic growth and investment was examined by akram (2017). according to the study, which used the ardl method, public external debt has a positive impact on economic growth, while debt servicing has a negative impact on per capita gdp and investment. furthermore, both per capita gdp and expenditure demonstrated positive and meaningful relationships with public external debt and debt servicing. udeh, ugwu, & onwuka (2016) investigated the impact of external debt on nigerian economic growth from 1980 to 2013 using the ols technique. according to the results, external debt is positively related to gdp in the short run but negatively related in the long run. further analysis showed that debt service is negatively correlated with gdp, while the exchange rate is positively correlated. from the review above, it is clear that none of the studies was able to look at the external debt exposure to exchange rate risk in nigeria, hence the gap in the literature. 3. methodology both the classical and keynesian schools of thought recognized the demand-side and supply-side factors as the main determinant of the exchange rate. when further expanded, this reveals that interest rate, inflation rate, government debt, and terms of trade among others, are the key macroeconomic variables that determine the exchange rate. for this study, the following variables will be adopted for modeling purposes and they include interest rate, trade openness, gdp growth rate, and public debt. the data for the study were sourced from the world development indicators (wdi) and were converted from annual to quarterly using eviews 9.0. the stated model below is estimated with the use of ols: 𝐸𝑋𝐶𝐻𝑅𝑡 = 𝛼 + 𝛽1𝐸𝑋𝑇𝐷𝑆𝑡 + 𝛽2𝐸𝑋𝑇𝐷𝑆𝑃𝑡 + 𝛽3𝐺𝐷𝑃𝐺𝑅𝑡 + 𝛽4𝑅𝐼𝑁𝑇𝑅𝑡 + 𝛽5𝑇𝑃𝐸𝑋𝑇𝐷𝑡 + 𝛽6𝑇𝑅𝑂𝑃𝑡 + 𝜇𝑡 (1) where 𝐸𝑋𝐶𝐻𝑅 is the dependent variable and represents the exchange rate in the country; 𝐸𝑋𝑇𝐷𝑆 is the external debt stock of the country; 𝐸𝑋𝑇𝐷𝑆𝑃 is the external debt service payment; 𝐺𝐷𝑃𝐺𝑅 is the gdp growth rate in the country; 𝑅𝐼𝑁𝑇𝑅 is the interest rate in the country; 𝑇𝑃𝐸𝑋𝑇𝐷 is the total payment on external debt; 𝑇𝑅𝑂𝑃 is the country’s trade openness; 𝛼 is the intercept; 𝛽1, 𝛽2, 𝛽3, 𝛽4, 𝛽5, 𝛽6 are the coefficients of the explanatory variables, respectively; 𝜇 is the error term which captures the variables not included in the model; and 𝑡 represents the period since it is a time series study. 3.1. unit root test the unit root test is necessary to verify if the data for the variables are all stationary. the ols estimation technique is hindered by mixed stationarity; hence, all the variables must have a uniform stationary status to permit the use of the ols and produce a reliable regression result. below is the common rule of thumb for the unit root test: 𝐸(𝑌𝑡) = 𝐸(𝜀𝑡 − 𝜀𝑡−1) = 0 𝑉𝑎𝑟(𝑌𝑡) = (𝑌𝑡 2) = 𝜎2 𝐶𝑜𝑣(𝑌𝑡 , 𝑌𝑡−1) = 𝐸(𝑌𝑡 − ẏ)(𝑌𝑡−1 − ẏ) = −𝜎2 3.2. autocorrelation when a mutual relationship or effect exists between two or more members of a series, it is regarded as autocorrelation (orji, ogwu, mba, & anthony-orji, 2021). the effect of such a relationship, if not taken care of, will produce spurious regression results that can’t be relied upon for policy purposes. e(µiµj) ≠ 0, i≠j asian journal of economics and empirical research, 2021, 8(1): 39-47 44 © 2021 by the authors; licensee asian online journal publishing group in this study, the hac newey–west coefficient covariance is used to correct for any presence of autocorrelation as well as heteroscedasticity in the regression equation. 3.3. diagnostic tests aside from the pre-estimation test for the unit root and the autocorrelation and heteroscedasticity tests, which come after the estimation, tests including the ramsey test of omitted variables, the jarque–bera test of normality, and the cusum and cusum square tests of stability are also performed in this study. 4. data analysis and interpretation table 1. descriptive statistics. exchr extds extdsp gdpgr rintr tpextd trop mean 95.36890 64.91793 2.683113 3.536163 0.533905 9.19e+08 48.55229 median 101.6973 60.25287 1.815186 3.668412 2.767927 7.27e+08 50.74836 maximum 364.5020 228.3718 8.350607 33.73578 25.28227 4.94e+09 81.81285 minimum 0.617708 4.130462 0.019316 -13.12788 -43.57266 67518065 20.72252 std. dev. 95.75284 58.23124 2.725498 6.289357 13.28987 7.78e+08 17.03783 skewness 1.048110 0.736520 0.664279 1.145153 -0.973938 1.802249 -0.179366 kurtosis 3.682679 2.803470 1.976149 8.423968 4.005163 8.285146 1.769892 jarque–bera 30.98371 14.07899 17.93501 220.9890 30.62915 260.8980 10.46683 probability 0.000000 0.000877 0.000127 0.000000 0.000000 0.000000 0.005335 sum 14591.44 9932.443 410.5163 541.0330 81.68749 1.41e+11 7428.500 sum sq. dev. 1393628. 515413.3 1129.107 6012.513 26846.32 9.21e+19 44123.72 observations 153 153 153 153 153 153 153 the results of the descriptive statistics from the original data in table 1 shows means of 95.36, 64.91, 48.55 for the exchange rate (exchr), external debt servicing (extds), and trade openness (trop), respectively, which are on the high side. similarly, the differences between their maximum and minimum values are also high indicating that the three variables are exposed to volatility or shocks. exchr was found to be influenced by the explanatory variables. for trade openness (trop), the activities going on in the international market are a possible cause. on a general level, the data for the entire variable looks good and normal, as shown by the jarque– bera probability that the data for the entire variable is significant at the 5% level. the results further show that all the variables are positively skewed except for real interest rate (rintr) and trade openness (trop), which are negatively skewed. table 2. unit root test. augmented dickey–fuller variable level (trend & intercept) first difference (trend & intercept) exchr -2.2611(1) -3.6774(0)** extds -2.9139(5) -4.0870(4)*** extdsp -3.3323(5)* -4.0859(4)*** gdpgr -3.0049(9) -4.2783(8)*** rintr -4.3800(9)*** -4.1088(12)** tpextd -3.9564(9)** -3.8628(12)** trop -1.7938(5) -4.1669(4)*** notes: 1. ***, **, * imply significance at the 1%, 5%, and 10% levels, respectively. 2. the numbers in parentheses for the unit root tests represent the lag of the dependent variable used to obtain the schwarz information criteria. the results of the unit root tests in table 2 show that all the variables are stationary at the first difference i(1) at trend and intercept, thus permitting the use of ordinary least squares (ols) for the regression analysis in this study. 5. diagnostic tests to authentic the regression results in this study the following diagnostic test is carried out: serial correlation test; heteroscedasticity test; normality test; specification error test; and the dynamic stability test. table 3. diagnostic test results. diagnostic tests f-statistic prob. autocorrelation test 2553.81 f(2,144) 0.000 heteroscedasticity test 6.65 f(6,146) 0.000 ramsey test 9.71 f(1,145) 0.000 jarque–bera test 17.53 0.000 table 3 shows the results of the various diagnostic tests. the autocorrelation test results indicate rejection of the null hypothesis of no serial correlation among the variables of the study at the 5% significant level. similarly, the result of the heteroscedasticity test permits the rejection of the null hypothesis of no heteroscedasticity at the 5% significant level. in both cases, we accept the alternate hypothesis that states that both serial correlation and heteroscedasticity exist in our model warranting the need to use the coefficient covariance results. also, the ramsey test for omitted variables indicates that the null hypothesis should be rejected and the alternative hypothesis accepted at the 5% conventional significance level. this means that some variables were omitted in the model, and this will likely include variables, such as inflation and politically related variables, that create an environment which enables economic activities to thrive in the country. the significance of the constant of the asian journal of economics and empirical research, 2021, 8(1): 39-47 45 © 2021 by the authors; licensee asian online journal publishing group regression results further validate the results of the ramsey test of omitted variables. finally, the jarque–bera results also shows that our model is normal, being correctly stated. -40 -20 0 20 40 60 80 100 120 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 cusum 5% significance -0.2 0.0 0.2 0.4 0.6 0.8 1.0 1.2 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 cusum of squares 5% significance figure 4. stability test. to check if our model is stable and ideal for prediction purposes, the cusum and cusum square tests were conducted. in figure 4, the first cusum graph shows how the model line lies within the 5% boundary, and at a later time deviated from the 5% significance boundary. the second graph shows even more severe cases of deviation from the 5% significance line. the two graphs clearly show that the model is not stable and thus not suitable for prediction purposes. in essence, it points to the fact that the exchange rate in nigeria is highly volatile, looking at it quarterly, and that prediction variables are not capable of predicting the future trend of the exchange rate. this is further validated by the cointegration result, which shows the absence of any long-run relationship, although it is not included here. however, previous studies have come up with similar cointegration results (fida et al., 2012; liliana, 2014). the results from the annual data show that the model is stable for the cusum test, whereas the cusum square test is in line with the result of this study, although the cusum and cusum square graphs from the annual data are not included in this manuscript. table 4. ols regression results. dependent variable: exchr variable coefficient std. error t-statistic prob. extds 0.2157 0.318852 0.676344 0.4999 extdsp -32.3571 9.135584 -3.541878 0.0005 gdpgr 2.5571 1.893060 1.350764 0.1789 rintr 0.4872 0.521118 0.934927 0.3514 tpextd 2.75e-08 1.03e-08 2.673141 0.0084 trop -1.9397 0.800535 -2.423057 0.0166 c 227.8307 43.32461 5.272076 0.0000 r-squared 0.644335 mean dependent var. 95.36890 adjusted r-squared 0.629718 s.d. dependent var. 95.75284 s.e. of regression 58.26634 akaike info criterion 11.01260 sum squared resid 495665.1 schwarz criterion 11.15125 log likelihood -835.4638 hannan–quinn criterion 11.06892 f-statistic 44.08307 durbin–watson stat. 0.036895 prob(f-statistic) 0.000000 wald f-statistic 12.48964 the regression result in table 4 shows that external debt stock (extds) has a positive and insignificant impact on the exchange rate (exchr) with a t-value of 0.67 and a p-value of 0.49. this implies that nigeria’s external debt stock does not influence the exchange rate situation in the country. on the other hand, external debt service payment (extdsp) has a negative significant impact on exchr at the 5% level, just as the t-value of 3.54 and p-value of 0.00 show, which implies that the payment made in servicing the country’s external debt is a strong determinant of the exchange rate (exchr). this result is in line with the a priori expectation that increasing the cost of servicing the external debt will make the country’s exchange rate worse-off, whereas a declining cost of serving external debt will better the country’s exchange rate (exchr) system. in the same vein, the gross domestic product growth rate (gdpgr) is expected to improve the country’s exchange rate with every increase. however, the result from this study failed to validate this economic theoretical expectation with an insignificant positive t-value of 1.35 and a p-value of 0.17. the real interest rate (rintr) also has a positive insignificant impact on the exchange rate (exchr), thereby falling short of the a priori expectation, as the t-value asian journal of economics and empirical research, 2021, 8(1): 39-47 46 © 2021 by the authors; licensee asian online journal publishing group of 0.93 and p-value of 0.35 reveals. based on economic expectation, one would expect the domestic interest rate to be less compared to the international interest rate and thus serve as motivation to borrow from home. in this way, there will be an increase in the demand for local currency thereby improving the exchange rate (exchr) in the country. this supports the findings of nwanne & eze (2015), who found that the long-term nature and the low interest rate charged on international debt has made external borrowing more attractive than domestic borrowing. the total payment made on external debt (tpextd) has a positive significant impact on the exchange rate (exchr) in nigeria, as shown by the t-value of 2.67 and p-value of 0.00. this implies that the more the external loan is repaid, the more the exchange rate will rise. the simple reason is that external borrowing and repayment transactions are conducted in foreign currency. therefore, since repaying foreign debt requires foreign currency, the demand for this foreign exchange will put pressure on the currency thereby increasing the exchange rate. the result shows that trade openness (trop) has a negative significant impact on the exchange rate (exchr) at the 5% level with a t-value of -2.24 and a p-value of 0.01. this is in line with the economic theory where the more a country is open to trading activities, the greater their foreign exchange earnings will be, which will build up their foreign reserve and international payment account. this will create more availability of foreign exchange for those who need it and reduce the pressure on foreign exchange. similarly, the more open a country is to trade, the more it will attract investors, thus the demand for domestic currency will increase, leading to appreciation. therefore, a better trade openness will lead to fewer exchange rate risk problems. the r2 of the regression result is 0.64, which shows that 64% of the changes in the dependent variable (exchr) were jointly caused by the explanatory variables. the remaining 36% are captured by the constant, which is significant. the wald f-statistic is 12.46 with a p-value of 0.00, indicating that the joint influence of the explanatory variables on exchr is significant. the hac newey–west coefficient covariance was used to edge out the effects of serial correlation and heteroscedasticity in the regression results; therefore, the durbin–watson result should be overlooked. on a general note, the issues relating to external debt are key factors influencing the exchange rate in nigeria given that the country is sufficiently open to trade. this suggests that nigeria’s external debt variables can be used to improve the country’s exchange rate system if well managed. 6. conclusion and recommendations this paper examined exchange rate risk and external debt in nigeria, and the quarterly data was analyzed with the use of the ols estimation technique. the study found that external debt service payment (extdsp), total payment on external debt (tpextd), and trade openness (trop) are significant. additionally, external debt service payment (extdsp) and trade openness (trop) negatively impact the exchange rate (exchr). tpextd has a positive significant impact on exchr at a 5% level of significance. the rest of the explanatory variables (external debt stock (extds), gross domestic product growth rate (gdpgr), and real interest rate (rintr)) are all positively insignificant at all levels of significance. this suggests that, given sufficient trade openness in nigeria, that the explanatory variables can be used to improve the country’s exchange rate system if well managed. references adamu, i. m., & rasiah, r. (2016). external debt and growth dynamics in nigeria. african development review, 28(3), 291-303. available at: https://doi.org/10.1111/1467-8268.12206. adeniran, a. o., azeez, m. i., & aremu, j. (2016). external debt and economic growth in nigeria: a vector auto-regression (var) approach. international journal of management and commerce innovations, 4(1), 706-714. akram, n. (2017). role of public debt in economic growth of sri lanka: an ardl approach. pakistan journal of applied economics, 27(2), 189212. ali, r., & mustafa, u. (2012). external debt accumulation and its impact on economic growth in pakistan. pakistan development review, 51(4), 79-97. available at: https://doi.org/10.30541/v51i4iipp.79-96. debt management office (dmo). (2018). annual report and statement of accounts. abuja, nigeria. august 30, 2019. 18-73. retrieved from: https://dmo.gov.ng/publications/reports/dmo-annual-report-statement-of-account/3060-2018-annual-report/file. draz, m. u., & ahmad, f. (2015). external debts and exchange rates of oil-producing and non-oil-producing nations: evidence from nigeria and pakistan. journal of advanced management science, 3(1), 8-12. ezenwa, c. s. (2012). the effect of external debt on economic growth of nigeria. a project presented to the department of economics, caritas university, emene enugu, in partial fulfillment for the award of bachelor of sciences (bsc) degree in economics. fida, b. a., khan, m. m., & sohail, m. k. (2012). analysis of exchange rate fluctuations and external debt: empirical evidence from pakistan. african journal of business management, 6(4), 1760-1768. available at: https://doi.org/10.5897/ajbm11.1283. ibi, e. e., & aganyi, a. (2015). impacts of external debt on economic growth in nigeria: a var approach. journal of business management and administration, 3(1), 1-5. ijeoma, n. (2013). an empirical analysis of the impact of debt on the nigerian economy. afrrev ijah: an international journal of arts and humanities, 2(3), 165-191. ijirshar, v. u., joseph, f., & godoo, m. (2016). the relationship between external debt and economic growth in nigeria. international journal of economics and management science, 6(5), 156-170. iyoboyi, m., & muftau, o. (2014). impact of exchange rate depreciation on the balance of payments: empirical evidence from nigeria. cogent economics & finance, 2(1), 1-23. available at: 10.1080/23322039.2014.923323. jebran, k., ali, k., hayat, u., & iqbal, a. (2016). public debt and economic growth: a reassessment. pakistan business review, 18(2), 307-324. kharusi, s. a., & ada, m. s. (2018). external debt and economic growth: the case of an emerging economy. journal of economic integration, 33(1), 1141-1157. available at: https://doi.org/10.11130/jei.2018.33.1.1141. kouladoum, j. c. (2018). external debts and real exchange rates in developing countries: evidence from chad. université de sarh, munich personal repec archive (pp. 1-14). munich: université de sarh. liliana, b. (2014). the impact of external debt on exchange rate variation in romania. economics & sociology, 7(3), 104-115. available at: https://doi.org/10.14254/2071-789x.2014/7-3/8. nwanne, t., & eze, o. (2015). assessing the effect of external debt servicing and receipt on exchange rate in nigeria. international journal of economics and finance, 7(9), 278-286. available at: https://doi.org/10.5539/ijef.v7n9p278. ogbonna, k. s., ibenta, s. n., chris-ejiogu, u. g., & atsanan, a. n. (2019). public debt services and nigerian economic growth: 1970-2017. european academic research, 6(10), 5724-5740. orji, a., ogwu, s. o., mba, n. p., & anthony-orji, o. i. (2021). energy demand and cooking energy cost in an oil-rich economy: a new evidence from nigeria. studia universitatis “vasilegoldis” arad. economics series, 31(1), 1-21. asian journal of economics and empirical research, 2021, 8(1): 39-47 47 © 2021 by the authors; licensee asian online journal publishing group quilent, a. o. (2015). an analysis on the effect of external public debt on exchange rate volatility in kenya. research project submitted in partial fulfillment of the requirement for the award of the degree masters of arts in economic policy and management of the university of nairobi, november 2015. saheed, z. s., sani, i. e., & idakwoji, b. o. (2015). impact of public external debt on exchange rate in nigeria. international finance and banking, 2(1), 15-26. available at: https://doi.org/10.5296/ifb.v2i1.7734. udeh, s. n., ugwu, j. i., & onwuka, i. o. (2016). external debt and economic growth: the nigeria experience. european journal of accounting auditing and finance research, 4(2), 33-48. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 48 © 2021 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 8, no. 2, 48-57, 2021 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2021.82.48.57 © 2021 by the authors; licensee asian online journal publishing group does sterilization policy exert an upward pressure on interest rate as dictated by theory? a nigerian example nzeh, innocent chile1  nwogwugwu, uche collins2 nkamnebe, ogochukwu edith3 millicent adanne eze4 abubakar yusuf5 bartholomew.o.n. okafor6 ( corresponding author) 1department of economics, renaissance university ugbawka, enugu state, nigeria. 2,3department of economics, nnamdi azikiwe university, awka, anambra state, nigeria. 4school of business, law and social sciences, abertay university, dundee, united kingdom. 5national metallurgical development centre (nmdc) jos, plateau state, nigeria. 6department of economics, nile university of nigeria, nigeria. abstract the implications of capital inflows on the economy and the fallout of the policy geared towards addressing these phenomena, especially the impact of the policy on interest rate, motivated this study. under the framework of the autoregressive distributed lag (ardl) technique and using monthly series over the period from 2010:m1 to 2021:m3, the findings show that in the short-run, sterilization policy leads to a rising interest rate in the current period. however, after a lag, sterilization policy depresses the interest rate. it was equally found that, in the long-run, sterilization policy pushes the interest rate up. also, a negative relationship was observed between money supply and interest rate in both the short-run and the long-run, and the exogenous variables in the model influence the interest rate significantly. we therefore recommend that different measures should be adopted to cushion the effect of unsustainable capital inflows to avoid repeated need for further sterilization and the increasing cost of sterilization in the long run. it is also recommended that exogenous variables should be factored in when determining a desirable interest rate in line with economic reality. keywords: sterilization policy, monetary policy, capital inflows, exchange rate, interest rate, ardl. jel classification: e52; f38; f31; b23. citation | nzeh, innocent chile; nwogwugwu, uche collins; nkamnebe, ogochukwu edith; millicent adanne eze; abubakar yusuf; bartholomew.o.n. okafor (2021). does sterilization policy exert an upward pressure on interest rate as dictated by theory? a nigerian example. asian journal of economics and empirical research, 8(2): 48-57. history: received: 30 april 2021 revised: 2 june 2021 accepted: 23 june 2021 published: 15 july 2021 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. background to the study ................................................................................................................................................................ 49 2. literature review ............................................................................................................................................................................ 52 3. analytical framework ..................................................................................................................................................................... 52 4. interpretation of results and discussion of findings .............................................................................................................. 54 5. conclusion and recommendations ............................................................................................................................................... 56 references .............................................................................................................................................................................................. 56 https://www.asianonlinejournals.com/index.php/ajeer/article/view/3083 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2021.82.48.57&domain=pdf&date_stamp=2017-01-14 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2021.82.48.57&domain=pdf&date_stamp=2017-01-14 https://orcid.org/0000-0002-7049-1699 https://orcid.org/0000-0003-0613-1012 https://orcid.org/0000-0002-2951-4027 https://orcid.org/0000-0003-3773-8183 https://orcid.org/0000-0002-3118-8224 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ asian journal of economics and empirical research, 2021, 8(2): 48-57 49 © 2021 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the existing literature by exploring whether the implementation of sterilization policy raises domestic interest rates in nigeria as suggested by theory. this study was conducted by adopting a relevant proxy for sterilization policy, which previous studies did not consider. 1. background to the study capital inflows have become a veritable means of cushioning the effects of a shortfall in revenue, especially for countries that usually experience an adverse balance of payments position. this is mainly the case in most developing countries that are in dire need of additional resources to survive occasional liquidity constraints. the current upsurge in capital inflows in developing countries, observed by calvo & reinhart (1998), is a recent development. the study contended that the nature of capital that flows into the economies of developing countries used to be in the form of official transfers. several factors have been noted to be responsible for these rising inflows, a major one being the relaxation of impediments to capital mobility across countries. capital inflows are needed as a way of obtaining additional resources; however, they come with some negative consequences if not well managed. as noted by lee (1997), rising capital inflows have a tendency to cause an increase in monetary aggregates, which is subject to diverse consequences, such as domestic currency appreciation and rising inflation. this situation arises as the monetary authorities intervene in the reserve accretion through the purchase of foreign exchange. such practice leads to a rise in the monetary base of the domestic commercial banks, thus giving rise to growth in monetary aggregates. capital inflows in nigeria have been increasing over the years, particularly since the country’s discovery of oil in commercial quantities, though with some years of decline. apart from the proceeds from the oil sector, which has been noted as the major source of liquidity in the country, other sources of capital inflows include, among others, foreign direct investment, foreign portfolio investment, diaspora remittances and growth in external debt. worthy of note is the recent upsurge in remittances, which accounts for a large share of the country’s gross domestic product (gdp). on realizing the importance of diaspora remittances, the central bank of nigeria (cbn), which is the official monetary regulatory authority, has been putting measures in place to attract remittances. currently, the cbn, in order to shore up remittances, has been offering five naira for every dollar sent from abroad, and consequently, the country’s reserves have improved. from figure 1 below, it can be seen that there is a rising trend in the sources of capital inflows in nigeria since the start of the current democratic dispensation in 1999. these sources include official development assistance (oda), remittances (rem), external debt (ext. debt), foreign portfolio investment (fpi) and foreign direct investment (fdi). the consolidation of the banking sector and other reforms put in place around 2005 stimulated investor confidence within this period, thus leading to growth in inflows. between 2007 and 2008, there was growth in the capital market activities partly due to conducive policies and bullish seasons in the advanced market economies, which trickled down to the domestic economy in the form of investments in the capital market. however, the economic meltdown of 2009 affected the country’s capital inflows. before 2016, external debt was low; however, the regime change in 2015 and this led to a rise in external debt, which pulled up capital inflows. figure 1. trend in sources of capital inflows in nigeria. countries witnessing excess and abrupt capital inflows put measures in place to avoid the likely negative consequences associated with the rising domestic money supply that this could trigger. several measures lead to countries witnessing capital inflows in order to mitigate the monetary effects of this development. some of these measures include exchange rate intervention, fiscal tightening, transfer of government’s deposits from the commercial banking system, and sterilization. among these measures, sterilization is usually given preference because of its timeliness of implementation and the absence of political interference associated with it. the popularity of sterilization has been noted by lee (1997) and reinhart & reinhart (1998). the term sterilization refers to measures put in place to neutralize the monetary effect of reserve inflows through the open market sales of domestic securities and increases in reserve requirements (takagi & esaka, 1999). in nigeria, the cbn, in order to sterilize systemic liquidity, mainly adopts foreign exchange sales. as a followup to this, the cbn also issues government bills and bonds in the primary market in addition to influencing the reserve position of commercial banks through change in the cash reserve ratio (crr). in addition to these, okpanachi (2013) observed that the cbn uses the repos and exchange rate swaps as well as withdrawal of public sector funds from the deposit money banks to mitigate the impact of rising inflows. in particular, the cbn has been using the open market operation (omo) consistently as it deliberates the position of the cash reserve ratio in line with the current money supply situation in each of its monthly monetary policy committee meetings. operationally, sterilization entails the monetary authorities altering the net domestic assets (ndas) in order to influence the change in net foreign assets (nfas). thus, a rise in nfas indicates that the monetary authorities asian journal of economics and empirical research, 2021, 8(2): 48-57 50 © 2021 by the authors; licensee asian online journal publishing group anticipate a rise in money supply due to foreign exchange intervention. consequently, the ndas are reduced to mitigate the effect of the rising money supply. however, the reverse is the case when the nfas fall. in figure 2 below, within the 2018–2019 period when capital inflows were high, the cbn engaged in a sterilization exercise as indicated by the reduction in ndas due to rising nfas. the band between nfas and ndas widens in any period when capital inflows associated with nfas rise very high. figure 2. the relationship between δnda and δnfa. the role of sterilization in neutralizing the monetary impact of capital inflows comes with costs. the limits to the use of sterilization have been noted by lee (1997) and include the fact that sterilization cannot be effective in the face of increasing capital mobility. the study also observed that sterilization does not work effectively over a longer period if shocks are persistent as it is not designed to handle the underlying causes of shocks. one major fallout of sterilization is that the interest rate differential can widen by reducing the nda through open market sales of domestic bonds, which leads to a further round of capital inflows. okpanachi (2013) corroborated this position and contended that sterilization cannot permanently neutralize the risks relating to high and persistent flows. this is partly due to the offsetting decrease in domestic assets that give rise to higher domestic interest rates in relation to foreign rates. consequently, as noted by ljubaj, martinis, & mrkalj (2010), the monetary authorities will find themselves in a vicious circle of implementing sterilization policy. therefore, the potential rise in domestic interest rate as a consequence of implementing sterilization policy motivated this study to investigate if this situation holds empirically and what monetary implications it portends, especially in nigeria where domestic interest rate is comparatively high. the choice of a proxy for sterilization policy is further motivation for this study. previous studies have always used the coefficient of nfa to proxy sterilization policy. it is our view that the argument for using the coefficient of nfa as proxy for sterilization policy can only hold water when investigating the degree of sterilization using the monetary policy reaction function, where any change in nfa is neutralized with a corresponding change in nda. however, if the objective is finding the impact of sterilization on any monetary policy variable, then the coefficient of nfa as a proxy for sterilization becomes weak. using nfa to proxy sterilization amounts to investigating the impact of capital inflows on the variable of interest, which defeats the objective of sterilization policy. we thus depart from previous studies by applying total sterilization as a proxy for sterilization policy. the formula for calculating total sterilization was obtained from lavigne (2008). the benefit of adopting this proxy is that, unlike the coefficient of nfa, it incorporates the two main measures that influence the reserve position of commercial banks, namely the open market operation (omo) and the cash reserve ratio. as observed by lavigne (2008), ‘’a measure of the total effects of all sterilization policies should integrate both market-friendly and nonmarket-friendly policies designed to limit domestic money multipliers’’. 1.1. some stylized facts the aftermath of capital inflows is their influence of the reserve position of the capital recipient country. nigeria’s foreign reserves have been experiencing fluctuations over the years in line with the country’s capital inflows. figure 3 below shows that the country’s reserves rose between 2007 and 2008. this was partly due to the high global demand for oil, which resulted in reserve accretion during that period. however, with the onset of the recession around 2008 coupled with the militants’ activities in the country’s oil-rich niger delta region which crippled oil production, reserves began to witness a downward trend, which only started picking up from 2012. the amnesty programme executed by the administration in 2010, which was used to quell the militancy in the niger delta region, led to an improvement in oil production, and this rubbed off on the country’s reserves. as observed by aghalino (2012), the amnesty programme was successful as witnessed in improved oil production and a reduction in bunkering activities in the niger delta region. from 2013, the reserve position began to show a rising trend until 2014, partly due to increased oil prices and relatively consistent policy of the administration. as the leadership of the country changed in 2015, the reserve position began to dwindle owing to the delay in the takeoff of the administration, which affected the policy direction and thus eroded investors’ confidence. however, the reserves started to improve in 2018 up until 2019, when it experienced a downward trend. currently, the reserves have depleted in such a way that the government has been urgently attempting to procure external debt to shore up the reserves. asian journal of economics and empirical research, 2021, 8(2): 48-57 51 © 2021 by the authors; licensee asian online journal publishing group figure 3. trend in nigeria’s foreign reserves from 2007–2019. the evidence in figure 4 shows that the treasury bill rate rose in 2019 up to around the third quarter, and this growth corresponds with the growth in external reserves. apart from sterilizing the reserve inflows through the omo, the government at both the state and federal levels has been floating bonds to raise funds, which led to the rising trend in the treasury bill rate. usually, the treasury bill rates are offered at a rate higher than the market rate. the essence of offering rates higher than the market rate is to make the bond attractive to investors because if foreign rates are more attractive, the subscription rate will be low and that could frustrate the sterilization effort of the monetary authorities. the success of the bond sell through the omo is expected to neutralize the monetary impact of reserves accumulation. as reserves began to decline around 2020, as depicted in figure 3 above, the omo began to slow down as evidenced from the declining trend in the treasury bill rate. figure 4. trend in treasury bill rate from 2019:m1–2020:m12. aizenman & glick (2008) contended that reserves accumulation has some monetary implications. the study noted that when the monetary authorities purchase foreign reserve assets, funding arrangements for this policy should be made. the funding could be in the form of increasing the reserve money base or by reducing the net domestic assets. the former choice has the potential of being inflationary, while the later has impact on the domestic reserve money base. lavigne (2008) noted that when a central bank purchases foreign exchange as a way of neutralizing the domestic currency appreciation, it can issue bonds to the domestic market to dampen the effect of this measure. accordingly, such a measure uses up the domestic money supply, thus effectively neutralizing its impact on domestic interest rates and inflation. in summary, the intervention of the monetary authorities regarding increasing capital inflows usually leads to an increase in money supply. figure 5 below shows that since 1999, the broad money supply has been witnessing a rising trend. consequently, monetary authorities react by using different measures to mitigate the impact of this development on the macroeconomic environment. figure 5. trend in nigeria’s broad money supply (m2). asian journal of economics and empirical research, 2021, 8(2): 48-57 52 © 2021 by the authors; licensee asian online journal publishing group 2. literature review in this study, we reviewed the basic literature at both country-specific and international levels. 2.1. empirical literature the need to mitigate the monetary impact of capital inflows has led to several studies on sterilization across different countries. using a multivariate dynamic regression and a sample of quarterly data from 28 countries over the period from 1990 to 2010, bleaney & devadas (2013) showed that broad money is sterilized to a significantly smaller degree than reserve money. in a study on nigeria, okpanachi (2013) showed that the degree of sterilization is significantly high. however, chung, hwang, & wang (2014) revealed that chinese monetary authorities sterilize almost all of the effects of international capital inflows, and this study is in line with previous studies on china. using the vector autoregressive (var) model, blanchard, adler, & de carvalho filho (2015) revealed that the global financial cycle drives gross flows and exchange rate movements in most of the countries sampled. begum (2014) investigated the extent of sterilization of the bangladesh bank and found that a long-run relationship exists between ndas and nfas. in a study on pakistan, khushk, gilal, & taherani (2015) found that the central bank partially sterilizes its foreign exchange operation, and for egypt, elhendawy (2015) showed the existence of a longrun positive relationship between sterilization and inflation. in a country-specific study for algeria, djedaiet & ayad (2017) showed evidence of full sterilization by the algerian bank, while in an international study involving some emerging market economies, ponomarenko (2019) found incomplete sterilization. arya, cavoli, & onur (2020) examined the relationship between foreign exchange rate and sterilization in 28 emerging market economies and showed that greater fixity of the exchange rate and sterilized intervention can potentially encourage capital inflows. in another study on nigeria, nzeh, nwogwugwu, uzoechina, chiedo, & anyachebelu (2020) showed that the degree of sterilization is relatively high and significant and that there is also significant but low capital mobility. however, the degree of capital mobility is higher than that reported by okpanachi (2013). hoang, nguyen, & nguyen (2020) evaluated the effectiveness of sterilization in vietnam and found that the state bank of vietnam (sbv) has not been able to fully neutralize the impact of inflows on the domestic money supply. for botswana, mannathoko (2020) investigated why monetary policy failed to contain inflation in the 2000s. findings showed how a series of policy decisions since 1999 led to a substantial loss of monetary policy autonomy, large offsetting inflows, unsustainable sterilization costs, high inflation, and real exchange rate appreciation. nzeh et al. (2020) investigated the effectiveness of sterilization policy in controlling money supply and capital inflows in nigeria. findings of the study show that the sterilization policy of the central bank of nigeria (cbn) is effective in regulating money supply and depressing capital inflows both in periods of normal capital inflows and in periods of intensive capital inflows. in another study on nigeria, jume (2021) assessed the monetary policy response of the cbn to the increases in capital inflows. results show that the cbn successfully offset 95% of capital inflows during the period of analysis. 3. analytical framework the analytical framework that guided our study is an adaptation of that used by edwards & khan (1985). a major issue in the model is the altering of the conditions for money market equilibrium to include the effects of the sterilization of capital inflows. through this, the model examines how much the sterilization exercise can put upward pressure on domestic interest rates, thus returning interest rates to the level that existed before the capital inflows episode. one main assumption of the model is that the higher the capital mobility, the more the domestic interest rate will be influenced by external factors, but as capital mobility decreases, the interest rate is driven more by domestic variables. as modified by cavoli (2005), the model can be explained as follows: * (1 )t t ti i =  + − 0 1  (1) equation 1 above represents the structural interest rate equation, and it states that the domestic interest rate (it) is a weighted average of international monetary conditions (i*t) and domestic monetary conditions ( t ). in the equation,  is a parameter that represents a country’s level of capital mobility, which lies between zero and one. the exogenous variable, represented by i*t, is measured by uncovered interest parity (uip). this is expressed in equation 2 as follows: (2) where ft is a foreign currency interest rate and te is the log of the current period exchange rate expressed in relation to the home price of the external currency. the expected fall in the value of exchange rate in the next time period is represented by 1 e te + . in equation 1, t is the domestic nominal interest rate, which serves as a shadow interest rate. this shadow rate captures conditions of disequilibrium, which come about due to excess demand or supply of money. cavoli (2005) contended that the shadow rate can be calculated as follows: 1 (m )e d t t t tm  += + + − (3) where  = full equilibrium real interest rate, 1 e t+ = expected future inflation rate, (m )d t tm − = a term that captures monetary disequilibrium. the interest rate ( t ) determined domestically can be derived from equation 3 above. by implication, any excess (shortfall) of money demand (md) in relation to money supply (ms) will lead to a rise (fall) in the interest rate determined domestically. as observed by cavoli (2005), money demand is a function of the full equilibrium interest asian journal of economics and empirical research, 2021, 8(2): 48-57 53 © 2021 by the authors; licensee asian online journal publishing group rate, expected future inflation, and income (y). the impact of sterilization policy geared towards neutralizing the fallout of reserve inflow enters into the expressions for the money stock, and this can be represented as follows: (1 )t tm f = +  0  (4) where  = the sterilization coefficient, which lies between zero and 1, f = change in net foreign assets (nfas). if we express equation 4 in log form, this becomes: (1 )kt tm f = +  (5) thereafter, the money stock can be specified as follows: (6) by substituting equation 5 into equation 6, this results in equation 7, as follows: (7) as noted by cavoli (2005), the domestic interest rate can be calculated by substituting equations 8 and 4 into equation 3 to find τt, which is substituted into equation 1. thus, deriving the domestic interest rate requires specifying the following equation: (8) in equation 8 above, i = domestic interest rate, i* = foreign interest rate, δf = change in reserve inflow, which proxies sterilization policy, m = money supply,  = expected inflation, p = the price level, and y is the output growth rate. 3.1. model specification modified from cavoli (2005), the model that guided this study is specified as follows: (9) in this study, we utilized the autoregressive distributed lag (ardl) bounds cointegration approach developed by pesaran, shin, & smith (2001). the choice of the model was first informed by the order of integration of the series, which showed an admixture of i(1) and i(0), thus suggesting the suitability of the model. second, it has been noted that whether the series are purely i(0) or purely i(1), the bounds testing approach can be applied to the model unlike the conventional cointegration techniques. beyond these, the strengths of the model were also interesting. one of these strengths is that the ardl cointegration approach has superior properties in small samples (pesaran & shin, 1999). also, despite the endogeneity of some of the model’s regressors, the model provides unbiased long-run estimates and valid t-statistics (narayan, 2005; odhiambo, 2009b). finally, a simultaneity method of assessing the shortand long-run effects of one variable on the other is guaranteed by the model (bentzen & engsted, 2001). in modelling the ardl, a dynamic unrestricted error correction model (uecm) can be derived via a simple linear transformation. the uecm integrates the short-run dynamics with the long-run equilibrium without losing any long-run information. according to pesaran et al. (2001), the f-test can be applied to determine the presence of a long-run relationship. this is achieved by restricting the coefficients of the lagged level variables (ho:  1 = 2 =  3 = 4 =  5 =  6= 7 = 0). pesaran et al. (2001) computed two sets of asymptotic critical values for the ardl cointegration test. these are the lower bounds critical values i(0) and the upper bounds critical values i(1). if the calculated f-statistic exceeds the upper bound critical value, we conclude in favor of a long-run relationship regardless of the order of integration. if the calculated f-statistic falls below the lower critical values, we cannot reject the null hypothesis of no cointegration. however, if the calculated f-statistic falls between the two critical bounds, inference would be inconclusive. generally, the ardl approach can be specified as follows: (10) where t represents the trend values denoted as tt ,........3,2,1= , and µt is the error term, which is independently and identically distributed with a zero mean and constant variance, i.e., ),0( 2  iidt  . adopting equation 9 above, and by applying the ardl approach to cointegration as exemplified in equation 10, the ardl that captures our objective is specified in equation 11 as follows: (11) where plr = prime lending rate, tstr = total sterilization, m2 = broad money supply (as a proxy for money supply), inflr = inflation rate, exchr = exchange rate, wop = world oil price, and forint = foreign interest rate.  1 to  7 and  1 to  7 are the short-run and long-run parameters, respectively. ∆ is the first difference operator, while k is the lag order. the residual ite is assumed to be normally distributed and white noise. the presence of a long-run relationship implies that we have to specify the error correction model (ecm). with this, we will be able to estimate both the short-run and the long-run coefficients. the ecm is thus specified in equation 12 as follows: asian journal of economics and empirical research, 2021, 8(2): 48-57 54 © 2021 by the authors; licensee asian online journal publishing group (12) where ect is the error correction term and  is the speed of adjustment. 3.2. variables and data sources we employed monthly series covering the period from january 2010 to march 2021. the prime lending rate was used instead of the official rate because the prime lending rate moves in tandem with economic activities in nigeria. the monetary policy rate, which is the official rate, is determined by the monetary authorities in their monthly committee meetings, and in most cases these rates are left unaltered for several months. as can be seen in appendix 1 below, the mpr stayed at 13.5% from march 2019 through to april 2020. however, the prime lending rate has been fluctuating with different values all through the sample period, indicating that it is more attuned to the dynamics of the economy. in a similar vein, the bureau de change (bdc) exchange rate of domestic currency to the dollar was used because of its dynamic nature in the country’s economy, being the rate that most economic agents utilize. the international price of the bonny light crude oil brand was used because it is nigeria’s crude oil brand. the foreign variables, such as foreign interest rate and world oil price, are included in the model to control for exogenous change in the global economic stance given that nigeria has integrated into the world economy and is import-dependent and therefore more susceptible to external shocks. following kim & roubini (2000), the us federal funds rate (ffr) was employed to proxy foreign interest rate. also, this study followed vinayagathasan (2013), who employed world oil price as a proxy for expected inflation. data on all the variables were sourced from the central bank of nigeria statistical bulletin, except data on foreign interest rate, which was obtained from the federal reserve bank of st. louis. 4. interpretation of results and discussion of findings 4.1. descriptive statistics the summary statistics of the variables used in the study are displayed in table 1 below. the basic characteristics of the data over the study period are displayed in table 1 and the findings reveal that the variable that exhibited the highest mean is m2 with a value of 20,298,885 and a standard deviation value of 7,142,150. this result indicates a spread in the variable. on the other hand, we found that tstr has the lowest mean of -2467.784 and a standard deviation of 1009555. tstr also has the highest range of 23151707, which implies that over the study period, the variable exhibited some volatility in its trend. table 1. result of descriptive statistics. plr tstr exchr fornint inflr m2 wop mean 16.23422 -2467.784 273.1013 1.577273 12.06089 20298885 5464427 median 16.65000 34100.37 222.9300 1.577273 11.70000 18965534 146.2281 maximum 19.05000 2093049 494.7000 2.490909 18.72000 38036535 38036535 minimum 0.000000 -10529329 151.8500 0.500000 7.700000 10446374 75.06000 std. dev. 2.043495 1009555 115.4450 0.533675 2.983592 7142150 12204595 skewness -4.380362 -8.471639 0.347535 -0.005709 0.443115 0.638267 1.820496 kurtosis 31.85221 89.35932 1.568082 1.816326 2.331946 2.694889 4.433321 probability 0.000000 0.000000 0.000804 0.019430 0.031300 0.007868 0.000000 sum 2191.620 -333150.8 36868.67 212.9318 1628.220 2.74e+09 7.38e+08 sum sq. dev. 559.5671 1.37e+14 1785890 38.16446 1192.844 6.84e+15 2.00e+16 in order to ensure that our variables behave well, we carried out a stationarity test of the series. this test is particularly helpful in the choice of the model to be adopted. both the augmented dickey–fuller test (adf) and the phillips–perron test (pp) were used in this study and the results were evaluated based on a 5% level of significance. the stationarity results in table 2 below indicate that foreign interest rate exhibited stationarity at level under the adf test but non-stationarity under the pp test. also, total sterilization is stationary at level, but other variables are non-stationary at level, that is, they are i(0). in table 3 below, after first difference, all the series become stationary, that is, they become i(1). 4.2. tests for stationarity table 2. results of stationarity at level. variable adf t-stat. pp t-stat. adf critical value at 5% pp critical value at 5% order of integration exchr -2.883239 -2.883073 0.9207 0.9319 non-stationary fornint -2.884477* -2.883073 0.0345 0.4453 adf i(0) inflr -2.883408 -2.883073 0.4863 0.5484 non-stationary m2 -2.883073 -2.883073 1.0000 1.0000 non-stationary tstr -2.885051* -2.883073* 0.0022 0.0000 i(0) wop -2.883073 -2.883073 0.9823 0.9846 non-stationary plr -2.884477 -2.883073 1.0000 1.0000 non-stationary note: figures with asterisks (*) indicate rejection of the null hypothesis at the 5% level. asian journal of economics and empirical research, 2021, 8(2): 48-57 55 © 2021 by the authors; licensee asian online journal publishing group table 3. result of stationarity at first difference variable adf t-stat. pp t-stat. adf critical value at 5% pp critical value at 5% order of integration δ exchr -2.883239* -2.883239* 0.0000 0.0000 i(1) δ fornint -2.884665* -2.883239* 0.0000 0.0001 i(1) δ inflr -2.883408* -2.883239* 0.0000 0.0000 i(1) δ m2 -2.883239* -2.883239* 0.0000 0.0000 i(1) δ tstr -2.883579* -2.883239* 0.0000 0.0000 i(1) δ wop -2.578420* -2.883239* 0.0000 0.0000 i(1) δ plr -2.884477* -2.883239* 0.0000 0.0000 i(1) note: figures with asterisks (*) indicate rejection of the null hypothesis at the 5% level. as the series show an admixture of i(0) and i(1), the ardl model was chosen to conduct the test of cointegration. in table 4 below, the f-statistic was compared with both the upper and lower critical values at the 5% level. the following conditions served as guides: if the value of the f-statistic is greater than the upper critical bound i(1), cointegration exists. on the other hand, if the value of the f-statistic falls below the lower critical bound i(0), there is an absence of cointegration. the results in table 4 below show that the f-statistic is 10.82689, which is higher than the upper critical bound (3.61) at the 5% level of significance. with respect to the findings, it can be concluded that cointegration exists among the series. as a further confirmation of the cointegrating relationship among the variables, the result of the error correction model (ecm) in table 5 below indicate that the coefficient of the ecm is negative and statistically significant, thus showing that a long-run relationship exists among the variables. the implication of the ecm result is that about 48% of errors generated in each period is automatically corrected by the system in the subsequent period. 4.3. ardl bounds test table 4. ardl bounds test results. test statistic value k f-statistic 10.82689 6 critical value bounds significance lower bound i(0) upper bound i(1) 10% 2.12 3.23 5% 2.45 3.61 2.5% 2.75 3.99 1% 3.15 4.43 the short-run results indicate that without a lag total sterilization positively impacts the prime lending rate, even though the value of the coefficient is minimal. this result is in line with the a priori expectation of a rising interest rate due to the implementation of the sterilization policy. as the monetary authorities float domestic bonds as a way to neutralize the monetary impact of capital inflows, money supply is reduced, which consequently leads to rising interest rates. a rise in interest rate tends to bring further capital inflows, which may lead to another round of sterilization. nigeria’s case is amplified by the already high interest rate in the country. however, after a lag, findings show that a negative relationship exists between total sterilization and the prime lending rate. we contend that the negative impact of sterilization after some lag could be due to the additional inflows made possible by the increasing interest rate, which is not instantaneously sterilized. it was noted that the exchange rate exerts a negative influence on the interest rate in nigeria, though this is not significant. the meaning of this is that as the domestic currency depreciates, the interest rate falls. the macroeconomic impact of a depreciating domestic exchange rate could be the reason for the falling interest rate. as the country’s currency weakens, there is a lull in business activities which transmits to the lending rate. foreign interest rate impacts positively on the domestic interest rate, and a rising foreign interest rate in relation to domestic interest rate means a capital outflow which impacts the domestic interest rate. the drain on liquidity as a consequence of capital outflow means that the interest rate has to rise in order to reverse the outflow. inflation rate also exhibited a positive impact on interest rate; however, this is not significant. a major concern of the monetary authorities in nigeria is rising inflation, which constantly puts pressure on them to reduce the interest rate, even in the face of the destabilizing impact of a high interest rate on the macroeconomic environment. money supply expectedly impacts the interest rate negatively, which is in line with the dictates of theory. as money supply increases, liquidity in the banking sector rises, which depresses the lending rate. the impact of oil price on the interest rate is mixed. while it negatively impacts the interest rate in the current period, its impact on the interest rate with a lag is negative. the current period result is in line with the a priori expectation that rising oil price leads to increased money supply, which improves liquidity in the banking system and causes the interest rate to fall. this is a typical scenario in nigeria, where a major source of revenue is from the oil sector. after some periods, however, rising oil price leads to a fall in the interest rate. this could be due to the policy measures put in place, which drain the liquidity in the system, thus resulting in a falling interest rate. 4.4. results of the ardl with selected model (3, 2, 0, 0, 0, 0, 4) the information in table 6 shows that all the series exhibited the expected outcomes. the reason for this could be because, in the long-run when all policy constraints are relaxed, the series exhibit their normal behavior. asian journal of economics and empirical research, 2021, 8(2): 48-57 56 © 2021 by the authors; licensee asian online journal publishing group table 5. short-run results. variable coefficient std. error t-statistic prob. d(plr(-1)) -0.152014 0.132392 -1.148204 0.2533 d(plr(-2)) 0.217696 0.134300 1.620967 0.1078 d(tstr) 0.000001 0.000000 15.667895 0.0000 d(tstr(-1)) -0.000000 0.000000 -2.304633 0.0230 d(exchr) -0.000447 0.002303 -0.194128 0.8464 d(fornint) 1.737159 0.784671 2.213869 0.0288 d(inflr) 0.046451 0.041861 1.109660 0.2695 d(m2) -0.000000 0.000000 -2.039587 0.0437 d(wop) -0.000000 0.000000 -2.200915 0.0297 d(wop(-3)) 0.000000 0.000000 1.731812 0.0860 ecm -0.476992 0.093753 -5.087773 0.0000 table 6. long-run results. variable coefficient std. error t-statistic prob. c 15.573695 1.126301 13.827290 0.0000 tstr 0.000003 0.000001 4.648281 0.0000 exchr -0.000937 0.004825 -0.194278 0.8463 fornint 3.641905 1.386389 2.626901 0.0098 inflr 0.097384 0.085456 1.139582 0.2568 m2 -0.000000 0.000000 -2.411642 0.0175 wop -0.000000 0.000000 -4.631758 0.0000 4.5. results of robust tests to further test the reliability of the model, tests were carried out for serial correlation, the normality of the model, and model specification. under the null hypothesis of the absence of serial correlation, the breusch–godfrey serial correlation lm test in appendix 2 below indicates that we do not have any reason to reject the null, thus showing that the model does not suffer from the problem of serial correlation. also, under the null hypothesis that the model is well specified, the ramsey reset test in appendix 2 indicates that we cannot reject the null, revealing that the model is well specified. however, the test of normality indicates that the errors are not normally distributed, and this could be attributed to the nature of data set that was employed. 5. conclusion and recommendations the aim of this research was to investigate if sterilization policy influences the interest rate in the direction inferred by theory in nigeria. theoretically, sterilization policy, through its depressing influence on money supply, is expected to lead to a rise in the interest rate. this assumption was investigated using monthly series over the period from 2010:m1 to 2021:m3 under the ardl framework. findings revealed that in the short-run, sterilization policy raises the interest rate in the current period, even though the impact is negligible. however, after a lag, sterilization policy pushes the interest rate to fall but without any visible impact. we also observed that sterilization policy raises the interest rate in the long-run. additionally, results indicated the existence of a negative relationship between money supply and interest rate in both the short-run and the long-run. the results of the exogenous variables employed in the study show that while foreign interest rates exert a positive influence on the domestic interest rate, oil price influences the domestic interest rate negatively. with respect to the findings of this study, it is recommended that, in the face of rising and unsustainable capital inflows, different measures should be adopted to cushion the effect of this on the macroeconomic environment. the rising interest rate associated with the implementation of a sterilization policy is an indication that the continuous use of bonds to sterilize inflows is subject to further rounds of increase as foreign investors may avail of the opportunity provided by the rising interest rate to push more short-term capital into the economy. apart from the fact that this scenario could lead to repeated rounds of sterilization, the fiscal cost of funding the debt thrown up by the floating of the bond has to be considered. it is also recommended that when choosing the interest rate, the monetary policy committee of the cbn should not overlook the impact of exogenous variables, such as foreign interest rates and oil price. references aghalino, s. o. 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(2001). bounds testing approaches to the analysis of level relationships. journal of applied econometrics, 16(3), 289-326. available at: https://doi.org/10.1002/jae.616. ponomarenko, a. (2019). does sterilized foreign exchange interventions cerate money? bank of russia working paper series no 40. reinhart, c., & reinhart, v. (1998). some lessons for policy makers who deal with the mixed blessing of capital inflows. munich personal repec archive (mpr) paper no. 7123. takagi, s., & esaka, t. (1999). sterilization and the capital inflow problem in east asia. economic. economic research institute , tokyo, japan. discussion paper no. 86. vinayagathasan, t. (2013). monetary policy and the real economy: a structural var approach for sri lanka. national graduate institute for policy studies, 13(13), 1-31. appendix 1. mpr and prime lending rate figures for 2019–2020. prime lending rate year jan. feb. march april may june july aug. sept. oct. nov. dec. 2019 16.01 16.08 14.92 18.23 15.33 15.8 15.46 15.4 15.15 15.07 14.91 14.99 2020 14.97 15.04 14.71 14.92 14.73 15.65 12.1 11.76 11.55 11.31 11.6 11.35 mpr 2019 14 14 13.5 13.5 13.5 13.5 13.5 13.5 13.5 13.5 13.5 13.5 2020 13.5 13.5 13.5 13.5 12.5 12.5 12.5 12.5 12.5 11.5 11.5 11.5 appendix 2. robust test results. ramsey reset test value df probability t-statistic 7.512990 114 0.6890 f-statistic 56.44501 (1, 114) 0.4039 breusch–godfrey serial correlation lm test f-statistic 1.051463 obs*r-squared 2.393366 prob. f(2,113) 0.3528 prob. chi-square(2) 0.3022 0 4 8 12 16 20 24 28 32 36 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 series: residuals sample 5 135 observations 131 mean 6.52e-15 median 0.017838 maximum 2.189281 minimum -1.917740 std. dev. 0.561729 skewness 0.034841 kurtosis 6.998872 jarque-bera 87.31060 probability 0.000000 appendix 3. normality test results. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 27 © 2019 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 6, no. 1, 27-35, 2019 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2019.61.27.35 © 2019 by the authors; licensee asian online journal publishing group revisiting the exports and economic growth nexus: rolling window cointegration and causality evidence from cote d’ivoire, malaysia, pakistan and south africa yaya keho1 1national school of statistics and applied economics (ensea) abidjan, côte d’ivoire abstract this paper reexamines the relationship between exports and economic growth in cote d’ivoire, malaysia, pakistan and south africa using time-varying cointegration and causality tests. the cointegration results suggest that exports, investment in physical capital and gdp move together in the long-run in the four countries. furthermore, the full sample granger causality tests support the export-led growth hypothesis for malaysia and pakistan, and the growth-led exports hypothesis for south africa. however, the rolling window cointegration and causality tests show that the long-run and also the causal relationships between exports and gdp are time-varying. for most time periods we do not find any causal relationship between exports and gdp. there are, however, sub-periods during which unidirectional or bidirectional causal relations were found. therefore, export-promoting strategies are not always effective tools to stimulate economic growth. keywords: exports, economic growth, rolling window regression, causality, cointegration, export-led growth, growth-led exports. jel classification: c32, f10, f43, o57. citation | yaya keho (2019). revisiting the exports and economic growth nexus: rolling window cointegration and causality evidence from cote d’ivoire, malaysia, pakistan and south africa. asian journal of economics and empirical research, 6(1): 27-35. history: received: 24 october 2018 revised: 19 november 2018 accepted: 1 january 2019 published: 21 january 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 28 2. models, data and methodology ................................................................................................................................................... 29 3. empirical results ............................................................................................................................................................................. 30 4. conclusion ......................................................................................................................................................................................... 33 references .............................................................................................................................................................................................. 34 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.61.27.35&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/263 https://orcid.org/0000-0002-0677-2146 http://asianonlinejournals.com/index.php/ajeer/article/view/263 https://orcid.org/0000-0002-0677-2146 http://asianonlinejournals.com/index.php/ajeer/article/view/263 https://orcid.org/0000-0002-0677-2146 asian journal of economics and empirical research, 2019, 6(1): 27-35 28 © 2019 by the authors; licensee asian online journal publishing group 1. introduction over the past decades, the relationship between exports and economic growth has been the subject of a growing literature. this attention increased when east asian economies that have relied on exports have achieved spectacular success in accelerating their economic growth. it is in view of this success that developing countries pursue export-promotion policies in order to boost economic growth. however, the empirical evidence regarding the causal relationship between exports and economic growth is inconclusive. a number of studies found that exports lead to economic growth (mamun and nath, 2005; jordaan and eita, 2007; hamdi, 2013; arodoye and iyoha, 2014) while others found that economic growth drives exports (ahmad and kwan, 1991; dhawan and biswal, 1999; chandra and love, 2005; srivastava and kapoor, 2007; alimi and muse, 2013; hassan and murtala, 2016). further studies still reported a bidirectional causal relationship between exports and economic growth (chandra, 2003; mahadevan, 2007; tsen, 2010; alimi, 2012; jarra, 2013; kumari and malhotra, 2014; lam, 2016) while others failed to find any significant causal relationship between the two variables (tang, 2006; bahmanioskooee and economidou, 2009). a number of shortcomings explain these contradictory findings. first, most of previous studies have relied on a bivariate framework in which the role of other relevant variables such as capital has been ignored. it is well-known that causality tests are sensitive to omitted variables (lütkepohl, 1982) and hence bivariate models may not be suitable for testing the export-growth nexus. second, causality testing in these studies is based on autoregressive models in which the choice of the order for lags is crucial. third, as they employed short data spans, most previous works may suffer from the “small sample” problem, which may lead to misleading inferences (dolado and lütkepohl, 1996; hatemi-j, 2002). finally, these studies used linear time series approaches in which parameters are assumed to be constant over time. they do not account for structural changes and nonlinearities in the causal relationship between exports and economic growth. the causal nexus between exports and economic growth variables may be unstable owing to frequent changes in the global economic and political environments. ignoring these changes may result in misleading results. this study addresses these shortcomings by using bootstrap and rolling regression methods to reexamine the exports and economic growth nexus for cote d’ivoire, pakistan, malaysia and south africa. these countries have been examined previously, yielding to contradictory results. in the case of cote d’ivoire, abdulai and jacquet (2002) found evidence supporting the export-led growth hypothesis over the period 1961 to 1997. for south africa, ukpolo (1998) failed to validate the export-led growth hypothesis but provided support for the growth-led export hypothesis. on the contrary, rangasamy (2009) provided support for the export-led growth hypothesis for south africa. reppas and christopoulos (2005) also found evidence supporting the growth-led export and not the export-led growth hypothesis for cote d’ivoire, gabon, south africa, malaysia, and pakistan. in the case of pakistan, love and chandra (2004); shirazi and manap (2005); parida and sahoo (2007) and shahbaz et al. (2011) confirmed the export-led growth hypothesis, while bahmani-oskooee (1993); khan and saqib (1993) and saleem and sial (2015) found bidirectional causal relationship between exports and output, and dodaro (1993), afzal and hussain (2010) and kumari and malhotra (2015) found no causal relationship between exports and economic growth. for malaysia, islam (1998) did not find any causal relationship between exports and economic growth, while al-yousif (1999); ekanayake (1999) and choong et al. (2005) provided evidence confirming the export-led growth hypothesis, and hassan and murtala (2016) found evidence validating the growth-led export hypothesis. furthermore, baharumshah and rashid (1999); furuoka (2007); mahadevan (2007) and lam (2016) found evidence of bidirectional causal link between the two variables. this study uses the rolling window regression to reconsider these conflicting findings. the study aims at showing that instability of the causal relationships between exports and economic growth is one of the reasons explaining the contradictory findings in the empirical literature. we use a time-varying approach to analyze the relationship between exports and economic growth for at least two reasons. first of all, the economic environment is subject to instabilities, which cause the coefficients to change over time. instability may occur due to economic crisis, oil price shocks, financial crisis, shifts in monetary policy, technological changes and political instability. it is well known by now that these shocks lower the power of standard tests of stationarity, cointegration and causality. another reason is given by the famous lucas critique that is coefficients change if an anticipated change in the policy regime occurs. furthermore, the sample periods of our study cover a number of events that may have significant impact upon the export-growth nexus. in particular, over the periods, a number of developing countries shifted their strategy from import-substitution to export promotion. in a study of malaysia, khalafalla and webb (2001) confirmed the export-led growth for the period 1965-1980 when policy was on import-substitution, and the growth-led exports for the export promotion period (1981-1996). stability is a desirable condition to formulate and implement effective macroeconomic policy. however, stability of the causal relationship between exports and economic growth has not been extensively investigated. time-varying regression methodology is an appealing approach given its ability to show the periods in which exports have causal effect on economic growth. tang (2013) was the first study using the rolling regression-based causality tests to investigate the export-growth nexus for malaysia over the period 1975-2010. the full sample results indicated a bidirectional causal relationship between exports and output. however the rolling window causality results show that the causal relationship is unstable over time. subsequently, tang et al. (2015) examined the export-growth relationship for hong kong, south korea, singapore and taiwan. when the full sample is used, they found evidence of bidirectional causality between exports and gdp. furthermore, using rolling causality tests they found that this causal relation is unstable over time. yang and wu (2015) revisited the causal nexus between exports and gdp for china and taiwan using rolling window granger causality tests. the results from full sample tests show evidence of bidirectional causality between the two variables. however, the results from rolling regressions indicate that the export-led growth hypothesis holds in some periods for china but not for taiwan. on the contrary, the growth-led export model is supported in some periods for both china and taiwan. however, their study does not apply rolling regression to cointegration tests. in this study, we incorporate rolling regression technique into the bounds test to cointegration suggested by pesaran et al. (2001) and the granger causality test developed by toda and yamamoto (1995). asian journal of economics and empirical research, 2019, 6(1): 27-35 29 © 2019 by the authors; licensee asian online journal publishing group the remainder of the paper is organized as follows. section 2 outlines the methodology of the empirical analysis. section 3 presents the empirical results, and section 4 concludes the study. 2. models, data and methodology 2.1 model and data the econometric model that will be used in this study is specified as follows: tttt kxy   210 (1) where y, k, and x represent the log of real gdp, real capital, and real exports, respectively. the study uses annual data for cote d’ivoire, malaysia, pakistan and south africa. the data set for each country consists of observations for real gdp (gdp), real exports (exports) and real gross fixed capital formation as proxy for capital (capital). the data is sourced from the world development indicators of the world bank. real gdp, real exports and real gross fixed capital formation are in constant 2005 us dollar. real exports have been computed on the basis of their shares in gdp. the study period differs across countries, depending on data availability. data for cote d’ivoire cover the period 1965-2014; data for malaysia and south africa cover the period 1960-2014; and data for pakistan are for the period 1967-2014. all the series are converted into natural logarithms. table-1. descriptive statistics of variables gdp capital exports ρ country sample mean sd. mean sd. mean sd. cote d’ivoire 1965-14 23.29 0.37 21.34 0.36 22.37 0.46 0.95 malaysia 1960-14 24.56 1.01 23.04 1.26 24.17 1.32 0.99 pakistan 1967-14 24.70 0.68 23.21 0.51 22.65 0.84 0.97 south africa 1960-14 2 .81 0.44 23.98 0.52 24.51 0.47 0.96 note: sd. denotes standard deviation. ρ is the correlation coefficient between exports and gdp. table 1 reports some descriptive statistics on the variables. the correlation coefficient suggests a positive relationship between exports and gdp. however, correlation does not mean causality. is there any evidence of the export-led growth or the reverse? does any causality exist between exports and gdp in the countries under study? our empirical analysis will address these questions. 2.2. the bounds testing approach to cointegration the study uses the bounds testing approach to cointegration to investigate the long-run relationship between exports and economic growth within the autoregressive distributed lag (ardl) model. the choice of this method lies in its small sample properties that have been documented in the literature (cheung and lai, 1993; inder, 1993; pesaran et al., 2001). the bounds testing procedure is based on the following equation: tit p i iit n i iit m i itttt ekxykxyy          0 3 0 2 1 11312110  (2) where δ is the difference operator, ϕ1, ϕ2 and ϕ3 the long-run multipliers and ϕ0 is the drift constant, while γ1i, γ2i and γ3i are the short-run dynamics of the variables. it should be noted that eq. (2) is estimated using each variable as the dependent variable. the presence of long-run relationship is tested by restricting coefficients of lagged level variables equal to zero. that is, the null hypothesis of no long-run relationship is 0321   . this hypothesis is tested by the mean of an f-test. the asymptotic critical values are provided by pesaran et al. (2001). the bounds testing procedure is sensitive to the selection of the lag structure (m, n, p). in this study, maximum lag length on each variable was set to five. 2.3. toda-yamamoto granger causality test to test for granger causality between exports and gdp, this study employs the modified-wald test proposed by toda and yamamoto (1995). this approach has the advantage of not requiring pre-testing for cointegration among the variables. it makes inference valid even when the variables are mixed integrated or cointegrated. the basic idea of this approach is to artificially augment the correct var order, p, with d extra lags, where d is the maximum likely order of integration of the series. thus, the model var to be estimated is as follows:                                                                                      t t t it it itdp pi iii iii iii it it itp i iii iii iii t t t e e e k x y k x y k x y 3 2 1 1 333 222 111 1 333 222 111 3 2 1          (3) once this augmented level var is estimated, a standard wald test is applied to the first lagged p explanatory variables to make causal inference. for example, the null hypothesis that exports do not granger cause gdp is γ11=γ12=…=γ1p=0. similarly, the null hypothesis that gdp does not granger cause exports is β21 = β22 =…= β2p =0. the computed wald-statistic has an asymptotic chi-square distribution with the degree of freedom equal to the number of constraints. 2.4. rolling window regression technique the full-sample cointegration and granger causality tests assume that the parameters of the models are constant over the entire sample period. this assumption is often violated because of frequent changes in the asian journal of economics and empirical research, 2019, 6(1): 27-35 30 © 2019 by the authors; licensee asian online journal publishing group economic environment. in order to overcome the time-varying relationship between exports and gdp, we incorporate the rolling regression technique into the bounds test and the granger causality test. the rolling window regression is based on changing subsamples of fixed size that sequentially roll over the sample period by adding one observation at the end of the sample while dropping one at the beginning. with window size l and full series length t, this method provides a sequence of t-l regressions. in this study, we choose a rolling window size of 25 years. thus, the first test statistic was estimated by using a subsample period from 1960 to 1989 for malaysia and south africa. the second test statistic was estimated by using data from 1961 to 1990. this rolling regression procedure continues until the last observation enters the regression. for interpretation, the 25-years rolling f-statistics for bounds tests are normalized by their 10 percent upper critical values computed using the simulation procedure described in pesaran et al. (2001). for values of the normalized fstatistic higher than 1.00, the null hypothesis of no long-run relationship is rejected. the rolling window procedure is also applied to the toda-yamamoto granger causality test. that is, we estimate an augmented level var model for a time span of 25 years rolling over the whole sample period. we then calculate the p-values of the rolling wald statistics for the null hypothesis of granger non-causality using residualbased bootstrap method. the principle of the residual-based bootstrap method involves drawing a number of mean adjusted residuals with replacement from the restricted model under the null hypothesis, then generating the dependent variable and calculating the test statistic. repeating this process 1000 times, we obtain the bootstrap pvalue as the percentage of bootstrap test statistics exceeding the observed test statistic. if the bootstrap p-value is lower than 0.10 then the null hypothesis is rejected. in other words, if the export-led growth hypothesis holds, then a large number of p-values will be lower than 0.10 when the sample rolls forward. 3. empirical results 3.1. unit root and cointegration test prior to investigating cointegration and causality, we conduct unit root tests to determine the order of integration for each series. this step is necessary to ensure that no variable is integrated at order two. we apply the unit root test of phillips and perron (1988). this test has been performed under the models with constant and trend. the results displayed in table 2 suggest that all the variables are integrated of order one. based on these results, the next step is to test for cointegration. table-2. results of unit root tests country level first difference gdp x k δgdp δx δk cote d’ivoire -3.209** -2.746 -1.963 -4.267* -7.467* -5.434* malaysia -1.154 -1.267 -1.911 -6.476* -5.645* -5.194* pakistan -0.909 -1.192 -1.335 -5.822* -8.960* -5.658* south africa -2.944 -2.205 -1.474 -4.484* -5.902* -3.702* note: gdp, k and x denote log of real gdp, real capital and real exports, respectively. * and ** denote the rejection of the null hypothesis of unit root at the 5% and 10% levels, respectively. the results of the bounds test disclosed in table 3 support the presence of a long-run relationship between exports, gross fixed capital formation and gdp for the four countries under study. the estimates of the long-run coefficients indicate that exports and gdp are positively correlated in the long-run. furthermore, the results support the export-led growth for cote d’ivoire and malaysia. exports are playing a significant role in the economic growth of these two countries. on the contrary, the results for south africa support the growth-driven exports hypothesis. table-3. results of bounds test for cointegration fgdp fx fk 10% critical bounds i(0) i(1) cote d’ivoire 7.900* 3.161 3.750 4.188 4.979 malaysia 5.072* 3.530 5.343* 4.225 4.702 pakistan 2.969 4.123 12.527* 4.188 4.979 south africa 8.877* 8.815* 1.907 4.225 4.702 note:* indicates the rejection of the null hypothesis of no cointegration at the 10% level. critical values for f-statistics are computed from simulations as described by pesaran et al. (2001). maximum lag length on each variable was set to 5. table-4. lon-run estimates country dependent variable is gdp dependent variable is exports coef. t-stat. coef. t-stat. cote d’ivoire 0.344** 1.956 0.422** 1.740 malaysia 0.119* 6.644 5.762* 7.075 pakistan 0.089* 3.543 3.671* 3.613 south africa 0.010 0.122 0.555* 2.772 note: * and **indicate significance at the 5% and 10% levels, respectively. 3.2. full-sample ganger causality test results before testing for causality, it is necessary to determine the lag length of the var models. the optimal lag length of each var model is determined using four criterions: akaike information criterion (aic), schwarz information criterion (sc), hannan-quinn information criterion (hq), and final prediction error (fpe). as the maximal integrated order of the series is 1, we estimate level vars of order p=k+1 in the toda-yamamoto procedure. the results of the full sample granger causality test are presented in table 5. these results indicate that exports have predictive power for economic growth in malaysia and pakistan, while economic growth has asian journal of economics and empirical research, 2019, 6(1): 27-35 31 © 2019 by the authors; licensee asian online journal publishing group predictive power for exports in south africa. there is no causal relationship between exports and gdp for cote d’ivoire. in other words, these results suggest that within the entire sample period (1960/67-2014) the export-led growth hypothesis holds for malaysia and pakistan, while the growth-led exports hypothesis is vindicated in south africa, and there is no support for neither of the two hypotheses for cote d’ivoire. these findings are in line with the results by ukpolo (1998) for south africa, choong et al. (2005) for malaysia, and shahbaz et al. (2011) for pakistan, but contrary to those of abdulai and jacquet (2002) for cote d’ivoire, rangasamy (2009) for south africa, and afzal and hussain (2010); kumari and malhotra (2015) and hassan and murtala (2016) for pakistan. a potential explanation for the conflicting results is that this study considers longer sample period compared to the existing studies. furthermore, in the presence of frequent structural changes, the pattern of the causal relationships between exports and gdp will show instability across different sub-samples and the full sample causality tests will not reflect such changes. for this reason, we proceed to test for parameter stability in the cointegrating and the causal relationships. table-5. full sample granger causality test lag (p) h0: exports do not cause gdp h0: gdp does not cause exports country stat. p-value stat. p-value cote d’ivoire 1 2.068 0.141 0.371 0.551 malaysia 2 6.397* 0.049 2.304 0.337 pakistan 4 10.00** 0.060 2.570 0.635 south africa 2 2.592 0.271 8.082* 0.020 note: * (**) indicates the rejection of the null hypothesis at the 5% (10%) level. p-values are computed from 1000 bootstrap replications. 3.3. parameter stability test results we test the temporal stability of both the long-run and short-run parameters. we test the stability of the longrun relationships using the lc statistic proposed by hansen (1992). the stability of the short-run parameters was tested using the sup-f, mean-f and exp-f statistics (andrews, 1993; andrews and ploberger, 1994). the outcome of these tests is reported in table 6. the results suggest that the long-run correlations between exports and gdp are not constant for the four countries. therefore, we can conclude that exports and gdp do not maintain a stable long-run relationship. with respect to the short-run parameters, the results show that the null hypothesis of parameter constancy in both gdp and export equations is rejected for all countries. overall, these results provide evidence of instability in the parameters of our models. therefore, inferences based on the full sample are no longer reliable. on this basis we reexamine the relationship between exports and gdp using the rolling window regression technique. table-6. parameter stability tests country gdp equation export equation sup-f exp-f mean-f lc sup-f exp-f mean-f lc cote d’ivoire 39.342* (0.000) 17.557* (0.000) 24.667* (0.000) 1.182* (<0.01) 29.595* (0.005) 12.283* (0.002) 10.447 (0.178) 0.392 (>0.2) malaysia 39.684* (0.000) 17.017* (0.000) 23.432* (0.000) 0.948* (<0.01) 43.981* (0.000) 19.661* (0.000) 30.608* (0.000) 0.416 (0.177) pakistan 66.004* (0.000) 30.932* (0.000) 52.171* (0.000) 0.768* (0.029) 48.202* (0.000) 22.438* (0.000) 35.004* (0.002) 0.349 (>0.20) south africa 34.708* (0.005) 14.591* (0.003) 20.250* (0.014) 1.666* (<0.01) 48.786* (0.000) 21.207* (0.000) 21.838* (0.007) 0.412** (0.077) note: * and ** denote significance at 5% and 10%, respectively. 3.4. rolling cointegration and causality tests results the results of the rolling bounds test are plotted in figure 1, with the horizontal axis showing the final observation in each of the 25-year rolling window and the vertical axis recording the maximum of normalized fstatistics. this figure reveals evidence of significant changes in the cointegrating relationships over the sample period. for cote d’ivoire, exports, capital formation and gdp are cointegrated from 1965 to 1989; however these variables are not coalescing in the long-run for years 1990, 1994 and 1997-1999. for pakistan, the three variables are cointegrated from 1967 to 2014 except for years 1998 and 2001-2002. in the cases of malaysia and south africa, the three variables are cointegrated over the period 1960-2014. asian journal of economics and empirical research, 2019, 6(1): 27-35 32 © 2019 by the authors; licensee asian online journal publishing group figure-1. the normalized f-statistics for rolling windows bounds test table-7. selected lag orders for rolling var models year cote d’ivoire malaysia pakistan south africa 1984 4 4 1985 4 4 1986 5 5 1987 5 5 1988 5 5 1989 1 5 5 1990 1 5 5 1991 5 5 4 4 1992 5 5 4 5 1993 5 5 4 4 1994 5 5 4 5 1995 1 4 4 5 1996 1 4 4 5 1997 2 4 5 4 1998 2 5 5 5 1999 5 5 5 3 2000 5 5 5 5 2001 5 5 5 3 2002 5 5 5 5 2003 5 5 5 5 2004 5 5 4 5 2005 5 2 5 5 2006 5 2 5 5 2007 5 2 5 5 2008 5 2 5 5 2009 5 2 5 5 2010 5 2 5 5 2011 5 2 5 5 2012 5 1 5 5 2013 5 1 5 5 2014 1 1 5 3 we now examine the time-varying causal relationships between exports and gdp. in most studies using rolling regression technique, the lag length of the rolling vars is assumed to be constant over time. here we relax this assumption and allow the rolling vars to have different lag lengths. because the window size is 25, a total of 31 lag lengths over the period 1984-2014 were selected for malaysia and south africa, while 26 and 24 lag lengths were selected for cote d’ivoire and pakistan, respectively. the lag orders selected for each rolling var and each country are summarized in table 7. the lag lengths selected for the rolling vars are in general higher than those of the full sample vars and show variation across windows, reflecting the time-varying nature of the full-sample var models. the bootstrap p-values of the rolling wald-tests are shown in figure 2. asian journal of economics and empirical research, 2019, 6(1): 27-35 33 © 2019 by the authors; licensee asian online journal publishing group figure-2. rolling window bootstrap p-values of granger non-causality wald-tests figure 2 shows that the causal nexus between exports and gdp is unstable over time. for cote d’ivoire, exports cause gdp for the 1989-1990, 1996 and 2007-2008 sub-periods, while gdp causes exports in 1994 and the two variables mutually cause each other in 1993. the result for these periods may be attributed to the economic crisis in 1990, the devaluation of the cfa franc currency in 1994 and the political crisis in september 1999, which led to political tension up to 2008. the finding of causal relationship between exports and gdp contradicts with the full sample test results. results for malaysia indicate that gdp has predictive power for exports for the years 1985 and 2003, while exports have predictive content for gdp for the sub periods 1999-2000, 2005-2011 and 2014, and a two-way causal relationship occurs from 1988 to 1990. these unstable causal links between exports and economic growth in malaysia can be due to some important events such as the world economic recession in the mid-1980s; the realignment of currencies after the plaza agreement in 1985; the asian financial crisis in 1997/98; the implementation of a pegged exchange rate and the capital control from 1998 to 2000; the severe acute respiratory syndrome and avian flu in 2003; and the global financial crisis in 2008. for pakistan, exports cause real gdp in 1992 and the sub-period 1995-1996. the results for south africa show evidence of causality running from exports to gdp for the years 1985 and 1989 and for the period 1991-1992. there is also a causality running from gdp to exports in 1993, and for the sub-periods 2003-2004 and 2009-2014. a two-way causal relationship occurs in 2008. these results highlight the importance of accounting for structural breaks and nonlinearities when examining the relationship between exports and economic growth given the contrast between the full sample and the rolling window tests results. our findings of instability of the causal relationship between exports and economic growth may partially explain the conflicting causality results in the existing empirical literature. 4. conclusion the study reexamines the relationship between exports and economic growth for cote d’ivoire, malaysia, pakistan and south africa, with two objectives. first, it tests whether there is a causal link between exports and economic growth. second, the study tests whether the causal relationship between the two variables is stable over time or time-varying. as opposed to previous studies the study uses the rolling window regression-based cointegration and causality tests. we first applied the full sample bounds test to cointegration which showed that exports, investment in physical capital and gdp share long-run relationships in the four countries. also, the full sample granger causality tests support the export-led growth hypothesis for malaysia and pakistan, and the growth-led exports hypothesis for south africa. there is no significant causal link between exports and real gdp asian journal of economics and empirical research, 2019, 6(1): 27-35 34 © 2019 by the authors; licensee asian online journal publishing group for cote d’ivoire. however, parameter stability tests make clear that these results are not uniform for different sample periods and vary due to structural changes, indicating that the full sample results are not reliable. therefore, the rolling window cointegration and causality tests were applied with a window size of 25 years. the results showed that the long-run and also the causal relationships between exports and gdp in each of the four countries are not stable over time. for most time periods we do not find any causal relationship between exports and gdp. there are, however, sub-periods during which unidirectional or bidirectional causal links were found. to sum up, the results of this study show that there is no stable causal relationship between exports and economic growth. the causal nexus between the two variables is time-varying. this suggests that traditional linear models that assume a constant and stable relation over time may not be appropriate to analyze the relationship between exports and economic growth. as such, researchers should use methods that account for structural changes and nonlinearities in the dynamic causal relationship between exports and economic growth. the time-varying nature of the exports and economic growth nexus may explain partly the conflicting 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responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 205 © 2019 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 6, no. 2, 205-215, 2019 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2019.62.205.215 © 2019 by the authors; licensee asian online journal publishing group the impact of research and development (r&d) expenditure on productivity growth: a panel data evidence from the uk manufacturing sector sixtus cyprian onyekwere department of economics and finance, university of portsmouth, uk. abstract this study focuses on the impact of research and development (r&d) expenditure on productivity growth for a panel of 13 uk manufacturing industries, using dataset from 1997 to 2014. the paper used the extended cobb-douglas production function, where r&d expenditure is included as one of the factor inputs, just like labour and capital. the study employs the fixed effects method for the panel data analysis and found r&d coefficient of 0.07, significant at 1%. the finding implies that, consistent with previous papers done for the uk manufacturing sector, r&d expenditure still has a positive relationship with productivity growth at panel industry level. however, the estimate 0.07 lends support to the argument of small coefficient for r&d, unlike other papers arguing for higher coefficient. thus, we align with the argument that r&d has a small positive impact on productivity growth. theoretical implication of this finding is that technological advancement which contributes to productivity growth is not exogenous; it can be determined by r&d decisions in firms and in industries. thus, policy recommendation of this research is for the uk government to provide incentives to increase innovation in the uk manufacturing industries by increasing research grants and subsidies given to firms. finaly, evidence from the result of this paper has shown that firms who wish to increase labour productivity should include r&d investment as one of their strategies. keywords: r&d, productivity, cobb-douglas production function, panel data, fixed effects, uk manufacturing industry. jel classification: l00. citation | sixtus cyprian onyekwere (2019). the impact of research and development (r&d) expenditure on productivity growth: a panel data evidence from the uk manufacturing sector. asian journal of economics and empirical research, 6(2): 205-215. history: received: 5 september 2019 revised: 9 october 2019 accepted: 13 november 2019 published: 20 december 2019 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 206 2. significance of study ..................................................................................................................................................................... 206 3. review of related literature ...................................................................................................................................................... 206 4. methodology and data ................................................................................................................................................................. 209 5. empirical results ........................................................................................................................................................................... 212 6. discussion ........................................................................................................................................................................................ 213 7. conclusion ....................................................................................................................................................................................... 213 references ............................................................................................................................................................................................ 214 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2019.62.205.215&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1177 https://orcid.org/0000-0002-1742-7620 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1177 https://orcid.org/0000-0002-1742-7620 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1177 https://orcid.org/0000-0002-1742-7620 asian journal of economics and empirical research, 2019, 6(2): 205-215 206 © 2019 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the existing literature by examining the impact of research and development (r&d) expenditure on productivity growth for a panel of 13 uk manufacturing industries, using dataset from 1997 to 2014. 1. introduction harari (2015) defines productivity growth as the increase in output per employee. it is generally believed among economics endogenous growth theorists such as romer (1986); romer (1990) and lucas (1988) that, one of the obvious ways to achieve productivity growth is through technological advancement, which they argue can result from investments in r&d (moen and burchardt, 2009). this is in contrast to previous exogenous growth theory proposed by solow (1956) which rather saw technological advancement as a factor outside the control of agents. since the work of romer (1986) an ample amount of research has been undertaken on this topic mostly in the usa, to understand the nature of the impact of technological advancement through r&d on productivity growth. researchers arguing on this topic adopt different r&d data for investigation such as, r&d expenditure, r&d patents and embodied r&d (intermediate and investment goods), depending on data availability. for this current research, the widely available r&d expenditure data is used as depicted on the title, to contribute to the arguments. the choice of focus on the uk manufacturing sector for this research is due to huge investments in r&d which flow from this sector. according to keen (2015) the four major business industries in 2013 which contributed to over 64% of the gross expenditure on r&d (gerd) in the uk all come from the manufacturing sector. they are; pharmaceutical industry 22%, motor vehicles and parts 11%, computer programming and information services 11%, and aerospace 9%. in addition,warwick (2010) reports that 75% of total expenditure on r&d in uk business came from the manufacturing sector in 2008. by implication, the manufacturing sector can be said to be the sector with the highest business r&d expenditure in the uk. this research therefore pays attention to this sector of the economy, using econometric valuation of r&d, which is in line with the economics endogenous growth theory. although previous studies confirm a positive impact of r&d on productivity growth, there are still ongoing arguments on the exact impact of r&d investments on productivity growth, with most arguments arising between time-series studies and cross-section studies. interests on this topic span from country level to industry level, down to firm level. most of these arguments started after the productivity slowdown in the 1970s in usa and uk industries, despite investments in r&d (cameron, 2003). holtz-eakin (2005) states that this productivity growth which slowed down in the 1970s led to a massive econometric analysis of the impact of r&d investment on productivity growth. according to holtz-eakin (2005) while some researchers report a zero r&d contribution to productivity growth, others report a massive contribution and the rest lie somewhere in-between the two extremes. thus, these contradictions poses a problem that need addressing. again, kafouros (2005) laments that the adoption of econometric valuation for r&d (as used in this present paper) which attracted much attention in usa, france and germany, has received less attention in the uk and therefore calls for more research. following the gaps identified in literature and the problems noted, this present study has set out the following objectives:  to ascertain the nature of the relationship between r&d expenditure and productivity growth in uk manufacturing industries.  to highlight the exact impact of r&d expenditure on productivity growth in uk manufacturing industries. 2. significance of study the aim of this research is to contribute to the existing body of literature, on the exact impact of r&d investments on productivity growth. this will help firms and government policy makers to make rational decisions on the most efficient way to allocate scarce resources towards the production of goods and services. again, the paper also contributes to the argument surrounding the endogenous growth theory. 3. review of related literature the importance of technology, innovation activities, and productivity growth are heavily emphasised in many academic papers. nevertheless, different papers focus on different aspects of the topic. studies at industry and firm level shows there are two most influential categories of papers found. they are those which argue for large coefficient for r&d and those which argue for small coefficient. those studies arguing for large coefficients for r&d are usually those using cross-section data while those which argue for small coefficient are those using timeseries data. the most recent emerging sets of papers are those which use panel data. according to holtz-eakin (2005) the elasticity of r&d for studies that use cross-section data at firm level range from 0.05 to 0.60 while those on industry level range from 0 to 0.50. this shows that industry level studies and firm level studies have so much in common in terms of r&d coefficient estimates. in support of this, cameron (1998) adds that, their literature search did not find any substantial difference between r&d estimates from studies at the firm level and those at the industry level, even when a normal thinking should be that industry level studies should have higher elasticity as a result of knowledge spill over. due to the close estimates between industry and firm level studies, our research did not see it necessary to discuss these papers separately instead; it pays more attention to whether it is a time-series or cross-section study, where there is serious contention on the size of the impact of r&d expenditure on productivity growth, as identified in holtz-eakin (2005). however, to be able to cover these papers in a broad sweep, there is a need for a table presentation. this will enable a clearer observation of results at a glance, as full details of papers are presented alongside findings. asian journal of economics and empirical research, 2019, 6(2): 205-215 207 © 2019 by the authors; licensee asian online journal publishing group 3.1. arguments for large impact from cross-section studies these papers as stated on the previous section generally report high coefficients for r&d. they are presented in table 1 and 2, putting industry level and firm level papers on different tables to observe if there is a pattern or not. table-1. industry level papers for selected estimates of the elasticity of private r&d from cross-sectional studies. paper country/level sample approach model/ variables r&d elasticity englander et al. (1988) 6 countries/ industry level 16 industries across six countries; 1970 to1983 cob-douglas production function ols/ tfp , r&d 0.16 -0.50 mansfield (1988) japan/ industry level 17 japanese manufacturing industries cob-douglas production function ols/ tfp, r&d 0.42 sterlacchini (1989) uk/ industry 15 industries from 1945-83 cobbdouglass production function ols/ tfp , r&d 0.12 to 0.2 czarnitzki and thorwarth (2012) uk/ industry uk industries from 2002 until 2007 cobbdouglass production function ols/ tfp, l, k ,r&d 0.13 table-2. firm level papers for selected estimates of the elasticity of private r&d from cross-sectional studies. paper country/level sample approach model/variables r&d elasticity minasian (1969) us/ firm level 17 u.s. firms (chemical industry); 1948 to 1957 cob-douglas production function ols/ gva, l, k, r&d 0.11 0.26 cuneo and mairesse (1984) france/ firm level 182 firms; 1972 to 1977 cob-douglas production function ols/ gva, l, k, r&d 0.20 griliches and mairesse (1990) us / firm level 525 u.s. manufacturing firms; 1973 to 1980 cob-douglas production function ols/ tfp, l, k, r&d 0.25 griliches and mairesse (1990) japan/ firm level japanese manufacturing firms; 1973 to 1980 cob-douglas production function ols/ tfp,l, k, r&d 0.20 0.56 hall and mairesse (1995) france/ firm level 197 french firms; 1980 to 1987 cob-douglas production function ols/ lp k, r&d 0.05 0.25 wang and tsai (2003) taiwan/ firm level 136 taiwanese manufacturing firms; 1994 to 2000 cob-douglas production function ols / output, r&d, with control variables 0.19 kafouros (2005) uk/ industry firm-level data (78 firms, 1989– 2002), 205 uk manufacturing cobb-douglass production function ols/ output (sales), l, k, r&d 0.04 from the table 1 and 2 the first observation is that there is no clear pattern in r&d elasticity estimates, to be able to differentiate firm level studies from industry level studies, just as cameron (2003) also claims. secondly, it can be observed that coefficients for r&d are very high, especially those of griliches and mairesse (1990); englander et al. (1988); mansfield (1988) and minasian (1969). except for kafouros (2005) who reports very low coefficient for r&d, others as seen in the table report very high r&d coefficient between 0.11 and 0.50. however, hall and mairesse (1995) argue against the result in kafouros (2005) pointing out that the use of sales to proxy for gva leads to bias r&d coefficient. nonetheless, it can also be observed that although estimates are consistently high, there are little variations. however, because these papers are conducted in different countries, different time periods, with little different specifications, authors such as hall and mairesse (1995); holtz-eakin (2005) and moen and burchardt (2010) sustain that the little differences in coefficients are inevitable. 3.2. arguments for small impact from time-series studies moving on to time-series studies, there appears to be a significant difference from the cross-section studies in table 1 above. as stated earlier, the elasticity estimates from time-series studies are generally much lower than those obtained from cross-sectional studies. holtz-eakin (2005) further states that, some studies that use timeseries estimates of r&d find elasticity that are insignificant, which weakens their argument of small contribution. example of such statistically insignificant time-series studies are mairesse and sassenou (1991) australian industry commission (1995) and hall and mairesse (1995). nevertheless, holtz-eakin (2005) explains that in statistical sense, the insignificance often encountered in time-series data is not surprising because the r&d data varies more in the cross-section dimension than in the time-series dimension which by implication, suggests that asian journal of economics and empirical research, 2019, 6(2): 205-215 208 © 2019 by the authors; licensee asian online journal publishing group firms or industries with high r&d expenditures have higher levels of productivity than those with less r&d expenditures. see table 3 and 4 for findings from some time-series studies. table-3. industry level papers for estimates of the elasticity of private r&d from time-series studies. paper country/level sample approach method/ variables r&d elasticity griliches and lichtenberg (1984b) us/ industry level 27 u.s. manufacturing industries; 1959 cob-douglas production function ols/ tfp, r&d 0.04 cameron and muellbauer (1996) uk/ industry manufacturing industries from 1962-92 cobb-douglass production function ols/ tfp , r&d 0.15 to 0.37 cameron (2003) uk/ industry manufacturing industry from 1960-1995 cobb-douglass p-function var/ tfp, r&d 0.29 hubert and pain (2001) uk/ industry 15 industries from 1983-92 cobb-douglass production function ols/ lp, k, r&d 0.029 griliches (1980a) us/ industry 39 2and 3-digit manufacturing industries 19591977 cobb-douglass production function ols/ tfp, r&d 0.06 table-4. firm level papers for estimates of the elasticity of private r&d from time-series studies. paper country/level sample approach method/variables r&d elasticity minasian (1969) us/ firm level 17 u.s. firms; 1948 to 1957 cob-douglas production function ols/ gva, l, k, r&d 0.08 griliches (1980b) us/ firm level 883 u.s. firms; 1957 to 1965 cob-douglas production function ols/ tfp, r&d 0.08 cuneo and mairesse (1984) france/ firm level 182 french manufacturing firms; 1972 to 1977 cob-douglas production function ols/ gva, l, k, r&d 0.05 griliches and lichtenberg (1984) us/ firm level 133 u.s. firms; 1966 to 1977 cob-douglas production function ols/ tfp, r&d 0.09 griliches (1986) us/ firm level 652 u.s. firms; 1966 to 1977 cob-douglas production function ols/ tfp, r&d 0.12 hall and mairesse (1995) france/ firm level 197 french firms; 1980 to 1987 cob-douglas production function ols/ lp, k, r&d 0.07 firstly, it can be observed from table 3 and 4 that just like the cross-section studies, there is no clear difference between the size of r&d coefficients from industry level and that of firm level is found. the only clear pattern is the huge reduction in r&d compared to those in table 12. as can be observed again, just like in cross-section studies, there are two papers found among time-series papers in table 3 which report surprising results. they are cameron (2003) and cameron and muellbauer (1996) that report very high coefficients for r&d, similar to those of cross-section studies. however, because cameron (2003) is the only paper which adopts a var method of estimation, it is a bit difficult to compare this with the rest of the papers using ols estimation method. according to holtz-eakin (2005) a method of estimation a researcher chooses also influences the findings.on the other hand, it is difficult to explain why cameron and muellbauer (1996) report such as high estimate which violates conventional findings for other time-series papers. more surprisingly, cameron and muellbauer (1996) also uses almost the same observation periods for the uk with that of hubert and pain (2001) which reports a much lower coefficient.thus, it becomes very difficult to decide whose estimate to accept. moreover, one general observation from these cross-section and time-series papers is that arguments do not only arise between them but also within them. as can be seen on table 12 and table 3-4 cross-section and timeseries studies generally report different estimates for r&d, which also leads to another aspect of inconclusive arguments on the exact elasticity of productivity with respect to r&d expenditure. 3.3. arguments from panel data studies to settle these arguments arising between time-series and cross-section studies, the immerging set of papers adopt a broader approach. these papers are those which try to carry the two dimensions of studies (time-series and cross-section) along at the same time during econometric design. these types of studies are generally referred to as panel data studies (asteriou and hall, 2011). good examples of such studies are grossman and helpman (1991) mcvicar (2002) and kafouros (2008). although wakelin (2001) and higon (2007) also adopts panel data but as stated earlier, this present research is neither interested in the rate of return studies nor interested in elasticity studies solely based on spillover effects, which those two papers study. thus, close attention is only given to grossman and helpman (1991) mcvicar (2002) and kafouros (2008) which study direct elasticity of private r&d for the uk. first of all, grossman and helpman (1991) uses panel data for 79 uk industries from 1976-79 using the fixed effects model to estimate r&d coefficient of 0.015. on the other hand, mcvicar (2002) uses the same approach but with different dataset for 7 industries from 1973-92 to report same coefficient of 0.015. although a little higher asian journal of economics and empirical research, 2019, 6(2): 205-215 209 © 2019 by the authors; licensee asian online journal publishing group coefficient was rather found in kafouros (2008) which uses dataset for 89 firms between 1989 and 2002, also adopting the fixed-effects model and finds elasticity estimate of around 0.10 and 0.16. see detail of papers on table 5: table-5. selected elasticity estimates of private r&d from panel data studies. paper country/level data approach method/ variables r&d coefficient geroski (1991) uk/ industry 79 industries from 1976-79 cobb-douglass production function fixed effects/ lp, k, r&d 0.015 mcvicar (2002) uk/ industry 7 industries from 1973-92 cobb-douglass production function fixed effects/ tfp, r&d 0.015 cameron et al. (2005) uk/ industry 13 manufacturing industries from 1971–1992 cobb-douglass production function ecm/ tfp, r&d, cu, controls 0.09-0.16 kafouros (2008) uk/ industry 89 firms between 1989 and 2002 aggregated to industry level cobb-douglass production function fixed effects/ output, l, k, r&d 0.10-0.16 as seen on table 5, it can be observed that these papers provide support for time-series papers which are presented on table 3-4 by reporting small coefficients for r&d. thus, the areguments on the size of the impact of r&d on productivity is therefore drifting in favour of time-series studies. these imply that perhaps, the impact of r&d on productivity growth is not as large as cross-section studies normally reports. nevertheless, this conclusion cannot be made untill there is a greater number of panel data studies which provide support for small coefficient, which is why the first research question for this research is highly important. recall that the first question seeks to know the extent of the impact of r&d expenditure on productivity growth. furthermore, there is an additional interest to also carry out individual time-series analysis for the industries in the uk manufacturing sector.this is to get a wider understanding of the nature of elasticity of productivity growth with respect to r&d expenditure within the industries. to address this, there is a need to call up previous papers done for the uk on this context, to understand what is already going on in these industries. 3.4. conclusion on literature review it is necessary to summarise the arguments after an extensive critical study of various views of authors on this topic. firstly, studies on this topic have either used error correction model (ecm), ols or fixed effects method for their research. however, every paper follows the extended cobb-douglas production function framework. those which study time-series and cross-section dimension generally apply ols estimation, while those which use panel data generally use fixed effects model or ecm. nevertheless, the general conclusion is that r&d has a positive relationship with productivity growth at all levels of aggregation, which confirms the endogenous growth theory. nonetheless, the arguments on the exact size of r&d coefficient is still inconclusive, with cross-section studies arguing for very high coefficients for r&d expenditure and time-series together with panel data studies arguing for small coefficient. two major gaps identified in this literature which needs filling are the minimal amount of panel data studies which investigate this specific topic to help address the problem; and the time lag since the last research was done for the uk using panel data. as observed in the study, the most recent panel data paper for the uk is kafouros (2008) whose observation period ended in 2002. therefore, between 2002 and 2015, economic events like the 2008 financial crisis would have impacted on the nature of the relationship between r&d expenditure and productivity growth in the uk manufacturing industries. 4. methodology and data 4.1. data the data for this research were chosen to be consistent with the data needed to successfully estimate the cobbdouglas production function for the uk manufacturing industries. the data used throughout this study is obtained from office for national statistics website which supplies data to eurostat1. they include, number of employees by industry, net physical capital by industry in chained volume measure (cvm) and output measured in gross value added (gva) by industry also in cvm. gva is simply calculated by subtracting the consumption of intermediate inputs2 from the output, which was calculated by office for national statistics (statistical, 2015). the choice of using net physical capital over gross physical capital is because in calculating net physical capital, yearly depreciation as a result of wear and tear is subtracted from the actual value thus, reflecting the yearly worth of the assets (statistical, 2015). additionally, the data for r&d expenditure (which proxies’ knowledge gain from innovation) is also obtained from ons as net r&d stock in cvm. many papers argue that r&d has some depreciation3. some authors use 10% and some use 15% but hall and mairesse (1995) argue that this has negligible impact on estimates. nevertheless, we also resort to net r&d data, depreciated by ons. see table 6 for the industries of interest. nevertheless, because the actual share of labour and capital inputs in total 1eurostat is the statistical office of the european union situated in luxembourg. its task is to provide the european union with statistics at european level that enable comparisons between countries and regions eurostat (2015). 2 intermediate consumption consists of the value of those goods and services consumed as inputs by the process of production, excluding fixed assets whose consumption are recorded as the consumption of fixed capita statistical (2015). 3 the premise for their argument is based on the fact that knowledge gain from r&d becomes obsolete at some point in time or new inventions are made to replace the old ones. thus, it becomes appropriate to subtract a certain depreciation rate from the r&d data. asian journal of economics and empirical research, 2019, 6(2): 205-215 210 © 2019 by the authors; licensee asian online journal publishing group cost for r&d is not found, the double counting problem emphasised in hall and mairesse (1995) is not corrected in r&d data. table-6. the 13 broad uk manufacturing industry classifications as defined by ons (2015). tabulation of industry sic_code sample: 1997 2014 included observations: 234 number of categories: 13 sic code count title c10t12 18 manufacturing food products, beverages and tobacco c13t15 18 manufacture of textiles, wearing apparel, leather and leather products c16t18 18 manufacture of wood and paper products, and printing c19 18 manufacture of coke and refined petroleum products c20 18 manufacture of chemicals and chemical products c21 18 manufacture of basic pharmaceutical products and pharmaceutical preparations c22_23 18 manufacture of rubber and plastics products, and other non-metallic mineral c24_25 18 manufacture of basic metals and fabricated metal products, except machinery and equipment c26 18 manufacture of computer, electronic and optical products c27 18 manufacture of electrical equipment c28 18 manufacture of machinery and equipment n.e.c. c29_30 18 manufacture of transport equipment c31t33 18 manufacture of furniture; other manufacturing; repair and installation of machinery and equipment total 234 table-7. descriptive statistics. sample: 1997 2014 dlnq/l dlnrd dlnk mean 0.004964 -0.004790 -0.005385 median 0.005835 -0.005362 -0.007517 maximum 0.053280 0.182322 0.394096 minimum -0.064515 -0.234401 -0.059976 std. dev. 0.014609 0.048597 0.038481 skewness -0.877042 -0.033505 5.274432 kurtosis 6.629870 6.641905 54.07541 jarque-bera 149.6609 122.1758 25046.45 probability 0.000000 0.000000 0.000000 sum 1.097058 -1.058538 -1.190118 sum sq. dev. 0.046955 0.519577 0.325780 observations 221 221 221 from the negative skewness of labour productivity and r&d expenditure in table 7, it is obvious that there are few industries with high growth in productivity and r&d expenditure over time. it is an expectation that such industries possessing high productivity growth would have invested heavily in r&d (kafouros, 2005). again, the mean value for r&d expenditure is negative, further indicating that growth in r&d expenditure has been slower in most industries than the rest over time. with these insights, it is certain that our data does not follow normal distribution. that is, skewness is less than zero, kurtosis is greater than 3 and probability is significant at 0.05 thus, regression results are likely not to show the true picture (gujarati and porter, 2010). however, the central limit theorem still permits the use of the data even when they are not normally distributed as normal distribution depends on the type of sample one obtains (gujarati and porter, 2010). table-8. correlations table. variables dlnq/l dlnrd dlnk dlnq/l 1.000000 0.097032 0.031428 dlnrd 0.097032 1.000000 0.350891 dlnk 0.031428 0.350891 1.000000 as seen on table 8, the correlations analysis show that growth in r&d expenditure is positively correlated with productivity growth up to 0.097%, which accords with our expectations of positive relationship between r&d expenditure and productivity growth (romer, 1986). another interesting fact is that capital investments appear to have lower correlation with productivity growth (that is, 0.031%) than r&d expenditure which implies that, investments in r&d yields more to productivity growth than investments in capital for the uk manufacturing industries. in addition, it is also observed that r&d expenditure is correlated with capital only up to 35%, which is not very high (that is, not up to 90%) therefore there is no problem of multicollinearity between explanatory variables (gujarati and porter, 2010). 4.2. methodology consistent with other papers reviewed in this study, with similar objective of investigating the impact of r&d on productivity growth, this paper also starts off the investigation with the conventional production function, which is also the starting point for wakelin (2001); geroski (1991); higon (2007) and many others. q = f (l, k) (1) the function on equation 1 above represents the relationship between output and factor inputs asian journal of economics and empirical research, 2019, 6(2): 205-215 211 © 2019 by the authors; licensee asian online journal publishing group where, q = is the quantity of output. l= the quantity of labour used in the production process. k= the amount of physical capital. this theory or function is constantly used in economics to represent the relationship between the output q and the combination of the production inputs l, k, and other inputs. for the purpose of our research objectives which is to investigate the impact of r&d expenditure, an extended form of the cobb-douglas production function which favour the endogenous growth theory introduced in romer (1986); romer (1990) and lucas (1988) is utilized, where r&d expenditure is incorporated into the regression as one of the factor inputs, just like labour and physical capital. this relationship is widely presented as follows: q it = akit b1 lit b2 rdit b3 (2) where: it = industry i at time t. q it = output in industry i at time t, measured in gross value added (gva). a = constant or state of technology. kit = net physical capital stock. lit = labour employed. rd it = knowledge stock (net r&d capital stock). b1 = the partial elasticity of output with respect to capital. b2 = partial elasticity of output with respect to labour. b3 = partial elasticity of output with respect to r&d. however, for estimation purposes, there is a need for an equation which is linear in its parameters (gujarati and porter, 2010). this implies that the application of logarithmic transformation to equation 2 which is the same approach adopted in griliches and lichtenberg (1984) becomes neccessarry. following this, while allowing for random influence in the industries uit, equation 2 is transformed as follows: log(qit)=log(akit b1lit b2rdit b3) (3) log (qit) = log (a) + log (kb1)it + log (lb2)it + log (rdb3)it + uit (4) log (qit) = log (a) + b1log (k)it + b2 log (l)it +b3log (rd)it + uit (5) equation 5 is now linear in terms of the parameters b1, b2 and b3. the sum of the exponents (b1 b2 and b3) indicates returns to scale: if b1+b2 +b3 =1, it implies constant returns to scale for all the production inputs l, k, rd. if b1+b2 + b3 < 1, it implies decreasing returns to scale. if b1+b2 + b3 > 1, it implies increasing returns to scale. nevertheless, the interpretation given to equation 5 according to czarnitzki and thorwarth (2012) is the partial elasticity of output log (qit) with respect to r&d expenditure log(rdit).this is different from our research interest, which is to investigate the elasticity of productivity with respect to r&d expenditure and not the actual output. however, in using the productivity approach, the question of what appropriate measure of productivity to adopt arises, which has posed serious arguments among early researchers according to kafouros (2008). while some reseachers adopt labour productivity as the desired measure, others have resorted to estimating total factor productivity (tfp). according to kafouros (2008) it was previously believed that tfp was a better measure because it incorporates all production inputs. however, recent findings in sargent and rodriguez (2000) cited in kafouros (2008) suggests that both measures have their place and that, none of them even shows the whole picture. the results of sargent and rodriguez (2000) suggest that the measure of productivity to be used should depend on factors such as the time period the researcher is interested in studying and the comparability of capital stock data. in their analysis, they suggest that if the time being studied is over a period of a decade or so, then the appropriate measure of productivity would be labour productivity. in contrast, if the interest is in long run trends of several decades, then tfp should be used. in addition, sargent and rodriguez (2000) opine that if the measures of capital stock are not comparable, then again labour productivity should be used. thus, giving that our research does not cover many decades, this research adopts the labour productivity measure as its measure of productivity. another benefit of using the labour productivity approach according to sargent and rodriguez (2000) is that, the labour productivity (lp) framework allows for easy comparision of returns from r&d investments with that of capital investments, which the tfp approach does not allow for as it eliminates capital input from the right hand side of the regression. that is, tfp[ log(q)it – b1log(k)it –b2log(l)it ] = log (a) + b3log(rd)it + uit, (6) the expression on equation 6 above gives the derivation of total factor productivity by eliminating the presense of capital and labour inputs from the equation. consequently, the labour productivity approach retains the individual factor inputs (labour and capital)as shown on equation 7 below: lp[log(q/l)it ] = log(a) + b1log(k)it + b3log(rd)it + uit (7) this labour productivity approach is the same productivity measure adopted in wakelin (2001); hubert and pain (2001); geroski (1991) also used in hall and mairesse (1995). nevertheless, there was no signicant difference found between tfp and lp studies in our literature review. respect that in adopting the the lp apporach, hall and mairesse (1995) state that the idea is simultaneously imposing that partial elasticity of output with respect to labour equals one for constant returns to scale to exist (that is, b2 = 1) although this is not tested in this study. for convenience, we rearrange equation 7 as follows: log (q/l) it = log (a) + b1log (k) it +b3log (rd) it + uit (8) the expression on the left hand side log(q/l) clearly defines labout productivity as the change in output per employee at a particular industry and specific time period, which is explained by capital log(kit) and r&d expenditure log(rdit). many authors, including wakelin (2001) maintain that equation 8 reduces the problem of multicollinearity present in equation 5 by removing one explanatory variable. asian journal of economics and empirical research, 2019, 6(2): 205-215 212 © 2019 by the authors; licensee asian online journal publishing group according to moen and burchardt (2009) estimating equation 8 at its present state will yield unreliable results and therefore r&d needs to be lagged. moen and burchardt (2009), stating that, r&d is found to take an average of 6 to 18 months to reach the finished development. this implies that a minimum lag of 1 year can be added to our r&d variable in equation 8 to adjust for the time it takes for r&d to start yielding results in the industries. according to nishioka and ripoll (2012) lagging r&d variable also goes to solve the endogeneity problem which could be present in equation 8 between r&d expenditure and productivity growth. additionally, in order to use variables in their rate of change form (that is, making variables stationary), which completely eliminates the problem of spurious regression, we apply first difference transformation to the log variables as advised in wakelin (2001). panel unit root test outputs are found in appendix 1, using im pesaran and shin w-stat, adf-fisher chi-square, pp-fisher chi-square and levin,lin &chu t. the results indicate that at level with individual industry intercept and trend, log variables still possess unit root, as we fail to reject this null hypothesis because of insignificant probability values at 0.05, coming from majority of the tests listed above. meanwhile at first difference, null hypothesis of unit root is confidently rejected because of significant probability values at 0.05 from all the tests. this leads to the final specification: δlog (q/l) it = log (a) + b1 δlog (k)it +b3 δlog (rd) it + b4 δlog (rd (1)) it + uit (9) thus, equation 9 above can be best interpreted as observing long-run elasticity of labour productivity with respect to r&d expenditure, denoted by b4. equation 9 thus becomes the final specification. the equation was therefore estimated using both fixed effects and random effects methods, and the hausman test was used to determine the appropriate method that produced a more desirable result. 5. empirical results the purpose of this section is to provide answer to research questions therefore; we start with regression results for equation 9 at a panel level for the industries. table-9. pooled ols. variable coefficient std. error t-statistic prob. c 0.005527 0.001041 5.307143 0.0000 dlnk -0.010417 0.028752 -0.362289 0.7175 dlnrd 0.012915 0.022969 0.562267 0.5746 dlnrd(-1) 0.060162 0.022202 2.709792 0.0073 table-10. fixed effects. variable coefficient std. error t-statistic prob. r2 0.121965 c 0.005890 0.001039 5.669168 0.0000 dlnk 0.021117 0.031876 0.662470 0.5085 dlnrd 0.022798 0.023052 0.988967 0.3239 dlnrd(-1) 0.070136 0.022279 3.148095 0.0019 table-11. random effects. variable coefficient std. error t-statistic prob. c 0.005527 0.001030 5.368104 0.0000 dlnk -0.010417 0.028426 -0.366450 0.7144 dlnrd 0.012915 0.022708 0.568725 0.5702 dlnrd(-1) 0.060162 0.021950 2.740918 0.0067 as explained in the methodology section, the acceptance of result from the random or fixed effect method would require the use of hausman test. note that, because the interest is in acknowledging differences within the industries, the pooled ols result which does not account for this, is disregarded in this research. table-12. hausman test: test for the appropriate method of estimation between fixed and random effects. correlated random effects hausman test equation: eq01 test cross-section random effects test summary chi-sq. statistic chi-sq. d.f. prob. cross-section random 8.699107 3 0.0336 as briefly mentioned earlier, the hausman test is a test which decides whether the fixed effects or random effects method is appropriate, based on differences in the correlation of the error terms with explanatory variables (gujarati and porter, 2009). the null hypotheses h0 is that the error terms are uncorrelated with explanatory variables and thus random effects method is appropriate, while the alternative ha is that error terms are correlated with explanatory variables and therefore fixed effects method is appropriate (gujarati and porter, 2009). because the p-value is significant at 5%, we reject the null hypothesis of uncorrelated error terms therefore, we proceed with results from the fixed effects method which are: b0= 0.006860 = intercept or productivity growth unattributed to explanatory variables. b1=0.021117= elasticity of productivity growth with respect to capital investment. b3=0.022798 = contemporaneous (immediate) effect of r&d on productivity growth. b4=0.070136 = long-run elasticity of productivity growth with respect to r&d expenditure. recall that interest is not in the contemporaneous effect of r&d. that is, the r&d without the one-year lag (b3). rather, we are interested in long-run effect (b4). asian journal of economics and empirical research, 2019, 6(2): 205-215 213 © 2019 by the authors; licensee asian online journal publishing group although the r2 of 0.12 seems small, it is similar to that reported in cameron et al. (2005) which is around 0.06. moreover, with the low p-value for the long-run r&d coefficient (less than 0.05) from the fixed effect method, we can infer that, if r&d expenditure increases by 1%, productivity will increase by 0.07%. 6. discussion the result reveal that, the extent of the impact of r&d on productivity growth in the uk manufacturing sector is about 0.07% for every 1 % rise in r&d expenditure. because this result is statistically significant at 10%, there is a confidence to compare it with other papers from the literature review. recall that the panel data studies are those which are placed on table 5. however, only those which also estimated fixed effect from the table are called up for comparison. they include geroski (1991); mcvicar (2002) and kafouros (2008). these three papers are the three most significant papers to this study. reasons being that they also study the uk at industry level, using the fixed effects method and a panel data. see table 13 to observe how our result compare with that of other panel data studies. table-13. comparisons with closest papers at panel level. paper country level type of data approach method/variables r&d coefficient geroski (1991) uk industry panel cobb-douglas production function fixed effects/ lp, k, r&d 0.015 mcvicar (2002) uk industry panel cobb-douglas production function fixed effects/ tfp, r&d 0.015 kafouros and wang (2008) uk firm level data aggregated to industry level panel cobb-douglas production function fixed effects/ output, l, k, r&d 0.10-0.16 allthough the result from this current study is a little different from those of other papers as seen on table 13 above, this is totally explanable. there are two general reasons identified in literature review to cause these minor differences in results. the first reason has to do with different research objectives and type of data for the different papers as highlited in hall and mairesse (1995) and holtz-eakin (2005) and the other has to do with fluctuations in the external business environment in different time periods being observed, highlighted in moen and burchardt (2010). judging from the angle of the type of data and research objectives, there are a number of interpretation as to why our study produces a slightly different estimate for the uk with regards to earlier papers. firstly, geroski (1991) employs a slightly different type of r&d expenditure dataset in their study, separating domestic from foreign r&d expenditure data to assess the impact of each type4 which means that their result has the tendency to be a little lower than that of this study. secondly, mcvicar (2002) only estimates for 7 uk manufacturing industries thus, it is possible that the inclusion of more industries in the study, as done in this paper should produce a slightly higher estimate. lastly, the huge difference between the result in kafouros and wang (2008) and that of this present research, is somewhat surprising. however, kafouros and wang (2008) is the only paper in this category which uses sales to proxy for output. they maintain that because gross value added was not available at the time of the research, the only option was to resort to sales.this means that their result is not expected to be precise with that of this paper. in fact, hall and mairesse (1995) argue against the use of sales to proxy for output sustaining that it leads to biased results. in a ddition, the 2008 financial crises created a hole in the data used for this study which means that perhaps, the coefficient of long-run r&d expenditure for this research would have probably been higher than it is, moving closer to that of kafouros and wang (2008). finally, by observing table 3 and 4 in literature review, one can appreciate that the long-run r&d coefficient for this present research is very similar to those reported in the tables. in fact, the impact of 0.07 found on this present paper is exactly the same size found for france by hall and mairesse (1995) while using time-series data. this implies that this study also joins other panel data studies to provide support for small coefficient for r&d, consistent with the arguments of time-series studies. however, there is still a need for further investigation at individual industry level using time-series data, to assess whether this is also the same picture dipicted. 7. conclusion the purpose of this study has been to investigate the impact of r&d expenditure on productivity growth using panel data. our general conclusion is that there is still a positive relationship between r&d expenditure and productivity growth for the uk manufacturing industries, with r&d elasticity of about 0.07% at panel level and significant at 1 %. the main implication of these findings is that technological advancement which contributes to productivity growth is not exogenous, contrary to solow (1956). that is, it can be determined by r&d decisions in firms and in industries, which is in favour of romer (1986); romer (1990) and lucas (1988). nevertheless, there are also some rare circumstances where this endogenous growth theory does not hold. for instance, kafouros and wang (2008) also confirm as well as this study that some industries do possess negative signs. in addition, this study clearly prefers investment in r&d to capital investments, as capital was generally found to contribute less to productivity growth compared to r&d investments. furthermore, the estimate for r&d coefficient found at the panel level provides support for the argument of small coefficient for studies using time-series data. thus, we can align with 4 domestic r&d is the r&d expenditure undertaken in the industry, while foreign r&d is usually that embodied in purchased capital goods higon (2007). asian journal of economics and empirical research, 2019, 6(2): 205-215 214 © 2019 by the authors; licensee asian online journal publishing group the argument of such studies on table 3-4 that r&d has a lesser impact on productivity growth than those coming from cross-section studies on table 1-2. the policy implication for this research is for the uk government to to provide incentives to increase innovation in the uk manufacturing industries. furthermore, the uk government also needs to design policies which encourage more of r&d investments in firms than capital investments. in addition, since an increase in r&d expenditure has the tendency to increase productivity which in-turn leads to improvement in living standards (harari, 2015) it is advised that the uk government provides r&d subsidies to struggling manufacturing industries, most of which are in the low-tech category, as this will contribute to economic growth. 7.1. limitations of study and recommendations for future research the major limitation is that, the double counting of labour and capital inputs in r&d is not corrected in our data. thus, it is likely that our results are bias. finally, our observation period is only for 18 years and because r&d expenditire does not vary much over time, the research requires longer observation period to be able to reach stronger conclusions. two important recommendations for improvements and further study on this research topic are one, to carry out more panel data studies using longer observation period of over 30 years and apply higher lags, as this will capture higher variations in r&d expenditure over time thus producing more reliable estimates. the last recommendation is to represent energy input in the cobb-douglass production function framework for the industries, to improve the specification. references asteriou, d. and s.g. hall, 2011. applied econometrics. london: palgrave macmillan. australian industry commission, 1995. research and development. canberra: government publishing servic. cameron, g., 1998. innovation and growth: a survey of the empirical evidence. oxford: nuffield college, oxford, ox1 1nf, uk. cameron, g., 2003. why did uk manufacturing productivity 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of economics and empirical research vol. 9, no. 2, 83-90, 2022 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v9i2.4118 © 2022 by the authors; licensee asian online journal publishing group do globalization, technology adoption and economic development influence income inequality in developing asian nations? shujaat abbas1  qazi muhammad adnan hye2 raja rehan3 sadaf mubeen4 ( corresponding author) 1ural federal university, russian federation. email: shujaat.abbas@urfu.ru 2mohammad ali jinnah university, karachi, pakistan. email: adnan.econ@gmail.com 3ilma university, karachi, pakistan. email: rajarehan3@hotmail.com 4national college of business administration and economics lahore, pakistan. email: sadaf.mubeengcu@yahoo.com abstract currently, income inequality has become an international issue that needs to be overcome and also requires the attention of researchers and policymakers. hence, this study is an attempt to explore the impact of globalization, technology adoption, and economic development on income inequality. for this purpose, 20 years of large-scale panel data over the period from 2001 to 2020 for ten emerging asian nations (iran, jordan, iraq, laos, pakistan, bangladesh, sri lanka, thailand, indonesia, and the philippines) is mined from the world bank database and kof globalization index. in order to inspect the empirical relationship among the selected variables, the panel data fixed effects model (fem) along with the robust standard error is employed. the results indicate that globalization, technology adoption, and economic development have a negative linkage with income inequality, which means these factors play a significant role in removing the income inequality in developing countries. this study provides insight for policymakers while developing policies regarding income inequality elimination in the country. keywords: globalization index, technology adoption, economic development, income inequality, net national income. jel classification: f60; f63; d63. citation | shujaat abbas; qazi muhammad adnan hye; raja rehan; sadaf mubeen (2022). do globalization, technology adoption and economic development influence income inequality in developing asian nations? asian journal of economics and empirical research, 9(2): 83-90. history: received: 13 december 2021 revised: 15 july 2022 accepted: 29 july 2022 published: 22 august 2022 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. authors’ contributions: all authors contributed equally to the conception and design of the study. competing interests: the authors declare that they have no conflict of interest. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study, that no vital features of the study have been omitted, and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 84 2. literature review ............................................................................................................................................................................ 85 3. research methods ............................................................................................................................................................................ 86 4. findings of the study ...................................................................................................................................................................... 87 5. discussions ........................................................................................................................................................................................ 88 6. conclusions ....................................................................................................................................................................................... 89 7. implications....................................................................................................................................................................................... 89 8. limitations and future recommendations ................................................................................................................................ 89 references .............................................................................................................................................................................................. 89 mailto:shujaat.abbas@urfu.ru mailto:adnan.econ@gmail.com mailto:rajarehan3@hotmail.com mailto:sadaf.mubeengcu@yahoo.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v9i2.4118 asian journal of economics and empirical research, 2022, 9(2): 83-90 84 © 2022 by the authors; licensee asian online journal publishing group contribution of this paper to the literature the study makes a distinction in economic-based literature. the findings obtained from this empirical study address the present issue of income inequality and also analyze the impacts of globalization, high technology exports, gdp, and nni on income inequality. 1. introduction with the passage of time, rapid technological changes have converted the world into a global village and it has reduced the differences among nations. unfortunately, this wave of globalization has also delivered some adverse effects, such as raised income inequality and unequal distribution of wealth (heshmati, 2007). in fact, the business community of any country is one of the core reasons for the unequal circulation of wealth (crane, husted, bapuji, & derry, 2014). also, in order to earn high revenue, the local business community is attracted more toward advanced nations’ markets (morisset, 2003). this trend marks an adverse effect on foreign direct investment (fdi), capital mobility, international trade, skilled labor, fewer available jobs, taxation, economic reforms, growing regional disparities, the role of communication media, etc., in developing countries. particularly, when developing nations’ industries move into the international market, they need to follow international business trends, such as adopting universally recommended technology, hiring highly skilled employees, and manufacturing products according to the global market needs. these factors urge companies to: 1) hire skilled labor from developed countries, which further leads to discrimination of local skilled manpower, leading to unemployment; 2) import highly demanded raw materials for better quality products, resulting in lower demand for local raw materials; 3) increase local taxes – once the business community moves towards the international market, this allows the government to levy more taxes to satisfy its financial needs. clearly, this specifies a strong association between globalization and income inequality (auguste, 2018; dorn, fuest, & potrafke, 2018; khan, shehzad, & ahmad, 2021). remarkably, technology advancement is one of the core reasons for increased globalization and income inequality. undeniably, information technology is one of the most expensive sectors in the world. the developed republics are inventing more technological tools for many different industries, which is followed by developing countries. adoption of the latest technology is one of the major differences between developed and developing nations (bauer, 2018). thus, in order to meet the requirements of the international market, developing nations’ business communities have no option but to adopt the globally recommended technology, otherwise they will be crushed by competitors. notably, the literature proposed the same, that technology impacts income inequality (asongu & odhiambo, 2019). thus, all the various sectors of the markets are forced to adopt modern technology to meet the current era requirements. consequently, new developments, such as accounting, inventory, supply chain, recording and other related software is introduced into the markets. hence, if the evolving nations do not adopt the latest technological advancements, they may not be able to meet the standards of the international markets, leaving them lagging behind and facing income inequality. therefore, even if a low degree of technological development is able to reduce income inequality, one may consider technological development as a core factor that reduces income inequality in developing countries (asongu & odhiambo, 2019; bauer, 2018; untari, priyarsono, & novianti, 2019). clearly, the adoption of technology is necessary for all levels of community. economic performance also plays a vital role in the prosperity of a country. visibly, the prime difference between developed and developing nations is their wealth and economic development growth rate (wu & li, 2017). in reality, the role of economic growth is the core factor that specifies the stability or instability of nations. therefore, it is vital for every nation to sustain its economic growth to ensure stability. notably, the economic policies of a country strongly influence its income inequality level. therefore, in order to keep up with recent developments and meet international standards, developing nations need to formulate their own policies regarding tax reforms, businessrelated issues, utility prices, etc., to maintain standards and meet global needs. however, the negative side of these policies are that they support the rich and crush the poor, sometimes leading to income inequality. this is why scholars have previously specified that economic development leads to income inequality (bolarinwa & akinlo, 2021; hailemariam, dzhumashev, & shahbaz, 2020; khan, saleem, & fatima, 2018). interestingly, globalization has also been considered to be a significant exogenous driver of inequality, especially in developing nations. particularly in emerging nations, these forces have exacerbated existing patterns of inequality in a variety of ways, including persistently high wealth inequality and intergenerational transfer of inequality due to unequal access to higher-level education. over the last three decades, the negative impact of financial and trade globalization on income inequality has been worsened by national policies that have had a detrimental influence on income distribution in developing countries. likewise, during the covid-19 pandemic, developing countries were more affected by income inequality as they have slower economic growth in comparison to developed countries. evidently, in spite of adopting similar strategies to survive the recent pandemic, the increasing amount of literature specifies that each nation postulates a dissimilar mortality rate due to income inequality (elgar, stefaniak, & wohl, 2020; mollalo, vahedi, & rivera, 2020; oronce, scannell, kawachi, & tsugawa, 2020). this opens a new debate and reignites the need to recognize developing countries’ economic factors for measuring inequality. although earlier studies have not provided a holistic view and conclusive findings, most of them agree that globalization, technological process and economic development are the core determinants that elucidate dynamic aspects of income distribution (see (milanovic, 2016; nolan, richiardi, & valenzuela, 2019)). nevertheless, the factors that help in attaining a fitting way of distributing income without hurting economic development remain unidentified (khan et al., 2021; untari et al., 2019). remarkably, numerous prior investigations that were conducted to inspect inequality determinants are countryor region-specific and rely on dissimilar estimation methods and data samples (see (asteriou, dimelis, & moudatsou, 2014; bukhari & munir, 2016; giri, pandey, & mohapatra, 2021)), hence delivering inconsistent outcomes and leaving gaps in the literature. for instance, current literature separately emphasizes technology, economic development and globalization, thus offering limited opinions regarding the sources of inequality. in view of this background, this study is set to offer numerous additions to the existing literature by recognizing inequality determinants in developing asian nations. the structure of the study is divided into various phases. in the first phase, the introduction of the study is presented. in the second phase, the evidence regarding globalization, technology adoption, economic development asian journal of economics and empirical research, 2022, 9(2): 83-90 85 © 2022 by the authors; licensee asian online journal publishing group and income inequality is discussed based on past studies. the third phase discusses the methodology regarding globalization, technology adoption, economic development and income inequality and related data and analyzes its validity. the fourth phase presents the findings of the study based on the analysis conducted. the paper ends with the conclusions, implications, and recommendations for future studies. 2. literature review over the past few years, numerous countries around the world faced substantial enhancement in globalization and economic freedom. this benefited the economic growth of many countries but also brought factors related to income inequality. roy-mukherjee and udeogu (2021) investigated the relationship between income inequality and neo-liberal globalization in the western balkan countries. the study indicates that proper arrangement of capital, trade and income are dependent on the good governance of globalization. the increased expenses due to globalization in developing countries highlighted the issue of income inequality. aluko, ibrahim, and atagbuzia (2021) examined the relationship between globalization and foreign direct investment that extended its influence on income inequality in africa. the study states that globalization plays an important role and influences income inequality. the limited knowledge has been considered a similar element in the globalization and liberalization that neglected the flow of income. therefore, the dimensions of globalization influences and economic freedom clearly indicate its dominant influence on the inequality of income. gozgor (2017) analyzed the impact of globalization on the unemployment structures that have a significant influence on income inequality. the finding states that robust potential exists in the globalization index that poses a strong influence over income inequality. the concepts of rich and poor are rigorously enumerated due to the quantifying impact of globalization. globalization has eliminated the distance among people but has also had various impacts on the lives of people. these impacts vary, from culture to income, due to the inappropriate distribution of essential elements among people globally. several dimensions of globalization that benefited the world with rising economic growth also disrupted the levels of income among the people. improper policy reforms that promoted sensitivity of inequality among different cultures and classes of people is also the biggest disaster in developing countries (khan et al., 2021). deregulation and improper social regulation also have a non-equalizing impact on income inequality in developing countries. technology has been a major intervention in the current world and eliminated a much-skilled labor force that has impacted people’s income. developing countries export their energy to developed countries that are influencing income inequality. sultanuzzaman, fan, mohamued, hossain, and islam (2019) explored the impacts of technology and exports on the growth of the economy and on the income inequality of asian countries. the study states that high technology exports not only disrupt the economic growth but also disrupts the income inequality among people. technology plays a vital role in the enhancement of economic growth, but exports have a larger impact. hayduk (2020) enumerated the high technology exports among developed countries influencing the income inequality in developing countries. the finding states that significant and severe impacts of technology exports impact skills as well as income inequality. income inequality is one of the greatest factors that is influenced by the export of high technology. idris, ismail, ibrahim, and hamzah (2021) assessed the trade of high technology from developing countries that clearly impacts income inequality. results indicated that inappropriate policies of retaining high technology create more unemployment and income inequality. usually, high technology is important in motivating workers as well as developing skills among the labor force. this benefits income stability and brings a more persistent inflow of money among the people without differentiation. more innovation within the industries develops people’s skills and motivates them to increase their efforts in support of the economy. the export of high technology reduces innovation in industries and influences the income inequality in various ways. the positions of people working in the industries were improved due to the implementation of high technology (untari et al., 2019). however, the export of high technology had a negative impact on people’s income but also influenced the economic growth of developing countries. the role of economic growth is dominant in the stability and instability of countries, whether developed or undeveloped. therefore, it is important for every country to sustain its economic growth to ensure the stability of every sector and every need pertaining to the working people. economic growth is defined as an increase in national per capita income and output. however, economic development does not imply an increase in people's living conditions. it might be due to a growth in income for the wealthy while the poor see little or no change in their living conditions. vladušić, dragović, and bašić (2018) interpreted the relation and growth of gross domestic product and private savings in bosnia and herzegovina, indicating its influence on income inequality. the study revealed that gross domestic product and its growth and decline has a major influence on income inequality. gross domestic product relates to the per capita growth that clearly impacts the income flows of the country. lalwani and chakraborty (2020) narrated the relationship between gross domestic product and aggregate earnings of developing countries that are influential on income inequality. the study indicates that there could be proper aggregate earnings of developing countries when the gross domestic product is properly and positively upgraded. the decrease in gross domestic product has a huge and lasting impact on the income inequality of developing countries from various stances. nugent and conway (2021) examined the relationship between ownership changes, income inequality and gross domestic product with various other factors. the findings indicate that the lack of growth in the gross domestic product and its sustainability shows a negative impact on income inequality. this is due to improper management of industries and regulation of institutions that contribute a major portion of their income to their governments. the need for stable social and political factors is also important as they impact the income inequality in developing countries. mostly, developing countries are unable to meet the standards of economic conditions due to decreased international investments. the unstable economic conditions also have a lasting impact on the income and lives of people, and this may also create uncertainty. low-income countries usually gain transitional growth by enlarging their political influence for attaining foreign investment to sustain their economic growth. the proper sustainability in economic growth and gross domestic product are instrumental in eliminating the factors of income inequality. national measures, especially the establishment of institutions to deal with inequality, can, nonetheless, play a significant role in lowering income disparity (hailemariam et al., 2020). a number of developing countries have used fiscal measures to reduce high levels of primary income disparity to lower levels of secondary and tertiary inequality. asian journal of economics and empirical research, 2022, 9(2): 83-90 86 © 2022 by the authors; licensee asian online journal publishing group the incomes of countries are based on different factors and sectors that are majorly highlighted by sustainability and increased economic growth. net national income is also defined as gross national income that is attained from higher asset sources. li and chen (2019) investigated the perspectives of global income chains and national income and their role in income distribution. findings revealed that a boost in the net national income could be vital for the elimination of income inequality. efficient management of net national income not only helps to sustain and increase economic growth but also benefits the livelihoods of people. arlotti and sabatinelli (2017) explored the support of net national income with the minimum income schemes for workers that influence income inequality. the results revealed that net national income is a strong factor related to global income that significantly impacts income inequality. developing countries retained their highest assets for developed countries for the sake of loans that reduced the net national income. liang (2021) examined the relationship between demand-driven growth and income distribution with the relevance of income traps that impact income inequality. the findings revealed that the net national income traps and their distribution are responsible for the influence on income inequality. this reduction has had a major impact on economic instability and income inequality among the chinese people. income inequality has been largely influenced by the net national income due to persistent higher expenses and lack of policy implementation. due to the higher loan schemes, most of the net national income is put toward the payments that largely impact the expenses and budgets of developing countries. this impact has not only restrained resource allocation but has also limited people’s income (khan et al., 2018). inflation and rising expenses of commodities are expanded due to the improper management of national income. lack of tax collection and income generation from developing countries contribute significantly to income inequality. 3. research methods this article investigates the impact of globalization, technology adoption, and economic development on income inequality, using data from secondary sources for ten developing asian countries for the analysis – iran, jordan, iraq, laos, pakistan, bangladesh, sri lanka, thailand, indonesia, and the philippines. large-scale panel data from 2001 to 2020 were extracted from the world bank (wb) database and the kof globalization index. in order to acquire robust outcomes, stata statistical software is employed. the current article established the equation using understudy constructs mentioned below: 𝐺𝐼𝑁𝐼𝐼𝑖𝑡 = 𝛼0 + 𝛽1𝐺𝐼𝑖𝑡 + 𝛽2𝐻𝑇𝐸𝑖𝑡 + 𝛽3𝐺𝐷𝑃𝑖𝑡 + 𝛽4𝑁𝑁𝐼𝑖𝑡 + 𝑒𝑖𝑡 (1) where: ginii = gini index. i = country. t = time period. gi = globalization index. hte = high technology export. gdp = gross domestic product. nni = net national income. this study uses income inequality as the dependent variable and measured as the gini index. globalization, technology adoption, and economic development are selected as predictors. globalization is measured as the kof globalization index, technology adoption has been measured as high technology export (% of manufactured exports), and economic development has been measured as the gdp growth (annual percentage) and net national income (annual % growth). the variables’ measurements and sources are detailed in table 1. table 1. measurements of the variables. s# variables measurement source 01 income inequality gini index wb 02 globalization globalization index kof 03 technology adoption high technology export (% of manufactured exports) wb 04 economic development gdp growth (annual percentage) wb net national income (annual % growth) wb this section also provides the statistical methods that are used in the study. the descriptive statistics expose the variables’ details, such as mean and standard deviation, and show the minimum and maximum values and number of observations. the correlation matrix is used to check the statistical relationship among the selected variables. analytically, the correlation clarifies the significant relationship among the selected variables (taylor, 1990). in addition, this study employs the variance inflation factor (vif) test to check the multicollinearity issue among the studied variables. multicollinearity scrutiny is grounded on the measure explained by several scholars who explicate that the variables possess a serious multicollinearity issue if its vif value exceeds 10 (see (akinwande, dikko, & samson, 2015; gujarati & porter, 2009; hernawati, hadi, aspiranti, & rehan, 2021; kennedy, 2008)). the equations of the test are detailed below: r2 y 𝑌𝑖𝑡 = 𝛼0 + 𝛽2𝑋2𝑖𝑡 + 𝛽3𝑋3𝑖𝑡 + 𝛽4𝑋4𝑖𝑡 + 𝛽5𝑋5𝑖𝑡 + 𝑒𝑖𝑡 (2) 𝑗 = 𝑅𝑌 2, 𝑅𝑋1 2 , 𝑅𝑋2, 2 𝑅𝑋3, 2 𝑅𝑋4, 2 𝑅𝑋5 2 (3) 𝑇𝑜𝑙𝑟𝑎𝑛𝑐𝑒 = 1 − 𝑅𝑗 2 𝑉𝐼𝐹 = 1 𝑇𝑜𝑙𝑒𝑟𝑎𝑛𝑐𝑒 (4) moreover, consistent with the practices of former scholars (see (atif, srivastav, sauytbekova, & arachchige, 2012; faustino & vali, 2013; perugini & tekin, 2022)), this study uses a balanced panel data model (pdm) to investigate the relationship among the selected variables. a panel data model is a combination of time series and cross-sectional data (abdul razak, rehan, zainudin, & hussain, 2018). a balanced panel data model specifies all time intervals with parallel observations. the pdm model is illustrated as follows: asian journal of economics and empirical research, 2022, 9(2): 83-90 87 © 2022 by the authors; licensee asian online journal publishing group pdm = 𝑦𝑖𝑡 = 𝛼𝑖 + 𝛾𝑡 + 𝛽𝑥𝑖𝑡 + 𝜀𝑖𝑡 (5) where, i is the engaged individuals (i = 1, 2, 3, 4…n), t is the period of time (t = 1, 2, 3, 4…t), 𝑦𝑖𝑡 is taken as the dependent variable (dv), 𝛼𝑖 represents the specific cross-sectional effects, and 𝛾𝑡 is the time series effects of the model. furthermore, 𝑥𝑖𝑡 is the independent variable, and 𝜖𝑖𝑡 is taken as error term effect and has a zero mean constant variance. for analytical purposes, this study adopts panel data static models (fixed and random effects models) to examine the association among the selected variables. the fixed effects model is a panel data model in which the parameters are fixed quantities, whereas in the random effects model, the parameters are not fixed and have random quantities (abdul razak et al., 2018). this study adopts the breusch–pagan lagrange multiplier (bp lm) test, that is presented by breusch and pagan (1980) to check which static model of panel data, either random or pooled effects, is suitable to test the selected variables. principally, the bp lm test uses the hausman test’s (hausman, 1978) ‘m’ statistics to check the hypothesis. the null hypothesis of the bp lm test confirms the acceptance of the pooled model (h0: pooled ols is accepted). however, if h0 is rejected, then we accept the random effects model (h1: random effects is accepted). subsequently, if the null hypothesis of the acceptance of the pooled ols is rejected then the hausman test is used to check the acceptance of the fixed or random effects models (breusch & pagan, 1980). technically, the hausman test compares both the fixed and random effects models. the null hypothesis of the hausman test confirms the acceptance of random effects model (h0: random effects exist). however, if the alternative hypothesis is selected, then the fixed effects model is preferred. statistically, if the value of the hausman test result is less than the significant value, the null hypothesis is rejected (abdul razak et al., 2018; hernawati et al., 2021). the equation of the test is set out below: 𝐻 = (𝑏1 − 𝑏0) (𝑉𝑎𝑟 (𝑏0) − 𝑉𝑎𝑟 (𝑏1)) (𝑏1 − 𝑏0) (6) here, h refers to the hausman test, 𝑏0 represents the null hypothesis related to the random effects model (rem) being the best model for the study, while 𝑏1 represents the alternative hypotheses, which is related to the fixed effects model (fem) being the best model for the study. technically, the fem controls the issues of heterogeneity and autocorrelation that generally exist in the pdm model. the equation of the model is given as follows: 𝑌𝑖𝑡 = 𝛽1𝑖 + 𝛽2𝑋2𝑖𝑡 + 𝛽3𝑋3𝑖𝑡 + 𝛽4𝑋4𝑖𝑡 + 𝛽5𝑋5𝑖𝑡 + 𝑢𝑖𝑡 (7) in the equation above, subscript i represents the individual country on the basis of their different characteristics. the estimation equation for the fem using the study’s constructs is as follows: 𝐺𝐼𝑁𝐼𝐼𝑖𝑡 = 𝛽1𝑖 + 𝛽2𝐺𝐼𝑖𝑡 + 𝛽3𝐻𝑇𝐸𝑖𝑡 + 𝛽4𝐺𝐷𝑃𝑖𝑡 + 𝛽5𝑁𝑁𝐼𝑖𝑡 + 𝑢𝑖𝑡 (8) importantly, this study also tests the relationship among the study’s variables by using a robust standard error model. this model is used because it adjusts the heterogeneity issues that generally exist in the pdm. moreover, this model also provides the best estimations, even with data that have heteroscedasticity and autocorrelation issues, because it adjusts the adverse effects of these issues (abdul razak et al., 2018). the estimation equation for the model is as follows: 𝐺𝐼𝑁𝐼𝐼𝑖𝑡 = 𝛽1𝐺𝐼𝑖𝑡 + 𝛽2𝐻𝑇𝐸𝑖𝑡 + 𝛽3𝐺𝐷𝑃𝑖𝑡 + 𝛽4𝑁𝑁𝐼𝑖𝑡 + ɛ𝑖𝑡 (9) 4. findings the current study has run the descriptive statistics that exposed the variables details, such as mean and standard deviation, and also showed the minimum and maximum values along with the number of observations. the results indicate that the mean value of ginii is 44.922, and the average value of gi is 47.936. in addition, the results also show that the average value of hte is 32.873, the mean value of gdp is 5.673%, and the mean value of nni is 3.637%. the descriptive statistics are detailed in table 2. table 2. descriptive statistics. variables obs. mean std. dev. min. max. ginii 200 44.922 2.349 25.982 55.493 gi 200 47.936 4.873 43.746 64.637 hte 200 32.873 1.652 22.763 35.627 gdp 200 5.673 1.704 4.657 10.627 nni 200 3.637 2.763 2.763 9.872 moreover, this study also ran the correlation matrix that shows the relationship among the studied variables. the figures indicate that gi, hte, gdp, and nni have a negative association with the gini index, which means the predictors reduce the income inequality in the country. table 3 shows the association among the variables in the correlation matrix. table 3. matrix of correlations. variables ginii gi hte gdp nni ginii 1.000 gi -0.543 1.000 hte -0.435 0.548 1.000 gdp -0.487 0.442 0.654 1.000 nni -0.342 0.322 0.622 0.329 1.000 in order to check the multicollinearity issue, the vif test was run. table 4 highlights that all the vif values are lower than 10, which indicates the absence of multicollinearity in the executed model. asian journal of economics and empirical research, 2022, 9(2): 83-90 88 © 2022 by the authors; licensee asian online journal publishing group table 4. variance inflation factor. variables vif 1/vif gi 3.763 0.266 hte 2.983 0.335 gdp 2.632 0.379 nni 3.909 0.256 mean vif 3.322 table 5 presents the results obtained from the breusch–pagan lm test. clearly, the p-values confirm the acceptance of the alternative hypothesis (p < 0.05). hence, the outcome indicates that the random effects model is more effective than the pooled ols model. table 5. breusch–pagan test. h0: pooled ols is accepted. h1: random effects is accepted. m value pr > m 7333 0.0001* note: * denotes significance at the 5% level. next, this study executes the hausman test to examine the best model for the empirical investigation. the outcome (see table 6) shows that the probability value is lower than 0.05. thus, the result clearly indicates that the fixed effects model (fem) is suitable for this analysis. table 6. hausman test. h0: random effects model is accepted. h1: fixed effects model is accepted. test coeff. chi-square test value 7.093 p-value 0.000 the results in table 7 relate to the fixed effects model outcomes. the results indicate that globalization, technology adoption, and economic development have a negative association with the gini index. evidently, the studied variables play a significant role in reducing income inequality in developing nations. notably, the r-squared value is less than 0.564, which indicates that the overall variation of the model is low. generally, in static panel modelling, a low r-squared value is not a serious issue. technically, when a panel data static model is more dominant by cross-section observations, the r-squared is considered low (frank & goyal, 2009). table 7. fixed effects model (fem). ginii beta s.d. t-value p-value l.l. u.l. sig. gi -0.546 0.283 -1.93 0.045 -1.331 -0.238 ** hte -1.876 0.763 -2.46 0.034 -1.540 -0.540 ** gdp -0.453 0.187 -2.42 0.036 -1.333 -0.234 ** nni -0.564 0.223 -2.53 0.029 -1.549 -0.658 ** constant 26.983 4.872 5.54 0.000 20.326 31.333 *** r-squared 0.564 number of obs. 200 f-test 2.432 prob. > f 0.031 note: *** p < .01, ** p < .05. table 8 displays the robust standard error findings, indicating that globalization, technology adoption, and economic development have a negative link with the gini index, which means these factors play a significant role in reducing income inequality in developing nations. table 8. robust standard error. ginii beta s.d. t p > t l.l. u.l. gi -0.645 0.289 2.232 0.022 -2.559 -0.275 hte -1.093 0.463 -2.361 0.019 -2.347 -1.943 gdp -2.873 1.221 -2.353 0.020 -1.536 -0.513 nni -5.473 2.712 -2.018 0.036 -1.280 -0.939 cons 6.040 1.321 -4.572 0.000 3.221 8.358 5. discussion the results show that globalization has a negative impact on income inequality. these results are supported by haseeb, suryanto, hartani, and jermsittiparsert (2020), who revealed that if there is income inequality in some regions, the population has potential opportunities to grow, succeed, earn more, and improve their living standards, while on the other hand, the situation is quite the opposite. globalization, which allows the transportation of people and goods from one region to another, reduces income inequality. these results are in line with the findings of law, naseem, lau, and trinugroho (2020), who highlighted that when there is a difference in the labor wages because of a difference in area, education, or social prestige, globalization enables individuals to offer their services for desired wages, thus minimizing income inequality. moreover, the results also show that high technology exports have a negative impact on income inequality. these results are in line with the findings of saraswati, maski, kalug, and sakti (2020), who revealed that sometimes a small group of people contains a larger portion of the national wealth because of the enhanced earnings opportunities through the use of high-quality resources, which they can afford on asian journal of economics and empirical research, 2022, 9(2): 83-90 89 © 2022 by the authors; licensee asian online journal publishing group account of their economic power. however, the facility to export high technology at an affordable price removes inequality in income distribution because it gives equal chances to grow economically at all levels. the results also reveal that gdp has a negative impact on income inequality. in comparison, these findings are in line with the outcomes of the study by gunasinghe, selvanathan, naranpanawa, and forster (2020), who suggested that the government should increase the gdp to raise their rank among other countries, resulting in the reduction of income inequality. similarly, the results also match with the findings of chang, gupta, and miller (2018), who stated that if a country is achieving high gdp, the government has a large number of revenues from commercial taxes. thus, the increased revenues enable the government to offer incentives to the lower circle of the population. this reduces income inequality and provides equal opportunities to the public to raise their living standards. furthermore, the results also declare that nni has a negative impact on income inequality. these results are in line with the findings of chancel and piketty (2019), who revealed that an increase in the national income of a country is helpful to control income. evidently, increases in the nni results in minimizing income inequality. 6. conclusions this study addresses the issue of income inequality in developing asian nations and analyzes the role of globalization, technology adoption, and economic development in reducing income inequality. for this purpose, a quantitative research technique was adopted, and the impacts of globalization, high technology exports, gdp, and nni on income inequality in developing countries were analyzed. the outcomes indicate that globalization, high technology exports, gdp, and nni have a negative relation with income inequality. the results show that if there is income inequality, in some locations, people have more opportunities to grow and have high living standards compared to others where the situation is totally different. globalization, which permits the transportation of people and goods from one place to another, reduces income inequality. the results show that the ability to export sophisticated high technology at a reasonable price reduces income inequality by providing equitable opportunities that contribute to economic prosperity. the results also revealed that if a country's gdp is high, the revenue from commercial taxes is considerable and allows the government to provide incentives for people in the lowest socioeconomic strata to rise up and contribute to economic progress. hence, this ultimately eliminates income inequality. similarly, when a country has high nni, economic activities and developmental work are at a peak, and the chances of income inequality are minimal. 7. implications this study offers distinct additions to economic-based literature. many renowned scholars have taken income inequality as the subject of their research and analyzed the impacts of globalization, high technology exports, gdp, and nni on income inequality, but hardly any studies have addressed globalization, high technology exports, gdp, and nni simultaneously as the indicators of income inequality. technology adoption is considered a part of economic development in most of the studies. here, the separate use of the two terms for analyzing income inequality contributes to the literature. the present study is relevant to developing countries where income inequality is one of the major issues. it guides the government and reformers on how to reduce and potentially eliminate income inequality. it suggests that with the increase in globalization, technology adoption, and economic development, income inequality can be controlled. 8. limitations and future recommendations a number of limitations are associated with this study but can be removed in future studies. this study only examines the impact of globalization, technology adoption, and economic development on the income inequality in a country. however, education, inflation, government policies, and developmental activities also play a great role. authors of future studies should include these factors for a better determination of aspects that influence income inequality. this study only addressed the relation of globalization, 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(2017). income inequality, economic growth, and subjective well-being: evidence from china. research in social stratification and mobility, 52, 49-58. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc., caused in relation to/arising from the use of the content. any queries should be directed to the corresponding author of the article. 73 © 2022 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 9, no. 2, 73-82, 2022 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v9i2.4106 © 2022 by the authors; licensee asian online journal publishing group the influence of working capital management on the profitability of listed manufacturing companies in tanzania dickson matiko kisyeri1 alex reuben kira2 ( corresponding author) 1,2department of accounting and finance, university of dodoma, tanzania. 1email: matikod@gmail.com tel: +255768325487 2email: alexkira10@gmail.com tel: +255713592266 abstract working capital management (wcm) and listed manufacturing companies (lmcs) profitability are subjects that have taken much attention of scholars globally because cash management, inventory management, receivables, and payables management components are vital elements for the performance of businesses. however, there is limited literature on the subject that considered the dupont analysis as a measure of lmcs’ profitability as well as that used the finite distributed lag model to analyze wcm variables and profitability. likewise, there is patchy recorded literature so far that tried to use administration expenses and marketing expenses to moderate the relationship between wcm and lmcs’ profitability. to bridge this knowledge gap, this study investigated the influence of wcm on profitability of lmcs’ on the dar es salaam stock exchange plc (dse), tanzania. the study used an explanatory research design based on objectivism philosophies whereby profitability data were collected from the financial reports of the listed manufacturing companies on dse. panel data with the finite distribution lag model was used to analyze the published audited financial reports for 14 years, from 2005 to 2018 inclusive, of listed manufacturing firms. the results showed that current year marketing and administration expenses as moderators cause a lag of three years in the average collection period and each for moderator to have a positive impact on profitability, while the current year average collection period had a negative impact on profitability. it is, therefore, recommended that lmcs in tanzania should consider the previous three years’ average collection period, administration expenses, marketing expenses, and effectiveness in managing working capital to enhance their profitability. keywords: average collection period, average payment period, number of day’s inventory, cash conversion cycle, profitability, dupont analysis. jel classification: m1, m3, m4. citation | dickson matiko kisyeri; alex reuben kira (2022). the influence of working capital management on the profitability of listed manufacturing companies in tanzania. asian journal of economics and empirical research, 9(2): 73-82. history: received: 18 may 2022 revised: 12 july 2022 accepted: 25 july 2022 published: 15 august 2022 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. authors’ contributions: both authors contributed equally to the conception and design of the study. competing interests: the authors declare that they have no conflict of interest. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 74 2. research methodology ................................................................................................................................................................... 74 3. results ............................................................................................................................................................................................... 77 4. discussion .......................................................................................................................................................................................... 77 5. conclusion, contribution, and recommendations .................................................................................................................... 80 references .............................................................................................................................................................................................. 82 mailto:matikod@gmail.com mailto:alexkira10@gmail.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v9i2.4106 https://orcid.org/0000-0003-2687-1093 https://orcid.org/0000-0002-9147-6500 asian journal of economics and empirical research, 2022, 9(2): 73-82 74 © 2022 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the current literature by ascertaining the influence of working capital management on listed manufacturing companies’ profitability in tanzania measured by the dupont analysis and the moderating effect of administration and marketing expenses between wcm and lmcs’ profitability using the finite distributed lag model. 1. introduction working capital management (wcm) and company profitability are subjects that have attracted much attention around the world from academics and business companies (nwakaego & ikechukwu, 2016). this is because working capital management is the vital element of the companies’ investment, control of circulating capital which is the heart of all business companies, and a measure of cash as well as the short-term business situation (utia, dewi, & sutisna, 2018). profitability on the other hand is the capacity of companies to earn revenue associated with sales, total assets, and owned capital (sartono, 2010). however, globally, several lmcs have been facing profitability challenges (tingbani, 2020). in africa, several lmcs have faced declining performance to the extent of being placed under receivership, and de-listing due to failure to pay dividends and other current liabilities (wanyoike, onyuma, & kung’u, 2021). similarly, in tanzania some lmcs have experienced losses as it is indicated by their financial reports published by the dse resulting in a small contribution to the country’s economy. although the literature reviewed back the idea that working capital management influences profitability (achode & rotich, 2016; ponsian, chrispina, tago, & mkiibi, 2014) there are conflicting results since some studies found that the same variables of working capital revealed a positive relationship with companies’ profitability, while a negative relationship with companies’ profitability was found in other studies (awan, shahid, hassan, & ahmad, 2014; ponsian et al., 2014). these conflicts are mainly due to companies operating in different economies and different environments. for instance, an environment with an unforeseen interruption in the supply of raw materials forces companies to keep a large inventory to ensure continuity of production, supply, and a positive impact of the number of days inventory on profitability (amponsah-kwatiah & asiamah, 2021; olaoye, adekanbi, & oluwadare, 2019). moreover, the studies reviewed did not consider the moderating effect that administration and marketing expenses have on the relationship between wcm and lmcs’ profitability. taking into consideration that some of the lmcs used in this study have been making losses although they are open to the public for investment and the fact that they should have competent employees, this study examined the effect of the two moderating variables on their management of current capital. additionally, the reviewed literature did not use the dupont analysis to measure profitability as in this study; instead, they used roe which is disaggregated to get the dupont analysis. also, unlike the previous studies, this study used a finite distributed lag model to analyze the relationship between wcm and profitability of lmcs in tanzania. therefore, this study attempted to fill the above literature gaps of knowledge by using tanzanian-listed manufacturing companies guided by the following hypothesis: 𝐻𝑜1: cash management has no significant influence on the profitability of lmcs in tanzania. 𝐻𝑜2: inventory management has no significant influence on the profitability of lmcs in tanzania. 𝐻𝑜3: accounts receivable management has no significant influence of on the profitability of lmcs in tanzania. 𝐻𝑜4: accounts payable management has no significant influence on the profitability of lmcs in tanzania. 𝐻𝑜5: there is no significant moderating effect of administration expense on wcm and profitability of lmcs in tanzania. 𝐻𝑜6: there is no significant moderating effect of marketing expense on wcm and profitability of lmcs in tanzania. 2. research methodology 2.1. research design according to utia et al. (2018) an explanatory research design is suitable where the scholar is endeavoring to explicate how the phenomenon functions by finding the fundamental factors that produce a change in it, in which case there is no independent variable manipulation. this study adopted an explanatory research design to analyze the influence of working capital management on the profitability of lmcs in the dse, tanzania. 2.2. targeted population the populations were all cross-sectionals from the year 2005 to 2018 inclusive from each of the six listed manufacturing companies, hence making a total population of 84 cross sectionals (6 companies x 14 fourteen financial statements years) = 84 cross sectionals). 2.3. sampling frame & techniques because of panels, a census approach was used to incorporate all six lmcs. 2.4. data collection methods and tools data were collected from audited annual financial statements of listed manufacturing companies listed on dse. the variables used in this study were cash holding ratio for cash management, the number of days’ inventory for inventory management, average collection period for receivables’ management, and average payment period for payables’ management as independent variables and the dupont analysis to explain company profitability. the moderating variables are administration expenses and marketing expenses. all these variables’ data were extracted from the financial statement of these lmcs’ websites. asian journal of economics and empirical research, 2022, 9(2): 73-82 75 © 2022 by the authors; licensee asian online journal publishing group 2.5. validity and reliability because the data were extracted from companies’ published audited financial statements they, therefore, produced valid results. the internal validity was verified with evidence that working capital management influenced profitability. 2.6. statistical treatment of data in this study, the finite distributed lags regression model was used to examine the influence of cash holding ratio (chr), average payment period (app), average collection period (acp), and the number of days inventory (ndi) on the dupont analysis. since a change of independent variable may not cause an immediate change of dependent variable, the finite distributed lag model (fdl) known as the geometric distributed lag model (gdlm) or koyck distributed lag model (kdlm) was used in the form of autoregression, in case of secondary data, to predict current values of a dependent variable based on current values of explanatory variables and a maximum number of lagged values of these explanatory variables. usually, autoregressive models involve using one or more lagged values of y as determinants of the current value yt. the koyck lag model is the simplest one, which has one lag of y with only the current value of x as repressors. adding lagged values of x in addition to lagged y variables leads to the rational lag model. contrary to the vector autoregression (var) model, which uses endogenous variables only with all variables having equal lags, the ardl model uses both endogenous and exogenous variables where variables may have different lags. the use of panel data rather than time-series data not only increases the total number of observations and their variations, but also reduces the noise coming from the individual time series. hence testing for heteroscedasticity and normality is not necessary for panel data analysis. 2.7. model and mathematical specification for panel data a panel of data has both time series and cross-sectional elements that embody quantitative information of the same entities over time across both time and space. hence, strictly, if the data are not on the same entities (for example, different firms or people) measured over time, then this would not be panel data. introducing a lagged dependent variable in a cross-sectional equation helps not only to increase the data requirements but also to provide a simple way to account for unnoticed historical factors about the dependent variable that cause or contribute to current differences in the dependent variable. initial effects are also captured by putting in lags of y (wooldridge, 2009). this study uses the panel multiple linear regressions in the form of the autoregressive distributed lag model that includes one or more lagged values of the dependent variable among its explanatory variables. it is also known as dynamic distributed-lag mode since it portrays the time path of the dependent variable about its past value. taking into consideration that the optimal lag was three and that all variables were stationary at i(0), the model can be specified as follows: dupontl = α + ∑(βdldupontl l=3 l=1 ) + ∑ ( βclchrl + βalacpl + βplappl + βilndil + βaladexl + βmlmkex ) l=3 l=0 + e where: l = lag year where l=lag 0 (current year), l1=1lag, l2=2 lags and l2=3 lags. dupont = profitability in terms of dupont. α = dupont assuming that all dependent variable are constant. βdl = coefficient for lag in dupont. chr = cash holding ratio (cash management). βcl = chr coefficient with lag. 𝐴𝐶𝑃 = average collection period (receivable management). βal = acp coefficient with lag. 𝐴𝑃𝑃 = average payable period (payable management). βpl = app coefficient with lag. ndi = number of days inventory (inventory management). βil = ndi coefficient with lag. admexp = administration expenses. βal = admex coefficient with lag. mktexp = marketing expenses. βml = mktex coefficient with lag. then all 𝛽𝑠 were tested to see if they are significant at α = 0.001, 0.05 and 0.01. significant 𝛽 shows that the dependent factor has an impact on dupont. since the study focused on manufacturing companies that may have different characteristics, the panel method was used to analyze companies as a group, rather than individually. the study used stata version 14 to analyze the data that was collected from the listed manufacturing companies’ financial statements. hence, the unit of analysis in this study is the manufacturing company. the panel used is a heterogeneous panel since the number of groups (six companies studied) is less than the number of years (fourteen years: from 2005 to 2018). in this study, finite distributed lags regression model was used to examine the influence of cash holding ratio (chr), average payment period (app), average collection period (acp), and the number of days inventory (ndi) on the dupont analysis. since a change of the independent variable may not cause an immediate change of the dependent variable, the finite distributed lag model (fdl) known as the geometric distributed lag model (gdlm) or koyck distributed lag model (kdlm) was used in the form of autoregression to predict current values of a dependent variable based on current values of explanatory variables and a maximum number of lagged values of these explanatory variables. the multicollinearity diagnostic was done by using the correlation matrix analysis and the asian journal of economics and empirical research, 2022, 9(2): 73-82 76 © 2022 by the authors; licensee asian online journal publishing group variance inflation factor (vif) where a vif of less than ten shows the absence of multicollinearity as required by panel models. the unit root diagnostic was done by using levin-lin-chu (llc) test with one lag, this study uses the panel multiple linear regressions in the form of the autoregressive distributed lag model that includes one or more lagged values of the dependent variable among its explanatory variables. the wilks’ lambda, pillai’s trace, lawley-hotelling trace, and roy’s largest root tests were also done to ascertain the equality of the group. all test results for equality of the six group means are satisfactory and therefore the homogeneity of the means is assumed. table 1. correlations matrix analysis. pearson correlation, n=84 year chr acp app ndi admexp mktexp dupont year correlation 1.000 sig. (2-tailed) chr correlation -0.052 1.000 sig. (2-tailed) 0.638 acp correlation 0.171 -0.592* 1.000 sig. (2-tailed) 0.120 0.000 app correlation 0.316* 0.049 0.187 1.000 sig. (2-tailed) 0.003 0.660 0.089 ndi correlation 0.213 0.400* -0.382* 0.374* 1.000 sig. (2-tailed) 0.052 0.000 0.000 0.000 admexp correlation 0.034 0.098 0.104 0.065 -0.263* 1.000 sig. (2-tailed) 0.759 0.375 0.346 0.559 0.016 mktexp correlation -0.034 -0.043 -0.116 -0.028 0.185 -0.872* 1.000 sig. (2-tailed) 0.757 0.698 0.291 0.799 0.091 0.000 dupont correlation -0.178 0.394* -0.369* -0.011 0.227* -0.043 0.270* 1.000 sig. (2-tailed) 0.105 0.000 0.001 0.920 0.038 0.700 0.013 note: *. correlation is significant at the 0.05 level (2-tailed). according to table 1, the coefficient of the cash holding ratio shows a positive and significant relationship with the dupont analysis as indicated by β = 0.394, at 0.05 level of significance, meaning that the unit increase in cash holding ratio leads to an increase in the dupont analysis by 0.394 units. the average collection period is negatively and significantly related to the dupont analysis with β = -0.369 at 0.05 level of significance, indicating that a unit increase of the average collection period will lead to a decrease in the dupont analysis by 0.369 units. the number of days inventory is positively and significantly related to the dupont analysis with β = 0.227 at 0.05 level of significance. this means that the unit increase of the number of day’s inventory increases the dupont analysis by 0.227 units. the other variables do not indicate a significant relationship with the dupont analysis. table 2. fixed effect regression of working capital variables on profitability. dupont coef. st. err. t-value p-value [95% conf interval] sig. chr 1.23 0.582 2.11 0.038 0.07 2.391 ** acp -0.347 0.188 -1.85 0.068 -0.721 0.026 * app -0.066 0.048 -1.36 0.177 -0.162 0.03 ndi 0 0.073 0.01 0.995 -0.145 0.146 constant 37.267 12.821 2.91 0.005 11.721 62.814 *** mean dependent var 25.996 sd dependent var 26.278 r-squared within 0.1390 number of observations 84.000 r-squared between 0.3233 prob > f 0.004 overall r-squared 0.1630 bayesian crit. (bic) 774.171 f-test 2.9880 akaike crit. (aic) 762.017 fixed effect regression of working capital with their lags on profitability dupont coef. st. err. t-value p-value [95% conf interval] sig chr 1.676 0.802 2.09 0.042 0.066 3.286 ** acp -0.363 0.267 -1.36 0.181 -0.899 0.174 app -0.024 0.053 -0.45 0.653 -0.131 0.083 ndi 0.107 0.118 0.90 0.372 -0.131 0.344 l2.chr 1.233 0.725 1.70 0.095 -0.222 2.687 * l2.acp -0.531 0.323 -1.64 0.106 -1.179 0.118 l3.acp 1.011 0.347 2.91 0.005 0.314 1.707 *** l.app 0.078 0.074 1.05 0.297 -0.071 0.228 l.ndi -0.124 0.125 -0.99 0.327 -0.375 0.127 constant -2.495 25.312 -0.10 0.922 -53.311 48.322 mean dependent var 25.337 sd dependent var 27.160 r-squared within 0.3146 number of observations 66.000 r-squared between 0.8280 prob > f 0.023 overall r-squared 0.4100 bayesian crit. (bic) 628.783 f-test 2.168 akaike crit. (aic) 606.887 note: *** p<.01, ** p<.05, * p<.1. table 2 reveal that the cash holding ratio and the average collection period contribute to the fixed effect regression of working capital variables on profitability at 0.05 and 0.1 level of significance and constant having a strong contribution to the model at 0.01 level of significance. the model is not plausible with the use of the independent variables alone because the overall r-squared is 0.1630 which means that only 16% of the variability of the dependent variable is explained by the model. asian journal of economics and empirical research, 2022, 9(2): 73-82 77 © 2022 by the authors; licensee asian online journal publishing group table 3. regression results of wcm variables, lags and moderators on profitability. dupont coef. st. err. t-value p-value [95% conf interval] sig. chr 0.927 0.847 1.09 0.28 -0.784 2.638 acp -0.942 0.404 -2.33 0.025 -1.758 -0.125 ** app -0.064 0.059 -1.09 0.284 -0.183 0.055 ndi 0.038 0.123 0.31 0.757 -0.21 0.287 l2.chr 0.375 0.857 0.44 0.664 -1.354 2.105 l3.chr -0.341 0.739 -0.46 0.647 -1.833 1.151 l.acp 0.316 0.416 0.76 0.453 -0.525 1.156 l2.acp -0.144 0.42 -0.34 0.734 -0.992 0.705 l3.acp 0.784 0.36 2.18 0.035 0.058 1.511 ** l.app 0.071 0.075 0.95 0.349 -0.081 0.224 l2.app -0.017 0.108 -0.16 0.874 -0.236 0.201 l3.app 0.03 0.119 0.25 0.801 -0.21 0.27 l.ndi -0.09 0.142 -0.64 0.528 -0.377 0.196 l2.ndi -0.009 0.147 -0.06 0.95 -0.307 0.288 l3.ndi 0.153 0.147 1.04 0.302 -0.143 0.45 admexp 1.231 0.37 3.33 0.002 0.484 1.979 *** mktexp 1.519 0.497 3.06 0.004 0.515 2.522 *** l.mktexp 0.33 0.534 0.62 0.541 -0.749 1.409 l.dupont 0.15 0.137 1.10 0.279 -0.126 0.427 constant -135.676 47.861 -2.83 0.007 -232.335 -39.018 *** mean dependent var 25.337 sd dependent var 27.160 r-squared within 0.4851 number of observations 66.000 r-squared between 0.8323 prob > f 0.022 overall r-squared 0.5216 bayesian crit. (bic) 648.255 f-test 2.0330 akaike crit. (aic) 604.462 note: *** p<.01, ** p<.05. table 3 indicates that the average collection period and its lag 3 have significant negative and positive effects on the model as evidenced by β= -0.942 and β= 0.784 at a 0.05 level of significance. the administration expenses and marketing expenses strongly moderate working capital management as evidenced by β= 1.231 and β= 1.519 at a 0.01 level of significance. the model is plausible since the overall r-squared is 0.5216 which means that 52% variability of the dependent variable is explained by the model. the results indicate acp negatively and significantly related to profitability meaning that the unit increase in average collection period will lead to a decrease in the dependent variable by .942 units, but a positive relationship with the lags, showing the unit increase of average collection period at lag 3 will lead to an increase of the dependent variable by .784 units. furthermore, the result has shown the two moderating variables to be the perfect moderators that positively moderate the relationship between working capital management and profitability as shown by administration expenses β= 1.231 and marketing expenses β= 1.519 at a 0.01 level of significance. 3. results 3.1. to determine the influence of cash management on profitability this objective was represented by the null hypothesis as follows: 𝐻𝑜1: cash management has no significant influence on the profitability of lmcs in tanzania. the analysis in table 1 revealed that cash management measured by cash holding ratio had a positive and significant relationship with the dupont analysis as indicated by β = 0.394, p = 0.05 level of significance unit increase of chr leads to an increase of the dupont analysis by 0.394 units. this further means that the increase in the cash balance of a company leads to an increase in profitability. with enough cash holding the company can meet its maturing obligations when they become due. in table 2, the fixed effect regression of working capital variables on profitability showed that chr has a positive and significant relationship with profitability without the moderating variable as indicated by β = 1.23, p = 0.038. this indicates that chr representing cash management has an influence on profitability without the moderators used in this study. it revealed the same result in the fixed effect regression of working capital variables with their lags on profitability as shown in the second part of table 2 without the moderators used in this study. here, chr is seen influencing profitability with its lag two showing partial positive and a significant relationship with profitability represented by β = 1.676, p = 0.042 and β = 1.233, p = 0.095. we can conclude that the analysis indicated that cash management has a positive and significant relationship with profitability measured by the dupont analysis. due to the above results of the data analysis, we reject the null hypothesis and accept the alternative hypothesis that cash management has a significant influence on the profitability of lmcs in tanzania. 3.2. to determine the influence of inventory management on profitability this objective was represented by the null hypothesis as follows: 𝐻𝑜2 : inventory management has no significant influence on profitability in terms of the dupont assessment for lmcs in tanzania. in table 1 correlation matrix analysis reveals the number of days inventory having a positive and significant relationship with the dupont assessment as indicated by β= 0.227, p=0.038 which means the unit increase in the number of days inventory leads to an increase in profitability measured by the dupont assessment by 0.227 units. in tables 2, and 3, the number of day’s inventory is revealed to have no influence on lmcs profitability measured by the dupont assessment. the number of day’s inventory has no significant influence on company profitability neither with the fixed-effects model or the random-effects model even when the lags and moderators are introduced into the model. asian journal of economics and empirical research, 2022, 9(2): 73-82 78 © 2022 by the authors; licensee asian online journal publishing group although some models indicated an insignificant relationship between inventory management and profitability, there is a relationship between inventory management and profitability. therefore, due to those indicating significant relationships, we reject the null hypothesis and accept the alternative hypothesis that inventory management has a significant influence on the profitability of lmcs in the dse. 3.3. to determine the influence of receivables’ management on profitability this objective was represented by the null hypothesis: 𝐻𝑂4 : receivable management has no significant influence on profitability based on the dupont assessment for lmcs in tanzania. in table 2, the fixed effect regression of working capital variables on profitability indicates the average collection period having a negative and significant relationship with profitability without moderators and lags. the fixed effect regression of working capital management with lags on profitability, average collection period has shown a strong positive relationship with profitability at its lag 3 as indicated by β= 1.011, p=0.01. in table 3 the regression results showed the average collection period having a negative and significant relationship with profitability at a 0.05 level of significance as indicated by β= -942, p=0.025 meaning that a unit increase in average collection period will lead to a decrease in profitability by 0.0942 units. with its lag 3, the result indicates a positive relationship between the average collection period and profitability of lmcs in the dse as shown by β= 0.784, p= 0.035 meaning that a unit increase in the average collection period will also lead to an increase in profitability (dupont) by 0.784 units. this will further mean that in 2015 the companies extended credit sales to capture the market before going back to the regular negative relationship to reduce day’s receivables management to improve liquidity. due to the above results from the data analysis, we reject the null hypothesis and accept the alternative hypothesis that receivables’ management has a significant influence on the profitability of lmcs in the dse. 3.4. to determine the influence of payables’ management on profitability this objective was represented by the null hypothesis as follows: 𝐻𝑂4: payable management has no significant influence on profitability in terms of dupont for lmcs in tanzania. according to table 1, the correlation matrix analysis results show that the average payment period has a negative and significant relationship with profitability measured by dupont as indicated by β= -0.011. table 3 indicates the average payment period having an insignificant negative relationship with profitability as indicated by β = -0.064, p= 0.284. 3.5. to find out the impact of administration expenses as a moderating variable this objective was represented by the null hypothesis: 𝐻𝑂5: administration expense has no impact on wcm and profitability of lmcs in the dse. in the regression results which have wcm variables, lags, and moderators in table 3, the administration expenses are shown to improve the relationship between receivables management and its lag 3 and profitability measured by the dupont assessment. the percentages of changes in profitability were improved from adjusted rsquared of approximately 37% to 52.2%. collaborating with marketing expenses, administration expenses is the perfect moderator to the relationship between the average collection period and the dupont assessment. this suggests that improving remuneration improves morale and job satisfaction, which leads to improved management of receivables and increased company profitability. 3.6. to find out the impact of marketing expenses as a moderating variable this objective was represented by the null hypothesis: 𝐻𝑂6: marketing expenses have no impact on wcm and profitability of lmcs in the dse. in table 3 with the overall regression results, the findings show marketing expense have a positive and significant relationship with profitability (dupont) as indicated by β = 1.519, p = 0.004 < 0.01 level of significance. this result means that a unit increase in marketing expense will improve wcm and leads to an increase in profitability (dupont) by 1.519 units. with the above results, we can reject the null hypothesis and accept the alternative hypothesis that marketing expenses have a moderating impact on the relationship between wcm and profitability of the lmcs in the dse. 4. discussion the purpose of this section is to discuss the findings of specific objectives in responding to the problem of this study. the discussion is on the results in response to the six specific objectives below. 4.1. the influence of cash management on profitability the correlation matrix results in table 1 reveal cash holding ratio (chr) has a positive and significant relationship with profitability and are also the same results that are revealed in table 2. this means that the increase in the company’s cash balance leads to an increase in profitability. with enough cash holding the company is able to meet its maturing obligations when they become due. the other studies that are in line with the findings of this study are augustine and jacob (2017); das (2017) and iftikhar (2017) who contend that the companies with enough cash holding are the companies that perform well financially and increase their profitability. the results show that if the companies increase their cash holding, their profitability will be increased because they will have enough cash to meet their expenditures and even make more investments into the same business or other businesses for expansion and operations. however, the results of this study are contrary to the results of the study by abushammala and sulaiman (2014) who revealed that companies having high cash holding do not take advantage of the investment of their cash in gainful business opportunities. asian journal of economics and empirical research, 2022, 9(2): 73-82 79 © 2022 by the authors; licensee asian online journal publishing group the introduction of lags in the fixed effects regression of working capital variables on profitability in table 2 also showed that the decisions made on the cash management in 2016 which is lag 2 also had an influence on the current year’s cash management. in other words, the companies needed to use the cash management information in 2016 to make good decisions about how to manage it in the current year. the companies can manage their current year cash well by making use of the historical decision and information on cash management or by observing what ways were used to manage cash in the past and the impact it had on profitability. if the way cash was managed did not bring good results, change will be needed. with lags observation, we further see the implication that the previous price and quality of the company’s products impacted past sales either negatively or positively. the impact of higher prices for the product in 2016 could reduce the number of customers using the product; poor quality in like manner would also reduce the customers in the same year or lag 2. the effect of these two happenings would impact the sales in 2017 and even in 2018. observing such past operations can assist in planning for the current business well-being and plans for the business’s future. the results have shown that the companies that have good cash management have also enough cash holding for operations and have experienced increased profitability as evidenced by tanga cement and tanzania breweries that have good cash management. the results for tatepa and tanzania oxygen on poor cash management are evidenced by their struggle to meet their recurring obligations because of having insufficient cash. 4.2. the influence of inventory management on profitability according to the findings from the results section, the correlation matrix analysis for secondary data in the results section table 1 revealed a positive and significant relationship between the number of days inventory and profitability meaning that increasing the number of days that inventory is in storage increases profitability against the cash conversion cycle theory, but in line with the findings of previous studies that indicated the longer time it takes to sell out inventory contributes to increased profitability of companies (boisjoly, conine, & mcdonald, 2020; nwachukwu, odo, & nwachukwu, 2016). this means that having enough storage of inventory can help in the continuity of production and supply in the time of scarcity of raw materials and finished products in the market for unforeseen events which could be political or natural calamities etc. however, a longer stay of inventory in storage can also mean that they are not of the quality needed by the market or customers and competition in the market may be strong if the company does not have an aggressive marketing strategy for its products. the other findings in table 2 in the results section show that inventory management indicates a negligible relationship with profitability. the number of day’s inventory is revealed as having no significant relationship with companies’ profitability from the analysis of the data without moderators, with moderators, and fixed effects regression with components’ lags in table 2. 4.3. the influence of receivables’ management on profitability furthermore, the correlation matrix analysis as reported in the findings section, showed an inverse relationship between acp and profitability measured by the dupont assessment. this suggests that the companies that made a profit observed the reduction of the time they took in collecting cash from credit sales, although in this way the sales volume and profitability are reduced while liquidity is increased. these findings agree with the findings of the previous studies by pais and gama (2015) and yakubu, alhassan, and fuseini (2017) that reducing the days that collection of cash from credit sales takes increases lmcs’ profitability. this further means that more sales are on a cash basis. the implication here is that lmcs can increase their profitability by ensuring that the average collection period is reduced while observing the sales trend to be alerted as and when they can extend reasonable credit sales to increase sales volume to maintain or even increase their customers and company profitability. a very important finding of this study concerning receivables management is the one in table 2. the fixed effect panel regression of working capital variables on profitability indicate a partial inverse significant relationship between average collection period and profitability without observing the effect of administration expenses, marketing expenses, and the historical or previous management decisions and actions in terms of lags effects on the same variable management. the result with lags further means that in a very competitive market or when a new product is introduced into the market, the credit sales in the first year will affect the sales for some following years to increase profitability before the company starts collecting cash to increase liquidity to sustain the business. furthermore, the implication may also be that due to the quality of the product, which could lead to increased selling price, the companies had to practice more credit extension periods as a way of attracting buyers and even increasing sales volume to new customers in 2015. this undertaking could take two years before controls of receivables and their reduction are enacted. this result is supported by the study of demirgüneş (2015) who studied the determinants of target dividend payout ratio and found that historical items related to profitability affect future target dividend payout. demirgüneş's paper suggests that the dividend paid year-to-year depends on the past years' income and even the year-to-year income growth. this is the same as the finding of this study that some companies’ growth in profitability is influenced by the credit sales made in 2015 before they went back to the normal practice of reducing the days of cash collection from credit sales as revealed in the 2018 results. the dynamic model of advertising cost with continuously distributed lags by lutoshkin and yamaltdinova (2018) suggests that companies can plan their current business well by using historical and accumulated information. the above results on lag 3 of the average collection period in 2015 on receivables can be used to make the decision on what to do for the current and future management of debtors. the decision made in 2015 whether to increase the price for the new and better quality product or to offer more credit sales to make the product better known to the market while also trying to increase sales volume for the old product attracting new customers affected the sales by either reducing or increasing the number of buyers and simultaneously increasing receivables and defaulters. this affected the performance of the business in both the past and the current period. 4.4. the influence of payables’ management on profitability according to the results section of this study, table 1 revealed a negative insignificant relationship between the average payment period and profitability, which infers that taking a few days to pay the suppliers is also part of asian journal of economics and empirical research, 2022, 9(2): 73-82 80 © 2022 by the authors; licensee asian online journal publishing group good payables management and this builds up the company’s relationship with its creditors and ensures a continuous supply of materials needed for production. this result is also realized in table 3 with the fixed effects panel regression of data. the results here mean that sometimes taking a short time to pay suppliers increases profitability in the sense that there will be no stoppage of the supply of raw materials hence continuing the flow of sales leading to increased profitability. this finding is also replicated in the studies by asaduzzaman and chowdhury (2014); kasozi (2017) and sathyamoorthi, mapharing, and selinkie (2018) which also revealed app having a negative and significant relationship with profitability. however, the results of this study contradict several reviewed studies that indicated average payment period and profitability having a positive relationship (achode & rotich, 2016; amponsah-kwatiah & asiamah, 2021; kasahun, 2020; yakubu et al., 2017). for these studies, the longer the delay in paying suppliers will result in more free short-term financing facilities for the companies that invested in the business to further increase their profitability. 4.5. the impact of administration expenses as a moderating variable administration expenses are considered in this scholarly work to find out how increased spending on administration and employees in general impact the relationship between working capital management and lmcs’ profitability. according to the results, tanzania breweries and tanzania cigarette companies are making a profit without spending much on their administration because it seems that their products are well known with sufficient customers due to their monopoly position in the market. whether or not they increase their revenues, they are not suffering losses. however, in the long run companies can suffer losses due to poor performance leading to low morale of employees and administration is debased due to low payment or lack of motivation. this seems to be one of the reasons why tatepa has been making losses for several years. according to the results of having low means of administration expenses, the company is not investing enough in its human resource. this reduces the incentive to work efficiently and lowers the performance of the company. 4.6. the impact of marketing expenses as a moderating variable the marketing expenses in this study are considered as a moderating variable to capture the impact it has on the relationship between working capital management and lmcs’ profitability. since marketing is what connects the companies’ products with consumers, marketing expenses were thought of as a vital link between working capital management and company profitability. according to the overall panel regression model results in the findings section in table 3, marketing expenses have a positive and significant relationship with profitability (dupont). the findings section shows marketing expenses moderating effect strongly contributing to strengthening the relationship between receivables management and its lag 3 with profitability. however, it has weakened the relationship between other independent variables and lmcs profitability, although the plausibility of the model has improved from 0.395 previously to 0.5216 meaning that the change in profitability is a dependent variable measured by the dupont assessment explained by the model is improved from 39.5% to 52.16%. this last result implies that in managing current assets and current liabilities, these lmcs need to closely observe what happened in the past and current management of receivables and also increase marketing strategies and remuneration for their employees to continue improving their profitability. the decisions made about receivables management in 2015 contributed to the current year’s influence of receivables management on profitability moderated by admexp and mktexp. 5. conclusion, contribution and recommendations this section brings the summary of the main findings of research based on the six specific objectives of the study, the conclusions, and implications as a result of the study, and the recommendations for improving lmcs’ profitability and further inquiry. 5.1. the influence of cash management on lmcs’ profitability panel data analysis, whether with or without lags, shows that the current cash holding ratio has a significant positive relationship with lmcs’ profitability, but had no significant effect when moderators were introduced. 5.2. the influence of inventory management on lmcs’ profitability the number of day’s inventory has no significant influence on profitability explained by the dupont assessment. 5.3. the influence of receivables management on lmcs’ profitability moderators (administration expenses and marketing expenses) increase the negative impact of current acp on profitability (β = -0.94) at a 0.05 level of significance, while the three years’ lag of acp (l3. acp) has a positive impact on profitability (β = 0.78) at 0.05 level of significance. the negative impact of current acp on profitability implies that decreasing current average days to collect cash from credit sales improves company profitability while the positive impact of acp (l3.acp) on profitability implies that increased days to collect cash over the past three years led to the increase in the current year’s profitability of lmcs. this result implies that decisions about managing receivables made in 2015, or the third year back, had an effect on the current period as far as receivables and cash management is concerned and influenced companies’ profitability. 5.4. the influence of payables management on lmcs’ profitability the study found that the average payment period did not have a significant influence on lmcs’ profitability even when the lags and moderators were introduced. asian journal of economics and empirical research, 2022, 9(2): 73-82 81 © 2022 by the authors; licensee asian online journal publishing group 5.5. the impact of administration and marketing as moderating variables this study revealed that moderators (administration expenses and marketing expenses) increase the negative impact of acp on profitability (β = -0.94) at a 0.05 level of significance, causing the three years’ lag of acp (l3. acp) to have a positive impact on profitability (β = 0.78) at 0.05 level of significance, while each moderator has a positive impact on profitability as indicated by (β = 1.23) and (β = 1.52) respectively at 0.01 level of significance. hence, increasing administration expenses strengthens the negative impact of the average collection period on lmcs’ profitability from 0.1 to 0.05 level of significance. this implies that increasing salaries and other benefits improve workers' morale to collect receivables quickly, which in turn increases company profitability. the current marketing expenses have a significant positive effect on profitability if it is included in the model by increasing the level of significance from 0.1 to 0.05. it implies that spending on marketing of the products contributes to improving the positive impact of receivables management (reducing the number of days that the companies take to collect payment from debtors) and in this way increases company profitability. 5.6. conclusions based on the results of this study, several logical conclusions and implications can be made for the objectives of the study as follows: 5.6.1. the influence of cash management on profitability referring to the evidence from the econometric analysis using correlation matrix, panel multiple regression, and finite distributed lag model, we conclude that observing the previous decisions and procedures used to manage cash can help in improving the current management of the variable and this will contribute to increasing the manufacturing companies’ profitability. the historical information on how cash was managed helps to rectify certain problems that could hinder the growth of the companies’ profitability. 5.6.2. the influence of inventory management on profitability referring to the empirical results, the insignificant negative relationship between the number of days inventory and company profitability also means that reducing the number of days inventory increases companies’ profitability because inventories are moving from storage to sales. 5.6.3. the influence of receivables’ management on profitability the positive impact of the three years’ lags of average collection period (acp) which, in this case is 2015, and each of the moderators indicates that implementing extended credit sales to customers to an acceptable level increased sales volume and profitability in 2015 and also brought a positive effect on the current period and company profitability. additionally, this means that by taking note of the past events on receivables behaviour, management can increase the current company profitability because what happened previously can inform some improvement plans. furthermore, the management can continue to increase the company’s profitability if they improve employees’ well-being including salaries and allowances and other benefits, and also increase necessary spending on marketing of their products as they manage their current capital as this will increase profitability. 5.6.4. the impact of administration expenses as a moderating variable we conclude that administration expenses are a perfect moderator between working capital and listed manufacturing companies’ profitability. this implies that increasing expenditure on administration, raising salaries and other benefits will increase the workers morale, improve working capital management and listed manufacturing companies’ profitability. its introduction contributes to improving the influence of wcm on profitability as indicated by the positive change of the rsquared from 41% to 52.2%. 5.6.5. the impact of marketing expenses as a moderating variable the empirical evidence revealed that marketing expenses perfectly and positively moderate working capital management and listed manufacturing companies’ profitability. this implies that increasing spending on marketing products will make them better known to customers, increase sales volume, and by doing so working capital management will be improved and listed manufacturing companies’ profitability increased. 5.7. contribution of the study the key contributions made by this study to the stock of knowledge are: first, this study has revealed that the lags can be used to explain the lmcs’ profitability in terms of working capital management aspects. the current capital can be improved by using previous information and can help devise improved ways of managing working capital currently and plan well for the future and increase profitability. second, this study contributes to knowledge by showing that working capital management indicate that the three-year lag of average collection period (l3acp) has a positive influence on working capital management and that current administration expenses and current marketing expenses have a significant positive impact on the relationship between working capital management and lmcs’ profitability. this shows that observing administration expenses and dealing with the marketing of products can help lmcs’ improve working capital management and continue increasing profitability. third, this study is the first attempt to investigate the influence of working capital management on profitability of the listed manufacturing companies in tanzania measured by the dupont assessment. using the dupont assessment can help companies to see the total picture of their performance by using the three elements of net profit margin, assets turnover, and equity multiplier. fourth, methodologically, this study contributes to knowledge by examining the influence of working capital management on profitability by using the finite distributed lag model. with this approach, this study revealed that to plan well and improve current working capital management, the company’s past management should be considered. asian journal of economics and empirical research, 2022, 9(2): 73-82 82 © 2022 by the authors; licensee asian online journal publishing group fifth, theoretically, this study contributes to knowledge by synthesizing cash conversion cycle theory, trade credit theory, economic order quantity theory, and consumer demand theory and, therefore, establishes a comprehensive theoretical framework that gives a new holistic analytical way of examining working capital components as determinants of profitability of lmcs. 5.8. recommendations based on the findings of this study, the following are recommendations made. 5.8.1. recommendations for improving manufacturing companies firstly, with cash management, besides maintaining a shorter cash cycle, the financial directors should establish an optimal cash balance to ensure that they don’t overspend. in this way, the companies will have enough cash to meet their recurring obligations. secondly, with inventory management, these listed manufacturing companies should make sure they reduce the number of days that they hold their inventory to increase sales and improve profitability. thirdly, with receivables management, these lmcs should ensure they reduce the number of days taken to collect payments from credit sales after they have made their products known to the market, and they should also observe past decisions that were made in managing receivables to do well in the current receivables’ management in order to increase lmcs’profitability. fourthly, administration and marketing expenses should be observed and increased or reduced whenever necessary to increase employees’ morale, and market the products to ensure increased sales and profitability. references abushammala, s. n., & sulaiman, j. 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(2017). the impact of working capital management on corporate performance: evidence from listed non-financial firms in ghana. european journal of accounting, auditing and finance research, 5(3), 68-75. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 105 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 1, 105-114, 2020 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2020.71.105.114 © 2020 by the authors; licensee asian online journal publishing group perceived macroeconomic factors and stock market capitalization: experience from the nigerian economy perspective suoye igoni1 itotenaan henry ogiri2 lucky orlu3 ( corresponding author) 1department of banking and finance, university of nigeria, nsukka, nigeria. 2postgraduate business school coordinator, gregory university, uturu, nigeria. 3department of economics, rivers state university, port harcourt, nigeria. abstract the interference of perceived macroeconomic variables on stock market performance despite the continuous management of monetary and fiscal policies has raised eyes brow and motivated for this study. the purpose of this study is to examine the magnitude of relationships of the perceived macroeconomic factors and stock market performance during its interface. therefore this study evaluated the prevailing interrelationships between nigerian stock market performance and the perceived macroeconomic factors of exchange rate, external reserves, gross domestic product, inflation rate and interest rate. the data information is sourced from central bank of nigeria statistical bulletin between 1985 and 2014. the augmented dickey fuller, johansen co-integration, and the error correction models were employed. the results of the adf revealed that all variables were stationery at first level differences. the results in johansen co-integration indicate a significant long run relationship between three studied variables that relate with the nigeria stock market performance. further, ecm results reported that gdp remains significant variable that respond to stock market performance positively, while inflation responded negatively, while interest rate and external reserves are shown to responding and adjusting to trends in stock market capitalization. and market capitalization and exchange rate are operating independent of each other. the study concluded that gdp and inflation rate constitute the significant policy variables of interest to manage and promote the desired performance of nigerian stock market. the study recommend for increase of output of goods and services, and adequate management of inflation rate. keywords: macroeconomic variables, stock market capitalization, augmented dickey fuller, johansen co-integration, error correction model, nigeria. jel classification: macroeconomic variables are the perceived factors which include exchange rate, external reserves, gross domestic product, inflation and interest rate. stock market capitalization is activity performance of the stock market. augmented dickey fuller is a tool used to test the data stationary. johansen co-integration is tool adopted to forecast the long run relationship of variables. error correction model is a model employed to test the short run relationships and speed of adjustment. nigeria is the country of study. citation | suoye igoni; itotenaan henry ogiri; lucky orlu (2020). perceived macroeconomic factors and stock market capitalization: experience from the nigerian economy perspective. asian journal of economics and empirical research, 7(1): 105-114. history: received: 20 january 2020 revised: 24 february 2020 accepted: 30 march 2020 published: 14 may 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 106 2. literature review .......................................................................................................................................................................... 106 3. methodology ................................................................................................................................................................................... 108 4. presentation of results and discussion of findings .............................................................................................................. 110 5. discussion of findings .................................................................................................................................................................. 113 6. conclusion ....................................................................................................................................................................................... 113 7. recommendation (s) ..................................................................................................................................................................... 113 references ............................................................................................................................................................................................ 113 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.71.105.114&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1629 https://orcid.org/0000-0003-3749-1563 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1629 https://orcid.org/0000-0003-3749-1563 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1629 https://orcid.org/0000-0003-3749-1563 asian journal of economics and empirical research, 2020, 7(1): 105-114 106 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to existing literature by examining the magnitude of relationships of the perceived macroeconomic factors and stock market performance during its interface. 1. introduction ability of the stock market to accelerate economic activities in emerging market remains important. the stock market no doubt plays a major role of financial intermediation in both developed and developing countries. financial intermediation is a function that links the suppliers of funds to those users of funds. the stock market provides opportunities for long term investment. it thus, offers the investors alternative investment avenues to put their surplus funds. most studies argue that stock market performance is influenced by some macroeconomic variables such as, interest rate, gdp, and inflation among others. ologunde, elumilade, and asaolu (2006) argue that some macroeconomic determinants could have a negative effect on investors’ decision to invest in the stock market. maku and atanda (2010) opine that monetary authorities should set macroeconomic target every budgetary year. the central bank of nigeria over these years has adopted series of policies to stabilize macro economy which affects nigerian stock market performance. this is to aid in achieving output growth, price stability, exchange rate, foreign reserves, employment etc. following series of reforms and policies on macroeconomic variables over these years, it is expected that significant could prevail among the set of macroeconomic variables. mcqueen and roley (1993) as well as järvinen (2000) stated that during depression, a higher unexpected economic growth might indicate the end of recession, which influences stock market positively. alternatively, higher than expected economic growth might bring about fears of overheating the economy, which might prompt monetary authorities to raise interest rates and thus constitute bad news in the stock market. their results were supportive of asymmetric relationships between stock market and macroeconomic factors. the relationship between stock market performance and macroeconomic determinants is well illustrated by miller and modigliani (1961). also, ross (1976) hypothesizes the relationship between stock prices and certain macroeconomic determinants since the fundamental value of stocks equals the expected present value of the firm's future dividends. thus stock price (return) performance is expected to be a product of feature macroeconomic determinants. in this literature; gross domestic product, inflation, and interest rates are considered as key macroeconomic determinants that influence performance of an emerging economy like nigeria. this however, calls for motivation to investigate the interrelationships between real sector and the financial sectors together these macroeconomic variables. the emphasis is to establish extent of support or interference among variables employed. sensitiveness to macroeconomic variables including gdp, inflation, and interest rate contribute a valuable subject in finance and economics. despite the increase of output of goods and services and constant management of macroeconomics variables the stock market performance seems unstable. the issue of stock trading performance in emerging market like nigeria has been a concern to investors. there are serious concerns about the sudden turn of events in both positive and negative direction with respect to the nigerian stock market. the instability of the nigeria stock market tends to be so sharp and it has become difficult for nigerian stock market to stabilize. though several studies have variedly identified this related problem, that poor management of macroeconomic variables and low level of output of goods and services can mere the financial sector activities. the study of osamwonyi and evbayiro-osagie (2012) evaluations indicated interrelationship between macroeconomic variables along with gdp through the employment of the vector error correction model. substantially, onwumere, ibe, okafor, and uche (2012) uphold the demand following hypothesis from economic growth to the financial sector through stock market capitalization. this shows that real sector can only be relied on the activities of the financial sector. largely their study neglected to examine the extent to which these macroeconomic aggregates support or promote economy in the process of output growth. impressively, igoni, onwumere, and ogiri (2020) discovered no significant impact on the nigerian economy performance tracing from digital environments as an indicator of macroeconomic factor. in light of the above, there is an urgent need not only to examine empirical the extent to which these variables support or reinforce each other in light of recent data within nigerian environment. the above key issues constitute the core problem and motivation for this study. this study is therefore aimed to examine the interrelationships prevailing between real sector and the financial sector in nexus of, exchange rate, external reserves, gross domestic product, interest rate inflation rate, stock market performance using recent nigeria data. the findings of this study will contribute significantly and shall be of use for scholars in resolving the prevailing controversy between the real sector and the financial sector together with the macroeconomic variables. and therefore, scholars will see the findings arising from this study as a reasonable addition to the existing body of knowledge. more so, results arising from this study will be used by the general public for awareness and understanding of the functional relationship between economic growth and stock market performance. also, public policy managers including central bank of nigeria, securities and exchange commission in nigeria will find this useful in the formulation, management and/or reviews of monetary and capital market policies. finally, industry practitioners such as bankers, investors, market/financial players and makers will find this study significant as it will expose the risk from the macroeconomic variables. the study period is between 1985 and 2014 of the central bank of nigeria data of various issues. the obvious limitation arises from the fact that stock exchange fact books, publication started in 1985, which makes it difficult to obtain data on stock market capitalization before this period while data on other study variables are available. in that circumstance therefore, the results of this study would have improved a bit if the data covered earlier periods. 2. literature review economic theory postulates that gdp, inflation, and interest rates as well as other macroeconomic indicators constitute valuable determinants or predictors of stock market performance. however, several schools of thoughts have offered theoretical explanations for stock market performance. prominent among the theories is arbitrage asian journal of economics and empirical research, 2020, 7(1): 105-114 107 © 2020 by the authors; licensee asian online journal publishing group pricing theory. the arbitrage pricing theory approach tries to explain the performance of stock market by positing that behavior of the stock market is influenced by some macroeconomic variables. the theory takes into account systematic factors common across all class of assets. the idea behind this theory is that stock market performances are generated by a number of common factors, for which different securities have different sensitivities in the market. the theory asserts that stock market performance is influenced by several independent factors. the central thesis of apt is that more than one systematic factor affects long-term average performance in the stock market. however, the problem with this is that the theory in itself provides no indication of what these factors are, so they need to be empirically determined. by implication, the theory itself does not tell the investor what these factors are. arbitrage pricing theory directly relates value of the security to fundamental macroeconomic factors driving it and by extension, measures the performance of market. existing literature suggests that a wide range of macroeconomic factors may be relevant. however in emerging stock markets, there is argument that not all of these macroeconomic factors are either relevant or appropriate, bilson, brailsford, and hooper (2000). the main empirical strength of the apt is that it permits the researcher to select whatever macroeconomic factors that provides theoretical explanation for particular sample at hand, greenewold and fraser (1997). sharpe (1984) argues that good investment managers identify important factors in the economy and market place and assess the extent to which different securities will respond to changes in those factors. there is no reason to assume or believe that a good factor for one period will be a better one for the next period. so do risk and prices which are associated with various factors as well as also the sensitivities of securities to those factors. extensive research has shown that more than four factors are relevant; cho, elton, and gruber (1984) contend that the number of stocks in the market or portfolios determines number of factors which are important (dhrymes, friend, & gultekin, 1984). the behavioral school of finance holds that market might fail to reflect, economic fundamentals under three conditions. when all three apply, the theory predicts that pricing biases in financial markets can be both significant and persistent. the first condition is irrational behavior. it holds that investors behave irrationally when they don’t correctly process all available information while forming their expectations of company’s future performance. second is systematic patterns behavior, which holds that even if individual investors decide to buy or sell without observing economic fundamentals, the impact on share prices would be limited. various scholars have evaluated the existing determinants of stock prices. the relationship between macroeconomic variables and stock market performance has necessitated divergent opinions among scholars macroeconomic variables are relied upon to explain the price of stock. in a claimed by erdogan and ozlale (2005) that stock market performance influences economic growth in turkey. gan, lee, yong, and zhang (2006) evaluate the relationship between new zealand stock market performance and seven macroeconomic variables between 1990 and 2003. johansen multivariate co-integration and grangercausality test were employed. the results demonstrated significant long term relationship between macroeconomic variables and on new zealand's stock market performance. however, the granger causality test results show that the stock market does not promote the macroeconomic variables. padhan (2007) investigates the relationship between economic growth and stock market performance in india between 1991 and 2005. johansen multivariate co-integration and granger causality test were applied. the results indicate significant long run and causality relationships between the variables of study. ahmed (2008) after employment of granger causality test as well as johansen's co-integration to study relationship between some macroeconomic variables and stock market in india, the results confirm prevalence of significant long run relationship between gdp and stock market performance. rahman, sidek, and tafri (2009) results indicated significant relationships between industrial production and stock market performance, while insignificant relationships prevail in interest rate of malaysian. ali, rehman, yilmaz, khan, and afzal (2010) explored the causal relationship between macroeconomic pointers and stock market prices in pakistan. data was extracted from bureau of statistics covering the period 1990 and 2008. the macroeconomic indicators were. the tests show no significant interrelationships were found between inflation, gdp and stock market performance. ozlen and ergun (2012) set out to evaluate the impacts of selected macroeconomic variables on stock market performance. employed macroeconomic variables included inflation, exchange rate, interest rate, and unemployment rate in stock market of 45 organizations. ardl (auto regressive distribution lag bound) technique was employed on data over the period 2005 to 2012. the results indicate that interest rates and exchange rates significantly influence market performance. abdulrasheed (2013) evaluated the nature of causal relationship between stock market performance and external trade in nigeria using monthly data over the period 2001 to 2011; however no significant relationships were detected. again, naik (2013) employed five macroeconomic variables; industrial production, inflation, money supply and interest rate to examine stock market performance in india. johansen’s co-integration and error correction models were employed. the results provide compelling evidenced of statically significant long run relationship between gdp and market capitalization was statistically significant effect. aweda, olusegun, and taofik (2014) utilized error correction model (ecm) and johansen's co-integration to evaluate the nature of long run relationship between macroeconomic variables and stock market performance in the usa. index of industrial production, interest rate, trade rates, consumer price index, unemployment rate and money supply were employed as macroeconomic aggregates. index of industrial production and interest rate were observed to have significant influence over stock market performance. teker and alp (2014) studied the relationship between interest rate and stock market performance in four emerging markets of turkey, brazil, china and hungary. the augmented dickey-fuller (adf) and phillips-person (pp) unit root tests were utilized to evaluate stationary of data variables. the results indicate that hungary markets demonstrated significant relationship between stock market and interest rate, while chinese markets indicate a lower support. further, the results provide evidence to show that every other stock market performance granger cause treasury bill rates. onneetse and khaufelo (2014) analyze the nature of long run relationship between macroeconomic variables in botswana stock market performance. the study employs error correction model and johansen's co-integration to examine quarterly information from period 1998 to 2012. the study utilized gdp, long-term loan costs, money supply, external reserves, inflation and exchange rate. the results demonstrate that the selected macroeconomic variables asian journal of economics and empirical research, 2020, 7(1): 105-114 108 © 2020 by the authors; licensee asian online journal publishing group significantly influence stock market performance in botswana. pooja (2014) examined the relationship between macroeconomic variables and indian stock market. granger causality test was employed to determine the nature of causal relationship among the variables of study based on monthly data over the period 2011 to 2012. the macroeconomic indicators include index of industrial production, money supply, interest rate, remote institutional speculation, exchange rate, unrefined petroleum cost and gold cost. the results indicate that index of industrial production significantly promotes indian stock market performance. in the same (vanita & seth, 2014) evaluated the relationship between stock market performance and selected macroeconomic variables in india. monthly information from 1997 to 2011 was secured for the macroeconomic variables. they include exchange rate, index for industrial production (iip), interest rate, money supply and oil price. the study employed adf and pp unit root tests, regression, arch model, granger causality and johansen co-integration tests to evaluate the data. inflation and exchange rates were found as significant variables on the performance of the stock market. amarasinhe and amarasinhe (2015) explored the dynamic relationship between interest rate and stock market performance in sri lanka. time series data for the period 2007 to 2013 was utilized in the study. additionally, all share price index (aspi) in colombo stock exchange was employed as indicator of market performance. the augmented dickey fuller test was utilized to determined stationary of the data while the granger causality test was employed to ascertain the extent to which the study variables support or promote themselves. the results indicate a unidirectional causality with causality flowing from interest rates to stock market performance. mutuku and ng’eny (2015) results discovered positive relationships between stock market and gdp, exchange rate, and treasury bills. the results provide significant evidence to assert the prevalence of significant relationships between the variables of study. mahmoud, elgazzar, and hanafy (2016) findings show a significant relationship in egypt between stock market performance and interest rate, while for tunisia stock market performance has no significant relationship with the consumer price index. kofie and ansah (2018) examine a study of the effect of inflation and exchange rate on stock market returns in ghana between january 2000 and december 2013 on a co-integration and error correction model tests. the results indicate the existence of significant long-run relationships between the ghana stock market, exchange rate, and inflation rate. further lee and brahmasrene (2018) evaluated the dynamical relationship between macroeconomic variables and stock prices in korea from1986 to october 2016 with interest on the exchange rate, money supply, industrial production, and inflation. the johansen co-integration and vector error correction model (vecm) initiated results indicated a long-run relationship between macroeconomic variables and stock prices of korea, while interest rate was not significantly related to stock market prices. however, external shocks did not constitute factors that affect the market in the study. more so, megaravalli and sampagnaro (2018) studied macroeconomic indicators and its impact on markets in asian; that includes india, china, and japan from january 2008 to november 2016 being monthly information. the co-integration and granger causality tests for analysis results show positive long-run relationships effects on stock market performance. also, mubarik and javid (2018) inspected the impact of macroeconomic volatility on stock market price changes in pakistan with employment of industrial production, inter-bank rate, interest rate, money supply, exchange rate and stock market price from july 1998 to june 2014. the results of auto-regression show significant volatility among employed macroeconomic variables except interest rate. meanwhile, tsaurai (2018) questioned the determinants of emerging market in argentina, brazil, colombia, mexico, peru, czech republic, greece, poland, portugal, russia, turkey, china, hong kong, indonesia, india, malaysia, philippines, republic of korea, thailand, singapore and south africa. the study adopts fdi, economic growth, infrastructural development, savings, inflations, trade openness, exchange rate, banking sector development and stock market liquidity. the results reveal relationships among adopted variables. and aldukhail (2019) measured the effect of macroeconomic variables on saudi stock market between 1997 and 2017 with employment of gdp, interest rate, and inflation rate as macroeconomic variables on saudi stock market price, shares value and traded shares. the analysis was carried out using ardl model and the results show no significant impact in the short run but statistically influence during long run. again, aryasta and artini (2019) account for the effects of macroeconomic indicators and global stock index on composite stock market price in indonesia with application of gross domestic product, exchange rate, inflation, interest rate, dow jones index, bse sensex index and shanghai index on composite stock index from the period january 2010 to december 2018. the multiple linear regression analysis technique application results indicated gdp, exchange rate, shanghai index significantly and positive affect stock market price. whereas inflation and interest rate were negatively affect stock prices in indonesia. thrust, bassar (2019) analyses the effect of sharia stock trading activity factors and macroeconomic variables performance in indonesia capital market. the study uses the capital asset pricing model capm) and the arbitrage pricing theory (apt). variables employs includes interest rate, inflation rate, exchange rate, market capitalization and trade volume between january 2014 and december 2018, and the results reveal existence of relationships between interest rate, exchange rate and stock market. however the above literature needs caution as majority of these studies have indicated just a little departure and mixture which this study tends solve that will contribute to existing body of knowledge. however, this interpretation from interrelationships between the real sector and the financial sector can be explained by stock market performance and gdp growth as well as selected macroeconomic variables. 3. methodology the design for this study is on country-specific. based on this, the ex-post facto research design is found useful for the study. as claimed by onwumere. (2009) that ex-post facto research design is fit for a work that quasiexperimental. originally, it is an attempt to expose the relationship between real sector and financial sector through macroeconomic and stock market capitalization in nigeria. this novelty adds in its design architecture, the econometric/analytical design to compliment the ex-post facto design. asian journal of economics and empirical research, 2020, 7(1): 105-114 109 © 2020 by the authors; licensee asian online journal publishing group the data sets for empirical estimation in this study have two major properties. firstly, the data is secondary. secondly, they are time series. time series are data sets that follow regular time-frequency. in this work, annualized data are used in the case of both the dependent and explanatory variables. in terms of sources, we extract our data from the central bank of nigeria fact books of various issues. as measurement necessities demand, some of the series may be transformed to add their goodness for the aim of study. this study covers the nigeria environment with particular focus on selected macroeconomic variables: exchange rate, external reserve, inflation, interest rate, gross domestic product and stock market capitalization as indicators of real sectors and financial sectors. it can arguably be said that the sets of data are in annualized form from 1985 to 2014. the theoretical leaning of this study is the arbitrage pricing theory (apt) as espoused by ross (1976). the theory takes into account systematic factors common across all class of assets. the idea behind this theory is that stock market performances are generated by several common factors, for which different securities have different sensitivities in the market. the central idea of apt is that more than one systematic factor affects long-term average performance in the stock market. the theory in itself provides relevant macroeconomic variables that include; exchange rate, external reserves, gross domestic product, inflation, and interest rate so they need to be empirically determined. expressing the apt functionally appears thus: ( ) (1) equation 1 above explained according to apt that macroeconomic variables influence the stock market performance. taking smp to be stock market performance indicators and environmental factors to be macroeconomic indicators such as interest rate, inflation rate, money supply and economic growth rate and stock market indicators to be all share index and market capitalization, we empirically estimate two functional relationships as follows: ( ) ( ) equation 2 explains that exchange rate, external reserves, gross domestic product, inflation, and interest rates are perceived macroeconomic factors that may influence stock market performance. from the theoretical standpoint, this study is designed to prove the reality or otherwise of the apt using variables from nigeria. generally, the regression form, following neter, wasseraman, and kutner (1989) equation 1 and 2 can be rewritten in econometric form, thus: ( ) where all the variables are as stated above and = the constant (the value of the dependent variable when all the repressors are at zero); are coefficient of the independent variables and is the noise or error term. the model's variable of this study is stock market capitalization as a broad dependent variable that is being symbiotically disclosed in macroeconomic variables and real sector of exchange rate, external reserves, gdp, inflation, and interest rates as independent variables. they serve as the explanatory variables for financial sector; stock market capitalization. the estimation process for this study follows the error correction model estimations, test of hypothesis and diagnostic/reliability tests including correlation matrix analysis. these sets of tests are designed to validate the goodness of the data sets for unit root stationary of the variables. the traditional augmented (dickey & fuller, 1976) test is adopted to show the unit root properties of the series following equation specified. δyt= β1 + β2 + β3+ β4 + β5 + δyt-1 + αi  m t 1 δyt-1 + εt (4) this equation indicates that all variables employed are subject unit root test to avoid spurious data during analysis. where the test is for: lag selection will be based on the bayesian criterion generated automatically by the estimation software following the form of equation 5: ( ) ( ̂) ( ) where: n represents either the sample size, the number of observations, or the number of data points in x. k represents free parameters to be estimated. ̂ represents the maximized value of the likelihood function for the estimated model m given as ̂= ( ̌ ) 3.1. long run and co-integration test (bound test) in this study we shall also carry out the long run test and error correction representation following the ordinary least square ols framework. the procedure as prescribed by pesaran, shin, and smith (2001) sets two critical values namely lower and the upper bound, and the decision guide is contained in table 1 below: table-1. decision rules for the bound tests process. state inference remark f stat is more than upper bound reject the null hypothesis a co-integrating relationship exists f stat less than the lower and upper bound refuse to reject null hypothesis no co-integrating relationship exists f stat at the chosen level of significance falls within the lower and upper bound inconclusive finding results is indecisive 3.2. error correction representation after establishing a possible short-term run relationship through the error correction model will be used to test the speed of adjustment of monetary policy to the shocks emanating from the digital currency. this will follow the form specified below: asian journal of economics and empirical research, 2020, 7(1): 105-114 110 © 2020 by the authors; licensee asian online journal publishing group for the model mcap as the dependent variable: ∑ ∑ ∑ ∑ ∑ ∑ ( ) equation 6 above denotes how variables will be responding to speed of adjustment. all the variables are discussed above with combined modeling of the short-run coefficients in the error correction framework. 3.3. priori expectorations the priori expectations are derived from underlying theoretical relationships been the dependence and each of the employed explanatory variables. these are presented as follows; exchange rate: an appreciation in the exchange rate of the naira would translate to a stronger value of the naira and consequently, on the economy thereby, directly boosting stock market performance. accordingly, the sensitivity of stock market performance to improvements in exchange rate is expected to be greater than zero, i.e. external reserves: increases in external reserves indicate higher economic performance which transmits directly to stock market performance. hence, a sensitivity of greater than zero for stock market performance with respect to external reserves i.e. gross domestic product: fundamentally, a rise in gross domestic product would imply enhanced business opportunities which directly raise stock market. investments and performance, thereby, yielding a sensitivity greater than zero with respect to gdp, i.e. inflation rate: inflation would reduce the real value of money by inducing higher prices. in this respect economic units would save less and consume an increased proportion of their earned income. this invariably reduces investment thereby, stock market performance. in that sense, a sensitivity of less than zero is expected. i.e. interest rate: an increase in interest rate implies higher cost of funds. this will invariably increase investors expected returns from investments since it implies a higher capitalization rate. higher interest rate would invariably induce economic units to save more which would be mobilized for investment thereby, inducing higher activities in the stock market. accordingly, i.e. is expected to be more than zero, all the variables are discussed above with a combined modeling of the short run and long run coefficients in the error correction framework. therefore the summary of priori expectations from the models tests of the hypotheses are given as follows: ( ) the equation above explains the expected position of a variable in the results if it happens to increase. therefore the priori expectation with regards to this will be thus: , , , , while to ensure that estimates are valid, efficient and unbiased inferences in this study, the diagnostic test contained in table 2 below shall be adopted. table-2. summary of adopted diagnostic tests. s/no test name test function decision rule 1. coefficient of correlation (r2) to measure the goodness of fit of the model the higher the r2 the better the fit 2. f-statistics to test the significance of the overall regression the p-value of f-stat less than 0.05 suggests that the model is good enough for analyses/inferences. 3. durbin watson statistics to measure the first-order autocorrelation dw approximately 2 shows evidence against the first-order autocorrelation. inferences in this study shall be made based on the outcome of the estimation approaches as well as conclusions drawn based on the tested hypotheses. the choice level of significance for all tests shall be the 0.05 or 5% level. all estimations shall be done using version 9 of the e-views estimation software. 4. presentation of results and discussion of findings 4.1. presentation of data the base data for this study is presented in the table 3. 4.2. adf unit root test results the results of the unit root test are presented in table 4. 4.3. adf data analysis in the above, the results of augmented dickey-fuller (adf) test statistics indicate that all variables became stationary at first difference. adf-test statistic -5.090450, -5.606112, -4.850510, -6.5645842, -6.009562, and 7.809319 are greater than the respective critical level values of -2.671853, -3.711457, -3.788030, -3.788030, 3.699871,-3.689194. besides, the respective probability values of 0.0003, 0.0001, 0.0010, 0.0000, 0.0000 and 0.0000 asian journal of economics and empirical research, 2020, 7(1): 105-114 111 © 2020 by the authors; licensee asian online journal publishing group are all less than 0.05 significance level, therefore the study refuses to accept the alternate hypothesis that there are unit roots. so the data are free from spurious and can be used for analysis. table-3. data of market capitalization (mcapr), exchange rate (exchr), external reserves (extrr), gross domestic product (gdpr), inflation rate (inflr) and interest rate (intr) for the period 1985 to 2014. year mcapr exchr extrr gdpr inflr intr 1985 0.17 0.89 0.25 11.33 1.0 8.50 1986 0.03 2.02 0.56 1.89 13.7 8.50 1987 0.17 4.02 0.22 -0.69 9.7 11.75 1988 0.18 4.54 -0.39 7.58 61.2 11.75 1989 0.22 7.39 0.75 7.15 44.7 17.50 1990 9.21 8.04 0.62 11.36 3.6 17.50 1991 0.29 9.91 0.21 0.01 23.0 15.00 1992 0.26 17.30 -0.02 2.63 48.8 21.00 1993 0.34 22.05 -0.35 1.56 61.3 26.90 1994 0.28 21.89 0.05 0.78 76.8 12.50 1995 0.63 21.89 0.20 2.15 51.6 12.50 1996 0.37 21.89 0.77 4.13 14.3 12.25 1997 -0.01 21.89 -0.01 2.89 10.2 12.00 1998 -0.07 21.89 -0.11 2.82 11.9 12.95 1999 0.12 92.69 0.68 1.19 0.2 17.00 2000 0.36 102.11 0.34 4.89 14.5 12.00 2001 0.29 111.94 0.34 4.72 16.5 12.95 2002 0.13 120.97 -0.17 4.63 12.2 18.88 2003 0.44 129.36 0.05 9.57 23.8 15.02 2004 0.36 133.50 0.57 6.58 10.0 14.21 2005 0.27 132.15 0.57 6.51 11.6 7.00 2006 0.43 128.65 0.33 6.03 8.5 8.80 2007 0.61 125.83 0.34 6.45 6.6 6.91 2008 -0.38 118.57 0.15 5.98 15.1 7.03 2009 -0.36 148.88 0.11 6.96 13.9 3.72 2010 0.29 150.30 -0.12 7.98 11.8 5.60 2011 0.03 153.86 0.07 7.43 10.3 11.16 2012 0.31 157.50 0.21 6.58 12.0 11.70 2013 0.22 157.31 0.17 6.89 8.0 10.75 2014 0.22 158.55 -0.10 6.89 8.0 10.70 table-4. adf unit root test. differenced variable adf-test statistic test of critical level order of integration probability value 1% 5% 10% d(exchr) -5.090450 -3.689194 -2.671853 -2.625121 1(1) 0.0003 d(extrr) -5.606112 -3.711457 -2.981038 -2.629906 1(1) 0.0001 d(inflr) -4.850510 -3.788030 -3.012363 -2.646119 1(1) 0.0010 d(intr) -6.5645842 -3.788030 -3.012363 -2.616119 1(1) 0.0000 d(mcapr) -6.009562 -3.699871 -2.976263 -2.627420 1(1) 0.0000 d(gdpr) -7.809319 -3.689194 -2.971853 -2.625121 1(1) 0.0000 the results of the correlation analysis is presented in table 5. table-5. correlation matrix analysis output of exchange rate (exchr), external reserves (extrr), inflation rate (inflr), interest rate (intr), market capitalization (mcapr) and gross domestic product (gdpr) for nigeria over the period of 1985 to 2014. variables exchr extrr inflr intr mcapr gdpr exchr 1 -0.053469478 -0.446845807 -0.390833145 -0.209405237 0.38683087 extrr -0.053469478 1 -0.377272145 -0.12755703 0.270097992 0.069067095 inflr -0.446845807 -0.377272145 1 0.422967866 -0.129224579 -0.322933789 intr -0.390833145 -0.12755703 0.422967866 1 0.228015639 -0.295249342 mcapr -0.209405237 0.270097992 -0.129224579 0.228015639 1 0.369127507 gdpr 0.38683087 0.069067095 -0.322933789 -0.295249342 0.369127507 1 4.4. correlation matrix data analysis the results of correlation analysis as presented in table 5 above shows that the highest correlation coefficient (measure of association) between the variables is 0.4468. therefore the results of correlation matrix in table 5 indicate the absence of any significant multicollinearity issues. 4.5. co-integration test results the results of johansen’s co-integration are shown in table 6: asian journal of economics and empirical research, 2020, 7(1): 105-114 112 © 2020 by the authors; licensee asian online journal publishing group table-6. results of co-integration test (johansen co-integration). hypothesized trace 0.05 probability no. of ce(s) eigenvalue statistic critical value prob.** none * 0.978604 198.1517 95.75366 0.0000 at most 1 * 0.743022 94.34908 69.81889 0.0002 at most 2 * 0.668601 57.66242 47.85613 0.0046 at most 3 0.541808 27.84275 29.79707 0.0827 at most 4 0.197646 6.770138 15.49471 0.6045 at most 5 0.030079 0.824586 3.841466 0.3638 trace test indicates 3 co-integrating e.q(s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level ** denotes prob. level the co-integration results presented in table 6 above indicate that there are three co-integrating equations. therefore, there is a significant relationship between the study variables. this is for fact the trace statistics of 198.1515, 94.34908 and 57.66242 are less than the corresponding critical values of 95.75366, 69.81889, and 47.85613 at 5% significance level, respectively. besides there exist probability values of 0.0000, 0.0002 and 0.0046 less than 0.05 significance level. 4.6. error correction test results the results of the error correction estimates are shown in table 7: table-7. output of error correction model. error correction model. dependent variable: d(mcapr). variable coefficient std. error t-statistic prob. c -0.173742 0.311942 -0.556969 0.5834 d(exchr) 0.009153 0.021795 0.419945 0.6788 d(extrr) -0.840929 0.824750 -1.019617 0.3195 d(gdpr) 0.525927 0.102378 5.137102 0.0000 d(inflr) -0.078452 0.018600 -4.217784 0.0004 d(intr) -0.003958 0.068653 -0.057654 0.9546 ecm(-1) -0.007913 0.207020 -0.038224 0.9699 r-squared 0.711477 mean dependent var 0.006786 adjusted r-squared 0.629042 s.d. dependent var 2.454062 s.e. of regression 1.494679 akaike info criterion 3.854018 sum squared resid 46.91536 schwarz criterion 4.187069 log likelihood -46.95625 hannan-quinn criter. 3.955835 f-statistic 8.630759 durbin-watson stat 1.921856 prob(f-statistic) 0.000084 this section presents the error correction model (ecm). in the above table, the result of -0.556969 values in respect to t-statistic is less than 2, and show sufficient evidence against the alternate hypothesis and is negative. the measurement of the goodness of fit in the model from the above results in the table, show a coefficient of correlation r2 value of (0.7114)2 0.7114 * 100 translating to 71.14% is strong and fit, as it is above 50%. it indicates that the model is good enough and has the power to predict the variables used. the 28.86% variation may be can explain by independent variables or other exogenous factors not captured in 1985 and 2014 during the short run respectively. in all the long run increase effect of shocks will be neutralized by the passage of time, since there are trace test that indicates 3 co-integrating equations at the 0.05 levels significance. it could be as a reason for balancing the variables in the equations and other variables not captured that were denote as an error term. the adjusted r2 (0.6290) 2 0.6290 * 100 translating to 62.90%. this implies the addition of more explanatory variables r2 is expected to reduce. while the result of s.e regression 1.494679 indicates the summary measurement base on the estimated variable of the residuals. the value of the log likelihood 46.95625 displayed the difference between restricted and unrestricted version 10 of the e-views soft wear. to test the significance of the overall regression, the study used the results of the probability f-statistic value of 0.000084 is less 0.05 in the table which suggest that the explanatory variables are significant enough to explain the outcome significance of the study. the sd dependent variable value of 2.454062 shows deviation from the average 0.006786. this suggested that 1% increase in stock market capitalization will bring about 0.65% of the explanatory variables. the akaike, schwarz and hannan-quinn criterion values of 3.854018, 4.187069, and 3.955835 respectively are relatively low as it is been use to choose the competing models. besides the lower the value is better. the durbin-watson stat results of 1.921856 revealed no evidence of the first-order autocorrelation as the value is approximately 2 and within the range. the coefficient results reveal that the market capitalization -0.173742 exerts negatively with exchr, (0.009153) exter, (-0.840929) gdpr, (0.525927) inflr, (-0.078452) and intr (-0.003958) although there is no significance in exchr, exter, and intr, while significance existed in gdpr and inflr. on the other hand gdpr and inflr responded positively and significantly to stock market capitalization performance. further, exchr responded positively and not significant to stock market capitalization, while exter and intr responded negatively and insignificant to stock market capitalization. 4.7. tests of hypotheses having performed the analysis, we proceeded to test the hypotheses of the priori formulated in section 3. to facilitate hypotheses testing, the hypotheses are re-stated in both their null and alternate forms below: asian journal of economics and empirical research, 2020, 7(1): 105-114 113 © 2020 by the authors; licensee asian online journal publishing group 4.8. test of hypothesis one the null and alternate versions of hypothesis three are stated as follows: (co-integration) ho1: there is no significant long run relationship between stock market capitalization and the set of exchange rate, external reserves, gross domestic product, inflation rate and interest rate in nigeria. ha1: there is a significant long run relationship between stock market capitalization and the set of exchange rate, external reserves, gross domestic product, inflation rate and interest rate in nigeria. table 6 above shows that the prevailing co-integrating equations are significance at 0.05 levels. since this prevails, we reject the null hypothesis of no significant long run relationship and accept alternate hypothesis that there exists a significant long run relationship among the set of study variables. 4.9. test of hypothesis two the null and alternate versions of hypothesis two are stated as follows: (ecm) ho2: there is no significant long run relationship between stock market capitalization and each of exchange rate, external reserves, gross domestic product, inflation rate and interest rate in nigeria. ha2: there is a significant long run relationship between stock market capitalization and each of exchange rate, external reserves, gross domestic product, inflation rate and interest rate in nigeria. from table 7, going by the probability values there is a significant long run relationship between stock market capitalization and each of gdp and inflation rate, while there is no significant between stock market capitalization and each of exchange rate, external reserves and interest rate. consequently, the null hypothesis is rejected in respect of gdp and inflation rate and the alternate hypothesis accepted in respect of exchange rate, external reserves, and interest rate with the hypothesis correspondingly rejected. 5. discussion of findings this study empirically, examined the interrelationship prevailing between stock market capitalization as a measure of performance and perceived macroeconomic factors namely exchange (exchr), external reserves (extrr), inflation (infr), interest rates (intr) and gross domestic product (gdpr). the results indicate a significant long run relationship between 3 variables that relate with the performance of nigeria stock market. further, ecm results reported that gdp remains significant variable that respond to stock market performance positively, while inflation responded negatively in a significant manner to stock market performance. more so, interest rate, external reserves and inflation are shown to responding and adjusting to trends in stock market capitalization while market capitalization and exchange rate are operating independent of each other. implications of the results in interest rate, external reserves and inflation could be that the monetary authorities are mismatching monetary policies management. these results reveal that nigerian output of goods and service grows the financial sector but in the short and in the long runs. 6. conclusion this study empirically, examines the interrelationships between macroeconomic determinants of external reserves, gdp, exchange, inflation, interest rates and stock market capitalization in nigeria. it is proceeds determine the extent to which these key macroeconomic variables promote and /or support the growth of nigeria stock market. while the short run regression analysis indicate a significant relationship between stock market performance and gross domestic product, the long run analysis indicate that the study variables are co-integrated and significantly related in the long run. in the short run however, the ecm results indicate that only gdp and inflation rate have significant relationship with the stock market capitalization while all the variables explain only 71.14% of the variations in market capitalization in the long run. the difference being about 28.86% are explained from factors not captured in the study. hence, it is attributed to error terms in equation 3 above. from above, it is concluded that gross domestic product and inflation rate constitute the significant policy variables of interest to promote and manage the desired performance of nigeria stock market. at the same time, interest rate is depicted as purely promoted by stock market performance and constitutes a derived effect. thrust, stock market performance in nigeria appears to be independent of exchange rate and external reserves performance and as such, cannot be influence by each other. a glaring contribution of this study to knowledge remains the empirical evidence on the extent to which stock market performance/operations promote interest rate movements which is not traced in other studies. recognition of stock market performance in the management of interest rate policies therefore, remains vital and compelling. 7. recommendation (s) in this light, the following recommendations are made: i.) inflation rate management should be employed as a measure for improved stock market performance in nigeria. ii.) 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(2014). stock market performance and macroeconomic factors: the study of indian equity market. global business review, 15(2), 291-316.available at: https://doi.org/10.1177/0972150914523599. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 25 © 2019 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 1, 25-35, 2020 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2020.71.25.35 © 2020 by the authors; licensee asian online journal publishing group development aid and human capital development in nigeria: a sector levelanalysis iyabo adeola olanrele1 segun subair awode2 ( corresponding author) 1,2economic and business policy department, nigerian institute of social and economic research, ibadan, nigeria. abstract developing countries are generally faced with financial gap and budget constraints, and as such are dependent on aids to meet basic social and economic responsibilities. however, there are increasing concerns regarding the effectiveness of aid in developing countries, owing to worsening social and economic outcomes despite the huge amount of aid received from donor countries and institutions. this study therefore examines the effects of sector specific aid such as: health aid and education aid on life expectancy and primary school enrolment rate respectively in nigeria, controlling for the influence of government expenditures on health and education. the autoregressive distributed lag (ardl) model was adopted with annual data from 1981 to 2017. findings revealed that health aid is beneficial as it significantly increases life expectancy by about 0.03%. recurrent expenditure complemented health aid by increasing life expectancy by 0.03%. however, education aid is detrimental to primary school enrolment as it reduces the rate by 0.07%. thus, it is concluded that education aid have not had the desired impact on education in nigeria. keywords: development aid, human capital development, government expenditures, life expectancy, primary school enrolment, ardl, nigeria. jel classification: c10, f35, h50, h51, h52. citation | iyabo adeola olanrele; segun subair awode (2020). development aid and human capital development in nigeria: a sector level-analysis. asian journal of economics and empirical research, 7(1): 25-35. history: received: 19 november 2019 revised: 23 december 2019 accepted: 28 january 2020 published: 26 february 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: both authors wish to acknowledge previous authors and scholars whose works were found useful to the study. authors also thank the central bank of nigeria, the world bank and the organisation for economic cooperation and development whose databases were consulted to source the data used for the empirical analyses. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 26 2. stylized facts on development aid and its effectiveness on human capital indicators................................................. 27 3. methodology and data ................................................................................................................................................................... 29 4. empirical results and discussion ................................................................................................................................................ 31 5. conclusion ......................................................................................................................................................................................... 34 references .............................................................................................................................................................................................. 34 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.71.25.35&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1355 https://orcid.org/0000-0001-7498-8961 https://orcid.org/0000-0003-3793-1805 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1355 https://orcid.org/0000-0001-7498-8961 https://orcid.org/0000-0003-3793-1805 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1355 https://orcid.org/0000-0001-7498-8961 https://orcid.org/0000-0003-3793-1805 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1355 https://orcid.org/0000-0001-7498-8961 https://orcid.org/0000-0003-3793-1805 asian journal of economics and empirical research, 2020, 7(1): 25-35 26 © 2019 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this paper contributes to the literature by examining the impact of specific aid to the health and education sectors on life expectancy and primary school enrolment in nigeria, rather than on overall economic growth which has been the focus of most studies on aid effectiveness in nigeria. 1. introduction the financial gap/budget constraints made development aid indispensable in developing countries. official development aid (oda) for development is meant to augment financial and technical assistance for social and economic development. aid is expected to help less developed countries out of deep-rooted problems of under development. the development benefits accrue through improved and high human development, a healthier society, and a higher standard of living. nigeria ranked one among the top ten aid recipients in africa. on the average, net official development assistance (oda) from all donors received in nigeria grew from us$ 301 million in the period 1970-97 to us$ 2162 million in 2010-16. in 48 years period (1970-2016), 4.5 per cent share of oda from all donors came to nigeria. commitment to the social sector was us$ 1947 million in the period 2016. using social indicator of education, nigeria ranked fifth among the top ten oda recipients in africa in 2016. the total commitment of us$ 209 million was made to education. in the health sector, the country ranked first, with a total of us$ 935 million received in the same period. despite this huge assistance, there are growing concerns over the performance of key human capital development indicators of health and education. education indicator measured by adult literacy revealed an average of 53.8 per cent literacy rate in the period 1991 to 2008. this translates to an illiteracy rate of above 40 per cent, which is phenomenal in a country with one of the largest education oda received in africa. although school enrolment has increased over time, basic enrolment in primary education shows a net value of about 63 per cent with a record of highest number of out of school children, which stood at 10.5 million. access to basic health facilities like the primary health care facilities (phf) remained a daunting challenge with long-term foreign finance in the country. nigeria’s ranking as the highest recipient of health oda in africa did not make a significant dent on key health indices like the infant mortality caused mostly by avoidable diseases like polio, measles, and malaria. the escalating incidence of maternal mortality equally cast aspersion on the effectiveness of oda in spite of its growing magnitude, with a huge impact on average life expectancy rate in the country. for instance, from 289 per 100,000 persons in 2013, maternal mortality rose to 576 in 2013 (wdi, 2017). further, the country has one of the highest records of under-five child mortality rate, after india and pakistan. evidence in nigeria indicates 100 under-five mortality per 1000 live births, a situation at variance with foreign donors spending on health. various findings have emerged from analysing the effects of oda on development. in specific terms, attention is paid to the literature addressing the role of aid in reducing the infant mortality rate. a study by kotsadam, østby, rustad, tollefsen, and urdal (2018) empirically established that geographical proximity to active aid projects reduces infant mortality in nigeria, especially among the less privileged group. the study adopted a subnational approach to oda-infant mortality relationship. also, evidence abounds that countries with an increase in the amount of health aid experience a more rapid decline in child mortality (douzounet & urbain, 2015). the study was carried out with data from 94 developing countries, nigeria inclusive. through female education and governance channels, the study established that a 1% increase in health aid saves the lives of four children in over five years. the conclusion reached is that the benefits of aid projects are location specific, such that biases arise if aid did not target those populations in greatest need. health aid was revealed to have a statistically significant and positive effect on infant mortality rate in developing countries (yousuf, 2012). specifically, a doubling of aid leads to an approximately 1.3% reduction in infant mortality rates. thus for an average aid recipient country, doubling per capita aid leads to a reduction of about 790 deaths per million live births in a particular year. however, the finding of woubedle (2011) on aid and infant mortality in africa was inconclusive. this is because the main determinants of infant mortality did not drive significant impact, which makes it difficult to make conclusions on the actual effect foreign aid has on infant mortality. thus raising a concern for aid fungibility, a term describing whether aid resources in africa are actually being used for their intended purposes or being switched by recipient countries (álvarez, borghi, acharya, & vassall, 2016). on the effectiveness of aid on education, douzounet and urbain (2015) used data for 34 african countries including nigeria, to assess the effectiveness of aid and its efficiency on primary school completion rate. they found that higher aid to education significantly increases the primary school completion rate in africa. strong heterogeneity in the efficient use of aid among african countries was also found. in countries like botswana, togo, and kenya, the distribution of efficiency scores was high while burkina faso, niger and rwanda has lowest efficiency scores, thus, suggesting an inefficient use of education aid. a positive correlation was found between aid and the initial level of education. studies abound in the literature on the impact of foreign aid on economic growth, health and education in both developed and developing countries (afridi & ventelou, 2013; birchler & michaelowa, 2016; hsiao & emdin, 2015; irfan & nehra, 2016; kotsadam et al., 2018; riddell & nino-zarazua, 2016). several empirical studies have investigated the impact of foreign aid on human capital development based on cross country analysis. however, there is dearth of empirical studies examining the impact of sector-specific oda on human capital development in nigeria. birchler and michaelowa (2016) notes that it is exciting to see the indirect effect of health oda on economic growth, however, education and health outcomes represent important components of human capital development which could as well be a means to growth and development. the question then remains whether oda for human capital development is effective in nigeria. studies like azarnert (2008); staicu and barbulescu (2017) have examined this relationship on health indicators such as life expectancy rate and fertility rate alone. okon (2012) used the human development index, which is a composite of asian journal of economics and empirical research, 2020, 7(1): 25-35 27 © 2019 by the authors; licensee asian online journal publishing group health, education and living standard index. other strands of literature empirically investigated the relationship between foreign aid and economic growth (nwosu, 2018; olanrele & ibrahim, 2015). departing from these literatures, this study investigates the effects of foreign aids on human capital development indicators. the analysis is at a disaggregated level, such that life expectancy and primary school enrolment rates are specified as a function of foreign aid in separate models. the rationale is to be able to account for human capital development on a broader spectrum rather than the narrow measure of health or education alone. the subsequent sections are outlined as follows: section 2 presents some stylized facts on development aid and its effectiveness on human capital development in nigeria. section 3 contains the methodology. section 4 gives the empirical results and discussion while section 5 concludes. 2. stylized facts on development aid and its effectiveness on human capital indicators 2.1. stylized facts on development aid this section discussed the trend of oda flow in nigeria, with emphasis on social sector that reflects the human capital development. a comparison was equally provided across the major aid recipients in africa. the total inflow of aid to nigeria increased gradually from 1970 to 2016. in the forty-six years period (19702016), aid received in nigeria grew by over 2000 per cent. there was a gradual increase from the 1970s to 1990s figure 1. however, a sudden rise was observed during the 2000s, when total aid received reached us$2,444 million from a modest value of us$ 282 million in the 1990s. this development could simply be alluded to the renewed donor interest, especially in improving key development indicators and the return of civil rule in nigeria in 1999. another reason could be due to an increase in total oda commitment to africa, which is seen in the surge in the share of nigeria’s oda received figure 2. a decline was recorded in the period 2010 to 2016. figure-1. oda to nigeria (annual averages). figure-2. annual average oda to nigeria (% of total received in africa). in 2016, more than half of the oda went to the social sector (72%). increase in internal crisis, such as boko haram insurgencies and the farmer-herders conflicts, contributed to the significant aid of 13% received in the humanitarian sector figure 3. relative to other major aid recipients in africa, nigeria is the only country with more than 10% oda for humanitarian purposes after ethiopia figure 4. as shown in figure 3 economic, multisector and the production sectors had 8%, 5% and 2% share in total oda received in 2016. asian journal of economics and empirical research, 2020, 7(1): 25-35 28 © 2019 by the authors; licensee asian online journal publishing group figure-3. oda by sector in 2016 (% of total). some four sub-saharan african countries and a north african country were the five largest recipients of aid in 2016. donor expenditure on aid was mostly on social and economic sectors. social aid, which had the largest share, was received by nigeria, tanzania, and kenya figure 4. the largest share of economic aid went to egypt, then ethiopia and kenya. general programme aid got the least share of donation in kenya and ethiopia. figure-4. oda to five largest recipient countries in africa by sector in 2016 (% of total). breaking the sectors further, figure 5 shows that health sector aid has the highest social sector oda received in the period 2012 to 2016. although there was a tremendous decline from us$ 1,154 million in 2013 to us$ 680 million in 2014, a sharp increase to the tune of us$ 2,193 was recorded in 2015. apparent is the fact that the education sector got the least aid among the two sub-sectors. in the analysis of the top 10 largest education aid recipients in africa, nigeria’s position hovers around 4th and 9th in the period 2012 to 2016. topping the list is nigeria, which ranked 1st among the 10 largest health aid recipients in the same period, except in 2014 when kenya got the largest health aid in africa. figure-5. social and economic sub-sector oda to nigeria. summarily, aid received for development purposes is huge in nigeria, and as such, aid is expected to make a meaningful contribution to key human capital development indicators in the country. 2.2. effectiveness of aid on human capital development ascertaining the effectiveness of aid entails that the performance of the selected key development indicators is examined. the key indicator targeted by health aid is to ensure a reduction in the rate of infant mortality, which impact average life expectancy rate. over the years there has been a gradual reduction in the rate of infant mortality vis-à-vis health aid figure 6. a decline of about 61% was recorded in the infant mortality rate in the space of 46 years (1970-2016). the decreasing rate cannot be accorded to health aid considering the pattern of asian journal of economics and empirical research, 2020, 7(1): 25-35 29 © 2019 by the authors; licensee asian online journal publishing group movement exhibited. with aid and other factors outside the scope of this study, the incidence of infant mortality rate is relatively high at the present rate of more 60 per cent. figure-6. trend of health aid and infant mortality rate. being one of the highest education aid recipient countries in africa, the number of children enrolled in the primary school is expected to increase, with a decreasing effect on the number of out of school children. the aim is to enhance human development through an increase in literacy rate and the country’s overall productivity. as shown in figure 7 the total enrolled population of the age group that officially corresponds to the primary school level was above 40 per cent in the period 1970 to 2016. the obvious challenge is the fact that the percentage of out-of-school children, in the same age group, was consistently above 30 per cent in the referenced period (world development indicator (wdi), 2018). in a proximate economy like south africa, the number of out-of-school children for the referenced group has reduced by about 76 per cent from 35 per cent in 1970 to 8 per cent in 2015. this explains the high rate of literacy in south africa (average 88 per cent) compared to nigeria’s (47 per cent). with education aid mostly channeled to primary school education (oecd-dac, 2015) the number of out of school children at this level is alarming. figure-7. trend of primary school enrolment rate. it is obvious from the foregoing discussion that aid has not brought about the desired development in nigeria going by the performance of the selected development indicators, especially education outcomes. the challenge then is how to internally enhance national development in the presence of abundant resources. 3. methodology and data 3.1. methodology this section presents the methodology adopted for this study. it first presents a conceptual framework that shows the link between development aid and human development outcomes. it then presents the econometric model adopted for the empirical analysis of the impact of development aid on human capital development in nigeria. asian journal of economics and empirical research, 2020, 7(1): 25-35 30 © 2019 by the authors; licensee asian online journal publishing group figure-8. conceptual framework of oda and human development indicators. source: adapted from johannesen and pirttilä (2016) and kotsadam et al. (2018) and modified. the underlying principle around the framework in figure 8 is that development indicators are basic necessities that should be enjoyed by the citizenry irrespective of social or economic strata. hence, where gaps exist, foreign development assistance is provided to support the policy focus of national governments in lifting individuals out of development quagmire. these external supports are justified in contexts where the government cannot meet their financial obligation due to limited finances or political will (johannesen & pirttilä, 2016). the overarching aim is that various direct and indirect outcomes are achieved for overall economic development. in line with the objective of this study which is to examine the human capital developmental outcomes of foreign aid in nigeria and in line with the conceptual framework, the study modeled official development assistance as a determinant of the two components of human capital development; education and health in separate models. the study controlled for the impact of government expenditure on both education and health in the respective models since foreign aid helps recipient countries to augment domestic budgetary allocations for provision of basic needs (johannesen & pirttilä, 2016; liu, fan, chao, & eden, 2019). therefore, the model for the study is specified below: ( )hcd f oda (1) where: hcd is human capital development and oda is official development assistance. by controlling for the impact of government expenditure, the model becomes: ( , )hcd f oda gexp (2) disaggregating government expenditure into its capital and recurrent components ( , , )hcd f oda cexp rexp (3) in order to capture human capital development, the study made use of life expectancy ratio (following mishra and newhouse (2009)) and primary school enrolment rate (following birchler and michaelowa (2016)) as measures of health and education outcomes respectively. furthermore, the study used sector-specific components of development assistance and government expenditures on health and education respectively. hence, the two working models become: ( , , )le f hoda cexph rexph (4) ( , , )pse f eoda cexpe rexpe (5) by specifying the models in functional form: 1 2 3ole hoda cexph rexph         (6) 1 2 3opse eoda cexpe rexpe         (7) a positive relationship is theoretically expected between the regressors and their respective regressands. following the model specification, this study uses the autoregressive distributed lag (ardl) technique to examine the relationship between foreign aids and human capital development in nigeria from 1981 to 2017. the study estimates two models; the first examines the impact of sector-specific aids to the health sector on life expectancy, while the other examines the impact of educational aids on primary school enrolment rate. the study controlled for the impact of sector-specific government expenditure in the two models, which was disaggregated into capital and recurrent health and education expenditures. hence, the econometric forms of the equations presented in equations 6 and 7 are expressed in ardl form to capture the short run and long run impacts of asian journal of economics and empirical research, 2020, 7(1): 25-35 31 © 2019 by the authors; licensee asian online journal publishing group foreign aid on human capital development, in line with pesaran, shin, and smith (2001); pesaran., shin, and smith (1996) are expressed thus: 0 1 1 2 1 3 1 4 1 1 2 3 1 1 2 1 3 1 4 1 1 0 0 0 log( ) log( ) log( ) log( ) log( ) ( ) ( ) log( ) ( ) t t t t t p q q q t j t j t j t t i j j j le le hoda cexph rexph le hoda cexph rexph                                          (8) 0 1 1 2 1 3 1 4 1 1 2 3 1 1 2 1 3 1 4 1 1 0 0 0 log( ) log( ) log( ) log( ) log( ) ( ) ( ) log( ) ( ) t t t t t p q q q t j t j t j t t i j j j pse pse eoda cexpe rexpe pse eoda cexpe rexpe                                          (9) where: let = life expectancy at time t. hodat = official development assistance to health sector at time t. cexpht = capital expenditure to health sector at time t. rexpht = recurrent expenditure to health sector at time t. pset = primary school enrolment at time t. eodat = official development assistance to education sector at time t. cexpet = capital expenditure to education sector at time t. rexpet = recurrent expenditure to education sector at time t. β0 = constant term. βi and αi (where i= 1-4) = parameter estimates. δ = lag operator term. (p,q) = lag length of the dependent and independent variables respectively. εt = error term at time t. we expect, a priori that αi and βi > 0. 3.2 data the data needs for the study were gotten from three sources. the study employed annual secondary time series data from 1981 to 2017 sourced from central bank of nigeria (cbn) annual statistical bulletin, world development indicators and organisation for economic co-operation and development statistical database. specifically, data on government expenditures (capital & recurrent) were gotten from cbn annual statistical bulletin, life expectancy and primary school enrolment rates were gotten from world development indicators while data on official development assistance (oda) were sourced from oecd statistical database. due to different units of measurements, the study made use of the logged values of all the variables in the series. table 1 indicates the summary of the variables, their definitions, measurement units and source of data. table-1. summary of variables and data sources. variables definition measurement (unit) source life expectancy the average number of years an individual is expected to live. total life expectancy at birth (years) wdi primary school enrolment rate percentage of children who are of official primary school age and are enrolled in primary school to the total population of children of the official primary school age. net primary school enrolment (%) wdi official development assistance (health & education) financial aid given by foreign governments and agencies to spur development in nigeria’s health and education sector. total official donors’ disbursement to health and education (usd millions) oecd capital expenditures (health & education) government expenses on nonfinancial assets e.g. infrastructures. federal government capital expenditures: education and health (₦' billion) cbn recurrent expenditures (health & education) government expenses on salaries and overheads. federal government recurrent expenditures: education and health (₦' billion) cbn 4. empirical results and discussion 4.1. introduction in this section, the empirical results of the study are discussed. the section begins with pre-estimation testing of the descriptive statistics and the unit root test analysis. the subsequent part of the section centres on the estimates of short and long run models as well as post-estimation diagnostic tests. 4.2. descriptive analysis table 2 shows the statistical properties of the selected variables. the skewness of the data series indicates that primary school enrolment showed an asymmetric or non-normal data distribution as the series relatively deviates from normality maintaining negative skewness, while others series are positively skewed. the kurtosis statistic shows that all the series are platykurtic in nature except primary school enrolment and recurrent expenditure on health which are leptokurtic and mesokurtic respectively. also,the jarque-bera test is a test of normality with its null hypothesis being that the series under consideration is normally distributed. based on our results using the pvalues associated with the jarque-bera statistics, capital expenditure on health, education oda and primary school enrolment are normally distributed while others are not. asian journal of economics and empirical research, 2020, 7(1): 25-35 32 © 2019 by the authors; licensee asian online journal publishing group table-2. descriptive statistics. variables cexph eoda hoda le pse rexpe rexph mean 49.03357 15720.34 11068.63 47.91595 92.33798 101.3627 59.05597 median 23.36560 12283.24 6428.560 46.12500 92.03793 39.88260 15.21808 maximum 167.6555 30299.08 33019.00 53.86633 113.0465 403.9571 257.7000 minimum 0.237600 5112.140 2601.780 45.63500 64.73919 0.162154 0.041315 std. dev. 56.82478 7600.551 8815.425 2.680016 10.30280 134.5181 82.98504 skewness 0.879647 0.522199 1.062673 0.978804 -0.102848 1.183198 1.269280 kurtosis 2.318879 1.789516 2.752844 2.425540 3.513886 2.875871 3.133389 jarque-bera 5.486852 3.940558 7.058026 6.416775 0.472351 8.656823 9.962366 probability 0.064350 0.139418 0.029334 0.040422 0.789642 0.013188 0.006866 observations 37 37 37 37 37 37 37 4.3. unit root test analysis table 3 details the summary results of the unit root test conducted on individual series using the augmented dickey-fuller (adf) stationary test. from the results, all the series are stationary at first difference, implying that they are integrated of order 1, which informs the usage of the autoregressive distributed lag (ardl) estimation technique which allows for a maximum order of integration of 1, following (raza, shahzad, tiwari, & shahbaz, 2016). table-3. summary of unit root test results. variable level first difference i (d) none constant constant and trend none constant constant and trend pse -0.6646 -3.2893* -2.1956 -5.0723* -5.0574* -5.0135* i(1) eoda 1.7548 -0.2162 -1.6724 -5.3795* -6.0508* -5.9782* i(1) cexpe -0.0469 -0.8963 -2.9821 -5.9342* -6.0151* -5.9259 i(1) rexpe 1.8928 0.8762 -1.2854 -4.6511* -5.1005* -5.4994* i(1) le 0.6123 -1.1871 -7.8324* -1.3941 -3.8139* -4.2847* i(1) hoda 2.5331 0.8481 -0.7984 -2.4051* -2.5546 -8.5093* i(1) cexph -0.0469 -0.8963 -2.9821 -5.9342* -6.0151* -5.9259 i(1) rexph 1.6448 0.7474 -1.3305 -7.4212* -6.1724* -7.4641* i(1) 5% critical values -1.9507 -2.9484 -3.5443 -1.9507 -2.9484 -3.5443 note: * indicates significance at 5% level. 4.4. bound testing analysis the bound test result as displayed in figure 4 showed that the computed statistics exceeds both the lower bound and upper bound in the two models. based on the computed statistics and critical values provided, we can conclude that there is co-integration among the series. table-4. bound test for co-integration. bounds test for co-integration health aid model education aid model test statistic value k test statistic value k f-statistic 25.31 3 f-statistic 7.32 3 critical value bounds critical value bounds significance i0 bound i1 bound significance i0 bound i1 bound 10% 2.72 3.77 10% 2.72 3.77 5% 3.23 4.35 5% 3.23 4.35 1% 4.29 5.61 1% 4.29 5.61 4.5. effect of health aid on life expectancy rate table 5 details the short-run and long-run result of the impact of health oda on life expectancy rate in nigeria. the results showed that the major independent variable, health oda has positive impact on life expectancy rate in both the short run and long run. however, while the short run impact is not significant, the long run impact is significant at 5 per cent level. specifically, a per cent increase in health aid increases life expectancy rate by about 0.03 per cent. this implies that the focus of health oda to nigeria is more long-run oriented and forward-looking rather than satisfying short-term health needs. the result justifies the effectiveness of developmental schemes and programs of foreign donors in nigeria’s health sector which has drastically increased access to infant immunization, thereby reducing mortality rate, and life expectancy rate in the country. by reporting a positive link between health oda and health outcomes, this result agrees with the findings of hsiao and emdin (2015), afridi and ventelou (2013) and kotsadam et al. (2018) but contrasts the findings of irfan and nehra (2016). also, the result showed that government capital expenditure on health in nigeria has negative impact on life expectancy rate both in the short run and long run. like the health oda, its short run impact is not significant but the long run impact is significant at 5 per cent level. this result could be explained on the grounds that in the face of increasing health oda, government’s own resources have been continually channelled to other areas of priority as the government deems fit, hence the negative effect of capital expenditure on life expectancy. furthermore, the result showed that government recurrent expenditure on health has significant positive impact on life expectancy in nigeria both in the short run and in the long run, with a larger magnitude in the long asian journal of economics and empirical research, 2020, 7(1): 25-35 33 © 2019 by the authors; licensee asian online journal publishing group run. this implies that government recurrent expenditure in the health sector has contributed meaningfully to enhancing life expectancy in nigeria, and as such a complement to health aid. the result showed that the error correction term is negative and significant, thus justifying the long run relationship established among the variables. it indicates that the system is able to adjust to long run equilibrium position at 3 per cent speed of adjustment. table-5. long and short run estimates of health aid model. dependent variable: log(le) variable coefficient std. error t-statistic prob. long run coefficients log(hoda) 0.026700 0.011350 2.352363 0.0265 log(cexph) -0.022455 0.009469 -2.371508 0.0254 log(rexph) 0.033763 0.007903 4.272115 0.0002 c 3.638690 0.104928 34.678078 0.0000 short run coefficients dlog(le(-1)) 0.871485 0.043848 19.875215 0.0000 dlog(hoda) 0.000847 0.000515 1.643276 0.1124 dlog(cexph) -0.000276 0.000187 -1.479959 0.1509 dlog(rexph) 0.000380 0.000143 2.653548 0.0134 dlog(rexph(-1)) -0.000260 0.000122 -2.135807 0.0423 cointeq(-1) -0.031718 0.006877 -4.611895 0.0001 4.6. effect of education aid on primary school enrolment rate table 6 presents the results of the short run and long run impact of education oda on primary school enrolment in nigeria. the result revealed that the variable of major interest, education aid, has positive impact on primary school enrolment in the short-run but with a long run negative impact, although both are not statistically significant at five per cent. also, government capital expenditure has a short run negative impact on primary school enrolment but a positive impact in the long run, with neither being statistically significant at five per cent level. furthermore, government recurrent expenditure has a positive but non-significant impact on primary school enrolment while its long-run impact is insignificantly negative. the implication of this result is that education aid and government expenditure on education has not had desired outcome on primary school enrolment in nigeria. this result points to allocative inefficiency or gross mismanagement and diversion of aids and funds, or both. this is not surprising, as the country boasts of the highest number of out of school children in the world, despite increasing budgetary allocation to education and being one of the top recipients of education oda in africa. the result therefore confirms the ineffectiveness of foreign aid whose aim is to enhance human capital development through an increase in literacy rate and the country’s overall productivity. this result opposes the findings of birchler and michaelowa (2016) and riddell and nino-zarazua (2016) who both found positive link between education oda and school enrolment rates in selected developing countries. the result showed a negative and significant coefficient of the error correction term, indicating that the series exhibit a convergence to long run equilibrium at approximately 89 per cent speed of adjustment. table-6. long and short run estimates of education aid model. dependent variable: log(pse) variable coefficient std. error t-statistic prob. long run coefficients log(cexpe) 0.043775 0.039810 1.099618 0.2860 log(eoda) -0.068323 0.065699 -1.039938 0.3121 log(rexpe) -0.026174 0.031791 -0.823306 0.4211 c 5.117431 0.605954 8.445253 0.0000 short run coefficients dlog(pse(-1)) 0.524485 0.173325 3.026031 0.0073 dlog(pse(-2)) 0.441879 0.187281 2.359444 0.0298 dlog(cexpe) -0.020886 0.033142 -0.630190 0.5365 dlog(cexpe(-1)) 0.005807 0.031254 0.185806 0.8547 dlog(cexpe(-2)) 0.019495 0.028118 0.693307 0.4970 dlog(cexpe(-3)) -0.071673 0.024658 -2.906713 0.0094 dlog(eoda) 0.195996 0.106883 1.833742 0.0833 dlog(eoda(-1)) 0.070350 0.140935 0.499162 0.6237 dlog(eoda(-2)) 0.161997 0.103092 1.571390 0.1335 dlog(rexpe) 0.017542 0.022986 0.763166 0.4553 cointeq(-1) -0.890500 0.169753 -5.245865 0.0001 4.7. diagnostic test results in addition to the regression estimates, the study conducted some diagnostic residual tests which include breusch-godfrey serial correlation lm and heteroskedasticity arch tests. in table 7, the f-statistics of the serial correlation tests in the models were insignificant suggesting the absence of serial correlation in the residual of the regression estimates. the f-statistics of the heteroskedasticity arch test was also insignificant confirming that the residual of the models were homoscedastic. the implication is that the regression estimates were appropriately estimated. asian journal of economics and empirical research, 2020, 7(1): 25-35 34 © 2019 by the authors; licensee asian online journal publishing group table-7. serial correlation and heteroscedasticity result. health aid model diagnostics statistics interpretation serial correlation (breusch-godfrey serial correlation lm test) fstat = 2.743172 (0.0843) no evidence of serial correlation heteroscedasticity (arch lm test) fstat = 0.395054 (0.9132) residual is homoscedastic education aid model diagnostics statistics interpretation serial correlation (breusch-godfrey serial correlation lm test) fstat = 2.072481 (0.1604) no evidence of serial correlation heteroscedasticity (arch lm test) fstat = 1.470491 (0.2164) residual is homoscedastic note: figures in parenthesis are probability values. 5. conclusion the financial gap/budget constraints have made aid attractive to aid recipient nations, with the aim to facilitate a development agenda. as such, this study examines the performance of foreign development aid on development in nigeria, with a particular interest on key human capital development indicators like life expectancy and the primary school enrolment rates as measures of health and education respectively. empirical results from the study confirmed a long run positive and significant relation between health aid and life expectancy rate in nigeria. specifically, an increase in health aid engenders about 0.03 per cent increase in life expectancy rate. increase in government expenditure was able to complement health aid in increasing the life expectancy rate, specifically the government recurrent expenditure. surprisingly, national infrastructural expenditure, that is the capital expenditure, reduces the rate of life expectancy. these findings suggest that life expectancy rate has improved with health aid and the national recurrent expenditure playing significant role, thus, the effectiveness of health aid. overdependence on foreign aid has its attendant consequent of stifling home grown development strategies, hence, government should increase infrastructure expenditure through public private partnership arrangement, which will help to provide and expand basic health care facilities for a healthier society. on the other hand, education aid has a non-significant positive impact on life expectancy rate in the short run and a negative but non-significant impact in the long run. likewise, both capital and recurrent expenditures had no significant impact on primary school enrolment rate in nigeria. this outcome alludes to the fact that foreign aid on education is not effective in nigeria, likewise, the national government expenditure. hence, a structural change that could engender the desired national transformation of this key development indicator requires a collective national action where all stakeholders including donor agencies, development partners and the government work together to ensure effective aid use strictly for their intended purposes. also, the nigeria’s government should work out effective strategies to increase the rate of primary school enrolment, which could be through an increase in education expenditure and a national law that stipulates all children within the primary school age bracket to be duly enrolled in schools while non-adhering parents gets punished accordingly. references afridi, m. a., & ventelou, b. 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(2017). a study of the relationship between foreign aid and human development in africa. international development, 135-152. available at: http://dx.doi.org/10.5772/67483. world development indicator (wdi). (2018). world bank. woubedle, a. (2011). aid and the african dilemma: the effect of foreign aid on human development in africa. a thesis submitted to the faculty of the graduate school of arts and sciences of georgetown university of the requirements for the degree of master of public policy. yousuf, a. s. (2012). impact of health aid on infant mortality rate. a dissertation submitted to university of nottingham. retrieved from: https://mpra.ub.uni-muenchen.de/42945/1/mpra_paper_42945.pdf. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. http://dx.doi.org/10.5772/67483 1 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 1, 1-7, 2020 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2020.71.1.7 © 2020 by the authors; licensee asian online journal publishing group impact of external debt on nigeria’s foreign reserve portfolios peter e. ayunku1 dumani markjackson2 ( corresponding author) 1department of banking and finance, niger delta university, wilberforce island, bayelsa state, nigeria. 2department of banking and finance, federal polytechnic, ekowe, yenagoa, bayelsa state, nigeria. abstract this study examines the impact of external debt and external debt servicing on the international reserves of nigeria. the theoretical underpinning of the study was anchored on dual gap theory and the self-insurance theory of external reserves. the after effect research design was adopted to examine the components of the study in retrospect. historical data spanning 1981 to 2018 was collated from the world development indicators and analyzed using the error correction mechanism as the unit of analyses and estimated employing the least square technique. the empirical findings indicate that external debt stock exert a negative and statistically significant impact on nigeria’s foreign exchange reserve portfolios. it further emerged that external debt service payments exert a positive but statistically insignificant impact on the international reserves of nigeria. the study concludes that external debt stock and external debt service payments has no significant impact on the international reserve portfolios of nigeria. the study recommends that, the fiscal managers of nigeria should exercise cushion in external borrowing in order to ensure that concomitant external debt service payments does not deplete the international reserves of the country. keywords: external debt, external debt servicing, international reserves, dual gap theory, self-insurance theory, nigeria. jel classification: h69, f31. citation | peter e. ayunku; dumani markjackson (2020). impact of external debt on nigeria’s foreign reserve portfolios. asian journal of economics and empirical research, 7(1): 1-7. history: received: 8 november 2019 revised: 11 december 2019 accepted: 15 january 2020 published: 3 february 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ......................................................................................................................................................................................... 2 2. theoretical framework ..................................................................................................................................................................... 2 3. review of related empirical studies .............................................................................................................................................. 3 4. methodology ........................................................................................................................................................................................ 4 5. econometric results .......................................................................................................................................................................... 5 6. conclusion ............................................................................................................................................................................................ 6 references ................................................................................................................................................................................................. 7 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.71.1.7&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1274 https://orcid.org/0000-0002-6120-3392 https://orcid.org/0000-0002-0012-2943 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1274 https://orcid.org/0000-0002-6120-3392 https://orcid.org/0000-0002-0012-2943 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1274 https://orcid.org/0000-0002-6120-3392 https://orcid.org/0000-0002-0012-2943 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1274 https://orcid.org/0000-0002-6120-3392 https://orcid.org/0000-0002-0012-2943 asian journal of economics and empirical research, 2020, 7(1): 1-7 2 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to existing literature by examining the impact of external debt and external debt servicing on the international reserves of nigeria. 1. introduction the funding challenges of developing countries are not alien to policy makers, researchers and academics. it is widely held that developing nations are constrained of sufficient funds to build basic infrastructure that would set the pace for capital formation and sustainable growth (ayadi and ayadi, 2008; saheed et al., 2015; rahaj, 2018). this implies that tax revenue, crude oil proceeds and proceeds from other natural endowments which form the bulk of government revenue in developing countries are inadequate to stimulate sustainable growth. this is as a result of their inability to build adequate collection structures, tax base and acute volatility of commodity prices. faced with shortfalls in revenue and the need to increase investment in public works, developing countries engage in deficit spending to bridge the gap in funding public expenditure. central to this axiom is the beliefs that increase in public expenditure cultivate and stimulate the national productivity possibility curve outwards. the origin of this theory can be traced to wagner’s law of increasing state activity of 1883 which averred that the size of economic development of a nation is directly a function of the size of public spending of that nation (magazzino et al., 2015; yoshito, 2015). nigeria has consequently been engaging in deficit spending as anchor to capital formation and sustainable output growth. plethora of studies has established that internal or external debt, when applied wholly on public works and infrastructure has the capacity to stimulate the economic wellbeing of a nation (oshikoya, 1989; asogwa et al., 2018). according to soludo (2013) public debt is needed to elevate and spur the size of aggregate investment and circumvent funding constraints of government budget in order cultivate sustainable growth and the gdp per capita of the nation. records show that the fall in commodity prices in 1978 pressured the federal government to borrow from overseas (external debt) due to its dwindling foreign exchange earnings from crude oil to meet her many public works and projects in order to better the lots of the people (ndubuisi, 2017; asogwa et al., 2018; rahaj, 2018). however, records indicate that nigeria used external loans to finance its first plan of development in 1962 (oshikoya, 1989). public expenditure funding over the years have not changed significantly as government has been using borrowed funds to finance its expenditure plan due to revenue shortfalls from tax and oil. the use of public debt in bridging the revenue shortfalls of the government is additionally creating a huge economic problem for countries as the debt figures continue to spiral. according to the debt management office (2019) nigeria’s foreign debt stands at 27.162 billion usd, while local debt stood at 56.72 billion usd as at june 30, 2019. this calls for concern even as it has been averred that much of public debt in nigeria have been misapplied due to indiscipline and thus fails to yield the anticipated results and reasons for the facility (senibi et al., 2016; rahaj, 2018). thus, making nigeria to be a highly indebted nation with poor public infrastructure, per capita income and national productivity. the exponetial increase in public expenditure enabled by external borrowings creates a huge burden on the nation. this is because the spiraling foreign debt stock poses a huge debt servicing obligation which has over the years gulped a gigantic sum of the national budget; thus, impeding national productivity possibilities (johansson, 2010). the repayment of the external debt stock and interest amount (otherwise called debt servicing) exert an enormous burden on the internatonal reserves of a nation due to the fact that the repayments are made in foreign currency. this implies that external settlements are sourced from the international reserves of the sovereign nation. they are also used to influence the exchange rate of the local currency. international reserves therefore, serve the purpose of preserving capital and provision of liquidity to meet the foreign exchange needs of the people (tule et al., 2015). thus, further serving as the store of the international value of the national currency (ito and mccauley, 2019) and other negative external shocks on the economy (espinoza and winant, 2014). in fact, it is averred that international reserves is a major pointer to the debtor nation’s ability to pay back the principal amount and interest on the external debt (onwuka and igwezea, 2014). although external debt could be a reproductive stimulant in a well cultured system with fiscal discipline; however, this is yet to be seen in nigeria owing to fiscal indiscipline and financial corruption. consequently, the twin attacks on the international reserves of the nation via concormitant debt servicing and foreign exchange for importation stand to drain the reserves without a corresponding increase in earnings. futher to this, economic theory holds that increasing external debt exposes a nation to high risk and that increasing foreign exchange reserves reduces the exposure level of a nation (mansour, 2013). however, debt servcing obligations stand to reduce the international reserve holdings of the nation. given the spiraling external debt position of the nation; it is important to understand the dynamics of these variables in nigeria. this tellingly makes it plausible to use econometric techniques to interrogate the interplay between external debt stock, debt servicing and international reserves. this is significant on sundry levels; (1) available extant studies are scant; (2) lately due to dwindling prices of primary commodities, developing nations are rapt on deficit financing via external debts, thus increasing the debt servicing obligation and depleting the international reserves of developing sovereign nations. thus, it is imperative to study this phenomenon and contribute to the body of knowledge on external debt and foreign exchange reserves in nigeria. 2. theoretical framework the theoretical under pinning of this study are the dual gap theory of debt and the self-insurance theory of external reserves. one common attribute of developing nations is their inability to accumulate aggregate savings large enough for investment in public works and infrastructure that would stimulate capital formation and national productivity. their inability to enhance aggregate investment due to low aggregate savings arising from fiscal indiscipline creates a puzzle on how best to raise funds for public spending. this creates an obvious gap in savings and investment which needs to be bridged. in other words, the shortfall needs to be filled to increase public capital. consequent on these, the dual gap theory of 1966 propagated by chenery states that lack of adequate domestic asian journal of economics and empirical research, 2020, 7(1): 1-7 3 © 2020 by the authors; licensee asian online journal publishing group savings creates a gap, and that the need to increase aggregate public spending in form of investments leads to foreign borrowings (chenery and strout, 1966; rahaj, 2018). self-insurance entails setting aside funds in order to mitigate possible unfortunate circumstances. it simply means maintaining a buffer stock to intervene on external shocks. thus, the self-insurance theory of external reserves holds that nations should accumulate international reserves in the form of hard foreign currency, bank deposits, near money instruments in foreign denominations like treasury bills and certificates, gold holdings and special drawing rights. the theory posit that this would help the country to mitigate external shocks and serve as a buffer stock to intervene on the foreign exchange rate of a country (akamobi and ugwunna, 2017). thus, the theory holds that reserve accumulation help ensure that the price of foreign to that of the local currency other time is stable. 3. review of related empirical studies several empirical studies have been carried out on external debt and foerign exchange reserves. however, there are scant studies on external debt and foreign exchange reserves in nigeria. this section presents review of related empirical studies on the major parameters of the study. nwachukwu et al. (2016) examined the impact of exchange rate on nigeria’s international reserves using daily data spanning 2014 to 2015. the data was estimated using the threshold vector error correction technique. the results indicate that the coefficient of the error correction term was statistically insignificant. the results further indicate that the adjustment flow in the variables flow from international reserves to exchange rate in nigeria. saheed et al. (2015) examined the effect external debt has on foreign exchange rate in nigeria. the study used foreign debt stock, debt service payment and foreign reserves as the explanatory variables, while foreign exchange rate was used as the explained variable otherwise known as the dependent variable. time series data was collated and estimated employing the ordinary least square technique. the results show that all the explanatory variables have statistically significant impact on foreign exchange rate in nigeria. senibi et al. (2016) investigated the impact of public debt on foreign exchange reserves in nigeria. historical data spanning 1981 to 2013 was collated and analyzed using fully modified ordinary least square method of estimation. the estimates indicate that public debt has a positive statistical impact on foreign exchange reserves in nigeria. onwuka and igwezea (2014) studied the impact of external reserves and external debt on nigeria’s exchange rate to the united state dollar. to achieve this, the study assumed that exchange rate is a function of external reserves and external debt in nigeria. time series data spanning 1981 to 2010 was collated. a multiple regression model was built and estimated using the ordinary least square technique. the results indicate the existence of a positive nexus between foreign reserves and external debt on foreign exchange rate in nigeria. ugwuegbe et al. (2016) investigated the impact of foreign debt and foreign grant on economic growth in nigeria, using time series data spanning 1980 to 2013. the data was estimated using the error correction technique following the least square technique. the empirical results indicate the existence of a significant linear nexus between external debt and national output. results further show that foreign grant exert a positive impact on economic growth at an insignificant rate. akpan (2016) examined the impact of international reserves of nigeria on gross domestic product, inflation, forex, unemployment, investment, foreign public debt and total trade. time series data spanning 2004 to 2010 was collated for the analyses and estimation. the study employed the least square technique for the estimation. the results indicate that gross domestic product and exchange rate exert a positive and significant impact on foreign exchange reserves. other results indicate that inflation, investment and total trade has a positive impact on external reserves at an insignificant rate. the results for external debt and unemployment rate were found to bear negative and insignificant impact on the external reserves of nigeria. asogwa et al. (2018) assessed the impact of foreign debts and foreign exchange reserves on economic growth in nigeria. the study assumed that gross domestic product is a function of nigeria’s external debt stock and reserves. time series data covering 2007 to 2016 was estimated employing the ordinary least square technique to empirically explain the changes in economic growth that is caused by the explanatory indicators of the study. it emerged that foreign debt service payments exert an insignificant indirect impact on output growth, while external debt amount had a direct impact on economic growth at an insignificant level. the study by ndubuisi (2017) examined foreign debt service payment, external debt, international reserves, and exchange rate on real gross domestic product in nigeria. historical data spanning 1985 to 2015 was collated and analyzed using the error correction technique. the results showed that foreign debt service payments exert a negative and insignificant impact on output growth in nigeria. eternal debt was found to have a linear and statistically significant impact economic growth in nigeria. international reserves and exchange rate which were used as control variables had a statistically significant impact the national productivity of nigeria. nwanne and eze (2015) examined the nexus between external debt stock, external debt service payment and foreign exchange rate in nigeria. time series data spanning 32 years, 1981 to 2013 was collated and analyzed using the johansson cointegration test, which established the existence of long run equilibrium relationship. the ordinary least technique was employed to determine the direct and magnitude of the relationship. the results indicate that external debt stock has a positive relationship with foreign exchange rate, while external debt service payment exerted a negative effect on exchange rate in nigeria. anidiobu and okolie (2016) carried out a response study on external debt and exchange rate volatility in nigeria. the study specifically set out to ascertain if external debt, external debt service payment and balance of trade has a positive and or significant relationship exist between these explanatory variables and exchange rate. historical data covering 1986 to 2013 and estimated using the ordinary least square technique. the study found that the external debt stock exerted a positive but insignificant effect on exchange rate. it also emerged that external debt service payment has a negative and insignificant influence on exchange rate. balance of trade however, indicated that the variable has a positive and significant impact on exchange rate in nigeria. asian journal of economics and empirical research, 2020, 7(1): 1-7 4 © 2020 by the authors; licensee asian online journal publishing group using the granger causality test and ordinary least square technique, draz and ahmad (2015) investigated the influence of foreign debt and crude oil prices on exchange rates in pakistan. time series data spanning 1965 to 2009 was collated for the analyses and estimation. the test results revealed that foreign debt exerted a statistically significant impact forex. it also emerge that world crude oil prices bear an insignificant impact on forex in pakistan. essien et al. (2016) investigated the effect of domestic and foreign debt on lending interest rates, consumer price index and national output in nigeria. the study used secondary time series data spanning 1970 to 2014. a var model was built and the estimates indicate that external shocks to the lag of foreign debt stock raised the lending interest rate. it further emerged that aggregate public debt exerted a statistically significant influence on consumer price index and national output in nigeria. the study by abdullahi et al. (2015) seeks to ascertain the determinant of external debt accumulation in nigeria. historical data covering 1980 to 2013 was collated and estimated using ardl. the study hypothesized that exchange rate, savings, lending interest rate and budget deficit as the determinants of foreign debt accumulation in nigeria. the study found that the independent variables of the study have a significant impact on external debt in nigeria in the long term; however, the adjustment speed was found to be weak in the short term. kouladoum (2018) investigated the impact of foreign debt stock on real foreign exchange rate in chad. the independent variables of the study are – external debt stock, external debt service payments, public spending, aggregate public investment, broad money supply and the degree of trade openness, whereas the endogenous variable of the study is real foreign exchange rate. historical data from 1975 to 2014 was collated and estimated using gmm. the results indicate that foreign debt stock exerts a positive and significant impact on the dependent variable at the 5% threshold. aggregate investment and government spending was found to be have a statistically insignificant negative impact on forex. other results indicate that broad money supply has a linear but insignificant influence, while debt service payment exerted a statistically significant nonlinear impact on real exchange rate in chad. eva et al. (2015) examined the determinants of external debt stock in malaysia. the study hypothesized gross domestic product, real interest rate, consumer price index and broad money supply as determinants of foreign debt in malaysia. time series data spanning 1970 to 2013 was collated for the empirical analysis. the ordinary least square technique and variance decomposition was used to estimate that data. findings from the study show that there is a long term equilibrium relationship between the independent variables and the dependent measure of the study. furthermore, the study found that real interest rate has a short term nexus with external debt. also, the variance analysis indicate that real interest rate was more potent exogenous variable than the other factors, whereas, consumer price index was found to be more potent endogenous variable amongst the variables of the study. olomola and ajayi (2018) investigated the factors affecting the foreign exchange reserves in west african states. the study hypothesized population, constant gdp per capita, constant exports receipts, percentage of imports to gdp and nominal exchange rate. historical data was collated for the estimation using the ordinary least square technique. it emerged that population, gdp per capita, export receipts exert positive and significant impact on international reserves. the estimates further show that the ratio of import to gdp and nominal exchange rate exerts a negative but significant impact on foreign exchange reserves. similarly, osigwe et al. (2015) appraised the factors determining external reserve portfolios of nigeria. the study theorized that the reserve portfolio of the country is determined by foreign exchange rate, crude oil exports, foreign direct inflows, real national output, lending interest rate, consumer price index and non-oil exports. to avoid spurious results, the augmented dickey fuller test to stabilize the series. the ordinary least square was used to estimate the data. the estimates indicate that national output, oil export and foreign direct investments have a linear and significant influence on foreign reserves. exchange rate and inflation were found to be negative and significant determinants of international reserves. furthermore, lending interest was found to be nonlinear and statistically insignificant influence on external reserves. the study concludes that gdp, oil exports and foreign capital inflow as the determinants of international reserves in nigeria. in another study on the determinants of international reserve holdings of nigeria by akamobi and ugwunna (2017). the authors holds that the factors affecting nigeria’s international reserves are real national income, inflation rate, lending interest rate, nominal foreign exchange rate, crude oil prices and domestic credit in the economy. they collated time series data spanning 1970 to 2013 to empirically ascertain their theoretical position. in order to absolve the long run and short term dynamics established using the cointegration test, the error correction technique was employed. the estimates from the analytical tool show that international crude oil prices and the supply of credit as the key determinants of nigeria’s external reserves. however, the other independent variables were found to be determinants of external reserves in the long run, meaning the effect they exert reserve accumulation is built over a long period of time. 4. methodology 4.1. research design the study adopted the after effect research design (also known as the ex post facto research design). the choice of this design is anchored on the fact that the researcher has no direct or indirect control over the behaviour of the phenomenon in the past. thus, the study used historical data to mimic and investigate the interaction of these variables spanning 1981 to 2018, a 37 years period in retrospect. 4.2. source and nature of data data for the study was collated from the world development indicators. this implies that the data for the study was collated from a secondary source. the nature of data collated for the study is time series data covering 1981 to 2018. asian journal of economics and empirical research, 2020, 7(1): 1-7 5 © 2020 by the authors; licensee asian online journal publishing group 4.3. model specification the model for this study is built following closely to extant literature on external debt and international reserves reviewed in this study. however, the study introduced exchange rate and lending interest rate as control to enable the interaction between the dependent and independent variables of the study. the functional relationship between the dependent variable and the explanatory variables is expressed as: exrs = f(exds, exdsp, exr) this is further transformed to an econometric model as follows: logexrst = ß + ß1logexdst + ß2logexdspt + ß3logexrt + µt ß is the intercept of the model, – are the coefficients of the independent indicators, t is time series, and µ is the error term of the model. exrs is nigeria’s total reserves comprising holdings of monetary gold, special drawing rights, reserves of imf members held by the imf, and holdings of foreign exchange under the control of monetary authorities. exds is total external debt. this is debt owed by nigeria repayable in currency, goods, or services. total external debt is the sum of public, publicly guaranteed, and private nonguaranteed long-term debt, use of imf credit, and short-term debt. short-term debt includes all debt having an original maturity of one year or less and interest in arrears on long-term debt. exdsp is total debt service payments. this is the sum of principal repayments and interest actually paid in currency, goods, or services on long-term debt, interest paid on short-term debt, and repayments (repurchases and charges). exr is foreign exchange rate. it is introduced as a control variable. further to this, the augmented dickey-fuller test is employed to solidify the time series first before they are estimated at their orders of integration. this is to avoid spurious results and estimates. furthermore, the johanson co-integration test was employed to ascertain whether long run equilibrium relationship exist in the model or not. the existence of a single long run equilibrium relationship gives econometric credence to carry out the error correction process. 5. econometric results 5.1. descriptive statistics table 1 presents the summary descriptive statistics of the variables of the study. table-1. descriptive statistics of the variables of the study descriptive stat exrs exds exdsp exr mean 9.911777 10.38712 9.289454 1.484203 median 9.874515 10.46272 9.270266 1.986346 maximum 10.72916 10.66500 9.944834 2.485840 minimum 8.969877 9.983057 8.695181 -0.209220 std. dev. 0.606889 0.172289 0.281641 0.858342 skewness -0.020680 -0.721515 0.095888 -0.763339 kurtosis 1.468697 2.490625 3.047192 2.270401 jarque-bera 3.715451 3.707850 0.061758 4.533174 probability 0.156027 0.156621 0.969593 0.103665 sum 376.6475 394.7107 352.9992 56.39973 sum sq. dev. 13.62764 1.098290 2.934895 27.25981 observations 38 38 38 38 the descriptive results indicate the observations are equal. the mean of the variables are; exrs (9.911777), exds (10.38712), exdsp (9.289454) and exr (1.484203). jarque-bera statistics shows that all the variables of the study are normally distributed. the analyses further show that, aside exdsp, all the other variables are negatively skewed. the variability of returned indicated by the standard deviation statistics indicate as follows; exrs (0.606889), exds (0.172289), exdsp (0.281641) and finally, exr (0.858342). comparatively, the values indicate that, all the variables are noticeable dispersed far below the mean and middle values. 5.2. augmented dickey-fuller statistics table 2 presents the summary unit root test statistics of the variables of the study. table-2. summary augmented dickey-fuller test results. variables adf statistics critical value @ 5% decision exrs -5.496947 -2.945842 i(1) exds -4.735518 -2.945842 i(1) exdsp -8.099317 -2.945842 i(1) exr -5.170243 -2.945842 i(1) note: the summary results indicate that all the variables are stationary at their first difference. this is symbolized as i(1). 5.3. johansen co-integration test results table 3 presents the johansen cointegration test results of the study. asian journal of economics and empirical research, 2020, 7(1): 1-7 6 © 2020 by the authors; licensee asian online journal publishing group table-3. summary johansen cointegration results. hypothesized trace 0.05 no. of ce(s) eigenvalue statistic critical value prob.** none * 0.613370 49.21195 47.85613 0.0371 at most 1 0.204982 15.00165 29.79707 0.7800 at most 2 0.134925 6.743598 15.49471 0.6076 at most 3 0.041498 1.525799 3.841466 0.2167 note: trace test indicates 1 cointegrating eqn(s) at the 0.05 level. * denotes rejection of the hypothesis at the 0.05 level the summary test results indicate the existence of long run equilibrium relationship in the model. specifically, the summary test results indicate the existence of a single cointegrating relationship in the model. this invariably gives econometric credence to carry out the error correction process. 5.4. error correction results table 4 presents the results of the error correction mechanism estimated using the least square technique. table-4. error correction results. dependent variable: d(exrs) variable coefficient std. error t-statistic prob. c 25.36673 3.099099 8.185195 0.0000 d(exds) -1.633171 0.276432 -5.908030 0.0000 d(exdsp) 0.049441 0.149019 0.331777 0.7426 d(exr) 0.679763 0.064195 10.58895 0.0000 ecm(-1) -0.357739 0.113057 -3.164225 0.0034 r-squared 0.874184 mean dependent var 9.943191 adjusted r-squared 0.855544 s.d. dependent var 0.595117 s.e. of regression 0.226188 akaike info criterion 0.007702 sum squared resid 1.381350 schwarz criterion 0.236723 log likelihood 4.876764 hannan-quinn criter. 0.083616 f-statistic 46.89958 durbin-watson stat 1.993854 prob(f-statistic) 0.000000 table 4 x-rays the impact of external debt stock and external debt service payments on nigeria’s foreign exchange reserves. the adjusted coefficient of determinant indicated that 86% variation in the dependent variable is explained by the explanatory variables used in the study. this implies that the remaining 14% of variation is not captured in this study. the adjusted r2 coefficient further indicates that the model is well fitted. this is corroborated by the dw statistics of 1.993854 (which is approximately 2); indicating that there is no first order serial autocorrelation. additionally, the indicator of the statistics of significance of the entire model (the fisher’s ratio) signaled that the model is statistically significant. furthermore, the coefficient of the error correction term is negative. this implies that the model has capacity to adjust and return periodically to equilibrium. specifically, the coefficient showed that there is a 36% slow speed of adjustment to equilibrium. this further indicates that the model is fit and adequate for the purpose of the study. furthermore, the explanatory variables aver as follows; external debt stock (exds), which captures nigeria’s external debt portfolio to foreign financial institutions indicated that the external debt stock exert a negative impact on nigeria’s foreign exchange reserve portfolios. the measure of significance (t-statistics) also indicated it has a statistically significant impact on international reserves. this is indicative of the fact that, the coefficient of external debt stock is negative and the p-value is below the 5% acceptable level of significance. this implies the external public debt stock has no bearing the accumulation of the international reserves of the country. this further avers that the external debt stock and international reserves have no direct link. this is contrary to economic theory which holds that exponential increase in the external debt stock would lead to the depletion of the reserves of a nation due to the fact that external settlements are sourced and paid from the international reserves of the sovereign nation. external debt service payments (exdsp), which captures the interest payable to internal financial institutions, indicated that the variable exerted a positive and statistically insignificant impact on the international reserves of nigeria. this is indicative of the fact that, the coefficient of external debt service payment is positive and the pvalue is above the 5% tolerable level of significance. this goes to say that external debt service payments have an insignificant capacity to deplete the foreign exchange reserve holding of nigeria. this implies that as the external debt service payments increase, maybe as a result of the accumulation of more external debt and or as a result of increase in international lending interest rate; so does it drain the international reserves of the nation at insignificant proportions. the finding by anidiobu and okolie (2016) is a close aproximation to the findings of this study. this closely follows economic theory which holds that exponential increase in the external debt servicing would lead to the depletion of the reserves of a nation due to the fact that external settlements are sourced and paid from the international reserves of the sovereign nation. 6. conclusion this study examines the impact of external debt and external debt servicing on the international reserves of nigeria. historical data spanning 1981 to 2018 was collated and analysed using the error correction mechanism as the unit of analyses and estimated employing the least square technique. the findings indicates that external debt stock exert a negative and statistically significant impact on nigeria’s foreign exchange reserve portfolios. this implies that external debt has no bearing on the foreign exchange reserve portfolios of the country. it further emerged that external debt service payments exert a positive but statistically insignificant impact on the asian journal of economics and empirical research, 2020, 7(1): 1-7 7 © 2020 by the authors; licensee asian online journal publishing group international reserves of nigeria. the study concludes that external debt stock and external debt service payments has no significant impact on the international reserve portfolios of nigeria. the study recommends that, the fiscal managers of nigeria should exercise cushion in external borrowing in order to ensure that spiraling external debt service payments does not deplete the international reserves of the country. references abdullahi, m.m., n.a.b.a. bakar and s.b. hassan, 2015. determining the macroeconomic factors of external debt accumulation in nigeria: an ardl bound test approach. procedia-social and behavioral sciences, 211: 745-752.available at: https://doi.org/10.1016/j.sbspro.2015.11.098. akamobi, o.g. and o.t. ugwunna, 2017. determinants of foreign reserve in nigeria. journal of economics and sustainable development, 8(20): 58-67. akpan, a.u., 2016. foreign reserves accumulation and macroeconomic environment: the nigerian experience (2004-2014). international journal of economics and finance studies, 8(1): 26-47. anidiobu, g.a. and p.i. okolie, 2016. responsiveness of foreign exchange rate to foreign debt: evidence from nigeria. international journal of arts humanities and social sciences, 1(5): 11-20. asogwa, j.o., u.l. onyekwelu and e. okechukwu, 2018. evaluation of the effect of federal government external debts and reserves on economic growth in nigeria. journal of economics and sustainable development, 9(6): 34-44. ayadi, f.s. and f.o. ayadi, 2008. the impact of external debt on economic growth: a comparative study of nigeria and south africa. journal of sustainable development in africa, 10(3): 234-264. chenery, h. and a. strout, 1966. foreign assistance and economic development. american economic review, 56(3): 679 733. debt management office, 2019. nigeria's external debt stock. debt management office. draz, m.u. and f. ahmad, 2015. external debts and exchange rates of oil-producing and non-oil-producing nations: evidence from nigeria and pakistan. journal of advanced management science, 3(1): 8-12. espinoza, r. and p. winant, 2014. a model of external debt and international reserves. essien, s.n., n. agboegbulem, m.k. mba and o.g. onumonu, 2016. an empirical analysis of the macroeconomic impact of 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and a. oluwaseun, 2016. public debt and external reserve: the nigerian experience (1981– 2013). economics research international: 1-7.available at: https://doi.org/10.1155/2016/1957017. soludo, c.c., 2013. the impact of external debt on economic growth: a comparative study of nigeria and south africa. journal of sustainable development in africa, 10(3): 55 – 59. tule, m.k., e. egbuna, j. sagbamah, s. abdusalam, o. ogundele and a. oduyemi, 2015. determination of optimal foreign exchange reserves in nigeria. central bank of nigeria, monetary policy. abuja: central bank of nigeria. ugwuegbe, s.u., i. okafor and c. akarogbe, 2016. effect of external borrowing and foreign aid on economic growth in nigeria. international journal of academic research in business and social sciences, 6(4): 155-175.available at: https://doi.org/10.6007/ijarbss/v6-i4/2087. yoshito, f., 2015. wagner’s law versus displacement effect. munich personal repec archive. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 38 © 2022 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 9, no. 1, 38-51, 2022 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v9i1.3803 © 2022 by the authors; licensee asian online journal publishing group shocks to monetary policy instruments: does credit to the private sector respond in a similar manner to public sector credit in nigeria? a vector autoregressive approach nzeh, innocent chile1 benedict i. uzoechina2 millicent adanne eze3 ozoh joan nwamaka4 okoli uju victoria5 ( corresponding author) 1department of economics, renaissance university, ugbawka, enugu state, nigeria. 1email: nzechile@yahoo.com tel: +234-8034222084 3school of business and social sciences, abertay university, dundee, united kingdom. 3email: ezemillicent@gmail.com tel: (+44)7459452103 2,4,5department of economics, nnamdi azikiwe university, awka, anambra state, nigeria. 2email: ib.uzoechina@unizik.edu.ng tel: +234-8063304867 4email: jn.ozoh@unizik.edu.ng tel: +234-8066678226 5email: uv.okoli@unizik.edu.ng tel: +234-8037685667 abstract this paper aims to investigate the response of private and public sector credit to shocks in monetary policy instruments with a view to ascertaining if the responses differ. the study utilized the vector autoregressive (var) model with monthly data covering the period from 2010m1 to 2021m8. findings show that credit to private sector responds positively to shocks in money supply and monetary policy rate (mpr) in all periods. however, the response to cash reserve requirement (crr) was negative beginning from period five, and it also responded negatively to foreign interest rate shock. on the other hand, credit to government was found to respond positively to shocks in money supply up to period two and crr in all the periods, but it responded negatively to mpr starting from period three. the results of the variance decomposition show that other than shocks to itself, which was 100% in the first period, shocks to other variables influence private sector credit. also, other than shocks to itself, which was 99.89% in the first period, shocks to other variables lead to shocks to credit to government. we therefore recommend that policies used to influence financial intermediation should factor in the sensitivity of both public and private sectors to these policy instruments and the impact of exogenous shocks should be factored into policy formulation. keywords: credit to private sector, credit to government, money supply, monetary policy, cash reserve requirement, var. jel classification: c53; e51; e52; h74. citation | nzeh, innocent chile; benedict i. uzoechina; millicent adanne eze; ozoh joan nwamaka; okoli uju victoria (2022). shocks to monetary policy instruments: does credit to the private sector respond in a similar manner to public sector credit in nigeria? a vector autoregressive approach. asian journal of economics and empirical research, 9(1): 38-51. history: received: 20 january 2022 revised: 28 february 2022 accepted: 15 march 2022 published: 24 march 2022 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. authors’ contributions: all authors contributed equally to the conception and design of the study. competing interests: the authors declare that they have no conflict of interest. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted, and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. background to the study ................................................................................................................................................................ 39 2. theoretical background ................................................................................................................................................................. 41 3. methodology ..................................................................................................................................................................................... 42 4. results presentation and discussion of findings ..................................................................................................................... 45 5. conclusion and recommendations ............................................................................................................................................... 47 references .............................................................................................................................................................................................. 48 mailto:nzechile@yahoo.com mailto:ezemillicent@gmail.com mailto:ib.uzoechina@unizik.edu.ng mailto:jn.ozoh@unizik.edu.ng mailto:uv.okoli@unizik.edu.ng https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v9i1.3803 https://orcid.org/0000-0002-1754-7446 https://orcid.org/0000-0002-2951-4027 https://orcid.org/0000-0003-1332-6440 https://orcid.org/0000-0003-4250-5413 asian journal of economics and empirical research, 2022, 9(1): 38-51 39 © 2022 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the existing literature by splitting credit provision into private and public sector and investigating how tools of monetary policy shapes the behavior of credit to each sector. 1. background to the study credit provision to both the government and the private sector is essential for the running of an economy owing to the fact that, for the government, projected revenue rarely matches expenditure, and for the private sector operators, access to funds is usually a herculean task mostly in developing countries such as nigeria. the roles of banks in credit provision through their intermediation activities cannot be over-emphasized. in playing these roles, they source funds from surplus units (lenders) which they lend to deficit units (borrowers). such financial intermediation roles have been noted to promote economic growth as funds, which would otherwise lie idle, are put to productive use. however, before this intermediation role becomes effective, the role of interest rate is recognized. a borrower pays to borrow money over an agreed period of time from a lender, and interest rates influence the lending behavior of banks. the dilemma that monetary authorities face is how to use monetary policy tools, such as interest rate, to strike a balance between low and high credit provision. this is because low credit provision stifles the economy, while high credit provision has the tendency to raise money supply to a level that could spiral into inflation. in a bid to influence credit provision, monetary authorities employ monetary policy tools to achieve this and other macroeconomic objectives. monetary policy is a deliberate action of monetary authorities designed to achieve certain economic objectives through the regulation of the quantity, cost and availability of money and credit (central bank of nigeria, 2016). nyong (2011) noted that “these arrangements are designed in lieu of the legal framework that is in place to govern the financial practices of banks and, consequently, influence the availability of financial resources.” among the objectives of monetary policy, price stability has of recent become very prominent and is the reason nigeria has embraced inflation targeting as a key monetary policy thrust. in nigeria, monetary policy action is implemented through the central bank of nigeria (cbn), which is the apex bank. in order to achieve the monetary policy objectives, the central bank usually uses indirect means, which involves choosing the tools or instruments they can directly control (central bank of nigeria, 2016). according to the report, among the instruments at the disposal of the bank are monetary policy rate, open market operation (omo), reserve requirements, selective control and moral suasion. to achieve the goals of monetary policy, instruments of monetary policy are directed at target variables. these targets could be operating targets such as short-term interest rate and aggregate reserves (monetary base, reserves, etc.) or intermediate targets such as monetary aggregates (m1, m2) and aggregate demand (central bank of nigeria, 2016). the cbn uses its monetary policy instruments to hit the operating targets in order to hit the intermediate targets with a view to achieving its objective. with monetary policy tools, the cbn can influence credit extension through the use of interest rate, which is geared towards adjusting the lending rates of deposit money banks and other financial institutions. a major issue this study aims to investigate is the behavior of credit provision arising from shocks to monetary policy instruments. nigeria is an open economy that is integrated with other economies. therefore, apart from domestic factors that could introduce dynamism in the economy, exogenous factors could also alter policy choices. for instance, sudden changes in foreign interest rates could influence credit provision, thus influencing the choice of monetary policy instrument. in deploying a particular monetary policy instrument to influence credit provision, it is pertinent to find out how credit to the public and private sectors reacts to the selected monetary policy tools. a policy tool that leads to high interest rate could be inimical to growth because financial institutions, being profitoriented entities, will take undue advantage of such a development by charging high interest rates to borrowers. these profiteering tendencies will end up raising the cost of capital for investment. among the major reasons that motivated this study is the unresolved controversy regarding the impact of monetary policy on credit provision in nigeria. afolabi, adeyemi, salawudeen, & fagbemi (2018) noted that the transmission process of monetary policy to credit availability is not one-directional in nigeria. empirical evidence in nigeria has equally supported this observation (adediran, george, alege, & obasaju, 2019; ademokoya, sanni, oke, & abogun, 2020; adeniyi, kayode, sakirat, & olamide, 2018). another motivation is lack of research on the behavior of credit to both the private sector and public sector arising from shocks to monetary policy tools. some earlier related empirical studies have focused on the nexus between monetary policy and credit to the private sector (osakwe, okoye, ezeala, & okeke, 2022; udoh, dauda, ajayi, & ikpechukwu, 2021), while others were not specific about the impact of credit to any sector of the economy (abuka, alinda, minoiu, peydró, & presbitero, 2019; afolabi et al., 2018; onoh & nwachukwu, 2017). this particular study presents a clear departure from these studies by decomposing the flow of bank financial intermediation into private and public sectors in order to ascertain the behavior of credit to each sector arising from shocks to monetary policy instruments. in nigeria, this study is more relevant considering that the aftermath of the covid-19 lockdown, which affected international oil price and other sources of capital inflows, has reduced the revenue profile of the government and thus puts it in a position where it competes with the private sector in sourcing funds in the domestic financial markets. knowledge of the behavior of credit to each sector will therefore enable monetary authorities to direct the tools of monetary policy in a way that government borrowing does not crowd out private sector borrowing. 1.1. some stylized facts on bank credit in nigeria over the years, commercial banks in nigeria have engaged in the traditional role of financial intermediation by way of assessing funds from surplus units and lending to deficit units. to effectively play this role, adequate capital is necessary. the banking consolidation of 2005, which pegged the minimum capital base of banks in nigeria from n2 billion to n25 billion, was among the attempts to provide enough liquidity to the banking sector. figure 1 shows the trend of credit to the government from 2010. credit to the government began to improve from april 2014 after a previous sharp decline and attained a peak in july 2017 after which it again declined. from october asian journal of economics and empirical research, 2022, 9(1): 38-51 40 © 2022 by the authors; licensee asian online journal publishing group 2018, it began to rise until july 2020 when it experienced a marginal fall and then began to rise again. it should be noted that the quest for government borrowing in nigeria is mainly spurred by a fall in the international price of oil, which is the mainstay of the country’s economy. thus, as the budget is benchmarked on the projected price of oil, a fall in the price of oil below this benchmark means that the country has to borrow to cushion the shortfall in projected revenue. to support this hypothesis, figure 2 shows that prior to 2014, oil price experienced a rising trend; however, after 2014 it exhibited a falling trend. a huge fall in oil price occurred in december 2019, and within this period, credit to government rose steeply. the gradual effect of the covid-19 pandemic cannot be ruled out as being responsible for this phenomenon. figure 1. trend in credit to the government. note: crgov= credit to government (measured in billions of naira). figure 2. trend in oil price. note: oilp = oil price. figure 3 shows that credit to the private sector experienced a marginal rise all through the sample period, indicating that private sector credit in the country is not encouraging. several factors have been identified that are responsible for this, among which are the risky environments under which the banks operate which makes them risk averse in extending credit to the private sector, lack of adequate collateral securities on the part of borrowers, and government borrowing through the banks which crowds out private sector borrowing. figure 4 shows that a strong correlation exists between credit to the private sector and broad money supply (m2) in nigeria. such a strong correlation explains the role of money supply in liquidity build-up in banks and how increased liquidity could encourage increased credit extension. figure 3. trend in credit to private sector. note: crpirv= credit to private sector (measured in billions of naira). asian journal of economics and empirical research, 2022, 9(1): 38-51 41 © 2022 by the authors; licensee asian online journal publishing group figure 4. trend in credit to private sector and money supply. note: crpriv = credit to the private sector. m2 = broad money supply. all variables are measured in billions of naira. figure 5 shows the link between foreign interest rate (proxied by the us funds rate) and prime lending rate in nigeria. the aim here is to tentatively check how deposit money banks react to changes in foreign interest rate. as profit-making entities, it is expected that each time foreign interest rate rises in relation to domestic interest rate, deposit money banks will channel their investments to foreign-currency-dominated investment outlets. the reverse is the case if foreign interest rate falls in relation to domestic interest rate. such investment decisions have the tendency to influence the flow of domestic credit provision. as shown in figure 5, in 2009 when the federal fund rate was flat, the prime lending rate was relatively high, and beginning from 2017 when the fund rate was experiencing a rising trend, the prime lending rate was flat. figure 5. trend in prime lending rate and foreign interest rate. note: fintr = foreign interest rate; plr = prime lending rate. 2. theoretical background the theoretical basis for this study relies on the theoretical views of john maynard keynes, which are contained in his famous work the general theory of employment, interest and money” published in 1936. the role of government in economic intervention is recognized by keynes as government is thought to stabilize the economy during the adverse phases of the business cycle and maintain full employment using fiscal policy measures. keynes advocated the use of monetary mechanisms to influence aggregate demand, even though he contended that the role of money in achieving this is not a direct one. keynes’ views on both fiscal and monetary policies presuppose a blend of both measures because, in some instances, monetary policy could fail to achieve its objective. following on keynes’ argument, amacher & ulbrich (1986) observed that monetary policy transmits to the larger economy through its influence on interest rate and thereafter to investment decisions of financial institutions, such as banks and other economic agents, and finally to output and income through the multiplier process. operationally, keynes’ hypothesis can be stated as follows: suppose the economy is experiencing recession, and to reflate the economy, the monetary authorities thought it necessary to purchase government securities through the open market operation (omo). such action is expected to increase the reserve position of deposit money banks (dmbs) and with increased liquidity banks will have enough leverage to extend credit. an empirical study by nzeh, uzoechina, eze, imoagwu, & ozoh (2022) has shown that an increase in bank reserves leads to improved credit to the private sector in nigeria. increased credit provision creates new demand deposits which lead to rising money supply. as money supply rises, interest rate is expected to fall, which, in turn, stimulates investment, leading to economic prosperity via the multiplier process. algebraically, the above channel can be stated as follows: gnpirmromo s →→→→→ where: omo = open market operations, r = reserves of deposit money banks, sm = money supply, r = rate of interest, i = investment, and gnp = gross national product. 0 100 200 300 400 500 600 700 800 2 0 1 0 m 1 2 0 1 0 m 7 2 0 1 1 m 1 2 0 1 1 m 7 2 0 1 2 m 1 2 0 1 2 m 7 2 0 1 3 m 1 2 0 1 3 m 7 2 0 1 4 m 1 2 0 1 4 m 7 2 0 1 5 m 1 2 0 1 5 m 7 2 0 1 6 m 1 2 0 1 6 m 7 2 0 1 7 m 1 2 0 1 7 m 7 2 0 1 8 m 1 2 0 1 8 m 7 2 0 1 9 m 1 2 0 1 9 m 7 2 0 2 0 m 1 2 0 2 0 m 7 2 0 2 1 m 1 2 0 2 1 m 7 crpriv m2 asian journal of economics and empirical research, 2022, 9(1): 38-51 42 © 2022 by the authors; licensee asian online journal publishing group 2.1. empirical literature review the importance of credit provision to the economy has led to studies devoted to investigating the factors affecting it. even though monetary policy is expected to influence credit provision in a certain direction, there is yet to be a consensus on the actual impact of the various monetary policy instruments on credit provision. in mauritius, preethee, allybokus, sookia, & gujadhur (2010) used a vector autoregressive (var) model with quarterly data from 1985q1 to 2006q4 to show that monetary policy is effective in credit provision in the shortrun. matemilola, bany-ariffin, & muhtar (2014) applied the momentum threshold autoregressive and asymmetric error correction models to reveal that bank lending rate adjusts to a decrease in the money market rate in south africa. a study on nigeria by onoh & nwachukwu (2017) used the ordinary least squares (ols) techniques to show that, while the monetary policy rate (mpr), cash reserve requirement (crr) and money supply have a positive link with loan extension, the liquidity ratio is negatively linked to it. using descriptive and ex post facto research design, ndubuaku, ifeanyi, nze, & onyemere (2017) showed that mpr did not have a significant impact on loans and advances during the sap era in nigeria. however, the impact is noticeable during the post-sap period. in another study on nigeria, afolabi et al. (2018) employed toda and yamamoto’s granger non-causality model to reveal that mpr proved to be a significant variable that causes bank loans and advances in nigeria. however, crr and other variables do not granger-cause loan and advances. fisera & kotlebova (2019) used the dynamic ordinary least squares (dols) and fully modified ordinary least squares (fmols) models to reveal that unconventional policies did not lift bank lending in slovakia and the czech republic in the post-crisis era. in a study involving developing countries, abuka et al. (2019) showed that monetary contraction reduces bank credit supply, increasing loan application rejections and tightening loan volume and rates. in nigeria, bassey & ekong (2019) used the var framework to reveal that mpr, money supply and crr were very effective in improving the credit performance of commercial banks in nigeria. adediran et al. (2019) employed the ardl framework with annual data covering the period from 1980 to 2015 to show that cash reserve requirement is significant in growing the nigerian economy compared to the monetary policy rate. using the fmols model with monthly data covering the period from 2007 to 2019, ademokoya et al. (2020) found that money supply significantly and positively influences bank credit in nigeria, while the liquidity ratio significantly but negatively influences bank credit in nigeria. however, the mpr and maximum lending rate did not significantly affect bank credit. aikman, lehnert, liang, & modugno (2020) used threshold vars to show that credit is an important conditioning variable for the effects of financial variables on macroeconomic performance in the us. in a study on sierra leone, bangura, ngombu, pessima, & kargbo (2021) employed the generalized method of moments (gmm) model to reveal that mpr significantly and negatively influences banks’ loan supply. for nigeria, udoh et al. (2021) used a var framework and monthly data spanning 2008–2018 to show that a positive shock to monetary policy rate has no effect on bank lending to the private sector. pham, le, & nguyen (2021) used different econometric techniques to show that an increase in the base rate is significantly associated with a contraction in bank liquidity creation in 23 vietnamese commercial banks. osakwe et al. (2022) used the ols technique to reveal that total private sector credit has a significant relationship on monetary policy rate, liquidity ratio and cash reserve ratio. 3. methodology in this paper, monthly data covering the period from 2010m1 to 2021m8 was used to analyze the response of bank financial intermediation to shocks in monetary policy instruments in nigeria. apart from data on foreign interest rate that were sourced from the federal bank of st louis, data on other variables were obtained from the central bank of nigeria’s statistical bulletin. exchange rate is in nominal form, while m2, credit to the private sector and credit to the government are in log form. because of the dynamic nature of the relationship among the variables, the var framework was used. the suitability of the var model for this topic is based on the fact that it enables us to treat all of the variables as endogenous such that it can handle any effect that variables have on each other. the var framework adopted is a departure from the studies that adopted the ols, dols and fmols models (ademokoya et al., 2020; fisera & kotlebova, 2019; onoh & nwachukwu, 2017). since monetary variables by their nature experience feedback, models that rely on a one-way approach cannot produce optimal results because possible feedback is ignored. however, the var approach is supported by allybokus, sookia, & gujadhur (2010); bassey & ekong (2019) and udoh et al. (2021). to ensure that a spurious regression is not run, first, the stationarity of the series was tested. in doing this, the augmented dickey–fuller (adf) and phillips–perron (pp frameworks were utilized. the order of integration of the series guided the choice of the var model. having shown that the series are i(1), we tested for cointegrating relationships using the johansen cointegration technique. the johansen cointegration test showed that the series are not cointegrated, thus eliminating the need to investigate a long-run impact. this led to estimation of the short-run unrestricted var model. in selecting the lag order for the var eight lags were chosen in the unrestricted var model without imposing any restriction on the coefficients. the optimal lag for the study was then selected using the hannan–quinn (hq) information criterion, following rummel (2015), who noted that the hannan–quinn information criterion is typically more appropriate for quarterly and monthly data. thus, for optimal lag order selection, lag 1 is suggested by this criterion. the stability of the var model was tested using the inverse roots of the autoregressive characteristic polynomial. for the identification of the relationships existing among the variables, the cholesky impulse response function in addition to the variance decomposition of the residuals are used in the study. 3.1. basic var model vector autoregression (var) is a framework applied to capture multivariate relationships in a model as the variables change over time. it is a type of stochastic process model in which each of the variables has an equation that models its evolution over time. the equation of each variable includes the lagged or past values of a particular variable as well as other variables’ lagged values in addition to the innovation (error term). the evolution of the endogenous variables, known as a set of k variables over time, is described by the var model. under this model, tt .....1= is used to number each time period. a vector, tx of length k , is modeled as a linear function of its https://en.wikipedia.org/wiki/stochastic_process https://en.wikipedia.org/wiki/lag_operator asian journal of economics and empirical research, 2022, 9(1): 38-51 43 © 2022 by the authors; licensee asian online journal publishing group lagged value. the order of var is very important and this order refers to the number of earlier periods to be included in the model. for instance, a thp order var denotes a var model that includes last p time periods of lags. a typical thp order var model can be represented in equation 1 as: 𝑥𝑡 = 𝑐 + 𝐴1𝑥𝑡−1 + 𝐴2𝑥𝑡−2+. . . . . . . . . 𝐴𝑝𝑥𝑡−𝑝 + 𝑒𝑡 (1) where: 1−tx = lag of tx . c = k-vector of constant intercepts. ta = -k) ×(k matrix that are time invariant. te = k-vector of error terms. the error terms or innovation must fulfill the following conditions: (i) 0)( =tee which implies that the error terms have a mean of zero; (ii) =)( 1 tteee (the covariance matrix of innovations is a kxk positive semi-definite matrix denoted as ω); (iii) 0)( =−ktteee (for every non-zero k, there is an absence of serial correlation across time). in a var framework, it should be noted that all the variables in the model have to be integrated of the same order. if cointegration exists among the variables, the var model must contain an error correction term, and should such a condition occur, the model turns to a vector error correction model (vecm), which can be seen as a restricted var. in the absence of cointegration, a short-run unrestricted var is used to estimate short-run impacts. a two-variable var(1) is expressed in matrix form in equation 2 as follows: [ 𝑥1,𝑡 𝑥2,𝑡 ] = [ 𝑐1 𝑐2 ] + [ 𝑎1,1 𝑎2,1 𝑎1,2 𝑎2,2 ]       − − 1,2 1,1 t t x x +       t t e e ,2 ,1 (2) where 2,1 cc are the constant terms. sa are the kxkmatrices. 21,ee are the error terms. the scalar representation of equation 2 can be stated in equations 3 and 4 as follows: 𝑥1,𝑡 = 𝑐1 + 𝑎1,1𝑥1,𝑡−1 + 𝑎1,2𝑥2,𝑡−1 + 𝑒1,𝑡 (3) 𝑥2,𝑡 = 𝑐2 + 𝑎1,1𝑥1,𝑡−1 + 𝑎2,2𝑥2,𝑡−1 + 𝑒2,𝑡 (4) in a more concise form, the general structure of the var model used for multivariate time series can be represented in equation 5 as follows: 𝑋𝑡 = 𝛢𝑖 + ∑ 𝛽𝑖 𝑘 𝑡==1 𝑋𝑡−1 + 𝜀𝑡 (5) where tx = 1kx vector of endogenous variables, i = vector of fixed intercept terms, t = white noise with ),( 2  oiidt  , and k = lag order. in this study, a seven-variable var model was run consisting of credit to the private sector, credit to the government, monetary policy rate, cash reserve requirement, exchange rate, money supply and foreign interest rate. the policy variables used in the study are monetary policy rate (mpr), cash reserve requirement (crr) and money supply, which is an intermediate target. while the mpr is a benchmark rate that the cbn influences in order to influence other rates in the economy, the cash reserve ratio is influenced in order to directly influence the reserve position of deposit money banks (dmbs). we decomposed financial intermediation into credit to the private sector and credit to the public sector. as noted by kim & roubini (2000), exchange rate is a forwardlooking asset price and, as such, can be treated as an exogenous variable in the model because the nigerian economy is an open economy. also, exchange rate stability is a major monetary policy objective in nigeria. foreign interest rate proxy by the us federal funds rate serves as another exogenous variable whose shock can be transmitted to the domestic economy. in matrix form, reflecting the variables used in this study, the var framework adopted is expressed in equation 6 as follows:                       t t t t t t t exchr fintr lm crr mpr lcrgov lcrpriv 2 =                       7 6 5 4 3 2 1 a a a a a a a + 1,7 1,6 1,5 1,4 1,3 1,2 1,1        2,7 2,6 2,5 2,4 2,3 2,2 2,1        3,7 3,6 3,5 3,4 3,3 3,2 3,1        4,7 4,6 4,5 4,4 4,3 4,2 4,1        5,7 5,6 5,5 5,4 5,3 5,2 5,1        6,7 6,6 6,5 6,4 6,3 6,2 6,1        7,7 7,6 7,5 7,4 7,3 7,2 7,1                              − − − − − − − 1 1 1 1 1 1 1 2 t t t t t t t exchr fintr lm crr mpr lcrgov lcrpriv +                           t t t t t t t exchr fintr lm crr mpr lcrgov lcrpriv        2 (6) where lcrpriv = log of credit to the private sector, lcrgov = log of credit to the government, mpr = monetary policy rate, crr= cash reserve requirement, lm2 = log of broad money supply (a proxy for money supply), fintr = foreign interest rate, and exchr= exchange rate. the intercept terms are indicated by the a https://en.wikipedia.org/wiki/y-intercept https://en.wikipedia.org/wiki/errors_and_residuals_in_statistics https://en.wikipedia.org/wiki/expected_value https://en.wikipedia.org/wiki/covariance_matrix https://en.wikipedia.org/wiki/positive-definite_matrix https://en.wikipedia.org/wiki/positive-definite_matrix https://en.wikipedia.org/wiki/correlation https://en.wikipedia.org/wiki/error_correction_model asian journal of economics and empirical research, 2022, 9(1): 38-51 44 © 2022 by the authors; licensee asian online journal publishing group terms, the regression coefficients are indicated by the  values, and the error term of each equation at time t is indicated by the  terms. 3.2. lag order selection lag length selection is a special feature in the var model. the model selection criterion enables us to determine the lag length. as a rule, in the approach to fitting var (p) models, one has to first specify a var with orders p = 0, ..., maxp and thereafter to choose the value of p that minimizes some model selection criteria. for a var (p) model, the selection criteria can be in the form of equation 7 below: 𝐼𝐶(𝑝) = 𝑙𝑛 |∑(𝑝) − | + 𝑐𝑇 ∗ 𝜑(𝑛, 𝑝) (7) where: )( pic denotes information criterion with order p.  − )( p = t t e t eet 1 1 1  −  −  is the residual covariance matrix. tc is a sequence indexed by t (the sample size). ),( pn is a function that denotes a penalty arising from large var(p) models. the akaike (aic), the bayesian (or schwarz) (bic/sic) and hannan–quinn (hqc) are the three commonly used information criteria. these information criteria can be expressed as follows in equations 8, 9 and 10: (8) (9) (10) where: t = the effective sample size.  −  = the maximum likelihood estimate of  −  . the lag order p is chosen in each case to minimize the value of the criterion over a range of alternative lag orders p, given by: ( ) −  ppp 1: . among these criteria, kilian (2001) noted that the schwarz information criterion (sic) and the hannan–quinn information criterion (hqc) are believed to be better suited when analyzing finite lag order var models, while the akaike information criterion (aic) is more appropriate for infinite order autoregressions. furthermore, the study observed, that of all the criteria, only the sic and hqc are strongly consistent for po. 3.3. impulse responses in order to analyze the dynamic behavior of financial intermediation proxy variables in the model owing to unanticipated shocks in the policy variables, the impulse response function is utilized. the impulse response function indicates the evolution of a variable over a period of time that is caused by a shock in another variable. it is the responses of all the variables in the model to a one-unit structural shock to one variable in the model and is plotted on the y-axis with the periods from the initial shock on the x-axis. the impulse response variable investigates the effect of a shock te to the variable kttx +, . enders (1995), as cited in gan, lee, yong, & zhang (2006), noted that each )(ijk is interpreted as the time-specific partial derivatives of the var moving average (vma) (∞) function. this is expressed in equation 11 as follows: 𝜓𝑗𝑘(𝑖) = 𝜕𝑥𝑗𝑖 𝜕𝑒𝑘 (11) equation 11 measures the change in the thj variable in period t arising from a unit shock to the thk variable in the current period. 3.4. variance decomposition the variance decomposition of the innovations shows the part of information contributed by each variable as an explanation of the evolution of other variables. in their study, allybokus et al. (2010) observed that to analyze the contribution of the error terms t to the total forecast error variance (fev), the system orthogonalized. accordingly, if =]'[ tte  and 1'=rr , where r is lower triangular, then 1]'[]',',[ == tterre  where t are the orthogonalized white noise innovations. applying the moving average (ma) form of the var process, jkt j jktx −+  = + =  0 , the optimal k-step forecast error is stated in equation 12 as follows: asian journal of economics and empirical research, 2022, 9(1): 38-51 45 © 2022 by the authors; licensee asian online journal publishing group jkt k j l t kt xx −+ = =+  + =−  1 01 = jkt k j jjkt k j j crr −+ − = −+ − − =  =  1 0 1 1 0 (12) 4. results presentation and discussion of findings this sub-section presents and interprets the results of the findings according to the processes followed in order to achieve the study’s objective. 4.1. stationarity results in every time series analysis, testing the order of integration of the series is essential to avoid generating results that are not relevant. in testing the stationarity of the series, this paper adopts the frameworks of the augmented dickey–fuller test (adf) and the phillips–perron test (pp), which are conducted at the 5% level of significance. as shown in table 1, the unit root results at level indicates that none of the series are stationary at the 5% level of significance apart from credit to the government under the pp. these results indicate that we cannot proceed with the analysis as any results generated based on these will be spurious. we therefore tested the unit root further by differencing the series by one period. the unit root results at first difference (see table 2) show that the series become integrated of order one i(1) after first differencing. table 1. result of the unit root tests at level. variables adf t-stat. pp t-stat. adf critical value at 5% pp critical value at 5% order of integration lcrpriv -2.42 -2.26 -3.44 -3.44 lcrgov -2.81 -4.84* -3.44 3.44 pp i(0) mpr -1.42 -1.50 -3.44 -3.44 crr -1.98 -2.74 -3.44 -3.44 lm2 -0.61 -0.18 -3.44 -3.44 fintr -1.20 -1.20 -3.44 -3.44 exchr -2.64 -2.17 -3.44 -3.44 note: figures with asterisks (*) indicate rejection of the null hypothesis at the 5% level. table 2. results of the unit root tests at first difference. variables adf t-stat. pp t-stat. adf critical value at 5% pp critical value at 5% order of integration ∆ lcrpriv -9.23* -9.23* -3.44 -3.44 i(1) ∆ lcrgov -16.5* -16.6* -3.44 -3.44 i(1) ∆ mpr -11.5* -11.5* -3.44 -3.44 i(1) ∆ crr -8.53* -11.8* -3.44 -3.44 i(1) ∆ lm2 -12.10* -13.2* -3.44 -3.44 i(1) ∆ fintr -7.33* -7.26* -3.44 -3.44 i(1) ∆ exchr -5.70* -6.50* -3.44 -3.44 i(1) note: figures with asterisks (*) indicate rejection of the null hypothesis at the 5% level. 4.2. lag selection criteria with the stationarity results showing that the series are i(1), it is proper to investigate the cointegrating relationship among the variables using the johansen cointegration technique. however, the lag order selection is a prerequisite for testing for cointegration. for lag order selection, eight lags were chosen in the unrestricted var model without imposing any restriction on the coefficients. in table 3, each selection criterion shows the optimal number of lags. the hannan–quinn information criterion was chosen to obtain the optimal lag for this study. table 3 shows that lag 1 is selected by both the hqc and sic 4.3. lag exclusion to further test the reliability of the chosen optimal lag, a lag exclusion test was conducted. this test is guided by the statistical significance of the p-value of the joint model variables. if the p-value is less than 0.05, we can conclude that the chosen lag is appropriate. table 4 shows the wald test results of the var lag exclusion. the test shows that the joint p-value is statistically significant at the 5% significance level. on account of this, the lag order selected by the hannan–quinn information criterion is appropriate for the study. table 3. var lag order selection criteria. lag log l lr fpe aic sic hqc 0 -1227.7 na 0.56 19.3 19.4 19.4 1 -115.6 2085.2 3.45 2.68 3.93* 3.19* 2 -50.3 115.3 2.69 2.43 4.77 3.38 3 6.29 93.8 2.43* 2.31* 5.74 3.70 4 41.9 55.07 3.09 2.52 7.04 4.36 5 79.9 54.7 3.87 2.69 8.30 4.97 6 134.5 72.5* 3.85 2.60 9.31 5.33 7 183.9 60.2 4.30 2.59 10.4 5.76 8 228.7 49.8 5.39 2.66 11.6 6.27 note: * indicates lag order selected by the chosen criterion. lr= likelihood ratio, fpe = final prediction error; aic:= akaike information criterion, sic = schwarz information criterion, hqc = hannan–quinn information criterion. asian journal of economics and empirical research, 2022, 9(1): 38-51 46 © 2022 by the authors; licensee asian online journal publishing group table 4. var lag exclusion wald tests. chi-squared test statistics for lag exclusion numbers in [ ] are p-values variables lcrpriv lcrgov mpr crr lm2 exchr fintr joint lag 1 166.03 [ 0.00] 29.7 [ 0.00] 142.6 [0.00] 99.6 [0.00] 92.2 [0.00] 356.2 [0.00] 284.9 [0.00] 1117.7 [0.00] lag 2 12.4 [ 0.09] 18.9 [ 0.008] 22.1 [0.002] 5.98 [0.54] 3.37 [0.85] 50.3 [ 1.24] 29.9 [ 9.82] 138.5 [ 1.77] df 7 7 7 7 7 7 7 7 4.4. inverse roots of the ar result the stability of the var model is essential for the reliability of the results. when a var model is stable, the implication is that any shocks in the system are temporary and will disappear after a period of time. in testing for var stability, the inverse roots of the autoregressive characteristic polynomial were employed. birman (2012) noted that in an autoregressive process, ar(1): ttot yy  ++= −11 , the prerequisite for stability is   11  . however, in a var system denoted as ttt xx ++= −110 , the condition for stability is that the roots of the characteristic equation of the matrix should lie inside the unit circle. the result of the inverse roots of the autoregressive characteristic polynomial, as shown in figure 6, indicates that the ar process is stationary since the roots of the equation are found within the unit circle. figure 6. inverse roots of the autoregressive characteristic polynomial. 4.5. cointegration results as noted earlier, the johansen cointegration test was used to investigate the long-run equilibrium relationship among the model variables since the series are integrated of order one, i.e., i(1). tables 5 and 6 display the results of the cointegration tests with both the trace and maximum eigenvalue tests indicating p-values that are greater than the 5% level of significance at all the levels. the results of these tests confirm that the series are not cointegrated. the implication of the non-existence of a long-run relationship among the series is that we cannot investigate the long-run impacts, thus we only have to consider a short-run relationship among the series. table 5. unrestricted cointegration rank test (trace). hypothesized no. of ce(s) eigenvalue trace statistic 0.05 critical value prob. none 0.23 105.9 125.6* 0.42 at most 1 0.17 71.8 95.8* 0.66 at most 2 0.15 47.1 69.8* 0.76 at most 3 0.10 25.2 47.9* 0.91 at most 4 0.05 10.3 29.8* 0.98 at most 5 0.02 3.28 15.5* 0.95 at most 6 0.004 0.56 3.84* 0.46 note: trace test indicates no cointegration at the 0.05 level. * denotes rejection of the hypothesis at the 0.05 level. table 6. unrestricted cointegration rank test (maximum eigenvalue). hypothesized no. of ce(s) eigenvalue max. eigen statistic 0.05 critical value prob. none 0.23 34.1 46.2* 0.52 at most 1 0.17 24.7 40.07* 0.79 at most 2 0.15 21.9 33.9* 0.6157 at most 3 0.11 14.9 27.6* 0.75 at most 4 0.05 6.99 21.1* 0.95 at most 5 0.02 2.72 14.3* 0.96 at most 6 0.004 0.56 3.84* 0.45 note: maximum eigenvalue test indicates no cointegration at the 0.05 level. * denotes rejection of the hypothesis at the 0.05 level. asian journal of economics and empirical research, 2022, 9(1): 38-51 47 © 2022 by the authors; licensee asian online journal publishing group 4.6. impulse response results the impulse response results in appendix 1 indicate that credit to the private sector responds positively to money supply in all the periods under study. this is in accord with a priori expectation as rising money supply without regulation increases liquidity in the banking system, which gives deposit money banks enough leverage to extend credit facilities. the macroeconomic implications of rising money supply, especially its impact on the price level, is among the major rationales for monetary policy intervention. in nigeria, the main policy thrust of the monetary authority is inflation targeting, bearing in mind that growing monetary aggregates cause inflation. the findings also show that credit to the private sector responds positively to monetary policy rate (mpr) in all the periods. however, this result is not supported by udoh et al. (2021), who found no significant link between credit to the private sector and shocks to the mpr. this finding is contrary to the objective of monetary policy as a tool to reduce the ability of banks to extend credit using contractionary monetary policy, such as increase in the mpr. as the mpr is a benchmark rate that influences other rates, we are of the view that banks take advantage of the rising interest rate occasioned by a high mpr to extend more credit to the private sector since they are profitoriented. this explains why the lending rate in nigeria is always very high compared to the deposit rate. it was also found that credit to the private sector responded positively to the cash reserve ratio (crr) up to the fourth period, but from period five the response became negative. as a tool to reduce the ability of banks to extend credit through influencing their reserve position, especially during inflationary periods, the cbn alters the cash reserve ratio in most of its monetary policy committee meetings to align with current macroeconomic reality. the fact that the actual impact of the policy is felt after the fourth period is an indication of the time the policy takes to influence the targeted objective. credit to the private sector was found to negatively respond to foreign interest rate starting from period two. as an exogenous variable, shocks to foreign interest rate reverberate to the domestic economy. a rise in us funds rate, for instance, provides an investment opportunity for deposit money banks such that it dampens their domestic financial intermediation role as they scramble to avail of the opportunity to invest in foreign denominated assets. credit to the private sector was found to respond negatively to the exchange rate from period two and thereafter. this shows the sensitivity of exchange rate to credit provision in nigeria as banks consider foreign currency denominated investment assets as alternatives to domestic credit extension. in another vein, credit to the government responded positively to money supply up to the second period, but thereafter the response became negative. we contend that a rising money supply reduces the need for the government to borrow money, and the falling interest rate this scenario entails provides additional rationale for reduced bank lending. findings also show that credit to the government responded negatively to the mpr starting from period three. this is contrary to the response of credit to the private sector to shocks in the mpr, which is positive throughout the whole period. since credit to the government is mainly in the form of bonds with a fixed interest rate, as the mpr is raised we contend that banks would prefer to lend to the private sector with a marketdetermined interest rate to generate more revenue. unlike the response of credit to the private sector to changes in the cash reserve requirement, credit to the government responds positively to the cash reserve requirement in all periods. the implication is that banks become risk averse when their reserves are reduced and would prefer to lend more to the government since public sector credit is more secure. in all the periods, results show that credit to the government responds positively to the foreign interest rate and the exchange rate. as an intermediate target that can be influenced to impact key monetary policy objectives, money supply was found to respond negatively to both the mpr and the crr after the first and second periods. rising money supply entails increases in policy instruments in order to neutralize the impact of monetary growth on the macroeconomic variables, especially price level. the findings reveal how shocks to foreign interest rate transmit to money supply in nigeria as money supply responds negatively to foreign interest rate after the first period. a rise in foreign interest rate in relation to domestic interest rate means that domestic interest rate bearing investment assets are becoming less attractive and the consequence is rising capital outflows and lower capital inflows, hence the reduction in money supply. 4.7. variance decomposition results the results of the variance decomposition in appendix 2 that other than shocks to itself, which was 100% in the first period, shocks to money supply explained about 0.81% of shocks to credit to the private sector in the second period, which continuously rise until it settled at 36% in the last period. shocks to the mpr explained about 1.4%, 2.8% and 3.9% in periods two, three and four, respectively, to shocks to credit to the private sector until it settled at 4% from period five until the last period. shocks to the crr explained about 0.4% of shocks to credit to the private sector, which marginally rose until it settled at approximately 3% in the last period. foreign interest rate shocks explained about 0.2% of shocks to credit to the private sector and these shocks fluctuated over the period. findings also reveal that other than shocks to itself, which was 99.89% in the first period, shocks to money supply explained about 0.58% of shocks to credit to the government in the second period, which fell to 0.47% in the third period, and then the shocks marginally reduced up until the last period. shocks to the mpr explained about 0.03% of shocks to credit to the government in the second period, which marginally rose to 0.05% in the third period, reduced to 0.047% in the fifth period, and finally settled at 0.14% in the last period. shocks to the crr explained about 0.96% of shocks to credit to the government in the second period, which increased thereafter until it settled at 3.6% in the last period. shocks to foreign interest rate explained about 1.16% of shocks to credit to the government in the second period, which marginally fluctuated until it settled at 2.1% in the last period. 5. conclusion and recommendations in this study, we set out to investigate the responses of credit to the private sector and credit to the government to shocks in monetary policy instruments using the var model with monthly data covering the period from 2010m1 to 2021m8. the findings reveal that credit to the private sector and credit to the government respond differently to shocks in monetary policy instruments. for instance, while credit to the government responded negatively to shocks in the mpr after couple of periods, the response of credit to the private sector to shocks in the mpr was positive through the entire period under study. also, as credit to the private sector responded negatively to shocks in the cash reserve requirement, the response of credit to the government was asian journal of economics and empirical research, 2022, 9(1): 38-51 48 © 2022 by the authors; licensee asian online journal publishing group positive throughout the whole period. we found that money supply responded negatively to shocks in the mpr and crr after a short period of time and also responded negatively to shocks in foreign interest rate. the conclusion of our findings is that different monetary policy tools exert different influences on both credit to the private sector and credit to the government. the policy implications of these findings are that, for a government that wants to improve private sector lending in order to improve productivity and reduce unemployment, it would not be appropriate to use uniform monetary policy tools to influence the direction of credit. the use of selective credit, though not commonly used, should be given priority to ensure that credit flows to the chosen sector. thus, for the monetary authorities to envisage that uniform monetary policy tools could influence the flow of credit to the two sectors of the economy in a similar direction could be misleading. second, even though both the crr and mpr work effectively in influencing money supply, which is used as an intermediate target, the inability to factor in the influence of foreign interest rate shock could work against the use of these tools to influence money supply. a rise in foreign interest rate, for instance, could lead to an abrupt capital outflow, which will reduce money supply and thus jeopardize the expansionary monetary stance of the monetary authorities and vice versa. consequently, we recommend that policy tools used to influence financial intermediation should factor in the sensitivity of both public and private sectors to changes in these tools. also, the use of both the mpr and crr to influence money supply should be given priority, especially during intense deflationary or inflationary periods, while monetary authorities should be conscious of the effects of exogenous shocks on domestic money supply. references abuka, c., alinda, r. k., minoiu, c., peydró, j.-l., & presbitero, a. f. 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(2017). monetary policy and credit delivery in commercial banks–evidence from nigeria. international journal of social sciences and management research, 3(7), 2545-5303. osakwe, c. i., okoye, n. j., ezeala, g., & okeke, l. n. (2022). monetary policy instruments: effect on the performance of deposit money banks in nigeria. journal of contemporary issues in accounting, 1(1), 74-90. pham, h. s. t., le, t., & nguyen, l. q. t. (2021). monetary policy and bank liquidity creation: does bank size matter? international economic journal, 35(2), 205-222. preethee, n., allybokus, m., sookia, n., & gujadhur, p. (2010). a vector autoregressive (var) approach to the credit channel for the monetary transmission mechanism in mauritius. university of mauritius research journal, 16(1), 169-195. rummel, o. (2015). economic modelling and forecasting: var, svar and vecm modelling. england: bank of england centre for central banking studies. udoh, e. a., dauda, m., ajayi, k. j., & ikpechukwu, n. c. (2021). monetary policy transmission in nigeria: does the credit channel work? the journal of developing areas, 55(1), 283-301. asian journal of economics and empirical research, 2022, 9(1): 38-51 49 © 2022 by the authors; licensee asian online journal publishing group -.02 .00 .02 .04 .06 .08 .10 1 2 3 4 5 6 7 8 9 10 11 12 lncrpriv lncrgov log(m2) mpr crr fintr exchr accumulated response of lncrpriv to cholesky one s.d. innovations -1 0 1 2 3 4 5 1 2 3 4 5 6 7 8 9 10 11 12 lncrpriv lncrgov log(m2) mpr crr fintr exchr accumulated response of lncrgov to cholesky one s.d. innovations -.10 -.05 .00 .05 .10 .15 .20 .25 1 2 3 4 5 6 7 8 9 10 11 12 lncrpriv lncrgov log(m2) mpr crr fintr exchr accumulated response of log(m2) to cholesky one s.d. innovations -1 0 1 2 3 4 1 2 3 4 5 6 7 8 9 10 11 12 lncrpriv lncrgov log(m2) mpr crr fintr exchr accumulated response of mpr to cholesky one s.d. innovations -2 0 2 4 6 8 1 2 3 4 5 6 7 8 9 10 11 12 lncrpriv lncrgov log(m2) mpr crr fintr exchr accumulated response of crr to cholesky one s.d. innovations -0.5 0.0 0.5 1.0 1.5 1 2 3 4 5 6 7 8 9 10 11 12 lncrpriv lncrgov log(m2) mpr crr fintr exchr accumulated response of fintr to cholesky one s.d. innovations -20 0 20 40 60 80 1 2 3 4 5 6 7 8 9 10 11 12 lncrpriv lncrgov log(m2) mpr crr fintr exchr accumulated response of exchr to cholesky one s.d. innovations appendix 1. impulse response results. appendix 2. variance decomposition results. variance decomposition of lcrpriv. period s.e. lcrpriv lcrgov l(m2) mpr crr fintr exchr 1 0.01 100.0 0.00 0.00 0.00 0.00 0.00 0.00 2 0.02 97.2 0.002 0.81 1.37 0.39 0.21 0.06 3 0.02 92.2 0.04 3.84 2.84 0.57 0.42 0.11 4 0.02 86.04 0.22 8.53 3.94 0.48 0.59 0.18 5 0.02 79.5 0.57 13.9 4.60 0.39 0.73 0.28 6 0.03 73.3 1.08 19.03 4.91 0.46 0.81 0.41 7 0.03 67.7 1.68 23.5 4.98 0.69 0.85 0.55 8 0.03 62.9 2.32 27.3 4.90 1.04 0.86 0.69 9 0.03 58.8 2.96 30.4 4.75 1.47 0.85 0.83 10 0.04 55.4 3.56 32.8 4.57 1.94 0.83 0.95 11 0.04 52.51 4.12 34.7 4.38 2.42 0.80 1.05 12 0.04 50.1 4.63 36.3 4.19 2.89 0.77 1.13 note: cholesky ordering: lcrpriv, lcrgov, l(m2), mpr, crr, fintr, exchr. variance decomposition of lcrgov. period s.e. lcrpriv lcrgov l(m2) mpr crr fintr exchr 1 1.04 0.10 99.9 0.00 0.00 0.00 0.00 0.00 2 1.145959 0.16 96.9 0.58 0.03 0.96 1.16 0.14 3 1.27 0.18 96.2 0.47 0.05 1.23 1.52 0.32 4 1.34 0.15 95.4 0.44 0.05 1.54 1.89 0.51 5 1.39 0.15 94.8 0.41 0.06 1.83 2.05 0.69 6 1.42 0.15 94.3 0.39 0.06 2.13 2.13 0.86 7 1.45 0.16 93.8 0.38 0.07 2.42 2.16 1.003 8 1.46 0.18 93.4 0.37 0.08 2.69 2.17 1.12 9 1.48 0.20 93.03 0.36 0.09 2.95 2.16 1.21 10 1.49 0.23 92.7 0.36 0.10 3.18 2.14 1.29 11 1.49 0.26 92.4 0.35 0.12 3.38 2.13 1.34 12 1.50 0.29 92.2 0.35 0.14 3.56 2.11 1.38 note: cholesky ordering: lcrpriv, lcrgov, l(m2), mpr, crr, fintr, exchr. asian journal of economics and empirical research, 2022, 9(1): 38-51 50 © 2022 by the authors; licensee asian online journal publishing group variance decomposition of l(m2). period s.e. lcrpriv lcrgov l(m2) mpr crr fintr exchr 1 0.03 2.66 4.89 92.4 0.00 0.00 0.00 0.00 2 0.04 4.60 5.35 88.8 1.09 0.03 0.14 0.006 3 0.05 7.52 6.81 83.5 1.59 0.15 0.33 0.09 4 0.06 11.03 7.89 78.2 2.09 0.26 0.40 0.18 5 0.06 14.5 8.71 73.2 2.47 0.39 0.44 0.27 6 0.07 17.7 9.30 69.004 2.76 0.51 0.46 0.35 7 0.07 20.4 9.72 65.5 2.92 0.63 0.47 0.41 8 0.08 22.8 10.008 62.5 3.02 0.75 0.48 0.44 9 0.08 24.8 10.2 60.1 3.08 0.86 0.49 0.48 10 0.09 26.6 10.4 58.03 3.09 0.97 0.51 0.50 11 0.09 28.02 10.4 56.3 3.09 1.07 0.53 0.52 12 0.09 29.3 10.5 54.9 3.07 1.18 0.55 0.56 note: cholesky ordering: lcrpriv, lcrgov, l(m2), mpr, crr, fintr, exchr. variance decomposition of mpr. period s.e. lcrpriv lcrgov l(m2) mpr crr fintr exchr 1 0.38 0.74 0.03 0.52 98.7 0.00 0.00 0.00 2 0.53 1.84 0.03 0.69 92.4 2.66 1.03 1.32 3 0.65 1.69 0.04 1.75 90.5 2.30 1.56 2.11 4 0.75 1.39 0.22 3.53 88.6 1.81 1.89 2.53 5 0.84 1.12 0.46 5.54 86.7 1.45 2.12 2.65 6 0.92 0.95 0.78 7.45 84.6 1.29 2.33 2.63 7 0.99 0.86 1.13 9.14 82.5 1.28 2.53 2.54 8 1.05 0.84 1.48 10.6 80.5 1.39 2.75 2.44 9 1.10 0.85 1.81 11.7 78.7 1.60 2.98 2.34 10 1.16 0.88 2.12 12.6 77.09 1.86 3.21 2.25 11 1.20 0.93 2.39 13.3 75.6 2.14 3.45 2.18 12 1.24 0.98 2.62 13.8 74.4 2.42 3.69 2.12 note: cholesky ordering: lcrpriv, lcrgov, l(m2), mpr, crr, fintr, exchr. variance decomposition of crr. period s.e. lcrpriv lcrgov l(m2) mpr crr fintr exchr 1 1.55 0.11 1.97 0.09 0.54 97.3 0.00 0.00 2 2.08 0.32 1.14 0.14 2.06 96.3 0.06 0.02 3 2.38 0.25 1.75 0.36 2.27 95.2 0.13 0.06 4 2.57 0.25 2.31 0.84 2.38 93.8 0.20 0.19 5 2.69 0.39 3.20 1.50 2.40 91.8 0.24 0.45 6 2.79 0.64 4.09 2.37 2.41 89.4 0.26 0.82 7 2.87 1.01 5.02 3.39 2.39 86.6 0.26 1.29 8 2.94 1.48 5.89 4.53 2.38 83.6 0.25 1.83 9 3.004 2.03 6.68 5.77 2.35 80.5 0.26 2.39 10 3.07 2.65 7.37 7.04 2.32 77.4 0.23 2.94 11 3.13 3.30 7.97 8.34 2.28 74.4 0.23 3.48 12 3.19 3.99 8.44 9.63 2.24 71.5 0.24 3.97 note: cholesky ordering: lcrpriv, lcrgov, l(m2), mpr, crr, fintr, exchr. variance decomposition of fintr. period s.e. lcrpriv lcrgov l(m2) mpr crr fintr exchr 1 0.10 4.68 0.17 0.29 0.27 0.08 94.5 0.00 2 0.18 6.25 0.15 0.12 0.40 0.13 92.5 0.46 3 0.24 7.03 0.19 0.07 0.24 0.08 91.03 1.35 4 0.28 7.29 0.21 0.05 0.25 0.07 89.5 2.66 5 0.32 7.29 0.24 0.04 0.56 0.08 87.5 4.28 6 0.35 7.19 0.26 0.03 1.16 0.11 85.1 6.10 7 0.38 7.06 0.26 0.03 1.98 0.17 82.5 8.02 8 0.41 6.92 0.25 0.04 2.95 0.24 79.7 9.91 9 0.46 6.80 0.23 0.05 3.99 0.33 76.8 11.7 10 0.46 6.71 0.21 0.06 5.04 0.42 74.2 13.4 11 0.48 6.64 0.19 0.08 6.05 0.53 71.6 14.9 12 0.50 6.60 0.17 0.10 7.007 0.62 69.2 16.3 note: cholesky ordering: lcrpriv, lcrgov, l(m2), mpr, crr, fintr, exchr. asian journal of economics and empirical research, 2022, 9(1): 38-51 51 © 2022 by the authors; licensee asian online journal publishing group variance decomposition of exchr. period s.e. lcrpriv lcrgov l(m2) mpr crr fintr exchr 1 6.31 13.8 0.30 0.39 12.7 0.002 3.15 69.6 2 11.2 22.4 0.48 1.03 8.58 0.01 3.75 63.8 3 15.1 26.2 0.75 1.74 7.17 0.12 4.40 59.6 4 18.0 27.9 1.12 2.72 6.29 0.36 4.79 56.9 5 20.3 28.5 1.61 3.90 5.58 0.67 4.92 54.8 6 22.08 28.8 2.21 5.19 4.94 0.97 4.87 53.05 7 23.5 28.8 2.91 6.47 4.41 1.27 4.70 51.4 8 24.6 28.9 3.66 7.67 4.003 1.53 4.49 49.7 9 25.6 28.9 4.43 8.77 3.76 1.75 4.26 48.08 10 26.6 29.1 5.17 9.73 3.60 1.94 4.06 46.4 11 27.4 29.3 5.87 10.4 3.58 2.09 3.82 44.7 12 28.1 29.5 6.52 11.3 3.65 2.20 3.63 43.1 note: cholesky ordering: lcrpriv, lcrgov, l(m2), mpr, crr, fintr, exchr. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc., caused in relation to/arising from the use of the content. any queries should be directed to the corresponding author of the article. 13 © 2022 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 9, no. 1, 13-20, 2022 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v9i1.3666 © 2022 by the authors; licensee asian online journal publishing group forecasting the oil volatility index using factors of uncertainty panagiotis delis1 stavros degiannakis1,2 konstantinos giannopoulos1 ( corresponding author) 1panteion university of social and political sciences, department of economic and regional development, athens, greece. 2bank of greece, athens, greece. 1email: p.delis@panteion.gr tel: 0030 2710227993 1,2email: s.degiannakis@panteion.gr tel: 0030 2109230916 1email: kwstasgiannopoulos@yahoo.gr tel: 0030 6980476424 abstract the oil volatility index (ovx) has attracted the attention of investors, as oil prices have been subject to high degrees of variation in the last few decades, and investors would therefore benefit from obtaining accurate forecasts of ovx. in this paper, we aim to develop models that can accurately generate ovx forecasts. the contribution of our study to the literature lies in the incorporation of different factors that reflect uncertainty as potential drivers of ovx. for example, implied volatility (iv) indices, such as the vix and gvz are examined. apart from the inclusion of iv indices, we investigate whether other uncertainty indicators play a significant role in generating ovx forecasts. our results show that the predictive ability of the models is not enhanced by the inclusion of most of the aforementioned factors of uncertainty, with the single exception of the u.s. economic policy uncertainty index, which seems to improve the forecasting ability of a simple model that focuses on the ovx as a target variable. keywords: volatility forecasting, crude oil, implied volatility, uncertainty, out-of-sample forecasting, statistical loss functions. jel classification: c10, g15, q47. citation | panagiotis delis; stavros degiannakis; konstantinos giannopoulos (2022). forecasting the oil volatility index using factors of uncertainty. asian journal of economics and empirical research, 9(1): 13-20. history: received: 29 november 2021 revised: 4 january 2022 accepted: 17 january 2022 published: 25 january 2022 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this research is co-financed by greece and the european union (european social fundesf) through the operational programme of human resources development, education and lifelong learning 2014-2020 (grant number, mis-5049106). authors’ contributions: all authors contributed to the conception and design of the study. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 14 2. ovx and uncertainty...................................................................................................................................................................... 14 3. data description .............................................................................................................................................................................. 15 4. methodology ..................................................................................................................................................................................... 16 5. evaluation framework .................................................................................................................................................................... 16 6. results ................................................................................................................................................................................................ 17 7. conclusion ......................................................................................................................................................................................... 19 references .............................................................................................................................................................................................. 19 mailto:p.delis@panteion.gr mailto:s.degiannakis@panteion.gr mailto:kwstasgiannopoulos@yahoo.gr http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.doi.org/10.20448/ajeer.v9i1.3666 https://orcid.org/0000-0002-7238-4352 https://orcid.org/0000-0003-1931-5494 asian journal of economics and empirical research, 2022, 9(1): 13-20 14 © 2022 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the existing literature by investigating the predictive performance of models that incorporate several factors of uncertainty, including implied volatility indices and other indicators that capture uncertainty, on the oil implied volatility index (ovx). moreover, the study focuses on generating ovx forecasts in an out-of-sample analysis. 1. introduction oil prices are experiencing a period of high volatility, which is of major importance to the global economy. oil price volatility can arise from either supply or demand shocks, which in turn are triggered by different factors of uncertainty. since oil price volatility is a measure that shows the level of change that oil prices undergo, investors are interested in predicting it. according to prior research (blair, poon, & taylor, 2001; frijns, tallau, & touranirad, 2010; giot, 2003) implied volatility (iv) indices provide increased predictive information when generating volatility forecasts. therefore, this study focuses on the oil volatility index (ovx) as a measure of oil price volatility, which is constructed by cboe using the implied volatility methodology.1 a small number of previous studies has focused on ovx predictability and the investigation of the variables that can improve the forecasting ability of the models used to generate ovx forecasts. for example, mazzeu, veiga, and mariti (2019) found that including the leverage in the conditional mean or variance of the basic heterogeneous autoregressive (har) model increases its predictive ability. however, they did not include exogenous information in their efforts to improve the forecasting performance of the simple har model. the literature includes papers that focus on generating forecasts for other iv indices, rather than ovx. for example, degiannakis (2008) provided an empirical model that produced one-dayahead predictions of the vix index and found that the intraday volatility measure did not yield significant incremental forecasting information on vix. konstantinidi, skiadopoulos, and tzagkaraki (2008) implemented six alternative model specifications, including models featuring economic variables as exogenous information, to generate forecasts for a number of european and u.s. iv indices. moreover, degiannakis, filis, and hassani (2018) applied parametric and non-parametric techniques in order to forecast implied volatility indices, such as the vix. in addition, the work of dunis, kellard, and snaith (2013) focused on forecasting the eur–usd iv index. in this paper, we study two different clusters of uncertainty, which each consist of indicators that may offer predictive information on ovx. the first cluster includes three iv indices that correspond to the main markets, namely the stock and commodity (gold) markets and the market reflecting the macroeconomic conditions. the second cluster includes indicators that can be of major importance for predicting uncertainty in the u.s. markets. the first variable in this cluster is the u.s. economic policy uncertainty (epu) index, which is based on newspaper archives and focuses on three main areas, namely the economy, the uncertainty, and the legislation or regulation. the second, namely the geopolitical risk (gpr) index, captures adverse geopolitical events by using newspaper articles covering geopolitical tensions. finally, a representative measure of the real business conditions is offered by the index constructed by aruoba-diebold-scotti (ads), which captures information from several economic indicators, such as weekly initial jobless claims, monthly industrial production and quarterly real gdp. the advantage of this index is that it extracts information from different frequencies. to the best of our knowledge, there are many studies that have focused on methodologies for generating iv forecasts. however, most of them have studied vix,2 the most representative iv index for the u.s. stock markets. in this case, we examine whether the forecasting ability of ovx, as a measure for crude oil volatility, can be improved by incorporating other iv indicators and factors of uncertainty within a simple methodological framework. the number of studies that have aimed to produce ovx forecasts is limited, and none of them has investigated the predictive information of all these factors of uncertainty on ovx, which is the main contribution of this paper. in order to evaluate the ovx forecasts, we implement two statistical loss functions, namely the mean squared predictive error (mspe) and the mean absolute error (mae). moreover, to enhance the evaluation framework, we apply the model confidence set (mcs) test. the results reveal that the individual model that incorporates the epu index outperforms the remaining models in an out-of-sample investigation. however, it is noted that the model that includes all exogenous variables does not outperform the simple autoregressive distributed lag (adl) model when referring to out-of-sample results compared to its performance on the in-sample analysis. the remainder of the paper is structured as follows. in section 2 we provide a review of the literature on the relationship between ovx and the exogenous factors representing uncertainty. in section 3 we describe the data used in the study. in section 4 we present the methodological framework implemented and the way the ovx forecasts are generated. the evaluation framework used for the obtained forecasts is presented in section 5, while in section 6 we discuss the in-sample and out-of-sample results. finally, section 7 concludes the study. 2. ovx and uncertainty 2.1. relationship between ovx and other iv indices the relationship between the crude oil market and other markets, such as the stock and foreign exchange, has been thoroughly investigated in recent years. several papers have focused on the interconnectedness between crude oil and other assets, with the majority of them emphasizing returns. for example, filis and chatziantoniou (2014) concentrated on the relationship between crude oil returns and aggregated stock market indices in a vector autoregression (var) model. moreover, filis, degiannakis, and floros (2011) and degiannakis, filis, and floros (2013) investigated the time-varying relationship between oil and stock markets by using multivariate garch models. however, because the volatility of crude oil prices is considered important to oil investors and policy makers, researchers have studied the relationship between these markets at a volatility level. liu, ji, and fan (2013) focused on the relationship between ovx and other iv indices and concluded that there is transmission from the stock market to the crude oil market, which they characterize as short-lived. however, the methodological framework of this study was limited to in-sample analysis. in an out-of-sample investigation, chatziantoniou, degiannakis, delis, and filis (2021) considered spillovers between ovx and other uncertainty indicators, such as the vix, and found that spillovers do not contain significant predictive information, which is something that the current paper studies 1 for further details, see: https://cdn.cboe.com/api/global/us_indices/governance/vix_methodology.pdf. 2 for example, see degiannakis (2008) and fernandes, medeiros, and scharth (2014). asian journal of economics and empirical research, 2022, 9(1): 13-20 15 © 2022 by the authors; licensee asian online journal publishing group in depth. more specifically, we generate out-of-sample forecasts of ovx by incorporating three core iv indices, namely the vix, the cboe gold etf volatility index (gvz) and the cboe/cbot 10-year u.s. treasury note volatility (tyvix). 2.2. relationship between ovx and other uncertainty factors aside from the studies that examine the relationship between ovx and other iv indices, a limited number of papers has focused on the relationship between ovx and certain indicators of uncertainty, such as that of chatziantoniou et al. (2021). in their study, indicators such as the economic policy uncertainty index, the partisan conflict index and the geopolitical risk index were examined for their predictive power when using their spillovers with the ovx. moreover, dutta, bouri, and saeed (2021) investigated the impact of news-based equity market volatility trackers on crude oil volatility. they found that several trackers provide better forecasting power than the vix, epu and gpr indices. 3. data description the target variable of this study is the iv of crude oil, namely the ovx. cboe constructed the ovx time series using the same methodology that produced the other iv time series. according to this methodology, in the case of vix, the index is calculated using the midpoint of real-time s&p 500 index (spx) option bid/ask quotes. more specifically, according to cboe, the vix index provides a measure of how much the market expects the s&p 500 index to fluctuate in the 30 days from the time of each tick of the vix index. the examined determinants of ovx that are included in the modelling framework are the following iv indices: vix, gvz and tyvix. the vix index, as mentioned above, is a calculation designed to produce a measure of constant, 30-day expected volatility of the u.s. stock market. the gvz is an estimate of the expected 30-day volatility of returns on the spdr gold shares etf and the tyvix is the implied volatility index representing the macroeconomic conditions. we use daily data from the 18th of september 2009 up to the 1st of october 2019 for the four iv indices (i.e. 2523 observations). all are extracted from the cboe website. regarding the other factors of uncertainty that are examined for their predictive information on ovx, we use daily data for the same period defined in the previous paragraph. the u.s. economic policy uncertainty index is based on newspaper archives that contain thousands of newspapers and other news sources. more particularly, for the calculation of this measure, the news sources are restricted to the united states.3 regarding the geopolitical risk factor, which is calculated by counting the number of articles related to adverse geopolitical events, the data is retrieved from the website of caldara and iacoviello.4 finally, the last factor of uncertainty we use is the aruoba-diebold-scotti (ads) business conditions index, which is designed to track real business conditions by taking into account data of macroeconomic variables at different frequencies. a major advantage of this index is the fact that at the time of any ads update, the index is based on all information of all indicators available at that time.5 table 1 provides a summary of the descriptive statistics for all variables, including the uncertainty factors used in this study. we first observe that the mean of ovx is higher than the means of the other iv indices. however, the coefficient of variation of vix is higher than those of ovx and the other iv indices. figure 1 and figure 2 illustrate the evolution of the iv indices and the other indicators that represent uncertainty. table 1. descriptive statistics. ovx vix gvz tyvix epu gpr ads mean 33.42 17.12 17.32 5.51 104.27 103.62 -0.10 median 32.10 15.73 16.83 5.30 89.80 97.22 -0.10 minimum 14.50 9.14 8.88 3.16 3.32 9.48 -0.81 maximum 78.97 48.00 39.95 10.33 490.89 361.02 0.88 std. dev. 10.18 5.71 4.93 1.32 60.01 38.29 0.32 skewness 0.79 1.61 0.86 0.68 1.59 1.22 0.34 kurtosis 3.78 6.35 4.17 2.85 6.88 5.84 3.01 coefficient of variation 0.30 0.33 0.28 0.24 0.58 0.37 -3.20 figure 1. all implied volatility indices, namely the ovx, vix, gvz and tyvix, over time. 3 the data is extracted from the relevant website: https://www.policyuncertainty.com/us_monthly.html. 4 for further details see the link: https://www.matteoiacoviello.com/gpr.htm. 5 the data is extracted from the website: https://www.philadelphiafed.org/surveys-and-data/real-time-data-research/ads. asian journal of economics and empirical research, 2022, 9(1): 13-20 16 © 2022 by the authors; licensee asian online journal publishing group figure 2. the other factors of uncertainty, namely the epu, gpr and ads business index, over time. 4. methodology 4.1. naïve models the simplest model we use for comparison purposes is an adl model, which is specified as follows: 𝑙𝑜𝑔(𝑂𝑉𝑋𝑡) = 𝑎0 (𝑡) + 𝑎1 (𝑡)𝑙𝑜𝑔(𝑂𝑉𝑋𝑡−1) + 𝜀𝑡, (1) where 𝑎0 (𝑡) , 𝑎1 (𝑡) are the rolling estimated coefficients and 𝜀𝑡 denotes the white noise. 4.2. models with exogenous information one of the main contributions of this study, though, is the fact that we investigate the predictive information that uncertainty factors from different categories might offer when generating ovx forecasts. in order to compare the forecasting ability of these exogenous variables to the ovx, we use the specification of the above adl model and add the uncertainty factors as exogenous variables in each model. therefore, each individual model that incorporates exogenous variables can be written as follows: 𝑙𝑜𝑔(𝑂𝑉𝑋𝑡) = 𝑎0 (𝑡) + 𝑎1 (𝑡)𝑙𝑜𝑔(𝑂𝑉𝑋𝑡−1) + 𝑏(𝑡)𝐸𝑋𝑡−1 (𝑖) + 𝜀𝑡 , (2) where 𝑎0 (𝑡) , 𝑎1 (𝑡) , 𝑏(𝑡) are the rolling estimated coefficients, and 𝐸𝑋𝑡−1 (𝑖) is the one-lagged exogenous variable i, which represents the uncertainty indicator that is different in each individual model. however, it is also important to study the information that all the exogenous variables offer in a model and see whether the predictive ability of this model is improved in comparison with the individual models. therefore, we further introduce a model with all exogenous variables added, which is written as follows: 𝑙𝑜𝑔(𝑂𝑉𝑋𝑡) = 𝑎0 (𝑡) + 𝑎1 (𝑡)𝑙𝑜𝑔(𝑂𝑉𝑋𝑡−1) +∑𝑏𝑖 (𝑡) 𝐸𝑋𝑡−1 (𝑖) 𝑀 𝑖=1 + 𝜀𝑡 , (3) where m is the total number of factors representing uncertainty, including the implied volatility indices and the other uncertainty indicators, such as the economic policy uncertainty index. 4.3. how are the ovx forecasts obtained/produced? the total number of days used in this study is 2522. the out-of-sample forecasting period consists of 1522 days, and we use 1000 days as an initial sample period. the choice of the initial sample period is based on the number of days used by the majority of prior studies, which can be justified by the fact that a large sample size is considered crucial for the estimation of the implemented models. moreover, it is important to note that the starting date of the out-of-sample forecasting period is september 11, 2013, which means that the period of the oil collapse between 2014 and 2016 is included in the sample. this is of major significance to this study because it gives us the ability to evaluate the forecasting performance of the models in this particularly volatile period and not only in more tranquil periods. in this paper, 1-day ahead ovx forecasts are generated based on a rolling window approach with a fixed window length of 1000 daily observations. the equation that shows how these ovx forecasts are generated from a model with a single exogenous variable is the following: 𝑂𝑉𝑋𝑡+1|𝑡 = exp⁡(𝑎0 (𝑡) + 𝑎1 (𝑡)𝑙𝑜𝑔(𝑂𝑉𝑋𝑡) + 𝑏(𝑡)𝐸𝑋𝑡 (𝑖) ). (4) 5. evaluation framework 5.1. statistical loss functions having obtained the 1-day ahead forecasts of ovx, we evaluate the predictive performance of the applied models in generating these forecasts. two well-known statistical loss functions, namely the mean squared predictive error (mspe) and the mean absolute error (mae), have been used to compare the forecasting ability of the implemented models. specifically, these two loss functions are computed as follows: 𝑀𝑆𝑃𝐸 = 1 𝑇1 ∑(𝑂𝑉𝑋𝑡+1|𝑡 − 𝑂𝑉𝑋𝑡+1) 2 𝑇1 𝑡=1 (5) asian journal of economics and empirical research, 2022, 9(1): 13-20 17 © 2022 by the authors; licensee asian online journal publishing group 𝑀𝐴𝐸 = 1 𝑇1 ∑|𝑂𝑉𝑋𝑡+1|𝑡 − 𝑂𝑉𝑋𝑡+1| 𝑇1 𝑡=1 , (6) where 𝑇1 is the number of out-of-sample forecasting days (𝑇1 = 1522). 5.2. model confidence set in addition to the abovementioned statistical loss functions, we aim to determine the set of models that are the best in terms of forecasting performance under the two loss functions. therefore, we use the mcs test proposed by hansen, lunde, and nason (2011) to further evaluate our ovx forecasts. this specific framework investigates the set of models that remains until the end in an elimination algorithm at a level of significance a. to start the process, we define the full set of models 𝑀 = 𝑀0 = {1,… ,𝑚0}, and the following null hypothesis of equal predictive ability is repeatedly tested: 𝐻0,𝑀:⁡𝐸(𝑑𝑗,𝑗∗,𝑡) = 0,⁡for  ⁡𝑗, 𝑗∗ ∈ 𝑀, (7) against this alternative one: 𝐻1,𝑀:⁡𝐸(𝑑𝑗,𝑗∗,𝑡) ≠ 0. (8) for some 𝑗, 𝑗∗ ∈ 𝑀. the 𝑑𝑗,𝑗∗,𝑡 is defined as 𝑑𝑗,𝑗∗,𝑡 = 𝐿𝐹𝑗,𝑡 − 𝐿𝐹𝑗∗,𝑡 with 𝐿𝐹𝑗,𝑡 to be denoted either as 𝐿𝐹𝑗,𝑡 = (𝑂𝑉𝑋𝑡+1|𝑡 − 𝑂𝑉𝑋𝑡+1) 2 or as 𝐿𝐹𝑗,𝑡 = |𝑂𝑉𝑋𝑡+1|𝑡 −𝑂𝑉𝑋𝑡+1|, where 𝑂𝑉𝑋𝑡+1|𝑡 is the 1-day ahead forecast of ovx generated by the 𝑗𝑡ℎ model. therefore, this procedure is repeated until the null hypothesis is no longer rejected. regarding the characteristics of the mcs test, we predefine the level of significance 𝑎 = 0.1 and the number of bootstrap replications is 10,000. 6. results first, it is important to note the relationship between the dependent variable, the ovx, and the explanatory variables considered in this study. as shown in figure 3, the relationship between ovx and the other uncertainty indicators does not seem to be linear. moreover, the correlation between ovx and the explanatory variables is not higher than 51%, which is the case for vix. figure 3. scatter plots between ovx and each of the uncertainty indicators used as explanatory variables in the modeling framework. in addition, table 2 shows that ovx is not correlated with epu or gpr and is negatively correlated with the ads business index. table 2. correlation matrix. ovx vix gvz tyvix epu gpr ads ovx 1.00 0.51 0.32 0.34 0.03 0.04 -0.27 vix 0.51 1.00 0.63 0.57 0.34 -0.12 0.10 gvz 0.32 0.63 1.00 0.68 0.23 -0.17 0.13 tyvix 0.34 0.57 0.68 1.00 0.27 -0.12 0.13 epu 0.03 0.34 0.23 0.27 1.00 -0.14 0.12 gpr 0.04 -0.12 -0.17 -0.12 -0.14 1.00 -0.02 ads -0.27 0.10 0.13 0.13 0.12 -0.02 1.00 asian journal of economics and empirical research, 2022, 9(1): 13-20 18 © 2022 by the authors; licensee asian online journal publishing group table 3. models’ estimations. individual model adl vix gvz tyvix epu gpr ads all-variables intercept 0.04485*** 0.04099*** 0.04643*** 0.04350*** 0.04636*** 0.04871*** 0.04800*** 0.05468*** (-0.01108) (0.01178) (0.01296) (0.01151) (0.01112) (0.01133) (0.01140) (0.01372) log(ovx) 1 lag 0.98704*** 0.98519*** 0.98728*** 0.98651*** 0.98739*** 0.98716*** 0.98603*** 0.98247*** (0.00319) (0.00372) (0.00335) (0.00342) (0.00319) (0.00319) (0.00330) (0.00406) log(vix) 1 lag 0.00368 0.00865* (0.00379) (0.00478) log(gvz) 1 lag -0.00085 -0.00710 (0.00364) (0.00538) log(tyvix) 1 lag 0.00192 0.00606 (0.00441) (0.00627) epu 1 lag -0.00003 -0.00004** (0.00002) (0.00002) gpr 1 lag -0.00004* -0.00005* (0.00003) (0.00003) ads 1 lag -0.00372 -0.00420 (0.00313) (0.00327) r^2 0.97439 0.97440 0.97439 0.97439 0.97442 0.97442 0.97441 0.97451 adjusted r^2 0.97438 0.97438 0.97437 0.97437 0.97440 0.97440 0.97439 0.97444 ll 4066.85090 4067.32246 4066.87857 4066.94522 4068.15174 4068.20648 4067.55525 4072.73837 aic -8129.70181 -8128.64492 -8127.75714 -8127.89044 -8130.30348 -8130.41296 -8129.11049 -8129.47674 bic -8118.03619 -8111.14649 -8110.25872 -8110.39202 -8112.80505 -8112.91454 -8111.61207 -8082.81428 note: results of the estimations for all models implemented in the empirical analysis. in the parentheses, the standard errors are presented. one, two and three asterisks denote rejection of the null hypothesis of a zero coefficient at the 1%, 5% and 10% level, respectively. asian journal of economics and empirical research, 2022, 9(1): 13-20 19 © 2022 by the authors; licensee asian online journal publishing group table 4. out-of-sample results. mspe mcs (squared errors) mae mcs (absolute errors) rw 3.379 0.705 1.204 0.819 adl 3.367 0.705 1.203 0.768 model vix 3.375 0.540 1.209 0.050 model gvz 3.378 0.540 1.201 0.875 model tyvix 3.380 0.256 1.205 0.324 model epu 3.361 1.000 1.201 1.000 model gpr 3.361 0.974 1.203 0.819 model ads 3.366 0.705 1.204 0.745 model all 3.373 0.705 1.206 0.324 regarding the models applied in this study, the results for the corresponding coefficients are shown in table 3. it is obvious that the one-lagged variable of ovx is always statistically significant at 1%. moreover, we can see that only gpr is statistically significant at 10%, when referring to the individual models. however, when we include all exogenous variables in the model, not only the coefficient of gpr but also those of epu and vix are statistically significant, which provides a clue to the potential predicting information these uncertainty indicators offer on ovx. moreover, this model presents the highest 𝑅2 in comparison with the other models. in this study, we assess several indicators’ ability to predict ovx, focusing on an out-of-sample investigation, as extensively described in section 4.3. after generating the 1-day ahead forecasts of ovx, we evaluate the forecasting performance of the implemented models, using two statistical loss functions and the mcs test. according to table 4, in terms of mspe, the individual models that include epu and gpr as exogenous variables are the two models that display a better performance compared to the remaining ones. when referring to the results of the mae statistical loss function, we see that the model that includes epu is again one of the best models, together with the model that has gvz as the exogenous variable. therefore, we can draw the conclusion that the individual model that includes epu outperforms the competing models, which can be justified by the results of the mcs test, which show that it is always included in the set of best models. it is worth noting that even if the model that includes all variables performs well in an in-sample analysis, it is inferior to several individual models in an out-of-sample investigation and cannot be considered adequate for generating ovx forecasts. even the simple adl model performs better than the model that includes all the uncertainty indicators from both categories, namely the implied volatility indices and the other factors of uncertainty representing geopolitical, economic and business conditions. 7. conclusion this paper aimed to find whether uncertainty indicators can offer predictive information on ovx and, if so, which indicators. we defined two groups of indicators representing uncertainty. the first group consisted of implied volatility indices, namely the vix, gvz and tyvix indices. the indicators in the second group represented economic, business and geopolitical risks; these were investigated afterwards. in the in-sample analysis, we observed that the model that included all indicators as exogenous variables could be considered the best one, with the highest coefficient of determination. however, the good performance of this model was not maintained in the out-of-sample investigation, in which it was even outperformed by an adl model that included only the first lag of the ovx. regarding the out-of-sample results and, more specifically, the results of the two statistical loss functions, the individual model that incorporated the epu indicator outperformed the remaining models for both the mspe and mae loss functions. the results of this paper might be considered inspiring for both academics and investors and give ideas for further research. one extension of this paper could be in the evaluation framework, which could be enhanced by implementing some trading strategies in order to discover whether the indicators included in the models could offer forecasting gains. references blair, b. j., poon, s. h., & taylor, s. j. 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(2019). modeling and forecasting the oil volatility index. journal of forecasting, 38(8), 773787.available at: https://doi.org/10.1002/for.2598. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 17 © 2021 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 8, no. 1, 17-26, 2021 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2021.81.17.26 © 2021 by the authors; licensee asian online journal publishing group performance and risks: islamic indices compared to conventional indices jamal agouram1 jamaa anoualigh2 lhoucine ben hssain3 ghizlane lakhnati4 ( corresponding author) 1,3,4lisad-ensa, ibn zohr university, agadir, morocco. 2faculty of law, economics and social sciences, ibn zohr university, agadir, morocco. abstract islamic finance is very successful in the global market, and leading traditional index providers have expanded their range and are now offering a multitude of islamic indices to facilitate the rapid development of islamic finance, especially sharia-compliant funds. this study evaluates and analyzes both islamic and non-islamic indices and their volatility, considering islamic finance's rise in popularity. the purpose of this research is to establish a comparison and then analyze the results of the performance of the dow jones world index (djw) and its islamic counterparts. the analysis of the outcomes will be in terms of performance measures. on the basis of the total risk, we will then compare the dow jones world index and its islamic counterparts. this risk would usually be captured by both the value-at-risk (var) and the conditional value-at-risk (cvar). the purpose of this paper is to demonstrate whether islamic indices are higher than the conventional indices and whether the overall risk for islamic indices is lower than for conventional indices. keywords: conditional value-at-risk, dow jones world index (djw), garch(1,1), islamic investment, performance, value-at-risk. jel classification: f37. citation | jamal agouram; jamaa anoualigh; lhoucine ben hssain; ghizlane lakhnati (2021). performance and risks: islamic indices compared to conventional indices. asian journal of economics and empirical research, 8(1): 17-26. history: received: 26 january 2021 revised: 2 march 2021 accepted: 29 march 2021 published: 19 april 2021 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interest. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 18 2. literature review ............................................................................................................................................................................ 18 3. data and methodology ................................................................................................................................................................... 19 4. empirical results and discussion ................................................................................................................................................ 21 5. conclusion ......................................................................................................................................................................................... 24 references .............................................................................................................................................................................................. 24 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2021.81.17.26&domain=pdf&date_stamp=2017-01-14 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2021.81.17.26&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/2813 http://orcid.org/0000-0002-1574-1464 http://orcid.org/0000-0002-3914-0129 https://orcid.org/0000-0001-9027-0300 http://orcid.org/0000-0001-9016-7741 asian journal of economics and empirical research, 2021, 8(1): 17-26 18 © 2021 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the existing literature on the comparison of performance and risk of islamic and conventional indices by combining the two aspects (performance and risk) using measures of performance (sharpe ratio, treynor ratio and jensen’s alpha) and risk (var and cvar). 1. introduction islamic finance has had great success in the global market. it has provided a wide range of sharia-compliant indices to enable the accelerated advancement of sharia-compliant funds and islamic finance. following this success, muslim countries have been proposing a financial model based on sharia, the law of the koran. in addition to adhering to the values and principles of islamic finance, exciting profit prospects are now being offered. at the end of 2009, the rating agency moody's estimated the size of the islamic finance market at $950 billion, with a rise of about 20% each year during the past three years. presently, there are approximately three hundred islamic financial institutions internationally in more than seventy-five nations. within a decade, islamic finance could capture 50% of the savings made by 1.6 billion muslims worldwide. in fact, the islamic financial system stands out as an alternative model of social responsibility that is more relevant and more profound than the model proposed by classical economic theories, according to several scholars such as chapra (2016); siddiqi (2004); siddiqi (2014); khan (1997); ahmed (2007) and visser (2019). this remarkable growth aims to satisfy the rising demand from the muslim community for ethical and socially responsible investment. indeed, the islamic financial system feeds on the moral and religious foundations derived from the sacred book (the koran) and the principles of sharia law. it is based on the following five principles: (i) the prohibition of interest (riba) and usury, (ii) taking a share of the profits and losses (musharakah), (iii) forbidding uncertainty (gharar) regarding sales, and speculation (maysir); (iv) the obligation to match financial income to actual assets; and (v) the prohibition of illegal (haram) products and sectors (elbousty & oubdi, 2017). faced with this surge in islamic finance, this study assesses the ability of islamic indices to cope with financial crises, and we will evaluate whether the islamic indices are more powerful in their returns and whether they are more stable. the key goal is to compare and evaluate the outcomes achieved by the dow jones world index (djw) and their islamic equivalents. initially, the comparison is made using measures of performance to see if the performance of islamic indices surpasses that of the conventional indices (dow jones). next, the dow jones world index is compared with its islamic counterparts based on cumulative risk as measured by conditional value-at-risk (cvar) and value-at-risk (var) to judge whether islamic indices are less risk-prone than the dow jones world index (djw). 2. literature review islamic entrepreneurship1 cannot be approached without reference to islamic law (sharia). this law, stemming from the muslim religion, is linked to the faith, customs, legislation, and economy of the muslim umma (community) and guides morality (abdullah & mikail, 2013; almarri & meewella, 2015; anggadwita, ramadani, alamanda, ratten, & hashani, 2017; carneiro-da-cunha, santos, souza, alssabak, & macau, 2015; muhammad, sairally, & habib, 2015; zulkifli & saripuddin, 2015). in fact, all economic activities carried out in islam are subject to halal (lawful) and haram (unlawful) guidelines, and therefore depend on the moral and social values that every muslim must follow (al rahahleh, bhatti, & misman, 2019; khatkhatay & nisar, 2007; naveed, khawaja, & maroof, 2020). this means that the accumulation of wealth should be a secondary priority because service to other human beings is the main priority and contributes to spiritual wellbeing (abdullah, kedah, & anwar, 2015; ashraf, 2019; ghoul, 2015). salma (2013) stressed through his study of a sample of 46 institutions which offer islamic financial services (iifs), that these must be sharia-compliant in addition to taking on traditional responsibilities (organizational, economic, legal and ethical) in accordance with the sharia way of fostering society's health. consequently, an islamic business owner has to invest in commercial activities in line with the muslim act standards (anggadwita et al., 2017; gümüsay, 2015; hamid & sa'ari, 2011; ramadani, dana, ratten, & tahiri, 2015). in addition, rehan, block, & fisch (2019) demonstrated a positive impact on business intentions through islamic principles and practices, while ramadani et al. (2015) and ghoul (2015) highlighted the fact that islam inspires muslims to do business and trade. anggadwita et al. (2017) noted that muslim beliefs inspire its followers to be entrepreneurial, creative and dynamic, and that entrepreneurship in islam is based on cooperation. gray, foster, & howard (2006) explain that an islamic entrepreneur should be diligent and have management expertise and skills. in islam, work is considered a religious activity within a society because it could help the community by enhancing people’s feeling of wellbeing (anggadwita et al., 2017; ghoul, 2015; ramadani et al., 2015; ratten et al., 2017). anggadwita, mulyaningsih, ramadani, & arwiyah (2015) also stress that female entrepreneurship must be facilitated, in particular, by an appropriate islamic education to take advantage of the opportunities offered by allah because this has a positive impact on improving and supporting the household, women's independence and selfrealization, and therefore supports the national economy. over the past three decades, sharia finance experienced the most rapid and unusual developments in the recent history of global financial services, and has moved from a niche position in the global financial system to one of the most dynamic and promising positions (ahmed, 2002; khan & bhatti, 2008). currently, islamic financial institutions are expanding internationally and are not exclusive to the muslim world, but are starting to expand into europe and the united states to capture some of the abundant liquidity from the persian gulf regions induced by the sharp rise in oil prices (ghoul, 2011). in contrast to traditional stock markets, the islamic stock market is one in which sharia-compliant stocks are traded (hashim, habib, isaacs, & gadhoum, 2017). the main difference between these two modes of financing is that islamic investment is based on fundamental islamic principles prohibiting speculation (maysir), interest, 1ratten, ramadani, dana, and gerguri-rashiti (2017) defines islamic entrepreneurship as “discovery, evaluation and exploitation of opportunities utilizing an islamic belief system in the business environment.” asian journal of economics and empirical research, 2021, 8(1): 17-26 19 © 2021 by the authors; licensee asian online journal publishing group excessive uncertainty, investments in industries deemed "unethical", and risk and return sharing (zahari, kamidjantono, & idham, 2009). islamic indices following sharia principles are subject to different criteria for selecting liquidity and financial ratios (el alaoui, bacha, masih, & asutay, 2016; hakim & rashidian, 2002). for this reason, islamic finance has attracted much attention in recent decades (ahmed, 2019; hkiri, hammoudeh, aloui, & yarovaya, 2017; jawadi, jawadi, & louhichi, 2014; medhioub & chaffai, 2016). however, profitability and risk are essential tools for measuring the attractiveness of an investment. it is also a critical determinant of performance that investors focus on during financial crises. investments in classical and islamic indices have been profitable, but the profits of islamic banks are much higher than those of conventional banks (chowdhury, 2015). several researchers have conducted studies on the financial performance of islamic indices and conventional indices. however, in recent years, several researchers have conducted empirical studies on the performance and risk of islamic stock market indices. some of these studies, such as that by atta (2000) who studied the djimi (dow jones islamic market index), concluded that the islamic stock index outperforms its conventional counterpart as well as generating a higher return than the conventional index. ahmad & ibrahim (2002) compared the klsi (kuala lumpur shariah index) with the kuala lumpur composite index (kcli) utilizing the sharpe ratio, the treynor ratio, the balanced jensen index, and a t-test for the period from 1999 until 2002. the outcomes showed that the klsi yield was lower than that of the klci, while, regarding risk, the klci was riskier than the klsi over the selected period. this last finding was shared by hussein (2004) who made a correlation between the presentation of the ftse global islamic index and the ftse all-world index. the presentation results were supportive of the islamic index, which was higher than its conventional counterpart. likewise, hussein & omran (2005) investigated the performance of the dow jones islamic market index (djimi). they observed that islamic indices beat their regular counterparts in positively trending markets, but were less fruitful in bear markets. yusof (2007) concentrated their investigation on the islamic index in malaysia, and the outcomes show a higher instability of islamic indices compared with their conventional counterparts. at the same time, al-zoubi & maghyereh (2007) analyzed the relative risk by contrasting the risk of the dow jones islamic list with that of the dow jones world list from 1996 to 2005. the outcomes show that the degree of risk of the islamic index is lower than the rest of the market. in addition, the kuala lumpur shariah index (klsi) and the kuala lumpur composite index (klsi) were studied by albaity & ahmad (2008), and the findings showed that islamic metrics were less effective than traditional metrics. hassan & girard (2010) studied the performance of the dow jones islamic index and conventional index series and concluded that the results were not statistically different. mehmood (2016) studied the performance in eight countries of islamic and conventional indices and found that, over the period as a whole, conventional stock indices outperformed islamic indices. however, islamic stock markets outperformed their peers during the global financial crisis period, with both adjusted and unadjusted performance measures. in addition, el alaoui et al. (2016) found, in seven european countries with a sample of 689 firms from the second quarter of 2008 to the first quarter of 2013, that sharia-compliant stocks have a lower market risk than conventional stocks. elbousty & oubdi (2017) compared the returns and volatility of islamic stock indices to their conventional counterparts in developed and emerging countries from 2002 to 2016. islamic indices outperform conventional indices in 80% of developed countries, and islamic indices outperform conventional indices in 14 emerging market countries, according to their findings. rejeb & arfaoui (2019) attempted to confirm whether islamic market indices outperform conventional market indices in both representational efficiency and degree of risk during recent financial stress using a garch(1,1) model. their experimental findings demonstrate that the islamic market indices exhibit high volatility and cannot avoid financial crises. on the basis of the literature review, in spite of the abundance of past academic work evaluating the comparison of performance and risks of islamic and conventional indices, the findings differ greatly and are not conclusive regarding the superiority of one over the other to date. following a similar line of research, this work combines the two aspects (performance and risk) using measures of performance (sharpe ratio, treynor ratio and jensen’s alpha) and risk (var and cvar). 3. data and methodology 3.1. data the database used contains both historical and real-time financial information, which allows us to obtain the daily prices of the various indices analyzed during the period from april 1, 2010, to april 15, 2020. the dow jones index family was selected because access to data for other indices is limited, especially islamic indices. for the analysis, the global indices considered are the dow jones world index and its islamic counterparts: the dow jones islamic market us mid-cap index (imusm), the dow jones islamic market world index (djim), the islamic market asia/pacific index (djiap), the dow jones islamic market world emerging markets index (djiemg), the dow jones islamic market malaysia index (djmy25), and the dow jones islamic market turkey index (djimtr). the dow jones islamic market world index is the equivalent index to the djw, but it satisfies the principles of sharia. each company included in the islamic index must comply with several requirements, including the type of product offered, economic activity, and the level of debt. 3.2. methodology there is a difference in the performance and risks of islamic indices and their traditional equivalents, as noted during the review of existing literature on this topic. a hypothetical-deductive quantitative analysis was chosen, which is one of the models used for scientific reasoning and research (tariq, 2015). in the context of this work, this asian journal of economics and empirical research, 2021, 8(1): 17-26 20 © 2021 by the authors; licensee asian online journal publishing group approach is used to show whether the output of islamic indices exceeds that of traditional indices and to demonstrate whether the overall risk of islamic indices is lower than that of conventional indices. however, the holistic-inductive qualitative approach is an alternative to validating these methods that have arisen in exploratory research to gain a global understanding of investors and their behaviours (dana & dana, 2005). to complement the numerous quantitative studies in management and, more specifically, in entrepreneurship, dana & dana (2005) promote more qualitative research with inductive holistic conceptions to generate new hypotheses to help formulate better policies for the future. this research is exploratory and descriptive in nature. first, in order to analyze and compare the performance of islamic indices with their conventional equivalents, we use financial performance measures (the sharpe ratio, the treynor ratio and jensen's alpha). in the second step, value-at-risk (var) and conditional value-at-risk (cvr) are used to compare the total risk of such indices (cvar). 3.3. performance measures to assess the performance of the dow jones world index and its islamic counterparts, this study looks at the return and instability qualities of each index alongside the risk-adjusted returns. to estimate the risk-adjusted performance of the djw and its islamic counterparts, the agouram & lakhnati (2016) methodology was used to establish a ranking of the different indices. performance measures that are used to compare our indices are: • the sharpe ratio: this calculates the excess return of the portfolio compared to the risk-free investment, but only relates to the volatility that negatively affects the asset. sp = e(rp) − rf σ(rp) (1) where e(rp) is the expected portfolio return, σ(rp) is the portfolio standard deviation, and rf is the risk-free return (in equation 1). • treynor ratio: this indicates the risk premium per unit of systematic risk. the treynor ratio is calculated as: tp = e(rp) − rf βp (2) where βp in equation 2 is the beta of the portfolio. • jensen’s alpha: to see exactly how the formula of jensen’s alpha works, let's look at the capm formula (in equation 3): e(rp) = rf + βp(e(rm) − rf) + α (3) jensen’s alpha value is calculated as follows: α = e(rp)−(rf + βp(e(rm) − rf) (4) where e(rm) is the expected market return (in equation 4). to make a comparison over the entire period chosen, performance measures are calculated for each month using the borda-kendall (bk) method, which has been used to establish a portfolio classification. the strategy of the bk method provides a primary location label of “1”, a second position label of “2”, etc. with this simple equation, the rating scale (zi) that each portfolio collects can be obtained: zi = ∑ j vij (5) p i=1 where j is the rank and vij is the vote; each investment is ranked in a jth ranking place. the best possible asset allocation would be the one with the lowest overall score (in equation 5). 3.3.1. risk measures in order to compare indices2, the value-at-risk (var) is used, taking into account the essential characteristics of asset returns (i.e., the profit pattern of the group in high and low unpredictability bundles with a non-typical circulation of profits, overwhelming tails, and a negative predisposition). in the var forecast for each index, the following elements are included: • initially, the garch(1,1) model is used to analyze the var's sensitivity to the yield distribution's characteristics (the variance that varies over time) by assuming that the portfolio's yield follows the normal distribution. • second, the var of each portfolio is numerically calculated based on the cornish–fisher expansion (cf) and johnson's distribution using moments to adjust for long queues and skewness in var predictions. • last, the conditional value-at-risk (cvar) is used to compare the indices because the results are similar to var. the cvar is able to take a much better appreciation of the queue risk. the var associated with risk x is given by equation 6: 𝑉𝑎𝑅 (𝑋) = 𝑖𝑛𝑓 {𝑥 | 𝑃 [𝑋 ≤ 𝑥]} (6) the cvar at the probability level, denoted by cvar (x), is the average value of the losses that exceed the var with a given confidence level. equation 7 gives us the following formula: 𝐶𝑉𝑎𝑅 (𝑋) = 𝐸 [𝑋 | 𝑋 < 𝑉 𝑎𝑅 (𝑋)] (7) the use of the data is as follows: (a) for performance measures: the entire period is used to calculate index performance using three performance measures: the sharpe ratio, the treynor ratio, and jensen’s alpha, in addition to the two summary statistics: mean return and standard deviation. (b) for the calculation of the var of the indices: the first 2170 daily returns are used, that correspond to the period from april 1, 2010, to june 3, 2018, for the estimation of volatility using the garch(1,1) model. second, the var is estimated by one day (h = 1) for risk levels (a = 1%, 5%, and 10%) over the period from june 4, 2018, to 2 as in agouram & lakhnati (2015a); agouram & lakhnati (2015b). asian journal of economics and empirical research, 2021, 8(1): 17-26 21 © 2021 by the authors; licensee asian online journal publishing group april 15, 2020 (720 values) using the garch(1,1) estimators. the estimated vars and the losses actually observed will be compared using a backtesting procedure. 4. empirical results and discussion this empirical analysis started with characteristics of the chosen indexes. we define the tests and the coefficients that allow the detection of the normality of the series, and then an investigation is carried out on the distribution of the series studied. (a) study of the normality of returns: for a long time, the behavior of the profitability series of financial securities was considered normal. however, in reality, several empirical studies have shown that these series are non-normal. their distributions are, on the contrary, asymmetrical, and display leptokurtosis, meaning that they are often thicker at the ends and reveal thick tails. the normality of the returns is checked by econometric tests, which are based on the determination of symmetry coefficients (skewness) and flattening (kurtosis). one of these tests is the jarque–bera statistic that synthesizes the two coefficients. the jarque–bera test is based on skewness coefficients and kurtosis, and it evaluates the simultaneous deviations of these coefficients with the reference values of normal distribution. table 1. descriptive statistics of indices. djiap djiemg djim djimtr djmy25 imusm indu mean 0.034 0.030 0.036 0.052 0.021 0.060 0.047 median 0.000 0.000 0.000 0.000 0.000 0.000 0.000 maximum 4.208 5.158 4.260 5.390 2.910 5.723 4.985 minimum -4.568 -6.082 -5.148 -7.899 -3.294 -7.398 -5.546 std. dev. 0.827 0.847 0.745 1.046 0.551 1.014 0.855 skewness -0.275 -0.175 -0.347 -0.469 -0.145 -0.286 -0.319 kurtosis 6.212 8.175 8.856 7.390 7.207 7.877 7.446 jarque–bera test 1283 3252 4203 2435 2149 2915 2438 probability 0.000 0.000 0.000 0.000 0.000 0.000 0.000 sum 99.634 87.433 103.014 150.382 60.877 175.389 136.018 observations 2901 2901 2901 2901 2901 2901 2901 (b) empirical results: using the jarque–bera test on normality, it was found that the distribution of the returns of the indices does not follow the normal distribution and is at a threshold of a = 1%. the values of the jarque–bera statistics for each title are given in table 1. they all exceed the critical value of the test, which is 9, and 83 for the threshold of a = 1%. the results obtained from the table above show that the skewness coefficient is negative for all indices, which means that the left side of their distributions are thick (negative direction). thus, the existence of asymmetrical behavior of the series of yields is studied, while the kurtosis coefficient results are greater than 3, which means that the tails are thicker than the normal law (leptokurtic distribution). as a result, the outcomes of the test of normality (jarque–bera) for each index lead us to exclude assumption of normality at a 99% degree of probability. this finding highlighted the very familiar properties of a series of financial returns, i.e., the returns of the various series are not distributed normally (agouram & lakhnati, 2015a, 2015b). in combination, the properties of asymmetry and leptocurticity were found to be true for the data. the index returns appear in figure 1. 4.1. performance measures table 2. comparison of returns. indices djw imusm djim djiap djiemg djmy25 djimtr borda points 161 545 540 546 678 254 440 rank 1 5 4 6 7 2 3 average rank 1.42 4.82 4.77 4.83 6 2.24 3.89 the monthly return rate results for the entire sampling period (see table 2) show that the imusm score is the lowest based on the 161-point borda-kendall approach, followed in second place by the djimtr with 254 points. the djw is third with 440 points, and the djmy25 index is in last place with a score of 678 points. table 3. comparison of volatilities. indices djw imusm djim djiap djiemg djmy25 djimtr borda points 776 226 429 592 113 653 375 rank 7 2 4 5 1 6 3 average rank 6.87 2 3.8 5.24 1 5.78 3.32 the results in table 3 are different from those related to rates of return. the least risky index is the djmy25, with 113 points for the entire period, followed by the djim index, while the djw comes in third place. asian journal of economics and empirical research, 2021, 8(1): 17-26 22 © 2021 by the authors; licensee asian online journal publishing group figure 1. graphical representation of index returns. table 4. performance comparison: sharpe ratio. indices djw imusm djim djiap djiemg djmy25 djimtr borda points 246 572 567 619 399 316 445 rank 1 6 5 7 3 2 4 average rank 2.18 5.06 5.02 5.48 3.53 2.8 3.94 from the results of the sharpe ratio in table 4, we can see that imusm has the highest score with 246 points, followed in second place by the djimtr with score of 316 points, while the djw comes in fifth place. table 5. performance comparison: treynor ratio. indices djw imusm djim djiap djiemg djmy25 djimtr borda points 378 720 465 692 249 190 470 rank 3 7 4 6 2 1 5 average rank 3.35 6.37 4.12 6.12 2.2 1.68 4.16 from the results in table 5, the djimtr index is the best out of all indices evaluated with a score of 190 points, followed by the djmy25 with a score of 249 points, while the djw index occupies the sixth place with a score of 470 points. table 6. performance comparison: jensen’s alpha. indices djw imusm djim djiap djiemg djmy25 djimtr borda points 219 720 441 679 466 195 444 rank 2 7 3 6 5 1 4 average rank 1.94 6.37 3.9 6.01 4.12 1.73 3.93 the outcomes of jensen's alpha scoring in table 6 show that the djimtr index is the highest of all indices, second is the imusm, followed by the djiap. since the classification of the indices results differ for each calculation, we have plotted the various classifications of indices for all the measures used in figure 1. figure 2 provides an overview of the seven indices' ranks. asian journal of economics and empirical research, 2021, 8(1): 17-26 23 © 2021 by the authors; licensee asian online journal publishing group figure 2. the different classifications of indices for all measures. 4.2. risk measures the evaluation of different forecasting methods is based on various statistical tests, such as unconditional coverage tests, independence tests, and conditional coverage tests. the results of the unconditional coverage test proposed by kupiec (1995) show that for the var garch(1,1) with the normal distribution, the cornish–fisher approximation and the johnson function, we find that the garch(1,1) models in our study are appropriate for the prediction of the var for the critical values of 1%, 5% and 10%, and the tests are valid for the estimation of var (tables 7, 8 and 9). in general, it was found that the var overruns for the conventional index are positioned between the islamic indices. thus, the conventional index is less risky than some islamic indices and riskier than the others for the 99%, 95% and 90% confidence levels and with the different estimation methods (normal distribution, cornish–fisher approximation and johnson function – see tables 10, 11 and 12). table 7. results of conditional and unconditional var coverage using the normal distribution. confidence level imusm djim djiap djiemg djmy25 djimtr djw 1% n 5 4 5 5 3 8 7 taux 0.007 0.006 0.007 0.007 0.004 0.011 0.010 lruc 0.748 1.694 0.748 0.748 3.148 0.091 0.005 lrind 5.936 n/a n/a n/a n/a n/a 3.774 lr cc 6.685 n/a n/a n/a n/a n/a 3.779 5% n 13 9 17 15 7 26 19 taux 0.018 0.013 0.024 0.021 0.010 0.036 0.026 lruc 20.150 29.944 12.903 16.253 36.120 3.166 10.036 lrind 31.198 32.718 13.572 17.267 n/a 9.414 16.475 lr cc 51.347 62.662 26.475 33.520 n/a 12.580 26.511 10% n 29 20 27 27 14 59 32 taux 0.040 0.028 0.038 0.038 0.019 0.082 0.045 lruc 20.150 29.944 12.903 16.253 36.120 3.166 10.036 lrind 31.198 32.718 13.572 17.267 n/a 9.414 16.475 lr cc 51.347 62.662 26.475 33.520 n/a 12.580 26.511 table 8. results of conditional and unconditional var coverage using the cornish–fisher approach. confidence level imusm djim djiap djiemg djmy25 djimtr djw 1% n 3 3 3 3 1 3 3 taux 0.004 0.004 0.004 0.004 0.001 0.004 0.004 lruc 3.148 3.148 3.148 3.148 8.471 3.148 3.148 lrind n/a n/a n/a n/a n/a n/a n/a lr cc n/a n/a n/a n/a n/a n/a n/a 5% n 20 11 20 20 8 37 25 taux 0.028 0.015 0.028 0.028 0.011 0.052 0.035 lruc 8.768 24.676 8.768 8.768 32.905 0.035 3.880 lrind 18.968 26.706 9.072 9.072 n/a 2.038 10.685 lr cc 27.736 51.382 17.840 17.840 n/a 2.073 14.565 10% n 59 37 49 51 30 86 48 taux 0.082 0.052 0.068 0.071 0.042 0.120 0.067 lruc 2.683 22.382 8.953 7.372 33.886 2.755 9.808 lrind 4.783 24.384 10.982 7.924 41.271 7.904 24.309 lr cc 7.466 46.766 19.935 15.297 75.158 10.659 34.117 in contrast to the var results, the cvar results show that the djw index has lower and stronger cvars compared to its islamic counterparts. based on these results, the djw index is not better in terms of risk since it records higher levels in terms of cvar at the 99%, 95% and 90% confidence levels, that is to say, this case study shows that the djw does not provide the best possible coverage against the downside risks of the market in comparison to some islamic indices that are less risky. asian journal of economics and empirical research, 2021, 8(1): 17-26 24 © 2021 by the authors; licensee asian online journal publishing group table 9. results of conditional and unconditional var coverage using the johnson function. confidence level imusm djim djiap djiemg djmy25 djimtr djw 1% n 7 6 8 10 4 14 14 taux 0.010 0.008 0.011 0.014 0.006 0.019 0.019 lruc 0.007 0.008 0.010 0.014 0.006 0.018 0.017 lrind 0.286 0.000 0.125 0.000 0.000 0.071 0.143 lr cc 0.714 1.000 0.875 1.000 1.000 0.929 0.857 5% n 28 16 27 24 12 50 30 taux 0.039 0.022 0.038 0.033 0.017 0.070 0.042 lruc 1.973 14.514 2.531 4.678 22.328 4.875 1.078 lrind 0.179 0.063 0.074 0.042 0.083 0.101 0.133 lr cc 0.821 0.938 0.926 0.958 0.917 0.899 0.867 10% n 59 36 47 47 29 84 44 taux 0.082 0.050 0.065 0.065 0.040 0.117 0.061 lruc 0.077 0.047 0.061 0.064 0.035 0.106 0.049 lrind 0.136 0.111 0.128 0.085 0.172 0.192 0.250 lr cc 0.864 0.889 0.872 0.915 0.828 0.808 0.750 table 10. cvar results of the var garch(1,1) model with normal distribution. confidence level imusm djim djiap djiemg djmy25 djimtr djw 1% -2.26 -2.23 -2.3 -2.2 -2.18 -2.38 -2.33 5% -1.61 -1.58 -1.61 -1.59 -1.73 -1.79 -1.66 10% -1.39 -1.28 -1.39 -1.3 -1.27 -1.38 -1.33 table 11. cvar results of the var garch(1,1) model with the cornish–fisher approach. confidence level imusm djim djiap djiemg djmy25 djimtr djw 1% -2.57 -2.89 -2.89 -2.69 -2.69 -3.46 -2.74 5% -1.54 -1.46 -1.5 -1.5 -1.52 -1.59 -1.55 10% -1.03 -0.95 -0.97 -1 -0.97 -1.03 -1.09 table 12. cvar results of the var garch(1,1) with the johnson function. confidence level imusm djim djiap djiemg djmy25 djimtr djw 1% -2 -2 -1.95 -1.87 -1.89 -2.05 -2.07 5% -1.08 -1 -0.99 -1.02 -1.01 -1.07 -1.01 10% -1.07 -0.99 -1.01 -1.04 -1 -1.07 -1.11 5. conclusion islamic investors all have a common desire to find investment opportunities that are compatible with their convictions, commitments, and moral values. ramadani et al. (2015) noted that entrepreneurship and islamic affairs will become increasingly important with globalization in the future. these entrepreneurs will, therefore, be led to make investments in assets compatible with sharia or simply on islamic indices. this article adds to the area of islamic business by supporting discussions from past research on the performance and risk of islamic indices, especially in the context of investment in international indexes (ahmad & ibrahim, 2002; atta, 2000; elbousty & oubdi, 2017; hussein, 2004; hussein & omran, 2005). moreover, it is only in recent years that researchers have been interested in management and management research with regard to spirituality and ethics in the workplace, among other religious ethics in the world of business and finance (balog, baker, & walker, 2014; dana, 2010; tracey, 2012). in addition, the findings of this study indicate the importance of islamic index investments. based on performance measures, some islamic indices outperform conventional indices. academic works differ on the outperformance or underperformance of islamic indices. indeed, it is the stock market indices and the islamic investment funds, in addition to the sukuk (financial certificate), which constitute the main tools of the offer of islamic finance in financial markets. the empirical application of a sample of indices to assess the contribution of performance and risk measures to the resolution of problems regarding the choice between islamic or conventional indices allowed us to obtain the following results: • the volatile, leptokurtic and asymmetric return sequence of our indices. this leads to a denial of the jarque– bera normality test. therefore, the distribution of returns of regular indices varies from the normal distribution. • the presence of volatility clusters in the different series of yields means that a crisis has severely disrupted the evolution of index prices. • improved performance of the value-at-risk by the use of the garch(1,1) model with student distribution, and the cornish–fisher approximation for estimating the volatility and quantiles of the distribution. • the performance of certain islamic indices may be better than that of traditional indices. thus, the use of an islamic index may be better for an investor than the use of a conventional index. • the risks of certain islamic indices are lower than those of conventional indices; therefore, an islamic index may be less risky than a conventional index. finally, the results obtained in this study confirm the relevance of investments in islamic indices. references abdullah, s., & mikail, s. a. 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(2015). concept of business ethics in islam: approach to the entrepreneur. journal of asian business strategy, 5(1), 13-18. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 159 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 2, 159-170, 2020 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2020.72.159.170 © 2020 by the authors; licensee asian online journal publishing group socio-economic factors of empowerment in developing countries rabnawaz khan1 jin xinxin2 yusheng kong3 emmanuel yamoah cobbold4 ( corresponding author) 1,4school of finance and economics, jiangsu university, jiangsu, zhenjiang, people’s republic of china. 2school of literature and language, jiangsu university, zhenjiang, jiangsu, zhenjiang, people’s republic of china. 3school of finance and economics, jiangsu university, zhenjiang, people’s republic of china. abstract the study is carried to identify the main socio economic cultural and political view determinants of women empowerment in the developing countries. the highest determination of the study is to analyze and identify the variables through which the process of women empowerment can be measured. this study is based on secondary data and reported to analyze the empowerment factor of women in 124 developing countries, the data was ordinal in nature and randomly selected from the population. the main investigation of this research study to analyzed the relationship of women fertility, socio-economic and political factor on the women empowerment. after conducting a cross sectional study for the most recent period, the findings of study show that the main deterrents towards women disempowerment are attributed as high fertility rates, high maternal mortality, gender inequality, lack of female‟s access towards education, health and economic opportunities, lack of leadership and decision making qualities. it is found that a patriarchal culture is equally responsible for women in sufferings and disempowerment. however, democracy and democratic culture can contribute well in upgrading the process of women empowerment in developing countries. keywords: democracy of women, socio-economic factors of women empowerment impact, health effects, education, political impact. jel classification: f43; f63; 115; 125. citation | rabnawaz khan; jin xinxin; yusheng kong; emmanuel yamoah cobbold (2020). socio-economic factors of empowerment in developing countries. asian journal of economics and empirical research, 7(2): 159-170. history: received: 10 april 2020 revised: 13 may 2020 accepted: 16 june 2020 published: 28 july 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: all authors contributed to the conception and design of the study. funding: national natural science foundation of china no: 71371087. i am also grateful my beloved comrade jin xinxin who helpful in each stage and stipulating me many times during my graduate school career. as a role model, mentor, and kindhearted, i never ever deny that thought or ideas who was really appreciating for me, but i also realized that my unknown anticipation is never ever to hold her benevolence with factual thought. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 160 2. literature review .......................................................................................................................................................................... 160 3. methodology ................................................................................................................................................................................... 161 4. data analysis .................................................................................................................................................................................. 162 5. results .............................................................................................................................................................................................. 163 6. discussion and finding ................................................................................................................................................................. 164 7. recommendation and conclusion .............................................................................................................................................. 169 references ............................................................................................................................................................................................ 169 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.72.159.170&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/1948 http://asianonlinejournals.com/index.php/ajeer/article/view/1948 asian journal of economics and empirical research, 2020, 7(2): 159-170 160 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this paper is indicating the women empowerment by socio-economic factor, fertility and political factor in the 142 developing countries. the prior research study concluded that the empowerment of women which positively affect the development and growth process of a country. 1. introduction the question of how women can be made more empowered has assumed increasingly important dimensions in the field of planning and development. empowerment of women are essentially the process of uplifting economic, social, and political status of women in the society. this study argues that women empowerment needs a multidimensional strategy encompassing economic, social, cultural, and political impact reform. for all this it is vital that women should have equal opportunities to participate in socio-economic and political frameworks. in other words, for the process of female empowerment it is necessary that women should be able to act freely, and acquire power to exercise their rights and potentials. thus, women empowerment can be defined as a process through which women get an equal and equitable status and position in a society. women empowerment has been defined as women access to get education, healthy economic and political access (sweeney, wilson, & brown, 2019). women are regarded as a best form of human capital and are regarded as important assets for a society and indispensable for the process of development (goldstein et al., 2019). research indicates that investments in women‟s employment, health, and education, are correlated with a range of positive outcomes. in this respect gender development studies in many countries reveal that for the process of growth and progress women should be able to enjoy equal rights in a society. but it is observed that socio-economic position of women in developing societies negatively affect their participation. traditions, cultures, laws, illiteracy, public unawareness, high fertility rates all contribute to the powerlessness of women in underdeveloped economies (liu, yu, bai, & chen, 2020). economic empowerment is one of the most powerful routes for women to achieve their highest potentials. numerous researches reveal that in developing countries, education and employment are the two strong social factors which can increase the process of women empowerment. women education, awareness and knowledge are critical to their complete success. the importance of female education he said that educated women can create educated children and educated mothers educate family which results in an educated population of a nation which builds a strong nation (montanari & bergh, 2019). women education is a powerful tool to modify their position and status in a society. education is considered as a milestone for women empowerment because it gives them the opportunity to respond to the challenges, to confront their traditional role and to change their lives. education is just as important and necessary for women access to jobs, mobility, political participation, good health, and legal systems (kim, 2018; malapit et al., 2019). women political participation is also an important tool and element in the process of empowerment. to empower women. it is essential that they should equally participate in the decision making process. it is vital because it will enhance their status in a society (kumar, 2020). nonetheless, in developing societies there are a number of such structural, social, cultural, economic and institutional factors which offer constraints towards women participation in politics. geneva based gender gap index 2014(undp) has depicted the situation of gender inequalities to assess the process of female empowerment in many countries for example it reveals from its report that india was ranked 134th for economic opportunity and participation, 126th for education, an impressive 15th for female political empowerment but 142nd, the second last, for health and survival. pakistan ranked 141st out of 142 countries in terms of economic opportunity and political participation for women, 132nd for access to education, 119th in health and survival and 85th for political empowerment. women empowerment is a multidimensional concept. to measure and monitor empowerment processes and outcomes, several frameworks and indices have been developed internationally like gender related development index gdi, gender gap index ggi, gender empowerment index gem, and gender inequality index gii. however, to synthesize and measure the process it is difficult to select any measure as an index of women empowerment, which can truly determine the effects of various socio-economic and political factors on women empowerment. however, in the present analysis cross sectional study is done to measure the process, taking fertility rate as an indicator of women empowerment. the present study is carried out with following specific objectives: 1. to identify the democracy, health, economically view , education and politics factors that affect women empowerment across the selected countries. 2. to critically assess the reasons behind the denial of women empowerment. 3. to suggest practical steps for the improvement of women empowerment in a society. 2. literature review the following dimensions which should be considered while measuring the process of empowerment i.e. legal, political, and economic and socio‐cultural dimensions. global health institute survey 2014 also indicates that female empowerment has multiple, interrelated and interdependent dimensions i.e. economic, social, cultural and political impact. that socio economic and political empowerment of women is an important element and is necessary for reducing their sufferings and for their equal participation in society. fisch et al. (2018) that there are a number of factors through which the process of women empowerment can be increased i.e. increasing their rights, resources, dignity, choices and opportunities. gambia found that there exists a strong positive relation between various socio economic and political aspects of women participation and the level of women empowerment. jahromi et al. (2019) hence improvements in women‟s well-being in terms of better health, nutrition, increased income, education, reduced violence, longer life span etc. are seen as prerequisites for women empowerment. female educational attainment, while studied female educational attainment, enrollment ratio, and “index of femaleness” in asian journal of economics and empirical research, 2020, 7(2): 159-170 161 © 2020 by the authors; licensee asian online journal publishing group education.vermeulen et al. (2018) a research paper, concluded that to increase the process of women empowerment in sub saharan african and asian countries, there should be availability of increased health services for poor women controlling birth rates, controlling maternal mortality ratios, the process of women empowerment can be promoted (matro, martin, wolf, shah, & mahadevan, 2018; riahi, mohammadi, rohani, & bidkhori, 2018). the prior research concluded that in most of the countries globally there exists a positive and direct relation between women empowerment and their economic participation, which also positively affect the development and growth process of a country. research in india, on women empowerment concluded that women economic participation affects their power of decision making, their freedom of movement and control over resources. he used certain demographic variables in his study and found that the role of education is crucial for female economic participation (teitelman, kim, waas, desenna, & duncan, 2018). he said that literacy, improved skills and selfemployment opportunities will positively affect the process of female empowerment. the status of women in health can also be visualized from their fertility, maternal mortality and life expectancy ratios. turning to health, in general women are under a longer life expectancy than men, but this female advantage is somewhat smaller in poor countries. gross et al. (2019) healthy life expectancy (hle) provides an indication of overall health for a population, representing the average equivalent number of years in full health that a newborn could expect to live if they were to pass through life. qi et al. (2018) life expectancy for women in developing countries is placed on average significantly lower than that of their counterparts in developed countries. political empowerment of women is one of the key issues of women‟s empowerment. it refers to the knowledge of political system and ways of access to it, family support for political activities, exercising the rights to vote, activities related to electoral process like voting, campaigning, holding party offices and contesting elections who control how to utilize income (ager et al., 2018; mckibbin, shackelford, & lopes, 2018). 3. methodology a cross-country regression analysis will be executed for all the developing countries of the world on the basis of the latest available data. the data will be taken from different sources like human development reports (hdrs) of the undp and world development indicators (wdi) of the world bank. in this research the fertility rate of 2014 taking as for dependent variable and other five independent variable like democracy, health, economically view, education and political situation. samari (2019) in the second stage of the dependent variable is taking from the fertility rate of 2013 same as independent variables in 2013 and in third stage taking the sum of dependent variable 2014 and 2013 and apply robust test (phelippeau, cazalis, & koskas, 2019; wu, satmary, peng, & hui, 2020) human development report, undp and world bank 2015 data bases, polity data scores data sheet, are the sources of data collection for all the indicators and variables of study (cobo et al., 2020; sciorio & anderson, 2019; tierney, 2020). 3.1. sample size and data our sample size constitutes 124 developing countries for which recent data are available. the reason for taking this sample is that developing countries are characterized by common developmental issues and similar developing features. and it will be reasonable / logical to measure the effects of the determinants of women empowerment on the basis of shared characteristics. this is a cross sectional study. data is taken for the years 2013 and 2014 to measure the process. 3.2. methods and procedures however, on the basis of our previous chapter‟s knowledge the general functional form of our research model is as under: we it = f [di t-1, hit-1, ecit-1, edit-1, pi t-1 the above model shows the effect of all the selected independent variables on the dependent variable i.e. women empowerment, where t stand for the 2014, and t-1 represents the year 2013. in this model, „we‟ stand for women empowerment. this variable is indicated by the fertility rate. d‟ stands for democracy, h‟ stands for female health status „„ec‟ represents economically view , ed‟ stands for female education, ʽp‟ represents the rate of political, it is being used to proxy for the prevalence of democratic culture in a society and participation of women in a country. moreover „f‟ is the functional notation and „i" represents developing countries. econometric form of our basic model will be as under: (w.e) i = β0 + β1di + β2hi+ β3ei + β4edi+ β5pi+ ei β0 is the constant intercept, α1 α2 α3 α4 α5 is the coefficients of independent variables i.e. female education, control over resources, health status, political participation and democracy respectively and “e” represents random term or it is residual. “i” indicates sample size i.e. 124 developing countries. 3.3. data analysis tools our research to analyze the data requires a quantitative approach. the datum needs to be analyzed using multiple regression analysis. this is a statistical technique to examine the relation between one or single dependent and several independent variables. as in multiple regression analysis, independent variables are utilized to predict dependent variables. in this type of statistical analysis, a linear combination of independent variables is the most authentic tool to predict a dependent variable, which is called the regression equation or model of regression. a linear regression equation is usually of the following form: women empowerment = βo + β1 democracy1+ β2 health 2 + β3 economically view 3 + β4 education 4 + β5 political view 5 +e βo = constant (it is equal to the mean if slope coefficients are zero) based on the above equation, the regression equation for our research study can be built as under five individual models. asian journal of economics and empirical research, 2020, 7(2): 159-170 162 © 2020 by the authors; licensee asian online journal publishing group 4. data analysis in data analysis procedure, the results have manipulated and finally conducted by descriptive statistically model. researcher has modified the critical value of each dependent and independent value by six models under the hypothesis evaluation. research by quantitative techniques the secondary data has been analyzed by using multi regression model. this statistically techniques have created the relation individually and have interoperable the female fertility factors by different independent variables. the variables analyzed the relationships between cross dependent variables. in multi regression, the statistically values have predicted the dependent variables. and, these predicted values have also determined the predicted and explained values (ng & wang, 2020). there are five models have determined the statistically value of multi-regression by following 4.1. democracy test democracy test have conducted on fertility rate of 2014 which is computed on bases of 2013 democracy rate, parliamentary seat, tertiary education, life expectancy and female income. the democracy test computed on 2013 individually as following equation. fertility 2014 = constant+ β1 democracy + β2 parliament+ β3 tertiary education + β4 life expectancy+ β5 female income+ e 4.2. economically view economic test has conducted on fertility rate of 2014 which is computed on bases of 2013 democracy, female income, gross secondary female education, maternal mortality, and female labor force participation. the economic test computed on 2013 individually as following equation. fertility 2014 = constant+ β1 democracy + β2 female income + β3 gross secondary female education + β4 maternal mortality + β5 female labor force participation + e 4.3. health test health test have conducted on fertility rate of 2014 which is computed on bases of 2013 democracy rate, parliamentary seat, gross secondary education, maternal mortality and female employment. the health test computed on 2013 individually as following equation. fertility 2014 = constant+ β1 democracy + β2 parliament+ β3 gross secondary education + β4 maternal mortality + β5 female employment + e 4.4. education test education test have conducted on fertility rate of 2014 which is computed on bases of 2013 democracy, female income, female gross primary education, maternal mortality and female per-capita income. the education test computed on 2013 individually as following equation. fertility 2014 = constant+ β1 democracy + β2 female income + β3 female gross primary education + β4 maternal mortality + β5 female per capita income + e 4.5. political view political test have conducted on fertility rate of 2014 which is computed on bases of 2013 democracy, female income, females mean years of schooling, female per-capita income and female life expectancy. the political test computed on 2013 individually as following equation. fertility 2014 = constant+ β1 democracy + β2 parliamentary seats + β3 females mean years of schooling + β4 female per-capita income + β5 female life expectancy + e the women‟s empowerment is necessary for the whole society. it may be defined as a process, the result of which may come out in such a way that women become able to take control of their lives, improve their skills, become able to solve their problems, and develop their inner qualities of self-reliance and confidence. women empowerment means that through women aware of their rights and self-confidence women improve and develop their ability to bring a change in her life. women empowerment is the process which can be defined as treating women like the equal companions with the same rights and duties as men have and increase their spiritual, political impact, social or economic strength (keats, 2018). figure-1.fertility rate of 2014. figure 1 shows different box regarding model 1 to 5, democracy, economically view , health, education and politics respectively. health and politics have directly impact on the women empowerment as compare to others. each model has elaborated regarding above equations with fertility 2014 individually. asian journal of economics and empirical research, 2020, 7(2): 159-170 163 © 2020 by the authors; licensee asian online journal publishing group baysal et al. (2018) identified the following dimensions which should be considered while measuring the process of empowerment i.e. legal, political impact, and economic and socio‐cultural dimensions. global health institute survey 2014 also indicates that female empowerment has multiple, interrelated and interdependent dimensions i.e. economic, social, cultural and political impact. that there are a lot of factors through which the process of women empowerment can be increased i.e. increasing their rights, resources, dignity, choices and opportunities. gambia found that there exists a strong positive relation between various socio economic and political impact aspects of women participation and the level of women empowerment. they concluded that women always want to improve their lives and wellbeing will increase their participation in all respects of lives and will also increase their confidence (zhang & li, 2017) figure-2.models distributed by countries. figure 2 shows 124 countries data along with different models. the democracy, economically impact, health, education, and politics respectively indicate different peaks. the politically involvement highly impact on women empowerment in all countries. according to beach e. observed education, good health and income as necessary for the women empowerment. he concluded that these factors are closely related to the process. he examined the impact of education on the empowerment of women as well as the challenges and changes that could be faced during the process. the various socio economic and cultural variables, which can affect women empowerment, found that there are a number of factors which affect process of women empowerment in a society (van et al., 2017). 5. results 5.1. mean and standard deviation of models interpretation: table 1 is indicated the descriptive statistics; variables models have shown the different value of mean of n=124 the highest mean of political involvement is 4898.234 which is 8.6% greater from education of female and 6.3% respectively from democracy rate. the standard deviation value shows the significant relation with each individual variable. the obtained values of these models show the significant result. the means that shows the significant on women empowerment. therefore, the obtained results show the expressive values of variables in n=124 individually. table-1. descriptive statistics variable mean sd variance sleekness fertility 2014 257.7823 246.6212 71619.03 1.54527 democracy 311.0230 262.6028 68960.21 1.462451 economically view 321.1452 259.9577 67578.0 1.440435 health 4436.229 3985.261 1.35000 0.924417 education 4473.826 3670.528 1.350000 0.925115 political impact 4898.234 3985.261 1.590000 0.960887 5.2. liner regression analysis of models the liner regression model of democracy test shows the insignificant effect on the women improvement. the coefficient for democracy is 0.08144. this means that for a 1-unit increase in the democracy, expect an approximately 1% point increase in the women improvement. this is statistically insignificant; in other words, the coefficients having p-values less than alpha are statistically insignificant. the coefficient for democracy is (.0.744) is not significantly different from 0 using alpha of 0.05 because its p-value is 0.744, which is greater than 0.05. the coefficient for democracy (.0255) is statistically have created negative effects on individually, because its p-value is definitely greater than 0.05. the (t-value) 0.33 is less than 2 which is also shows the insignificant effects on the women improvement individually. the coefficient for economically view is 0.77719. this means that for a 1-unit increase in the economically view, expect an approximately 1% point increase in the fertility 2014. this is statistically significant; in other words, the coefficients having p-values less than alpha are statistically significant. the coefficient for economically view is (.002) is significantly different from 0 using alpha of 0.05 because its p-value is 0.002, which is less than 0.05. the coefficient for economically view is statistically have created positive effects on individually, because its p-value is definitely less than 0.05. the sum of ss model/ss total is equal to 7434168.59, the value of r-square is 0.8185 and r2 is 0.8107. the degree of freedom associated with source of variance; the model degrees of freedom corresponds to the number of predictors minus 1 (k-1). the total variance is n-1, there are 1 predictor of independent variable so the df is (1242) is and the sum of squares divided by their respective df. for the models 6087816.96 / 5 = 1211693.39. for the asian journal of economics and empirical research, 2020, 7(2): 159-170 164 © 2020 by the authors; licensee asian online journal publishing group residual, 1349351.63 / 117 = 11532.9199, these are computed so you can compute the f ratio, dividing the mean square model by the mean square residual to test the significance of the predictors in the model. f and prob > f – the f-value is the mean square model (1216963.39) divided by the mean square residual (11532.9199), yielding f=105.22 the p-value associated with this f value is very small (0.0000). the root mse – root mse is the standard deviation of the error term, and is the square root of the mean square residual, which is 107.39. this estimated table shows the relationship between democracy, economically view, health, education, politics and dependent variable women improvement. these estimates shows the amount of increase in fertility scores that would be predicted by a 1 unit increase in the predictor. 5.3. regression analysis of models table-2. regression analysis of all models source democracy economically view health education political impact t-test 22.36 23.51 -5.17 -5.16 -5.58 p>|t| 0.000 0.000 0.000 0.000 0.000 coefficient of model 0.8423 -0.0278 -0.0284 -0.0284 -0.0278 f(1,122) 493.00 552.84 26.71 26.630 31.090 table 2 shows the individually effects of each predictor on women empowerment. the (t-value) of individually model is 22.36 in democracy which is greater than 2, the significant f-value typically (p<.05), and the predicator result shows the f value is.000 it means it less the.05 so it shows the significant effects on fertility 2014 the dependent variable, which is proxy of women empowerment. the coefficient of democracy is 0.84231 with rsquare 0.8029 with n=124 number of individuals. the obtained value of model 2 economic (t-value) of individually model is 23.51 in economically view which is greater than 2, the significant f-value typically (p<.05), and the predicator result shows the f value is.000 it means it less the.05 so it shows the significant effects on fertility 2014 the dependent variable. the coefficient of economically view is 0.858670 with r-square 0.8192 with n=124 number of individuals. 5.4. pearson correlation of models table-3. correlation. fertility 2014 democracy economically view health education political impact fertility 2014 1.0000 democracy 0.8961 1.0000 economically view 0.9045 0.9880 1.0000 health -0.4232 -0.4793 -0.4682 1.0000 education -0.4236 -0.4784 -0.4678 0.9999 1.0000 political impact -0.4500 -0.5072 -0.4957 0.9198 0.9189 1.0000 table-4.pairwise correlation with 2013 to 2014. fertility 2013-14 democracy economically view health education political impact fertility 2013-14 1.0000 democracy 0.9383 1.0000 economically view 0.9403 0.9880 1.0000 health -0.4511 -0.4793 -0.4682 1.0000 education -0.4501 -0.4784 -0.4678 0.9999 1.0000 political impact -0.4841 -0.5072 -0.4957 0.9198 0.9189 1.0000 table-5. pairwise correlation with 2013. fertility 2013 democracy economically view health education political impact fertility 2013 1.0000 democracy 0.9426 1.0000 economically view 0.9386 0.9880 1.0000 health -0.4602 -0.4793 -0.4682 1.0000 education -0.4588 -0.4784 -0.4678 0.9999 1.0000 political impact -0.4977 -0.5072 1.0000 0.9198 0.9189 1.0000 table-6. aic and bic. sources aic bic r adjusted r2 democracy 1507.439 1513.063 0.8029 0.8013 economically view 1508.745 1514.386 0.8192 0.8177 health 1696.291 1701.93 0.1769 0.1729 education 1696.361 1702.002 0.1719 0.1724 political impact 1692.688 1698.328 0.2031 0.1966 6. discussion and finding first hypothesis: the women should have equal opportunities to participate in socio economic and political frameworks. carlberg, singer, and vichinsky (2018) and the female empowerment it is necessary that women asian journal of economics and empirical research, 2020, 7(2): 159-170 165 © 2020 by the authors; licensee asian online journal publishing group should be in a position to act freely, and acquire power to exercise their rights and potentials. thus, women empowerment can be described as a process through which women get an equal and equitable status and position in a society of individual variables. researcher obtains statistically significant constant term in different variables, and the women improvement has analyzed with (t-value) is 22.20 in democracy with p>|t| 0.000. 1-unit increase in the democracy, expect an approximately 0.842 percent increase in fertility 2004. a number of researches on women empowerment have concluded that democracy participation of females can increase their knowledge, confidence, skills and empowerment level. an economically empowered woman will come out control over various financial and material resources. stevenson, hurt, and trotter (2017) therefore, the fertility rate of 2014 has analyzed the value along with r-squared, which determined the significant relations with it. the obtained values of the collinearity statistics show the stepwise multiple linear regression analysis, that researcher have determined a non-significant intercept but highly significant vehicle theft coefficient for collinearity test, which the researcher can interpret as for every n=124 samples individually. the pearson correlation of r= 0.9880 with economically view and -0.5072 with politics table 4, therefore it creating the negative effects on economically view, health and politics individually. the sample provided sufficient evidence to conclude that there is a significant, nonzero correlation in the population. the test based on α=.05 in the critical region of a two tail tests. according to robust test table 5 r= 0.9426, which is 4.9% greater as compare to fertility in 2014. so, in the same period the obtained value in same year is greater comparatively fertility of 2014. the robust test shows the highly significant value as compare to 2014 individually. regarding fertility 2013 and 2014 the r=0.938 which is greater 4.49% in fertility 2014 and 0.4% in fertility 2013. therefore, the summation of year‟s fertility shows highly significant value compare to lag years. figure-3. fertility rate with democracy. figure 3 shows the democracy of women empowerment in the fertility rate of 2014, the model have elaborated fertility rate of 2014 which is computed on bases of 2013 democracy rate, parliamentary seat, tertiary education, life expectancy and female income. the highest rate of democracy is between 0 to 1000 in axes and the democracy of women have increase in period of 0. second hypothesis: the developing countries socio-economic condition can be helpful to promote women status. economically view approximates an egalitarian system or a system where women have equal rights and opportunities to participate in socio economic and political spheres. researcher obtains statistically significant constant term in different variables, and the women improvement has analyzed with 0.9045 in economically view and 0.9880 with democracy. the obtained values of the collinearity statistics show the stepwise multiple linear regression analysis, that researcher have determined a non-significant intercept but highly significant vehicle theft coefficient for collinearity test, which the researcher can interpret as for every n=124 samples individually. the pearson correlation of r= 0.9880 with democracy and with politics is -0.4957 table 3, therefore it creating the positive effects on democracy and negative impact on education and politics individually (altiparmak & derya, 2018) the sample provided sufficient evidence to conclude that there is a significant, nonzero correlation in the population. the test based on α=.05 in the critical region of a two tail tests. according to robust test table 5 r= 0.9386, which is 3.36% greater as compare to fertility in 2014. so, in the same period the obtained value in same year is greater comparatively fertility of 2014. the robust test shows the highly significant value as compare to 2014 individually. regarding fertility 2013 and 2014 the r=0.9403 which is greater 3.60% in fertility 2014 and .018% in fertility 2013. therefore, the summation of year‟s fertility shows highly significant value compare to lag years. asian journal of economics and empirical research, 2020, 7(2): 159-170 166 © 2020 by the authors; licensee asian online journal publishing group figure-4. fertility 2014 with health. figure 4, shows the lowess smoother of fertility 2014 and health. where the expected bandwidth of 0.8 is used, so it shows 80% of data are used in smoothing each point. and smaller bandwidth follows the original data more closely in this model. third hypothesis: third hypothesis: the women empowerment means that through women aware of their rights and self-confidence women improve and develop their ability to bring a change in her life. park et al. (2017) women empowerment is a work which can be defined as treating women like the equal companions with the same rights and duties as men have and increase their spiritual, political, social, or economic strength. empowering women enhance their ability to influence changes and to create a better society. figure-5. sunflower between health and fertility 2014. figure 5 shows the minimum observation in sunflower is 3 in light and 13 in dark view. the bin height of fertility 2014 and health is chosen to make bin regular hexagons with maximum of 1 dark patel form 14 maximum observation in bin, the blue circles shows the individual observation of model, brown petal on green background shows the light sunflowers and black petal on orange background shows dark sunflowers in 124 number of observations. researcher obtains statistically significant constant term in different variables, and the women improvement has analyzed with democracy, parliament seat, gross enrollment in primary education, secondary education, maternal and female labor. researcher obtains statistically significant constant term in different variables, and the women improvement has analyzed with -0.4232 in health view and -0.4682 with economically and -0.4793 with democracy table 3, therefore, it creating the negative effects on democracy and economically view individually and shows the weak relationship among them. the sample provided sufficient evidence to conclude that there is a significant, nonzero correlation in the population. the test based on α=.05 in the critical region of a two tail tests. according to robust test table 5 r= 0.4602, which is 8.03% greater as compare to fertility in 2014. so, in the same period the obtained value in same year is greater comparatively fertility of 2014. the robust test shows the highly significant value as compare to 2014 individually. regarding fertility 2013 and 2014 the r=-0.4511 which is greater 6.18% in fertility 2014 and 2.02% in fertility 2013. therefore, the summation of year‟s fertility shows highly significant value compare to lag years. asian journal of economics and empirical research, 2020, 7(2): 159-170 167 © 2020 by the authors; licensee asian online journal publishing group figure-6.economic view of 2014 fertility. figure 6, shows the lowess smoother of fertility 2014 and economically view. where the expected bandwidth of 0.8 is used, so it shows 80% of data are used in smoothing each point. and smaller bandwidth follow the original data more closely in this model. fourth hypothesis: the “empowerment” is a process of development by which the disempowered individuals and groups become able to control and manage their lives. other researchers highlighted that the economic elements of empowerment refer primarily to the capability of women‟s earnings for a living. women are important for growth and development but in most of the developing societies women are deprived of their basic rights to get education, health and inheritance. researcher obtains statistically significant constant term in different variables, and the women improvement has analyzed with -0.4226 in education and -0.4784 with democracy, -0.4678 with economically view and .9999 with health table 3, the obtained values of the collinearity statistics show the stepwise multiple linear regression analysis, that researcher have determined a non-significant intercept but highly significant vehicle theft coefficient for collinearity test, which the researcher can interpret as for every n=124 samples individually. therefore, it creating the negative effects on democracy and economically view but created positive and strongly correlated with health individually. the sample provided sufficient evidence to conclude that there is a significant, nonzero correlation in the population. the test based on α=.05 in the critical region of a two tail tests. according to robust test table 5, r= -4226, which is 7.89% greater as compare to fertility in 2014. so, in the same period the obtained value in same year is greater comparatively fertility of 2014. the robust test shows the highly significant value as compare to 2014 individually. regarding fertility 2013 and 2014 the r=-0.4501 which is greater 6.10% in fertility 2014 and 1.93% in fertility 2013. therefore, the summation of year‟s fertility shows highly significant value compare to lag years. figure-7. 2014 fertility with education. figure 7, shows the lowess smoother of fertility 2014 and economically view. where the expected bandwidth of 0.8 is used, so it shows 80% of data are used in smoothing each point. and smaller bandwidth follow the original data more closely in this model. fifth hypothesis researcher obtain statistically significant constant term in different variables, and the women improvement has analyzed with democracy, parliament seat, mean years of schooling females, female income per capita, and females life expectancy 2013. researcher obtains statistically significant constant term in different variables, and the women improvement has analyzed with -0.4500 in politics and -0.5072 with democracy, -0.4957 with economically view, 0.9198 with health and 0.9189 with education table 3, the obtained values of the collinearity statistics show the stepwise multiple linear regression analysis, that researcher have determined a non-significant intercept but highly significant vehicle theft coefficient for collinearity test, which the researcher can interpret as for every n=124 samples individually. therefore, it creating the negative effects on democracy and economically view but created positive and strongly correlated with health and education individually. asian journal of economics and empirical research, 2020, 7(2): 159-170 168 © 2020 by the authors; licensee asian online journal publishing group figure-8. robust test between two years (2013-14). figure 8, shows the box plot of dependent and independent variables. where the both years of fertility have taken along with predictors of models. the highest box value is political impact and lowest value is fertility 2013 in lag year. the sample provided sufficient evidence to conclude that there is a significant, nonzero correlation in the population. the test based on α=.05 in the critical region of a two tail tests. according to robust test table 5, r= .4500, which is 9.58% greater as compare to fertility in 2014. so, in the same period the obtained value in same year is greater comparatively fertility of 2014. the robust test shows the highly significant value as compare to 2014 individually. regarding fertility 2013 and 2014 the r=-0.4841 which is greater 7.04% in fertility 2014 and 5.22% in fertility 2013. therefore, the summation of year‟s fertility shows highly significant value compare to lag years. figure-9. politically impact with 2014 fertility figure 9, shows the lowess smoother of fertility 2014 and politically view. where the expected bandwidth of 0.8 is used, so it shows 80% of data are used in smoothing each point. and smaller bandwidth follow the original data more closely in this model. figure-10. sunflower between 2014 fertility and political impact. figure 10 shows the minimum observation in sunflower is 3 in light and 13 in dark view. the bin height of fertility 2014 and political impact is chosen to make bin regular hexagons with maximum of 1 dark patel form 14 maximum observation in bin, the blue circles shows the individual observation of model, brown petal on green background shows the light sunflowers and black petal on orange background shows dark sunflowers in 124 asian journal of economics and empirical research, 2020, 7(2): 159-170 169 © 2020 by the authors; licensee asian online journal publishing group number of observations. table 6 is indicated the akaike information criterion (aic) is a way of selecting a model from a set of models with different style. the chosen model is the one that minimizes the kullback-leibler distance between the model and the truth in different expects. 1507.439 is the value of aic, as compare to the bayesian information criterion (bic) to compare models. the random distribution of variables. in this model bic value is greater than as compare to aic. therefore, this model shows the high random distribution as compare to other individuals. the economically view of women empowerment shows 1508.745 is the value of aic, in this model bic value is greater than as compare to aic. therefore, this model shows the high random distribution as compare to other individuals. therefore, this model shows the high random distribution as compare to other individuals. the political impact involvement of women empowerment shows 1692.688 is the value of aic, as compare to the bayesian information criterion (bic) to compare models. the random distribution of variables. in this model bic value is greater than as compare to aic. therefore, this model shows the high random distribution as compare to other individuals. in case of fertility 2014 and economically view of r-square is 0.8192 and 0.2197 with p-value of 0.000 so it shows the view of economic effect on 1 percent 0.8579 but health have directly affected on economically view individually with -0.03310 coefficient value. in other case if fertility 2014 have taking relationship with health r-square shows 0.1796 and 0.998, it effect on 1 percent of -0.0283665 coefficient value of health. and also, the health education effect on health with 1.002541 coefficient value. in last case the fertility 2014 with education so the r-square is 0.1746 and 0.8445. the 1 percent change effect on education with -0.0329 the coefficient of education and political impact also effect on education with 0.8463 in endogenous variable of fertility 2014 and education. 7. recommendation and conclusion because of analysis and discussion some findings emerged on the surface which are as follows; about the findings of the analysis the following recommendations are proposed to remove the obstacles and to promote the process of women empowerment; 1. the role and contribution of women through improving and promoting life skills and educational opportunities for them. 2. also, to strengthen opportunities for post-primary education for girls to ensure their primary education 3. to reduce gender gaps there should be increased opportunities for secondary and tertiary education for girls. 4. there is a strong need to strengthen labor policies affecting women. and expand women‟s access to credit and economic opportunities. 5. there is a requirement to expand reproductive health programs and family support policies. and strengthen nutrition, disease prevention, and maternal health programs. 6. to ensure women political participation there should be an increase women‟s share of seats in national parliaments and local governments. and discriminatory laws and gender blind policies should be discouraged. 7. ensuring female property and inheritance rights and a non-patriarchal culture would help to empower women both economically and socially and rectify a fundamental injustice of gender inequality. 8. supporting them in information. knowledge, developing contact, presenting issues, and advocacy skills etc. will also be a very helpful and effective strategy which will ensure their path of empowerment. 9. initiating and promoting programs for reducing gender gaps necessary for women development. the study was performed on determining and highlighting the main socio cultural economic and political factors of women empowerment and analyzing the impact of female literacy, economic and political participation, female health services and a non-patriarchal culture in promoting the process. it is concluded that cultural values and patriarchy are responsible for women disempowerment in most of the countries of the third world. moreover, it has restricted the path of women to get education and access, better health and career opportunities. lack of education and low literacy is the main deterrents towards women economic disempowerment. and therefore, women of third world countries continue to be lagging behind in every respect of life and participate in politics. women of underdeveloped countries contain a number of socio economic and political issues which have hindered their path of empowerment. among all these fertilities is considered to be an important factor which can determine their socio economic and political position and status in various countries. fertility is also available to be an effective measure of women empowerment. it is found that lower fertility rates and reduce the number of pregnancies in females depict, better health and use of more contraceptives by women. low fertility also explains that women are controlled by their reproductive decisions in a family. in the light of above literature, it is concluded that the process of women empowerment is the result of diverse socio cultural economic and political factors. the above literature has also highlighted numerous such factors and variables which are responsible for women disempowerment in developing countries. these factors include, lack and limited access to education, lack of confidence and freedom, lack of control over resources, imbalanced sex ratio, poor health, high fertility and maternal mortality rates, low life expectancy, non-availability of health services, lack of leadership and decision making opportunities and patriarchal culture etc. it is evident from the above literature that though women are facing various obstacles towards their empowerment, but the level of empowerment is also increasing. it is evident from the above literature that the phenomenon of low fertility rates across many of the countries of the world is being helpful in describing the process of women empowerment. the need is that women participation in all respects of lives should be increased which is also crucial for the overall development. reducing gender gaps and increasing equal socio economic opportunities, will ensure welfare and empowerment. references ager, b., jansen, j., porter, d., phillips, k., glassey, r., rankin, n., & skandarajah, a. 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(2020). women's preconception health patterns in traditional chinese medicine as a predictor of fertility outcomes. journal of integrative medicine, 18(3), 222-228.available at: https://doi.org/10.1016/j.joim.2020.01.006. zhang, c., & li, t. (2017). culture, fertility and the socioeconomic status of women. china economic review, 45, 279-288.available at: https://doi.org/10.1016/j.chieco.2016.07.012. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 67 © 2021 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 8, no. 2, 67-72, 2021 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2021.82.67.72 © 2021 by the authors; licensee asian online journal publishing group examining the impact of movements of the commodity price on the value of the baltic dry index during the covid-19 pandemic nikola radivojevic1 almir muhovic2 milica josimovic3 miroslav pimic4 ( corresponding author) 1academy at applied studies sumadia, kraguevac, serbia. email: radivojevic034@gmail.com tel: +381600555173 2institute for vegetable crops, smederevska palanka, serbia. 3university of novi sad, technical faculty “mihajlo pupin”, zrenjanin, serbia. 4valjevo city government, valjevo, serbia. abstract the baltic dry index (bdi) is one of the most well-known indexes, as it is perceived to be a leading indicator of economic activity. reductions in the movement of people, commodities, and capital during economic crises, such as the financial crisis of 2008 and 2009, as well as the current economic crisis generated by the covid-19 pandemic, were affected by the reduction of economic activities. the paper aims to examine whether the changes in these raw materials affect the changes in the value of the bdi. for these purposes, the generalized method of moments (gmm) and 2sls estimators are used. the results show that different raw materials have different impacts on the value of the bdi, which indicates that the individual movements of the value of raw materials which composes the bdi cannot forecast its movement. keywords: the baltic dry index, covid-19 pandemic, economic crises, commodities, gmm and 2sls estimators. jel classification: c01, c22, c24, g01 citation | nikola radivojevic; almir muhovic; milica josimovic; miroslav pimic (2021). examining the impact of movements of the commodity price on the value of the baltic dry index during the covid-19 pandemic. asian journal of economics and empirical research, 8(2): 67-72. history: received: 19 july 2021 revised: 17 august 2021 accepted: 6 september 2021 published: 22 september 2021 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 68 2. literature review ............................................................................................................................................................................ 68 3. data and methodology ................................................................................................................................................................... 69 4. empirical analysis and discussion of results ........................................................................................................................... 70 5. conclusion ......................................................................................................................................................................................... 71 references .............................................................................................................................................................................................. 71 mailto:radivojevic034@gmail.com http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.doi.org/10.20448/journal.501.2021.82.67.72 https://orcid.org/0000-0002-6137-4431 https://orcid.org/0000-0003-1479-2654 https://orcid.org/0000-0003-2180-0237 https://orcid.org/0000-0002-7848-440x https://www.doi.org/10.20448/journal.501.2021.82.67.72 https://orcid.org/0000-0002-6137-4431 https://orcid.org/0000-0003-1479-2654 https://orcid.org/0000-0003-2180-0237 https://orcid.org/0000-0002-7848-440x https://www.doi.org/10.20448/journal.501.2021.82.67.72 https://orcid.org/0000-0002-6137-4431 https://orcid.org/0000-0003-1479-2654 https://orcid.org/0000-0003-2180-0237 https://orcid.org/0000-0002-7848-440x https://www.doi.org/10.20448/journal.501.2021.82.67.72 https://orcid.org/0000-0002-6137-4431 https://orcid.org/0000-0003-1479-2654 https://orcid.org/0000-0003-2180-0237 https://orcid.org/0000-0002-7848-440x https://www.doi.org/10.20448/journal.501.2021.82.67.72 https://orcid.org/0000-0002-6137-4431 https://orcid.org/0000-0003-1479-2654 https://orcid.org/0000-0003-2180-0237 https://orcid.org/0000-0002-7848-440x https://www.doi.org/10.20448/journal.501.2021.82.67.72 https://orcid.org/0000-0002-6137-4431 https://orcid.org/0000-0003-1479-2654 https://orcid.org/0000-0003-2180-0237 https://orcid.org/0000-0002-7848-440x asian journal of economics and empirical research, 2021, 8(2): 67-72 68 © 2021 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the existing literature by revealing that different raw materials have different impacts on the value of the bdi, which indicates that, based on individual movements, the value of raw materials which composes the bdi cannot forecast its movement. 1. introduction the baltic dry index (bdi) is one of the most well-known indexes, and it is perceived to be a leading indicator of economic activity. the reason for this lies in the fact that it reflects changes in supply and demand for imported raw materials used in manufacturing. the prevailing view in professional and academic circles is that changes in values of this index are a good indicator of future global economic activities (faqin & sim, 2013). although, it should be noted that the bdi is not the only dry bulk index available; it derives its popularity from the fact that is the most comprehensive index (for details see precision trading systems, 2013). additionally, it derives its popularity from the fact that a real-time indicator is difficult to manipulate, since it is driven by clear forces of supply and demand (hassan, sanchez, & yu, 2011). the bdi is a list of daily weighted average freight prices of shipping raw materials for use in production processes across the globe. it incorporates aspects of future economic activity and thus has the characteristics of a leading economic indicator (papailias, thomakos, & liu, 2017). more precisely, the bdi is a benchmark for the price of transporting major raw materials by sea. in other words, it is an index that measures changes in the cost of transporting various raw materials, which are transported by sea. the creator of the index, the baltic stock exchange, which is based in london, describes it as the index of average prices paid for the transport of dry bulk materials for 26 different shipping routes carrying coal, iron ore, grains, and many other commodities. it consists of three sub-indices – capesize, panamax and supramax – and they measure different sizes of dry bulk carriers or merchant ships. given the above, it is not surprising that this index is often referred to as a shipping and trade index. the basic characteristic of the index is reflected in high volatility, which many studies have testified. there are several reasons for this. the first is that the supply of large carriers by sea is quite small with long lead times and high production costs, while on the other hand, the demand for the transport of raw materials is determined by the level of economic activity, which is ultimately determined by the price of raw materials and their supply and demand. hence, the volatility of the raw material market also affects the volatility of this index. reductions in the movement of people, goods and capital under economic crisis conditions were affected by the reduction in economic activities. it is worth pointing out that the analysis of the basic trend of the bdi movements in the period before the economic crisis shows that the index fell to near record lows just before the credit crisis hit stocks full force (see unctad (2009)). this is a clear signal that the index can be used as a tool for stock market forecasting. the decrease in economic activity affects the increase in price volatility, which is the main characteristic of commodity markets. the reasons for commodity price volatility differ by commodity and may change over the course of time. but, in general, low short-term elasticities of supply and demand cause any shock to production or consumption to translate into significant price fluctuations (mayer, 2010). the outbreak of covid19 has been accompanied by widespread declines in global commodity prices (bank, 2020). in such conditions, it is expected that these changes affect the decrease in the value of the bdi. in order to examine whether the changes in these raw materials affect the values of the bdi and to what extent, the paper analyzes the impact of changes in the value of basic raw materials on the change in the value of the bdi. in other words, the aim is to examine the relationship between the bdi and the major raw materials, whose freight prices enter the calculation of the bdi. the paper is structured as follows: the first part of the paper provides the introduction to the study; the second part gives an overview of the most significant and relevant empirical research and presents the results of previous research in this field; the third part of the paper provides a description of the analyzed data and the methodology used; in the fourth section, the results are presented, analyzed and discussed; and the final part of the paper summarizes the findings and outlines the conclusions. 2. literature review there is an abundance of literature on the bdi that can be classified into two groups. the first group consists of papers that focus on the development of more reliable procedures and models to predict changes in freight rates. the development of various models is caused by fact that risk and uncertainty in the shipping market have increased dramatically. interestingly, maritime freight rates fell by 50% on average, while global trade increased by 400% from 1870 to 1913 (jacks & pendakur, 2010). driehuis (1970) was the first to design a good model for forecasting freight rates. similar attempts were made by marlow & gardner (1980), and beenstock & vergottis (1989a) and beenstock & vergottis (1989b). cullinane, mason, & cape (1999) applied the box–jenkins approach to forecast the movements of the baltic freight index (bfi). more recently, makridakis, merikas, merika, tsionas, & izzeldin (2020) presented a new model to predict changes in freight rates and apply it to the bdi. the findings they reported show that the new model was very successful in forecasting the bdi movement. thalassinos, hanias, curtis, & thalassinos (2013) used the false nearest neighbors (fnn) method to forecast the bdi, and tsioumas, papadimitriou, smirlis, & zahran (2017) used a multivariate vector autoregressive model with exogenous variables (varx). zeng, qu, ng, & zhao (2016) developed a new forecasting approach in literature known as empirical mode decomposition (emd). this approach is based on artificial neural networks (ann). geman & smith (2012) investigated the bdi and suggested several diffusion models that are able to capture the unique features of its trajectories, such as large swings and high volatility. the second group includes papers that examine the relationship between the bdi and various microeconomic and macroeconomic indicators and commodities. tsioumas & papadimitriou (2015) investigated the lead–lag relationship between china’s steel output and various baltic exchange indices and concluded that there is a significant causality effect of chinese steel production on the dry bulk freight market. similar results were asian journal of economics and empirical research, 2021, 8(2): 67-72 69 © 2021 by the authors; licensee asian online journal publishing group presented by tsioumas & papadimitriou (2016). their results provide evidence in favor of an existing significant causality between certain commodity prices and the freight rates of bulk carriers. a significant part of these papers focuses on testing the hypothesis that the bdi functions as a signal that promptly responds to crisis effects. these papers focus on analyzing the bdi as a supply and demand signal for the stock market. faqin & sim (2013) examined the link between the bdi as a proxy for trade and income improvements for the 48 least developed countries. since trade is endogenous in the determination of income levels, they used the bdi as a proxy for trade and developed a new measure of trade cost as an external source of variation in trade, which, in turn, is used to construct the within-country estimate of the causal effect that trade has on the income of the least developed countries. they found that a reduction in the bdi has a positive effect on the income of least developed countries through the trade channel; a 1% expansion in trade raises the gdp per capita by approximately 0.5% on average. this estimate is much larger than what was previously found in the literature and its quantitative significance emphasizes the importance of trade for the economic development of low income countries (faqin & sim, 2013). papailias et al. (2017) found that variations in the bdi are strongly associated with fluctuations in commodity markets, such as coal, steel, iron, corn, and wheat markets. they also showed that it is possible, by applying trigonometric regression, to improve forecasting in the bdi movements, and thus movements of commodity markets. similar studies were conducted by adland & cullinane (2005); koekebakker, adland, & sødal (2006) and batchelor, alizadeh, & visvikis (2007). they studied the bdi series as a whole rather than analyzing the spot or forward rates separately. lin & sim (2013) examined the relationship between the bdi and trade in sub-saharan countries, and they also investigated the impact of the bdi on the transitory negative income shocks. they found that there is a strong relationship between the bdi and trade and the impact of the bdi on the transitory negative income shocks. the seasonal properties and forecasting in the dry bulk shipping sector were the subject of research conducted by cullinane et al. (1999); kavussanos & alizadeh-m (2001) and kavussanos & alizadeh-m (2002). the results of these studies imply that a considerable proportion of the bdi variations can be predicted by a combination of explanatory factors and the cyclical pattern that exists in the series. kavussanos & nomikos (1999) and kavussanos & visvikis (2004) studied the relationship between freight futures and spot prices using the var and vec models. kavussanos & visvikis (2004) and kavussanos, visvikis, & menachof (2004) utilized a cointegration analysis to examine the predictability of the forward freight agreements (ffa) in the panamax freight market. jurun, ratković, & moro (2015) examined the relationship between the bdi as the key indicator of economic and business activities, and the business results of shipping companies. they studied the relationship between the bdi and performance excellence of the representative shipping companies. the results of their study show that there is a strong relationship between the average annual bdi values as an indicator of the cyclical nature of the maritime market and results of the representative shipping companies. jurun et al. (2015) used the adjusted altman z-score to measure business results. the conclusion of their study is that the bdi serves as a good signal for the buying or selling of certain shares. in other words, it provides a reliable basis for making decisions. they came to this conclusion based on the discovery a high correlation exists between short-term (quarterly) average bdi values and a company’s business excellence. all of the abovementioned papers suggest possible endogeneity problems. 3. data and methodology as already mentioned, the aim of the paper is to examine the relationship between the bdi and major raw materials, such as corn, coal crude oil, iron ore, soybeans, copper, tin, wheat, aluminum, zinc, nickel, gold, rice and lead, whose freight prices enter the bdi. the raw materials were selected from the aforementioned empirical studies that confirm the link between the bdi and the major raw materials. data were collected from the official federal reserve bank of st. louis and bloomberg websites for the period between november 1999 and september 2020. for purpose of this study, monthly data was used. this study used a multiple linear regression model on a set of explanatory variables as mentioned above. the econometric model is expressed below, with the bdi as the dependent variable. (1) where bdi is the baltic dry index; cor is corn price; coa is coal price; cru is crude oil price; iro is iron ore; soy represents soybeans; lea is lead, cop represents copper, tin represents tin; whe represents wheat, alu is aluminum, zin is zinc, nil is nickel, gol represents gold, and ric represents rice; is the model error. according to wooldridge (2003) and radivojevic & jovovic (2017), the ordinary least squares (ols) model represents the most efficient estimator. however, it is true only if all the assumptions on which it is based are met. otherwise, it will generate biased/unbiased and consistent/inconsistent estimates (some of these combinations) depending on which assumptions are not met. from the literature review on this subject, it was observed that researchers have concluded that this topic might run the risk of endogeneity. the problem of the possible endogeneity of one or more independent variables may be solved using the two-stage least squares (2sls) method but the instrumental variables must not be weak. for that reason, the 2sls method has been employed in this study. mladenovic & pavlovic (2003) warned that the 2sls usually generates biased and consistent estimates. in addition, we have used the generalized method of moments (gmm). unlike other estimators, the main advantage of the gmm is that it can be used even when the assumptions of other estimators are not satisfied. generally speaking, the gmm can be viewed as a generalization of many other methods, and as a result, it is less likely to be misspecified (chaussé, 2010). the gmm generates correct standard errors and p-values, provided that the specified moment conditions are valid. it is based on the simple idea that the estimations of parameters are done by solving a set of moment conditions. for the purpose of this study, a one-step1 iv-gmm was used. since the gmm depends only on moment conditions, it is a reliable estimation procedure for many models in economics and 1 of the available two-step and one-step gmms, the one-step gmm estimator was chosen as it tends to be less biased in smaller sample sizes (see arellano & bond (1991)). asian journal of economics and empirical research, 2021, 8(2): 67-72 70 © 2021 by the authors; licensee asian online journal publishing group finance, especially for models which suffer from endogeneity problems because it provides the efficient estimations of instrumental variables under “orthogonality conditions”, with the instrumental variables and the error term being orthogonal in the expectation sense (radivojević et al., 2019). 4. empirical analysis and discussion of results table 1 shows the results of the descriptive statistics of the data set. as can be seen from table 1, the bdi ranges from 306.9 to 10843.65, which indicates a very high disparity between the minimum and maximum index values. the very high value of the standard deviation of the bdi testifies to a large fluctuation in the value of this index, and this a similar case for the values of all commodities. the excess kurtosis ranges from 4.84 in the case of the bdi index to -1.09 in the case of copper. this indicates that the bdi index has significant leptokurtosis. the skewness of all the commodities and the index is different from zero, which indicates that they have asymmetric distribution. table 1. descriptive statistics of selected variables. bdi cor coa cru iro soy cop lea mean 2268.77 164.72 73.21 60.62 67.44 336.30 5332.50 1621.46 standard deviation 2027.69 63.74 33.92 26.22 48.01 115.60 2353.37 753.00 excess kurtosis 4.84 0.13 0.02 -0.70 -0.61 -0.74 -1.09 -0.86 skewness 2.14 0.89 0.52 0.43 0.63 0.30 -0.35 -0.23 minimum 306.90 75.06 24.00 16.55 11.93 158.61 1377.38 412.61 maximum 10843.65 333.00 195.19 133.88 187.18 622.91 9880.94 3722.61 no. obs. 251 251 251 251 251 251 251 251 tin whe alu zin nic gol ric mean 14726.08 184.20 1902.17 1944.61 15341.74 958.33 391.55 standard deviation 7022.54 64.56 414.70 798.11 7751.67 482.84 153.35 excess kurtosis -1.07 0.08 -0.07 -0.23 4.30 -1.31 1.04 skewness -0.10 0.82 0.77 0.39 1.74 -0.06 0.69 minimum 3698.37 90.44 1283.53 748.81 4830.78 260.75 162.10 maximum 32347.69 403.81 3067.46 4381.45 51783.33 1971.17 1015.21 no. obs. 251 251 251 251 251 251 251 to identify a potential multicollinearity problem, the next step included an analysis of the matrix correlation; the results are presented in table 2. table 2. matrix correlation. bdi cor coa cru iro soy cop tin whe alu zin nic gol ric lea bdi 1.00 cor -0.03 1.00 coa 0.18 0.76 1.00 cru 0.29 0.80 0.79 1.00 iro -0.23 0.82 0.71 0.70 1.00 soy 0.01 0.93 0.77 0.81 0.80 1.00 cop 0.15 0.80 0.81 0.85 0.79 0.78 1.00 tin -0.09 0.83 0.85 0.75 0.86 0.87 0.88 1.00 whe 0.27 0.86 0.71 0.84 0.64 0.85 0.78 0.72 1.00 alu 0.55 0.46 0.63 0.69 0.33 0.38 0.76 0.48 0.57 1.00 zin 0.15 0.35 0.49 0.45 0.37 0.34 0.76 0.58 0.35 0.73 1.00 nic 0.58 0.40 0.40 0.58 0.30 0.33 0.66 0.37 0.52 0.84 0.64 1.00 gol -0.31 0.78 0.67 0.56 0.86 0.79 0.78 0.88 0.59 0.26 0.51 0.19 1.00 ric 0.13 0.79 0.81 0.75 0.73 0.81 0.75 0.76 0.72 0.48 0.35 0.35 0.72 1.00 lea 0.17 0.70 0.78 0.72 0.70 0.76 0.90 0.88 0.71 0.62 0.75 0.55 0.78 0.69 1.00 as can be seen from table 2, there is a strong correlation (above 0.800) between certain commodities. for this reason, eight variables were excluded from further analysis (cor, coa, cru, soy, cop, tin, gol and alu). as two different estimation methods are used, two different sets of results are illustrated in table 3. the 2sls results in table 3 show that there is: 1) a positive and significant relationship between the bdi and nic – every 1% increase in nic causes an increase of 0.217% in the bdi; 2) a positive and significant correlation between ric and the bdi – for every 1% increase in the value of rice, the npl’s rate will rise by approximately 4.17%; 3) a positive and significant relationship between lea and the bdi – every 1% rise in lea leads to a 1.61% increase in its bdi value. these results are in line with those found by papailias et al. (2017), tsioumas & papadimitriou (2015) and tsioumas & papadimitriou (2016). the results obtained from the 2sls also show that there is: 1) a negative and significant relationship between iro, as one of the main commodities for international trade, and the bdi index – for every rise of 1% in iro, the bdi value will decrease by 35.95%; and 2) a negative and significant correlation between zin and the bdi – every 1% increase in zin will decrease the bdi by 1.501%. the one-step gmm method provided similar results: 1) there is a positive and significant relationship between the bdi and nic – every increase in nic of 1% causes an increase of 0.207% in the bdi; 2) a positive and significant correlation between ric and the bdi – for every 1% increase in the value of rice, the npl’s rate will rise by approximately 3.8%; 3) a positive and significant relationship between lea and the bdi – every 1% rise in lea corresponds to a 1.45% increase in the value of the bdi. asian journal of economics and empirical research, 2021, 8(2): 67-72 71 © 2021 by the authors; licensee asian online journal publishing group table 3. 2sls and one-step gmm method results. 2sls regressor coefficient std. error t-ratio p-value const 525.294 289.874 1.812 0.071 * iro −35.952 2.378 −15.12 <0.0001 *** whe −2.633 2.246 −1.173 0.242 zin −1.501 0.179 −8.386 <0.0001 *** nic 0.217 0.014 15.610 <0.0001 *** ric 4.178 0.791 5.280 <0.0001 *** lea 1.610 0.240 6.695 <0.0001 *** r-squared = 0.71 adjusted r-squared = 0.70 hausman test: chi-square(1) = 4.41037; p-value = 0.035 weak instrument test f-statistic (1,243) = 1110.79 one-step gmm regressor coefficient std. error z-ratio p-value const 300.320 381.020 0.790 0.431 iro −36.24 3.550 -10.090 <0.0001 *** whe 0.450 2.819 0.160 0.872 zin -1.385 0.183 -7.560 <0.0001 *** nic 0.207 0.021 9.570 <0.0001 *** ric 3.800 1.344 2.830 <0.005 *** lea 1.451 0.295 4.930 <0.0001 *** note: ***, **, * indicate significance at the 1%, 5% and 10% levels, respectively. the results obtained from the one-step gmm show that there is: 1) a negative and significant relationship between iro and the bdi index – for every rise of 1% in iro, the value of the bdi will decrease by 36.24%; and 2) a negative and significant correlation between zin and the bdi – every increase in zin of 1% will decrease the bdi value by 1.385%. both methods suggest that there is no significant relationship between whe and the bdi index. 5. conclusion this paper examined the relationship between the bdi and major raw materials, whose freight enters the calculation of the value of the bdi index. the aim of the paper was to examine whether the changes in the value of these raw materials affect the changes in the value of the bdi, and to what extent they affect it. for purpose of the study, a multiple linear regression model was used. to estimate the model parameters, the 2sls and gmm estimators were used. the survey covers the period from the day the indexes were created to the present day. this period includes two major economic crises: the great economic crisis of 2008 and the current crisis caused by the covid-19 pandemic. the findings of this research suggest that iron ore has a crucial deterministic role for the bdi, unveiling that the value of this raw material is oppositely linked to the value of the index. also, the findings of this research suggest that there is a negative and significant correlation between zinc and the bdi. the results of the paper imply that there is a positive and significant relationship between the index and lead, nickel and rice. a significant relationship was not found between the bdi index and wheat. however, this result is not in line with abovementioned studies. references adland, r., & cullinane, k. 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(2016). a new approach for baltic dry index forecasting based on empirical mode decomposition and neural networks. maritime economics & logistics, 18(2), 192-210. available at: https://doi.org/10.1057/mel.2015.2. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 1 © 2022 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 9, no. 1, 1-12, 2022 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2022.91.1.12 © 2022 by the authors; licensee asian online journal publishing group the risk-taking behaviour of tunisian banks in the post-revolution era: a panel ardl-pmg approach zied saadaoui1 salma mokdadi2 ( corresponding author) 1,2école supérieure de commerce de tunis, manouba university, tunisia. 1email : saadaouizied@gmail.com tel : 00216-98-506-876 2email : mokdadi.salma@gmail.com tel : 00216-53-75-39-82 abstract this study investigates the long-term determinants of capital buffers and risk-taking adjustment by focusing on a sample of listed tunisian commercial banks. this research uses hand-collected semi-annual data. the panel autoregressive distributed lags technique is used to control for unit root processes and to check for long-term determinants of capital and risk-taking adjustment. the empirical findings prove the existence of a moral hazard and procyclical behaviour of tunisian banks in response to capital requirements. however, some results indicate that capital standards are still an important prudential tool for ensuring the robustness of tunisian banks. there have been no previous studies focusing on this issue in the context of the tunisian banking system in the turbulent post-revolution era. this paper innovates by assuming that a set of bank-specific, macroeconomic and regulatory variables exert a long-term rather than a short-term influence on capital buffers and risk-taking. the research does not consider a possible long-term simultaneous relationship between capital and risk-taking. the sample could be extended if data were available. tunisian banks are advised to diversify their sources of revenues and to thoroughly revise their business models in order to become less dependent on revenues from traditional intermediation activities and to reduce the procyclicality of the banking system. keywords: capital requirements, bank risk-taking, procyclicality, long-term adjustment, panel ardl-pmg, tunisia. jel classification: g21; g28. citation | zied saadaoui; salma mokdadi (2022). the risktaking behaviour of tunisian banks in the post-revolution era: a panel ardl-pmg approach. asian journal of economics and empirical research, 9(1): 1-12. history: received: 15 november 2021 revised: 17 december 2021 accepted: 24 december 2021 published: 3 january 2022 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. authors’ contributions: both authors contributed to the conception and design of the study. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ......................................................................................................................................................................................... 2 2. how do banks react to capital requirements? .......................................................................................................................... 2 3. empirical methodology and data ................................................................................................................................................... 3 4. empirical results ................................................................................................................................................................................ 6 5. conclusion and policy implications ............................................................................................................................................. 11 references .............................................................................................................................................................................................. 11 mailto:saadaouizied@gmail.com mailto:mokdadi.salma@gmail.com http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.doi.org/10.20448/journal.501.2022.91.1.12 https://orcid.org/0000-0003-3275-2111 https://orcid.org/0000-0002-5346-9967 asian journal of economics and empirical research, 2022, 9(1): 1-12 2 © 2022 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study investigates the long-term determinants of capital buffers and risk-taking adjustment by focusing on a sample composed of the listed tunisian commercial banks. 1. introduction recently, in the aftermath of the revolution, the tunisian regulatory authority (the central bank of tunisia cbt) adopted several prudential directives inspired by basel iii. more specifically, between 2012 and 2014, the minimum risk-weighted capital ratio moved from 8% to 10% and further steps were taken to enhance the quality of regulatory capital through a redefinition of regulatory capital instruments. banks have had to deal with several other prudential reforms related to loan loss and liquidity management. in addition to this stringent regulatory environment, the tunisian economy experienced a twin deficits deterioration (current and budgetary deficits) causing a depreciation of the tunisian dinar and exposing banks to a liquidity stress. more importantly, the hike of the price inflation rate led the cbt to revise upward, on several occasions, its policy rate. with the increase of the money market rate, tunisian banks experienced a deceleration of their credit supply mainly caused by an increase in borrowing costs. tunisian banks were also forced to increase the remuneration of deposit and saving accounts and to bear higher borrowing costs on the interbank market. during this period, the economic growth rate was also quite volatile and reached its lowest levels in decades, exposing banks to business cycle fluctuations. consequently, it is interesting to explore the long-term reaction of tunisian banks in response to these turbulent regulatory and macroeconomic environments and especially to the capital regulation reform. this paper focuses exclusively on the long-term impacts of bank-specific variables, business cycle and regulatory pressure on the capital buffers and risk-taking adjustment of the largest tunisian banks during the post-revolution era. even though recent macroeconomic and regulatory events exerted, and are still exerting, a tremendous impact on the business environment in which tunisian banks are operating, there are as yet, to the best of our knowledge, no studies that focus on this issue in the context of the tunisian banking system in the turbulent post-revolution era. moreover, although several studies have explored the determinants of capital and risk-taking adjustment, this has mainly been through the estimation of simultaneous equation frameworks that focus on short-term causality (el-khoury, 2020; godlewski, 2005; jacques & nigro, 1997; nguyen, gan, & li, 2019; rime, 2001; saadaoui, 2014; shim, 2013; shrieves & dahl, 1992; zheng, moudud-ul-huq, rahman, & ashraf, 2017). static or dynamic panel models have been used for this purpose without disentangling the short-term from the long-term effects. also, these methods may produce biased estimators, due to the problem of non-stationarity. this paper innovates by assuming that a set of bank-specific, macroeconomic and regulatory variables exerts a long-term rather than a short-term effect on capital buffers and risk-taking. we expect these explanatory factors to have a homogenous long-term impact on the capital buffers and risk adjustments of listed tunisian banks. the panel autoregressive distributed lags technique is used to control for unit root processes and to check for long-term determinants of capital and risk-taking adjustment. the second section of this paper provides a brief review of the theoretical and empirical literature focusing on banks’ responses to capital requirements. the third section presents the research methodology used to explore the reaction of banks to capital requirements and the long-term determinants of tunisian banks’ capital and risk-taking decisions. in the fourth section, after running unit root tests, we present the statistical properties of the selected variables. then, the estimation results are presented and interpreted. the last section concludes the paper with some policy implications. 2. how do banks react to capital requirements? 2.1. theoretical arguments the purpose behind the adoption of the basel committee’s capital standards by a large number of jurisdictions around the world was to contain excessive bank risk-taking and prevent banking crises. however, this regulatory tool may unexpectedly induce excessive risk-taking when depositors’ funds are insured. when the deposit insurance premium is under-priced, bank shareholders are expected to boost asset returns by increasing debts and reducing capital investment in order to maximize deposit-insurance option value (merton, 1977). this risky behaviour is theoretically explained by the moral hazard related to deposit-insurance systems with flat premiums. in their seminal work, shrieves & dahl (1992) proved the existence of a negative relationship between bank risktaking and bank capital. in addition, regarding their funding structure, banks often prefer debt over capital instruments because the latter are costly. equity capital requires high risk-premiums in addition to administrative, screening and operational costs. binding capital requirements and leverage restrictions in the presence of market imperfections like asymmetric information, agency conflicts and costly-state screening may induce banks to follow risky strategies in order to increase earnings more rapidly and/or to preserve shareholders’ value, while avoiding regulatory sanctions (besanko & kanatas, 1996; blum, 1999; jeitschko & jeung, 2005; kopecky & vanhoose, 2006). also, banks seeking to recapitalize faster or to improve their conformity to capital standards may adopt risky competitive strategies. in monopolistic competitive deposit markets, capital requirements generate additional costs that make this prudential tool pareto-inefficient. indeed, harsh competition may push banks to increase interest rates on deposits in order to preserve their market power. this behaviour is likely to undermine the intermediation margin of value-maximizing banks, making them more inclined to invest in riskier assets or even to pursue gambling strategies to increase revenues (hellmann, murdock, & stiglitz, 2000). in response to more stringent capital standards, banks that want to preserve their market power may target a higher charter value by setting higher interest rates on loans which may induce higher risk taking behaviour in borrowing firms. in consequence, increased capital requirements could destabilize the banking system through higher intermediation costs (hakenes & schnabel, 2011). moreover, banks are also expected to adjust their capital in reaction to boom and bust periods. cognitive biases, leading to a disaster myopia problem, may exacerbate the countercyclical behaviour of capital buffers. under asian journal of economics and empirical research, 2022, 9(1): 1-12 3 © 2022 by the authors; licensee asian online journal publishing group this assumption, banks are expected to underestimate risk and reduce capital coverage during upturns and expected to adopt excessive deleveraging strategies during downturns (borio, furfine, & lowe, 2001; curry, fissel, & hanweck, 2008; lowe, 2002). in addition, the existence of capital adjustment costs due to asymmetric information in capital markets impedes forward-looking banks from reacting instantaneously to unexpected loan losses during upturns. these adjustment costs give rise to a negative co-movement between bank capital and the business cycle (estrella, 2004). on the other hand, imperfections related to risk measurement biases often lead to an underestimation of unexpected loan losses during upturns and to an overestimation of risks during downturns (borio et al., 2001; curry et al., 2008). 2.2. empirical evidence on the empirical side, several american researchers have explored the determinants of the capital decisions of us banks before the adoption of the basel i international capital framework in june 1988 (keeley, 1988; marcus, 1983; mingo, 1975). they found that capital standards were already efficient in improving the capital position of us banks. the literature after the adoption of the basel i and basel ii international capital standards by a large number of developed and emerging economies has explored the main research issues of the simultaneous relationship between capital and risk-taking, the impact of regulatory pressure on bank behaviour and the procyclicality of banking systems. the empirical contributions have mainly focused on the short-term mechanisms governing the simultaneous relationship between bank capital and risk-taking. they have shown ambiguous results concerning the bidirectional causality between capital and risk-taking. some studies demonstrated that banks operating under capital constraints increase risk-taking in response to upward capital adjustments, reflecting an asset-substitution problem in the presence of asymmetric information between banks and regulatory authorities (godlewski, 2005; jacques & nigro, 1997; rime, 2001; saadaoui, 2011; shrieves & dahl, 1992; zheng et al., 2017). in conformity with marcus (1983) and keeley (1988), other studies found that the incentive constraint related to capital requirements induces banks to reduce risk-taking capital increases (cannata & quagliariello, 2006; el-khoury, 2020; nguyen et al., 2019; saadaoui., 2014). in contrast, other contributions found that capital standards induce a positive reaction of bank capital to excessive risk-taking (cannata & quagliariello, 2006; rime, 2001; shrieves & dahl, 1992). however, there is also a great deal of evidence that risk-taking is associated with a decrease rather than an increase of capital, suggesting the existence of a bank moral hazard (coffinet, coudert, pop, & pouvelle, 2012; el-khoury, 2020; nguyen et al., 2019; saadaoui., 2014; zheng et al., 2017). one strand of empirical studies, using different measures of regulatory pressure, found that undercapitalized banks are more inclined to increase capital and/or reduce risk-taking in order to improve their conformity with capital rules (aggarwal & jacques, 2001; godlewski, 2005; guidara, soumaré, & tchana, 2013; saadaoui, 2011; shrieves & dahl, 1992). however, other findings provide puzzling results on the reaction of banks to regulatory pressure. in fact, for various samples of banks operating in different countries and with different income levels, banks are found to increase risk-taking and/or to reduce capital in the presence of stronger regulatory pressure, suggesting the existence of a moral hazard or gambling for resurrection problems (el-khoury, 2020; nguyen et al., 2019). similarly, findings concerning the procyclicality of bank behaviour also remain inconclusive. although the procyclicality of capital buffers has been verified for many developed countries, this behaviour is less evident in emerging countries’ banking systems (coffinet et al., 2012; jokipii & milne, 2008; saadaoui, 2015; shim, 2013). 3. empirical methodology and data 3.1. variables and hypotheses in contrast with previous empirical studies, but building on their theoretical frameworks, the following model assumes that the relationship between dependent and independent variables is not only constrained by short-term dynamics but also by an adjustment to a long-term equilibrium. to investigate the long-term determinants of the capital and risk-taking decisions of tunisian banks, two separate equations are estimated by regressing bank capital and risk-taking on a set of bank-specific and macroeconomic variables. 3.1.1. capita buffer equation for the first equation, capital buffers (buf) are more interesting to use as a dependent variable than total capital ratio because it is rare for the capital ratio to fall below the required minimum. rather, banks often hold a total capital ratio higher than the minimum for strategic purposes. indeed, capital buffers may serve as a cushion against regulatory sanctions caused by unanticipated endogenous or exogenous shocks. capital buffers also serve as a signalling tool about bank robustness to investors and market actors. by signalling a good situation, higher capital buffers ease the access to capital markets and decrease the cost of wholesale funds. in addition, capital buffers are expected to make banks more able to seize unexpected investment opportunities (lindquist, 2004; marcus, 1983). the non-performing loans (risk) ratio is used as a proxy for bank risk-taking. the expected impact of risktaking on capital buffers is ambiguous. by definition, the total regulatory capital ratio should increase when banks pursue risky investment strategies. also, risk-taking often increases as a consequence of excessive leverage; in this case, as each unit of assets should be financed by a minimum level of regulatory capital, an improvement of the total capital ratio is expected when leverage is increased. however, in the presence of market imperfection and asymmetric information between banks and regulatory authorities, a moral hazard problem comes into play, as banks’ shareholders may prefer increased leverage and risk-taking in order to maximize shareholders’ value in the presence of implicit or explicit deposit insurance subsidies. the importance of loans in the assets structure is captured by the variable lta. this is introduced to check whether an upward adjustment of capital buffers is done on the assets side through a reduction of lending supply and a deleveraging process aimed at reducing assets’ risk-weights or vice-versa. in this case a negative relationship is expected between lta and buf. asian journal of economics and empirical research, 2022, 9(1): 1-12 4 © 2022 by the authors; licensee asian online journal publishing group in addition, bank size (size) is also expected to influence capital buffers in the long-term. large banks benefit from better market reputation, an easier access to capital markets, and can issue shares at lower costs. also, as demonstrated by bikker, spierdijk, and finnie (2006), large banks often benefit from a higher charter value that provides them with additional revenues through wider interest margins, which makes recapitalization easier. for these two reasons, large banks are expected to operate with lower capital buffer levels. however, from another point of view, the tight relationship between bank size and market power invites the opposite hypothesis, a positive relationship between size and buf, which is also plausible. according to the competition-fragility hypothesis, small banks operating with lower market power are more inclined to engage in riskier investments in order to increase profitability and preserve their charter value (keeley, 1988). this could translate into a positive relationship between bank size and capital buffers in the long term. furthermore, the relationship between business cycle (cycle) and capital buffers is tested. as explained above, the long-term equilibrium may indicate that business cycle triggers a downward adjustment of capital buffers, illustrating a countercyclical behaviour of banks. cognitive biases and the existence of capital adjustment costs are two theoretical arguments explaining this kind of destabilizing behaviour. but it is also possible to observe a positive relationship between cycle and buf when forward-looking banks are more aware of loan loss accumulation during periods of expansion, urging them to build adequate capital buffers during this phase. we also introduce an indicator of regulatory pressure (reg). this indicator expresses the probability of a bank being in a situation of non-conformity with capital requirements and hence exposed to regulatory sanctions, while taking into account the volatility of its total capital ratio. this variable is of primary importance to tunisian banks because after 2011 the minimum required capital level was revised upward twice, from 8% to 9% with a transitory period between january and december 2013, and from 9% to 10% between january and december 2014. we expect a positive impact of reg on buf, since increased regulatory pressure exerts a positive influence on capital buffers by inducing undercapitalized banks to increase capital buffers and reduce capital volatility to avoid regulatory sanctions. 3.1.2. risk-taking equation in the second equation, risk is taken as the dependent variable. the first explanatory variable buf is thought to impact risk in different ways. on the one hand, an increase of capital buffers is expected to enhance shareholders’ awareness by inducing them to avoid excessive leverage and risk-taking. on the other hand, due to market imperfections, banks could be more prone to risk-taking after capital increase, as explained earlier. loan loss provisions (llp) are introduced as a potential long-term determinant of bank risk-taking. a negative relationship could arise between llp and risk since the higher provisioning, indicating an accumulation of loan losses and a deterioration of the quality of assets, impedes banks from engaging in risky investments in the future (aggarwal & jacques, 2001). we might also observe a positive long-term impact of llp on bank risk-taking. this impact is channelled through bank earnings, as a higher llp ratio may signal lower expected earnings due to a poor management of loans, translating into more loan losses in the future (louzis, vouldis, & metaxas, 2012). also, as suggested by rajan (1994), bank credit policy could rely not only on the objective of value maximization, but on short-term market concerns about the reputation of the bank’s management. accordingly, when banks hold a high level of loan loss provisions, this gives them more latitude to invest in risky npv projects in order to inflate current earnings and signal a good profitability to the market. in turn, more investments in risky npv projects should give rise to an increase in future loan losses, suggesting a positive relationship between llp and risk. the long-term relationship between size and risk could be either positive or negative. a positive relationship could be explained by the fact that large banks are more able to diversify their investments and funding sources and are then more able to improve risk and income diversification (louzis et al., 2012; salas & saurina, 2002). a negative relationship is related to the too-big-to-fail moral hazard problem, emanating from large banks that benefit from government subsidies and less effective market discipline (schaeck, cihak, & wolfe, 2009; stern & feldman, 2004). in addition, a negative long-term relationship between cycle and risk indicates that risk measurement biases keep banks from accurately assessing default risks during expansion phases, giving rise to a materialization of loan losses during economic downturns. finally, the impact of reg on bank risk-taking is estimated. a negative impact of reg on risk is expected, meaning that when the distance between the regulatory capital ratio and the minimum requirement decrease, banks will avoid risk-taking under pressure of regulatory sanctions. 3.2. model specification to test the long-term determinants of capital and risk decisions, the panel autoregressive distributed lag (panel ardl) technique is used, which incorporates heterogeneous panel regression into the error correction model (pesaran, shin, & smith, 1999). building on several empirical models of capital buffers and risk-taking adjustment (equations 1 and 2 respectively) and based on the above analysis, the following specifications are estimated: 𝐵𝑈𝐹𝑖𝑡 = 𝜃𝑜𝑡 + 𝜃1𝑡𝑅𝐼𝑆𝐾𝑖𝑡 + 𝜃2𝑡𝐿𝑇𝐴𝑖𝑡 + 𝜃3𝑡𝑆𝐼𝑍𝐸𝑖𝑡 + 𝜃4𝑡𝐶𝑌𝐶𝐿𝐸𝑡 + 𝜃5𝑡𝑅𝐸𝐺𝑖𝑡 + 𝜇𝑖 + 𝜖𝑖𝑡 (1) 𝑅𝐼𝑆𝐾𝑖𝑡 = 𝜋𝑜𝑡 + 𝜋1𝑡𝐵𝑈𝐹𝑖𝑡 + 𝜋2𝑡𝐿𝐿𝑃𝑖𝑡 + 𝜋3𝑡𝑆𝐼𝑍𝐸𝑖𝑡 + 𝜋4𝑡𝐶𝑌𝐶𝐿𝐸𝑡 + 𝜋5𝑡𝑅𝐸𝐺𝑖𝑡 + 𝛼𝑖 + 𝜔𝑖𝑡 (2) the indexes i and t indicate banks and periods, respectively. coefficients 𝜃𝑜𝑡 and 𝜋𝑜𝑡 are the intercepts for the two equations, 𝜇𝑖 and 𝛼𝑖 the fixed bank effects, 𝜖𝑖𝑡and 𝜔𝑖𝑡the error terms, which are assumed to be independently and normally distributed. these two equations are estimated separately. in fact, this study does not focus on the short-term simultaneous relationship between capital and risk-taking; rather its main purpose is to estimate the long-term determinants of capital and risk-taking adjustment. moreover, by including lags of both endogenous and exogenous variables, panel ardl is able to mitigate the endogeneity problem which may eventually be caused by, among others, simultaneous relationships (samargandi, fidrmuc, & ghosh, 2015). later in this paper, an additional estimation step will be run, substituting the two dependent variables (buf and risk) by other proxies of capital and risk-taking while keeping the same explanatory variables. asian journal of economics and empirical research, 2022, 9(1): 1-12 5 © 2022 by the authors; licensee asian online journal publishing group all variables are observed at a semi-annual frequency. bufit is computed as the difference between observed total capital ratio and the minimum requirement, riskit is the ratio of non-performing loans to total gross loans, llpit is the ratio of loan loss provisions to total gross loans, while ltait is the ratio of net loans to total assets and sizeit is the logarithm of total assets. the business cycle indicator cyclet is computed by a trend elimination method, using hodrick–prescott data filtering to isolate the cyclical component of the semi-annual real gdp growth rate. reg is a dummy variable. if the observed total capital ratio (tcr) exceeds the minimum required level, reg is equal to the difference between the tcr minus the sum of the minimum required level and the standard deviation of tcr computed using a five-year rolling window on the data going back to 2004. if tcr is lower than the minimum required level, then reg is equal to zero. for the two equations, the optimal lag orders on the first-differenced variables are selected according to the schwarz information criterion (sic) or the akaike information criterion (aic). the ardl dynamic panel specifications of equations 1 and 2 are as follows: 𝐵𝑈𝐹𝑖𝑡 = 𝜆𝑖𝐵𝑈𝐹𝑖,𝑡−1𝜇𝑖 + 𝛿10𝑖𝑅𝐼𝑆𝐾𝑖𝑡 + 𝛿11𝑖𝑅𝐼𝑆𝐾𝑖𝑡−1 + 𝛿20𝑖𝐿𝑇𝐴𝑖𝑡 + 𝛿21𝑖𝐿𝑇𝐴𝑖𝑡−1 + 𝛿30𝑖𝑆𝐼𝑍𝐸𝑖𝑡 + 𝛿31𝑖𝑆𝐼𝑍𝐸𝑖𝑡−1 + 𝛿40𝑖𝐶𝑌𝐶𝐿𝐸𝑡 + 𝛿41𝑖𝐶𝑌𝐶𝐿𝐸𝑡−1 + 𝛿50𝑖𝑅𝐸𝐺𝑖𝑡 + 𝛿51𝑖𝑅𝐸𝐺𝑖𝑡−1 + 𝜖𝑖𝑡(3) 𝑅𝐼𝑆𝐾𝑖𝑡 = 𝛾𝑖𝑅𝐼𝑆𝐾𝑖,𝑡−1𝛼𝑖 + 𝜌10𝑖𝐵𝑈𝐹𝑖𝑡 + 𝜌11𝑖𝐵𝑈𝐹𝑖𝑡−1 + 𝜌20𝑖𝐿𝐿𝑃𝑖𝑡 + 𝜌21𝑖𝐿𝐿𝑃𝑖𝑡−1 + 𝜌30𝑖𝑆𝐼𝑍𝐸𝑖𝑡 + 𝜌31𝑖𝑆𝐼𝑍𝐸𝑖𝑡−1 + 𝜌40𝑖𝐶𝑌𝐶𝐿𝐸𝑡 + 𝜌41𝑖𝐶𝑌𝐶𝐿𝐸𝑡−1 + 𝜌50𝑖𝑅𝐸𝐺𝑖𝑡 + 𝜌51𝑖𝑅𝐸𝐺𝑖𝑡−1 + 𝜔𝑖𝑡(4) then, equations 3 and 4 are reparametrized to include an error correction term as follows: ∆𝐵𝑈𝐹𝑖𝑡 = 𝜑𝑖(𝐵𝑈𝐹𝑖,𝑡−1 − 𝜃0𝑖 − 𝜃1𝑖𝑅𝐼𝑆𝐾𝑖𝑡 − 𝜃2𝑖𝐿𝑇𝐴𝑖𝑡 − 𝜃3𝑖𝑆𝐼𝑍𝐸𝑖𝑡 − 𝜃4𝑖𝐶𝑌𝐶𝐿𝐸𝑡 − 𝜃5𝑖𝑅𝐸𝐺𝑖𝑡) + 𝜃11𝑖∆𝑅𝐼𝑆𝐾𝑖𝑡 + 𝜃21𝑖∆𝐿𝑇𝐴𝑖𝑡 + 𝜃31𝑖∆𝑆𝐼𝑍𝐸𝑖𝑡 + 𝜃41𝑖∆𝐶𝑌𝐶𝐿𝐸𝑡 + 𝜃51𝑖∆𝑅𝐸𝐺𝑖𝑡−1 + 𝜖𝑖𝑡(5) where 𝜑𝑖 = −(1 − 𝜆𝑖), 𝜃0𝑖 = 𝜇𝑖 1−𝜆𝑖 , 𝜃1𝑖 = 𝛿10𝑖+𝛿11𝑖 1−𝜆𝑖 , 𝜃2𝑖 = 𝛿20𝑖+𝛿21𝑖 1−𝜆𝑖 , 𝜃3𝑖 = 𝛿30𝑖+𝛿31𝑖 1−𝜆𝑖 , 𝜃4𝑖 = 𝛿40𝑖+𝛿41𝑖 1−𝜆𝑖 , 𝜃5𝑖 = 𝛿50𝑖+𝛿51𝑖 1−𝜆𝑖 ∆𝑅𝐼𝑆𝐾𝑖𝑡 = 𝜏𝑖 (𝑅𝐼𝑆𝐾𝑖,𝑡−1 − 𝜋0𝑖 − 𝜋1𝑖𝑑𝐵𝑈𝐹𝑖𝑡 − 𝜋2𝑖𝐿𝐿𝑃𝑖𝑡 − 𝜋3𝑖𝑆𝐼𝑍𝐸𝑖𝑡 − 𝜋4𝑖𝐶𝑌𝐶𝐿𝐸𝑡 − 𝜋5𝑖𝑅𝐸𝐺𝑖𝑡) + 𝜋11𝑖∆𝐵𝑈𝐹𝑖𝑡 + 𝜋21𝑖∆𝐿𝐿𝑃𝑖𝑡 + 𝜋31𝑖∆𝑆𝐼𝑍𝐸𝑖𝑡 + 𝜋41𝑖∆𝐶𝑌𝐶𝐿𝐸𝑡 + 𝜋51𝑖∆𝑅𝐸𝐺𝑖𝑡−1 + 𝜔𝑖𝑡 (6) where 𝜏𝑖 = −(1 − 𝛾𝑖), 𝜋0𝑖 = 𝛼𝑖 1−𝛾𝑖 , 𝜋1𝑖 = 𝜌10𝑖+𝜌11𝑖 1−𝛾𝑖 , 𝜋2𝑖 = 𝜌20𝑖+𝜌21𝑖 1−𝛾𝑖 , 𝜋3𝑖 = 𝜌30𝑖+𝜌31𝑖 1−𝛾𝑖 , 𝜋4𝑖 = 𝜌40𝑖+𝜌41𝑖 1−𝛾𝑖 , 𝜋5𝑖 = 𝜌50𝑖+𝜌51𝑖 1−𝛾𝑖 the parameters 𝜑𝑖and 𝜏𝑖 indicate the error-correcting speeds of adjustment to equilibrium for each unit. these two parameters must take negative values, meaning that the variables exhibit a return to long-run equilibrium. the pooled mean group (pmg) estimator developed by pesaran et al. (1999) is used to estimate the parameters of equations 5 and 6 and to take into consideration the long-term equilibrium and the heterogeneity of the dynamic adjustment process. this choice has three main advantages: first, the dynamic nature of the adjustment of capital buffers should be captured to take into consideration the capital and risk-taking speed of adjustment. static panel techniques using random or fixed individual effects do not consider the dynamic nature of these variables. they are also unable to assume a variation of the slope coefficient across individuals (banks in our case) by imposing a homogeneity restriction and control only for the structural heterogeneity between cross-sections. second, when using dynamic panel data, the pmg estimators are more appropriate for small size samples than the general method of moment (gmm) estimator, which is more efficient for large n (individual dimension) small t (time dimension) samples. small n samples, like the one used in this paper, may affect the reliability of the tests for the validity of instruments and autocorrelation used under the gmm estimator, leading to inefficient results. also, as the study period is relatively large, the non-stationarity problem makes the gmm estimator biased, since it is only efficient under short-run dynamics. in addition, gmm estimation requires the slope coefficient of lagged dependent variables to be homogenous, which may lead to spurious long-run estimates (pesaran et al., 1999; samargandi et al., 2015). finally, the pmg estimator is considered more consistent and efficient among panel error-correction estimators, assuming short-run cross-section heterogeneity and long-run homogeneity restrictions.1 this estimator combines pooled and averaged coefficients, leading to heterogeneous estimators for the short-run and requiring the long-run slope coefficient to be homogenous across individuals (banks in this case). 3.3. sample and data we assume that the determinants of capital and risk-taking exert a homogenous impact in the long run. this could be an appropriate restriction in the case of tunisian banks, at least the ten largest ones. indeed, these banks largely dominate the loan and deposit markets, share similar market and business model orientations, and are closely and homogenously supervised by the cbt. also, there are few apparent disparities between the risk management mechanisms and governance modes of these banks. hence, we expect the long-term capital and risktaking decisions of the listed tunisian banks to be homogenous in response to the endogenous risks, macroeconomic volatility and regulatory measures. accordingly, this paper focuses on a sample of listed tunisian commercial banks. this sample is representative since more than 90% of the banking system’s total assets are held by this group of banks. data are observed with a semi-annual frequency from june 2009 to june 2018. balance-sheet data were hand-collected from banks’ annual reports and semi-annual financial statements published by the financial market council (the financial market authority). regulatory and macroeconomic data are provided by the cbt. 1 there are two alternative estimators: mean group (mg) and dynamic fixed effects (dfe). the mg estimator is very sensitive to individual and time dimensions, which must be large enough to produce consistent estimators. in the case of a small sample size, the dfe estimator could be sensitive to endogenous problems between error terms and lagged dependent variables, leading to a simultaneous equation bias. asian journal of economics and empirical research, 2022, 9(1): 1-12 6 © 2022 by the authors; licensee asian online journal publishing group 4. empirical results 4.1. unit root tests and descriptive statistics the im, perasan and shin (ips), levin, lin and chu (llc), and breitung and hadri lm unit root tests, including intercept and time trend, were used to capture the unit root processes followed by the variables included in the model. these four unit root tests were employed to determine the order of integration of each variable, which must not exceed i(1) order under the ardl model (pesaran et al., 1999). as indicated in table 1, none of the variables included in the two specifications is found to have an order of integration higher than one. the variable size is found to be i(1) by all unit root tests, while buf and lta are found to be i(1) by ips and breitung tests and i(0) by the remaining unit root tests. table 1. unit root tests. llc ips breitung hadri lm test level first diff level first diff level first diff level first diff buf -3.56** -6.01** 0.46 -3.93** 0.7735 -6.84** 0.8207 0.4617** risk -6.37** -5.95** -2.60** -4.51** 1.44 -2.90** 0.73** 0.23** size 1.09 -2.62** 3.49 -6.86** 7.17 -5.49** 0.96 -0.22** llp -2.93** -8.00** -4.73** -8.61** -5.74** -6.94** 0.13** -0.47** lta -2.61** -4.75** -1.01 -7.41** -0.78 -5.17** 0.73** -0.24** cycle -17.39** -14.59** -2.53** -4.14** -5.70** -5.03** 0.51** 0.31** reg -2.87** -4.23** -1.59* -6.58** 0.82 0.44** notes: h0: the variable follows a unit root process. *: h0 is rejected with a confidence level higher than 99%. **: h0 is rejected with a confidence level higher than 95%. ips unit root test is not possible for reg because it contains zero values. the order of integration of risk is found to be i(0) by all unit root tests except the breitung test, which indicates an order of integration for this variable of i(1). also, the regulatory pressure variable reg is found to have an order of integration of i(1) by the hadri lm test only; all the other tests indicate a i(0) process for this variable. in short, unit root tests suggest that the panel ardl technique is suitable for the estimation of the two model specifications. table 2 presents the descriptive statistics of the variables. despite the persitence of macroeconomic and financial turmoil since the revolution, the average level of buf continues to be positive and reach almost 2.1% while the median level of buf is slightly lower at 1.9%. however, the level of non-performing loans (risk) is quite high, with a median of almost 10% and a much higher average standing at 13.8% of total gross loans. the standard deviation of risk is relatively high, indicating a strong disparity of asset quality between state and private banks that increased further after the revolution. table 2 also shows that lta stands at 74.2% of total assets, indicating that traditional intermediation strongly dominates the business model of tunisian banks, whereas semi-annual loan loss provisions represent on average of 5.7% of total gross loans. the correlation matrix shows that buf is negatively correlated with risk, llp, and size and positively correlated with reg. in turn, risk is positvely correlated with lta, size, llp and reg with a relative strong correlation with the latter variable. reg shows a positive correlation with size and llp, while cycle is not significantly correlated with any of the other variables. table 2. statistical properties and correlation matrix. buf risk size llp lta cycle reg mean 0.021 0.138 15.486 0.006 0.742 0.000 0.013 median 0.019 0.097 15.513 0.005 0.755 0.001 0 st. dev 0.037 0.104 0.429 0.005 0.091 0.015 0.034 min -0.156 0.033 14.346 -0.006 0.434 -0.035 0 max 0.137 0.469 16.453 0.051 0.987 0.027 0.232 correlation matrix buf 1 risk -0.402 1 size -0.327 0.310 1 llp -0.429 0.400 0.213 1 lta -0.119 0.208 -0.133 0.099 1 cycle 0.0044 0.011 -0.002 -0.043 -0.089 1 reg -0.420 0.532 0.149 0.209 0.060 -0.036 1 moreover, figure 1 illustrates some interesting elements concerning the co-evolution of the average values of buf, risk and reg. starting from the revolution year, the ratio of non-performing loans (risk) began a significant increase, going from an average of almost 12% in june 2011 to 16% in december 2015. state banks, which bore the major responsibility of this quick rise of credit risk, benefited from an extensive recapitalization plan funded entirely by the government. before receiving these funds, they were forced to consume a large part of their accumulated retained earnings (a component of tier 1 capital ratio) in order to absorb loan losses and improve the provisioning of assets risk. this explains why average capital buffers dropped sharply from almost 4% in december 2012 to -1% in june 2013. after the recapitalization of the state banks, the tunisian banking system began to restore its capital cushion, reaching an average value of 2% in december 2015 and remaining more or less stable until 2018. figure 1 shows that after the capital regulatory reform, which extended from december 2012 to december 2014, reg stood at a level slightly higher that its level before the reform and that, paradoxically, the average value of the capital buffers ratio decreased significantly (see figure 1). asian journal of economics and empirical research, 2022, 9(1): 1-12 7 © 2022 by the authors; licensee asian online journal publishing group figure 1. co-evolution of capital buffers, risk-taking and regulatory pressure. 4.2. estimation results table 3 presents the estimation results of the capital buffer equation using the panel ardl-pmg estimator as the main econometric estimation method (column 1). estimation outputs using fixed and random specific effects (generalized least squares – gls method) are also provided for comparison purposes to check for the relevance of the dynamic nature of the dependent variables. in fact, these static panel estimators, contrary to the panel ardlpmg estimator, do not take into consideration the adjustment dynamics of bank capital and risk-taking (columns 2 and 3, respectively). the two-stage instrumental variable regression with fixed effects is used as an additional way to gauge the robustness of the panel ardl-pmg estimator and to minimize biases related to the limited number of observed cross-sections (column 4).2 the interpretation of the results is mainly based on the panel ardl-pmg outputs. the comparison with the other estimation methods is only mentioned when relevant. 4.2.1. first results as mentioned, in the first column of table 3, the existence of a long-term relationship is confirmed only if the error correction term (𝜑𝑖) is negative and not lower than -1. indeed, the parameter 𝜑𝑖takes a negative sign and reaches almost -10%, proving the existence of a mean reversion to a long-run equilibrium and that buf is cointegrated with its determinants. the low value of 𝜑𝑖also indicates that the cost of the adjustment of capital buffers is relatively high. concerning the long-term adjustment of capital buffers, the estimation in equation 5 indicates that all explanatory variables exert a significant long-term impact on capital buffers adjustment. an increase of risk (ratio of non-performing loans) by one percentage point (p.p.) results in a long-term decrease of buf by 0.33 p.p. this coefficient is quite similar to that produced by the panel iv method and more significant than those provided by the fixed and random effect estimators. table 3. long-term determinants of capital buffers. (1) (2) (3) (4) pmg fixed random iv risk -0.3347 (0.010) -0.1540 (0.000) -0.1250 (0.001) -0.3336 (0.000) lta -0.3236 (0.012) -0.1976 (0.000) -0.1595 (0.000) -0.2379 (0.005) size 0.0111 (0.594) -0.0269 (0.001) -0.0271 (0.000) -0.0300 (0.007) cycle -0.4395 (0.083) -0.0974 (0.407) -0.0803 (0.493) -0.0774 (0.597) reg 2.7525 (0.010) -0.1566 (0.024) -0.1697 (0.013) 0.2752 (0.012) intercept 0.6087 (0.000) 0.5793 (0.000) 0.7048 (0.000) err. correction -0.10 (0.007) #observations 190 190 180 r² within/overall 0.24 0.22 hausmann statistic 22.16 hansen-sargan p-value 0.88 f-statistic 15.24 note: the dependent variable is capital buffers (buf). the sample of listed tunisian banks is observed between 2009 and 2018 using half-year observations. hausman statistic: hausman specification test. hansensargan p-value: hansen-sargan test for over-identifying restrictions. f-statistic: fisher statistic test. p-values are in parentheses. 2 to control for endogeneity using the panel iv estimation method, the explanatory variables are instrumented using one to two lags of their own values. the hansen (1982) j test for over-identifying restrictions and the f statistic are used to check the validity of instruments used in the first stage regression as well as the strength of the chosen instruments (staiger & stock, 1997). asian journal of economics and empirical research, 2022, 9(1): 1-12 8 © 2022 by the authors; licensee asian online journal publishing group this result confirms that tunisian banks react to a deterioration of their assets quality by adjusting their capital buffers downward, which may be due to different reasons. it may indicate a kind of moral hazard behaviour from banks at a long-term horizon in order to preserve or increase their shareholders’ value. this finding was observed in other banking systems, albeit at short-term horizons (el-khoury, 2020; heid, porath, & stolz, 2003; jacques & nigro, 1997; zheng et al., 2017). the insufficient level of loan loss provisions could also explain the incapacity of tunisian banks to cover future losses by adequately increasing their capital buffers. also, the negative long-term impact of risk on buf might simply be explained by a change in the capital investment strategy when banks target lower capital buffers. the estimation of parameter 𝜃2𝑖 in equation 5 suggests a long-term downward adjustment of capital buffers in response to an increase of lta. reciprocally, a 1 p.p. decrease in lta induces a long-term increase of buf by 0.32 p.p., demonstrating that deleveraging is a main channel through which banks could adjust their capital buffers upward. this result was also found in the case of other emerging countries’ banking systems (fonseca & gonzález, 2010; garcía-suaza, gómez-gonzales, pabón, & tenjo-galarza, 2012). the long-term relationship between cycle and buf is negative and significant, demonstrating that capital buffers are countercyclical. when compared with the other estimation methods, only the panel ardl-pmg estimator is significant among the four, demonstrating that this countercyclical reaction of capital buffers to business cycle is mainly observed in the long run [about five years, or 1/0.1017 (=10) half-years if we base our interpretation on the estimated error correction term]. this result is congruent with the results found for other developed and emerging countries’ banking systems (ayuso, pérez, & saurina, 2004; jokipii & milne, 2008; nguyen et al., 2019; saadaoui., 2014; shim, 2013; stolz & wedow, 2011). this risky behaviour could be theoretically explained by the existence of cognitive biases that cause excessive deleveraging during crisis periods or by the existence of capital adjustment costs. the latter assumption is more appropriate in the case of tunisian banks because they operate in a shallow capital market characterized by important information asymmetries. moreover, these banks faced a persistent need for liquidity over the last decade, making the opportunity cost of holding capital very important. finally, the estimated parameter 𝜃5𝑖related to reg stands at 2.75 and is highly significant, demonstrating that regulatory pressure exerts a very important long-term positive impact on capital adjustment. the panel ardlpmg estimator indicates a much more important impact (in absolute value) of regulatory pressure in the long run than the other estimation methods. the fixed and random effects methods indicate the opposite effect, while the panel iv method corroborates the positive impact of reg on buf found using the panel ardl-pmg technique. this highlights the pertinence of using an estimation method that takes into consideration the dynamic adjustment of bank capital and risk-taking and also deals with the problem of endogeneity. this result corroborates, among others, the findings of rime (2001) and godlewski (2005), revealing that despite the risky behaviour of tunisian banks, the adoption and the revision of the minimum required capital imposed by the cbt motivated the banks to preserve their capital buffers. concerning equation 6, we can see in the first column of table 4 (panel ardl-pmg estimates) that the error correction term is negative and stands within the unit circle, proving that the dynamics of the explanatory variables adjust from a short-term situation to a long-term equilibrium path. the value of -33% indicates that tunisian banks adjust their risk-taking behaviours more quickly than their capital buffers. regarding the impact of bank capital buffers on the risk-taking adjustment, we note that only the panel ardlpmg estimator is significant, demonstrating that the link between the two variables is mainly established in the long run. the long-term relationship between buf and risk is negative and significant, as demonstrated by the panel ardl-pmg estimations. an increase of capital buffers by 1 p.p. causes a decrease of risk by 0.21 p.p. in the long run, indicating that higher capital cushions prove to be efficient in improving assets quality and reducing moral hazard by restricting bank leverage and inducing bank shareholders to avoid excessive risk-taking. previous empirical studies focusing on the short-term dynamics of bank risk-taking have reported the same result (cannata & quagliariello, 2006; elkhoury, 2020; hussain & hassan, 2004; nguyen et al., 2019). there is no evidence for a long-standing impact of loan loss provisioning on bank risk-taking, as shown by the non-significant parameter linking llp to risk in column (5). the static fixed and random specific effect estimations demonstrate a positive impact of llp on risk. however, this result is challenged when we take into account the endogeneity of the explanatory variables using the panel iv method. in contrast to equation 5, bank size is found to exert a very significant long-term impact on bank risk-taking. in accordance with our expectations, larger banks achieve better assets quality in the long run through better diversification. this significant relationship is only found by the panel ardl-pmg estimator, proving that the diversification and scale economies mechanisms related to bank size mostly take place in the long run [if we assume a readjustment to the long-run equilibrium after 1/0.33 = three half-years (≈1.5 years)]. additionally, the positive relationship between cycle and risk confirms the hypothesis of a procyclical risk-taking behaviour of tunisian banks. finally, the regulatory pressure variable exerts a positive and significant long-term effect on risk. a 1 p.p. increase of reg induces a long-term increase in the non-performing loans ratio of 0.74 p.p. this is an unexpected effect of capital requirements and indicates that tunisian banks tend to increase risk-taking in response to greater regulatory pressure. this result may be explained by various theoretical arguments such as those outlined earlier in this paper. it also confirms previous empirical findings, like those of cannata and quagliariello (2006) and saadaoui (2011). to sum up, capital requirements lead to ambiguous outcomes. capital standards seem to be harmful for banking system stability since there is evidence of a moral hazard problem in the long-term, as demonstrated by the negative relationship between risk and buf in equation 5. asian journal of economics and empirical research, 2022, 9(1): 1-12 9 © 2022 by the authors; licensee asian online journal publishing group table 4. long-term determinants of risk-taking. (5) (6) (7) (8) pmg fixed random iv buf -0.2097 (0.029) -0.1830 (0.224) -0.1742 (0.242) 0.1875 (0.419) llp 0.0304 (0.933) 1.6338 (0.044) 1.8013 (0.024) 2.6891 (0.168) size -0.0268 (0.000) -0.0182 (0.252) -0.0133 (0.392) 0.0106 (0.640) cycle (0.1765) (0.008) 0.1631 (0.443) 0.1674 (0.431) 0.1232 (0.531) reg 0.7463 (0.000) 0.7150 (0.000) 0.7330 (0.000) 0.7741 (0.000) intercept 0.4053 (0.105) 0.3271 (0.180) -0.0561 (0.877) err. correction -0.3318 (0.000) #observations 180 190 190 180 r² within/overall 0.2452 0.3292 hausmann statistic 20.13 hansen-sargan p-value 0.29 f-statistic 62.01 note: the dependent variable is the non-performing loans ratio (risk). the sample of listed tunisian banks is observed between 2009 and 2018 using half-year observations. hausman statistic: hausman specification test. hansen-sargan p-value: hansen-sargan test for over-identifying restrictions. fstatistic: fisher statistic test. p-values are in parentheses. there is also evidence for countercyclical capital buffers and an unexpected long-term impact of regulatory pressure on bank risk-taking, since reg is positively related to risk. however, some results show that capital requirements have helped to improve the stability of the tunisian banking system. indeed, higher capital buffers lead to a significant decrease of bank risk-taking in the long run. there is also evidence of procyclical bank risktaking. moreover, regulatory pressure is associated with a long-term improvement of capital cushion. the findings also show that tunisian banks mainly adjust their capital buffers in the long run through leverage adjustment. in addition, larger banks behave more cautiously at a long-run horizon than small ones, as evidenced by the positive impact of size on buf and its negative impact on risk. in order to bring further details to these results, the following section provides new estimations after changing the two dependent variables in order to refine the previous results and develop our understanding of the long-term determinants of capital and bank risk-taking adjustments by tunisian banks during the last decade. 4.2.2. additional estimations as explained earlier, the capital buffers ratio includes in its denominator the volume of risk-weighted assets that could also vary depending on risk-taking and regulatory pressure. the long-term impact of these variables on bank capital is isolated as much as possible using the equity ratio (equity) as the dependent variable of equation 5 instead of capital buffers. in fact, equity, computed as the volume of equity capital on total assets, does not include risk-weights in its denominator like the ratio of capital buffers does. moreover, bank risk-taking should not only be captured through actual and future loan losses but also through other losses that cumulate over time, which may be caused by bad management, under-provisioning, agency conflicts, etc. hence, it is also appropriate to assume that excessive risk-taking is tightly related to the probability of failure. in consequence, in equation 6, we substitute risk with the standard deviation of return on assets (sd_roa) measured by a six-period rolling window (3 years) standard deviation of pre-tax income on total assets. this step may contribute additional interesting results concerning the influence exerted by capital requirements and regulatory pressure on the volatility of return on assets, particularly through the banks’ risk-taking behaviour. as shown in column (9) of table 5, the error correction term (ect) is negative and significant when equity is used as the dependent variable, proving the convergence toward a long-term equilibrium. the ect stands at -30%, meaning that for tunisian banks the cost of equity adjustment is almost equal to the cost of capital buffers adjustment. in addition, the coefficient related to risk is not significantly different from zero in the long run. however, the static panel, as well as the instrumental variable estimator, reveals a negative and significant impact of risk-taking on equity capital, confirming the negative and significant effect of risk on capital buffers demonstrated in table 4. this result confirms the hypothesis of bank moral hazard, since it suggests that an increase in risk-taking is mainly caused by an increase in the volume of risk-weighted assets without an equivalent and sufficient increase of regulatory capital, leading to an overall decrease of the capital buffers ratio. column (9) also shows that the longterm impact of lta on equity contrasts sharply with its impact on buf. indeed, lta has a positive and significant impact on equity, demonstrating that the business model of tunisian banks, which is mainly based on traditional intermediation, is likely to help them consolidate their revenues and capital positions. the opposite impact exerted by lta on buf in table 3 proves, however, that tunisian banks essentially adjust their leverage through the adjustment of risk weights. in other words, the adjustment of capital buffers through the change of targeted lending growth induces tunisian banks to operate a trade-off between earnings and capital on the one side, and conformity with capital rules on the other. when banks target higher capital buffers they reduce lending and leverage to cut down on risk-weighted assets. reciprocally, a higher leverage increases risk-weighted assets and exerts a downward pressure on buf, despite its positive impact and bank revenues. in addition, the estimated parameter related to cycle is positive and significantly different from zero. this result suggests that tunisian banks do not adjust equity capital in a countercyclical way, as they do in the case of capital buffers. asian journal of economics and empirical research, 2022, 9(1): 1-12 10 © 2022 by the authors; licensee asian online journal publishing group in consequence, the countercyclicality of buf seems to be mainly caused by a procyclicality of lending and risk-weight adjustments (the denominator of buf) rather than by a countercyclicality of equity capital (the numerator of buf). finally, regulatory pressure has a positive and significant impact on equity in the long run. the same relationship was found in table 3 between reg and buf, albeit with a lower magnitude. the dynamic feature of bank capital adjustment and the accompanying endogeneity issues are once again raised by these results, as the panel ardl-pmg estimator contradicts the results of the static panel estimators. accordingly, regulatory sanctions related to capital requirements exert an important long-term influence on the conformity of banks to capital standards. table 6 presents the estimation outputs when sd_roa is used as the dependent variable instead of risk. the results in column (13) show that the ect related to the pmg estimator is negative and significant, confirming the existence of a mean reversion to a long-run equilibrium and the cointegration of sd_roa with the selected explanatory variables. the long-term estimator indicates a negative and significant impact of buf on assets return volatility that is in line with the previous result relating buf to risk. this shows that capital buffers induce tunisian banks to improve the quality of their assets in the long run. we also note that the longterm relationship between llp and sd_roa is positive and significant, an effect which was not observed for the relationship between llp and risk. this finding is confirmed by the static panel estimators, although bank provisioning seems to be more impactful in the long term. this positive impact may be explained by the theoretical arguments of louzis et al. (2012), who stipulated that loan loss provisions are created in expectation of poor earning outcomes and higher assets volatility. also, as suggested by rajan (1994), higher loan loss provisions, by providing more latitude for banks to invest in risky assets, may lead to a higher probability of failure in the long run. table 6 provides another interesting result related to the procyclicality of bank risk-taking. in fact, in contrast to the previous results, assets volatility is countercyclical, being lower during expansion phases and higher during downturns. the different cyclical behaviour exhibited by risk (which was found to be countercyclical in table 5) may be explained by the ex-post nature of non-performing loans, which may be accounted for with a time-lag of a half year or more. hence, the countercyclicality of assets return volatility, when combined with the procyclicality of capital buffers, may produce harmful effects on the real economy during periods of recession. concerning the impact of regulatory pressure on return volatility, the four estimation methods indicate a positive and significant impact of reg, which is in accordance with the results found earlier when risk was taken as the dependent variable. this result confirms the fact that tunisian banks respond to stronger regulatory pressure by increasing risk-taking, which may lead to higher return volatility in the long run. some interesting deductions follow from these results. indeed, risk has a negative long-term impact on capital buffers, whereas its impact on equity is not significant in the long run. the static panel estimators even report a negative impact of risk on equity. accordingly, it seems that capital requirements create a moral hazard problem, since an increase in the volume of risk-weighted assets is not adequately covered by a sufficient increase in capital buffers. in addition, regulatory pressure has an ambiguous effect on banking system stability. this variable is found to exert an expected positive long-term influence on banks’ capital buffers and equity capital but also leads to more risk-taking and higher assets volatility in the long run. on the other hand, the results also show that capital requirements are beneficial for banking stability, since higher capital buffers significantly improve the quality of assets in the long run. the results also show that regulatory pressure has an important long-term and positive impact on equity and buf. in addition, the long-term positive impact of leverage on equity and its negative impact on buf confirm that tunisian banks operate a trade-off when targeting higher capital buffers by reducing leverage and risk-taking between their conformity to regulatory rules and higher revenues (major source of recapitalization) which depend on leverage. moreover, the countercyclicality of capital buffers is mainly related to procyclical lending behaviour and volatility of return on assets. table 5. long-term determinants of capital equity. (1) (2) (3) (4) pmg fixed random iv risk 0.0546 (0.472) -0.0791 (0.003) -0.0788 (0.002) -0.1654 (0.001) lta 0.0614 (0.029) -0.0220 (0.450) -0.0184 (0.506) -0.0823 (0.115) size 0.0016 (0.716) 0.0064 (0.200) 0.0056 (0.252) 0.0105 (0.124) cycle 0.2107 (0.000) -0.0323 (0.663) -0.0305 (0.678) -0.0818 (0.364) reg 0.3863 (0.035) -0.1584 (0.000) -0.1594 (0.000) 0.0620 (0.357) intercept 0.0134 (0.861) 0.0242 (0.746) 0.0034 (0.976) err. correction -0.3083 (0.000) #observations 180 190 190 170 r² within/overall 0.18 0.17 hausmann statistic 0.72 hansen-sargan p-value 0.27 f-statistic 34.90 note: the dependent variable is the ratio of equity capital (equity). the sample of listed tunisian banks is observed between 2009 and 2018 using half-year observations. hausman statistic: hausman specification test. hansen-sargan p-value: hansen-sargan test for over-identifying restrictions. f-statistic: fisher statistic test. pvalues are in parentheses. asian journal of economics and empirical research, 2022, 9(1): 1-12 11 © 2022 by the authors; licensee asian online journal publishing group table 6. long-term determinants of return on assets volatility. note: the dependent variable is the ratio of equity capital (equity). the sample of listed tunisian banks is observed between 2009 and 2018 using half-year observations. hausman statistic: hausman specification test. hansen-sargan p-value: hansen-sargan test for over-identifying restrictions. f-statistic: fisher statistic test. p-values are in parentheses. 5. conclusion and policy implications the macroeconomic, institutional and regulatory context in which tunisian banks are operating has changed considerably since the revolution. the joint effects of a more volatile macroeconomic environment and more restrictive monetary policies are exerting stronger liquidity constraints and market pressures on banks. in addition, the cbt introduced a package of regulatory reforms within a short time interval that included an increase of the minimum required capital ratio and the redefinition of regulatory capital instruments. despite these facts, only few studies have been conducted that help to provide a clear picture of the reaction of tunisian banks to this tumultuous economic and regulatory environment.this study investigates the long-term determinants of capital buffers and risk-taking adjustment by focusing on a sample of the listed tunisian commercial banks observed between june 2009 and june 2018. a panel ardl is estimated using the pmg technique in order to take into consideration the long-term equilibrium and the heterogeneity of the dynamic adjustment process. the estimation of the panel ardl demonstrates the existence of a long-term dynamic that relates capital buffers and risk-taking to a vector of bank-specific and macroeconomic variables. the reaction of tunisian banks to capital requirements shows conflicting results. capital requirements prove to be an important prudential tool for the robustness of tunisian banks, as higher capital buffers improve the quality of assets in the long run through a reduction of non-performing loans and a reduced volatility of returns on assets. regulatory sanctions also induce undercapitalised banks to significantly increase their capital buffers and equity capital in the long run. however, more stringent capital requirements could be harmful to banking stability, as they are expected to give rise to a moral hazard problem. moreover, regulatory pressure may also induce undercapitalized banks to increase risktaking. another interesting finding is that the long-term adjustment of capital buffers is mostly channelled through lending growth and leverage. thus, in the long run, tunisian banks seem to be confronted with a trade-off between their level of conformity to capital rules and their profitability, since more leverage leads to more revenue and eases recapitalization. in consequence, when tunisian banks target higher capital buffers by reducing leverage and risk-taking, they are likely to reduce revenues which are a major source of recapitalization. in addition, the capital behaviour of tunisian banks is found to be countercyclical, mainly due to procyclical lending and risktaking behaviour, which is confirmed by the negative relationship between asset return volatility and business cycle. these results have some microand macro-prudential policy implications. first, the upward revision of the minimum capital requirements between 2012 and 2014 seems to have had a positive effect on banking stability since tunisian banks operating under higher regulatory pressure are improving their capital position in the long run. the cbt should consolidate this regulatory measure and proceed to enlarge the scope of their capital standards by including additional technical requirements that allow for more convergence toward international standards, like the standardized approach and the internal-rating-based approach to risk assessment. second, the cbt should improve its supervisory mechanisms to enforce better risk monitoring practices in conjunction with the latest capital regulatory reform in order to avoid bank moral hazard. on the other hand, however, tunisian banks need to overcome their dependence on lending and leverage as major channels for capital buffers adjustment. other channels should be improved, such as equity issuance, which remains tightly related to the liquidity level of the domestic capital market. in the same vein, tunisian banks should diversify their sources of revenues and thoroughly revise their business models to become less dependent on revenues from traditional intermediation activities and to reduce the procyclicality of the banking system. references aggarwal, r., & jacques, k. 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(2017). does the ownership structure matter for banks’ capital regulation and risk-taking behavior? empirical evidence from a developing country. research in international business and finance, 42, 404-421. available at: https://doi.org/10.1016/j.ribaf.2017.07.035. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 64 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 1, 64-73, 2020 issn(e) 2409-2622: / issn(p) 2518-010x doi: 10.20448/journal.501.2020.71.64.73 © 2020 by the authors; licensee asian online journal publishing group dynamic effect of public expenditure on oil producing economy: an empirical evidence from nigeria iyabo a. olanrele economics and business policy department, nigerian institute of social and economic research (niser) nigeria. abstract the paper examines the economic growth effect of government expenditure in nigeria employing annual data from 1970 to 2017. specifically, the study examines the shortand long-term effect of federal government total, recurrent, and capital expenditure on the real gross domestic product (gdp). different from the existing literature, the paper also shows the extent of oil sector integration, at the sectoral level, by investigating the effect of government expenditure on the agriculture and manufacturing sectors. the analysis was carried out using the autoregressive distribute lag (ardl) technique. empirical results show that the aggregate government spending has a positive effect on the real gdp on the short and long-run. mixed outcomes were realized when the effect of government expenditure on agricultural and manufacturing sector outputs were considered. in the short-run, total government expenditure cause agriculture sector output to decline. the long-run accumulated government spending leads to an increase in the agricultural sector output. the total government expenditure exerts a negative effect on the manufacturing sector output in the short-run. the effect was positive in the long-run. outcomes from analyzing the differential effect of expenditure types on the real gdp show that capital expenditure had no impact on the real gdp, while government recurrent expenditure had a positive significant impact. thus, efforts should be geared towards increasing capital spending for commensurate integration of oil benefits in the nigerian economy. keywords: government expenditure, oil-producing economy, sectoral output, recurrent expenditure, capital expenditure, nigeria. jel classification: e60; e62. citation | iyabo a. olanrele (2020). dynamic effect of public expenditure on oil producing economy: an empirical evidence from nigeria. asian journal of economics and empirical research, 7(1): 64-73. history: received: 27 november 2019 revised: 10 january 2020 accepted: 17 february 2020 published: 31 march 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 65 2. government expenditure and the nigerian economy ............................................................................................................. 65 3. literature review ............................................................................................................................................................................ 66 4. data and methodology ................................................................................................................................................................... 67 5. analysis of results and discussions ............................................................................................................................................. 68 6. conclusion ......................................................................................................................................................................................... 71 references .............................................................................................................................................................................................. 71 appendices ............................................................................................................................................................................................. 71 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.71.64.73&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1464 https://orcid.org/0000-0001-7498-8961 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1464 https://orcid.org/0000-0001-7498-8961 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1464 https://orcid.org/0000-0001-7498-8961 asian journal of economics and empirical research, 2020, 7(1): 64-73 65 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature the study contributes to the literature by showing the extent to which government expenditure impacts on output at more disaggregated levelagriculture and manufacturing sector outputs. by this, the study was able to capture the extent to which the oil sector integrates with the real sectors of the economy. 1. introduction in oil producing economies, oil revenue is belief to serve as a main contributor to government budgetary expenditure stirring economic activities. strong oil dependent nature of these economies, measured by oil export and oil revenue to gdp ratio, supports this claim. while this remains, it is unclear if the performance of these economies, indicated by the real gross domestic product (gdp) , is affected by government spending over the years. the underlying assumption is built on a keynesian notion where public spending is expected to stir economic activities, thereby economic growth. in a period of 47 years (1970-2017), nigeria gained about n83,748 billion (72.2% of total revenue), oil revenue, however, this did not make a meaningful impact on the economy. federal government total expenditure increased from n0.9 billion in 1970 to about n8, 302 billion in 2017(central bank of nigeria annual statistical bulletincbn, various issues). the share of recurrent expenditure in total expenditure was about 78% to 86% in the review period. while capital expenditure used for financing development projects was just about 28% and 12% in the same period. the declining share of capital expenditure is a reflection of the country’s bulging population vis-à-vis the size of its civil service. this concern as further shown by the share of government expenditures to gdp, which was between 1.03% for the recurrent expenditure and 0.14% for the capital expenditure in 2017. while some studies have empirically established the effect of government expenditure on economic growth, outcomes remain inconclusive (babatunde, 2018; chude & chude, 2013; ebong, ogwumike, udongwo, & ayodele, 2016). departing from this strand of literature, this study examines the relationship between government expenditure and economic growth in nigeria based on a modified (barro, 1990) endogenous growth model while applying recent data. further, i explore the short and long term dynamics of the effect of government expenditure and economic growth. the short-run scenario suits the keynesian proposition of government short-run intervention. to this effect, the study investigated the subsequent outlined objectives. firstly, i examine the effect of total public expenditure on aggregate output (real gdp). secondly, to capture the level of oil sector integration with the other key sectors of the economy, i investigated the agriculture and manufacturing sector effects of total government expenditure. the selected sectors are the bedrock of the real sector of the nigerian economy. in the last objective, i analyse the differential effect of public recurrent and capital (development) expenditures on real gdp. the disaggregated analysis is carried out to account for channels of intervention on economic growth. the study is structured into six sections: section ii provides a summary of government expenditure and the nigerian economy. section iii dwells on the theoretical and empirical review of relevant literature. section iv presents the methodology and the dataset used in the analysis. section v presents and discussed the results. the conclusion and some recommendations were provided in section vi. 2. government expenditure and the nigerian economy nigeria being an oil dependent economy has, a large chunk of its economic activities dominated by oil revenue. since the era of global oil boom of the 1970s, the federal government budgetary plans have revolved majorly on crude oil sales proceeds. a clear picture of this is seen in figure 1, where trend in total government expenditure is closely related to oil revenue. a simple reason for this is because of the dominant share of oil revenue in the total revenue, which is more than 50 per cent in the entire period of 1970 to 2017 table 1. figure-1. trend in total federal government expenditure and revenues. source: cbn statistical bulletin (various issues) and world bank (2018). total federal government expenditure in nigeria, which comprise of recurrent and capital expenditures, has grown significantly over the years. total federal government expenditure in the period 1970-1979 increases from n 4.8 billion to n 8601.7 billion in 2010-2017, suggesting a gradual expansion in government activities. the share of capital expenditure, which was about 57% in the period 1970-79, declined drastically, giving way to recurrent expenditure in the subsequent period. by 2010-07, it has decreased to 16.8%. the burden of recurrent expenditure became huge as a result of the over-bloated size of the country’s civil service that has continue to constraint asian journal of economics and empirical research, 2020, 7(1): 64-73 66 © 2020 by the authors; licensee asian online journal publishing group development expenditure. although government activities are on the increase, the size, measured by total federal government expenditure to real gdp, is below 1% over the past four decades table 1. table-1. summary of fiscal aggregates (annual average). 1970-79 1980-89 1990-99 2000-09 2010-07 federal government revenue total revenue (billions of naira 4.8 19.6 376.3 4231.7 8601.7 oil revenue (% of total) 73.5 72.0 75.5 80.8 67.6 non-oil revenue (% of total) 26.5 27.9 24.5 19.2 32.4 federal government expenditure total expenditure ( billions of naira) 4.3 17.9 302.1 1829.4 5217.1 recurrent expenditure (% of total) 50.4 57.0 46.1 66.2 80.5 capital expenditure (% of total) 57.2 42.4 53.9 30.3 16.8 total expenditure (% of real gdp) 0.00 0.01 0.13 0.49 0.82 increase in the size of nigeria’s economy was not directly linked to total federal government expenditure figure 2. although moving in the same direction, total federal government expenditure saw significant improvement from 1999, a period that coincides with the beginning of nigeria’s civil regime. for instance, total expenditure that was about n487 billion in 1998 suddenly surged to about n948 in 1999, which is about 95% increase between the two-year period. hitherto, the military regime was the mainstay of the country, with its attendant effect on government activities. beyond this, recurrent expenditure drives the overall movement in total expenditure compared to the capital expenditure that has no clear-cut relationship with the size of nigeria’s economy measured by the real gdp figure 3. figure-2. trend in real gdp and total federal government expenditure. 1. figure-3. trend in real gdp and government expenditures. 3. literature review 3.1. theory of government expenditure the wagner’s law of increasing state activities hypothesized that as the state develops, the real income increases, and as such, the share of public expenditure may increase in the long-run (magazzino, giolli, & mele, 2015; wijeweera & garis, 2009). thus, the period of development is accompanied by large size government expenditure. the assumption is that: first, when the economy grows, development would occur and as such, the role of public sector diminished to accommodate the private sector. second, as the economy evolves, the need for basic infrastructures, such as education and health infrastructures, would lead to a rise in real income. in a contrary opinion, wiseman and peacock stated that public expenditure moves in a cyclical manner and not in a smooth pattern. the study by taiwo and abayomi (2011) and magazzino et al. (2015) explained that as the size of the economy increases, public expenditure would show a gradual upward trend. however, periodic distortions tend to alter the smooth path of public expenditure. the distortions usually occur in periods of war, asian journal of economics and empirical research, 2020, 7(1): 64-73 67 © 2020 by the authors; licensee asian online journal publishing group social unrest, natural disaster etc. as such, it would become imperative to increase public spending by raising taxation. the situation is known as the peacock-wiseman displacement effect. according to keynes, public expenditure is an exogenous phenomenon that can stimulate economic growth (gukat & ogboru, 2017). by this, it is expected that government stimulates economic activities, thus, increasing aggregate demand. as such, public expenditure stabilizes the economy in the short-run. however, persistent increase in government expenditure has implication for increasing the general price level, thus, causing unemployment. 3.2. public expenditure and the economy: an empirical review at the aggregate and disaggregate level, several studies have examined the issue of public expenditureeconomic growth nexus. findings, however, remain inconclusive. the subsequent discussion presents some of the studies that conclude for the positive effects of government expenditure, followed by the summary of the studies that found no impact on the nigerian economy. a study by olayungbo and olayemi (2018) examined the relationships among non-oil revenue, government spending, and economic growth. they used data from 1981 to 2015 based on an error correction model, impulse response and granger causality test. the results of the short run and long run indicated that government spending exerts a negative effect on economic growth. okolo, edeme, and emmanuel (2018) examined the relationship between capital expenditure and infrastructural development in nigeria using data for the period 1970 to 2017. the estimation was carried out using an autoregressive distributed lag (ardl) model. findings from the study reveals that capital expenditure has a potential to engender a positive impact on infrastructural development in the long-run if not hindered by external debt. gukat and ogboru (2017) investigates the effects of government expenditure on the nigerian economic growth. an ordinary least square technique and an error correction model were employed with data from 1981 to 2016. their result shows that government expenditure has no effect on economic growth. likewise, a study by ajayi and aluko (2016) reveals that government expenditure has no effect on economic growth. a disaggregated effect of government expenditure on economic growth was investigated by ogundipe and oluwatobi (2013). the analysis was based on the johansen technique for the period of 1970-2009. the study revealed a short-run negative effect of capital expenditure impacted negatively on economic growth. the study by chude and chude (2013) was among the strand of literature that show the positive effect of government expenditure on economic growth. the study investigated the effect of public education expenditure on economic growth in nigeria for the period 1977 to 2012. an error correction model (ecm) was employed. their findings established a long-run positive relationship between government education expenditure and economic growth. using a granger causality test and the johansen cointegration technique, a study by okoro (2013) shows that a long-run relationship between government spending and economic growth in nigeria exist. several other studies came out with a mixed evidence. for example, dikeogu, ohale, and otto (2016) examined the impact of public expenditure on economic growth in nigeria from 1970 to 2013. the study adopted the econometric technique of ordinary least squares (ols) and error correct mechanism (ecm). the findings reveal that aggregate government expenditure do not impact significantly on economic growth, while disaggregate government expenditure exerts a significant impact on economic growth. ebong et al. (2016) assesses the impact of government capital expenditure on economic growth in nigeria using data for 1970 to 2012. the study made use of ordinary least square regression technique. the results show that capital expenditures on agriculture have no significant influence on growth both in the long and short runs. short-run and long-run impacts on growth of capital expenditures were positive. nworji, okwu, obiwuru, and nworji (2012) examined the effect of public expenditure on economic growth in nigeria for the period 1970 – 2009. the study made used of the ols regression technique. empirical findings showed that capital and recurrent expenditure on economic services had insignificant negative effect on economic growth. however, capital and recurrent expenditures on social and community services and recurrent expenditure on transfers had significant positive effect on economic growth. 4. data and methodology 4.1. data the data type employed in this study is secondary in nature, spanning the period of 1970-2017. this period, in the history of nigeria’s development, covers the era of oil boom and oil decline. the era of oil boom is associated with increasing oil revenue, which is expected to pass-through government expenditure and its overall size in economic activities. in the four specified models, nine (9) variables were used and sourced from various national and international data base. real gdp is the aggregate output, computed as the sum of gross value-added by all resident producers in nigeria measured in constant local currency (wdi, 2018). agricultural and manufacturing sector gdp is the monetary value of goods and services produced in the respective sectors (cbn, various issues). total government expenditure is an outflow of resources from government to other sectors of the economy whether requited or unrequited and is divided into recurrent expenditure (payments for salaries and overheads) and capital expenditure (payments for non-financial assets) (cbn, various issues). the inflation rate is designed to measure the rate of increase in aprice index and is a percentage rate of change in consumer price level over time (cbn, various issues). the interest rate employed in this study is the prime lending rate, which is the lending rate used in providing loan and advances. it is computed from monthly interest rate returns (cbn, various issues). domestic credit to private sector refers to financial resources provided to the private sector by financial corporations, such as through loans, purchases of non-equity securities, and trade credits and other accounts receivable, that establish a claim for repayment (wdi, 2018). in this study the private sector credit is given as a share of gdp. asian journal of economics and empirical research, 2020, 7(1): 64-73 68 © 2020 by the authors; licensee asian online journal publishing group 4.2. methodology the basic framework employed in this study is the endogenous growth model developed by barro (1990). the framework incorporates public sector into a simple economic growth model to capture the empirical predictions in the size of government and economic growth nexus. in this study, the framework is modified to capture some peculiarities of the nigerian economy, hence a simple production model with the interaction of government expenditure is specified as: (1) the estimable form of equation (1) is further expressed as; (2) in equation 1, real gross domestic product (rgdp) is a measure of output, which may be aggregate output (rgdp), agricultural sector output (gdpagric), or manufacturing sector output (gdpman). government expenditure (gexp) is an indicator of either total federal government expenditure, capital (capex) or recurrent expenditure (repex). while other control parameters such as inflation (inflation), credit to private sector (pcred), and interest rate (intr) are allow to serve as control variables predicating the behaviour of the aggregate output in nigeria (arewa & nwakahma, 2013; austin & ogbole, 2014). in ascertaining the short and long-run dynamic behaviour of the relationships, an autoregressive distributed lag (ardl) model is employed. although suitable for small and large sample size, the short-run scenario suits keynes proposition of government short-run intervention. in analyzing the ardl model, the long-run cointegration must be established. when cointegration is established, the short and long-run model will be estimated based on equations 3 and 4 specified below. further, in analyzing the model, an appropriate lag length has to be selected, which is usually based on the least lag length selection criterion. the conditional ardl (p, q1… q4) and (p, q1), the long-run model for output indicator was estimated based on the specification in equation 3. ∑ ∑ ∑ ∑ ∑ (3) the ecm representation of the model is given by: ∑ ∑ ∑ ∑ ∑ (4) the speed of adjustment is denoted in equation 4, which is the error correction mechanism. its coefficient is expected to turn out negative and significant for confirmation of a short-run relationship. the remaining part of the section highlights the process of the model estimation technique outlined within the ardl technique. a perquisite in a time series analysis is to check the stationarity of the data, so as to avoid making a misleading policy decision. as such, the study checked for the unit root properties of the selected variables in the model setup based on the augmented dickey fuller (adf) and philips perron (pp) tests. the following step dwells on establishing the long-run cointegration relationship, and then the short-run and long-run estimates. 5. analysis of results and discussions 5.1. unit root test the ardl bound test requires that the order of integration of all variables do not exceed i(1), as ardl bound test is hinged on the basic assumption that the series are either i(0), i(1) or a mixture of both (ouattara, 2004; pesaran, shin, & smith, 2001). using the augmented dickey-fuller (adf) and phillips perron (pp) unit root tests, the order of integration of the variables are i(1) as expressed in table 2. having established this, we proceed to testing for the long-run cointegrating relationship in the models. table-2. unit root test result. augmented dickey fuller phillips perron variable intercept intercept and trend remarks intercept intercept and trend remarks toexp -7.627 -7.770 i(1) -7.591 -7.733 i(1) repex -8.226 -8.147 i(1) -8.504 -8.437 i(1) capex -7.044 -7.667 i(1) -7.120 -7.607 i(1) inflation -6.989 -6.933 i(1) -14.298 -14.395 i(1) intr -7.714 -7.620 i(1) -9.664 -9.535 i(1) rgdpagric -5.810 -5.708 i(1) -5.804 -5.739 i(1) rgdpman -4.900 -5.349 1(1) -6.777 -6.788 i(1) rgdp -5.109 -5.381 i(1) -5.266 -5.435 i(1) pcred -4.289 -4.102 i(1) -4.881 -4.217 i(1) 5.2. bound test cointegration the bound test results presented in table 3 shows the long-run cointegration relationship in the four (4) models empirically analyzed in this study. cointegrating relationship is determined by comparing the computed fstatistic, which captures the statistical significance of the model with the lower and upper bound critical values provided by narayan (2004). the null hypothesis suggests that all slope coefficients are equal to zero, where the fstatistic falls within the upper and lower bound critical values. the calculated f-statistics of rgdp model of 4.269 is higher than the upper critical value for i(1) bound at 5 per cent. however, rgdpagric model was found to be asian journal of economics and empirical research, 2020, 7(1): 64-73 69 © 2020 by the authors; licensee asian online journal publishing group inconclusive since the calculated f-statistics (3.224) lied between the critical value for i(0) and i(1) bounds at 10 per cent. this suggests that both the long and short-run models can be considered. the calculated f-statistics of rgdpman and rgdp* models of 6.024 and 4.269 is higher than the upper critical value for i(1) bound at 1 and 5 per cent respectively. therefore, we reject the null hypothesis and conclude for a cointegrating relationship. table-3. bound test cointegration result model k f-stat outcome rgdp=f(toexp, inflation, intr, pcred) 3 4.821 cointegrated rgdpagric=f(toexp, inflation, intr, pcred) 3 3.224 cointegrated rgdpman=f(toexp, inflation, intr, pcred) 3 6.024 cointegrated rgdp*=(repex, capex, inflation, intr, pcred) 4 4.269 cointegrated note: rgdp* model is the model estimated with recurrent and capital expenditure. 5.3. estimated results the various estimations carried out in the study are presented in table 4 to 7. table 4 shows the result on real gdp and total expenditure. as expected, total government expenditure (topex) has a positive impact on real gdp (rgdp) on the short and long-run. both scenarios are significant at 1%. other control variables came out with the expected sign on the short and long-run. the significance of the relationship was consistent for inflation rate (inflation) and the private sector credit (pcred) in both scenarios. table-4. estimated short and long-run coefficients for real aggregate output model. dependent variable: rgdp selected model: (4,0,0,5 criterion: adjusted r2 short-run cointegrating form variable coefficient std. error t-statistic prob. d(rgdp(-1)) 0.127 0.144 0.882 0.385 d(topex) 0.025 0.009 2.931 0.007 d(intr) 0.001 0.002 0.812 0.423 d(inflation) -0.002 0.001 -2,428 0.022 d(pcred) 0.005 0.003 1.955 0.060 cointeq(-1) -0.185 0.045 -4.115 0.000 ecm = long-run cointegrating form variable coefficient std. error t-statistic prob. toexp 0.135 0.034 3.936 0.001 intr 0.008 0.010 0.795 0.433 inflation -0.014 0.005 -3.145 0.004 pcred 0.029 0.013 2.189 0.037 c 11.726 0.168 69.999 0.000 note: rgdp is real gross domestic product, topex is total federal government expenditure, intr is nominal interest rate, inflation is the consumer price inflation rate, and pcred is credit to private sector. the output indicator, real gdp (rgdp) was disaggregated to capture the possibility of the integration of the oil sector revenue through total government expenditure in enhancing sectoral inclusiveness. as such, tables 5 and 6 show the impact of total government expenditure (topex) on agricultural and the manufacturing sector respectively. the short-run impact of total government expenditure was negative and insignificant on agriculture output. specifically, a 1% increase in total government expenditure dampens agriculture sector performance by about 0.2%. this could be as a result of non-integration of oil revenue through government expenditure on the real sector of the economy. with accumulated government spending, total government expenditure engenders agricultural output growth to about 0.2% on the long-run at a 5% level of significance. only inflation rate (inflation) turns out with an expected significant sign on the long-run. other variables were perverse in sign and insignificance. table-5. estimated short and long-run coefficients for agricultural output model. dependent variable: rgdpagric selected model: (3,3, 0,4) criterion: adjusted r2 short-run cointegrating form variable coefficient std. error t-statistic prob. d(rgdpagric(-1)) 0.268 0.179 1.499 0.144 d(inflation) -0.002 0.003 -0.615 0.543 d(intr) -0.006 0.008 -0.741 0.465 d(toexp(-1) -0.191 0.203 -0.938 0.356 d(pcred) 0.012 0.013 0.875 0.389 cointeq(-1) -0.344 0.114 -3.025 0.005 long-run cointegrating form variable coefficient std. error t-statistic prob. inflation -0.021 0.012 -1.795 0.083 intr -0.017 0.023 -0.751 0.459 toexp 0.174 0.078 2.227 0.034 pcred 0.034 0.034 0.995 0.328 c 7.978 0.410 19.451 0.000 note: rgdpagric is real gross domestic product of the agricultural sector, topex is total federal government expenditure, intr is nominal interest rate, inflation is the consumer price inflation rate, and pcred is credit to private sector. asian journal of economics and empirical research, 2020, 7(1): 64-73 70 © 2020 by the authors; licensee asian online journal publishing group the total government expenditure (topex) has a negative and significant effect on the manufacturing sector output (rdgpman) on the short-run, table 6. the long-run scenario, though positive, is not significant. obvious of the infrastructural dearth in the country, public expenditure overtime has not been productive considering the short-run negative impact and the weak long-run relationship on the manufacturing sector output. hence, with the magnitude of oil revenue realized in the country, total government expenditure did not impact on the manufacturing sector output. in the short and long-run, all other variables in the model came out with the expected signs, except for the interest rate (intr), which is positive on the long-run. their levels of significance is presented in the result. table-6. estimated short and long-run coefficients for manufacturing output model. dependent variable: rgdpman selected model: (4,3,1,1) criterion: aic fixed regressor: short-run cointegrating form variable coefficient std. error t-statistic prob. d(rgdpman(-2)) 0.529 0.162 3.273 0.003 d(topex(-1) -0.331 0.164 -2.019 0.053 d(intr) -0.001 0.008 -0.082 0.935 d(inflation) -0.003 0.002 -1.310 0.200 d(pcred) 0.023 0.011 2.129 0.042 cointeq(-1) -0.465 0.101 -4.603 0.000 long-run cointegrating form variable coefficient std. error t-statistic prob. toexp 0.013 0.055 0.230 0.820 intr 0.029 0.017 1.669 0.106 inflation -0.002 0.005 -0.472 0.640 pcred 0.049 0.022 2.223 0.034 c 6.883 0.246 27.982 0.000 note: rgdp is real gross domestic product of the manufacturing sector, topex is total federal government expenditure, intr is nominal interest rate, inflation is the consumer price inflation rate, and pcred is credit to private sector. in considering the differential effects of expenditure types on real gdp (rgdp), i consider the effect of recurrent and capital expenditure on rgdp, table 7. the results show that capital expenditure, both on the short and long-run, makes no impact on rgdp. unlike the short-run, the finding is significant on the long-run. an increase in capital expenditure rather worsens the aggregate output growth. distinctly, the short and long-run effect of recurrent expenditure was positive on the real gdp and only significant, at 1%, on the long-run. it is important to note that: first, the effect of the recurrent expenditure in total government expenditure explains the plausible observed impact on the real gdp growth second, the results obtained reaffirm the trend analysis presented in figure 3 (section 2). across board, the short-run error correction mechanism (ecm), performed to expectation, in term of the signs and significance. implying that the short-run models quickly revert to the long-run equilibrium value. table-7. estimated short and long-run coefficients of aggregate output model with disaggregated expenditure. dependent variable: rgdp selected model: (4,1, 1,1,1) criterion: adjusted r2 short-run cointegrating form variable coefficient std. error t-statistic prob. d(rgdp(-1)) 0.188 0.143 1.312 0.200 d(capex) -0.020 0.025 -0.817 0.420 d(repex) 0.024 0.035 0.686 0.498 d(intr) 0.001 0.002 0.660 0.514 d(inflation) -0.002 0.001 -3.5i8 0.001 d(pcred) 0.006 0.003 2.133 0.041 cointeq(-1) -0.213 0.049 -4.312 0.000 long-run cointegrating form variable coefficient std. error t-statistic prob. capex -0.268 0.076 -3.542 0.001 repex 0.357 0.070 5.110 0.000 intr -0.007 0.010 -0.690 0.496 inflation -0.003 0.003 -1.158 0.256 pcred 0.029 0.012 2.443 0.021 c 11.956 0.148 80.569 0.000 note: rgdp is real gross domestic product, repex is total federal government recurrent expenditure, capex is total federal government capital expenditure, intr is nominal interest rate, inflation is the consumer price inflation rate, and pcred is credit to private sector. in ascertaining the credibility of the adopted models, especially for policy inferences, the lm test for serial correlation was employed. the cumulative sum of recursive residuals (cusum) stability condition of the error correction for each of the model was also tested. these are reported in appendix 1 and 2. the test for serial correlation was conducted based on the null hypothesis that the residuals are serially uncorrelated. the f-statistic p-values, which are insignificant, indicate the acceptance of this null (appendix 1). thus, the conclusion that the asian journal of economics and empirical research, 2020, 7(1): 64-73 71 © 2020 by the authors; licensee asian online journal publishing group residuals are serially uncorrelated. the stability condition of the error correction models, which was tested based on cumulative sum of recursive residuals (cusum), show that all plots fall within the critical bands, hence, the four (4) short-run models are structurally stable appendix 2. 6. conclusion oil revenue is belief to serve as a major source of public expenditure stirring economic activities in oilproducing countries. hence, this study examines the dynamic effects of government expenditure on economic growth in nigeria, using data from 1970 to 2017. the short and long-run scenarios were analyzed based on the ardl approach. specifically, the study examines the effects of total government expenditure on the real gdp. distinct from existing literature, i show the level of oil sector integration on the key sectors of the economy by investigated the agriculture and manufacturing sector effects of total government expenditure. the last objective analyses the differential effects of government recurrent and capital (development) expenditure on the real gdp. results of the first objective showed that total government expenditure has a positive impact on the real gdp in the short and long-run. mixed outcomes were realized when the effect of government expenditure on agricultural and manufacturing sector outputs was considered. in the short-run, total government expenditure decreases agriculture output. long-run accumulated government spending increases the agricultural output growth. on the manufacturing sector output, the total government expenditure exerts a negative effect in the short-run. the long-run scenario, though positive, is not significant. results from analyzing the differential effects of expenditure types on real gdp showed that capital expenditure, both in the short and long-run, makes no impact on the real gdp. however, the recurrent expenditure has a positive significant effect on the real gdp, both in the short and long-run. suggesting that the effect of the recurrent expenditure in total government expenditure explains the plausible observed impact on the real gdp growth. from the empirical findings, the huge magnitude of oil revenue realized in the country has not increase the impact of government expenditure, especially the capital spending that spurs productive activities, and by implication economic growth. this suggest that efforts should be geared towards increasing capital spending for commensurate integration of oil benefits into the major sectors of the economy and the economy at large. further research should explore the relationship between government expenditure and economic growth across the major oil producing countries in africa. this will avail the opportunity of establishing the extent to which the benefits from oil revenue have enhance real sector development across african oil-producing economies. . references ajayi, m. a., & aluko, o. a. (2016). the causality between government expenditure and economic growth in nigeria: a toda-yamamoto approach. journal of economics & business research, 22(2), 77-89. arewa, a., & nwakahma, p. c. (2013). macroeconomic variables and the dynamic effect of public expenditure: long-term trend analysis in nigeria. journal of knowledge management, economics and information technology, 3(6), 1-2. austin, m. a., & ogbole, o. f. (2014). public sector spending and macroeconomic variables in nigeria. european journal of business and management, 6(18), 232-243. babatunde, s. a. (2018). government spending on infrastructure and economic growth in nigeria. economic research-ekonomska istraživanja, 31(1), 997-1014.available at: https://doi.org/10.1080/1331677x.2018.1436453. barro, r. j. (1990). government spending in a simple model of endogeneous growth. journal of political economy, 98(5, part 2), s103s125.available at: https://doi.org/10.1086/261726. chude, n. p., & chude, d. i. (2013). impact of government expenditure on economic growth in nigeria. international journal of business and management review, 1(4), 64-71. dikeogu, c. c., ohale, l., & otto, g. (2016). public expenditure and economic growth in nigeria. international journal of advanced academic research | social & management sciences, 2(12), 23-40. ebong, f., ogwumike, f., udongwo, u., & ayodele, o. (2016). impact of government expenditure on economic growth in nigeria: a disaggregated analysis. asian journal of economics and empirical research, 3(1), 113-121. gukat, b. t., & ogboru, i. (2017). an empirical analysis of government expenditure and economic growth in nigeria. journal of economics and development studies, 5(4), 122-134. magazzino, c., giolli, l., & mele, m. (2015). wagner’s law and peacock and wiseman’s displacement effect in european union countries: a panel data study. international journal of economics and financial issues, 5(3), 812-819. narayan, p. k. (2004). fiji’s tourism exports: an ardl model. tourism economics, 10(2), 193-206.available at: https://doi.or/10.5367/000000004323142425. nworji, i. d., okwu, a. t., obiwuru, t., & nworji, l. o. (2012). effects of public expenditure on economic growth in nigeria: a disaggregated time series analysis. international journal of management sciences and business research, 1(7), 1-15. ogundipe, a., & oluwatobi, j. (2013). government spending and economic growth in nigeria: evidence from disaggregated analysis. journal of business management and applied economics, 2(4), 1-10. okolo, c. v., edeme, r. k., & emmanuel, c. (2018). economic analysis of capital expenditure and infrastructural development in nigeria. journal of infrastructure development, 10(1-2), 52-62.available at: https://doi.org/10.1177/0974930618809173. okoro, a. s. (2013). government spending and economic growth in nigeria (1980-2011). global journal of management and business research economics and commerce, 13(5), 35-42. olayungbo, d., & olayemi, o. (2018). dynamic relationships among non-oil revenue, government spending and economic growth in an oil producing country: evidence from nigeria. future business journal, 4(2), 246-260.available at: https://doi.org/10.1016/j.fbj.2018.07.002. ouattara, b. (2004). modelling the long run determinants of private investment in senegal. the school of economics discussion paper series 0413, economics, the univesrity of manchester. pesaran, m. h., shin, y., & smith, r. j. (2001). bounds testing approaches to the analysis of level relationships. journal of applied econometrics, 16(3), 289-326.available at: https://doi.org/10.1002/jae.616. taiwo, m., & abayomi, t. (2011). government expenditure and economic development: empirical eveidence from nigeria. european journal of business management, 3(9), 19-28. wijeweera, a., & garis, t. (2009). wagner’s law and social welfare: the case of the kingdom of saudi arabia. applied econometrics and international development, 9(2), 199-209. world bank. (2018). world development indicators. retrieved from: https://data.worldbank.org/country/nigeria. appendices the results of tests of serial correlation for the various models adopted in this study are presented in appendix 1. the f-statistic p-values, which are insignificant, indicate the acceptance of the null hypothesis of no serial correlation in the estimated models. asian journal of economics and empirical research, 2020, 7(1): 64-73 72 © 2020 by the authors; licensee asian online journal publishing group appendix-1. lm serial correlation results. model prob. chi-square f-statistic p-value rgdp=f(toexp, inflation, intr, pcred) 0.3843 0.5411 rgdpagric=f(toexp, inflation, intr, pcred) 0.2041 0.3501 rgdpman=f(toexp, inflation, intr, pcred) 0.1095 0.2956 rgdp*=(repex, capex, inflation, intr, pcred) 0.2757 0.4296 note: rgdp* model is the model estimated with recurrent and capital expenditure. appendix 2a to 2d indicate the tests of structural stability of the estimated short-run models. the critical values fall within the upper and lower bounds of the graphs, thus suggesting that all estimated short-run models in the study are structurally stable. appendix-2. cumulative sum of recursive residuals (cusum) stability test. -16 -12 -8 -4 0 4 8 12 16 90 92 94 96 98 00 02 04 06 08 10 12 14 16 cusum 5% significance a: rgdp (with total government expenditure) model cumulative sum of recursive residuals -0.4 -0.2 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 90 92 94 96 98 00 02 04 06 08 10 12 14 16 cusum of squares 5% significance b: rgdpagric model cumulative sum of recursive residuals -16 -12 -8 -4 0 4 8 12 16 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 cusum 5% significance c: rgdpman model cumulative sum of recursive residuals asian journal of economics and empirical research, 2020, 7(1): 64-73 73 © 2020 by the authors; licensee asian online journal publishing group -16 -12 -8 -4 0 4 8 12 16 90 92 94 96 98 00 02 04 06 08 10 12 14 16 cusum 5% significance d: rgdp (with current and recurrent expenditure) model cumulative sum of recursive residuals asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 52 © 2022 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 9, no. 1, 52-58, 2022 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v9i1.3841 © 2022 by the authors; licensee asian online journal publishing group the potential of re-exports: a probability for fiji’s trade growth amit prakash1 priteshni chand2 ( corresponding author) 1,2department of economics, the university of fiji, fiji. 1email: amitp@unifiji.ac.fj tel: +6796640600 ext:196 2email: priteshnic@unifiji.ac.fj tel: +6796640600 eext:159 abstract this study investigates the significance of re-exports in fiji. the dominance of the re-export of domestic exports is indisputable in fiji; however, there is lack of literature concerning the performance of re-exports to total exports transiting the fijian economy. this study aspires to fill that gap offering suggestions to strengthen the total exports of fiji by diversifying the trade policies. time series data is used for total exports, re-exports and domestic exports from 1985 to 2018 to establish an ardl model. the model was subjected to diagnostic testing with a favorable outcome regarding the stability of the model for hypothesis testing. the findings re-affirm that reexports are a significant predictor of fiji’s total exports and trade growth. this research signifies the need for national policies to include the promotion of re-exports. conclusively, the finding of this study is instrumental in updating or reshaping development policies for inclusive growth. keywords: re-exports, trade growth, value adding, trade balance, inclusive policies, ardl. jel classification: c13; f14; f18. citation | amit prakash; priteshni chand (2022). the potential of re-exports: a probability for fiji’s trade growth. asian journal of economics and empirical research, 9(1): 52-58. history: received: 2 february 2022 revised: 8 march 2022 accepted: 22 march 2022 published: 12 april 2022 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this research is supported by the fiji higher education commission (fhec) via the university of fiji (grant number: 2016govtgrt002). authors’ contributions: both authors contributed equally to the conception and design of the study. competing interests: the authors declare that they have no conflict of interest. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted, and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 53 2. literature review ............................................................................................................................................................................ 53 3. data and empirical model ............................................................................................................................................................. 55 4. empirical results and analysis ..................................................................................................................................................... 55 5. conclusion and policy implications ............................................................................................................................................. 57 references .............................................................................................................................................................................................. 57 mailto:amitp@unifiji.ac.fj mailto:priteshnic@unifiji.ac.fj https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v9i1.3841 https://orcid.org/0000-0002-1289-4449 https://orcid.org/0000-0003-3486-1573 asian journal of economics and empirical research, 2022, 9(1): 52-58 53 © 2022 by the authors; licensee asian online journal publishing group contribution of this paper to the literature the current study contributes to the growing literature on trade policies accentuating the significance of re-exports to total exports for small island states. 1. introduction re-exportation has coexisted with international trade, and in the last decade, re-export trading has immensely intensified. ollus & simola (2007) acknowledged that re-exports contributed 5%–15% of world exports in 2002, and hong kong’s share of re-exports grew from about 20% in the 1960s to 90% of current exports. the wto (2017) reported that hong kong’s and china’s re-exports have increased from $179 billion in 2000 to $491 billion in 2016. moreover, the strong emergence of re-exports has been aligned with growth in international trade, logistical efficiency, addressing asymmetric information, and a robust increase in global transport volumes, tariffs, quotas and taxation (hanson & robert, 2001; ollus & simola, 2007). the logistical readiness reflects the ports’ efficiency in ensuring effective and competitive transport activities that guarantee low-cost goods delivery. in addition, the hong kong traders have acquired specialized knowledge on chinese products that enable traders to market the products to the relevant destinations based on demand. on the other hand, fisman et al. (2007), as cited in ollus & simola (2007), criticized hong kong traders for propagating a grey market1 and evading chinese tariffs. furthermore, in latvia, re-exports have accounted for a significant share of the total merchandise exports attributed to globalization (beņkovskis, bērziņa, & zorgenfreija, 2016). an exogenous component for influencing the volume of re-exports is world trade, which was expected to grow by a modest 2.4% in 2017 with a forecast of 2.1%–4.0% for 2018 (wto, 2017). re-exports represent commodities that are isolated from any further value adding in the intermediate economy; thus, it is re-exported in the original form in which it was imported. moreover, there is a transfer of the commodity ownership to the purchasing economy. hence, in transit trade2, the ownership does not shift to the purchaser in the intermediate country. the dilemma of inclusion or exclusion of re-exports in trade statistics is subjective to the trade classification system. ollus & simola (2007) reported that under the general trade system, re-exports are recorded as both imports and exports; however, the special trade system (recommended by the un) warrants the exclusion of re-exports from exports and imports. in addition, failure to properly account for re-exports will distort an economy’s market share and sector competitiveness. moreover, ignoring re-exports may cloud the potential contribution of domestic exports to an economy’s progress. on the other hand, transiting commodities generate revenue for the domestic government. benjamin, golub, & mbaye (2013) disclosed that the trade duties from re-exports are a major contributor to government revenue of the gambia and benin in africa. re-exports also generate revenue through repackaging, resale, and costs related to the storage and transportation of these commodities (gehlhar, 2010). it is now easier than ever to link economies due to economic globalization (the interaction and integration of goods, services, capital, technology and information). the oecd (2017) reported that globalization encourages firms to restructure their production processes through international outsourcing and offshore activities. benefiting from globalization without violating the basic concept of comparative advantage shapes global value chains (gvcs). gvcs combine different stages of production processes or supply side outputs of multiple countries in producing finished goods that link local producers to international markets. fung (2013) summed up gvcs by suggesting that products made today are “made in the world” rather than in a single country. in light of gvcs, multinational companies have been perceived as agents of re-exports; however, intra3 firm trade involves the transfer of semi-finished products that must undergo value adding. according to ollus & simola (2007), only a fraction of intra-trade occurring between multinational companies can be regarded as re-exportation. the fiji islands is a cluster of approximately 330 islands with a land mass of 18,333 sq km of which roughly a third is inhabited. during colonialism, fiji gained access to the london market, revitalized its sugar industry that was highly capital intensive, addressed the labor shortage via the indenture system, and diversified into copra, bananas and gold to sustain trade balance with falling sandalwood, bêche-de-mer and cotton production (gounder, 2013). the post-colonial era has been shadowed by political instabilities (the coups of 1987, 2000 and 2006)4. the dominance of the agriculture sector has subsided, and in the 2000s, fiji’s gross domestic product was primarily carried by the service sector followed by the manufacturing and agriculture sectors, respectively. fiji is an upper middle-income country with a gross national income (gni) per capita between $4,096 and $12,695 (world bank, 2022). this study aspires to explore the re-export behavior in fiji by examining the types and volumes of commodities transiting the fijian hub. the study provides important insights for fiji policy makers on how fiji can converge and participate in the global re-exportation market. the rest of the article is organized as follows: section 2 reviews the existing literature; section 3 describes the empirical model and data; section 4 discloses the empirical results; and section 5 concludes. 2. literature review over the years, re-exports have been a substantial component of total exports surpassing the volume of domestic exports not only in fiji but in numerous other countries as well. the contribution of re-exports to the gross domestic product (gdp) has nearly doubled in the past twenty years. although the re-exportation of goods does not transform the commodity in any way but value is added to it in terms of labelling and repacking, commonly termed as the re-export mark-up. it is basically the divergence from the import unit value and the export unit value (dawer & jain, 2015)5. even though re-exports are considered a part of domestic exports, this inclusion may have several implications for the exporting country. 1 the grey market constitutes distribution of commodities through channels that are legal but unintended by the original manufacturer. moreover, the economic activity via the grey market is not accounted for in official statistics. 2 transit trade is never recorded in the trade statistics (ollus & simola, 2007). 3 intra trade involves trading products that belong to the same industry which are both exported and imported. 4 there were two coups in 1987—may 14 and september 25. the 2000 coup was on may 19. the fourth coup was on december 5, 2006. 5 see the conference paper on re-exports in the us and india which clarifies policy guidelines with reference to the aforementioned countries. asian journal of economics and empirical research, 2022, 9(1): 52-58 54 © 2022 by the authors; licensee asian online journal publishing group a substantial amount of exports from finland to russia is made up of re-exports. ollus & simola (2007) examined the re-export behavior from finland to russia in 2005. high-value goods such as electronics and vehicles were under scrutiny. it is believed that re-exports misrepresent volumes of trade when they are not separated from exports, thus distorting the image of a country’s market share and consequently its competitiveness in the export market. reexporting goods has become increasingly important for the dutch economy over recent decades. furthermore, re-exports have grown more rapidly during the past two decades than exports of dutch-produced goods (statistics netherlands, 2016). kusters & verbruggen (2001) substantiate the claim that re-exports have been growing rapidly by studying the trends in the dutch economy. however, they argue that the products that are reexported are not produced in the domestic country, thus the service, commercial and transport sectors will mostly be affected. the levels of employment and income are affected in the respective sectors of the economy as the commodities/transactions originate from another country. it is believed that recording re-export transactions should not have an impact on the trade balance since they would be crossed out, but the import prices may not always match the export prices, thus giving rise to over or underestimation of the prices. moreover, as exports have conventionally been the drivers of economic growth, re-exports can mask the link between trade and economic growth thus altering the market share of a country. additionally, as mentioned earlier, re-exports are included in determining the total merchandise trade value, but for some countries, such as hong kong, china, the volume of re-exports is so extensive (around $498 billion in 2015) that it has been excluded from the world and asian aggregates6. burger, thissen, van oort, & diodato (2014) found that the classification of re-exported commodities as a component of total exports not only distorts the trading pattern but also affects the magnitude of trade. at times, the re-exports are double-counted as the final destination may differ from the registered destination leading to a fallacious volume of trade. a country’s internal trade is also impacted as large re-exports underestimate the proportion of domestic trade in a country. this study uses a new and coextensive dataset consisting of goods and services for 25 european countries and their dominant trading partners to examine the trade variations in commodities and services while controlling for the re-export of goods explicitly to determine the volume of trade in goods and services. it was concluded that although more goods are bilaterally traded in comparison to services, distance does not deter trade in services. lankhuizen & thissen (2014) argue that the data on bilateral trade flows are not adjusted for re-exports when estimating models of international trade, which indicates that a re-exporting country is taken as the country where trade has originated from as well as being the final destination of the trade flow. by not accommodating for reexportation, the trade data may result in distance decay of trade being erroneously valued, a country’s major trading partners may not be properly recognized and the volume of total world trade is therefore overvalued. moreover, this may lead to a misguided export promotion policy by the policy makers and overvaluing the volume of trade will result in misrepresenting trade in achieving economic growth and development. this study attempts to correct these trade patterns by collating data from 40 countries listed in the world input-output database with 59 categories of products from 2000 to 2012. the data was corrected for re-exports by employing a controlled non-linear accession method. the results revealed a significant difference in the trade of goods between countries (over 5% on average), and the distances are miscalculated, thus having consequences for a country’s trade policies. it is indisputable that lower trade barriers increase the movement of goods across the globe. a study by rettab & azzam (2008) took port expenses and their effect on the concentration of re-exports into consideration. they postulated that shipping costs and coordination are major factors influencing the clustering of re-exports. a relative statics model was formulated that measured the degree of the effect of port costs on the re-export concentration, and further developed predicaments under which the re-export intensity was inversely related to the port costs. the costs and re-export intensities were analyzed for five asian ports, namely mumbai, dammam, dubai, hong kong and manama. the costs at ports included services offered there and the cost of storage, transport and documentation. they discovered that the transportation costs and logistics had the most significant impact on re-export intensity. another study by mellens, noordman, & verbruggen (2007) revealed that the growth of re-exports in the netherlands has been booming and so is the re-exports in world trade. a total of ten european countries’ trade data was analyzed for this study by using the export performance index and market performance index. the result of this study indicates that the re-export values are double-counted in the global trade figures. this depicts that the volume of world trade is expanding at a faster rate than the production of exports, which is clearly a misrepresentation of world trade. despite these discrepancies, there are motivations for engaging in re-exportation activities, especially for some multinational firms. one major benefit highlighted in this study is that multinational companies often engage in these activities to avoid tax/tariffs or infringe quotas set by the government. an intermediate country is used by the country of origin to supply products to the destination country without being concerned about the tax/tariff regulations because it will be bypassing them. apparent revelations about the trade indicators are that the growth of the export market is magnified, and there is an amplified loss of market share for manufacturers in the netherlands. however, beņkovskis et al. (2016) found that including re-exports not only magnifies the total exports market but also has other serious consequences. a study that examined latvia’s re-exports used an anonymized firmlevel trade database which provides data from 2005 to 2013 with detailed information on international trade. the study revealed that when re-exports are part of total exports, the actual impact of shocks on certain commodities and trading partners are not measured accurately. there are more implications for the domestic economy as the real impact may be over or understated regarding certain commodities and trading partner countries. the study emphasized that re-exports should not be undermined since the average mark-ups on re-exports were significant, and that engaging in re-export activities may contribute to a country’s gdp. despite the impediments of recording re-exports as part of domestic exports, this phenomenon has continued to grow. it offers lower transportation costs as many countries act as transport hubs of international trade in goods and they are well developed and have excessive storage space and transporting avenues. large storage spaces and ease of transportation together with tariff avoidance are the factors that incentivize the growth of re-exportation. moreover, as an intermediary, a re-exporting country may possess better knowledge on the product sources and 6 see world trade statistical review, 2016 asian journal of economics and empirical research, 2022, 9(1): 52-58 55 © 2022 by the authors; licensee asian online journal publishing group markets in which the product is in demand, therefore reducing asymmetric information between the buyers and the sellers. re-exporting generally applies to differentiated goods, such as machinery or electronic devices. furthermore, it enhances efficiency and increases the ease of doing business between traders (hanson & robert, 2001). 3. data and empirical model the period of study is 1985–2018 with data sourced from the fiji bureau of statistics. in compiling the data, there were two-phase interviews conducted by the researchers. the interviews involved consultation and deliberation on fiji’s re-export market with personnel from the fiji bureau of statistics and the trade unit in the ministry of industry, trade and tourism. the dataset includes revised trade balances for 2016 and 2017 with provisional values for 2018. annual time series data on total exports (fj$ 000), domestic exports (fj$ 000), and reexports (fj$ 000) was sourced from the merchandise trade statistics release of the fiji bureau of statistics. in ascertaining the importance and significance of re-exports, the explained variable of total exports is determined using re-exports and domestic exports. to establish the appropriate model, a unit root test using the augmented dickey–fuller (adf) test was utilized to check the stationarity of the variables. the series were found to be stationary at level i(0) and at first difference i(1), thus it is appropriate to use the autoregressive distributed lag (ardl) model. the ardl model can capture both long-run and short-run relations of the cointegrated variables. the following model is used with data in log (ln) form: 𝐿𝑁𝑇𝐸𝑋𝑃𝑡 = 𝛽0 + 𝛽1𝐿𝑁𝐷𝐸𝑋𝑃𝑡 + 𝛽2 𝐿𝑁𝑅𝐸𝑋𝑃𝑡 − 𝐷𝑖𝑠𝑟𝑢𝑝𝑡𝑖𝑜𝑛𝑠𝑡 + 𝜇𝑡 (1) where lntexp is the total exports that represent annual merchandise exports for fiji; lndexp is domestic exports capturing the commodities that were produced domestically in fiji; and lnexp signifies re-exported commodities that are isolated from any further value adding in the intermediate economy and is thus re-exported in the original form in which it was imported. furthermore, it is expected that both domestic exports and re-exports will have a positive sign. in addition, disruptions capture the potential distortion to total exports. disruptions used in this model are political instabilities, cyclones, drought, flash floods, and global economic crises, where the presence of disruptions = 1 and the absence of disruptions = 0. it is highly anticipated that disruptions will have a negative sign. the error correction version of the above is as follows: ∆𝐿𝑁𝑇𝐸𝑋𝑃𝑡 = 𝛽0 + ∑𝑖 𝛽1∆𝐿𝑁𝑇𝐸𝑋𝑃𝑡−1 + ∑𝑖 𝛽2∆𝐿𝑁𝐷𝐸𝑋𝑃𝑡−1 + ∑𝑖 𝛽3∆𝐿𝑁𝑅𝐸𝑋𝑃𝑡−1 + 𝛼1𝐿𝑁𝑇𝐸𝑋𝑃𝑡−1 + 𝛼2𝐿𝑁𝐷𝐸𝑋𝑃𝑡−1 + 𝛼3𝐿𝑁𝑅𝐸𝑋𝑃𝑡−1 − 𝐷𝑖𝑠𝑟𝑢𝑝𝑡𝑖𝑜𝑛𝑠𝑡 + 𝜇𝑡 (2) the ardl (2,2,1,0) model was selected based on the akaike information criterion. the above models were estimated using eviews 9.0. 4. empirical results and analysis this section presents the findings in two subsections. subsection 4.1 displays graphical measures, and subsection 4.2 presents the ardl analysis. 4.1. graphical measures fiji’s total exports were immensely outlined by domestic exports until the late 2000s (see figure 1). however, re-exports have abruptly re-shaped the total exports since 2009. as such, the fluctuations in re-exports narrated the movement in total exports, while domestic exports displayed calm and marginal disruptions. a momentary observation may favor re-exports outweighing domestic exports and criticize government efforts to promote domestic exports. however, the ratio of domestic exports to total exports dominates the total exports with the exception of the period from 2012 to 2014 (see figure 2). furthermore, re-exports have seen a substantial growth as a percentage of total exports from 2009. a notable finding is that re-exports have the capability of escorting total exports when domestic exports contract. an explicit case is the declining domestic exports percentage from 2009 to 2011 due to the floods in fiji in january 2009, while escalating re-exports neutralized the anticipated drastic fall in total exports (see figure 2). figure 1. fiji’s total exports, re-exports and domestic exports (fj$ 000), 1985–2018. source: fiji bureau of statistics (2019). asian journal of economics and empirical research, 2022, 9(1): 52-58 56 © 2022 by the authors; licensee asian online journal publishing group the disparity between the domestic export percentage and the re-export percentage to total exports in 1985 was 40.46% and was dominated by domestic exports (figure 2). however, in 2018 the disparity between the ratios is 12.56% with the domestic export ratio at 56.28% and the re-export ratio at 43.72%. this highlights the significant proportion of total export share captured by re-exports over the years. figure 2. fiji’s domestic exports to total exports (%) and re-exports to total exports (%), 1985–2018. source: fiji bureau of statistics (2019). the findings do not imply that re-exports are superior to domestic exports or that re-exports can replace domestic exports. an investigation was carried out to re-affirm significance of re-exports as a probable cause for fiji’s trade growth. the reserve bank of fiji (2017) disclosed that fiji acts as the regional transshipment hub for petroleum products as regional countries do not have the storage capacity to import petroleum. in 2007, the national growth document, sustainable economic and empowerment development strategy (seeds) 2008–2010, advocated diversifying the domestic export markets to improve fiji’s involvement in the global market and its economic advancement. furthermore, the roadmap for democracy and sustainable socio-economic development (rdssed) 2010–2014 outlined tools for domestic export promotion, such as the national export strategy and demand driven approach. in 2014, the green growth framework for fiji: restoring the balance in development that is sustainable for future complemented the rdssed. an interesting phenomenon is the absence of including re-exports in national policies. 4.2. regression analysis table 1 presents the results of the ardl test statistics specified in equation 2 with total exports as the dependent variable. as anticipated, domestic exports and re-exports are highly significant positive determinants of total exports both in the short and long runs (see table 2). furthermore, the outputs below substantiate that reexportation is a significant predictor of total exports in fiji. it is highly recommended that an inclusive national policy is implemented to explore the potential of re-exportation in fiji. table 1. ardl test statistics. coefficient estimates t-statistics long-run estimates equation 2 α (constant) 0.797** 2.092 β (lndexp) 0.755*** 21.049 δ (lnrexp) 0.227*** 12.095 disruptions -0.012 -0.612 short-run estimates δ constant 0.751** 1.056 δ lndexp 0.808*** 17.743 δ lnrexp 0.223*** 14.860 disruptions -0.009 -0.606 adjusted r2 --0.99 durbin–watson statistic --2.13 note: *** significant at the 1% level; ** significant at the 5% level. moreover, disruption is negative and not significant (see table 2). it may be that political instability does not influence total exports because during political instability, when the traditional trading partners imposed trade sanctions, fiji was able to successfully collaborate with asian and north american markets. thus, the export market was not compromised. in addition, the few possible justifications put forward for the adverse effects caused by cyclones, droughts and flash flooding are insignificant as these natural disasters do not affect all the divisions in fiji simultaneously, the relief aid from other countries fast-track the recovery period, and the global prices of commodities that fiji export may have revised upwards. in addition, spill-over from the global economic crisis may have been marginal for fiji. fiji is a small island developing state and its participation in the global export market may have been too minimal to feel the full effects of the global crisis. asian journal of economics and empirical research, 2022, 9(1): 52-58 57 © 2022 by the authors; licensee asian online journal publishing group table 2. variable coefficients: predicted and actual. independent variable predicted sign actual sign – long run actual sign – short run domestic exports positive positive, significant positive, significant re-exports positive positive, significant positive, significant disruptions negative negative, not significant negative, not significant table 3 outlines the various residual diagnostic test results. the model generally satisfies the diagnostic criteria, such as the residuals being free of autocorrelation based on the breusch–godfrey serial correlation lm test. in addition, the model has the correct functional form (no misspecification) based on ramsey’s reset test and the residuals were normally distributed based on the jarque–bera test. furthermore, the model is desirable (constant error variance) based on the breusch–pagan–godfrey test. the error correction model cointegrating coefficient was -0.76, thus the long-run adjustment is 76% and significant. the model cleared the bounds test where the f-statistics rejected the null hypothesis at all significance levels establishing a long-run relationship between the cointegrating variables. table 3. diagnostic tests. test obs. r-squared p-value serial correlation 2.548 0.2796 heteroscedasticity: bpg 13.213 0.1532 heteroscedasticity: arch 1.480 0.2236 functional form --0.8178 residual normality --0.3313 5. conclusion and policy implications total exports encompass the re-exports and domestic exports in international trading accounts. domestic exports include merchandise that is locally produced, while re-exports are commodities that are exported in their original imported form. the importance of re-exports to fiji’s trade balance over the past few years is evident as reexports have dominated total exports overshadowing domestic exports. countries only have an interim possession of the commodities that are exported but the gains from trade are attained at the macro level. these gains are in terms of the tax revenues generated by the government, revenues gained from the marked-up prices of the commodities, and revenue arising from transportation and storage costs as many ports act as hubs. moreover, the benefits are not only limited to the gains realized by the exporting country but the costs for the trading partners are also reduced. re-exportation further reduces the predicament of asymmetric information among trading partners. taking into consideration the contributions of re-exports to total exports, the study entails an investigation to determine the significance of re-exports to fiji’s total exports. therefore, the shortand long-run effects of re-exports to total exports were analyzed using the ardl approach and the results suggest that re-exports are a significant predictor of total exports in the short run as well as the long run. currently, there is no policy on trade promotion with regard to re-exports in the national export strategy of fiji, therefore, policies should be designed and directed towards enhancing the re-exports base to gain higher benefits from trade. improving the storage capacities of fiji’s ports will permit more bulk buying and on-time delivery of goods. also, improving the infrastructure of the airports and the wharfs to cater for more cargo planes and vessels to facilitate faster delivery of goods to the destination countries will enhance the growth of the re-export sector in fiji. being the hub of the south pacific, fiji can reap the benefits of international trading by expanding its re-export capacity as the results suggest a high correlation between re-exports and total exports in the short and long runs. references benjamin, n., golub, s., & mbaye, a. (2013). world trade organization. paper presented at the 14th wto chairs annual conference. geneva, 11 – 12 july 2013. world trade organization. [accessed: 17 december 2017]. beņkovskis, k., bērziņa, s., & zorgenfreija, l. (2016). evaluation of latvia’s re-exports using firm-level trade data. baltic journal of economics, 16(1), 1-20.available at: https://doi.org/10.1080/1406099x.2016.1163891. burger, m. j., thissen, m. j., van oort, f. g., & diodato, d. (2014). the magnitude and distance decay of trade in goods and services: new evidence for european countries. spatial economic analysis, 9(3), 231-259.available at: https://doi.org/10.1080/17421772.2014.930166. dawer, a., & jain, a. (2015). policy comparison of us and indian re-exports: suggestive lessons for india. paper presented at the in: 2nd international conference on science, technology and management. fiji bureau of statistics. (2019). international merchandise trade statistics. retrieved from: https://www.statsfiji.gov.fj/images/documents/economics_statistics/annual_reports/tradestatistics/international_merchandise_trade_statistics/2019-international-merchandise-trade-statistics.pdf fung, v. (2013). governance through partnership in a changing world. retrieved from: https://www.wto.org/english/res_e/booksp_e/aid4tradeglobalvalue13_intro_e.pdf. gehlhar, m. (2010). re-export trade for the netherlands and singapore. retrieved from: https://www.gtap.agecon.purdue.edu/resources/download/5117.pdf [accessed 28 august 2016]. gounder, n. (2013). trade liberalization and poverty in fiji: a computable general equilibrium microsimulation analysis. phd thesis, griffith university, gold coast. hanson, g. h., & robert, f. c. (2001). intermediaries in entrepôt trade: hong kong re-exports of chinese goods. nber working paper no. 8088, cambridge. kusters, a., & verbruggen, j. (2001). re-exports and the dutch market position. cpb report, 4, 35-40. lankhuizen, m., & thissen, m. (2014). identifying true trade patterns: correcting bilateral trade flows for re-exports. paper presented at the 22nd international input-output conference & 4th edition of the international school of i-o analysis. 14-18 july 2014, lisbon, portugal. mellens, m., noordman, h., & verbruggen, j. (2007). re-exports: international comparison and implications for performance indicators. cpb netherlands bureau for economic policy analysis, 149. oecd. (2017). global value chains (gvcs) – oecd. retrieved from: https://www.oecd.org/industry/ind/global-value-chains.htm. ollus, s.-e., & simola, h. (2007). finnish re-exports to russia. bank of finland institute for economies in transition. 5/2007. retrieved from: https://helda.helsinki.fi/bof/bitstream/handle/123456789/12614/129313.pdf?sequence=1. rettab, b., & azzam, a. (2008). re-export intensity and trade costs: port facilities and services. maritime economics & logistics, 10(3), 229242.available at: https://doi.org/10.1057/mel.2008.2. https://www.statsfiji.gov.fj/images/documents/economics_statistics/annual_reports/trade-statistics/international_merchandise_trade_statistics/2019-international-merchandise-trade-statistics.pdf https://www.statsfiji.gov.fj/images/documents/economics_statistics/annual_reports/trade-statistics/international_merchandise_trade_statistics/2019-international-merchandise-trade-statistics.pdf http://www.wto.org/english/res_e/booksp_e/aid4tradeglobalvalue13_intro_e.pdf http://www.gtap.agecon.purdue.edu/resources/download/5117.pdf http://www.oecd.org/industry/ind/global-value-chains.htm asian journal of economics and empirical research, 2022, 9(1): 52-58 58 © 2022 by the authors; licensee asian online journal publishing group statistics netherlands. (2016). trends in the netherlands 2016. retrieved from: https://www.cbs.nl/en-gb/publication/2016/26/trends-inthe-netherlands-2016. the reserve bank of fiji. (2017). fiji and international trade. suva: fiji bureau of statistics. world bank. (2022). world bank country and lending groups. retrieved from: https://datahelpdesk.worldbank.org/knowledgebase/articles/906519-world-bank-country-and-lending-groups. wto. (2017). wto | 2017 press releases -trade recovery expected in 2017 and 2018, amid policy uncertaintypress/793. retrieved from: https://www.wto.org/english/news_e/pres17_e/pr791_e.htm [accessed 5 jun. 2017]. the asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc., caused in relation to/arising from the use of the content. any queries should be directed to the corresponding author of the article. http://www.cbs.nl/en-gb/publication/2016/26/trends-in-the-netherlands-2016 http://www.cbs.nl/en-gb/publication/2016/26/trends-in-the-netherlands-2016 http://www.wto.org/english/news_e/pres17_e/pr791_e.htm 155 asian journal of economics and empirical research vol. 5, no. 2, 155-164, 2018 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2018.52.155.164 effects of the determinants of foreign direct investment in nigeria: error correction mechanism ebire, kolawole1  onmonya, o. lucky2 inim, v. ekemini3 (corresponding author) 1,2research fellow, institute of development finance and project management, nigeria 3international organisation of migration, nigeria abstract to attract more foreign direct investment (fdi) inflows is the important institutional policies of the most of nations all over the world. identifying the key determinants of fdi inflows is therefore seen as an important task for policy makers. this study, therefore, investigates the major determinants of fdi in nigeria spanning from 1986 2017. the secondary source of data was used for the study which was first subjected to stationarity test using augmented dickeyfuller and phillips perron test. findings showed that all variables were found to be integrated order one. cointegration analysis showed that there exists a long run relationship among the variables. based on this findings, error correction mechanism was used in testing the hypotheses. the result showed that exchange rate, gdp, first lag of gdp, military expenditure, first lag of military expenditure, political stability and financial development are the major determinants of fdi inflows to nigeria. the empirical findings of this study show that government at all levels should tackle the menace of insecurity ravaging the economy and portraying the country as insecure thereby creating a secure environment for fdi inflows. democratic regimes should be sustained and investment policies should be instituted or improved on, in order to create a friendly environment to attract more fdi inflows. keywords: foreign direct investment, gdp, error correction mechanism, nigeria. jel classification: f21, f23, o11, c3. citation | ebire, kolawole; onmonya, o. lucky; inim, v. ekemini (2018). effects of the determinants of foreign direct investment in nigeria: error correction mechanism. asian journal of economics and empirical research, 5(2): 155-164. history: received: 22 june 2018 revised: 7 august 2018 accepted: 12 september 2018 published: 9 october 2018 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group contribution/acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 156 2. theoretical framework and literature review ...................................................................................................................... 156 3. methodology ................................................................................................................................................................................... 159 4. discussion of results .................................................................................................................................................................... 159 5. conclusion and policy recommendations ................................................................................................................................ 161 references ............................................................................................................................................................................................ 162 appendices ........................................................................................................................................................................................... 163 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2018.52.155.164&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/255 https://orcid.org/0000-0001-7000-2552 http://asianonlinejournals.com/index.php/ajeer/article/view/255 https://orcid.org/0000-0001-7000-2552 http://asianonlinejournals.com/index.php/ajeer/article/view/255 https://orcid.org/0000-0001-7000-2552 asian journal of economics and empirical research, 2018, 5(2): 155-164 156 1. introduction foreign direct investment (fdi) over the years have received increased attention which is been described as a key element of globalization, and also a driver of employment opportunities, technological transfer, productivity, and ultimately economic growth (smith, 1997). fdi has proven to possess the capability to increase tax revenues and improve management, technology, as well as labor skills in host countries as opined by todaro and stephen (2003). in order to achieve these benefits, countries strategically position themselves by creating an investment friendly environment through various policies and regulations. organisation for economic co-operation and development (2008) defined fdi as cross border investment by a resident entity in one economy with the objective of obtaining a lasting interest in an enterprise resident in another economy. they stressed that the lasting interest implies the existence of a long-term relationship between the direct investor and the enterprise and a significant degree of influence by the direct investor on the management of the enterprise. ownership of at least 10% of the voting power, representing the influence by the investor, is the basic criterion used. fdi figures sourced from the central bank of nigeria (cbn) shows that between 1970 and 1985, fdi fluctuated which may be due the country recovery from civil war and the indigenization policy which restricted fdi inflows to certain sectors of the economy which were exclusively left for indigenes. however, 1986 marked the deregulation of the nigerian economy which gave room for effective and efficient economic and business activities by relaxing laws and regulations that hinder free competition in supply of goods and services. fdi data shows that the figure jumped from $4.5 billion in 1985 to $5.0 billion in 1986. in 1987, fdi increased to $5.2 billion, which increased to $5.8 billion in 1988 and rose up to $6.2 billion in 1989. the figures kept rising until 1995 which marked the enactment of the nigerian investment promotion commission (nipc) act, with the objective to open up all sectors to fdi, which according to united nation conference on trade and development (1999) allowed for 100% foreign ownership in all sectors, with the exception of the petroleum sector (where fdi is limited to joint ventures or production sharing). 1999 marked the return to democratic rule which was accompanied by the national economic empowerment and development strategy (needs) aimed at embracing a private sector led growth strategy. since then, fdi inflow in nigeria have continued to be on the rise as much as $94.4 billion in 2016. the tremendous benefits of fdi to host states prompted successive administrations in nigeria to pursue various reforms to attract fdi inflows. these reforms includes the deregulation of the economy, the industrial policy of 1989, the establishment of the nigeria investment promotion commission (nipc) in 1995, and the signing of bilateral investment treaties in the late 1990s (wafure and abu, 2010). these policies further included the reforms done by the federal government of nigeria in 2015 to enable foreign investors on the ease of doing business in nigeria, spearheaded by the ministry of trade, commerce and investment. these reforms were articulated in strategic plans, annual budgets as well as the monetary and fiscal policies through which it attempted to control indicators like inflation, interest rates, exchange rates, aggregate spending, deficit spending and gdp growth rate. however, the world bank report (2003) noted that the nigerian government's policy of economic deregulation and liberalization opened up new windows of opportunity to all investors wishing to invest in the country's economy. also, on the ease of doing business index which rank economies against each other based on how the regulatory environment is conducive to business operations, world bank report shows that nigeria ranked 145 among 190 economies. this is an improvement from 169th position in 2016. the distinction of this study from other studies on the determinants of fdi inflows in nigeria is that there has been a period gap as most studies stopped at 2010 (wafure and abu, 2010; uwubanmwen and ajao, 2012; oba and onuoha, 2013; ndem et al., 2014). beyond this period, lots of macroeconomic activities changed such as nigeria gdp growing to become highest in africa, depreciation of the nigerian naira to us dollar, increase in insecurity across the country which led to increase in military expenditure and fluctuations in government consumption expenditure. more so, giving the conflicting findings in previous studies, this study therefore, intends to fill this existing gap and in addition, includes other variables such as financial development and government consumption expenditure, military expenditure and political stability which are not common in nigerian studies but have been identified as key determinants of fdi. therefore, the broad objective of this study is to investigate the determinants of fdi inflows to nigeria. 2. theoretical framework and literature review several theories of fdi exists in literatures. common among them includes; product life-cycle theory, internalization theory of fdi and eclectic theory. however, the theory that underpin this study is eclectic paradigm attributed to dunning (1979; 2000). it provides a framework that groups micro and macro level determinants in order to analyze why and where multinational companies (mncs) invest abroad. the framework posits that, firms invest abroad to look for three types of advantages: ownership (o), location (l), and internalization (i) advantages. hence, it is called the oli framework. the ownership specific advantages (of property rights/patents, expertise and other intangible assets) allow a firm to compete with others in the markets it serves regardless of the disadvantages of being foreign because, it is able to have access to and exploit and export natural resources and resource-based products that are available to it. the location advantages are those that make the chosen foreign country a more attractive site for fdi than the others, hence the reason for the fdi is to supply the domestic market of the recipient country through an affiliate. the location advantages may arise from differences in country natural endowments, government regulations, transport costs, macroeconomic stability, and cultural factors. internalization advantages on the other hand arise from exploiting imperfections in external markets, including reduction of uncertainty and transaction costs in order to generate knowledge more efficiently as well as the reduction of state-generated imperfections such as tariffs, foreign exchange controls, and subsidies. the concept of fdi is broad and several attempts have been made by different authors to define it. this section therefore reviews some of the definitions of fdi. farrell (2008) defined fdi as a package of capital, technology, management, and entrepreneurship, which permits a firm to operate and offer commodities and services in a foreign marketplace. according to him, firms seek to take advantage of a new large market, which is considered as a traditional motive for fdi. this work, however, adopts the definition by the oecd (2014) which defines fdi as asian journal of economics and empirical research, 2018, 5(2): 155-164 157 cross border investment by a resident entity in one economy with the aim of obtaining a durable interest in an enterprise resident in another economic system. oecd stressed that the lasting interest implies the existence of a long-term relationship between the direct investor and the enterprise and a substantial degree of influence by the direct investor on the management of the enterprise. ownership of at least 10% of the voting power, representing the influence by the investor, is the basic criterion used. 2.1. foreign direct investment inflow in nigeria the nigerian market is a large market for investors and profit seeking co-operations. in order to place nigeria as one of the largest economies in the world, several policies were instituted by government at various levels to achieve this goal. efforts were made by the federal government through the nigerian investment promotion commission act in 1995 to open different sectors of the nigerian economy to fdi, allowing complete ownership in all sectors (with exception to petroleum sector where fdi is limited to joint ventures or production sharing contracts) through fair treatment and tax incentives. this was aimed at promoting import substitution policy. other laws were enacted equally to both domestic and foreign investors. they include: banking and other financial institutions act (1991), foreign exchange act (1995), money laundering act (2003), investment and securities act (2007), electric power sector reform act (2005), nigerian mineral and mining act (2007), nigeria extractive industries transparency initiative (neiti) act (2007), central bank of nigeria act (2007), the nigerian oil and gas content development act (2010). according to unctad (1999) oil exploration has been the dominant target for most international commentary on fdi for the last 30 years and its impact on the nigerian economy has been large. beyond the oil industry, and in manufacturing in particular, foreign affiliates are few and have had no significant development impact. while foreign investors have been able to deploy capital and technology in exploration and extraction of crude oil, same cannot be said of the manufacturing sector which has been stagnated for decades. concerning the service industry, particularly the telecommunications had a significant impact on the expansion of mobile telephone in nigeria since its launch of global system for mobile (gsm) licensing in 2001. the competition among licensed firms have attracted billion of dollars into the nigerian economy. according to unctad (1999) mtn alone invested more that $3billion into the sector. 2.2. main determinants of fdi several determinants of fdi have been identified in literatures both in the context of nigeria and the world at large. edwin (2014) argued that there are no unanimously accepted single factor that determines the flow of investment. he further stated that at best, literatures provide information on the full rate of factors that are likely to induce the flow of fdi anywhere. it is worthy of note that, not all determinants are equally important to investors in every location at all the times. however, some determinants may be more important to a given investor for a given time to another investor. ogunleye (2014) noted that while it is difficult to determine the exact quantity and quality of fdi determinants that should be present in a location for it to attract a given level of inflows, it is nevertheless clear that a critical minimum of these determinants must be present before fdi inflows begin to occur. the following are the main determinants of fdi identified in the review of various literatures. i. market size (gdp) ii. natural resources iii. openness iv. inflation rate v. exchange rate vi. interest rate vii. infrastructure viii. fiscal deficit ix. debt ratio x. size (ratio of government consumption to gdp) xi. political stability xii. electricity consumption xiii. transportation and communication xiv. telephone lines xv. labour cost (wages) xvi. human capital xvii. corporate tax xviii. bank credit xix. finance access xx. financial development xxi. military expenditure xxii. gross capital formation xxiii. export xxiv. import xxv. external debt the following determinants are therefore, examined in this study to test if they exist any influence on fdi inflows in nigeria. 2.2.1. government consumption expenditure (gce) this is measured as the ratio of government consumption expenditure to gdp. it indicated the extent of government involvement in the economy which is expected to bear a direct relationship to economic growth and fdi because a higher level of government consumption should translate into provision of social infrastructure that should encourage production, growth and fdi inflows. anyanwu (2011) argued that a relative small government asian journal of economics and empirical research, 2018, 5(2): 155-164 158 makes it leaner and more efficient through better remuneration packages. hence the smaller a government, the more efficient it is perceived to be, thus creating a conducive environment for robust private investment. however, a relatively large government tends to crowd out private studies on government consumption expenditure and fdi inflows. anyanwu (2011) examined the factors that cause fdi to flow into african countries. using ols, results from panel regression for the period 1980-2007 indicate that, high government consumption expenditure attracts fdi inflows to africa. 2.2.2. financial development (findev) according to al nasser and gomez (2009) financial development is important in fdi decisions because it affects the cost structure of investment projects. kinda (2010) observes that financial development is an engine of economic growth, providing better business opportunities for customers and firms. this is proxy by the ratio of domestic credit to the private sector to gdp. this is an indicator of domestic financial development, potentially an important factor in driving international finance. anyanwu (2011) stated that a high level of credit to the private sector is an indication of the abundance of domestic capital. as such, foreign capital in the form of fdi would not be needed as much, hence a negative relationship between private credit and fdi inflows. he further explained that another possible explanation is that such negative relation is another manifestation of the negative relationship that exists between fdi and other types of flows, mainly bank loans. empirical studies such as, shahrudin et al. (2010) who examined the determinants of fdi in malaysia for the period 1970-2008. the causality and dynamic relationships between fdi and its key determinants is identified using autoregressive distributed lag (ardl) framework. the result suggests that among the variables, financial development contribute positively to the inflow of fdi in malaysia. also in the study conducted by dutta and roy (2011) investigated the role of political risk in the association of fdi and financial development using a panel of 97 countries. the regression result showed that the impact of financial development on fdi becomes negative beyond a threshold level of financial development. anyanwu (2011) examined the factors that causes fdi to go to african countries. using ols, results from a panel for the period 1980-2007. the regression result indicated that higher financial development has negative effect on fdi inflows. 2.2.3. economy openness (ecopen) the openness index is an economic metric calculated as the ratio of country’s total trade measured as the sum of exports plus imports, to the country’s gdp (i.e export + imports)/gdp. the effect of economy openness on fdi inflows depends on the type of fdi. when a country receives market-seeking fdi, i.e. when foreign firms aim at serving local market, economy openness may reduce fdi inflows. mijiyawa (2015) argued that multinational firms that seek to service local markets may decide to set up subsidiaries in the host nation when it is hard to import their wares in that country. in contrast, multinational firms that are engaged in export-oriented activities may choose to locate in a more open economy, since trade protectionism may increase transaction costs; thereby, reducing economic competitiveness and exports. thus, the effect of economy openness on fdi inflows is ambiguous. however, the apriori expectation is positive. several authors have found that trade openness is a major determinant of fdi. these studies include: uwubanmwen and ajao (2012); gichamo (2012); enu et al. (2013); blonigen and piger (2014); ndem et al. (2014) and maghori (2014). on the contrary, njogo (2013) found a negative and insignificant impact on fdi in nigeria. while abubakar and abdullahi (2013) found that openness of the economy do not attract fdi in nigeria 2.2.4. gross domestic product (gdp) market size and its growth is regarded as an important determinant of fdi inflows into the host country. apriori expectation is expected to positive. several studies carried out in this area have established a correlation between fdi and the size of the market (proxy by gdp). they include; in malaysia, shahrudin et al. (2010) found out that economic growth contribute positively to fdi inflows. in africa, (gichamo, 2012; sichei and kinyondo, 2012) also found a positive correlation between gdp and fdi. in nigeria, offiong and atsu (2014); ndem et al. (2014), ojong et al. (2015) and danladi and uwaifo (2015) found that economic growth has a positive impact on fdi. on the contrary, oba and onuoha (2013) showed that gdp does not bring about fdi in nigeria. while uwubanmwen and ajao (2012) and njogo (2013) found economic growth had a positive but insignificant impact on fdi 2.2.5. military expenditure (milexp) military expenditure also known as defense budget of a country, is the amount of funds spent on equipping the military in a given year. the apriori expectation is that it negatively impacts fdi because an increase military expenditure most especially in crises prone regions discourages foreign investors from coming into the country for fear of instability. awan et al. (2014) found military expenditure increases, which depicts the foreign disinterest in pakistan fdi inflows. 2.2.6. exchange rate (exr) another factor that determines fdi inflows is the exchange rate which is measured as the official exchange rate to the us dollar annual average. the apriori expectation is that high exchange rate lead to a negative influence on fdi. wafure and abu (2010) argued that, if the exchange rate of a country depreciates, it attracts fdi since foreign firms may merge with or acquire domestic industries. several studies have been conducted in this regards. danladi and uwaifo (2015) examined the impact of the determinants of fdi in nigeria. the study covers the period 1980 to 2013. using vecm, the findings of the study revealed exchange rate have a positive relationship with fdi and exchange rate lag two have a negative relationship with fdi. chakrabarti (2001), dinda (2008), wafure and abu (2010), uwubanmwen and ajao (2012), isah (2012), ndem et al. (2014) found that exchange rate impacts fdi inflows. on the contrary, njogo (2013) found a negative but non-significant impact on fdi. ohazulike (2012) found a positive but insignificant relationship with fdi asian journal of economics and empirical research, 2018, 5(2): 155-164 159 2.2.7. inflation rate (infr) the apriori expectation is negative because high inflation rate affects investment. idowu and awe (2014) noted that fdi into nigeria has been relatively low and not encouraging given the high inflation rate. dinda (2008); uwubanmwen and ajao (2012); maghori (2014) and danladi and uwaifo (2015) found that inflation rate is major determinant of fdi in nigeria. ohazulike (2012) found negative but significant relationship with fdi in nigeria. 2.2.8. interest rate (inr) economic theory posits that fdi is sensitive to domestic interest rate. uwubanmwen and ajao (2012) found that interest rate is a major determinant of fdi in nigeria. danladi and uwaifo (2015) found a negative impact of first and second lag interest rate on fdi inflows. they argued that a stable interest rate is necessary for attracting fdi. 2.2.9. political stability (polsta) according to ogunleye (2014) political instability has to do with the abnormal changing of leaders, government policies, security issues to government and regime type. the stability of political administrative regimes of a nation has great significance to the operations of foreign firms. based on wafure and abu (2010) study, we assign 0 dummy to represent civilian rule while dummy 1 was used to represent military rule. political instability has been noted by a number of researchers to have a negative and statistically significant impact on fdi. it also showed that fdi into nigeria has been relatively low and not encouraging given the high political instability factors. ndem et al. (2014) added that political risk is unfavorable to fdi inflows. wafure and abu (2010) found a significant impact of political instability on fdi 3. methodology this study adopts ex-post facto research design. secondary data were sourced from cbn library covering the period from 1986-2017. the data were first subjected to unit root test to test for stationarity using augmented dickey fuller (adf) test and phillips perron (pp) test in order to avoid spurious regression. thereafter, johansen cointegration test was employed to test the long run relationship among the variables, which informed our decision to use error correction mechanism (ecm). the analysis were carried out using eviews 8.0 3.1. model specification according to gujarati (2004) the ecm which was developed by engle and granger is a means of reconciling the short run behavior of an economic variable with its long run behavior. the model captures the relationship between fdi and the explanatory variables. the ecm equation is given as: δyt = α0 + αi-kδxti + α2ecm + ἑt therefore, the model that captures both the dependent and independent variable is stated below: fdit = β0 + β1gdpt + β2inflrt + β3exrt + β4irt + β5opent + β6fdt + β7gcet + β8polstat + β9met + β10ecmt + εt fdi – denotes foreign direct investment which is measured as annual fdi inflows gdp – denotes gross domestic product measured as real gdp exr – denotes exchange rate which is the official exchange rate to us$ (annual average) ir – denotes interest rate which is the annual interest rate inflr – denotes inflation rate which is measured as the annual inflation rate open – denotes openness which is the sum of export and import as a percentage of gdp fd – which is financial development measured as domestic credit to the private sector as % of gdp gce – denotes government consumption expenditure measured as % of gdp polsta – denotes political instability which captures both military rule and civilian rule. thus, democratic rule=0 and military rule=1 me – denotes military expenditure β1β9 – coefficient of the explanatory variables ε error term 4. discussion of results 4.1. unit root test before estimating the equation, the variables were subjected to stationary tests of time series in order to avoid the problem of spurious regression. if the data series is differenced and it is found to be stationary, then they can be integrated to the order of one or greater, otherwise, a non-stationary series exists. the unit roots test was evaluated using augmented dickey-fuller and phillips and perron (1988) tests which are based on the null hypotheses of non-stationarity and failure to reject the null, implies rejection and the need for appropriate differencing to induce stationarity. asian journal of economics and empirical research, 2018, 5(2): 155-164 160 table-4.1. augmented dickey fuller and phillips perron unit root tests variables adf t-statistics order pp t-statistics order fdi -12.06654*** i(1) -6.949881*** i(1) exr -3143501** i(1) -3.143501** i(1) gce -4.995258*** i(1) -6.885009*** i(1) gdp -5.454176*** i(1) -5.454137*** i(1) inflr -6.722432*** i(1) -6.424541*** i(1) ir -6.280258*** i(1) -6.393089*** i(1) me -7.569897*** i(1) -9.092233*** i(1) open -3.331116* i(1) -6.949881*** i(1) pi -5.477226*** i(1) -5.477891*** i(1) fd -5.447909*** i(1) -8.834956*** i(1) note: ***, ** and * represent significant level at 1%, 5% and 10% mackinnon critical values source: eviews output (2018) table 4.1 shows the stationarity test results which was carried out to test the presence of unit root which was tested at 5% mackinnon critical value. this study employed both adf and pp because, the adf is conducted by augmenting the preceding three equations by adding the lagged values of the dependent variable, the idea being to include enough terms so that the error term is serially uncorrelated. on the other hand, pp test use nonparametric statistical methods to take care of the serial correlation in the error terms without adding lagged difference terms (gujarati, 2004). from our analysis, all variables were found to be stationary at first difference. this outcome therefore inform our decision to conduct a cointegration test. 4.2. cointegration test johansen cointegration was conducted to test the existence of a long run relationship among the variables. prior to that conducting the cointegration test, we first ascertain the optimal lag length criteria for the variables using akaike information criterion (aic), schwarz information criterion (sc) and hannan-quinn information criterion (hq) criteria and it was found that 1 lag is more suitable for our analysis. the result of the johansen cointegration test presented in appendices a, indicates at least 9 cointegration equation. the result therefore, confirms the existence of cointegration among the variables. hence, we can conclude that there exists a long run relationship among variables. 4.3. error correction mechanism (ecm) table-4.2. ecm analysis variables coefficient t-statistics d(fdi(-1)) -2.602120 -2.750874** d(exr) 1.376394 4.535312*** d(exr(-1)) -1.102865 -1.470040 d(gce) 0.002202 0.295150 d(gce(-1)) -0.000714 -0.057711 d(gdp) 0.007346 6.802431*** d(gdp(-1)) 0.002101 2.566541** d(inflr) -0.081347 -0.585461 d(inflr(-1)) 0.002038 0.018091 d(ir) -1.247293 -1.633631 d(ir(-1)) -0.763600 -1.100212 d(me) -4.77e-10 -3.598387*** d(me(-1)) -2.32e-10 -2.505289** d(open) -0.080610 -0.092137 d(open(-1)) 0.450622 0.729162 d(polsta) 77.81528 3.103546*** d(polsta(-1)) -49.68462 -0.880266 d(fd) 4.255127 3.305438*** d(fd(-1)) 0.356056 0.295557 ecm(-1) -2.322095 -2.714946** r2-97.7%, adj. r2-92.7%, f-statistics-19.50537*** note: *** and ** represent significant level at 1% and 5% respectively source: eviews output (2018) having established the cointegrating criteria which was found to be cointegrated. ecm was therefore analysed to measures the speed of adjustment to equilibrium. the ecm is significant, if it has a negative sign which implies that the present value of the dependent variable adjust rapidly to changes in the independent variable. a higher percentage of ecm indicates a feedback of that value or an adjustment of that value from the previous period disequilibrium of the present level of the dependent variable and the present and past level of the independent variables. appendix b shows the result of the ecm which is in line with our a priori expectations. the negative sign of ecm value in the model shows that, the ecm is significant at 5%. this implies that the present value of the independent variables adjust rapidly to changes in fdi. the ecm value of -2.322095 shows a feedback of about 232.2% of the short-run disequilibrium and inconsistencies were being corrected and incorporated into the longrun equilibrium. the coefficient of determination denoted as r2 is 0.977 which implies that 97.7% of the total variations in fdi is accounted for by the explanatory variables: exchange rate, gdp, government consumption expenditure, inflation rate, interest rate, political stability, military expenditure, economy openness and financial development. after asian journal of economics and empirical research, 2018, 5(2): 155-164 161 adjusting the r2, the total variation becomes 92.7%. also, the fitness of the model was tested using the f-statistics which shows that the model is statistically fit as indicated by the significance level of 1%. table 4.2 shows the analysis of the determinants of fdi inflows in nigeria. the analysis shows that fdi lag one negatively influence fdi inflows in nigeria. result also shows that exchange rate has a positive and significant impact on fdi inflows. implying that an increase in exchange rate depreciates local currency and thus attracts more fdi inflow in nigeria. this has been the nigerian experience as the nigerian naira has continued to depreciate over the years and an increase in the volume of fdi inflows. wafure and abu (2010) argued that, if the exchange rate of country depreciates, it attracts fdi since foreign firms may merge with or acquire domestic industries. this findings is contrary to the apriori expectation and the findings of danladi and uwaifo (2015). however, several studies have found a positive impact of exchange rate on fdi inflows (wafure and abu, 2010; isah, 2012; ndem et al., 2014). the first lag of exchange rate was found to be negative but insignificant to fdi inflows. gce was found to be positive but insignificant while the first lag of gce was found to be negative and insignificant. the table shows that gdp and first lag of gdp was positive and significant to fdi inflows in nigeria at 1% and 5% significant level respectively, which is in line with apriori expectations and findings of previous studies (sichei and kinyondo, 2012; ndem et al., 2014; ojong et al., 2015). based on this finding, it can be implied that gdp is a determinant of fdi inflows in nigeria as an increase in gdp also proxy as market size in some literatures signifies that the market is large and still growing and hence attract fdi inflows. also, inflation rate and interest rate had the apriori sign but were found to be insignificant. military expenditure and military expenditure lag one were found to have negative and significant impact of fdi inflows in nigeria at 1% and 5% level of significant respectively. awan et al. (2014) argued that as military expenditure increases, fdi decreases as a result of foreign disinterest in a nation plague with insecurity challenges. this has been the nigerian experience, with cases of various levels of insecurity ranging from niger delta militancy activities (kidnapping of expatriates, bombing of pipelines etc) and boko haram (bombing of towns and villages and invasion in north eastern part of nigeria) and various forms of insecurity in other parts of the country. this has sent a negative signal to the international community about the security level in nigeria and consequently, discourages foreign investors from entering the market. this findings is supported by the fact that billions of dollars have been invested in equipping the military to combat these insecurity. the result shows that economy openness is insignificant to fdi inflow in nigeria which is against our apriori expectation. however, various studies such as uwubanmwen and ajao (2012); gichamo (2012); enu et al. (2013); blonigen and piger (2014); ndem et al. (2014); maghori (2014) found positive impact of openness on fdi inflows. the table also shows the result of political stability which has a positive and significant impact on fdi inflow at 1%. political instability makes government policies unstable and unpredictable, thereby discouraging foreign investors. impliedly, since 1999, nigeria have experience uninterrupted democratic rules coupled with distinctive investment policies to drive the economy and attract fdi. lastly, financial development positively and significantly impacts fdi inflows in nigeria at 1% level of significance. impliedly, kinda (2010) observed that financial development is an engine of economic growth, providing better business opportunities for firms and an important factor in driving international finance. 4.4. diagnostic tests in order to avoid spurious regression analysis, the residuals of the regression result were subjected to various diagnostic checks such as normality test, serial correlation and hetteroskedasticity test. 4.4.1. normality test in order to test whether the residuals of the ecm regression model was normally distributed, jarque-bera test statistic was employed. the test statistic measures the difference of the skewness and kurtosis of the series with those from the normal distribution. the result shows that the jarque-bera value is not significant at 1%, 5% and 10% significant level resulting in the failure to reject the null hypotheses which states that our model is normally distributed. thus, result from the jarque-bera test revealed that our model is normally distributed. (see appendix b). 4.4.2. serial correlation test the residuals of the regression equation were tested for serial correlation using the breusch godfrey serial correlation lm test. the null hypothesis was tested which stated that there is no serial correlation. this was necessary because, serial correlation in the residuals will lead to incorrect estimates of the standard errors, and invalid statistical inference for the coefficients of the equation. from our analysis, the null hypothesis for our regression models was accepted, which states that there was no serial correlation. (see appendix c). 4.4.3. heteroskedasticity test one of the statistical assumptions of ols is that the error terms for all observations have a common variance (homoscedastic). on the contrary, varying variance errors are said to be heteroskedastic. the heteroskedasticity was tested in the residuals of the estimations using the breusch-pagan-godfrey test. ignoring the heteroskedasticity effect on the residuals of time series may result in the loss of efficiency of the estimators. the null hypothesis was stated as there is no heteroskedasticity. from our analysis, the models had no heteroskedasticity. hence, we could not find reasons to reject the null hypotheses because they were insignificant at 1%, 5% and 10%. (see appendix d). 5. conclusion and policy recommendations the importance of fdi inflows to the nigerian economy coupled with the security concerns which has increased military budget, and the continues uninterrupted democratic dispensation in nigeria informed this study to investigate the effect of the determinants of fdi inflows in nigeria spanning over the period 1986 – 2017. ecm model was specified and estimated to analyse the data. the variables were first subject to unit root test using adf and pp. result showed that all variables were found to be i(1). thereafter, the long run relationship was tested asian journal of economics and empirical research, 2018, 5(2): 155-164 162 using johansen cointegration test which established the existence of a long run relationship between the variables. ecm analysis was performed and the findings revealed that the speed of adjustment to its long run equilibrium was corrected at 232%. the result showed that exchange rate, gdp, first lag of gdp, military expenditure, first lag of military expenditure, political stability and financial development are the major determinants of fdi inflows to nigeria. the residuals of the analysis were further subjected to various diagnostic tests such as jarque-bera test of normality. bruesch-godfrey test of serial correlation which shows that the variables have no problem of serial correlation, breusch-pagan-godfrey test of heteroskedasticity shows that there was no heteroskedasticity in the variables. based on the findings; the following recommendations are put forward: i. the positive impact of gdp implies that gdp is a determinant of fdi inflows. hence, the federal government through its ministries and agencies should strengthen the investment policy to collaborate with both multi national cooperation’s and local industries to enable free flow of investment in order to boost the economy. ii. military expenditure was found to be negatively significant to fdi inflows. this is as a result of growing insecurity across the country. therefore, government at all levels should tackle the menace of insecurity ravaging the economy and portraying the country as insecure thereby creating a secured environment for fdi inflows. iii. political stability was found to be positively significant. therefore, democratic regimes should be sustained and investment policies should be instituted or improved on, in order to create a friendly environment to attract more fdi inflows. iv. financial development is an important determinant of fdi. thus, the federal government should improve the quality of domestic financial system by integrating them into global financial markets to make the economy more attractive to foreign investors. v. given the positive impact of exchange rate of fdi inflows, government through its monetary authority should ensure a stronger and stable nigeria naira against the us dollar. this would encourage foreign investors into the country knowing fully well they can invest 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bank report, 2003. sustainable development in a dynamic world. appendices appendix a: error correction mechanism analysis dependent variable: fdi method: least squares date: 07/09/18 time: 10:20 sample (adjusted): 1988 2017 included observations: 30 after adjustments variable coefficient std. error t-statistic prob. c 15.32034 3.912690 3.915553 0.0035 d(fdi(-1)) -2.602120 0.945925 -2.750874 0.0224 d(exr) 1.376394 0.303484 4.535312 0.0014 d(exr(-1)) -1.102865 0.750228 -1.470040 0.1756 d(gce) 0.002202 0.007459 0.295150 0.7746 d(gce(-1)) -0.000714 0.012367 -0.057711 0.9552 d(gdp) 0.007346 0.001080 6.802431 0.0001 d(gdp(-1)) 0.002101 0.000819 2.566541 0.0304 d(inflr) -0.081347 0.138945 -0.585461 0.5726 d(inflr(-1)) 0.002038 0.112651 0.018091 0.9860 d(ir) -1.247293 0.763510 -1.633631 0.1368 d(ir(-1)) -0.763600 0.694048 -1.100212 0.2998 d(me) -4.77e-10 1.32e-10 -3.598387 0.0058 d(me(-1)) -2.32e-10 9.27e-11 -2.505289 0.0336 d(open) -0.080610 0.874895 -0.092137 0.9286 d(open(-1)) 0.450622 0.618000 0.729162 0.4844 d(polsta) 77.81528 25.07302 3.103546 0.0126 d(polsta(-1)) -49.68462 56.44271 -0.880266 0.4016 d(fd) 4.255127 1.287311 3.305438 0.0092 d(fd(-1)) 0.356056 1.204695 0.295557 0.7743 ecm(-1) -2.322095 0.855301 -2.714946 0.0238 r-squared 0.977452 mean dependent var 34.36000 adjusted r-squared 0.927346 s.d. dependent var 29.08445 s.e. of regression 7.839555 akaike info criterion 7.152269 sum squared resid 553.1277 schwarz criterion 8.133107 log likelihood -86.28403 hannan-quinn criter. 7.466047 f-statistic 19.50753 durbin-watson stat 2.057702 prob(f-statistic) 0.000040 http://dx.doi.org/10.5539/ijbm.v7n24p67 asian journal of economics and empirical research, 2018, 5(2): 155-164 164 appendix-b. jarque-bera test of normality 0 1 2 3 4 5 6 7 8 -7.5 -5.0 -2.5 0.0 2.5 5.0 7.5 10.0 12.5 series: residuals sample 1988 2017 observations 30 mean 4.59e-15 median -0.501561 maximum 11.32549 minimum -6.640895 std. dev. 4.367307 skewness 0.647505 kurtosis 2.968313 jarque-bera 2.097567 probability 0.350364 appendix c: breusch-godfrey serial correlation lm test: f-statistic 0.351771 prob. f(2,7) 0.7152 obs*r-squared 2.739810 prob. chi-square(2) 0.2541 appendix d: heteroskedasticity test: breusch-pagan-godfrey f-statistic 0.559732 prob. f(20,9) 0.8659 obs*r-squared 16.63011 prob. chi-square(20) 0.6768 scaled explained ss 1.472997 prob. chi-square(20) 1.0000 asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 15 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 1, 15-24, 2020 issn(e) 2409-2622/ issn(p) 2518-010x doi: 10.20448/journal.501.2020.71.15.24 © 2020 by the authors; licensee asian online journal publishing group nexus between foreign remittances and economic growth in nigeria: role of the financial sector kassey p. garba1 wasiu adekunle2 oluwatosin adeniyi3 ( corresponding author) 1professor at the department of economics, university of ibadan, nigeria. 2research analyst at the nigerian economic summit group (nesg), lagos, nigeria. 3senior lecturer (ph.d.) at the department of economics, university of ibadan, nigeria. abstract in recent times, the economic growth literature is becoming more interested in the macroeconomic impacts of foreign remittances. this focus could be because foreign remittances now constitute the largest source of foreign capital flows for developing countries next to foreign direct investment (fdi). to this end, the present study analyzed the possible role of the financial sector in the nexus between foreign remittances and economic growth in nigeria over the period of 1981 to 2015. to circumvent the possible endogeneity problem among foreign remittances, financial development and economic growth, we employed the two-stage least squares (2sls) technique. unlike the previous findings, we offered new evidence that the complementarity or substitutability between foreign remittances and financial development in promoting nigeria’s economic growth depends on the indicators of financial development used. we confirmed the complementary hypothesis in the case of the quantitative indicators of financial development, while we validated the substitutability hypothesis in favour of its qualitative measure. both migrant workers and their beneficiaries should be encouraged to make use of banks so that foreign remittances could be made available to finance genuine investments. this could be possibly achieved through boosting the confidence of migrant workers in the domestic financial system and by raising the deposit rate so as to entice the beneficiaries to save a large chunk of remittances received. keywords: foreign remittances, financial sector, economic growth, complementarity, substitutability, two-stage least squares. jel classification: c26; e22; f21; o23. citation | kassey p. garba; wasiu adekunle; oluwatosin adeniyi (2020). nexus between foreign remittances and economic growth in nigeria: role of the financial sector. asian journal of economics and empirical research, 7(1): 15-24. history: received: 14 november 2019 revised: 18 december 2019 accepted: 22 january 2020 published: 24 february 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 16 2. empirical literature review ......................................................................................................................................................... 17 3. methodological approach and data ............................................................................................................................................ 17 4. empirical results and discussions ............................................................................................................................................... 20 5. conclusion ......................................................................................................................................................................................... 22 references .............................................................................................................................................................................................. 23 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.71.15.24&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1350 https://orcid.org/0000-0002-2848-5391 https://orcid.org/0000-0003-4968-3642 https://orcid.org/0000-0001-6033-7869 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1350 https://orcid.org/0000-0002-2848-5391 https://orcid.org/0000-0003-4968-3642 https://orcid.org/0000-0001-6033-7869 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1350 https://orcid.org/0000-0002-2848-5391 https://orcid.org/0000-0003-4968-3642 https://orcid.org/0000-0001-6033-7869 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1350 https://orcid.org/0000-0002-2848-5391 https://orcid.org/0000-0003-4968-3642 https://orcid.org/0000-0001-6033-7869 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1350 https://orcid.org/0000-0002-2848-5391 https://orcid.org/0000-0003-4968-3642 https://orcid.org/0000-0001-6033-7869 asian journal of economics and empirical research, 2020, 7(1): 15-24 16 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature: this study investigates whether the domestic financial sector and foreign remittances could be described as complements or substitutes in advancing economic growth in nigeria. 1. introduction the growing debates over the sources of economic growth of developing countries have taken the centre-stage of the economics literature for more than half a century ago.1 the sources of economic growth that have been identified include labour force, physical capital investment, foreign capital flows, human capital, as well as, research and development (r&d). institutional factors ranging from political freedom, political instability to voice and accountability have also been argued to play key roles in the growth and development of a country (fayissa and nsiah, 2010). in recent times, the economic growth literature is becoming more interested in the macroeconomic impacts of foreign remittances. this focus could be because remittances now constitute the largest source of foreign capital flows for developing countries next to foreign direct investment (fdi) as it currently represents almost double foreign aid receipts of developing countries (see, for instance, (giuliano and ruiz-arranz, 2009; bettin and zazzaro, 2011)). there have been efforts made by past authors towards analyzing the possible linkage between remittances and economic growth through various channels including consumption, investment, financial sector, institutions, and human capital2. the first attempt to quantify the impact of foreign remittances on economic growth depending on the complementarity or substitutability between foreign remittances and financial sector development is attributed to giuliano and ruiz-arranz (2009). according to the authors, since foreign remittances are largely spent on consumption, the spill-over effect on the long-term growth are more likely to be minimal. therefore, a possible linkage between remittances and growth is the level of financial development in the recipient country. apart from easing the liquidity constraints and improving the access to credit for the migrant’s relatives, remittance inflows, if effectively intermediated, should permit the funding of growth-enhancing projects by financially constrained entrepreneurs. this implies a complementary relationship between remittances and financial development in promoting growth (bettin and zazzaro, 2011). however, giuliano and ruiz-arranz (2009) argued that foreign remittances could become a substitute for inefficient or nonexistent credit markets by allowing local entrepreneurs bypass the high transaction costs usually associated with collateral security requirement. meanwhile, informal money transfers are attractive to many immigrants since they are easily accessible, do not require proof of identity, cheap to access, and are reliable as the migrant’s friends and relatives are involved. this has the consequence of reducing drastically the portion of remittances intermediated via formal channels, majorly banks (nyamongo et al., 2012). in sub-saharan africa, nigeria was the highest recipient of foreign remittances in 2009 followed by sudan and kenya. nigeria received an average of $3.23 billion per annum over the period of 1980 to 2009 (nyamongo et al., 2012). this trend is indicative of the high level of emigration in nigeria. the increasing number of emigrants are partly due to rising population size, as well as, political upheavals that have threatened the socio-economic stability of the country since independence (nyamongo et al., 2012). beyond these two factors, yet another important “push factor” has been economic migration, that is, the so-called search for greener pastures. coincidentally, nigeria’s financial sector remains largely shallow and underdeveloped despite the various financial reforms that have been instituted over time, starting with the structural adjustment programme (sap) in july, 19863. in light of the aforementioned, the current study, therefore, makes an attempt to analyze the complementarity or substitutability between foreign remittances and financial development in economic growth with respect to nigeria. specifically, the two key questions addressed in this study are: (i) do foreign remittances have a significant impact on growth in nigeria? (ii) does the financial sector development have a role to play in the linkage between remittances and growth? having acknowledged the existing literature on the current subject matter, this study offers the following innovations. first, it represents a pioneer attempt to investigate the role of the financial sector in the nexus between foreign remittances and economic growth in the nigerian context4. second, this study differs from previous studies by employing both quantitative and qualitative measures of financial development, which represent the volume and efficiency indicators of financial development (oyinlola and adedeji, 2017). since official remittances flow into the country through banks, only banking development indicators would be employed. third, to differ from the existing literature, this study resolves the possible endogeneity bias that might exist among remittances, finance and growth by employing an instrumental variable (iv) estimation technique known as the two-stage least squares.5 the remainder of the study is structured as follows. section two contains the empirical literature review. methodological approach and data constitute the discussions in section three. section four discusses empirical results, while section five concludes. 1see, for instance, solow (1956), cheneryand strout, (1966), romer (1986) and lucas (1988) among others. 2see, for instance, jongawanich (2007), ramirez and sharma, (2008), barajas, chami, fullenkamp, gapen and montiel, (2009), catrinescu,. leon-ledesma, piracha and quillin, (2009), giuliano and ruiz-arranz, (2009), bettin and zazzaro, (2011), nyamongo, misati, kipyegon and ndirangu, (2012), barguellil and zaiem, (2013), chia (2014), tung (2015) and el hama (2016) to mention a few. 3see ogujiuba and obiechina, (2011), umejiaku (2011) and ikeora, igbodika and andabai, (2016) for a review of financial sector reforms in nigeria since 1986. 4for the nigerian economy, there is a vast literature covering finance-growth nexus (see, for example, adelakun (2010); balago (2014), dandume (2014), ogwumike and salisu, (2012), adeniyi, oyinlola, omisakin and egwaikhide, (2015) remittances-finance nexus (see, for example, oke (2011), kayode and adeleye, (2016) and remittances-growth nexus (see, for example, odionye and emerole, (2015). 5they include, among others, the studies by adelakun (2010), oke (2011), motelle (2011), balago (2014), chia (2014), odionye and emerole, (2015) and tung (2015). asian journal of economics and empirical research, 2020, 7(1): 15-24 17 © 2020 by the authors; licensee asian online journal publishing group 2. empirical literature review this section entails a review of four strands of the empirical literature concerning the direct and indirect relationships among foreign remittances, financial development and economic growth. 2.1. remittances-finance nexus aggarwal et al. (2011) reported a positive impact of remittances on financial development in the case of 109 developing countries between 1975 and 2007. other authors that have confirmed the positive linkage between remittances and financial development include (chowdhury, 2011) for bangladesh over the period of 1971 to 2008; oke (2011) in the nigerian context for the period of 1997 and 2009; ojapinwa and bashorun (2014) for 32 subsaharan african (ssa) countries between 1996 and 2010, and shahzad et al. (2014) in the context of south asia over the period of 1989 to 2011. in terms of causality between remittances and finance, there were mixed results. for instance, chowdhury (2011) established unidirectional causality from remittances to financial development in the case of bangladesh, whereas (akkoyunlu, 2013) found no evidence of causality between remittances and finance for the turkish economy. 2.2. finance-growth nexus allen and ndikumana (1998) found that liquid liabilities have a positive effect on growth, whereas less conclusive results were generated in favour of other indicators of financial development, namely, credit to private sector and credit by banks, in the case of sadc region between 1970 and 1996. subsequently, a number of authors have established a positive impact of finance on growth irrespective of the indicators of financial development used. they include, among others, adelakun (2010) for the nigerian economy between 1980 and 2008; agbélénko and kibet (2015) for the waemu region between 1981 and 2010, and oyinlola and adedeji (2017) for 19 countries in sub-saharan africa over the period of 1999 to 2014. the literature also suggests unidirectional causality from financial development to growth (examples include, balago (2014) for the nigerian economy and agbélénko and kibet (2015) in their study of the 9 francophone west african countries). 2.3. remittances-growth nexus a number of studies have established a significant and positive impact of foreign remittances on economic growth irrespective of specifications used. for instance, vargas-silva et al. (2009) reported that remittances had a positive effect on real gross domestic product per capita growth in the case of 20 asian countries between 1988 and 2007. other studies that have confirmed the positive relationship between foreign remittances and economic growth include, among others, ahortor and adenutsi (2009) in the case of 31 small open economies across africa, latin america and the caribbean between 1996 and 2006; fayissa and nsiah (2010) for 36 african counties over the period of 1980 to 2004; odionye and emerole (2015) in the nigerian context for the period of 1981 to 2011, and meyer and shera (2017) for 6 high remittances receiving countries between 1999 and 2013.6 similarly, catrinescu et al. (2009) reported that remittances had positive and significant effects on growth across the specifications considered. however, barajas et al. (2009) found no positive impact of remittances on long-term growth, and, as such, the authors established a negative relationship for 80 countries over the period of 1970 to 2004. 2.4. remittances-growth nexus: the role of finance the literature is mixed about the potency of finance in enhancing or dampening the growth effects of remittances. for instance, some authors found that finance magnifies the role of remittances in promoting growth thereby lending empirical support to the complementarity hypothesis. for instance, mundaca (2009) reported that remittances had significant positive impact on growth in the long run, while financial intermediation helped to magnify the growth effects of remittances in their study of 25 latin american and the caribbean (lac) countries between 1970 and 2002. other authors that have confirmed the complementarity hypothesis include, among others, bettin and zazzaro (2011) in the case of 66 developing countries between 1970 and 2005; nyamongo et al. (2012) for 36 african countries over the period from 1980 to 2009; chia (2014) for malaysian economy for the period 1984 to 2013, and el hama (2016) in relation to 12 mena countries between 1984 and 2012. however, other authors found remittances and finance as substitutes in promoting growth. for instance, ramirez and sharma (2008) revealed that although foreign remittances had a positive effect on economic growth, both remittances and financial development acted as substitutes in promoting growth. other authors that have confirmed the substitutability hypothesis, include, giuliano and ruiz-arranz (2009) which covered 100 developing countries within the period of 1975 to 2002, and tung (2015) for the vietnamese economy between 1996 and 2012. in addition, a large quantum of the empirical literature reviewed above, with the exception of bettin and zazzaro (2011) and oyinlola and adedeji (2017) utilized only the quantitative measures of financial development. this study attempts to fill this gap. similarly, endogeneity bias that could exist among foreign remittances, financial development and economic growth has not been properly resolved in previous country-specific studies. the present study would also address this important issue. 3. methodological approach and data in order to resolve the possible endogeneity bias among foreign remittances, financial development and economic growth, the study finds it appropriate to employ the two-stage least squares (2sls) technique. this study follows the routine procedures involved in time-series analysis ranging from unit root test, cointegration test to model estimation and post-estimation tests. these steps and data issues are discussed in turn following model specification. 6the list of sampled countries included albania, bulgaria, macedonia, moldova, romania and bosnia herzegovina. asian journal of economics and empirical research, 2020, 7(1): 15-24 18 © 2020 by the authors; licensee asian online journal publishing group 3.1. model specification the present study adapts the dynamic model of giuliano and ruiz-arranz (2009) to analyze possible complementarity and/or substitutability linkage between foreign remittances and financial development in promoting nigeria’s economic growth. the empirical model is stated as follows: (1) (2) equation 1 implies that economic growth is a function of foreign remittances and financial sector development. equation 2 identifies four indicators of financial sector development; where, is the natural log of real gross domestic product in the current period, and is the natural log of real gross domestic product in the previous period, such that indicates time period; is the remittance inflows (% of gdp); is a vector of quantitative and qualitative indicators of financial development. the quantitative indicators (which measure the volume of financial development) include bank deposit, % of gdp ( ), liquid liabilities, % of gdp ( ), and domestic credit to private sector, % of gdp ( ), whereas the only qualitative indicator (which measures the efficiency of financial development) is interest rate spread ( ), that is defined as the difference between lending rate and deposit rate. ) is a term involving the interaction between remittance inflows and indicators of financial development. it is included to capture the role of financial development in the relationship between foreign remittance inflows and economic growth. in this study, the control variables, including, gross fixed capital formation, government final consumption expenditure, and trade openness are used as part of the instruments to control for possible endogeneity problem, and they are not stated explicitly as part of the explanatory variables. while , , , are regression coefficients, is a stochastic disturbance term. 3.2. a priori expectations , , or . if , then foreign remittance inflows and financial development have complementary role in promoting growth). if , then foreign remittance inflows and financial development are substitutes in promoting growth). 3.3. unit root tests 3.3.1. the adf unit root test following dickey and fuller (1979) a random walk process may have no drift (or intercept), or it may have a drift, or it may have both deterministic and stochastic trends (gujarati and porter, 2009). to allow for these variants, dickey and fuller started by specifying the general test regression (the model that includes both the deterministic and stochastic trends), and then obtain the other two possibilities by restricting some parameters. the general test regression is + (3) equation 3 implies that yt is a random walk with drift (or intercept) and deterministic time trend restricting = 0 gives + (4) equation 4 implies that yt is a random walk with drift only also, restricting = = 0 gives + (5) equation 5 implies that yt is a random walk without drift and time trend to take care of possible serial correlation in the errors (εt), dickey and fuller developed another test called the augmented dickey-fuller (adf) test. this test augments the general dickey-fuller test regression above (that is, eq. 3) by including the lagged difference term(s) of the variable in question (in this case yt) and then restricting the intercept coefficient and the coefficient on time trend to zero to obtain the other possibilities. the general test regression (that is, equation 3) now becomes + (6) equation 6 augments equation 3 above with the lagged difference terms of yt so as to correct for possible serial correlation inherent in the variable yt. the number of lagged difference terms (in this case m) included in the test regression can be determined using information criteria, such as, schwartz information criterion (sic) and akaike information criterion (aic) until the errors become white noise (that is, the errors having constant mean and variance, and being uncorrelated with one another). the null and the alternative hypotheses being tested are, respectively h0: δ = 0 (y is non-stationary or contains a unit root) (7) h1: δ < 0 (y is stationary or does not contain a unit root) (8) the rejection of equation 7 implies that equation 8 is valid, otherwise we will not reject the validity of the former. the null hypothesis is tested against its alternative using the conventional t-ratio for , stated as ̂ ̂ ⁄ . (9) equation 9 is the student’s t statistic which is computed as the ratio of the estimated coefficient to its standard error. asian journal of economics and empirical research, 2020, 7(1): 15-24 19 © 2020 by the authors; licensee asian online journal publishing group 3.3.2. the phillips-perron (pp) test phillips and perron (1988) proposed an alternative (nonparametric) method of controlling for serial correlation when testing for a unit root. the pp method estimates the non-augmented df test equation (that is, equation 3), and then modifies the t-ratio of the autoregressive coefficient δ so that serial correlation does not affect the asymptotic distribution of the test statistic. the pp test is based on the test statistic stated as ̂ ⁄ ̂ ⁄ (10) equation 10 is the modified t-ratio which is the difference between the unadjusted t-ratio (as in equation 9) and the second term [ ̂ ⁄ ] that accounts for possible serial correlation; an approach that can be described as non-parametric, unlike the adf test which adopts a parametric approach, represented by the fourth term in equation 6 above. ̂ is the estimated autoregressive coefficient, is the t-ratio of , ̂ is the coefficient standard error, and is the standard error of the test regression. also, is a consistent estimate of the error variance calculated as ⁄ , where is the number of regressors, while is an estimator of the residual spectrum at frequency zero. 3.4. the ardl bounds cointegration test traditional approaches to testing for the existence of long-run relationships, such as, engle-granger and johansen cointegration methods require all variables to be strictly i(1). in order to accommodate variables with different orders of integration, pesaran et al. (2001) developed the autoregressive distributed lag (ardl) model. it has the advantage that variables in a cointegrating relationship can be either i(0), i(1) or a combination of both. an autoregressive distributed lag (ardl) is a least squares regression that contains lags of the dependent variable (called the autoregressive terms) and of the explanatory variable(s) (called the distributed lag terms). ardl models are usually denoted in notational terms as ardl ( , ,..., ), where is the number of lags for the dependent variable, is the number of lags for the first explanatory variable, is the number of lags of the explanatory variable, and is the number of explanatory variables ( ..., ). for simplicity sake, this study adopts the ardl (1, 1) subsequently. following pesaran et al. (2001) the general ardl specification is: ardl ( , ,..., ): (11) equation 11 is an ardl model which include number of lags for the dependent variable ( ) and number of lags for the independent variables ( ); while the minimum number of lags for the former is one, that of the latter is zero. in the current case, we will consider ardl (1, 1), where = 1, = 1 and where (0, 1) ardl (1, 1): (12) equation 12 is an autoregressive distributed lag model with one lag term for each of the dependent and independent variables. using the information that: and (13)a equation 13a implies that the first order difference of a variable is the difference between its values in two adjacent time periods. and (13)b equation 13b is an alternative way of expressing equation 13a. substitute for and in equation 12 gives. (14) collect like terms and express as a function of in difference form: (15) equation 15 is the basic error correction model, with the first three terms constituting the error correction term (ect), in line with the specification of the initial originators of the ardl model (that is, pesaran et al. (2001)). equation 15 can be re-written as: (16) equation 16 is an alternative way of expressing equation 15 by factoring out the term . by letting (17) equation 17 shows a composite parameter that involves three other parameters ( , and ) replacing equation 17 in equation 16, the error correction model version of equation 12 becomes (18) equation 18 is the abridged version of equation 15, where (19) equation 19 shows that the error correction term is the residual (or estimated error term) that is generated from the long-run segment of the ardl model that relates with [since equation 19 can be re-written as = ]; where is the error correction term and its coefficient ( ) is the rate of adjustment of the dependent variable from its short-run disequilibrium to its long-run equilibrium value following a shock to the asian journal of economics and empirical research, 2020, 7(1): 15-24 20 © 2020 by the authors; licensee asian online journal publishing group explanatory variable at period which is now corrected at period . the a priori expectation is that the coefficient is expected to be negative and statistically significant for and to be cointegrated. the null and the alternative hypotheses are: h0: (there is no cointegration or no long-run relationship between and ). (20) h1: ≠ 0 (there is cointegration or long-run relationship between and ). (21) 3.5. the two-stage least squares technique one of the assumptions of the classical linear regression model (clrm) states that the error term of an equation should be uncorrelated with each of the explanatory variables in the equation. if such a correlation exists, then the ordinary least squares (ols) regression is biased. to avoid what is called “simultaneity bias”, alternative estimation techniques would be explored depending on whether or not an equation in the system of equations is exactly identified or is overidentified. in general, in cases of exact identification, the appropriate technique is the method of “indirect least squares (ils)”, while in cases of overidentified equations, the “two-stage least squares (2sls)” method is the most commonly used (asteriou and hall, 2007). following gujarati and porter (2009) the two-stage least squares (2sls) method is usually preferred over the indirect least squares (ils) method for the following reasons: (1) the 2sls can be applied to an individual equation in the system without directly taking into account any other equation(s) in the system. hence, for solving econometric models involving a large number of equation, 2sls offers an economical method. (2) unlike ils, which provides multiple estimates of parameters in the overidentified equations, 2sls provides only one estimate per parameter. (3) although specially designed to handle overidentified equations, the 2sls method can also be applied to exactly identified equations. in this case, ils and 2sls will give identical estimates. owing to the reasons stated above, the two-stage least squares (2sls) technique is employed in this study. the estimation procedure involves two stages as follows: stage 1: regress each endogenous variable (say, ) which is a regressor as well, on all of the endogenous and lagged endogenous variables in the entire system by using simple ols and obtain the fitted values of the endogenous variables of these regressions; stage 2: use the fitted values from values from stage 1 as proxies or instruments for the endogenous regressors in the original (structural form) equations. the instruments are variables that are stochastic and independently distributed of the error term. one requirement is that the coefficients of determination (r-squared) of the estimated equations in stage 1 should be relatively high. this is in order to ensure that the fitted (that is, ̂) and the actual are highly correlated so as to justify ̂ as a good instrument for (asteriou and hall, 2007). 3.6. data scope and sources the present study employs annual data series on the nigerian economy covering the period from 1981 to 2015 collected from different sources. the data on real gross domestic product, gross fixed capital formation, government final consumption expenditure, trade openness, and interest rate spread were obtained from the world bank’s (word development indicators (wdi), 2017) whereas the data on remittance inflows and other financial development indicators (bank deposits, liquid liabilities, and domestic credit to private sector, all expressed as percentages of gdp) were collected from the financial structure dataset as updated by beck et al. (2015) in september, 2015. 4. empirical results and discussions here, the results of empirical analysis ranging from preliminary analysis (covering descriptive statistics, unit root test and cointegration test) to regression results are reported. 4.1. preliminary analysis 4.1.1. descriptive statistics table 1 presents the summary statistics on the main variables used in this study over the period of 1981 to 2015. the average value of real gdp is n210 billion. other variables including remittance inflows (%), bank deposits (% of gdp), liquid liabilities (% of gdp), domestic credit to private sector (% of gdp), and interest rate spread have their respective means as 3.49%, 17.42%, 23.43%, 14.31%, and 6.14 percentage points. the nigerian financial sector is highly liquid with liquid liabilities having the highest mean value among the financial development indicators used. in terms of volatility as measured by the coefficient of variation of each variable, remittance inflows appear to be highly volatile with the highest coefficient of 105.59%, whereas the least volatile series is liquid liabilities with the lowest coefficient of 28.89%. in terms of the shape of the probability density of each variable as accounted for by jarque-bera statistic, liquid liabilities and interest rate spread are found to follow normal distribution, while other variables do not. table-1. summary of descriptive statistics variable obs. mean/average standard deviation coefficient of variation (%) jarque-bera stat 35 210,000,000,000 115,000,000,000 54.7619 6.0362[0.0489] 35 3.4982 3.6938 105.5914 7.7679[0.0206] 35 17.4153 5.4808 31.4712 7.5431[0.0230] 35 23.4278 6.7696 28.8956 3.9569[0.1383] 35 14.3137 5.3519 37.3901 95.889[0.0000] 35 6.1416 2.8549 46.4846 1.6958[0.4283] asian journal of economics and empirical research, 2020, 7(1): 15-24 21 © 2020 by the authors; licensee asian online journal publishing group the non-normality of the majority of the series is an indication of the increasing variance of each variable over time. there is, therefore, the need to examine the unit root and cointegration properties in the variables so as to avoid the estimation of a spurious regression in the final analysis. the subsequent sections are devoted to addressing these issues one after the other. 4.1.2. results of unit root tests the results of adf and phillips-perron unit root tests are self-reinforcing (see table 2). it is observed that only test regressions that are close to rejecting the null hypothesis of nonstationarity are reported. accordingly, while domestic credit to private credit appears to be stationary at level and therefore requires no differencing, all other variables achieved stationarity after first differencing, and results are robust to the choice of unit root test approaches used. table-2. results of unit root tests. variable adf test phillips-perron test order of integration level 1st difference level 1st difference -2.0679a -4.9122a*** -2.0667a -4.8611a*** i(1) -2.5067a -6.1471a*** -2.5721a -6.2969a*** i(1) -2.5019b -5.7185b*** -2.4214b -6.9583b*** i(1) -2.6957a -5.9501a*** -2.3236b -7.9462b*** i(1) -2.6367b* …………….. -2.6367b* …………….. i(0) -2.6528a -5.9659a*** -2.6348a -12.4971a*** i(1) note: ***, **, and * indicate the rejection of the null hypothesis of a unit root at 1%, 5% and 10% significant levels, respectively; i(d) is the order of integration and it refers to the number of differencing required for a series to become stationary; †implies that a series that is stationary at levels and does not require reporting its first difference; superscripts “a”, “b” and “c” denote models with intercept and trend, with intercept only and with none, respectively. 4.1.3. result of ardl bounds test for cointegration the bounds cointegration test becomes appropriate for the reason that this study employed variables with different orders of integration, namely i(0) and i(1) series. since four indicators of financial development are involved, results of cointegration test based on a total of four models are reported in table 3. models i, ii, iii and iv capture, respectively, indicators including, bank deposits, liquid liabilities, domestic credit to private sector and interest rate spread. it can be observed that irrespective of the financial development indicators used, there exists no long-run relationship between real gdp and its determinants, namely, remittance inflows and financial development indicators as the f-statistic associated with each model is below the lower critical bound (i(0)) at the 10% significance level. table-3. result of bounds cointegration test. model i model ii model iii model iv f-statistic 1.5783 1.8966 1.3357 1.8352 critical values significance i(0) bound i(1) bound 10% 2.72 3.77 5% 3.23 4.35 2.5% 3.69 4.89 1% 4.29 5.61 4.1.4. the regression results having established the absence of a long-run relationship between foreign remittances and economic growth irrespective of the indicators of financial development used, the study focuses mainly on the short-run ardl estimates (similar to equation 11 above). table 4 presents the two-stage least squares estimates of remittancesgrowth nexus for each of the four financial development indicators employed. irrespective of the financial development indicator used, there is a one-to-one positive association between the current value of real gdp and its previous value, and the autoregressive coefficients in all cases are statistically significant at 1% level of significance. this implies that the dynamics of determination of real gdp in nigeria follows adaptive expectation. across the four specifications but one, remittance inflows exert negative effects7 on real gdp. in model i, a 1 percentage point increase in remittance inflows tend to generate a decline in real gdp by 4.4% on average keeping other variables constant. in model ii, remittance inflows have the potential to reduce real gdp by 3.9%, and in model iii, by 5.5%. in the first three specifications, the coefficients on remittance inflows are individually significant at 1% level of significance. however, in model iv, 1 percentage point increase in remittance inflows could generate an increase in real gdp by 5.6% on average keeping other explanatory variables constant. the impact coefficient is however not statistically significant at the 10% level. across the first three specifications, financial development measured by bank deposits, liquid liabilities, and domestic credit to private sector, respectively are found to dampen8 real gdp growth. every 1 percentage point increase in bank deposit leads on average to a 1.5% decline in real gdp keeping other variables constant; liquid liabilities cause a much smaller decline of 0.9%, and domestic credit to private sector leads to a decline in real gdp of 2.7% on average. these results reflect the shallow nature of nigeria’s financial sector in its financial intermediation role between the surplus (savers) and deficit (investors) units in the economy. however, a 1 percentage point increase in interest rate spread leads to a rise in real gdp by 2.3% on average keeping other explanatory variables constant. while the impact coefficients on the volume of finance (bank deposits, liquid 7this result complements the findings of barajas, chami, fullenkamp, gapen and montiel, (2009) but is in contrast to the findings of odionye and emerole, (2015). 8result contrasts with the findings of adelakun (2010). asian journal of economics and empirical research, 2020, 7(1): 15-24 22 © 2020 by the authors; licensee asian online journal publishing group liabilities, and domestic credit to private sector) are statistically significant at the 5% level, the impact coefficient on the efficiency of finance, proxied by the interest rate spread, is significant at 10% level of significance. this result is counter-intuitive since the expectation is that prospective investors are discouraged from borrowing due to high cost of credit (or higher lending rate). the inefficiency in the financial system is therefore obvious through the increasing gap between lending rate and deposit rate. across the first three specifications, remittance inflows relate complementarily with financial development to promote growth, though with an insignificant margin. remittances impact growth positively and indirectly through bank deposits and liquid liabilities9 by a marginal effect of 0.2%, and through domestic credit to private sector by a much higher marginal effect of 0.4% keeping other variables constant. these impact coefficients are statistically significant at 5 to 10% level. this result is an indication that domestic credit to private sector has higher growth potential than banks deposits and liquid liabilities, particularly through the investment channel. however, the interaction between remittance inflows and interest rate spread dampens10 growth. remittances impacts growth negatively and indirectly through the interest rate spread by a factor of 0.9% keeping other explanatory variables constant, though the impact is insignificant at 10% level of significance. this result is reflective of the substitutability between foreign remittances and financial development in promoting economic growth in nigeria.11 the explanatory power of the four models as measured by the adjusted r2 is very high and ranges between 0.97 and 0.98. this implies that across the four specifications, about 97% to 98% of the total variation in real gdp is being explained by remittance inflows, financial development indicators and interactions between the two variables. irrespective of specifications, the j-statistics, which test the validity of the instruments, show that the instruments used in this study are valid since the associated probabilities are in excess of 0.1 (that is, p > 0.1). in addition, the endogeneity test conducted on the explanatory variables in all four models suggests the acceptance of the null hypothesis that the explanatory variables in each model are exogenous; hence, the issue of reverse causality has been carefully addressed in this study. table-4. two-stage least square estimates of the nexus between growth and remittances. dependent variable: variable model ia model iib model iiic model ivd 1.032***(0.045) 1.005***( 0.039) 1.034***( 0.049) 1.015***( 0.049) -0.044*( 0.023) -0.039*( 0.021) -0.055*( 0.029) 0.056(0.037) -0.015**( 0.007) 0.002**( 0.001) -0.009**( 0.004) 0.002*( 0.001) -0.027**( 0.012) 0.004**( 0.002) 0.023*( 0.012) -0.009(0.006) -0.534(1.141) 0.145(1.021) -0.472(1.245) -0.453(1.265) adjusted 0.9761 0.9791 0.9672 0.9729 f-statistic 325.43[0.0000] 372.45[0.0000] 238.03[0.0000] 286.78[0.0000] j-statistic 1.6946[0.4286] 2.3202[0.3135] 0.1753[0.9161] 1.7045[0.4265] endogeneity test 4.2006[0.3795] 3.1807[0.5280] 6.4794[0.1661] 4.8028[0.3081] list of instruments note: ***, **, and * indicate the rejection of the null hypothesis of no relationship and/or association at 1%, 5% and 10% respectively; the values in parentheses and block brackets are, respectively, the standard errors and the probabilities. superscripts a, b, c, and d imply that the four models capture, respectively, bank deposits, liquid liabilities, domestic credit to private sector, and interest rate spread as the indicators of financial development. 5. conclusion motivated by the unsettled debate in the literature concerning the role of financial sector in the nexus between foreign remittances and economic growth, the present study has analyzed the complementarity or substitutability between remittances and financial development in advancing nigeria’s economic growth between 1981 and 2015. to circumvent the possible endogeneity problem among remittances, financial development and growth, the twostage least squares (2sls) technique was employed. across the specifications considered, findings showed the absence of a long-run relationship between foreign remittances and growth having properly accounted for the role of financial sector development. across specifications, foreign remittance inflows had negative and significant effect on economic growth with financial development indicators including bank deposits, liquid liabilities and domestic credit to private sector being accounted for, whereas it had positive effect on growth when interest rate spread is controlled for as the financial development indicator. mixed results were generated concerning the growth effects of financial development indicators used in this study: while the indicators that measure the volume of finance were growth dampening, the efficiency indicator was found to be growth enhancing. in addition, in contrast to previous findings, this study offered new evidence that the complementarity or substitutability between remittances and financial development in economic growth depends on the indicators of financial development used. in other words, the complementarity hypothesis was confirmed in the case of the quantitative indicators (that is, bank deposits, liquid liabilities and domestic credit to 9result parallels the findings of previous studies including, mundaca (2009), bettin and zazzaro, (2011), nyamongo, misati, kipyegon and ndirangu, (2012), chia (2014) and el hama (2016). 10result confirms the previous findings of ramirez and sharma, (2008), giuliano and ruiz-arranz, (2009) and tung (2015). 11according to bettin and zazzaro, (2011) the negative interactive effect of remittances and interest rate spread captures the diminishing marginal impact of financial sector size on economic growth. asian journal of economics and empirical research, 2020, 7(1): 15-24 23 © 2020 by the authors; licensee asian online journal publishing group private sector), while the substitutability hypothesis was validated in the case of the qualitative measure of financial sector development (that is, interest rate spread). based on these findings, it is important that the 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https://doi.org/10.4314/afrrev.v5i3.67355. vargas-silva, c., s. jha and g. sugiyarto, 2009. remittances in asia: implications for the fight against poverty and the pursuit of economic growth. asian development bank (adb) working paper series no. 182. word development indicators (wdi), 2017. database of the world bank. available from https://data.worldbank.org/country/nigeria. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 115 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 2, 115-125, 2020 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2020.72.115.125 © 2020 by the authors; licensee asian online journal publishing group effects of high-voltage overhead power lines (hvopls) on residential property prices wadu mesthrige jayantha1 lebunu hewage udara willhelm abeydeera2 ( corresponding author) 1rmit university, melbourne, australia. 2the hong kong polytechnic university, hong kong. abstract research findings on the effects of high-voltage overhead power lines on values of neighborhood properties remain inconclusive and inadequately explored. this study aims to investigate the effects of hvopls on market values and sale-prices of residential properties in the vicinity. the empirical results based on a hedonic price model show that hvotls impart a significant negative effect on nearby residential properties. results show that affected properties are selling at a discount price compared to properties without the influence of hvopls. the market value of a residential unit located within physical distance of 300-meters of power-lines, and pylon, are on average, 34.2% and 18% lower than comparable properties, respectively. furthermore, results suggest that it is the physical distance to hvopl structures that accounts more for the value diminution compared to the visual impact of the structure. the results imply that the market value of properties adjacent to hvopl corridors is reduced significantly. this discourages potential property buyers. the study contributes to the knowledge in two-ways: (i) it shows the greater impact of hvopls on property prices with a larger reduction in valuation than previous studies; and (ii) effects of the different visual impact of pylons compared with that of cables are clearly distinguished. keywords: hvopls, residential property price, value diminution, hong kong. jel classification: l94, r31. citation | wadu mesthrige jayantha; lebunu hewage udara willhelm abeydeera (2020). effects of high-voltage overhead power lines (hvopls) on residential property prices. asian journal of economics and empirical research, 7(2): 115-125. history: received: 22 january 2020 revised: 27 february 2020 accepted: 2 april 2020 published: 15 may 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 116 2. review of past studies to identify hvotl key factors influencing property values ................................................. 117 3. methodology ................................................................................................................................................................................... 118 4. empirical findings ........................................................................................................................................................................ 120 5. summary and conclusions ........................................................................................................................................................... 123 references ............................................................................................................................................................................................ 124 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.72.115.125&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1633 https://orcid.org/0000-0002-6304-9093 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1633 https://orcid.org/0000-0002-6304-9093 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1633 https://orcid.org/0000-0002-6304-9093 asian journal of economics and empirical research, 2020, 7(2): 115-125 116 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this paper investigated the effect of hvopl on market values and sale prices of residential properties. accordingly, the study findings revealed that market value and the sale-price of residential properties which are at a close proximity to hvopls tend to be lower. this paper contributes to literature in two ways. firstly, it shows the greater impact of hvopls on property prices with a larger reduction in valuation than previous studies. secondly, the effects of the different visual impact of pylons compared with that of cables are clearly distinguished. 1. introduction the impact of high-voltage overhead transmission power lines (hvopls) on nearby properties has been in the public eye since the mid-1980s in a variety of countries. since then, this issue has been studied extensively by many scholars and institutions across the globe. some claim that there are serious negative effects on nearby properties due to various reasons. some valuation studies claim a value diminution of between 2 and 10% in residential property (e.g., (bond & hopkins, 2000; callanan & hargreaves, 1995; colwell, 1990; hamilton & schwann, 1995; rosiers, 1998)). sims and dent (2005) for instance, find that housing property prices located within 100 meters radius of the power cables drop between 6-17% in value. they further found out that the negative influence on value for properties having a front view of a pylon (reduced by 14.4%) is greater than those having a rearview (reduced by 7.1%). other studies also support the idea that value diminution is even larger in properties facing a pylon (hamilton & schwann, 1995) presumably only for visual reasons, but this is not specified. more recently, a more analytical investigation by elliott and wadley (2002) mention that transmission lines can cause serious negative externalities to surrounding properties mainly due to: (1) potential health hazards; (2) visual unattractiveness; and (3) disturbing sounds. the most recent linkages to health issues include the study by doukas, karakosta, flamos, and psarras (2011) that found out that prolonged exposure to hvopls can cause a greater risk of leukemia in children. negative externalities arise from the negative impact on the surrounding environment regarding aesthetic aspects, and the visual unattractiveness is mentioned in several studies (hamilton & schwann, 1995; rosiers, 1998; sims & dent, 2005). for the disturbing sounds caused by overhead power lines, a new zealand study already pointed to this problem 25 years ago, while a recent study clarified that electric noise may be produced when the cables carry electricity with greater than 400-800kv (doukas et al., 2011). most of these studies have been predominantly grounded in the us, with limited research in the uk, canada, and new zealand, while research in this area is extremely limited in the asian region. in the review of the literature overall, it is noted however that there is no conclusive evidence about the influence of hvopls on the nearby housing prices, but rather mixed findings. whilst some researchers claim significant value reduction, others suggest no real value effects. for example, a significant body of studies suggest a negative effect of hvopls on the value of nearby residential housing properties (hamilton & schwann, 1995; may, corbin, & hollins, 2011; mitteness, 1998; rosiers., 2002; sims & dent, 2005) some scholars reveal that the impact is negligible (bond & hopkins, 2000). a few studies even suggest that there is no significant price difference between properties near overhead cables and those far away from them (kung & seagle, 1992) and point out that claimed health effects (by some other studies) due to living closer to hvopls have not been sufficiently verified (sims & dent, 2005) while some other studies find out that any negative effect would diminish as time passes by (colwell, 1990) and as distance between electrical pylon/overhead cable and property increases (hamilton & schwann, 1995). apart from the fairly recent study by doukas et al. (2011) there is no clear evidence that living in close proximity to hvopls causes bad health effects. yet property buyers’ perception of purchasing properties near hvopls seems to have a considerable negative influence on the market value of those properties. conventional wisdom suggests that there is indeed a negative effect of hvopls on the value of residential properties (delaney & timmons, 1992) although many studies could not establish such a relationship. thus, property professionals have realized the importance of taking into account the public perception in the assessment of properties (sims, 2002). as mentioned by goeters (1997: quoted in rosiers (2002)) the us government has directly advised states to implement regulations and safety measures in regard to installing hvopls in areas near residential properties. however, the effect of hvopls on market and sale-value of properties in the vicinity in hong kong remains untouched. to the authors’ knowledge, to date there has not been a single comprehensive study in this area, investigating the impact of high-voltage power cables on residential property value. this might be partly attributed to the lack of unavailability of reliable transaction information, and partly be due to the fact that most of the housing developments are located in the inner city where transmission lines mostly have been laid underground. however, there are many areas in hong kong that have high-powered overhead transmission lines that are located in closer proximity to housing developments. hence, it is necessary to accurately evaluate marketability and the value of properties adjacent to hvopls in order for property developers and investors as well as buyers to make informed investment decisions. the present study aims to evaluate the effects of hvopls on values of nearby residential properties. the study will be able to investigate if there is any negative public perception of properties closer to hvopls and if so whether it will be translated into lower property value or not. specifically, the study investigates:  the visual impact of the pylon and overhead power lines on adjacent residential property price.  the effect of adjacent to the pylon and overhead power transmission lines on residential property price. this study is a little different from other existing studies in the literature. almost all the existing studies are based on low-rise and single-family house contexts. research in this area in a high-rise residential setting is very limited. in fact, we have not come across a single study in the literature. the present research is based upon a highrise residential context, in which the effect of hvopls on properties may be clearer, and hence may be a more serious issue for households and property owners. therefore, potential property buyers and existing owners, as well as tenants, may have a different perception of properties adjacent to hvopls. this issue is important not only asian journal of economics and empirical research, 2020, 7(2): 115-125 117 © 2020 by the authors; licensee asian online journal publishing group for property owners or buyers but also for property appraisers, mortgage underwriters, tax assessors as well as those who are involved with the valuation profession (delaney & timmons, 1992). 2. review of past studies to identify hvotl key factors influencing property values there is a considerable body of literature focussing the possible impact of hvotls on various types of properties. though there is an extensive literature investigating the impact of hvotls on values of residential properties, their quality is uneven, varying from unreliable reports to comprehensive research studies based on rigorous analyses (chalmers & voorvaart, 2009). the main body of research that investigates the effects of hvotls on values of property is grounded in the us (e.g., (chalmers & voorvaart, 2009; colwell, 1990; dear, 1992; delaney & timmons, 1992; jackson & pitts, 2010; kinnard & dickey, 1995; kung & seagle, 1992; mitteness, 1998; pitts & jackson, 2007; priestley & evans, 1996; william, 1990)). there have also been some research studies undertaken in the uk in this area (e.g., (dent & sims, 1998, 1999; gallimore & jayne, 1999; may et al., 2011; sims & dent, 2005)) while limited studies were conducted in new zealand (e.g., (bond, 1995; bond & hopkins, 2000; callanan & hargreaves, 1995)) and elsewhere (e.g., (doukas et al., 2011; hamilton & schwann, 1995)). the literature review can be broadly divided into two categories, namely, property-based studies that explore the value effects; and studies that investigate the effects of living in properties adjacent to hvopls on occupant health. most of the research studies investigating the impact on property value are based in the us, and are mainly aimed at investigating whether or not the negative public perception of living closer to hvopls has been converted into lower property values or not (doukas et al., 2011). however, the results of these studies vary significantly, from significantly negative effects to no real effects. some studies carried out in the 1970s claim that there is no value reduction in properties in proximity to hvopls. certain studies even claimed that there is an increase in property value in properties adjacent to a power line corridor (sims, 2002). this perhaps might have been due to the unsophisticated methods used in assessing the results. most studies carried out since the late 1970s, however, tend to claim a negative effect of hvopls on values of nearby residential properties. the negative market effect, according to these studies, is mainly attributed to the visual and aural pollution, but not because of any adverse health and safety reasons (sims & dent, 2005). some of these studies (bond & hopkins, 2000; hamilton & schwann, 1995; kauko & peltomaa, 1998; rosiers, 1998) claim a property value diminution of between 2 and 10%. in an early study, peter and foley (1979) based on a sales analysis for a 164 single-family housing sample in illinois, showed that there are significant value differences of properties that are located in the distance of 50 and 200 feet (15 to 70m) from a power distribution line. colwell (1990) in another study, concluded that the value diminution effect caused due to proximity to high-voltage power lines diminishes with the time as well as distance. it, however, mentions that the value reduction effect on residential properties near pylons (towers) was temporary. these findings were supported in a study done in canada in the late 1990s. rosiers (1998) find that properties located closer to transmission lines and pylons suffer only a little value diminution compared to properties located further away with a direct view on power lines or pylons. these two studies suggest that value diminution is mainly due to the visual impact. delaney and timmons (1992) using a survey administered in 1990 together with a paired sales analysis, claim that the market property value of the residential properties closer to transmission corridors was approximately 10.01% lower than comparable properties within same market segment. survey results indicate visual effect, health concerns, undesirable sounds and the feeling of unsafe perception as the most common reasons for this value diminution. similar findings were reported by some other studies (gregory & winterfeldt, 1996; hamilton & schwann, 1995). in a study carried out in new zealand, callanan and hargreaves (1995) claimed that there is a huge value reduction in properties closer to hvopls. according to the results, the value of properties located at a distance of 10m from the pylon was dropped by 27%; 13.6% at 20m; 5.4% at 50 meters; and 2.7% at a distance of 100 meters. in another study in the same residential location, bond (1995) surveyed property valuers/professionals and owners in order to get their opinions of marketability of properties closer to hvopls. according to the study, both these groups have expressed a negative view of marketability of properties closer to hvopls. hamilton and schwann (1995) in a detached dwellings study in vancouver, also showed a value reduction in properties near hvopls, but such effects are restricted to a narrow band. it is found that any negative impact is mainly due to the visual externalities of the transmission lines. a significant body of valuation studies using econometric methodologies (e.g., (bond & hopkins, 2000; callanan & hargreaves, 1995; rosiers, 1998; rosiers, 2002)) indicates a general reduction in housing value of between 2 and 10%. the impacts of pylons on the value of properties are even negative (bond & hopkins, 2000; callanan & hargreaves, 1995; hamilton & schwann, 1995; rosiers, 1998). in contrast, certain researchers find no value reduction (kung & seagle, 1992). in particular, early studies concluded that hvotls have little or no effect on property value. about half of the studies reviewed by kroll and priestly (1992) found no value diminution effects. kinnard (1988: cited in delaney and timmons (1992)) reported more than seventy-five studies (published and unpublished) of this nature carried out during the mid-1950s to 1988. another set of studies used statistical models to determine if hvotls have any impact on nearby properties kinnard et al., 1984; brown, 1976; blinder, 1979; sherman, 1974; vredenburgh, 1974 (cited in delaney and timmons (1992)). some studies find that negative effects disappear beyond 400-feet (hamilton & schwann, 1995). likewise, for properties closer to newly installed transmission lines or modified prevailing lines, the drop in the value of those properties lessens over time, even tend to fade away after 4-10 years (kroll 1994: cited in kinnard (1996)). to conclude, even though there is no conclusive evidence on what effect hvopls have on property prices and market values of nearby properties, there is a reasonable fear and concern (negative perception), among public and potential property buyers, of living in properties adjacent to high-voltage transmission lines and pylons due to various reasons such as visual unattractiveness, potential health hazards, safety concerns and disturbing sounds. the literature review shows that there are several important interplaying factors that can influence the effect of asian journal of economics and empirical research, 2020, 7(2): 115-125 118 © 2020 by the authors; licensee asian online journal publishing group hvopls on the residential property values: the distance and adjacent (closer proximity) to pylons and power lines; and the view of pylons and power lines. these are the main factors that the present study is aiming to analyze. 2.1. hvotls and property development in hong kong in hong kong, power lines can either be overhead or underground lines. the overhead power lines, mostly found in the new territories (nt) including outlying islands, are often interwoven among vegetation. this needs to be considered as a safety issue because trees in contact with lines may cause a voltage dip or even power interruption. besides, most importantly, power lines and hvopl structures can affect real property causing serious concerns about health hazards and safety issues. there are residential developments adjacent to these power transmission lines and towers (hvopl structures) in the nt. certainly, not many people like the idea of living closer to metal towers or power lines that carry high-voltage current. it is, therefore, a rationale to think that there might be at least some downward tug on home values in properties adjacent to transmission lines (razzi, 2009). the importance and gravity of this issue in hong kong are recognized, although no serious research efforts have been made yet. for instance, lam and au (1997) mention that although research results on effects of electromagnetic fields (emf) on humans are inconclusive, it is very important to have some measurement on emf of the environment for precaution. in fact, hong kong, in 1990, adopts international radiation protection association (irpa) guidelines and, electrical and mechanical services department (emsd) advised power companies by issuing these guidelines regarding the limits of exposure to the emf (research and library services division, 1995). according to these guidelines, when an erection of overhead power lines is planned (in the case of open spaces), the following considerations should be taken into account: (i) the electric field should be set within 5 kv per meter; and (ii) the magnetic flux density cannot exceed 0.1 milli-tesla (research and library services division, 1995). furthermore, a working group, with the chairmanship of a directorate staff of emsd, was established in 1993 to look into this emf issue in detail (research and library services division, 1995). this group comprises of representatives from various institutions such as power companies, tertiary education institutions and a variety of government institutions. the recommendations of the working group, which was revealed in 1995, included the application of irpa guidelines in hong kong; the implementation of careful avoidance in the planning of new developments; a suitable public education agenda and involvement in the who (research and library services division, 1995). all these initiations and recognitions indicate the significance of this issue. but, surprisingly a single comprehensive study examining the effect of power transmission lines on nearby properties has not been carried out to date. the present study fills this research gap. 3. methodology 3.1. hedonic pricing models (hpm) in housing research the hedonic price model (hpm) remains the most appropriate and reliable tool in assessing the effects of various externalities on housing value, although it has its own drawbacks (rosiers, 2002). a significant body of studies that investigates the effects of hvotls on properties has used a hedonic approach in the literature (callanan & hargreaves, 1995; colwell, 1990; hamilton & schwann, 1995; kinnard & dickey, 1995; rosiers, 2002). studies, in particular, valuation studies that used robust methodologies such as econometric modeling or regression methods (bond & hopkins, 2000; callanan & hargreaves, 1995; rosiers, 1998; rosiers, 2002) have produced findings with a greater degree of reliability (sims & dent, 2005). the value of the residential property is determined by various attributes such as structural, environmental and locational (neighborhood) variables. thus, the value of a residential property unit can be considered as a function of these different characteristics. these attributes can be broken down into smaller elements such as floor-area, size, view, location, etc., thus making it a non-homogenous product (sirmans, macpherson, & zietz, 2005). the price value of a residential property unit can, therefore, be estimated as a function of these attributes. the hpm is considered as an ideal tool to analyze the value of this type of heterogeneous commodity. the hedonic price model, as a tool to assess the effects of these attributes on housing price, has its own advantages. first, the hpm method is arguably the most reliable analytical method in assessing a variety of environmental externalities as it can show buyers’ dis-utility arising from any apparent hazard through their actual pricing behavior (rosiers, 2002). second, it has its own strength to analyze the implied associations between the commodity (residential property in this case) and its attributes (freeman, 1979). marginal implicit prices of these various attributes can be effectively estimated with this tool, which would then help to approximate marginal willingness to pay. third, a regression model has a greater benefit of being not totally dependent on the prejudiced judgment, but it also stands for an objective reflection of the data (chalmers & voorvaart, 2009). finally, an important thing of hpm is that it permits the total value of a property to be broken down into small components; allowing us to recognize the individual effects of each component/attribute (hui, lau, & khan, 2011). therefore, it can separate the contribution of the market value of each attribute of the property (rosiers, 2002). the hpm is capable enough to give a broader picture of those property attributes that are normally consistently appreciated by buyers irrespective of the location (hui et al., 2011). the present study also, therefore, uses the hpm to investigate the effects of high-voltage transmission lines (hvopls) on the values of residential properties in the vicinity. more specifically, the study aims at examining both positive effect and negative effects, if any, arising from immediate proximity to, as well as view (visual impact) on, an hvopl corridor. put different, the model will investigate whether the externalities, if any, (positive or negative) are transformed into changes in property values. to investigate whether a potential home buyer will consider negative effects resulting from (and thus pay a low premium) residential property closer to an hvopl corridor, the property transaction records of residential properties (adjacent to an hvopl corridor) were used in the model. a variety of attributes (variables) determines the market price and value of a residential property unit. after careful consideration, the present research nevertheless selected only a few standard variables (attributes) with significant influence on residential property asian journal of economics and empirical research, 2020, 7(2): 115-125 119 © 2020 by the authors; licensee asian online journal publishing group price, along with hvopl and pylon-specific variables. examination of these hvotl-specific variables is the main task of the present study. therefore, the hpm model consists of a combination of property-specific (structural), hvotl-specific (environmental) and location-specific attributes. the study adopts a semi-log form of hpm. the logged residential price was regressed against a set of combined logged and unlogged variables. those variables that have a non-linear relationship with the property are in the form of logged variables, whilst those are with a linear relationship with the price are in the form of unlogged ones. the study proposed the following hpm model: ln (p)i = δ0 +δ1 ln (size)i +δ2 ln (floor)i +δ3 ln (age)i + δ4 (north)i + δ5 (east)i + δ6 (south)i +δ7 (west)i + δ8 (green)i +δ9 (pview)i +δ10 (lview)i +δ11 (dpylon)i +δ12 (dline)i + i where ln (p) stands for logged residential property price, δ 1…..δ12 represent the coefficients of variables to be estimated; δ0 represents the constant term and i the error term. descriptions of all the variables including variable definitions and other statistics are reported in table 1. table-1. the attributes and their expected relationship with property price. attributes abbreviation characteristics definition expected sign (+/-) structural location environmental lnp lnsize lnfloor lnage orientation north east south west view gview pview lview dpylon dline transaction price gross floor area floor level floor facing north facing east facing south facing west green view pylon view transmission live view distance from the pylon distance from the transmission lines the transaction price of the apartment in hk$ in log form gross floor area in square feet in log form number of floors above the ground in log form age of the unit in the year at the transaction date 1 if the unit is facing the east direction; 0 otherwise 1 if the unit is facing the east direction; 0 otherwise 1 if the unit is facing the south direction; 0 otherwise 1 if the unit is facing the west direction; 0 otherwise 1 if the unit has a green view (trees/mountains); 0 otherwise 1 if the unit is facing a pylon; 0 otherwise 1 if the unit is facing transmission lines; 0 otherwise 1 if the unit is located within 300m from the pylon; 0 otherwise 1 if the property is located within 300m from the transmission line; 0 otherwise / + + + + + + + 3.2. description of data selection the study area for this research is the wong tai sin (wts) district. wong tai sin is one of the highly-dense populated districts in the kowloon peninsula with a median monthly domestic household income of hk$ 17,000 (population census, 2011). in this study, residential estates that are located within 300 meters of high-voltage transmission lines and pylons in wts district were selected. non-closer adjacent properties were also included from the same market area of residential developments in the district. details of the selected residential estates are summarized in table 2. table-2. summary of selected estates. name of the property address date of occupation transaction data (during 2007-2016) kingsford terrace 8 king tung street 07/2003 439 scenic view 63 fung shing street 09/1999 565 hilltop gardens 33 fung shing street 06/1990 725 sun lai garden 2 king tung street 06/1985 846 tsui chuk garden 8 chui chuk street 09/1989/ 07/1991 680 note: as sun lai garden, kingsford terrace and tsui chuk garden were built under the psps scheme, only transactions with premium paid to the housing authority were taken into analysis. these private residential developments were selected for 3 characteristics: all these residential estates are located close to hvopl corridor; residents of these estates are in a similar income group, and they are a similar distance to the mass transit railway (mtr) station. this approach would certainly cancel out price effects that asian journal of economics and empirical research, 2020, 7(2): 115-125 120 © 2020 by the authors; licensee asian online journal publishing group might be caused by these facilities in the model. on the other hand, a variety of other amenities that are available around these residential developments, that are also similar and most importantly are shared by residents in these developments. these amenities consist of a library, swimming pool, urban parks, and sports center. as all the residents have access to all the amenities equally, there is no need for us to introduce these attributes to the model, and that makes the model simple and easy to handle. a sample of 955 residential transactions was used in the study table 2, which consists of small-large residential property units (gfa of 447 – 955 sq. ft.). the value range of the properties (per unit) in the sample is hk$0.58m and hk$4.71m. the data were obtained from the economic property research centre (eprc) limited, which is a web-based database, and a variety of governmental publications. the transaction records of all selected housing estates in the period of 1st january 2007 and 31st december 2016 were obtained from the eprc. the selling price of the unit recorded in the eprc is taken as the transaction property price. all the records of sale and purchase agreements (asp) of the chosen properties during the above time period were chosen for the study. property specific attributes such as building age, floor level, floor area, orientation, and view were also obtained from the eprc database. in addition, the information about pylon and transmission line (power line) views were obtained from google maps (maps.google.com) and geoinfo maps. the distances to pylons and transmission lines were calculated using geoinfo map information from the lands department. time effects of property price needed to be removed in order to obtain the real property price. this was done by using a price index built up by the rating and valuation department. the study proposes three models in order to better understand what, if any, effects hvopls have on market values of nearby residential properties. model 1 incorporates all the variables: property-specific, location-specific and hvopl-specific. model 2 incorporates power line-specific variables along with other standard variables (property and location-specific), and model 3 is performed with pylon-specific variables along with other standard variables see table 3 for a summary of variables in these models. in this way, we will be able to better understand the price and value effects of properties, if any, resulting from being adjacent to an hvopl corridor. all three models are based on a sample of 3255 transactions. table-3. variables used in models. variables model 1 model 2 model 3 lnp √ √ √ ln (size) √ √ √ ln (floor) √ √ √ ln (age) √ √ √ north √ √ √ south √ √ √ west √ √ √ east √ √ √ green √ √ √ pview √ √ lview √ √ dpylon √ √ dline √ √ 3.3. analysis of the hpm results there is a variety of standard statistical techniques to verify and interpret the results of a regression (hpm) model. the most commonly used ones are r2, adjusted r2, simple t-test, and f-test. r2 reflects how well real data can be approximated with a regression line. on the other hand, the adjusted r2 reflects how well new variables improve the overall performance of the model. thus, adjusted r2 is more important in an interpretation of the results of a regression model. the value of adjusted r2 ranges from 0 to 1, with values closer to 1 being the best and vice versa. similarly, the student t-test is very important in interpreting the results of a regression model. this is basically used to test individual variables. the t-statistic tests the hypothesis of every single parameter of variables. the absolute value of the t-statistic is compared with the critical t-value in order to test the significance of each variable. the null hypothesis is rejected if the estimated t-statistic is larger than the critical t-value, which suggests that the selected particular variable performs well in the model. similarly, the f-statistic reflects the overall performance of the model. the overall model is said to be significant and perform better if the estimated f-value larger than the critical value. 4. empirical findings 4.1. analysis of hedonic price models (hpms) the estimated empirical results of hpms are analyzed in this section. descriptive statistics of the variables used for the models are summarized in table 4. the analyses for three hedonic pricing models were performed. the model 1 analysis was performed with all the variables: property-specific, location-specific and hvotl-specific. next, hvotl-specific variables were divided into power line-specific variables and pylon (tower)-specific variables. accordingly, model 2 analysis was performed with power line-specific variables along with location and property-specific variables, whilst pylon (tower)-specific variables along with location and property-specific variables were included in model 3. the reason why this classification is made (between models 2 and 3) is to reaffirm the results obtained from model 1. asian journal of economics and empirical research, 2020, 7(2): 115-125 121 © 2020 by the authors; licensee asian online journal publishing group table-4. summary of descriptive statistics. variable mean std min max lnp 0.5631 0.3262 -0.5444 1.5489 ln (size) 6.4305 0.1857 6.1026 6.8617 ln (floor) 2.5806 0.8587 0 3.8286 ln (age) 2.6516 0.4242 1.6094 3.2581 north 0.4681 0.4992 0 1 south 0.3885 0.4877 0 1 west 0.3717 0.4835 0 1 east 0.4681 0.4992 0 1 green 0.6126 0.4874 0 1 pview 0.1298 0.3363 0 1 lview 0.2702 0.4442 0 1 dpylon 0.5183 0.4999 0 1 dline 0.5539 0.4973 0 1 4.2. analysis of model 1 table 5 reports the empirically-estimated statistics of the model 1, including coefficients of variables and the r2 along with goodness-of-fit statistics. empirical results show that all the independent variables included in the model are statistically significant and also carry the anticipated theoretical signs. the 0.84 of adjusted r2 indicates that 84 percent of the variation of the residential property price is explained by the selected independent variables. the f-statistic of that reflects the overall performance of the model is found to be 419.2, which comfortably exceed the critical value, suggest that the chosen explanatory variables in the model are jointly statistically significant. this suggests that the overall model performs very well. table-5. coefficients of model 1. variable coefficient sig. constant -5.6591* 0.000 ln (size) 1.1297* 0.000 ln (floor) 0.0582* 0.000 ln (age) -0.4943* 0.000 north 0.1132* 0.000 south 0.1367* 0.000 west 0.1300* 0.000 east 0.1294* 0.000 green 0.0401* 0.001 pview -0.0172 0.342 lview -0.0801* 0.000 dpylon 0.1780* 0.000 dline -0.3427* 0.000 adj. r2 0.8402 f-value 419.2 note: *indicates significant at 1% level. results reveal that all hvopl-specific variables (except pview) in the model are statistically highly significant. for instance, the negative coefficient of (-0.342) dline with t-statistic of 9.8266 suggests that this variable is highly significant (1% level). this suggests that if the residential unit is located within physical distance of 300 meters of power lines, the residential property price experiences a significant drop by {100[exp(0.342)-1]} percent = 34.2 percent. in other words, buyers tend to pay significantly less for these properties (a significant discount) compared to similar properties located further away from power lines. the other variable, that represents the distance to hvopl, dpylon is also highly significant. the coefficient 0.178 of dpylon implies that the price of properties located within 300 of pylon drops by {100[exp(0.178)-1]} 18 percent. however, the negative impact of living in close proximity to a pylon is less than living directly adjacent to power lines. this suggests that people seem to think about living in close proximity to power lines more problematic (due to safety/health concerns) than proximity to pylons (towers). it is clear from the results that affected properties (within 300 meters of hvopls) are selling at a discount compared to properties without any influence of hvopls. turning to variables that represent the visual impact or view of hvopl structures, one variable (lview) is significant while the other (pview) is not. the variable lview is found be highly significant with a coefficient of 0.08 and also with the expected sign suggesting that the value of a property located with a view of power lines (that is, a view facing power lines) drops by{100[exp(0.08)-1]} 8 percent. according to the results, visual encumbrance of transmission lines appears to exert a stronger negative impact on property value compared to the visual encumbrance of pylons. this is a bit surprising because generally, a tower can cause a severe visual obstruction compared to power lines. overall, results suggest that it is the distance to hvopl structure (power lines and pylons) that accounts more for the value decline compared to the view of hvopl structures. in other words, potential buyers seem to consider physical distance to power lines (location of power lines) more seriously compared to the physical distance to pylons when deciding to buy a property. however, one thing is certain from the results. whether it is power lines or pylons, hvopls impart a serious negative effect on nearby properties, suggesting that the market value of residential properties can be adversely affected if the properties are adjacent to hvopl corridors. the reason is straightforward. a house is a durable commodity, and it is a significant and major lifetime investment for many people. in purchasing a commodity like that, people usually consider many factors including environmental, location and other physical attributes when purchasing a property. among environmental attributes, safety and health issues, as well as electric noises, play an important role. potential property buyers not asian journal of economics and empirical research, 2020, 7(2): 115-125 122 © 2020 by the authors; licensee asian online journal publishing group only consider the interior quality of a housing property, but also the outside environment, in particular, the quality and safety of the neighborhood and a better environment over the other factors. even if the buyers do not have any previous bad experience living in close proximity to an hvotl (and also not known about such experience to others), a property adjacent to an hvotl corridor is still valued lower compared to one far away from an hvotl corridor. certainly, not many people enjoy visual encumbrances or other safety and health burdens. thus, people may discount the value of these types of properties, which are in closer proximity to power lines and pylons. the results thus very clearly reflect that the quality of the neighborhood (no visual encumbrance and health hazards) is an important element in making a property purchase decision. this finding is very much in line with some previous studies in the literature (e.g., (bond & hopkins, 2000; callanan & hargreaves, 1995; delaney & timmons, 1992; hamilton & schwann, 1995; rosiers, 2002; sims & dent, 2005)) although the negative effect of hvotl is seemingly stronger in the present study. this is to be expected since the setting and the context for the present study is entirely different from most of the previous studies. as several studies note and as common sense obviously dictates, findings of a particular study may not be applied to every property because different studies are based on different settings. while most of the existing studies are single-family house or detached houses, hong kong is considered a metropolitan city full of high-rise buildings. so, people living in high-rise residential buildings may have some serious visual obstructions (compared to single and low-rise settings) due to power lines and may experience safety, noise and health hazard burdens more acutely and differently. hence people tend to discount these properties at a higher rate. on the other hand, hong kong's property market is so volatile and sensitive to many factors, and thus people tend to take extra precaution in making decisions to select their home. in particular, this is true when it comes to long-term investment decisions, such as buying properties. all the other variables (property and location-specific variables) included in the model were also found to be statistically highly significant. the positive coefficient 1.129 of lnsize suggests there is a positive relationship between housing price and the size of the unit. it is evident that a unit with a larger floor area would be more expensive compared to a smaller unit since the demand for these is high compared to the available supply. the variable lnfloor represents the level of the floor that a unit is located. the positive sign suggests that the potential buyers are certainly willing to pay a higher premium for a unit in a higher level as the higher floor levels are better in many aspects, in particular in a busy and noisy city like hong kong. in such a highly densely populated (and busy) city like hong kong, it is not surprising that people would be happy to pay more to live in a higher floor to enjoy fresh air, stronger airflow, and better view. the negative coefficient of lnage indicates the property prices decrease as time goes by since the building structure deteriorates with time. obviously, as the aged buildings need higher maintenance costs the potential demand for these buildings would be lower and hence the price. orientation is another important factor that buyers take into account when purchasing a property in hong kong. south is usually considered as a better orientation as units facing south would enjoy a better prevailing airflow (ventilation) and optimum natural lighting. the positive coefficient of south indicates this. people also consider east as relatively a better orientation, though not better than south. the positive coefficient implies this situation. in contrast, as housing units facing west can expose occupants to hot weather more severely in summer and a lot cooler in winter (though hong kong winter may not be that cold), the west is normally is considered as the worst orientation. finally, flats facing north will be cooler in winter, but this may not be a big issue as hong kong has only a mild winter. the worst part of north is that those flats may not get enough sunlight. but, in the model, however, west and north have positive coefficients. this might perhaps be due to the fact that people do not take the orientation west as that bad as long as the unit has a green view (good view). this clearly reflects from the results of the model: the estimated positive coefficient (0.040) of the variable green suggests a clear positive impact on property prices. having a green (or sea view) view is preferred by many people whilst units with views that are blocked by surrounding high rise buildings and structures are considered negatively. table-6. coefficients of the model 2. variable coefficient sig. constant -5.0426* 0.000 ln (size) 0.9934* 0.000 ln (floor) 0.0549* 0.000 ln (age) -0.3783* 0.000 north 0.0203 0.287 south 0.0376* 0.013 west 0.0591* 0.001 east 0.0534* 0.003 green 0.0522* 0.000 pview -0.0165* 0.384 lview -0.0760* 0.000 adj. r2 0.824 0.000 f-value 448.3 0.000 note: *indicates significant at 1% level. 4.3. results of hpm models 2 and 3 to reaffirm the results obtained from model 1, (in particular the effect of hvotl-specific factors, which is the main aim of the study), the study performed two more models (models 2 and 3). the estimated hpm results of the models 2 and 3 are summarized in table 6 and table 7, respectively. as found in the results of model 1, these two models have explanatory powers, and all the explanatory variables (except pview in model 2 and green in model 3) are found to be highly significant with the anticipated signs. the results also suggest that about 83 percent of the total variation of the residential property price is described by these two models (almost the same as asian journal of economics and empirical research, 2020, 7(2): 115-125 123 © 2020 by the authors; licensee asian online journal publishing group in model 1). this is reflected through the adjusted r2 values (0.82 and 0.83). the corresponding p-values (0.000) of f-statistic of both models suggest that all the explanatory variables are jointly statistically significant. table-7. coefficients of the model 3. variable coefficient sig. constant -5.8317* 0.000 ln (size) 1.1576* 0.000 ln (floor) 0.0561* 0.000 ln (age) -0.4876* 0.000 north 0.1069* 0.000 south 0.1409* 0.000 west 0.1398* 0.000 east 0.1173* 0.000 green 0.0126* 0.178 dpylon 0.1314* 0.000 dline -0.3401* 0.000 adj. r2 0.833 0.000 f-value 478.1 0.000 note: *indicates significant at 1% level. the main emphasis of the study is on the hvopl-specific variables. empirical results of both models (2 and 3), as shown in table 6 and table 7, are very much consistent with the results of the model 1. as in the case of model 1, all the hvopl-specific variables (except pview) are highly significant along with the anticipated negative sign. the coefficient of lview is -0.0759 (model 2), which is almost same (0.080) as in model 1. the corresponding t-value and the p-value are -4.857 and 0.000, respectively. likewise, the variable dline (model 3) is highly significant and carries the coefficient of -0.34, which is again same as in model 1. this implies that the hvopls have a strong negative impact on the values of residential properties. this finding reaffirms the findings of model 1 with regard to the significance of hvopls variables on property price. this suggests that people are aware of the negative possible link between power line proximity and health and safety, and this concern is being incorporated into the price determination of a property. this concern (by potential buyers), therefore, in turn, has already been capitalized into lower property values. the coefficients of all hvopls variables in all the models are highly significant. this undoubtedly indicates that property buyers tend to pay a lower price for properties nearby hvopls. however, the magnitude of coefficients of variables that represent the physical distance to power lines (dline) and pylons (dpylon) is larger than that in visual impact variables (lview and pview). that means people seem to think that a property with a far view of power lines or pylons is better than a property located physically adjacent to power lines or towers. findings of the present research suggest that value diminution of property is mainly due to the physical proximity to power lines, but due very little to their visual impact. this implies that prospective buyers are health conscious. 5. summary and conclusions the primary objective of this study was to investigate the effects of hvopls on the values of residential properties in hong kong. the study adopted a hedonic price model to empirically investigate what effects if any, power lines and pylons have on the value of nearby residential properties. the study finds that hvopls impart a significant negative effect on residential properties. the empirical results suggest that physical proximity and the visual presence of pylons, as well as transmission lines, have a significant adverse effect on property values of the nearby properties. it was found that the market price and value of residential properties located adjacent to hvopl structures are less than comparable properties in the same market area. the price of a residential unit located within a physical distance of 300 meters of power lines decreases significantly, by 34.2 percent. likewise, the price of property located within 300 meters of a pylon drops by 18 percent. also, the market value of property facing power lines is, on average, 8 percent lower than comparable properties in the area. therefore, it is clear from the results that affected properties are selling at a discount to similar properties which are without any influence of hvopls. for example, for a property worth of hk$ 4 million, one is willing to pay only hk$ 2.632 million when the property located within 300 meters of power lines and hk$ 3.28 million when the property is located within 300 meters of a pylon. similarly, the figure for a property facing power lines would reduce to hk$ 3.68 million. the results show that the adverse effect of living in properties adjacent to high-voltage power lines is greater than living closer to pylons. high-voltage transmission lines can cause undesirable electric noise and also cables carrying a high-volume of electricity can produce electric noise (doukas et al., 2011). the presence of overhead power lines may create an undesirable aesthetic image to the surrounding environment which would certainly cause a negative effect to the surrounding properties. the results also indicate that it is the physical distance to hvopl structure (lines and pylon) that accounts more for the value diminution compared to the view (visual impact) of the structure. several implications can be drawn from the findings. first, properties located in closer proximity to an hvopl corridor not only affect potential buyers in the first-hand housing market but also distract people buying or renting properties in the second-hand property market. as there is a negative public perception of the impact of hvopls due to various reasons as discussed in the literature review, potential buyers or investors are reluctant to invest in these properties. the presence of hvopls provides a negative image of the property in the eyes of the prospective buyers. this can significantly lower the market potential of the property and hence competitiveness of the property in the market can be adversely affected, leading to a lower price. second, the undesirable quality level and the unhealthy living atmosphere that hvopls bring to the property may increase the awareness of the general public. therefore, potential property buyers and existing owners, as well as tenants, may have a serious negative perception of properties adjacent to hvopls. this issue is important not asian journal of economics and empirical research, 2020, 7(2): 115-125 124 © 2020 by the authors; licensee asian online journal publishing group only for property owners or buyers but also for property appraisers, mortgage underwriters, tax assessors as well as those who are involved with the valuation profession. some important implications can be drawn from the findings of this study for local planning authorities, developers and stakeholders within the electricity supply industry. as per policymakers, the findings of the research may shed light on the main phenomenon underlying the widespread negative public perception regarding the presence of hvopls: the necessity of the market to take public perception of the hvopls into consideration in investment decisions. although it may cost relatively less to purchase land (for constructing residential developments) near hvopls corridors, developers perceive that increasing public awareness on unhealthy living environments brings their attention to hvopls and leads to an uncompetitive business environment. it may also help authorities to further refine the planning and installation of hvopls away from residential areas in the future. in particular, knowledge about the effects of transmission lines and in particular its effects on property values are important when new projects are initiated. therefore, this study would be useful for those stakeholders who are involved with making these decisions. the research findings could be useful for planning authorities and developers in deciding to initiate new development schemes where there are hvopl corridors. this research, it is hoped, may well inform concerned establishments in their discourses with property developers in the future. finally, such authorities can also take account of measures in their development plans regarding new property developments 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(2005). the composition of hedonic pricing models. journal of real estate literature, 13(1), 1-44. william, k. j. (1990). the impact of high-voltage transmission lines on real estate values. journal of property tax management, 1(4), 324-346. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 125 © 2024 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 11, no. 2, 125-133, 2024 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v11i2.6311 © 2024 by the authors; licensee asian online journal publishing group testing the neutrality of money, labor, and capital in pakistan's agriculture sector waleed mulk1 shakil ahmad2 waqar younas3 syed yawar ali4 ( corresponding author) 1higher education department, khyber pakhtunkhwa, pakistan. 1email: waleedmulk@gmail.com 2school of international trade and economics, university of international business and economics, beijing, china. 2email: de202160007@uibe.edu.cn 3,4 pakistan institute of development economics pide, islamabad, pakistan. 3email: eco.waqaryounas18@gmail.com 4email: syawaralienvieco@gmail.com abstract this study investigates the neutrality of money in pakistan's agriculture sector by analyzing semi-annual data from 1991s1 to 2019s2. we employ the impulse response function, variance decomposition, johansen cointegration, vecm, and the granger causality test. the johansen cointegration approach demonstrates a continuous relationship between the variables over time. the granger causality test indicates no short-term causal relationship between agricultural productivity and the broad money supply. on the other hand, agricultural production has a shortterm causal relationship with inflation and capital. long-term outcomes corroborate the empirical findings of the cointegration test, suggesting the existence of a cointegration connection. the impulse-response and variance decomposition tests indicate that the broad money supply has a statistically significant positive effect on shortand long-term agricultural productivity. on the other hand, inflation has both short-term and long-term detrimental effects on agricultural productivity. meanwhile, short-term and long-term labor and capital shocks symmetrically affect agricultural productivity. consequently, our results refute the long-term money neutrality hypothesis. the results of this paper will assist policymakers and researchers in gaining a more comprehensive understanding of the impact of inflation, labor, capital, and the broad money supply on pakistan's emerging economy. keywords: agricultural, capital shocks, labor, pakistan, money supply, vecm. jel classification: e41; f66. citation | mulk, w., ahmad, s., younas, w., & ali, s. y. (2024). testing the neutrality of money, labor, and capital in pakistan’s agriculture sector. asian journal of economics and empirical research, 11(2), 125–133. 10.20448/ajeer.v11i2.6311 history: received: 30 september 2024 revised: 4 december 2024 accepted: 19 december 2024 published: 31 december 2024 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. data availability statement: the corresponding author may provide study data upon reasonable request. competing interests: the authors declare that they have no competing interests. authors’ contributions: all authors contributed equally to the conception and design of the study. all authors have read and agreed to the published version of the manuscript. contents 1. introduction .................................................................................................................................................................................... 126 2. literature review .......................................................................................................................................................................... 126 3. materials and methods ................................................................................................................................................................. 127 4. estimation technique and empirical results.......................................................................................................................... 128 5. conclusion and policy recommendations ................................................................................................................................ 132 references ............................................................................................................................................................................................ 132 mailto:waleedmulk@gmail.com mailto:de202160007@uibe.edu.cn mailto:eco.waqaryounas18@gmail.com mailto:syawaralienvieco@gmail.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v11i2.6311 https://orcid.org/0000-0003-3744-9162 asian journal of economics and empirical research, 2024, 11(2): 125-133 126 © 2024 by the authors; licensee asian online journal publishing group contribution of this paper to literature implementing pakistani monetary policy raises questions about the impact of money supply on agricultural productivity. the study investigates the monetary neutrality of pakistan's agriculture sector, aiming to identify solutions and answer these questions. it examines the effects of money supply on agricultural productivity and evaluates the long-term market neutrality (lmn) in the sector. 1. introduction in macroeconomics, selecting the right policies and methods to reduce inequality, ensure stability, and enhance economic growth and development is essential. the central bank uses monetary policies to attain objectives such as controlling inflation, providing an environment favorable to increasing output and employment to maximum levels, and sustaining the currency's value. by changing the money supply and interest rate, these policies can achieve various economic goals, including enhancing economic growth, creating employment, and maintaining price levels (arani, ghasemi, & safakish, 2017). however, one of the most contentious economic issues is the effectiveness or ineffectiveness of monetary approaches in actual variables (also known as the neutrality of money in the economy). the two main hypotheses that explain this association are long-run money neutrality (lmn) and long-run super money neutrality (lsmn). according to the lmn hypothesis, a permanent change in the money supply has no long-term effect on the level of actual variables. in contrast, the lsmn hypothesis argues that a permanent change in the money supply growth rate has no long-term impact on the level of actual variables (ekomie, 2013). diverse schools of thought, including classical, keynesian, and monetarist, have different perspectives on the function of money in the economy. the irving-fisher quantity theory of money supports the classical monetary theory, the first theory of monetary policy that most people agreed on, by demonstrating the link between economic data and monetary policy. increasing the money supply does not affect real prices, jobless rates, or the real economy. instead, it raises all prices and wages in the same way. in the past, money neutrality was an important part of classical economics. however, a new study shows that it doesn't always hold (ahmed & suliman, 2011). however, the new keynesian argues that because of imperfect market information transmission and price rigidity (price stickiness), money supply changes appear to have a short-term influence on actual variables such as gross domestic product (gdp) and employment levels (ahmed & mortaza, 2010). milton friedman, the leader of the monetarist school, argued that the classical theory, which allows money to change real variables in the short run but only nominal magnitudes in the long run, is more accurate than the keynesian theory. the notion of monetary neutrality has been the subject of extensive research over the years. however, the results have been mixed and inconclusive, with some supporting the long-run money neutrality hypothesis and others rejecting it (see, for example, (ekomie, 2013; fasanya, onakoya, & agboluaje, 2013; kamaan & nyamongo, 2014; khieu, 2014; onyeiwu, 2012; sulku, 2011). however, pakistan's economy has grown by 3.94 percent in fy2021, a significantly higher rate than in the preceding two years (-0.47 percent in fy2020 and 2.08 percent in fy2019). agriculture is the largest sector, adding 19.2% to pakistan's gdp and employing 38.5 percent of the country's labor force. agriculture is the primary source of income for more than 65-70 percent of the population. however, some studies have revealed that monetary policy plays a significant role in the agricultural sector, for example, hassen and hamdi (2020). discovered that interest rate changes had the most significant impact on the manufacturing and services sectors. in contrast, inflation had the most significant negative impact on the agriculture industry in the context of the tunisian economy. additionally, macroeconomic policy changes influence interest rates and inflation, thereby impacting the agricultural economy. changes in interest rates influence variables such as variable production costs, long-term capital investments, cash flow, land prices, and exchange rates. considering the above facts, two questions arise within the context of the economy's monetary policy implementation. does the pakistani economy's money supply affect agricultural productivity? is the long-term impact of money on pakistan's agricultural sector neutral? the study's main objective is to investigate pakistan's agriculture sector's monetary neutrality to identify a solution and find an answer to the abovementioned questions. therefore, this study makes a two-fold contribution to literature. on the one hand, it examines the effects of money supply on agricultural productivity. on the other hand, it evaluates the lmn in pakistan's agriculture sector. the sections are organized as follows: the relationship between inflation, economic growth, and monetary policy is the primary focus of the literature review in section 2. section 3 provides information about the study's data and methodology. section 4 discusses empirical data and analysis to achieve the objectives. finally, the study summarizes the findings in the last section and presents policy recommendations. 2. literature review this section offers a comprehensive review of the literature on the impacts of monetary policy on economic growth in the short and long run. the available literature shows that different econometric approaches, eras, and proxy variables have been used in various studies, and it also focuses on other nations and country groups. to examine the lmn, numerous empirical studies have highlighted the relationship between monetary policy and economic growth. for instance, jawaid, qadri, and ali (2011) analyzed annual data from 1981 to 2009 to investigate how pakistan's monetary, fiscal, and trade policies impacted the country's economic growth. their findings, based on cointegration and the error correction model (ecm), revealed a direct correlation between money supply and economic growth in the short and long run. similarly, chaudhry, qamber, and farooq (2012) studied the shortand long-term relationships among monetary policy, inflation, and economic growth in pakistan from 1972 to 2010. their results indicated that the monetary policy variable of call money had a significant longterm impact. however, utilizing the cointegration method and ecm was insignificant in the short run. additionally, kareem, afolabi, raheem, and bashir (2013) examined the influences of fiscal and monetary policies on nigeria’s economic growth from 1998 to 2008 using the ordinary least squares (ols) method and a correlation matrix. their research found that monetary factors, particularly narrow and broad money, primarily drive the growth of nigeria's economy, as indicated by the real gdp growth rate. asian journal of economics and empirical research, 2024, 11(2): 125-133 127 © 2024 by the authors; licensee asian online journal publishing group havi and enu (2014) examined the relative effects of monetary and fiscal policies on ghana's economic growth from 1980 to 2012, employing the ordinary least squares (ols) methodology. the findings demonstrate that money supply serves as an indicator of monetary policy, exhibiting a positive and statistically significant impact on ghana's economy. carare, de resende, levin, and zhang (2021) conducted an empirical study using a crosscountry panel dataset of 79 low-income countries (lics) from 1990 to 2015 to assess the impact of external shocks on real gdp growth. the study identified significant differences between low-income countries with fixed normal exchange rates and those where the central bank targets monetary aggregates or inflation. an event study was conducted to analyze the output growth of the central african franc (cfa) compared to 18 analogous countries outside the cfa zone. the study decisively rejected the monetary neutrality hypothesis, providing substantial evidence that monetary policy frameworks enhance price and macroeconomic stability in lics. unexpected devaluation occurred in january 1994; the results indicate it was significant. cyrus (2014) employed the recursive vector auto regressive (var) method to analyze the effects of monetary and fiscal policy shocks on kenyan economic development, utilizing time series data from 1997 to 2010, which differs from prior research approaches. monetary policy does not impact actual output, encompassing money supply and short-term interest rates. nevertheless, the authors identified several factors contributing to weak links, including the absence of a structural, institutional, and regulatory framework. lashkary and kashani (2011) assessed the influence of monetary variables on economic growth in iran. an econometric regression model analysis utilized a monetary approach to secondary data from 1959 to 2008. the findings indicate no significant relationship among employment, economic growth, real economic indicators, and money volume. singh, das, and baig (2015) conducted a study examining the relationship between india's money supply, production, and pricing in both the short and long terms, employing the johansen test for cointegration and the granger causality test for causation. the findings underscored the importance of variable selection in analyzing the relationship between money, output, and price. also, they found no long-term correlation between the money supply and production using quarterly or monthly data in india. numerous studies have also found a limited link between economic growth and the money supply, for example, coibion (2012). while comparing the standard var versus the most significant impacts, the impact on the us economy of monetary shocks from 1970 to 1996 was assessed using romer and romer (2004) technique (r and r). using the usual var approach, the researchers discovered that monetary policy shocks explained a tiny portion of the real-economy changes assessed by industrial production or unemployment. additionally, the researchers demonstrated the ineffectiveness of the standard var in explaining the recessions of 1980–1982 and 1990. smets and wouters (2007) developed a model for the medium-sized effects of monetary shocks on actual variables, such as dynamic stochastic general equilibrium (dsge). milani and treadwell (2012) used a small-scale dsge model. assessed the consequences of unanticipated and anticipated monetary policy shocks (2012). for us data from 1960q1 to 2009q1, likelihood-based techniques were utilized to estimate observable variables, including inflation, federal funds rate, and output gap. they also establish that unexpected shocks from monetary had a more minor and shorter-lasting influence on output than anticipated policy shocks, which have a significant, delayed, and longlasting effect. the percentage of economic growth related to monetary policy has stayed relatively low. in (2015), researchers used the vector error correction model (vecm) and quarterly data from 1996 to 2014 in malaysia to examine the long-term trend of monetary aggregates. their findings revealed that there was minimal evidence to back up malaysia's monetary neutrality perspective. hassen and hamdi (2020) it is one of the few research studies that explored how the monetary policy of the tunisian central bank affected sectoral and overall economic growth, particularly during times of crisis. they used quarterly data from 2000 to 2018 to conduct an empirical vecm analysis. over time, overall and sector economic growth is positively associated with the primary interest rate and negatively related to inflation. when they examined the effects on each activity sector independently, they found that changes in the primary interest rate highly affect manufacturing and services. moreover, inflation has a highly negative impact on the agriculture sector. most studies find the link between monetary policy and economic growth and focus on this relationship. however, this study employed an empirical technique called vecm modeling to examine the effect of money supply on agricultural productivity. this allows us to accept or reject the lmn hypothesis in the pakistani economy. furthermore, no study has yet explored this relationship in pakistan using various control factors. 3. materials and methods 3.1. data and description of variables this research aims to examine the lmn in pakistan’s agricultural sector. semi-annual time series data from 1991s1 to 2019s2 for the variables are gathered from wb (2021). hassen and hamdi (2020) used the control variables, such as inflation, labor, and capital, in their study. to examine the connection between monetary policy and the sectoral economy's growth. the table presents a list of parameters that were used in the examination: table 1. description of data. variables symbols description units dependent variable agricultural productivity agr agriculture, forestry, and fishing, value added per worker constant 2010 us$ independent variables money supply m2 broad money (monetary policy tool) % of gdp inflation inf consumer prices semi-annual % labor lfpr labor force participation rate % of the total population, ages 15-64 capital gfcf gross fixed capital formation % of gdp table 1 presents key variables related to agricultural productivity, distinguishing between one dependent variable and several independent variables. the dependent variable, agricultural productivity, is measured by the value added per worker in the agriculture, forestry, and fishing sectors, expressed in constant 2010 us dollars. the independent variables include money supply, inflation, labor force participation rate, and gross fixed capital asian journal of economics and empirical research, 2024, 11(2): 125-133 128 © 2024 by the authors; licensee asian online journal publishing group formation, each evaluated as a percentage of gdp or the population, providing insight into factors influencing agricultural productivity. 3.2. model the study methodology begins with a test of traditional linear cointegration using the vecm model based on johansen's technique, which employs the likelihood maximum (lm) to the var model, assuming that errors are allocated uniformly across samples. in its simplest form, the var model looks like this: 𝑦𝑡 = 𝐴𝑜 + 𝐴1𝑦𝑡−1 + ⋯ + 𝐴𝑘𝑦𝑡−𝑘 + 𝜀𝑡 (1) where t=1…., t, 𝐴𝑜 is the vector of constants from 𝐴1 to 𝐴𝑘 be coefficients of matrices and 𝜀𝑡 is the vector of disturbances that have serially no mutual relationship disturbances, and 0 means variances of homoscedasticity. the vector of endogenous variable is the 𝑦𝑡 . 3.3. methodology the empirical estimation of the study methods is outlined below. to start, the jarque-bera test and descriptive analysis are used to make sure the distribution is normal. after that, the augmented dickey-fuller (adf) and phillips-perron (pp) tests were used to determine the existence of the unit root. unlike the adf test, the pp test corrects the t-statistics of the coefficients of the lagged variables rather than adding the different terms of the lagged variables to account for serial correlations. the intercept and the trend have been submitted to the unit root test. the cointegration test, which was created by johansen and juselius (1990) is used to find cointegrating vectors in a set of non-stationary time series data and to look into the long-term relationship between the variables once it has been established that the variables are stationary. the null hypothesis states that there are only r cointegrating vectors, as opposed to the alternative of (r+1) cointegrating vectors. the following formula is used to compute the maximum eigenvalue statistic: 𝜆𝑚𝑎𝑥𝑖 = −𝑇𝑙𝑛(1 − 𝜆𝑟+1) a rare statistic tests the null hypothesis of r co-integrating vector against the alternative of r or more cointegrating vectors. it is given by. 𝜆𝑡𝑟𝑎𝑐𝑒 = −𝑇∑𝑙𝑛(1 − 𝜆𝑖) if one or more cointegrating vectors are found, the basic var approach only generates the expected outcomes if an error-correcting term is included in the model. consequently, a vecm takes the following form: ∆𝐴𝐺𝑅 = 𝛼1 + ∑ 𝜃1∆𝐴𝐺𝑅𝑡−𝑖 𝑚 𝑖=0 + ∑ 𝜃1∆𝐿𝑅𝑡−𝑖 𝑛 𝑖=0 + ∑ 𝜃1∆𝐼𝑁𝐹𝑡−𝑖 +𝑜 𝑖=0 ∑ 𝜃1∆𝐿𝐹𝑃𝑅𝑡−𝑖 + ∑ 𝜃1∆𝐺𝐹𝐶𝐹 + 𝜆1𝐸𝐶𝑇𝑡−1 + 𝜀𝑡 𝑞 𝑖=0 𝑝 𝑖=0 (2) under these specifications, the parameter (𝜆) of the lagged error correction term (𝐸𝐶𝑇𝑡−1) represents the longrun relation in the variables being evaluated at the equilibrium point. the akaike information criteria (aic) has been used to identify the optimal lag length for the variables to protect them from over/under parameterization problems, which can lead to bias and inefficiency in estimations. to validate the long-run equilibrium relationship in the variables, the parameter of the error correction term must be negative, statistically significant in terms of its related t-value, and smaller than one. furthermore, it analyzes the shortand long-run causal directions between the variables by using the vecm framework and the granger causality test. however, to ensure the stability of the vecm and uncover further information, several diagnostic tests are applied, including impulse response analysis and variance decomposition analysis. 4. estimation technique and empirical results 4.1. descriptive analysis table 2 provides an overview of all variables' statistics. according to the table, all mean values of the variables represent the average level seen in the data set. lfpr has the highest mean value (1723.04), whereas inf has the lowest (8.38). each series' mean-over-median ratio is approximately 1. furthermore, a range of variance between each series' maximum and minimum is proven to be adequate compared to the mean. the standard deviation illustrates how data differs from the mean. a low standard deviation shows that the data points are close to the meaning of the data set. a high standard deviation shows that the data points are spread over a broader range of values. agr, inf, and gfcf are positively skewed, while m2 is negatively skewed regarding the skewness of the variables. the kurtosis statistics of the variables show that only agr and inf exhibit leptokurtic behavior, while all other variables exhibit platykurtic behavior. combine the skewness and kurtosis measures to determine if a random variable has a normal distribution. the jarque-bera test for normality generally distributes the residuals of all the study’s variables. table 2. summary statistics. variable agr m2 inf lfpr gfcf mean 1723.048 48.623 8.387 52.902 15.607 median 1723.759 48.100 7.921 52.67 15.742 maximum 1927.92 59.036 20.286 55.08 19.129 minimum 1553.845 34.799 2.529 50.5 12.520 std. dev. 83.952 6.687 4.104 1.214 1.758 skewness 0.279 -0.154 0.601 0.102 0.189 kurtosis 3.757 2.173 3.420 2.052 2.017 jarque-bera 2.140 1.882 3.921 2.273 2.681 probability 0.342 0.390 0.140 0.320 0.261 on the other hand, correlation refers to the degree of linkage interrelation between two variables. table 3 summarizes the results of the correlation matrix. the correlation coefficients are small among all explanatory variables, ranging from 0.12 to 0.37, except for 0.67 for gfcf and lfpr. asian journal of economics and empirical research, 2024, 11(2): 125-133 129 © 2024 by the authors; licensee asian online journal publishing group table 3. results of the correlation matrix. variable agr m2 inf lfpr gfcf agr 1 m2 0.283 1 inf -0.372 0.127 1 lfpr 0.275 0.626 -0.287 1 gfcf -0.269 -0.236 0.365 -0.677 1 4.2. results of unit root test the current study is an attempt to use the adf test. dickey and fuller (1979) and the pp test (phillips & perron, 1988). to goal is to determine whether the chosen variables are stationary and to pinpoint their level of integration. table 4, which presents the tests, explains that all the variables are non-stationary at their levels but are stationary at the first difference or integrated of order me (1). table 4. unit-root test pp and adf. unit-root test (adf) variable at level at first difference with intercept and trend with intercept and trend agr -2.371 -6.485* m2 -2.759 -7.422* inf -2.298 -6.147* lfpr -3.112 -7.475* gfcf -2.288 -7.324* unit-root test (pp) variable at level at first difference with intercept and trend with intercept and trend agr -2.450 -7.550* m2 -2.508 -7.436* inf -2.298 -7.379* lfpr -3.127 -7.519* gfcf -2.530 -7.324* note: (*) indicate significance at the 1% levels, respectively. leg length is based on aic, and probability is based on mackinnon (1996) a one-sided p-value. 4.3. results of the cointegration test formulating the ideal lag number is essential to applying the johansen method. with a randomly chosen lag interval, a var model was first established with the endogenous variables agr, m2, inf, lfpr, and gfcf. the appropriate lag interval for the study was then determined by applying a lag interval determination test to the residuals. table 5 summarizes the results of this test. the order of optimal lag length is decided by using aic. table 5. lag intervals test. information criteria for selection lag logl lr fpe aic sc hq 0 -770.204 na 3483 29.252 29.438 29.324 1 -566.313 361.618 4096.417* 22.502 23.617* 22.931* 2 -558.799 11.909 8130.903 23.162 25.206 23.948 3 -517.644 57.461* 4723.407 22.552 25.526 23.696 4 -496.108 26.005 6144.502 22.683 26.586 24.184 5 -464.646 32.055 6078.337 22.439* 27.272 24.297 note: the criterion's chosen lag order is indicated by a *. fpe: final prediction error, lr: sequential modified lr test statistic (each test at 5% level), akaike information criterion (aic), schwarz information criterion (sc), and hannan-quinn information criterion (hq). in addition, the autocorrelation lm test was used to see if there was any autocorrelation in the error terms of the var model. the lm tests 𝐻𝑜show that there is no autocorrelation problem. the probability value of the fifth lag is more significant than 0.05, which means that 𝐻𝑜 cannot be rejected, indicating no autocorrelation problem. table 6 explains the results of the test. furthermore, ar roots must be smaller than 1 for the var to be stable. figure 1 illustrates the placement of all inverse roots within the unit circle. as a result of this circumstance, it was determined that the var meets the stability criteria. also, the white test was employed to see if the model had a problem of heteroscedasticity. the null hypothesis explains the homoscedasticity in the test. table 7 also presents the result of this test. the probability value is more significant than 0.05, indicating that we cannot reject the null hypothesis. in other words, it was found that there was no heteroscedasticity problem in this model. however, the cointegration relationship was tested using the johansen cointegration approach. the findings are shown in table 8. the trace and maximum eigenvalue tests give three cointegrating equations at the 5% significance level. as a result, this study attempts the vector error correction model. table 6. lm test. lag lm statistics p-value 1 15.942 0.916 2 38.373 0.042 3 16.072 0.912 4 78.418 0.000 5 9.535 0.997 6 26.735 0.369 7 7.136 0.999 8 49.903 0.002 9 5.117 1.000 10 33.421 0.120 asian journal of economics and empirical research, 2024, 11(2): 125-133 130 © 2024 by the authors; licensee asian online journal publishing group figure 1. var stability test. table 7. white test results. chi-sq df prob. 429.696 450 0.747 table 8. johansen cointegration test result. result of the cointegration test trace statistic max-eigen statistic null hypothesis value c.v (0.05) prob. null hypothesis value c.v (0.05) prob. none * 169.511 69.818 0.000 none * 94.735 33.876 0.000 at most 1 * 74.776 47.856 0.000 at most 1* 35.821 27.584 0.003 at most 2* 38.954 29.797 0.003 at most 2* 30.029 21.131 0.002 at most 3 8.925 15.494 0.372 at most 3 7.296 14.264 0.454 at most 4 1.629 3.841 0.201 at most 4 1.629 3.841 0.201 note: the rejection of the null hypothesis is denoted ∗at the 0.05 level. (*) indicates significance at the 1% levels, respectively. based on the above results, the study used three cointegration equations on the vecm. then, the granger causality test was run to find the variables' shortand long-term causality relationships. the result in table 9 indicates that m2 and agr, about our interest factors, had no significant short-run correlation. however, shortrun causality exists when moving from inf and gfcf to agr. in the long run, these findings support empirical findings from the cointegration test, indicating the existence of a cointegration relation. when the agr is the dependent variable, the parameter of the error correction term is negative, less than one, and significant at 1 percent, suggesting that there is long-run causation extending from the broad money supply, inflation, labor, and capital to agricultural production. the coefficient (-0.7317) indicates a correction of approximately 73 percent every six months for any deviation from the long-run equilibrium between the variables. table 9. granger causality results based on vecm. dv chi-square statistics of lagged, 1st difference term (p-value) ∆(𝑨𝑮𝑹) ∆(𝑴𝟐) ∆(𝑰𝑵𝑭) ∆(𝑳𝑭𝑷𝑹) ∆(𝑮𝑭𝑪𝑭) ∆(𝐴𝐺𝑅) - 8.643 (0.124) 25.680* (0.000) 3.829 (0.574) 9.796*** (0.081) ∆(𝑀2) 4.655 (0.459) - 15.319* (0.009) 17.900* (0.003) 4.611 (0.465) ∆(𝐼𝑁𝐹) 1.654 (0.894) 4.778 (0.443) - 1.481 (0.915) 4.473 (0.483) ∆(𝐿𝐹𝑃𝑅) 32.195* (0.000) 6.211 (0.286) 17.511* 0.003 - 23.606* (0.000) ∆(𝐺𝐹𝐶𝐹) 4.156 (0.527) 5.179 (0.394) 4.404 (0.492) 4.160 (0.526) - the coefficients of error correction terms [t-statistic] dv ect1 ect2 ect3 ∆(𝐴𝐺𝑅) -0.731* [-3.785] 8.576** [ 2.659] -15.949* [-3.831] ∆(𝑀2) 0.022*** [ 2.023] -0.708* [-3.840] 0.546** [ 2.292] ∆(𝐼𝑁𝐹) -0.002 [-0.152] -0.127 [-0.545] 0.012 [ 0.040] ∆(𝐿𝐹𝑃𝑅) -5.163 [-0.038] 0.019 [ 0.881] -0.020 [-0.714] ∆(𝐺𝐹𝐶𝐹) -0.003 [-0.906] 0.050 [ 0.716] -0.125 [-1.385] note: (*), (**), (***) significant at the 1%, 5%, and 10% respectively. asian journal of economics and empirical research, 2024, 11(2): 125-133 131 © 2024 by the authors; licensee asian online journal publishing group we also used diagnostic testing on vecm residuals. table 10 shows the outcomes of these tests. the table shows that the vecm residuals have no serial correlation or heteroscedasticity issues. in conclusion, the residuals of the estimated specifications pass the residual diagnostics tests, indicating the robustness of the estimation findings. table 10. residual diagnostics test results of vecm. diagnostic tests obs.*r-squared p-values 𝐿𝑀𝑆𝐶 2.780 0.249 𝑥𝐻𝐸𝑇 2 0.537 0.463 4.5. impulse response and variance decomposition results granger causality further illuminate the information that impulse response functions (irfs) provide. irfs help explain the direction of a relationship, as well as how long it takes for these effects to manifest. you can use irfs to demonstrate a dependent variable's response to an independent variable shock. as a result, figure 2 shows the agr responses to m2, inf, lfpr, and capital across 10 semi-annual time horizons. each deviation shock to the m2 appears to trigger a positive and consistent reaction in the agr, both the short and long term. this positive influence rises until the seventh period, abruptly declining. on the other hand, inf has an inverse impact on agr in both the long and short run. until the second period, the plotted impulses demonstrate that agr begins to decline. following that, it rises during period three but then begins to fall until the seventh period; after that, it suddenly rises. in response to a one-standard-deviation impulse to the lfpr, the agr decreases up to the second period and then begins to increase until the fifth period. it then begins to decline until the seventh period, then begins to rise until it reaches a stable level up to the ninth period, then it begins to rise again. similarly, a one standard deviation impulse to lfpr causes agr to decline from period two to period three, then grow until the seventh period, then fall until it reaches a stable level until the ninth period, after which it rises again. therefore, in both cases, negative and positive responses exist. as a result, the shocks to lfpr and gfcf have a symmetric impact on agr in both the short and long run. finally, we used a variance decomposition test to see how monetary policy and other factors affected agricultural productivity. variance decomposition enables us to determine the extent to which the volatility of the dependent variable explains its variability. it also illustrates the extent to which each independent factor explains the variance in the dependent variable. table 11 displays a forecasted variance decomposition of agr over 10 semi-annual time horizons. in the short term, or period two, the shock to agr accounts for 98.69% of the variance in agr (own shock). the shock to m2, inf, lfpr, and gfcf can cause 0.07, 1.08, 0.11, and 0.02 percent variations in agr, respectively. while in the long run, that is, period ten, a shock to agr accounts for 65.65% of the variation of the fluctuation in agr (own shock), m2, inf, lfpr, and gfcf can cause 3.05%, 13.43%, 3.5%, and 12.27% fluctuation to agr, respectively. broad money supply positively impacts agricultural production (measured in constant price), but the analysis disproves the lmn hypothesis in both the short and long runs. this finding is consistent with that of carare et al. (2021); havi and enu (2014) and muhammad, wasti, hussain, and lal (2009) who proved that long-term monetary policy is not neutral. in contrast, inflation has adverse shortand long-term effects on agricultural productivity. this result agrees with hassen and hamdi (2020). input prices, commodity prices, and land values impact inflation. consequently, inflation leads to a fall in agricultural productivity, whereas labor and capital have a symmetric impact. figure 2. impulse response of m2, inf, lfpr, and gfcf on agr. note: lmsc and xhet 2 represent the breusch-godfrey serial correlation lm test, and the arch test, respectively. asian journal of economics and empirical research, 2024, 11(2): 125-133 132 © 2024 by the authors; licensee asian online journal publishing group table 11. variance decomposition of agriculture per worker (apw). period agr m2 inf lfpr gfcf 1 100 0.000 0.000 0.000 0.000 2 98.693 0.078 1.089 0.113 0.024 3 87.293 0.057 1.446 3.312 7.890 4 84.285 0.104 1.158 3.423 11.028 5 81.094 0.946 2.901 3.474 11.582 6 76.831 1.194 6.893 3.771 11.308 7 71.341 2.525 10.603 3.785 11.744 8 67.626 3.056 13.439 3.599 12.277 9 65.652 3.001 15.428 3.568 12.348 10 64.252 2.943 16.794 3.659 12.349 5. conclusion and policy recommendations the current study investigates money neutrality in pakistan's agriculture sector using semi-annual data from 1991s1 to 2019s2 within the vecm framework. first, the study conducts unit root tests using adf and pp. as a result, all the variables at the first difference level were stationary. using the var technique, the study determined the optimal lag length for our equation model. we employed the johansen cointegration test in the second phase to analyze the cointegration relationship between the variables, identifying three cointegrating equations. as a result, we decided to use vecm. when agricultural productivity was the dependent variable, the coefficient of error correction term was statistically significant at 1% and had a negative sign. according to vecm analysis, equilibrium returned to normal at 73% every six months. we applied the granger causality test, based on vecm modeling, in the third phase to examine causality between the shortand long-term variables. according to granger's causality results, broad money and agricultural productivity had no short-run causal association. however, due to inflation and capital, there was short-term causality in the movement of agricultural productivity. the cointegration findings suggest and confirm that there is a long-run relationship. the present study attempts the last phase's impulse response and variance decomposition tests. the results demonstrate a positive and consistent response in both shortand long-term agricultural productivity to a one-standard-deviation shock in broad money. on the other hand, inflation has a damaging longterm and short-term impact on agricultural production. however, labor and capital shocks had symmetric effects on agricultural production in both the short and long run. as a result, our findings refute the long-run money neutrality hypothesis. the findings reveal that agricultural production is vulnerable to monetary, inflation, labor, and capital shocks. policymakers in developing countries, such as pakistan, should diversify the economy to reduce the impact of inflation shocks and boost the sector's share of gdp. as a result, the economy will be more resilient to unanticipated shocks and sustain stability for the long term. references ahmed, a. e. m., & suliman, s. z. 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(2021). world development indicators. retrieved from https://data.worldbank.org asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.1257/0002828042002651 https://data.worldbank.org/ 40 © 2025 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 12, no. 1, 40-51, 2025 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v12i1.6825 © 2025 by the authors; licensee asian online journal publishing group measuring the financial health using the altman z-score model: a case study on listed banks in bangladesh md. tamim hasan1 rownok ara2 ( corresponding author) 1department of business administration, northern university bangladesh. email: tamim.hasan@nub.ac.bd 2department of accounting and information systems, jashore university of science and technology, bangladesh. email: rownokararr@gmail.com abstract the study evaluates the financial performance of publicly listed banks in bangladesh and forecasts potential financial distress using the altman z-score model. based solely on secondary data from annual reports of the banks over the period 2018 to 2023, the analysis reveals alarming findings. across the listed banks, 34 banks scored an average z score of below the threshold level, placing them in the “financial distress zone”, indicating a likelihood of financial difficulty or potential bankruptcy in the near future. notably, 16 banks are not only scored below the threshold level and were placed in the financial distress zone but also recorded negative values, indicating a high risk of imminent financial collapsed. only two banks namely union bank and uttara bank achieved average z scores above the threshold level and were categorized in the “grey zone”, suggesting a reduced risk of financial distress in the short-term, though they should still remain conscious about their financial activities. the findings underscore the need for regulatory authorities to implement proactive measures to address financial instability within the banking sector. additionally, the results offer valuable insights for bank managers, shareholders, investors, lenders, and customers to assess and mitigate financial risks, thereby contributing to informed decisions and promoting financial stability across the industry. keywords: altman z-score, bankruptcy, banking industry, financial health, financial distress, financial risk, financial performance, financial stability. jel classification: c53; g33; g21; g32; g01. citation | hasan, m. t., & ara, r. (2025). measuring the financial health using the altman z-score model: a case study on listed banks in bangladesh. asian journal of economics and empirical research, 12(1), 40–51. 10.20448/ajeer.v12i1.6825 history: received: 30 april 2025 revised: 26 may 2025 accepted: 12 june 2025 published: 25 june 2025 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. competing interests: the authors declare that they have no competing interests. authors’ contributions: both authors contributed equally to the conception and design of the study. both authors have read and agreed to the published version of the manuscript. contents 1. introduction ...................................................................................................................................................................................... 41 2. literature review ............................................................................................................................................................................ 41 3. materials and methods ................................................................................................................................................................... 42 4. result and discussion ..................................................................................................................................................................... 43 5. conclusion ......................................................................................................................................................................................... 45 references .............................................................................................................................................................................................. 45 appendix ................................................................................................................................................................................................ 45 mailto:tamim.hasan@nub.ac.bd mailto:rownokararr@gmail.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v12i1.6825 https://orcid.org/0000-0002-7114-0348 https://orcid.org/0009-0005-9323-8839 asian journal of economics and empirical research, 2025, 12(1): 40-51 41 © 2025 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study uniquely applies altman’s z-score model to all 36 listed bangladeshi banks from 2018 to 2023, highlighting the sector’s financial distress amid the july 2024 revolution. it offers timely insights into banking vulnerabilities during a period marked by political upheaval, economic disruption, and systematic corruption. 1. introduction rapid financial integration, technological development, and demographic shifts over the past 20 years have produced both significant new difficulties and opportunities for national economies (qamruzzaman, 2014). in such a quickly changing and competitive market, banks and other financial organizations serve as the foundation of the entire economy. they offer funding for economic growth, infrastructure improvements, employment growth, and modernization. additionally, banks have a significant impact on society by influencing not only individual consumers’ spending but also the expansion of entire financial sectors (uddin & kaium, 2015). bangladeshi banking sector has recently grown in terms of the number of institutions, sophisticated financial tools, asset size, skilled human resources, etc. however, there are several reasons such as default loans, financial errors, money laundering, internal and external scams and many more, this sector of the economy has been facing enormous difficulties. as a result, the banking sector’s total performance is significantly impacted (khatun, 2018). moreover, the central bank and financial professionals in in the country are currently concerned about the stability of the financial system. at present, the stability of bangladeshi banking system and economy is of highest importance, as bangladesh is going through a lot of political instability due to the ongoing student movement in bangladesh. reportedly, the prime minister was forced to resign. in that case, people have become anxious about their savings deposited in different commercial banks in bangladesh. besides, the performance of banking sector has been worsening gradually over the years. as a consequence, the study is conducted to examine and predict the financial health of 36 listed banks of bangladesh over the period from 2018 to 2023. the study aims to evaluate the performance of the banks, forecast the banking industry’s future financial distress, assess the risk of bankruptcy, validate the altman z-score model, and forecast future distress using the altman’s z-score model. financial distress is a situation in which a business or individual is unable to generate revenue or income due to its inability to fulfill or pay its financial obligations. the final stage before bankruptcy is typically preceded by a period of financial strain. this is often caused by high fixed costs, illiquid assets, or revenue streams vulnerable to economic downturns (nath, biswas, rashid, & biswas, 2020). fisher (1936) often known as sir ronald aylmer fisher, created the linear discriminant analysis method in 1936. on the other hand, altman (1968) developed the “z-score model” for bankruptcy prediction in 1968. it is essentially a modified description of r.a. fisher’s discriminant analysis method. whether a company will file for bankruptcy within two years or not can be predicted using the z-score method. the z-score algorithm makes use of an organization’s income statement and balance sheet figures to assess its financial soundness (nath et al., 2020). this study uses altman’s z-score model to forecast the financial health of bangladesh’s banking sector. the main aim of this study is to use the altman z-score model to forecast the financial health of 36 listed banks of bangladesh over the period from 2018 to 2023. the secondary data is collected for this study. the rest of this paper is organized as follows. part 2 describes the literature review of the study. part 3 and 4 contain the research methodology, the discussions and analysis of the study. part 5 describes the summary of the study. 2. literature review the altman z-score, introduced by altman (1968), is a widely recognized and utilized model for predicting corporate bankruptcy and assessing financial health. originally developed for manufacturing firms, the z-score model has undergone various adaptations to be applicable across different industries, including the banking sector. altman’s pioneering work built upon previous research by beaver (1966) who used a univariate analysis to predict business failures. in contrast, altman’s model employs multivariate discriminant analysis, incorporating several financial ratios to improve prediction accuracy. over time, the model has been refined to better suit the changing dynamics of global financial systems. altman, haldeman, & narayanan (1977) introduced the zeta model, which extended the original z-score to predict financial distress up to five years before bankruptcy, making it highly relevant for long-term financial planning. subsequent revisions, such as the altman z-score plus, have further broadened its applicability to both public and private firms, manufacturing and non-manufacturing entities, and companies across different geographic regions (altman, 2002). in the context of banking, the z-score has proven to be a valuable tool for regulators, investors, and managers to gauge financial stability and predict distress. for instance, chieng (2013) confirmed the validity of the z-score model in predicting the future distress of european banks, demonstrating its robustness even during the financial crisis. similarly, studies on bangladeshi banks have employed the z-score to compare the financial health of conventional and shariah-compliant banks, revealing that islamic banks often exhibit higher financial stability (saha & navila, 2018). despite its widespread use, the altman z-score model is not without limitations. critics point out that the model’s reliance on accounting data, which may be subject to manipulation, and its assumption of linearity in the relationships between variables, can sometimes result in inaccurate predictions (li & rahgozar, 2012). nonetheless, the z-score remains a crucial metric in financial analysis, particularly for its simplicity and effectiveness in providing early warnings of financial distress. altman, hartzell, & peck (1995) added a constant (+3.25) to the z-score values to normalize them and make scores of zero or below “equivalent to the default situation”. a confirmatory study using eurozone banks was undertaken in 2013 to support this updated model. chieng (2013) chose four distressed banks and used data from the previous five years to demonstrate that the altman z-score model can predict future bank distress. the study’s findings supported altman z-score’s ability to predict eurozone banks’ behavior. additional research has been conducted by siskos (2014) in this regard. he concluded that utilizing altman z-score and beneish m-score, the enron’s scandal of 2001 could have been detected, which ultimately contributed to the largest business bankruptcy asian journal of economics and empirical research, 2025, 12(1): 40-51 42 © 2025 by the authors; licensee asian online journal publishing group in history (ahmed, 2015). as a result, this study applies the z-score model to evaluate the financial health of bangladeshi listed banks. parvin, rahman, and nitu (2016) compared the z-scores of state-owned commercial banks (socbs) and private commercial banks (pcbs) to predict the financial health of the banking sector using altman’s z-score model. the data shows that socbs were in better financial health than pcbs. in the empirical analysis of the liquidity, profitability, and solvency, abdullah (2015) discovered that while 22 banks were insolvent during the financial years from 2009 to 2014, only 7 banks were in a sound financial position. additionally, islamic or sariah-compliant banks performed better than conventional banks. he also noted that state-owned banks have improved compared to previous performance. mostofa, rezina, and hasan (2016) used the z score model of altman to predict the financial distress of bangladesh’s private sector banking industry and found that the model was 72% accurate at predicting bankruptcy two years in advance. however, previous studies have not been conducted on all the listed banks of bangladesh. bangladesh is currently experiencing significant financial instability due to political turmoil, as mentioned earlier. moreover, bangladeshi financial institutions, including bangladesh bank, have been facing widespread loan scams. furthermore, the stability of the financial system has become a major concern for the central bank and professionals in our country. the current priority is ensuring the stability of bangladesh’s banking system and economy, especially given the ongoing political unrest triggered by recent student movements. this situation even led to the resignation of the prime minister. in light of these circumstances, this study has been undertaken to assess and predict the financial health of 36 listed banks in bangladesh over the period from 2018 to 2023. considering all these issues, the study is conducted to predict the financial health of bangladeshi listed banks. in conclusion, the altman z-score has established itself as an essential tool in assessing the financial health and stability of banks. its continued relevance, despite evolving market conditions, underscores the model's robustness and adaptability, making it a cornerstone of financial risk assessment in the banking sector. 3. materials and methods 3.1. sample selection and data sources this study focuses on 36 banks that were listed on the dhaka stock exchange (dse) as of december 2023, covering the period from 2018 to 2023. the financial health of these banks is assessed using ratios such as working capital to total assets, retained earnings to total assets, earnings before interest and tax to total assets, and shareholders’ equity to total liabilities. most of the data was gathered from the annual reports of the banks. 3.2. variables’ definition and measurements this study adopts altman’s z-score model to assess the bankruptcy risk of the listed banks in bangladesh. the model utilizes four financial ratios, each representing a distinct aspect of a firm’s financial health. table 1 presents these independent variables, including their formulas and descriptions. financial evaluations, which primarily rely on financial statements, are among the oldest and most significant methods for assessing business performance (qamruzzaman, 2014). the main purpose of this study is to forecast the financial stability of bangladeshi banking sector. particular attention has been paid to the 36 listed banks of bangladesh. in addition, arguments presented by various authors regarding financial ratios and indicators used for bankruptcy prediction served as inspiration for this study (beaver, 1966). the four independent variables in the altman z-score model, each representing typical financial ratios, are weighted by coefficients. the following equation for insolvency or potential bankruptcy of non-manufacturing or service businesses has been examined using the altman z score model (altman, 1968). 𝐹𝑜𝑟𝑚𝑢𝑙𝑎: 𝑍 − 𝑆𝑐𝑜𝑟𝑒 𝑏𝑎𝑛𝑘𝑟𝑢𝑝𝑡𝑐𝑦 𝑚𝑜𝑑𝑒𝑙: 𝑍 = 6.56𝑋1 + 3.26𝑋2 + 6.72𝑋3 + 1.05𝑋4 where, table 1. independent variables of z-score. variable formula description x1 (current assets − current liabilities) / total assets this ratio represents the firm's liquid assets. x2 retained earnings / total assets. it displays the age and earning capacity of the company. x3 earnings before interest and taxes / total assets in addition to tax and leverage variables, it analyzes operating efficiency. it displays operating income x4 market value of equity / book value of total liabilities this ratio shows how the fair market value of a company's share has performed in relation to the book value of the outstanding loan capital. 3.3. zones of discriminations the altman z-score model categorizes banks into distinct zones based on their financial health, aiding in the assessment of bankruptcy risk. table 2 presents these zones, portraying the threshold and corresponding interpretations. table 2. indicator of z-score. sl score indicator description 1 z > 2.6 “safe” the bank is financially stable, and there is little chance that it will experience financial trouble. the bank’s financial situation is sound, it can be argued. 2 1.1 ≤ z ≤ 2.6 “grey” the bank is in the gray area, which suggests there is less chance that it may soon experience financial trouble. 3 z < 1.1 “distress” the likelihood that the bank may experience financial difficulty or possibly bankruptcy in the near future is very high. one may say that the bank is in a precarious position. asian journal of economics and empirical research, 2025, 12(1): 40-51 43 © 2025 by the authors; licensee asian online journal publishing group secondary data were collected from annual reports of the banks. the study particularly focuses on the six-year period between 2018 and 2023 using publicly available financial reports. the z-score model was used to predict the financially distressed and non-distressed banks after various financial ratios were computed for the study’s analysis. the following equation has been examined for bankruptcy or potential insolvency of non-manufacturing or service industries using the altman z score model (altman, 1968). 3.4. tool applied 𝑍 − 𝑆𝑐𝑜𝑟𝑒 𝑏𝑎𝑛𝑘𝑟𝑢𝑝𝑡𝑐𝑦 𝑚𝑜𝑑𝑒𝑙: 𝑍 = 6.56𝑋1 + 3.26𝑋2 + 6.72𝑋3 + 1.05𝑋4 • where, x1= working capital / total asset. a common metric for assessing a business’s liquidity, effectiveness, and general health is working capital. total assets display all bank assets, including shortand long-term investments. a bank’s liquidity and capacity to fulfill short-term obligations to creditors are shown by the wc/ta ratio. • x2= retained earnings / total assets. the amount of net earnings carried over to the following years is known as retained earnings. the ratio used to determine a bank’s cumulative profitability is accumulated retained earnings to total asset (ta). • x3= operating earnings / total assets. ebit, or earnings before interest and taxes, displays a bank’s operating profit. an organization’s operational efficiency is measured by ebit to total asset. the value of this ratio reveals the firm’s ability to make enough money to cover fixed obligations like interest. • x4= market value of equity / total liabilities. this ratio represents the market value of shareholders’ equity relative to total liabilities. in relation to the total liabilities, this ratio showed how the fair market value of the bank’s stock performed. a higher ratio typically indicates a stronger market perception, often reflected in increasing share prices. the higher the values of each of the four ratios required to construct the z-score, the better. it suggests that a bank’s financial health improves with higher ratios (parvin et al., 2016). beaver was a pioneer in the empirical study of bankruptcy risk; yet, the univariate structure of the model that he created is chiefly responsible for his work’s limitations. it only permits the use of one ratio at once (beaver, 1966). by adding four additional factors to the model in altman (1968) improved on beaver’s work and produced a prediction of manufacturing firm failure that was ultimately more accurate. beaver’s model and altman’s multidiscriminant analysis (mda) model differed in the financial ratios selected for optimal prediction accuracy. altman classified companies into two mutually exclusive categories: bankrupt and non-bankrupt. the zeta credit risk model was created by altman et al. (1977) as a second-generation discriminant model that “seemed to be quite accurate for up to five years prior to failure” (altman, 2002). to account for various criteria and the shifting corporate landscape, the z-score model has been revised frequently (altman, 2002). 4. result and discussion here, table 3 shows the average calculation of z score for ab bank limited and the calculation for the rest of the banks is shown in the appendix 1. table 4 shows the discriminant zones of the listed banks of bangladesh using z-score model. according to this approach, any commercial bank that receives a score higher than 2.6 should be classified as safe. however, if it doesn’t get a score of at least 1.1, it will be placed in the distress zone and more likely to be declared bankrupt. if the z score falls in the range between 1.1 and 2.6, it should be in the grey area. table 3. data analysis of ab bank limited (see appendix for the rest of the listed banks). bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. ab bank 2023 0.015 0.036 0.041 0.022 0.110 0.146 2022 0.008 0.041 0.046 0.023 0.120 2021 0.159 0.047 0.032 0.031 0.270 2020 0.006 0.056 0.023 0.028 0.110 2019 0.008 0.061 0.025 0.019 0.110 2018 0.036 0.070 0.015 0.032 0.150 the present study showed had an average z-score of less than 1.1 and are placed in the “distress zone” except 02 banks namely union bank and uttara bank. this indicates that there is a high probability of some banks becoming bankrupt in the near future. however, the average z-scores of union bank and uttara bank are 1.30 and 1.56, respectively. among 36 banks, union bank and uttara bank are placed under “grey zone”. this indicates that there is less probability of having financial trouble in near future but they also need to be cautious about their financial activities. table 4. average zscore table of 36 listed banks and their financial health. sl no. bank name year 2023 year 2022 year 2021 year 2020 year 2019 year 2018 avg. z score indicator std. dev. 1 ab bank 0.114 0.119 0.268 0.113 0.113 0.152 0.146 distress 0.061 2 al-arafah bank -2.906 0.191 1.320 -1.269 0.506 0.404 -0.293 distress 1.532 3 bank asia 0.221 0.414 0.453 0.382 0.355 0.418 0.374 distress 0.082 4 brac bank 1.108 0.853 1.236 0.623 0.796 0.919 0.922 distress 0.220 5 city bank -0.311 -0.218 -0.048 -0.216 -0.348 0.121 -0.170 distress 0.176 6 dhaka bank -1.255 -1.176 -1.101 -1.098 -0.754 -0.619 -1.000 distress 0.253 7 dutch-bangla bank 0.439 0.787 0.580 0.425 0.637 0.574 0.574 distress 0.134 8 eastern bank 0.949 0.935 1.185 0.965 0.978 0.946 0.993 distress 0.095 9 exim bank -0.669 -0.667 -0.609 -0.512 -0.447 -0.488 -0.565 distress 0.096 10 fsibl 0.272 0.316 0.307 0.254 0.333 0.174 0.276 distress 0.058 11 global islami bank 0.559 0.533 0.327 0.406 0.330 0.339 0.416 distress 0.105 asian journal of economics and empirical research, 2025, 12(1): 40-51 44 © 2025 by the authors; licensee asian online journal publishing group sl no. bank name year 2023 year 2022 year 2021 year 2020 year 2019 year 2018 avg. z score indicator std. dev. 12 icb islamic bank -6.739 -9.214 -4.684 -8.537 -5.759 -5.222 -6.692 distress 1.835 13 ific bank -0.528 -0.449 -0.068 0.062 0.080 -0.030 -0.156 distress 0.265 14 islami bank -0.358 0.365 0.294 0.428 0.450 0.493 0.279 distress 0.319 15 jamuna bank -0.797 -0.250 -0.509 -0.195 -0.019 0.522 -0.208 distress 0.449 16 mercantile bank 0.363 0.363 0.303 0.409 0.367 0.440 0.374 distress 0.047 17 midland bank -0.540 0.873 0.248 0.062 1.359 0.518 0.420 distress 0.660 18 mutual trust bank 0.283 0.398 0.336 0.317 0.199 0.246 0.296 distress 0.070 19 national bank -5.931 -1.176 0.077 0.061 0.011 -0.585 -1.257 distress 2.342 20 ncc bank 0.166 0.367 0.317 0.576 0.310 0.271 0.335 distress 0.136 21 nrb bank -1.198 -1.181 -0.789 -0.503 -0.948 -1.027 -0.941 distress 0.263 22 nrbc bank -1.708 -1.512 -1.245 -0.955 -0.282 0.387 -0.886 distress 0.798 23 one bank -1.527 -1.230 -1.065 -0.972 0.155 0.168 -0.745 distress 0.727 24 the premier bank -0.754 -0.934 -1.023 -0.930 -1.348 -1.534 -1.087 distress 0.294 25 prime bank 0.361 0.066 0.579 1.025 0.744 0.292 0.511 distress 0.344 26 pubali bank 0.600 0.549 -12.031 0.426 0.397 0.439 -1.603 distress 5.109 27 rupali bank -1.507 -1.450 -1.548 -1.389 -1.102 -0.920 -1.319 distress 0.251 28 sbac bank 0.439 0.423 0.600 0.734 0.685 0.814 0.616 distress 0.159 29 shahjalal islami bank 0.408 0.406 0.463 0.363 0.396 0.318 0.392 distress 0.049 30 social islami bank 0.178 0.208 0.181 0.188 0.210 0.243 0.201 distress 0.025 31 southeast bank -0.111 -0.404 -0.073 0.372 -0.015 -0.177 -0.068 distress 0.254 32 standard bank 0.294 0.442 0.501 0.582 0.266 0.584 0.445 distress 0.138 33 trust bank -2.038 -1.826 -1.581 -1.948 -1.494 -1.312 -1.700 distress 0.283 34 ucb 0.366 0.192 0.287 0.530 0.552 0.629 0.426 distress 0.171 35 union bank 1.293 1.363 1.149 1.374 1.644 0.997 1.303 grey 0.220 36 uttara bank 1.856 1.525 1.469 1.806 1.241 1.489 1.564 grey 0.230 note: 2.6>safe, between 1.1 to 2.6= grey, and 1.1<=distress however, the most alarming issue is that 16 banks including al-arafah bank, city bank, dhaka bank, exim bank, icb islami bank, ific bank, jamuna bank, national bank, nrb, nrbc, one bank, the premier bank, pubali bank, rupali bank, southeast bank and trust bank scored negative point while measuring the financial health. according to the zone of criteria of altman z-score, these 16 banks are not only scored below 1.1 and were placed in the financial distress zone but also received negative scores; indicating that these banks might be financially collapsed in the near future as their liquidity, overall working capital, total asset, total liabilities, market value of equity, operating earnings and retained earnings are in a precarious condition. it is surprisingly found that icb islami bank scored a z-score of -6.69 during the study period from 2018 to 2023. hence, there is a high likelihood that icb islami bank may soon become bankrupt. in that condition, immediate action should be taken by the authority of the icb islami bank to improve their financial condition. all banks were performing poorly during the study period from 2018 to 2023 in terms of financial stability as all of them scored less than 1.1 except two banks. the likelihood that all the banks may experience financial difficulty or possibly bankruptcy in the near future is very high. one may assume that all the banks are in a precarious position. the authoritative body of all the listed banks in bangladesh must be concerned about their performance. they should take necessary steps for improving their banks’ performance. otherwise, all of them might face huge financial instability in the near future. a graphical presentation of average z score and their financial health is attached below. figure 1. financial health score of 36 listed banks. this figure 1 presents the negative discriminant zone in rust and positive zone in navy blue color. rust colors banks are in very precarious position in terms of financial stability. in this case, every bank should be cautious asian journal of economics and empirical research, 2025, 12(1): 40-51 45 © 2025 by the authors; licensee asian online journal publishing group regarding their financial stability. they need to find out how to perform well and take necessary steps to fix their financial health. 5. conclusion the foundation of the economy is the banking system. as the public’s trust and confidence are essential to the banking industry, the entire financial sector would crumble if the public lacked trust and confidence in the banking sector. hence, the primary duty of banking industry is to uphold and preserve public confidence (nath et al., 2020). however, it is found that all the listed banks of bangladesh are not performing well. the result showed that there is high likelihood that the mentioned banks may fail. the overall z-scores of 34 banks are below the standard which is an indication of a strong potential for failure within a short time. all the banks should act immediately to allay concerns about their ability to continue operating. this study provides a detailed picture of the financial performance of bangladeshi listed banks. the findings show that operating effectiveness is gradually declining as a result of an excessive amount of nonperforming loans. according to mostofa et al. (2016) loans are a bank’s asset, but when they are written off as bad loans, it negatively impacts the bank’s financial performance. both financial trouble and insolvency could result from these actions. as a result, the management of these institutions needs to demonstrate managerial effectiveness while being more cautious with loan issuance. the study predicts only the financial health and bankruptcy of the listed banks in dhaka stock exchange. however, the study does not provide any indication of how banks that are placed in the financial distress zone, would be able to overcome the financial instability. hence, further research could be conducted on why these banks will keep on suffering from financial instability and which factors could help them overcome bankruptcy in the future. references abdullah, m. (2015). an empirical analysis of liquidity, profitability and solvency of bangladeshi banks. journal of business & financial affairs, 5, 157. ahmed, t. a. (2015). prediction of financial distress in banking sector of bangladesh and need for regulation by frc. journal of the cost and management, 43(1), 1817-5090. altman, e. i. (1968). financial ratios, discriminant analysis and the prediction of corporate bankruptcy. the journal of finance, 23(4), 589609. altman, e. i. (2002). revisiting credit scoring models in a basel 2 environment. salomon center for the study of financial institutions, 2(1), 2-37. altman, e. i., haldeman, r. g., & narayanan, p. (1977). zetatm analysis a new model to identify bankruptcy risk of corporations. journal of banking & finance, 1(1), 29-54. altman, e. i., hartzell, j., & peck, m. (1995). emerging markets corporate bonds: a scoring system. new york: salomon brothers inc. beaver, w. h. (1966). financial ratios as predictors of failure. journal of accounting research, 4, 71-111. chieng, j. (2013). verifying the validity of altman’s z” score as a predictor of bank failures in the case of the eurozone. doctoral dissertation, dublin, national college of ireland. fisher, r. a. (1936). the use of multiple measurements in taxonomic problems. annals of eugenics, 7(2), 179–188. khatun, f. (2018). banking sector in bangladesh: moving from diagnosis to action. centre for policy dialogue. retrieved from https://cpd.org.bd/ li, j., & rahgozar, r. (2012). application of the z-score model with consideration of total assets volatility in predicting corporate financial failures from 2000-2010. journal of accounting and finance, 12(2), 11-19. mostofa, m., rezina, s., & hasan, m. (2016). predicting the financial distress in the banking industry of bangladesh: a case study on private commercial banks. australian academy of accounting and finance review, 2(1), 1–14. nath, s. d., biswas, p. k., rashid, m. a., & biswas, m. r. (2020). financial distress prediction through altman z-score model: a case study of state owned commercial banks of bangladesh. indian journal of commerce and management studies, 11(3), 60-67. parvin, a., rahman, b., & nitu, a. a. (2016). prediction of financial health of banking industry in bangladesh using altman’s z score: a comparison between state-owned commercial banks and private commercial banks. paper presented at the proceedings of the international conference for bankers and academics, 335-344. qamruzzaman, m. (2014). predicting bankruptcy: evidence from private commercial banks in bangladesh. international journal of financial economics, 2(3), 114-121. saha, d., & navila, r. k. (2018). bankruptcy risk prediction using altman z-score model: an empirical study on private commercial banks of bangladesh. the jahangirnagar journal of business studies, 7(1), 127-136. siskos, d. (2014). detecting financial reporting fraud–lessons learned by enron corp. available at ssrn, 2390522. uddin, m. m., & kaium, m. a. (2015). financial health soundness measurement of private commercial banks in bangladesh: an observation of selected banks. the journal of nepalese business studies, 9(1), 20–36. https://cpd.org.bd/ asian journal of economics and empirical research, 2025, 12(1): 40-51 46 © 2025 by the authors; licensee asian online journal publishing group appendix appendix 1. data analysis of 36 listed banks of bangladesh using z score indicator and value. bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. ab bank 2023 0.015 0.036 0.041 0.022 0.110 0.146 2022 0.008 0.041 0.046 0.023 0.120 2021 0.159 0.047 0.032 0.031 0.270 2020 0.005 0.056 0.023 0.028 0.110 2019 0.008 0.061 0.025 0.018 0.110 2018 0.036 0.070 0.015 0.032 0.150 data analysis of ab bank limited bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. al-arafah islami bank 2023 -3.701 0.102 0.643 0.050 -2.910 -0.293 2022 0.061 0.011 0.066 0.052 0.190 2021 1.169 0.013 0.070 0.068 1.320 2020 -1.423 0.013 0.077 0.063 -1.270 2019 0.300 0.013 0.139 0.054 0.510 2018 0.189 0.018 0.125 0.071 0.400 data analysis of al-arafah islami bank bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. bank asia 2023 0.074 0.023 0.068 0.055 0.220 0.374 2022 0.242 0.020 0.095 0.057 0.410 2021 0.300 0.020 0.069 0.064 0.450 2020 0.244 0.015 0.065 0.058 0.380 2019 0.196 0.016 0.075 0.067 0.350 2018 0.227 0.018 0.101 0.072 0.420 data analysis of bank asia bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. brac bank 2023 0.795 0.129 0.103 0.081 1.110 0.922 2022 0.508 0.145 0.095 0.105 0.850 2021 0.806 0.163 0.088 0.179 1.240 2020 0.260 0.117 0.093 0.153 0.620 2019 0.354 0.120 0.121 0.201 0.800 2018 0.376 0.121 0.162 0.259 0.920 data analysis of brac bank bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. city bank 2023 -0.567 0.071 0.132 0.052 -0.310 -0.170 2022 -0.449 0.052 0.122 0.057 -0.220 2021 -0.340 0.063 0.151 0.078 -0.050 2020 -0.459 0.049 0.121 0.074 -0.220 2019 -0.605 0.027 0.162 0.068 -0.350 2018 -0.145 0.021 0.144 0.102 0.120 data analysis of city bank bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. dhaka bank 2023 -1.383 0.019 0.072 0.037 -1.250 -1.000 2022 -1.315 0.023 0.076 0.040 -1.180 2021 -1.252 0.022 0.085 0.044 -1.100 2020 -1.231 0.023 0.070 0.040 -1.100 2019 -0.957 0.018 0.145 0.040 -0.750 2018 -0.846 0.017 0.163 0.047 -0.620 data analysis of dhaka bank bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. dutch-bangla bank 2023 0.067 0.158 0.130 0.085 0.440 0.574 asian journal of economics and empirical research, 2025, 12(1): 40-51 47 © 2025 by the authors; licensee asian online journal publishing group 2022 0.458 0.132 0.107 0.089 0.790 2021 0.236 0.118 0.106 0.120 0.580 2020 0.100 0.102 0.137 0.085 0.430 2019 0.307 0.088 0.128 0.113 0.640 2018 0.262 0.087 0.131 0.094 0.570 data analysis of dutch-bangla bank bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. eastern bank 2023 0.657 0.083 0.129 0.079 0.950 0.993 2022 0.651 0.078 0.121 0.084 0.930 2021 0.853 0.079 0.146 0.107 1.190 2020 0.646 0.086 0.133 0.099 0.960 2019 0.704 0.058 0.126 0.091 0.980 2018 0.671 0.057 0.111 0.106 0.950 data analysis of eastern bank bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. exim bank 2023 -0.772 0.012 0.062 0.029 -0.670 -0.565 2022 -0.789 0.012 0.079 0.031 -0.670 2021 -0.708 0.011 0.051 0.038 -0.610 2020 -0.640 0.016 0.074 0.039 -0.510 2019 -0.577 0.017 0.076 0.037 -0.450 2018 -0.633 0.020 0.077 0.049 -0.490 data analysis of exim bank bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. first security islami bank 2023 0.188 0.005 0.062 0.017 0.270 0.276 2022 0.232 0.005 0.060 0.018 0.320 2021 0.203 0.005 0.073 0.026 0.310 2020 0.164 0.006 0.065 0.019 0.250 2019 0.057 0.007 0.061 0.208 0.330 2018 0.085 0.008 0.056 0.025 0.170 data analysis of first security islami bank bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. global islami bank 2023 0.396 0.027 0.080 0.056 0.560 0.416 2022 0.349 0.033 0.088 0.063 0.530 2021 0.250 0.024 0.013 0.039 0.330 2020 0.249 0.018 0.100 0.039 0.410 2019 0.222 0.007 0.055 0.045 0.330 2018 0.205 0.017 0.071 0.046 0.340 data analysis of global islami bank bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. icb islamic bank limited 2023 -0.428 -6.118 -0.353 0.160 -6.740 -6.692 2022 -3.113 -6.106 -0.161 0.166 -9.210 2021 0.804 -5.414 -0.228 0.154 -4.680 2020 -3.103 -5.455 -0.109 0.131 -8.540 2019 -0.192 -5.410 -0.249 0.093 -5.760 2018 0.112 -5.200 -0.284 0.150 -5.220 data analysis of icb islamic bank limited bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. ific bank 2023 -0.676 0.050 0.054 0.044 -0.530 -0.156 2022 -0.616 0.046 0.071 0.049 -0.450 2021 -0.272 0.040 0.085 0.079 -0.070 2020 -0.096 0.038 0.042 0.078 0.060 2019 -0.118 0.050 0.096 0.052 0.080 asian journal of economics and empirical research, 2025, 12(1): 40-51 48 © 2025 by the authors; licensee asian online journal publishing group 2018 -0.206 0.049 0.069 0.058 -0.030 data analysis of ific bank bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. islami bank bangladesh 2023 -0.447 0.005 0.056 0.028 -0.360 0.279 2022 0.273 0.005 0.055 0.032 0.360 2021 0.204 0.005 0.048 0.037 0.290 2020 0.333 0.006 0.053 0.036 0.430 2019 0.315 0.007 0.085 0.044 0.450 2018 0.324 0.007 0.095 0.067 0.490 data analysis of islami bank bangladesh bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. jamuna bank 2023 -0.980 0.026 0.094 0.062 -0.800 -0.208 2022 -0.428 0.036 0.078 0.064 -0.250 2021 -0.728 0.040 0.103 0.076 -0.510 2020 -0.415 0.031 0.121 0.068 -0.200 2019 -0.235 0.022 0.130 0.064 -0.020 2018 0.325 0.022 0.107 0.067 0.520 data analysis of jamuna bank bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. mercantile bank 2023 0.264 0.012 0.046 0.041 0.360 0.374 2022 0.250 0.014 0.056 0.043 0.360 2021 0.148 0.018 0.082 0.055 0.300 2020 0.295 0.015 0.057 0.042 0.410 2019 0.232 0.015 0.075 0.044 0.370 2018 0.264 0.013 0.098 0.065 0.440 data analysis of mercantile bank bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. midland bank 2023 -0.807 0.034 0.103 0.130 -0.540 0.420 2022 0.661 0.013 0.092 0.107 0.870 2021 0.005 0.014 0.110 0.119 0.250 2020 -0.204 0.024 0.102 0.140 0.060 2019 1.038 0.021 0.134 0.166 1.360 2018 0.138 0.030 0.162 0.188 0.520 data analysis of midland bank bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. mutual trust bank 2023 0.130 0.041 0.065 0.046 0.280 0.296 2022 0.254 0.035 0.061 0.047 0.400 2021 0.163 0.037 0.078 0.058 0.340 2020 0.171 0.026 0.046 0.074 0.320 2019 0.013 0.029 0.081 0.076 0.200 2018 0.036 0.032 0.077 0.101 0.250 data analysis of mutual trust bank bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. national bank 2023 -5.579 -0.152 -0.252 0.052 -5.930 -1.257 2022 -0.732 -0.052 -0.450 0.058 -1.180 2021 -0.022 0.044 0.011 0.045 0.080 2020 -0.079 0.013 0.083 0.045 0.060 2019 -0.167 0.019 0.105 0.054 0.010 2018 -0.786 0.021 0.115 0.065 -0.580 data analysis of national bank bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. ncc bank 2023 -0.004 0.017 0.102 0.052 0.170 0.335 asian journal of economics and empirical research, 2025, 12(1): 40-51 49 © 2025 by the authors; licensee asian online journal publishing group 2022 0.180 0.016 0.116 0.055 0.370 2021 0.129 0.021 0.104 0.064 0.320 2020 0.393 0.020 0.105 0.059 0.580 2019 0.136 0.022 0.104 0.049 0.310 2018 0.091 0.017 0.097 0.066 0.270 data analysis of ncc bank bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. nrb bank 2023 -1.442 0.039 0.109 0.096 -1.200 -0.941 2022 -1.385 0.042 0.063 0.099 -1.180 2021 -0.985 0.016 0.069 0.111 -0.790 2020 -0.747 0.028 0.116 0.100 -0.500 2019 -1.029 -0.001 -0.015 0.097 -0.950 2018 -1.254 0.034 0.089 0.104 -1.030 data analysis of nrb bank bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. nrbc bank 2023 -1.902 0.039 0.083 0.071 -1.710 -0.886 2022 -1.735 0.036 0.110 0.078 -1.510 2021 -1.575 0.043 0.143 0.143 -1.250 2020 -1.279 0.037 0.121 0.167 -0.950 2019 -0.652 0.037 0.153 0.179 -0.280 2018 -0.038 0.041 0.157 0.227 0.390 data analysis of nrbc bank bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. one bank 2023 -1.613 0.017 0.034 0.034 -1.530 -0.745 2022 -1.326 0.016 0.048 0.032 -1.230 2021 -1.142 0.013 0.035 0.030 -1.060 2020 -1.059 0.019 0.041 0.027 -0.970 2019 0.057 0.018 0.057 0.024 0.150 2018 0.066 0.016 0.060 0.026 0.170 data analysis of one bank bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. the premier bank plc 2023 -0.918 0.037 0.082 0.044 -0.750 -1.087 2022 -1.120 0.035 0.106 0.044 -0.930 2021 -1.213 0.037 0.103 0.049 -1.020 2020 -1.086 0.040 0.078 0.038 -0.930 2019 -1.561 0.047 0.116 0.050 -1.350 2018 -1.745 0.038 0.118 0.054 -1.530 data analysis of the premier bank plc bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. prime bank plc 2023 0.139 0.070 0.095 0.057 0.360 0.511 2022 -0.143 0.056 0.096 0.057 0.070 2021 0.366 0.043 0.099 0.071 0.580 2020 0.853 0.034 0.075 0.064 1.020 2019 0.562 0.020 0.090 0.073 0.740 2018 0.101 0.020 0.092 0.079 0.290 data analysis of prime bank plc bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. pubali bank plc 2023 0.368 0.095 0.100 0.037 0.600 -1.603 2022 0.337 0.085 0.084 0.042 0.550 2021 -12.218 0.076 0.061 0.049 -12.030 2020 0.242 0.065 0.070 0.049 0.430 2019 0.206 0.058 0.074 0.058 0.400 asian journal of economics and empirical research, 2025, 12(1): 40-51 50 © 2025 by the authors; licensee asian online journal publishing group 2018 0.236 0.034 0.098 0.071 0.440 data analysis of pubali bank plc bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. rupali bank plc 2023 -1.542 0.003 0.012 0.020 -1.510 -1.319 2022 -1.478 0.003 0.007 0.018 -1.450 2021 -1.583 0.003 0.009 0.023 -1.550 2020 -1.418 0.004 0.005 0.020 -1.390 2019 -1.152 0.004 0.013 0.032 -1.100 2018 -0.967 0.004 0.011 0.032 -0.920 data analysis of rupali bank plc bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. sbac bank plc 2023 0.261 0.010 0.082 0.086 0.440 0.616 2022 0.233 0.012 0.084 0.095 0.420 2021 0.376 0.023 0.067 0.133 0.600 2020 0.460 0.025 0.104 0.145 0.730 2019 0.381 0.024 0.140 0.139 0.680 2018 0.477 0.027 0.156 0.154 0.810 data analysis of sbac bank plc bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. shahjalal islami bank plc 2023 0.191 0.017 0.135 0.065 0.410 0.392 2022 0.179 0.017 0.144 0.067 0.410 2021 0.263 0.017 0.105 0.079 0.460 2020 0.181 0.013 0.083 0.085 0.360 2019 0.197 0.012 0.097 0.091 0.400 2018 0.119 0.012 0.081 0.106 0.320 data analysis of shahjalal islami bank plc bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. social islami bank plc 2023 0.082 0.011 0.056 0.029 0.180 0.201 2022 0.104 0.012 0.060 0.032 0.210 2021 0.081 0.011 0.049 0.039 0.180 2020 0.091 0.009 0.054 0.035 0.190 2019 0.100 0.010 0.061 0.039 0.210 2018 0.104 0.010 0.085 0.045 0.240 data analysis of social islami bank plc bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. southeast bank plc 2023 -0.205 0.011 0.046 0.038 -0.110 -0.068 2022 -0.504 0.009 0.052 0.039 -0.400 2021 -0.169 0.011 0.044 0.042 -0.070 2020 0.281 0.009 0.046 0.036 0.370 2019 -0.153 0.027 0.070 0.042 -0.010 2018 -0.333 0.025 0.082 0.049 -0.180 data analysis of southeast bank plc bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. standard bank plc 2023 0.188 0.007 0.057 0.042 0.290 0.445 2022 0.345 0.007 0.044 0.045 0.440 2021 0.396 0.010 0.041 0.055 0.500 2020 0.462 0.010 0.066 0.043 0.580 2019 0.121 0.015 0.086 0.044 0.270 2018 0.417 0.015 0.073 0.078 0.580 data analysis of standard bank plc bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. trust bank limited 2023 -2.228 0.033 0.092 0.066 -2.040 -1.700 asian journal of economics and empirical research, 2025, 12(1): 40-51 51 © 2025 by the authors; licensee asian online journal publishing group 2022 -2.033 0.027 0.109 0.071 -1.830 2021 -1.776 0.032 0.092 0.071 -1.580 2020 -2.128 0.030 0.083 0.067 -1.950 2019 -1.692 0.028 0.107 0.063 -1.490 2018 -1.519 0.025 0.106 0.077 -1.310 data analysis of trust bank limited bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. united commercial bank plc 2023 0.257 0.030 0.049 0.029 0.370 0.426 2022 0.069 0.031 0.059 0.032 0.190 2021 0.153 0.034 0.062 0.039 0.290 2020 0.382 0.038 0.071 0.039 0.530 2019 0.399 0.037 0.077 0.039 0.550 2018 0.457 0.034 0.085 0.052 0.630 data analysis of united commercial bank plc bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. union bank plc 2023 1.161 0.024 0.074 0.034 1.290 1.303 2022 1.225 0.027 0.076 0.037 1.360 2021 1.037 0.025 0.062 0.025 1.150 2020 1.250 0.023 0.071 0.030 1.370 2019 1.527 0.027 0.055 0.035 1.640 2018 0.846 0.027 0.079 0.044 1.000 data analysis of union bank plc bank name year 6.56 x1 3.26 x2 6.72 x3 1.05 x4 z avg. uttara bank plc 2023 1.596 0.035 0.153 0.071 1.860 1.564 2022 1.284 0.032 0.140 0.070 1.520 2021 1.266 0.027 0.108 0.068 1.470 2020 1.608 0.023 0.113 0.062 1.810 2019 1.021 0.025 0.130 0.066 1.240 2018 1.287 0.030 0.104 0.068 1.490 data analysis of uttara bank plc asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 30 © 2024 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 11, no. 1, 30-43, 2024 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v11i1.5797 © 2024 by the authors; licensee asian online journal publishing group the time-varying impact of us monetary policy spillovers on small open economies: evidence from indonesia saba ndayezhin danladi1 aliyu rafindadi sanusi2 ( corresponding author) 1,2department of economics, abu business school, ahmadu bello university-zaria, nigeria. 1email: danladinsaba@gmail.com 2email: aliyurafindadiz@yahoo.com abstract this study examines the impact of the us monetary policy spillover on indonesia’s macroeconomic and financial variables using quarterly data for the period 2000–2020 for both domestic and us variables. the study uses a bayesian form of a time-varying parameter (tvp) vector autoregressive (var) model with stochastic volatility to look at how real gdp, inflation, the exchange rate, the stock market return, and the monetary policy rate react to a shock in us monetary policy. we find that us monetary policy spillovers, on average, boost indonesia’s real gdp, stock market returns, and bilateral exchange rate vis a vis the us dollar but also trigger domestic inflation beyond what indonesia’s policy reaction could counteract. however, there are significant differences between the variables' responses to easing and tightening shocks, on the one hand, and conventional vs. unconventional monetary policy, on the other. finally, we found substantial time variation corresponding to major global events, including the global financial crisis and implementation of unconventional monetary policy, the taper tantrum of 2013–2014, and the severe lockdown in the wake of the covid-19 pandemic in 2019–2020. these findings underscore the importance for policymakers in indonesia to closely monitor and anticipate the impact of us monetary policy spillovers on domestic macroeconomic variables. this knowledge can inform more effective policy responses and risk management strategies to safeguard economic stability and promote sustainable growth. keywords: indonesia, macroeconomic variables, monetary policy spillover, small open economy, time-varying var, us. jel classification: f33; f41; f42. citation | danladi, s. n., & sanusi, a. r. (2024). the time-varying impact of us monetary policy spillovers on small open economies: evidence from indonesia. asian journal of economics and empirical research, 11(1), 30–43. 10.20448/ajeer.v11i1.5797 history: received: 1 april 2024 revised: 6 may 2024 accepted: 24 may 2024 published: 10 july 2024 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. data availability statement: the corresponding author may provide study data upon reasonable request. competing interests: the authors declare that they have no competing interests. authors’ contributions: both authors contributed equally to the conception and design of the study. both authors have read and agreed to the published version of the manuscript. contents 1. introduction ...................................................................................................................................................................................... 31 2. stylized facts .................................................................................................................................................................................... 32 3. data and methodological framework ......................................................................................................................................... 33 4. results and discussions .................................................................................................................................................................. 35 5. robustness of the results .............................................................................................................................................................. 41 6. conclusion ......................................................................................................................................................................................... 42 references .............................................................................................................................................................................................. 42 mailto:danladinsaba@gmail.com mailto:aliyurafindadiz@yahoo.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v11i1.5797 https://orcid.org/0009-0003-5229-4514 https://orcid.org/0000-0003-0735-2159 asian journal of economics and empirical research, 2024, 11(1): 30-43 31 © 2024 by the authors; licensee asian online journal publishing group contribution of this paper to the literature first, we employ a consistent measure of us monetary policy to estimate dynamic effects over time. secondly, we differentiate between easing and tightening cycles, as well as conventional and unconventional policy eras. lastly, we incorporate time-varying parameters to study the complex dynamics of us monetary policy spillovers on the indonesian economy. 1. introduction economic theory widely accepts the use of monetary policy to influence domestic output and prices in the short run, and empirical monetary and macroeconomic literature well documents its effectiveness. however, these dynamics have been put into question following the global financial crises (gfcs) in 2008 and the implementation of unconventional monetary policy (ump) in the us and other advanced economies (aes) in the wake of the crisis. the spillover from ump, such as quantitative easing (qe) and forward guidance, has increased the complexity of the conduct of monetary policy across the globe. this is especially motivated for small open economies (soes) with strong trade and financial ties with aes. while monetary policy has always had spillover effects, recent decades have amplified the uncertainties and risks surrounding these effects (danladi, 2022). a better understanding of these dynamics is crucial for understanding how monetary policy works and for the efficient conduct of monetary policy. while there has been a renewed interest in studying the transmission of foreign shocks to emerging market economies in recent decades, surprisingly, fewer research efforts that specifically answer these questions for the indonesian macro-economy have been made. to provide additional insight, this study examines the propagation of us monetary policy shocks to indonesia's economy. our choice of the us and indonesia is largely motivated by the rising trade and financial ties between indonesia and aes, including the us (see figure 1 and 2 in section 2 below). over the years, indonesia's financial markets have been exposed to capital flows driven by the global financial cycle and fluctuations in exchange rates. these and other factors have contributed to the inclusion of indonesia in the "fragile five” in recent times (see shin (2014)). several investment and policy concerns can also be highlighted for our choice of the indonesian economy. from a policy point of view, since monetary policy spillovers from the core economies can substantially limit the effectiveness of domestic monetary policy in soes (cao & dinger, 2022), the effect of monetary policy spillovers from the us, if not well understood and managed, could complicate domestic monetary policy challenges for indonesia. this can endanger capital flows in the form of capital reversal or at least a sudden stop in capital inflows (see (bundesbank, 2020; gajewski et al., 2019)). the risk of losing monetary policy autonomy (a situation where authorities adjust rates in addition to the desire to keep domestic inflation or output under control) can be costly. portfolio investors, who are mostly risk-averse agents, are always concerned about how much build-up risk may affect their investment as they rebalance their portfolios towards the soes. studying indonesia's economy allows us to make small open-economy assumptions and study the dynamics of such propagation. this study makes three contributions to the existing literature. first, we focus on estimating the dynamic effects of us monetary policy shocks using a consistent measure of us monetary policy over time. second, we disentangled the shock series into easing and tightening cycles, on the one hand, and partitioned the dataset into conventional and unconventional monetary policy eras, on the other. these allow us to understand how the indonesian economy responded to us monetary policy easing and tightening cycles, as well as conventional and unconventional monetary policy eras. third, we consider a variant of the structural var (svar) model that features time variation in the parameters to ascertain whether the transmission has changed over time. over the years, prominent issues that have beset this area of research include, among others: finding an appropriate policy variable to identify the monetary policy that correctly accounts for zero lower bounds and widely implemented ump; dealing with possible structural breaks and nonlinearities occasioned by major domestic and global events in the recent past; and controlling for the outside world. to solve these problems, we use krippner (2020) short shadow rate (ssr) as a stand-in for the monetary policy rate and build a block-exogenous time-varying parameter-vector autoregressive (tvp-var) model. our approach consists of three steps. first, we use the structural vector autoregression (svar) model, which has parameters that change over time and stochastic volatility, to figure out how the us monetary policy shock affected indonesia's most important macroeconomic and financial variables. second, we extended the benchmark var by replacing the us monetary policy shock with us positive and negative shocks, which we disentangled using an asymmetric nonlinear autoregressive distributive lag (ardl) model. this allowed us to compare the effects of us monetary policy tightening and easing cycles on indonesian macroeconomic and financial variables. finally, we partitioned the dataset into a conventional era when the policy rate was the main tool in the us and an ump era when the policy rate was at zero lower bound (zlb) and the economic slacks persisted. we then compared their effects on the selected variables for the indonesian economy. the study finds that us monetary policy spillovers, on average, boost indonesia’s real gdp, stock market returns, and bilateral exchange rate vis-à-vis the us dollar and trigger inflation beyond what the corresponding policy reaction could counteract. however, decomposing the shock into easing and tightening shocks reveals significant differences. we find that the effect of us monetary policy shocks on real gdp, the exchange rate, and the policy rate is asymmetric, as the variables appreciate in response to tightening and easing shocks. conversely, we find a symmetrical effect on inflation and stock market returns. indonesia’s inflation responded positively to us monetary policy tightening shocks and negatively to easing shocks. stock market returns responded positively to us monetary policy easing shocks and negatively to tightening, respectively. we also found that macroeconomic variables responded differently to us conventional and ump shocks. while real gdp and inflation responded positively to us conventional monetary policy shocks, ump shocks, on the other hand, depressed both gdp and inflation. the exchange rate appreciates in response to us ump shocks and depreciates in response to conventional monetary policy shocks. while stock market returns responded positively to both shocks, the response to ump was stronger and longer. to stimulate declining output, policy rates rise in response to conventional monetary policy shocks and fall in response to ump shocks. finally, we also found substantial time variation in the effects corresponding to major global events, including the gfc and implementation of ump, the taper tantrum of 2013–2014, and the great lockdown in the wake of the covid-19 pandemic in 2019– 2020. our findings are robust to alternative uses of effective federal fund rates to identify us monetary policy. while the irfs for the full sample and ump sub-sample are significantly different from the baseline model, the irfs for asian journal of economics and empirical research, 2024, 11(1): 30-43 32 © 2024 by the authors; licensee asian online journal publishing group the conventional monetary policy sample are quite similar. the only difference is in the exchange rate variable. our findings have implications that encourage further research. our analysis only considered monetary policy spillovers from the us to indonesia. this is an important starting point. the next extension is to consider other advanced economies with strong trade and financial ties with indonesia, such as japan and the euro area. we couldn't include them here, as we leave this significant gap for future research. we organized the rest of the study as follows: in section 2, we present some stylized facts about the indonesian economy. in section 3, we describe the methodology and data that are deployed in this paper. in section 4, we present the results. section 5 shows how our results are robust to alternative measurements of the us monetary policy stance. section 6 concludes the paper. 2. stylized facts 2.1. motivation for the choice of us figure 1 represents foreign portfolio investment (fpi) from aes to indonesia over the sample period (2000– 2020). the figure on the left-hand side shows that over the sample period, the magnitude of fpi from aes to indonesia generally increases in absolute terms. this suggests increasing interconnectedness between indonesia and the aes on the one hand and significant vulnerability to foreign shocks on the other. comparing the fpi from the aes to indonesia, the figure on the right-hand panel indicates that the us has the largest fpi, followed by the euro area, the uk, japan, and canada. china, italy, australia, and france had the least fpi in indonesia during the period under review. this justifies the us's decision to conduct this study. figure1. magnitude of portfolio inflows from aes to indonesia 2000-2020. source: computed from imf consolidated portfolio investment survey. figure 2 shows that portfolio investment flow from the us to indonesia has increased substantially over the years. however, the flows featured occasional declines, depicting major events in the us. for example, we can see a decline in us portfolio flows in 2008, presumably due to uncertainties surrounding the first round of quantitative easing in the us. up until 2013, taper tantrums mainly caused a decline in the flow. the flow rose in 2014 and fell again in 2015, following a 25 basis point hike in the federal fund rate for the first time since 2008. after reaching its peak in 2017, the flow declined in 2018 and rose again in 2019, followed by another decline, arguably due to the great lockdown in 2020. figure 2. portfolio investment from the us to indonesia. source: computed from imf consolidated portfolio investment survey. asian journal of economics and empirical research, 2024, 11(1): 30-43 33 © 2024 by the authors; licensee asian online journal publishing group figure 3. trade between the united states and indonesia 2000 -2020. figure 3 also shows that the trade relationship (measured in terms of exports and imports) between the united states and indonesia increased on average over the years. however, there has been considerable fluctuation. for example, the trade value in 2009 declined compared to 2008 and 2010. we also observed a similar decline in 2012 and 2016. the observed trend affected both import and export volumes. 2.2. shadow rate as a consistent measure of monetary policy stance figure 4 shows the estimated us shadow rate and fed federal fund rate (fffr) from 2000 to 2020. at first glance, the shadow rate closely resembles the ffr during the conventional monetary policy era (from 2000 to 2008). this boosts our confidence in using the shadow rate to measure monetary policy stances. furthermore, between 2008 and 2016, it can be observed that while the fffr remained at zero, suggesting zero lower bound (zlb), the shadow rate, on the other hand, turned negative, reflecting the unconventional monetary policy (ump) measures implemented by the us fed in the wake of the global financial crisis (gfc). the us fed hiked the policy rate by 25 basis points once per year after it remained at zlb until 2015. in 2017, the fed raised the rate three times, and in 2018, the rate was raised four times. however, the covid-19 pandemic forced the fed to cut the policy rate three times in 2019 to stimulate the economy and bring it back to another round of zlb. we can describe this phase as the period of policy normalization, where we adjusted the policy rate in response to economic dynamics. figure 4. trend of us fed-shadow rate & federal fund rate. 3. data and methodological framework 3.1. data to identify us monetary policy shocks, we utilized quarterly data from 2000q1 to 2020q4 on the industrial production index (ipi), consumer price index (cpi), and us shadow policy rate. we extracted the ipi and cpi from the international financial statistics of the international monetary fund (imf) and used alternative variables. namely, real gross domestic product (rgdp), gdp deflator, and effective federal fund rate (ffr) were obtained asian journal of economics and empirical research, 2024, 11(1): 30-43 34 © 2024 by the authors; licensee asian online journal publishing group from the federal reserve bank of st. louis (fred). we take the shadow rate provided by krippner (2020) as our measure of monetary policy to account for zlb and the entire stimulus occasioned by ump implemented in the wake of gfc. to conduct our empirical analysis, we utilized quarterly data from 2000q1 to 2020q4 for the indonesian economy to examine the spillover effects of us monetary policy shocks. the dataset used for this purpose consists of indonesia's rgdp, cpi, bilateral exchange rate, stock market index, and short-term monetary policy rate (mpr). the alternative variables used were the 3-monthly inter-bank rate, ipi, and gdp deflator. we obtained the data from the international financial statistics of the imf, fred, and bank indonesia databases. rgdp, ipi, cpi, and stock market index were transformed to their respective growth rates, computed as 100*log (series/series (-1). the global oil price obtained from the fred database is used in this study to control for global factor. 3.2. methodological framework the current study builds on the work of salisu and gupta (2021) and mumtaz and theodoridis (2020) by estimating a structural vector-autoregressive model with time-varying parameters and stochastic volatility (tvpsvar-sv model) to show how monetary policy changes in the us affect the indonesian economy. the behavioral model is of the following form: 𝑦𝑖𝑡 = 𝑎0,𝑖𝑡 + ∑𝛽𝑖,𝑡 𝑝 𝑘=1 𝑦𝑡−𝑘 + ∑γ𝑖,ℓ 𝑃∗ ℓ=0 𝜒𝑖,𝑡−ℓ + ∑φ𝑖ℓ 𝑞 ℓ=0 ℎ̃𝑡−ℓ + ω𝑖𝑡 1/2 𝑒𝑖𝑡, e𝑖𝑡 ↔ 𝑁(0,1), (1) where the vectors of endogenous variables for the indonesia economy in period t are given by 𝑦𝑖,𝑡 = (𝑅𝑒 𝑎 𝑙 𝐺𝐷𝑃𝑡 , inf𝑡, mpr𝑡, smr𝑡, exr𝑡) (1.1) similarly, 𝑋𝑖𝑡is a vector of weekly exogenous variables, in this case, us monetary policy shock and global oil prices as a measure of us monetary policy spillover and global factor respectively. x𝑖,𝑡 = (𝑀𝑃𝑅𝑡 𝑈𝑆, 𝑂𝑖𝑙𝑃𝑡 𝑈𝑆) (1.2) in equation 1 𝛼0,𝑖𝑡denotes intercepts and a vector of time-varying coefficients of constants for each i,𝑦𝑖𝑡 which denotes a vector of indonesia’s endogenous variables used in this study. this comprises both macroeconomic and financial variables of interest defined as real gross domestic product (rgdp), domestic cpi inflation (inf), domestic monetary policy rate (mpr), stock market returns (smr), and exchange rate (exr). xit represents the vector of exogenous variables that control for external shocks (us monetary policy spillover and global oil prices). a crucial variable is our choice of mprus. our primary measure of us monetary policy is the us shadow rate, as provided by krippner. the shadow rate is derived from an estimated term structure model. one major pro of this measure of monetary policy is that it is used as a single indicator across monetary policy regimes, i.e., for both the period before the zlb became binding and after (tillmann, kim, & park, 2019). thℎ̄𝑖𝑡 = [ℎ1𝑡, ℎ2𝑡 , . . . , ℎ𝑁𝑡] is refers to vectors of stochastic volatilities of the structural shocks in the var. the𝛽, 𝛤and 𝛷 are the time-varying coefficients of endogenous lag variables, lag exogenous variable, and volatility of the structural shocks, respectively. the subscripts i = 1, 2,…, n, t = 1,…, t denotes time, and k is the optimal lag length of the var model to be chosen with the aid of the schwarz information criterion (sic). the time-subscripts t attached to the coefficients in equation 1 indicates that the coefficients are time-varying and not constant. ω𝑖𝑡 = 𝐴 −1𝐻𝑖𝑡𝐴 −1′ . (2) equation 2 is a vector of random disturbances with𝐻 being a diagonal matrix of orthogonalized volatility shocks and𝐴 a matrix of contemporaneous effects. hence, the time-varying matrices 𝐻𝑖𝑡and a in equation 2 are given by 𝐻𝑡 = ( 𝑒𝑥𝑝( ℎ1𝑡) 0 0 0 0 0 0 0 𝑒𝑥𝑝( ℎ2𝑡) 0 0 0 0 0 0 0 𝑒𝑥𝑝( ℎ3𝑡) 0 0 0 0 0 0 0 𝑒𝑥𝑝( ℎ4𝑡) 0 0 0 0 0 0 0 𝑒𝑥𝑝( ℎ5𝑡) 0 0 0 0 0 0 0 𝑒𝑥𝑝( ℎ6𝑡) 0 0 0 0 0 0 0 𝑒𝑥𝑝( ℎ7𝑡)) ( 𝜀𝑡 oilp 𝜀𝑡 mprsus 𝜀𝑡 rgdp 𝜀𝑡 inf 𝜀𝑡 mpr 𝜀𝑡 smr 𝜀𝑡 exr ) (3) the structure of the a (the structural matrix) is carefully chosen to model the contemporaneous relationship among the reduced-form shocks. the choice of the structure of the a matrix is of the form: 𝐴 = ( ∆𝑂𝐼𝐿𝑃𝑡 ∆𝑀𝑃𝑅𝑡 𝑈𝑆 ∆𝑅𝐺𝐷𝑃𝑡 ∆𝐼𝑁𝐹𝑡 ∆𝑀𝑃𝑅𝑡 ∆𝑆𝑀𝑅𝑡 ∆𝐸𝑋𝑅𝑡 ) = ( 1 0 0 0 0 0 0 �̃�2,1 1 0 0 0 0 0 �̃�3,1 �̃�3,2 1 0 0 0 0 �̃�4,1 �̃�4,2 �̃�4,3 1 0 0 0 �̃�5,1 �̃�5,2 �̃�5,3 �̃�5,4 1 0 0 �̃�6,1 �̃�6,2 �̃�6,3 �̃�6,4 �̃�6,5 1 0 �̃�7,1 �̃�7,2 �̃�7,3 �̃�7,4 �̃�7,5 �̃�7,6 1) ( 𝜇𝑡 oilp 𝜇𝑡 mprsus 𝜇𝑡 rgdp 𝜇𝑡 inf 𝜇𝑡 mpr 𝜇𝑡 smr 𝜇𝑡 exr ) (4) to recover the information in the structural equation, we impose restrictions in matrix a and h in equation 4 and 5, explained in section 3.2.4. the terms𝜀𝑡 𝑂𝐼𝐿𝑃, 𝜀𝑡 𝑀𝑃𝑅𝑈𝑆 , 𝜀𝑡 𝑅𝐺𝐷𝑃 , 𝜀𝑡 𝐼𝑁𝐹 , 𝜀𝑡 𝑀𝑃𝑅 , 𝜀𝑡 𝑆𝑀𝑅 , 𝜀𝑡 𝐸𝑋𝑅 are the structural shocks associated with respective equations and 𝜇𝑡 𝑂𝐼𝐿𝑃 , 𝜇𝑡 𝑀𝑃𝑅𝑈𝑆 , 𝜇𝑡 𝑅𝐺𝐷𝑃 , 𝜇𝑡 𝐼𝑁𝐹 , 𝜇𝑡 𝑀𝑃𝑅 , 𝜇𝑡 𝑆𝑀𝑅 , 𝜇𝑡 𝐸𝑋𝑅are residuals in the reducedform disturbances to both the exogenous foreign and endogenous domestic variable, which represents an unexpected movement (given information in the system) of each variable. the transition equation for the stochastic volatility is of the form: asian journal of economics and empirical research, 2024, 11(1): 30-43 35 © 2024 by the authors; licensee asian online journal publishing group ℎ𝑖𝑡 =∑𝑘𝑗𝑦𝑡−𝑗 + 𝑝 𝑗=1 ∑𝜃𝑗ℎ̃𝑡−𝑗 + 𝜂𝑖𝑡, 𝜂𝑖𝑡 ↔ 𝑁(0, 𝑄𝑖), 𝐸(𝑒𝑖𝑡,𝜂𝑖𝑡) 𝑝 𝑗−1 = 0 (5) and the elements of 𝐴𝑡follow a first-order autoregressive process. 𝑎𝑗𝑡 = 𝜌𝑗𝑎𝑗𝑡−1 + 𝑞𝑗 1/2 𝜐𝑗𝑡,𝑗 = 1. . 𝑛 (6) there are two noteworthy features of the complete system defined by equation 1, 2, and 5. first, equation 1 allows the volatility of the structural shocks ℎ̃𝑡to have a (lagged) impact on the endogenous variables𝑦𝑡. in our specification, the log volatility enters the var equations rather than its level. this is primarily because the level of volatility is sensitive to the scaling of the endogenous variables, which can sometimes result in computational instability. second, note that the structure of matrix a in equation 2 determines the interpretation of structural shocks, and hence their volatilityℎ̃𝑡. equation 4’s lower triangular structure for a suggests that we can interpret the monetary policy shock's log volatility, limiting its impact on gdp growth and inflation during the current period. the appropriate placement of the economic interpretation of the structural shocks is important because it allows the model to tackle the analysis of volatility's impact in a theoretically consistent manner. alternatively, one may consider inequality or sign restrictions on the off-diagonal elements of a as a device to identify the shocks. third, the transition equation 5 allows for dynamic interaction among volatilities and endogenous variables, thus capturing any feedback effects that may be present in the data. 3.2.1. identification scheme the structure of 𝛽𝑖 and 𝛷𝑖 incorporates a small open economy assumption for indonesia. we incorporate the prior belief that lagged indonesia’s endogenous variables and (lagged and contemporaneous) stochastic volatilities have a negligible impact on the exogenous variables (global oil prices and us monetary policy). in our benchmark model, the contemporaneous and the lagged value ofℎ̃𝑖𝑡 affect𝑍𝑡ed. the global oil prices and us monetary policy is assumed to be completely exogenous to the domestic variables. it is common knowledge to identify that the foreign variable does not respond contemporaneously or with lags to the movement in the domestic variables in a small-open economy because such economies have no powerful impact on the advanced economy. it is important to note that the way variables influence each other is based on economic theory and depends on their position in the identification scheme. hence, we assume that domestic variables are deemed not to affect the foreign variables, and the transmission of foreign shocks to the domestic economy can be very rapid (berkelmans, 2005). the non-zero coefficients (�̃�𝑘𝑗) in the matrices indicate that the variable𝑗 affects the variable𝑘 instantaneously. in the a matrix above, the first two rows measure the effect of global oil prices and us monetary policy spillovers on indonesia’s economy. the third and fourth equations represent output and inflation dynamics. based on the small open economy new keynesian model, inflation is a function of output, monetary policy, and exchange rate, while output dynamics is modelled as a function of output, inflation, monetary policy, and exchange rate. therefore, while the real gdp responds instantaneously to oil prices and us monetary policy, inf, and mpr, inflation responds contemporaneously to mprus, gdp, and mpr. the fifth row indicates the monetary policy equation for indonesia in accordance with the modified soe-taylor's rule, where mpr responds contemporaneously to mprus, inf, and gdp. rows 6 and 7 indicate that while stock market returns respond to global oil prices, us monetary policy, domestic monetary policy, output, and inflation, the exchange rate responds instantaneously to all the variables (see elbourne and de haan (2006)). 3.2.2. identification of us monetary policy shocks to identify the us monetary policy shock, we follow the lead of tillmann et al. (2019) and canova (2005) to derive the shock component from an estimated var for the us. the auxiliary var includes real economic activity measured by the change in industrial production and the change in the consumer price index, as well as the change in krippner (2020) shadow rate. we estimated the shock component of the shadow rate, i.e., the unexpected changes in us monetary policy stance that are not the result of the stability of the us economy. the shocking series obtained by imposing a cholesky decomposition of the covariance matrix was fed into the var model for the indonesian economy to account for the spillover effects. 3.2.3. estimation technique the models were estimated using a standard markov chain monte carlo (mcmc) method (see liu and morley (2014)). the technique is appealing more because of its ability to address pile-up problems (see sargan and bhargava (1983); shephard and harvey (1990) and stock and watson (1998)). the high dimensionality and nonlinearity of the problem contribute to the preferability of this econometric technique. such a model may be characterized by multiple peaks, some of which are in uninteresting or implausible regions of the parameter space. bayesian methods efficiently deal with the high dimension of the parameter space and the model's nonlinearities, splitting the original estimation problem into smaller and simpler ones. here, we use gibb's sampling for the posterior numerical evaluation of the parameters of interest. gibb's sampling is a particular variant of markov chain monte carlo (mcmc) methods that consists of drawing from lower-dimensional conditional posteriors. when direct sampling proves difficult, it aids in obtaining an approximate sequence of observations from a specified multivariate probability distribution. finally, observe that mcmc is a smoothing method and therefore delivers smoothed estimates, i.e., estimates of the parameters of interest based on the entire available set of data. 4. results and discussions 4.1. preliminary analysis table 1 displays the basic descriptive statistics of the data used in this study. the variables described include real activity (gdp), inflation (inf), and monetary policy rate (mpr) for both indonesia and the us; stock market returns (smr); and exchange rate (exr) for indonesia; and global oil prices as a proxy for global factors. the average real gdp, inflation, and policy rate in indonesia are higher than in the us, according to the table. asian journal of economics and empirical research, 2024, 11(1): 30-43 36 © 2024 by the authors; licensee asian online journal publishing group table 1. summary statistics. variables mean std. dev. max. min. endogenous real gdp 1.20 1.06 3.20 -7.14 inflation 1.49 1.37 9.84 -0.22 policy rate 7.75 3.14 18.38 3.30 stock returns 3.41 10.82 29.99 -45.58 exchange rate 10915.65 2165.43 14754.34 8413.00 exogenous real gdp 0.07 2.53 10.69 -14.46 inflation 0.51 0.69 2.17 -2.87 policy rate 0.94 2.61 6.55 -3.74 oil price 0.23 10.96 25.56 -60.32 4.1.1. unit root tests table 2 displays the results of unit root tests conducted to determine the data's time series properties. we conducted and reported three unit root tests for this purpose: the augmented dickey-fuller (adf), phillips perron (pp), and adf with a structural break. we find a mixed order of integration among the variables. while most of the variables (such as real gdp, inflation, stock market returns, and shadow rate) are stationary at this level, other variables (exchange rate and short-term policy rate) become stationary after the first difference. however, all of the variables reveal structural breaks at different dates. given this, we conducted a nonlinear ardl and decomposed the shock series into positive and negative values for further analysis. table 2. unit root test results. country adf unit root test pp unit root test adf test with structural break indonesia variables t-stat. i(d) t-stat. i(d) t-stat. i(d) break date gdp -9.08 i(0) -9.13 i(0) -18.65 i(0) 2020q2 inf -7.20 i(0) -7.29 i(0) -11.29 i(0) 2005q4 mpr -4.11 i(1) -4.11 i(0) -5.18 i(0) 2005q4 exr -9.39 i(1) -9.39 i(1) -10.14 i(1) 2001q2 smr -6.63 i(0) -6.40 i(0) -7.79 i(0) 2008q4 us us-ssr -4.26 i(0) -4.14 i(0) -5.24 i(0) 2008q1 note: gdp, inf, mpr, smr, exr and us-ssr denote real activity, inflation, monetary policy rate, stock market returns, exchange rate, and shock to us shadow rate, respectively. while t-stat denotes t-statistics, i(d) represents the order of integration indicated by the test statistics employed. 4.1.2. parameter stability test in this section, we reported three test results, the hansen (1992) and pesaran (1997) parameter stability test results, also known as hansen lc test (table 3), the quandt-andrews breakpoint test for one or more unknown structural breakpoints (table 4), the cumulative sum of recursive residuals (cusum) tests, and the cumulative sum (cusum) of recursive residuals and cusum of square (cusumsq) tests for parameter stability figure 61. table 3. hansen parameter instability. lc statistics stochastic trends (m) deterministic trend (k) excluded trends (p2) probability 7.19 6 0 0 <0.01 table 4. quandt–andrews unknown breakpoint test. statistics value p-value max.lr f-stat.(2018q1) 43.6 0.00 max. wald f-stat. (2018q1) 305 0.00 exp lrf-stat. 17.9 0.00 exp wald f-stat. 148 0.00 ave lrf-stat. 7.16 0.00 ave wald f-stat. 50.1 0.00 two of the three-parameter stability tests—the lc test and the cusumsq test—fail to accept the null hypothesis of no sudden shift in the regime. this implies that there is strong evidence that parameters are not stable for the us monetary policy shock-indonesia macroeconomic variables relationship. similarly, the three quandtandrews tests reported in table 4 reject the null hypothesis of no breakpoints within a 15% trimmed sample period, suggesting the existence of breakpoints. this further justifies the use of tvp-var. the test is conducted based on the maximum statistic, the exp statistic, and the ave statistic. we calculated the probability values using hansen's method and compared a total of 55 breakpoints. 4.2. results from the us structural var figure 5 depicts the shock-to-us shadow rate determined by the us structural var model. upon first glance, the shock appears to be episodic, allowing for the easy identification of several episodes. the period from 2000–2003, where the shock series were mostly negative, was followed by a positive period from 2004–2007. we observed the largest contraction in the period 2008–2013, which trended at a decreasing rate. from 2014 to 2019, the shock showed a positive trend, followed by another contraction. the observed shocks from 2008 are arguably due to the global financial crisis and the massive us ump implementation. the taper tantrum runs from 2013 to 2014. the last negative episode from 2019 to 2020 corresponds to the period of the covid-19 pandemic's great lockdown. in sum, the identification approach recovers disturbances that are structurally interpretable and have a time path that 1 the cusum test identifies systematic changes in the regression coefficients, while the cusumsq test detects sudden changes from the constancy of the regression coefficients. note: std. dev., max., and min. denotes standard deviation, maximum, and minimum, respectively. asian journal of economics and empirical research, 2024, 11(1): 30-43 37 © 2024 by the authors; licensee asian online journal publishing group accounts for selected historical episodes reasonably well. the next section investigates the transmission of these shocks to indonesia's economy. figure 5. time path of us monetary policy shock. figure 6. cusum and cusumsq tests for parameter stability. 4.3. results from the indonesia svar this section presents the tvp-var result, which estimates the impact of us monetary policy spillover on indonesia's macroeconomic and financial variables. we contrast the effect of us monetary policy contraction and expansion shocks with a total shock that combined both tightening and easing shocks. we also contrast the total shock during the conventional monetary policy era in the us with the unconventional monetary policy (ump). both the constant coefficient and time-varying impulse response functions (irfs) of indonesia’s real and financial variables to us monetary policy are presented and discussed. while the tightening and easing shocks are presented in figure 7a and figure 7b, the conventional and ump shocks are also reported in figure 8a and figure 8b. 4.3.1. spillover effects from us monetary policy tightening vs easing shocks to indonesia figure 7a shows the constant coefficient impulse response of indonesia’s macroeconomic and financial variables to us monetary policy tightening and easing shocks. indonesia's real gdp responded positively to both monetary policy easing and tightening shocks. while the responses are weak, the easing shock has a stronger effect than the tightening cycle. a two-country mundell-fleming model predicts the dominance of the us output expansion impact, as evidenced by the rise of indonesia's real gdp in response to us monetary policy easing, which can lead to a rise in export demand from indonesia and, consequently, an increase in output. however, the asymmetry suggested by the positive responses of real gdp to both easing and tightening cycles is quite puzzling. asian journal of economics and empirical research, 2024, 11(1): 30-43 38 © 2024 by the authors; licensee asian online journal publishing group figure 7a. impulse response function (irf) of indonesia’s real and financial variable to us monetary policy tightening and easing shocks. inflation's response to us monetary policy easing and tightening shocks resembles symmetry. while inflation declined in response to the easing shock for about two quarters before it turned positive, the inflation rate's response to the tightening cycle was positive on impact and turned negative after three quarters. both the exchange rate's responses to us easing and tightening shocks were negative. this suggests an exchange rate appreciation in favor of the indonesian lira. although the appreciation is stronger and longer in response to the easing cycle compared to the tightening cycle, this suggests a weak form of asymmetric effect. the response to the easing cycle turned positive (depreciation) after the second quarter, while the response to the tightening cycle died out after the second quarter. the figure further shows that while stock market returns in indonesia responded positively to the us monetary policy easing cycle, the returns responded negatively to the tightening cycle. although the effect of easing shock is stronger compared to tightening shocks. this suggests a symmetrical effect of us monetary policy spillovers on indonesia’s stock market returns. this finding is at variance with tillmann et al. (2019). they found that us tightening has a stronger impact on emerging financial markets than an easing policy does. the bank of indonesia responded positively to both monetary policy tightening in the us and the easing cycle. the response approximates the asymmetric effect of us monetary policy spillovers on indonesia's policy rate. however, the dynamics are in line with some of the previous studies. for example, the response to indonesia's monetary policy rate collaborates with the findings of eterovic, sweet, and eterovic (2022). they discovered that when us rates ease, the absolute value of policy rates in emerging markets changes more than when they tighten. asian journal of economics and empirical research, 2024, 11(1): 30-43 39 © 2024 by the authors; licensee asian online journal publishing group figure 7b. time-varying irf of indonesia’s real and financial variable to us monetary policy tightening and easing shocks. figure 7b shows indonesia's time-varying cumulative impulse responses to monetary policy tightening and easing shocks from the us fed to real and financial variables. these responses, with the exception of exchange rates and stock returns, clearly feature time variation over time. in 2008, the strongest time variation, which is also common to almost all variables, was observed. peaks in 2017 and 2020 are weaker than in 2008. these variations can be attributed to various factors, such as the global financial crises, the implementation of ump by the us fed in 2008, the three consecutive hikes in ffr in 2017, and the advent of covid-19, which led to a significant lockdown. 4.4. spillovers effects from aes conventional vs unconventional monetary policy shocks in this section, we compare the spillovers of conventional and unconventional monetary policy (ump) to ascertain whether indonesia’s macroeconomic and financial variables respond differently over the periods. a handful of empirical studies (e.g., (hajek & horvath, 2018; kucharčuková, claeys, & vašíček, 2016)) found that while spillovers from conventional monetary policy have a stronger effect on macroeconomic variables, the effect of ump is stronger on the exchange rate but muted and less significant on macroeconomic variables. for this purpose, we split the sample period into conventional and ump eras. while the period from 2000 – 2007 is classified as the conventional monetary policy era, the period from 2008 – 2015 is classified as ump. figure 8a and 8b present the constant coefficient and time-varying impulse responses of indonesia’s macroeconomic and financial variables to us conventional and ump shocks. from figure 8a shows that the endogenous variables' responses to conventional and ump are consistent with the existing literature. first, compared to conventional monetary policy, the exchange rate response to the ump is stronger. second, conventional monetary policy exerts stronger effects on other macroeconomic variables compared to ump. while the impact of conventional monetary policy shocks on real gdp is positive and has remained largely so for over three years, the impact of ump on real gdp was initially positive and turned negative from the 4th quarter through the rest of the asian journal of economics and empirical research, 2024, 11(1): 30-43 40 © 2024 by the authors; licensee asian online journal publishing group horizon. the effect of conventional monetary policy was inflationary in indonesia and lasted for over three years before it died out. on the other hand, the effect of ump on inflation is negative, but it turned positive after the 2nd quarter and continued to fluctuate thereafter. while stock market returns responded positively to both conventional and ump, the effect of ump was stronger and lasted for over six quarters before it finally died out. surprisingly, the policy rate responded positively to conventional monetary policy shocks and negatively to ump shocks. however, the us monetary policy spillovers over the sample period boost indonesia's real gdp, stock market returns, and bilateral exchange rate vis-à-vis the us dollar, triggering inflation beyond what the corresponding policy reaction could counteract. according to figure 8b, while the coefficients of most of the variables are approximately constant, there are elements of time variation in the response of exchange rates and stock returns to conventional monetary policy shocks. stock returns and policy rates respond to the ump policy, as well as some time variation. figure 8a. irfs of spillovers from us conventional vs unconventional monetary policy to indonesia. asian journal of economics and empirical research, 2024, 11(1): 30-43 41 © 2024 by the authors; licensee asian online journal publishing group figure 8b. time-varying irfs of spillovers from us conventional vs unconventional monetary policy to indonesia. 5. robustness of the results in this section, we identify us monetary policy shocks using the effective federal funds rate (effr) as opposed to using the shadow rate. we then contrast the time-varying impulse responses obtained using effr (figure 9) to the ones identified using the us shadow rate (figure 8b). the goal is to determine whether the shadow rate is effective in identifying us monetary policy shocks. since the shadow rate went beyond zero and became negative from 2008 to 2015 compared to effr (figure 4), we expect some differences, at least within that period. therefore, we incorporate effr instead of shadow rate in this segment in the us svar model. we then treat the residuals as unanticipated shocks in us policy rates and use them in the indonesia tvp-var model by following the same procedure. asian journal of economics and empirical research, 2024, 11(1): 30-43 42 © 2024 by the authors; licensee asian online journal publishing group figure 9. time-varying irfs of spillovers from us conventional vs unconventional monetary policy to indonesia. the baseline model for both the us svar and indonesia svar models is the same as in the later model. the estimates from this model are presented in figure 9. while the responses from this approach for the full sample and unconventional sub-sample substantially differ from our earlier results, the result of the conventional sub-sample, except for the exchange rate, is quite similar. from the full sample irfs, the period between 2001 to 2008 is quite similar in the two scenarios. this reflects the period where the shadow rate significantly mimics the effr (figure 4). the observed difference during the unconventional period in the two scenarios highlights the importance of using the shadow rate to identify us monetary policy shocks. the difference is substantially explained by the unconventional monetary policy (ump) implemented in the wake of the gfc. this is the point where the shadow rate falls below zero to reflect the effect of the ump. therefore, disaggregating the irfs into conventional and unconventional era shows that the full sample analysis using shadow rate and time-varying var model is apt and fit the data substantially. 6. conclusion this study examines the propagation of us monetary policy spillover to the indonesian economy over the period 2000–2020. our study primarily focuses on the transmission of us monetary policy spillover effects on indonesia’s real gdp, inflation, exchange rate, stock market returns, and policy rate. we conducted the data analysis in two stages: first, we identified the unanticipated shocks in a us svar model using the cholesky decomposition identification scheme to find the residuals from this model. secondly, we then incorporate these shocks into our indonesian tvp-var-x model to capture the spillover effects of the us monetary policy stance on the indonesian economy using the irfs obtained. the study finds that us monetary policy spillovers, on average, boost indonesia’s real gdp and stock market returns, appreciate the bilateral exchange rate vis-à-vis the us dollar, and trigger inflation beyond what the corresponding policy reaction could counteract. however, decomposing the shock into easing and tightening shocks reveals significant differences. we find that the effect of us monetary policy shocks on real gdp, the exchange rate, and the policy rate is asymmetric, as the variables appreciate in response to both tightening and easing shocks. on the contrary, the effects on inflation and stock market returns are symmetrical. indonesia's inflation responded positively to us monetary policy tightening shocks and negatively to easing shocks. the stock market's returns responded positively and negatively to us easing and tightening shocks, respectively. we also found that macroeconomic variables responded differently to us conventional and ump shocks. while real gdp and inflation responded positively to us conventional monetary policy shocks, ump shocks, on the other hand, depressed both gdp and inflation. the exchange rate appreciates in response to us ump shocks and depreciates in response to conventional monetary policy shocks. while stock market returns responded positively to both shocks, the response to ump was stronger and longer. to stimulate declining output, policy rates rise in response to conventional monetary policy shocks and fall in response to ump shocks. finally, we also found substantial time variation in the effects corresponding to major global events, including the gfc and implementation of ump, the taper tantrum of 2013–2014, and the great lockdown in the wake of the covid-19 pandemic in 2019–2020. the contribution of the study is twofold. first, we investigate the spillover effects of us monetary policy on the indonesian economy using the shadow rate against the ffr. this choice of shadow rate is motivated by the desire to capture the effects of ump implemented in the wake of gfc. secondly, we constructed a block-exogenous svar model that features time-varying parameters. the rationale behind this decision is to deal with potential structural breaks and nonlinearities caused by major domestic and global events in the past. our findings have implications that encourage further research. in our analysis, we only considered spillovers of monetary policy from the united states to indonesia. this is an important starting point. the next extension is to consider other advanced economies with strong trade and financial ties with indonesia, such as japan and the euro area. we were unable to include them in our analysis, leaving a significant gap for future research. references berkelmans, l. 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(2019). the spillover effects of us monetary policy on emerging market economies. international journal of finance & economics, 24(3), 1313-1332. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.1016/j.jce.2005.11.004 https://doi.org/10.1016/j.iref.2022.08.005 https://doi.org/10.1016/j.jimonfin.2018.08.009 https://doi.org/10.1016/j.ecosys.2017.10.001 https://doi.org/10.1016/0161-8938(92)90019-9 https://doi.org/10.1111/jmcb.12613 https://doi.org/10.1016/j.jpolmod.2016.02.002 https://doi.org/10.1016/j.jmoneco.2019.03.011 https://doi.org/10.1111/1468-0297.00151 https://doi.org/10.1080/13504851.2020.1834498 https://doi.org/10.2307/1912252 https://doi.org/10.1111/j.1467-9892.1990.tb00062.x https://doi.org/10.2307/2669631 178 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 2, 178-185, 2020 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2020.72.178.185 © 2020 by the authors; licensee asian online journal publishing group credit constraints and the productivity of small and medium-sized enterprises: evidence from canada mark lim1 jessica foster2 ( corresponding author) 1,2university of ottawa, canada. abstract small and medium-sized enterprises (smes) are regulators of the business environment. in canada, smes represent about 50 percent of businesses and are responsible for over 60 percent of the country’s employment. the role of smes in the development of a country can’t be ignored, as they are vital indicators of economic development. the size and cash flow of a company's assets are reliable indicators of credit constraints (cc), which results in a cc agent for models that use an asset-to-liability ratio. we focus on the actual impact of a previously estimated score in cases where corporate credit is limited. investment and employment decisions are based on productivity shocks (ps) and the possibility of cc. using variables, our model indicates the importance of measured credit restrictions being distinguished, such as cash flows that indicate productivity levels and the probability of cc. the data samples are from 2009 to 2014, although the measurement of cc is only available from 2011. therefore, we use the model of credit constraint estimation to anticipate the likelihood of cc in the months before and after 2011. the findings reflect that the firm’s size, debt to assets ratio, and cash flow are significant factors in the evaluation of the cc, whereas long-term debt (ltd) to asset ratio wasn’t found to be significant. the study also evaluates and estimates firm-level productivity. keywords: credit constraints; productivity; canada. citation | mark lim; jessica foster (2020). credit constraints and the productivity of small and medium-sized enterprises: evidence from canada. asian journal of economics and empirical research, 7(2): 178-185. history: received: 20 may 2020 revised: 23 june 2020 accepted: 27 july 2020 published: 17 august 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ............................................................................................................................................................................................................ 179 2. literature review .................................................................................................................................................................................................. 179 3. data collection ....................................................................................................................................................................................................... 180 4. credit constraints and productivity .................................................................................................................................................................. 182 5. discussion and conclusion ................................................................................................................................................................................... 183 6. research implications and limitations ............................................................................................................................................................. 184 references .................................................................................................................................................................................................................... 184 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.72.178.185&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/2027 http://asianonlinejournals.com/index.php/ajeer/article/view/2027 asian journal of economics and empirical research, 2020, 7(2): 178-185 179 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature. this research paper makes two important and constructive contributions towards effectively understanding and forecasting financial constraints (fc), such as sales growth and ltds, as well as their direct impacts on the performance level of the firm. first, the present study adds to existing research on cc, specifically in relation to small businesses. to our knowledge, the present research is the first to analyze fc in smes independently from examined outcomes and results of ef. second, the following study significantly contributes to effectively forecasting the relationship between fc and productivity at an organizational level, which is mainly based on productivity measurements and a consideration of fc. 1. introduction credit constraints (cc), which can be determined through an evaluation of the activities and outcomes of a firm and its external financing (ef) (dubé, brunelle, & legros, 2016), result in a reduction in the rate of productivity of smes of canada, in comparison to larger organizations. organizations that achieve high levels of productivity and compatibility and use innovative technology are less likely to face the problem of financial constraints (fc) (ramkissoon & mavondo, 2017). therefore, smes in canada should overcome the issue of fc so that their productivity can increase, which will provide better results and products for customers. several characteristics of an organization can act as an alternative to determining the cc of a firm, which helps to discover the firm’s needs in terms of ef (calic, shevchenko, ghasemaghaei, bontis, & tokcan, 2020). the general phenomenon of credit and cc has been gaining considerable attention from academic practitioners and analysts over the last few years (chatterjee, karray, & sigué, 2019). however, it has been noted that, even now, a performance and overall presentation gap exists in smes; although a large number of smes perform as successful businesses, their growth is lower than other businesses in this sector. rose (2016) has suggested that, in order to address this productivity and exclusive performance gap, the significant contextual variables affecting the intentions of smes need to be investigated in detail, as existing research on cc and its impacts on smes and their performance are limited. therefore, studies needs to be conducted on smes in certain countries and regions (ortiz‐de-mandojana & bansal, 2016); kraja (2018) in order to evaluate the impact of certain tangibles (buallay, hamdan, and zureigat, 2017), investigate the overall impact of corporate governance, and (al-haddad, taleb, and badran (2018) evaluate the impact of growth and tangibility on the productivity of smes. hence, understating cc and its impact on overall levels of productivity in smes and other firms is important in order to address the gaps in academic studies. the current study explores the impact of cc on the performance and productivity of smes. the above discussions and justification statement have guided the development of the following objectives and purposes. the main aim of this study is to investigate the exclusive impact of cc on productivity levels in smes in canada, including sales growth, total assets, and long-term debt (ltd). the given study also computes the likelihood of a business being constrained by credit and other factors, as well as analyzing observed outcomes and the results of ef. moreover, the current paper is associated with research on measuring and quantifying the significance of financial variables and how they influence factual variables, such as productivity, investment, and employment levels. this research paper makes two important and constructive contributions towards effectively understanding and forecasting financial constraints (fc), such as sales growth and ltds, as well as their direct impacts on the performance level of the firm. first, the present study adds to existing research on cc, specifically in relation to small businesses. to our knowledge, the present research is the first to analyze fc in smes independently from examined outcomes and results of ef. second, the following study significantly contributes to effectively forecasting the relationship between fc and productivity at an organizational level, which is mainly based on productivity measurements and a consideration of fc. this research paper has deep benefits and advantages both in practice and in theory. theoretically, the paper contributes to the current body of data on variables that affect productivity levels in firms, and practically, the findings and suggestions of this paper are beneficial for academic scholars and policymakers. the remainder of the paper will be organized as follows: in the second chapter, the analyst will review relevant literature; in the third chapter, the analyst will estimate and measure the extent to which smes are restricted by ef; in chapter four, the analyst will measure the extent to which investment and employment development are influenced by fc, capacity, and productivity; and in chapter five, the analyst will conclude the findings of the study. 2. literature review although several theories on fc have emerged, most of the models and frameworks focused on understanding the constraints on business firms and organizations (wetzel & hofmann, 2019). according to bolton (2016), constraints have just as much of an impact and significance on the overall finances of a business, and expertly trained financial advisors play a crucial role in helping businesses and clients to understand the constraints and restrictions of their business objectives. according to this theory, fc limit certain economic actions and productivity levels in businesses, and according to dinopoulos, kalyvitis, and katsimi (2020), they must be accommodated. for instance, a broker may restrict an sme from short selling, margin trading, and other options that may limit an sme’s investment, which will influence the productivity of the firm. this theory also states that fc are specific and objective obstacles and restrictions, as opposed to being typical and subjective (dasgupta, li, & yan, 2017). according to bilal, khan, and akoorie (2016), fc refer to any factors that limit the amount and quality of investment options for investors. every business and sme faces both internal and external constraints (miao & wang, 2018), such as a lack of knowledge or information and an insignificant cash flow. furthermore, this theory states that regulations and policies exert restrictions on the profitability level of businesses. these constraints range from governmental limitations on imports and exports, conditional limitations that manage materials used, to certain policies that must be accomplished. generally, their influence on development can be strengthened. financial factors and variables are common constraints for businesses and smes, and according to this theory, they range from insufficient budget allocations or distributions to excessive payments and overhead expenditures (eapen, yeo, & sasidharan, 2019). for example, if a business does not have the capital to buy more stock, its ability asian journal of economics and empirical research, 2020, 7(2): 178-185 180 © 2020 by the authors; licensee asian online journal publishing group to sell is a constraint that affects its overall business performance. similarly, if more staff are needed but the budget cannot accommodate additional payments, the entire growth of the business will be limited. 2.1. credit constraints and the productivity level of smes according to li, liao, and zhao (2018), cc is the factor that businesses must confront in order to implement its business strategy, as each business has its own particular combination of constraints and limitations that collectively impact its competitive position and image within its sector. according to jin, zhao, and kumbhakar (2019), smes are essentially a way to ensure that assets work overtime, as physical assets typically depreciate with time and credit tends to decrease in value, mainly due to inflation. in comparison, investments in competitive business environments have a remarkable predisposition to increase in value over credit and time. in order to execute this remarkable feat, smes and different firms must maintain productive assets and continually implement new processes and practices to stay competitive. as such credit is essential, certain limitations that enable credit to be used more efficiently, such as credit management and other significant practices, are basic management considerations. moreover, according to altomonte, gamba, mancusi, and vezzulli (2016), assets are an important form of cc, encompassing all intangible resources that contribute to the future cash flow and productivity of an sme. an effective example of an asset-related constraint, according to choi, furceri, huang, and loungani (2018), is a slow piece of equipment on a production line that directly influences the entire productivity of a business. any current assets, including property, ip, equipment, represent constraints that significantly influence the productivity of a business. according to cao and leung (2019), liquid assets such as investments and cash are a particular constraint that directly influences the productivity of the business, as cash is critical to pay for operating costs and other payments. if a firm runs out of cash, everything related to productivity tends to collapse. fast sales growth (sg) and development can be both an advantage and disadvantage for many firms, as it generates the potential for greater profit and productivity while demanding more cash to support significant growth (bokpin, ackah, & kunawotor, 2018). as described by aghion, bergeaud, cette, lecat, and maghin (2019), the influence of sg on the balance sheet and productivity is considerable, specifically in terms of business inventory checks and accounts receivable because these trading assets are necessary for the sme’s financial and operating cycle. in the simplest terms, smes start with capital and then they purchase materials and equipment that are processed, manufactured, sold, distributed and finally converted to cash. not only does this influence the liquidity of the sme, but, according to hasan and sheldon (2016), it also directly influences and impacts the productivity of business level conversations. sg significantly affects the productivity of smes in several ways; for those reliant on a significant number of smaller suppliers, it increases their liquidity, which may allow them to ensure the best contractors on constructive terms or rapidly enhance their supply base over a short period of time, in order to respond to market needs and requirements (yang, 2018). in contrast, smes that predominantly need to make considerable investments in property, people and equipment to support major initiatives may have much simpler needs exclusive of essential liquidity; therefore, essential investments cannot be generated, or must be scaled back, perhaps to the degree that leads to certain missed opportunity (ganau, 2016). the ltd of an organization increases the need for ef, which, in turn, leads to an increase in the rate of productivity, especially in small firms in canada because they have fewer cc. research by dörr, raissi, and weber (2018) has stated that the operations of a firm can be expanded as a result of ltd, and it also allows small enterprises to gain access to the financial sector. bannerman and fu (2019) explain the fact that, if an organization has access to ltd finance, it becomes possible for the organization to spend money on equipment and innovative capital, which helps it to increase its rate of productivity. it also allows organizations to invest in innovative techniques, tools, machinery, and technology so that effective products can be produced. the theory of fc proves that a lack of knowledge and insignificant cash flow can cause a decrease in an organization’s productivity. hasan., kobeissi, liu, and wang (2018) confirmed a direct relationship between productivity levels and ltd, as an increase in one variable results in a decrease in the other, and vice versa. 3. data collection data was collected from smes operating in canada. smes employ between 50–500 people and are responsible for more than 50 percent of the output generated by the business sector (rispoli, leung, & baldwin, 2013). data was acquired from the survey on financing of small and medium-sized enterprises (sfsme), in addition to other experimental data. the sfsme maintains a cross-sectional database of canadian businesses that employ less than 500 workers and have a reported profit of less than 50 million dollars. the database provides details and information on the firm’s petition for financing, the reasons why loan requests are terminated, the loan utility process, the interest rate of the loan, the type of interest (compounded, simple, annual, biannual), the collaterals used for securing the loan position, and whether or not the loan amount is ensured by the government. the database also offers information with regard to the equity financing, leasing, and governmental financing properties of the smes. the data is formally available for 2004, 2007, 2011. the administrative sources provide information on sfsme firms using financial statements. for the purposes of this study, the data from 2011 have been used; however, the financing activities from 2007 are also reported. the data is based on sfsme survey results. 3.1. measurement of credit constraints as the measurements of cc are only available for 2011, characteristics and estimations are being calculated for that year (moscalu, girardone, & calabrese, 2019). in order to assess cc probability in the years before and after 2011, the model of cc estimation was used. foreign financing is unconditional, as it is safer than in 2011. in order to make sure that chinese smes will be financially restricted, scores have been assigned according to their knowledge of activities and outcomes. this is less likely to occur in high-scoring companies. companies report whether they have applied for sfsme data (bena & jurajda, 2011). the types of financial instruments include long-term loans, lease financing, government grants, equity, trade credit, and short-term loans. asian journal of economics and empirical research, 2020, 7(2): 178-185 181 © 2020 by the authors; licensee asian online journal publishing group the values given in parentheses indicate the robust standard errors; (*) indicates the importance of coefficients at a degree of 10%; (**) indicates a level of 5%; and (***) indicates a level of 1% for p values. table 1 reports the main results of the estimated measured fc as a function of the characteristics of the firm. the “full model” column reports probit estimations using a sample selection, the “fc” column reports the probability of three degrees, and the “needfin” column reports the estimations of the sample selections. in this paper, the reasons for not requesting ef are also reported, with many companies stating they do not need ef and others stating that ef is expensive. the measured cc only refers to the observed ef results; our scale does not differentiate between companies with high levels of debt and companies in financial difficulty. the debt-to-asset ratio is useful, but it cannot be obtained (guiso, jappelli, padula, & pagano, 2004). demand may vary from one sector to another, as a result of certain sectors acquiring a great increase in productivity. financial restrictions do not depend on the sector of each company. 3.2. selection of credit constraints the age and size of a firm are important factors to consider when identifying cc, which is why they are often used in the literature. the estimated values show that large companies have cc if they need ef support (lucey, zhang, & finance, 2011). in table 2, the “mlc” column refers to the most likely constraints and the “lc” column shows the likely constrains. according to the collateral constraint model, large companies can use more guarantees to obtain ef, so they are more likely to apply for credit; if they do, their results are less likely because they provide more collateral results. in companies, the marginal effects of the size of the assets are, most probably, both negative and statistically significant, as shown in table 2. negative marginal effects appear when the company is ten years old or older, but the statistics are only important when the company is twenty years old or older. to summarize the findings of the estimations of the inclusion of cc, it can be stated that proxy variables such as the size and age of the firm, cash flow, and the current debt and dividend levels are effective constraints in the evaluation of smes. table 1. characteristics of firms variables full model (2) (3) fc needfin fc fc long-term debt/assets 0.009 −0.200∗∗ 0.075 0.052 (0.042) (0.046) (0.049) (0.039) current debt/assets 0.165∗∗∗ 0.253∗∗∗ 0.08 0.090∗∗∗ (0.048) (0.063) (0.057) (0.054) sales growth −0.006 0.102 −0.04 0.044 (0.047) (0.075) (0.072) (0.033) current assets/assets −0.629 0.715 −0.767 −0.1 (1.262) (1.354) (1.455) (1.485) cash flow/assets −0.211∗∗∗ −0.128∗∗∗ −0.193∗∗∗ −0.201∗∗∗ (0.056) (0.033) (0.069) (0.047) in (assets) −0.201∗∗∗ 0.134∗∗ −0.271∗∗∗ −0.086 (0.012) (0.060) (0.057) (0.058) 1{dividend>0} −0.192∗∗∗ −0.01 −0.200∗∗∗ −0.152∗∗ (0.069) (0.048) (0.072) (0.067) {3<age<=5} 0.086 −0.021 0.081 0.053 (0.054) (0.081) (0.062) (0.082) {5<age<=10} 0.188∗∗∗ 0.002 0.176∗∗ 0.136∗∗ (0.029) (0.069) (0.075) (0.048) {10<age<=15} 0.009 −0.200∗∗ 0.075 0.052 (0.042) (0.046) (0.049) (0.039) {15<age<=20} −0.201∗∗∗ 0.134∗∗ −0.271∗∗∗ −0.086 (0.012) (0.060) (0.057) (0.058) {20<age<=25} −0.192∗∗∗ −0.01 −0.200∗∗∗ −0.152∗∗ (0.069) (0.048) (0.072) (0.067) {25<age} 0.086 −0.021 0.081 0.053 (0.054) (0.081) (0.062) (0.082) {3<age<=5) * in (assets } 0.188∗∗∗ 0.002 0.176∗∗ 0.136∗∗ (0.029) (0.069) (0.075) (0.048) {5<age<=10) * in (assets } 0.009 −0.200∗∗ 0.075 0.052 (0.042) (0.046) (0.049) (0.039) {10<age<=15) * in (assets} 0.165∗∗∗ 0.253∗∗∗ 0.08 0.090∗∗∗ (0.048) (0.063) (0.057) (0.054) {15<age<=20) * in (ssets} 0.086 −0.021 0.081 0.053 (0.054) (0.081) (0.062) (0.082) {20<age<=25) * in (assets} 0.188∗∗∗ 0.002 0.176∗∗ 0.136∗∗ (0.029) (0.069) (0.075) (0.048) note: ***, **, and * represent statistically significant levels of 1%, 5%, and 10%, respectively. asian journal of economics and empirical research, 2020, 7(2): 178-185 182 © 2020 by the authors; licensee asian online journal publishing group table 2. mlc and lc mlc lc standard error dy/dx standard error dy/dx in assets 0.002 -0.016 0.002 -0.013 business age <=3 0.023 0.021 0.023 0.020 business age >25 0.020 -0.027 0.018 -0.021 cashflow/assets 0.008 0.028 0.013 0.028 long-term debt/assets 0.006 0.000 0.007 0.000 current assets/debt 0.011 -0.037 0.011 -0.036 4. credit constraints and productivity the main influence of cc lies in the fact that they can affect the growth of a firm by hindering and limiting the ability of the firm to make decisions in terms of investment and recruitment. these decisions are also dependent on the overall productivity of the firm, which will be estimated. the total-factor productivity (tfp) of the firm is estimated using a structural procedure that is fixated on the production level of firms, as discussed by olley and pakes (1992). an extended version of their suggested method has been followed in the present study. in much of the previous empirical literature, the estimation of the production function was abstracted from the cc, while the control factors of employment and investment were found to be functions of a firm’s ability to finance and acquire tfp. therefore, these factors will not be omitted, and the method of inclusion has been updated. as suggested by ackerberg, caves, and frazer (2015), an estimation of production function was carried out, so that the cc can be taken into consideration. the tfp was then used as an independent variable so that its likelihood to be constrained could also be calculated. this process allows for the evaluation of the relationship between productivity and cc. the process of productivity is assumed to take the following form: ( ) =∑ ( ) + in the case that 4 = 5 = 6 =0, the term is presumed to be exogenous. the endogenous component of the productivity is determined by the investments and measures of the cc, which are considered for both lagged and level periods. lagged investments can impact a firm’s productivity through innovation and other value additions. 4.1. production function estimations first, the correlation between productivity estimates and fc were evaluated in order to understand whether or not they were related. for the estimation process, lagged labor, capital, and the square of lagged labor were considered to be instrumental to the calculation. the estimates of the parameters are defined in the table 3. the first row of the table summarizes and presents results calculated using the ordinary least squares (ols) method, the second row assumes that 4 = 0, and the third row shows the estimations of the endogenous tfp ( 4 ≠ 0). the last two rows in table 3 display the estimations of the tfp and cc. the exogenous productivity estimates were found to be greater than the estimates when they were evaluated after omitting the fc. this result was expected, as the correlation coefficient among the production factors and the cc was negative. in terms of production capacity, the capacity of labor and capital was more significant than estimated, excluding ef and fc. this was also to be expected, as productivity factors and cc were negatively correlated when a two-stage generalized methods of moments (gmm) was estimated to include cc. when increased, the real relationship between total input and productivity was restored, which resulted in an increased growth in labor. for example, due to borrowing restrictions, a manufacturing firm observed a low wage input compared to other firms with the same total production level. table 3. estimates of the parameters 𝛼 l std. err. 𝛼 k std. err. rhs vars. in tfp shock process (i) no financing decisions ols 0.714 0.007 0.048 0.003 – (ii) no financing decisions 2-stage, exog 0.651 0.165 0.053 0.012 – 2-stage, endo 0.632 0.092 0.051 0.008 xjt−1 (iii) with, but without financial constrain 2-stage, exog 0.664 0.194 0.056 0.012 – 2-stage, endo 0.637 0.205 0.055 0.012 f cjt−1 2-stage, endo 0.622 0.202 0.055 0.012 f cjt−1,xjt−1,f cjt−1 ∗xjt−1 (iv) with financial 2-stage, exog constraint 0.663 0.102 0.058 0.012 – 2-stage, endo 0.682 0.360 0.062 0.021 f cjt−1 2-stage, endo 0.671 0.270 0.062 0.012 f cjt−1,xjt−1 2-stage, endo 0.671 0.258 0.062 0.011 f cjt−1,xjt−1,f cjt−1 · xjt−1 2-stage, endo 0.642 0.234 0.056 0.012 f cjt−1,xjt−1,f cjt−1 · xjt−1,f cjt−1 · jt−1 asian journal of economics and empirical research, 2020, 7(2): 178-185 183 © 2020 by the authors; licensee asian online journal publishing group table 4. estimations of the impact of tfp on credit (1) fc need fin (2) fc need fin current debt/assets 0.185∗∗∗ 0.273∗∗∗ 0.182∗∗ 0.288∗∗∗ (0.056) (0.043) (0.072) (0.053) long-term debt/assets 0.002 0.149∗∗∗ 0.054 0.157∗∗ (0.046) (0.041) (0.059) (0.072) current assets/assets 0.0656 −0.167∗∗ 0.007 −0.237∗∗ (0.118) (0.073) (0.111) (0.091) ln(assets) −0.076∗∗∗ 0.219∗∗∗ −0.078∗∗∗ 0.205∗∗∗ (0.011) (0.084) (0.013) (0.085) sales growth −0.037 0.248∗∗∗ −0.012 0.212∗∗ (0.117) (0.045) (0.091) (0.074) cash flow/assets −0.136∗∗∗ −0.101∗ −0.188∗∗∗ −0.081 (0.054) (0.062) (0.035) (0.075) 1{dividend>0} −0.178∗∗∗ −0.028 −0.114∗∗ −0.011 (0.067) (0.043) (0.057) (0.041) tfp −0.268∗∗∗ −0.070 (0.092) (0.098) lagged tfp −0.307∗∗∗ −0.121 (0.092) (0.091) note: ***, **, and * represent statistically significant levels of 1%, 5%, and 10%, respectively. if the assessment removes cc when estimating productivity at the firm level, determining the capacity of the production function could be biased, especially if both employment and investment are measured; the data shows that both investment and employment are measurable (beck, demirgüç-kunt, & maksimovic, 2005) that are negatively associated with fc. in this study, the results show that, if these ef and loans are excluded from all production functions and structural estimates, there is reduction in negative projections of capital and wages (guiso et al., 2004). tables 4 and 5 estimate the impact of tfp on cc alternatives available for firms. the key difference between the two estimations is that, in table 4, the tfp was estimated independently from fc, whereas the estimations in table 5 also present the influence of fc on tfp inputs. in both of the tables it can be seen that the cc is found to be significant. moreover, the tfp and lagged tfp measures are also significant. these results indicate that the productivity of firms is affected if cc are applied. these limits influence the decision making, loan receiving, and investment planning of businesses. as smes are responsible for half the business output in canada, cc and fc applied to these businesses need to be reduced so that productivity can be improved. table 5. estimate the impact of tfp on credit (1) fc need fin (2) fc need fin current debt/assets 0.191∗∗∗ 0.262∗∗∗ 0.193∗∗∗ 0.264∗∗∗ (0.073) (0.052) (0.055) (0.041) long-term debt/assets 0.025 0.158∗∗∗ 0.015 0.174∗∗∗ (0.037) (0.054) (0.055) (0.051) current assets/assets 0.046 −0.184∗∗ 0.038 −0.187∗∗ (0.123) (0.087) (0.116) (0.081) ln(assets) −0.149∗∗∗ 0.181∗∗ −0.107∗∗∗ 0.232∗∗∗ (0.012) (0.071) (0.012) (0.072) sales growth 0.017 0.224∗∗∗ −0.054 0.204∗∗∗ (0.091) (0.053) (0.099) (0.062) cash flow/assets −0.185∗∗∗ −0.084∗ −0.149∗∗∗ −0.079 (0.052) (0.047) (0.042) (0.061) 1{dividend>0} −0.191∗∗∗ −0.017 −0.171∗∗ −0.021 (0.065) (0.027) (0.089) (0.041) tfp −0.032 −0.135∗∗ (0.087) (0.072) lagged tfp −0.071 −0.181∗∗∗ (0.090) (0.063) note: ***, **, and * represent statistically significant levels of 1%, 5%, and 10%, respectively. 5. discussion and conclusion by incorporating exclusive data on investment procedures and results from smes in canada, we have concluded that companies will be forced towards ef, which reflects the financial struggles of borrowing businesses. the benefit of our measurement is that it separates the need for ef from the possibility of having to borrow, which was missing from previous studies (de nicolò & juvenal, 2014). businesses with a high cash-flow to assets ratio are less likely to need financial support, although they would be forced to do so if necessary. following previous studies, the results of this study have managed to resolve two arguments: first, the fact that the use of cash flow sensitivity of investment can be used as indirect evidence of friction in the credit market, and second, that the result asian journal of economics and empirical research, 2020, 7(2): 178-185 184 © 2020 by the authors; licensee asian online journal publishing group of such sensitivity can be a model without financial problems. our assessment suggests that these two arguments only partially capture the role of cash flow (bena & jurajda, 2011). higher levels of investment and cash flow can be generated through higher productivity levels. smes do not need ef, such as high productivity. the main cash flow shows that the company's financial position is stable and can provide a high level of investment support to firms. the results of the present study are supported by recent and past literature. cao & leung (2019) used a similar approach to the one applied in this study in order to evaluate the impact of cc on firm productivity in canada. the findings have shown that, if constraints are put on the credit ability of smes, they risk limiting their growth. chen and guariglia (2013) and yang (2018) studied the influence of fc on the productivity of the firm. the findings also suggest that productivity is affected in private firms and other firms with lower liquidity, due to the limited availability of internal and ef. the availability of finance is extremely important for the long-term productivity of organizations, and limiting the credit availability of smes hinders their opportunity to grow (amos & zanhouo, 2019; bremus & fratzscher, 2014; coad, pellegrino, savona, & technology, 2016). in the sfsme data, companies report whether or not they applied for ef, and if they have, what the results were. the types of financing include longand short-term loans, lease financing, government grants, equity, and trade credit. our results also found that, if the estimated coefficient of labor and capital are omitted, estimates of capital regulations and wages in production funds can increase productivity constraints and decrease the cc. there is a negative relationship between input and productivity estimates, and this downward bias leads to an upward bias. the estimates were negatively correlated with negative credit barriers, without correcting for bias. 6. research implications and limitations the results of this study have certain policy applications. our research has found that governments want to keep its strategy in situations where small businesses are subsidized on productivity. in terms of ef, if small companies have a large production capacity but cannot grow, this contributes to the overall production loss. however, government assistance can help to increase the overall productivity of a firm by overcoming financial difficulties. such a policy could have a long-term effect on the growth of the economy. a strategy that only depends on the size of the company is less effective, as some small companies are less productive, and these strategies may not necessarily help them overcome financial difficulties and grow. smes improve their performance in terms of the firm’s potential. liquidity reduction policies are effective in helping smes avoid financial pressures. the demand for foreign aid is determined by the need for investment and employment, which is, in turn, a major blow to productivity. in order to assess the possibilities of economic coercion and production processes in the economic system, it is necessary to evaluate a fully defined dynamic model of investment and financing, which includes the fc theory. references ackerberg, d. a., caves, k., & frazer, g. 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(2019). supply chain finance, financial constraints and corporate performance: an explorative network analysis and future research agenda. international journal of production economics, 216, 364-383. available at: https://doi.org/10.1016/j.ijpe.2019.07.001. yang, w. (2018). empirical study on effect of credit constraints on productivity of firms in growth enterprise market of china. journal of finance and economics, 6(5), 173-177. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 27 © 2021 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 8, no. 1, 27-38, 2021 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2021.81.27.38 © 2021 by the authors; licensee asian online journal publishing group ho chi minh stock exchange market: operations and efficiency van nguyen hong tran1 hamid r seddighi2 ( corresponding author) 1sunderland business school, university of sunderland, sunderland, the uk. abstract this paper presents an up-to-date account of market operations of the ho chi minh stock exchange and examines its informational efficiency in recent years. the daily closing prices and rates of return of the vietnam (vn) index – the major market index of the ho chi minh stock exchange (hose) – and ten stocks chosen from different sectors are employed, from january 2, 2018, to december 31, 2019, to investigate the random walk hypothesis of market efficiency using the lo–mackinlay variance ratio test and the chow–denning multiple variance ratio test. our results show that the market index and individual sample stocks conform to the null hypothesis of a random walk type 3 model of a weak form market efficiency. the paper also presents the results of an event study to examine the semi-strong form market efficiency of the hose. the empirical results on this type indicate that there are significant abnormal returns and significant cumulative abnormal returns by trading the stocks around events. however, these results are inconsistent with the requirements of a semi-strong form market efficiency, and it thus appears that further improvements in the transmission of information and its speed within this market are needed to further improve the efficiency of this emerging market. keywords: emerging stock markets, market operation, market efficiency, ho chi minh stock exchange, variance ratio test, event study. jel classification: c12; g14. citation | van nguyen hong tran; hamid r seddighi (2021). ho chi minh stock exchange market: operations and efficiency. asian journal of economics and empirical research, 8(1): 27-38. history: received: 4 february 2021 revised: 8 march 2021 accepted: 12 april 2021 published: 31 may 2021 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interest. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction to ho chi minh stock exchange and its market operations ......................................................................... 28 2. literature review ............................................................................................................................................................................ 30 3. data and the empirical methodology ............................................................................................................................ 31 4. empirical results ............................................................................................................................................................................. 32 5. implications and conclusions ........................................................................................................................................................ 35 references .............................................................................................................................................................................................. 36 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2021.81.27.38&domain=pdf&date_stamp=2017-01-14 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2021.81.27.38&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/2953 https://orcid.org/0000-0003-0817-7698 https://orcid.org/0000-0003-3679-0545 asian journal of economics and empirical research, 2021, 8(1): 27-38 28 © 2021 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this paper presents an up-to-date account of market operations of the ho chi minh stock exchange and examines its informational efficiency in recent years. 1. introduction to ho chi minh stock exchange and its market operations vietnam’s stock exchange markets are currently some of the most dynamic emerging stock markets in asia (pham, nguyen, & vo, 2018). ho chi minh stock exchange (hose) and hanoi stock exchange (hnx) are key platforms for trading listed stocks in vietnam (huong & thuy, 2016). the hose is vietnam’s largest stock exchange, and it is the main market for trading stocks of large corporations. since the initial milestones of establishing the vietnamese stock market, there has been significant enhancement and development of this stock market. the government has focused on regaining trust in the market and its operations, particularly since the global financial crisis in 2010. restructuring the securities market has been a primary strategic project of the vietnamese government and the ministry of finance since 2012 (the prime minister, 2012). from 2000 to 2019, the listed value on the hose jumped by vnd 883,670 billion (see figure 1). the market liquidity in 2019 remained stable. the average trading volume per session in 2019 was about 182.5 million shares, which is equivalent to an average trading value of vnd 4,128 billion per session (ho chi minh stock exchange, 2019). market capitalization on the hose in 2019 peaked at nearly vnd 3.28 trillion, which was over twice the market capitalization at the hose in 2016 (see figure 1). the market capitalization at the hose accounted for more than 95% of the equity market capitalization nationwide. figure 1. listed values and market capitalization on the hose from 2000 to 2019. source: ho chi minh stock exchange (2019). the market capitalization at the hose in 2018 was 2.87, which is equivalent to nearly 52% of the gross domestic product (gdp) of vietnam (ho chi minh stock exchange, 2018) (see figure 2). this was slightly more than the ratios of indonesia and china in the same year but far from the levels reported in the philippines, malaysia, and thailand (the world bank, 2019). the performance of hose could be explained by abundant liquidity and positive market expectations of the state-owned enterprise equitization process (the world bank, 2019). the market capitalization at the hose in 2019 was equivalent to nearly 54% of vietnam’s gdp in 2019, which rose by 2% compared to the market capitalization at the hose in the previous year (ho chi minh stock exchange, 2019). figure 2. market capitalization compared to regional peers (% of 2018 gdp). source: the world bank (2019). further, the market liquidity of the vietnamese stock market was compared to regional peers (see figure 3). the vietnamese stock market was more active with a moderate turnover ratio of 40%, which was in the midrange of the ratios obtained by the other frontiers and emerging markets in the region (the world bank, 2019). 3 2 1 5 0 0 1 ,0 0 0 1 ,1 2 0 1 ,3 3 6 1 ,9 1 8 1 4 ,0 6 1 3 8 ,0 5 0 7 5 ,5 3 9 1 1 7 ,9 8 8 1 7 1 ,8 2 7 2 0 2 ,0 6 6 2 4 8 ,5 0 1 2 6 9 ,4 5 0 3 3 0 ,1 9 0 4 2 4 ,8 6 7 4 9 3 ,8 8 7 6 1 8 ,4 2 7 7 9 8 ,3 0 9 8 8 3 ,6 7 0 9 8 6 1 ,5 7 0 2 ,4 3 6 2 ,3 7 0 4 ,2 3 7 7 ,3 9 0 1 4 7 ,9 6 7 3 6 4 ,4 2 5 1 6 9 ,3 4 6 4 9 4 ,0 7 2 5 9 1 ,3 4 5 4 5 3 ,7 8 4 6 7 8 ,4 0 3 8 4 2 ,1 0 5 9 8 5 ,2 5 8 1 ,1 4 6 ,9 2 5 1 ,4 9 1 ,7 7 8 2 ,6 1 4 ,1 5 0 2 ,8 7 5 ,5 4 4 3 ,2 7 9 ,6 1 6 2 0 0 0 2 0 0 1 2 0 0 2 2 0 0 3 2 0 0 4 2 0 0 5 2 0 0 6 2 0 0 7 2 0 0 8 2 0 0 9 2 0 1 0 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7 2 0 1 8 2 0 1 9 listed value (vnd bil.) market capitalisation (vnd bil.) 47% 52% 47% 93% 98% 113% 0% 20% 40% 60% 80% 100% 120% indonesia vietnam china philippines thailand malaysia asian journal of economics and empirical research, 2021, 8(1): 27-38 29 © 2021 by the authors; licensee asian online journal publishing group figure 3. market liquidity compared to regional peers (turnover, ratio %). source: the world bank (2019). in 2019, the price-to-earnings ratio (p/e) of the vn index was 16.5 (see table 1). compared with the p/e of other peer markets in southeast asia, the p/e of the vn index was the lowest and below the average p/e of 19.12. nonetheless, regarding the economic growth potential using oecd's gdp growth forecast for the period from 2019 to 2023, vietnam is one of the economies which was predicted to obtain the greatest growth rate. thus, the hose is expected to achieve a positive growth in the future to gradually narrow the gap to the other regional markets. table 1. price-to-earnings (p/e) ratios of the vn index and other indices in southeast asia. market index country expected gdp 2019–2023 (%) p/e p/e forward 1 year vn index vietnam 6.5 16.5 16.8 pcomp index philippines 3.7 19.4 16.7 set index thailand 6.6 18.7 20.1 fbmklci index malaysia 5.2 21.2 21.9 jci index indonesia 4.6 19.8 19 average 5.32 19.12 18.9 source: kb securities vietnam (2019); oecd (2019). the correlations between return on equity (roe) and price-to-book values (p/b) of asian countries are presented in figure 4. the vn index had a high roe and a high p/b index compared to the ratios of other asian countries. furthermore, vietnam became southeast asia’s best-performing stock market in 2019 with a 12% gain for the vn index on the hose (preiss, 2019). vietnam was the third-best performing market in the world over the past five years (preiss, 2019). this provides positive growth potential for the market in the future. figure 4. roe – p/b values of asian countries. source: kb securities vietnam (2019). as of december 31, 2019, there were 378 listed company stocks on the hose; the ten major sectors on the hose are energy, materials, industrials, consumer discretionary, consumer staples, health care, financial, real estate, utilities and information technology. article 6 of decree no.39/2018/nd-cp states that classifications of enterprises could depend on the number of employees participating in social insurance and the total annual revenue or the total capital of enterprises (the government, 2018). accordingly, 100% of companies listed on the hose were large companies (see figure 5). 22% 40% 207% 13% 77% 34% 0% 50% 100% 150% 200% 250% indonesia vietnam china philippines thailand malaysia market liquidity (turnover, ratio %) asian journal of economics and empirical research, 2021, 8(1): 27-38 30 © 2021 by the authors; licensee asian online journal publishing group figure 5. classifications of companies listed on the hose based on company size. according to article 4 of the law on enterprises no. 68/2014/qh13, state-owned enterprises are redefined as enterprises in which 100% of the charter capital is held by the state (the national assembly, 2014). based on the current law, 100% of companies listed on the hose and the hnx are not state-owned companies. however, under article 141 of the law on enterprises no. 68/2014/qh13, conditions for conducting the general meeting of shareholders were listed. it is stated that the general meeting of shareholders shall be conducted when the number of attending shareholders represents at least 51% of the total number of votes. additionally, resolutions are passed if the number of shareholders represents at least 65% of the total votes and all attending shareholders agree. it is of concern whether the proportion of state stockholders in the listed companies is equal to or greater than 51% (see figure 6). currently, the state owns at least 51% of the outstanding stocks of 20% of the listed companies on the hose. figure 6. state ownership of companies listed on the hose. 2. literature review there has been a considerable growth in demand for investment funds in vietnam, resulting in significant market activities on the vietnamese stock exchanges in terms of both market capitalization and liquidity (gupta, yang, & basu, 2014; vo & truong, 2018). the new listings of companies and participation of foreign investors have accelerated the hose market’s development in recent years (vo & truong, 2018). despite the rapid rise in the market activities in recent years, there is a limited number of studies on the key emerging market operations and efficiency. dong loc, lanjouw, & lensink (2010) used weekly price series of the vn index and the five oldest stocks on the stock exchange to test for market efficiency. the results obtained from the autocorrelation tests, run tests and variance ratio tests all failed to support the random walk hypothesis of a weak form market efficiency. these findings were consistent with those of do, le, & nguyen (2015), luu, pham, & pham (2016) and shaik & maheswaran (2017), whose detailed statistical investigations showed that the vietnamese stock market is not weak form efficient. however, phan & zhou (2014) and gupta et al. (2014) indicated a gradual improvement towards market efficiency, although, overall, the vietnamese stock market has remained inefficient for more than ten years. results under the assumption of homoscedastic and heteroscedastic increments in these papers provided enough evidence to accept the random walk hypothesis in the third sub-period, which implies that the vietnamese stock market was weak form efficient after the crisis. tran & mai (2015) investigated the effects of dividend announcements on share prices in the vietnamese stock market using an event study method. the dataset included closing prices and adjusted closing prices of 233 companies listed on the hose with a total of 979 dividend announcements between 2008 and 2014 (tran & mai, 2015). there were three groups of dividend announcements in the study – dividend increases, dividend decreases and no change. it was indicated that the mean and median values of abnormal returns from day -2 to day -1 in the dividend increase cluster were significantly positive. moreover, the abnormal trading volume was significantly different from zero from day 0 to day +5 in these three groups. this provided strong statistical evidence of information leakage or insider trading before the announcement date and the low transparency level of the stock market (tran & mai, 2015). therefore, the market was not semi-strong efficient. the empirical research of tran, nguyen, & pham (2016) appraised semi-strong form efficiency in the vietnamese stock market by analyzing the market reaction to dividend and earnings announcements. it involved 100% 0%0% large companies medium companies small companies 20% 80% state ownership over 51% state ownership less than 51% asian journal of economics and empirical research, 2021, 8(1): 27-38 31 © 2021 by the authors; licensee asian online journal publishing group 247 listed companies on the hose from 2014 to 2015 (tran et al., 2016). the daily stock prices of the vn index and each firm were used for 20 days around the publishing day from the hose database, and the data consisted of announcements of dividends and quarterly earnings of the companies. as a result, there was an insignificant reaction to the announcement day and in few days around it. additionally, there were significant abnormal returns within 20 trading days surrounding the date of dividend and earnings announcements. the stock prices did not promptly and adequately reflect the new information and these announcements had a significant impact on the stock prices in the event window of 20 days. in other words, the evidence did not support the requirements of a semi-strong form in the vietnamese stock market (tran et al., 2016). appendix 1 presents a summary of empirical studies related to the vietnamese stock market. it is evident from this brief review of recent studies that there are clear gaps in the literature in two key areas. first, there is little empirical evidence available on the status of this market efficiency after the changes of regulations in 2012. second, there appears to be little up to date information regarding this market’s operations and activities in recent years. this paper aims to fill these gaps, and its purpose is twofold: 1. to provide an up-to-date account of the recent operations of the ho chi minh stock exchange (hose) market under the new market regulations since 2012. 2. to test the efficiency of this market based on the random walk model and event study using recent data relating to market activities after the introduction of the new market regulations in 2012. the first point is provided in the first section of the introduction to the ho chi minh stock exchange and its market operations, and the second is fulfilled in the following sections. the remainder of the work is organized as follows: section 3 discusses the data and the empirical methodology of this study; section 4 discusses the empirical results of the hose market efficiency; and section 5 discusses the implications and conclusions of the study. 3. data and the empirical methodology to fulfill the gap and meet the research objectives, the study examines the overall stock price behavior of the hose stock price index (vn index) and the stock price behavior of ten of its listed companies which were selected randomly from ten sectors. these are: an phat bioplastics joint stock company (aaa) from the materials sector; binh duong water environment joint stock company (bwe) from the utilities sector; bidv securities joint stock company (bsi) from the financial sector; dong a plastic group joint stock company (dag) from industrials; digiworld corp (dgw) from the information technology sector; binh dinh pharmaceutical and medical equipment joint stock company (dbd) from the health care sector; danang rubber joint stock company (drc) from the consumer discretionary sector; vietnam national petroleum group (plx) from the energy sector; saigon beer – alcohol – beverage corporation (sab) from the consumer staples sector; and sai gon thuong tin real estate joint stock company (scr) from the real estate sector. daily stock prices for the vn index and the above listed companies were collected for the period from january 2, 2018, to december 31, 2019, generating 498 observations on the market index and each of the selected stocks. the testing procedures involve the following steps: (1) variance ratio tests under the independently and identically distributed assumptions are performed without bias correction to test the homoscedastic random walk model; (2) multiple variance ratio tests are performed by repeating the previous procedure but allowing for heteroscedasticity in the data and using bootstrapping to illustrate the statistical significance. wright’s rank variance ratio test was also conducted to support the tests in step 1 and step 2. wright (2000) proposed the variance ratio tests that do not rely on asymptotic approximations and are done under homoscedasticity; (3) if the null hypothesis of a random walk model is not rejected in all cases, the study then performs an event study analysis to test the semi-strong market form efficiency. combining all sample data, the study uses 5478 observations. we start by implementing tests of random walks and weak form market efficiency. then, semi-strong form efficiency is examined if the requirements of a weak form market efficiency are met in all sample cases. 3.1. weak form tests to appraise the market efficiency, the random walk model is employed and is defined as: pt = µ + pt-1 + ɛt or δpt = yt = pt – pt-1 = µ + ɛt (1) where: δpt (yt) is the continuously pounded rate of return for a stock at time t. pt and pt-1 are the natural logarithms of the stock prices at time t and t-1. µ is an unknown drift parameter. ɛt is the random disturbance term. equation 1 is used to examine whether the daily stock returns/movements are randomly distributed. the random walk implies uncorrelated residuals and hence uncorrelated returns (δpt). the hypotheses to be tested are: h0: vietnamese market indices and stock prices follow a random walk. h1: vietnamese market indices and stock prices do not follow a random walk. campbell, lo, & mackinlay (1997) classified three types of random walk. random walk type 1 (rw1) allows for homoscedasticity and it is known as the homoscedastic random walk hypothesis. random walk type 2 (rw2) and random walk type 3 (rw3) allow for heteroscedasticity. rw2 is used to test the assumption of unconditional heteroscedasticity in the random disturbances. rw3 is more general, and it is used to examine the assumption of the conditional heteroscedastic random walk hypothesis. additionally, rw1 is considered as a special case of rw2, and rw1 and rw2 are special cases of rw3. rw1 is the strongest form of random walk, and rw3 is the weakest form of random walk (campbell et al., 1997). thus, this study employs tests to examine rw1 and rw3. the statistical tests are conducted using eviews 10. regarding the decision-making process used in this study, in order for the market to meet the requirements of rw1 or rw3, the results obtained from these tests, in all cases, are required to show that the null hypothesis is asian journal of economics and empirical research, 2021, 8(1): 27-38 32 © 2021 by the authors; licensee asian online journal publishing group not rejected. the single variance ratio test by lo & mackinlay (1988) and the multiple variance ratio test by chow & denning (1993) are two key tests, while other tests are also considered as supporting tests in this study. the single variance ratio test by lo & mackinlay (1988) is employed to test the individual null hypothesis of a random walk, while the multiple variance ratio test by chow & denning (1993) is used to examine the joint null hypothesis. this work requires all results of the lo & mackinlay tests and the chow & denning tests to not be rejected under the null hypothesis of rw1 or rw3 if the market meets the requirements of rw1 or rw3. 3.2. semi-strong form tests if the results of the above tests indicate that the null hypothesis is not rejected in all sample cases, tests of semistrong form market efficiency might be conducted via an event study. the event study gauges the effects of a specific event on stockholder wealth by examining an abnormal movement of stock prices around the event (mann & babbar, 2017). the abnormal returns refer to the difference between the actual returns after an event and the normal returns that a firm would have gained without the effects of such an event (eryigit & eryigit, 2019; mann & babbar, 2017). the event study method has a variety of applications and contributions in accounting and finance research (mackinlay, 1997). the most popular model to estimate normal behavior is a regression based on the actual return of the stock and the actual return of the market index or industry index (benninga, 2014). the paper collects and analyzes the stock daily closing prices and rates of returns of the vn index – the major market index in the hose, and drc and bwe – two listed companies randomly selected from the hose. bwe is one of the newly listed company stocks, while drc is one of the existing listed company stocks. this method has been used to investigate several specific firms and economy-wide events (benninga, 2014). in this study, three event days on which there were huge daily changes in the vn index closing prices and its rates of returns were randomly chosen. the information is summarized in table 2. table 2. chosen events in event study based on vn index. no date daily returns event 1 05/02/18 -5.10% information from the chairman of the state securities commission related to the roadmap for applying an increase of the initial margin and impact of volatility of the us stock market impacted investor sentiment. 2 03/07/18 -4.34% fears of an escalating trade war between the us and china and the problems of climbing exchange rates and lowering expected profits of listed companies. 3 11/10/18 -4.84% selloffs of european and american stocks due to concerns about rising us government bond yields and psychological effects of the escalating trade war on investors. with randomly chosen securities and event dates, there should be no abnormal performance on average if the stock market has semi-strong form efficiency (brown & warner, 1985). a parametric t-test is utilized to evaluate whether abnormal returns (ars) and cumulative abnormal returns (cars) are significantly different from zero. the parametric t-test in this work is performed based on the studies of brown & warner (1985); mackinlay (1997) and eryigit & eryigit (2019). the abnormal return (ar) for a stock i on day t is calculated as follows: arit = yit – (αi + βiymt) (2) where: yit represents actual stock return on day t; αi + βiymt represents returns expected by the α, β and corresponding market return of the stock. equation 2 investigates the abnormal returns (arit) using the market return model. it assumes a linear relationship between market return, individual asset return, and constant variance. the cumulative abnormal return (car) for a stock i on day t is calculated as: cari,t = cari,t-1 + arit or 𝐶𝐴𝑅𝑖,(𝜏2,𝜏3) = ∑ 𝐴𝑅𝑖,𝑡 𝜏3 𝑡=𝜏2 (3) according to mackinlay (1997), abnormal returns need to be cumulated to analyze the general effect of the event. abnormal returns are cumulated based on time as per equation 3. cumulating based on time reflects cumulative abnormal returns in the event window. the hypotheses to be tested include: h0: the abnormal returns (ars) and cumulative abnormal returns (cars) are close to zero. h1: the abnormal returns (ars) and cumulative abnormal returns (cars) are greatly different from zero. the parametric t-test in this study is conducted in excel. the alternative hypotheses indicate that ars and cars could be less or more than zero, so the tests are two-tailed. with a significant level of 5%, h0 will not be rejected if the calculated t-value belongs to the range of -1.96–1.96. within this framework, the hose would be considered to be semi-strong form efficient if the null hypothesis that ars and cars are close to zero is not rejected at a prespecified level of significance. 4. empirical results 4.1. weak form market efficiency the variance ratio tests are conducted using the eviews statistical package to examine the random walk model and martingale hypothesis for the daily return data of the market index and ten stock prices from january 2, 2018, to december 31, 2019. the default settings used in this study to test the specified lists are 2, 5, 10, 20, and 30 to investigate the data for the periods of 2 working days, 5 working days, 10 working days, 20 working days and 30 working days. the detailed statistical results of the vn index are provided in appendix 2. the procedure is also carried out on the data of the chosen listed companies on the hose. table 3 summarizes the results of the variance asian journal of economics and empirical research, 2021, 8(1): 27-38 33 © 2021 by the authors; licensee asian online journal publishing group ratio tests on the logarithm of daily closing prices of the vn index and the listed companies on the hose. the statistical results of the joint null hypothesis tests are presented in appendix 3. table 3. statistical results of the vn index and ten companies listed on the hose. no. market index/ company code homoscedastic random walk hypothesis conditional heteroscedastic random walk hypothesis wright's rank variance ratio tests individual null hypothesis joint null hypothesis individual null hypothesis joint null hypothesis individual null hypothesis joint null hypothesis lo & mackinlay test chow & denning test wald-type test lo & mackinlay test chow & denning test lo & mackinlay test chow & denning test wald-type test 1 vn index rejected rejected rejected not rejected not rejected not rejected not rejected rejected 2 aaa not rejected not rejected rejected not rejected not rejected not rejected not rejected rejected 3 bwe not rejected not rejected rejected not rejected not rejected not rejected not rejected rejected 4 bsi not rejected not rejected rejected not rejected not rejected not rejected not rejected rejected 5 dag not rejected not rejected rejected not rejected not rejected not rejected not rejected rejected 6 dgw not rejected not rejected not rejected not rejected not rejected not rejected not rejected rejected 7 dbd not rejected not rejected rejected not rejected not rejected not rejected not rejected rejected 8 drc not rejected not rejected rejected not rejected not rejected not rejected not rejected rejected 9 plx not rejected not rejected rejected not rejected not rejected not rejected not rejected rejected 10 sab not rejected not rejected rejected not rejected not rejected rejected rejected rejected 11 scr not rejected not rejected rejected not rejected not rejected not rejected not rejected rejected no. of rejected nulls 1 1 10 0 0 1 1 11 rw1 is the strictest form of random walk. in rw1, there are independently and identically distributed increments with a mean of 0 and a variance of 𝜎2. when a stock market is weak form efficient, the market indices or stock prices of any listed company should meet the requirements of weak form efficiency. the results for the vn index from the homoscedastic random walk model test consistently reject the joint and individual null hypotheses of a random walk under homoscedasticity based on the chow–denning and lo–mackinlay tests. further, the richardson–smith wald test statistic does not accept the joint null hypothesis in ten cases. therefore, it could strongly reject the null hypothesis of rw1 under homoscedasticity. the rejection of the random walk null hypothesis is supported by wright’s rank variance ratio test, which is also used to test the rw1 model. a rejection of the joint null hypothesis in the case of sab leads to the joint null hypothesis of a random walk also being rejected on the hose based on the chow–denning test. moreover, there is a rejection of the individual null hypothesis in the case of sab based on the lo–mackinlay test, so the individual null hypothesis of a random walk is not accepted on the hose. additionally, the richardson–smith wald test statistic does not accept the joint null hypothesis in 11 cases. subsequently, there is a strong rejection of the null hypothesis of rw1 based on the results of all tests carried out. in terms of the multiple variance ratio test, all of the chow–denning maximum |𝑧|statistic values are less than the critical value of 1.96, and their corresponding p-values are all more than the significant value of 0.05. moreover, in the individual tests, the variance ratio statistics are not significantly and statistically different from 1.0, all absolute values of the z-statistic are less than the critical value of 1.96 and their appropriate bootstrap p-values are all greater than the 5% significance level. the joint null hypothesis and the individual null hypothesis of a martingale are not rejected under conditional heteroscedasticity. this indicates that the logarithm of the stock price series of the vn index and the selected listed companies on the hose are almost certainly random and conform to the hypothesis of rw3. therefore, the null hypothesis of a martingale could not be rejected on the logarithms of the vn index and all chosen stocks on the hose at the5% significance level. according to the martingale hypothesis, the expected returns and price changes projected on the basis of information fully reflected in the current price are zero, the stock price sequence will follow a martingale (dong loc et al., 2010). this intimates that there is no systematic price movement and it could lead to an effective linear forecasting rule in the market. 4.2. semi-strong form market efficiency the ho chi minh stock exchange appears to meet the conditions of the weak form efficient market hypothesis, so the semi-strong form efficient hypothesis will be assessed. in this work, the shortest time gap between announcement dates of any two chosen events impacting the market indices and stocks on the hose is 70 days. moreover, the estimation window is regarded as the period before the event, and the longest event window in this work is 21 days of (-10, +10). thus, in this study, the estimation window will be 35 days until the day before the event window (-10; +10). in addition, there are two types of mistakes in a statistical hypothesis test (stock & watson, 2015). in the study, the type i significance level is defined, and it is crucial to evaluate other smaller event windows to limit the possibility of a type ii error occurring. therefore, this research also considers other event windows (-5; +5) and (-1; +1) to understand the reaction of the stock prices to the information raised. the abnormal returns (ars) for drc and bwe related to event 1 are provided in table 4. on the event day, the ars under the market-adjusted returns for drc and bwe are -2.463% and -2.948%, respectively. these values are statistically insignificant at the 5% significance level. however, on day -6 in the event window for bwe, there is a huge abnormal return of 6.375% and its corresponding t-statistic value is 1.991. this is statistically significant at the 5% significance level, which implies that significant ars could be gained six days before the event day by exploiting the relevant information leakage. this leads to the rejection of the null hypothesis that ars are close to zero. asian journal of economics and empirical research, 2021, 8(1): 27-38 34 © 2021 by the authors; licensee asian online journal publishing group table 4. event 1 – abnormal returns for drc and bwe. event 1 drc bwe date in event study ar t-statistics of ar significance date in event study ar t-statistics of ar significance -10 -1.942% -0.633 no -10 1.418% 0.443 no -9 -0.731% -0.239 no -9 0.020% 0.006 no -8 -2.823% -0.921 no -8 -4.218% -1.317 no -7 -5.069% -1.653 no -7 -1.430% -0.446 no -6 3.099% 1.011 no -6 6.375% 1.991 yes -5 -0.096% -0.031 no -5 1.225% 0.383 no -4 -1.230% -0.401 no -4 -0.031% -0.010 no -3 -3.026% -0.987 no -3 -1.589% -0.496 no -2 -1.046% -0.341 no -2 -0.068% -0.021 no -1 0.090% 0.029 no -1 -1.231% -0.384 no 0 -2.463% -0.803 no 0 -2.948% -0.921 no 1 2.441% 0.796 no 1 0.150% 0.047 no 2 -0.999% -0.326 no 2 1.594% 0.498 no 3 0.159% 0.052 no 3 -0.415% -0.129 no 4 -0.711% -0.232 no 4 0.395% 0.123 no 5 1.550% 0.506 no 5 1.264% 0.395 no 6 -1.139% -0.372 no 6 -1.444% -0.451 no 7 -1.471% -0.480 no 7 -1.167% -0.364 no 8 -2.512% -0.819 no 8 -0.788% -0.246 no 9 -0.861% -0.281 no 9 0.713% 0.223 no 10 -2.026% -0.661 no 10 1.127% 0.352 no table 5. event 2 – abnormal returns for drc and bwe. event 2 drc bwe date in event study ar t-statistics of ar significance date in event study ar t-statistics of ar significance -10 8.835% 1.178 no -10 -1.928% -0.655 no -9 6.328% 0.844 no -9 -2.951% -1.002 no -8 5.324% 0.710 no -8 1.542% 0.524 no -7 4.497% 0.600 no -7 7.599% 2.58 yes -6 5.155% 0.687 no -6 0.773% 0.262 no -5 10.496% 1.399 no -5 -3.796% -1.289 no -4 9.414% 1.255 no -4 0.318% 0.108 no -3 8.820% 1.176 no -3 2.766% 0.939 no -2 6.499% 0.866 no -2 0.801% 0.272 no -1 6.353% 0.847 no -1 0.021% 0.007 no 0 3.907% 0.521 no 0 0.838% 0.284 no 1 0.421% 0.056 no 1 1.062% 0.361 no 2 1.746% 0.233 no 2 0.951% 0.323 no 3 -0.247% -0.033 no 3 -2.683% -0.911 no 4 -1.376% -0.183 no 4 3.061% 1.039 no 5 0.047% 0.006 no 5 0.859% 0.292 no 6 -0.040% -0.005 no 6 0.042% 0.014 no 7 0.241% 0.032 no 7 1.096% 0.372 no 8 0.907% 0.121 no 8 3.229% 1.096 no 9 5.762% 0.768 no 9 1.728% 0.587 no 10 6.440% 0.859 no 10 1.951% 0.662 no the daily abnormal returns (ars) during the event window related to event 2 are detailed in table 5. the ars for drc and bwe on the event day are 3.907% and 0.838%, respectively, but they are not significant at the 5% significance level. the same holds good for the entire event window for drc as its ars are not significant on any of the days. however, on day -7 in the event window for bwe, there is a massive ar of 7.599% with a t-statistic value of 2.580, which indicates that the ars of bwe could be obtained seven days before the event day. this causes a rejection of the null hypothesis that ars are close to zero. the behavior of the abnormal returns (ars) for drc and bwe during the event window related to event 3 is summarized in table 6. the ars for drc and bwe are all insignificant at the 5% significance level. therefore, it is unable to reject the null hypothesis of no significant ars. the behavior of the cumulative abnormal returns (cars) around the events is presented in table 7. the results of the cars are investigated in different event windows (-10; +10), (-5; +5) and (-1; +1). the cars for events 1 and 3 are mostly negative in these event windows, but they are all statistically insignificant. this reflects that the market reacts negatively to the information related to events 1 and 3, but its impact is not significant. thus, there is a lack of evidence to reject the null hypothesis of no significant cars for events 1 and 3. asian journal of economics and empirical research, 2021, 8(1): 27-38 35 © 2021 by the authors; licensee asian online journal publishing group table 6. event 3 – abnormal returns for drc and bwe. event 3 drc bwe date in event study ar t-statistics of ar significance date in event study ar t-statistics of ar significance -10 6.302% 0.695 no -10 -1.220% -0.532 no -9 5.910% 0.652 no -9 2.154% 0.939 no -8 3.899% 0.43 no -8 -1.841% -0.803 no -7 2.139% 0.236 no -7 -1.473% -0.642 no -6 4.630% 0.51 no -6 3.951% 1.723 no -5 2.610% 0.288 no -5 -1.901% -0.829 no -4 3.819% 0.421 no -4 -1.962% -0.855 no -3 2.036% 0.224 no -3 -0.755% -0.329 no -2 -1.205% -0.133 no -2 0.885% 0.386 no -1 -1.670% -0.184 no -1 -1.875% -0.818 no 0 2.079% 0.229 no 0 -3.917% -1.708 no 1 -10.263% -1.132 no 1 2.245% 0.979 no 2 -2.209% -0.244 no 2 -1.204% -0.525 no 3 -6.845% -0.755 no 3 1.037% 0.452 no 4 -5.962% -0.657 no 4 1.057% 0.461 no 5 -5.168% -0.57 no 5 -0.292% -0.127 no 6 -5.925% -0.653 no 6 -0.328% -0.143 no 7 -13.375% -1.475 no 7 0.177% 0.077 no 8 -16.072% -1.772 no 8 0.790% 0.344 no 9 -16.323% -1.8 no 9 -0.429% -0.187 no 10 -16.229% -1.789 no 10 -1.484% -0.647 no table 7. cumulative abnormal returns for drc and bwe. event 1 drc bwe window car t-statistics of car significance window car t-statistics of car significance (-10; +10) -20.805% -1.481 no (-10; +10) -1.047% -0.071 no (-5; +5) -5.331% -0.524 no (-5; +5) -1.653% -0.156 no (-1; +1) 0.068% 0.013 no (-1; +1) -4.029% -0.726 no event 2 drc bwe window car t-statistics of car significance window car t-statistics of car significance (-10; +10) 89.526% 2.604 yes (-10; +10) 17.277% 1.280 no (-5; +5) 46.077% 1.852 no (-5; +5) 4.198% 0.430 no (-1; +1) 10.680% 0.822 no (-1; +1) 1.921% 0.377 no event 3 drc bwe window car t-statistics of car significance window car t-statistics of car significance (-10; +10) -67.819% -1.632 no (-10; +10) -6.384% -0.608 no (-5; +5) -22.777% -0.757 no (-5; +5) -6.682% -0.879 no (-1; +1) -9.854% -0.627 no (-1; +1) -3.547% -0.893 no on the other hand, the cars for drc and bwe for event 2 are all positive in all these different event windows. this denotes that the market reacts optimistically to the event. the car for drc in the (-10; +10) event window is 89.526%, and its t-statistic value of 2.604 is much greater than the critical value of 1.96. this could be explained by the continuous positive ars for drc from day -10 to day +2, though the values are insignificant. this suggests that fears of an escalating trade war between the us and china and the issues of increasing exchange rates and a reduction in the expected profits of listed companies have significant positive effects on its car in the (10; +10) event window. the significant car value for drc in this event window results in the strong rejection of the null hypothesis of no significant cars. in summary, the statistical results proved that the ars and cars for drc and bwe are greatly different from zero in some cases, so the null hypothesis of no significant ars and cars is rejected. this indicates that the hose market is not semi-strong form efficient. 5. implications and conclusions our empirical investigation on the hose reveals that the vn index and the stock prices of a sample of randomly selected companies from 10 different listed sectors all satisfy the requirements of rw3. this finding implies that the increments are uncorrelated, but they are clearly neither independent nor identically distributed because their squared increments are correlated. this suggests that the hose is fairly efficient in the weak form and it would not be possible to accurately predict the price movement of the vn index and the selected listed companies on the hose to earn consistent excess returns over a sustained period based on their historical price changes. this is a statistically significant result as it could imply that recent policies designed to improve market operations and efficiency have been effective. with regard to semi-strong form market efficiency, however, the results show that significant abnormal returns could be gained six days or seven days before the event day, but no significant ars happen on the actual asian journal of economics and empirical research, 2021, 8(1): 27-38 36 © 2021 by the authors; licensee asian online journal publishing group event date. this emphasizes the fact that information is leaked to the market prior to the announcement day. as a result, the null hypothesis of no significant ars cannot be accepted. furthermore, according to the results of event 2, the car for drc in the event window of (-10; +10) is 89.526%, and its t-statistic value of 2.604 is much greater than the critical value of 1.96. this leads to the rejection of the null hypothesis that cars are close to zero. the investors incur significant abnormal returns and significant cumulative abnormal returns by trading the stocks. this finding implies that the hose is not yet capable of accurately, and at the corresponding time, incorporating the publicly available information into the stock prices, and thus fails to satisfy the requirements of a semi-strong form market efficiency. to remedy this shortcoming in market operations, a range of new policies designed to eliminate information leakages and enhance transmission of information are needed if the efficiency of this key emerging market is to be further improved. references benninga, s. 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(2000). alternative variance-ratio tests using ranks and signs. journal of business & economic statistics, 18(1), 1-9. available at: https://doi.org/10.2307/1392131. http://www.forbes.com/sites/rainermichaelpreiss/2019/04/05/vietnams-stocks-offer-long-term-profits-with-status-upgrades/#66dcb6491c20 http://www.forbes.com/sites/rainermichaelpreiss/2019/04/05/vietnams-stocks-offer-long-term-profits-with-status-upgrades/#66dcb6491c20 asian journal of economics and empirical research, 2021, 8(1): 27-38 37 © 2021 by the authors; licensee asian online journal publishing group appendix the joint and individual null hypotheses are rejected based on the chow–denning test, the lo–mackinlay test and the wald test under homoscedasticity (see tables a1, a2 & a3). under heteroscedasticity, the joint and individual null hypotheses of a martingale could not be rejected based on the chow–denning test and the lo– mackinlay test (see tables a1 & a2). table a1. single variance ratio test on log pt (vn index). null hypothesis: log pt is a random walk date: 03/31/20 time: 14:17 sample: 1/02/2018 12/31/2019 included observations: 497 (after adjustments) standard error estimates assume no heteroscedasticity use biased variance estimates user-specified lags: 2 5 10 20 30 joint tests value df probability max |z| (at period 5)* 2.051586 497 0.1855 wald (chi-square) 13.51411 5 0.0190 individual tests period var. ratio std. error z-statistic probability 2 1.000700 0.044856 0.015608 0.9875 5 1.201619 0.098275 2.051586 0.0402 10 1.170853 0.151452 1.128102 0.2593 20 1.038178 0.222931 0.171253 0.8640 30 0.992365 0.276593 -0.027605 0.9780 * probability approximation using studentized maximum modulus with parameter value 5 and infinite degrees of freedom test details (mean = -7.15338111347e-05) period variance var. ratio obs. 1 0.00012 -497 2 0.00012 1.00070 496 5 0.00015 1.20162 493 10 0.00014 1.17085 488 20 0.00013 1.03818 478 30 0.00012 0.99236 468 table a2. multiple variance ratio test on log pt (vn index). null hypothesis: log pt is a martingale date: 03/31/20 time: 14:17 sample: 1/02/2018 12/31/2019 included observations: 497 (after adjustments) heteroscedasticity robust standard error estimates use biased variance estimates user-specified lags: 2 5 10 20 30 joint tests value df probability max |z| (at period 5)* 1.390532 497 0.5925 individual tests period var. ratio std. error z-statistic probability 2 1.000700 0.067692 0.010342 0.9917 5 1.201619 0.144994 1.390532 0.1644 10 1.170853 0.214893 0.795062 0.4266 20 1.038178 0.304677 0.125305 0.9003 30 0.992365 0.367704 -0.020765 0.9834 * probability approximation using studentized maximum modulus with parameter value 5 and infinite degrees of freedom test details (mean = -7.15338111347e-05) period variance var. ratio obs. 1 0.00012 -497 2 0.00012 1.00070 496 5 0.00015 1.20162 493 10 0.00014 1.17085 488 20 0.00013 1.03818 478 30 0.00012 0.99236 468 asian journal of economics and empirical research, 2021, 8(1): 27-38 38 © 2021 by the authors; licensee asian online journal publishing group table a3. rank variance ratio test on log pt (vn index). null hypothesis: log pt is a random walk date: 03/31/20 time: 14:18 sample: 1/02/2018 12/31/2019 included observations: 497 (after adjustments) standard error estimates assume no heteroscedasticity user-specified lags: 2 5 10 20 30 test probabilities computed using permutation bootstrap: reps = 5000, rng = kn, seed = 1000 joint tests value df probability max |z| (at period 5) 1.793294 497 0.1778 wald (chi-square) 6.430104 5 0.2664 individual tests period var. ratio std. error z-statistic probability 2 1.019309 0.044856 0.430472 0.6778 5 1.176236 0.098275 1.793294 0.0674 10 1.194238 0.151452 1.282507 0.2010 20 1.167488 0.222931 0.751298 0.4838 30 1.096058 0.276593 0.347291 0.7580 test details (mean = 0) period variance var. ratio obs. 1 1.00000 -497 2 1.01931 1.01931 496 5 1.17624 1.17624 493 10 1.19424 1.19424 488 20 1.16749 1.16749 478 30 1.09606 1.09606 468 this table summarizes the statistical test results in all joint null hypothesis tests. the probability approximation in the chow–denning test is conducted using a studentized maximum modulus with a parameter value of 5 and infinite degrees of freedom. appendix 3. statistical results of joint null hypothesis tests. no. market index/ company code homoscedastic random walk hypothesis (rw1) conditional heteroscedastic random walk hypothesis (rw3) wright's rank variance ratio tests joint null hypothesis joint null hypothesis joint null hypothesis chow & denning test (max |z| at period m) wald-type test (chisquare) chow & denning test (max |z| at period m) chow & denning test (max |z| at period m) wald-type test (chisquare) 1 vn index 2.051586 13.514110 1.390532 1.793294 6.43010 2 aaa 1.518724 4.396357 1.175483 1.347282 4.42633 3 bwe 0.728012 4.751010 0.688696 0.738522 4.96286 4 bsi 1.685831 5.940855 1.394067 1.935761 7.26802 5 dag 1.328480 4.299466 1.172319 1.671795 7.91515 6 dgw 1.060222 1.772857 0.854374 1.223552 3.09841 7 dbd 0.891214 2.702539 0.663286 1.437285 3.03724 8 drc 1.335389 4.690794 1.235332 1.450079 4.21442 9 plx 1.509040 7.136878 1.076068 1.637842 4.17150 10 sab 1.952080 4.402822 1.164296 2.037932 4.81433 11 scr 1.269829 9.310069 0.908594 1.205051 3.82641 no. of rejected nulls 1 10 0 1 11 asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 67 © 2022 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 9, no. 2, 67-72, 2022 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v9i2.4055 © 2022 by the authors; licensee asian online journal publishing group do interest rate and inflation matter for exchange rate fluctuation in bangladesh? an ardl approach mamun chowdhury department of economics, jagannath university, dhaka, bangladesh. email: mamun@eco.jnu.ac.bd abstract this research explores the effects of inflation and interest rate on the nominal exchange rate in bangladesh using data from 1980 to 2021. the augmented dicky-fuller (adf) test is used to find the order of integration whereas the ardl approach has been used to determine the causality and cointegration among the variables. the ardl bounds testing approach revealed a stable and statistically significant long-run relationship between interest rate (ir), inflation (inf) and exchange rate (er). the long-run ardl model advocates that an increase in the lending interest rate leads to a significant appreciation of bangladeshi currency in terms of usd. at the same time, the inflation has a positive but insignificant impact on the exchange rate at 5% level of significance. in the short-run, the effects of the interest rate on the exchange rate are positive and significant but the inflationary effect on the exchange rate is not statistically significant. hence, the study recommends an efficient management of interest rate and inflation in bangladesh to keep balance in the exchange rate. keywords: exchange rate, inflation, interest rate, ardl model, foreign exchange earnings, bangladesh. jel classification: c12; c32; c87; f41; e50. citation | mamun chowdhury (2022). do interest rate and inflation matter for exchange rate fluctuation in bangladesh? an ardl approach. asian journal of economics and empirical research, 9(2): 67-72. history: received: 10 february 2022 revised: 23 march 2022 accepted: 7 april 2022 published: 18 july 2022 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 68 2. literature review ............................................................................................................................................................................ 69 3. data and methodology ................................................................................................................................................................... 70 4. results and discussion ................................................................................................................................................................... 70 5. conclusion and policy recommendations .................................................................................................................................. 71 references .............................................................................................................................................................................................. 72 mailto:mamun@eco.jnu.ac.bd https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v9i2.4055 https://orcid.org/0000-0002-5181-1466 asian journal of economics and empirical research, 2022, 9(2): 67-72 68 © 2022 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to existing literature by exploring whether the two key macroeconomic variables such as interest rate and inflation can be crucial factors to unstable the nominal exchange rate in a developing country like bangladesh. 1. introduction both interest rate and inflation are the key to having an impact on the nominal exchange rate, consistent with many economic theories. the traditional economic theories argue that an increase in the domestic lending interest rate would provide incentives for foreign investors to invest in financial markets. the influx of such foreign capital, would, therefore, appreciate the national currency. on the contrary, a lower domestic interest rate would depreciate currency value and as a result, boost the capital outflow (mgammal, 2012). as opined by ogege (2019), the interest rate is the most essential component of the economy because it affects international trade through borrowing costs, savings, and investment. fisher (1930)also explained the inflationary effect on the exchange rate by concluding that the increase in the inflation rate would depreciate the value of the domestic currency. this is because the higher the rate of inflation, the higher volume of imports which dampens the export performance. the seminal work by engel (1986), has also pointed out that the negative relationship between the nominal interest rate and exchange rate takes place if the inflation rate of a country increases and the expected inflation rate decreases. the theory of purchasing power parity (ppp) has also attributed a negative relationship between inflation and nominal exchange rate in the same vein. overall, the impact of interest rate and inflation on the exchange rate is still conflicting as theoretical and empirical literature have failed to provide conclusive evidence about the effects of interest rate and inflation on the exchange rate. nevertheless, in bangladesh, the correlation between these three macroeconomic variables may be stronger as they were fluctuating altogether since the 1980s. refer to table 1. this volatility may be due to lower levels of output growth, inadequate foreign direct investment (fdi), and the political turmoil between 1980 and 1990. after the 2000s, overwhelming government debts from the banking sector and the massive capital flight have contributed to the worsening liquidity scenario. this leads to an increase in the interest rate and inflation. the trend of the nominal exchange rate also showed a steady devaluation of bdt during this period. this paper has intended to explore whether the changes in the interest rate and inflation have any influence on the devaluation of bdt against the usd. furthermore, divergences in the findings of some theories were motivation to take up this issue in bangladesh. however, this study has some significance for bangladesh's economy as its economic growth is highly sensitive to the changes in the exchange rate. this has exposed the country’s remittance and export sector to greater vulnerability. the excess devaluation of its currency would increase the import cost. on the contrary, its appreciation might have an effect on the export performance and remittance inflow. hence, the stability in the interest rate and inflation is important for bangladesh to keep its exchange rate in a steady-state position. given this context, this paper aims to address the following two issues. first, to investigate whether the nominal exchange rate of bdt(bangladesh) in terms of usd posits a cointegration relation with interest rate and inflation. second, to examine the effects of fluctuations in the interest rate and inflation on the long-run and short-run behavior of the nominal exchange rate in bangladesh. 1.1. exchange rate, interest rate and inflation nexus in bangladesh the transition of bangladesh's economy since(to) independence was not smooth. since then, the country has faced several economic policy shifts. for example, it adopted socialism shortly after the independence and thereby nationalized all its soes. the socialistic mode of production, however, did not bring success to the economic growth for which the country had to enter into the privatization-led free-market economy in the early 1980s. the statistics show that the economy was not performing well, even in the realm of a privatization-based free-market economy. the economy was facing several challenges ranging from low gdp growth to ensuring food security. the key macroeconomic variables such as interest rate, inflation and exchange rate showed volatility as the monetary aggregates were not steady. this might be due to the persistent lower export growth, high import cost, low remittance inflow, poor foreign direct investment and high payment of external debt interest. table 1. trend of exchange rate, lending interest rate and consumer price index in bangladesh. year exchange rate interest rate consumer price index 1980 15.45 11.33 17.92 1985 27.99 12 27.80 1990 34.57 16 49.85 1995 40.28 14 63.73 2000 52.14 12.75 80.22 2005 64.33 10.62 102.69 2010 69.65 12.22 163.52 2015 77.95 11.71 227.39 2020 84.87 8.3 282.685 2021 85.08 7.3 298.395 source: 1) world development indicators (wdi), world bank, 2). world economic outlook 2020 (weo), imf. from the statistics depicted in table 1, the bdt had been continuing to have depreciated since the 1980s. from 1983 onwards, the country experienced 89 adjustments in exchange rate. among which 83 were observed downwards and the remaining were upward (islam, 2002). on occasion, the government had intentionally kept its currency value lower against the usd aiming to boost its export sector. the practice of an adjustable peg system had made it easier for the government to keep the currency value favorable to international trade. despite this, during the 1980s and 1990s, the nominal exchange rate of bangladesh was being further depreciated. the domestic interest rate and inflation were volatile and at the same time, the export earnings and remittances were not strong asian journal of economics and empirical research, 2022, 9(2): 67-72 69 © 2022 by the authors; licensee asian online journal publishing group enough to prevent bdt from being further depreciated. however, in early 2000, the booming export sector and remittance earnings along with the stability in macroeconomic aggregates have provided bangladesh with some economic strength to adopt a floating exchange rate system. the statistics as displayed in table 1 show that the nominal exchange rate of bangladesh was not steady, even in the realm of floating exchange rate. after 2005, the rate of depreciation of bdt was not less comparing to the previous decades. so why did the exchange rate of bdt depreciate while the country had better export earnings and remittance inflow? the volatility in the interest rate and inflation after 2000 may be the reason for the downturn of bdt values against the usd. the statistics evident in table 1 have strengthened this possibility as the interest rate was significantly higher after 2000, which reached its peak in 2017 and the consumer price index became parallel to this skyrocketing interest rate. furthermore, as per the economic theory, the increase in the interest rate and inflation can depreciate currency by rising imports. on the other hand, the increased interest rate can also appreciate the currency by increasing the demand for foreign capital. 1.2. theoretical background of the research many classical and contemporary economic theories have highlighted the relationship between interest rates, inflation, and exchange rates. their findings, however, were not similar which has made this a long-debated issue in macroeconomics. several economic theories such as the international fisher effect (ife), the theory of purchasing power parity (ppp), the views of keynesian and chicago schools, etc. have produced the following different conclusions. the international fisher effect is an extended form of the fisher effect which postulates a positive correlation between nominal interest rate and expected rate of inflation. according to the theory, as is stated by dornbush, fischer, and startz (2009), the country will tend to experience depreciation in relation to its currency value if it has a higher rate of interest compared to its trading partners. according to the theory of purchasing power parity, the ratio of purchasing power of the two countries is a strong determinant of the nominal exchange rate. the real exchange rate turns out to be less than 1(%) if a country faces higher inflation in comparison with another country. this implies that the country has to depreciate its currency value to make the real exchange rate equal to 1(%). furthermore, the views of the chicago school and keynesian thought can also be some good examples in analyzing the interest rate, inflation and exchange rate relationship. the chicago school considers the fluctuation in interest rate a prime source for the deviation of the nominal exchange rate. the school believes that the higher cost of production, which is caused by the higher lending interest rate, leads to an increase in the exchange rate of domestic currency because the country now faces inflation and depreciation(frankle, 1979). alternatively, the keynesian views find an appreciation of domestic currency value due to the effect of increased nominal interest rate in the domestic financial market. keynes explains this relationship based on the theory of sticky prices. the theory argued that any increase in nominal interest rate, which might be the result of the tight monetary policy, eventually leads to an increase in real interest rate because there is a sticky price in the goods market. the higher rate of real interest rate would, therefore, bring foreign capital to the country. hence, following the keynes view, there would be an appreciation of domestic currency value as the inflow of foreign capital will increase the demand for domestic currency in the foreign exchange market. 2. literature review this section explores different types of literature on the nexus between interest rate, inflation, and exchange rate for the different economies. the aim is to understand how the exchange rate of bangladesh and many other countries respond to the changes in the interest rate and inflation. for example, by using structural vector autoregressive (svar) and cholesky factorization method (karim, 2019) found that the increase in domestic interest rate attracts foreign investors and thereby causes the appreciation of bangladesh taka against usd. on the other hand, chowdhury and hossain (2014) have shown that the increase in interest rate in bangladesh creates a depreciation of the taka in terms of usd. likewise, amin, murshed, and chowdhury (2018) and hossain and ahmed (2009) have found a similar result. now, in the context of the global economy, the work of carneiro and rossi (2013) and shodipe (2018) are good examples to start with. in their seminal work, the authors argued that prudent macroeconomic policy is necessary for the economy to prevent further appreciation of currency value which has been caused by the increase in interest rate. however, a cross-country analysis by kui si, xiao-lin, chang, and lu (2018) has also shown positive comovement between interest rate and exchange rate for the economy of brics countries. on the other hand, (hacker, h. kim, & manson, 2009) showed that the increase in interest rate leads to appreciating the currency value in the short run for selected seven pairs of countries. yung (2017) has concluded that the interest rate is negatively related to the exchange rate. the work of khan, teng, and khan (2019) has also estimated negative effects of interest rate and inflation on the exchange rate in the chinese economy. saraç and karagöz (2016) in their work, however, interestingly found no evidence that a higher interest rate can cause exchange rate differentials in turkey’s economy. hossain (2002) argued that the increase in the consumer price index leads to a higher nominal exchange rate in bangladesh. murshed (2018), on the other hand, has found no evidence of granger causality from inflation to exchange rate in bangladesh. ali, mahmood, and bashir (2015) have studied the relationship between inflation, interest rate and exchange rate for the pakistan economy and found bi-direction granger causality between inflation and exchange rate. dilmaghani and tehranchian (2015), on the other hand, alleged that a country with a higher domestic inflation rate faces devaluation of its currency value. the seminal work by sean, pastpipatkul, and boonyakunakorn (2019) demonstrated that the increase in money supply causes inflation in cambodia and the increased inflation depreciates its currency value in consequence. similarly, joof and jallow (2020) argued that a 1% increase in the inflation rate in the gambia result from a 0.39% devaluation of domestic currency value against the us dollar. the works by fetai, koku, caushi, and fetai (2016) have found that the exchange rate volatility is the supreme cause of generating inflationary pressure in western balkan countries. asian journal of economics and empirical research, 2022, 9(2): 67-72 70 © 2022 by the authors; licensee asian online journal publishing group 3. data and methodology the entire data set deployed in this research has been collected from two sources, the world development indicators (wdi) of the world bank (wb) and the world economic outlook of imf. however, this study employed the autoregressive distributive lag (ardl) model developed by pesaran, shin, and smith (2001) to investigate the short-run and long-run relationship between the studied variables. this method was used because it provides some advantages compared to other traditional methods like (engle & granger, 1987) two-step procedures and johansen and juselius (1990). for example, the ardl model is likely to be more efficient, even with a small sample size, whereas the johansen juselius test requires a relatively large sample size to obtain valid results (ghatak & siddiki, 2001). an additional advantage of this model is that it can determine the level of relationship between the variables even if the regressors are integrated at different orders such as i(0) and i(1). on the contrary, the johansen juselius test provides results if the variables are integrated at i (1). furthermore, the ardl model is successful to address the endogeneity problem. this is because it allows satisfactory lags that can provide unbiased long-run estimates and valid t-statistics even when the time series are not integrated at the same level. moreover, this approach can also provide the simultaneous assessment of the long-run and short-run effects of one variable on another. the following model shows the long-run relationship of the time series. δert = ɑ1+ β1ert-i + β2irt-i+ β3inft-i + ∑ θ p i=1 i∆ert-i +∑ λ p i=1 i∆nirt-i+ ∑ ψ p i=1 i∆ninft-i+ε1t(1) δirt = ɑ2+ β1irt-i + β2ert-i + β3inft-i + ∑ θ p i=1 i∆ert-i +∑ λ p i=1 i∆nirt-i+ ∑ ψ p i=1 i∆ninft-i+ ε2t(2) δinft = ɑ3+β1inft-i + β2ert-i+ β3irt-i + ∑ θ p i=1 i∆ert-i +∑ λ p i=1 i∆nirt-i+ ∑ ψ p i=1 i∆ninft-i + ε3t (3) where, δ stands for the first difference operator, ɑi (i= 1....3) is the constant term, βi (i=1...3) represents coefficients of the lagged levels, θi, λi, and 𝛙i (i= 1-p) signifies the coefficients of lagged variables and εit (i= 1...3) implies the error terms which is assumed to be serially uncorrelated. the lag length is denoted by p which is determined by the minimum value of schwartz information criteria (sic). however, the equation can be divided into two parts. the first portion which is denoted by βi represents the long-run relationship. on the contrary, the portion with the summation sign would provide the short-run dynamics of error correction. the ardl bound test provides the wald test (f-statistics) that estimates the long-run cointegration among variables. the lagged level variables are restricted to zero to form a null hypothesis. pesaran et al. (2001) have argued that the calculated f-statistics need to be compared with upper bound and lower bound critical values for the estimation of the relationship. according to the model, the null hypothesis would be rejected if the value of calculated f-statistics goes above the value of the upper bound. on the other hand, if the calculated f-statistic value is found below the lower bound critical value, the null hypothesis cannot be rejected. however, the inference remains inconclusive if the value of f-statistics is positioned within these two bounds. if cointegration exists, the model would look into the estimation of long-run coefficients and short-run parameters along with error correction. therefore, the ardl model with error correction term is presented below to estimate the long-run and short-run coefficients. δert= ɑ1+ β1ert-i+ β2irt-i+ β3inft-i+ ∑ θ p i=1 i∆ert-i +∑ λ p i=1 i∆nirt-i + ∑ ψ p i=1 i∆ninft-i+δ1 ectti+ε1t (4) δirt= ɑ2 + β1irt-i + β2ert-i+ β3inft-i + ∑ θ p i=1 i∆ert-i +∑ λ p i=1 i∆nirt-i + ∑ ψ p i=1 i∆ninft-i + δ2 ectt-i+ε2t(5) δinft= ɑ3+ β1inft-i+ β2ert-i+ β3irt-i+ ∑ θ p i=1 i∆ert-i+∑ λ p i=1 i∆nirt-i + ∑ ψ p i=1 i∆ninft-i + δ3 ectti+ε3t(6) equation 4 presents the target model of this research which estimates the effects of inflation and interest rate on the exchange rate with the error correction term. in the same vein, equation 5 and 6 postulates the effects of corresponding explanatory variables in the equations when interest rate (δir) and inflation (δinf) at time t appear as dependent variables. the error correction term in the equation stands for the long-run equilibrium speed of adjustment. however, the convergence to the long-run equilibrium would occur if the sign of the error correction term is found negative and the coefficient of the term is significant. 4. results and discussion although the ardl bound testing approach can accommodate variables in any order such as i(0), i(1), or their mixture, it cannot be employed in any of the variables integrated at order 2 that is i(2). therefore, the ardl approach requires testing the stochastic properties of the time series to be confirmed that none of the variables are i(2). the widely used augmented dickey-fuller test is employed in this research to make sure the stochastic properties of the variables. table 2. unit root test (adf) for the period of 1980 to 2021. intercept with trend and intercept series at level first difference series at level first difference variables test statistic test statistics test statistics test statistics ln er -5.28 (0) * -3.91(0)* -4.07(0)* -6.42(1)* ln ir -0.27(1) -3.75(0)* -1.35(1) -4.22(0)* ln inf -1.51(1) -7.29(1)* 5.86(0)* -7.22(1)* notes: * denotes rejection of null hypothesis at a 5% level of significance. the figure in parenthesis indicates the optimal lag length determined by schwartz information criteria (sic). the results depicted in table 2 indicate some mixed integrations. for example, while the variable lner is confirmed stationary at i(0), the variable like lnir exhibits stationary at i(1). this dichotomy continues for lninf as well. the variable lninf is found stationary at i(1) with intercept but if we check its unit root in the case of with trend and intercept it does not need the first difference to be stationary. hence, table 2 indicates that the order of integration of the series is a mixture of i(0) and i(1) and none of the series are i(2). thus, the unit root results indicate that the paper needs to employ the ardl approach the order of integration is a mixture of i(0) and i(1) and none of them are i(2). asian journal of economics and empirical research, 2022, 9(2): 67-72 71 © 2022 by the authors; licensee asian online journal publishing group the ardl bounds testing method will check co-integration for equations (4), (5) and (6) where each variable appears lhs simultaneously. this method provides f-statistics at a 5% level of significance as presented in table 3. table 3. ardl bound test for co integration. functions value of f statistics critical values at a 5% level of significance inferences i(0) i(1) f(lner/lnir, lninf) 27.2* 3.1 3.87 cointegrated f(lnir/lner, lninf) 2.45 3.1 3.87 not cointegrated f(lninf/lner, lnir) 9.12* 3.1 3.87 cointegrated note: 1: * indicates the rejection of the null hypothesis at a 5% level of significance. this method determines co-integration among variables if the f-statistics value is greater than the upper bound value produced at a 1% or 5% or 10% level of significance (pesaran et al., 2001). according to the results, the long-run cointegration relationship is evident among the variables when lner and lninf appear as dependent variables as the values of calculated f-statistics of these functions are greater than the 5% upper bound value. the estimated results show there is a stable long-run relationship between interest rate, inflation, and exchange rate in bangladesh. on the contrary, the changes in the nominal exchange rate and inflation do not have any long-term effects on the interest rate when the interest rate appears as a dependent variable. however, in this research, my target model is (4) where the exchange rate appears as a dependent variable and the bound test result confirms the long-run relationship among the variables of this model. that being said, we need the long-run estimators of the model to measure the effects of regressors on the dependent variable. the optimal lag length is determined by the schwartz information criteria (sic) criterion which selects ardl (1, 1, 0) model. the results of long-run coefficients are presented in table 4. table 4. ardl long run and short run approach with lner as dependent variable. function coefficient std. error t-statistic probability lnir -1.05 0.39 -2.69 0.01 lninf 0.18 0.10 1.69 0.09 c 0.62 0.12 5.18 0.00 d(lir) 0.11 0.07 1.46 0.15 cointeq(-1)* -0.10 0.01 -10.9 0.00 note: * indicates ecm value is negative and significant. the long-run approach provides the long-run coefficients of regressors and probability value of t-statistics. the coefficient of lnir is estimated at -1.058382 and the probability of t-statistics suggests this result is highly significant. this long-run estimator advocates the negative relationship between interest rate and exchange rate. the nominal exchange rate in bangladesh decreases by 105% per annum if the nominal lending interest rate rises by 1% in the long run. this finding goes parallel to the keynesian thought which postulates that a unit increase in interest rate appreciates the currency value to a greater extent. on the contrary, inflation (lninf) in bangladesh is positive, but insignificant long-run effects on the nominal exchange rate. the exchange rate of bdt depreciates by 17.6% per annum against usd for a 1% increase in the general price level in bangladesh. the short-run effect of the interest rate is not similar to the long-run effect. the effects of the interest rate on the exchange rate are positive in the short run. as shown by the results, the increase in interest rate by 1% point depreciates the currency value of bdt by 10.6% in the short run. these short-run effects are also statistically insignificant as the p-value of t-statistics is greater than 5%. however, the error correction term is statistically significant. the negative sign before it implies that the long-run disequilibrium will turn back to a steady-state by any external shock imposed on the economy. the lower value (-0.0101283) of the error correction term is indicating that it will take a longer period to make the adjustment process. 5. conclusion and policy recommendations the stability in the exchange rate regime is crucial for bangladesh's economy due to its recent economic growth relying heavily on foreign exchange earnings. its export earnings and remittance inflow would significantly increase cost if there is unsteadiness in the exchange rate. the economy would cost the payment of import bills and external debt as well if the exchange rate cannot be kept under control. however, it is a challenge for bangladesh to keep the exchange rate under control in the floating exchange rate system. except for the rmg export and the remittances, the country has not any significant economic strength that can make the bdt stronger against the usd. on the contrary, the amount of money outgoing from bangladesh is increasing rapidly. hence, the stability in the interest rate and inflation is crucial for bangladesh as these two have direct impacts on both the inflow and outflow of money. the empirical results of this study have been found by using the ardl method are statistically significant as the coefficient of the cointegrating equation has been found negative and the probability value of t-statistics is less than 5%. in the long run, the impact of inflation and interest rate on the exchange rate is not similar. the exchange rate appreciated by 105.8% for a 1% increase in interest rate. on the other hand, the exchange rate depreciated by 17.6% if the inflation rate goes up by 1%. in the short run, however, the increase in the interest rate causes a little depreciation of bdt. moreover, the value of the error correction term is found very low which is only at 1.01%. the slower adjustment indicates that the economy will take a longer time to correct any disequilibrium in the interest rate and inflation to get the exchange rate into a steady-state situation. the monetary policy is therefore requiring efficient management of interest rate and inflation as the exchange rate in bangladesh is found highly elastic to the interest rate which can impact badly on the foreign exchange earnings. paradoxically, an increased interest rate can be an effective strategy for bangladesh, while the exchange rate depreciates sharply. however, the monetary authority in bangladesh should also consider the slow adjustment asian journal of economics and empirical research, 2022, 9(2): 67-72 72 © 2022 by the authors; licensee asian online journal publishing group process toward the long-run equilibrium in the exchange rate. the value of the speed of adjustment is found extremely low which would entail higher associated costs if the monetary authority fails to keep interest rate and inflation stable. references ali, t. m., mahmood, m. t., & bashir, t. 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(2019). money supply, inflation and exchange rate movement: the case of cambodia by bayesian var approach. journal of management, economics, and industrial organization, 3(1), 63-81.available at: https://doi.org/10.31039/jomeino.2019.3.1.5. shodipe, t. (2018). the impact of real interest rate on real exchange rate: evidence from japan, 2018 awards for excellence in student research and creative activity – documents. 5. retrieved from: https://thekeep.eiu.edu/lib_awards_2018_docs/5. yung, j. (2017). can interest rate factors explain exchange rate fluctuations? globalization and monetary policy institute, federal reserve bank of dallas, working paper no. 207, 1-37. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 153 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 2, 153-158, 2020 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2020.72.153.158 © 2020 by the authors; licensee asian online journal publishing group the impact of innovation on entrepreneurial orientation: a case study of smes in osun state opeoluwaseun ojekemi1 tomiwa sunday adebayo2 ( corresponding author) 1,2cyprus international university, northern cyprus mersin, faculty of economics and administrative science department of business administration, turkey. abstract the study aim is to examine the impact of process innovation, product innovation and market innovation on entrepreneurial orientation using osun state as a case study. the study based on the cdm theoretical framework. questionnaires were distributed to smes in osun state. the 350 questionnaires were distributed to the respondents; however, only 201 were filled properly and returned. the multiple regression was deployed to investigate this relationship. the study findings shows; (i) there are positive relationship between product innovation and entrepreneurial orientation; (ii) there is positive relationship between process innovation and entrepreneurial orientation; and (iii) there is positive relationship between market innovation and entrepreneurial orientation. keywords: e.o, market innovation, process innovation, product innovation, smes, regression technique. jel classification: c21, f23. citation | opeoluwaseun ojekemi; tomiwa sunday adebayo (2020). the impact of innovation on entrepreneurial orientation: a case study of smes in osun state. asian journal of economics and empirical research, 7(2): 153-158. history: received: 26 march 2020 revised: 30 april 2020 accepted: 5 june 2020 published: 3 july 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 154 2. theoretical review ....................................................................................................................................................................... 154 3. empirical review ........................................................................................................................................................................... 154 4. data and methodology ................................................................................................................................................................. 155 5. data analysis and interpretation ............................................................................................................................................... 156 6. conclusion and recommendation .............................................................................................................................................. 157 references ............................................................................................................................................................................................ 157 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.72.153.158&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1831 https://orcid.org/0000-0001-6252-7404 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1831 https://orcid.org/0000-0001-6252-7404 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1831 https://orcid.org/0000-0001-6252-7404 asian journal of economics and empirical research, 2020, 7(2): 153-158 154 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study is unique because it investigates the impact of innovation on entrepreneurial orientation among smes using osun state as a case study which is yet to be investigated. 1. introduction due to the low probability of job opportunities and risk of unemployment, the behavioral attitude of youth’s especially nigerian youths towards entrepreneurship has apparently changed. the role of upcoming businesses and entrepreneurship played in creating a job opening, encouraging youths to be innovative and boosting of the nation’s gross domestic product is very vital as opined by hall (2011). this is vital, as unemployment rates are increasing massively and growth of the economy has slowed down. the firm capacity to offer better designs and make quality products outstanding to its competitors will make the firm more competitive (d’cruz & rugman, 1992). the changes in the market, makes it hard to find any industry who do not innovate. damanpour and gopalakrishnan (2001) describe innovation as a new design similar to a device, product or service regulations adopted by the organization. also, nohria and gulati (1996) concur to the above definition. entrepreneurial orientation has its source in the process of strategizing (mintzberg, 1973) and it is first examined by miller (1983). it is a multidimensional concept, it is defined as one that is “involves in product market innovation, take up somewhat ventures that are risky and is the lead to come up with ’proactive’ innovations, beating their competitors at what they do. entrepreneurial orientation (eo) is a firm-level strategic orientation which captures an organization's strategy-making practices, managerial philosophies, and firm behaviors that are entrepreneurial in nature. the firm capacity to offer better designs and make quality products outstanding to its competitors will make the firm more competitive (d’cruz & rugman, 1992). over times, innovation has rigorously elevated for the private, the non-profit, and the public sector. however, its effects on smes have not been rigorously determined. the emphasis has managed to be the impact of evaluating the effects of innovation on economic entrepreneurial orientation. this work will be limited only to innovation including, product, market and process. over the years, numerous research have been conducted about the impact of innovation on entrepreneurial activities (julnes & holzer, 2001; pérez-luño, wiklund, & cabrera, 2011; roper, youtie, shapira, & fernández-ribas, 2010; salavou & lioukas, 2003). the above researchers noted that the strategy utilized is to boost the effectiveness of innovation in smes. there's a lot to be learned from innovation, even so, those that isn't productive. it is a major challenge for several small and medium-sized businesses and this is the major reason why creativity is less popular in a state such as osun state. this research therefore proposes to take a careful look at the effect of process, product, and market innovation on entrepreneurial orientation in osun state nigeria, to determine whether innovations have an adverse or positive influence on entrepreneurial orientation. determining the impact of product, market and process innovation on entrepreneurial orientation is the main aim of this study. no research on the effect of process, product and market innovation on entrepreneurial orientation has indeed been conducted in osun state. the remaining part of this study is designed as follows: theoretical review and empirical review which are the second and third segment respectively. data and methodology is described in the fourth section while analysis is interpreted in the fifth section. the last section concludes the study with suggestions proposed. 2. theoretical review theoretical studies including hall (2011); mairesse (2009); kemp, folkeringa, de jong, and wubben (2003) were generally based on the variant crépon, duguet, and mairessec (1998) model (cdm). this model described the three-stage interaction between inputs for innovation, output for innovation, and productivity. several researchers conducted an overwhelming majority of studies on innovations on this framework. this model pinpoints that the capitalized research and development is often employed as a factor for innovation input. this three-stage equation shed more light on the choice to innovate. furthermore, kuratko, ireland, covin, and hornsby (2005) and encaoua, guellec, and martínez (2006) concur that the relationship between market innovation and process innovation and sales is positive in the future. the major reason behind this scenario is that market and process innovation agrees with a monopoly that is temporary via the patents mechanism, which in most cases is one of the major obstacles to firm-followers to entry. therefore, this research is based on the 3-step innovation process mode. 3. empirical review over the years, numerous studies have investigated the link between innovation and entrepreneurial orientation kuratko et al. (2005); pérez-luño et al. (2011) and beekman, steiner, and wasserman (2012). baker and sinkula (2009) analyzed the complementary effects of market orientation and entrepreneurial orientation on profitability in small businesses. the authors deployed the regression analysis to examine the interaction. finding from this study shows that innovation has positive and significant link with entrepreneurial orientation. ferreira, coelho, and moutinho (2020) investigated the dynamic capabilities, creativity and innovation capability and their impact on competitive advantage and firm performance in portugal. the investigators deployed 387 enterprises to examine this relationship. finding shows that the indirect impact of exploitative and explorative capabilities mediated by creativity and innovation competences (hereinafter ic) gives evidence of the influence on competitive advantage and firm's performance. furthermore, the dynamic capability and innovation competences positively affect performance, while entrepreneurial orientation (hereinafter eo) is a moderator. wang, dass, arnett, and yu (2020) explored the connection between the management's entrepreneurial intention and its comparative strategic focus on valuation-creation versus value-appropriation was scrutinized. this also explores the moderating positions of relative efficiency, reward systems, and flexibility on the financial market, on the above relation. utilizing a multi-source dataset between 2007 and 2015 of 337 standard & poor (s&p) 500 firms. findings of the study show that business-oriented managers appear to concentrate more on creating value (e.g. new product development) than shareholder value. guo, wang, and chen (2020) looking at the mediating effect of supply chain learning, evaluated the green entrepreneurial orientation and green innovation. this paper asian journal of economics and empirical research, 2020, 7(2): 153-158 155 © 2020 by the authors; licensee asian online journal publishing group conceptualizes a theoretical framework for geo, green incremental innovation and green disruptive innovation, and is using empirical data from 416 chinese companies for research. the findings show a strong influence on environmental incremental innovation and disruptive innovation for corporate geos. supply chain technology impacts green gradual and revolutionary innovation significantly. additionally, learning the corporate supply chain plays a moderating role in the interaction between geo and green radical innovation, and also plays a mediating role in the relationship between geo and green radical innovations. zhao, li, tan, and liu (2008) examined the moderating effects of eo on the connection of mo and performance in small chinese firms. to evaluate this dynamics, simulation of the structural equation was deployed. finding from the research suggests that mo is directly associated with firm efficiency, alone or in combination with other components of the eo. more precisely, creativity and proactiveness have positively moderated the mo-performance interaction. arzubiaga, kotlar, de massis, maseda, and iturralde (2018) examined entrepreneurial mindset and creativity in family smes. the use of 230 spanish family smes revealed that family participation in the bod has a detrimental impact on their ability to turn eo into creativity. in addition, we show that the strategic involvement of the bod in service, control tasks, provision of knowledge and skills have beneficial benefits while bod activity intensity has a strikingly detrimental impact. to investigate the impact of mo as a mediating variable in the interaction between eo and performance of small and medium-sized enterprises (smes), amin, thurasamy, aldakhil, and kaswuri (2016) deployed a total of 500 smes in the manufacturing industry of food and beverages were involved in this study with a response rate of 117. the findings show that eo has a significant relationship with mo, and mo has a significant relationship with sme performance. mo will mediate the relationship between eo and smes’ performance. dost, arshad, and afsar (2018) examined the impact of eo on process innovation capability types and the position of social capital as moderator. authors gathered data from pakistan's chemical manufacturing companies, and examined it cautiously using various regression techniques. the results showed that gradual and revolutionary process progress is encouraged by proactiveness and risk-taking. social capital moderation also highlighted the effect that proactivity had on progressive creativity in systems. nevertheless, social capital moderation did not affirm the effect risktaking had on incremental and revolutionary innovation in the process. 4. data and methodology methodology is the theoretical and comprehensive assessment of the strategies that apply to an area of study. furthermore, this study is descriptive oriented in terms of data gathering, tracking and control of the degree of variables. moreover, in terms of method, logic and the quantitative and deductive time respectively. in terms of geography, this study is also conducted amongst selected entrepreneurs in each local government in osun state, nigeria. the survey consisted of 210 smes in the state of osun. though, 350 questionnaires were distributed, only 201 were properly filled and returned. the figure 1 below depicts the study research design. figure-1. research model. in this study, the convenience sampling1 was deployed. thus, this research employed 201 smes to investigate this relationship in osun states. the study utilized the multiple regression technique to investigate the interaction amongst the variables. the first thing is to formulate the economic function. ………………………………………………………….………………………. [1] the next thing is to formulate the economic model …………………………………………………………………… [2] the econometric framework is formulated by introducing the error term into the economic model. ………………………………………………………...……... [3] 1convenience sampling is a type of non-probability sampling that involves the sample being drawn from that part of the population that is close to hand. asian journal of economics and empirical research, 2020, 7(2): 153-158 156 © 2020 by the authors; licensee asian online journal publishing group in equation 3 above, eo depicts the entrepreneurial orientation, pro denotes the process innovation, prd signifies the product innovation, mrt illustrates the market innovation, β1, β2, β3, denotes coefficients of the regression while the error term is denoted by e. 5. data analysis and interpretation before analysis is carried out, it is important to determine the internal consistency of the data deployed. thus, the reliability of data set was determined. this is done with the aid of cronbach's alpha to verify the internal consistency. by using the benchmark of α = 0.70 set by revelle and zinbarg (2009). the investigators concluded that the data are consistent internally as depicted below in table 1. table-1. reliability test. scale cronbach's alpha number of items proactivity 0.957 5 risk taking 0.870 3 innovativeness 0.960 5 process innovation 0.746 3 product innovation 0.975 5 market innovation 0.746 3 5.1. descriptive statistics it is vital to ascertain data description before running a regression analysis. the variables utilized in this paper is represented by the table below. parameters such as mean, standard deviation, minimum and maximum are key information that will be explained based. table-2. descriptive statistics. tests market innovation product innovation process innovation proactivity risk taking innovativeness mean 4.04 3.68 3.90 3.98 3.40 3.45 std. dev 0.75 0.80 0.64 0.57 0.73 0.72 minimum 2.00 1.50 2.00 1.67 2.00 1.68 maximum 5.00 5.00 5.00 5.00 5.00 5.00 observation 201 201 201 201 201 201 table 2 above illustrates the study descriptive statistics. the mean for market innovation, product innovation, process innovation, proactivity, risk taking and innovativeness are 4.04, 3.68, 3.90, 3.98, 3.40 and 3.45 respectively. the range for market innovation is between 2.00 and 5.00, between 1.50 and 5.00 for product innovation, between 2.00 and 5.00 for process innovation and between 1.67 and 5.00 for proactivity, between 2.0 and 5.00 for for risk taking and between 1.68 and 5.00 for innoativeness. the standard deviation for market innovation, product innovation, process innovation, proactivity, risk taking and innovativeness 0.75, 0.80, 0.64, 0.57, 0.73 and 0.72 respectively. table-3. regression estimate showing the impact of market innovation, product innovation and process innovation on entrepreneurial orientation. hypotheses relationship coefficient β t-value pvalue reseult (constant) -22.729 -13.98 0.000 h1 pro →eo 5.958 53.833 0.000 supported h2 prd →eo 0.374 5.879 0.000 supported h3 mrk →eo 2.034 14.249 0.000 supported r2 0.982 adj r2 0.982 durbin watson 2.124 note: dependent variable: entrepreneurial orientation, pro: processinnovation, prd: product innovation, mrt: market innovation * signifies 1% level of significance the equation of the regression is interpreted by equations 1 and 2 respectively. ……………………………... ……….……………. [4] y= -22.729 +5.958pro + 0.374prd + 2.034mrk…………………………............................[5] where; y denotes entrepreneurial orientation, pro1 stands for process innovation, prd2 means product innovation, mrk3 represents market iinnovation, β1, β2, β3, denotes coefficients of the regression, and ε indicates the error term table 3 illustrates the influence of market innovation, product innovation and process innovation on entrepreneurial orientation. findings shows; (i) there is positive connection between product innovation and entreprenuerial orientation. this means that when other variables are held constant 1% incresae in process innovation will lead to 5.95% increase in entrepreneurial orientation. this finding aligns with the findings of baker and sinkula (2009) and dost et al. (2018); (ii) there is positive connection between process innovation and entreprenuerial orientation. this means that when other variables are held constant 1% incresae in product innovation will lead to 0.374%% increase in entrepreneurial orientation. this finding align with the outcome of pérez-luño et al. (2011) and beekman et al. (2012) and (iii) there is positive connection between market innovation and entreprenuerial orientation. this means that when other variables are held constant 1% incresae in market asian journal of economics and empirical research, 2020, 7(2): 153-158 157 © 2020 by the authors; licensee asian online journal publishing group innovation will lead to 2.03% increase in entrepreneurial orientation this outcome concur with the finding of zhao et al. (2008) and amin et al. (2016). the r2 and the adjusted r2 revealed that 98% of the discrepancy in entreprenuerial orientation can be explained by the market innovation, product innovation and process innovation. error term account for the remaining 2%. also the value of the durbin watson (2.124) shows that there is no sign of serial correlation in the model. 5.2. hypotheses testing in table 4 below, it is clear that all our independent variables (process, product, and market innovation) have a positive and significant relationship with the dependent variable (entrepreneurial orientation). thus, all the independent variables influence the dependent variable table-4. hypotheses table. null hypotheses criteria for acceptance decision product innovation does not influence eo accept ho if the p-value > 5% product innovation impact eo posively process innovation does not influence eo accept ho if the p-value > 5% process innovation impact eo posively market innovation does not influence eo accept ho if the p-value > 5% market innovation impact eo posively 6. conclusion and recommendation 6.1. conclusion the study aim is to examine the interaction between process innovation, product innovation and market innovation on etrepreneurial orientation using osun state as a case study. the study rest on the cdm theoretical framework. questionaires were distributed to smes in osun state. more than 300 questionaires were distributed to the respondents, however, only 201 were filled properly and returned. the multiple regression was deployed to investigate this relationship. findings shows; (i) there is positive connection between product innovation and entreprenuerial orientation. this finding corrobarate with the findings of wang et al. (2020) and dost et al. (2018); (ii) there is positive connection between process innovation and entreprenuerial orientation. this finding align with the outcome of jafarzadeh (2005) and beekman et al. (2012) and (iii) there is positive connection between market innovation and entreprenuerial orientation. this outcome concur with the finding of zhao et al. (2008) and amin et al. (2016). 6.2. recommendations since there is a positive and significant relationship between product innovation, process innovation and market innovation on entrepreneurial orientation, the study suggests the followings; (i) entrepreneurs should give greater attention to business innovation as it has a significant impact on entrepreneurship; (ii) entrepreneurs should pay closer attention to product creativity, because it has a significant impact on entrepreneurial orientation; and (iii) entrepreneurs should pay much more attention to process innovation, as it has a strong impact on the entrepreneurial orientation. 6.3. limitations of study while a broad survey of 201 smes enterprise has been utilized in this study, this survey can also involve more companies. focus was laid on a fiveor more-worker entrepreneur. this study exempts entrepreneurs with under 5 employees. the selection of respondents indicated exclusion of start-ups and micro-enterprises. this is a big factor which potential work should be work on. also, large companies were not involved in the research. thus future research is needed to provide additional understanding of the role of product , process and market innovation on eo. references amin, m., thurasamy, r., aldakhil, a. m., & kaswuri, a. h. b. (2016). the effect of market orientation as a mediating variable in the relationship between entrepreneurial orientation and smes performance. nankai business review international, 7(1), 39-59.available at: https://doi.org/10.1108/nbri-08-2015-0019. arzubiaga, u., kotlar, j., de massis, a., maseda, a., & iturralde, t. (2018). entrepreneurial orientation and innovation in family smes: unveiling the (actual) impact of the board of directors. journal of business venturing, 33(4), 455-469.available at: https://doi.org/10.1016/j.jbusvent.2018.03.002. baker, w. e., & sinkula, j. m. (2009). the complementary effects of market orientation and entrepreneurial orientation on profitability in small businesses. journal of small business management, 47(4), 443-464.available at: https://doi.org/10.1111/j.1540627x.2009.00278.x. beekman, a. v., steiner, s., & wasserman, m. e. (2012). where innovation does a world of good: entrepreneurial orientation and innovative outcomes in nonprofit organizations. journal of strategic innovation and sustainability, 8(2), 22-36. crépon, b., duguet, e., & mairessec, j. (1998). research, innovation and productivi [ty: an econometric analysis at the firm level. economics of innovation and new technology, 7(2), 115-158.available at: https://doi.org/10.1080/10438599800000031. d’cruz, j., & rugman, a. (1992). business networks for international competitiveness. business quarterly, 56(4), 101-107. damanpour, f., & gopalakrishnan, s. (2001). the dynamics of the adoption of product and process innovations in organizations. journal of management studies, 38(1), 45-65.available at: https://doi.org/10.1111/1467-6486.00227. dost, m., arshad, m., & afsar, b. (2018). the influence of entrepreneurial orientation on types of process innovation capabilities and moderating role of social capital. entrepreneurship research journal, 8(4), 1-15.available at: https://doi.org/10.1515/erj-2017-0212. encaoua, d., guellec, d., & martínez, c. (2006). patent systems for encouraging innovation: lessons from economic analysis. research policy, 35(9), 1423-1440.available at: https://doi.org/10.1016/j.respol.2006.07.004. ferreira, j., coelho, a., & moutinho, l. (2020). dynamic capabilities, creativity and innovation capability and their impact on competitive advantage and firm performance: the moderating role of entrepreneurial orientation. technovation, 92, 102061.available at: https://doi.org/10.1016/j.technovation.2018.11.004. guo, y., wang, l., & chen, y. (2020). green entrepreneurial orientation and green innovation: the mediating effect of supply chain learning. sage open, 10(1), 2158244019898798.available at: https://doi.org/10.1177/2158244019898798. asian journal of economics and empirical research, 2020, 7(2): 153-158 158 © 2020 by the authors; licensee asian online journal publishing group hall, b. h. (2011). innovation and productivity (no. w17178). national bureau of economic research isenberg, d. (2011). the entrepreneurship ecosystem strategy as a new paradigm for economy policy: principles for cultivating entrepreneurship, babson entrepreneurship ecosystem project. babson park: ma: babson college. jafarzadeh, m. (2005). designation and explanation of a model for anticipating entrepreneurship of graduates: tehran university case. doctoral dissertation, doctoral dissertation, tehran university. julnes, p. d. l., & holzer, m. (2001). promoting the utilization of performance measures in public organizations: an empirical study of factors affecting adoption and implementation. public administration review, 61(6), 693-708.available at: https://doi.org/10.1111/0033-3352.00140. kemp, r. g., folkeringa, m., de jong, j. p., & wubben, e. f. (2003). innovation and firm performance (no. h 200207). zoetermeer, the netherlands: eim. kuratko, d. f., ireland, r. d., covin, j. g., & hornsby, j. s. (2005). a model of middle–level managers’ entrepreneurial behavior. entrepreneurship theory and practice, 29(6), 699-716.available at: https://doi.org/10.1111/j.1540-6520.2005.00104.x. mairesse, j. (2009). using innovation surveys for econometric analysis. in b. h. hall and n. rosenberg (eds.), handbook of the economics of innovation (vol. 2). north holland: elsevier. miller, d. (1983). the correlates of entrepreneurship in three types of firms. management science, 29(7), 770-791.available at: https://doi.org/10.1287/mnsc.29.7.770. mintzberg, h. (1973). strategy-making in three modes. california management review, 16(2), 44-53.available at: https://doi.org/10.2307/41164491. nohria, n., & gulati, r. (1996). is slack good or bad for innovation? academy of management journal, 39(5), 1245-1264.available at: https://doi.org/10.5465/256998. pérez-luño, a., wiklund, j., & cabrera, r. v. (2011). the dual nature of innovative activity: how entrepreneurial orientation influences innovation generation and adoption. journal of business venturing, 26(5), 555-571.available at: https://doi.org/10.1016/j.jbusvent.2010.03.001. revelle, w., & zinbarg, r. e. (2009). coefficients alpha, beta, omega, and the glb: comments on sijtsma. psychometrika, 74(1), 145154.available at: https://doi.org/10.1007/s11336-008-9102-z. roper, s., youtie, j., shapira, p., & fernández-ribas, a. (2010). knowledge, capabilities and manufacturing innovation: a usa–europe comparison. regional studies, 44(3), 253-279.available at: https://doi.org/10.1080/00343400802360410. salavou, h., & lioukas, s. (2003). radical product innovations in smes: the dominance of entrepreneurial orientation. creativity and innovation management, 12(2), 94-108.available at: https://doi.org/10.1111/1467-8691.00272. wang, x., dass, m., arnett, d. b., & yu, x. (2020). understanding firms’ relative strategic emphases: an entrepreneurial orientation explanation. industrial marketing management, 84, 151-164.available at: https://doi.org/10.1016/j.indmarman.2019.06.009. zhao, y., li, y., tan, j., & liu, y. (2008). moderating effects of entrepreneurial orientation on market orientation-performance linkage: evidence from chinese small firms. journal of small business management, 46(1), 113-133.available at: https://doi.org/10.1111/j.1540-627x.2007.00235.x. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 91 © 2022 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 9, no. 2, 91-99, 2022 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v9i2.4120 © 2022 by the authors; licensee asian online journal publishing group early warning of bank failure in the arab region: a logit regression approach rami obeid the university of jordan, jordan. email: rami.obeid3@gmail.com abstract the global financial crisis of 2008 taught the biggest lesson of anticipating a financial crisis. the current study aimed to highlight the importance of central banks to build early warning systems to reduce the costs of resolution procedures of weak banks. the data was obtained from published annual reports and balance sheets of 60 commercial banks in the arab region for the period 2000-2010. using the logistic regression model to predict the performance of banks or anticipating the possibility of bank failure and build an early warning system, the study identified a few financial indicators such as capital adequacy ratio (car); liquidity (liq); cost to income ratio cir; return on. assets (roa); and non-performing loans (npl). the impact of the gdp variable on bank`s failure was also determined to capture economic risks. the results showed that financial soundness indicators (fsi) can be used efficiently to predict bank failure, that the variables of roa and car had the greatest impact on the probability of the bank’s survival, while no statistical significance was seen for the gdp variable. the paper recommends the importance of the financial stability and banking supervision departments to build early warning systems. the study would provide useful insights to both household and corporate sectors to look for early warning signs that predict the performance of the banking sector in the arab countries. the fsis suggested in the study would also play a prominent role in predicting the success or failure of banks in the arab region. keywords: logit model, early warning systems, bank failures, financial soundness indicators, central banks, financial stability. jel classification: g21; g33; c34; c35. citation | rami obeid (2022). early warning of bank failure in the arab region: a logit regression approach. asian journal of economics and empirical research, 9(2): 91-99. history: received: 25 may 2022 revised: 18 july 2022 accepted: 3 august 2022 published: 22 august 2022 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 92 2. literature review ............................................................................................................................................................................ 92 3. model and data ................................................................................................................................................................................ 94 4. econometric methodology ............................................................................................................................................................ 95 5. analysis of the results .................................................................................................................................................................... 95 6. conclusion and policy recommendations .................................................................................................................................. 97 references .............................................................................................................................................................................................. 98 mailto:rami.obeid3@gmail.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v9i2.4120 https://orcid.org/0000-0003-3829-5812 asian journal of economics and empirical research, 2022, 9(2): 91-99 92 © 2022 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study provides an opportunity for central banks and researchers to identify the financial, banking, and economic variables that can be used to predict the failure of banks in the arab region using the logistic regression model, especially since few previous studies have dealt with this issue regarding the arab region. 1. introduction after the global financial crisis in 2008, the supervisory authorities had developed new systems for a continuous monitoring process, represented in the development of early warning systems in order to predict the future conditions of banks, especially those that may suffer from potential challenges in the future. determining the existence of the problem bank and finding a solution to it is important to ensure the safety of the bank, and to achieve stability in the whole financial system, since banks are the main component of the financial system, and if any bank is liquidated, this will lead to negative effects on the economy in general, which negatively affects financial stability. building early warning systems and predicting the occurrence of crises is very important, as it helps to predict the possibilities of bank failure, thus reducing the possibility of banking crises in general, as well as reducing the costs of addressing their effects, with the aim of analyzing the framework and process of identifying the challenges that the bank may face, in addition to the timing and method of intervention. experience has proven the importance of having a precautionary framework for dealing with banks facing challenges at an early stage. one of the most important challenges facing the supervisory authorities of banks is to ensure the existence of effective supervision at the macro and micro levels and maintain financial stability. therefore, dealing with banking crises must begin with anticipating the crisis before it occurs, and therefore it is necessary to adopt macro-prudential control in order to identify, monitor and reduce risks to the financial system as a whole. all methods used in early warning systems depend on statistical and econometric models to predict the performance of the financial sector, whether at the individual level or at the macro level. depending on micro/macro financial and economic variables, the application of early warning systems requires the existence of a comprehensive and reliable historical database. in the event that a historical database is not available, simpler methods can be used. for example, the performance of “x” bank can be compared through certain indicators with the average value of these indicators in the banking sector as a whole. examples of early warning indicators that can be used by central banks are the following: a. the aggregate micro prudential indicators (ampis) can be used by central banks to conduct an analytical framework, according to which indicators are compared at the micro level with the aggregate indicators in order to analyze the soundness or weakness of the banks and their trends. this method is characterized as being easy to apply, and the data used can be provided, using nonparametric statistics. b. the heat map tool is one of the important tools to identify and monitor weaknesses and strengths in the banking sector by displaying them in the form of a risk map, in which a color gradient is used to indicate the quality or weakness of the financial indicators used for each bank. c. stress tests are an important tool of risk management that aims to measure the ability of the banking system to withstand financial shocks and high risks, and interest in these tests increased after the global financial crisis 2008. these tests are used by central banks and commercial banks to measure their ability to withstand financial shocks and the high risks that they may be exposed to. these tests aim to assess the financial conditions of banks within stressed scenarios that may occur, and therefore the results of these tests can be used to determine the levels of capital and liquidity that must be maintained by banks to enhance their ability to withstand financial shocks and high risks. these tests have a predictable future dimension in risk assessment using econometric models based on historical information. these tests can also help bank managements understand the bank's situation in a time of crisis. d. multiple discriminant analysis: many researchers work to predict the failure of companies using different methodologies. altman (1968) conducted a multiple discriminant analysis on the data of 66 industrial companies including 33 bankrupt companies, used as financial variables. altman's study shows that the model used in the study is effective in predicting bankruptcy even two years before the crisis, but with less accuracy if compared to a shorter time. also, early warning systems were developed for non-linear relationships using logistic regression models, which will be explained later in this study. e. financial stability indicators: there is a growing interest of the regulatory authorities in the issue of developing and preparing an indicator of financial stability, recognizing the importance of evaluating systemic risks on a regular basis, and thus assessing the financial stability in general. many supervisory authorities have developed new systems for the continuous supervision process at the micro and macro levels, represented in the development of financial stability indicators, in order to assess the stability of the financial sector. where financial stability indicators are considered as an early warning system that reduces the possibility of crises, as well as reducing the costs of addressing their effects. this study will provide a methodology for developing an early warning system to predict bank failure in the arab countries based on variables related to the financial soundness indicators for the banks. the study sample included 60 commercial banks in the arab region during the period (2000-2010). 2. literature review altman (1968) tried to build an early warning system to anticipate the failure of industrial institutions. the study used the multiple discriminant analysis for 33 bankrupt companies and found that bankruptcy of industrial companies can be predicted using some important financial indicates such as (1) retained earnings / total assets, (2) earnings before interest and taxes / total assets, (3) working capital / total assets, (4) sales / total assets, (5) book value of equity / book value of liabilities. martin (1977) showed that it is possible to build an early warning system to predict the performance of banks in the period of 1975–1976, the paper used 25 financial ratios asian journal of economics and empirical research, 2022, 9(2): 91-99 93 © 2022 by the authors; licensee asian online journal publishing group from the federal reserve bank of new york`s database and used altman methodology (logit analysis) to predict bank failures. after 1980, the researchers focused on using the logit analysis or the linear logistic regression model by the method of maximum likelihood. they used this method to overcome the defects of the multiple discriminant analysis method (see (tennyson, ingram, & dugan, 1990; zavgren, 1983)). zmijewski (1984) tried to predict the american firm`s failure determinants for 1200 firms during the period (1972-1978), by using the probit model to find the relationship between the financial ratios and the bankruptcies of the industrial firms. the results showed that the net profit to assets ratio, the credit to assets ratio and the assets to liabilities ratio can be used to predict the performance of the industrial firms. soo-wah, nor, and yatim (2001) also used eleven financial ratios in malaysia. the results showed the variables: current asset to current liabilities ratio, sales to current asset ratio, changes in earning after tax percentage have a significant impact on the firm’s performance, and they can be used to predict the financial distress. furthermore, the results showed that the rate of predictive accuracy in this paper at 82,4%. zhao, sinha, and ge (2009) tried to predict the bank failure used logistic regression, neural network, decision tree, and k-nearest neighbor. the results revealed that that feature construction improved classifier performance and that the degree of improvement varies significantly across the methods. glezakos, mylonakis, and oikonomou (2010) used the logit model to predict the failure of 60 companies (20 bankrupt companies and 40 healthy companies) in greece, the paper concluded that financial ratios can be used to predict the failure of banks, especially the variables related to capital, liquidity, and profitability indicators. wong, wong, and leung (2010) developed a panel probit model to predict the banking failure probability for emeap economies. the results revealed the banking sector is currently more capable to absorb financial and economic shocks similar to those that occurred during the asian financial crisis. maricica and georgeta (2012) attempted to build an early warning system using that financial ratio to provide signals to discriminate between failed and survival firms. avkiran and cai (2012) showed that the data envelopment analysis (dea) can be used to predict the failure of the banking system in the usa, the study used a sample consists of 218 banks. serrano-cinca and gutiérrez-nieto (2013) applied the partial least square discriminant analysis (plsda) to predict the failure of the banking system in the usa during the financial crisis period in 2008, the found that the results of using the plsda methodology are very accurate compared to the results obtained by linear discriminant analysis and support vector machine. zaghdoudi (2013) tried to adopt an early warning system using logistic regression method in order to predict the bank failures in the tunisian banking sector. the study showed that bank profitability per employee, ability of bank to repay its debt, leverage ratio and the banking operations has a negative impact on the bank`s failure. erdogan (2016) attempted to develop an early warning system for the banking sector in turkey using panel data during the period 2002 to 2012. the study used random panel logistic regression versus pooled logistic regression. the return on assets ratio (roa) was the dependent variable which expressed the bank failure. the study used several financial indicators as an independent variable, such as: operational efficiency, equity, deposit, asset quality. the study revealed that random-effect logistic regression was the best prediction performance. momparler, carmona, and climent (2016) applied the boosted classification tree methodology to anticipate the bankruptcy failure of 155 banks in europe, the paper covered the period 2006–2012 using 25 financial ratios. the results indicated that there is a positive relationship between the assets, non-operating income, and loans to deposits, and the bank failure; conversely, the results revealed that there is a negative relationship between the interbank ratio the lower the bank failure. barboza, kimura, and altman (2017) used machine learning models to predict the failure of more than 10,000 north american firms, and compared their performance with results from neural networks, logistic regression, and discriminant analysis. they covered the period from 1985 to 2013. the study used the machine learning techniques to enhance the accuracy of the prediction; furthermore, they attempted to find the bankruptcy determinants using altman’s z-score. they used six financial indicators which were previously used in carton and hofer (2006); furthermore, they added new variables, such as change in price-to-book, the operating margin, number of employees , change in return-on-equity, and growth measures related to assets, sales, as dependent variables. the results showed that machine learning models had more accuracy in relation to the other mentioned models, while the machine learning technique related to random forest, and the logit regression and the discriminant regression led to 87%, 69% and 50% accuracy, respectively. the study found that the results become more accurate when the additional variables are included. kapinos and mitnik (2016) found that the top-down approach to stress testing banks in the usa can be used to examine the banks solvency. cleary and hebb (2016) examined the failures of 132 american banks during the period 2002–2009 using discriminant analysis. the results showed that two most important variables to predict the bank`s failure were related to capital and credit quality, in addition to the profitability variables. the paper revealed that the model can easily be applied to many firms in order to predict their performance, and the model can distinguish between healthy and distressed banks. chiaramonte, liu, poli, and zhou (2016) used z-score to predict the failure of the commercial banks in the usa, the paper covered the period from 2004 to 2012, the paper revealed that the z-score can be used to predict 76% of bank failures, the results showed that this percentage will not be increased if an additional set of other banks and macro level variables will be added. bongini, iwanicz-drozdowska, smaga, and witkowski (2018) tried to predict the banking system failure using z-score and camels indicators for 20 countries in europe during the period 1995-2014, the results showed that the predictive power of the z-score was weak. cheong and ramasamy (2019) used the logistic regression to predict the performance of 536 failed and nonfailed banks in the usa, the results showed that the capital adequacy ratio (car) and the return on average equity (roe) have a negative on the probability of failure. in other words, the paper showed that banks that have higher levels of financial solvency and operational efficiency have a lower probability of bankruptcy. on the other hand, the results revealed that ratio of net loans to total assets, credit growth and impaired loans have a positive relationship with the probability of failure. shrivastava, jeyanthi, and singh (2020) developed an early warning system for the indian banks during the period (2000-2017), the paper used bank specific variables, market variables asian journal of economics and empirical research, 2022, 9(2): 91-99 94 © 2022 by the authors; licensee asian online journal publishing group and economic variables. the paper applied synthetic minority oversampling technique (smote) and lasso regression to mitigate the redundant features from the failure predictive model, then the paper applied some techniques to avoid the bias and overfitting compared to the logistic regression, this approach will lead to get the best predictive model obeid (2021) tried to build an early warning system for the arab banking sector using the logistic regression model. the study covered the period 2005-2015 to predict the bank`s failure for 40 banks in the arab region. the financial indicators such as capital adequacy ratio, assets quality, profitability were used to predict the bankruptcy in the arab banking sector. the study used also the gdp variable to capture the impact of economic risks on the bank`s performance. the study revealed the ability of the financial soundness indicators to predict bank bankruptcy. on the other hand, the results showed that there was no significant statistical relationship between the gdp and the bank`s performance. messi, kenny, and ogren (2021) tried to analyze the swedish experience of the international crisis of 1907, the paper showed that the structure of the banks’ asset played a more significant role in their subsequent fate. the results revealed that the non-performing loans and lending against equities variables the most important banking indicators which can be used to predict of crisis. these variables significantly affected the lifespan of swedish banks in the aftermath of the 1907 crisis. 3. model and data this paper attempted to build an early warning system to examine the determinants of bank failure in the arab region, based on the financial soundness indicators. the impact of the gdp variable was also tested on bank`s failure to capture the economic risks. the data was obtained from published annual reports and balance sheets of banks from the commercial bank’s websites and the databases of the capital market authorities in the arab countries during the period (2000-2010), while we obtained the gdp data from the arab monetary fund database. the definitions of the independent variables used in this paper to predict the bankruptcy of the banking system in the arab region are shown in table 1, while the dependent variable takes a dummy value of zero or one based on the bank's failure or survival, as clarified later in section four: table 1. definition of independent variables. variables variables abbreviation definition previous studies which have used the variable to predict the probability of failure capital adequacy ratio car (tier 1+ tier 2 capital)/risk-weighted assets) cleary and hebb (2016); erdogan (2016); cheong and ramasamy (2019); obeid (2021) cost-income ratio cir total administrative expenses/total annual income zaghdoudi (2013); cheong and ramasamy (2019); obeid (2021) non-performing loans npl total non-performing loans/total loans glezakos et al. (2010); cleary and hebb (2016); erdogan (2016); messi et al. (2021) return on assets roa net income/ total assets zmijewski (1984); cleary and hebb (2016) liquid assets liq liquid assets (cash and short-term assets)/total assets glezakos et al. (2010); zaghdoudi (2013); obeid (2021) gross domestic product gdp the real gross domestic product growth rate kadri and mayes (2009); obeid (2021) regarding the expected relationship between the independent variables and the probability of bank`s failure (dependent variable), it is expected that the financial solvency of the bank has an inverse relationship with the possibility of bankruptcy, as the high capital adequacy ratio (car) reduces the chances of the bank defaulting, it is known that capital adequacy increases the bank's ability to absorb potential shocks (obeid, 2021). as for the costincome rati0 (cir), it is expected that it has a positive relationship with the possibility of bankruptcy of the bank, as the increase in expenses consumes the bank's liquidity and indicates a decrease in the operational efficiency of the bank (obeid & adeinat, 2017). regarding non-performing loans, it is expected that it has a positive relationship with the possibility of bankruptcy of the bank, as the increase in the percentage of non-performing loans without adequate provisions leads to a decline in the quality of the credit portfolio, and thus may expose the bank to bankruptcy risks if no corrective plans and actions are put in place (glezakos et al., 2010). as for the return on assets (roa) variable, it is expected to have a negative relationship with the probability of bank bankruptcy, as the bank’s generation of profits indicates its operational efficiency, and profits enhance capital bases and enhance the confidence of the bank’s customers, thus reducing the possibility of bank default (obeid & adeinat, 2017). as for liquid assets, it is expected to have a negative relationship with the probability of bank bankruptcy, as the presence of high levels of liquid assets enhances the bank's ability to meet its obligations and enables it to employ its liquidity with less risks, thus reducing the chances of bank bankruptcy (zaghdoudi, 2013). finally, as for the gdp variable, it is expected to have a negative relationship with the possibility of bank bankruptcy, since the stable economic environment encourages investors to borrow from banks, as well as may increase the income of the individual and corporate sectors, which will positively reflect on the quality of the credit portfolio, and thus improve financial positions for banks (kadri & mayes, 2009; obeid & awad, 2018). asian journal of economics and empirical research, 2022, 9(2): 91-99 95 © 2022 by the authors; licensee asian online journal publishing group 4. econometric methodology the current study used the logit regression approach by the method of maximum likelihood. the model adopted the following formula: ln ( pit 1−pit ) = zit = β0 + β1carit + β2cirit + β3nplit + β4roait + β5liqit + β6gdpit + εit (1) i = 1, 2, … , n, t = 1, 2, … , t pit(y|x) = 1 1+e−zit ,pє[0,1] (2) where i refers to bank at time; t, zit refers to the linear regression which is obtained from the following equation: zit = β0 + β1xi,t−k (3) xi is a vector that refers to financial and economic variables that will be used to predict the banking sector failure, carit is the capital adequacy ratio of the bank, cirit is the operational efficiency (cost income ratio), nplit is the credit risk (non-performing loans), roait is the profitability indicator (return on assets), liqit is the liquid assets ratio, and gdpit is the real gross domestic product growth rate, and εit is the disturbance term. pit is the probability of (yi=1) in case the bank (i) is at risk of bankruptcy, and the probability of (yi=0) for the viable bank with low risk bankruptcy. the logit model is considered as one of the most applied approaches which predicts the failure of banks (see (demirguc-kunt & detragiache, 1998; obeid, 2021)). we analyzed the factors which explained the banks bankruptcy in the arab world. this paper used the financial soundness indicators to predict potential failures (see (altman, 1968; jagtiani, kolari, lemieux, & shin, 2002; obeid, 2021)). back to equation 3, the binomial regression was used in the logit model, we estimated the probability of bankruptcy or failure p(z). to predict the probability of survival (y = 0) or failure (bankruptcy) (y = 1), we used the following logistic model: pi,t(y) = { p(z) = 1 1+e −(β0+β1xi,t−k) , y = 1 1 − p(z) = 1 − 1 1+e −(β0+β1xi,t−k) , y = 0 (4) where: pi,t: probability that bank (i) bankruptcy at time (t), pє[0,1]. xi: vector which contain the variables that will be used to predict bankruptcy of bank (i). zit: linear regression extracted from vector xi, zє(-∞,∞). k: the year before the bankruptcy period. e: euler's number. β: vector contains the regression`s coefficients. the generalized linear method was used in order to calculate the scores (nelder & wedderburn, 1972). then, we used the lagrangian`s maximum likelihood function to obtain the parameters βd as following: max l(y|x, b) (5) next step, we solved the following equation to find the values of the intercept and β `s: l(y|x, b) = p(y|x), where: p(y|x) = ∏ [pi yi(1 − pi) 1−yin j=1 (6) so: log lp(y|x, b) = ∏ [yjlog( 1 1+e −(β0+β1xi,t−k)) + (1 − yj)log(n j=1 1 1+e −(β0+β1xi,t−k))] (7) where: p: the probability of the bankruptcy of bank (i) at the time (t), pє[0,1]. xi: vector contains the variables to be used to predict the bankruptcy of bank. k: the year before the bankruptcy period. β: regression`s coefficients. final step, we used the akaike information criterion (aic), this helped to choose the most important performing explanatory variables to predict the bankruptcy of bank as following: aic= -2logl+2p (8) where: l: the maximum likelihood of the fitted model. p: the number of estimated parameters. 5. analysis of the results 5.1. descriptive analysis the descriptive data of the explanatory variables are shown in table 2, taking into account that some variables have reached zero as a minimum value due to the bank`s failure in a specific period of time (such as: car, liq, and cir), while the minimum value of roa reached about -4.5%, and this value mainly indicates high operating losses and/or poor risk management and/or excessive risk-taking that is not based on an accurate assessment of the borrowers. regarding the npl ratio, the minimum value reached about 1.5%, which indicates an efficient credit risk management. as for the maximum values for the study variables, the value of car reached about 20.3%, which indicates the ability of bank to absorb and withstand financial and economic shocks, but at the same time the high ratios of car may affect negatively on the bank`s operational efficiency, because the bank may exaggerate in not granting credit. regarding the liq variable, the highest value reaches 93.9%, and this indicates the ability of the banking system to fulfill its obligations. asian journal of economics and empirical research, 2022, 9(2): 91-99 96 © 2022 by the authors; licensee asian online journal publishing group table 2. summary statistics of the variables. descriptive data car liq cir roa npl mean 0.14 0.58 0.68 0.01 0.07 median 0.16 0.65 0.63 0.01 0.07 maximum 0.20 0.94 1.33 0.02 0.16 minimum 0.00 0.00 0.00 -0.05 0.02 std. dev. 0.05 0.28 0.29 0.01 0.04 skewness -1.17 -0.75 0.38 -2.10 0.54 kurtosis 3.66 2.43 2.65 7.81 2.21 jarque-bera 16.13 7.06 1.93 111.89 4.88 probability 0.00 0.03 0.38 0.00 0.09 observations 660 660 660 660 660 note: car: capital adequacy ratio; liq: liquidity; cir: cost to income ratio; roa: return on. assets; npl: non-performing loans. regarding the cost to income ratio, the highest value has reached about 133%, and this may indicate a vulnerability in the operational efficiency. this value is often seen in weak banks that suffer in their financial positions. as for the roa variable, the highest value is seen 2.1%, and this gives a good indication of the efficiency of generating profits from assets. regarding the npl ratio, which reached 16%, it shows a weakness in credit risk management, and this may lead to a high possibility of bank`s bankruptcy. at this stage, the role of central banks is very important, they should put a comprehensive corrective plan for these banks to avoid reaching further financial deterioration. 5.2. bank failure prediction table 3 shows the results of estimating the logistic regression equation. it must be emphasized that the parameter values provide evidence of the relationship between the independent variables and the probability of the bank’s survival (the dependent variable), and not the size of the effects. the results showed that all banking variables were statistically significant, while it was not proven whether there is any relationship between gdp growth and bank bankruptcy. however, it must be emphasized the importance of taking economic risks into account when measuring the risks of the financial system (obeid & awad, 2018). with regard to banking variables, the results showed that a high percentage of npl has a negative relationship with the probability of the bank’s survival, meaning that a high percentage of npl may lead to a higher probability of bank failure, especially in the absence of sufficient provisions at the bank. this result supports the importance of adopting the ifrs9 standard, which included the importance of banks’ building provisions towards non-performing and performing credit. this further enhances the bank’s strength (obeid, 2022). about the capital adequacy ratio (car), the results showed a positive relationship with the probability of the bank’s survival, as the high car enhances the bank’s ability to withstand potential financial shocks, and this explains the growing interest from the basel committee on banking supervision in improving the quantity and quality of banking sector capitals, as well as building capital buffers (such as ccyb, ccob and dsibs buffer), in accordance with the requirements of basel iii. as for the ratio of liquid assets to total assets, it was associated with a positive relationship with the probability of the bank's survival, as maintaining good liquidity levels enhances the solvency of the bank and its ability to meet its obligations. it is worth noting that the basel requirements focused on enhancing the ability of banks to provide the necessary liquidity to meet short and long-term obligations, through the liquidity coverage and net stable funding ratios. as for the return on assets (roa) variable, as expected, it was associated with a positive relationship with the probability of the bank's survival, as the generation of profits gives evidence of enhancing the operational efficiency of the bank. finally, the results showed that there is a negative relationship between the percentage of operating expenses (cir) and the probability of the bank’s survival, as the increase in operating expenses indicates the weakness of the bank’s management. this may incur losses that affect its financial position, and thus increases the possibility of bank failure. the cost to income ratio (cir) is one of the most important determinants of operational efficiency (obeid & adeinat, 2017). table 3. logistic regression results. variables estimate p-value constant -9.377** 0.035 npl -0.821*** 0.000 car 0.142** 0.022 liq 0.087** 0.069 roa 0.423* 0.098 cir -0.087** 0.018 gdp 0.042 0.609 mcfadden r-squared 0.8256 -2 log likelihood 54.061 lr statistics 235.039 p-value [0.000] notes: the values in brackets are the p‐values of the tests. ***, ** and * denote significance at the 1%, 5% and 10% levels, respectively. car: capital adequacy ratio; liq: liquidity; cir: cost to income ratio; roa: return on. assets; npl: non-performing loans; gdp: gross domestic product regarding the size of the impact of the logistic model variables on the probability of the bank's survival, it is noted from table 4 that the rate of return on assets (roa) and then the capital adequacy ratio (car) are the most influential, but in general, table 4 showed the importance of the role of financial soundness indicators in predicting the bank's performance in terms of success or failure. asian journal of economics and empirical research, 2022, 9(2): 91-99 97 © 2022 by the authors; licensee asian online journal publishing group table 4. odd ratio for the significant variables. variables odd ratio constant 0 npl 0.44 car 1.15 liq 1.09 roa 1.53 cir 0.92 note: car: capital adequacy ratio; liq: liquidity; cir: cost to income ratio; roa: return on. assets; npl: nonperforming loans. finally, table 5 shows the expectation-prediction evaluation for binary specification (success cut-off point=0.5) while table 6 shows the goodness-of-fit evaluation for binary specification, the andrews statistic test has a value of 231.2, while the hosmer-lemeshow test has a value of 51.6. the hl test is used for risk prediction models, it evaluates how the data fits the model the accuracy of the prediction (hosmer, lemeshow, & sturdivant, 2013). table 5. expectation-prediction evaluation for binary specification. equation: eq01 success cutoff: c = 0.5 results estimated equation constant probability dep=0 dep=1 total dep=0 dep=1 total p(dep=1)<=c 59 1 60 0 0 0 p(dep=1)>c 1 599 600 60 600 660 total 60 600 660 60 600 660 correct 59 599 658 0 600 600 % correct 98.33 99.83 99.70 0.00 100.00 90.91 % incorrect 1.67 0.17 0.30 100.00 0.00 9.09 total gain* 98.33 -0.25 8.64 percent gain** 98.33 na 95.00 results estimated equation constant probability dep=0 dep=1 total dep=0 dep=1 total e(# of dep=0) 58.32 1.68 60.00 3.64 56.36 60.00 e(# of dep=1) 1.68 598.32 600.00 36.36 563.64 600.00 total 60.00 600.00 660.00 60.00 600.00 660.00 correct 58.32 598.32 647.64 3.64 563.64 567.28 % correct 97.20 99.72 98.13 9.09 90.91 83.47 % incorrect 2.80 0.28 1.77 90.91 9.09 16.53 total gain* 86.71 8.67 15.77 percent gain** 95.38 95.38 95.38 note: *change “%correct” from default (constant probability) specification. **percent of incorrect (default) prediction corrected by equation. table 6. goodness-of-fit evaluation for binary specification. andrews and hosmer-lemeshow grouping based upon predicted risk (randomize ties) no. quantile of risk dep=0 dep=1 total h-l low high actual expect actual expect obs. value 1 2.e-06 0.705 54 54.72 12 12.28 66 1.51 2 0.734 0.995 6 6.49 60 62.51 66 4.35 3 0.996 0.998 0 0.13 66 65.87 66 3.73 4 0.998 0.999 0 0.06 66 65.94 66 5.86 5 0.999 0.999 0 0.04 66 65.96 66 6.03 6 0.999 0.999 0 0.03 66 65.97 66 6.02 7 0.999 0.999 0 0.02 66 65.98 66 6.01 8 0.999 0.999 0 0.01 66 65.99 66 6.01 9 0.999 0.999 0 0.01 66 65.99 66 6.00 10 0.999 1.000 0 0.00 66 65.99 66 6.00 total 60 61.51 600 602.49 660 51.56 h-l statistic 51.56 prob. chi-sq(8) 0.00 andrews statistic 231.21 prob. chi-sq(10) 0.00 6. conclusion and policy recommendations this paper attempted to build a logistic model to predict the performance of the banking sector in the arab countries, with the aim of providing early warning tools to central banks. such a proactive step would enable them to anticipate the performance of banks, and thus avoid incurring costs to address any risks that may worsen any situation of crisis. when a bank faces a particular crisis, it must deal with the crisis by predicting it much before it occurs. this study showed that banking variables had a statistically significant importance and could be used in predicting the occurrence of the crisis. the study also showed that the rate of return on assets (roa) had the most important role in predicting the crisis, followed by the capital adequacy ratio (car), and the liquid assets to total assets ratio, costs to income ratio (cir), and non-performing loans (npl) to total loans, respectively. as for the economic variables, they had no statistically significant impact on the banking performance. it should also be noted that the effect of the ratio of non-performing loans to total loans, and the ratio of cost to income ratios had a asian journal of economics and empirical research, 2022, 9(2): 91-99 98 © 2022 by the authors; licensee asian online journal publishing group negative impact on the banks' performance (e.g., increased probability of bank failure), while the relationship was positive for the other remaining variables (decreased probability of bank failure). this paper focused on the importance of central banks to build early warning systems for the banking sector, which may reduce the costs of resolution procedures towards the weak banks. in this paper, a logistic regression model was used to predict the performance of banks or anticipating the possibility of bank failure in the arab region. accordingly, the paper recommends the importance of the financial stability and banking supervision departments in central banks to build early warning systems for the banking sector. this will help continue to enhance the resilience of the banking sector, apply the requirements of basel and international financial reporting standard no. 9, and strengthen the banking crisis management system. in this context, early warning systems can be built using a set of variables that depends on the financial soundness indicators of or the “camels” classification system for the banking system. itis also possible to add some economic variables in order to capture economic risks as they may play a role in the performance of the banking sector. this study also showed that financial variables played a more important role in predicting bank bankruptcy, but this did not mean neglecting economic variables in predicting bank failure, when building econometrics models or early warning systems that predicted its performance. finally, the findings of this study support the findings of obeid (2021) about predicting the performance of the banking sector in the arab countries using logistic regression models, as the mentioned study concluded that financial soundness indicators (fsis) have the most prominent role in predicting the failure of banks in the arab region, while there is no impact of the gdp variable on the failure of banks. however, as we mentioned earlier, the impact of economic risks must be constantly evaluated when predicting the failure of banks, as economic conditions may have indirect and/or direct effects on the performance of banks. in the event of an economic crisis, this may lead to a decline in cash flows to the household and corporate sectors, which may lead to a rise in bank default rates. this might increase credit risks which might prompt central banks to take a set of stimulus measures for the individual sectors and companies with the aim of preventing them from defaulting on the one hand, and preserving the financial sector on the other. references altman, e. i. 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(2001). predicting corporate financial distress using the logit model: the case of malaysia. asian academy of management journal, 6(1), 49-61.available at: https://doi.org/10.2308/accr.2004.79.4.1011. asian journal of economics and empirical research, 2022, 9(2): 91-99 99 © 2022 by the authors; licensee asian online journal publishing group tennyson, b. m., ingram, r. w., & dugan, m. t. (1990). assessing the information content of narrative disclosures in explaining bankruptcy. journal of business finance & accounting, 17(3), 391-410.available at: https://doi.org/10.1111/j.14685957.1990.tb01193.x. wong, j., wong, t., & leung, p. (2010). predicting banking distress in the emeap economies. journal of financial stability, 6(3), 169– 179.available at: https://doi.org/10.1016/j.jfs.2010.01.001. zaghdoudi, t. (2013). bank failure prediction with logistic regression. international journal of economics and financial issues, 3(2), 537-543. zavgren, c. (1983). the prediction of corporate failure: the state of the art. journal of accounting literature, 2(1), 1-38. zhao, h., sinha, a., & ge, w. (2009). effects of feature construction on classification performance: an empirical study in bank failure prediction. expert systems with applications, 36(2), 2633–2644.available at: https://doi.org/10.1016/j.eswa.2008.01.053. zmijewski, m. e. (1984). methodological issues related to the estimation of financial distress prediction models. journal of accounting research, 22, 59-82.available at: https://doi.org/10.2307/2490859. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 92 © 2024 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 11, no. 2, 92-102, 2024 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v11i2.6082 © 2024 by the authors; licensee asian online journal publishing group exchange rate innovation, global pandemic and stock market returns: empirical evidence from ecowas countries ambrose nnaemeka omeje1 ndubuisi obeka chukwu2 augustine jideofor mba3 ( corresponding author) 1,2,3department of economics, faculty of the social sciences, university of nigeria, nsukka, nigeria. 1email: ambrose.omeje@unn.edu.ng 2email: ndubuisi.chukwu@unn.edu.ng 3email: mba.augustine@unn.edu.ng abstract this study used the panel var impulse response function model and high-frequency monthly data from 2020m1 to 2021m12 to examine the response of innovations in the exchange rate and stock market returns to the covid-19 pandemic in economic communities of west african states (ecowas). the study found that the effect of shocks of covid-19 today on future exchange rate innovation worsens the real conditions of exchange rate innovation in ecowas countries. again, the impact of the shocks of covid-19 today on future stock market returns encourages the real conditions of stock market returns in ecowas countries. it was recommended that instead of lockdown, ecowas governments should explore other policy options peculiar to the region in covid-19 containment and also strive harder to deepen the stock market and encourage increased utilization of information and communication technology in stock market trading to cut costs, raise returns and connect trade with the rest of the world’s stock markets. keywords: ecowas, exchange rate innovation, global pandemic, impulse response function, panel var, stock market returns. jel classification: e44; g0; c23; c3. citation | omeje, a. n., chukwu, n. o., & mba, a. j. (2024). exchange rate innovation, global pandemic and stock market returns: empirical evidence from ecowas countries. asian journal of economics and empirical research, 11(2), 92–102. 10.20448/ajeer.v11i2.6082 history: received: 20 august 2024 revised: 8 october 2024 accepted: 18 october 2024 published: 7 november 2024 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. data availability statement: the corresponding author may provide study data upon reasonable request. competing interests: the authors declare that they have no competing interests. authors’ contributions: conducted data analysis, a.n.o.; reviewed literature, n.o.c.; conceptualized the work. a.j.m. all authors have read and agreed to the published version of the manuscript. contents 1. introduction ...................................................................................................................................................................................... 93 2. literature review ............................................................................................................................................................................ 93 3. methodology and data ................................................................................................................................................................... 95 4. empirical results and discussion ................................................................................................................................................ 96 5. conclusion and policy recommendations ................................................................................................................................ 100 references ............................................................................................................................................................................................ 100 mailto:ambrose.omeje@unn.edu.ng mailto:ndubuisi.chukwu@unn.edu.ng mailto:mba.augustine@unn.edu.ng https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v11i2.6082 https://orcid.org/0000-0002-4847-3232 https://orcid.org/0000-0002-8648-6296 https://orcid.org/0000-0002-6375-0090 asian journal of economics and empirical research, 2024, 11(2): 92-102 93 © 2024 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study is original in its use of a panel var impulse response function model with highfrequency monthly data from 2020m1 to 2021m12 specifically examining the differential impacts of covid-19 on exchange rate innovations and stock market returns in ecowas countries highlighting the unique regional responses. 1. introduction the recent global pandemic of covid-19 and its variants has become a worldwide risk as exemplified by the nature of its impact. the unexpected worldwide event has tested the sustainability and strength of almost every economic and social framework (singh & shaik, 2021). on march 11, 2020, the world health organization (who) labeled it a global pandemic due to the speed and rate of its global spread. governments from worldwide have worked together since the who proclamation to put policies in place to stop its spread. regular hand washing with soap and hand sanitizer, wearing a nose mask in public, forbidding all social, political and religious gatherings, restricting movement within states and regions, banning international travel, physical and social seclusion and total economic lockdown are all included in the measures (world health organisation, 2020). the economic effects of some of these policy initiatives have started to unravel in many economies especially african economies even though they may sound nice and have a clear goal to reduce health risks (ifelunini, ugwu, ichoku, omeje, & ihim, 2018; raifu, kumeka, & aminu, 2021) african economies have been ravaged by the recent global pandemic. the multifaceted crisis affected the economy and the health system and grossly impacted both the demand and supply sides. the supply chain and demand experienced reductions since people work mostly from home and consume less while firms diminished their productivity and investment (loayza & pennings, 2020). thus, the pandemic has devastated effects in all sectors, especially the commodity, stock and foreign exchange markets (chowdhury, 2022; manasseh & omeje, 2016). according to the world bank report, crude oil prices crashed by 50% in the first quarter of 2020 (world bank, 2020). this was the result of excess supply, low demand, and a lack of storage space (wilson, 2020). this affected the foreign exchange earnings of african countries that rely heavily on oil exportation. the covid-19's adverse impact on crude oil prices was transient (singh & shaik, 2021). the impact on stock markets was more evident particularly during the first wave (mzoughi, urom, uddin, & guesmi, 2020). during the first wave, stock markets fell all around the world, including in africa as a result of largely adverse reports continuing to flow in western countries on the spread of covid-19 (conlon & mcgee, 2020; sharif, aloui, & yarovaya, 2020; zhang, hu, & ji, 2020). the world economic forum believed that the financial sector will have lost a total of around 9 trillion us dollars between the first and second quarters of 2020 (world economic forum, 2020). according to the international monetary fund (imf), the recent global pandemic generated a severe economic crisis different from the others (georgieva, 2020). prospects for most countries in west africa were bad after the hit of the first wave of covid-19 particularly when crude oil and other commodity prices crashed in the first quarter of 2020. several countries in west africa managed to keep growth positive in 2020 including ghana with 1.7% growth (after 6.5% in 2019) while côte d’ivoire maintained a 1.8% growth rate (compared to 6.4% in 2019). however, nigeria which heavily relies on oil saw its economy contract by 3%. the nigerian stock market also suffered ending the first quarter of 2020 with a 3.72% decrease resulting in a loss of nearly $2 billion (zoungrana, toe, & toé, 2021). additionally, the currencies of most west african countries depreciated during the pandemic exposing local firms to exchange rate risks (omeje, ifelunini, mba, & okereke, 2022; zerihun, 2021). exchange rate risk has an impact on a firm's value (dominguez & tesar, 2006) which forces firms to devote significant resources to managing the risk (jorion, 1991). studies have sought to look into how covid-19 has affected financial markets with the rapid spread of the recent global pandemic. this study is of the view that the global pandemic disrupted among others, foreign exchange markets (iyke, 2020a; narayan, 2020) and insurance markets (wang, zhang, zhang, gao, & lin, 2021), oil markets (devpura & narayan, 2020; iyke, 2020b; prabheesh, garg, & padhan, 2020) and stock markets (mazur, dang, & vo, 2020; narayan, sharma, phan, & liu, 2020; topcu & gulal, 2020). however, studies that have linked innovation in exchange rate to stock market returns during the present worldwide pandemic were not carried out in ecowas countries as a whole. in this sense, the current objective is to examine the response of innovations in exchange rate and stock market returns to the covid-19 pandemic in ecowas countries. the rest of this paper is structured as follows: literature review, methodology, data analysis and conclusion and policy recommendation. 2. literature review in terms of the theoretical underpinning of this study, relevant theoretical literature was examined. for instance, the safe-haven theory suggests that during times of uncertainty, investors flock to safe assets, like gold or currencies of countries with stable economies (conlon & mcgee, 2020; latif et al., 2021). this can lead to a stronger currency for those countries and a weaker currency for countries that are seen as being more risky (conlon & mcgee, 2020). this theory is very relevant to this study because during the covid-19 pandemic, the stipulation of this theory was experienced as investors moved their money to safe assets like the us dollar and the swiss franc. again, the relationship between the stock market returns and foreign exchange rate was theoretically supported (agyei et al., 2022). another relevant theory is the flow-oriented theory of dornbusch and fischer (1980) which focused on the link that exists between exchange rates and some variables that are capable of making any economy volatile which in the case of this study include global pandemic and stock market returns. according to this theory, the demand and supply of currencies in the foreign exchange market predominantly influence the rates of exchange which in turn are influenced by the goods, services and financial capital flow of different economies (dornbusch & fischer, 1980). dornbusch and fischer (1980) argued that changes in relative prices and interest rates affect the demand for and supply of currencies. for example, when there is a relative rise in domestic interest rate with respect to foreign interest rates, foreign investors would be enticed, hence creating a rise in domestic currency demand. similarly, changes in expectations about future exchange rates or economic conditions can influence the supply and demand for currencies (iyke & ho, 2021). the flow-oriented theory emphasizes the importance of expectations and adjusts asian journal of economics and empirical research, 2024, 11(2): 92-102 94 © 2024 by the authors; licensee asian online journal publishing group in the short-run to maintain equilibrium in the foreign exchange market. it suggests that exchange rate changes can help restore balance between domestic and foreign goods markets facilitating the adjustment process in the economy (tan et al., 2022). on the other hand, the portfolio balance theory of frankel (1984) focused on the relationship between exchange rates and portfolio investment flows. this theory suggests that exchange rates are influenced by the preferences of investors for different currencies as they allocate their portfolios (frankel, 1984). investors allocate their portfolios based on a combination of risk and return considerations. they choose currencies based on the expected returns and risk associated with holding assets denominated in those currencies. if the expected returns of a particular currency increase, investors will demand more of that currency leading to an appreciation in its exchange rate. the portfolio balance theory also emphasizes the role of capital mobility and the integration of financial markets (khan & abbas, 2015). it suggests that changes in portfolio investment flows can lead to shifts in exchange rates (khan & abbas, 2015). the flow-oriented theory of dornbusch and fischer (1980) and the portfolio balance theory of frankel (1984) highlight the importance of flows of goods, services and financial capital in determining exchange rates. the portfolio balance theory specifically considered the role of portfolio investment flows and investor preferences in exchange rate determination while the flow-oriented theory focused on broader macroeconomic factors. empirically, there is a dearth of literature that examines exchange rate innovation, global pandemic and stock market returns in ecowas countries. as a result, this study reviewed related empirical literature with respect to exchange rate, covid-19 and stock market. for instance, rai and garg (2022) examined whether covid-19 significantly influences the dynamic relationship of briics (brazil, russia, india, indonesia, china and south africa) economies’ stock market and exchange rate. the study used vector autoregressive (var) model and time series daily data spanning from 2020d1 to 2020d30 to discover that covid-19significantly and inversely impacts the worldwide economy. the study also analyzed the dynamic connection between the exchange rate and stock market in each of the brics (brazil, russia, india, china, and south africa) economies and found that pandemic had a significant influence on the varying relationship that exists among stock market and exchange rate in the briics economies. this influence here raises the volatility of both the stock market and exchange rate in all of the briics economies. however, it was recommended that there is a need to consider the influence of the covid-19 pandemic on the monetary markets in these emerging economies. similarly, wong (2022) examined the connections between the rate of exchange and stock prices in several countries like japan, the us and other european countries. an econometric model based on ordinary least squares (ols) was applied to the time series panel data generated for the study to test whether there exist causal connections among real stock prices and real rates of exchange. the finding of the study showed that rates of exchange significantly affect stock prices although the strength of the connections varies across countries. again, the study found that when domestic currency is depreciated, it would lead to a rise in stock prices. however, when it is appreciated, it would result to a fall in stock prices. it was recommended that policymakers need to ensure stable rates of exchange. similarly, jamal and bhat (2022) adopted panel data and the panel autoregressive distributed lag (ardl) model to assess the movement of exchange rates in the uk, china, turkey, india, italy, and brazil. it was found that an increase in deaths as a result of covid-19 depreciated exchange rates in the sampled economies. in a different study that relates stock market and covid-19, sharif et al. (2020) studied the interrelationships between covid-19, stock market, oil price volatility shock and the ambiguity of american economic strategy, and geopolitical risk. the study used time-series monthly data from 2020m1 to 2020m4 to investigate the influence of these factors on the us stock market. the study found that the pandemic and oil price volatility shock had a negative impact on the us stock market while geopolitical risk had a positive influence on the us stock market. the study recommended the need to consider the factors studied when making economic decisions by policymakers and investors. similarly, hatmanu and cautisanu (2021) examined how covid-19 affected the romanian stock market. monthly time series data from 2020m1 to 2020m12 and descriptive statistics ols based multiple regression were adopted for the study. it was found that covid-19 had a negative and significant influence on the romanian stock market with the key stock index undergoing a sharp fall in 2020m3 with a gradual recovery thereafter. it was recommended by the study that there is a need for policymakers and investors to consider the unique characteristics of the pandemic when making decisions about investments and economic policies. raifu et al. (2021) investigated the influence of the covid-19 and lockdown policies on the stock earnings of 201 enterprises registered on the stock market of nigeria. the study employed collectively ols and panel data analysis models. the study showed that covid-19 negatively and significantly influence stock market of nigeria with the market facing a significant decrease in returns during the covid-19. the study also revealed that the lockdown policies carried out by the nigerian government exert significant reverse influence on firm stock earnings especially those found around the sectors of consumer goods and finance. the study recommended that investors and policymakers need to gently consider the potential influence of related policies and pandemic on the stock market and private companies. latif et al. (2021) examined the relationship that exists between changes in stock returns and covid-19 using time series monthly data from the stock markets of china, japan and the united states from 2020m1 to 2020m12 and employed an econometric model based on ols to analyze the data. it was revealed that covid-19 inversely and significantly influenced changes in stock returns in all three countries. there was an observed increase in stock return volatility and a decline in market liquidity during covid-19. furthermore, this study also empirically showed that covid-19 led to increased market uncertainty as reflected in the higher levels of market volatility. therefore, this study suggested that there is a need for monitoring of market trends during periods of economic uncertainty by relevant stakeholders. rehman, kang, ahmad, and vo (2021) investigated how covid-19 could influence the g7 member countries’ stock market volatility, returns and trading volume using time series monthly data from 2019m1 to 2020m12 and granger causality test and the generalized autoregressive conditional heteroscedasticity (garch) model. there exist negative significant effects of covid-19 on the g7 member countries’ stock market returns. the virus increased stock market volatility and reduced trading volume. the study suggested that the government should strive harder to contain this virus so as to ensure the stability of stock markets and the associated returns and trading volume rise. asian journal of economics and empirical research, 2024, 11(2): 92-102 95 © 2024 by the authors; licensee asian online journal publishing group lahmiri and bekiros (2021) assessed how covid-19 affects the long memory of volatility and returns in crypto currency and stock markets through the application of time series monthly data from 2015m1 to 2020m11. in a bid to determine the hurst exponent which is a measure of long-term dependence or long memory, for bitcoin, ethereum, the standard and poor's 500 (s&p 500), and the national association of securities dealers automated quotations (nasdaq) 100, the study applied the detrended fluctuation analysis (dfa) and the fractional integration technique, to and found that the effect of the virus on long memory was more pronounced in crypto currency markets than in stock markets. this suggests that the crypto currency markets were more damaged by the pandemic than the stock markets due to their higher volatility and lower liquidity. however, government and relevant agencies should educate people on this impact since knowing the dynamics of long-term dependence in financial markets especially during periods of financial and economic stress is important for all and sundry. furthermore, basuony, bouaddi, ali, and emadeldeen (2022) tried to determine how global stock markets were being affected by covid-19 through the adoption of time series monthly panel data from 2020m1 to 2020m6 generated from 13 countries of the world. the effect of covid-19 on stock market returns was heterogeneous across countries with some countries being more affected than others. they attribute this heterogeneity to differences in the severity of the pandemic, the effectiveness of government policies and the structure of the economies. this study revealed that there exist significant and widespread effects of covid-19 on global stock markets with significant negative impacts on returns in all 13 countries studied. it was recommended that the government through its relevant authorities should encourage people to know and understand the underlying forces changing global financial markets and the potential effect of external stocks on these markets to be safe. in an entirely different but related study, rakshit and neog (2021) examined how covid-19 affects stock market earnings and volatilities using time series data from the s&p 500 table and the nasdaq complex index from 2019m1 to 2021m12. covid-19 has contributed significantly towards stock market volatility with higher levels of volatility persisting even after the initial stock in 2020m3. the study brought insights into the complex and dynamic relationship between the pandemic and stock market. it was suggested among others that there is a need for varying factors that aid in good understanding the effects of covid-19 on the global economy to be put in place by the government. there are also studies that looked at investments like the study by agyei et al. (2022) who examined how the covid-19 pandemic affected the costs of imported rice, maize, native rice and sorghum in sub-saharan africa. time series monthly data from 2019m1 to 2020m12 and ols based multiple regression models were employed by the study for results analysis. it was revealed by the study that covid-19 exerted a significant negative influence on the costs of imported rice, maize, native rice and sorghum in the sub region. a supply chain of these foods was disrupted and their production, distribution and marketing were also halted due to restrictions on movement and trade, the closure of borders and the reduced capacity of transportation systems. the study highlighted the need for policymakers and stakeholders in the agricultural sector to take care of covid-19 challenges and its attendant effects to ensure food security and stability in ssa. similarly, omeje et al. (2022) looked at how the informal sectors’ socioeconomics were being affected by covid-19 in nigeria using survey data from 340 informal business, descriptive statistics and a logit model. it was shown by the study that informal businesses making up about 83% were badly affected by covid-19. in terms of their socioeconomic characteristics, it was found that occupation, age, labour cost, sex, receiving palliative, transport cost and location were the main significant factor that covid-19 impacted. it was recommended that government need to ensure the sustainability of informal businesses for a faster recovery of the economy. xiang, ma, yu, wang, and yin (2022) examined on a global scale how the dynamics of covid-19 pandemic contagion are being spread using a mathematical model and the susceptible-exposed-infectious-recovered (seir) model. this study indicated that the pandemic spreads through contagion channels directly and indirectly through its findings. they noted that the direct contagion channel is more important during the outbreak’s early stages while that of the indirect contagion channel is more significant at a later stage. it was recommended among others by the study that relevant stakeholders and the government need to provide to the people insights on how the virus is being contracted even before and at early stage to ensure effective interventions in controlling its spread across different regions and countries of the world. omeje, mba, and anyanwu (2023) and omeje et al. (2023) also applied var to study the covid-19 pandemic, employment differential and health expenditure relationship and environmental pollution and climate change relationship with respect to sub-saharan african countries. these studies could not empirically give evidence of how exchange rate innovation, global pandemic and stock market returns interconnect with each other in ecowas countries, hence the need for this study. 3. methodology and data 3.1. methodology in this study, we applied the panel var technique in our estimation. the adopted econometric specification of the model assumes the reduced form given below: 𝑀𝑖𝑡 = π(ℎ)𝑀𝑖𝑡 + 𝜇𝑖 + 𝜀𝑖𝑡 (1) where 𝑀𝑖𝑡 is a vector of stationary variables, π(ℎ) is a matrix polynomial in the lag operator defined as π(ℎ) = π1ℎ1 + π2ℎ2 + π3ℎ3. . . +π𝑝ℎ𝑝, 𝜇𝑖 represents a vector of country-specific effects and 𝜀𝑖𝑡 is a vector of idiosyncratic errors. the model includes variables such as the number of covid-19 cases, exchange rate, stock returns and interest rates. we compute the impulse response functions (irf) and the variance decomposition (vdc) after estimating all of panel var parameters. the irf illustrates how an endogenous variable reacts over time to a shock in a different system variable (omeje, mba, obodoechi, ukwueze, & urama, 2023; paul & omeje, 2022). on the other hand, vdc quantifies the contributions of each shock source to the variance of each endogenous variable over a specific forecast horizon. 3.2. data and sources the data was generated from the 2021 world development indicators of the world bank and worldometer’s covid-19 data, 2022. a panel of three ecowas member countries and high-frequency monthly data was used from 2020m1 – 2021m12 for each of the three ecowas countries. in terms of definitions and sources, several cases of covid-19 were sourced from worldometer’s covid-19, 2022 whereas exchange rate, stock returns, asian journal of economics and empirical research, 2024, 11(2): 92-102 96 © 2024 by the authors; licensee asian online journal publishing group interest rate and inflation rate were represented as xchrate, stockm~t, intrate, and infltn and were sourced from 2021 world development indicators of the world bank. 4. empirical results and discussion 4.1. descriptive statistics and variables in the panel var model descriptive statistics were applied to the model variables to investigate the nature of the variables in the panel var model and the features of the data. this study looks at how much variation there is in the model variables' mean, standard deviation and minimum and maximum values. as a result, table 1 provides descriptive statistics for the panel var model variables. table 1. descriptive statistics results of panel var model variables. variables mean std. dev. min. max. observations xchrate overall 220.521 210.631 1.796 510.527 n = 72 between 256.105 1.875 502.284 n = 3 within 4.793 212.278 228.765 t = 24 covid-19 overall 88717.33 84422.54 419 241513 n = 72 between 81159.67 3122 164560 n = 3 within 51711.26 11764.33 165670.3 t = 24 stockm~t overall 4.377 2.649 0.353 8.200 n = 72 between 0.864 3.568 5.286 n = 3 within 2.542 0.453 8.301 t = 24 intrate overall 10.409 3.931 5.14 15.376 n = 72 between 4.741 5.218 14.509 n = 3 within 0.506 9.542 11.276 t = 24 infltn overall 6.973 4.869 -1.107 12.095 n = 72 between 5.702 0.659 11.746 n = 3 within 1.316 5.207 8.739 t = 24 table 1 shows that the mean, standard deviation and corresponding minimum and maximum values for each variable exhibit sufficient variation. the total number of observations for the study (n) is 72 from january 2020 (2020m1) to december 2021 (2021m12) for each of the three ecowas countries. the between-panel group (n) consists of three observations representing the number of ecowas member countries sampled due to the availability of stock return data. the within-group panel (t) has 24 observations corresponding to the time periods for each country from january 2020 to december 2021. the mean exchange rate (xchrate) is approximately 220.52%, the mean number of covid-19 cases is about 88,717.33, stock market returns (stockm~t) amount to approximately usd 4.38 billion, the interest rate (intrate) is around 10.41%, and the inflation rate (infltn) is about 6.97%. similarly, this study also examined the panel unit root test of the model variables to ascertain the stationarity level of these model variables. furthermore, the study utilized the fisher-type panel unit-root test based on the augmented dickey-fuller (adf) test of unit root. as a result, table 2 contains the study's results for the panel unit root test. table 2. panel unit root test results of the model variables. variables inverse chi-squared p inverse normal z inverse logit l* modified inv. chi-squared pm p-values variable integration orders xchrate 57.380 -6.594 -9.397 14.832 0.0000 i(1) covid19 57.380 -6.594 -9.397 14.832 0.0000 i(1) stockmret 57.380 -6.594 -9.397 14.832 0.0000 i(1) intrate 38.254 -5.384 -7.761 12.110 0.0000 i(1) infltn 57.380 -6.594 -9.397 14.832 0.0000 i(1) note: l* = inverse logit. table 2 shows that all four tests of the panel unit root based on fisher adf vehemently rejected the null hypothesis that all panels have unit roots after the first difference. this suggests that for all the examined variables, the inverse logit l* test and the inverse normal z test are in agreement. the modified inverse ¬¬χ2 pm test and the inverse ¬χ2 p test both agree with each other. p-values of all the model variables tested (xchrate, covid-19 stockmret, intrate, and infltn) revealed that they are all significant after the first difference and as a result, are integrated of order one (that is i (1)) at the 5% level of significance. 4.2. results of the panel var model presented this subsection presents the results of the panel var model in an attempt to ascertain the response of innovations in exchange rates and returns of the stock market to the covid-19 pandemic in ecowas countries. as a result, table 3 presents the panel var model's summary results. asian journal of economics and empirical research, 2024, 11(2): 92-102 97 © 2024 by the authors; licensee asian online journal publishing group table 3. summary results of the panel var model. variables coef. std. err. z p>|z| xchrate xchrate l1. 0.966 0.283 3.41 0.001 covid -19 l1. -5.567 1.898 -2.93 0.003 stockmret l1. -55.637 86.299 -0.64 0.519 intrate l1. -0.147 6.020 -0.02 0.981 covid -19 xchrate l1. -0.000 0.000 -0.57 0.570 covid -19 l1. 0.964 0.077 12.56 0.000 stockmret l1. 1.304 0.307 4.24 0.000 intrate l1. -0.039 0.055 -0.71 0.477 stockmret xchrate l1. 0.000 0.000 1.43 0.152 covid -19 l1. 0.003 0.003 0.94 0.348 stockmret l1. 1.022 0.021 48.69 0.000 intrate l1. 0.005 0.004 1.05 0.291 intrate xchrate l1. -0.000 0.000 -0.07 0.941 covid -19 l1. -0.033 0.044 -0.77 0.443 stockmret l1. -0.418 0.336 -1.24 0.213 intrate l1. 0.874 0.105 8.33 0.000 interpreting the panel var model is always very difficult. hence, this study employed the orthogonalized panel vector autoregressive impulse response function (pvar – irf) to examine the study objective (i.e., to ascertain the response of innovations in exchange rate and stock market returns to the covid-19 pandemic in ecowas countries). however, table 2 suggests that in the exchange rate equation (xchrate), the covid-19 pandemic has a negative and significant effect on the exchange rate (xchrate) in ecowas countries by about 5.566697%. but in the stock market return equation (stockmret), the covid-19 pandemic has a positive but insignificant effect on the stock market return equation (stockmret) in ecowas countries by about 0.35324%. in the interest rate equation (intrate), the covid-19 pandemic also exerts a negative but insignificant effect on the interest rate (intrate) in ecowas countries by about 3.39404%. this study resorted to the panel var impulse response function (pvar – irf) to ascertain the response of innovations in exchange rate and stock market returns to the covid-19 pandemic in ecowas countries. hence, this is presented below. figure 1. orthogonalized impulse response function of exchange rate on covid-19. figure 1 demonstrates how innovations in the exchange rate (xchrate) react to covid -19 stimulus by gradually releasing significant and negative effects from the first period up to the tenth period without displaying asian journal of economics and empirical research, 2024, 11(2): 92-102 98 © 2024 by the authors; licensee asian online journal publishing group any indication of when it would eventually fade off in any of the periods. in other words, the empirical result suggests that a single standard innovation in covid -19 causes negative effects on exchange rate innovation (xchrate). the results also demonstrate that these effects are within the 95% confidence interval. the implication here is that with innovation in covid -19 by 1%, exchange rate innovation (xchrate) would also be significantly affected in the next period. the impact of shocks of covid -19 today on future exchange rate innovation (xchrate) does not decay to 0 fast, rather, it worsens the real conditions of exchange rate innovation (xchrate) in ecowas countries. this implies that covid -19 the effects of a shock on exchange rate innovation (xchrate) today does not show any sign of decay to 0 within the study period. this may be that all ecowas countries are mainly importers of all kinds of goods and services rather than exporters. they are primary or intermediate producers that sell their products at a cheaper rate and import the processed products at higher prices. with respect to ascertaining the response of stock market returns (stockmret) to the covid-19 pandemic in ecowas countries, the study presents figure 2 given below. figure 2. orthogonalized impulse response function of stock market returns on covid -19. according to figure 2, when covid -19 generates an impulse, stock market returns (stockmret) react by emitting gradually considerable positive impacts from the first period up to the tenth period without exhibiting any indication of when it would eventually die off. the empirical results suggest that a one-standard deviation innovation in covid-19 has a substantial positive impact on stock market returns (stockmret). additionally, these effects fall within the 95% confidence interval. this indicates that a 1% innovation in covid-19 would significantly influence stock market returns (stockmret) in the subsequent period. furthermore, the impact of today's covid-19 shocks on future stock market returns does not decay to zero quickly. instead, it reinforces the real conditions of stock market returns in ecowas countries. this implies that the effects of a shock on stock market returns today do not diminish to zero within the study period over time. this empirical finding may result from the increased use of information and communication technology in stock market trading during the covid19 period. figure 3. orthogonalized impulse response function of interest rate on covid-19. for figure 3, when over time provides an impulse, interest rate (intrate) reacts by gradually releasing significant negative effects from the first period up to the tenth period, when it ultimately goes away. according to the empirical findings, a one-standard deviation innovation in covid-19 has a considerable negative impact on the asian journal of economics and empirical research, 2024, 11(2): 92-102 99 © 2024 by the authors; licensee asian online journal publishing group interest rate (intrate). the results also indicate that these impacts fall within the 95% confidence interval. this implies that a 1% innovation in covid-19 would significantly affect the interest rate (intrate) in the subsequent period. furthermore, the impact of today's covid-19 shocks on future interest rates decays to zero quickly, worsening the real conditions of interest rates in ecowas countries. thus, as time progresses, the effects of a shock to the interest rate today diminish rapidly within the study period. table 4. summary results of the panel var stability test. eigenvalue real imaginary modulus 0.962 0 0.962 0.962 0 0.962 0.962 0 0.962 0.208 0 0.208 4.3. panel var stability test table 4's pvar stability test results show that all of the eigenvalues are less than one and hence lie inside the unit circle. as a result, the pvar meets the stability requirement. the graph in figure 4 clearly illustrates this scenario. figure 4. pvar stability test graph. all of the eigenvalues' roots are shown to be inside the unit circle in figure 4. the panel var process is said to be stationary. the pvar model used to estimate model variables passed the eigenvalue stability test as shown by the results of the pvar stability test table and graph indicating that the pvar satisfied the stability criteria. table 5. summary results of the panel var forecast-error variance decomposition. response variable and forecast horizon impulse variable xchrate covid-19 stockmret intrate xchrate 0 0 0 0 0 1 1 0 0 0 2 0.999 0.000 0.000 3.580 3 0.998 0.001 0.000 1.310 4 0.995 0.003 0.001 3.340 5 0.993 0.005 0.002 7.390 6 0.988 0.008 0.004 0.000 7 0.982 0.011 0.007 0.000 8 0.975 0.015 0.009 0.000 9 0.966 0.020 0.014 0.000 10 0.954 0.026 0.019 0.000 stockmret 0 0 0 0 0 1 0.000 0.066 0.934 0.000 2 0.003 0.077 0.916 0.003 3 0.010 0.088 0.893 0.009 4 0.020 0.098 0.865 0.017 5 0.033 0.106 0.836 0.024 6 0.048 0.113 0.807 0.032 note: all the eigenvalues lie inside the unit circle. pvar satisfies the stability condition. asian journal of economics and empirical research, 2024, 11(2): 92-102 100 © 2024 by the authors; licensee asian online journal publishing group response variable and forecast horizon impulse variable xchrate covid-19 stockmret intrate 7 0.063 0.119 0.779 0.039 8 0.079 0.124 0.751 0.047 9 0.095 0.128 0.725 0.051 10 0.112 0.131 0.701 0.056 table 5 reveals the impact of shocks to covid-19 on the exchange rate (xchrate) and stock market returns (stockmret) in ecowas countries presenting the results of the panel forecast error variance decomposition. the findings indicate that a unit orthogonal shock in covid-19 accounts for 0.000%, 0.000%, 0.001%, 0.003%, and 0.004% of the variance in the forecast error of innovations in the exchange rate (xchrate) during the first, second, third, fourth, and fifth timeframes, respectively. however, from the sixth to the tenth horizon, a unit orthogonal shock in covid-19 is the sole contributor to the variance in the forecast error of innovations in the exchange rate (xchrate), accounting for 0.008%, 0.01%, 0.015%, 0.020%, and 0.026%. the results indicate that a unit orthogonal shock in covid-19 accounts for 0.000%, 0.065%, 0.078%, 0.088%, 0.098%, and 0.106% of the variance in the forecast error of stock market returns (stockmret) during the first through fifth horizons, respectively. in contrast, from the sixth to the tenth horizon, a unit orthogonal shock in covid-19 is responsible for 0.113%, 0.119%, 0.123%, 0.127%, and 0.131% of the variance in the forecast error of stock market returns (stockmret). 5. conclusion and policy recommendations this study empirically analysed exchange rate innovation, global pandemic and stock market returns using evidence from ecowas countries. the study applied the panel var impulse response function (irf) model and high frequency data from world development indicators and worldometer covid-19 data sets from 2020m1 to 2021m12 to examine the response of innovations in the exchange rate and stock market returns to the covid-19 pandemic in ecowas countries. the study's findings thus showed that when covid-19 provides an impulse, innovations in the exchange rate (xchrate) react by emitting gradually significant negative effects up to the tenth period without exhibiting any indication that they will eventually die off in any of the periods. in other words, the empirical result suggests that a single standard innovation in covid-19 causes negative effects on exchange rate innovation (xchrate). the results also demonstrate that these effects are within the 95% confidence interval. it follows that if innovation in covid-19 increases by 1%, exchange rate innovation (xchrate) will likewise be significantly impacted in the next time frame. the impact of shocks of covid-19 today on future exchange rate innovation (xchrate) does not decay to 0 fast; rather, it worsens the real conditions of exchange rate innovation (xchrate) in ecowas countries. this means that the effects of a shock on exchange rate innovation (xchrate) today do not show any sign of decay to 0 within the study period as time goes by. the results regarding stock market returns (stockmret) indicate that when covid-19 produces an impulse, stock market returns respond with gradually increasing significant positive effects that persist through the tenth period without showing any signs of diminishing. consequently, the empirical findings reveal that a one-standard deviation innovation in covid-19 has significant positive effects on stock market returns (stockmret) which fall within the 95% confidence interval. this implies that a 1% innovation in covid-19 would also significantly affect stock market returns (stockmret) in the subsequent period. furthermore, the impact of today's covid-19 shocks on future stock market returns does not decay to zero quickly; rather, it reinforces the underlying conditions of stock market returns in ecowas countries. this suggests that the effects of a shock on stock market returns (stockmret) today do not show any sign of decay to 0 within the study period as time goes by. this finding may be as a result of the increased utilization of information and communication technology in stock market trading during the covid-19 period. therefore, the study recommends from its empirical evidence that 1. ecowas country governments should try harder to look inward to explore each country’s peculiarities that may aid in the containment of the spread of covid-19, since the effects of shocks of covid-19 today on future exchange rate innovation do not decay to zero fast; rather, it worsens the real conditions of exchange rate innovation in ecowas countries. 2. governments of ecowas countries should urgently explore policy options beyond lockdown measures, as the study reveals that covid-19 has a significantly negative impact on innovations in the exchange rate within the region. imposing lockdowns in the face of poverty and hunger is not the best solution for the ecowas region, given that member countries primarily produce and export goods at low prices while importing them at higher rates. 3. governments in ecowas countries should strive harder to deepen the stock market the more and encourage increased utilization of information and communication technology in stock market trading in a bid to cut costs, raise more returns, and connect trade with other stock markets in the rest of the world. 4. ecowas country governments need to encourage increase in investment by creating favourable investment climate that would encourage ease of doing business in the region. 5. governments in the ecowas region and its monetary or regulatory authorities should also help in stabilizing and bringing down the lending interest rate for productive investments in the region since it was found that shocks of covid-19 today on future interest rates worsen the real conditions of interest rate in ecowas countries. references agyei, s. k., bossman, a., asafo− adjei, e., asiamah, o., adela, v., & adorm− takyi, c. 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(2021). covid‐19 outbreak and stocks return on the west african economic and monetary union's stock market: an empirical analysis of the relationship through the event study approach. international journal of finance & economics, 28(2), 1404-1422. https://doi.org/10.1002/ijfe.2484 asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://www.weforum.org/agenda/2020/03/stock-market-volatility-coronavirus/ https://www.who.int/emergencies/diseases/novel-coronavirus-2019/situation-reports https://doi.org/10.3389/fpubh.2021.809987 https://doi.org/10.11648/j.jpsir.20210404.13 https://doi.org/10.1142/9789811239618_0004 https://doi.org/10.1002/ijfe.2484 20 © 2023 by the author; licensee asian online journal publishing group asian journal of economics and empirical research vol. 10, no. 1, 20-30, 2023 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v10i1.4414 © 2023 by the author; licensee asian online journal publishing group capital controls and capital flow volatility during global shocks: indian experience sujit kumar department of economics, banaras hindu university, and union bank of india, mumbai, india. email: sujitkaimur@gmail.com abstract this paper examines the issue of capital controls in india and their effectiveness in stabilizing the capital flow volatility in the economy. it documents the evolution of the capital controls regime in india since its economic liberalization in 1991 and focuses on india’s experience with capital controls in the period leading up to the global financial crisis (gfc) of 2008 until the taper tantrum aftermath in 2013. we construct a capital controls index based on data from the imf’s annual report on exchange arrangements and exchange restrictions (areaer). the index shows careful ease of capital controls by indian policymakers in the financial sectors, i.e., the capital market, money market and direct investment, over the 2001–2008 period. the index further shows that the process of decontrol in the capital market stagnated during 2009–2014 due to the gfc to insulate the indian economy from global shocks. this paper further explores the impact of capital controls in managing capital flow volatility in the context of the gfc. using the tobit estimation approach, we show that capital controls effectively reduce capital flow volatility in the pre-gfc period followed by a limited impact post-gfc. this complements the capital account liberalization process during pre-gfc period. our findings support india’s prudent approach to capital account management as financial markets evolve to manage risk efficiently in a large economy. keywords: capital controls, capital flow, current account deficit, exchange rate, fdi, fii, global financial crisis, imf areaer. jel classification: e4; e5; f3; f4. citation | kumar, s. (2023). capital controls and capital flow volatility during global shocks: indian experience. asian journal of economics and empirical research, 10(1), 20–30. 10.20448/ajeer.v10i1.4414 history: received: 7 november 2022 revised: 23 december 2022 accepted: 2 january 2023 published: 18 january 2023 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study, that no vital features of the study have been omitted, and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 21 2. capital controls ............................................................................................................................................................................... 22 3. capital controls regime in india ................................................................................................................................................. 22 4. a review of the literature ............................................................................................................................................................. 23 5. data..................................................................................................................................................................................................... 24 6. methodology ..................................................................................................................................................................................... 25 7. empirical evidence .......................................................................................................................................................................... 25 8. conclusion ......................................................................................................................................................................................... 28 references .............................................................................................................................................................................................. 28 mailto:sujitkaimur@gmail.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v10i1.4414 https://orcid.org/0000-0003-2875-0586 asian journal of economics and empirical research, 2023, 10(1): 20-30 21 © 2023 by the author; licensee asian online journal publishing group contribution of this paper to the literature this paper makes two key contributions to the literature. first, it provides an analysis of the changes in the capital control regime in india preand post-gfc and its implication for capital flows. second, it shows that the effectiveness of control regimes in managing capital flow volatility reduced during the post-gfc period. 1. introduction capital flows to emerging economies have an extensive impact on their short-term financial needs and their long-term economic goals.1 foreign capital relaxes credit constraints, brings knowledge and discipline to the host country, augments investment resources, and increases capital allocation efficiency and productivity, thus enhancing economic growth (ahmed & zlate, 2014; harrison, love, & mcmillan, 2004; tong & wei, 2011). however, capital inflows also hurt economic performance through several channels – transfer of resources from tradeable to non-tradable sectors, leading to slow productivity growth; financial market volatility due to episodes of sudden stops after large capital inflows; exchange rate volatility; and high foreign debt exposure (benigno, converse, & fornaro, 2015; calvo & reinhart, 2000; gourinchas & obstfeld, 2012). several emerging economies have experienced multiple episodes of volatile capital flows during the 1980s and 1990s (forbes & warnock, 2012). capital flows dried up in the late 1990s, but they surged again during the mid-2000s, followed by sharp contraction during the 2008 global financial crisis (gfc) and remained highly volatile post-gfc and until after the taper tantrum2 episode in 2013. these episodes posed serious risks to the macro-financial stability of economies with thin domestic financial markets, placed higher dependence on global finance, limited export capacity, and weakened the policy framework and buffers (borio, james, & shin, 2016; bruno & shin, 2015; coeurdacier, hélène, & pablo, 2019; kim, 2012). such instances and structural economic vulnerabilities led these economies to adopt regulatory measures, such as capital controls, to manage macrofinancial stability risks related to capital inflows.3 india, as one of the major emerging economies, maintained a calibrated approach to capital control measures since the 1990s, gradually liberalizing them in the following decades. during this period, india experienced strong economic growth and managed to recover more robustly from the gfc compared to other emerging economies (gallagher, 2011). given this background, this paper aims to analyze india’s capital controls regime in the light of global financial crisis and the role of capital controls in restricting capital flow volatility during global shocks (the gfc of 2008 and the taper tantrum episode of 2013). we aim to answer two related research questions here. first, what is the effect of capital controls on capital flows? second, does an increase in capital control measures reduce the capital flow volatility for the indian economy. for the first part of our analysis, we constructed a capital control index with 13 categories using qualitative data on restrictions on the capital account for the 2001–2014 period, comprising the preand post-gfc phases. further, we aggregated the index for capital inflows and outflows and finally constructed an aggregate capital control index for net capital inflows. we first illustrate that the net capital control index eased before the gfc, and the net inflow increased during this period. after the gfc, net capital control increased in the face of volatile capital inflows. using the disaggregated categories of the capital control index for foreign direct investment (fdi) and foreign institutional investment (fii), we also depict that fii-based capital control measures follow similar dynamics as the net capital inflows. however, fdi-based capital control measures eased until 2005 and remained stagnant afterwards. as expected, fdi inflows consistently rose, being the more stable category of capital inflows. we further show a gradual relaxation of capital control measures for inflows and outflows. finally, we also illustrate that the capital control measures for the capital market, money market, and direct investment consistently declined during the 2004–2014 period. in the next part of our analysis, we estimate the impact of capital controls on the volatility of capital flows using the tobit model estimation. we include key macroeconomic control variables (inflation, current account to gdp, and the interest rate differential between india and the usa) in our estimation procedure. the full period (2001–2014) estimation shows that capital controls are highly effective in reducing capital flow volatility in india. we further split the data into preand post-gfc periods to analyze the relative effectiveness of capital control for managing capital flow volatility. we found that capital controls significantly reduced capital flow volatility in both periods. however, they were relatively more effective during the pre-gfc period compared to the postgfc period. our results indicate that india cautiously relaxed its capital control measures for different categories of capital control during the pre-gfc period and experienced increased capital inflows. however, post-gfc they gradually imposed the capital control tools to manage capital flow volatility. based on the estimation results, these measures remained effective in managing moderate capital flow volatility during the pre-gfc period, but they had limited success in reducing financial fragilities in the post-gfc phase. our results nicely dovetail with the existing literature that has mostly focused on the general impact of capital controls on the gross capital flows and exchange rate. magud, reinhart, and rogoff (2011) summarized that capital controls allow some space for monetary policy independence and partly alter the composition of capital inflows. several other studies used a cross-country framework and analyzed the countercyclicality of capital controls and the effectiveness of different types of capital control measures (cerutti, claessens, & laeven, 2017; fernández, rebucci, & uribe, 2015). several related studies analyzed country-specific evidence (i.e., in chile and malaysia) on capital control and found it to have a limited impact on capital flows and was ineffective in preventing currency volatility (edwards, 2004; forbes., 2005). however, previous studies have not examined the 1 capital inflows help a country to access funds for high yield investments, inducing growth in the economy. capital inflows in the form of foreign direct investment (fdi) also bring better technology and management techniques that help to raise economic productivity and growth. capital outflows provide an opportunity for individuals and firms to access the global market to earn high returns on financial assets, diversify the risk, borrow low-cost funds that help to reduce volatility, and facilitate smooth consumption and income in the economy. it was believed that such global integration and opening up the economy would enhance a country’s welfare more than a closed economic system. 2 taper tantrum refers to the period between may and august of 2013 when the us federal reserve signaled a reduction in the pace of monthly asset purchases that triggered the capital outflows from emerging markets. 3 in the early 2000s, the international monetary fund (imf) strongly criticized capital control measures as key obstacles to global financial integration that restrict the benefits of global capital flows. however, post-gfc, they reversed their stance on capital controls and supported their limited use in the face of volatile capital flows (gallagher, 2011; kohli & belaisch, 2012). asian journal of economics and empirical research, 2023, 10(1): 20-30 22 © 2023 by the author; licensee asian online journal publishing group robustness of the capital control regime in india and the comparative effectiveness of capital controls during the preand post-gfc periods. the remainder of the paper is organized as follows: section 2 describes the types and purposes of capital controls; section 3 documents the capital control regime in india since its economic liberalization in 1991; section 4 provides details on the literature available on the measure of capital controls and the role of capital controls as a tool to limit the volatility of domestic financial markets and economic stabilization; sections 5 and 6 provide details on the data and the methodology adopted to analyze the capital control regime in india; section 7 presents the estimation results; and section 8 concludes. 2. capital controls capital controls are tools used to limit or redirect capital account transactions in an economy. capital controls refer to various measures such as taxes, price or quality controls, prohibitions on international trade in financial assets, etc. stiglitz (2002) suggested that the relaxation of capital controls was a major cause of the east asian currency crisis. it further argues that the rapid movement of funds into and out of the country is clearly destabilizing, which is a point brought home by the east asian crisis where capital flows, in some cases, exceeded almost 10% of gdp. capital market liberalization has not always led to rapid growth, rather it can lead to greater risks. edwards (2004) argued that high capital mobility increases macroeconomic volatility and poses greater destabilizing effects from external shocks. this paper further posits that if capital flows decline suddenly, the country would be permanently left with a smaller export market. in addition, capital inflows cause bubbles and booms, especially in the real estate sector, that makes the economy more vulnerable. hence, capital controls are also considered useful tools that limit currency volatility brought about by capital flows in developing countries. such a deep and negative impact of capital mobility strengthens the need for capital controls to stabilize the economy, especially in the context of emerging market economies. considering the experience of several economies over the years, the imf (2022) revised its institutional view to accommodate capital flow management measures as being useful in certain circumstances but should not be used as a substitute for warranted macroeconomic adjustment. 2.1. types of capital controls the different types of capital control measures are as follows: • market-based controls: unremunerated reserve requirements and taxation of financial flows discourage the targeted transactions by increasing their cost. • administrative controls: administrative controls prohibit or impose explicit quantitative limits on capital transactions because they often subject these transactions to the approval of the authorities. administrative controls are usually less transparent than market-based controls. 2.2. purposes of capital controls capital controls have a long history, starting from world war i. the purposes of capital controls are as follows: • generate revenue/finance (during the two world wars of 1914–1918 and 1939–1945): imposed on outflows. • enforce financial repression/credit allocation (developing countries): imposed on outflows. • correct the balance of payment (bop) deficits (us interest equalization tax 1963): imposed on outflows. • correct the bop surplus (german bardepot scheme 1972–1973): imposed on inflows. • prevent potentially volatile inflows (chilean encaje 1991–1998): imposed on inflows. • prevent financial destabilization (chilean encaje 1991–1998): imposed on inflows. • prevent real appreciation (chilean encaje 1991–1998): imposed on inflows. • restrict foreign ownership of domestic assets: imposed on inflows. • preserve saving for domestic use: imposed on outflows. • protect domestic financial firms: imposed on inflows and outflows. 3. capital controls regime in india the indian economy had an almost closed capital account in the post-independence period. however, india began the process of liberalization in the 1980s to benefit from globalization. thereafter, india faced a balance of payment crisis in 1991, which led its policymakers to speed up market reforms. since the economic liberalization in 1991, indian policymakers have taken several steps to gradually liberalize the capital account, but numerous restrictions and controls remain unchanged. we discuss below the key changes in the capital control regime in the preand post-gfc periods. 3.1. s.s. tarapore committee i (1997) government of india constituted the tarapore committee on capital account convertibility under the chairmanship of s.s. tarapore. its purpose was to provide a road map for capital account liberalization. the committee suggested various recommendations, including reducing the fiscal deficit, targeting medium-term low inflation, and fully deregulating the interest rates. it also suggested having a 5% band around the neutral real effective exchange rate (reer), the reserve bank of india (rbi) should intervene whenever the reer is outside the band, foreign exchange reserves should not be less than six months of imports, the forward exchange rate should reflect the interest rate differential, etc. liberalization of capital inflows should be in tandem with the liberalization of capital outflows. foreign direct investment and portfolio inflows should be regulated by transparent guidelines set out by the rbi and should obtain prior approval if needed. however, the east asian crisis (1997) and its contagion effect reduced the possibility of the implementation of the tarapore committee’s recommendations. since then, significant liberalization with respect to inward foreign investment occurred as asian journal of economics and empirical research, 2023, 10(1): 20-30 23 © 2023 by the author; licensee asian online journal publishing group economic conditions improved in india. in 2006, another tarapore committee was constituted to explore the possibility of full capital account convertibility (fcac). 3.2. tarapore committee ii (2006) the committee opined that full convertibility of the capital account should be adopted successively in three phases, i.e., 2006–07 (phase i), 2007–08 and 2008–09 (phase ii), and 2009–10 and 2010–11 (phase iii). the objective of fcac was to minimize the cost of capital, both equity and debt, to boost investments and growth in the indian economy. the tarapore committee emphasized that capital controls should be separate from procedural issues in order to monitor the capital controls more closely. further, the committee recommended that all commercial banks should be brought under single banking legislation. to enhance banking system resilience amid crises, the committee recommended implementing robust risk management systems with stress testing frameworks. it recommended the adoption of an economic capital framework, and risk-based resource allocation. the committee also suggested that fii through participatory notes should be banned, and yearly limits of external commercial borrowing should be increased. 3.3. policy changes during 2006–08 several policy measures were brought in to liberalize the economy after the second tarapore committee report. foreign investment up to 49% was allowed in stock exchange with the approval of foreign investment promotion board. up to 100% of fdi was allowed in industries such as coal and lignite mining, petroleum and natural gas, and industrial explosives. (rajan, rongala, & ghosh, 2008). indian venture funds registered with the securities and exchange board of india (sebi) were allowed to invest in the equity of offshore venture capital undertakings. individual residents were allowed to remit up to $50,000 (from $25,000 previously) in a financial year for any capital and current account transactions. the limit of overseas investments by indian companies was raised from 200% to 300% of its net worth. the annual limit for residents’ real estate acquisitions was increased from $10,000 to $20,000. an aggregate limit for overseas investments through mutual fund schemes was increased from $4 billion to $5 billion. 3.4. capital controls: after the 2008 global financial crisis the collapse of lehman brothers in september 2008 severely affected the global financial system. its effects also spilled over into emerging market economies since they are more vulnerable due to weak economic fundamentals. the indian economy also slowed down and registered lower growth compared to the pre-gfc period. capital inflows dropped from $30 billion to slightly negative values in october to december 2008. it was also a testing time for the capital controls regime in the indian economy. it needed to insulate the economy and minimize the risk of the effects of a global crisis on india’s financial market. due to the gfc, less intervention in the indian capital account was observed, and it was occasionally tightened if deemed necessary by policymakers. post-gfc, the capital account was rationalized to clear ambiguities for international investors in an attempt to win back their confidence. india took a gradual approach and remained cautious in opening capital account due to the gfc.4 the limit on foreign investment was gradually raised, and borrowing and outbound investment by domestic investors was allowed once the crisis settled. the indian economy witnessed two different environments of capital flows, those before and after the gfc and, accordingly, the capital controls regime. therefore, it is important to empirically explore the shape of the capital control regime in india during the gfc and its ability to contain volatility in the financial market. 4. literature review this paper reviews two key strands of literature, the measurement of capital control using different types of qualitative survey data, and the role of capital controls in managing capital flows. the first strand of literature focuses on different methods to measure capital control through different types of indices. the measures of capital control use information on legal restrictions on capital inflows and outflows of the economy. there is a vast amount of literature on the construction of capital control measures through an index which also evolved over time. quinn (1997) provides the first method to measure capital restriction using the disaggregated annual report on exchange arrangements and exchange restrictions (areaer) data. quinn’s openness index combines international current account transactions and capital account transactions. however, its methodology is more suited to the earlier format of areaer data. johnston and tamirisa (1998) provided one of the most disaggregated measures of capital controls, which combines all the classifications of the imf’s areaer data. the study by rossi (1999) focuses on 15 developing countries, and it constructs a separate index for capital inflow and outflow by modifying the method of johnston and tamirisa (1998). glick and hutchison (2005) studied panel data of 67 countries from 1975 to 1997 using imf areaer data on capital control measures. miniane (2004) created an index with 13 categories using disaggregated data reported in the areaer. this index captures the changes from no control to full controls. however, the method is binary in nature and is therefore not able to distinguish the intensity of the effect of capital control on each category. edwards (2004) developed an index on capital mobility based on data of 163 countries from 1970–2000. chinn and ito (2006) constructed an index on capital account openness using the principal component analysis. this index uses restrictions on four categories, i.e., multiple exchange rates, current account restrictions, a five-year restriction on the capital account, and export proceeds. potchamanawong (2007) created a capital control index using imf areaer data. thirteen different types of capital restrictions were used to build this index, and each type is given an equal weight while averaging. each category of control has a range between zero and one with 0.25point intervals. a higher value indicates a greater level of control. ghosh (2012) provides the most comprehensive index of capital controls using disaggregated data from the imf. this index uses the information on disaggregated categories of capital account, information on capital account restrictions, and the surrender of export proceeds. it also presents a separate index for capital inflows 4 we provide details of the policy changes in the indian capital account post-gfc in the appendix, section a.1 asian journal of economics and empirical research, 2023, 10(1): 20-30 24 © 2023 by the author; licensee asian online journal publishing group and outflows. several related studies further developed the index of capital controls (fernández et al., 2015; klein, 2012). schindler (2009) and uribe (2006) constructed a capital control index for 10 asset categories for the period from 1995–2017 for capital inflows and outflows. in this paper, we use the methods presented by quinn (1997); potchamanawong (2007); and ghosh (2012) to construct a measure of capital controls in india. the second strand of the literature focuses on the role of capital control in macroeconomic management and represents a different view on its effectiveness. bhagwati (1998) identified liberalization of the capital account as the main cause behind several crises experienced by countries over the years. klein (2012) conducted a panel data analysis of 44 countries that provide little evidence of efficacy of capital controls on the growth of financial variables, reer or gdp. krugman (1999) argued that imposing capital controls may be effective in stabilizing the economy. magud et al. (2011) further showed that capital controls make monetary policy more independent and reduce exchange rate pressure. ostry, ghosh, chamon, and qureshi (2011) showed that there be no one-size-fits-all policy to deal with destabilizing short-term capital inflows. however, capital controls make a legitimate component of policy response to surges in capital inflows. prasad, rajan, and subramanian (2006); prasad, rajan, and subramanian (2007); and prasad and rajan (2008) showed that excessive capital flows lead to rapid exchange rate appreciation, reducing export competitiveness of emerging market economies. this volatility in capital flows have severe consequences for employment and output. therefore, emerging market economies are required to limit capital flows. ostry et al. (2010) and korinek (2011) showed that capital controls are effective tools that can reduce credit growth, reduce the build-up of an asset bubble, and the lower risk of capital surge. blundell-wignall and roulet (2014) showed that capital restrictions are useful in times of economic prosperity ; lowering restrictions on bonds and fdi flows gives better growth outcomes. bruno, shim, and shin (2017) showed that banking sector-based capital controls are effective in mitigating excess bank inflows in asia-pacific economies. to substantiate the role of capital controls as an effective instrument, the imf (2022) further revised its institutional view to accommodate capital flow management measures as they are “useful in certain circumstances”. given the existing empirical evidence in the literature, we next explore the research gap identified in the literature. the data used to conduct the analysis is discussed in the following section. 5. data for the analysis, data on both qualitative and quantitative metrics is used. the qualitative data of annual frequency is used to create the capital control index, while the data on quarterly frequency for the economic variables over a 14-year period (2001–2014) is taken for the quantitative analysis. we refer to the annual report on exchange arrangements and exchange restrictions (areaer) of the international monetary fund (imf) to get information on the legal restrictions on member countries’ capital accounts. this information is coded to create a de jure measure of capital controls. the qualitative data on capital account transactions from the areaer is disaggregated into the following thirteen categories: 1. controls on capital market securities. 2. controls on money market instruments. 3. controls on collective investment securities. 4. controls on derivatives and other instruments. 5. controls on commercial credit. 6. controls on financial credit. 7. controls on guarantees, sureties, and financial backup facilities. 8. controls on direct investments. 9. controls on repatriation of profits or liquidation of direct investments. 10. controls on real estate transactions. 11. controls on personal capital movements. 12. provisions specific to commercial banks and other credit institutions. 13. provisions specific to institutional investors. data on the other macroeconomic variables is taken from the rbi on a quarterly basis from 2001–2014. these variables include inflation, the current account deficit to gdp, the interest rate differential between the us and india, and the first difference of the exchange rate. 5.1. summary statistics table 1 presents a summary of the data used for the analysis. net inflow to gdp ranges from 1% to 6% during the 2001–2014 period. the quarterly average of the exchange rate data was very volatile, ranging from 39 rs./$ to 62 rs./$ during the same period. the rupee was strong before the gfc because of large inflows into the indian economy, but it depreciated due to massive capital outflows in the post-gfc period. the average current account deficit (cad) to gdp remained at -2% during the 2001–2014 period. it shows a sustainable level of cad, which could be financed by a 2% level, on average, of net inflows to gdp during the same time period. inflation was also quite volatile during the period of analysis and remained very high until recently when it reached its lowest level of 0.3% in december 2014. average inflation was at 6.3%, posing a greater risk for the economy and reducing investors’ confidence. net inflows were attracted into the indian economy due to high returns on financial assets during 2004q1– 2008q2. this process came to a halt due to the gfc, which suddenly led to a massive withdrawal from the indian market by investors. the indian market witnessed a massive net outflow of rs. 140 billion in december 2008 caused by the lehman brothers collapse, which panicked investors, leading to withdrawal. later inflows subsequently improved and a net capital inflow of rs. 1,232 billion was posted in june 2014. asian journal of economics and empirical research, 2023, 10(1): 20-30 25 © 2023 by the author; licensee asian online journal publishing group table 1. data summary (2001q1–2014q4). statistic n mean std. dev. min. max. trade balance (rs. in billion) 56 -1,535.438 756.521 -3,161.105 -311.550 current account (rs. in billion) 56 -466.020 422.096 -1,720.313 199.320 net capital inflow (rs. in billion) 56 429.831 326.513 -140.402 1,232.271 net inflow to gdp 56 0.025 0.015 -0.013 0.062 current account deficit to gdp 56 -0.023 0.019 -0.068 0.027 trade deficit to gdp 56 -0.082 0.020 -0.125 -0.035 inflation (%) 56 6.339 2.657 0.330 11.020 average exchange rate (rs/us $) 56 48.814 6.713 39.470 62.130 note: figures are in billions of rs. and percent. overall, the indian financial market was quite volatile during the 2007–2013 period. before the gfc, the economy posted consistently high growth rates of 7%–8%, which dropped to 5% on average in the post-gfc years. at the same time, capital flows, exchange rate and inflation worsened but later improved as the effect of the crisis lessened. however, such changes in the indian economy makes it very important to understand how these changes shaped the capital controls, which is an important tool to limit the volatility and risk in the market. 6. methodology this paper conducts two separate analyses to explore the intensity and shape of capital controls though an index and determine how capital control influences the capital flow volatility in india. 6.1. construction of the capital control index the creation of the index on capital control was motivated by the works of potchamanawong (2007) and ghosh (2012). the index is derived using information on the restrictions on capital transactions as per the rules listed below. the values for the transactions range from zero to one, with 0.25 intervals. higher values indicate greater control on capital account transactions. • 0: no restrictions (i.e., capital transactions are freely permitted); only a report or notification post transaction may be required by the government. • 0.25: no prior approval is required, but registration or supporting evidence is required. transactions are required to be made through exchange houses or authorized banks. • 0.5: no prior approval is required; however, there are quantitative restrictions, such as limited ownership and limits on the amount that can be transferred per period; ‘yes’ is allocated to the categories in which no other information is present. • 0.75: prior approval is needed before undertaking any transaction; approval is awarded on a case-by-case basis. • 1: no transaction is permitted. a separate index was created for capital inflows and outflows using restrictions on each of the 13 categories of capital account. the index is further aggregated by the equally weighted averages of all categories to construct the consolidated capital control index. the above rule for the creation of the index incorporates the time taken by firms or individuals to conduct a capital account transaction having dealt with bureaucratic procedure. such a procedure imposed on capital account transactions discourages capital mobility within the country. this criterion captures the cost of moving capital between countries, which increases when capital account restrictions are imposed. the imf areaer data states the requirement of evidence, permission, and approval for capital account transactions. 6.2. capital flow volatility and capital controls: tobit model estimation the capital control index analysis is supplemented by estimating the impact of capital controls on capital flow volatility. we capture capital flow volatility through four quarters of moving standard deviations of net inflow/gdp as a de facto measure of capital flow. we use the tobit model estimation procedure since our dependent variable (capital flow volatility) ranges between 0 and 1 and it is censored on the left. our estimation model is as follows: capflow_volt = α0 + α1cap-controlst + α2(cad/gdp)t + α3inflation + α4(rt − rt∗) + α5πt + α5∆ext + εt where capflow_volt is capital flow volatility (four quarters moving standard deviations of net capital inflows to gdp), cap-controlst is the quarterly interpolation of the capital control index, cad/gdp is the current account deficit to gdp, π is inflation, (rt−rt∗) is the interest rate differential between the 10-year government securities of india and the usa. 7. empirical evidence 7.1. capital control index and capital flows in figure 1, the index of capital inflows is compared with net capital inflows in india from 1999–2014. it can be observed that the capital control index declines over the years, which shows decontrol of the capital account. before 2008, the index shows that controls eased and net capital inflow increased. asian journal of economics and empirical research, 2023, 10(1): 20-30 26 © 2023 by the author; licensee asian online journal publishing group figure 1. capital control index and total net inflows. as the financial crisis deepened in the global market, it led to massive outflows from the indian economy. it can be observed from the figure that the capital control index (net capital inflows) remained stagnant during 2009–2014, suggesting stagnancy in the decontrol of the capital account to tackle risk spillover posed by the crisis. the index is further disaggregated to closely observe the changes in the main categories of capital inflows, such as net portfolio inflows and fdi. figure 2 shows a similar trend to that in figure 1. net portfolio inflows were quite volatile after the october to december 2008 quarter and the capital control index on portfolios remained almost stagnant from 2008–2014. net inflows in the portfolio category saw a huge dip in december 2008, showing massive outflows from the indian market. figure 2. portfolio inflows and portfolio category index. in contrast with portfolio inflow, fdi is long-term investment in an economy. the index on the fdi category shows that capital controls on the index remained stagnant from 2006 to 2014 (see figure 3). however, inflows in the fdi category continued to rise until the first quarter of 2009. unlike the portfolio category, outflows in fdi occurred with a lag, and massive outflows in fdi continued from january–march 2009 to october– december 2010. thereafter, net fdi inflows improved. capital controls in the fdi category remained unchanged but inflows were affected mainly due to the 2008 financial crisis. figure 3. fdi inflow and fdi category index. asian journal of economics and empirical research, 2023, 10(1): 20-30 27 © 2023 by the author; licensee asian online journal publishing group the index on capital inflow and outflow is shown in figure 4, which shows that both moved close together from 1999 to 2014. the correlation between capital inflow and outflow is 0.95, as shown in appendix table 3. this suggest that capital controls on inflows and outflows are combined, discarding any asymmetric distortion in either category. historically, countries such as chile, the us and malaysia have imposed controls in either category of capital flow as deemed necessary. such practices are not encouraged in india, as shown in figure 4. figure 4. capital control index: capital inflows and outflows. finally, the control regimes in each category and the degree of intervention in each kind of market are compared. figure 5 shows the capital control index for the money market, the capital market, and fdi. the money market instrument shows short-term investment, while the capital market and fdi represent long-term investment in the economy. figure 5 also shows that the money market and fdi have had less intervention compared to the capital market during the 2009–2013 period. figure 5. capital control index: capital control, money market and foreign direct investment. 7.2. estimation results: capital account openness and capital control table 2 shows the empirical results for capital account volatility using the tobit estimation in the context of the gfc. we find that capital controls are highly significant and strongly contract capital flow volatility over the study period. a unit increase in capital control measure reduces the volatility of capital flows by 0.46 standard deviation. further, we split the sample into preand post-gfc periods to closely investigate the role of capital controls in reducing capital flow volatility during the shock of the gfc. we found that capital controls are highly effective in reducing capital flow volatility (0.54 standard deviation) compared to the post-gfc period (0.08 standard deviation). this shows the muted impact of capital controls on capital flow volatility in the post gfc phase when the indian economy was hit by two major shocks – the post-gfc hangover and the taper tantrum episode in 2013 – and the market was highly uncertain due to global financial stability conditions. the indian economy also endured an exchange rate depreciation period and a high inflation phase post gfc. the reserve bank of india used the interest rate as a defense to manage exchange rate volatility and capital flow volatility, which proved to be largely ineffective (goyal, 2014). asian journal of economics and empirical research, 2023, 10(1): 20-30 28 © 2023 by the author; licensee asian online journal publishing group table 2. capital flow volatility and capital controls (tobit estimation). variable dependent variable: volatility in net inflow to gdp full period (2001q1–2014q4) pre-gfc period (2001q1–2008q4) post-gfc period (2009q1–2014q4) capital controls -0.460*** -0.532* -0.008* -0.096 -0.237 -0.004 interest rate differential 0.0001 -0.0003 0.00001 -0.0003 -0.0004 -0.0003 inflation -0.0004 0.001 -0.003*** -0.001 -0.003 -0.001 exchange rate -0.001 -0.001 -0.001 -0.0004 -0.0004 -0.0004 cad to gdp -0.141*** -0.065* -0.075 -0.045 -0.028 -0.059 constant 0.246*** 0.281* 0.034 -0.049 -0.129 -0.077 observations 50 26 24 note: * p < 0.1, *** p < 0.01; cad: current account deficit; gdp: gross domestic product. standard deviations are given below the coefficient values. these results highlight the deterring role of capital controls in managing capital flows in the indian context. since the indian economy gradually liberalized capital controls until 2008 and relaxed capital control measures in several parts of the economy, capital controls became limited in affecting capital flows and their volatility after the gfc. however, the results emphasize that capital controls limited the repercussions of capital flow volatility on the indian economy to some extent and potentially limited the global shock spillover to the indian financial market in the post-gfc period. 8. conclusion there is a comprehensive debate over capital controls being effective tools for macroeconomic management and economic stability. this paper is an attempt to ascertain whether capital controls proved to be an effective tool for india to stabilize its economy during the global financial crisis. this paper explored the shape and intensity of the capital control regime in the indian economy before and after the gfc, supplemented with an analysis of the role of capital control to deter capital flow volatility in india. the capital control index suggests that india still maintained significant control despite substantial liberalization in the pre-gfc period. the index analysis further shows that the process of capital account liberalization slowed down due to the gfc. most importantly, it shows that instead of further tightening the capital control regime due to the gfc, policymakers chose to let the controls remain almost stagnant in the post-gfc period. this emphasizes the irreversible nature of market reforms in any economy. the policy action chosen during the gfc was to continue with contemporary controls and wait for further reforms until the impact of the crisis lessened and the market stabilized. capital account liberalization (or capital control) analysis through the capital control index was extended to analyze capital account openness and its determinants using the tobit regression model. our results show that capital controls are effective in managing capital flow volatility in general and were partially effective post gfc. indian economic recovery from the gfc may have been possible due to the sound capital control regime that remained stagnant during the post-gfc period. the capital control regime proved to be an important tool to better manage the crisis in developing countries such as india. as the indian economy matures and integrates into the global financial market over time, gradual removal of capital controls should be adopted for sustained growth and development. this research can be further extended to construct an index by combining de facto and de jure measures of capital controls, which may be better able to capture the movement in capital controls and the impact on other macroeconomic factors. possible future research could also analyze the capital control regime by comparing a monthly index on capital controls with the exchange rate movement to determine a possible causality between capital control and the exchange rate in india. references ahmed, s., & zlate, a. 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(2006). on overborrowing. american economic review, 96(2), 417-421. appendix: correlation table for capital inflow and outflow. table 3. correlation matrix for capital inflow and outflow. index type capital inflow index capital outflow index capital inflow index 1 0.953 capital outflow index 0.953 1 a.1 changes in the capital control regime post gfc. the following section contains some important policy changes in capital control on a yearly basis from the imf’s annual report on exchange arrangements and exchange restrictions (areaer) from 2009–2013. 2009 • the limit on investments by fiis in corporate bonds was raised from $6 billion to $15 billion. • banks were not allowed to grant new loans or renew existing loans in excess of rs. 10 million (previously, rs. 2 million) against non-resident external rupees. the relaxation in all-in-cost ceilings allowed during the financial crisis period after approval was withdrawn. accordingly, the all-in-cost ceilings under the approval route are the london interbank offered rate (libor)5 plus 300 basis points (bps) for an average maturity period from three years to five years, and the libor plus 500 bps for an average maturity period of greater than five years. 2010 • foreign institutional investment (fii) was allowed to offer domestic government securities and foreign sovereign securities, with a rating of aaa and considered among the safest from a risk perspective, as collateral to the recognized stock exchanges in india in addition to cash. previously, they were not 5 the london interbank offered rate is the average interest rate estimated by leading banks in london to determine what the average leading bank would be charged if it borrows from other banks. https://doi.org/10.1016/j.jinteco.2012.03.006 https://doi.org/10.1080/17520843.2012.699896 https://doi.org/10.1016/j.jimonfin.2004.11.004 https://doi.org/10.1016/j.jdeveco.2003.10.002 https://doi.org/10.1057/imfer.2011.19 https://doi.org/10.1057/imfer.2011.15 https://doi.org/10.1257/jep.22.3.149 https://doi.org/10.2307/2952073 https://www.researchgate.net/profile/ramya-ghosh/publication/228511082_attracting_foreign_direct_investment_fdi_to_india/links/00b7d52b7fda291d00000000/attracting-foreign-direct-investment-fdi-to-india.pdf https://www.researchgate.net/profile/ramya-ghosh/publication/228511082_attracting_foreign_direct_investment_fdi_to_india/links/00b7d52b7fda291d00000000/attracting-foreign-direct-investment-fdi-to-india.pdf https://www.researchgate.net/profile/ramya-ghosh/publication/228511082_attracting_foreign_direct_investment_fdi_to_india/links/00b7d52b7fda291d00000000/attracting-foreign-direct-investment-fdi-to-india.pdf https://doi.org/10.1057/imfsp.2008.28 https://doi.org/10.1177/000271602128748697 https://doi.org/10.1093/rfs/hhq078 asian journal of economics and empirical research, 2023, 10(1): 20-30 30 © 2023 by the author; licensee asian online journal publishing group permitted to offer domestic government securities as collateral for their transactions in the cash segment of the market. • external commercial borrowing (ecb) can be raised by eligible borrowers in the telecommunications sector to meet the spectrum allocation payment from rupee resources, which can be refinanced with longterm ecb under the approval route, subject to certain conditions. • to promote development of the infrastructure sector, a separate category of non-bank financial companies (nbfcs), namely infrastructure finance companies (ifcs), was introduced. • takeout financing through ecb is allowed under the approval route to refinance rupee loans from domestic banks by corporate borrowers developing infrastructure in seaports, airports, roads, and power sectors. 2011 • fii was permitted for non-convertible debentures/bonds issued by nbfcs categorized as ifcs by the rbi, within an overall limit of us $25 billion, subject to conditions. • the limit of fii in government securities of us $5 billion was increased, raising the cap to us $15 billion, and the limit of fii investment in corporate bonds of us $5 billion was also increased, raising the cap to us $20 billion. the limit for infrastructure bonds (separate from corporate bonds) was retained at us $25 billion. • the external commercial borrowing (ecb) policy was liberalized and rationalized. the limit for eligible borrowers for ecb under the automatic route each financial year was enhanced as follows: o firms in the real, industrial, and infrastructure sectors: us $750 million or equivalent (previously us $500 million or equivalent). o firms in specified service sectors, namely hotels (hospitality), hospitals (healthcare), and software (it): us $200 million or equivalent (previously us$100 million or equivalent). o borrowers in the infrastructure sector may use ecb in renminbi (official currency of the people's republic of china) up to a ceiling of us $1 billion per financial year under the approval route. o fdi up to 100% under the automatic route was permitted for greenfield investments in the pharmaceutical sector, and fdi up to 100% was permitted for brownfield investments (i.e., investments in existing companies) in the pharmaceutical sector under the government approval route. 2012 • indian companies in the manufacturing and infrastructure sectors that have foreign exchange earnings may use ecb for the repayment of outstanding rupee loans for capital expenditures and/or new rupee capital expenditures under the approval route. the overall ceiling for this ecb is us $10 billion. • qualified foreign investors are allowed to invest in mutual funds that hold at least 25% of their assets (in debt, in equity, or both). • banks may grant loans against non-resident (external) rupee accounts and foreign currency non-resident (bank) accounts either to the depositors or third parties, subject to conditions. 2013 • residents may invest in companies listed on recognized foreign stock exchanges up to the equivalent of us $75,000. • foreign institutional investors may invest up to us $25 billion in government securities (previously us $20 billion) and corporate debt instruments up to us $50 billion (previously us $45 billion). • resident individuals are allowed to make overseas direct investments subject to certain terms and conditions. 2014 • interest rates offered by banks on non-resident external deposits may not exceed those offered on comparable domestic rupee deposits. • the cash reserve ratio and statutory liquidity ratio maintenance exemption on incremental foreign currency non-resident (fcnr(b)) deposits and non-resident external deposits (increment over july 26, 2013) of maturity greater than three years was withdrawn. • fii is not allowed to buy government bonds with less than three months of maturity to reduce exchange rate volatility observed by short capital inflows in the country. the asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc., caused in relation to/arising from the use of the content. any queries should be directed to the corresponding author of the article. 44 © 2024 by the author; licensee asian online journal publishing group asian journal of economics and empirical research vol. 11, no. 2, 44-49, 2024 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v11i2.5890 © 2024 by the author; licensee asian online journal publishing group not all investors are the same: evidence from investor holdings of local-currency debt in indonesia amr hosny international monetary fund, 1900 pennsylvania avenue nw, washington, dc 20431, usa. email: ahosny@imf.org abstract this paper examines the global and domestic factors driving different investor holdings of local currency (lc) sovereign debt in indonesia. using an autoregressive distributed lag co-integration approach, using monthly data for indonesia over 2002m12-2022m12, we find that non-resident holdings of lc debt in indonesia are mostly driven by global factors such as commodity prices and volatility in global bond markets, while domestic investors (such as domestic banks and institutional investors) are mostly driven by higher debt security issuances and bank of indonesia (bi) acts as a residual financier under adverse conditions. we also find evidence that foreign investors follow the "benchmark effect" and are attracted by higher domestic yields. results are mostly robust to different specifications. these results call for a further deepening of the investor base, especially domestic nonbanks, to support market depth and reduce volatility. keywords: foreign holdings, indonesia, local currency debt, portfolio flows. jel classification: f30; g11; g15; o16. citation | hosny, a. (2024). not all investors are the same: evidence from investor holdings of local-currency debt in indonesia. asian journal of economics and empirical research, 11(2), 44–49. 10.20448/ajeer.v11i2.5890 history: received: 4 april 2024 revised: 18 july 2024 accepted: 2 august 2024 published: 16 august 2024 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. data availability statement: amr hosny may provide study data upon reasonable request. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. acknowledgement: the views expressed in this paper are those of the author and do not necessarily represent the views of the imf, its executive board, or imf management. contents 1. introduction and motivation ......................................................................................................................................................... 45 2. empirical methodology and results ............................................................................................................................................ 47 3. conclusion and policy implications ............................................................................................................................................. 48 references .............................................................................................................................................................................................. 48 mailto:ahosny@imf.org https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://orcid.org/0000-0001-8952-8757 https://www.doi.org/10.20448/ajeer.v11i2.5890 asian journal of economics and empirical research, 2024, 11(2): 44-49 45 © 2024 by the author; licensee asian online journal publishing group contribution of this paper to the literature we contribute to the empirical literature on the determinants of investor holdings of sovereign debt by looking at the role of both global and domestic factors, and on different resident and nonresident investors, whereas the literature has been mostly focused on the role of global factors on non-resident holdings. 1. introduction and motivation indonesia has experienced a significant decline in the nonresident (nr) share of local-currency (lc) debt coinciding with the pandemic. public debt reached around 40 percent of gross domestic product (gdp) in 2022 from 30.6 percent in 2019 (as illustrated in figure 1), mostly driven by higher lc debt issuances, owing to the exceptional fiscal measures deployed in 2020-22 to fight the covid-19 pandemic, during which the fiscal rule was temporarily suspended and the bi-mof introduced a burden-sharing financing agreement. at the same, time, the nr share of lc debt declined from 39 percent in 2019q4 (one of the highest ratios across a large sample of ems from arslanalp and tsuda (2014) to about 14 percent at end-2022. while the institutional investors’ (mutual funds, insurance companies, and pension funds) share of lc debt holdings have remained broadly stable, the shares of bank of indonesia (bi) and domestic banks have increased during covid years, in line with bi’s primary market purchases under the bi-mof burden-sharing financing agreement (as illustrated in figure 2). nr holdings have shown some signs of recovery in recent months and remain mostly concentrated in long-dated securities (as illustrated in figure 3). figure 1. public debt (by currency, in percent of gdp. the recent fall in the nr share of lc debt is unprecedented historically, and relative to other ems. since covid-19, the decline in nr holdings of lc debt has been almost 3 percent of gdp. the decline can be broken down into two periods. in the first period, covering 2020 and 2021, large nr outflows mainly reflected the covid shock, and bi started primary market purchases under the bi-mof agreement amid rising fiscal deficits. the decline in nr holdings continued in 2022, amid the tightening in global financial conditions driven by the fed tightening (also see imf (2021)). figure 2. investor profile indonesia-govt. lc bonds (share of govt securities outstanding, monthly). source: ministry of finance (mof) & ceic. asian journal of economics and empirical research, 2024, 11(2): 44-49 46 © 2024 by the author; licensee asian online journal publishing group figure 3. foreign holdings of lc debt, by remaining maturity (in trillions, rupiah). source: mof & haver. the nr share of lc debt in indonesia is now close to the average emerging market (em). indonesia had the second highest nr share of lc debt in 2019q4, just before the pandemic, but now stands at about the em average (as illustrated in figure 4). at the same time, the limited size and role of domestic nonbanks (institutional investors) may partially explain the historically high share of nr holdings in indonesia (as illustrated in figure 5). figure 4. foreign holdings of lc government debt securities (in percent of total). source: arslanalp and tsuda (2014). figure 5. domestic nonbanks' holdings of lc government debt securities (in percent of total). source: arslanalp and tsuda (2014). different investor profiles come with different risks. sovereign borrowing can help buffer the economy from the impact of adverse macroeconomic shocks. but it can also make a country vulnerable to financial distress. on top of that, not all investors are the same. the literature points to several pros and cons of having a higher nr share of lc debt: • pros: foreign investors can improve price discovery, increase demand for longer-maturity instruments and provide liquidity (arslanalp & tsuda, 2014; bae, 2012). greater foreign participation can reduce long-term asian journal of economics and empirical research, 2024, 11(2): 44-49 47 © 2024 by the author; licensee asian online journal publishing group government bond yields due to a more diversified investor base (arslanalp & tsuda, 2014; christian ebeke & lu, 2015; lu & dmitry, 2017; peiris, 2010).1 a higher nr share can also minimize the crowding-out of private credit and the sovereign-bank nexus (asonuma et al., 2015; broner, erce, martin, & ventura, 2014). • cons: higher nr shares can increase rollover and exchange rate risks (calvo, izquierdo, & talvi, 2006). higher nr shares can also increase risks to sudden stops or capital reversals, as these flows are more volatile and short term in nature (bis, 2007; calvo et al., 2006). bhattacharya, johnson, nkusu, and wang (2022) also argue that a nr investor base can be a more volatile and less stable source of funding for the sovereign. in addition, there is some evidence of increased yield volatility with higher shares of nr holdings (c. ebeke & kyobe, 2015; christian ebeke & lu, 2015). burger and warnock (2007) argue that u.s. investors avoid lc bonds that have returns with historically high variance and negative skewness–features that are predominant in ems. against this background, this paper examines the global and domestic factors driving different investor holdings of local currency (lc) sovereign debt in indonesia. we contribute to the literature by looking at the role of both global and domestic factors, and on different resident and non-resident investors, whereas the literature has been mostly focused on the role of global factors on non-resident holdings (for example see arslanalp and tsuda (2014)). to distinguish long-run from short-run effects, we use the autoregressive distributed lag (ardl) co-integration approach of pesaran, shin, and smith (2001) using monthly data over the period 2002m2-2022m12. we find that foreign participation in the lc debt market in the long run is positively correlated with global factors such as global commodity prices, volatility in global bond markets, and global interest rates. we also find some evidence that higher domestic yields may attract foreigners. domestic banks and non-banks tend to increase their holdings with higher debt issuances, and bi acts as a residual financier under adverse global conditions. results are mostly robust to different specifications. this paper is structured as follows. after this introduction, section b presents the empirical methodology and results. section c concludes and presents some policy implications. 2. empirical methodology and results the decision of different investors to hold lc government debt can reflect both global and domestic conditions. domestic (or pull) factors usually include domestic bond yields, the amount of debt issuance, and different countryspecific risks. global (or push) factors typically include global commodity prices, global interest rates and financial market volatility. for a survey of the empirical literature on the drivers of capital inflows into ems, see for instance (koepke, 2018). global factors tend to carry a large weight in index-funds and decisions to invest in lc debt in ems. several studies argue that portfolio flows to ems tend to be correlated, driven by the so-called “benchmark effect” (see (arslanalp, drakopoulos, goel, & koepke, 2020; arslanalp & tsuda, 2015; bis, 2007; brandão-marques, luis, ichiue., & oura., 2015)). this refers to the observation that benchmark-driven investors are typically more sensitive to global than country-specific factors, as their investments consider ems as an asset class, thus focusing mainly on factors that affect ems as a group, rather than on country-specific developments.2 raddatz, schmukler, and williams (2017) find that benchmarks explain, on average, between 40-70 percent of equity and bond mutual fund portfolio allocations after controlling for country-specific effects. rey (2015) argues that capital flows are mainly driven by monetary conditions in main financial centers. sienaert (2012) highlights the role of benchmark index inclusion, or the risk of exclusion if already included, in affecting investment decisions of institutional investors. we model investor holdings of lc debt in indonesia as a function of domestic and global factors. using timeseries data for indonesia, we examine the role of both domestic and global factors in the investment decisions of different types of resident and non-resident investors (see koepke (2018) and hosny (2020) for a survey of the empirical literature). specifically, using monthly data for indonesia over 2002m12-2022m12, we estimate the following equation: investor holdings𝑡 = 𝛽0 + 𝛽1𝑑𝑜𝑚𝑒𝑠𝑡𝑖𝑐𝑡 + 𝛽2𝑔𝑙𝑜𝑏𝑎𝑙𝑡 + 𝜀𝑡 where the dependent variable represents different investor holdings of indonesia’s lc tradable debt securities. the investors include foreign investors (lcdebt_f), domestic banks (lcdebt_bank), bi (lcdebt_bi), and nonbank residents or institutional investors (lcdebt_nbres). we regress the holdings of these investor types on a set of domestic and global variables following the literature (bae, 2012; fang, hardy, & lewis, 2022; grigorian, 2019; koepke, 2018; konopczak, 2015; rey, 2015). all variables, except bond yields, are expressed in logs. • domestic factors include the rate of return on domestic securities, specifically the ten-year sovereign bond yield (yield_10y), and lc debt issuances (issuances). • global factors include an index of global commodity prices (comm prices) as indonesia is a diversified commodity exporter, a measure of global financial volatility in bonds (move),3 as well as the ten-year us bond yield (yieldus_10y) to account for the opportunity cost of investing in indonesia. to distinguish long-run from short-run effects, we use the autoregressive distributed lag (ardl) co-integration approach of pesaran et al. (2001). the long-run equation is represented in levels and the short-run equation is represented as an error correction equation in first differences. both equations are simultaneously estimated by ordinary least squares (ols). an advantage of the ardl procedure is that it is applied irrespective of the timeseries properties of the regressors.4 in estimating the models, we use information criteria to select the optimum lag.5 results point to the importance of global factors especially for nonresidents, while domestic investor holdings are mostly associated with higher debt security issuances, and bi acts as a residual financier under adverse conditions. 1asonuma, said, and heiko (2015) find that high domestic banks’ holdings of domestic debt (home bias) can generally reduce borrowing costs, but this effect diminishes during crisis and maybe associated with less responsive fiscal policy. 2 benchmark-driven investors are those who invest in countries through a fund that either tracks or closely follows a flagship benchmark index. one of such indices is the j.p. morgan government bond index-emerging markets (gbi-em), which tracks local currency bonds issued by ems. indonesia has a weight of 10 percent in the gbi-em index as of end-december 2021, ahead of countries like malaysia and south africa. 3 the merrill lynch option volatility expectations (move) index tracks the movement in u.s. treasury yield volatility implied by current prices of one-month options on 2-year, 5-year, 10-year and 30-year treasuries. it is published by ice bofaml and can be accessed at https://macrovar.com/unitedstates/move-index/. it has been cited that one can think of move as the “vix for bonds”. 4 specifically, the pesaran et al. (2001) bounds testing approach reports two sets of critical values; an upper bound critical value assuming all variables are i(1), and a lower bound assuming all are i(0). if the calculated f-statistic is above the upper bound, then the variables are jointly statistically significant, indicating long-run cointegration. 5 see bahmani-oskooee and tanku (2008) for details. panopoulou and pittis (2004) provide evidence that ardl generally performs better than alternative methods, such as dynamic ols, both in terms of estimation precision and reliability of statistical inferences. https://macrovar.com/united-states/move-index/ https://macrovar.com/united-states/move-index/ asian journal of economics and empirical research, 2024, 11(2): 44-49 48 © 2024 by the author; licensee asian online journal publishing group we find that foreign holdings are associated with global factors, such as global commodity prices and volatility in global bond markets. see table 1 for full results. table 1. ardl long-run model: 2002m12-2022m12 for indonesia. lcdebt_f lcdebt_banks lcdebt_bi lcdebt_nbres domestic factors: yield_10y 0.249* (0.149) 0.044 (0.033) 0.056 (0.063) -0.023 (0.026) issuances 1.102*** (0.391) 0.521*** (0.093) 1.926*** (0.166) 1.196*** (0.073) global factors: yieldus_10y -0.103 (0.234) -0.043 (0.083) 0.202* (0.106) 0.015 (0.049) comm prices 1.783** (0.710) -0.310* (0.185) -0.976** (0.406) 0.187 (0.134) move -1.949** (0.814) -0.203 (0.158) 0.789*** (0.269) 0.427*** (0.131) observations 227 227 206 231 r-squared 0.406 0.403 0.351 0.355 ardl (5,4,2,0,1,1) (6,0,6,4,0,1) (4,0,0,0,0,0) (6,2,1,0,0,0) sample full full full full note: standard errors in parentheses. *** p<0.01, ** p<0.05, * p<0.1 this result is in line with the "benchmark effect" of rey (2015) and arslanalp et al. (2020) in ems.6 we also find some evidence that higher domestic yields may attract foreigners. all investors seem to increase their holdings with higher debt security issuances. holdings of resident banks and bi seem to decrease with higher global commodity prices, potentially because in such cases nr shares increase and/or banks may prefer lending to the private sector linked to commodities. the bi increases its holdings with higher debt issuances as expected, but importantly its holdings are also positively correlated with a worsening in the global factors considered in the regression, indicating that bi acts as a residual financier under adverse conditions. this result is also in line with findings from the literature on “home bias”; i.e. domestic investors are willing to hold domestic bonds under conditions that would make foreign investors exit (bhattacharya et al., 2022). results are mostly robust to different specifications. we experiment with different robustness checks. this includes adding new independent variables such as the exchange rate (idr/usd) and a measure of country risk (proxied by the icrg index),7 as well as different definitions of independent variables, including yield spreads (instead of domestic and u.s. yields separately), commodities (oil vs all commodities), yield maturities (5y vs 10y), a measure of global expected volatility of equities (vix),8 and real instead of nominal yields. we also examine different sample periods (before covid-19), and different definitions of the dependent variable (holdings to gdp ratio, and holdings to total debt ratio instead of the nominal value of holdings).9 3. conclusion and policy implications in this paper we find that nr investors in indonesia mostly respond to global factors. using time-series econometrics on indonesian data over 2002m2-2022m12, we find that foreign participation in the lc debt market in the long-run is positively correlated with global factors such as global commodity prices, volatility in global bond markets, and global interest rates. we also find some evidence that higher domestic yields may attract foreigners. domestic banks and non-banks tend to increase their holdings with higher debt issuances, and bi acts as a residual financier under adverse global conditions. even if global factors are a major driver of nr inflows, domestic policies in ems also matter. this is in line with ghosh, ostry, and qureshi (2016) and lu and yakovlev (2018). amstad, eli, and jimmy (2016) find similar evidence, where they argue that while movements in global risk factors determine whether spreads rise or fall over time, the extent to which these spreads rise or fall depends on domestic country-specific factors. strong policies and fundamentals during periods of capital inflows – such as macroeconomic stability, fiscal and external buffers, and institutional quality – would make the country more resilient when capital flows reverse. references amstad, m., eli, r., & jimmy, s. 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(2012). foreign investment in local currency bonds: considerations for emerging market public debt managers. retrieved from wb policy research working paper no. 6284. the world bank group: asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.1016/j.jmoneco.2013.11.009 https://doi.org/10.2139/ssrn.2404322 https://doi.org/10.1596/29444 258 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 2, 258-267, 2020 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2020.72.258.267 © 2020 by the authors; licensee asian online journal publishing group dealing with demand heterogeneity on health care provider choice – the case of rural china martine audibert1 yong he2 jacky mathonnat3 1,2universite clermont auvergne, cnrs, cerdi, france. 3professor emeritus in economics, clermont auvergne university, senior fellow, ferdi, france. ( corresponding author) abstract we built a database of two samples of patients surveyed within the same regions in rural china over a time interval of 18 years, and presumed varying demand heterogeneity due to income increase and people aging. we find that while the mean price and distance negative effects on patients choice were present in both time periods, their differences in heterogeneity, which were confirmed with the mixed multinomial logit (mmnl), could have crucial importance in avoiding erroneous policy making based merely on mean price and distance effects. we also find that while both the multinomial logit (mnl) and the mmnl are able to predict price and distance effects with low heterogeneity, only the mmnl appears able to detect the price effect when heterogeneity is high. these findings suggest using caution when interpreting estimation results with the mnl in cases of high heterogeneity. keywords: price effect, distance effect, healthcare choice, preference heterogeneity, multinomial logit, mixed multinomial logit models, chinese rural households. jel classification: d1; c5; i1. citation | martine audibert; yong he; jacky mathonnat (2020). dealing with demand heterogeneity on health care provider choice – the case of rural china. asian journal of economics and empirical research, 7(2): 258-267. history: received: 20 july 2020 revised: 24 august 2020 accepted: 28 september 2020 published: 7 october 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 259 2. issues on heterogeneity in healthcare demand ..................................................................................................................... 259 3. estimation method and data ...................................................................................................................................................... 261 4. estimation results ......................................................................................................................................................................... 264 5. conclusions ..................................................................................................................................................................................... 267 references ............................................................................................................................................................................................ 267 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.72.258.267&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/2199 asian journal of economics and empirical research, 2020, 7(2): 258-267 259 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to existing literature by providing evidence that the most popular multinomial logit model works only in the case of the choice with homogenous demand, and to avoid estimating bias, the mixed multinomial logit is indispensable when demand becomes heterogeneity. 1. introduction the demand for health care and the effects of price and distance on patients’ provider choices have been subject to extensive studies that carry important policy implications. for instance, a weak price effect implies a high demand for more expensive and high quality healthcare services, and thus suggests the need for resource allocation towards large and well-equipped hospitals. studies on distance effect can help to optimize geographical allocation of medical resources. a strong distance effect suggests the need for a more decentralized system with small and nearby healthcare providers. there is, however, a serious gap on how these effects manifest and are interpreted in the presence of demand heterogeneity among patients. by demand (or choice) heterogeneity, we mean the extent of the difference in demand among the patients in function of the healthcare prices and of the distances of the healthcare providers. in other words, they are the variances of the price and distance effects across the patients. this issue is crucial for health care because some significant changes in heterogeneity could change the sense or the extent of the mean price and (or) distance effects. difference in demand heterogeneity gives rise to different policy implications. the first objective of this study, therefore, is to fill the gap in the healthcare literature with the estimation of the effects of price and distance on healthcare provider choice in the presence of various types of demand heterogeneity and illustrate the importance of taking heterogeneity into account in policy making. we construct two samples of patients from the same villages of nine chinese provinces over two periods: 19891993 and 2004-2006. we focus on the two most important factors that could lead patients’ provider choices to become more (or less) heterogeneous: during two periods, the average real income per capita were more than doubled, along with a sharp increase in income inequality, and the average age of patients significantly increased. it is reasonable to assume that an increase in patient income, while causing a weaker price effect, will lead provider choices based on healthcare price to be more heterogeneous, because these choices are henceforth made based on their difference in preferences on quality, and other observed and unobserved aspects of health care. we can also expect that more elderly patients would be less likely to choose a provider based on healthcare price and more likely to choose providers based on proximity. therefore, choice heterogeneity based on price and distance could be expected to be lower with population aging. our second objective is methodological. there have been a number of studies with divergent conclusions on the estimation robustness of two econometric models. the conditional multinomial logit model (mnl) is mostly used for estimating healthcare demand, but is considered by some people as not suitable in cases of high choice heterogeneity. the mixed multinomial logit model (mmnl), which has emerged more recently, offers the possibility of decomposing individual preferences. comparing the performance between the two models in the presence of preference heterogeneity will allow us to contribute to the existing literature on the relative robustness of these two models. the first finding of our study is that while the mean price and distance effects on provider choices by patients were present in both time periods, their presumed differences in heterogeneity are confirmed with mmnl testing. more precisely, during the second period, while the heterogeneity of choices based on price increased, mainly due to aging of patients, the heterogeneity of choices based on distance decreased. the second finding is that, while both the mnl and the mmnl are able to predict price and distance effects with low heterogeneity, only the mmnl detected the price effect when heterogeneity was high. this finding suggests using caution when interpreting estimation results with the mnl in cases of high heterogeneity. the remainder of the paper is organized as follows. section 2 introduces the literature on the estimations of price and distance effects and explains why this study focusing on demand heterogeneity in rural china fills a gap in the literature. it also presents the issue on the choice between the mnl and mmnl models and the contributions with this study. section 3 sets up the econometric model and describes the two-period samples. section 4 analyzes the results and section 5 concludes. 2. issues on heterogeneity in healthcare demand 2.1. previous work on price and distance effects there is abundant literature on healthcare provider choice in developing countries. as explanatory factors, income and price have always received special attention. results obtained have led to contradictory conclusions. several studies have found that income and price had significant elasticity on provider choice (sahn & stifel, 2000), while others have found that these factors were not important determinants whereas the perceived quality of health care had a greater effect. several authors have undertaken systematic literature reviews on access to care. one of the missing points in previous works is the absence of theoretical and empirical considerations on demand heterogeneity. the study on heterogeneity in relation to mean effects could significantly contribute to our understanding of healthcare demand. this analysis on income and price effects also applies to studies on the distance effect over provider choice. this effect is important in developing countries where access to transport is more costly than in developed countries. the distance effect, especially its heterogeneity, has rarely been examined except by borah (2006) in the case of india. 2.2. why rural china provides a good case for demand heterogeneity between late 1980 and mid-2000, china achieved some deep social economical changes. the first was general income growth. the average gdp growth of china was 9% between 1989 and 2004, and gdp in 2004 was 8.07 times that of 1989 at current prices and 3.8 times at constant prices. incomes of rural and urban households in 2004 were 4.88 and 6.86 times those of 1989, respectively, at current prices. converted to incomes at constant prices, the asian journal of economics and empirical research, 2020, 7(2): 258-267 260 © 2020 by the authors; licensee asian online journal publishing group income of rural households in 2004 was 2.3 times that of 1989. in our sample, the average per capita income at constant prices and household assets in 2004-2006 are 2.4 and 3.1 times those in 1989-1993, respectively. an obvious effect of general income growth would be that healthcare choices became more heterogeneous among patients because of the decrease of budget constraints. general income growth could also reduce distance effect and make the impact of distance on preference more heterogeneous because the choices become less constraint by the transports costs. another factor that affects choice heterogeneity is population aging. in 1990, 5.57% of the total population were over 65 years old. by 2005, this percentage had nearly doubled to 9.07%, with 9.48% and 8.12% for rural and urban populations, respectively. in our samples, with average age increased from 44 to 56 and the percentage of people over 65 doubled and their health naturally decreased, patients’ provider choices would be, in general, less sensitive to price and more affected by some other factors. as elderly people tend not to like to travel, there is a stronger distance effect and reduced heterogeneity of distance impacts. along with income growth and aging, several sources of unobservable heterogeneity can potentially evolve and affect changes in demand heterogeneity: on the side of unobserved healthcare provider attributes, there are at least two: 1) factors in non-price competition and 2) transport accessibility. in particular, the perception of non-price competition by the local population is an unobserved variable for research. for transport accessibility, given that distance is an observed variable, the accessibility that varies with specific transportation conditions across the same type of healthcare provider is an unobserved factor. on the side of personal preference variations of rural patients, there can be several sources. first, there are differences in judgments on the efficiency of chinese medicine across patients. second, there are differences in patient perceptions about the effectiveness of the same type of health providers due to their experiences in health care. third, there are differences in the connections with personal relationship networks. fourth, there is subjectivity in self-assessment of health. the social, cultural and psychological factors that shape self-assessment clearly vary from patient to patient. to summarize, with the increases in income and age of our patient samples and enlargement of the choice set, all above-mentioned sources of heterogeneity are subject to significant change, and thus enlarge the extent of heterogeneity in patients’ healthcare preferences. the impact of price effect can be expected to be more heterogeneous in the second period, but distance effect is expected to be uncertain, depending on which influence is more important: the income growth that reduces the distance effect but increases its heterogeneity, or the aging of the population that increases the distance effect and reduces its heterogeneity. 2.3. mnl and mmnl in the presence of heterogeneity mcfadden’s choice model (mcfadden, 1974) which relies on the conditional multinomial logit (mnl) model, has long been the leading tool for empirical studies. as the mnl model is based on the independent and identically distributed (iid) assumption, and hence on the independence of irrelevant alternatives (iia) assumption, its failure to deal with heterogeneity is deemed capable of resulting in inferior model specification, spurious test results and invalid conclusions (louviere, hensher, & swait, 2000). the mixed multinomial logit (mmnl) is similar to the mnl except that it allows parameter estimates to vary across individuals. according to the authors of the mmnl, in the presence of large-scale heterogeneity, the mmnl that relaxes iid will lead to marked improvement in estimations relating to the mnl. the mmnl leads to gaining generality, but the estimation simplicity that characterizes the mnl is lost. thus, when the mnl is not biased, it is preferred. to illustrate the difference between the mnl and the mmnl, consider the following utility function: 𝑈𝑖𝑗 = 𝛼𝑖𝑍𝑖𝑗 + 휀𝑖𝑗 = (𝛼 + 𝜉𝑖)𝑍𝑖𝑗 + 휀𝑖𝑗 (1) where 𝑈𝑖𝑗 is the utility of individual i choosing state j, 𝑍𝑖𝑗 and 𝛼𝑖 represent all the observed factors and their parameters obtained from the model. in the first equality of the equation, the coefficient 𝛼𝑖 differs across individuals. like the mnl, the mmnl assumes that the error terms, εij, are iid. however, it relaxes the restriction that α is the same for each individual, allowing it to be stochastic instead. the second equality in equation 1 expresses another way to look at the mmnl. 𝑎𝑖 is perceived as its mean, 𝛼 , and a deviation around the mean, 𝜉𝑖 , which differs across individuals. with non-zero error components,𝜉𝑖𝑍𝑖𝑗 , utility becomes correlated across alternatives, which relaxes the iia assumption. thus, the mmnl incorporates taste variations across individuals. through attributing each respondent to a random term, taste variations, unobserved heterogeneity in alternatives and unobserved heterogeneous choice sets are allowed (bhat, 2000b). the empirical issue is to compare their estimation performance. most comparisons are on the willingness-topay (wtp) for various attributes of the alternatives in which mean coefficients are transformed in terms of wtp. some authors, such as horowitz (1980) and van den, kroes, and verhoef (2009) argued that random unobserved heterogeneity in the marginal utilities does not bias mnl estimates. carlsson (2003) and dahlberg and matias (2003) reached the same conclusion and indicated that there are no conflicting signs with the two models and that the magnitude of the coefficients are very close, with just a few exceptions. by contrast, bhat (1998) found that wtp for all attributes are higher with the mmnl than with the mnl, indicating that the mnl underestimates wtp. revelt and train (1998) showed significant differences in wtp for some attributes while for others it showed none. other researchers provided evidence that wtp is higher for some attributes but lower for others with the mmnl than with the mnl. van den et al. (2009) found that the mnl underestimates the wtp for travel time compared with the mmnl, but overestimates the wtp for other attributes. train (1998) showed that the wtp is larger with the mmnl than with the mnl. he concluded that there is probably no general answer to whether or not the mnl gives correct estimates when heterogeneity is present. only a few works have reached the conclusion that in the presence of heterogeneity, mnl models lead to estimating failures. persson (2002) suggested that model choice indeed has implications for the results since the welfare estimates from the two models differ quite remarkably. there are conflicting signs between the mnl and the mmnl. asian journal of economics and empirical research, 2020, 7(2): 258-267 261 © 2020 by the authors; licensee asian online journal publishing group to conclude, the debate around the potential bias using the mnl in the case of preference heterogeneity is not yet closed. while few works (borah, 2006; canaviri, 2007; harris & keane, 1998; hole, 2008; qian, pong, yin, nagarajan, & meng, 2009) have used the mmnl in healthcare demand studies, this study could offer a promising case and will provide new evidence on the relative performance between the two methods. 3. estimation method and data 3.1. model specification let the utility of a patient i ∈ [1, i ] be a function of health status, h, and non-health consumption, x. 𝑈 = 𝑈(ℎ𝑖, 𝑥𝑖) (2) health status, h, is determined by the quantity and quality of health care (c), other health inputs (e.g., sanitation) and food consumption (f); and individual attributes such as age, gender, education, state of insurance, and asset (r). ℎ𝑖 = ℎ(𝐶𝑖, 𝐹𝑖 , 𝑅𝑖) (3) healthcare demand is a function of the price of health care (p) and the distance to the healthcare provider (d). the importance of d is that distance not only implies cost of access, but also reflects to some extent the reputation and quality of providers. 𝐶𝑖 = 𝐶(𝑝, 𝐷) (4) finally, the other health input, f, is a function of expenditures on these inputs (𝐸𝑖). 𝐹𝑖 = 𝐹(𝐸𝑖) (5) with equation 2 to 5, we get the indirect utility function expressed in equation 6 in the case where individual i chooses healthcare provider j, and in which 𝑦𝑖 − 𝑝𝑖𝑗 − 𝐸𝑖 is the budget for non-health consumption (y is income). 𝑉𝑖𝑗 ∗ = 𝑈(ℎ(𝐶𝑖𝑗(𝑝𝑖𝑗 , 𝐷𝑖𝑗), 𝐹(𝐸𝑖), 𝑅𝑖), 𝑦𝑖 − 𝑝𝑖𝑗 − 𝐸𝑖) (6) among the healthcare provider alternatives, the patient will choose the one that maximizes his/her indirect utility function. the choice rule is expressed by equation 7. 𝑉𝑖𝑗 = 1, if 𝑉𝑖𝑗 ∗ = 𝑀𝑎𝑥(𝑉𝑖1 ∗ , 𝑉𝑖2 ∗ , … 𝑉𝑖𝐽 ∗ ) 𝑉𝑖𝑗 = 0, otherwise (7) to make the model amenable to econometric estimation, we must define a functional form of the above indirect utility function. this is expressed by equation 8 in which the first term on the right is the deterministic component of utility in the function of the above-defined four types of attributes, and the second term is a disturbance term. the term 𝐸𝑖 appeared in equations 5 and 6 is now unobserved and is treated as one part of the error term. 𝑉𝑖𝑗 = 𝑉𝑖𝑗 ∗ (𝑝𝑖𝑗, 𝐷𝑖𝑗, 𝑦𝑖 , 𝑅𝑖) + 휀𝑖𝑗 (8) equation 8 must be parameterized to allow estimations. the first term can be rewritten as: 𝑉𝑖𝑗 ∗ (. ) = 𝑍𝑖𝑗𝛽𝑧 + 𝑋𝑖𝛽𝑥𝑗 (9) the x variables are patient-specific characteristics such as age, marital status, insurance status and income. the z variables are alternative healthcare provider-specific characteristics such as distance, price, healthcare quality and so on. with these defined variables, we get 𝑉𝑖𝑗 = 𝛼𝑗 + 𝛽1𝑝𝑖𝑗 + 𝛽2𝐷𝑖𝑗 + 𝛽3𝑗𝑦𝑖 + 𝛽4𝑗𝑅𝑖 + 휀𝑖𝑗 (10) the variable p, the healthcare price, and d, the distance to healthcare provider are two provider-specific variables. the y, income and r, individual attributes other than income, are patient-specific variables. thus, in our econometric estimations, the coefficients of p and d are kept constant across options while those of y and all components of r vary across options. if equation 10 is estimated with the mnl, the basic form of the mmnl, and with alternative specific constants 𝛼𝑗 and attributes 𝑥𝑖𝑗 (here, x represents both z and x variables in the equation 9 the result will be: 𝑃𝑟𝑜𝑏(𝑗) = exp (𝛼𝑗+𝛽𝑗 ′𝑥𝑖𝑗) ∑ exp (𝛼𝑞+𝛽𝑞 ′ 𝑥𝑖𝑞) 𝐽 𝑞=1 (11) the difference between the mmnl and the mnl is that in the former, one part of the coefficients is random; in the latter, all coefficients are non-random. in equation 11, 𝛽𝑗 ′ is composed of 𝛽𝑗𝑖 with 𝛽𝑗𝑖 = { 𝛽𝑗 + 𝜎𝑗𝜂𝑗𝑖 𝑖𝑓 𝑟𝑎𝑛𝑑𝑜𝑚 𝛽𝑗 ′ 𝑖𝑓 𝑛𝑜𝑛 − 𝑟𝑎𝑛𝑑𝑜𝑚 (12) where 𝛽𝑗 is the population mean, 𝜂𝑗𝑖 is the individual specific heterogeneity, with mean 0 and standard deviation 1, and 𝜎𝑗 is the standard deviation of the distribution of 𝛽𝑗𝑖 around 𝛽𝑗. the elements of 𝛽𝑗𝑖 are distributed randomly across individuals with fixed means. we set both price and distance to healthcare providers as random variables. it would be interesting to estimate the heterogeneity in the preferences for both price and distance. if the random terms are normally distributed, 𝛽𝑘𝑖~𝑁𝑜𝑟𝑚𝑎𝑙 [𝛽𝑘 + 𝛿𝑘 ′ 𝑤𝑖, 𝜎𝑘 2 ] (13) equation 13 has useful empirical implications and we will return to them in discussing their application. as the usual choice, we will use the normal distribution. finally, to make our model more realistic, we will allow the two random parameters to be correlated. 3.2. data, variables and characteristics of the samples data are from the chns database edited by the carolina population center (cpc, university of north carolina). the survey covers about 16,000 individuals from more than 3,000 households (about two-thirds from rural and one-third from urban populations) in nine representative provinces. it is a longitudinal survey with seven waves (1989, 1991, 1993, 1997, 2000, 2004, 2006, 2009, and 2011). the reasons we do not use the data after 2006 are two. first, rural exodus has been accelerating since 2009. according to 2009 survey, in rural area, around 40% of household members left home and worked in cities. asian journal of economics and empirical research, 2020, 7(2): 258-267 262 © 2020 by the authors; licensee asian online journal publishing group extending to 2009 may exacerbate the bias in comparisons. second, healthcare reform could also affect demand heterogeneity. as health insurance reforms began in 2003 but took several years to implement and only reached a real impact after 2006, the obtained results could be interpreted as being impacted by insurance reforms. we build two samples. within each sample, income, healthcare prices and supply conditions were not meaningfully evolved, but between them these factors were substantially changed. the number of patients interviewed who were ill was smaller in the first waves than in the last (population aging appears to be the main cause). thus, to keep some equilibrium between the two samples, we merged three time periods of two-year intervals (1989, 1991 and 1993) for the first sample and two time periods of two-year intervals (2004 and 2006) for the second sample, for a total of 2,117 and 2,594 observations, respectively. the first sample included individuals under 18 years old as the following waves did not. we conducted a logistic regression analog of the chow test to check whether the healthcare demand of the under-18 differed from that of the over-18 (see (demaris, 2004)). results showed that the two models indeed differed. consequently, observations of individuals under 18 were removed. finally, our samples included 1,457 rural individuals who reported having been ill in 1989, 1991 or 1993, and 2,594 individuals who reported being ill in 2004 or 2006. as our data panel included attrition and replacement, we checked the frequency of the patients and whether attrition was non-random. in the 1989-1993 sample, only 11.6% and 0.06% patients were surveyed two and three times; in the 2004-2006’ sample, 16.3% patients were surveyed twice. chns data collectors have not given more details on attrition. nevertheless, as deaton (1997, 19-20) stated, the rate of refusal of participation is lower in developing countries. it must be still lower in rural china since political institutions exert strong control. thus, we attribute lack of participation on the part of villagers to their physical absence, their moves or their deaths. therefore, attrition can be regarded as random. table 1 presents all variables used and their definitions. table-1. definition of the variables. village-c (v) =1 if the choice of treatment is village clinic; =0 otherwise. town-c (t) =1 if the choice of treatment is township health center; =0 otherwise. county-h (c) =1 if the choice of treatment is county or higher level city hospital; =0 otherwise. other-type (o) =1 if the source of treatment is pharmacy, private clinic and other clinic; =0 otherwise. self-treatment (s) =1 if treatment by self is chosen; =0 otherwise. pj medical expense at constant prices of alternative j after eventual reimbursement by insurance multiplied by 10−3; j=v, t, c, o, s. the expense of self-care is assumed =0. dist0j =1 if distance <0.5 km; =0 otherwise; j=v, t, c, o. dist1j =1 if distance >=0.5 km & <3; =0 otherwise; j=v, t, c, o. dist2j =1 if distance >=3 km &<10km; =0 otherwise; j=v, t, c, o. dist3j =1 if distance >=10 km; =0 otherwise; j=v, t, c, o. age age of the patient in the wave. female =1 if the patient is female; =0 if male. marital =1 if the patient is married; =0 otherwise. edu_level =1 graduated from primary school; =2 lower middle school degree; =3 upper middle school degree; =4 technical or vocational degree; =5 university or college degree; =6 master’s degree or higher. nonfarm_job =1 if the patient’s job is not farmer; =0 otherwise. farmer =1 if the patient’s job is farmer; =0 otherwise. no_job =1 if the patient has not job;=0 otherwise. no_insured =1 if the patient is not insured; =0 otherwise. urban_insurance =1 if for family members, the patient’s insurance is one of the following types: commercial, free medical, workers compensation, and for the members that are urban employee, pass-way model, block model, catastrophic disease; =0 otherwise. cooperative_insurance =1 if the patient’s insurance type is rural cooperative; =0 otherwise. other_insurance =1 if the patient’s insurance is other than urban_insurance and cooperative_insurance (they include among others health insurance for women and children, epi (expanded program of immunization) and insurance for children); =0 otherwise. severity =1 if the illness or injury was answered by the patient as not severe; =2 somewhat severe; =3 quite severe. fever =1 if individual suffered from fever; =0 otherwise. chronic =1 if individual suffered from chronic diseases; =0 otherwise. other_deseases =1 if individual suffered from diseases other than fever and chronic diseases; =0 otherwise. hhsize the number of the household members. income the annual per capita income at constant prices of the household multiplied by 10-3. asset the annual household value of the asset index. rural_popu_rate the share of the rural employees in total labor of the village. village_size the household number of the village multiplied by10-3. suburb =1 if the village is near a city; =0 otherwise. notes: 1) data come from the chns database; 2) the first five items (v, t, c, o, s) concern the dependent variable spread in a selected set of healthcare providers; 3) all of the following variables concern the independent variables; 4) with the exception of the first five and the last three, all of the remaining variables are individual-specific attributes; 5) the last three variables were used to take into account environmental features; rural_popu_rate is a proxy of the development level of the village, village_size is a proxy of the village clinic’s size, and suburb reflects the proximity of the village to the urban medical infrastructure; 6) asset and 𝑃𝑗are built with the method described in section 3.2. the chns database provides household per capita annual income at a constant price. as the impact of a household’s income and assets on their healthcare provider choice can be quite different, we built an asset index and simultaneously used income and asset to measure income and wealth effects. following several authors (filmer & asian journal of economics and empirical research, 2020, 7(2): 258-267 263 © 2020 by the authors; licensee asian online journal publishing group kinnon, 2008; sahn & stifel, 2000) we used the 9 items, with 4 to 8 modalities for each, and then employed principal components analysis to derive weights (filmer & kinnon, 2008) for the asset index.1 we also wrestled with how to compensate for missing data on healthcare prices. the mmnl requires the prices of all alternative providers, while only the prices of the providers that the patients effectively visited were recorded in the survey. thus, the prices of alternative providers that patients did not visit needed to be imputed. following gertler, locay, and sanderson (1987); gertler and van der (1990) and borah (2006) we used the stata ice program created by royston (2004) to impute the lacking price data. all reported prices were converted at constant prices using the weights given by the chns data provider. the chosen predictors of prices included 16 variables: age, female, marital, edu_level, nonfarm_job, farmer, income, severity, year, province, urban_insurance, cooperative_insurance, other_insurance, fever, chronic, and hospitalized (=1 if hospitalized; =0 otherwise). the descriptive statistics of actual plus imputed prices by type of provider are presented in table 2. table 2 calls for some brief comments. first, comparing the two samples, income, asset, education level, healthcare price, the share of patients with insurance, and village size were meaningfully increased over time. two other increases, linked with population aging, were the no_job (composed notably by the retired), and chronic. second, in general, the share of the big and middle hospitals (township health centers and county hospitals) in chosen healthcare providers increased from 30% to 32% in favor of county hospitals (from 9% to 18%) and to the detriment of township centers (from 21% to 14%). the share of small clinics (village clinics in 1989-1993 and village clinics plus other_type in 2004-2006) decreased from 48% to 33%. their 15% reduction appears to have benefited self-treatment, which grew 14%.2 table-2. descriptive statistics. 1989-1993 (n=1457) 2004-2006 (n=2594) sample distribution by provider choice mean sd min max mean sd min max village-c (v) 0.48 0.50 0 1 0.22 0.41 0 1 town-c (t) 0.21 0.41 0 1 0.14 0.35 0 1 county-h (c) 0.09 0.29 0 1 0.18 0.39 0 1 other-type (o) 0.11 0.32 0 1 self-treatment (s) 0.21 0.41 0 1 0.35 0.48 0 1 p_v 0.074 0.078 0 0.477 0.096 0.079 0 0.598 p_t 0.159 0.162 0 0.859 0.207 0.169 0 1.166 p_c 0.466 0.617 0 3.506 0.651 0.597 0 3.808 p_o 0.204 0.318 0 3.972 dist0_v 1 0 1 1 1 0 1 1 dist0_t 0.40 0.49 0 1 0.48 0.50 0 1 dist1_t 0.39 0.49 0 1 0.36 0.48 0 1 dist2_t 0.21 0.40 0 1 0.15 0.36 0 1 dist3_t 0 0 0 0 0 0 0 0 dist0_c 0.13 0.34 0 1 0.23 0.41 0 1 dist1_c 0.16 0.37 0 1 0.22 0.42 0 1 dist2_c 0.22 0.41 0 1 0.25 0.43 0 1 dist3_c 0.49 0.50 0 1 0.30 0.46 0 1 dist0_o 0.63 0.48 0 1 dist1_o 0.26 0.44 0 1 dist2_o 0.09 0.29 0 1 dist3_o 0.02 0.15 0 1 age 44.47 15.41 18 92 55.88 15.12 18 97 female 0.53 0.50 0 1 0.57 0.49 0 1 marital 0.84 0.37 0 1 0.80 0.40 0 1 edu_level 0.98 1.06 0 5 1.17 1.21 0 6 nonfarm_job 0.26 0.44 0 1 0.13 0.35 0 1 farmer 0.60 0.49 0 1 0.35 0.48 0 1 no_job 0.14 0.35 0 1 0.51 0.50 0 1 no_insured 0.80 0.40 0 1 0.64 0.48 0 1 urban_insurance 0.15 0.36 0 1 0.10 0.30 0 1 cooperative_insurance 0.03 0.17 0 1 0.25 0.43 0 1 other_insurance 0.02 0.13 0 1 0.01 0.10 0 1 severity 1.71 0.70 1 3 1.70 0.67 1 3 fever 0.35 0.48 0 1 0.26 0.44 0 1 chronic 0.13 0.33 0 1 0.34 0.47 0 1 other_diseases 0.52 0.50 0 1 0.40 0.49 0 1 hhsize 4.40 1.50 1 13 3.66 1.69 0 13 income 2.91 2.26 0.45 22.20 7.03 8.03 0.18 210.95 asset 0.39 0.77 -1.05 3.08 1.20 0.96 -0.62 3.87 rural_popu_rate 0.52 0.34 0 1 0.41 0.30 0 1 village_size 0.66 0.74 0.03 6.00 1.01 1.19 0.04 8.00 suburb 0.28 0.45 0 1 0.24 0.43 0 1 1 the items are 1) drinking water (4 choices); 2) toilet facilities (8 choices); 3) kind of lighting (5 choices); 4) kind of fuel for cooking (8 choices); 5) type of ownership of house (6 choices); 6) ownership of electrical appliances and other goods (the number of appliances varied between 15 to 18 according to the periods of survey, and this information was absent only in 1989); 7) means of transportation (5 types); 8) type of farm machinery (5 types); and 9) household commercial equipment (6 types). the coefficients of correlation between the obtained asset and income were 0.29 for both periods (1989-1993 and 2004-2006) and were significant at 1%. 2 other_type generally includes very small healthcare providers that practice chinese medicine near a pharmacy, or the retired doctors that open a clinic with elementary equipment. they are far from being a growing alternative force to the three principal healthcare providers. asian journal of economics and empirical research, 2020, 7(2): 258-267 264 © 2020 by the authors; licensee asian online journal publishing group notes: 1) data come from the chns database; 2) the first five items (v, t, c, o, s) concern the dependent variable spread in a selected set of healthcare providers; 3) all of the following variables concern the independent variables; 4) with the exception of the first five and the last three, all of the remaining variables are individual-specific attributes; 5) the last three variables were used to take into account environmental features; rural_popu_rate is a proxy of the development level of the village, village_size is a proxy of the village clinic’s size, and suburb reflects the proximity of the village to the urban medical infrastructure; 6) asset and 𝑃𝑗are built with the method described in section 3.2. 4. estimation results tables 3 and 4 contain the regression results of the 1989-1993 and 2004-2006 data samples, respectively. the software used for both models is nlogit. mmnl estimates are obtained with 100 halton draws. 4.1. mnl versus mmnl for both periods, the mmnl yields higher likelihood values and provides improved fits over the mnl (likelihood ratio test is significant at less than 0.01), indicating that the explanatory power of the mixed logit is greater than with the standard logit. two other measures commonly used to compare competing regression models are the akaike information criterion (aic) and bayesian information criterion (bic). these measures account for both the goodness of fit of the model and its parsimony. each measure penalizes a larger model for using additional degrees of freedom while rewarding improvements in goodness of fit. the bic places a higher penalty on using degrees of freedom than the aic. according to the aic, the mmnl is better while according to the bic, the mnl is preferred. thus, the results are not conclusive. assuming individual rationality, a negative price effect is expected. table 3 shows that according to both models in 1989-1993, there were clear price effects. the estimated means are -0.377 (significant at 5%) and -1.606 (significant at 1%) for the mnl and the mmnl, respectively. the coefficients of random variables in the mmnl are consistently of greater magnitude (in absolute terms) than those from the mnl. revelt and train (1998) obtained similar results. according to the authors, this is not surprising since a random parameter model decomposes the unobserved portion of utility and normalizes parameters on the basis of part of the unobserved portions. table-3. regression results on1989-1993 sample. mnl mmnl village-c town-c county-h village-c town-c county-h price -0.377 (0.169)** -1.606 (0.414)*** distance1 0.049 (0.155) -0.135 (0.311) distance2 -0.346 (0.197)* -0.494 (0.287)* distance3 -0.407 (0.312) -4.323 (1.749)** intercept 0.102 -1.467 -2.86 0.091 -1.520 -3.349 (0.596) (0.727)** (0.943)*** (0.605) (0.780)* (1.257)*** age -0.018 -0.016 -0.04 -0.018 -0.016 -0.005 (0.006)*** (0.007)** (0.009) (0.006)*** (0.007)** (0.011) edu_level 0.109 0.070 0.027 0.114 0.072 -0.033 (0.087) (0.103) (0.130) (0.088) (0.110) (0.172) women 0.432 0.300 0.268 0.440 0.270 0.401 (0.152)*** (0.181)* (0.235) (0.153)*** (0.193) (0.323) hhsize -0.018 0.051 0.049 -0.018 0.047 0.111 (0.048) (0.058) (0.074) (0.049) (0.062) (0.095) asset 0.382 0.424 0.110 0.440 0.424 -0.195 (0.149)** (0.173)** (0.220) (0.153)*** (0.184)** (0.301) income -0.027 -0.023 0.059 -0.026 -0.023 0.130 (0.037) (0.042) (0.049) (0.037) (0.045) (0.072)* severity 0.443 0.786 0.938 0.484 0.910 0.977 (0.111)*** (0.129)*** (0.167)*** (0.113)*** (0.148)*** (0.220)*** marital 0.356 0.367 0.576 0.355 0.383 0.636 (0.189)* (0.231) (0.310)* (0.190)* (0.248) (0.399) urban_insurance -0.082 0.222 0.107 -0.067 0.276 0.221 (0.288) (0.342) (0.394) (0.293) (0.364) (0.489) cooperative_insurance 0.393 0.294 0.947 0.428 0.307 1.623 (0.532) (0.590) (0.702) (0.537) (0.629) (0.926)* nonfarm_job 0.459* 0.243 0.240 0.462 0.196 0.244 (0.276) (0.331) (0.383) (0.280)* (0.354) (0.479) farmer 0.129 -0.035 -0.149 0.120 -0.064 -0.273 (0.244) (0.286) (0.362) (0.248) (0.310) (0.510) fever -0.184 -0.518 -0.624 -0.218 -0.654 -0.721 (0.153) (0.186)*** (0.250)** (0.155) (0.204)*** (0.336)** chronic 0.043 -0.229 -0.103 0.071 -0.308 0.280 (0.231) (0.276) (0.337) (0.233) (0.296) (0.423) rural_popu_rate 0.403 0.382 -0.068 0.398 0.315 0.088 (0.341) (0.401) (0.533) (0.344) (0.429) (0.749) village_size 0.227* -0.107 0.390 0.237 -0.123 0.520 (0.134)* (0.193) (0.158)** (0.138)* (0.206) (0.181)*** suburb -0.088 -0.710 -0.240 -0.070 -0.718 -0.091 (0.272) (0.337)** (0.423) (0.276) (0.369)* (0.571) province dummies yes (omitted) yes (omitted) yes (omitted) yes (omitted) yes (omitted) yes (omitted) wave dummies yes (omitted) yes (omitted) yes (omitted) yes (omitted) yes (omitted) yes (omitted) asian journal of economics and empirical research, 2020, 7(2): 258-267 265 © 2020 by the authors; licensee asian online journal publishing group sd of parameter distributions price 2.100 (0.433)*** distance1 1.083 (0.700) distance2 0.795 (0.545) distance3 3.935 (1.070)*** n 1457 1457 log-like -1663.084 -1648.234 mcfadden pseudo r2 0.184 chi squared 248.499 743.195 significance level 0.00000 0.00000 aic 3496.169 3486.467 bic 3945.320 3988.460 notes: 1) data come from the chns database; 2) village-c, town-c, and county-h concern the dependent variable spread in a selected set of healthcare providers; 3) with the exception of the last three, all of the remaining explanatory variables are individual-specific attributes, and their definitions are made in table 1; 4) the last three variables were used to take into account environmental features. rural_popu_rate is a proxy of the development level of the village, village_size is a proxy of the village clinic’s size, and suburb reflects the proximity of the village to the urban medical infrastructure; 5) asset and price are built with the method described in section 3.2; 6) standard error is in parentheses. *** indicates significance at 1%; ** indicates significance at 5%; and * indicates significance at 10%. table-4. regression results on 2004-2006 sample. mnl mmnl village-c town-c county-h othertype village-c town-c county-h othertype price 0.010 (0.088) -0.409 (0.191)** distance1 -0.486 (0.095)*** -0.831 (0.205)*** distance2 -0.508 (0.124)*** -0.698 (0.193)*** distance3 -0.872 (0.170)*** -1.148 (0.235)*** intercept -1.070 -1.351 -1.239 -1.114 -1.073 -1.449 -1.283 -1.260 (0.510)** (0.576)** (0.551)** (0.639)* (0.514)** (0.619)** (0.626)** (0.680)* age -0.0005 -0.006 -0.015 -0.010 -0.001 -0.006 -0.016 -0.010 (0.005) (0.006) (0.005)*** (0.006)* (0.005) (0.006) (0.006)*** (0.006)* edu_level -0.057 -0.116 -0.101 -0.075 -0.057 -0.119 -0.106 -0.066 (0.066) (0.073) (0.064) (0.075) (0.067) (0.078) (0.072) (0.078) women 0.083 -0.051 -0.038 -0.098 0.083 -0.059 -0.050 -0.091 (0.127) (0.142) (0.133) (0.150) (0.128) (0.151) (0.150) (0.157) hhsize -0.007 0.009 -0.015 -0.113 -0.007 0.010 -0.014 -0.125 (0.039) (0.044) (0.041) (0.049)** (0.039) (0.046) (0.046) (0.051)** asset -0.143 0.089 0.202 0.059 -0.142 0.085 0.241 0.086 (0.092) (0.103) (0.092)** (0.110) (0.092) (0.110) (0.104)** (0.116) income -0.004 -0.005 -0.003 -0.011 -0.002 -0.008 -0.002 -0.012 (0.009) (0.011) (0.009) (0.012) (0.008) (0.012) (0.010) (0.013) severity 0.388 0.930 1.124 0.621 0.406 1.042 1.252 0.678 (0.095)*** (0.103)*** (0.098)*** (0.112)*** (0.097)*** (0.115)*** (0.118)*** (0.119)*** marital 0.068 0.135 0.281 0.154 0.076 0.148 0.376 0.177 (0.151) (0.174) (0.164)* (0.182) (0.153) (0.186) (0.184)** (0.190) urban_insur ance -0.354 0.158 0.456 0.136 -0.347 0.146 0.487 0.179 (0.294) (0.281) (0.211)** (0.278) (0.296) (0.302) (0.240)** (0.291) cooperative_ insurance 0.257 -0.046 -0.199 0.131 0.247 -0.049 -0.236 0.118 (0.163) (0.190) (0.191) (0.211) (0.165) (0.203) (0.215) (0.222) nonfarm_job -0.039 0.045 -0.647 -0.288 -0.055 0.081 -0.722 -0.343 (0.211) (0.226) (0.211)*** (0.241) (0.213) (0.242) (0.237)*** (0.253) farmer 0.082 -0.073 -0.387 -0.070 0.083 -0.051 -0.452 -0.067 (0.145) (0.163) (0.171)** (0.182) (0.146) (0.175) (0.191)** (0.191) fever 0.914 0.383 -0.638 0.664 0.906 0.384 -0.746 0.702 (0.144)*** (0.168)** (0.183)*** (0.170)*** (0.146)**** (0.180)** (0.203)*** (0.179)*** chronic -0.083 -0.138 -0.182 -0.414 -0.075 -0.133 -0.189 -0.424 (0.143) (0.154) (0.137) (0.176)** (0.144) (0.165) (0.154) (-0.184)** rural_ popu_rate 0.612 -0.165 -0.036 -0.239 0.614 -0.244 0.009 -0.325 (0.288)** (0.329) (0.346) (0.376) (0.291)** (0.352) (0.386) (0.396) village_size -0.104 0.026 0.083 -0.087 -0.103 0.031 0.096 -0.092 (0.084) (0.081) (0.055) (0.077) (0.085) (0.085) (0.062) (0.081) suburb -0.420 -1.621 -0.133 -0.116 -0.399 -1.653 -0.191 -0.141 (0.224)* (0.263)*** (0.223) (0.248) (0.227)* (0.277)*** (0.255) (0.262) province dummies yes (omitted) yes (omitted) yes (omitted) yes (omitted) yes (omitted) yes (omitted) yes (omitted) yes (omitted) wave dummies yes (omitted) yes (omitted) yes (omitted) yes (omitted) yes (omitted) yes (omitted) yes (omitted) yes (omitted) sd of parameter distributions price 1.375 (0.261)*** distance1 1.292 (0.338)*** distance2 1.131 (0.373)*** asian journal of economics and empirical research, 2020, 7(2): 258-267 266 © 2020 by the authors; licensee asian online journal publishing group distance3 0.853 (0.357)** n 2594 2594 log-like -3493.772 -3480.662 mcfadden pseudo r2 0.166 chi squared 954.192 1388.440 significance level 0.00000 0.00000 aic 7211.545 7205.324 bic 3945.320 3988.460 notes: 1) data come from the chns database; 2) village-c, town-c, county-h, and other-type concern the dependent variable spread in a selected set of healthcare providers; 3) with the exception of the last three, all of the remaining explanatory variables are individual-specific attributes, and their definitions are made in table 1; 4) the last three variables were used to take into account environmental features. rural_popu_rate is a proxy of the development level of the village, village_size is a proxy of the village clinic’s size, and suburb reflects the proximity of the village to the urban medical infrastructure; 5) asset and price are built with the method described in section 3.2; 6) standard error is in parentheses. *** indicates significance at 1%; ** indicates significance at 5%; and * indicates significance at 10%. the most striking result is that in the 2004-2006 period, unlike with the mmnl, price effect disappeared with the mnl. as shown in table 4, the coefficient of price is 0.01 and is no longer significant. nevertheless, in the mmnl model, price effect was present with a coefficient of -0.409 (significant at 5%). principally on the basis of this difference, we judge that the mnl analysis does not produce logical or consistent signs for price estimates. the second random variable is distance to healthcare provider. in accordance with the analysis on price effect, the coefficients of distances with the mmnl are higher than with the mnl. however, unlike the price effect in sign and significance, there is not meaningful divergence of distance effects between the two models (except distance3 in 1989-1993). in 1989-1993, distance1 is insignificant in both the mmnl and the mnl. in 2004-2006, nevertheless, all distance dummies are significantly negative, indicating that distant healthcare providers are less likely to be chosen. given that the variables other than price and distance are patient-specific and do not vary by healthcare provider, they cannot be assigned with a random term; their coefficients with the mmnl and the mnl are similar in sign and extent. as their interpretations are out of the scope of either study on heterogeneity or comparison between the mmnl and the mnl, we choose to show them without comments. 4.2. the importance of heterogeneity analysis in interpreting price and distance effects the mmnl provides information on the heterogeneity of provider choice in price and distance. in tables 3 and 4, the standard deviations of price parameters are 2.1 and 1.375 for the two samples, respectively and both are significant at 1%, indicating that parameters indeed vary in the population. following equation 13, we can easily calculate the level of this heterogeneity with the criterion of the percentage of patients for which the coefficients of price are above zero; the result is presented in table 5. in 1989-1993, while about 80 % of patients followed the rule that when the price rises, the demand falls, it is not observed for 20% of patients. that percentage rose to 38.30% in 2004-2006, indicating that heterogeneity in price preferences meaningfully increased in the second period. meanwhile, whereas heterogeneity in distance2 was unchanged, both distance1 and distance3 have decreased (from 45.03% to 26%, and 13.59% to 8.92%, respectively). table-5. heterogeneity measured by percentage of patients of which the coefficients of price or distances >0. period 1989-1993 2004-2006 price 22.22% 38.30% distance1 45.03% 26.00% distance2 26.73% 26.86% distance3 13.59% 8.92% notes: 1. data come from the chns database; 2) price and distances are built with the method described in section 3.2, and their coefficients are found in tables 3 and 4; 3) calculated with equation 13 and using the mean coefficients and sd of parameter distributions from table 3 and 4. it is time to explain why the information on choice heterogeneity has crucial importance for our study on price and distance effects, and to what extent the provision of this information allows us to avoid biased interpretations of these effects. comparing the absolute levels of the coefficients of price between two periods in tables 3 and 4, we observe a significant decrease of the mean price effect (from -1.606 to -0.409). with this decrease, the appealing policy would be to allocate more resources to high quality services. however, without checking the heterogeneity level, this policy implication could be problematic. the coefficients of variation (sd/mean), indeed, rise from 1.3 to 3.2, indicating a rise of the heterogeneity level. but, as indicated in table 5, the percentage of patients who followed the rule that demand falls as price rises only decreased from 77.8% to 61.7%. these indicators on heterogeneity suggest the existence of a majority of patients with modest incomes and imply a persistent need to lower the price of services. in this case, the policy aiming to favor highand high quality services would be erroneous. assume now an evaluation of distance effect for the purpose of a geographical allocation of healthcare resources. in general, a weaker mean distance effect suggests a more geographically concentrated distribution (focusing on several modern and large hospitals to serve the distant population). by contrast, the high mean distance effect indicates a demand for proximity and hence a geographically more decentralized structure. income growth and aging oppositely affect the mean level of the distance effect. hence, the distance effect depends on which force: income growth or aging, is more prevalent. merely focusing on mean effect would likely lead to a biased policy. if the influence of income growth is higher than aging, the mean distance effect becomes weaker and the concentration solution with more large hospitals could be a relevant answer, because traveling for a longer distance asian journal of economics and empirical research, 2020, 7(2): 258-267 267 © 2020 by the authors; licensee asian online journal publishing group matters less. but it could be wrong if income inequality becomes high, leading to a larger demand for nearer and cheaper healthcare services. in the case where the influences of income growth and aging are equal so that the mean level of distance effects is the same, the mean level would be unable to give any insight in the necessary direction of policy change. in such a case, knowing the heterogeneity level and being able to quantitatively identify the sources of the heterogeneity make identifying appropriate solutions possible. for instance, if low heterogeneity of the distance effect is caused by either aging or income inequality (leading to a state of more “poor”), the efficient solution would be to fund more local small healthcare structures. on the contrary, if high heterogeneity is caused by increasing preferences in quality, concentrating on a solution that provides large and modern hearth care structures would be efficient. 5. conclusions we found that over the two periods, mainly due to income increase and aging, the price effect became weaker and more heterogeneous; 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(2009). choice of train ticket: a study on dutch travelers. vu university working paper. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 186 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 2, 186-192, 2020 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2020.72.186.192 © 2020 by the authors; licensee asian online journal publishing group growth, research & development, and uncertainty: an empirical analysis in finland stephen walters university of helsinki, finland. abstract invention and innovation are the most important aspects in the growth and development of a country. investors come up with innovative ideas that can play a role in the development of technology in the country. the research and development (r&d) sector is very much associated with this, as it comprises researchers who have the ability to think creatively and come up with innovative ideas and designs for firms. it can be stated that countries where the research sector is well-developed and well-maintained have a greater chance to enjoy better economic growth (eg). the core purpose of the current study is to understand the influence of r&d and uncertainties associated with r&d on the eg of finland. based on this context, the researcher has gathered data on relative variables in finland for 29 years and applied a stochastic model. the results obtained show that uncertainty in the research sector has a negative influence on the eg in finland. the results also indicate the fact that, as uncertainty in the research sector increases, the distribution or allocation of human capital will shift from the research sector to the final goods sector. moreover, it was also found that uncertainty has a negative impact on welfare. this study has significant implications for the r&d sector in finland, in the sense that it has the potential to guide the research sector towards improvement through an increase in the number of patents and the establishment of research institutions that can reduce impact of uncertainty. keywords: research and development; uncertainty; economic growth; finland; final goods; human capital; welfare. citation | stephen walters (2020). growth, research & development, and uncertainty: an empirical analysis in finland. asian journal of economics and empirical research, 7(2): 186-192. history: received: 25 may 2020 revised: 29 june 2020 accepted: 31 july 2020 published: 17 august 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ................................................................................................................................................................. 187 2. methodology ............................................................................................................................................................... 188 3. analysis ......................................................................................................................................................................... 189 4. discussion and conclusion ....................................................................................................................................... 191 references ........................................................................................................................................................................ 191 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.72.186.192&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/2028 http://asianonlinejournals.com/index.php/ajeer/article/view/2028 asian journal of economics and empirical research, 2020, 7(2): 186-192 187 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature the aims of current study is to understand the influence of r&d and uncertainties associated with r&d on the eg of finland. based on this context, the researcher has gathered data on relative variables in finland for 29 years and applied a stochastic model. 1. introduction commonly, the growth of a country is inversely proportional to r&d uncertainty, as a high rate of r&d uncertainty results in a reduction in the rate of economic growth (eg) (colak, gungoraydinoglu, & öztekin, 2018). a high rate of r&d uncertainty also results in deteriorating welfare levels, which affects the decisions of an organization. it may also cause a reduction in the willingness of organizations to invest in r&d (gu & wang, 2018). in finland, there are high levels of certainty in some organizations, which actually ends up hindering r&d and negatively affecting eg. therefore, it is important to resolve this issue so that the eg of finland can be increased. innovative technology and r&d help to increase eg, but r&d can also harm growth if an organization experiences high rates of uncertainty. a phenomenal effort has been undertaken in the past few decades with regard to the eg of different countries through different perspectives, such as recent research by tsuboi (2020). tsuboi evaluated the overall impact and role of natural resources and other activities on economic uncertainty in european countries. in fact, much of the research that has been carried out in previous years has evaluated eg and other indicators. furthermore, the overall influence of physical capital and infrastructure on eg has also been investigated in particular areas and firms, mainly by applying certain data practices and empirical approaches. however, research has not been conducted on finland and its overall eg, and no studies have described the direct role of r&d and its impact on a nation‘s development and eg. hence, this research paper is unique and significant in terms of understanding the role and impact of r&d on the eg of finland. in other words, the current research study is justified because no other scholar or academic researcher has explained or evaluated the relationship between uncertainty and the eg of a country. based on the above discussion and justification statement, the current study has the following aims:  the main target of the current paper is to empirically analyze the impact of various r&d efforts on the overall eg of finland.  the second objective and purpose of the present research paper is to empirically find the impact of uncertainty on the economic development of finland.  moreover, the given paper also considers the impact of uncertainty factors on the entire eg of finland, mainly through the stochastic model and r&d. moreover, the present research study also contributes to theoretical literature and policy design. the analyst of this research has mainly discussed and considered literature concerning the risks and threats of uncertainty and how they influence the eg of a country. furthermore, the given paper can also be adopted by several policymakers in finland to make economic decisions concerning r&d and uncertainty in economic activities, in order to enhance the overall eg and development of a country and region, as well as its sustainability. furthermore, the results of the present paper have profound theoretical advantages. theoretically, this paper contributes constructively to the current body of information and data on the above factors and variables, predominantly through an evaluation of the impact of r&d and uncertainty factors on the eg of a nation. the rest of the paper is organized as follows: section two presents information on the study‘s philosophy, approach, data collection methods and techniques, as well as population and sampling techniques; section three presents a descriptive and demographic analysis and interpretation of the data; section four concludes the findings of the paper with a discussion and presentation of the implications and limitations of the paper; and the final section provides significant and beneficial suggestions about the study. according to strulik (2017), ugt was mainly developed in light of the failure of the endogenous growth model to express significant empirical regularities and developments in overall growth mechanisms, and to contribute to the momentous rise in uncertainty across regions in two nations (nielsen, 2016). unlike earlier growth models and theories that have focused on the modern growth administration, the current theory encapsulates the entire growth process over the course of human existence. according to kawalec (2020), the demanding part of the differential timing was the transition from allusion stagnation to sustained eg in the emergence of uncertainty across nations and countries. ugt was initially advanced by oded galor and his colleagues, who were able to efficiently transition from an epoch of stagnation to an era of continued eg using a single dynamical mechanism (d'albis, greulich, & ponthière, 2018). according to attar (2020), this theory captures the basic steps and processes of growth, including the malthusian era that was prevalent throughout the majority of human history. following the enticement of the malthusian era, there was an emergence of human r&d as the major and central component of growth mechanism. this formed the origin of the modern technological era of continual eg, as well as the beginning of differing uncertainties across regions over the past few decades (ross, fisch, & varga, 2018; yoo & kim, 2019). moreover, this theory has proposed that, during the majority of human existence, r&d advancements were mainly offset by population growth as the majority of living standards were near survival levels, according to madsen and strulik (2020). although the strengthening connection between the degree of technological and research progress and the volume and balance of the entire population has gradually improved the extent of r&d, according to boehlke (2018), improving the significance of knowledge highlights our capability to adapt to a changing technological and r&d environment. this theory also states that the increasing distribution of certain resources towards research has generated a degree of uncertainty and a decline in productivity. this ensures that entire economies will distribute a significant portion of r&d benefits towards increasing income per capita; the alternative goes against the development of population, and paves the way for constant eg (içer, 2017). this theory further proposed that variations and changes in biological properties as well as institutional and cultural settings have developed a certain pace of change across many regions—predominantly from stagnation towards development. furthermore, the current theory explores the nexus between the degree of uncertainty in economic asian journal of economics and empirical research, 2020, 7(2): 186-192 188 © 2020 by the authors; licensee asian online journal publishing group activities and the process of eg (diebolt & perrin, 2019). specifically, it advances the hypothesis that uncertainty factors and forces have a direct role in transforming the global economy from stagnation to growth (garcíaquevedo, pellegrino, & savona, 2017). in finland, r&d is known as research and technological development (r&td). according to yüksel (2017), r&td mainly refers to innovative practices undertaken by central governments and corporations when developing new products and services that have, according to wang and wang (2019), a direct impact on the overall eg of the country. r&d constitutes the initial process of developing a potential new advancement. according to zafar, shahbaz, hou, and sinha (2019), r&d processes differ from region to region, with two initial models of r&d; some r&d establishments are staffed by engineers who are directly tasked with generating modified goods and products, and others are, according to yazgan and yalçinkaya (2018), staffed with industrial experts who are tasked with applied research in technological as well as scientific fields, which may support the nation‘s current and future eg (freimane & bāliņa, 2016). according to recep and alabaş (2017), r&d differs from the huge majority of corporate practices in that it is not expected or intended to acquire quick profit and growth and it typically carries significant risks and an uncertain return on investment (roi). saidi and mongi (2018) have claimed that r&d is important in terms of acquiring significant growth, mainly through advertising new products and services. empirically, different studies have found a direct nexus between r&d, economic productivity and eg across all nations (blanco, gu, & prieger, 2016); however, this direct nexus is much more significant in high-tech nations than low-tech nations. in studies by hong (2017) and dinçer, yüksel, adalı, and aydın (2019), countries with high technological capabilities were found to have more positive effects, while nations with low technological capabilities experienced negative effects. khairutdinov et al. (2018) have stated that this has resulted in high-tech regions being awarded subsidies on merit, while low-tech countries have typically been given subsidies that depended on name recognition. moreover, according to afonso (2016), high-end technological advancements and innovations have been a fundamental dynamic of finland‘s eg and industrial enlargement for a long time. continual support through governmental rules and policies has contributed to a significant variety of support that encourages r&d. as a result, the nation has used innovation, specifically in niche telecommunications, to support its production and service firms to efficiently compete in the global economic arena. uncertainty refers to the state of not being certain about a particular situation that may change in a positive or negative way. if the economy of a country is uncertain, this creates a critical situation (baharumshah, slesman, & wohar, 2016). uncertainty in the economy is often described as an unpredictable economic situation. however, it essentially refers to negative economic events. uncertainty in the economy of any country involves every individual, whether or not they are actively involved in the economic market. the primary impact of uncertainty is that it creates volatility in inflation rates; in other words, inflation uncertainty. uncertainty creates a horrible environment for unemployed people and unemployment itself creates a negative effect that every member of society is affected by (jiang, juan, & he, 2018). uncertainty also plays a major role in the devaluation of the currency of the economy, which causes a decline in business and affects the conditions of the economy. thus, every section of the economy, including government policymakers and all individuals who are directly or indirectly involved in the economy, face a dismal situation. in these circumstances, governments face such crucial situations that they become helpless and they borrow at high interest rates, which means that the projects and schemes the government announces have high rates that are sometimes out of the range of common citizens (ghosh, 2019). business workers and owners go through difficult situations that may cause a deadlock, leading to the collapse of many smes. this uncertainty in the economy involves many other factors that may cause foreign investors to stop their business activities. this will damage the structure of the government‘s economic system and policies will be also be affected. currently, uncertainty in the global economy is affecting the finnish economy. the bank of finland have stated that, in the year 2020, their eg level will slow down, reaching 1.3%. the finnish economy is facing great challenges and the economic downfall has created a challenging situation for the finnish economy (vauhkonen & packalen, 2018). housing construction growth has decreased, which has affected a lot of private investment. this study broadly evaluates the issue of economic uncertainty and its effects on the economy of finland, as well as the relationship between uncertainty and eg. it is a fact that the economy is facing certain uncertain conditions that negatively affect eg, with projects being left incomplete. smes have also been badly affected. investors and businesspeople have suffered, as they have all been negatively impacted by the extent of the eg. furthermore, public unrest is apparent. foreign companies feel unable to develop their projects or start new projects and unemployment is causing people to face very serious situations. economic policies face a challenging situation in terms of developing new options and resources. based on the literature review, the hypothesis of the current study is: there is a significant relationship between r&d uncertainty and the eg of a country. 2. methodology the core purpose of this study is to uncover the influence of r&d and the uncertainties associated with it on the eg of finland. based on this, the researcher has, for over 29 years, gathered data on relative variables concerning finland and applied the methodology that will be discussed in this section. the researcher has developed a stochastic version of a past model developed by romer (1990). before explaining the developed version of this model in detail, an important aspect to be discussed is that the overall economy of any country is made up of three sectors. the first sector is the final goods sector, in which different consumer goods are produced using labor forces and capital goods. the second sector of the economy is composed of various capital goods, also referred to as intermediate goods, which are produced using creative ideas and raw material. the last sector of the economy is the r&d sector, which focuses on human capital and its ability to derive new and innovative ideas using human minds. another thing that must be kept in mind is that the current study uses the context of finland; therefore, the assumption will be that the population of finland and their labor force are consistent. another interesting phenomenon to be considered here is that, when a researcher develops a new kind of capital good, the company who produces it acquires a patent against that design, which provides that company with the exclusive right to produce that design and sell it to the market. this patent provides an advantage for that company, as it means that asian journal of economics and empirical research, 2020, 7(2): 186-192 189 © 2020 by the authors; licensee asian online journal publishing group there will be no competitor in the market and all profits and revenues will be acquired by that particular company. as a result, the researcher who invented the design gets compensation from the company. let us consider a closed economy that contains a significant number of households that are experiencing crra, or ―constant relative risk aversion‖. ∫ in this equation, ϕ shows the relative risk aversion coefficient; e shows the expectation operator and is associated with the information obtained by the households; and ‗p‘ denotes the discount rate that is subjective and related to each household. as discussed earlier, the researcher has considered the population and labor of the country to be constant. an economy has the right to distribute available stocks in different ways. these stocks may be distributed in the output production and new capital production, which have been denoted by hy and ha respectively. cumulatively, the two become h. in this regard, y is given as: in this equation, l is the amount of labor that has been considered to be constant by the researcher. the law of the motion of capital can be demonstrated as: in this equation, δ represents the depreciation factor of the capital, k. the basic equation, in cases of technological progress, is that the law of motion is linked to the total amount of designs produced or developed by researchers or the total amount of knowledge possessed by them. knowledge, in this regard, is a factor that can be employed by different authors in their research on similar contexts (bucci, colapinto, forster, & la torre, 2011; hiraguchi, 2013). this was the essence of the model developed by romer and, following that model, technological progress will be considered as an endogenous variable in this study. the total amount of designs by researchers, which is represented as ‗a‘, undergoes the brownian process with the equation presented as follows: in this particular equation, μ represents the parameters of the productivity of firms and ha represents the total amount of labor included in the r&d sector. similarly, σ is the coefficient linked to technology and dz (t) shows the brownian motion or process in the aforementioned equation. importantly, the brownian process has a normal distribution when being considered for only a limited or finite period of time. as time passes in the given time, the variance associated with this process enhances. however, if a longer run is taken in a similar context, the behavior of the brownian process will be such that it will eventually reach infinity. this is because of the fact that the brownian process is nonstationary in nature. in this regard, the equation presented above is not the same as the one presented by the other researchers because of the involvement of control variable ha. this difference can also be explained on the basis that, in past research, technological progress was taken to be exogenous, whereas it is endogenous in the current study. in the case of such past research, the model would not be able to find out the ways in which the growth rate is associated with technology or technological progress (tsuboi, 2019). using this equation, it is possible that the distribution of human capital or the impact of labor on two economic sectors, such as r&d and final goods, can be examined effectively, in accordance with the expected growth rate. in the same means, it is possible to identify the way in which the results of uncertainty affect welfare. one serious issue that arises with regard to the economy, which is related to utility maximization, is linked to the law of motion and capital. the second issue is the stochastic equation that includes technological functions, and the last issue is the resource limitation presented by hy + ha = h, which means that the labor force used to develop products and ideas make up the labor force of the whole economy. however, these issues have been effectively resolved through the application of the hamilton jacobi-bellman (hjb) equation. the final form of this equation is given as: ( ) it must be noted here that the model developed by romer is complex; therefore, a very careful method must be used in order to reach a solution. the aforementioned model does not provide a viable solution; therefore, an alternative solution must be required. this can be achieved using a theorem, the final form of which is given as: ( ) ( ) 3. analysis assuming the constant nature of consumption capital ratio, the possibility that the optimum consumption level and the total amount of ideas are independent from each other is very rare, which is in line with past research. in addition, it has also been found that consumption and uncertainty are also independent of each other, as per the equation of the law of motion of capital. the reason behind this is the absence of uncertainty during different time periods. the final equation of the theorem presented earlier in this study indicates that human capital distribution in the department of r&d is based on different factors, especially uncertainty. in other words, if uncertainty levels with regard to r&d are higher, the firms will feel reluctant to add more human capital in this particular sector, which will ultimately result in a shortage of innovative and creative ideas. due to this shortage, fewer ideas will be generated and less progress will be made by firms. in order to find the growth rate, the following equation can be developed: asian journal of economics and empirical research, 2020, 7(2): 186-192 190 © 2020 by the authors; licensee asian online journal publishing group ( ) in this equation, λ is equal to (1-α)(α+β). it can be noted that technological growth rate is increasing alongside the total amount of human capital. in an economy in which human capital is higher, eg will also be greater. the reason behind this result is that, when human capital is greater, there is a higher chance that human capital will be distributed in the r&d sector of firms, which will lead to new and innovative ideas and more technological progress (figure 1). as per figure 1, four responses have been presented in relation to the increased uncertainty in the r&d sector. the first response shows that human capital distribution in the r&d sector will decrease as uncertainty increases, as previously discussed. the next response presents a totally opposite behavior, which states that, when uncertainty in the research sector increases, the distribution of human capital increases in the final goods sector. the next response regarding eg presents the same negative response in terms of the research sector and human capital. in other words, an increase in uncertainty in the research sector leads to a fall in the overall eg. furthermore, welfare shows a similar negative response to uncertainty. figure-1. response to uncertainty in the r&d sector 3.1. welfare welfare was taken as the control variable in the study. as previously discussed in reference to the figure 1, it shows a negative response to uncertainty in the r&d sector. as this uncertainty increases, less human capital is invested in the sector and fewer ideas are generated with regard to new designs and innovations. in this case, the function of welfare increases the total amount of ideas by research sector. it can also be confirmed that, as human capital decreases in this particular sector, there is a reduction in technological growth and the total amount of ideas have reduced their influence on welfare due to increasing uncertainty. in this way, welfare has been included as a control variable in the study and its relationship with uncertainty has been studied. 3.2. regression estimation the results of the regression estimation have been given in table 1. these results indicate that uncertainty in the research sector has a significant and negative impact on human capital distribution in the same sector. the results also suggest that uncertainty has a positive and significant impact on the final goods sector. on the contrary, in the cases of eg and welfare, the impact of uncertainty is also negative. table 1. regression estimations variables r&d uncertainty coefficient p-value hc distribution in r&d sector -0.335* 0.0263 hc distribution in final goods sector 0.264** 0.0022 economic growth -0.174** 0.0041 welfare -0.242* 0.0129 asian journal of economics and empirical research, 2020, 7(2): 186-192 191 © 2020 by the authors; licensee asian online journal publishing group 4. discussion and conclusion 4.1. discussion the current study is based on the core purpose of uncovering the influence of r&d and the uncertainties associated with it on the eg of finland. based on this context, the researcher gathered data on relevant variables over 29 years and then applied a stochastic model in accordance with similar previous research. the main result of the study has proven that uncertainty in the research sector has a negative influence on eg, which means that, if the uncertainty level in the r&d sector is high, firms will hesitate to add more human capital to this particular sector and, as a result, there will be a shortage of innovative and creative ideas and designs. if this occurs, fewer ideas will be developed and less economic progress will be made by firms. this result is in line with past studies (kaur & singh, 2016; ustabaş & ersin, 2016). the next result from this study relates to the distribution of human capital in two major sectors of the economy: the r&d sector and the final goods sector. it has been estimated that, as uncertainty increases in the research sector, the distribution or allocation of human capital will shift from the research sector to the final goods sector. in other words, the firms will tend to add more human capital to the final goods sector, as opposed to the research sector, as the former has the ability to provide guaranteed revenue, while the latter is experiencing uncertainty in that regard. this result can be confirmed using past literature (cetenak & oransay, 2017; saito, 2017). another result of the study is related to the control variable of welfare. its response to uncertainty is also negative, which means that welfare activities will decrease as uncertainty rises in the research sector. this result is in agreement with studies conducted by other researchers on similar topics (cadil, mirosnik, petkovova, & mirvald, 2018; huang, yang, & cheng, 2017). 4.2. conclusion the results show that uncertainty in the research sector has a negative influence on the eg of finland. it has also been estimated that, as uncertainty increases in the research sector, the distribution or allocation of human capital will shift from the research sector to the final goods sector. moreover, welfare‘s response to uncertainty was also found as negative. these results lead to the conclusion that firms in finland need to improve their research sector by increasing the number of patents and establishing research institutions that will lead to a reduction in the impact of uncertainty. this will provide room for more human capital in this sector, as well enhancing the eg of finland in the long-ter. 4.3. implications and limitations the current study is very beneficial for the r&d sector of finland and other countries, in the sense that it has the potential to guide the improvement of the research sector of a country by increasing the number of patents and establishing research institutions in order to reduce the impact of uncertainty. this will not only provide room for more human capital in this sector, but it will also enhance the eg of finland in the long-term. additionally, this study is beneficial for researchers, as they can obtain literature about the stochastic model used in the study and the results obtained. in the future, researchers must conduct this study in countries other than finland in order to increase the scope of the topic. they can also incorporate other factors associated with different sectors in the country, in order to also understand their perspective. it is recommended that future research uses different quantitative techniques and tools to carry out these estimations in a more reliable way. references afonso, o. 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(2019). from nonrenewable to renewable energy and its impact on economic growth: the role of research & development expenditures in asia-pacific economic cooperation countries. journal of cleaner production, 212, 1166-1178. available at: https://doi.org/10.1016/j.jclepro.2018.12.081. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 10 © 2021 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 8, no. 1, 10-16, 2021 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2021.81.10.16 © 2021 by the authors; licensee asian online journal publishing group aspects hindering the development and survival of small and medium-sized enterprises in pakistan: stability perspective shoaib ali school of management, jiangsu university, zhenjiang, china. abstract this article explores aspects that hinder the development and survival of smalland medium-sized enterprises (smes) in pakistan. a survey was developed to collect information from 226 sme owners and staff members in selected provinces in pakistan, and a statistical approach was used. the results of the research indicate that the expected constraints, including lack of management knowledge, corruption, decaying infrastructure, absence of financial funds, and inadequate earnings, hinder sme development and survival in pakistan. considering these elements will help legislators, non-governmental organizations (ngos), shareholders, policymakers, and others to create well-structured policies and plans that will aggressively promote the efficiency and stability of smes in pakistan. the significance of this research derives from the reality that few studies have been conducted on the development and survival of smes in pakistan from a stability perspective. keywords: development and survival, small & medium enterprises (smes), stability, pakistan. jel classification: h12; l32; o01; q01. citation | shoaib ali (2021). aspects hindering the development and survival of small and medium enterprises in pakistan: stability perspective. asian journal of economics and empirical research, 8(1): 10-16. history: received: 16 november 2020 revised: 28 december 2020 accepted: 19 january 2021 published: 25 february 2021 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interest regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study that was reported, that no vital features of the study have been omitted, and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 11 2. review of literature ........................................................................................................................................................................ 12 3. methodology ..................................................................................................................................................................................... 13 4. findings of the research ................................................................................................................................................................ 13 5. conclusion and future research .................................................................................................................................................. 15 references .............................................................................................................................................................................................. 15 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2021.81.10.16&domain=pdf&date_stamp=2017-01-14 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2021.81.10.16&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/2689 asian journal of economics and empirical research, 2021, 8(1): 10-16 11 © 2021 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the existing literature by exploring aspects that hinder the development and survival of smalland medium-sized enterprises (smes) in pakistan from a stability perspective. 1. introduction unlike large companies, smes, with their constrained financial resources and funds and inadequate management facilities, tend to receive substantially less financing in the development of an economy. however, the significance of smes cannot be stressed enough in the economic development of a country (syed, ahmadani, shaikh, & shaikh, 2012). smes make up almost 90% of the contribution among all formal sector enterprises. promoting small-scale industries would assist in achieving many goals and could help reduce the problem of widespread underemployment, particularly in developing economies such as pakistan. this issue is expected to worsen with the accumulation of returning laborers from developing countries. when compared with larger industries, smes apply more labor-intensive strategies and use a significant source of revenue. they intensively use the readily available development factor by focusing on domestic inputs, as well as increasing government foreign exchange. saeed (2013) highlighted that smes are important users of scarce resources and have stronger relations with other local economic sectors. even these inherent characteristics of smes make it important for a system to be implemented whereby funding can be obtained for various business operations, particularly technical upgrades, promotion, training, and the creation of financial and human capital. the development agency for smes, small and medium enterprise development authority (smeda), is pakistan's cornerstone organization providing the requisite resources to enable smes to address endogenous flaws in nature (sadiq, 2010). smes are a means of moving forward in developing economies. as research on the significance of smes is ongoing, progress on the issues and the growth of pakistan's smes is decelerating. many smes are not approved by government entities and do not have a reference for receiving smeda support or assistance (ali, azam, muhammad naveed, & abid, 2020). however, the smeda has performed well and progressed during times when the proliferation of smes was restrained. therefore, this study encourages the recognition of the value of smes and explores the influential drivers from the stability perspective of sme development in pakistan. though smes' growth accomplishments are normal, it is known that entrepreneurs face many hurdles that restrict their success and development. sme growth analysis has found that the frequency of decline is greater in developing economies than in all other industrialized economies (okpara, 2011). the challenges facing smes in pakistan are related to economic development, which are substantially different from those confronted in developed economies. overall, the problems hindering the development and survival of smes and causing their failure in pakistan can be divided into five main categories, namely the absence of financial funds, lack of management knowledge, corruption, high interest rates, and decaying infrastructure. these difficulties severely hinder the sustainable growth of smes (jamali, anka, & khooharo, 2010). in pakistan, the smeda operates to promote smes but concentrates mainly on upper-income domains, though many pakistani smes are in the lower-income segments. small business finance corporations (sbfc) are, along with the smeda, supporting smes in pakistan to acquire credit financing; however, weak, incomplete, and inconsistent government action and tax regulations are the key hurdles to the development of smes (ali shah, mehmood, aamir hashmi, maqsood shah, & muhammad shaikh, 2011). a few previous types of research have analytically examined the problems affecting the socioeconomic growth of smes in other developing economies, such as malaysia, bangladesh, and indonesia. according to the national statistics bureau of china, smes represented 99.3% of all enterprises in china in 2012, and they contributed 60% of china's gdp (shannxi, 2016). this statistic indicates the high value of smes in both advanced and developing economies. however, smes are facing substantial barriers, especially in developing countries. this study seeks to identify the key challenges facing smes in pakistan and analyze the reasons for the barriers to their development. thus, we can detail a strategy in pakistan with appropriate insights to achieve quick and stable development of the economy. the studies on pakistan, and the impacts of a few characteristics in the overall evaluation of the economic development of pakistan smes, are discussed on an interpersonal basis. several other articles have studied whether or not significant influencing conditions are acceptable for enterprises (ali et al., 2020). this study will demonstrate the importance of highlighting the hindrance factors in pakistan's sme development. second, the results of the research will make it more feasible to build a stable environment for policymakers and entrepreneurs and gain support that will encourage the development of smes. third, this is an opportunity for pakistan's smes to procure new awareness of observable evidence. interestingly, this study will help sme owners in pakistan to understand the aspects which are hindering their development. pakistan's smes are critical to the country’s economic development, but they do not get the support they need due to limited visibility and the absence of awareness. there is insufficient information on the development of smes, and extensive research in this field is still needed. entrepreneurs need to have in-depth knowledge of the problems hindering the development of pakistan's smes, and this study examines the recognition of measures that influence their survival. furthermore, recent research examines the consequences of training, several dynamics of business success, and the introduction of stability to the hindering elements that lead to sme failure. figure 1 shows the theoretical framework constructed on the basis of evaluating the imperative elements that lead to sme failure in pakistan. these elements also lead to business development failure and will ultimately reduce the number of smes. this research also includes marketing, which is essential to sme promotion at the national and international levels, although the primary focus of this research is to establish and emphasize the factors hindering the development of smes in pakistan. asian journal of economics and empirical research, 2021, 8(1): 10-16 12 © 2021 by the authors; licensee asian online journal publishing group figure 1. theoretical framework. 2. literature review the literature on obstacles to sme development is comparatively broad (wang, 2016). a couple of the important articles from the 1990s are studies of sri lanka's clothing industry and tanzania's building and design businesses (sánchez-rodríguez, martínez-lorente, & hemsworth, 2019). three main barriers were defined by levy (1993), namely access to financing, access to non-financial resources, and increased costs. furthermore, he indicated that the principal barrier that financial restrictions created was the difficulty for organizations to expand. a heavy tax restriction was also established as a major barrier for smes. the study concentrated on particular sectors to provide more comprehensive and specific insights on the issues facing smes. however, the findings could not be widely used due to the lack of revised data and the cost of performing the necessary assessments. prior research has also demonstrated that a variety of obstacles, particularly a lack of funding and strategic support, are hampering the development of sme enterprises, but the level at which scarce financial means is a major barrier to corporate development remains uncertain. results demonstrate that extra funding is frequently not needed to undertake a profitable business operation and that a shortage of capital could be offset by innovation and effort (dia, 1996; godsell, 1991; harper & soon, 1979; hart, 1972). furthermore, kallon (1990) indicated that the ratio of funding required to start a company is negatively significant when it comes to the company's rate of expansion. he further stated that having exposure to credit facilities did not, in a meaningful way, lead to successful entrepreneurship, and if it did, the association might be unfavorable. the challenges concerning the advancement of smes within particular areas have been studied by a large number of researchers (almanei, salonitis, & xu, 2017; lampadarios, 2016; paul, parthasarathy, & gupta, 2017), although, as a community, relatively few studies have focused on developing economies such as pakistan. by studying developing economies as a collective, it is possible to expose certain common challenges. in developing economies, the association among companies' attributes and obstacles to their development is an essential part of the discussion (wang, 2016), and various forms of businesses ownership as drivers of development are an especially important concern. wang (2016) further added that private companies grow quicker than state-owned firms, which usually focus their priorities on work development but have a less productive use of resources. however, comparisons between small public and private smes are very unusual, and this is likely associated with the success of major large corporations (saastamoinen, reijonen, & tammi, 2018). on the contrary, a few other studies have found that local enterprises are being poorly capitalized. to establish and maintain an enterprise, entrepreneurs prefer to rely mostly on their own savings or borrow from their relatives. this source of capital structure is restrictive, and access to anticipated benefits is an obstacle. kallon (1990) evaluated that, for their primary source of finance, 67.5% of the enterprises surveyed relied on individual investments, 12.3% had access to family resources, 8.2% used financial institutions, and 9.6% drew funds from associates, stakeholders and other resources. keyser, de kruif, & frese (2000) highlighted that insufficient financial resources were reported to be the main challenge for entrepreneurs because only 26% of businesspeople secured sufficient finance to establish their organizations. according to research by lisbona, palaci, salanova, & frese (2018), the volume of financial resources was noticed to be positively linked to business performance. analysis of the role of resources in sme failure in pakistan is inconsistent and thus brings uncertainty (ali et al., 2020). this reinforces the significance of this research; it is important to develop an improved perception of the function of investment throughout the achievement or insolvency of smes in pakistan. as a whole, although they need funding, most small companies do not fulfill the criteria for bank loans, while those who do fulfill the criteria find bank loans extremely costly in terms of the repayment schedule (gray, cooley, & lutabingwa, 1997). management challenges have been considered as significant drivers of enterprise insolvency for smes, particularly accounting, financing, training, and management concerns. inadequate record management and inefficient core management abilities are significant contributors to the insolvency of smes in pakistan. the absence of management knowledge makes it impossible for entrepreneurs to thrive (naveed, hongxing, akhtar, anwer, & alemzero, 2020). many other reasons impeding the development of smes have also been reported, such as ineffective recordkeeping, entrepreneurial immaturity, technological incompetence, poor management skills, lack of preparation, and inadequate marketing analysis (lussier, 1996; mahadea, 1997; van scheers & radipere, 2005). however, many researchers have not established the management issues or difficulties that lead to the failure of smes in pakistan. identifying the management issues that contribute most to the failure of smes will be a crucial step in solving the problem. corruption, decaying infrastructure, impoverished regions, inability to perform basic marketing plans, as well as other recognized influences all negatively affect sme development (tushabomwe-kazooba, 2006). corruption, deception and other illegal activities are the biggest challenges for smes. in specific developing economies, these practices have significantly hindered business entrepreneurship. these dishonest operations allow those in positions of authority, government, and control to earn profits quickly and illegally. therefore, corruption, in asian journal of economics and empirical research, 2021, 8(1): 10-16 13 © 2021 by the authors; licensee asian online journal publishing group particular, affects individuals in multiple business sectors, especially smes. it also compromises the respect and commitment of smes to challenge the legal structure, public credibility, and taxation regime (pope & international, 2000). virtually every developing economy has its own variant of corruption with an unquantifiable expense to businesspeople, communities, municipal government, and the social system as a whole. consequently, from previous studies, the effect of corruption on the growth of smes is still uncertain. therefore, an awareness of the unique effects of corruption on the development of smes when designing approaches to resolve the problem is essential. the research highlighted concerns, such as the absence of financial funds, insufficient management knowledge, corruption, decaying infrastructure, and high interest rates, which lead to sme failure. in pakistan, the lack of management knowledge and corruption are major barriers to the development of smes. therefore, it is necessary to determine which variables affect the advancement of smes. these variables include weak competition for goods and services and the inability to access or buy technologies. one of the key accomplishments of sme ownership is that it enables individuals, particularly those who are unemployed, to join the socioeconomic norms of the community (harris & gibson, 2006). however, to drive the economy's development forward, pakistan depends on sme stability. in pakistan, the company loss rate shows that new and inexperienced enterprises are in desperate need of support, and to obtain support, the challenges they encounter need to be recognized. 2.1. hypothesis development previous sme surveys in developing economies have described lack of financial capital, lack of managerial skills, corruption, and inadequate infrastructure as primary barriers to the development of smes (kiggundu, 2002; okpara & wynn, 2007; tushabomwe-kazooba, 2006). although some investigations produced contradictory outcomes, others have demonstrated discrepancies that make further study essential. as a result, the following hypotheses have been formulated to strengthen our awareness of the challenges faced by smes in pakistan: h1: lack of management knowledge is negatively linked to sme failure. h2: corruption is negatively linked to sme failure. h3: decaying infrastructure is negatively linked to sme failure. h4: absence of financial funds is negatively linked to sme failure. 3. methodology 3.1. sample design the questionnaire designed for this study was distributed to a random group of 320 owners and staff members of different smes in the province of punjab, pakistan. the enterprises were selected randomly from smeda1 and the federation of pakistan chambers of commerce & industry (fpcci)2. the questionnaires were forwarded by hand to the listed firms' locations, and the data was gathered by hand on a specified pick-up day to encourage a high rate of response. five educated coordinators and three team assistants were given responsibility for the dissemination and selection of the questionnaire. the delivery was carried out in this manner to avoid local postal system challenges and to respond directly to questions regarding the context and purpose of the study. out of the 320 questionnaires circulated, 226 were collected, reflecting an answer rate of approximately 70%. the study took place between april 12 and august 20, 2019. 3.2. data collection instruments two types of instruments were used to gather statistics, the demographic survey, and the small enterprise questionnaire, which focused on 30 measures related to the main concerns facing smes in pakistan. the questions were expressed with a potential spectrum of reactions using a likert-type scale, where 1 = strongly agree and 5 = strongly disagree. 3.3. instrument validation the instruments were proposed to a group consisting of five sme professionals, who were consultants for validation in pakistan and china. for each of the tools, the professionals were asked to study the items to decide whether these elements were beyond the reading skills and comprehension of pakistan's sme owners and staff. the instruments were resubmitted to the professionals for further examination after several small changes and improvements were made. for the analysis, the professionals suggested using modified tools, and cronbach's α was 0.82. 4. research findings 4.1. factor analysis a factor analysis reviewing the survival aspects of smes in pakistan was undertaken to assess if there was a resolved collection of difficulties or causes. each object had a minimum factor loading of 0.50, and 54.55% of the variation was clarified by four variables (lack of management knowledge, corruption, decaying infrastructure, absence of financial funds), as shown in table 1. the variable reliabilities are 0.88, 0.85, 0.84, and 0.86, respectively. 4.2. descriptive analysis and correlation matrix table 2 contains the descriptive statistics and correlations for the study variables proposed in this research. the mean and standard deviation (sd) results are as follows: lmk (mean = 4.32, sd = 0.61), corruption (mean = 4.59, sd = 0.52), di (mean = 4.31, sd = 0.61), and aff (mean = 4.76, sd = 0.79). the table shows the outcomes of the correlation between the study variables and sme performance. 1 https://smeda.org/index.php?option=com_phocadownload&view=category&id=44:punjab-clusterprofiles&itemid=742 2 http://www.pastic.gov.pk/database_chamber_of_comm.aspx https://smeda.org/index.php?option=com_phocadownload&view=category&id=44:punjab-clusterprofiles&itemid=742 http://www.pastic.gov.pk/database_chamber_of_comm.aspx asian journal of economics and empirical research, 2021, 8(1): 10-16 14 © 2021 by the authors; licensee asian online journal publishing group table 1. item description and factor analysis. description factor loading lack of management knowledge (lmk) (α = 0.88) deficiency of management knowledge 0.87 deficiency of knowledge in sme management 0.85 deficiency of training in enterprise management 0.81 deficiency of training in financial planning 0.83 deficiency of training in the marketing department 0.88 deficiency of training in accounts 0.84 deficiency of training in hr management 0.82 lack of specialist staff 0.78 deficiency in mentoring employees 0.68 variance 28 corruption (α = 0.85) value squeezing 0.86 illegal ways of covering corruption 0.82 availing of the government contract against money 0.85 using other means of sources for corruption 0.87 offering money to acquire a loan 0.67 providing extra interest on a loan 0.77 solving business matters with money 0.87 offering money is normal in firms 0.88 variance 24 decaying infrastructure (di) (α = 0.84) bad state of roads 0.86 slow means of communication 0.82 unreliable power source 0.76 harbor mobbing means 0.78 overcrowding of bridges and roads 0.81 variance 23 absence of financial funds (aff) (α = 0.86) insufficient financial sources 0.84 insufficient financial funding 0.83 difficulty in receiving loans 0.87 deficiency in financial regulations 0.85 variance 25 table 2. descriptive statistics and correlation analysis. variable mean sd 1 2 3 4 5 6 7 8 9 gender 1.59 0.98 age 39.02 5.25 0.16 qualification 15.76 6.34 0.15 0.13 experience 7.49 0.94 0.30 0.11 0.20 lmk 4.32 0.61 0.23 0.13 0.40 -0.35 corruption 4.59 0.52 0.16 0.11 0.20 -0.29 -0.70 di 4.31 0.61 0.20 0.13 0.08 -0.25 -0.65 0.59 aff 4.76 0.79 0.26 0.18 0.12 -0.33 -0.59 0.63 -0.57 sme performance 3.23 0.52 0.11 0.23 0.25 -0.28 -0.65 0.62 -0.49 -0.62 the results indicate that there is a clear negative relationship between sme performance and lmk, corruption and aff. these relationships support h1, h2 and h4. the results are also compatible with previous research that showed that these variables have a negative effect on the growth of small businesses (keyser et al., 2000; lussier, 1996; mahadea, 1997; mambula, 2002; monkhouse, 1995; okpara, 2011; tushabomwe-kazooba, 2006). it's worth noting that corruption and decaying infrastructure are not as significant to sme staff as the absence of financial funds, inadequate education, and lack of management knowledge. 4.3. multiple regression analysis table 3 shows the outcomes of the multiple regression of the research variables by analyzing the incremental effects of lmk, corruption, di and aff, and all significantly lead to sme failure. these results support h3. also, r2 = 68, which indicates a 68% variance in smes due to lmk, corruption, di and aff. table 3. multiple regression variables. variable β r p-value lmk 0.65 0.53 0.000* corruption 0.71 0.66 0.002* di 0.69 0.67 0.004** aff 0.55 0.67 0.000* note: * p < 0.05; ** p < 0.01, r2 = 68. 4.4. results and discussion this research contributes to our knowledge about the influences that restrict the development of pakistan's smes by focusing on the four most significant results – lack of management knowledge, corruption, decaying asian journal of economics and empirical research, 2021, 8(1): 10-16 15 © 2021 by the authors; licensee asian online journal publishing group infrastructure, and the absence of financial funds. all were found to be negatively correlated to sme failure, and this is supported by previous research (keyser et al., 2000; lussier, 1996; mahadea, 1997; mambula, 2002; monkhouse, 1995; okpara, 2011; tushabomwe-kazooba, 2006). the findings demonstrate the effects of the absence of financial funds brought on by the failure to collect money and the inability to obtain funding from financial institutions. the challenge of borrowing money from the bank is difficult due to the lack of necessary guarantees of fund loans, and it is one of the key factors identified for the lack of financial funds. these results are also in line with those of okpara & wynn (2007). outcomes indicate that corruption negatively correlates with smes. there are also discouraging concerns around sme corruption and its effect on enterprises. however, if smeda arranged seminars on the awareness of sme stability and development, this would help to reduce some of the negative issues. lack of management knowledge is another barrier to the advancement of smes in pakistan. according to the results, the majority of owners do not have sufficient information regarding business operation or staff training. consequently, insufficient training and lack of expertise in management skills have detrimental implications and significantly contribute to the failure of smes. however, operating enterprises in rural communities that are not easily accessible can be troublesome, even though rural communities may have a strong market for their goods. in terms of business sustainability, this reduces the willingness of smes to grow and, in turn, earn a profit. 4.5. sme stability regardless of all the proposed outcomes, the stability of smes is essential for growth and development. many types of research have found that sme stability is the key to boosting the economic level of any country via employment and income, and developing countries need to take serious steps to reduce or eliminate the challenges that have been identified. as previously explained, the main constraints for smes in pakistan need to be addressed urgently to create sme stability. therefore, it is suggested that initiatives aimed at encouraging, helping, and promoting smes would lead to economic development and stability, thus improving sme success and performance. 5. conclusion and future research smes are advancement drivers for developing countries such as pakistan, and they provide substantial support for employment, which assists in easing poverty. built on the outcomes of this research, numerous aspects were recognized as liable for hindering sme development and survival in pakistan. overall, these are a lack of management knowledge, corruption, a decaying infrastructure, and an absence of financial funds. insufficient funds and the difficulties of securing finance from monetary associations and federal organizations were also highlighted as the main aspects hindering sme development. the unfavorable policy structure discourages entrepreneurs from seeking capital for start-up or for the expansion of current operations. additionally, a serious communication flaw has been recognized among confined enterprise services benefactors regarding funding. the inadequacy of existing management knowledge and skills is a major constraint for smes. the enterprise owners and staff who took part in this study stated that they had very little or no management knowledge or experience before opening their enterprises. they specified this lack of essential enterprise management knowledge as a significant hindrance in relation to development and survival. decaying infrastructure is an additional barrier to sme growth. important infrastructure and facilities, such as roads, highways, electricity, and other telecommunication arrangements that might facilitate success for smes, are not sufficiently available. corruption is also a huge constraint to sme survival and development in pakistan. the majority of owners and staff stated that the procedure of obtaining support from the federal government is not just difficult but also relies on bribery and political links. to build on what we have studied in this research, the focus could be enhanced to include the capture of additional problem regions in the literature. also, future research should include a larger sample geographically. 5.1. recommendations the findings of this study demonstrate that a variety of reasons are responsible for hindering the development of smes in pakistan. sme owners are advised to obtain cheap loans, get low-interest loans from financial institutions, borrow from friends and family, arrange advance consumer payments, or obtain loans from micro institutions. it is also suggested that the government should take the requisite steps at local, state, and federal levels to begin improving and sustaining pakistan's current infrastructure. references ali, s., azam, f., muhammad naveed, h., & abid, w. 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(2016). incubators, smes, and economic development of china. international journal of multimedia and ubiquitous engineering, 11(1), 311–318.available at: https://doi.org/10.14257/ijmue.2016.11.1.29 syed, a., ahmadani, m. m., shaikh, n., & shaikh, f. m. (2012). impact analysis of smes sector in economic development of pakistan: a case of sindh. journal of asian business strategy, 2(2), 44–53. tushabomwe-kazooba, c. (2006). causes of small business failure in uganda: a case study from bushenyi and mbarara towns. 8, 27-35. van scheers, l., & radipere, s. (2005). perceptions of small business owners on managerial skills: problems in business development in south africa. world review of science, technology and sustainable development, 2(3-4), 336–351.available at: https://doi.org/10.1504/wrstsd.2005.007692. wang, y. (2016). what are the biggest obstacles to growth of smes in developing countries?–an empirical evidence from an enterprise survey. borsa istanbul review, 16(3), 167–176.available at: https://doi.org/10.1016/j.bir.2016.06.001. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 74 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 1, 74-90, 2020 issn(e) 2409-2622: / issn(p) 2518-010x doi: 10.20448/journal.501.2020.71.74.90 © 2020 by the authors; licensee asian online journal publishing group financial development and monetary transmission mechanism in nigeria (19862017) olajide oyadeyi1 temidayo akinbobola2 ( corresponding author) 1student, obafemi awolowo university, nigeria. 2head and professor of international economics, obafemi awolowo university, nigeria. abstract this study explored the impacts of the different aspects of financial development on monetary transmission mechanism in nigeria from the period of 1986-2017 using quarterly data. variables such as broad money supply, debt stock, stock market capitalization, stock market value traded, total deposit money bank’s asset, total financial assets, private sector credit, inflation rate, monetary policy rate, exchange rate, all share index and output, were used to carry out this investigation. the study adopted pesaran, shin, and smith (2001) ardl framework to check the impacts of these individual financial development indicators and how they affect monetary transmission mechanism. the findings suggested that financial development indicators and their interactions with the policy rate influenced each channel of monetary policy with different degrees. banking sector indicators (size and activity measures) had more influence on the channels of monetary policy transmission compared to capital market indicators, while financial market liberalization had the least influence on the channels of monetary policy transmission. however, the significance of the individual financial development indicators was found to be very weak on exchange rate channel, while the influence of the financial market indicators was strongest on the interest rate channel, thereby supporting previous studies that interest rate channel is the most dominant channel of monetary policy for nigeria. finally, the paper recommended that financial reforms must be geared towards strengthening the implementation of monetary policy and the channels through which monetary policies impact real economic activity. keywords: financial development, monetary policy, monetary transmission mechanism, banking sector development, stock market development, bond market development, financial liberalization. jel classification: e44, e50, e52. citation | olajide oyadeyi; temidayo akinbobola (2020). financial development and monetary transmission mechanism in nigeria (1986-2017). asian journal of economics and empirical research, 7(1): 74-90. history: received: 8 january 2020 revised: 19 february 2020 accepted: 23 march 2020 published: 16 april 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: both authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 75 2. review of empirical literature ..................................................................................................................................................... 76 3. methodology ..................................................................................................................................................................................... 77 4. analysis and presentation of results ........................................................................................................................................... 78 5. conclusion and policy recommendation .................................................................................................................................... 88 references .............................................................................................................................................................................................. 88 appendix ................................................................................................................................................................................................ 89 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.71.74.90&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1516 https://orcid.org/0000-0002-3799-9765 https://orcid.org/0000-0001-6707-5523 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1516 https://orcid.org/0000-0002-3799-9765 https://orcid.org/0000-0001-6707-5523 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1516 https://orcid.org/0000-0002-3799-9765 https://orcid.org/0000-0001-6707-5523 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1516 https://orcid.org/0000-0002-3799-9765 https://orcid.org/0000-0001-6707-5523 asian journal of economics and empirical research, 2020, 7(1): 74-90 75 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study explored the impacts of the different aspects of financial development on monetary transmission mechanism in nigeria from the period of 1986-2017 using quarterly data. 1. introduction financial sector development potentially plays an important and fundamental role with the general growth or development in any economy. central to the financial sector are banks. they are the conduit through which funds flow within an economy. their major role involves intermediation, that is, moving funds from the surplus agents to deficit units. these banks are divided into banking and non-banking financial institutions. the banking financial institutions are also known as deposit taking institutions. they move funds from surplus agents to the deficit units. typical examples of these deposit taking institutions include the central bank, commercial banks and the development banks. the non-banking institutions are not depository institutions, but they also play the role of channeling funds from surplus to deficit units. examples of non-banking institutions are investment banks, contractual savings institutions1, insurance companies, payday lenders, cooperative societies, institutional investors, finance companies2 and so on. by implication, how an economy manages these institutions largely depend on the extent of development within the financial system and the monetary transmission framework available in any economy (visco, 2007). on the global scene, financial sector reforms have improved the competitive and profitability levels globally vis-a-vis the introduction of market-based instruments, the removal of financial market and capital account restrictions and the liberalization of these markets to promote innovation and competition (goldberg, 2013; spiegel, 2008). consequently, financial sector developments have provided the guidance and foundations for globally competitive economies and improving the growth conditions in many economies, since these economies not only produce their goods and services for domestic consumption, but also export these goods and services internationally (johnston & sundararajan, 1999). in nigeria, financial sector reforms have taken the form of financial market liberalization and deregulation. these liberalization policies took effect in the 80s, with the introduction of structural adjustment program (sap) instituted by international monetary fund (adesoye, 2014). here, indirect or market-based instruments were adopted to achieve the ultimate objectives of price stability and sustainable growth (akpan, 2011). the policy also ensured private sector restrictions were removed to encourage more private sector participation in improving the economy (akpan, 2011). however, policy inconsistency and implementation problems have affected the extent through which these reforms affected monetary policy transmission and consequently, macroeconomic performance. monetary transmission mechanism is a description of how monetary policy is being transmitted into an economy via several channels. its effectiveness hinges greatly on the extent of development within the financial system. however, it is a known fact that the nigerian financial system is one of the most underdeveloped financial institutions in the world today and there are worrying features of the system. first of all, nigeria still has an undiversified and unspecialized banking system (babajide, 2011). this means that several institutions overlap in performing other sector functions. take for instance, commercial banks are expected to provide retail banking services to customers but they also engage in providing wholesale transactions. same as the merchant banks as well as other banks. the difference in their performance lies in the quality of service and value added. furthermore, these institutions both lend to corporate bodies, governments and individuals and are mostly structured in urban areas (babajide, 2011). the only exceptions to this case in terms of functions are the insurance companies and development banks who perform their main obligations. as earlier stated, financial sector development is very important in the conduct and performance of any economy (claus & grimes, 2003; visco, 2007). this is because the effectiveness of transmitting monetary policy into an economy depends on the structure and functioning of the financial system. this role has been solely given to the central banks because a stable and sound financial system is arguably a pre-condition for the effective adoption of monetary policy operations within an economy (claus & grimes, 2003). even though there has been some evidence in the literature3 about past researches on financial development and monetary policy in nigeria, the effects of financial development on monetary transmission mechanism are yet to be ascertained for nigeria. furthermore, and as a deviation from other studies4, this study intends to measure how the different aspects of the financial sector has been able to affect the different transmission channels through which monetary policy may influence an economy. thus, banking sector development, capital market development, bond market development as well as financial liberalization were used to model financial sector developments in nigeria, while the different channels of monetary policy that were examined include interest rate channel, exchange rate channel, credit channel, asset price channel as well as expectations channel. in addition, this paper also explored the joint interaction between financial development and monetary policy on each channel of monetary policy. the essence of this is to be able to determine if financial development and its interaction with the policy rate can be used as policy tools to strengthen monetary transmission mechanism in nigeria. finally, this study examines the role of structural breaks in modelling this relationship in nigeria. the consensus in the literature is that the incorporation of structural break or reform issues in the modeling of monetary policy and its transmission is methodologically imperative (doguwa, olowofeso, uyaebo, adamu, & bada, 2014). therefore, this study will examine the impact of financial development on each monetary policy channel in nigeria and it is therefore expected that the findings of this study would provide more understanding on the linkages between financial development and monetary transmission mechanism in nigeria. the rest of the paper is organized as follows: section two reviews the empirical literature, while section three focuses on the methodology. section four presents the results, while the final section concludes the paper with some policy recommendations. 1 contractual savings institutions include pension funds and mutual funds. 2 primarily, finance companies sell bonds and commercial papers. 3such as ikhide (1996); jegede (2014); otalu, aladesanmi, and olufayo (2014) and apanisile and osinubi (2019). 4christensen, fung, and meh (2006); alpanda and aysun (2012); goldberg (2013) and billi and vredin (2014). asian journal of economics and empirical research, 2020, 7(1): 74-90 76 © 2020 by the authors; licensee asian online journal publishing group 2. review of empirical literature 2.1. developed country review on financial development and monetary policy transmission there are quite a number of studies on the relationship between financial development and monetary policy transmission in developed and developing countries. earliest among them are the works of brunner and meltzer (1963). their paper examined the effect of financial intermediaries on the transmission channels of monetary policy in the us. the study showed that a pure flow analysis misreads the significance of many flow magnitudes. that is, they are more appropriately interpreted as adjustment flows in a wealth allocation process. these remarks, most unfortunately, cannot justify in any sense the wealth adjustment hypothesis of money, interest, and income that was specified. the study however suggested that these remarks point to directions of research permitting an appraisal relative to standard-flow conceptions. in 2002, bean, larsen, and nikolov (2002) using cross correlation and var analysis evaluated the role of financial frictions in the monetary transmission mechanism on the euro area from 1970 to 2000. the study found out that financial frictions and their asymmetric nature may lead to uncertainties in determining the period the economy will adjust to monetary policy changes. christensen et al. (2006) modelled financial channels for monetary policy analysis in canada using financialaccelerator mechanism, totem models and dsge models. the study indicated that adopting these methodologies are crucial and are capable of addressing policy issues within an economy. similarly, devereux and sutherland (2007) examined the relationship between financial globalization and monetary policy in canada using the dsge framework. the results generally suggested that while an improvement in financial globalization affects the framework in the operation of monetary policy, it may not affect the core objectives of optimal monetary policy. however, singh, razi, endut, and ramlee (2007) examined how the monetary transmission mechanism is affected by financial market developments in asian countries in relation to developed countries of the world from the period of 1980 to 2006. the study suggested that financial development led to a strengthened interest rate pass-through in asian financial markets, both in the short and long run with faster adjustment speed. furthermore, the study revealed that developed countries are characterized by a lower degree of interest rate pass-through. in the same way as bean et al. (2002); visco (2007) investigated the connection between financial deepening and the monetary transmission mechanism in the european area. the study suggested that financial liberalization may now make it more difficult to pursue dual objectives in terms of inflation and exchange rates. spiegel (2008) reexamined the impact of financial globalization on monetary policy in 127 countries (oecd countries and other developed countries) from the period of 1980 to 2004. the study also suggested that it would prove a challenging task to establish a sound relationship between financial openness and monetary policy. however, alpanda and aysun (2012) studied the relationship between global banking and the balance sheet channel of monetary transmission mechanism in the us. the results revealed that improved banking operations may have led to the improved effectiveness in the conduct and performance of the federal reserve, thus strengthening the balance sheet channel. finally, the result affirmed the theoretically positive relationship between bank globalization and the balance sheet channel of monetary policy. correspondingly, aysun, brady, and honig (2012) also examined the effect of financial frictions on the strength of the credit channel of monetary transmission of 61 developed countries, using monthly data and spanning the period 1984 m1 to 2008 m5. the study revealed the dominance of the credit channel with countries that possess a high financial friction level. furthermore, the study revealed that monetary policy had a greater influence on external finance premiums, by directly influencing asset prices, as well as borrower’s leverage. using structural var (svar) models on cross-country data, the study revealed the theoretically positive relationship between financial frictions and the strength of the credit channel. similarly, goldberg (2013) empirically investigated the relationship among banking globalization, transmission and monetary policy autonomy for 113 countries from the period of 1995 to 2009. the study revealed that expansion of global banks as they enter other countries tend to reduce their frictions in international capital flows. in europe, billi and vredin (2014) examined the nexus between monetary policy and financial stability in sweden. the study was of the view that since the macro-prudential models that were adopted prior to the financial crises could not predict the crises, then these macro-prudential policies were insignificant, but they provided useful guidance on the relationship between financial stability and monetary policy. in contrast, kryvtsov, molico, and tomlin (2015) carried out an empirical investigation on the relationship between monetary policy and financial stability since financial system stability should influence monetary transmission mechanism in canada. the study showed that monetary policy cannot be devoid of financial stability problems and that monetary policy conduct can also be influenced by strong macroprudential policies. tayssir and feryel (2017) reviewed the question whether central banks and their monetary policies promote financial development. the paper employed methods of linking financial development and measures of central bank variables using a panel framework. the sample period was made up of a panel of 22 countries over the period 1980 to 2010, using the var methodology. the study used several macroeconomic variables, institutional quality variables and several measures of financial development. the results revealed that monetary policy and other central bank characteristics significantly influenced financial development for all the observed countries. 2.2. developing country review on financial development and monetary policy transmission ikhide (1996) reviewed the impact of financial liberalization on monetary policy in nigeria, with a focus on the transition from the direct monetary policy regime to the indirect monetary policy regime. the study through the use of ols technique concluded that a range of measures were needed in restructuring insolvent banks, and a new policy should be introduced to deal with offending market participants. furthermore, the study revealed that the secondary market needs to be further developed. the study also noted that even if all these were achieved, there was still a need for the government to improve the fiscal deficit conditions and remove interest rate ceilings for the money market to function efficiently. in thailand, sirivedhin (1998) examined the relationship that exist between reforms in the financial system and monetary transmission mechanism in thailand from the period of 1989 to 1995. using a var model, the study revealed that interest rate channel has become more effective over the years due to the influence from foreign interest rates. the study further confirmed that the liberalization of financial asian journal of economics and empirical research, 2020, 7(1): 74-90 77 © 2020 by the authors; licensee asian online journal publishing group markets improved the process of financial deepening, thereby increasing access to investments in a range of financial assets. in new zealand however, claus. and smith (1999) examined the role of financial intermediaries and the credit channel of monetary transmission mechanism in new zealand from the year 1982 to 1999. the study was of the view that the financial system as well as the credit markets may have affected the real economy. furthermore, financial frictions as well as asymmetric information within credit markets may have increased the impact of monetary policy on interest rates, thus affecting inflation and output. in chile, alfaro, franken, garcía, and jara (2003) carried out a study on bank lending channel and the monetary transmission mechanism in chile during the period 1990 to 2002 using data from both the banking sector and the corporate sector. the study concluded that the bank-lending channel was the main channel of monetary policy transmission for chile. claus and grimes (2003) critically reviewed asymmetric information, financial intermediation and the monetary transmission mechanism in new zealand. the paper suggested that information and transaction costs were at the heart of the assumptions upon which the modigliani-miller theorem was based, therefore, making them important for monetary transmission mechanism. the paper further suggested that the models adopted by macroeconomists were not practicable as these models do not incorporate the significance of financial intermediaries in the credit markets. on the contrary, mohan (2006) examined the nexus between financial sector reforms and monetary policy in india between 1969 and 2005 using descriptive and econometric techniques. the study revealed that monetary policy was able to maintain price stability and credit availability to support investment and growth for the indian economy. spiegel (2008) reexamined the impact of financial globalization on monetary policy in sub-saharan africa from the period of 1980 to 2004. the results confirmed an inverse relationship between median inflation and financial globalization in the baseline model. in a panel study, nissanke (2010) carried out a study on the global financial crisis and the developing world by looking in depth at the transmission channels, fall-outs for industrial development and possible implications for industries and welfare of 36 developing countries using dynamic panel methodology. the study revealed that due to the financial crises, foreign investments tend to reduce significantly since these developing countries in most cases do not possess the resources needed to take advantage of foreign investments. however, montiel, adam, mbowe, and o’connell (2012) carried out a study to determine the relationship between financial architecture and the monetary transmission mechanism in tanzania from 2001 to 2010. the empirical results suggested that the monetary authorities in tanzania does not have the impetus for a strong short-term stabilization policy. furthermore, transmission to the loan rate also appeared to be particularly very weak. ozşuca (2012) carried out a study on banks and monetary policy transmission mechanism in turkey. the results found out that the bank lending channel was efficient for the period of 1988-2001, and its impact became stronger afterwards. the findings also showed that banks’ risk-taking behavior responds positively to low interest rate levels for all risk measures. the study concluded that the large and well capitalized banks were less prone to taking risks. lerskullawat (2014) examined the relationship between financial development and monetary transmission mechanism in thailand. the study revealed that interest rate affected bank loans negatively in the bank lending channel. in the firms’ balance sheet channel however, monetary policy was effective when firms were not faced with financial difficulties and constraints and vice versa when these firms became financially constrained. lastly, the study found out that measures of financial development had a weaker effect on interest rate vis-à-vis the credit channel, but have a stronger effect on the interest rate vis-a-vis interest rate channel. on the contrary, jegede (2014) studied the effects of monetary policy on commercial bank lending in nigeria between 1988 and 2008. the findings indicated that there exists a long run relationship among the estimated macroeconomic variables. the study’s main conclusion was that bank loans and advances were not stirred by monetary policy in the long term; however, their total credit was more receptive to their cash reserves. similarly, otalu et al. (2014) in their study examined the relationship between monetary policy and commercial banks performance in nigeria through the credit creation channel. the study found out that the monetary policy variables affected how commercial banks could create credits. notwithstanding, the results also confirmed that broad money supply and reserves had a more compelling impact on credit creation compared to any other monetary policy instrument and thus, recommended that effective monetary policy operations is necessary in order to be able to control the available credits that commercial banks make available to the real sector. on the contrary, hwa (2015) carried out a study on the transmission of financial stress and its interactions with monetary policy responses in asian-5 economies (indonesia, malaysia, philippines, thailand and singapore) and the us. the study suggested that financial stress negatively influenced the real economy. however, this diminished gradually over the long run. the study also found out that shocks to monetary policy had a significant influence on output gradually and over the long run. effiong, esu, and chuku (2017) carried out an empirical investigation to check whether financial development influenced the effectiveness of monetary policy on output and inflation in africa from the period of 1990 to 2015, using a panel data set of 39 african countries. the study found a weak influence of financial development on monetary policy effectiveness in africa. furthermore, the results showed no relationship between financial development and output growth but a negative relationship between financial development and inflation only at their contemporaneous levels. 3. methodology in order to examine the impacts of financial development indicators and their interactions with the policy rate on each transmission channel of monetary policy, the ardl model proposed by pesaran et al. (2001) was formulated, and this can be expressed as below: 1 1 2 1 3 1 4 1 1 0 0 0 * * p p p p t j t j j t j j t j j t j t t t t t j j j j k k fd mpr fd dv k fd mpr fd dv                                       (1) asian journal of economics and empirical research, 2020, 7(1): 74-90 78 © 2020 by the authors; licensee asian online journal publishing group equation 1 denotes the unrestricted version of ardl specification which models financial development and its interaction with the policy rate on each transmission channel of monetary policy. where is the difference operator; the drift component, is the white noise,  are the long-run multiplier, and kt represents interest rate channel, exchange rate channel, credit channel, asset price channel and expectation’s channel in each case. monetary policy rate was used as proxy for the interest rate channel, exchange rate was used as proxy for the exchange rate channel, log of private sector credit was used as proxy for the credit channel, the log of all share index was used as proxy for the asset price channel, while consumer price index was used as proxy for the expectation channel. furthermore, as a deviation from other studies that used money supply or private sector credit to gdp ratio to denote financial sector development, this study develops broader ways of measuring financial sector development. thus, banking sector development, capital market development, bond market development as well as financial market liberalization was used to represent financial sector development. in addition, dv is used to capture structural breaks in the modelling framework. also, fd*mpr is meant to capture the interactive effects between financial development and the policy rate. these were with the view of capturing the interactions between financial development and monetary policy as these may have policy implications on the transmission channels of monetary policy. 4. analysis and presentation of results this paper applied quarterly data series from 1986 to 2017 on broad money supply, debt stock, stock market capitalization, stock market value traded, total deposit money bank’s asset, total financial assets, private sector credit, inflation rate, monetary policy rate, exchange rate, all share index and real output. these data were sourced from the central bank of nigeria (2017) while data on financial openness was sourced from chinn and ito (2017). the descriptive statistic results in table 1 showed that the mean and median values lie within their maximum and minimum values showing a good level of consistency. furthermore, financial efficiency displays the least variability with a standard deviation of 0.05, whereas, the skewness statistics revealed that all the variables were positively skewed except for banking development by size and financial liberalization. the kurtosis of nine of the variables included in the analysis (bsda, cmda, cmds, feff, bmd, int lcch, exc and iec) exceeds three, meaning that the series follows a leptokurtic distribution. this means that the series are greatly peaked relative to the normal distribution (mesokurtic distribution). on the contrary, bsds, flo and lasp follows a platykurtic distribution, as their values are less than three, which implies that their distribution is less peaked relative to the normal distribution. finally, the correlation matrix results in table 2 showed that each financial development indicator were weakly correlated to each channel of monetary policy, which implies that the evidence of serial correlation was found to be weak among the observed variables. since this paper incorporated structural breaks within the framework, then the zivot and andrew (1992) and perron (2006) unit root test were adopted to test the unit root properties of the series. the results in table 3 indicate that the variables were a mix of being stationary in their level and differenced form. the bound test result was established in table 4 in order to investigate if there was a movement from the short to long run. table 4 showed that at 5% significance level, there was a movement from the short run to the long run on all financial development indicators on interest rate channel, while the only movements to the long run in the credit channel are from banking sector development by activity measure and bond market innovations. from exchange rate channel, there was no movement from the short to long run, while the asset price result displayed in table 4 showed that capital market development by size and financial efficiency were the only variables to show a long run movement. finally, the expectations channel showed that there were long run movements on all financial development indicators except for financial liberalization. the implication of this result is that co-integration exists when there are movements from the short run to the long run. 4.1. banking sector development and monetary transmission mechanism since the bound test results has been estimated and verified, the next task is to estimate the ardl model. the analyses of the banking sector results were informed by two separate analysis – banking sector development according to size and banking sector development according to activity. the paper first discusses the results of banking sector development according to size. from table 5, the previous lags of the dependent variable influenced interest rates in the current period. furthermore, the interest rate channel result proved that the banking development by size in the current period does not significantly affect interest rate channel. furthermore, the current and third quarter policy rate significantly affect interest rate channel. also, when the policy rate interacts with bank development by size, it significantly influenced interest rate channel. finally, the result of the interaction between bank size and monetary policy displays an overshooting interest rate pass-through. the interpretation of this outcome is that bank assets are highly generated compared to other institutions within the financial system. the implication of this result is that a bigger bank size leads to a higher level of financial intermediation; however, banks would have less influence on their deposits and lending. these outcomes are in consonance with previous results such as singh et al. (2007) for developed countries and lerskullawat (2014) for developing countries. asian journal of economics and empirical research, 2020, 7(1): 74-90 79 © 2020 by the authors; licensee asian online journal publishing group table-1. descriptive characteristics. descriptive statistics bsda bsds cmda cmds feff bmd flo int lcch exc lasp iec mean 17.0830 0.8761 1.6005 14.0204 0.0653 7.2867 -1.0425 14.0954 7248.346 96.2482 15964.01 19.1267 median 4.6799 0.9011 0.1213 2.9575 0.0530 2.6084 -0.7119 13.5000 873.9359 114.5131 10873.77 11.3500 max 80.7425 1.2538 11.9829 92.9443 0.2570 33.4598 -0.5838 26.7000 49304.08 305.9333 60952.95 73.1000 min 0.4064 0.5293 0.0019 0.1016 0.0061 0.4245 -2.0771 6.0000 14.8000 1.0016 138.4656 2.1379 sd 22.0318 0.1821 2.7706 21.2255 0.0489 8.7963 0.5451 3.8445 12925.44 79.0033 15117.83 17.8358 skew 1.3370 -0.0952 2.0981 1.8704 1.1623 1.3965 -0.8504 0.5224 2.1762 0.6121 0.7859 1.5410 kurt 3.3834 2.1794 6.8319 6.0643 4.6740 3.8826 1.9117 4.3081 6.688918 3.0420 2.8329 4.0263 j-bera 38.9199 3.7849 172.2183 124.7128 43.7663 45.7569 21.7458 14.9465 173.6090 8.0016 13.3241 56.2737 prob 0.0000 0.1507 0.0000 0.0000 0.0000 0.0000 0.0000 0.0006 0.0000 0.0183 0.0013 0.0000 sum 2186.626 112.1434 204.8697 1794.611 8.3618 932.6985 133.443 1804.211 927788.3 12319.78 2043393. 2448.221 ssd 61645.94 4.2099 974.8960 57216.25 0.3040 9826.555 37.7341 1877.057 2.12e+10 792673.0 2.90e+10 40400.51 obs 128 128 128 128 128 128 128 128 128 128 128 128 note: bsds – bank size, bsda – bank activity, cmds – capital market size, cmda – capital market activity, feff – financial market efficiency, bmd – bond market development, flo – financial liberalization, int – interest rate, exc – exchange rate, cch – private credits, asp – asset prices, iec – inflation expectations. asian journal of economics and empirical research, 2020, 7(1): 74-90 80 © 2020 by the authors; licensee asian online journal publishing group table-2. correlation matrix. variables int cch exc asp iec bsds -0.52757 0.218535 -0.0555 -0.03021 0.067763 bsda -0.41731 0.104568 0.413315 -0.03981 -0.36691 cmds -0.4678 0.006795 0.316772 -0.06015 -0.35624 cmda -0.41559 0.05645 0.306046 0.023556 -0.32569 feff -0.3408 -0.05731 0.29849 0.031713 -0.35213 bmd -0.32884 0.057431 0.38578 -0.0744 -0.35968 flo -0.42133 0.423784 0.023033 0.04434 -0.24251 table-3. unit root test – zivot andrews and perron test. variables test level t-stats break decision bsds za -3.3339 2011q2 i(1) perron -3.358 2011q1 i(1) bsda za -3.5094 2013q1 i(1) perron -4.8022 2013q1 i(1) cmds za -3.3086 2013q1 i(1) perron -4.0571 2013q1 i(1) cmda za -3.2429 2003q3 i(1) perron -3.7189 2013q1 i(1) feff za -3.9923 2013q1 i(1) perron -4.2137 2013q1 i(1) bmd za -3.4493 2013q1 i(1) perron -5.1869 2013q1 i(1) flo za -4.2539 1997q3 i(1) perron -4.6028 1997q1 i(1) int za -4.1805 2004q1 i(1) perron -3.7267 2003q4 i(1) cch za -2.0832 2013q1 i(1) perron -1.1013 2013q1 i(1) exc za -1.5569 1999q1 i(1) perron -1.646 2013q1 i(1) asp za -4.4876 2003q2 i(1) perron -5.0372 2008q1 i(1) iec za -5.4576 1996q1 i(0) perron -5.637 1995q4 i(0) note: the za critical value with intercept are -5.34(1%), -4.93(5%) and -4.58(10%). the perron critical value with intercept are -5.92(1%), -5.23(5%) and -4.92(10%). ***, ** and * denote significance at 1%, 5% and 10% levels, respectively. table-4. bound test result. f-statistic int rate credit exc rate asp exp lower(5%) 3.79 3.79 3.79 3.79 3.79 upper(5%) 4.85 4.85 4.85 4.85 4.85 bsds 13.75 1.92 0.87 0.98 6.78 bsda 14.14 4.95 1.08 1.25 5.11 cmds 14.72 1.85 1.32 16.44 5.11 cmda 14.63 1.83 1.19 1.79 6.67 feff 15.43 1.97 1.06 6.05 6.33 bmd 14.33 5.43 1.28 1.06 5.11 flo 14.65 1.27 0.93 1.09 3.73 the interpretation of the cointegrating equation is that the coefficient has to be negative and its probability value has to be significant for there to be a movement to the long run. based on the analysis, the adjustment speed towards equilibrium is approximately 37%, meaning that it is adjusting at a pace of 37% quarterly towards equilibrium. for the credit channel, the result showed that the size measure of the banking sector and its interaction term does not significantly affect the credit channel in the short run for nigeria. however, the structural break date significantly influenced this channel. this implies that the rise in money supply, domestic credits to government and private sectors and investor confidence in the stock market due to its strong performance during the period led to key improvements in the credit channel of monetary policy. the error correction term however was in line with a priori since it has a negative sign and was statistically significant. these results are not in line with previous results such as singh et al. (2007); visco (2007) and aysun et al. (2012) for developed countries and claus and smith (1999); aysun et al. (2012); lerskullawat (2014) for developing countries. for exchange rate channel, the size measure of bank development does not significantly influence the exchange rate channel. however, when it interacts with the policy rate, it significantly improves the effect of bank size on exchange rate channel. hence, this result confirms that the size measure of banks leads to an appreciation in exchange rate. this result is in line with theory since a bigger bank size leads to a higher level of financial intermediation and a better opportunity for banks to obtain loans even from international sources and for their product offerings to be available at the international market at favorable exchange rate. therefore, developments in asian journal of economics and empirical research, 2020, 7(1): 74-90 81 © 2020 by the authors; licensee asian online journal publishing group bank size can be used as a tool to improve exchange rate management, which in turn strengthens exchange rate channel in the short run, since exchange rate channel facilitates business and investments across borders. for asset price channel, the lag of the dependent variable also significantly influences asset prices in the short term. furthermore, bank size development significantly affects asset prices positively. the implication of this result is that banking sector development by size leads to a higher level of financial intermediation and thus, reduces over dependence of capital market firms sourcing funds internally since these firms can source funds externally by issuing equity or debt instruments at a lower funding and agency cost. moreover, when the policy rate interacts with bank size development, it also significantly influences asset prices at 5% significance level. this result is in line with a priori, since a higher level of bank size implies a high level of financial intermediation and reduces over dependence of capital market firms sourcing funds internally since more funds can be generated by issuing equity or debt instruments in the short run. these outcomes are also in consonance with previous results such as singh et al. (2007); visco (2007) and aysun et al. (2012) for developed countries and and claus. and smith (1999); aysun et al. (2012); lerskullawat (2014) for developing countries. for inflation expectations channel, the results from table 5 showed that banking sector development and its interaction with the policy rate does not influence inflation expectations in the short period. however, the structural break dates of first quarter 1991 and 1996 affected inflation expectations. this implies that the financial market deregulation policies of 1991 improved inflation expectations, while the exchange rate deregulation policy of 1996 significantly reduced inflation expectations in the short period. the error correction term however was in line with the theoretical expectation since it was significant with the appropriate sign. in the long term, the results of the impact of banking sector development and its interaction term in table 6 does not significantly improve interest rate channel. however, the policy rate significantly improved the interest rate channel of monetary policy in the long run. therefore, a unit increase in monetary policy rate improves this channel by approximately 1.6 units. for inflation expectations channel, the result showed that bank size and its interaction term does not significantly influence inflation expectations in the long run. however, the financial market liberalization polices of 1991 significantly improved inflation expectations, while the deregulation policies of 1996 significantly reduced inflation expectations in the long run for nigeria. the diagnostic test models have a very high adjusted r2, which indicates our result is robust enough since it indicates that the independent variables greatly explained the dependent variable, while the serial correlation and homoscedasticity test showed that the models are not serially correlated and are homoscedastic. table-5. short run result of the banking sector development by size. variable int cch exc asp iec lag of dependent variable (-1) 0.3146 0.4959 (0.0001)*** (0.0000)*** lag of dependent variable (-2) 0.2211 (0.0094)*** d(bsds * mpr) 1.0848 -131.0 6.4817 -3932 0.3727 (0.0179)** (0.5664) (0.0010)*** (0.0436)** (0.6838) d(bsds) -9.2031 2779 -3.498221 69196 -2.2378 (0.1968) (0.4083) (0.8382) (0.0140)** (0.8618) d(mpr) -0.8100 76.79 -4.355635 -0.1904 (0.0205)** (0.7082) (0.0059)*** (0.8134) d(mpr(-3)) -0.2067 (0.0218)** du_2005q1 0.3102 (0.6662) du_2011q4 0.2557 (0.7040) du_2013q2 3508 (0.0009)*** du_2008q2 356.2 (0.6016) du_1991q1 6.0736 (0.0341)** du_1996q1 -10.5961 (0.0062)** ect(-1) -0.373889 -0.0632 0.019717 -0.031254 -0.2503 (0.0000)*** (0.0327)** (0.2174) (0.1266) (0.0000)*** note: ***, ** and * denote significance at 1%, 5% and 10% levels respectively. for banking sector development by activity, the results in table 7 showed that bank activity in the current period does not significantly affect interest rate channel; however, the previous quarter activity measure of banking sector development significantly affects interest rate channel. the interaction between bank activity and monetary policy showed an incomplete lower degree of pass-through for nigeria. by implication, a higher activity value indicates improvements in banking sector activity in terms of deposits, savings and loan services. therefore, this reduces the elasticity of demand for deposit and loans leading to a lower degree of interest rate pass-through. for the credit channel, the previous lags of the dependent variable influenced the credit channel in the current period. furthermore, the result showed that the third lag of bank activity measurement and the first lag of its asian journal of economics and empirical research, 2020, 7(1): 74-90 82 © 2020 by the authors; licensee asian online journal publishing group interaction term significantly affect the credit channel in the short period for nigeria. by implication, a higher activity value indicates improvements in banking sector activity in terms of services provided to customers, which will encourage deposits, savings and loan facilities and thus reduce the impact of monetary policy rate on the bank lending channel. this outcome is in consonance with previous results such as singh et al. (2007); visco (2007) and aysun et al. (2012) for developed countries and claus. and smith (1999); aysun et al. (2012); lerskullawat (2014) for developing countries. finally, the cointegrating equation and the structural break date significantly influenced this channel as earlier indicated under the size measure. table-6. long run result of the banking sector development by size. variable int cch exc asp iec bsds * mpr -0.6787 -2073 -10.82 -125820 1.489091 (0.2782) (0.5720) (0.8620) (0.2120) (0.6784) bsds 4.0006 43977 177.42 2213945 -8.9402 (0.6918) (0.4197) (0.8380) (0.1836) (0.8609) mpr 1.554 1215 5.6657 -0.7606 (0.0056)*** (0.7106) (0.9180) (0.8114) du_2005q1 0.8297 (0.6726) du_2011q4 0.6839 (0.6986) du_2013q2 55506 (0.0002)*** du_2008q2 11396 (0.5223) du_1991q1 24.26 (0.0160)** du_1996q1 -42.3323 (0.0006)*** c -4.5412 -25874 -130.3 19339 28.724504 (0.6162) (0.6171) (0.8780) (0.0860) (0.5528) adj. r2 0.8914 0.9758 0.9833 0.9718 0.8216 serial correlation 0.2945 0.0992 0.2283 0.5739 0.6021 heteroscedasticity 0.0565 0.9381 0.8584 0.2017 0.8898 note: ***, ** and * denote significance at 1%, 5% and 10% levels respectively. table-7. short run result of the banking sector development by activity. variable int cch exc asp iec lag of dependent variable (-1) 0.3025 -0.0585 0.5769 (0.0003)*** (0.5048) (0.0000)*** lag of dependent variable (-2) 0.1722 -0.1708 (0.0471)** (0.0545)* d(bsda * mpr) 0.0012 1.8679 -0.0116 -17.2671 -0.0027 (0.7590) (0.6712) (0.3427) (0.1696) (0.7567) d(bsda(-1) * mpr(-1)) 0.0072 7.7121 (0.0721)* (0.0870)* d(bsda(-2) * mpr(-2)) 0.0025 (0.0776)* d(bsda) -0.0391 61.6602 0.0906 304.01 0.0342 (0.5411) (0.3994) (0.5745) (0.0502)* (0.7673) d(bsda(-1)) -0.1325 (0.0371)** d(bsda(-3)) 67.6776 (0.0140)** d(mpr) 0.0109 -22.9725 0.3691 0.1865 (0.9110) (0.7377) (0.3164) (0.4706) d(mpr(-3)) -0.2035 (0.0265)** du_2005q1 0.2725 (0.7097) du_2011q4 0.7964 (0.2854) du_2013q2 8801 579.45 (0.0000)*** (0.5157) du_2008q3 664.26 (0.3875) du_1996q1 -5.1165 (0.0143)** ect(-1) -0.3818 -0.1667 0.0258 -0.0484 -0.1938 (0.0000)*** (0.0000)*** (0.0711)* (0.0135)** (0.0002)*** note: ***, ** and * denote significance at 1%, 5% and 10% levels, respectively. asian journal of economics and empirical research, 2020, 7(1): 74-90 83 © 2020 by the authors; licensee asian online journal publishing group for exchange rate channel, the activity measure of banks does not significantly influence the exchange rate channel. this result was also confirmed when the activity measure interacted with the policy rate. for asset price channel, the lag of the dependent variable also significantly influenced asset prices in the short term. furthermore, the activity measure of banks also influences asset prices positively. the implication of this result is that banking sector development by activity leads to higher levels of financial intermediation and thus, reduces over dependence of capital market firms sourcing funds internally since these firms can source funds externally by issuing equity or debt instruments at a lower funding and agency cost. for inflation expectations channel, the results from table 7 showed that banking sector development by activity and its interaction with the policy rate does not significantly affect inflation expectations in the short period. however, the structural break date of 1996 significantly affected inflation expectations. this implies that the financial market deregulation policies of 1996 significantly reduced inflation expectations in the near term. the error correction term was also in line with theoretical expectation. in the long term, the interaction term as displayed in table 8 significantly weakened the interest rate channel. furthermore, the policy rate significantly improved the interest rate channel of monetary policy in the long run. this result is in line with a priori since the interaction term is theoretically expected to weaken interest rates. by implication, a higher activity value indicates improvements in banking sector activity in terms of services provided to customers, leading to lesser levels of interest rate pass-through. for inflation expectations channel, the result showed that banking sector development by activity and its interaction term does not significantly influence inflation expectations in the long term. however, the structural break date of 1996 significantly affected inflation expectations. this implies that the financial market deregulation policies of 1996 significantly reduced inflation expectations in the long run for nigeria. for the credit channel of monetary policy, the results of banking sector development by activity and its interaction term where insignificant on the credit channel. furthermore, the structural break date significantly influenced this channel. table-8. long run result of the banking sector development by activity. variable int cch exc asp iec bsda * mpr -0.0142 -20.4102 0.45 -964.96 -0.0139 (0.0352)** (0.1652) (0.3570) (0.0552)* (0.7576) bsda 0.1442 316.77 -3.51 13817 0.1765 (0.1212) (0.1070) (0.5820) (0.0391)** (0.7684) mpr 1.3069 -137.78 -14.3 0.9628 (0.0000)*** (0.7381) (0.3180) (0.4776) du_2005q1 0.7138 (0.7153) du_2011q4 2.0861 (0.2566) du_2013q2 52782 11975 (0.0000)*** (0.5189) du_2008q2 13728 (0.3339) du_1996q1 -26.41 (0.0033)** c -5.4433 2889 170.55 12839 23.91 (0.1284) (0.6637) (0.4240) (0.0277)** (0.2796) adj. r2 0.8846 0.9783 0.9818 0.9728 0.8164 serial correlation 0.2619 0.1484 0.5381 0.9897 0.4356 heteroscedasticity 0.5324 0.9924 0.9181 0.2017 0.8360 note: ***, ** and * denote significance at 1%, 5% and 10% levels, respectively. 4.2. capital market development and monetary transmission mechanism the analyses of the capital market and monetary transmission mechanism were informed from three separate analyses which are the size measure, activity measure and efficiency measure. the first discussion borders around the size measure. from table 9, the previous lags of the dependent variable influenced current interest rate, while the third lag of monetary policy rate also influenced interest rates positively. however, the interest rate channel result proved that capital market size and its interaction term does not significantly influence interest rate channel. the cointegrating equation was however significant, implying that 34% of the short run errors are corrected in the long term. for the credit channel, the result showed that the size measure of capital market development and its interaction term does not influence the credit channel in the near term. however, the structural break date significantly influenced this channel. the error correction term was also in line with theoretical expectation. for exchange rate channel, capital market size does not significantly influence the exchange rate channel. this result was also confirmed when the size measure interacted with the policy rate. for inflation expectations channel, the results from table 9 showed that capital market size and its joint interaction with monetary policy does not significantly affect inflation expectations in the near term. however, the structural break date of 1996 significantly affected inflation expectations. this implies that the financial market deregulation policies of 1996 significantly reduced inflation expectations in the near term. the error correction term was also in line with theoretical expectation. for asset price channel, the lag of the dependent variable significantly influenced asset prices in the near term. furthermore, the size measure of capital market development significantly influenced asset prices. the implication of this result is that capital market size leads to a higher degree of financial disintermediation and thus, reduces over dependence of capital market firms sourcing funds internally since these firms can source funds externally by issuing equity or debt instruments at a lower funding and agency cost. this result is in line with a priori, since a greater capital market size indicates higher levels of disintermediation. the error correction term even though asian journal of economics and empirical research, 2020, 7(1): 74-90 84 © 2020 by the authors; licensee asian online journal publishing group negative, was statistically insignificant. this means that a movement to the long term may not be possible since the two conditions for a movement to occur was not satisfied. the results of the activity and efficiency measure of capital market development were also in line with the size measure of capital market development in the short run as verified from tables 11 and 13 (see appendix). table-9. size measure of capital market development short run result. variable int cch exc asp iec lag of dependent variable (-1) 0.3124 0.2757 (0.0002)*** (0.0021)*** lag of dependent variable (-2) 0.1508 (0.0808)* d(cmds * mpr) -0.0019 -1.4487 -0.0136 -44.66 -0.0036 (0.4649) (0.6092) (0.3654) (0.0000)*** (0.7368) d(cmds(-2) * mpr(-2)) -26.27 (0.0089)*** d(cmds(-3) * mpr(-3)) -8.7837 (0.0002)*** d(cmds) 0.0081 23.3271 0.0713 693.71 0.0361 (0.8119) (0.4935) (0.6835) (0.0000)*** (0.7716) d(cmds(-1)) -227.61 (0.0594)* d(cmds(-2)) 250.35 (0.0277)** d(mpr) 0.0279 -24.7336 0.2327 5.8013 0.1699 (0.7583) (0.7031) (0.4979) (0.9169) (0.4789) d(mpr(-3)) -0.1639 (0.0697)* du_2005q1 0.7742 (0.3047) du_2011q4 -0.1332 (0.8561) du_2013q2 3574 (0.0010)*** du_2009q3 771.55 (0.1051) du_1996q1 -5.0179 (0.0149)** ect(-1) -0.3400 -0.0614 0.0259 -0.0087 -0.1941 (0.0000)*** (0.0387)** (0.0639)* (0.6224) (0.0002)*** note: ***, ** and * denote significance at 1%, 5% and 10% levels, respectively. table-10. size measure of capital market development long run result. variable int cch exc asp iec cmds * mpr -0.0057 -23.577 0.5268 -3537 -0.0185 (0.4617) (0.6219) (0.3582) (0.6585) (0.7381) cmds 0.0237 379.64 -2.753 83199 0.1861 (0.8112) (0.5119) (0.6775) (0.6369) (0.7730) mpr 1.1971 -402.53 -8.9903 670.12 0.8756 (0.0000)*** (0.7013) (0.4752) (0.9269) (0.4869) du_2005q1 2.2769 (0.3346) du_2011q4 -0.3917 (0.8576) du_2013q2 58160 (0.0003)*** du_2009q3 89124 (0.5747) du_1996q1 -25.8566 (0.0033)*** c -3.9144 8844 82.7958 16074 25.27 (0.2941) (0.5950) (0.6821) (0.8609) (0.2217) adj. r2 0.8808 0.9758 0.9819 0.9833 0.8164 serial correlation 0.3844 0.6726 0.6206 0.2764 0.4293 heteroscedasticity 0.0742 0.9303 0.9161 0.0069 0.8354 note: ***, ** and * denote significance at 1%, 5% and 10% levels, respectively. in the long term, the interaction between monetary policy and capital market size were insignificant as confirmed in table 10. however, the signs confirmed the a priori expectation between the variables in the long run. the policy rate significantly improved interest rate in the long term. for inflation expectations channel, the result showed that capital market size and its interaction term does not significantly influence inflation expectations in the long run. despite the insignificant result, the result still confirms the positive relationship between capital asian journal of economics and empirical research, 2020, 7(1): 74-90 85 © 2020 by the authors; licensee asian online journal publishing group market sector by size measure and inflation expectations in the long run. however, the structural break date of 1996 significantly affected inflation expectations. this implies that the financial market deregulation policies of 1996 significantly reduced inflation expectations in the long run for nigeria. the long run results of the activity and efficiency measure of capital market development were also in line with the results earlier generated on the size measure of capital market development as verified in tables 12 and 14 (see appendix). 4.3. bond market development and monetary transmission mechanism from table 15, the previous lags of the dependent variable influenced interest rates in the current period, while the third lag of monetary policy also influenced interest rates. the interest rate channel result proved that bond market development and its interaction term significantly influence interest rate. furthermore, the interaction term confirms the positive expectation between bond market development and interest rate channel in the near term. by implication, a rise in this measure depicts improvements in fund services available to banks within the financial system, thereby leading to an improvement in banks risk diversification and liquidity, thereby strengthening interest rate channel in the short term. this outcome follows a priori on the relationship between the two variables. furthermore, the coefficient of the adjustment speed is approximately 39%, meaning that it is adjusting at a pace of 39% quarterly towards equilibrium. for the credit channel, the second lag of the dependent variable also significantly influenced the credit channel. furthermore, the first and third lag of bond market development and first lag of the interaction term significantly influenced the credit channel in the near term. by implication, improved developments within the equity and bond space leads to better prospects to invest in new security instruments and consequently, improved diversification of assets, hence, strengthening the credit channel in the near term. furthermore, the structural break date significantly influenced this channel. the error correction term was also in line with theoretical expectation. for exchange rate channel, bond market development does not significantly influence the exchange rate channel. this result was also confirmed when bond market development interacted with the policy rate. table-15. bond market development short run result. variable int cch exc asp iec lag of dependent variable (-1) 0.3046 -0.0612 0.5406 (0.0003)*** (0.4814) (0.0000)*** lag of dependent variable (-2) 0.1724 -0.1686 (0.0477)** (0.0547)* d(bmd* mpr) 0.0061 -1.6973 -0.0255 -57.327 -0.0063 (0.6038) (0.8924) (0.4565) (0.1300) (0.7972) d(bmd(-1) * mpr(-1)) 0.0199 40.8191 (0.0835)* (0.0144)** d(bmd(-2) * mpr(-2)) 0.0068 -13.4204 (0.0422)* (0.3919) d(bmd(-3) * mpr(-3)) -19.0588 (0.1443) d(bmd) -0.1692 277.1392 0.1808 882.959 0.0850 (0.3919) (0.2248) (0.7014) (0.0657)* (0.8018) d(bmd(-1)) -0.3708 -615.695 54.729 (0.0585)* (0.0405)** (0.5153) d(bmd(-2)) 218.712 -131.111 (0.4500) (0.1147) d(bmd(-3)) 509.958 -149.986 (0.0327)** (0.0687)* d(mpr) 0.0075 49.670 0.3727 -50.8251 0.1866 (0.9419) (0.5249) (0.3466) (0.5181) (0.5020) d(mpr(-3)) -0.2210 (0.0160)** du_2005q1 0.1002 (0.8939) du_2011q4 1.0301 (0.1945) du_2013q2 10190 (0.0000)*** du_2008q2 -435.340 (0.6077) du_2012q4 2093.44 (0.0417)** du_1996q1 -5.1502 (0.0134)** ect(-1) -0.3942 -0.1901 0.0257 -0.0488 -0.1938 (0.0000)*** (0.0000)*** (0.0693)* (0.0447)** (0.0002)*** note: ***, ** and * denote significance at 1%, 5% and 10% levels, respectively. asian journal of economics and empirical research, 2020, 7(1): 74-90 86 © 2020 by the authors; licensee asian online journal publishing group for asset price channel, the lag of the dependent variable significantly influenced asset prices in the short run. furthermore, bond market development and its third lag influenced asset prices. the implication of this result is that bond market development improved equity and bond market, and this led to better prospects to invest in new security instruments and consequently, improved asset prices, thereby improving the performance of the capital market. also, the break date of 2012 fourth quarter significantly improved asset prices. finally, the error correction term as expected follows a priori expectation. for inflation expectations channel, the results from table 15 showed that bond market development and its interaction with monetary policy does not influence inflation expectations in the near term. however, the structural break date of 1996 significantly affected inflation expectations. this implies that the financial market deregulation policies of 1996 significantly reduced inflation expectations in the near term. the error correction term was also in line with a priori. in the long term as presented in table 16, the result of bond market development, monetary policy and their interaction were significant on interest rate channel. by implication, a rise in this measure depicts improved avenues to access funds within the financial system, thereby leading to an improvement in banks risk diversification and liquidity. consequently, the interest rate channel is being strengthened in the long term for nigeria. this result is in line with the theoretical expectation. for the credit channel, bond market development significantly influenced the credit channel in the near term with the correct sign. by implication, improved developments within the equity and bond space leads to improved avenues to invest in new security instruments and consequently, improved diversification of assets, hence, strengthening the credit channel in the long term. these results correspond with earlier works like singh et al. (2007); visco (2007) and aysun et al. (2012) for developed countries and claus. and smith (1999); aysun et al. (2012); lerskullawat (2014) for developing countries. furthermore, the structural break date significantly influenced this channel. for inflation expectations channel, the result showed that bond market development and its interaction term does not significantly influence inflation expectations in the near term. however, the structural break date of 1996 significantly affected inflation expectations. this implies that the financial market deregulation policies of 1996 significantly reduced inflation expectations in the long run for nigeria. table-16. bond market development long run result. variable int cch exc asp iec bmd* mpr -0.0456 -55.9741 0.9912 -3078.43 -0.0323 (0.0204)** (0.1312) (0.4625) (0.0874)* (0.7977) bmd 0.5116 1015.5 -7.0366 47563.88 0.4386 (0.0690)* (0.0458)** (0.7029) (0.0728)* (0.8025) mpr 1.3858 261.31 -14.505 -1041.9 0.9628 (0.0000)*** (0.5238) (0.3416) (0.4613) (0.5077) du_2005q1 0.2541 (0.8946) du_2011q4 2.6129 (0.1619) du_2013q2 53607 (0.0000)*** du_2008q2 -8924.4 (0.6443) du_2012q4 42915 (0.1103) du_1996q1 -26.5793 (0.0030)*** c -6.4641 -4259.5 165.975 30564 23.9454 (0.0759)* (0.5264) (0.4674) (0.1613) (0.3074) adj. r2 0.8866 0.9788 0.9818 0.9727 0.8163 serial correlation 0.3104 0.1047 0.5439 0.7017 0.4341 heteroscedasticity 0.6217 0.9532 0.9186 0.2017 0.8349 note: ***, ** and * denote significance at 1%, 5% and 10% levels, respectively. 4.4. financial market liberalization and monetary transmission mechanism from table 17, the previous lag of the dependent variable influenced interest rates in the present period, while the policy rate also influenced interest rates. the interest rate channel result proved that financial market liberalization and the third lag of the interaction term significantly influenced interest rate channel. furthermore, the interaction term confirms the positive expectation between the interaction term and interest rate channel, while the result also confirms the negative relationship between financial liberalization and interest rate channel in the near term. by implication, the relaxation of financial market restrictions will improve business activities through investments in capital market instruments. this implies more avenues for banks to source for funding thereby weakening interest rate channel. however, for the interaction term, the liberalization in capital account and banking sector deregulation leads to improvements within foreign exchange management and the credit risk process, improving banks’ ability to provide liquidity within the financial system. this result provides the impetus when financial market liberalization interacts with the policy rate. the results of financial liberalization and the interaction term are in line with a priori since this measure can have a positive or negative outcome on interest rate in the near term. the cointegrating equation’s interpretation is that its coefficient has to be negative and its probability value has to be significant for there to be a movement to the long term. based on the analysis, the coefficient of the adjustment speed is approximately 38%, meaning that it is adjusting at a pace of 38% quarterly towards equilibrium. therefore, it can be concluded that the error correction term is in line with a priori expectation. for the credit channel, financial market liberalization and its interaction term does not significantly influence the credit channel in the near term. for exchange rate channel, the result is also insignificant, and this shows that asian journal of economics and empirical research, 2020, 7(1): 74-90 87 © 2020 by the authors; licensee asian online journal publishing group financial market liberalization and its interaction term does not improve the exchange rate process. by implication, financial market liberalization and its interaction term has not improved the credit risk and foreign exchange process for nigeria in the near term. the asset price channel also followed suite since financial market liberalization and its interaction with monetary policy were not found to significantly improve the asset price channel. by implication, the relaxation of financial market restrictions did not improve business activities within the capital market space. the error correction terms were also statistically insignificant for the three channels of monetary policy. for inflation expectations channel, the results from table 17 showed that the third lag of financial market liberalization influenced inflation expectations in the short run. however, when financial liberalization interacted with the policy rate, the result became insignificant. by implication, the relaxation of market restrictions improved business activities within the financial system via issuing capital market securities and investments. this reduces inflation expectations in the near term for nigeria. the error correction term was also in line with theoretical expectation. finally, table 18 presented the long-term result. for interest rate channel, the result of financial market liberalization, the policy rate and their interaction term were significant. by implication, the liberalization in capital account and banking sector deregulation leads to improvements in the credit risk process and foreign exchange management, and this improves the ability of banks in providing financial system liquidity, thus strengthening interest rate channel in the long term. however, when the policy rate interacts with financial market liberalization, the implication of the result is that the removal of restrictions within the financial system will improve business activities through investments in financial securities. this implies more avenues for banks to source for funding thereby weakening interest rate channel in the long term for nigeria. finally, the other channels were not cointegrated as verified through the bound test procedure, which implies that their long run results were insignificant for nigeria. table-17. financial liberalization short run result. variable int cch exc asp iec lag of dependent variable (-1) 0.2889 0.5082 (0.0004)*** (0.0000)*** d(flo* mpr) 0.1324 -24.8998 0.2007 454.608 -0.1011 (0.1294) (0.7879) (0.2253) (0.7518) (0.3894) d(flo(-1) * mpr(-1)) -0.0013 (0.9869) d(flo(-2) * mpr(-2)) 0.0556 (0.4448) d(flo(-3) * mpr(-3)) 0.1300 (0.0201)** d(flo) -4.6347 640.015 2.8736 -8065 12.6140 (0.0621)* (0.6535) (0.7952) (0.7533) (0.2486) d(flo(-1)) 0.6838 9.6719 (0.8597) (0.3788) d(flo(-2)) -3.3224 15.4808 (0.1680) (0.1571) d(flo(-3)) -39.4902 (0.0004)*** d(mpr) 0.1897 -45.1689 0.5479 -24.0212 0.0181 (0.0525)* (0.6964) (0.1355) (0.7529) (0.9472) ect(-1) -0.3838 0.0193 0.0045 -0.0311 -0.1133 (0.0000)*** (0.2450) (0.7925) (0.1129) (0.0276)** note: ***, ** and * denote significance at 1%, 5% and 10% levels, respectively. table-18. financial liberalization long run result. variable int cch exc asp iec flo* mpr -0.4914 1290.12 -44.716 14613 -0.8924 (0.0320)** (0.7938) (0.8192) (0.7507) (0.3100) flo 6.3909 -33161 -640.08 -259240 214.88 (0.0731)* (0.6871) (0.8460) (0.7524) (0.2055) mpr 0.4942 2340.32 -122.04 -772.13 0.1598 (0.0412)** (0.7133) (0.8040) (0.7260) (0.9477) c 5.257 -59804 584.988 31886 3.2179 (0.1171) (0.5755) (0.7701) (0.3012) (0.9037) adj. r2 0.8887 0.9738 0.9817 0.9697 0.8205 serial correlation 0.4312 0.8351 0.3481 0.5923 0.1258 heteroscedasticity 0.2246 0.9417 0.9149 0.2017 0.7759 note: ***, ** and * denote significance at 1%, 5% and 10% levels, respectively. asian journal of economics and empirical research, 2020, 7(1): 74-90 88 © 2020 by the authors; licensee asian online journal publishing group 5. conclusion and policy recommendation this paper explored the impact of financial development on monetary transmission mechanism in nigeria. based on the findings from the analyses, the paper showed that financial development indicators and their interactions with the policy rate influenced each channel of monetary policy to different degrees. banking sector indicators (size and activity measures) had more influence on the channels of monetary policy compared to capital market indicators, while financial market liberalization had the least influence on the channels of monetary policy. however, the significance of the individual financial development indicators was found to be very weak on exchange rate channel, while the influence of the financial market indicators was strongest on the interest rate channel, thereby supporting previous studies that interest rate channel is the most dominant channel of monetary policy for nigeria. consequently, financial development can be used as a tool to strengthen monetary transmission mechanism in nigeria. in light of the above, efforts must be directed by all stakeholders to ensure that financial system reforms are geared towards the strengthening and implementation of monetary policy and the channels through which monetary policies impact an economy. references adesoye, a. 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(2007). financial deepening and the monetary policy transmission mechanism. paper presented at the exchange, iv joint high-level eurosystem – bank of russia seminar, moscow, 10-12 october. http://www.cbn.gov.ng/ http://web.pdx.edu/~ito/chinn-ito_website.htm http://hdl.handle.net/10419/129686 asian journal of economics and empirical research, 2020, 7(1): 74-90 89 © 2020 by the authors; licensee asian online journal publishing group zivot, e., & andrew, d. w. k. (1992). further evidence on the great crash, the oilprice shock and the unit root hypothesis. journal of business andeconomic statistics, 10(3), 251 –270. appendix table-11. activity measure of capital market development short run result. variable int cch exc asp iec lag of dependent variable (-1) 0.3115 0.4329 0.1368 (0.0002)*** (0.0000)*** (0.1496) lag of dependent variable (-2) 0.1494 -0.1472 (0.0854)* (0.0828)* d(cmda * mpr) -0.0094 -13.3232 -0.0757 -154.09 -0.0314 (0.5457) (0.4576) (0.3894) (0.0005)*** (0.6188) d(cmda(-1) * mpr(-1)) 16.2277 90.7691 (0.1121) (0.0444)** d(cmda) 0.0421 367.2100 0.4772 3361.12 0.3539 (0.8441) (0.1236) (0.6749) (0.0000)*** (0.6698) d(cmda(-1)) -1674 (0.025)** d(mpr) 0.0199 -39.5019 0.2806 -89.3473 0.2209 (0.8245) (0.5313) (0.3988) (0.2227) (0.3550) d(mpr(-3)) -0.1626 (0.0733)* du_2005q1 0.5494 (0.4315) du_2011q4 0.0626 (0.9263) du_2013q2 4961.1611 (0.0001)*** du_2009q3 183.09 (0.7848) du_1992q2 3.5097 (0.2456) du_1997q1 -7.6060 (0.0240)** ect(-1) -0.3419 -0.0917 0.0237 -0.0368 -0.2483 (0.0000)*** (0.0049)*** (0.0852)* (0.1968) (0.0003)*** note: ***, ** and * denote significance at 1%, 5% and 10% levels, respectively. table-12. activity measure of capital market development long run result. variable int cch exc asp iec cmda* mpr -0.0276 -366.794 3.1933 1544 -0.1265 (0.5431) (0.0861)* (0.3984) (0.3120) (0.6216) cmda 0.1230 4006 -20.119 -15228 1.4254 (0.8437) (0.1314) (0.6746) (0.4020) (0.6725) mpr 1.1806 -430.9697 -11.831 -2429 0.8898 (0.0000)*** (0.5284) (0.3851) (0.3330) (0.3636) du_2005q1 1.6069 (0.4523) du_2011q4 0.1831 (0.9259) du_2013q2 54127 (0.0000)*** du_2009q3 4977 (0.7580) du_1992q2 14.1357 (0.1719) du_1997q1 -30.6335 (0.0006)*** c -3.7966 9686 134.31 50992 15.7221 (0.3040) (0.3737) (0.5197) (0.2400) (0.3519) adj. r2 0.8797 0.9763 0.9818 0.9787 0.8132 serial correlation 0.4469 0.4149 0.5242 0.3583 0.2805 heteroscedasticity 0.0984 0.7530 0.9145 0.0664 0.7438 note: ***, ** and * denote significance at 1%, 5% and 10% levels, respectively. asian journal of economics and empirical research, 2020, 7(1): 74-90 90 © 2020 by the authors; licensee asian online journal publishing group table-13. financial market efficiency short run result. variable int cch exc asp iec lag of dependent variable (-1) 0.3217 0.4780 0.1406 (0.0001)*** (0.0000)*** (0.1464) lag of dependent variable (-2) 0.1906 (0.0245)** d(fef* mpr) -0.7723 -900.13 -4.9637 13381 -0.9976 (0.3383) (0.3251) (0.2803) (0.0021)*** (0.7653) d(fef(-1) * mpr(-1)) 0.1837 7422 (0.7224) (0.1057) d(fef(-2) * mpr(-2)) 0.6573 -13484 (0.1026) (0.0014)*** d(fef) 7.9135 12073 42.6446 -159718 22.5765 (0.4611) (0.3606) (0.5072) (0.0027)*** (0.6330) d(fef(-2)) 150564 (0.0028)*** d(mpr) 0.0278 5.7090 0.5404 -25.5036 0.268988 (0.7814) (0.9462) (0.2239) (0.7301) (0.4015) d(mpr(-3)) -0.1877 (0.0359)** du_2011q4 0.7036 (0.0903)* du_2013q2 3654 (0.0009)*** du_2003q4 4049 (0.0001)*** du_2008q2 -2479 (0.0043)*** du_2012q4 1097 (0.1973) du_1992q2 3.1139 (0.2929) du_1997q2 -7.4312 (0.0297)** ect(-1) -0.4197 -0.0636 0.0241 -0.1173 -0.2352 (0.0000)*** (0.0328)** (0.0798)* (0.0002)*** (0.0004)*** note: ***, ** and * denote significance at 1%, 5% and 10% levels, respectively. table-14. financial market efficiency long run result. variable int cch exc asp iec fef* mpr -3.2571 -14162 205.887 197877 -4.2422 (0.0749)* (0.3334) (0.3115) (0.0128)** (0.7672) fef 18.8567 189962 -1769 -2294313 95.9991 (0.4607) (0.3627) (0.5194) (0.0177)** (0.6374) mpr 1.1497 89.8304 -22.41 -217.49 1.1438 (0.0000)*** (0.9462) (0.2368) (0.7253) (0.4123) du_2011q4 1.6765 (0.0788)* du_2013q2 57502 (0.0002)*** du_2003q4 34526 (0.0000)*** du_2008q2 -21136 (0.0185)** du_2012q4 9355 (0.1850) du_1992q2 13.241 (0.2258) du_1997q2 -31.5989 (0.0015)*** c -1.7462 3104 250.45 9001 10.6306 (0.5553)* (0.8831) (0.3557) (0.3800) (0.6444) adj. r2 0.8868 0.9735 0.9818 0.9771 0.8125 serial correlation 0.4754 0.6732 0.5129 0.3232 0.4228 heteroscedasticity 0.1321 0.9162 0.9189 0.4684 0.7551 note: ***, ** and * denote significance at 1%, 5% and 10% levels, respectively. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 58 © 2021 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 8, no. 2, 58-66, 2021 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2021.82.58.66 © 2021 by the authors; licensee asian online journal publishing group energy – growth nexus: a case of south asian countries saddam hussain1 chunjiao yu2 liu wan3 ( corresponding author) 1,3department of international economics & trade, business school, hubei university, wuhan, p.r. china. 2open economy research centre, business school, hubei university, wuhan, p.r. china. abstract the relationship between energy consumption and economic growth is a hot topic in today's society, and this paper aims to empirically verify the relationship between the two. this article analyzes the relation of energy consumption to economic growth in south asian countries (afghanistan, bangladesh, bhutan, india, pakistan, sri lanka, and nepal) along with the macroeconomic determinants that affect the total economic growth – foreign direct investment (fdi) growth, the consumer price index (cpi) rate and population growth – in order to avoid omitted variable bias and misleading results. the time span of this study covers the period from 1980 to 2019. to examine the significant relation of these determinants and the impact of energy consumption on economic growth, pooled regression, fixed effects, bidirectional fixed effects, random effects, and gls estimation regression models are used. the estimated results show a positive correlation between energy consumption and all other economic determinants of economic growth, except cpi, where a negative correlation was found. keywords: energy consumption, population, cpi, fdi, gdp, panel data models. jel classification: e21, j10, e31, f21, e01, c33. citation | saddam hussain; chunjiao yu; liu wan (2021). energy – growth nexusa case of south asian countries. asian journal of economics and empirical research, 8(2): 58-66. history: received: 27 may 2021 revised: 29 june 2021 accepted: 31 june 2021 published: 2 september 2021 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: the authors are grateful to the two anonymous reviewers for their kind suggestions and valuable comments. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 59 2. literature review ............................................................................................................................................................................ 59 3. an overview of energy consumption in south asia countries ............................................................................................. 60 4. methodology and data ................................................................................................................................................................... 61 5. empirical results and discussion ................................................................................................................................................ 63 6. conclusion and policies suggestion............................................................................................................................................. 64 references .............................................................................................................................................................................................. 65 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/3261 https://orcid.org/0000-0001-6078-3164 https://orcid.org/0000-0002-4979-3844 https://orcid.org/0000-0002-9171-4433 http://asianonlinejournals.com/index.php/ajeer/article/view/3261 https://orcid.org/0000-0001-6078-3164 https://orcid.org/0000-0002-4979-3844 https://orcid.org/0000-0002-9171-4433 http://asianonlinejournals.com/index.php/ajeer/article/view/3261 https://orcid.org/0000-0001-6078-3164 https://orcid.org/0000-0002-4979-3844 https://orcid.org/0000-0002-9171-4433 http://asianonlinejournals.com/index.php/ajeer/article/view/3261 https://orcid.org/0000-0001-6078-3164 https://orcid.org/0000-0002-4979-3844 https://orcid.org/0000-0002-9171-4433 http://asianonlinejournals.com/index.php/ajeer/article/view/3261 https://orcid.org/0000-0001-6078-3164 https://orcid.org/0000-0002-4979-3844 https://orcid.org/0000-0002-9171-4433 asian journal of economics and empirical research, 2021, 8(2): 58-66 59 © 2021 by the authors; licensee asian online journal publishing group contribution of this paper to the literature even though mainstream economic growth theory has paid little attention to the role of energy in economic growth, there has been a mass of literature over the past two decades that has examined the relationship between economic growth and energy consumption using data from a single country or a panel of countries. it is a stylized economic fact that there is strong interdependence and causality between economic growth and energy consumption, but the existence and direction of causality are still not clearly defined. to the best of our knowledge, no study to date has focused on south asian countries using data for the time span and using the macroeconomic determinants used in this study, so it is hoped that this study will contribute to enriching the existing literature on this subject matter. 1. introduction humans have utilized many different means and methods of acquiring energy resources in the quest for improved comfort and security and the fulfillment of human needs via progressively more complex forms. energy‟s role in bringing man out of the stone age and into the era of advanced technology is of enormous significance and cannot be ignored (riaz & stern, 1984). energy is one of the most basic tools for increasing production, enhancing factors of production (e.g., labor and capital), the augmentation of technological changes, and a way toward a brighter future in the sense of economic development in any country (vera & langlois, 2007). the dependency of economic growth and energy consumption are correlated (burney, 1995; cheng, 1995; cheng & lai, 1997). the recent upsurge in the prices of energy attenuation of on-hand resources, the exploration for substitute energy sources, and energy protection technologies have highlighted the causal relationship between energy consumption and economic development (aqeel & butt, 2001; cheng, 1995; hou, 2009; huang, hwang, & yang, 2008; payne, 2010). energy – the fundamental constituent of substantial infrastructure – is the primary reason for the success of any country‟s growth endeavors (rafindadi & ozturk, 2017). expansion of an economy is closely associated with the consumption of energy because a higher production growth rate will result in higher energy usage, and using energy more efficiently ultimately leads to economic growth (halicioglu, 2009). socioeconomic development requires focus on health, education, agriculture, manufacturing and services industries, and the overall upgrade of infrastructure, which eventually increases energy consumption (bilgen, 2014; sadorsky, 2010). as a matter of fact, the growth aptitude of developing countries, including south asian countries in a linear association, lies in the field of energy production (cabraal, barnes, & agarwal, 2005). in the case of south asia‟s developing and underdeveloped countries, with comparatively low energy resources and a high demand for energy consumption, the fundamental prerequisite is to stimulate economic growth (komal & abbas, 2015). historically, all these countries greatly depended on oil, gas and coal imports, which negatively affected their annual economic growth rate due to their huge spend on energy imports (rauf, wang, yuan, & tan, 2015). the effect of energy consumption on total economic growth (foreign direct investment, production growth, employment growth rate, etc.) has been discussed in recent energy-related economic literature. this article discusses impact of energy consumption on the economic growth in south asia. energy is the pertinent source of human advancement and social improvement, and economic growth necessitates the demand for energy due to the increase in technological development and economic expansion by increasing production. the publication on this subject matter was first presented in the late seventies by kraft & kraft (1978), who used data from 1947 to 1974 for the united states and presented the evidence in the defense of causality running from gnp to energy consumption. later on, other researchers also supported and defended their results. a very recent example is that of china, where economic development led to a higher demand for energy (he, gao, & wang, 2012). an increase in economic growth requires a huge amount of energy to be consumed. likewise, more effective energy application requires a privileged rank of economic growth (kraft & kraft, 1978). several researchers‟ analyses have explored the causal relationships between energy consumption and economic growth using employment rate, interest rate, stock valves or per capita income as a substitute for the latter. for example, in hungary, ozturk & acaravci (2010) discovered a bidirectional granger causality between economic growth and energy variables (ozturk & acaravci, 2010). similarly, the vector error correction model presented by belloumi showed the causal relationship between income and energy consumption in tunisia from 1971 to 2004 (belloumi, 2009). in the current globalized world, countries‟ increasing demand for energy and their economic growth dependency on it is one of the important issues under discussion. although economists and macroeconomic theories focus on two factors – production, and labor and capital – they almost ignore the role of energy, but it can still be considered as one of the important factors of production (stern & cleveland, 2004). apart from its role in the production function, the utilization of energy is also regarded as a gauge for the measurement of the socioeconomic development of a country (alam & butt, 2002). this is why the importance of share of energy consumption in the factors of production increases rapidly (pérezlombard, ortiz, & pout, 2008). 2. literature review as mentioned above, kraft & kraft (1978) were the first to analyze the relation of economic growth to energy consumption by using the approach taken by sims (1972) for the usa by means of long-run annual data for the period from 1947 to 1974, and the results indicated that a boost in economic activities may have some bearing on energy utilization but not vice versa. after this initiative, economists akarca & long (1980) reexamined the analysis by kraft & kraft (1978) on the us economy from 1974 to 1990, and they concluded that no causal relation exists between economic growth and energy consumption. similarly, the conclusion of the analysis conducted by eden & jin (1992) defended the “no relation” hypothesis. the panel data analysis on the energy and economic growth nexus from six asian countries (india, indonesia, pakistan, philippines, malaysia, singapore) conducted by masih & masih (1996) found that three out of the six (india, indonesia and pakistan) were cointegrated and the remaining three (philippines, malaysia and singapore) were not (masih & masih, 1996). in 1997, masih & masih asian journal of economics and empirical research, 2021, 8(2): 58-66 60 © 2021 by the authors; licensee asian online journal publishing group (1997) carried out another analysis on energy demand verses economic growth and the price of energy in two highly energy-dependent countries, north korea and taiwan, and concluded that national income, energy consumption and prices moved unidirectionally (in parallel) in the long run as well as the short run. different studies show the role of prices as a determinant of energy demand and the importance of energy for economic development in asian countries (dargahi & khameneh, 2019; lee & chang, 2008; ruhul, rafiq, & hassan, 2008; shahbaz, zakaria, shahzad, & mahalik, 2018; stern, 2010; yuan, kang, zhao, & hu, 2008). similarly, different studies using different economic models and techniques to determine the connection between energy and economic development in south asian countries also prove that there is a causal relationship (akhmat & zaman, 2013; asghar, 2008; azam, khan, bakhtyar, & emirullah, 2015; hossain & saeki, 2011; khan, qayyum, & ahmad, 2007; nasreen, anwar, & ozturk, 2017; noor & siddiqi, 2010; rezitis & ahammad, 2015). the fact is that energy is a fundamental factor in economic growth but the policies for energy conservation are applicable and feasible for countries with slow economic growth. while analyzing energy importance, some studies argue that there are some other variables (ozturk, 2010), these include the emission of co2 lean & smyth (2010a); munir, lean, & smyth (2020), exports volume (hossain., 2012; lean & smyth, 2010c; sami, 2011), employment and population factors (chang, fang, & wen, 2001; narayan & smyth, 2005; wang, wang, zhou, zhu, & lu, 2011), prices of energy consumption (lean & smyth, 2010b; tang & tan, 2013; wang, su, li, & ponce, 2019), and foreign direct investment (fdi) among other factors (bekhet & othman, 2011; chandran & tang, 2013; kivyiro & arminen, 2014). various analyses have assessed the correlation between energy consumption and economic development. energy consumption is of particular interest as it is not only associated with economic prosperity but is also a measure of socioeconomic enhancement (kanagawa & nakata, 2008). for example, a strong correlation was found between energy consumption and economic growth by testing the correlation for around 100 countries (ferguson, wilkinson, & hill, 2000). similarly, as evidence, there are various studies that show the causal relationship between energy consumption and economic prosperity in china (shiu & lam, 2004), turkey (altinay & karagol, 2005), india (ghosh, 2002), and korea (ghosh, 2002). the evidence for pakistan also discloses the effects of energy consumption on economic growth appreciably (abbas & choudhury, 2013; ashraf, javid, & javid, 2013; shahbaz & lean, 2012). various studies have used numerous types of data and different methodologies to investigate the relationship between economic growth and energy consumption. these include cointegration and hsiao‟s version of granger causality (aqeel & butt, 2001) for the short and long runs, bidirectional causality (hye & riaz, 2008), and the cointegration and vector error correction models (kakar & khilji, 2011). regardless of the escalating volume of literature on causality between energy consumption and economic growth, no analysis has enumerated the causality between energy consumption, foreign direct investment (fdi), consumer price index (cpi), population growth and economic growth in south asia, so the aim of this study is to fill this gap. 3. an overview of energy consumption in south asia countries a rapid expansion in energy consumption in south asia in recent years has been followed by economic development. according to the energy information administration (2004) report, the energy consumption increased by approximately 64% during the period from 1992 to 2002, which rose from 2.8% in 1992 to around 4.1% of the total global commercial energy consumption. however, regardless of the expansion in energy demand, south asia has continued to be amid the bottommost levels of the world‟s per capita energy consumption, with energy consumption per unit of gdp endured amongst the topmost level. in 2002, the consumption of commercial energy was as shown in table 1. table 1. commercial energy consumption in south asia in 2002. energy source percentage consumption of the total energy coal 46% petroleum 34% natural gas 12% hydroelectricity 6% nuclear energy 1% others sources 0.3% source: u.s. energy information administration. there is an extensive discrepancy between historic commercial energy resources and energy demand amongst south asian countries. for example, bangladesh, pakistan, sri lanka, afghanistan and india greatly depend on fossil fuels such as petroleum, natural gas and coal, while hydropower is a major source of energy consumption in bhutan and nepal. all these countries have substantial potential to generate and share renewable energy which will greatly assist the optimal energy supply solution of the region. south asian countries need enriched regional energy allocation to manipulate their economies of scale via more efficient interand intra-regional energy trade structures. south asian countries are confronted with the issues of a rapidly increasing demand for energy and scarce energy supply. the commercial per capita energy consumption in the region is low, implying the lack of capacity and the regions‟ potential for excessive energy consumption as we can see from the per capita energy consumption in table 2. however, these countries are trying their best to overcome the shortages. they are working to expand their conventional energy resources and energy supply to attract further foreign investment, especially in the energy sector, i.e., energy infrastructure development, enhanced efficiency, denationalization of energy sectors, and encouraging and developing regional energy trade and investment. the total energy supply of south asia rose by 4.1%, which was approximately 36% of the total energy supply of the world where the major consumption was by industrial sectors, and around 51% of the total consumption, which is a good indicator of economic growth in the region (world energy balances). asian journal of economics and empirical research, 2021, 8(2): 58-66 61 © 2021 by the authors; licensee asian online journal publishing group table 2. per capita energy consumption in south asia (in kg of oil equivalent per capita (kgoe)). year afghanistan bangladesh india nepal pakistan bhutan sri lanka 2010 1137.33 1696.825 5075.993 849.062 4100.52 33091.05 3238.458 2011 1494.08 1822.913 5305.549 897.919 4008.01 31754.89 3379.239 2012 1292.41 1929.179 5511.19 948.769 3662.24 30952.62 3382.808 2013 1016.69 1965.017 5655.344 996.539 4186.10 33450.26 3417.39 2014 889.32 2025.167 5973.568 1083.285 3945.60 31512.39 3058.006 2015 956.51 2355.331 6099.98 961.595 4071.35 33456.44 3864.875 2016 1010.01 2361.492 6305.748 1720.801 4347.25 33586.22 4095.598 2017 1049.24 2422.379 6501.978 1225.582 4503.21 33690.25 4298.055 2018 992.24 2551.016 6838.842 1552.256 4552.28 34251.21 4564.024 2019 1006.51 2995.38 6923.931 1805.235 4567.14 35125.15 4671.618 average 1084.437 2212.47 6019.212 1204.104 4194.1 33087.05 3797.007 source: world development indicators. 4. methodology and data to explore the relationship between energy consumption and economic growth in the presence of fdi, cpi and population growth, panel data of south asian countries was used for the period from 1980 to 2019 and several regression models were applied for the analysis. the ordinary least squares (ols) regression method is used for estimating parameters in the regression analysis of cross-sectional data. the results of the estimation given by the regression methods from data panel regression, a combination of cross-sectional data and time series where the measurement of the same cross-sectional unit is made at different times, is the best linear unbiased estimation (blue). hence, the model can be constructed in the following way: where , is a -dimensional vector of explanatory variables without a constant term, , is the intercept, which is independent of and , , is a vector, the slopes, is independent of and , , is the error, which varies over and . for individual characteristics (which do not vary over time), may also be included. unobserved (constant) individual factors, i.e., if not all variables are available, may be captured by . for example, we decompose as follows: where has mean value of 0, is homoscedastic, and is not serially correlated. in this breakdown, all individual characteristics, including all observed as well as all unobserved ones, which do not vary over time, are summarized by . for our panel data analysis, the general form of relationship is: = ( , 𝑊 , ); = 1, … , 𝑛 = 1, … , as there are options to apply the model in different ways to get different required results, the pooled regression model is used because a single value for the period is required, not for any time fraction or cross section so we specify a one-line regression equation for the whole data as follows: = + + 𝛾𝑊 + 𝜃 + the results are as shown in table 1, model 1, which clearly shows that both the core explanatory variables and the control variables are significant. after that, the random effects model was used to find the impact of the independent variables (energy consumption, fdi, cpi, and population growth). 4.1. random effects the random effects model presumes that the entity‟s error term is not correlated with the predictors, which allows for time-invariant variables to play a role as explanatory variables. the functional association among the variables can be stipulated in following form: the ‟s are rvs with a similar variance. the value is particular for individual . the ‟s of different individuals are independent with a mean value of zero, and their distribution is supposed to be close to normal. the overall mean is taken as , and is time invariant and homoscedastic across individuals. there is only one additional parameter, . only participates in corr( ), and defines both and . as long as i.e., are uncorrelated with and , the explanatory variables are exogenous and the estimates are consistent. the random effects model is needed to identify the individual features that may or may not affect the predictor variables. however, the issue with this model is that certain variables may not be available, thus leading to omitted variable bias in the model. also, there are some related cases where the exogeneity assumption tends to be violated. the resultant inconsistency can be diverted by using a fixed effects model instead. 4.2. fixed effect model if represents the individual intercepts (fixed for given n), the general fixed effects regression model will be as follows: asian journal of economics and empirical research, 2021, 8(2): 58-66 62 © 2021 by the authors; licensee asian online journal publishing group with t = 1 . . . t time periods and = 1 . . . , n = cross-sectional units, contains the omitted variables that are constant over time, and for every unit ( ) is the fixed effects and persuades unobserved heterogeneity in the model. the observed part of the heterogeneity is represented by ( , and contains the remaining omitted variables. no overall intercept is (usually) included in the model. under the fixed effects model, consistency does not require the individual intercepts (whose coefficients are the and to be uncorrelated, only must hold. there are additional parameters for capturing the individual heteroscedasticity. to choose between the fixed effects and random effects models, the hausman test is used. 4.3. hausman test in the hausman test, the null hypothesis is that and are uncorrelated. therefore, two estimators are compared: one that is consistent under both hypotheses, and one is that consistent (and efficient) only under the null hypothesis. a significant difference between both indicates that is unlikely to hold. is the random effects model: ha is the fixed effects model: βre is consistent (and efficient) under h0 but not under ha. βfe is consistent under h0 and ha. the hausman test with a p-value of 0.0000 indicates that we should use the fixed effects model. the test is based on the following wald statistics: 𝑊 where w is allotted as x2 with (k-1) degrees of freedom, whereas k is the total parameters in the model. if the critical value of w is gotten from the wald statistics table, then null hypothesis will be rejected. that means that both estimators are consistent and there is no correlation between the variables and the random effects, so in this case the fixed effects model is better. the main aim behind the test is to find out if both estimates are consistent, then the value should not be too large – both should be closer together. the value of must be parallel to the sum of the squares of the differences between the two sets of estimators. hence, if the value is greater, the null hypothesis is more likely to be invalid. the addition of efficiently weighs the differences in inverse proportion to the variance var[ ]. if this value is large, then the measure is likely to restrain the difference between and . however, if this variance value is small then that difference between and is given significant weight. the hausman test is a statistical analysis used to select whether the fixed effects model or the random effects model is the most suitable for use. the conclusions that we have to make after carrying out the hausman test are: 1. if the hausman test result is h0 or has a p-value > 0.05, then the random effects model is chosen. then we have to further proceed with the lagrange multiplier test to determine whether we use the random effects or the common effect model. 2. if the hausman test result is h1 or has a p-value < 0.05, then the fixed effects model is chosen because when p = 0.0000 it means that the variables are significantly correlated. thus, the fixed effects gls regression model based on the hausman test confirms if the results are significant. the general functional association among the variables for the fixed effects is: ∑ where: is the dependent variable observed for individual ( at time ( ), is the number of independent variables, is the parameters for each independent variable , is the time variant, is the unobserved time-invariant individual effect, and is the error term. since is not directly observable and cannot be directly measured, the fe model eliminates by depreciating the variables by means of the within transformation: ̅ ̅ ̅ ̅ here where ̅ ∑ ̅ ∑ 𝑛 ̅ ∑ since is constant, ̅ , and hence the effect is eliminated. the fe estimator is then obtained by an ols regression of ̈ . to find out further strength of the relation between these variables and its significance, we find the heteroscedasticity by using heteroscedastic model. asian journal of economics and empirical research, 2021, 8(2): 58-66 63 © 2021 by the authors; licensee asian online journal publishing group 4.4. testing for heteroscedasticity for this test, a general form of the breusch–pagan test is applicable. here, is tested to check whether it depends on a set of third variables . 𝛾 where, for the function h (.), h (0) = 1 and h (.) > 0 holds. the null hypothesis is 𝛾 = 0. n (t − 1) is the multiple of the of the auxiliary regression = 𝛾 + is distributed under h0 asymptotically χ2 (j) with j degrees of freedom. 2 u χ2 ( ). although heteroscedasticity does not cause prejudice in the coefficient estimates, it does, however, cause them to be less precise; the lower precision strengthens the probability that the coefficient estimates are further from the accurate population value. then, we tested for heteroscedasticity and concluded that it should be taken into consideration, so the gls method was applied and the weighted white heteroscedasticity robust standard errors were used to correct it. the gls is considered unbiased only if the x‟s are independent of all and . generally, under the re assumptions, it will be more efficient than ols and consist for n → ∞ (t fix, or t → ∞) if and [ ] holds. under weak conditions (errors need not be normal), the feasible gls is asymptotically normal. 4.5. data description annual data for energy consumption (kg of oil equivalent per capita), gdp per capita (billion us$), foreign direct investment (fdi) (billion us$), gdp (billion us$), inflation rate represented by the consumer price index (cpi) rate, and total population data were downloaded from the world bank‟s world development indicators, world data, our world in data and macro trend data for the period from 1980 to 2019. the selected period and countries were dictated by data obtainability. this study explores the linkage of energy consumption, population growth, cpi and fdi with economic growth in south asian countries (afghanistan, bangladesh, bhutan, india, pakistan, sri lanka, and nepal) to determine whether these variables positively or negatively affect economic growth. numerous studies have been carried out to examine the causality between energy consumption and economic growth and acquired distinct outcomes. however, cpi, fdi and population growth were not taken into consideration in previous studies, so this study aims to fill the gap by taking cpi, fdi and population growth into consideration. using panel data, econometric models are applied to investigate the causation among economic growth, energy consumption, inflation, cpi, fdi, and total population growth. the panel data for population, energy consumption per capita, cpi, fdi, and gdp are explained in table 3. table 3. data descriptions and sources. variable name description source ln population log of real population in billions world bank‟s world development indicators ln per capita energy use log of per capita energy consumption in kgoe (kg of oil equivalent per capita) our world in data ln cpi log of consumer price index rate per year world data ln gdp (real) log of real gross domestic product (gdp) in billions of us$ world bank‟s world development indicators, macro trend data ln fdi log of real foreign direct investment in billions of us$ macro trend data 5. empirical results and discussion based on the above analysis, the regression model is set as follows: here, is the dependent variable observed for individual country i at time t, denotes the equivalent energy consumption per capita, denotes the total inward foreign investment received, denotes the total population by the end of that year, stands for the weighted price of local goods, is the unobserved time-invariant individual effect, and is the error term. panel data for seven countries from 1980 to 2019 was used to determine the impact of energy consumption on economic growth. the results of the hausman tests indicate that the fixed effects model is the most appropriate for use in this study. the heteroscedasticity problem is also taken into account, and the robust generalized least squares (gls) technique was applied to deal with this, so the new results are unbiased, consistent, efficient and similar to our previous results. table 4 shows all the empirical results based on the analysis. first of all, this paper estimates the mixed effect of the data by the least squares method, and the results are shown in table 4 model 3 under the gdp pool heading, and both the core explanatory variables and the control variables are significant. second, due to the existence of individual effects among countries, this paper uses the fixed effects and random effects models (see table 4, model 1 and model 2). the results show that energy has a significant impact on gdp, but cpi and population have no significant impact on gdp under the control of individual fixed effects. in order to ensure the unbiased test results, the hausman test was applied. the p-value of the results was 0.0000, indicating that the fixed effect model should be selected. then, since the data in this paper spans 39 years, it is necessary to test whether there is time effect in the data. after controlling for the individual fixed effects, this paper uses the two-way fixed effects model, and controls the time effect. the results (see table 4 model 5) show that the impact of energy on gdp is still significant, but the coefficient is reduced because the time asian journal of economics and empirical research, 2021, 8(2): 58-66 64 © 2021 by the authors; licensee asian online journal publishing group effect in the sample is controlled among the control variables, and the increase of the fluctuation of the national inflation level will have a negative impact on the economic scale of the country. finally, in order to avoid data heteroscedasticity affecting the validity of the estimation results, this paper uses the gls estimation method (see table 4 model 4). the results obtained are similar to other models and do not affect the explanatory power of energy on gdp. to sum up, the text uses five models to test the relationship between national energy and economic scale, and all prove that energy has a positive and significant impact on gdp, indicating that with the improvement of energy, it can significantly promote the development of national gdp. table 4. estimation results. variable (1) gdp fe (2) gdp re (3) gdp pool (4) gdp gls (5) gdp time fe ln energy per capita 1.171*** (7.30) 0.964*** (17.80) 0.430*** (11.38) 0.459*** (13.73) 0.458*** (4.18) ln fdi 0.002 (0.08) 0.020 (1.31) 0.087*** (5.49) 0.129*** (10.54) -0.035 (-1.01) ln cpi -0.016 (-1.75) -0.025*** (-3.28) -0.036*** (-5.03) -0.044*** (-7.70) -0.017** (-2.58) ln population 1.060 (1.54) 1.102*** (18.70) 0.901*** (37.84) 0.913*** (45.22) -1.361 (-1.18) constant -24.226* (-1.99) -23.289*** (-19.73) -15.506*** (-26.02) -15.908*** (-29.95) 21.390 (1.10) observations 261 261 261 261 261 r-squared 0.822 0.902 0.925 number of ids 7 7 7 7 company fe yes yes year fe yes note: robust t-statistics are in parentheses; *** p < 0.01, ** p < 0.05, * p < 0.1. 6. conclusion and policy suggestions the purpose of conducting this study is to investigate the impact of energy consumption on economic growth in south asia on the basis of panel data from 1980 to 2019. to deflect the bias influences in obtaining the results of the bivariate analysis of the causal relationship, population, cpi rate and fdi are also included as additional variables for the causal relationship between energy consumption and gdp growth. our findings advocate that energy consumption, fdi, population growth and cpi have a causal relationship with gdp. energy consumption, fdi and population growth have a positive impact on the overall gdp growth rate, while cpi affects the growth of gdp in a negative way. the present study represents the empirical results of determining factors affecting gdp in south asia, so the findings of this paper have a clear message for the governments to improve and enhance energy production, which will help to improve fdi and gdp. the centuriesold relationship between economic growth and basic energy demand is beginning to double. even as the population and economies continue to grow, global energy demand will increase significantly. some energy sources are declining and new sources of energy are emerging, and the potential for sustainability is staggering. but countries have to foresee issues and consider strategies and develop innovative plans to overcome the impending scarcity and demand for energy. in summary, the empirical results of the study recommend the following policies to enhance economic growth and strategies for the efficient use of energy: 6.1. strategies and policies first, policy makers may limit energy consumption for industries whose energy consumption does not obstruct economic growth. second, as energy consumption is an essential factor for economic growth in most industries, conserving energy relies on industrial innovation and technological transformations in their production practices. therefore, governments need to formulate sustainable policies for economic development by encouraging low energy use in industrial production. third, in order to accomplish prompt economic growth, south asian countries may take on the policy of energy sector development.  governments should develop macroeconomic conditions, i.e., establish secure and lasting economic situations of low inflation rate, employment, and market-oriented reforms, which reshape economic growth in an encouraging and constructive way.  free market supply-side policies should be encouraged by the governments to enhance economic growth. for example, the denationalization of production and services sectors, supervision of regulation to lower taxes, and make rules and regulations trouble-free to motivate private sector investment.  government supply-side policies should be encouraged to increase investment in „public goods‟, i.e., highquality education, public transportation systems and healthcare in order to fulfill the prerequisites of a developing economy.  export-oriented policies should be developed to minimize tariff obstructions and promote free trade as a means to enhance economic growth.  a policy of diversification from the production sector to the services sector should also be considered to increase economic growth (fuchs, 1968), for example, divergence from the production industry (agriculture, industrial) to the services industry (manufacturing, construction and fabrication). however, analyzing the determinants concerning the regional proficiency of the countries as well as the governments and policy makers of the region require further exploration. additionally, a sectorial exploration is asian journal of economics and empirical research, 2021, 8(2): 58-66 65 © 2021 by the authors; licensee asian online journal publishing group also anticipated to enrich the knowledge of industries associated with the energy sectors, production, fdi flow and their determinants. references abbas, f., & choudhury, n. 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(2008). energy consumption and economic growth: evidence from china at both aggregated and disaggregated levels. energy economics, 30(6), 3077-3094. available at: https://doi.org/10.1016/j.eneco.2008.03.007. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 39 © 2023 by the author; licensee asian online journal publishing group asian journal of economics and empirical research vol. 10, no. 2, 39-47, 2023 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v10i2.5196 © 2023 by the author; licensee asian online journal publishing group does financial sector development have a sustainable level of effects on inclusive growth in sub-saharan african countries? evidence from dynamic panel threshold analysis abiodun sunday olayiwola department of economics, chrisland university, abeokuta, nigeria. email: abiodunolayiwola37@gmail.com abstract this study examines the threshold level of financial sector development on inclusive growth in subsaharan africa (ssa) between 2000 and 2020 with the view to ascertain the level of sustainability in the relationship between financial sector development and inclusive growth in ssa countries. data extracted from the world development indicator (wdi) and international financial statistics (ifs) were analysed using dynamic panel threshold (dpt) techniques. findings revealed that there exists a positive and significant sustainable level of financial sector development of 0.098 (out of a scale of 0-1.0) that can stimulate inclusive growth in ssa. likewise, findings at the subregional level showed that three out of four (western, eastern, and central african sub-region) except the southern african region, indicated the existence of a threshold level of financial sector development that can effectively impact inclusive growth. therefore, this study concludes that the relationship between inclusive growth and financial sector development in most ssa countries is nonlinear and conditional on certain macroeconomic policies. it is recommended that policymakers in respective ssa sub-regions and countries implement policies that will promote relevant financial innovations, reforms, and efficiency in financial inclusion in other to promote financial development above the minimum threshold level in ssa countries. keywords: central ssa sub-region, dpt, eastern, financial sector development, inclusive growth, southern, western. jel classification: o10; o40; o47; o49; o55; o57. citation | olayiwola, a. s. (2023). does financial sector development have a sustainable level of effects on inclusive growth in sub-saharan african countries? evidence from dynamic panel threshold analysis. asian journal of economics and empirical research, 10(2), 39– 47. 10.20448/ajeer.v10i2.5196 history: received: 28 june 2023 revised: 7 september 2023 accepted: 10 october 2023 published: 4 december 2023 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. contents 1. introduction ...................................................................................................................................................................................... 40 2. literature review ............................................................................................................................................................................ 42 3. model specification ......................................................................................................................................................................... 43 4. findings and discussion of results .............................................................................................................................................. 44 5. conclusion and policy recommendation .................................................................................................................................... 45 references .............................................................................................................................................................................................. 46 mailto:abiodunolayiwola37@gmail.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v10i2.5196 https://orcid.org/0000-0002-3923-4248 asian journal of economics and empirical research, 2023, 10(2): 39-47 40 © 2023 by the author; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the growing body of literature by investigating the threshold effects of financial sector development on inclusive growth using sub-regional comparative analysis among ssa sub-regional blocs and, offers proper perception and guiding principle to researchers and policymakers on the subject matter of finance–inclusive growth nexus. 1. introduction financial sector development can be defined as a set of improvements in the quality of the financial system's institutions, instruments, markets, and regulatory frameworks with the goal of lowering transaction costs and facilitating the exchange of goods and services through access to financial services. as a result, sector operations have unwavering effects on private wealth, company and customer behaviour, and the economy's cyclical performance. as a result, a well-developed financial sector has been regarded as a crucial impact in encouraging inclusive growth, and a failing financial sector remains one of the reasons why many developing countries around the world stay backward also, financial sector progress in both developed and developing countries can be viewed as a driver of inclusive growth and advancement because it facilitates the mobilisation of funds to; promote resourceful capital allocation, increase total factor productivity, facilitate free flow of goods and services and reduce inequality of opportunity through financial inclusion (adusei, 2019; international monetary fund, 2016; khan, ahmed, & bibi, 2019; world bank, 2015). considering the developing region of sub-saharan africa in the last two decades, the financial sector development in most of ssa's countries has advanced, especially in middle-income countries. however, the financial market in ssa still lags compared to other regions of the world (olayiwola, 2022; olayiwola & akinbobola, 2022; world bank, 2018). figure 1. financial sector development index in selected ssa countries. figure 2. financial sector development index in selected western african countries. figure 3. financial sector development index in selected southern african countries. asian journal of economics and empirical research, 2023, 10(2): 39-47 41 © 2023 by the author; licensee asian online journal publishing group figure 4. financial sector development index in selected eastern african countries. figure 5. financial sector development index in selected central african countries. on the other hand, the call for inclusive growth becomes topical in line with the united nations' sustainable development goals (sdgs) given the fact that, inclusive growth is an evolutional dimension of growth that allows the poor and every stratum of the economy to benefit and participate in the economic growth process. also, despite increases in their gross domestic products (gdp) (in the last 20 years before the covid-19 outbreak), most developing countries of ssa still have very low living standards, job opportunities, health, and education indicators. as a result, this concept becomes critical in this study because it is all about improving the general level of investment, productive economy, and education. inclusive growth is a multifaceted idea of economic growth that is at the center of policy debates around the world because it provides more information about the growth of an economy than ordinary gdp (asian development bank strategy, 2020; clarke, xu, & fou, 2017; imf, 2016b; joseph, olayiwola, & yinusa, 2019; kiani & ullah, 2015; munir & ullah, 2018; olayiwola, 2022; olayiwola & akinbobola, 2022; olayiwola & joseph, 2020; olayiwola, okunade, & fatai, 2021). figure 6. inclusive growth in selected ssa countries. figure 6 illustrates the level of inclusive growth index in selected ssa countries. furthermore, despite well-established empirical links between the development of the financial sector and economic growth (a subset of inclusive growth), research outcomes in the context of threshold analysis from existing studies have remained mixed and inconclusive. some empirical evidence suggested that financial sector development has supported economic progress in emerging economies and as such concluded that there is a threshold beyond which financial sector development can yield contrary effect on the economy (aluko & ibrahim, 2020; bucci & marsiglio, 2019; cecchetti & kharoubi, 2015; ibrahim & alagidede, 2017b; imf, 2016a; law & singh, 2014; ruiz, 2018; sahay et al., 2015). conversely, some other studies stated that the development of financial sector and the state of economic growth are unrelated. they concluded that there were no specific thresholds to distinguish between countries and regions that are more financially developed from those that are not (demetriades & rousseau, 2016; ductor & grechyna, 2015; law & singh, 2014; mhadhbi, 2014). hence, this study re-examines these conflicting views using inclusive growth which is a broad-based economic growth since studies in this area are relatively scarce in sub-saharan africa (ssa). therefore, in dealing with a critical question of how can finance guarantee inclusiveness in the growth process of any economy in ssa, the concept of inclusive growth which views economic growth from a wider-range and broader perspective becomes necessary for policy resolutions in sub-saharan african countries. this is because inclusive growth is not only seen as an instrumental for enhancing economic inclusivity of nations but also a pivot asian journal of economics and empirical research, 2023, 10(2): 39-47 42 © 2023 by the author; licensee asian online journal publishing group for ensuring sustainable development (a long run economic phenomenon). considering this, this study provides answer to this question of whether the development of financial sector has any major effect on inclusive growth or not, and at what level can this be sustained in sub-saharan african (ssa) countries. thus, it contributes to the growing body of literature by investigating the threshold effects of financial sector development on inclusive growth using sub-regional comparative analysis which has not been fully explored in the literature (particularly in the developing region of ssa). in fact, most research in sub-saharan african (ssa) countries and other developing nations concentrated on ordinary gdp in their finance-growth nexus. this study also pays close attention to the peculiarities and divergences of each subregional blocs because these subregional economic communities are now considered as the pillars of sub-sahara african (ssa) economy and as such separating and comparing them would offer proper perception and guiding principle for policy recommendations on this subject matter. this research is divided into five components. the second section is a review of empirical literature. section three covers the methodology/model specification; and provides additional information on variable measurement and data sources. section four offers the study's findings and discussion, while section five concludes the study with policy recommendations. 2. literature review the relationship between the activities of the financial system and economic growth is one of the most extensively researched issues in economic study, owing to the importance of finance in the growth of any economy. there are numerous studies that support a strong link between financial development and economic growth, beginning with schumpeter (1911), as supported by odhiambo (2010); uddin, shahbaz, arouri, and teulon (2014); and beck and maimbo (2014), among others, which had shown empirically how important and crucial the financial sector is to the success of any economy. however, the last decade has also witnessed a number of investigations testing the connection between finance and the growth of an economy using country-specific and other forms of data with series of econometric tools and some of these studies show that; nations with improved financial system seem to progress sooner; and well-operating financial systems ease external financing constraints that hinder industrial development while others argued that issues concerning financial development and growth nexus remains extremely complex and as such should be taken with extreme caution (nyasha & odhiambo, 2018; puatwoe & piabuo, 2017). also, it was confirmed that significant economic growth via private sector development and improvement in the public sector performance, are strongly linked to the development of financial sector (dhrifi, 2018; kargbo & adamu, 2016). likewise, the empirical findings of beck and maimbo (2014); asghar and hussain (2014); urbšienė and sendriy (2014); fang and jiang (2014); ibrahim and alagidede (2017b) and bist (2018) point to the fact that financial sector development helps in reducing economic volatility; promotes growth substantially in the long-run while on the contrary, some authors (chen, hongo, ssali, nyaranga, & nderitu, 2020; ibrahim & alagidede, 2017a; okonji, nnadi, & igbanugo, 2018) preach that the overall effect of financial sector advancement on the economy depends highly on some indicators as well as the nature of shock to the financial sector development and argue that financial development impacts economic growth negatively through the pressure of uncertainty in the financial system. in the context of threshold analysis, research outcomes from existing studies have remained mixed and inconclusive. some empirical evidences regarding financial sector development growth nexus, have suggested that financial sector development has supported growth in emerging countries and concluded that there could be a point outside which financial development can have hostile influence on economic growth (aluko & ibrahim, 2020; bucci & marsiglio, 2019; cecchetti & kharoubi, 2015; law & singh, 2014; swamy & dharani, 2019) while some concluded that there were no specific thresholds to distinguish between countries and regions that are more financially developed from those that are not (demetriades & rousseau, 2016; ductor & grechyna, 2015; mhadhbi, 2014). it should be noted that most of these extant studies combined data from both advanced and emerging economies and as such conclusions may not be directly applicable to a purely developing sub-saharan africa (ssa) region. besides, these studies used only one-dimensional measure of financial sector development instead of a multidimensional measure (composite measure of financial sector development) that largely captures the rudimentary functions of the financial sector. they also ignored the direct and dynamic threshold level of financial sector development on broadbased growth (inclusive growth) which is the main objectives of this present study. for example, while researching the relationship between financial development and growth, arcand, berkes, and panizza (2015) discovered that there is a threshold effect because progress in the level of finance begins to have a negative effect on productivity when credit to the private sector, as a measure of financial development, reaches 80 to 100% of gdp. their findings were like wachtel (2011) discovery of a vanishing effect of financial development on economic growth. in addition, law and singh (2014) investigated the impact of financial development on economic growth in 87 advanced and developing countries, revealing that higher levels of finance are essentially unfavourable to economic growth. similarly, while studying the threshold effect between 1980 and 2008, samargandi, fidrmuc, and ghosh (2015) discovered an inverted u-shaped relationship between financial development and economic growth. on the other hand, the studies by mhadhbi (2014); ductor and grechyna (2015) and demetriades and rousseau (2016) while investigating financial development – growth nexus concluded there was no specific thresholds to distinguish between countries that are more financially developed (high or middle income countries) from those that are less developed (middle or low income countries) and as such financial development may not be a substantial determinant of growth when it comes to the issue of threshold. findings from mishra and narayan (2015) while examining finance–growth relationship for 43 advanced and emerging economies, reveal that financial sector development influences growth positively if a nation’s level of finance is developed beyond their cross–sectional averages, and negatively affects growth if the level of finance is developed is below the cross–sectional averages between 1980 and 2012. their findings also revealed that finance promotes economic growth more in emerging nations than advanced economies. however, these generalized findings and conclusion may not be reliable for a purely sub-saharan african (ssa) study in the context of dynamic threshold and sustainable level of financial sector development that can directly impact economic growth that is inclusive in nature, given the fact that the data used in these studies comprises of both developed and developing countries. kargbo and adamu (2016) supported the finance-led growth hypothesis when investigating the relationship between financial development and economic growth in sierra leone between 1970 and 2008. while adeniyi, asian journal of economics and empirical research, 2023, 10(2): 39-47 43 © 2023 by the author; licensee asian online journal publishing group oyinlola, omisakin, and egwaikhide (2015) discovered a u-shaped association between finance and growth using an autoregressive distributed lag growth model with nigeria as a case study, and advocated that finance reduces growth up to a certain threshold beyond which it begins to increase growth, this contradicts earlier findings by cecchetti and kharoubi (2015). okonji et al. (2018) investigated financial depth as a measure of financial sector development then found that financial depth and stability have encouraging effects on economic growth while credit and lending deposit spread had damaging effects on economic growth. it was also revealed that other financial sector development indicators apart from access to financial service have negative effects on discomfort index, which implies that financial sector development could improve economic welfare. further, many empirical studies have pointed out that financial development results in faster economic growth with welfare implications (kargbo & adamu, 2016; nwakobi, oleka, & ananwude, 2019). the findings of these studies did not determine optimal level of the aggregate welfare gains of financial sector development that benefit the whole economy in the same way or whether it disproportionally benefits the affluent or the underprivileged. on the issue of financeinclusive growth nexus, olusola and yinusa (2016) investigated this relationship in nigeria and discovered that the impact of financial development on inclusive growth relies mainly on the measure of finance. though, it was revealed that both trade openness and capital investment are necessary for inclusive growth. also, in this study, financial development remained negatively related to inclusive growth as against the findings of oluwasogo, oduntan, and oluwatoyin (2017) that revealed a positive nexus between them and by implication suggested that financial development alone can promote inclusive growth better in nigeria. another related study by ajakaiye and tella (2014) on the potential trade-off between the regulation and stability of the financial sector in nigeria by considering the implications of regulation on financial inclusion and inclusive growth, revealed that regulations strongly influence the stability of the sector as an essential tool for achieving financial inclusion and growth. however, these studies, though country-specific, did not provide adequate and comprehensive method of measuring and capturing inclusive growth and ignore the issues of threshold level effect in this nexus. 3. model specification this study is based on the supply-leading hypothesis that views financial sector development as an instrument for promoting innovation. the proposition of this view emphasizes that advancement of financial sector has a helpful effect on economic growth (which could be all-encompassing in nature) because the benefit flows from financial sector development to growth due to some level of progress in productivity (wealth accumulation) or an upsurge in the rate of savings together with the rate of capital. according to this theory, the financial system can only promote economic growth and development by providing finance in advance of demand (patrick, 1966). therefore, supply leading gives room for resources to be transferred from one sector to another, promotes innovations in terms of entrepreneurial development, propels growth and create incentives for increased saving from the liberation of financial market and as such financial sector boosts the process of inclusive growth. in other words, inclusive growth (ig) is a function of a financial sector development (fsd) and this is stated as: 𝐼𝐺 = 𝐹( 𝐹𝑆𝐷, 𝑋) (1) where fsd stands for financial sector development, ig is the vector of inclusive growth index variables and x represents other control variables. linearizing equation 1, is the transformational form is specified as: 𝐼𝐺𝑖𝑡 = 𝛽0 + 𝛼1𝐹𝑆𝐷𝑖𝑡 + 𝛼2𝑋𝑖𝑡 + 𝜀𝑖𝑡 (2) where, 𝜀𝑖𝑡 = μ𝑖 + ν𝑖𝑡 (3) 𝜀𝑖𝑡 signifies the composite error term made up of the country-specific term _i and the time-varying disturbance term v_it, both of which are supposed to remain identically and independently distributed. similarly, equation 2 is changed to a dynamic panel model. thus, by adjusting equation 2 to represent the panel threshold regression model created by seo and shin (2016) and seo, kim, and kim (2019), equation 4 which explains the threshold level of financial sector development that can affect inclusive growth in ssa can be derived as: 𝐼𝐺𝑖𝑡 = (1, 𝑥𝑖𝑡 ′ )𝛼1 1 {𝐹𝑆𝐷𝑖𝑡 ≤ 𝛾 } + (1, 𝑥𝑖𝑡 ′ )𝛼2 1{ 𝐹𝑆𝐷𝑖𝑡 > 𝛾 } + 𝜀𝑖𝑡𝜀𝑖𝑡 − (𝜌𝑖 + 𝜔𝑖𝑡) (4) with i =1, . . ., n, t = 1, . . . , t 𝐼𝐺𝐼𝑖𝑡 represents the dependent variable, which is a vector of inclusive growth indicators for nation i at time t; 𝑥𝑖𝑡 ′ represents 𝑘1 × 1 vector of time-changing regressions consisting of sets of covariates representing control variables; 1{ . } represents an indicator function; 𝐹𝑆𝐷𝑖𝑡 stands for the threshold or transition variable of financial development; 𝛾 denotes the threshold estimate; 𝛼1 and 𝛼2 are the gradient coefficients related to regimes (1 & 2) separately; 𝜀𝑖𝑡 represents error term obtainable from the unobserved individual fixed effect (𝜌𝑖 ) and zero mean “idiosyncratic random disturbance” (𝜔𝑖𝑡) (olaniyi, 2021; seo et al., 2019). the dynamic panel threshold method is still chosen over other threshold analysis methods because it allows the transitional variable(s) and other covariates to be endogenous. it also generates a resilient bootstrap method that establishes the presence of a threshold effect if the bootstrap pvalue based on a higher statistical value exceeds the predicted levels of significance (aluko, 2020; seo & shin, 2016). 3.1. measurement of variable and sources of data the study collects annual data from 2000 to 2020, a period of 21 years. the descriptions and data sources are listed below. fsd (financial sector development index): the fsd index is a combined component of financial sector expansion that includes nine influences that summarize how advanced the financial segment is, based on the depth, access, and competence of financial institutions and financial markets (source: international financial statistics, ifs). ig (inclusive growth index): this is an evolutionary component and comprehensive extreme degree of economic growth that allows the impoverished to benefit from and contribute to the economic growth process. the inclusive growth index is calculated using the z-sum score technique and is based on important economic development indicators such as education expenditure (%gdp), mortality rate under-5, primary school enrollment, health expenditure (%gdp), gdp per capita, investment, total reserve, and employment (all sourced from the world development indicator, wdi). as instrumental factors, other variables such as trade openness and inflation are used. asian journal of economics and empirical research, 2023, 10(2): 39-47 44 © 2023 by the author; licensee asian online journal publishing group 4. findings and discussion of results the dynamic panel threshold (dpt) results in tables 1-5 show that all lag-dependent variables have statistically significant effects on their current states in all panels of ssa nations and sub-regions at the 1% level of significance. this demonstrates the significance of inclusive growth indicators' starting state in the present level of inclusive growth indices in ssa nations and sub-regions. this supports the use of a dynamic panel data model. as a result, the dynamic panel threshold (dpt) model used in this work is suitable. the estimated dpt results in table 1 from the panel of ssa nations show that financial sector development has a positive and statistically significant threshold value of 0.98 on inclusive growth in the sub-saharan africa (ssa) area. this means that the threshold level required for financial sector development to have an impact on inclusive growth in sub-saharan african (ssa) countries is 0.1 (on a scale of 1.0). this implies that for inclusive growth indicators to successfully contribute to poverty reduction, most ssa nations must operate and maintain a minimum level of development in the financial sector that is more than 0.1 on a scale of 0 to 1.0. according to this minimum requirement, financial sector development cannot drive inclusive growth indicators to reduce poverty in any country that operates below this minimum degree of financial sector development. indeed, as illustrated in figure 1, financial sector development in the majority of the selected ssa nations is running, on average, above this threshold point. this finding contradicts the findings of law and singh (2014), mhadhbi (2014), ductor and grechyna (2015), and demetriades and rousseau (2016), who concluded that financial sector development and "state of economic growth" are unrelated and that at most frequency levels, there are no specific thresholds to distinguish between financially developed countries and regions. aside from establishing this threshold level, the results show that the kink slope is statistically significant at the 1% level of significance (3.68). as a result, there appears to be a nonlinear link between financial sector development and inclusive growth in subsaharan africa (ssa). that is, the link between inclusive growth and financial sector development is indirect and so, on average, dependent on macroeconomic policies in ssa. 4.1. evidence from west african sub-region of ssa this sub-section focuses on the amount of financial sector development required to effectively promote inclusive growth in the ssa west african sub-region. table 2 reveals that the financial sector development has a positive and statistically significant threshold value of 1%. this demonstrates that the minimal level of financial sector development required in west african countries to achieve favourable effects on inclusive growth is 0.12 (0.116) on a scale of 1.0. this suggests that, on average, financial sector expansion cannot boost inclusive growth to yield acceptable results in the west african sub-region when a country operates below this threshold level. the average sustainable level at which finance sector expansion might effectively accompany inclusive growth in western african nations is 0.12. this research outcome from west african sub-region contradicts the findings of mhadhbi (2014); ductor and grechyna (2015) and demetriades and rousseau (2016) which concluded there was no specific thresholds to distinguish between countries that are more financially developed from those that are less developed. one of the reasons for this outcome could be that most west african countries have their financial sector development indicators around this threshold (see figure 2). meanwhile, inclusive growth would be effectively stimulated to reduce poverty level if the development in the financial sector, on the average, is persistently above the 0.12 threshold level in most west african countries. 4.2. evidence from southern african sub-region of ssa the dynamic panel threshold (dpt) results in table 3 indicate that financial sector development, on the average, has positive but not statistically significant threshold value. this indicates that the minimum level of development in the financial sector required in the southern african countries to positively impact poverty reduction effects of inclusive growth is 0.12 out of the scale of 1.0. this implies that financial sector development has propensity to impact inclusive growth positively if above 0.12 on the average. it is obvious that this insignificant value may have occurred since it has been revealed in figure 3 that most countries, if not all, in southern african sub-region have their financial sector development indicators far above this threshold level. this stands in line with the conclusion of mhadhbi (2014); ductor and grechyna (2015) and demetriades and rousseau (2016) that financial sector development may not be a substantial determinant of growth that is inclusive in nature when it comes to the issue of threshold because there were no significant thresholds to distinguish between countries that are more financially developed from those that are less developed. 4.3. evidence from east african sub-region of ssa the east african sub-region's financial sector development threshold value is positive and statistically significant at 1%. this conclusion implies that the minimal value of financial sector development required to enable equitable growth and poverty reduction in east african nations is 0.11 on a scale of 1.0 (see table 4). as a result, for inclusive growth to have a significant influence on poverty reduction, financial sector development metrics in most east african nations must be consistently above 0.11. this shows that, on average, certain nations in the east african sub-region, as shown in figure 4, are functioning below this threshold level, while others achieve this level but are inconsistent in their financial sector development. comparatively, this research outcome, like other ssa sub-regions apart from south african countries, indicates existence of threshold level of financial sector development that can effectively impact inclusive growth. this supports some of the previous empirical findings regarding the threshold effects of financial sector development on growth (aluko & ibrahim, 2020; arcand et al., 2015; bucci & marsiglio, 2019; samargandi et al., 2015; swamy & dharani, 2019). 4.4. evidence from central african sub-region of ssa according to the dtp results in table 5, financial sector development in the central african sub-region of ssa has a positive and statistically significant threshold level at the 1 percent level of significance. this means that the financial sector development index must be more than 0.10 on a scale of 1.0 before the industry may successfully impact inclusive growth. however, the average level of development in the financial sector in most central african countries falls below the threshold value specified in section one's descriptive figure 5. as a result, most of the asian journal of economics and empirical research, 2023, 10(2): 39-47 45 © 2023 by the author; licensee asian online journal publishing group countries in this subregion operate below this criterion. this could be one of the key reasons why inclusive growth is so low in this subregion, given that the financial sector in most central african nations has not evolved to the point of successfully channeling financial resources to the productive sector. this research concludes that, as in the case of west and east african sub-regions, there exists a threshold level beyond which financial sector development can effectively and positively impact poverty reduction effects of inclusive growth in central african countries if adequate policies and measures to develop financial systems are put in place. table 1. dynamic panel (dpt) threshold of financial sector development on inclusive growth in ssa. dependent variable: ig crosssection: 33 time = 21 no of bootstrap: 1000 prob > boots: 0.000 coefficient std. error z p>|z| [95% conf. interval] ssa: all selected countries lag_ig 0.319* 0.016 19.900 0.000 0.2877 0.3506 fsd -3.906* 0.470 -8.300 0.000 -4.8275 2.9838 fsd_ig -0.831* 0.015 -56.980 0.000 -0.8599 0.8027 kink_slope 3.680* 0.456 8.070 0.000 2.7860 4.5733 threshold (r) 0.098* 0.001 99.050 0.000 0.0962 0.1001 note: * and ** denote 1% and 5% level of significance respectively. fsd, ig and fsd_ig represent financial sector development index, inclusive growth index and the interaction between fsd and ig respectively. also, r is the threshold level of financial sector development. table 2. results of dpt of financial sector development on inclusive growth in west african region. cross-section:11 time = 21 west african subregion dependent variable: ig coefficient std. error z p>|z| [95% conf. interval] lag_ig -0.127* 0.036 -3.560 0.001 -0.3933 0.1389 fsd -2.824** 1.234 -2.290 0.022 -5.2429 0.4059 fsd_ig -1.280* 0.156 -8.200 0.000 -1.5862 0.9739 kink_slope 2.040 1.241 1.640 0.100 -0.3935 4.4727 threshold (r) 0.116* 0.010 11.400 0.000 0.0961 0.1360 note: * and ** denote 1% and 5% level of significance respectively. fsd, ig and fsd_ig represent financial sector development index, inclusive growth index and the interaction between fsd and ig respectively. also, r is the threshold level of financial sector development. table 3. results of dpt of financial sector development on inclusive growth in south african region. cross-section:08 time = 21 south african subregion dependent variable: ig coefficient std. error z p>|z| [95% conf. interval] lag_ig -0.341* 0.011 -30.860 0.000 -0.6793 0.6572 fsd 5.255 35.196 0.150 0.881 -63.727 74.2367 fsd_ig -1.077** 0.533 -2.020 0.043 -2.1213 0.0324 kink_slope -5.505 36.150 -0.150 0.879 -76.3575 65.3474 threshold (r) 0.117 0.281 0.420 0.678 -0.4343 0.6680 note: * and ** denote 1% and 5% level of significance respectively. fsd, ig and fsd_ig represent financial sector development, index, inclusive growth index and the interaction between fsd and ig respectively. also, r is the threshold level of financial sector development. table 4. results of dpt of financial sector development on inclusive growth in east african region. cross-section:07 time = 21 east african subregion dependent variable: ig coefficient std. error z p>|z| [95% conf. interval] lag_ig 1.222* 0.129 9.510 0.000 -2.2664 2.5237 fsd -1.698 7.776 -0.220 0.827 -16.9388 13.5419 fsd_ig -0.635* 0.229 -2.780 0.006 -1.0830 0.1866 kink_slope 1.960 10.240 0.190 0.848 -18.1091 22.0297 threshold (r) 0.112* 0.015 7.250 0.000 -0.0360 0.2597 note: * denotes 1% level of significance respectively. fsd, ig and fsd_ig represent financial sector development, index, inclusive growth index and the interaction between fsd and ig respectively. also, r is the threshold level of financial sector development. table 5. results of dynamic panel threshold of financial sector development on inclusive growth in central african sub-region. cross-section:07 time = 21 central african subregion dependent variable: ig coefficient std. error z p>|z| [95% conf. interval] lag_ig -0.438* 0.130 -3.350 0.000 -0.9882 0.7273 fsd -6.524 5.663 -1.150 0.249 -17.6234 4.5751 fsd_ig -1.196 1.520 -0.790 0.431 -4.1752 1.7834 kink_slope 7.685 6.384 1.200 0.229 -4.8265 20.1972 threshold (r) 0.102* 0.006 18.340 0.000 0.0913 0.1131 note: * denotes 1%, level of significance respectively. fsd, ig and fsd_ig represent financial sector development index, inclusive growth index and the interaction between fsd and ig respectively. also, r is the threshold level of financial sector development. 5. conclusion and policy recommendation this study explores the threshold level of financial sector development that can affect inclusive growth in subsaharan africa (ssa) between 2000 and 2020 to determine the nature of the relationship between financial sector development and inclusive growth in ssa nations. the results of the threshold level of financial sector development (minimum level) beyond which inclusive growth indicators are effectively stimulated in sub-saharan africa (ssa) revealed that there exists a positive and significant threshold level beyond which financial sector development can asian journal of economics and empirical research, 2023, 10(2): 39-47 46 © 2023 by the author; licensee asian online journal publishing group effectively impact inclusive growth, and thus the relationship between inclusive growth and financial sector development is not direct. in comparison, outcomes from the east african sub-region, like those from other ssa subregions other than south africa, suggested the presence of a threshold level of financial sector development that can successfully impact inclusive growth. the study concludes that the relationship between inclusive growth and financial sector development in most ssa countries is not direct (nonlinear) and as such conditional, on average, on certain macroeconomic policies. as a result, policymakers in respective ssa countries and sub-regions are advised to implement special monetary regulatory policies such as liberalisation, deregulation, and risk-mitigation policies that promote the 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(2018). world development indicators; poverty and inequality. washington: world bank. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.1186/s40854-017-0073-x https://doi.org/10.1016/j.iref.2017.08.009 https://doi.org/10.1016/j.worlddev.2014.11.010 https://doi.org/10.1177/1536867x19874243 https://doi.org/10.1016/j.jeconom.2016.03.005 https://doi.org/10.1016/j.iref.2019.06.001 https://doi.org/10.1016/j.econmod.2013.09.049 https://doi.org/10.1057/ces.2011.16 224 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 2, 224-234, 2020 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2020.72.224.234 © 2020 by the authors; licensee asian online journal publishing group the provision of long-term credit and firm growth in developing countries jennifer watson texas a & m university, usa. abstract this study evaluates the impact of the provision of long-term credit (ltc) on the growth of small and young firms in developing countries. the growth of firms is evaluated on the basis of employment growth and total sales. credit provisions have also been collected from the shortand ltc extended to the private sector. this study uses data on firm levels from more than 19000 firms in 52 countries between 2006–2016. in order to avoid the endogeneity issues that usually occur in such studies, this study has implemented a cross-country model to evaluate the significance of total bank credit, both longand short-term, on the growth of sales and employment. the econometric results indicate that the availability of short-term credit (stc) is more beneficial for the growth of the firms, i.e. stc was found to have a significant impact on employment growth and sales in small and young firms. although positive, ltc seemed to have no significance in the growth of the small and young firms. this study suggests that the prime reason behind these results is the availability of long-term loans for small and young firms. keywords: developing countries; bank credit; growth development. citation | jennifer watson (2020). the provision of long-term credit and firm growth in developing countries. asian journal of economics and empirical research, 7(2): 224-234. history: received: 3 july 2020 revised: 5 august 2020 accepted: 8 september 2020 published: 28 september 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. background of the study .............................................................................................................................................................. 225 2. literature review .......................................................................................................................................................................... 225 3. research methods .......................................................................................................................................................................... 227 4. findings ........................................................................................................................................................................................... 229 5. discussion ........................................................................................................................................................................................ 233 6. conclusion ....................................................................................................................................................................................... 233 references ............................................................................................................................................................................................ 233 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.72.224.234&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/2186 asian journal of economics and empirical research, 2020, 7(2): 224-234 225 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to existing literature by evaluating the impact of the provision of long-term credit (ltc) on the growth of small and young firms in developing countries. 1. background of the study in developing countries, the main focus is long-term credit (ltc) and the growth of an organization (leroy, baumung, boettcher, scherf, & hoffmann, 2016). for this purpose, different strategies and policies have been developed by different organizations in developing countries to make it possible to increase productivity and economic growth. developing countries focus on the achievement of ltc without focusing on the subsequent effects on the environment and other factors (susilowati, fuddin, pramuja, anindyntha, & primitasari, 2019). some organizations are able to consume innovative technology and tools by having greater access to long-term loans, which could also result in higher returns (alam & murad, 2020). badayi, matemilola, bany-ariffin, and theng (2020). this illustrates the fact that a greater provision of ltc helps to benefit new firms at the country level. the overall process and phenomenon of ltc and its impacts have been gaining considerable attention from academic experts and other analysts over the past few years (ansah et al., 2016). nevertheless, the performance of firms has been noticed by several scholars and analysts in different developing nations and regions, as there are a significant amount of firms and organizations that are performing successfully (léon, 2020). andrade, cahn, fraisse, and mésonnier (2019) recommended that, in order to address any gaps or shortcomings in a firm’s performance (fp), some contextual factors and variables like ltc and stc, which affect the quality of a firm, need to be identified and evaluated in detail. research on the impact of the growth of employment (goe) on fp is limited, so studies needs to be conducted on firms and businesses in different developing regions and countries (leon, 2019). as of yet, no studies have evaluated the direct impact of goe on ltc and stc performance; therefore, this research is new and justified in understanding the direct influence of goe and sales of total sales (sts). with regard to external debt, figure 1 shows that the ratio of debt was different over different time periods. figure 1. average external debt payments. in line with the above justification statement, the aims of the paper are: • to examine the exclusive impact of goe on stc and ltc in developing nations. • to analyze the influence of sts on the stc and ltc in developing countries. • to explore the impact of goe and sts on bank credit (bc) in developing countries. the given study empirically identifies whether or not a higher degree of ltc provision influences the development of small and medium organizations and businesses. therefore, the given effort has profound theoretical benefits, as well as practical impacts. theoretically, the results of the given study contribute to the current knowledge on the above variables through an analysis of the effects of goe on ltc and stc in developing countries. the remainder of the research study is framed as follows: section two discusses and presents current literature on long-term and short-term finance, as well as the organization’s overall performance and presentation; sections three and four consist of the methodology of the study and the data of the paper; section five presents the main econometric outcomes and findings, as well as robustness checks; finally, section six provides a significant demonstration on the types of access to credit and a logical conclusion. 2. literature review 2.1. theory of long-term finance (ltf) this theory is mainly studied and developed within the disciplines of management, finance, economics, and accountancy (schoenmaker & schramade, 2019). theoretically, this theory is concerned with the investment and deployment of assets and liabilities over time, as it is predominantly about performing valuation and asset or money allocation that is based on risk, challenges, and uncertainty over future consequences, while incorporating the time value of money (schroeder, clark, & cathey, 2019). according to this theory, financing and crediting play a crucial role in the development of every business and firm, mainly because, according to schoenmaker and schramade (2019), firms often need financing to pay for assets, equipment, and other significant items for their business. this theory also states that ltc and support are usually needed to acquire new assets and resources for the overall development of the business and firm expansion (andersen, 2020). moreover, this theory demonstrates the fact that ltf is expected to have a direct impact on overall business development by stimulating some forms of investment. this leads to an increase in employment in the region. in other words, organizations incorporate ltc asian journal of economics and empirical research, 2020, 7(2): 224-234 226 © 2020 by the authors; licensee asian online journal publishing group to buy fixed resources and assets to finance working capital, which leads to an increase in sales and employment (dou & ji, 2019). 2.2. the relationship between employment growth and bank credit sharifi, haldar, and rao (2019) describe the fact that the relationship between bank credit and employment growth as complicated because the variables that play a vital role in measuring the access of an organization to finance, which also reflects its petition for labor. botev, égert, and jawadi (2019) have examined the fact that organizations that have access to finance are more likely to experience employment growth than those that do not have access to finance. the research conducted by aghion, bergeaud, cette, lecat, and maghin (2019) has stated that the relationship between bank credit and employment growth can be determined with the help of credit bureaus that act as an exogenous shock for the supply of credit. this also leads to employment growth of up to 5%, compared to countries where cb has not been introduced yet. it has been proved by the theory of ltf that this relationship focuses on the deployment of resources and accountabilities. therefore, this paper poses the following hypothesis: h1: there is a direct and significant connection between bank credit and employment growth. 2.3. the interdependence between the growth of employment and short-term credit according to aghion et al. (2019), an stc is a form of credit that is developed to support short-term personal credit, as well as business and firm capital. according to cecchetti and kharroubi (2019), this directly impacts levels of employment. moreover, palacín-sánchez, canto-cuevas, and di-pietro (2019) demonstrate that short-term credit (stc) is a type of credit that mainly includes a borrowed wealth quantity and interest that must be paid by a given period—usually within a year from getting the loan. these factors all directly and significantly impact the goe in firms and businesses. according to mian, sufi, and verner (2020), stc is a value option and opportunity, especially for small firms or startups in developing countries, which results in a huge amount of employment and firm growth. moreover, according to the corporate financial institute (cfi), an stc is a form of loan and credit that is entirely generated to support small business capital requirements because stc provides fast cash and capital when the cash flow of a business is deficient (ferrando & mulier, 2013). these types of credits and loans have shorter repayment periods than traditional credit, which is why they are extremely attractive and positive options for employment generation in small firms. according to li, loutskina, and strahan (2019), this directly affects the overall development and performance of the business. the above theory of financing supports the interdependence between stc and goe and the growth of the firm because the theory of ltf states that credit and financing prove to be significant for the creation of employment in businesses, as they provide quick capital to firms. h2: there is a significant connection between employment growth and stc. 2.4. the nexus between the development of employment and long-term credit ltc and financing can be described as any financial credit tools with a maturity limit of one year, such as bank credits, leasing and bonds, and public and private equity tools. according to monaghan and ingold (2019), maturity refers to the amount of time between the conception of a financial claim (bond, financial tools, and loan) and the final payment date and the point at which the remaining interest is due. extending the capability design of capital is typically seen to be the basis of substantial employment expansion and firm growth because ltc contributes to faster employment growth, significant welfare, and the stability of the business in two favorable ways—by minimizing rollover challenges for borrowers and by improving the availability of ltc tools. this allows employees and businesses to respond life-cycle risks (aghion et al., 2019). consequently, the above discussion leads to the establishment of the following hypothesis: h3: there is a favorable connection between employment growth and ltc. 2.5. the association between sales of total sales and bank credit the performance of a firm is primarily dependent on the positive relationship between the growth of total sales and bank credit. nurmawati, rahman, and baridwan (2020) state that the access of a firm to finance will help it to acquire financial assets and instruments that help it to increase its economic growth capasso, gianfrate, and spinelli (2020). banks are considered to be the best engine for the increment of the economic growth of a firm. dai, byrnes, liu, and vasarhelyi (2019) describe the positive impact of bank loans on the development of a business if finance is available and if the added value that has been created by those sectors is available. the ltf theory has supported this relationship by stating that bank credit plays a direct role in the development of a firm, along with the sales of total sales, because finance is required by organizations to pay for equipment and assets. thus, the present research poses the below hypothesis: h4: there is a positive interdependence between the sales growth of firms and bank credit. 2.6. the interrelation between sales of a total of sales and short-term credit stc and finance prove to be very beneficial and advantageous for firms and businesses who need cash flow for further growth and sales; stc can be an invaluable process to get a business through a difficult period until additional resources become available. according to capasso et al. (2020), the major advantage of stc in terms of sales is that, upon approval, a business can receive benefits within a month, as well as receiving a higher level of total sales and revenue benefits. the amount of stc is optimal for the overall sales of the business, which further impacts the entire economy of the firm. in well-structured markets and businesses, borrowers will enter short-term contracts based on their financial requirements and how they agree to distribute the issues involved at various maturities. this directly influences the sales process and positively impacts the sales of total sales ratio (fuertescallen & cuellar-fernandez, 2019). what matters for the financial capability of the contracts is that borrowers have complete access to financial tools that allow firms to experience a significant degree of sales and revenue. therefore, this study proposes the following hypothesis: h5: there is a positive relationship between the growth of a firm’s sales and stc. asian journal of economics and empirical research, 2020, 7(2): 224-234 227 © 2020 by the authors; licensee asian online journal publishing group 2.7. the connection between the sales of total sales and long-term credit according to wang, wu, yin, and zhou (2019) the advantages and benefits offered by ltc compared to stc are mostly related to their different maturities and procedures, as long-term financing offers longer benefits, in terms of financial benefits and sales, at a fixed-rate. as described by chaudhuri, voorhees, and beck (2019), ltc enables businesses and firms to align their capital structures with their long-term strategic objectives, which provides direct benefits in terms of sales and revenue, thereby affording the firm more time to realize a return on investment (roi). the maturity linked to long-term financing effectively affects sales, as well as improving the revenue generated from total sales. empirical papers have pointed out that a firm can gain huge sales and revenue benefits from long-term connections with the same investor (karabarbounis & macnamara, 2019). recent research papers have demonstrated that ltc provides greater flexibility in terms of sales and resources to fund capital demands. hence, based on the above arguments, this study hypothesizes that: h6: there is a direct and favorable connection between long-term financing and the sales growth of firms. 3. research methods this study used methods introduced by fafchamps and schündeln (2013) and applied them to a multiple country framework. this method differentiates from the original strategy in two ways. the method developed by fafchamps and schündeln (2013) considers municipalities and, in line with recent work by léon (2020), this study considers countries. the method followed for calculating growth opportunities is perceived to be a bit different than the original method. a specific measure for each sector-country has been developed. the growth opportunity index has been calculated on the basis of the method followed by fafchamps and schündeln (2013), which considers two measures of inculcation for each reference group. firm size and age have been considered as the characteristics for the reference groups. the basic econometric model is as follows: 𝑔𝑖𝑠𝑐𝑡 = 𝛽(𝐺𝑠𝑐𝑡 × 𝐹𝑐𝑡) + 𝛿𝐺𝑠𝑐𝑡 + 𝛼𝑠𝑡+𝛼𝑐𝑡 + 휀𝑖𝑠𝑐𝑡 (1) where the subscripts i, s, c and t refer to firm, country, sector and year. the term 𝑔𝑖𝑠𝑐𝑡represents the annual rate of growth for the firm (i) belonging to sector (s) in country (c) and in the year (t). the term 𝐹𝑐𝑡represents the development of the banking sector in each country. the study introduces vectors of sector-year dummies and country year dummies so that the unobserved country and sectoral factors can be controlled. the term 𝐺𝑠𝑐𝑡 is included in the regression, in order to account for shocks affecting the sectors and countries that are measured by growth opportunities. equation 1 has been extended to include shortand long-term loans and credit availed by the organizations: 𝑔𝑖𝑠𝑐𝑡 = 𝛽𝑆𝑇(𝐺𝑠𝑐𝑡 × 𝐹𝑐𝑡 𝑆𝑇) + 𝛽𝐿𝑇(𝐺𝑠𝑐𝑡 × 𝐹𝑐𝑡 𝐿𝑇) + 𝛿𝐺𝑠𝑐𝑡 + 𝛼𝑠𝑡+𝛼𝑐𝑡 + 휀𝑖𝑠𝑐𝑡 (2) the term 𝐹𝑐𝑡 𝑆𝑇 represents the ratio of the stc to the gdp of country (c) in time (t), and the term 𝐹𝑐𝑡 𝐿𝑇 represents the ratio of the ltc of a firm to the gdp in a certain country (c) and time (t). the literature supports the supposition that the availability of stc is beneficial for firm growth. 3.1. variables firm level data was extracted from the es database of the world bank. the firm level data was used to build the dependent variables: employment growth and total sales growth. the data on total sales and the number of employees from the preceding year and a further three years before the surveys were also included. data regarding sales has also been collected on the same grounds. however, the sales values were deflated using a base year (2010) and the values for each country’s gdp deflator was sourced from wdi. the index of growth opportunity was calculated using the average rate of growth of the reference group that comprises less constrained firms. in the basic model, 50 employees were considered. some sectors in developing economies do not include firms with more than 50 or 100 employees; therefore, they are both considered to be the benchmark size. recent research has proven that older firms are more capable of gaining access to bank loans than younger organizations, irrespective of size. therefore, the reference threshold for a firm’s age has been mandated at 25 and 20 years. the growth opportunity in this scenario reflects the growth of the organizations’ employment and sales. dummy variables regarding the sector of the firm, i.e. whether it is a subsidiary, exporter, privately held, or government owned, are also introduced in the study. the independent variables represent the maturity of the bank credits allowed for firms under consideration. data regarding these variables were collected from the credit structure database. the independent variables in this study are: the total bank credit over gdp as a sum of shortand ltc, stc, defined as the credit extended by the banking sector over gdp to organizations with a maturity period of one year or less, and ltc, defined as the credit extended by the banking sector over gdp with a maturity of over a year. the variable total credit accounts for the total loans extended to organizations by banks. 3.2. sample the total sample consisted of 52 countries characterized by their size and age. the period under consideration was 2006–2016. the sample consisted of firms from 43 countries, with the final sample representing a total of 19282 firms from countries under consideration. in table 1, the first column represents the name of the country from which the data was collected; the second column details the year in which the data was collected; the third column represents the total number of firms registered on the database; and the next two columns (size and age) represent the total number of firms characterized according to specifications of age and size. asian journal of economics and empirical research, 2020, 7(2): 224-234 228 © 2020 by the authors; licensee asian online journal publishing group table 1. sample country year obs. benchmark size>50 size>100 age>20 age>25 albania 2007 216 19 7 1 1 albania 2013 227 31 8 6 0 azerbaijan 2009 265 56 30 59 55 azerbaijan 2013 291 37 16 24 12 bahamas 2010 130 33 17 64 47 barbados 2010 132 36 26 52 35 belarus 2008 222 75 54 38 35 belarus 2013 294 71 47 68 34 botswana 2006 242 42 21 40 24 botswana 2010 216 48 24 61 41 bulgaria 2007 942 273 160 42 33 bulgaria 2009 238 48 30 13 12 bulgaria 2013 272 60 35 68 11 burkinafaso 2009 283 39 20 45 34 burundi 2006 211 14 3 24 13 burundi 2014 131 20 7 34 22 chile 2004 872 366 239 385 300 chile 2006 802 278 160 418 318 chile 2010 913 375 253 569 467 congo 2009 57 6 3 12 10 croatia 2013 303 50 29 92 25 czech republic 2009 187 64 38 6 5 czech republic 2013 227 47 26 91 4 coˆte d’ivoire 2011 257 32 25 36 18 dr congo 2007 265 17 9 42 36 dr congo 2011 286 45 28 72 41 dr congo 2012 362 38 14 57 34 djibouti 2014 131 4 4 51 34 dominica 2011 145 14 5 33 24 estonia 2008 221 89 55 19 11 estonia 2014 210 34 19 58 3 fyr macedonia 2006 283 80 47 45 36 fyr macedonia 2012 318 31 15 84 18 gabon 2007 91 15 9 24 19 georgia 2006 282 54 25 11 9 georgia 2011 251 31 12 24 11 grenada 2012 121 18 9 61 46 guinea 2008 185 8 4 11 8 guinea bissau 2009 131 6 4 14 7 hungary 2006 278 111 74 18 8 hungary 2014 240 47 31 57 11 jordan 2013 372 103 71 129 87 kazakhstan 2010 415 140 93 10 7 kazakhstan 2012 485 82 52 42 13 kosovo 2008 226 21 12 30 16 kosovo 2011 156 15 6 47 11 kyrgyz republic 2008 181 42 22 28 32 kyrgyz republic 2012 241 55 25 27 8 latvia 2006 210 94 58 7 7 latvia 2012 237 34 21 38 4 lithuania 2007 239 71 49 14 11 lithuania 2012 186 45 23 38 8 madagascar 2007 38 17 9 6 5 madagascar 2007 380 98 51 126 88 madagascar 2014 278 62 45 63 42 malaysia 2016 537 223 123 169 92 mali 2008 421 12 7 46 26 mali 2011 216 14 2 24 14 mali 2015 104 32 10 35 25 morocco 2014 282 92 52 112 88 nigeria 2007 95 13 2 24 22 nigeria 2013 1,257 95 43 313 185 poland 2007 248 73 45 53 32 poland 2012 384 82 46 158 51 romania 2008 362 127 83 12 12 romania 2012 466 97 52 105 11 russia 2008 783 383 264 116 102 russia 2011 3,167 628 324 253 115 rwanda 2007 141 13 8 29 18 rwanda 2012 183 37 17 30 32 senegal 2002 36 15 9 10 7 senegal 2008 400 28 11 69 52 senegal 2013 410 52 27 102 65 serbia 2008 318 98 70 80 75 serbia 2012 287 65 42 104 28 ukraine 2009 661 189 133 90 81 ukraine 2012 670 130 78 77 23 yemen 2011 312 57 33 93 71 yemen 2012 272 44 27 122 72 asian journal of economics and empirical research, 2020, 7(2): 224-234 229 © 2020 by the authors; licensee asian online journal publishing group 4. findings the descriptive statistics have been reported in table 1. it can be seen that the mean employment growth is 4.4, whereas the sales growth is 0.8 percent. moreover, the descriptive analysis showed that most firms wer 15 years old and the average number of employees appointed was eleven. moreover, 17 percent of these firms belong to the export sector, 14 percent operate as subsidiaries, 5.6 percent operate as private organizations and 0.39 percent are owned by the government. the average amount of total credit extended to organizations is 37 percent; of this percentage, 12 percent has been characterized as a short-term loan and 25 percent has been considered to be a long-term loan. table 2. descriptive statistics variable mean std. dev min max dependent variable growth of employment 4.4207 11.359 -31.951 47.144 growth of total sales 0.8468 20 -53.594 65.369 independent variables f (total credit over gdp) 36.813 27.501 0.7265 122.57 fst (stc over gdp) 11.842 8.64 0.703 51.764 flt ( over gdp) 25.342 23.051 0.027 92.049 control variables size (in log) 2.4109 0.7935 0 3.8919 age 15.189 11.147 0 100 export 0.1759 0.3805 0 1 subsidiary 0.1443 0.3511 0 1 state-owned 0.0039 0.0612 0 1 privately-held 0.5624 0.496 0 1 table 2 summarizes the credit representation of the total sample, i.e. the 52 developing countries that have been taken into consideration. the basic descriptive statistics displayed in table 2 show that the total credit represents 47 percent of the gdp of the developing countries, and about 60 percent of the loans have credit maturities that are greater than one year; in other words, it is predominantly long-term loans that have been issued. it can be seen from the trends presented in the table that the level of ltc increases with the relative level of income. for example, we can see that, in low income countries, long-term bank loans represent less than 5 percent of the total loans, although they exceed 50 percent in high-income countries. table 3. credit information by country credit over gdp perc. of sample total short-t. long-t. long-t.a obs country all countries 46.8 13.7 33.7 59 1,200 52 by income level low income 11.5 7.1 4.4 33.7 194 10 lower middle income 21.7 9.5 12.2 48.0 168 10 upper middle income 42.7 11.8 30.9 65.3 297 12 high income 70.4 19.2 51.2 70.1 541 20 4.1. total credit first, the effects of the total credit on employment growth have been analyzed and are presented in table 3. the coefficient of interest is the interaction term g*f. the positive coefficients imply that small firms are growing more successfully, especially if they are positioned in a country with a high level of credit. the results also point out that total credit doesn’t necessarily stimulate employment growth in small firms. the computed coefficients of interaction terms are positive, yet insignificant. the young firms (the results are shown in columns 6–10) provide more positive conclusions, indicating that the impact of total credit on employment growth is significant at the 10 and 5 percent level of significance. the firm level control variables are reliable and consistent with expectations. asian journal of economics and empirical research, 2020, 7(2): 224-234 230 © 2020 by the authors; licensee asian online journal publishing group table 4.total credit and employment growth benchmark large firms (employees > 50) benchmark old firms (age >20) (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) g*f 0.000253 0.000472 0.00104 0.00395 0.0041 0.00035 0.000728 0.000635 0.00543** 0.00465* (-0.26) -0.48 -0.86 -1.2 -1.37 -0.34 -0.66 -0.51 -2.04 -1.69 g 0.0685* 0.0368 0.00512 0.01 0.0975 0.0457 0.0204 0.0349 0.0166 0.242 -1.71 -0.86 -0.2 (-0.32) -0.46 -1.06 -0.4 -0.62 (-0.31) (-1.19) empl 4.302*** 3.966*** 3.967*** 3.966*** 2.282*** 2.071*** 2.073*** 2.078*** (-11.08) (-8.31) (-8.30) (-8.31) (-9.61) (-7.55) (-7.57) (-7.57) age 0.0891*** 0.0967*** 0.0967*** 0.0979*** 0.268*** 0.301*** 0.303*** 0.302*** (-7.25) (-7.44) (-7.45) (-7.48) (-7.91) (-8.78) (-8.81) (-8.81) export 1.947*** 2.042*** 2.038*** 2.038*** 1.765*** 1.861*** 1.860*** 1.861*** -6.46 -7.37 -7.2 -7.3 -7.42 -7.38 -7.38 -7.3 subsidiary 0.972*** 1.191** 1.191*** 1.193*** 0.935*** 1.062*** 1.066*** 1.064*** -2.75 -2.62 -2.62 -2.63 -2.85 -2.73 -2.73 -2.73 state-owned 0.108 1.276 1.293 1.28 0.392 2.286** 2.301** 2.295** (-0.06) (-0.84) (-0.85) (-0.85) (-0.27) (-2.54) (-2.57) (-2.56) privately-held 0.642** 0.652* 0.654* 0.653* 0.592** 0.572* 0.575* 0.571* -2.17 -1.87 -1.88 -1.87 -2.38 -1.84 -1.85 -1.83 r2 0.003 0.101 0.098 0.098 0.098 0.003 0.078 0.09 0.08 0.09 note: ∗, ∗∗ and *** depicts 0.01, 0.05 and 0.10 levels of significant respectively. table 5. total credit and sales growth benchmark large firms (employees > 50) benchmark old firms (age >20) (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) g*f 0.000732 0.000961 0.00062 0.000681 0.000172 0.000756 0.000172 0.000439 0.000419 0.00028 -0.68 -0.91 -0.47 (-0.26) (-0.05) (-0.91) (-0.22) (-0.52) -0.16 -0.07 g 0.0322 0.0241 0.032 0.0472 0.183 (0.93) 0.0356 0.0157 0.0176 0.00822 0.0256 -1.27 -0.88 -0.83 -1.06 -1.17 -0.48 -0.41 -0.18 (-0.13) empl 2.101*** 2.044*** 2.033*** 2.032*** 1.275*** 1.235*** 1.256*** 1.237*** (-5.03) (-3.92) (-3.92) (-3.92) (-5.33) (-4.62) (-4.62) (-4.62) age 0.127*** 0.132*** 0.132*** 0.132*** 0.457*** 0.498*** 0.498*** 0.498*** (-7.08) (-6.32) (-6.31) (-6.31) (-7.23) (-7.08) (-7.07) (-7.07) export 1.864*** 2.388*** 2.386*** 2.384*** 1.688*** 2.202*** 2.198*** 2.201*** -3.08 -3.87 -3.86 -3.86 -3.77 -4.54 -4.53 -4.53 subsidiary 1.526** 1.223* 1.222* 1.221* 1.097** 0.892 (1.56) 0.893 (1.56) 0.892 (1.56) -2.45 -1.71 -1.71 -1.71 -2.15 state-owned 1.032 (0.35) 3.908 (1.55) 3.921 (1.56) 3.931 (1.58) 0.668 (0.32) 2.252 (1.04) 2.238 (1.03) 2.241 (1.03) privately-held 0.0412 0.113 0.113 0.106 0.727 (1.17) 0.655 (0.92) 0.658 (0.92) 0.654 (0.91) -0.06 (-0.15) (-0.15) (-0.14) r2 0.005 0.021 0.023 0.023 0.023 0.003 0.024 0.028 0.028 0.028 note: ∗, ∗∗ and *** depicts 0.01, 0.05 and 0.10 levels of significant respectively. asian journal of economics and empirical research, 2020, 7(2): 224-234 231 © 2020 by the authors; licensee asian online journal publishing group table 6. longand short-term credit and growth of employment. benchmark large firms (employees > 50) benchmark old firms (age >20) (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) g*fst 0.00635* 0.00603+ 0.0102** 0.0105** 0.0104** 0.00341 0.00186 0.00686 0.00972** 0.0109** -1.74 -1.52 -2.28 -2.36 -2.32 -0.67 -0.38 -1.32 -2.22 -2.36 g*flt 0.00158* 0.000643 0.00032 0.00102 0.0012 0.000189 0.000582 0.000216 0.00482+ 0.00287 (-1.78) (-0.58) (-0.25) -0.32 -0.32 (-0.13) -0.3 (-0.13) -1.48 -0.79 g 0.0332 0.00688 0.0513 0.0562 0.0348 0.0282 0.0126 0.00473 0.043 0.377+ -0.72 -0.13 (-0.83) (-0.91) (-0.14) -0.52 -0.25 (-0.07) (-0.76) (-1.58) empl 4.312*** 3.967*** 3.967*** 3.967*** 2.282*** 2.072*** 2.073*** 2.074*** (-11.06) (-8.32) (-8.32) (-8.32) (-9.61) (-7.54) (-7.58) (-7.59) age 0.0888*** 0.0969*** 0.0968*** 0.0966*** 0.268*** 0.301*** 0.302*** 0.302*** (-7.23) (-7.43) (-7.43) (-7.43) (-7.91) (-8.78) (-8.81) (-8.82) export 1.948*** 2.042*** 2.041*** 2.042*** 1.766*** 1.861*** 1.862*** 1.863*** -6.48 -7.42 -7.41 -7.41 -7.42 -7.38 -7.42 -7.42 subsidiary 0.971*** 1.198*** 1.199*** 1.197*** 0.935*** 1.062*** 1.065*** 1.064*** -2.74 -2.64 -2.64 -2.64 -2.87 -2.73 -2.73 -2.73 state-owned 0.0874 1.236 1.246 1.246 0.392 2.282** 2.293** 2.286** (-0.07) (-0.82) (-0.82) (-0.82) (-0.28) (-2.57) (-2.56) (-2.55) privately-held 0.645** 0.655* 0.658* 0.658* 0.594** 0.589* 0.586* 0.581* -2.17 -1.99 -1.88 -1.88 -2.32 -1.87 -1.89 -1.87 r2 0.003 0.101 0.2 0.2 0.2 0.003 0.077 0.07 0.06 0.07 note: ∗, ∗∗ and *** depicts 0.01, 0.05 and 0.10 levels of significant respectively. asian journal of economics and empirical research, 2020, 7(2): 224-234 232 © 2020 by the authors; licensee asian online journal publishing group table 7. shortand long-term credit and sales growth benchmark large firms (employees > 50) benchmark old firms (age >20) (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) g*fst 0.00583+ 0.00692* 0.00842+ 0.00867+ 0.00941+ 0.00815* 0.0101** 0.00918** 0.00888* 0.00854* -1.61 -1.92 -1.48 -1.5 -1.57 -1.93 -2.43 -2.05 -1.88 -1.82 g*flt 0.000557 0.000537 0.000728 0.00544* 0.00632+ 0.00148** 0.00101* 0.000942 0.00227 0.00323 (-0.38) (-0.36) (-0.46) (-1.77) (-1.62) (-2.45) (-1.78) (-1.33) (-1.12) (-1.26) g 0.00458 0.00785 0.023 0.00442 0.0966 0.0187 0.0454 0.0496 0.0422 0.172 -0.15 (-0.27) (-0.46) (-0.08) (-0.42) (-0.52) (-1.17) (-0.94) (-0.77) (-0.85) empl 2.098*** 2.054*** 2.048*** 2.048*** 1.287*** 1.252*** 1.248*** 1.250*** (-5.04) (-3.92) (-3.91) (-3.91) (-5.34) (-4.64) (-4.63) (-4.63) age 0.127*** 0.133*** 0.133*** 0.132*** 0.457*** 0.501*** 0.501*** 0.501*** (-7.08) (-6.32) (-6.33) (-6.32) (-7.25) (-7.11) (-7.11) (-7.11) export 1.868*** 2.393*** 2.388*** 2.386*** 1.687*** 2.198*** 2.198*** 2.198*** -3.2 -3.87 -3.86 -3.88 -3.78 -4.52 -4.52 -4.52 subsidiary 1.513** 1.217* 1.212* 1.212* 1.104** 0.908 (1.61) 0.901 (1.61) 0.907 (1.61) -2.42 -1.72 -1.72 -1.72 -2.17 state-owned 1.076 (0.36) 3.998 (1.58) 4.086 (1.63) 4.102 (1.63) 0.606 (0.27) 2.202 (1.02) 2.217 (1.02) 2.226 (1.02) privately-held 0.0441 0.106 0.102 0.104 0.757 (1.21) 0.694 (0.96) 0.695 (0.97) 0.691 (0.96) -0.07 (-0.15) (-0.14) (-0.15) r2 0.004 0.021 0.023 0.023 0.023 0.001 0.022 0.026 0.026 0.026 note: ∗, ∗∗ and *** depicts 0.01, 0.05 and 0.10 levels of significant respectively. asian journal of economics and empirical research, 2020, 7(2): 224-234 233 © 2020 by the authors; licensee asian online journal publishing group table 4 represents the evaluation of the impact of total credit on total sales growth. the growth opportunity, i.e. the level of the sales growth, is evaluated by calculating the average growth rate of the total sales of large firms (firms with more than 50 employees) and old firms (firms that are older than 20 years). the interaction term f*g, i.e. the evaluation of the sales growth and total credit, were positive; however, the coefficients weren’t significant. the firm level control variables are reliable and consistent with expectations. small and young firms were observed to have grown significantly faster than their counterparts. firms belonging to the export sector and subsidiaries presented consistent growth rates that were significant at the 10 and 5 percent levels. 4.2. effects of short-term and long-term credit table 5 represents the impact of the availability of short-term loans on firm growth from the perspective of employees. long-term loans, however, seem to have no impact. in particular, the coefficients of the interaction term generated by short-term loans and the growth of employment were statistically significant and positive, irrespective of the size of the firm. the effects of stc were also appeared to be economically significant. on the other hand, it can be seen that the impact of ltc and the interaction terms generated between ltc and employment growth values were positive yet insignificant. table 6 presents the impact of shortand ltc on the firms’ growth of sales. first, it can be seen that shortterm loans benefit the growth of the firm. second, the results also indicate that the ratio of ltc over gdp isn’t significant; it does not seem to have a reasonable impact on the performance of firms. these results imply that stcs are beneficial for the growth optimization of young and small firms. 5. discussion this study evaluated the impact of the longand stc on the employment and sales growth opportunities of firms in 52 developing countries. a wide number of studies have analyzed the effects of longand stc on the overall performance and growth of organizations. a significant proportion of studies, however, found an insignificant link between ltc and firm growth. a reasonable explanation is that ltc isn’t crucial for daily operations, as working capital requirements of small and young firms is markedly important (field, pande, papp, & rigol, 2013; getachew, 2016; lay, 2020; leon, 2018; leon, 2019). studies by fisman and love (2007) and fafchamps and schündeln (2013) studied the impact of growth opportunities by including it in the base model and analyzing its relationship with credit growth maturity. these studies also reported the insignificance of ltc extensions and their relevance to firm growth. a study by léon (2020) focused on the external financial dependence of organizations and credit maturity, and the results indicated that external financial dependence is significant for the stc of firms. this study also pointed out that young firms are significantly correlated with external financial dependence and the provision of stc. a study by khan, ghafoor, qureshi, and rehman (2018) empirically investigated the role of the banking market, evaluating developments in the financial structure and the growth of financial dependence in the manufacturing sector of china. the study evaluated growth between1999– 2014. the study employed structural and non-structural methods to evaluate the impact of the banking market structure and its relationship with the growth of the manufacturing sector. the results indicated that competition between banks inspires the growth of the industry. chauvet and jacolin (2017) explored the effects of firm performance from the perspective of bank concentration or credit extension activities, and the financial inclusion of firms in emerging and developing countries. this particular study employed the use of firm level data from 79 developing and emerging countries. the results indicated that the distribution of financial services across firms seems to have a positive impact on the overall growth of organizations. this positive impact or growth becomes greater when the bank’s concentration is less significant. 6. conclusion this study evaluated the impact of the provision of longand stc on the growth of the firms. the study was performed on a dataset of 52 developing countries with a total of 19282 firms characterized on the basis of size (number of employees) and age. the growth of the firms was evaluated on the basis of employment growth and sales. it appears that entrepreneurs in developing economies should be able to benefit from the provision of ltc so that investments can be extended. however, this study found that ltc doesn’t have an impact on the sales and employment growth of small and young firms in developing economies. the results also indicated that the availability of stc is beneficial for the growth of small and young firms. the evaluation of the total bank credit pointed out that growth in sales and employment is significant over shorter periods of time because of capital requirements. the results of this study can be applied when developing policies. the results have indicated that access and availability of stc is of considerable importance for the growth of small firms. therefore, policies that are developed in favor of ltc may have a negative impact on the growth of new firms. as a result, banking policies in developing economies need to be adjusted so that the client base can be widened, and loans can be extended to parties other than existing clientele. one limitation of this study is the fact that it explores ltc and how it isn’t beneficial for the growth of small firms, but it doesn’t explore the rationale behind this occurrence. moreover, the data set was only 52 developing countries, so future studies should focus on diversifying and increasing the sample size. references aghion, p., bergeaud, a., cette, g., lecat, r., & maghin, h. 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(2019). trade credit, ownership and informal financing in china. pacific-basin finance journal, 57, 101177.available at: https://doi.org/10.1016/j.pacfin.2019.101177. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 235 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 2, 235-241, 2020 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2020.72.235.241 © 2020 by the authors; licensee asian online journal publishing group wealth inequality, governance and economic growth in china tian aw yong south china normal university, china. abstract recently, there has been an increasing interest from policymakers, advocates and researchers on the extent to which the growth of the economy can impact income inequality. this research has been focused on the relationship between these variables. the author has recognized the need to focus on wealth as the income indicator, as well as the importance of studying wealth inequality (wi). this is more viable and important than researching income inequality, as this has been studied extensively, as has the impact that governance policies have on the growth of a country’s economy. for the purpose of examining these variables, data from 30 selected chinese provinces has been used. the panel dataset from 2000–2012 has been extracted from credit suisse. this study has predominantly investigated the impact of wealth inequality on economic growth (eg). the study has made use of the gmm estimation system in order to suggest that wealth inequality has a negative impact on the eg of china. moreover, this empirical investigation has revealed the fact that the impact of wealth inequality on eg has been mitigated by an improved quality of governance. keywords: wealth inequality; economic growth; governance; gmm growth estimator. citation | tian aw yong (2020). wealth inequality, governance and economic growth in china. asian journal of economics and empirical research, 7(2): 235-241. history: received: 7 july 2020 revised: 10 august 2020 accepted: 14 september 2020 published: 29 september 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 236 2. literature review .......................................................................................................................................................................... 236 3. methods ........................................................................................................................................................................................... 238 4. results and discussion ................................................................................................................................................................. 238 5. discussion and conclusion ........................................................................................................................................................... 240 6. research implications ................................................................................................................................................................... 240 7. limitations of the study ............................................................................................................................................................... 240 references ............................................................................................................................................................................................ 241 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.72.235.241&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/2192 https://www.asianonlinejournals.com/index.php/ajeer/article/view/2192 asian journal of economics and empirical research, 2020, 7(2): 235-241 236 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to existing literature by investigating the relationship between wealth inequality, governance and economic growth in 30 selected chinese provinces. 1. introduction generally, the rate of eg is inversely proportional to the rate of wealth inequality (wi). this helps to determine the potential causes and implications of the functional distribution of the wealth approach (berg & ostry, 2017). the increase in wi is a result of several policies in china, including the long-term growth of the economy and long-lasting and high-speed efficiency (zhao & tang, 2018). according to riti, song, shu, and kamah (2017), political pressure has increased due to wi, which has resulted in a reduction of growth and investment. furthermore, socio-political instability is an issue derived from inequalities that have resulted in the slowing down of growth and capital accretion. the effects of wi on eg in china can be alleviated by improved governance and supremacy (shi & sun, 2017). wealth equality (we) and governance have been gaining significant attention from academic practitioners and scholars over the past few years (wu & li, 2017), who have explored the fact that, even now, a wealth equality gap exits in the economic performance of a country (piketty, yang, & zucman, 2019). li (2016) has recommended that, in order to address the governance and we limitations, some important contextual factors that directly affect the overall eg of a nation need to be identified and evaluated in detail. as research on we and governance are rare, studies on the eg of developing regions need to be conducted (zhou & song, 2016), and the impact of human capital (hc) must also be tested (wei, wu, & zhang, 2019). diao (2018) identified and evaluated the impact of technology and physical capital on the overall eg of the country. furthermore, understanding wealth and governance from the perspective of economic development is significant. therefore, this research explores the impact of wi and governance on the eg of china. figure 1 shows the income inequality in china over the last 12 years. figure-1. wealth inequality n china following the above discussion and justification statement, the initial and major objective of the current study is to analyze the impact of wi on the eg of china; the second purpose of the study is to investigate the relationship between governance and economic performance in china. the current paper also empirically investigates the impact of wi on the overall economic presentation of china in the current situation, predominantly using credit suisse's information and statistics. in summary, the particular interest of the following research are the connections between eg, wealth, and governance activities in china. factual and observed findings point to negative connections between wi and eg; they recommend that the insignificant impact of wi on development may become significant in nations with enhanced governance activities. china is one of the developing countries that has been facing issues related to wi (guan, wei, lu, dai, & su, 2018). the scope of this study covers the influence of wi on eg and governance of china, as the link between economic inequality and growth in china has become a topic of interest (liu, 2018). this study provides useful implications for the chinese government regarding the development of its economy. the particular significance of this study lies in its focus on the economic development of china and its use of the theory of economic inequality to study the relationship between wi, governance, and eg. the research study is organized as follows: sections two and three present the empirical and observed model and framework, data, methods, and techniques, respectively; section four presents the estimations and calculations; robustness checks are presented in section five; the results and discussion are presented in section six; and the last section concludes the by presenting the findings and implications of the study. 2. literature review there is a huge variation of economic inequalities (ei); and ei is most notably measured using the distribution of income (the amount of public money paid) and the distribution of wealth (the amount of money and wealth the public owns). the theory also states that, in addition to the ei between nations and regions, there are also significant types of ei between different groups of the public (bapuji, ertug, & shaw, 2020). according to this theory, significant types of eg measurements focus on wealth, income, and, sometimes, consumption. the theory also suggests that a greater level of inequality hinders the overall eg of the country, as land and hc inequality minimizes development and increases income inequality. whereas globalization has minimized global inequality between countries, it has improved inequality within states and countries (bapuji & chrispal, 2018). furthermore, asian journal of economics and empirical research, 2020, 7(2): 235-241 237 © 2020 by the authors; licensee asian online journal publishing group this theory suggests that a degree of inequality can have a significant and positive impact on eg in the short-term; however, some theories and models have found empirical proof of an insignificant correlation of about 0.4-0.7% between long-term growth rates and sustained ei. according to this theory, eg is suppressed in economically unequal countries and societies after a phase of improved development and growth, owing to a reduction in the availability of investments for public capital (ritter & solt, 2019). furthermore, physical capital is becoming scarce, as fewer peoples have funds to invest in education and training. as a consequence, needs for hc are critical or impossible to meet, which leads to a reduction in eg (ruck, mistry, & flanagan, 2019). consequently, the market needs to improve in order to better deal with risky unsecured loans, which further enhance the lender’s risk exposure. moreover, this theory also states that, when wealth distribution becomes concentrated in a small number of politicians, political power tends to become unstable. this affects the effectiveness of governance, which further affects the eg of the nation. 2.1. wealth inequality and economic growth according to islam and mcgillivray (2019), the most notable methods to measure income distribution include the total amount of public money paid and the distribution of wealth, which is the amount of money and wealth the public owns. furthermore, the theory also states that, in addition to ei between nations and regions, there are also significant types of ei between different groups of the public (stiglitz, 2016). according to this theory, significant types of eg measurements focus on wealth, income, and sometimes consumption (adrián risso & sánchez carrera, 2019). akinci (2018) illustrates that the theory also suggests that a greater level of inequality hinders the overall eg of the country, with land and human capital (hc) inequality minimizing development more than income inequality. although globalization has minimized global inequality between countries, it has also heightened inequalities between states and countries (lorenzi, 2016). furthermore, this theory also suggests that a degree of inequality can have a significant and positive impact on eg in the short-term; however, some theories and models have found empirical proof of an insignificant correlation of about 0.4-0.7% between long-term growth rates and sustained ei (chen, lee, & tsai, 2019; scheffer, van bavel, van de leemput, & van nes, 2017). according to this theory, eg is suppressed in economically unequal countries and societies after a phase of improved development and growth, owing to a reduction in the availability of investments for public capital. furthermore, as physical capital is scarce, fewer people have the funds to invest in education and training. as a consequence, needs for hc are critical or impossible to meet, which leads to a reduction in eg (lee & son, 2016). consequently, the market needs to improve in order to better deal with risky unsecured loans, which further enhance the lender’s risk exposure. moreover, this theory also states that, when wealth distribution becomes concentrated in a small number of politicians, political power tends to become unstable. this affects the effectiveness of governance, which further affects the eg of the nation. the above discussion leads to the development of the following hypothesis: h1: there is a direct and significant relationship between wi and the eg of the country. 2.2. governance and economic development research conducted by ogidan, adekola, grace, and oluwanishola (2017) briefly explored the fact that better governance leads to better economic development. good governance results in a sustainable environment that helps to enhance economic development, as the use of innovative technology is related to good governance. improved governance can help a country to overcome wi, which leads to an improvement in the credit sector so that its products can increase. if a country is well governed, the small issue of wi cannot harm the growth of its economy; in fact, it can help to provide high-quality products. it has been stated by kyriacou (2016) that the negative effects of wi can be made positive by laudable and significant governance. countries that face the problem of credit inequality should have a better and more advanced governance, so that eg can increase; this will change a developing country into a developed country (scheve & stasavage, 2017). most small organizations do not focus on governance; thus, they face the problem of reduced eg and credit inequality. azam (2016) has described the fact that governance can be considered as the certain manner or order in which authority is implemented in terms of the administration of a country’s social and economic resources with regard to its development. governments are regularly replaced, monitored, and selected during the process of governance, depending on their capacity to implement strategies and policies and garner the respect of the residents in a country. governance helps to govern social and economic interactions between institutions. as such, corruption can lead to the issue of wi and poverty, which could result in a reduction in the growth of a country’s economy; however, this issue can be resolved with advanced governance. the variations within countries with regard to the distribution of wealth and eg can be investigated efficiently and reliably through sustainable governance. it has been proven by franz (2017) that eg and wi are highly dependent on the governance of the country, i.e. eg is reduced by wi. however, this can be decreased through enhanced governance and the ability to restrict the unequal dissemination of wealth across several economies. the theory of economic inequality has stated that eg measurements focus on income, wealth, and consumption. additionally, the greater level of inequality obstructs the overall eg of a country, along with land and hc inequality, by minimizing development more than credit inequality. based on the above discussion, the present research poses the following hypothesis: h2: there is a direct and positive connection between governance practices and the eg of a nation. 2.3. model specification the author of this research has used an unbalanced panel growth regression model to analyze the empirical links between the variables of wi and growth (johnson, de dios, & martin, 2010). this model is presented as follows: (1) in equation 1, the represents the per capita gdp growth rate that is measured using the first difference of the natural logarithm of the value, , which is the natural logarithm that has been used to calculate the per capita real gdp that has been lagged at one period. the measurement of wi is shown by , asian journal of economics and empirical research, 2020, 7(2): 235-241 238 © 2020 by the authors; licensee asian online journal publishing group which has been measured in the wealth share of the top ten percent; represents the control variables that include the measurement of trade openness, the rate of inflation, institutional quality, the ratio of investment, school attainment, and population growth. the fixed effects that are unobserved are represented by , and is used as the time dummy. finally, the random error is indicated as . 2.4. data the variables specified in the model presented in equation 1 have been constructed as follows:  as previously mentioned, the real per capita gdp growth rate has been measured using the first difference of its natural logarithm. in the equation, α represents the income share of the capital of china, which has been set to 0.30 following guidelines by gollin (2002).  the measurement of wi has been taken as the wealth share made by the top ten percent of the population. the wealth share data has been acquired from a recent credit report (suisse, 2013). the researcher has considered the top wealth share as a measurement of wi because:  it is easy and simple to understand.  it is not exposed to oversensitivity of the lower levels of wealth changes.  faster growth occurs in the top portions of the wealth share.  the gini coefficient supports this selection, and the top percentile is the most commonly used measure in research on wi (suisse, 2013). the researcher has made use of several control variables in this study, including:  gross fixed investment over gdp (ratio).  average number of years of schooling of those who are 25 years old and above.  sum of the exports and imports over the gdp (ratio).  population growth rate.  rate of inflation (measured as the consumer price index inflation).  institutional stability. in addition, the researcher has taken into account a poverty ratio, which is the percentage of the population that lives below the threshold of $1.9 per day, in order to estimate the impact of poverty on the wi growth rate. the dataset from 2000–2012 of 30 selected chinese provinces have been extracted from credit suisse. 3. methods the researcher has used the gmm estimator to conduct the empirical estimation of equation 1, which has been used to handle the issues of unobserved heterogeneity and endogeneity in the estimation data. this estimator performs better in the presence of these issues, compared to other simpler estimators (baum, schaffer, & stillman, 2003). this estimator is a preferred methodology for the calculation of growth models because it has the ability to exploit restrictions of stationarity. the dynamic panel model, thus, is as follows: ́ (2) in equation 2, y represents real per capita gdp; x is the marker for the explanatory variables except for the value of y and π; and ρ and ε are the same as in equation 1. the following equation represents this model after it has been re-parameterized: ́ (3) in equation 3, there is a simultaneity problem because the lagged value of the dependent variable has been correlated with the fixed effects; therefore, the following first difference equation has been proposed (arellano & bover, 1995): + ́ + (4) in equation 4, δ is used to show the first difference operator. for the purpose of handling the endogeneity in the regressors and the issues of potential correlations, an instrumental variable approach will be used in equation 4. the researcher has used the gmm estimator because the proposed relationship between wi and eg has a tendency to be impacted by issues such as endogeneity and reverse causality, and the endogenous variables have been instrumented in a suitable lag form so that they do not correlate to error terms. even though the gmm model may not fully resolve these issues, it will provide a better result than an ols regression model. the hansen test has been used to consider the validity of the instruments, and the f-statistics have been calculated to show the joint significance of the estimated coefficients. moreover, ar(1) and ar(2) tests have been performed to check he serial correlation in the error term. finally, the gmm made an assumption that there is no correlation in the crosssectional error terms and, therefore, period dummies have been used (roodman, 2009). 4. results and discussion the regression results are provided in this section. the impact of wi and governance on the eg of china were initially calculated using a simple ols regression and then by the gmm estimator, in order to analyze the effects of lagged parameters and ensure the robustness of the findings. table 1 presents the results of the ols estimations for equation 1 in china between 2000–2012. the analysis is proceeded with the estimations of the baseline regressions for the model defined in equation 1. in table 1, columns (1) and (4) present the regression results, which show that the growth of gdp per capita has regressed in terms of wi and the lagged parameter of gdp per capita. asian journal of economics and empirical research, 2020, 7(2): 235-241 239 © 2020 by the authors; licensee asian online journal publishing group table 1. gmm estimation variables (1) (2) (3) (4) (5) (6) wi it -0.15*** (-2.82) -0.17** (-2.22) -0.19* (2.03) -0.19** (-2.43) -0.22* (-1.82) -0.23 (-1.58) ln (real gdp per capitai,t1) investment ratio it -0.02* (-1.63) -0.07*** (-3.38) -0.43*** (-3.87) -0.08*** (-2.75) 0.44*** (4.24) -0.03* (-1.88) -0.09*** (-3.37) -0.42*** (-3.85) -0.09*** (-2.94) -0.43*** (4.17) school attainment it 0.02 (0.67) 0.02 (0.53) 0.02 (0.87) 0.02 (0.66) trade openness it 0.03*** (4.29) 0.04*** (3.23) 0.05*** (4.08) 0.04*** (2.85) population growthist inflationist polity it -0.02 (-1.07) -0.02 (-1.12) 0.12** (-2.54) 0.02 (1.07) -0.02 (-1.08) -0.02 (-1.25) 0.13** -(2.52) 0.02 (0.88) -r-squared 0.23 0.37 0.38 0.23 0.33 0.37 note: ∗, ∗∗ and *** depicts 0.10, 0.05 and 0.01 levels of significant respectively. table 2. two-step gmm variables (1) (2) (3) (4) (5) (6) (7) wealth inequalityit voice & accountibilityit -0.34** (-2.54) -0.16 (-1.31) -0.32** (-2.31) -0.37*** (-2.95) -0.31*** (-2.82) -0.28** (2.32) -0.27*** -(2.79) -0.22** -(2.35) political stabilityit -0.03 (-0.48) govt. effectivenessit -0.11 (-1.42) regulatory qualityit -0.05 (-0.85) rule of lawit 0.08 (1.51) control of corruptionit 0.05 (1.41) polityit 0.02 wealth inequalityit voice & accountibilityit 0.46* (1.67) (1.42) wealth inequalityit political stabilityit 0.12 (1.57) wealth inequalityit govt. effectivenessit 0.26* (1.88) wealth inequalityit regulatory qualityit 0.35* (1.72) wealth inequalityit rule of lawit 0.26* (1.71) wealth inequalityit control of corruptionit 0.23** (2.26) wealth inequalityit polityit 0.03** (1.98) ln(real gdp per capitai,t1) -0.02 (-0.68) -0.06*** (-2.71) -0.03 (1.12) -0.03* (-1.83) -0.07*** (-3.79) -0.05*** -(2.70) -0.02 (-0.62) investment ratioit school attainmentit 0.08 (0.38) 0.02 (0.04) 0.33*** (2.95) 0.02 (1.26) 0.32** (2.53) 0.01* (1.83) 0.28** (2.51) 0.02 (0.27) 0.23** (2.47) 0.02** (2.31) 0.39** (2.01) 0.02 (0.58) 0.03 (0.22) 0.02 (0.63) trade opennessit 0.01 (0.37) 0.01 (0.71) 0.01 (0.02) 0.01 (0.07) 0.01 (0.33) 0.01 (0.46) 0.01 (0.15) population growthit inflationit ar(1)-p-value 0.01 (0.85) 0.14 (0.76) 0.00 0.02* (1.67) 0.14 (1.12) 0.00 0.01 (0.10) 0.10 (0.94) 0.00 0.01 (0.24) 0.18 (1.17) 0.00 0.01 (0.56) 0.01 (0.15) 0.00 0.03 (1.63) 0.02 (0.28) 0.00 0.01 (0.55) 0.38 (1.15) 0.00 ar(2)-p-value 0.49 0.37 0.38 0.28 0.39 0.54 0.19 sargan test 0.23 (0.78) 0.79 (0.58) 0.99 (0.48) 0.45 (0.28) 0.55 (0.34) 0.67 (0.23) 0.55 (0.33) note: ∗, ∗∗ and *** depicts 0.10, 0.05 and 0.01 levels of significant respectively. the estimated parameters of wi are 1.15 and 0.19 for the wealth share of the top one and ten percent of china’s population. the estimated coefficients were found to be negative and statistically significant. this indicates that unequal wealth distribution considerably weakens the gdp per capita, i.e. the average income earned by each individual in an economy. these findings suggest that the region is characterized by an unequal distribution of wealth, as china has a detrimental and negative growth output. in the models displayed in columns (2) and (4), the control variables—investment, trade openness, population growth, and schooling—have been included in the regression estimation as well. the coefficients of wi have increased. however, they remain negative and are significant at the five percent level. in columns (3) and (6), the complete set of control variables, including inflation and policy formulation, have been added to the regression estimation procedure so that the complete effect of these factors on the growth output of china can be evaluated. the variable inflation serves as a proxy term for the asian journal of economics and empirical research, 2020, 7(2): 235-241 240 © 2020 by the authors; licensee asian online journal publishing group stability of the macroeconomic policy, which is used as an evaluative indicator for the measurement of institutional quality. the coefficients of wi were found to have remained negative, which implying an inverse relationship. this suggests that an increase in gdp per capita reduces wi, and an increase in wi is detriment to gdp per capita and, ultimately, the growth of china. the coefficients were found to have a relatively weak significance. these findings suggest that the proportionate distribution of wealth, proper policy infrastructure, trade regulations, and education attainments will increase the eg of china, and a reasonable distribution of resources across the population will help the eg of the chinese nation. 4.1. system gmm growth and governance effects table 2 presents the results of the estimations of equation 1 using the two-step gmm estimation, which is used for the evaluation of robustness. this includes ar1 and ar2 tests that evaluate the first and second order serial correlations. moreover, the sargan test has been used to evaluate the model’s over-estimation. the tests and evaluations of the robustness are significant. the coefficients of wi were found to be negative and statistically significant, which suggests the same findings as in table 1. however, the gmm estimations show that, in comparison to the ols estimations in table 1, the estimated coefficients for wi are considerably higher and are also more significant, which indicates the fact that estimations in the first computation was subject to some measurement biases that have been eradicated in the gmm estimation. on average, a unit increase in the inequality of wealth distribution causes a decrease in the growth rate of gdp per capita by 0.31–0.32 units. moreover, in this estimation procedure, the variables for the estimation effects of governance factors were introduced. this examination was based on whether or not the relationship between eg and wi is dependent on the level of governance. the governance factors under consideration were accountability and voice, the effectiveness of the government, regulatory quality, corruption control, political stability, the absence of violence, and the rule of law. results are demonstrated in table 2 and columns 1-6 show that wi has a recurring and negative influence on the growth factor of the economy. the coefficients of the governance indicators were found to be negative and statistically insignificant. however, the interaction terms generated between wi and the governance indicators were found to be significant for the overall growth output. therefore, the lone impact of governance factors doesn’t nullify or increase the eg of china; however, in the presence of wi, they become important considerations. the results of the first and second order serial correlations analyzed using ar1 and ar2 tests were insignificant, as were the results of the sargan test, which shows that, in both cases, the null hypotheses for the test results were accepted, i.e. the model wasn’t overestimated and there was no indication of serial correlation in the results. 5. discussion and conclusion since the financial crisis in 2007–2008, the inequality in the distribution of wealth has been a major issue in developed and economically sound countries (bogliacino & maestri, 2016). the percentages of income and wealth of financially stable populations in emerging countries such as india and china have been found to have increased significantly after the crisis. studies by lorenzi (2016) and islam and mcgillivray (2019) evaluated the impact of wi and governance factors in gmm countries and their effects on the eg of the regions under consideration. these studies support the findings of the present study, reporting that an increased wi is detrimental for the economic affluence of the regions under consideration. kennedy, smyth, valadkhani, and chen (2017) evaluated the effects of income and wi in the australian context, finding that the negative tax returns for the population were below the average income range; lee and son (2016) used a dynamic panel approach, finding the same results as were found in our evaluations. the impact of governance on the economy and its growth factors has been established through the literature (alam, kiterage, & bizuayehu, 2017; azam, 2016; emara, 2016; franz, 2017; wilson, 2016). the findings of this study, as well as many other studies, have established the fact that an increase in corruption in developing and developed countries, as well as the poor regulatory environment, have contributed to the increase in income inequality of poverty persistence. this has reduced the eg output of countries and systems, as well as affecting the taxation systems. the association between inequalities in the distribution of wealth and its relationship to eg has become the major focus of many empirical and theoretical investigations. however, the empirical results and justifications are still inconclusive. this study uses data from china to study the impact of wi and governance factors on the eg of the country. the results have been derived from a systematic gmm dynamic panel and the results suggest that the wi has a strong negative impact on the eg of the people’s republic of china. this statistically significant relationship and the resultant adverse impact of wi on eg was found to be present, even when regressors were estimated using the same specifications. the results were found to be robust. moreover, the economic analysis also included the evaluation of the impact of governance factors on the relationship between eg and wi. the findings suggest that an increased accountability, less corruption, increased and high-quality regulatory institutions, a justifiable rule of law, and a higher stability of the government can help in the eradication and control of wi in order to promote the eg of a region. 6. research implications this paper’s findings have led to the implementation of several policies and suggestions. the first states that wi is not good for eg, as wi has a strong effect on income and wealth growth factors. furthermore, institutional reforms would be able to improve the efficiency of governance, and the support of wealth distribution should be focused on reducing the negative impact of wi on eg. policymakers can improve governance through the mitigation of eg issues brought about by income inequalities and wi in the population. in order to successfully implement governance-focused reforms, a better understanding of the channels that can be used to improve the economic outlook of rapidly developing countries like china is required. 7. limitations of the study the primary limitation in this research is the fact that it is geographically constrained to china, as the data has been collected from this country. china is a diverse country that has observed a rapid growth in its economy and is asian journal of economics and empirical research, 2020, 7(2): 235-241 241 © 2020 by the authors; licensee asian online journal publishing group gradually emerging as a world power, which differs from other countries in the region. consequently, the results of the economic and wi factors cannot be generalized across other regions. to improve the effectiveness, reliability, and accuracy of the model, future researchers should include data from other countries and regions. references adrián risso, w., & sánchez carrera, e. j. 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(2016). income inequality in china: causes and policy responses. china economic journal, 9(2), 186-208. available at: https://doi.org/10.1080/17538963.2016.1168203. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 12 © 2024 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 11, no. 1, 12-20, 2024 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v11i1.5487 © 2024 by the authors; licensee asian online journal publishing group examining the dynamics of risk, performance, and volatility during covid-19: evidence from moroccan stock market mustapha amzil1 ahmed ait bari2 lahoucine asllam3 ( corresponding author) 1,2,3laboratory for studies and applied, research economic sciences, faculty of legal, economic and social sciences, ibn-zohr agadir university, morocco. 1email: mustapha.amzil@edu.uiz.ac.ma 2email: a.aitbari@uiz.ac.ma 3email: laho11@gmail.com abstract this study delves into the repercussions of the covid-19 pandemic on the moroccan stock market, with a specific focus on the masi index and sectoral indices. the examination encompasses distinct pre-covid and during-covid periods, shedding light on the market’s evolution, marked by unique phases and fluctuations. notably, the masi index experienced a significant downturn in march 2020, indicative of the pandemic’s disruptive impact on investor behavior. despite this setback, the market showcased remarkable resilience, staging a swift recovery and surpassing pre-crisis levels by the close of 2020. this rebound can be attributed to various factors, including historically low bond yields, the initiation of vaccination campaigns, and the resumption of dividend payouts by the banking sector. our findings bring forth a nuanced understanding of performance and risk dynamics across individual sectors. moreover, there is a noteworthy surge in correlations between sectoral returns during the covid-19 period, limiting diversification options for investors and exposing them to heightened risks. the volatility patterns, analyzed using garch models, underscore the dynamic nature of the masi index, exhibiting stability in the pre-pandemic phase and a transient disturbance during the initial pandemic shock. this study contributes to the existing body of literature on the global financial impact of covid-19, providing valuable insights into the moroccan context. the results emphasize the significance of comprehending sector-specific vulnerabilities and market dynamics for both investors and policymakers. in navigating the uncertainties of the post-pandemic era, these insights offer crucial perspectives for market participants to make informed decisions and adapt optimal strategies. keywords: covid-19, garch model market, masi index, moroccan financial market, psychological impact, risk measures, volatility. jel classification: g32; g10; c60. citation | amzil, m., bari, a. a., & asllam, l. (2024). examining the dynamics of risk, performance, and volatility during covid-19: evidence from moroccan stock market. asian journal of economics and empirical research, 11(1), 12–20. 10.20448/ajeer.v11i1.5487 history: received: 4 january 2024 revised: 23 february 2024 accepted: 1 march 2024 published: 21 march 2024 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. data availability statement: the data supporting the findings of this study can be found at http://www.casablanca-bourse.com. competing interests: the authors declare that they have no competing interests. authors’ contributions: all authors contributed equally to the conception and design of the study. all authors have read and agreed to the published version of the manuscript. contents 1. introduction ...................................................................................................................................................................................... 13 2. preliminary ........................................................................................................................................................................................ 14 3. results and discussion ................................................................................................................................................................... 15 4. conclusion ......................................................................................................................................................................................... 19 references .............................................................................................................................................................................................. 20 mailto:mustapha.amzil@edu.uiz.ac.ma mailto:a.aitbari@uiz.ac.ma mailto:laho11@gmail.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v11i1.5487 https://orcid.org/0009-0007-9875-1775 https://orcid.org/0009-0005-6046-2375 asian journal of economics and empirical research, 2024, 11(1): 12-20 13 © 2024 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study investigates the covid-19 pandemic's impact on the moroccan stock market, particularly the masi index. through analysis spanning pre-covid and during-covid periods, it illuminates market evolution and resilience, despite a significant downturn in march 2020. results highlight sector-specific vulnerabilities and market dynamics, providing valuable insights for investors and policymakers. 1. introduction in the realm of finance, outbreaks represent extreme events that often defy easy anticipation. the challenge in foreseeing these events lies in the fact that their triggering causes are typically relatively insignificant events or the accumulation of seemingly minor occurrences. financial crises, in particular, are marked by sudden and pronounced declines in the value of financial assets. across the landscape of financial history, numerous instances of outbreaks have shaken the general stability of specific financial systems or even the global financial ecosystem. for further exploration of this phenomenon, we recommend delving into works such as allen and gale (2007); claessens and kose (2013); eichengreen (2002); helleiner (2011) and shiller (2012), and the references therein. morocco recorded its first confirmed case of coronavirus-2019 (covid-19) on march 2nd, 2020. subsequently, on march 11th, the world health organization declared covid-19 a global pandemic. since this pivotal moment, the repercussions of the outbreak on the daily social life of individuals have been profound. in response to the imperative of curbing the virus's spread, millions of people worldwide have experienced lockdowns and stringent restrictions, leading to a significant slowdown in consumer activity. the resultant economic slowdown, in turn, has reverberated across the global financial system, and morocco is not exempt from these challenging economic dynamics. the global ramifications of the covid-19 health crisis have reverberated across all sectors worldwide. in a study by baker et al. (2020) this health crisis was identified as the most influential factor impacting the stock market. additionally, ashraf (2020) demonstrated a pronounced reaction of stock markets to the heightened risk of covid-19 infection. this heightened risk adversely affected the performance of various chinese sectors, particularly in areas such as transport and tourism, as highlighted by shen, fu, pan, yu, and chen (2020). furthermore, gu, ying, zhang, and tao (2020) conducted an empirical analysis to assess the impact of covid-19 on the performance of several sectors, utilizing a sample of 34,000 companies. their findings indicated a substantial 57% reduction in electricity consumption during the first week of the covid-19 outbreak, illustrating the widespread effects of the crisis on diverse aspects of economic activity. in a separate study, wang, zhang, wang, and fu (2020) scrutinized the impact of covid-19 on china's insurance industry. their investigation revealed that the emergence of covid-19 had a detrimental effect on the sector's overall performance. collectively, these studies underscore the extensive repercussions of the covid-19 crisis, not only on public health but also on global economic sectors and industries. moreover, the influence of covid-19 on the performance of the banking sector in europe was notable primarily during the initial phase. this scenario can be attributed to the multifaceted measures implemented by european governments, as elucidated by batten, choudhury, kinateder, and wagner (2023). notably, governments extended financial assistance to uphold the standard of living for citizens. concurrently, regulatory measures were introduced, ranging from travel restrictions to the closure of both public and private establishments, initially through partial containment measures and subsequently transitioning to total containment strategies. these interventions were devised to mitigate the socio-economic impact of covid-19. these circumstances wielded a profound influence on business activities, creating upheavals in various markets and sectors, notably impacting the tourism sector. the study conducted by bouri, cepni, gabauer, and gupta (2021) delved into the response of the new zealand government to the challenges posed by covid-19, particularly in the context of secondary sector equity returns, employing a garch model. the investigation revealed a fluctuating dynamic correlation among secondary sector stock returns, initially exhibiting negativity and subsequently turning positive in march 2020. this shift underscored an increased interdependence among different secondary sector stocks, with eight secondary sector returns exhibiting a positive and significant impact. notably, this positive impact extended to the nz50 (new zealand exchange, nzsx 50). however, the study also brought to light that certain government policies, including economic stimulus plans and travel bans, did not exert a discernible influence on the performance of shares in specific sectors such as real estate and healthcare. this nuanced finding suggests that the impact of government interventions varied across sectors, indicating a complex and sector-specific response to the challenges posed by the covid-19 pandemic. theoretically, it is essential to acknowledge that the interdependence among major markets may experience an increase. as demonstrated by aslam et al. (2020) who studied 56 stock market indices using tvp-var variances, positive correlations emerged due to the substantial uncertainty surrounding the onset of the covid-19 pandemic. additionally, bouri et al. (2021) explored the connectivity between various assets, including crude oil, currencies, global equities, gold, and bonds, in relation to covid-19. their findings indicated a swift and concerning impact on the performance of these assets. the global dynamic connectivity of these assets, which was relatively stable before covid-19, experienced significant changes. notably, bonds assumed the role of the primary shock transmitter during the covid-19 epidemic, contrasting with the pre-pandemic scenario where the dollar and equity indices held that position. le, do, nguyen, and sensoy (2021) contributed insights by studying dependency networks of international financial assets in the context of covid-19. they revealed an asymmetric influence, with right-tail dependencies becoming weaker and less responsive to left-tail ones. furthermore, they identified us treasuries and bitcoin as assets disconnected from others in the dependency networks, portraying them as weak assets for global investors during the covid-19 period. in a different context, the impact of covid-19 on stock market volatility was evident in germany and england, as indicated by garch models (yousef, 2020). the study suggested that covid-19 significantly increased stock market volatility. analyzing the behavior of the s&p 1200 global shariah and nonshariah sector indices, dharani, hassan, rabbani, and huq (2022) affirmed that non-shariah indices exhibited higher volatility than shariah indices. this observation aligns with the findings of takyi and bentum-ennin (2021) who demonstrated that falling sectors in african stock markets were significantly more volatile than rising sectors. this article aims to contribute to the existing body of theoretical and empirical literature by examining the impact of covid-19 on the moroccan stock market, specifically using the masi index. the study seeks to provide insights asian journal of economics and empirical research, 2024, 11(1): 12-20 14 © 2024 by the authors; licensee asian online journal publishing group into the performance of the moroccan stock market before and after the introduction of covid-19, aligning with broader global trends observed in financial markets. the primary objective of this paper is to assess the impact of the covid-19 outbreak on the moroccan financial market by scrutinizing the behavior of the masi index. the masi index, short for the moroccan all shares index, serves as the principal stock index, providing insights into the performance of all companies listed on the casablanca stock exchange. to achieve this goal, we aim to analyze both the value and returns of the masi index, employing various risk and variability measures. additionally, our investigation will extend to studying the intracorrelation among the diverse assets that constitute the masi index. this comprehensive analysis seeks to shed light on the nuanced dynamics of the moroccan financial market in response to the challenges posed by the covid19 outbreak. the rest of the paper is organized as follows. section i presents some preliminaries about risk, variability and correlation measures and the used model. section 3 provides result and discussion. the last section concludes. 2. preliminary we consider a probability space (ω, ℱ, p). let 𝐿∞: = 𝐿∞(ω,ℱ, p) be the space of equivalent classes of essentially bounded continuous random variables. we denote 𝑋 the random outcome of a financial position, and 𝐹𝑋 is the cumulative distribution function of 𝑋. we begin by providing the definition and some theoretical axioms of risk measures. definition 2.1. a risk measure is a functional 𝜌: 𝐿∞ → r, which may satisfy the following properties: • monotonicity: if 𝑋 ≤ 𝑌, then 𝜌(𝑋) ≤ 𝜌(𝑌), ∀𝑋, 𝑌 ∈ 𝐿∞. • translation invariance: 𝜌(𝑋 + 𝐶) = 𝜌(𝑋) + 𝐶, ∀𝐶 ∈ r, ∀𝑋 ∈ 𝐿∞. • positive homogeneity: 𝜌(𝜆𝑋) = 𝜆𝜌(𝑋), ∀𝜆 ≥ 0, ∀𝑋 ∈ 𝐿∞. • sub-additivity: 𝜌(𝑋 + 𝑌) ≤ 𝜌(𝑋) + 𝜌(𝑌), ∀𝑋, 𝑌 ∈ 𝐿∞. • convexity: 𝜌(𝜆𝑋 + (1 − 𝜆)𝑌) ≤ 𝜆𝜌(𝑋) + (1 − 𝜆)𝜌(𝑌), ∀𝑋, 𝑌 ∈ 𝐿∞, ∀𝜆 ∈ [0,1]. • law invariance: if 𝐹𝑋 = 𝐹𝑌 , then 𝜌(𝑋) = 𝜌(𝑌), ∀𝑋, 𝑌 ∈ 𝐿∞. • co-monotonic additivity: 𝜌(𝑋 + 𝑌) = 𝜌(𝑋) + 𝜌(𝑌) for every co-monotonic pair 𝑋, 𝑌 ∈ 𝐿∞. the first property, monotonicity, indicates that for a position that generates worse results than the second, its risk is expected to be higher. the second property, translation invariance, informs that if a certain gain is added to the position, the risk is expected to decrease by the same amount. risk measures that respect both axioms are known as monetary risk measures. the third property, positive homogeneity, indicates that the risk of the position increases with its size. sub-additivity shows that the risk of a combined position is less than or equal to the sum of the risks of the individual assets that make up the portfolio. when a risk measure fulfills monotonicity, translation invariance, positive homogeneity and sub-additivity, it is known as a coherent risk measure in the sense proposed by artzner, delbaen, eber, and heath (1999). positive homogeneity and sub-additivity together imply convexity. for more details, see föllmer and schied (2002) and frittelli and gianin (2002). the next property, law invariance, points that two positions that have the same distribution have equal risks. the last property, co-monotonic additivity, shows that, for co-monotonic pair of financial positions, the risk of a combined position is equal to the sum of risks of the individual assets that make up the portfolio. for more details regarding the properties above, we refer to delbaen (2012). the functionals provided below are examples of risk measures. value-at-risk (var): this is the most common risk measure in financial industry, and it represents the αquantile of x. it can be interpreted as the maximum loss expected for a given significance level of risk such that: var𝛼⁡(𝑋) = inf{𝑥: 𝐹𝑋(𝑥) ≥ 𝛼} = 𝐹𝑋 −1(𝛼), 𝛼 ∈ [0,1], ∀𝑋 ∈ 𝐿∞. # (1) • expected shortfall (es): this measure represents the expected value of the losses, since it exceeds the 𝛼quantile of 𝑋, that is, the var. one can define the es as follows: 𝐸𝑆𝛼(𝑋) = 1 1−𝛼 ∫   1 𝛼  𝐹𝑋 −1(𝑢)𝑑𝑢, 𝛼 ∈ (0,1], ∀𝑋 ∈ 𝐿∞# (2) now we are going to define variability measures and provide some of their properties. definition 2.2. a variability measure is a functional 𝜈: 𝐿∞ → r+that may satisfy the following properties: • non-negativity: 𝜈(𝑋) = 0 for all constant 𝑋 ∈ 𝐿∞ and 𝜈(𝑋) > 0 for all non-constant 𝑋 ∈ 𝐿∞. • translation insensitivity: 𝜈(𝑋 + 𝐶) = 𝜈(𝑋), ∀𝐶 ∈ 𝐑, ∀𝑋 ∈ 𝐿∞. • positive homogeneity: 𝜈(𝜆𝑋) = 𝜆𝜈(𝑋), ∀𝜆 ≥ 0,∀∈ 𝐿∞. • sub-additivity: 𝜈(𝑋 + 𝑌) ≤ 𝜈(𝑋) + 𝜈(𝑌), ∀𝑋, 𝑌 ∈ 𝐿∞. • convexity: 𝜈(𝜆𝑋 + (1 − 𝜆)𝑌) ≤ 𝜆𝜈(𝑋) + (1 − 𝜆)𝜈(𝑌), ∀𝑋, 𝑌 ∈ 𝐿∞, ∀𝜆 ∈ [0,1]. • law invariance: if 𝐹𝑋 = 𝐹𝑌, then 𝜈(𝑋) = 𝜈(𝑌), ∀𝑋, 𝑌 ∈ 𝐿∞. • co-monotonic additivity: 𝜈(𝑋 + 𝑌) = 𝜈(𝑋) + 𝜈(𝑌) for every co-monotonic pair , 𝑌 ∈ 𝐿∞. the first property, non-negativity, indicates that any non-constant position have nonnegative variability. the next axiom, translation insensitivity, informs that the deviation value does not change if a constant is added. when a variability measure fulfills non-negativity and translation insensitivity, it is labelled as a proper variability measure. if a proper variability measure fulfills, positive homogeneity and sub-additivity it is know as a generalized variability measure, in the sense proposed by rockafellar, uryasev, and zabarankin (2006). for more details regarding financial interpretation of these properties, we refer to rockafellar et al. (2006) and pflug and romisch (2007). we illustrate the variability concept with some examples: • variance (var): var⁡(𝑋) = 𝔼[(𝑋 − 𝔼[𝑋])2], ∀𝑋 ∈ 𝐿∞# (3) • standard deviation (sd): 𝑆𝐷(𝑋) = (√𝔼[(𝑋 − 𝔼[𝑋])2]), ∀𝑋 ∈ 𝐿∞# (4) asian journal of economics and empirical research, 2024, 11(1): 12-20 15 © 2024 by the authors; licensee asian online journal publishing group 2.1. performance measures regarding the variable 𝑋, we will consider the following measures. sharp ratio = 𝔼[𝑋]−𝑟𝑓 𝜎(𝑋) , ⁡ treynor ratio = 𝔼[𝑋]−𝑟𝑓 𝛽(𝑋) . # (5) where: 𝛽(𝑋) and 𝑟𝑓 denote, respectively, beta of variable 𝑋 and the risk-free rate (refer to sharpe (1963) and treynor (1962)). skewness (6) and kurtosis (7) are among the most widely examined measures in the field of descriptive statistics across various disciplines, such that, skewness (𝑋) ⁡= 𝔼[(𝑋−𝔼[𝑋])3] 𝜎(𝑋)3 # (6) kurtosis⁡(𝑋) ⁡= 𝔼[(𝑋−𝔼[𝑋])4] 𝜎(𝑋)4 # (7) 2.2. garch model the garch model, introduced by engle (1982) and further developed by bollerslev (1986) serves as the foundation for our analysis. in this study, we employed the garch⁡(1,1) model, recognized for its simplicity and widespread applicability in modeling financial processes. karmakar (2005) recommended the use of garch⁡(1,1) to visualize conditional volatility in stock returns. consistent with the formulation in bollerslev (1986) the equation for the conditional variance in the garch⁡(1,1) model is expressed as follows: ℎ𝑡 2 = 𝜔0 +𝜔1𝜖𝑡−1 2 +𝜔2ℎ𝑡−1 2 + 𝑣𝑡 . # (8) where, 𝜖𝑡 ∽ 𝒩(0, 𝜎𝑡 2) is the error obtained from equation (9): 𝑋𝑡 = 𝛼0 + 𝛽𝑖𝑋𝑡−1 + 𝛽𝑗𝜖𝑡−1 + 𝜖𝑡 , # (9) additionally, 𝜔1 represents the arch coefficient, and 𝜔2 is the garch coefficient, both expected to be nonnegative ( 𝜔1 ≥ 0 and 𝜔2 ≥ 0 ). furthermore, the conditions 𝜔1 +𝜔2 < 1 and 𝜔0 ≥ 0 are imposed. the sum of 𝜔1 and 𝜔2 serves as an indicator of the model's quality. a value close to one for 𝜔1 +𝜔2 suggests persistence in the considered garch model. 3. results and discussion 3.1. data we aim to analyze the moroccan all shares index (masi) along with the time series data of individual sector indices on the casablance 1 stock exchange (as shown in table 2), covering the period from january 2017 to december 2021. this timeframe is segmented into two distinct periods: the pre-covid period, spanning from january 1, 2017, to march 1, 2020, and the during-covid period, extending from march 2, 2020, to december 31, 2021. the demarcation of these periods is crucial for understanding the dynamics of casablanca's sectoral indices, particularly considering that moroccan authorities reported the first case of covid-19 on march 2, 2020. the data was retrieved from the casablanca stock exchange website. moving forward, we denote xt as the daily return of each index on day t, calculated using the following formula: 𝑋:= 𝑋𝑡 = log⁡ ( 𝑃𝑡 𝑃𝑡−1 ) × 100# (10) where, 𝑃𝑡 and 𝑃𝑡−1 are, respectively, the prices of each index on day 𝑡 and 𝑡 − 1. figure 1. masi evolution before and during covid-19. based on figure 1, we can see that the masi index fluctuates in different ways. this erratic fluctuation, generating up and down cycles over shorter or longer periods, can be divided into two major phases. the first phase before the covid-19 crisis and the second phase during and after the onset of this crisis. within this framework, we observe in the first phase that the masi index recorded an increase between the first quarter of 2017 and the first quarter of 2018.this improvement is essentially due to the performance of cyclical sectors, 1 http://www.casablanca-bourse.com http://www.casablanca-bourse.com/ asian journal of economics and empirical research, 2024, 11(1): 12-20 16 © 2024 by the authors; licensee asian online journal publishing group namely: buildings and construction materials and real estate participation and development. during 2019, the masi index fell before making a small recovery at the start of 2020, this situation may be due to the underperformance of certain sectors compared with that of masi, by way of example the oil & gas and utilities sectors. in march 2020, we observe a remarkable drop in the masi index due to the health crisis and the repercussions of containment on the behavior of investors and the economy as a whole. moreover, we note that the return to equilibrium did not take long and that the masi index has continued to rise to a significant level, even exceeding the value recorded during the first quarter of 2018. this improvement can be explained by the resilience of certain sectors (agrifood and pharmaceuticals). from the last quarter of 2020 onwards, the rotation in favor of cyclical sectors picked up significantly, against a backdrop of economic optimism and a return to the initial situation of activity as a whole. the progress made in vaccinating against the covid-19 pandemic, the significant easing of restrictions on mobility and the effective launch of the national economic recovery plan are all factors that will encourage investors to position themselves in cyclical segments in the near future. figure 2. return of masi before and during covid-19. based on figure 2, we can see that masi index returns fluctuate within a range of 0.5 and -0.5, and that this fluctuation is almost stable between the first quarter of 2017 and the first two months of 2020. in march 2020, masi yields recorded a remarkable fall, which took only enough time to return to the initial state. this recovery saw an improvement in returns, particularly between the last six months of 2020 and the first quarter of 2021. in fact, the drop in masi returns can be explained by the uncertainty surrounding the evolution of the covid-19 pandemic, which at the start of the crisis caused major disruptions to the financial markets, particularly on the casablanca stock exchange, which recorded significant underperformance and high volatility. in addition, the fall in the masi index can also be explained by a 50% drop in the property development sector, as well as the banking sector, which lost more than a third of its valuation at the height of the crisis. the recovery of the masi index after the covid-19 stock market shock is due to 3 factors that have a positive impact on investors' perception of equities. firstly, historically low bond yields; secondly, the launch of the vaccination campaign in morocco and abroad in december; and thirdly, the return to dividend payouts by the banking sector. finally, the masi has been on an uptrend since the end of september 2020, reflected in a +10.4% rise to the end of november. as a result, the equities market reduced its annual losses to −9.7%, compared with −26.2% at the height of the stock market crash. table 1. descriptive statistics of masi during and before covid-19. periods mean sd max. min. kurtuisis skewness median before covid 19 0.0043 0.5244 1.9549 -1.9641 1.7569 0.0876 0.0022 during covid 19 0.0129 0.9722 5.3054 -9.2317 27.3963 -2.7079 0.0369 3.2. market behaviors before and during covid-19 3.2.1. descriptive statistics table 1 shows the descriptive statistics of our study, such as standard deviation (s), skewness (skew), kurtosis (kurt), maximum (max), median, mean and minimum (min). in addition, we calculated both the performance and risk of the masi index before and during the covid-19 period and the correlation between sectors for both periods (see tables 2, 3, 4 and 5). the descriptive statistics presented in table 1 show that the masi index over the covid19 period has high returns, but also high risk and is associated with high kurtosis. in other words, the masi index during the pandemic period experienced high gains, but these were coupled with high risk which is associated with high kurtosis. in contrast, the masi index prior to covid-19 is less risky and less rewarding. specifically, after the covid-19 is triggered, the standard deviation and mean of the masi index become more significant (0.5244; 0.9722 and 0.0043; 0.0129) these observations confirm the impact of covid-19 on stock index volatility. in addition, it should be noted that, during the covid-19 period, the skewness coefficient is different from 0 and the kurtosis coefficient is greater than 3. in addition, the median differs from the mean for both periods. similarly, for the pre-pandemic period, all but the kurtosis coefficient is below 3. in addition, we noticed that the majority of correlation coefficients between yields increased after the appearance of covid-19, as shown in (tables 4 and 5). asian journal of economics and empirical research, 2024, 11(1): 12-20 17 © 2024 by the authors; licensee asian online journal publishing group 3.2.2. volatility of the market examining figure 3 in detail, we observe a period of remarkable stability in the volatility of masi index returns leading up to the emergence of the pandemic. the pre-pandemic phase is characterized by a consistent and predictable pattern in the volatility of the masi index. however, with the onset of the pandemic, a transient disturbance is noticeable, affecting the volatility for a relatively short duration. intriguingly, after this initial perturbation, the volatility tends to revert to the earlier observed levels, resembling the conditions prevailing before the onset of the health crisis. this nuanced analysis underscores the dynamic nature of the masi index, with its volatility demonstrating resilience and a tendency to return to established patterns even in the face of significant external disruptions such as the pandemic. figure 3. volatility of masi overall the period. 3.3. risk and performance of sectors before and during covid-19. in this subsection, we are examining the risk and performance of sectors both before and during covid-19 to provide a clear understanding of the sectors that have significantly influenced the behavior of masi. table 2. symbols and sectors. symbol sector symbol sector s1 utilities s12 pharmaceutical industry index s2 electricity index s13 oil and gaz s3 mining index s14 materiels logiciels & services informatiques s4 food producers & processors index s15 forestry & paper s5 insurance index s16 beverages s6 telecommunications index s17 transportation services index s7 banks index s18 holding companies s8 distributors index s19 construction & building materials s9 real estate participation and promotion s20 leisures and hotels s10 chemicals index s21 investment companies & other finance s11 transport index s22 engineering & equipment industrial goods table 3. risk and performance of sectors before covid-19. sector mean sharp ratio treynor sd beta es kurtuisis skewness median s1 -0.0251 -0.0120 -0.0429 2.0881 0.5863 -0.0564 4.9959 -0.1763 0.0000 s2 0.0257 0.0166 0.0401 1.5508 0.6412 -0.0354 1.9279 -0.1366 0.0000 s3 -0.0257 -0.0179 -0.0358 1.4425 0.7191 -0.0372 4.8238 -0.5473 0.0000 s4 0.0339 0.0343 0.0437 0.9894 0.7755 -0.0228 1.7378 -0.0871 0.0282 s5 0.0062 0.0041 0.0065 1.5134 0.9485 -0.0399 5.8713 -0.6022 0.0148 s6 0.0050 0.0059 0.0054 0.8514 0.9317 -0.0204 18.1679 -0.9177 0.0000 s7 0.0109 0.0166 0.0120 0.6590 0.9143 -0.0131 1.1556 0.3411 0.0042 s8 0.0543 0.0411 0.0827 1.3212 0.6566 -0.0320 6.6402 -0.2081 0.0074 s9 -0.2247 -0.1196 -0.1907 1.8791 1.1782 -0.0504 4.0149 -0.3204 -0.1067 s10 0.0484 0.0181 0.0459 2.6707 1.0539 -0.0603 2.0051 0.0579 0.0000 s11 0.0381 0.0241 1.8744 1.5790 0.0203 -0.0399 7.9466 0.2733 0.0000 s12 0.0025 0.0021 0.0414 1.1796 0.0605 -0.0321 8.5675 0.2500 0.0000 s13 0.0285 0.0166 0.0317 1.7203 0.8993 -0.0436 4.0329 -0.0967 0.0000 s14 0.1190 0.0964 0.2336 1.2342 0.5093 -0.0265 3.7132 0.4127 0.0285 s15 -0.0879 -0.0245 -0.1805 3.5798 0.4867 -0.0810 16.4514 -1.2407 0.0000 s16 0.0224 0.0153 0.0394 1.4629 0.5674 -0.0398 6.6817 -0.1662 0.0000 s17 0.0683 0.0539 0.0708 1.2683 0.9646 -0.0274 11.9240 -0.1938 0.0000 s18 0.0363 0.0187 0.0550 1.9432 0.6600 -0.0481 4.5201 -0.0870 0.0000 s19 -0.0186 -0.0128 -0.0104 1.4532 1.7796 -0.0349 3.9416 -0.3035 -0.0024 s20 0.0393 0.0159 0.0524 2.4691 0.7500 -0.0573 3.5126 0.0540 0.0000 s21 0.0144 0.0138 0.0586 1.0450 0.2456 -0.0269 4.0997 -0.3356 0.0000 s22 -0.2555 -0.1194 -2.7630 2.1400 0.0925 -0.0587 2.4390 -0.5620 0.0000 asian journal of economics and empirical research, 2024, 11(1): 12-20 18 © 2024 by the authors; licensee asian online journal publishing group table 4. risk and performance of sectors before covid-19. sector mean sharp ratio treynor sd beta es kurtuisis skewness median s1 -0.0946 -0.0502 -0.1833 1.8830 0.5158 -0.0485 4.2792 -0.7283 0.0000 s2 0.0415 0.0285 0.0595 1.4557 0.6967 -0.0352 5.8351 -0.6683 0.0000 s3 0.0837 0.0548 0.0985 1.5266 0.8505 -0.0362 5.1828 -0.8736 0.1337 s4 0.0194 0.0168 0.0215 1.1543 0.9053 -0.0287 10.7454 -1.1681 0.0037 s5 0.0284 0.0276 0.0447 1.0259 0.6344 -0.0280 13.6971 -1.7441 0.0292 s6 -0.0238 -0.0227 -0.0270 1.0505 0.8837 -0.0271 22.0853 -1.7643 0.0000 s7 -0.0030 -0.0025 -0.0026 1.2038 1.1718 -0.0320 18.5008 -1.9715 0.0467 s8 0.0709 0.0585 0.0980 1.2128 0.7233 -0.0313 5.2935 -0.4778 0.0225 s9 0.0365 0.0178 0.0324 2.0589 1.1271 -0.0457 2.2348 -0.2220 -0.0502 s10 0.0918 0.0478 0.1315 1.9211 0.6982 -0.0462 2.7727 -0.8604 0.0009 s11 -0.0463 -0.0268 -0.0704 1.7251 0.6578 -0.0440 3.5792 -0.5171 0.0000 s12 0.2634 0.2250 7.1513 1.1707 0.0368 -0.0264 3.1975 0.2836 0.0000 s13 0.0496 0.0381 0.0736 1.3043 0.6745 -0.0335 4.3899 -0.9455 0.0118 s14 0.0850 0.0624 0.0910 1.3610 0.9339 -0.0343 13.6121 -1.8828 0.0265 s15 0.0623 0.0241 0.1733 2.5823 0.3596 -0.0557 0.5190 -0.3999 0.0000 s16 -0.0009 -0.0007 -0.0013 1.4071 0.7149 -0.0390 10.1749 -1.0470 0.0000 s17 0.0535 0.0332 0.0423 1.6121 1.2634 -0.0431 10.1957 -1.4877 0.0181 s18 -0.0424 -0.0213 -0.0441 1.9883 0.9622 -0.0504 3.5601 -0.8350 0.0000 s19 0.0111 0.0079 0.0092 1.4141 1.2009 -0.0385 8.9419 -1.4279 0.0429 s20 -0.0881 -0.0403 -0.1666 2.1835 0.5285 -0.0491 2.1127 -0.4207 0.0000 s21 -0.0179 -0.0184 -0.0525 0.9721 0.3401 -0.0233 4.5795 -0.7213 0.0000 s22 0.2580 0.1159 0.7850 2.2253 0.3286 -0.0451 0.2002 -0.0370 0.0000 the tabulated data (table 3,4) provides a comprehensive insight into the diverse repercussions of the covid19 pandemic on various sectors, unveiling a clear dichotomy through performance measures. evidently, eleven sectors (s1, s4, s6, s7, s11, s14, s16, s17, s18, s20, s21) grappled with adverse effects, typified by s1's substantial decline in mean from -0.0251 to -0.0946, sharp ratio from -0.0120 to -0.0502, and treynor ratio from -0.0429 to 0.1833. conversely, an opposing trend emerged among eleven other sectors (s2, s3, s5, s8, s9, s10, s12, s13, s15, s19, s22), showcasing positive effects attributed to the pandemic. for instance, s2 demonstrated an upswing in mean from 0.0257 to 0.0415, sharp ratio from 0.0166 to 0.0285, and treynor ratio from 0.0401 to 0.0595. an alternative perspective, considering risk measures, elucidates the pandemic's influence on sectoral risk profiles. positive impacts are discernible across 11 sectors (s1, s2, s3, s6, s7, s9, s11, s14, s17, s18, s19), as exemplified by s1's marked reduction in standard deviation from 2.0881 to 1.8830, a decrease in beta from 0.5863 to 0.5158, and a shift in expected shortfall from -0.0564 to -0.0485. in contrast, 11 sectors (s4, s5, s8, s10, s12, s13, s15, s16, s20, s21, s22) experience adverse risk dynamics, illustrated by s5's substantial increase in standard deviation from 1.0259 to 1.5134, a rise in beta from 0.4344 to 0.9485, and an escalation of expected shortfall from -0.0280 to -0.0399. these nuanced observations underscore the sector-specific impacts of the covid-19 pandemic on financial performance, highlighting both positive and negative dimensions across the diverse spectrum of sectors. 3.4. correlation between sectors moreover, the data presented in tables 5 and 6 demonstrates a noteworthy surge in the correlation of returns amid the covid-19 period. prior to the onset of the pandemic, the correlation coefficient remained below 30%. however, during the covid-19 period, the correlation coefficient among certain sectors soared, reaching as high as 72%. this substantial increase in correlation suggests a heightened level of interdependence among sectors during the pandemic. as a consequence, investors encountered a scenario with fewer opportunities for effective diversification, exposing them to elevated levels of risk. the surge in correlation during this period underscores the challenges faced by investors in maintaining a diversified portfolio, further emphasizing the intricate and interconnected dynamics prevalent in the financial landscape during the covid-19 crisis. table 5. correlation between sectors before covid 19. sector s1 s2 s3 s4 s5 s6 s7 s8 s9 s10 s11 s1 1.000 -0.078 0.070 0.074 0.097 0.067 0.001 0.145 0.058 -0.016 0.016 s2 -0.078 1.000 0.035 0.078 0.098 0.123 0.141 0.016 0.033 0.059 0.026 s3 0.070 0.035 1.000 0.078 0.078 0.081 0.160 0.086 0.105 0.079 0.028 s4 0.074 0.078 0.078 1.000 0.108 0.097 0.229 0.148 0.144 0.125 0.017 s5 0.097 0.098 0.078 0.108 1.000 0.115 0.089 0.107 0.093 0.008 -0.003 s6 0.067 0.123 0.081 0.097 0.115 1.000 0.295 0.075 0.155 0.084 -0.019 s7 0.001 0.141 0.160 0.229 0.089 0.295 1.000 0.078 0.141 0.136 -0.032 s8 0.145 0.016 0.086 0.148 0.107 0.075 0.078 1.000 0.132 0.030 -0.026 s9 0.058 0.033 0.105 0.144 0.093 0.155 0.141 0.132 1.000 0.121 0.056 s10 -0.016 0.059 0.079 0.125 0.008 0.084 0.136 0.030 0.121 1.000 0.072 s11 0.016 0.026 0.028 0.017 -0.003 -0.019 -0.032 -0.026 0.056 0.072 1.000 s12 -0.006 0.048 0.009 0.037 -0.036 -0.017 0.022 0.003 0.029 0.046 0.109 s13 0.169 0.036 0.121 0.173 0.058 0.049 0.075 0.147 0.128 0.100 -0.027 s14 0.118 0.050 0.115 0.028 0.110 0.110 0.091 0.080 0.109 0.046 0.061 s15 0.062 0.013 0.019 0.037 0.060 0.023 0.018 0.017 0.090 0.088 0.004 s16 0.075 0.034 0.030 0.070 0.107 0.056 0.077 0.055 0.025 0.066 0.068 s17 0.121 0.021 0.111 0.256 0.049 0.218 0.213 0.132 0.142 0.124 -0.009 s18 0.074 0.035 0.123 0.093 0.144 0.094 0.042 0.149 0.126 0.055 0.021 s19 0.074 0.066 0.078 0.169 0.160 0.159 0.235 0.122 0.121 0.089 0.015 s20 -0.011 -0.020 0.080 0.108 0.041 0.063 0.096 0.032 0.089 0.077 0.075 s21 0.099 -0.023 0.096 0.150 0.045 -0.031 0.077 0.042 0.088 0.048 0.045 s22 0.013 -0.085 0.109 0.012 0.020 -0.005 0.008 0.025 0.048 0.036 0.016 sector s12 s13 s14 s15 s16 s17 s18 s19 s20 s21 s22 s1 -0.006 0.169 0.118 0.062 0.075 0.121 0.074 0.074 -0.011 0.099 0.013 s2 0.048 0.036 0.050 0.013 0.034 0.021 0.035 0.066 -0.020 -0.023 -0.085 s3 0.009 0.121 0.115 0.019 0.030 0.111 0.123 0.078 0.080 0.096 0.109 asian journal of economics and empirical research, 2024, 11(1): 12-20 19 © 2024 by the authors; licensee asian online journal publishing group sector s1 s2 s3 s4 s5 s6 s7 s8 s9 s10 s11 s4 0.037 0.173 0.028 0.037 0.070 0.256 0.093 0.169 0.108 0.150 0.012 s5 -0.036 0.058 0.110 0.060 0.107 0.049 0.144 0.160 0.041 0.045 0.020 s6 -0.017 0.049 0.110 0.023 0.056 0.218 0.094 0.159 0.063 -0.031 -0.005 s7 0.022 0.075 0.091 0.018 0.077 0.213 0.042 0.235 0.096 0.077 0.008 s8 0.003 0.147 0.080 0.017 0.055 0.132 0.149 0.122 0.032 0.042 0.025 s9 0.029 0.128 0.109 0.090 0.025 0.142 0.126 0.121 0.089 0.088 0.048 s10 0.046 0.100 0.046 0.088 0.066 0.124 0.055 0.089 0.077 0.048 0.036 s11 0.109 -0.027 0.061 0.004 0.068 -0.009 0.021 0.015 0.075 0.045 0.016 s12 1.000 -0.052 0.010 0.005 -0.020 -0.003 0.004 0.029 -0.035 0.032 -0.057 s13 -0.052 1.000 0.078 0.039 0.143 0.172 0.105 0.073 0.061 0.084 0.023 s14 0.010 0.078 1.000 0.050 0.156 0.069 0.079 0.126 0.056 0.058 0.100 s15 0.005 0.039 0.050 1.000 0.044 -0.005 -0.024 0.055 -0.024 -0.056 -0.004 s16 -0.020 0.143 0.156 0.044 1.000 0.108 -0.015 0.106 0.041 0.049 0.058 s17 -0.003 0.172 0.069 -0.005 0.108 1.000 0.048 0.175 0.123 0.047 0.000 s18 0.004 0.105 0.079 -0.024 -0.015 0.048 1.000 0.086 0.112 0.111 0.100 s19 0.029 0.073 0.126 0.055 0.106 0.175 0.086 1.000 0.095 0.049 -0.007 s20 -0.035 0.061 0.056 -0.024 0.041 0.123 0.112 0.095 1.000 0.029 0.057 s21 0.032 0.084 0.058 -0.056 0.049 0.047 0.111 0.049 0.029 1.000 0.108 s22 -0.057 0.023 0.100 -0.004 0.058 0.000 0.100 -0.007 0.057 0.108 1.000 table 6. correlation between sectors during covid 19. sector s1 s2 s3 s4 s5 s6 s7 s8 s9 s10 s11 s1 1.000 0.084 0.187 0.223 0.205 0.189 0.225 0.220 0.179 0.168 0.061 s2 0.084 1.000 0.323 0.350 0.304 0.381 0.403 0.257 0.226 0.241 0.172 s3 0.187 0.323 1.000 0.386 0.301 0.408 0.489 0.283 0.293 0.188 0.282 s4 0.223 0.350 0.386 1.000 0.443 0.567 0.675 0.435 0.426 0.319 0.253 s5 0.205 0.304 0.301 0.443 1.000 0.482 0.529 0.380 0.275 0.287 0.251 s6 0.189 0.381 0.408 0.567 0.482 1.000 0.717 0.403 0.401 0.290 0.273 s7 0.225 0.403 0.489 0.675 0.529 0.717 1.000 0.524 0.488 0.302 0.351 s8 0.220 0.257 0.283 0.435 0.380 0.403 0.524 1.000 0.324 0.251 0.178 s9 0.179 0.226 0.293 0.426 0.275 0.401 0.488 0.324 1.000 0.278 0.282 s10 0.168 0.241 0.188 0.319 0.287 0.290 0.302 0.251 0.278 1.000 0.096 s11 0.061 0.172 0.282 0.253 0.251 0.273 0.351 0.178 0.282 0.096 1.000 s12 0.009 0.004 0.007 0.029 -0.016 0.027 0.009 0.049 0.021 -0.052 0.002 s13 0.150 0.209 0.279 0.372 0.361 0.315 0.440 0.323 0.244 0.184 0.235 s14 0.258 0.282 0.390 0.529 0.439 0.507 0.586 0.443 0.414 0.305 0.308 s15 0.110 0.113 0.061 0.131 0.163 0.123 0.104 0.093 0.203 0.155 0.025 s16 0.202 0.231 0.292 0.397 0.297 0.340 0.466 0.368 0.272 0.247 0.255 s17 0.267 0.400 0.428 0.582 0.425 0.641 0.682 0.411 0.420 0.239 0.265 s18 0.192 0.243 0.262 0.346 0.313 0.357 0.442 0.240 0.243 0.249 0.185 s19 0.187 0.323 0.419 0.593 0.459 0.586 0.721 0.438 0.420 0.235 0.309 s20 0.131 0.126 0.157 0.211 0.194 0.170 0.190 0.111 0.217 0.174 0.191 s21 0.111 0.140 0.222 0.266 0.227 0.247 0.316 0.188 0.199 0.164 0.131 s22 0.058 0.088 0.095 0.100 0.123 0.081 0.136 0.067 0.053 0.043 -0.005 sector s12 s13 s14 s15 s16 s17 s18 s19 s20 s21 s22 s1 0.009 0.150 0.258 0.110 0.202 0.267 0.192 0.187 0.131 0.111 0.058 s2 0.004 0.209 0.282 0.113 0.231 0.400 0.243 0.323 0.126 0.140 0.088 s3 0.007 0.279 0.390 0.061 0.292 0.428 0.262 0.419 0.157 0.222 0.095 s4 0.029 0.372 0.529 0.131 0.397 0.582 0.346 0.593 0.211 0.266 0.100 s5 -0.016 0.361 0.439 0.163 0.297 0.425 0.313 0.459 0.194 0.227 0.123 s6 0.027 0.315 0.507 0.123 0.340 0.641 0.357 0.586 0.170 0.247 0.081 s7 0.009 0.440 0.586 0.104 0.466 0.682 0.442 0.721 0.190 0.316 0.136 s8 0.049 0.323 0.443 0.093 0.368 0.411 0.240 0.438 0.111 0.188 0.067 s9 0.021 0.244 0.414 0.203 0.272 0.420 0.243 0.420 0.217 0.199 0.053 s10 -0.052 0.184 0.305 0.155 0.247 0.239 0.249 0.235 0.174 0.164 0.043 s11 0.002 0.235 0.308 0.025 0.255 0.265 0.185 0.309 0.191 0.131 -0.005 s12 1.000 -0.018 0.016 -0.060 0.016 0.024 -0.013 0.035 0.029 -0.005 -0.002 s13 -0.018 1.000 0.396 0.095 0.275 0.317 0.233 0.395 0.159 0.186 0.149 s14 0.016 0.396 1.000 0.113 0.388 0.516 0.383 0.534 0.209 0.271 0.067 s15 -0.060 0.095 0.113 1.000 0.077 0.064 0.050 0.083 0.115 0.126 0.191 s16 0.016 0.275 0.388 0.077 1.000 0.332 0.250 0.362 0.221 0.250 0.058 s17 0.024 0.317 0.516 0.064 0.332 1.000 0.391 0.593 0.140 0.254 0.112 s18 -0.013 0.233 0.383 0.050 0.250 0.391 1.000 0.376 0.089 0.182 0.031 s19 0.035 0.395 0.534 0.083 0.362 0.593 0.376 1.000 0.212 0.261 0.127 s20 0.029 0.159 0.209 0.115 0.221 0.140 0.089 0.212 1.000 0.121 0.071 s21 -0.005 0.186 0.271 0.126 0.250 0.254 0.182 0.261 0.121 1.000 0.113 s22 -0.002 0.149 0.067 0.191 0.058 0.112 0.031 0.127 0.071 0.113 1.000 4. conclusion in conclusion, our investigation into the impact of covid-19 on the moroccan stock market, focusing on the masi index and sectoral indices, reveals nuanced dynamics and sector specific vulnerabilities. the delineation of the pre-covid and during-covid periods provides a comprehensive understanding of the market's evolution, marked by distinctive phases and fluctuations. analyzing the masi index, we observed a significant drop in march 2020, reflective of the pandemic's disruptive influence on investor behavior and economic activities. nevertheless, the market displayed resilience, swiftly recovering and even surpassing pre-crisis levels by the end of 2020. this remarkable rebound can be attributed to various factors, including historically low bond yields, the initiation of vaccination campaigns, and the resumption of dividend payouts by the banking sector. examining individual asian journal of economics and empirical research, 2024, 11(1): 12-20 20 © 2024 by the authors; licensee asian online journal publishing group sectors, our findings exhibit a dichotomy in performance and risk. also, we found a significant increase in correlations between sectoral returns during the covid-19 period. the interconnectedness among sectors heightened, limiting diversification choices for investors and exposing them to increased risks. moreover, the analysis of volatility patterns emphasizes the masi index's dynamic nature, showcasing stability in the prepandemic phase and a transient disturbance during the initial pandemic shock. our study contributes to the theoretical and empirical literature on the global financial impact of covid-19, offering insights into the moroccan context. the findings underscore the 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(2020). spillover of covid-19: impact on stock market volatility. international journal of psychosocial rehabilitation, 24(6), 1806918081. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.4337/9781785366468 https://doi.org/10.1016/j.ribaf.2020.101249 https://doi.org/10.1016/j.bir.2020.09.003 https://doi.org/10.1007/s10479-022-04523-8 https://doi.org/10.1093/oso/9780198774310.003.0003 https://doi.org/10.1016/j.irfa.2020.101646 https://doi.org/10.1016/j.ribaf.2021.101537 https://doi.org/10.1093/oso/9780198774310.003.0001 https://doi.org/10.1007/s007800200072 https://doi.org/10.1016/s0378-4266(02)00270-4 https://doi.org/10.1080/1540496x.2020.1789455 https://doi.org/10.1146/annurev-polisci-050409-112539 https://doi.org/10.1016/j.frl.2020.101800 https://doi.org/10.1007/s00780-005-0165-8 https://doi.org/10.1287/mnsc.9.2.277 https://doi.org/10.1016/j.jeconbus.2020.105968 https://doi.org/10.2139/ssrn.628187 https://doi.org/10.1080/1540496x.2020.1791074 1 © 2024 by the author; licensee asian online journal publishing group asian journal of economics and empirical research vol. 11, no. 1, 1-11, 2024 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v11i1.5327 © 2024 by the author; licensee asian online journal publishing group public spending and economic growth: the role of institutions in ivory coast sohalio ouattara economic policies and modeling, alassane ouattara university of bouake, côte d'ivoire. email: sohalioouat2030@gmail.com abstract several studies have analysed the effects of public spending, institutions and interaction between public spending and institutions on economic activity. this existing literature has ignored the effect of institutional shocks on the relationship between public spending and economic growth. to fill this gap, the current study aims to estimate the effects of public spending, institutional factors and institutional shocks on gdp per capita in ivory coast. it uses annual data that covers the period 1984-2019. we exploit the principal component analysis technique to construct an institutional composite index. we then estimate two nonlinear autoregressive distributed lag models with interaction variables such as institutional index and public spending, corruption and public spending. the empirical results reveal symmetric effects of long-run institutional and corruption shocks on gdp per capita. in contrast, the effects of institutions are asymmetric in the short term. negative institutional shocks worsen gdp per capita in the short term, as do positive corruption shocks in the long term. similarly, public spending promotes economic growth, but neither institutions nor corruption significantly accentuate its effects. these results imply that improving the efficiency of public spending requires a prior improvement in the institutional framework and, above all, in the fight against corruption. keywords: corruption, efficiency public spending, institutions, nardl bounds tests. jel classification: o43; h54; c43; c22. citation | ouattara, s. (2024). public spending and economic growth: the role of institutions in ivory coast. asian journal of economics and empirical research, 11(1), 1–11. 10.20448/ajeer.v11i1.5327 history: received: 25 october 2023 revised: 21 december 2023 accepted: 5 january 2024 published: 17 january 2024 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. data availability statement: sohalio ouattara may provide study data upon reasonable request. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. contents 1. introduction ......................................................................................................................................................................................... 2 2. literature review ............................................................................................................................................................................... 2 3. empirical framework......................................................................................................................................................................... 4 4. results and discussion ...................................................................................................................................................................... 6 5. conclusion ............................................................................................................................................................................................ 9 references .............................................................................................................................................................................................. 10 mailto:sohalioouat2030@gmail.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v11i1.5327 https://orcid.org/0009-0004-0690-7014 asian journal of economics and empirical research, 2024, 11(1): 1-11 2 © 2024 by the author; licensee asian online journal publishing group contribution of this paper to the literature several studies emphasized the relationship between public spending and economic growth, taking institutions into account. however, these studies ignored the nonlinear nature of institutions. unlike these papers, this article provides a new analysis of the effects of institutions and corruption by considering the effects of their shocks on economic growth. 1. introduction since the third united nations international conference on financing for development in addis-abeba in july 2015, the idea that domestic public resources should be mobilized has been widely defended. this thesis takes on even more meaning in a context where development aid is stagnating, as well as the limited debt capacity of countries in monetary union. however, in developing countries, a large public sector is needed to provide basic infrastructure and launch projects that are essential for development, and which are not undertaken by the private sector. for this reason, the mobilization of domestic public resources is becoming more necessary the ever, and improving the efficiency of public spending remains essential for developing countries. public spending is said to be efficient if it improves economic growth. according to rota-graziosi, arezki, and dama (2021), improving the quality of public spending fosters a virtuous circle between public spending efficiency, fiscal civic-mindedness and revenue mobilization. this idea corroborates the thesis that productive expenditure is necessary for long-term economic growth, supported by the authors of endogenous growth. it’s clear that developing countries are struggling to get off the ground, yet public spending is rising steadily. this is the case in ivory coast, where public spending has risen from an average of 7.85% of gdp between 1984 and 1989 to 15.35% of gdp between 2010 and 2019. however, ivory coast is ranked among the countries with the lowest level of human capital, with a value of 0.538, occupying 162nd place out of 189 countries in 2019. as a result, public spending may be inefficient or ineffective. a key reason for this could be the level of institutions. as north (1990) points out, institutions are a major cause of economic development in both the short and long-term. in fact, a country with good institutions is able to avoid the waste and misappropriation of public resources, and provide a sound framework that guarantees economic agents in general, and investors in particular. however, if we look closely, institutions have deteriorated over the same period. indeed, between 1984 and 1989, the composite institutional index stood at 0.58, before dropping to 0.26 between 2010 and 2019. in contrast, corruption is slowly declining, from an average of 0.58 to 0.47 in the 2000-2009 and 2010-2019 periods respectively. in this context, we wonder about the role of institutions in the relationship between public spending and economic growth in ivory coast? in other words, does public spending improve economic growth? how do institutional shocks affect economic growth? how do institutions affect the relationship between public spending and economic growth? this study seems important in the current context of ivory coast, as no specific study exists in this country. also, unlike existing studies, this study goes beyond the simple determinant of economic growth. it uses sophisticated modeling to analyze the effects of public spending, institutional shocks and corruption shocks on gdp per capita. this study contributes to the debate on the relationship between public spending and economic growth. the rest of this article is organized as follow. the section 2 presents the literature review on the institution’s contribution to the relationship between public spending and economic growth. the data and methodology are discussed in section 3. the 4th section is devoted to the presentation of results and discussion. the conclusion is presented in section 5. 2. literature review the impact of public spending on economic activity in general, and on economic growth in particular, has been the subject of a number of theoretical and empirical studies. examples include studies by butkiewicz and yanikkaya (2011); friday, ogwumike, udongwo, and ayodele (2016); chinwuba and ibrahim (2016) and oyinlola and akinnibosun (2013). indeed friday et al. (2016) assessed the impact of public investment on economic growth in nigeria. the authors disaggregated public investment into agricultural, health, education and infrastructure public investment. for this purpose, they used an error correction model with annual data covering the period 1970 to 2012. the results showed that overall public investment is effective. similarly, public investment in education and infrastructure is growth enhancing in both the short and long term. the effects of public investment in health are insignificant. as for public investment in agriculture, it has no influence in the short or long term. the work of chinwuba and ibrahim (2016) seeks to identify the determinants of growth in nigeria. the authors use quarterly data from 1986 to 2013 and co-integration method with bounds. they conclude that only population and trade openness have been determinants of economic growth in nigeria. however, the authors encourage strong transparency in public affairs. abdulrasheed (2017) analyzed the causal relationship between public and revenue in nigeria. the author used annual data and applied the co-integration technique and a vector autoregressive error correction model. the results highlight a long-term relationship between public spending and public revenues. an increase in public spending requires a simultaneous increase in public revenues to avoid widening the budget deficit and jeopardizing long-term growth. oyinlola and akinnibosun (2013) examined the relationship between public spending and economic growth in nigeria over the period 1970 – 2009. a disaggregated level of public spending was used using the gregory-hansen structural break co-integration technique. the results confirmed wagner’s law in the long term. the results also revealed that public spending on investment in infrastructure and human resources is conducive to economic growth. the work of butkiewicz and yanikkaya (2011) highlighted the effects of public spending on spending on economic growth, focusing on the level of efficiency of country governments over the period 1970–2004. the results revealed that public consumption expenditure is detrimental to economic growth. however, developing countries with efficient governments recorded lower negative effects from consumer spending than those with inefficient governments. in fact, developing countries with inefficient government tend to crowd out the private sector, so that public investment is substituted for private investment. secondly, all developing countries benefit from the positive effects of public capital expenditure, regardless of the state of government. unlike this study, the work of afonso and jalles (2016) integrated institutions into their analysis and also in a broader context. the results first indicated a negative effect of government size and positive effect of institutions on economic activity. asian journal of economics and empirical research, 2024, 11(1): 1-11 3 © 2024 by the author; licensee asian online journal publishing group secondly, good-quality institutions mitigate the negative effects of government size. in other words, the better the quality of institutions, the less the negative effect of government size. afonso, jalles, and venâncio (2022) estimate public spending efficiency scores in organization for economic co-operation and development (oecd) countries and assess how these scores affect capital markets. the authors use a sample of 35 oecd countries over the period 2007-2020 and data envelopment analysis (dea) to estimate the scores. they then use linear regression models to estimate the relationship between public spending efficiency and sovereign debt rating. the results revealed that an improvement in public spending efficiency leads to a higher sovereign debt rating. the relationship between institutional quality and development was recently analyzed by vianna and mollick (2018) on a panel of 192 countries. the results indicated that a 0.1-point increase in institutional quality leads to a 3.9% improvement in gdp per capita. oppong, atchulo, and oman (2023) analyzed the effects of institutional quality and public debt on economic growth in 35 sub-saharan african countries over the period 2010 – 2020. they used fixed-effects estimation techniques and generalized systems of moments. the authors conclude that institutional quality has a negative effect on public debt and a positive effect on economic growth. secondly, public debt has a strong negative and significant effect on economic growth. these results show that countries with weak institutions are likely to be over-indebted or even insolvent, which would further undermine economic growth. the effect of public spending on economic growth is only significant in countries with good institutions. clearly, good institutional quality guarantees optimal use of public resources and mitigates the negative effects of public spending on gdp per capita. however analyzing the contribution of institutional factors to inclusive growth in ivory. botchuin (2021) used the bounds co-integration approach and an ardl model over the period going from 1984 to 2018. the results showed that only government stability as institutional factors has a significant effect on inclusive growth in the short and long term. hussen (2023) examined the relationship between institutional quality and economic growth in sub-saharan africa. the author uses a panel of 31 countries over the period 1991 to 2015 applying the generalized method systems of moments. furthermore, he classifies institutions into three categories: investment-promoting economic institutions, democratic and regulatory institutions and conflict-preventing institutions. the results indicate that investment-promoting economic and democratic and regulatory institutions promote investment and economic growth. conflict-preventing institutions, on the other hand, have no significant impact on economic growth. it therefore seems crucial that good quality institutions are indispensable for improving investment and economic growth. arvin, pradhan, and nair (2021) the relationships between institutional quality, public spending, tax revenues and economic growth in low and middle income countries over the period 2005-2019. they borrowed modelling to study short and long-term relationships, as well as causal relationships. firstly, the results indicated endogenous temporal causal relationships between certain short and long-term variables. secondly, the results revealed that institutional quality, public spending and tax revenues altogether have favorable effects on economic growth in the studied countries. thirdly, the results showed that there is no causal relationship between institutional quality and public spending in either the short or long-term. in other words, public spending has no significant effect on the quality of institutions. they rather have a positive impact on economic growth in the countries studied. corruption being a variant of institutions, several studies have examined its effects on economic activity. recently, many studies such as shleifer and vishny (1993); mauro (1998); tanzi and davoodi (1997); dzhumashev (2014) and agostino, dunne, and pieroni (2016) have indicated that corruption distorts public spending. in fact, corruption leads to allocation of public resources to less productive areas and above all to making less optimal allocations. agostino et al. (2016) examined the effects of corruption and public spending on economic growth in african countries. to this end, authors used an endogenous growth model, subsequently decomposing public spending into military spending and public investment spending. estimation of the resulting model on the sample showed firstly that the growth rate is strongly and significantly influenced by the interaction between corruption and military public spending, while the effect of the interaction between corruption and investment spending is weak. secondly, the results revealed that countries with high levels of political instability experienced more extreme negative effects of corruption on economic growth, both directly and indirectly through higher military spending. finally, the results highlighted a neutral effect of government size on economic growth. mauro (1998) used icrg corruption index data for the period 1982-1995 to analyze the relationship between corruption and the composition of public spending. the author applied ordinary least squares estimation and the results revealed that corruption creates distortions. in other words, corruption increases the level of public spending and, at the same time, changes the structure of public spending away from more productive sectors such as health and education to less productive sectors. hakizimana (2021) analyzed the effects of corruption on economic growth in congo. the author used quarterly data dating from the first quarter of 2003 to the fourth quarter of 2019 to estimate a nonlinear autoregressive distributed lag (nardl) model. the results highlighted the existence of asymmetric effects of corruption on short and long-run economic growth. furthermore, the results emphasized that economic growth is more sensitive to an increase of the corruption perception index than its decrease. corruption harms economic activity through private and public investment. dzhumashev (2014) examined the relationship between bureaucratic corruption and economic growth, showing the role of governance, public spending and economic development. the author therefore used the endogenous growth model, then constructed an interaction model and a panel sample of three countries: kenya, turkey and the uk, categorized respectively as low-income, middle –income and high-income countries. the sample data covered the period from 1960 to 2010. the results revealed that corruption worsens the efficiency of public spending. however, the effects of corruption on economic growth depend on the weight of regulation and productive public inputs. similarly, the role of governance in the relationship between corruption and economic growth seems somewhat unclear, insofar as it determines the incidence of corruption and the efficiency of public spending. afonso and rodrigues (2022) sought to determine the transmission channels of the negative effects of corruption on economic growth over a sample of 48 countries covering the period from 2012 to 2019. as such, the authors use dynamic models and the generalized method of moments. the results indicated that corruption has a negative and significant impact on gdp per capita. in other words, corruption affects economic performance in general and public finance variables in particular (afonso & rodrigues, 2022; ali & ahmed, 2017; barişik & baris, asian journal of economics and empirical research, 2024, 11(1): 1-11 4 © 2024 by the author; licensee asian online journal publishing group 2017; kim, ha, & kim, 2017; dani rodrik, 1999). furthermore, rodrik (1999) examined the influence of institutions such as corruption control, rule and law, political instability and government effectiveness on economic growth. the author concluded the better institutional quality boosts economic growth. indeed, he argues that countries with good institutions tend to manage available resources more efficiently than countries with poor institutions. arawomo and adeoye (2020) examined the effect of institutions in the relationship between public spending and economic growth in nigeria over the 1986-2016. the authors estimated an ardl (autoregressive distributed lag). they used corruption, law and order plus democracy as institutional variables, and disaggregated public spending into current and capital expenditure. the results revealed firstly that corruption affects the relationship between public investment expenditure and growth, as well as the relationship between public current expenditure and economic growth, in a significant and negative way. secondly, democracy has a negative and significant effect on the relationship between public capital expenditure and economic growth, while it generates positive and significant effects in the relationship between public current expenditure and economic growth. finally, law and order has negative and significant effect on the relationship between current public expenditure and economic growth, while generating positive effects in the relationship public investment spending and economic growth. in contrast, other studies such as diandy and seck (2021) have concluded that institutions have a negative impact on economic growth. however, the authors justify this result by pointing out that the institutions level of these countries is low. they argue that there is a minimum level at which the institutions become conducive to economic activity. contrary to several works that found corruption to be detrimental to economic growth, the work of mallik and saha (2016) revealed a positive effect of corruption on economic growth in a panel of 146 countries over the period 1984-2009. the authors argued that in moderately corrupt countries, corruption invigorates economic growth by reducing red tape. all in all, the results are mixed as to the role of institutions in the relationship between public spending and economic growth. moreover, there is less empirical work on developing countries, and in particular ivory coast, to justify specific analyses of the latter. 3. empirical framework this part of the study first presents the data and structure of the institutional index, and finally the econometric framework. a large literature has shown the importance of institutions in economic activity. studies such as north (1990); acemoglu (2008) and keho (2012) have shown that good institutions are a condition for sustainable growth. in other words, the classic factors of economic growth (labor and capital) are limited to accelerating growth in the long term. thus, institutions could play a key role in the efficiency of public spending. 3.1. scope of study this study uses annual data for the period 1984-2019. gross domestic product (gdp) per capita is an indicator for measuring the social well-being of a population. the working population represents the labor force, private investment presented by private gross fixed capital formation and public debt are social well-being factors used as control variables in this study. these variables are taken from the world-development-indicators (wdi) database. the degree of trade openness variable is taken from central bank of west africa (bceao) database, and the institutional variables are taken from the international country risk guide (icrg) database. 3.2. data analysis in the empirical literature, there is no single indicator for measuring the level of institutional quality. several indicators have been used to study the effects of institutional quality on economic activity. following this study selects government stability, bureaucratic quality, investment conditions, law and order, democratic accountability, economic and social condition and corruption. these indicators come from the icrg produced by the political risk service group (prs-group). the advantage of these data is that they are available over a relatively long period, from 1984 to 2019, with no missing values. using all these seven indicators in a model can lead to problems of multicollinearity, as these variables may be highly correlated. similarly, there is also the risk of over-identification due to the large number of coefficients to be estimated. on the other hand, using each of these variables can lead to omission bias. one solution to these problems is to combine the variables into a single indicator with specific weights, like the human development index (hdi) frequently published by the united nations development program (undp). however, such an approach comes up against the question of the weights to be assigned to each variable. in order to avoid any subjectivity in defining these weights, we resort to a principal component analysis (pca). this involves “letting the data speak” so that they themselves determine their respective weights (keho, 2012). diandy and seck (2021) used kaufman indicators and the pca technique to construct a composite index of institutions. unlike that study, we use the first six indicators from “political risk service group” (prs group) to construct our composite index. in addition, these indicators are used to construct our composite index because they can be interpreted in the same direction. in other words, the higher these indicators are, the better the quality of the institutions. table 1. principal component analysis results. components eigen value pca1 pca2 pca3 pca4 pca5 pca6 3.355 1.247 0.744 0.379 0.194 0.081 proportion (%) 55.91 20.78 12.40 6.31 3.23 1.34 cumulative (%) 55.91 76.70 89.10 95.42 99.65 100 variable vector 1 vector 2 vector 3 vector 4 vector 5 vector 6 qb 0.948 -0.117 0.073 0.043 -0.199 0.202 rl 0.847 -0.171 0.217 -0.380 0.248 0.008 cse 0.790 0.128 0.529 0.232 -0.070 -0.144 sg -0.760 0.314 0.516 0.127 0.155 0.135 dem 0.728 0.431 -0.382 0.299 0.221 0.026 pi 0.084 0.951 -0.020 -0.272 -0.122 -0.011 note: qb: bureaucratic quality; rl: law and order; cse: economic and social condition; sg: government stability; dem: democratic accountability; pi: investment conditions. asian journal of economics and empirical research, 2024, 11(1): 1-11 5 © 2024 by the author; licensee asian online journal publishing group finally, corruption alone would be considered as institutional quality, as this variable is an essential phenomenon that undermines the economic development of developing countries, particularly that of ivory coast. pca also requires prior testing of variable reducibility, using the bartlett (1950) and kaiser-meyer-olkin (kmo) tests (kaiser, 1974). the kmo index thus measures the adequacy of the variables used in the pca analysis. kmo values of 0.8 and above are considered well, those between 0.5 and 0.7 are acceptable, and those below 0.5 are unacceptable. in our case, the kmo index is equal to 0.635, so we use pca. the results of the principal component analysis are shown in table 1. this table shows that the first principal component extracts 55.91% of the initial total variance, the second principal component restores around 20.78% of the variance, and so on. under these conditions, we retain the first two components, since together they account for 79.70% of the total variance. the percentages of variance explained by each of these two components are used to obtain the specific weights used to calculate the institutional composite index. the index values were then normalized according to the formula: 𝐼𝑄𝑛𝑜𝑟𝑚 = (𝐼𝑄 − 𝐼𝑄𝑚𝑖𝑛) (𝐼𝑄𝑚𝑎𝑥 − 𝐼𝑄𝑚𝑖𝑛)⁄ values range from 0 to 1 with a high value indicating a good quality institution. similarly, corruption values have been transformed the closer the value is to 1, the more corrupt the country. table 2. average public spending/gdp ratio and institutional indices. period 1984-1989 1990-1999 2000-2009 2010-2019 pe_gdp 7.85 7.79 9.60 15.35 iqn 0.58 0.80 0.31 0.26 corn 0.72 0.80 0.58 0.47 table 2 shows trends in the ratio of public spending/gdp (pe_gdp), the composite index of institutions (iqn) and corruption (corn). over the 1984-1989 period, the public spending ratio averaged 7.85% of gdp. this was followed by a slight decline in the public spending ratio (-0.06%) over the period 1990-1999. both decades saw an increase in the public spending ratio. this increase is strongest over the 2010-2019 period, rising from an average of 9.60% of gdp to 15.35% of gdp an increase of (5.75%). we also note that over the 1984-1989 period, the composite institutional index and corruption are 0.58 and 0.72 respectively. the composite index of institutions and corruption reached a maximum level of 0.80. over the last two decades, the composite institutional index has fallen from 0.80 to 0.31 over the period 2000-2009. as for corruption, there was drop of (-0.11) between the penultimate and final decades. this analysis shows the need for a study of the role of institutions in improving the efficiency of public spending in ivory coast. 3.3. model specification we borrow the theoretical approach of the cobb-douglas production function defined as follows: 𝑌𝑡 = 𝐹(𝐴𝑡 , 𝐾𝑡 , 𝐿𝑡) = 𝐴𝑡𝐾𝛼𝐿1−𝛼 𝛼 𝑎𝑛𝑑 1 − 𝛼 > 0 (1) where yt is real gdp per capita at time t, lt is labor force, kt physical capital stock and at is total factor productivity, reflecting the level of technology and efficiency of the economy. by dividing yt by lt, we obtain: 𝑌𝑡 𝐿𝑡 = 𝐴𝑡 𝐿𝑡 × 𝐾𝑡 𝛼𝐿𝑡 𝐿𝑡 𝛼 = 𝐴𝑡𝐾𝑡 𝛼 𝐿𝑡 𝛼 (2) linearizing equation 2, we obtain: ln 𝑌𝑡 = ln 𝐴𝑡 + 𝛼 ln 𝐾𝑡 + (1 − 𝛼) ln 𝐿𝑡 (3) let’s ask 𝛽 = 1 − 𝛼 and 𝐾𝑡 = 𝑃𝐸𝑡 + 𝐾𝑝𝑟𝑡 we have: ln 𝑌𝑡 = ln 𝐴𝑡 + 𝛼2 ln 𝑃𝐸𝑡 + 𝛼4 ln 𝐾𝑝𝑟𝑡 + β ln 𝐿𝑡 (4) where pe is public spending and kpr is private investment (private gross fixed capital formation). authors such as north (1990); rodrik (2000); keho (2012) and hussen (2023) have argued that improved productivity can be the result of a developed institutional environment. hence we posit: 𝐴𝑡 = 𝐺(𝑖𝑛𝑠𝑡) = 𝐴0𝑒𝜃𝑖𝑛𝑠𝑡 (5) replacing (5) in (4) we obtain: 𝑙𝑛𝑌𝑡 = 𝑙𝑛𝐴0 + 𝜃𝑖𝑛𝑠𝑡𝑡 + 𝛼2𝑙𝑛𝑃𝐸𝑡 + 𝛼4𝑙𝑛𝐾𝑝𝑟𝑡 + 𝛽𝑙𝑛𝐿𝑡 (6) to capture the fact that institutions condition the relationship between the efficiency of public spending and gross domestic product per capita, we introduce an interaction variable between overall public spending and institutions: 𝑖𝑛𝑠𝑡 × 𝑙𝑛𝑃𝐸. equation 6 thus becomes: 𝑙𝑛𝑌𝑡 = 𝑙𝑛𝐴0 + 𝜃𝑖𝑛𝑠𝑡𝑡 + 𝛼2𝑙𝑛𝑃𝐸𝑡 + 𝛼4𝑙𝑛𝐾𝑝𝑟𝑡 + 𝛼5(𝑖𝑛𝑠𝑡𝑡 ∗ 𝑙𝑛𝑃𝐸𝑡) + 𝛽𝑙𝑛𝐿𝑡 (7) by posing 𝜃 = 𝛼3; 𝛽 = 𝛼6 and 𝜀𝑡: the error term iid (0; 𝜎𝜇 2 ). we can rewrite equation 7 as follows: 𝑙𝑛𝑌𝑡 = 𝑙𝑛𝐴0 + 𝛼2𝑙𝑛𝑃𝐸𝑡 + 𝛼3𝑖𝑛𝑠𝑡𝑡 + 𝛼4𝑙𝑛𝐾𝑝𝑟𝑡 + 𝛼5(𝑖𝑛𝑠𝑡𝑡 ∗ 𝑙𝑛𝑃𝐸𝑡) + 𝛼6𝑙𝑛𝐿𝑡 + 𝜀𝑡 (8) following the literature, we include in the model other factors that explain gross domestic product per capita, such as the degree of trade openness (do) (hakizimana, 2021) and public debt (det). 𝑙𝑛𝑌𝑡 = 𝑙𝑛𝐴0 + 𝛼2𝑙𝑛𝑃𝐸𝑡 + 𝛼3𝑖𝑛𝑠𝑡𝑡 + 𝛼4𝑙𝑛𝐾𝑝𝑟𝑡 + 𝛼5(𝑖𝑛𝑠𝑡𝑡 ∗ 𝑙𝑛𝑃𝐸𝑡) + 𝛼6𝑙𝑛𝐿𝑡 + 𝛼7𝑙𝑛𝐷𝑒𝑡𝑡 + 𝛼8𝐷𝑂𝑡 + 𝜀𝑡 (9) according to table 3, the study variables are stationary at level or in first difference. thus, if the variables are co-integrated, we will analyze the short and long-term dynamism of the relationship. as proposed by pesaran, shin, and smith (2001), we can rewrite (9) in the form of an autoregressive distributed lag (ardl) model presented as follows: ∆𝑙𝑛𝑌𝑡 = 𝑙𝑛𝐴0 + ∑ 𝛼1∆𝑙𝑛𝑌𝑡−1 𝑝−1 𝑖=1 + ∑ 𝛼2∆𝑙𝑛𝑃𝐸𝑡−1 𝑞−1 𝑖=0 + ∑ 𝛼3∆𝑖𝑛𝑠𝑡𝑡−1 𝑟−1 𝑖=0 + ∑ 𝛼4∆𝑙𝑛𝐾𝑝𝑟𝑡−1 𝑠−1 𝑖=0 + ∑ 𝛼5∆(𝑖𝑛𝑠𝑡𝑡−1 ∗ 𝑙𝑛𝑃𝐸𝑡−1)𝑡−1 𝑖=0 + ∑ 𝛼6∆𝑙𝑛𝐿𝑡−1 𝑢−1 𝑖=0 + ∑ 𝛼7∆𝑙𝑛𝐷𝑒𝑡𝑡−1 𝑣−1 𝑖=0 + ∑ 𝛼8∆𝐷𝑂𝑡−1 𝑤−1 𝑖=0 + ∑ 𝛼9∆𝑑𝑢𝑚𝑡−1 𝑥−1 𝑖=0 + 𝜃1𝑙𝑛𝑌𝑡−1 + 𝜃2𝑙𝑛𝑃𝐸𝑡−1 + 𝜃3𝑖𝑛𝑠𝑡𝑡−1 + 𝜃4𝑙𝑛𝐾𝑝𝑟𝑡−1 + 𝜃5(𝑖𝑛𝑠𝑡𝑡−1 ∗ 𝑙𝑛𝑃𝐸𝑡−1) + 𝜃6𝑙𝑛𝐿𝑡−1 + 𝜃7𝑙𝑛𝐷𝑒𝑡𝑡−1 + 𝜃8𝐷𝑂𝑡−1 + 𝜃9𝑑𝑢𝑚𝑡−1 + 𝜀𝑡 (10) with ∆ the first difference operator: 𝛼1-𝛼9 the error-correction model representation; 𝜃1-𝜃9 denotes long-term relationships; 𝑝 − 1, …, 𝑥 − 1 are the lag numbers of the variables; dum an indicator variable capturing changes following the creation and devaluation of the fcfa. however, the above ardl model does not take into account the direction of institutions. in other words, there may be potential asymmetric effects of institutional improvements and degradations on gdp per capita. a number of events, such as political instability and socio-economic and political crises, can lead to a sharp deterioration in asian journal of economics and empirical research, 2024, 11(1): 1-11 6 © 2024 by the author; licensee asian online journal publishing group institutions. as a result, a more appropriate model is needed to accurately reflect the complexity of the real world. thus, we explore the nonlinear ardl (nardl) model developed by shin, yu, and greenwood-nimmo (2014). according to authors such as schorderet (2003) and shin et al. (2014), the starting point is to decompose institutional time series (𝑖𝑛𝑠𝑡) into its positive (𝑖𝑛𝑠𝑡𝑡 +) and negative (𝑖𝑛𝑠𝑡𝑡 −) partial sums: 𝑃𝑂𝑆 = 𝑖𝑛𝑠𝑡𝑡 + = ∑ ∆𝑖𝑛𝑠𝑡𝑗 +𝑡 𝑗=1 = ∑ 𝑚𝑎𝑥(∆𝑖𝑛𝑠𝑡𝑗, 0)𝑡 𝑗=1 (11) 𝑁𝐸𝐺 = 𝑖𝑛𝑠𝑡𝑡 − = ∑ ∆𝑖𝑛𝑠𝑡𝑗 − = ∑ 𝑚𝑖𝑛(∆𝑖𝑛𝑠𝑡𝑗, 0)𝑡 𝑗=1 𝑡 𝑗=1 (12) with ∆𝑖𝑛𝑠𝑡𝑗 +and ∆𝑖𝑛𝑠𝑡𝑗 −capturing positive (improvements) and negative (degradations) variations in institutional quality. thus the models to be estimated follow the demonstration of shin et al. (2014) are as follows: ∆𝑙𝑛𝑌𝑡 = 𝑙𝑛𝐴0 + ∑ 𝛼1∆𝑙𝑛𝑌𝑡−1 𝑝−1 𝑖=1 + ∑ 𝛼2∆𝑙𝑛𝑃𝐸𝑡−1 𝑞−1 𝑖=0 + ∑ 𝛼3 +∆𝑖𝑛𝑠𝑡𝑡−1 + + ∑ 𝛼3 −∆𝑖𝑛𝑠𝑡𝑡−1 −𝑟−1 𝑖=0 𝑟−1 𝑖=0 + ∑ 𝛼4∆𝑙𝑛𝐾𝑝𝑟𝑡−1 𝑠−1 𝑖=0 + ∑ 𝛼5∆(𝑖𝑛𝑠𝑡𝑡−1 ∗ 𝑙𝑛𝑃𝐸𝑡−1)𝑡−1 𝑖=0 + ∑ 𝛼6∆𝑙𝑛𝐿𝑡−1 𝑢−1 𝑖=0 + ∑ 𝛼7∆𝑙𝑛𝐷𝑒𝑡𝑡−1 𝑣−1 𝑖=0 + ∑ 𝛼8∆𝐷𝑂𝑡−1 𝑤−1 𝑖=0 + ∑ 𝛼9∆𝑑𝑢𝑚𝑡−1 𝑥−1 𝑖=0 + 𝜃1𝑙𝑛𝑌𝑡−1 + 𝜃2𝑙𝑛𝑃𝐸𝑡−1 + 𝜃3 +𝑖𝑛𝑠𝑡𝑡−1 + + 𝜃3 −𝑖𝑛𝑠𝑡𝑡−1 − + 𝜃4𝑙𝑛𝐾𝑝𝑟𝑡−1 + 𝜃5(𝑖𝑛𝑠𝑡𝑡−1 ∗ 𝑙𝑛𝑃𝐸𝑡−1) + 𝜃6𝑙𝑛𝐿𝑡−1 + 𝜃7𝑙𝑛𝐷𝑒𝑡𝑡−1 + 𝜃8𝐷𝑂𝑡−1 + 𝜃9𝑑𝑢𝑚𝑡−1 + 𝜀𝑡 (13) with −𝜃2 𝜃1 ⁄ , −𝜃3 𝜃1 ⁄ , −𝜃3 ′ 𝜃1 ⁄ , −𝜃4 𝜃1 ⁄ , −𝜃5 𝜃1 ⁄ , −𝜃6 𝜃1 ⁄ , −𝜃7 𝜃1 ⁄ , −𝜃8 𝜃1 ⁄ , −𝜃9 𝜃1 ⁄ are the long-term coefficients. we expect the fit coefficient 𝜃1 < 0 we can rewrite the long-run form of (13) as follows: 𝑦𝑡 = 𝛽0 + 𝛽1𝑙𝑛𝑌𝑡−1 + 𝛽2𝑙𝑛𝑃𝐸𝑡 + 𝛽3 +𝑖𝑛𝑠𝑡𝑡 + + 𝛽3 −𝑖𝑛𝑠𝑡𝑡 − + 𝛽4𝑙𝑛𝐾𝑝𝑟𝑡 + 𝛽5(𝑖𝑛𝑠𝑡𝑡 ∗ 𝑙𝑛𝑃𝐸𝑡) + 𝛽6𝑙𝑛𝐿𝑡 + 𝛽7𝑙𝑛𝐷𝑒𝑡𝑡 + 𝛽8𝐷𝑂𝑡 + 𝛽9𝑑𝑢𝑚𝑡 + 𝜀𝑡 (14) having estimated the long-run coefficients, we examine how institutional variables affect the relationship between public spending and gdp per capita. from (13), we calculate the marginal effect as follows: 𝜕𝑦𝑡 𝜕𝑙𝑛𝑃𝐸𝑡 = 𝛽2 + 𝛽5𝑖𝑛𝑠𝑡𝑡 (15) equation 15 shows that the marginal effect of public spending on gdp per capita depends on institutional quality. if 𝛽2 𝑎𝑛𝑑 𝛽5 are all positive or respectively negative, then public spending has a positive or respectively negative effect on gdp per capita and institutions accentuate this impact. if 𝛽2 > 0 𝑎𝑛𝑑 𝛽5 < 0, then public spending has a positive effect on gdp per capita but institutions reduce this positive impact. if 𝛽2 < 0 𝑎𝑛𝑑 𝛽5 > 0, then public spending has negative effect on gdp per capita but institutions mitigate this negative impact. 3.4. nardl model estimation procedure as with any time series analysis, the first step is to test the order of integration of variables. thus, for a nardl model, we need to ensure that no variable is integrated of order two i (2). the second step is to test for cointegration between variables. in view of the results of unit-root tests, we use the test of pesaran et al. (2001) to test the existence of a long-term relationship between the variables in our two models. furthermore, unlike the cointegration tests of engel and granger (1987); johansen (1988) and johansen (1991), the bounds test to cointegration initiated by pesaran and shin (1999) is used when the series have a mixed order of integration (some being stationary and others non-stationary), which is in line with our results. this test formulates the hypothesis as follows: 𝐻0: 𝜃1 = 𝜃2 = ⋯ = 𝜃9 against the alternative hypothesis: 𝐻1: 𝜃1 ≠ 𝜃2 ≠ ⋯ ≠ 𝜃9 in practice, this test is performed by comparing the calculated fisher (fcal) values with the simulated critical values. if we assume 𝜔0 to be the lower bound and 𝜔1 the upper bound, then we have: 𝐹𝑐𝑎𝑙 > 𝜔1: existence of co-integration. 𝐹𝑐𝑎𝑙 < 𝜔0: no co-integration. 𝜔0 < 𝐹𝑐𝑎𝑙 < 𝜔1: no conclusion. the third step is to test the long-run symmetry (𝜃3 + = 𝜃3 −) and also the short-term symmetry, by comparing the sum of positive and negative dynamic coefficients (∑ 𝑖𝑛𝑠𝑡𝑡 + + ∑ 𝑖𝑛𝑠𝑡𝑡 −𝑟−1 𝑖=0 𝑟−1 𝑖=0 ). finally, we check the robustness of the model using diagnostic tests. and so, we move on to the results. 4. results and discussion 4.1. results 4.1.1. unit-root tests for the variables to avoid spurious regressions, it is necessary to test for the unit root of the series to analyze their stochastic properties. to this end, we use two tests, namely the augmented dickey and fuller (1981) and zivot and andrews (2002) tests. these tests respectively assume, under the null hypothesis, that the series has a unit root and that the series has a unit root without any break. as for the alternative hypothesis, these tests respectively assume that the series is stationary and the series is stationary with a single break. in case of conflict between the two tests, we prefer the zivot-andrews results. depending on the results of the stationarity tests reported in table 3, the variables are integrated of order i(0) or order i(1). with the exception of labor force, institutional variables (iqn and corn) and interaction variables, the other variables are stationary in first differences. asian journal of economics and empirical research, 2024, 11(1): 1-11 7 © 2024 by the author; licensee asian online journal publishing group table 3. unit root tests results. variable adf zivot-andrews remark level 1st differenced level break date 1st differenced break date lngdp 1.196 (-2.976) -3.222** (-2.967) -0.824 (-4.193) 1989 -6.231** (-4.443) 1994 i(1) lnl -0.408 (-2.951) -5.315** (-2.986) -4.768** (-4.443) 1990 -23.263** (-4.443) 1990 i(0) lnkpr -2.656 (-2.957) -3.102** (-2.960) -1.767 (-4.443) 1993 -7.423** (-4.443) 2011 i(1) lnpe 0.955 (-2.948) -5.166** (-2.951) -1.260 (-4.443) 2011 -5.754** (-4.443) 1990 i(1) lndet -2.075 (-2.951) -4.568** (-2.951) -2.255 (-4.443) 2002 -6.054** (-4.443) 2013 i(1) do -2.968** (-2.948) -5.803** (-2.951) -4.148 (-4.443) 2013 -6.124** (-4.443) 1994 i(1) iqn -1.662 (-2.948) -6.824** (-2.951) -5.018** (-4.443) 2002 -7.593** (-4.443) 1990 i(0) corn -2.355 (-2.951) -4.396** (-2.951) -4.759** (-4.443) 1995 -5.625** (-4.443) 1996 i(0) iqn*lnpe -1.789 (-2.948) -6.688** (-2.951) -5.652** (-4.443) 2001 -7.132** (-4.443) 1990 i(0) cor*lnpe -2.819 (-2.951) -4.439** (-2.951) -4.788** (-4.443) 1995 -5.400** (-4.443) 1996 i(0) note: ** indicate stationary at 5%; adf, test of augmented dickey and fuller (1981), test of zivot and andrews (2002). 4.1.2. co-integration test for nonlinear ardl the aim here is to verify the existence of a long-term relationship. table 4. symmetric bound test results. model 1 h0: no co-integration value 5% critical bounds 1% critical bounds i(0) i(1) i(0) i(1) f-statistic 11.35 2.14 3.30 2.65 3.97 model 2 5% critical bounds 1% critical bounds h0: no co-integration value i(0) i(1) i(0) i(1) f-statistic 5.03 1.86 3.05 2.37 3.68 note: the f-statistic values at 1% of significance indicating a long-run relationship. source: pesaran et al. (2001). table 4 highlights the results of nardl bounds tests. in fact, the calculated fisher value (11.35 and 5.03) is greater than the limit (respectively 3.97 and 3.68 at to 1% threshold), so the null hypothesis of no co-integration is rejected. there is therefore a long-term relationship between public spending and gdp per capita in the presence of institutional factors (iqn and corn). the next step will be to assess the effects of public spending in the presence of institutions, and especially of short and long-term institutional shocks, on gdp per capita in ivory coast. these results are presented in tables 5 and 6. 4.1.3. estimation and asymmetry test results table 5. nonlinear long-run results. variable model 1: nardl(1.1.1.0.0.1.1.1.0.1) model 2: nardl(1.0.0.0.0.0.0.0.1.1) coefficient t-statistic probability coefficient t-statistic probability ln l -1.891 -2.891 0.010 0.228 2.609 0.015 ln kpr 0.255 1.648 0.117 0.148 1.576 0.128 ln pe 0.351 2.262 0.037 0.282 1.875 0.073 iqn_pos -3.858 -1.317 0.205 iqn_neg -3.844 -1.324 0.202 iqn*lnpe 0.461 1.207 0.243 corn_pos -0.286 -2.145 0.042 corn_neg 0.093 0.911 0.371 corn*lnpe 0.073 1.507 0.145 do 0.001 2.709 0.014 0.0008 1.061 0.299 ln det 0.155 2.628 0.017 -0.001 -0.015 0.988 dum -0.918 -6.049 0.000 -0.909 -2.840 0.009 note: the dependent variable is ln (gdp per capita). table 6. short-run estimates. variable model 1 model 2 coefficient t-statistic probability coefficient t-statistic probability c 29.064 13.201 0.000 δ(ln l) -0.541 -1.690 0.109 δ(ln kpr) 0.044 0.807 0.430 δ(iqn_neg) -4.829 -10.632 0.000 δ(iqn*lnpe) 0.566 11.001 0.000 δ(do) -0.0005 -2.526 0.002 -0.0007 -2.506 0.019 δ(dum) cointeq(-1) -0.487 -0.976 -13.242 -13.178 0.000 0.000 -0.389 -0.590 -7.986 -8.370 0.000 0.000 r-squared: 0.91 dw=2.12 r-squared=0.76 dw=1.55 adj r-squared=0.88 prob (f-statistic)=0.000 adj r-squared= 0.75 note: the dependent variable is ln (gdp per capita), dw indicates durbin-watson statistic. asian journal of economics and empirical research, 2024, 11(1): 1-11 8 © 2024 by the author; licensee asian online journal publishing group table 5 presents the long-run estimation results of models 1 and 2 to explain the dependent variable. for model 1, labor force, public spending, trade openness and public debt are significant at the 5% level. in model 2, labor force and positive institutional shocks (corruption) are significant at the 5% level. table 6 shows the shortterm estimation for the two models. indeed, model 1 indicates that, in the short-term, negative institutional shocks, the interaction between institutions and public spending and trade openness are significant at the 1% level. as expected, the recall force cointeq (-1) is negative and significant at the 1% threshold, meaning that any exogenous shock in one of the variables will produce convergence towards equilibrium. this model also shows a predictive power of 91%. for model 2, trade openness is significant at the 5% level. the model’s recall force is negative and significant at 1%. model 2 has a predictive power of 76%. table 7. asymmetry test results. wald test model 1 model 2 ꭕ2 chi-square probability ꭕ2 chi-square probability wsr 8.08 0.004 na na wlr 0.08 0.766 0.02 0.871 note: the null hypothesis is that the coefficients are symmetric. wsr and wlr denote the short and long-run wald statistic symmetries, na indicates that the values are not available (short-term coefficients for corruption shocks are zero). table 7 presents the results of the test for symmetries. the long-run statistics calculated for the two models are equal to 0.08 and 0.02, with respective probabilities of 0.766 and 0.871, all of which are greater than 5%. we therefore accept the null hypothesis, rejecting the alternative hypothesis of asymmetry. consequently, gdp per capita reacts in the same way in the long-term to both positive and negative institutional shocks. as for model 1, in the short-term, the calculated statistic is equal to 8.08 with a probability of 0.004, which is less than 5%. the null hypothesis is thus rejected in favor of the alternative hypothesis. consequently, the effects of institutional shocks on gdp per capita are asymmetrical in the short-term. 4.1.4. nonlinear ardl diagnostic tests' table 8. diagnostics tests results. test type tests model 1 model 2 value prob. value prob. autocorrelation breusch-godfrey 0.28 0.754* 0.63 0.542* arch 3.12 0.087* 0.29 0.588* heteroskedasticity test breusch-pagan-godfrey 1.59 0.168* 2.76 0.018 jarque-bera 0.06 0.967* 0.07 0.961* normality test anderson-darling 0.37 0.401* 0.27 0.646* specification test ramsey reset 0.87 0.361* 2.14 0.157* note: * denotes acceptance of null hypothesis. table 8 shows the results of the autocorrelation, heteroskedasticity, and error normality and specification tests. the breusch-godfrey test is used to test error autocorrelation for both models. this test confirms the absence of error autocorrelation at the 5% threshold for both models. the breusch-pagan-godfrey and arch tests are used to test error heteroskedasticity. these tests show values of 1.59 and 3.12, with respective probabilities of 0.168 and 0.087 for model 1. similarly, these tests show values of 2.76 and 0.29, with probabilities of 0.018 and 0.588 respectively. the null hypothesis of no heteroskedasticity of errors is thus accepted for both models. the jarquebera and anderson darling tests show that the errors follow a normal distribution in the estimated models. the ramsey reset test shows that no variables are omitted, so the estimated models are well specified. to test the stability of the models, the cusum and cusum of squares tests are used, and the results confirm their stability. they are presented in figures 1 and 2. the various tests carried out confirm the robustness of the estimated models, so we can interpret and discuss the results. figure 1. cumulative sum of recursive residuals plot and cumulative sum squares of recursive residuals plot for model1. asian journal of economics and empirical research, 2024, 11(1): 1-11 9 © 2024 by the author; licensee asian online journal publishing group figure 2. cumulative sum of recursive residuals plot and cumulative sum squares of recursive residuals plot for model 2. 4.2. discussion this article presents three major results. firstly, institutional and corruption shocks are symmetrical in the long-run. whereas the effects of institutional shocks are asymmetrical in the short-term. secondly, negative institutional shocks generate negative effects on gdp per capita in the short-term. similarly, positive corruption shocks deteriorate economic growth in the long-run. finally, the current level of institutions favors the positive effects of public spending on economic growth, but not significantly so. the effects of institutional and corruption shocks are symmetrical in the long-run. the effects of a positive corruption shock are detrimental to economic growth in long-run. a 1% positive variation in corruption leads to a 28.6% drop in gdp per capita. this result is in line with theory and corroborates with the findings of hakizimana (2021); dzhumashev (2014) and arawomo and adeoye (2020), it invalidates the results of mallik and saha (2016) who revealed a positive effect of corruption on economic growth. as for negative corruption shocks, the effects are positive but not significant, suggesting that the current level of corruption is very high. the effects of short-term institutional shocks are asymmetric. a negative variation in the institutional index of 1% causes gdp per capita to fall by 4.829. this result shows the importance of improving institutions in ivory coast. the result is similar to the findings of dani rodrik (1999); sani, said, ismail, and mazlan (2019); oppong et al. (2023); vianna and mollick (2018) and hussen (2023). institutions improve the effects of public spending on gdp per capita, but only significantly over time. in other words, they accentuate the positive effect of public spending on gdp per capita. the result contradicts those of diandy and seck (2021) who argued that institutions negatively affect economic growth in sub-saharan africa. the results reveal that public spending boosts gdp per capita. a 1% increase in public spending leads to a 0.351% rise gdp per capita, all other things being equal. this result confirms the keynesian thesis and that of the authors of endogenous growth as to the necessity of the state in the economic fabric of a country. it is also in line with the results of arawomo and adeoye (2020); arvin et al. (2021) and friday et al. (2016). the degree of trade openness and public debt encourage gdp per capita in ivory coast in the long-term. indeed, a 1% increase in public debt leads to a 0.155% increase in gdp per capita. this result rejects the findings of oppong et al. (2023), who found that public debt has a negative impact on economic growth. in fact, public debt is an alternative means of financing major public projects. efficient management and productive project financing can only boost economic growth. similarly, a one unit increase in trade openness improves gdp per capita by 0.1%. this result is in line with the findings of chinwuba and ibrahim (2016). however, the degree of openness has negative short-term effects. a one-unit variation in the degree of openness leads to a 0.05% drop in gdp per capita. finally, the results for labor force are mixed for both models. 5. conclusion the question of whether public spending improves economic growth is still topical, with the results of empirical work controversial. this question has important policy implications for improving the quality of public spending. this study examined the role of institutions in the relationship between public spending and economic growth in ivory coast. to do so, it used annual data covering the period 1984-2019. it constructed an institutional composite index using the pca method, and estimated nardl models in which it introduced two interaction variables. also exploiting the pesaran et al. (2001) bounds co-integration test and wald symmetry test, she found clear evidence a long-run relationship between public spending and real gdp per capita, as well as symmetric effects of institutions and corruption in the long-run. the effects of institutional shocks are asymmetrical in the short-term. estimation results show that public spending promotes economic growth, but institutions do not significantly accentuate its effects. negative institutional shocks deteriorate gdp per capita in the short-term, while positive corruption shocks deteriorate gdp per capita in the long-term. this means that a deterioration in institutions leads to a fall in gdp per capita. similarly, the current level of institutions appears to be weak to effectively boost the positive effects of public spending on gdp per capita. the main policy implication we draw from this study is that, to improve the effectiveness of public spending in ivory coast, a credible strategy should focus on improving institutional factors and effectively combating corruption. any attempt to increase public spending without first improving institutional quality will be less productive, if not counter-productive. this study used sophisticated econometric methods, which enabled us to go asian journal of economics and empirical research, 2024, 11(1): 1-11 10 © 2024 by the author; licensee asian online journal publishing group beyond the simple role of institutions by observing the effects of their shocks on gdp per capita. the limitation of this study is that it does not take account of all institutional variables. future research could therefore focus on other institutional variables not used in this study, to construct a second institutional composite index, for example. references abdulrasheed, b. 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(2002). further evidence on the great crash, the oil-price shock, and the unit-root hypothesis. journal of business & economic statistics, 20(1), 25-44. https://doi.org/10.2307/1391541 asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.2139/ssrn.1807745 https://doi.org/10.1016/j.jeconbus.2017.12.002 https://doi.org/10.2307/1391541 59 © 2022 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 9, no. 1, 59-66, 2022 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v9i1.3876 © 2022 by the authors; licensee asian online journal publishing group the significance of foreign direct investment registered projects and employment creation in the sectors of ghana’s economy evans yeboah1 dacosta boateng agyei2 ran li3 anita sossoe4 mavis tetteh5 aisha amankwa6 ( corresponding author) 1,2,3,4,5,6faculty of business and economics, mendel university, brno, czech republic. 1email: xyeboah1@mendelu.cz tel: +420608353123 2email: xagyei@mendelu.cz tel: +420608388700 3email: xli2@mendelu.cz tel: +420770608925 4email: xsossoe@mendelu.cz tel: +420605969060 5email: xtetteh@mendelu.cz tel: +420773154319 6email: xamankw2@mendelu.cz tel: +420605791191 abstract the flow of foreign direct investment (fdi) into the ghanaian economy has contributed significantly to the various sectors. this study seeks to assess the impact of registered investment (fdi and domestic) projects on employment generation in the agriculture, building & construction, manufacturing, and service sectors. the data for this study was obtained from the ghana investment promotion centre (gipc) for the period 2001 to 2018. the kwiatkowski-phillipsschmidt-shin (kpss) test showed a unit root existence in the time series. the regression results show no significant impact of registered investment projects on the agriculture and manufacturing sectors at a 5% significance level. our findings also indicated that employment creation through registered investment projects has no effect on the manufacturing industry. the outcome also revealed that the service sector benefits more from fdi than the other sectors. it is recommended that the government boost these non-performing sectors with incentives to attract more investors. keywords: fdi, sectors, registered projects, employment, impact, economic growth. jel classification: e22, f21, o16, r53 citation | evans yeboah; dacosta boateng agyei; ran li; anita sossoe; mavis tetteh; aisha amankwa (2022). the significance of foreign direct investment registered projects and employment creation in the sectors of ghana’s economy. asian journal of economics and empirical research, 9(1): 59-66. history: received: 10 february 2022 revised: 23 march 2022 accepted: 7 april 2022 published: 26 april 2022 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. authors’ contributions: all authors contributed equally to the conception and design of the study. competing interests: the authors declare that they have no conflict of interest. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 60 2. literature review ............................................................................................................................................................................ 60 3. methodology and data ................................................................................................................................................................... 61 4. results and discussion ................................................................................................................................................................... 62 5. conclusion ......................................................................................................................................................................................... 65 references .............................................................................................................................................................................................. 66 mailto:xyeboah1@mendelu.cz mailto:xagyei@mendelu.cz mailto:xli2@mendelu.cz mailto:xsossoe@mendelu.cz mailto:xtetteh@mendelu.cz mailto:xamankw2@mendelu.cz https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v9i1.3876 https://orcid.org/0000-0002-0934-3996 https://orcid.org/0000-0002-8668-2086 https://orcid.org/0000-0001-5539-2783 https://orcid.org/0000-0001-7464-2872 https://orcid.org/0000-0002-1949-523x https://orcid.org/0000-0003-2724-3603 asian journal of economics and empirical research, 2022, 9(1): 59-66 60 © 2022 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the existing literature on the assessment of the significance of fdi’s contribution to an economy, including the various sectors’ response to fdi and factors that affect the inflows. this paper presents the impact of fdi and domestic registered investment projects through regression analysis. 1. introduction every country aims to achieve economic growth through sound macroeconomic policies. over the past decades, many nations have experimented with different avenues through which this goal can be attained (evans, samuel, & prince, 2021). investment is an important factor in the composition of aggregate expenditure in every economy and has a significant influence on growth through productivity levels and job creation (okwu, oseni, & obiakor, 2020). however, foreign direct investment (fdi) can also contribute to the development of a country through the accumulation of physical and human capital or by enhancing total productivity (rodan, 1997). over the past years, host countries have exploited these impacts of fdi (alhassan, gakpetor, kyei, & akomeah, 2018). in terms of economic growth and improving people’s welfare, ghana has recognized the role of fdi in supporting its economic activities. fdi is also beneficial to the home country as it helps in the expansion of the market, lowering cost factors and other tariff measures (world bank, 2010). the flow of fdi to the african continent is projected to shrink between 25% and 40% in 2020, based on the gross domestic product (gdp) growth forecast and some investment-specific factors (unctad, 2020). since ghana accepted the structural adjustment program formulated by the world bank in response to the economic crisis in early 1980, the country has attracted many foreign investors. since 1983, the government of ghana has executed these policies more consistently than the government of any other african country (sayre, 1994). fdi inflows have increased the competition among the business sectors in ghana. the country has witnessed significant investment in transport, health, education, and electricity (ebenezer, agoba, & abebreseh, 2017). these investments are split between wholly foreign-owned and joint ventures (between ghanaians and foreign investors). investment inflows into the various sectors of the ghanaian economy are distributed as registered projects. the distribution to the sectors is captured by the ghana investment promotion centre (gipc) quarterly reports during the investment’s fiscal period. the gipc is an institution formed under the gipc act 1994 (act 478) to advocate, interrelate and ease investment in ghana (evans & rose, 2021). according to the gipc, steady economic growth has been the result of a massive expansion in fdi inflow into ghana; from 2006 to 2010, fdi inflow into ghana increased at a compound yearly growth rate of 41%, from $636 million to $2.527 billion (evans et al., 2021). between 1994 and 2013, there were a total of 4,714 registered investment projects, of which 22.14% were in the manufacturing sector, 29.29% were in the service sector, 16.35% in general trading, 8.67% in building and construction, 8.54% in the tourism sector, 5.17% in liaison, and 5.13% and 4.66% in the agriculture and export trade sectors, respectively (kusi, 2012). meanwhile, between january and june 2021, ghana recorded 122 projects with an estimated total investment of us$874.01 million (gipc, 2021). conversely, quantitative findings have shown that fdi’s impact on global employment is more modest and is more important in host developing countries than in host developed nations, especially in production areas (unctad, 1999). fdi facilitates employment in the host country, as most jobs are created through registered projects in the economy’s various sectors. the number of jobs expected to result from fdi is split among ghanaians and expatriates. employment creation generates short-term opportunities that have a direct impact or create additional lasting livelihoods (evans et al., 2021). this paper focuses on the effect of registered projects on the various sectors of the ghanaian economy. 1.1. objective the motivation for this paper is the result of the recent increase in fdi flow to the african continent, from which ghana is not an exception. the distribution of fdi registered projects among the various sectors has inspired a high level of expectation of economic growth in ghana. the contribution of each sectoral level is measured as a proportion of total gdp. as numerous studies have shown fdi to play a significant role in many economies, there is a need for us to assess the significance of fdi and local investments in the sectors of the ghanaian economy. this study has two main goals. the first is to investigate the impact of registered projects through fdi and domestic investments on the agriculture, building & construction, manufacturing, and service sectors. the second is to examine the employment created through investment registered projects and how this is distributed among the selected sectors. 2. literature review the effect of fdi influx into the industrial, construction, and service sectors on economic growth was investigated in a panel of 16 central, eastern, and southern european cese nations, using data from different periods between 1998 and 2012. the analysis of the decomposition of fdi showed that fdi in the industrial and service sectors has a positive and significant impact on economic growth (miteski & stefanova, 2017). another study considered the impact of fdi in the agriculture, manufacturing, and service sectors on economic growth. this empirical analysis used panel data from 2000 to 2015 from five countries: china, pakistan, india, bangladesh, and sri lanka. the results revealed that fdi in manufacturing has the greatest potential to increase economic advancement compared to investment in other sectors (haider & muhammad, 2016). other studies have evaluated the relationship between fdi and growth at the sector level. in one study, the effect was examined using a panel cointegration test followed by a random-effects model. the results showed that at the sector level, growth affects fdi, but fdi does not affect growth (areej & shahid, 2017). another study applied the autoregressive distributed lag (ardl) method to investigate the relationship between fdi and growth in the mining sector using data from1988 to 2018. the results indicated that in this sector, fdi has a significant positive relationship with a country’s gdp in the long run. fdi in mining was revealed to have relatively greater effects compared to fdi in non-mining sectors and domestic investment (plaxedes & seetanah, 2020). investigating the nature and behavior of total and sectoral fdi inflow in south asian countries in recent years, another study adopted a holistic approach to studying and analyzing the fdi-growth dynamics. the results showed that the impact of fdi in south asia is influenced by the sectoral composition of the fdi (saswata, nitya, & bhawna, asian journal of economics and empirical research, 2022, 9(1): 59-66 61 © 2022 by the authors; licensee asian online journal publishing group 2020). furthermore, the relationship between fdi and income inequality has been analyzed. one study estimated the impact of fdi from a sector perspective and identified 3 major sectors: the primary sector, manufacturing industry, and services. using panel data for 13 economies from 1980 to 2009, the study found a positive effect of fdi on income inequality in the service and manufacturing sectors (macarena, 2016). using a multiple linear regression model and ordinary least squares (ols) estimation, the influence of fdi on economic growth has been examined. one study distinguished ten different sectors in the united states. according to its findings, not all forms of fdi appear to be advantageous to host economies. however, certain industries have a favorable impact on economic growth, while others have a negative effect (donny, 2018). another study used a sample of 10 cee for the period 1995–2019 and looked at the system determinants and transmission mechanisms of the sectoral structure of fdi inflows. this study followed on from earlier research, and the empirical component included the construction of a panel model. the results showed that the most effective strategy to attract developmentally-efficient fdi is to change the local economy's structure through explicit industrial and investment policies (mario, kusanović, & jakovac, 2021). using the vector autoregressive (vars) model, fdi has been shown to have a considerable beneficial impact on economic growth in both the short and long run (saidatulakmal & abdillahi, 2021). a study revealed that, in the long run, both the rate of fdi inflows and the rate of foreign tourism have had a favorable impact on the rate of economic growth in estonia (amin & glenn, 2021). using sectoral data as the primary source of information to determine the direct effect of fdi on gdp, another analysis forecasted that fdi in the industry, tourism, and agriculture sectors has an overall highly favorable and significant impact on gdp over a ten-year period (ram & seema, 2018). 2.1. fdi and employment generation the impact of fdi inflows on lowand high-skilled workers' employment and wages in mexico's manufacturing and service sectors has been investigated. the study used a quarterly panel dataset spanning mexico's 32 states from 2005 to 2018. according to the findings, increased fdi influx into the manufacturing sector had a favorable influence on lowand high-skilled employment. in the service sector, however, the results are inconclusive throughout the model for both types of employment (eduardo, ozuna, & zamora, 2020). another study indicated a general positive correlation between external investment and local employment at the national level, although it identified significant variances between regions and sectors (riccardo, ganau, & storper, 2022). using johansen's cointegration approach and toda and yamamoto's granger causality test, other researchers investigated the long-run link between outbound fdi and employment in china. according to the data, outward fdi from china resulted in favorable job development, particularly in the tertiary sector (huiqun & lu, 2011). another study examined the impact of fdi and economic growth in turkey on overall employment and female employment. the findings demonstrated that fdi harms overall employment and female employment, whereas economic growth has a beneficial impact on overall employment and female employment (umit & alkan, 2016). using suitable descriptive analysis, a further study analyzed the impact of fdi on job creation in india. the results demonstrated that the impact on job creation in india is obvious, but fdi inflows may not play a key role in the country's growth rate. (ronismita & swapnamoyee, 2020). a single equation error correction model was used to examine the impact of fdi on employment in macedonian industrial sectors. the findings showed that fdi and human costs are statistically significant determinants that positively affect employment in the manufacturing subsectors, implying that, as a result of their interaction, companies with fdi may have higher productivity (dimitar, 2017). in another study, using panel data from 1994 to 2017, the authors examined the impact of fdi on youth unemployment in the southern african development community (sadc) area. the findings suggested that fdi has a slight impact on lowering youth unemployment in the sadc region (dadirai et al., 2021). finally, providing a general overview of the flow of fdi to ghana by considering the overall number of registered projects and using employment creation to assess their significance, yeboah and anning (2020) showed that ghanaians enjoyed about 85% of the total jobs created between 2013 and 2018. 3. methodology and data this study seeks to investigate the comparative influence of fdi and domestic registered projects and investment on employment generated in the various sectors of the ghanaian economy. however, to avoid having too wide a focus, we have focused on the agriculture, building & construction, manufacturing, and service sectors. to assess the impact of fdi on an economy, a series of tests must be carried out to ascertain the short and long-run relationships between the variables. these tests include multivariate, multicollinearity, unit-root, correlation, and auto-correlation (among the error terms) analyses. these tests are carried out to obtain a simple linear regression using ordinary least squares (ols). the study used secondary data from gipc for the period 2001 to 2018. first, a summary statistic was carried out of all the variables to obtain the means and standard deviations; these are shown in table 1. moreover, figure 1 shows the time trends of fdi projects in the various sectors. we tested for unit root presence in the variables using the kwiatkowski-phillips-schmidt-shin (kpss) test. under the null hypothesis (𝐻0), 𝜇𝑡 is constant, and the variance of 𝜀𝑡 is zero. on the other hand, under the alternative hypothesis (𝐻1), 𝜇𝑡 is a random walk, and the variance of 𝜀𝑡 is positive. the kpss test thus shows a unit root presence in each of the variables (agriculture sector, building & construction sector, manufacturing sector, and service sector). it is known that time series involve a different approach to the analysis of economic data (granger, 1981). secondly, a multicollinearity test was carried out using variance inflation factors (vif). the symptoms of multicollinearity in a regression model include an increase in the variance of regression coefficients. the vif approach ( 𝛽 ̂𝑗) indicates the relative variance of the j-th coefficient of regression. it holds that vif ( 𝛽 ̂𝑗)  1. if vif ( 𝛽 ̂𝑗) exceeds the limit of 10, it is an indication of severe multicollinearity in the model. the variance of the j-th regression coefficient can be written as in equation 1. var ( 𝛽 ̂𝑗)= 𝜎 ̂𝑒 2 ( 1−𝑅𝑗 2).∑ (𝑥𝑗− �̅�)2𝑛 𝑖=1 = var ( 𝛽 ̂𝑗)= 𝜎 ̂𝑒 2 ∑ (𝑥𝑗− �̅�)2𝑛 𝑖=1 (1) asian journal of economics and empirical research, 2022, 9(1): 59-66 62 © 2022 by the authors; licensee asian online journal publishing group the last test is to verify that there is no autocorrelation between predicted variables and the error terms from the regression outputs. using the durbin-watson (dw) autocorrelation test, the hypotheses are h0: there is no first-order autocorrelation, and h1: there is first-order autocorrelation. the calculation for this test is shown in equation 2. 𝑑 = ∑ (𝑒𝑡−𝑒𝑡−1)2𝑇 𝑡=2 ∑ 𝑒𝑡 2𝑇 𝑡 (2) the dw test is not capable of testing for a higher order of autocorrelation of the error terms. the rule of dw states that 1.5< d <2.5 is the no autocorrelation range. model equation 3 contains non-significant regressors (agriculture and manufacturing sectors). the p-value of the explained sum of squares reduction f-test suggests that non-significant coefficients are zeros and can be removed from the model. the backward elimination method can be applied to remove the non-significant explanatory variables and enhance the performance of the resulting model. it begins with the removal of the non-significant coefficients as indicated by the high p-value. after applying the backward elimination method, we arrived at model equation 4. in model equation 4, the constant is non-significant, and it is affected by pure heteroskedasticity. pure heteroskedasticity is due to a correct model specification and does not cause a systematic error (bias). because the error term does not have a constant variance, it is necessary to find out which regressor is causing the heteroskedasticity. heteroskedasticity violates classical assumption number five, which makes model 4 less than ideal. after applying the principles and steps for handling pure heteroskedasticity, we obtained model equation 5 by removing the manufacturing sector from the equation. 𝑇𝑜𝑡𝑎𝑙 𝐹𝐷𝐼 𝑝𝑟𝑜𝑗𝑒𝑐𝑡𝑠𝑡=𝛽0 + 𝛽1𝐴𝑔𝑟𝑖𝑐𝑢𝑙𝑡𝑢𝑟𝑒𝑡 + 𝛽2building and construction𝑡 + 𝛽3manufacturing𝑡 + 𝛽4service𝑡 + 𝜀𝑡 (3) 𝑇𝑜𝑡𝑎𝑙 𝐹𝐷𝐼 𝑝𝑟𝑜𝑗𝑒𝑐𝑡𝑠𝑡= 𝛽0 +𝛽1building and construction𝑡+𝛽2manufacturing𝑡 + 𝛽3service𝑡 + 𝜀𝑡 (4) 𝑇𝑜𝑡𝑎𝑙 𝐹𝐷𝐼 𝑝𝑟𝑜𝑗𝑒𝑐𝑡𝑠𝑡 = 𝛽0 +𝛽1building and construction𝑡 + 𝛽2service𝑡 + 𝜀𝑡 (5) to assess fdi registered projects’ impact on the total number of jobs, we considered the number of jobs created in the selected sectors. the total number of jobs for ghanaians and expatriates in each of the sectors is modeled on the overall employment from fdi. model equations 6 and 7 are generated by the logarithm transformation of each of the variables. the estimate of the expected number of jobs to be created from the registered investment projects is thus: 𝑙𝑛total fdi employment 𝑡=𝛽0 + 𝛽1 𝑙𝑛agriculture𝑡 + 𝛽2 𝑙𝑛building and construction𝑡 + 𝛽3𝑙𝑛manufacturing𝑡 + 𝛽4𝑙𝑛service𝑡 +𝜀𝑡 (6) 𝑙𝑛total fdi employment 𝑡= 𝛽0 +𝛽1 𝑙𝑛agriculture𝑡 + 𝛽2 𝑙𝑛building and construction𝑡 + 𝛽3𝑙𝑛service𝑡 + 𝜀𝑡 (7) under the model estimation of the impact of fdi registered projects, the total of fdi projects is the dependent variable, whereas the agriculture, building & construction, manufacturing, and service sectors are the explanatory variables. the total number of fdi registered projects is measured in hundreds, whereas the total fdi employment is measured in thousands. 𝛽1, 𝛽2, 𝛽3, 𝑎𝑛𝑑 𝛽4 are the regression coefficients, while 𝜀𝑡 indicates the error term, and 𝛽0 represents the constant term of the obtained model. all the analyses were carried out using gretl software. the significance level of p-values is set at 5%. the p-values can be used as an index of the “strength of the evidence” against the null hypothesis (h0) (fisher, 1925). having chosen the statistic from the data for this study and the probability associated with this statistic, if the probability is smaller than 5%, we reject h0. according to the literature, the proposed level of p=0.05 means that a “1 in 20 chance is being exceeded by chance”, and this is a suitable limit for statistical significance (fisher, 1935). fisher explained that it is usual and convenient for experimenters to take 5% as a standard level of significance and to ignore all outcomes which fail to reach this standard (fisher, 1925). this leads to their elimination from further discussion. table 1. summary statistics. variable mean median s.d. min max total fdi projects 252.7 202.0 109 138.0 514.0 service 76.8 63.5 42.7 37.0 195.0 manufacturing 53.2 51.0 13.0 39.0 86.0 building and construction 22.8 19.0 14.8 8.00 61.0 agriculture 10.0 10.5 4.63 1.00 16.0 4. results and discussion the summary statistics of the variables in table 1 show that the service sector had the highest median with 63.5%, followed by the manufacturing sector with 51%, and building & construction with 19%, whereas the agriculture sector had the lowest median with 10.5%. similarly, the time series plots in figure 1 show an upward trend of fdi-distributed projects in the service, manufacturing, and building & construction sectors, while the agriculture sector had a downward trend. in addition, table 2 below shows the results of the multicollinearity test of the regression outputs. the table shows no multicollinearity among the variables. model 1 in table 3 shows a non-significant impact of fdi registered projects on the agriculture and manufacturing sectors. the constant of model 1 is also non-significant. however, the impact on the service and building & construction sectors is significant. the regression output for model 2 is indicated in table 4; the constant is zero because it is not statistically significant. however, the coefficient of the manufacturing sector became statistically significant after applying backward elimination to the agriculture sector. asian journal of economics and empirical research, 2022, 9(1): 59-66 63 © 2022 by the authors; licensee asian online journal publishing group figure 1. time series trends per sector. table 2. multicollinearity test. variables variance inflation factor service 2.981 manufacturing 1.325 building and construction 3.259 agriculture 1.112 table 3. model1 estimation. variables coefficient std. error t-ratio p-value constant 7.056 27.32 0.2584 0.8002 service 1.414 0.245 5.780 6.38e-05*** manufacturing 1.113 0.535 2.083 0.0576* building and construction 2.791 0.736 3.795 0.0022*** agriculture 1.320 1.378 0.958 0.3553 model 1 variants. regression statistics figure regression statistics figure mean dependent var 251.67 s.d. dependent var 108.62 sum squared residuals 8073.49 s.e. of regression 24.920 r-squared 0.959 adjusted rsquared 0.947 f (4, 13) 77.55 p-value(f) 6.15e-09 log-likelihood −80.49 akaike criterion 170.98 schwarz criterion 175.44 hannan-quinn 171.60 rho −0.480 durbin-watson 2.919 note: significance codes: ‘***’ 0.001, ‘*’ 0.05. table 4. model 2 estimation. variables coefficient std. error t-ratio p-value constant 14.50 26.12 0.55 0.5875 service 1.44 0.243 5.92 3.73e-05*** manufacturing 1.17 0.529 2.21 0.0439** building and construction 2.82 0.732 3.86 0.0017*** model 2 variants. regression statistics figure regression statistics figure mean dependent variance 251.67 s.d. dependent var 108.7 sum squared residuals 8644.09 s.e. of regression 24.84 r-squared 0.956 adjusted r-squared 0.947 f (3, 14) 103.69 p-value(f) 8.47e-10 log-likelihood −81.11 akaike criterion 170.21 schwarz criterion 173.78 hannan-quinn 170.70 rho −0.402 durbin-watson 2.78 note: significance codes: ‘***’ 0.001, ‘**’ 0.01. asian journal of economics and empirical research, 2022, 9(1): 59-66 64 © 2022 by the authors; licensee asian online journal publishing group the coefficients of model 1 show a positive response from the various sectors in response to fdi and local registered investment projects. the dw value shows a higher negative serial correlation. the percentage of variation explained in the dependent variable was about 96%. model 2 in table 4 shows autocorrelation due to the dw test value. model 3 in table 5 indicates that the total of fdi registered projects has a positive impact on both the service and building & construction sectors. however, the significance level of the service sector is higher than that of the building & construction sector. also, the constant has become statistically significant (nonzero). model 3 shows no serial correlation based on the figure for dw in the output. however, the information criterion has increased compared to models 1 and 2. figure 2 indicates a normal distribution of the error term from the regression output. table 5. model 3 estimation. variables coefficient std. error t-ratio p-value constant 65.46 13.86 4.722 0.0003*** service 1.440 0.272 5.286 9.14e-05*** building and construction 3.319 0.783 4.236 0.0007*** model 3 variants. regression statistics figure regression statistics figure mean dependent variance 251.67 s.d. dependent var 108.66 sum squared residual 11671.78 s.e. of regression 27.89 r-squared 0.94 adjusted r-squared 0.934 f (2, 15) 121.48 p-value(f) 5.42e-10 log-likelihood −83.81 akaike criterion 173.62 schwarz criterion 176.29 hannan-quinn 173.99 rho −0.159 durbin-watson 2.298 note: significance codes: ‘***’ 0.001. figure 2. normality test result from model 3 estimation output. to assess the impact of fdi and local registered investment projects on employment creation in the sectors, we needed to use the total estimated number of jobs created. the values for the time series were transformed into logs for a correct model specification. figure 3 shows the log transformation of the time series plots for the agriculture, building & construction, manufacturing, and service sectors. figure 3. time series plot (fdi and domestic employment) in the sectors. asian journal of economics and empirical research, 2022, 9(1): 59-66 65 © 2022 by the authors; licensee asian online journal publishing group the regression output from model 4 in table 6 on the employment impact of fdi on the sectors shows that the coefficients of the manufacturing and building & construction sectors are non-significant. this means that the nonsignificant p-values of the regressors need to be removed from the model to obtain the final regression model (model 5). table 6. model 4 estimation. variables coefficient std. error t-ratio p-value constant 0.787 1.556 0.504 0.6221 l_agriculture 0.278 0.053 5.230 0.0002*** l_service 0.319 0.098 3.263 0.0062*** l_buildingconst 0.181 0.086 2.096 0.0562* l_manufacturing 0.373 0.186 2.006 0.0661* model 4 variants. regression statistics figure regression statistics figure mean dependent variance 9.901 s.d. dependent var 0.992 sum squared residual 1.570 s.e. of regression 0.347 r-squared 0.906 adjusted r-squared 0.877 f (4, 13) 31.39 p-value(f) 1.44e-06 log-likelihood −3.589 akaike criterion 17.179 schwarz criterion 21.63 hannan-quinn 17.793 rho −0.258 durbin-watson 2.483 note: significance codes: ‘***’ 0.001 ‘*’ 0.05. the results of model 5 in table 7 indicate a significant impact of fdi on employment in the agriculture, building & construction, and service sectors. the constant is statistically significant and nonzero. however, the agriculture and service sectors respond more significantly to fdi than the building & construction sector. comparing the information criteria in model 4 to model 5, it is clear that model 4 has the lowest information criteria, but a nonsignificant coefficient does not provide any economic meaning to those variables. model 5 is burdened with firstorder autocorrelation. regarding model 5, the constant, agriculture, and service sectors were below a 1% significance level, while the building & construction sector was around 2%. table 7. model 5 estimation. variables coefficient std. error t-ratio p-value constant 3.610 0.731 4.938 0.0002*** l_agriculture 0.251 0.057 4.425 0.0006*** l_service 0.335 0.107 3.110 0.0077*** l_buildingconst 0.223 0.092 2.418 0.0298** model 5 variants. regression statistics figure regression statistics figure mean dependent variance 9.90 s.d. dependent var 0.992 sum squared residual 2.06 s.e. of regression 0.383 r-squared 0.87 adjusted r-squared 0.851 f (3, 14) 33.3 p-value(f) 1.25e-06 log-likelihood −6.1 akaike criterion 20.14 schwarz criterion 23.6 hannan-quinn 20.53 rho 0.28 durbin-watson 1.367 note: significance codes: ‘***’ 0.001 ‘**’ 0.01. the results indicated that from 2001 to 2018, the distribution of fdi registered projects among the various sectors was not significant in the agriculture and manufacturing sectors. this implies that greater effort is needed to enhance the performance of both the agriculture and manufacturing sectors in terms of attracting fdi and domestic investment. regarding employment creation from fdi through the registered projects, only the manufacturing sector seemed not to have a significant response in terms of the number of jobs generated through investment during the selected period. a critical point of the analysis is that more fdi projects are allocated to the service sector than to other sectors in the ghanaian economy. the recent efforts in the manufacturing sector on the part of the current administration seek to address the low performance in that sector. the excellent performance of the building & construction sector in terms of fdi employment is due to the huge investment in housing and construction activities in the country in recent years. the results of all the models show that the manufacturing sector’s responses to fdi and local investment were at a 5% significance level, which indicates a less significant impact. however, based on the results, we cannot rule out that fdi and domestic investment have no effect on the manufacturing sector. we excluded the significance level of investment in the manufacturing sector as a result of our restriction to a 5% significance level. the r-squared from all the models indicates an excellent fit. 5. conclusion this study has confirmed the significance of fdi and domestic investment registered projects distributed among the agriculture, building & construction, manufacturing, and service sectors. the kpss test indicated a unit root presence in the selected time series variables. ols regression showed that registered fdi projects have no significant effect on the agriculture and manufacturing sectors. however, the building & construction and service sectors enjoy a significant impact from the registered investment projects. on the other hand, when testing for the influence of fdi on the employment created in the selected sectors, no significant effect was found on job creation in the manufacturing sector. conversely, fdi did have a positive impact on employment generated in the agriculture, building & construction, and service sectors. this study has significant implications for policymakers and the government of ghana since the outcome showed that some sectors are not responding optimally to fdi and domestic registered investment projects. manufacturing is an essential tool for transforming an economy, and there is a need for the government to improve the investment situation in the manufacturing sector. however, there are fewer asian journal of economics and empirical research, 2022, 9(1): 59-66 66 © 2022 by the authors; licensee asian online journal publishing group registered projects in the agriculture sector, although it serves as a source of employment for most people in the country. it would be helpful for the government to boost these non-performing sectors with incentives to attract more investors. also, there is a need to modernize the agriculture sector to enhance its efficiency. based on the results, the service sector performs better than the other sectors. however, this outcome may not be sufficient to explain the factors behind the non-performance of the manufacturing sector in terms of employment creation from investment. as the results confirm that the agriculture and manufacturing sectors are 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(2020). investment in ghana: an overview of fdi components and the impact on employment creation in the ghanaian economy. economics, management and sustainability, 5(1), 6-16.available at: https://doi.org/10.14254/jems.2020.5-1.1. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 134 © 2024 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 11, no. 2, 134-140, 2024 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v11i2.6387 © 2024 by the authors; licensee asian online journal publishing group does quality-adjusted human capital matter for economic growth of malaysia: time series analysis amelia putri1 emily bellamy2 westcliff university, irvine, usa. email: aputri@westcliff.edu ( corresponding author) abstract human capital plays a crucial role in driving productivity development and enhancing the standard of living. human capital refers to the collective knowledge and skills possessed by individuals, which significantly contribute to enhancing productivity and are closely linked to economic growth and development. the significance of human capital in driving innovation and productivity in the case of malaysia cannot be overlooked. the primary objective of this study is to conduct an empirical analysis of the impact of human capital on the economic growth (eg) of malaysia over the period from 1990 to 2022. this study utilized quality-adjusted human capital to accurately reflect the underlying significance of human capital. hence, this study contributes to the existing body of literature by using quality-adjusted human capital in the case of malaysia. to check the cointegration among variables, this study uses the fisher type bayer-hanck cointegration test and johansen cointegration techniques. using the ardl approach, we find a positive impact of human capital on economic growth. this implies that labor with developed human capital is more productive and hence contributes more to economic growth. to optimize the positive impact of human capital on economic growth in malaysia, it is imperative to establish a comprehensive array of policy recommendations that encompass both the quantity and quality of human capital development. keywords: economic growth, quality-adjusted human capital, time series data. citation | putri, a., & bellamy, e. (2024). does quality-adjusted human capital matter for economic growth of malaysia: time series analysis. asian journal of economics and empirical research, 11(2), 134–140. 10.20448/ajeer.v11i2.6387 history: received: 15 october 2024 revised: 2 december 2024 accepted: 19 december 2024 published: 30 december 2024 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. competing interests: the authors declare that they have no competing interests. authors’ contributions: both authors contributed equally to the conception and design of the study. both authors have read and agreed to the published version of the manuscript. contents 1. introduction .................................................................................................................................................................................... 135 2. literature review .......................................................................................................................................................................... 135 3. methodology ................................................................................................................................................................................... 136 4. results and discussion ................................................................................................................................................................. 137 5. conclusion ....................................................................................................................................................................................... 139 references ............................................................................................................................................................................................ 139 mailto:aputri@westcliff.edu https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v11i2.6387 asian journal of economics and empirical research, 2024, 11(2): 134-140 135 © 2024 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study examines the impact of human capital on economic growth in the case of malaysia over the period of 1990 to 2022. this study utilized quality-adjusted human capital (number of publications, number of patents, and labor force) to accurately reflect the underlying significance of human capital in malaysia. 1. introduction it is widely acknowledged that human capital plays a crucial role in driving productivity development and enhancing the standard of living. human capital refers to the collective knowledge and skills possessed by individuals, which significantly contribute to enhancing productivity and are closely linked to economic growth and development. prior research has extensively debated the impact of human capital on economic growth. human capital is generally recognized as the catalyst for innovation and productivity in economies. enhancing productivity can be achieved by employing novel technologies, which, in turn, foster economic efficiency. in their respective works, romer (1986) and lucas jr (1988) examined the concept of human capital as a significant driver of both increasing returns and dispersion in growth rates among nations. the primary school enrollment ratio is commonly employed in academic literature as a significant indicator of human capital. according to barro (1991) research, there exists a significant correlation between the primary school enrollment ratio and economic growth. the allocation of resources toward the development of human capital has been widely recognized as a significant driver of economic growth and productivity in industrialized nations. one of the primary factors contributing to the low per capita gdp in developing nations is the limited allocation of resources toward human capital development. the contemporary growth models of economic growth prioritize the concept that investments in human capital play a significant role in fostering economic growth. according to these perspectives, the development of persistent growth is attributed to the actions of individuals within the economy. the potential exists for human capital to exert an additional influence on the attraction of other factors, such as physical investment, thereby making a quantifiable contribution to the increase in per capita income. the significance of allocating sufficient attention to human capital is underscored by the recent endeavor to efficiently accumulate physical capital in economically disadvantaged regions. this phenomenon can be attributed to the recognition that the effective allocation of physical resources is contingent upon the presence of human resources. if there is a lack of adequate investment in human capital, the ability to effectively employ additional physical capital is limited. the optimal use of physical capital necessitates the presence of individuals possessing technical, professional, and administrative knowledge. lucas jr (1988) posits that the inadequate provision of physical capital to impoverished nations can be attributed to their relatively limited availability of complementary intellectual capital. hence, it is generally inferred that human capital facilitates the adoption of advanced technology from foreign countries (alderman, behrman, ross, & sabot, 1996; anand & sen, 2000; appleton & teal, 1998; balach & law, 2015; gyimah-brempong & wilson, 2004). furthermore, it is worth noting that human capital plays a significant role in explaining the disparities observed in the production and growth rates of pertinent input indicators. the subject of examining the correlation between human capital and economic growth is a topic of considerable debate. moreover, the enhancement of human capital fosters entrepreneurial pursuits and nurtures a societal environment that places importance on innovation and the propensity to undertake risks, both of which are crucial for the advancement of economies that exhibit both dynamism and resilience. furthermore, human capital contributes to the advancement of social capital and the formation of unified societies by promoting equitable opportunities and enabling individuals to actively participate in economic activities. according to solow (1957), technological innovation was seen as a significant driver of productivity growth. mankiw, romer, and weil (1992) subsequently incorporated human capital into the growth model, recognizing its significant impact on productivity and output growth. easterly and levine (2003) and wang, li, and fang (2018) incorporated additional variables into the growth models. these theories regarded technological innovation as a crucial determinant of countries' growth rates. in addition, investments in human capital play a significant role in mitigating poverty, fostering social cohesion, and enhancing living standards. this is achieved by equipping individuals with the necessary skills and knowledge to actively participate in the economy and society. consequently, understanding the influence of human capital on economic growth is not only a theoretical pursuit but a crucial requirement for policymakers and stakeholders striving to establish a trajectory toward sustainable development in malaysia. the significance of human capital in driving innovation and productivity in the case of malaysia cannot be overstated, given the country's rapid industrialization and technological advancements, both of which are crucial for achieving sustainable economic prosperity. in recent years, malaysia has performed remarkably in enhancing its human capital. the country focuses on prioritizing the enhancement of its human resource capabilities to be competitive with industrialized nations in the context of increasing global technology advancements. however, the country is facing several issues related to human capital, which need to be solved for the country's future productivity. hence, it is important to explore the impact of human capital on the economic growth of malaysia. to sustain its competitiveness in the global market, malaysia focuses on possessing a workforce that is both highly skilled and adaptable. the country is keen to develop knowledge-intensive industries. this study examines the impact of human capital on economic growth in malaysia from 1990 to 2022. the present study undertakes an empirical analysis to assess the influence of human capital on malaysia's economic growth. it utilizes quality-adjusted human capital to accurately reflect the underlying significance of human capital in the country. quality-adjusted human capital considers the number of publications, patents, and the labor force. the rest of the study is organized as follows: section 2 presents the literature review. section 3 presents the data, model, and econometric methods. section 4 presents the results and discussions. the final section provides concluding remarks and policy implications. 2. literature review after the introduction of new growth theories, the issue of human capital and economic growth has become a topic of great interest among researchers and academia. lucas jr (1988); romer (1986); romer (1990); romer (1994) and barro (1991) considered human capital an important factor contributing to economic growth. the model asian journal of economics and empirical research, 2024, 11(2): 134-140 136 © 2024 by the authors; licensee asian online journal publishing group proposed by lucas jr (1988) incorporates the concept of human capital, specifically schooling, and elucidates the impact of individuals' time allocation to various activities on their future productivity and degree of human capital. the study conducted by barro (1991) employed school enrollment rates as a surrogate measure for human capital and examined the relationship between human capital and economic growth. following the footsteps of lucas jr (1988); romer (1990) and barro (1991), there has been a significant amount of research conducted on the human capital-led growth nexus (aghion, howitt, & murtin, 2010; alderman et al., 1996; anand & sen, 2000; appleton & teal, 1998; baldacci, clements, gupta, & cui, 2008; bokhari, 2017; farooq, arshi, sattar, & khalil, 2020). the keynesian model, which stated that there are two components of production—labor and capital—was the foundation upon which the solow model of economic growth was constructed. when it came to human capital formation, however, the model did not take any considerations into account. after some time had passed, researchers began incorporating human capital into the production function, which they referred to as the human capital-augmented production flow. productivity can be significantly increased by investing in human capital, which can be accomplished through educational advancement. nevertheless, the extent of the effect that education has on growth varies between leading countries and those that are lagging behind. barro (1991) contends that there is a high correlation between growth performance and human capital, which is assessed by educational attainment while also taking into account life expectancy. inferring similar findings, behrman, ross, and sabot (2008) conclude that life expectancy and educational attainment are significant for economic development. they also argue that these factors matter. additionally, pelinescu (2015) expanded his research by contrasting the effects of human capital and physical capital on the success of an organization. when compared to the growth effect of physical capital, the author contends that the scale of the effect that human capital has on growth is far greater. the authors lópez-bazo and motellón (2012) contend that there is a significant correlation between human capital and the earnings of workers. when compared to regions with low educational attainment, the authors discovered that regions with high educational attainment have higher pay for workers. this is in contrast to regions with low educational attainment. a lack of studies has been conducted to examine the impact of human capital on economic growth in the case of malaysia (akinwale, 2020a, 2020b, 2022; alshuaibi, 2017; baldacci et al., 2008; hanushek, 2013; khodabakhshi, 2011; maitra, 2018; mathur, 1999; mihut & plesoianu, 2014; pelinescu, 2015; rastogi, 2002; sapkota, 2014; sehrawat & giri, 2017; sharpe, 2001; shuaibu & oladayo, 2016; siddiqui & rehman, 2016; wigley & akkoyunlu-wigley, 2006). the findings of these studies indicate that human capital, which may be enhanced through educational progress, exerts a substantial impact on productivity growth. however, a notable constraint of these studies pertains to the use of weak proxies as indicators of human capital. furthermore, while these studies examine the correlation between human capital and economic growth, their focus mostly lies on the rise of the financial industry. additional studies have been conducted. akinwale (2022) employed the autoregressive distributed lag (ardl) approach to ascertain the significant impact of research and development, along with technological innovation, on the economic growth of malaysia. according to alshuaibi (2017), malaysia demonstrates a strong inclination towards enhancing innovation, particularly within the information technology industry, as part of the government's efforts to diversify its economy in alignment with vision 2030. this can impact the economic progress of the nation. lin (2004) categorized higher education in taiwan into four distinct domains to examine its influence on three specific sectors of the economy from 1965 to 2000. the higher education system was divided into distinct domains, namely education, social sciences, and humanities, and it was seen as a significant contributor to the overall productivity of society. the study eliminated participants who had degrees from foreign nations. in relation to the level of output in taiwan throughout the examined time frame, the results suggest that three out of the four fields exhibit a significant and favorable impact. based on the research findings, it can be observed that a rise in higher education is associated with a corresponding gain in real production. the various forms of higher education had diverse impacts on the tangible outcomes in the specific field under investigation. the humanities failed to satisfy the demands of the labor force, while the natural sciences emerged as the primary drivers of economic growth. according to the findings of akinwale (2020b), a triangular relationship exists between growth, research and development, and innovation. the authors emphasize the importance of promoting both public and private support for research and development, as well as innovative endeavors. the primary objective of this effort is to enhance the level of innovation, thereby ensuring the nation's continued prominence as a participant in a comprehensive knowledge-based economy. gyimah-brempong and wilson (2004) conducted a study utilizing panel data to examine the correlation between health and the per capita population growth rate in countries belonging to the organization for economic co-operation and development (oecd) and sub-saharan africa. an extended iteration of the solow growth model was employed during the inquiry. the empirical data indicate a statistically significant and positive correlation between the growth rate of per capita income and human capital. the effects exhibited a quadratic nature. to summarize, human capital is a significant factor that influences the rate of economic growth in both leading and lagging countries. in previous research, the effect of human capital (represented by education level and health status) on economic growth was investigated independently. previous studies employed different proxies to quantify human capital, such as school enrollment rates, dropout rates, and literacy rates. nevertheless, these proxies fail to represent the true picture of a country’s human capital because they attach similar weights irrespective of quality differences. since quality is more essential than quantity, this study utilized quality-adjusted human capital to accurately reflect the underlying significance of human capital in malaysia. the quality-adjusted human capital takes into account the number of publications, number of patents, and labor force. previous studies in the case of malaysia have not considered quality while measuring human capital. hence, this study makes a substantial contribution to the existing body of literature by utilizing quality-adjusted human capital. 3. methodology 3.1. model, data and analytical techniques to examine the impact of human capital on economic growth in the presence of control variables (investment and trade openness), the empirical model is provided as: 𝑌𝑡 = 𝛽𝑜 + 𝛽1 𝐻𝐶𝑡 + 𝛽2 𝐼𝑁𝑉𝑡 + 𝛽3 𝑇𝑂𝑡 + 𝜂𝑡 (1) asian journal of economics and empirical research, 2024, 11(2): 134-140 137 © 2024 by the authors; licensee asian online journal publishing group where y represents the real gdp growth rate, hc refers to human capital, inv represents investment (as a percentage of gross domestic product (gdp)), and to represents trade openness (the sum of exports and imports as a percentage of gdp). 𝜂𝑡 represents the white noise error term, and the subscript t indicates the period. this study uses a quality-adjusted human capital variable to measure human capital. following ali, cantner, and roy (2016), the quality-adjusted human capital (qahc) variable can be measured by the following equation: 𝑄𝐴𝐻𝐶 = 𝐻𝐶 ∗ (𝑃𝑢𝑏𝑙𝑖𝑐𝑎𝑡𝑖𝑜𝑛𝑠/𝐿 + 𝑃𝑎𝑡𝑒𝑛𝑡𝑠/𝐿) (2) where l represents the labor force. the time span of the study ranges from 1990 to 2022. the data for all variables are obtained from world bank (2022). the significance of human capital in influencing output is well acknowledged. countries are able to create products effectively as a result of the growth in human capital development. human capital facilitates the adoption of advanced technology from foreign countries. furthermore, it is worth noting that human capital plays a significant role in explaining the disparities observed in the production and growth rates of pertinent input indicators. the relationship between human capital and economic growth is expected to be positive. the real sector of the economy experiences significant benefits as a result of the rise in investment. hence, it is anticipated that investment will have a positive impact on economic growth. this study incorporates trade openness as a control variable in growth regression, building upon the research conducted by romer (1994); sala-i-martin (1996) and dollar and kraay (2002). it is anticipated that an augmentation in the level of openness will result in an improvement in production. based on the observed correlation between the coefficient of γ and hc, it may be inferred that there exists a simultaneous relationship between hc and output growth. therefore, ols will yield incongruous outcomes. 3.2. analytical techniques one of the most captivating subjects of discourse among econometricians pertains to the implementation of error correction mechanisms (ecm) and cointegration methodologies. the application of these methodologies as empirical instruments has gained considerable prominence in recent times. an issue that arises, nonetheless, is the applicability of these methodologies to stationary data. the utilization of ecm is recommended due to its versatility and applicability to both stationary and non-stationary data. conversely, durr (1992) argues that ecm is unsuitable for the analysis of stationary data under consideration. durr (1993) pertains to the data that were modeled using the ecm, which are unequivocally cointegrated. regarding the acceptability of stationary data in error correction models, a contentious debate has persisted since 1993 without resolution. researchers have gained a more comprehensive understanding of the ways in which theory is linked to time series during the development process as a result of these contentious debates. the evaluation of immediate and enduring consequences is facilitated by error correction models, which not only provide a reliable modeling technique but also enable estimation. 3.2.1. unit root test applying ols regression on time series data without ensuring stationarity would result in false regression, meaning that the estimates would be unreliable. to address this issue, the data is rendered stationary by the process of taking differences. to assess the unit root properties of each series, the current study used augmented dickeyfuller (adf) and phillips-perron (pp) unit root tests to examine the order of integration of variables. when conducting these tests, varying lag orders are employed, which are determined based on the aic and sbc criteria. this study also uses the nonparametric (phillips, 1988) unit root test, which controls for serial correlation while testing for a unit root. 3.2.2. fisher type bayer-hanck (2013) cointegration test we use the fisher-type bayer and hanck (2013) cointegration test to explore the long-run relationship among the variables of model 1. the bayer and hanck (b-y) cointegration method is a unified strategy that integrates multiple independent cointegration tests. the analysis provides an opportunity to incorporate factors that have been significantly underrepresented in the equation. the fisher formula by bayer and hanck (2013) is employed in the test to combine the probability values derived from various cointegration approaches. 3.2.3. ardl econometric approach there are various reasons why the ardl technique is considered robust and efficient in comparison to other econometric approaches such as ordinary least squares (ols) and fully modified least squares (fmols). nevertheless, the primary justification for employing ardl over alternative methodologies is that it facilitates the effective handling of structural breaks. moreover, ardl operates effectively in contexts of heterogeneity. it is advantageous for securing optimal outcomes in the presence of endogeneity. the utilization of the ardl instrumental variable technique involves the incorporation of the lagged dependent variable in equation 2, as it is acknowledged that the ols method tends to overestimate the coefficient of the stringent lagged dependent variable. therefore, this study used the ardl technique to examine the impact of human capital, investment, and trade openness on economic growth in the case of malaysia. the ardl approach consists of estimating the following equation. 𝛥(𝑌)𝑖𝑡 = 𝛼 + ∑ 𝛽𝑗𝛥(𝑌)𝑡 − 𝑗𝑛 𝑗=1 + ∑ 𝛾𝑗𝛥(𝐻𝐶)𝑡 − 𝑗𝑛 𝑗=1 + ∑ 𝛿𝑗𝛥(𝐼𝑁𝑉)𝑡 − 𝑗𝑛 𝑗=1 + ∑ 𝜓𝑗𝛥(𝑇𝑂)𝑡 − 𝑗𝑛 𝑗=1 + 𝜆1(𝑌)𝑡 − 1 + 𝜆2(𝐻𝐶)𝑡 − 1 + 𝜆3(𝐼𝑁𝑉)𝑡 − 1 + 𝜆4(𝑇𝑂)𝑡 − 1 + ηt (3) where ηt captures the error correction in the model. in this study, the analyses are based on equation 3, which captures the long-run features, but the study also estimates the dynamic model of equation 4, which reflects only a short-term perspective and disturbance. 4. results and discussion within the context of malaysia, this study investigates the relationship between human capital, investment, and trade openness in relation to economic growth. with the intention of serving this objective, this study provides an estimation of the model, in which human capital, investment, and trade openness are considered explanatory asian journal of economics and empirical research, 2024, 11(2): 134-140 138 © 2024 by the authors; licensee asian online journal publishing group variables, and economic growth is regarded as the dependent variable. this research employs the ardl econometric technique to estimate the model. additionally, this study utilizes the johansen (jj) cointegration technique to determine whether the variables are cointegrated with one another. however, before proceeding with the estimation of the model, it is essential to ensure that the data series possesses stationarity features. this research uses the adf and phillips-perron (pp) unit root tests to accomplish this goal. table 1 presents the correlation matrix of variables. the real gdp growth rate (y) is highly correlated with all other variables. however, the degree of association between independent variables is very low. given that the real gdp growth rate (y) is the dependent variable in the correlation matrix, it follows that the model will always explain at least one of these variables. as a result, the correlation between y and the explanatory factors is stronger (greater than 0.5), which indicates that the explanatory variables are connected with economic performance. when it comes to the variables that explain the phenomenon, there is no correlation coefficient that is notably high among the variables that explain the phenomenon. table 1. correlation matrix. variables y qahc inv to y 1 ------ qahc 0.73 1 ---- inv 0.81 0.14 1 to 0.78 0.16 0.29 1 the results of the adf unit root test are presented in table 2. the results indicate that the variables y, hc, inv, and to are non-stationary at the level and stationary at the first difference. hence, all variables are firstdifference stationary. table 2. unit root test. variable i (0) i (1) y -0.782 -3.241** qahc -1.651 -4.671*** inv -2.092 -3.002* to -1.624 -4.178*** we use the fisher type bayer-hanck cointegration test to explore the long-run relationship among variables y with hc, inv, and to. the results of the fisher type bayer-hanck test are presented in table 3. the results show that all variables in model 1 are cointegrated. therefore, it is inferred that economic growth is cointegrated with human capital, investment, and trade openness. table 3. fisher-type bayer-hanck cointegration test. variables eg jj ba bo test statistics -13.2712 98.5203 28.7204 81.6192 p-value(s) 0. 0000 0.0000 0.0000 0.0000 eg-j 61.0983** eg-j-ba-bo 98.7146** note: ** represents significant at 5% level. the findings of the ardl approach are presented in table 4. the results suggest that human capital, investment, and trade openness are positively related to the real gdp growth rate. the symbol ecm (-1) represents the speed of adjustment, indicating that the government's policy should be fully implemented within a period of more than one year, with a rapid pace of adjustment towards equilibrium. the coefficient of qahc is both positive and statistically significant, indicating a positive impact of qahc on economic growth. in other words, an increase in qahc leads to a corresponding increase in growth. the significant and positive coefficient of qahc implies that labor with developed human capital is more productive and hence contributes more to economic growth. the results are consistent with the findings of alderman et al. (1996); gyimahbrempong and wilson (2004); balach and law (2015) and sehrawat and giri (2017). human capital refers to the collective knowledge and skills possessed by individuals, which significantly contribute to enhancing productivity and are closely linked to economic growth and development. the enhancement of productivity is significantly influenced by the development of human capital through educational advancement. the allocation of resources toward the development of human capital has been widely recognized as a significant driver of economic growth and productivity in industrialized nations. one of the primary factors contributing to the high per capita gdp in malaysia is the efficient allocation of resources toward human capital development. human capital facilitates the adoption of advanced technology from foreign countries. furthermore, it is worth noting that human capital plays a significant role in explaining the disparities observed in the production and growth rates of pertinent input indicators. both human capital and trade openness have been found to have a positive impact on economic growth in malaysia. the rise of knowledge-based economies is facilitated by human capital, which in turn contributes to economic growth. according to romer (1990), the enhancement of qualities, abilities, and skills contributes to the economic growth of a nation, hence benefiting the economy. the relationship between human capital and output growth is mediated by the processes of input accumulation and technological advancement. the phenomenon of growing returns to scale is influenced by the rate of human capital growth, as human capital introduces externalities into the production process. additionally, a clear relationship exists between investment (inv) and economic growth. the coefficient of inv is positive and statistically significant, indicating a positive impact of inv on economic growth. an increase in inv leads to a corresponding increase in growth. this is due to the fact that investment contributes positively to economic growth. note: *, ** and *** represent significant at 10%, 5%, and 1% respectively. asian journal of economics and empirical research, 2024, 11(2): 134-140 139 © 2024 by the authors; licensee asian online journal publishing group table 4. ardl results. variables coefficients constant 1.084*** [0.007] qahc 0.197*** [0.006] inv 0.019** [0.028] to 0.098*** [0.003] ec (-1) -0.652** [0.018] note: values in the [] are the p-values. ** and *** represents significant at 5% and 1% respectively. 5. conclusion malaysia has demonstrated significant advancements in enhancing its human capital in recent years. to remain competitive with industrialized nations in the context of increasing global technology advancements, the country is prioritizing the enhancement of its human resources capabilities. malaysia, as a nation abundant in resources, encounters a multitude of issues pertaining to its human capital, the enhancement of which is anticipated to exert a significant impact on the country's future productivity. previous scholarly research has conducted individual investigations on the impact of human capital, specifically education level and health status, on economic growth. furthermore, a significant amount of research is conducted to specifically investigate the impact of human capital on economic growth. to the best of our current understanding, this study represents the inaugural empirical investigation of the influence of human capital on economic growth. furthermore, no research has been conducted to investigate this matter in the context of malaysia. this study employed quality-adjusted human capital as a means to accurately measure the true value of human capital, as it is argued that quality has greater significance than quantity. in addition, this research employs quality-adjusted human capital as a means to measure human capital in malaysia. prior to this endeavor, there has been a lack of research conducted on the utilization of quality-adjusted human capital as a measure to capture human capital. therefore, this research makes a substantial contribution to the existing body of literature by examining the impact of quality-adjusted human capital on the economic growth of malaysia. the real growth rate in gdp is employed as a measure of economic growth. in addition, investment and trade openness are used as control variables. the study holds significance due to the pressing need for government policies aimed at enhancing the standard of living for the general population and effectively increasing productivity through the implementation of the development of human capital. this study utilizes a time series methodology to conduct a model analysis, wherein many tests are employed to assess the statistical significance of both the data and the model. the unit root test is utilized to assess the stationarity and stability of the data by applying it to each variable in the model. the empirical findings derived from the ardl technique indicate a positive relationship between economic growth and various factors, namely human capital, investment, and trade openness. to optimize the positive impact of human capital on economic growth in malaysia, it is imperative to establish a comprehensive array of policy recommendations that encompass both the quantity and quality of human capital development. the allocation of resources towards education at all levels is of utmost importance. these investments should encompass not only the augmentation of enrollment rates but also the enhancement of educational quality, ensuring that students obtain the requisite information and skills necessary for the modern market. moreover, it is crucial to enhance vocational training and opportunities for lifelong learning to guarantee a continuous improvement of skills and flexibility in the labor force. furthermore, policy should strive to attract and retain skilled individuals by providing avenues for professional growth and entrepreneurial pursuits, alongside delivering competitive remuneration in the market and fostering a conducive business climate. this study is limited to exploring the role of quality-adjusted human capital on the economic growth of malaysia. in the future, studies may be carried out to explore the role of quality-adjusted human capital on economic growth in a panel data framework. references aghion, p., howitt, p., & murtin, f. 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(2022). world development indicators (wdi). washington dc. retrieved from https://databank.worldbank.org/source/worlddevelopment-indicators asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.2307/2937943 https://doi.org/10.1111/j.1467-9892.2012.814.x https://doi.org/10.1111/j.1467-9892.2012.814.x https://doi.org/10.1016/j.jdeveco.2006.07.004 https://doi.org/10.1093/pan/4.1.185 https://doi.org/10.2307/2938963 https://doi.org/10.1016/s0304-3932(02)00200-3 https://doi.org/10.32368/fjes.20201606 https://doi.org/10.1016/j.qref.2003.07.002 https://doi.org/10.1016/j.econedurev.2013.04.005 https://doi.org/10.7763/ijtef.2011.v2.111 https://doi.org/10.1016/j.asieco.2004.02.006 https://doi.org/10.1080/00343404.2011.579092 https://doi.org/10.1177/1391561418799110 https://doi.org/10.1177/089124249901300301 https://doi.org/10.1111/j.1475-4932.1988.tb02075.x https://doi.org/10.1111/j.1475-4932.1988.tb02075.x https://doi.org/10.3233/hsm-2002-21402 https://doi.org/10.1086/261420 https://doi.org/10.1086/261725 https://doi.org/10.1257/jep.8.1.3 https://doi.org/10.2307/2235375 https://doi.org/10.1108/ijse-05-2015-0131 https://doi.org/10.12775/oec.2016.030 https://doi.org/10.1080/00036846.2016.1245841 https://doi.org/10.1016/j.rser.2017.06.025 https://doi.org/10.1007/s11205-005-0209-7 https://databank.worldbank.org/source/world-development-indicators https://databank.worldbank.org/source/world-development-indicators 132 © 2022 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 9, no. 2, 132-149, 2022 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v9i2.4260 © 2022 by the authors; licensee asian online journal publishing group specialist ceos versus generalist ceos: ceo type and firm performance following initial public offerings on the chinese market wei hua school of finance, nanjing audit university, nanjing, china. email: whua@nau.edu.cn abstract this study focuses on the effect of chief executive officer (ceo)-level characteristics on a firm’s survival following initial public offerings (ipos). specifically, it looks at the impact of generalist ceos between july 2009 and july 2021 on the likelihood of firm failure and ipo survival. this study uses principal component analysis to create a generalist skills index based on ceo work experience, including the number of roles that the ceo has held, the number of firms in which the ceo has worked, the number of industries in which the ceo has worked, whether the ceo has taken a ceo position in other firms, whether the ceo has worked in a conglomerate, and whether the ceo holds a professional title. the results of the cox proportional hazards model reveal that companies with a generalist ceo have a higher probability of failing than companies with a specialist ceo, which suggests that generalist ceos pursue higher salaries and higher reputations through switching between different industries and firms. performance-related compensation and ceo turnover in companies with generalist ceos explain the higher probability of firm failure. the main results still hold after controlling for ceo power, board and firm characteristics, and testing using the logit model. this research on the connection between generalist ceos and a firm’s failure risk also offers insight into a company's ceo hiring choice and job market activities. keywords: ceo compensation, ceo power, ceo turnover, chinese ipo survival, generalist ceo, specialist ceo. jel classification: g30, g40. citation | wei, h. (2022). specialist ceos versus generalist ceos: ceo type and firm performance following initial public offerings on the chinese market. asian journal of economics and empirical research, 9(2), 132-149. 10.20448/ajeer.v9i2.4260 history: received: 5 september 2022 revised: 12 october 2022 accepted: 24 october 2022 published: 2 november 2022 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate and transparent account of the study, that no vital features of the study have been omitted, and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 133 2. literature review .......................................................................................................................................................................... 134 3. sample and data............................................................................................................................................................................. 134 4. empirical analysis ......................................................................................................................................................................... 136 5. implication and conclusion ......................................................................................................................................................... 145 references ............................................................................................................................................................................................ 147 mailto:whua@nau.edu.cn https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v9i2.4260 https://orcid.org/0000-0003-2563-4491 asian journal of economics and empirical research, 2022, 9(2): 132-149 133 © 2022 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study is the first to examine how a ceo's managerial expertise affects a company's ability to survive following an initial public offering (ipo) on the chinese stock market. a generalist ceo index is constructed based on six proxies, including whether a ceo holds a professional title. in addition, compensation and ceo turnover are investigated to establish the cause of a firm’s higher risk of failure with a generalist ceo. 1. introduction existing research demonstrates that, although an ipo can generate a significant initial return on the first trading day, it will ultimately perform poorly. international and mainland evidence reveals that firms' long-term performance is low (e.g., (chi & padgett, 2005; loughran & ritter, 1995; ritter, 1991)). an international company that performs poorly will either be bought or delisted under the regulations and guidelines governing stock market delisting. however, due to ineffective delisting laws in china, underperforming chinese companies are less likely to be removed from the market and are more likely to receive warnings from the china securities regulatory commission (csrc) (cheng, aerts, & jorissen, 2010; jiang & wang, 2008; zhou, zhang, yang, su, & an, 2018). since the stock market's inception, there have been only 167 delisted companies in the chinese a-share and b-share markets. as a result, it is improper to define a failing firm as one that has been delisted. firms that have experienced two consecutive years of negative profits will be alerted by csrc, and "*st" will be added before the stock code. in this study, a firm is considered to have failed if it has had two consecutive years of negative profits and its stock code begins with "*st" before the code number, which is distinct from the worldwide definition of firm failure. previous research has demonstrated that certain corporate characteristics, such as the first return, underwriter reputation and insider directors, have an impact on firm performance after the initial offering (carter, dark, & singh, 1998; durukan, 2002; jain & kini, 1994). however, we don't know a lot about the ceo-level factors that influence how well a company performs after becoming public. in recent years, academics have begun to focus on how human traits, particularly those of the ceo, affect a firm's growth (buyl, boone, hendriks, & matthyssens, 2011; huang, 2013; nelson, 2005). the ceo of a company is typically hired due to his experience, reputation, and social circle. although boards have the authority to hire or fire the ceo and control a majority of the company's shares, the ceo is in charge of running the business on a daily basis and making important decisions. as a result, a ceo's traits might determine how well a company performs. for instance, a senior ceo is often more conventional, risk-averse, and unlikely to implement dramatic changes (amran, yusof, ishak, & aripin, 2014; chowdhury & fink, 2017; serfling, 2014). female ceos tend to be more cautious and risk-averse than male ceos (khan & vieito, 2013; lam, mcguinness, & vieito, 2013). moreover, hambrick and mason (1984) postulate that the managerial ability of a ceo has a more critical effect on a firm's performance than other characteristics. a diverse environment seems to be a popular trend for ceo curriculum vitae (crossland, zyung, hiller, & hambrick, 2014). we can categorize ceo types based on their working environment. while some ceos choose to remain in one area or company long term, others prefer to transition between several industries and companies. we refer to these as specialist and generalist ceos, respectively (datta & iskandar‐datta, 2014; gounopoulos & pham, 2018). because ceos play an essential part in decision-making, the question that this study aims to answer is whether a ceo's preference in a diverse employment environment is vital for a firm's survival. a generalist ceo actively seeks employment and is more likely to change companies and sectors. also, a generalist ceo's pay and compensation are more likely to increase after leaving previous companies if they can establish a solid reputation through a few risky but successful undertakings. prior studies show that ceos with various career experiences make decisions that deviate from the firm's current strategy and shareholders' opinions (hamori & koyuncu, 2015; louca, petrou, & procopiou, 2020) and are more likely to accept change and reform (musteen, barker iii, & baeten, 2006). higher remuneration that is based on the ceo's success will promote risky investments that have a higher failure rate. in addition, diverse ceos bring different strategies to the table which can bring instability to the company. hence, companies with a generalist ceo have a higher ceo turnover rate and are more likely to fail. a specialist ceo, on the other hand, is less active in the employment market. due to their limited mobility, long-term employment is preferred. as a result, specialist ceos make choices that may be in line with those of the board and with the existing business strategy. therefore, this study contends that companies with a specialist ceo have a reduced failure probability and are less likely to receive csrc warnings. it can be claimed that certain aspects of a company could influence how the ceo's style affects the viability of the business. consequently, this study first controls for three boards, namely the chinext (a nasdaq-style subsidiary of the shenzhen stock exchange), the szse (shenzhen stock exchange), and the sse (shanghai stock exchange), which have established various company criteria and provide various regulatory guidelines. then, it controls for high-tech firms, which are more likely to issue offerings in the chinext and szse, and experience rapid growth and involve more risk. others may argue that a generalist ceo's impact on a company's longevity can be affected by other traits. for instance, a ceo with a larger percentage of shares may have greater influence over the company's decision-making and may drive a generalist ceo's effect on the company's survival (barnhart & rosenstein, 1998; li, moshirian, nguyen, & tan, 2007; mehran, 1995). as a result, the study also controls for ceo power, which is created by employing principal component analysis (pca) based on ceo tenure, ownership, founder/chairman status, and political connections. this research is the first to examine how a ceo's managerial expertise affects a company's ability to survive on the chinese stock market. previous research has shown that a firm's decision-making is influenced by the ceo's age, tenure, remuneration, and gender (amran et al., 2014; chen & zheng, 2014; chowdhury & fink, 2017). a generalist skills index based on five proxies plus a professional title variable, a peculiar situation in the chinese market, is used in this paper to specifically describe the ceo type. second, compensation and ceo turnover are investigated to establish the cause of a firm’s failure with a generalist ceo. third, robustness tests are conducted asian journal of economics and empirical research, 2022, 9(2): 132-149 134 © 2022 by the authors; licensee asian online journal publishing group to examine whether firm characteristics and other ceo characteristics can drive the effect of ceo type on a firm's survival. the final results can assist companies in choosing a ceo based on their long-term goals. the rest of the paper is organized as follows: section 2 discusses the related literature; section 3 presents the data sample and data summary; section 4 presents the primary empirical evidence of the cox proportional hazards model and robustness check, and section 5 concludes. 2. literature review a previous study by hambrick and mason (1984) states that managerial background characteristics can predict a firm's strategic choices and performance levels. many studies show that a ceo’s personal traits, demographic background, and experience are important factors in explaining their decision-making and can affect a firm's performance. buyl et al. (2011) showed that a ceo’s characteristics affect their decision-making through their psychological traits, such as risk-loving or conservative. specifically, warfield, wild, and wild (1995) showed that ceo ownership is positively correlated with firm value. barber and odean (2001) stated that female ceos are more risk-averse than male ceos and are more likely to opt for less risky strategies and decisions. chen and zheng (2014) examined the relationship between ceo tenure and risk-taking behavior, and the results showed that such a relationship depends on the information asymmetry regarding the ceo’s ability. chowdhury and fink (2017) found that older ceos invest in less research and development (r&d), and ceo age is associated with reducing firm equity risk. the initial public offering (ipo) market demonstrates significant information asymmetry, and firms are required to disclose their financial information to the public. however, the agency problem arises between shareholders and managers in an ipo (bebchuk & fried, 2003; nyberg, fulmer, gerhart, & carpenter, 2010), which causes a moral hazard issue between principals and agents. while ceos without ownership interests prioritize their immediate income and experience accumulation, shareholders' returns are mostly based on a company's long-term performance and survival. a generalist ceo's agency problem will worsen, since a ceo with a diverse work environment tends to switch between different companies or industries. their pay is boosted by changing jobs rather than being directly correlated to the company's performance. according to mishra (2014), a ceo with a more general managerial aptitude deviates from the shareholders' decision-making behavior and causes a serious agency problem. generalist ceos may undertake high-risk ventures to enhance their reputation, increase their pay in line with the additional value of the company, and gain easier access to the job market. hambrick, geletkanycz, and fredrickson (1993) state that a generalist ceo may make decisions that are not in line with the present corporate strategy. crossland et al. (2014) state that generalist ceos are more likely to accept change and renovation with risk propensity. specialist ceos, on the other hand, only focus on a specific industry, or work for a company for a long period. because they are more devoted to a company and more concerned with its long-term survival, their reduced employment mobility alleviates agency issues (datta & iskandar‐ datta, 2014; gounopoulos & pham, 2018). their high level of stability necessitates that they focus on a long-term and sustainable approach rather than making adventurous or hazardous decisions. a specialist ceo comes to a conclusion that may be in line with that of the shareholders. a specialist ceo's pay also has a strong relationship with the success of the company. 3. sample and data 3.1. sample construction the data for this study, including firms’ financial information and ceo profiles, was collected from the china stock market & accounting research (csmar) database, which is a comprehensive research-oriented database focusing on china's finance and economy that is highly regarded by a number of top-tier journals. the data sample spans from july 2009 to july 2021 for the chinese a-share market. contrary to earlier research (e.g., (ahmad & jelic, 2014; alhadab, clacher, & keasey, 2015; gounopoulos & pham, 2018), which typically defines failing enterprises as those delisted from the board, this study defines failed firms as ones that the csrc has issued a warning to due to having two consecutive years of negative profits. only 167 companies have been removed from the board during the history of the chinese stock market, and between july 2009 and july 2021, only 100 companies were delisted. the main reason for this low number is because some underperforming corporations can evade punishment due to the subjective nature of the delisting regulations. as a result, according to the definition taken by this study, failed enterprises are those that the csrc have issued warnings to and those with stock codes that begin with "*st", which denotes two consecutive years of negative profitability for the company. the ipo data was gathered for 1,217 listed enterprises from july 2009 to july 2015 to provide ample track time for survival analysis. according to custódio, ferreira, and matos (2013) and gounopoulos and pham (2018), the principal component analysis (pca) was employed to construct the generalist skills index based on ceo work experience. the proxies of ceo work experience include the number of roles that the ceo has held, the number of firms the ceo has worked in, the number of industries the ceo has worked in, whether the ceo has held the same position in other firms, and whether the ceo has worked in a conglomerate. a dummy variable is also included that indicates if the ceo has a professional title, which is a slight departure from custódio et al. (2013) and gounopoulos and pham (2018). the professional titles include engineer, accountant, lawyer, professor, among others. to earn respect within the industry in china, it is common practice to obtain a professional title. the dummy equals zero if the ceo holds a professional title, and one otherwise. using six proxies, the first factor of the pca is applied to determine the generalist skills index. the index is higher when the degree of general managerial ability is higher. in addition, a specialist is defined if the generalist index value is below the index median, and a generalist is defined if the generalist index value is above the index median. similarly, ceo power is constructed by pca based on five variables, namely whether the ceo is a chairman, whether the ceo is a founder, ceo ownership, ceo tenure, and whether the ceo is politically connected. different from gounopoulos and pham (2018), the dummy variable "if the ceo is politically connected" is also asian journal of economics and empirical research, 2022, 9(2): 132-149 135 © 2022 by the authors; licensee asian online journal publishing group included in this study because there appears to be a connection between the ceo's influence over the company and whether or not he or she is politically connected (e.g., (wang, 2015; wang & wu, 2020)). 3.2. data summary table 1 shows the distribution of successful and unsuccessful enterprises after their initial public offering. an observation interval for a specific amount of time is necessary for survival analysis. as a result, the study sample includes businesses whose listing periods range from july 2009 to july 2015 as well as the entire period of time for which performance data was collected, from july 2009 to july 2021. panel a demonstrates that, overall, 83.81% of enterprises were still operating as of july 2021, while 16.19% were labeled as failures. panel b provides the firm distribution by listing year. first, only 97 companies went public in 2009 as a result of the financial crisis, and of those, 22.68% received warnings for their sub-par performance. then, in 2010, there was a surge of ipos, bringing the total to 343. the release of previously authorized ipo applications was most likely to occur in 2010 as a result of the global financial recovery. the ratio of unsuccessful ipos varied between 16% and 20% between 2010 and 2012. only two companies went public in china in 2013 due to an ipo moratorium. in 2014, 124 companies went public, and 219 in 2015. only half as many bankrupt businesses were present as in prior years. panel c presents the firm distribution by board. the lowest number of companies going public and the lowest percentage of unsuccessful companies are both a result of the sse's strictest listing and initial public offering (ipo) regulations. the failure rate for smalland medium-sized businesses served by chinext is 20.93%, or about three times that of the sse. the szse has a 15.97% failure rate, which is approximately twice as high as that of the sse. table 1. firm distribution following ipo. panel a. ipo distribution (07/2009 to 07/2021) firm number % of total observations survived 1020 83.81% failed 197 16.19% total 1.217 panel b. ipo distribution by listing year ipo year total survived failed 2009 97 75 77.32% 22 22.68% 2010 343 273 79.59% 70 20.41% 2011 279 232 83.15% 47 16.85% 2012 153 125 81.70% 28 18.30% 2013 2 2 100% 0 0 2014 124 114 91.94% 10 8.06% 2015 219 199 90.87% 20 9.13% panel c. ipo distribution by board board total survived failed chinext 492 389 79.07% 103 20.93% sse 224 210 93.75% 14 6.25% szse 501 421 84.03% 80 15.97% note: this table shows the survived and failed firms' distribution on the chinese a-share market from july 2009 to july 2021. panel a breaks down the ipo distribution into two groups: survived and failed. enterprises are classified as failed firms if they have two consecutive years of negative profits, otherwise they are classified as surviving firms. panel b describes the ipo distribution by year. panel c describes the ipo distribution by board, including the chinext index, the shanghai stock exchange (sse), and the shenzhen stock exchange (szse). table 2. specialist ceo vs. generalist ceo distribution. panel a. ceo type distribution by listing year year ceo type number of ipos survived failed 2009 specialist 47 45 95.74% 2 4.26% generalist 50 30 60% 20 40% 2010 specialist 161 136 84.47% 25 15.53% generalist 182 137 75.27% 45 24.73% 2011 specialist 145 124 85.52% 21 14.48% generalist 134 108 80.60% 26 19.40% 2012 specialist 84 70 83.33% 14 16.67% generalist 69 55 79.71% 14 20.29% 2013 specialist 1 1 100% 0 0 generalist 1 1 100% 0 0 2014 specialist 76 72 94.74% 4 5.26% generalist 48 42 87.50% 6 12.50% 2015 specialist 98 93 94.90% 5 5.10% generalist 121 106 87.60% 15 12.40% panel b. ceo type distribution by board board ceo type number of ipos survived failed chinext specialist 250 209 83.60% 41 16.40% generalist 242 180 74.38% 62 25.62% sse specialist 128 120 93.75% 8 6.25% generalist 96 90 93.75% 6 6.25% szse specialist 234 212 90.60% 22 9.40% generalist 267 209 78.28% 58 21.72% notes: this table shows the distribution of specialist ceos and generalist ceos. panel a classifies the ceo type in each ipo in terms of survived firms and failed firms by year. panel b shows the specialist and generalist ceo distribution in each ipo in terms of survived firms and failed firms by board. asian journal of economics and empirical research, 2022, 9(2): 132-149 136 © 2022 by the authors; licensee asian online journal publishing group the specialist versus generalist ceo data is displayed in table 2. panel a shows the distribution of specialist and generalist ceos in each business ipo. the results show that the firms with a specialist ceo are less likely to be defined as failed than firms with a generalist ceo. two businesses with a specialist ceo collapsed in 2009, but 45 businesses with a specialist ceo survived. also, 30 out of 50 businesses with a generalist ceo survived, while 20 failed. in 2009, 4.26% of companies with a specialist ceo and 40% of companies with a generalist ceo failed. in 2010, 25 out of 161 businesses with a specialist ceo failed. similar results are also seen for companies with a specialist ceo and a generalist ceo from 2011 to 2015. a company run by a generalist is typically more likely to be classified as a failing company. the specialist versus generalist ceos by board are depicted in panel b. in the chinext, sse and szse, the percentages of failing businesses with a specialist ceo are 16.40%, 6.25%, and 9.40%, respectively. additionally, in the chinext, sse and szse, the proportions of failing businesses with a generalist ceo are 25.62%, 6.25% and 21.72%, respectively. it is challenging to draw the conclusion that companies on the sse with a specialist ceo have a higher chance of surviving due to the varying sample sizes in each board. panel b presents the summary statistics of five proxies constructing ceo power. the three dummy variables are given a value of one if the ceo is also the chairman, founder, and politically connected, and zero otherwise. specialist ceos had a lower average for three dummy variables, while generalist ceos had a greater average. this indicates that generalist ceos have a modest advantage over specialists in terms of power. the average ceo tenure and ownership, however, are marginally longer and higher for a specialist ceo and shorter and lower for a generalist ceo. for example, the average ceo ownership is 0.14 for generalist ceos and 0.15 for specialist ceos. specialist ceos had a 1.72 average tenure, compared to 1.67 for generalist ceos. between companies with specialist ceos and those with generalist ceos, there is typically little variation in the power of the ceo. panel c lists the ceo's other attributes, including age, gender, education level, and compensation. the average age of ceos is 47.42; for specialist ceos, it is 47.09; and for generalist ceos, it is 47.76. the ceo gender dummy is one for men and zero for women. gender is 0.94 on average. if a ceo has a bachelor's degree or higher, their education dummy is one, otherwise it is zero. education is 0.39 on average. the typical ceo compensation is 604 million renminbi (rmb) for generalists and 651 million rmb for experts. according to the t-test, there is no significant difference in ceo remuneration, education, or gender between companies for specialist and nonspecialist ceos. panel d presents the firm and ipo characteristics. the average natural logarithm age of a firm is 8.08 days. companies that have a specialist ceo have a slightly longer history than those that employ a generalist. for companies with a specialist ceo and companies with a general ceo, respectively, the average natural logarithm of revenue is 20.36 million rmb and 20.37 million rmb. the average leverage is 0.24, while the average profitability is 0.10. in comparison to companies with a generalist ceo, those with a specialist ceo have less diversity and poorer initial returns. for companies with a specialist ceo, the average level of diversification is 6.96, and the initial return is 0.38. companies with a generalist ceo have a 7.50 diversification and a 0.40 initial return. if a company employs a top-tier underwriter and a top-tier auditor, the top-tier underwriter and top-tier auditor dummy variables are one, otherwise they are zero. the average top underwriter is 0.20, and the typical top-tier auditor is 0.56. market-to-book ratios for companies with a specialist ceo and a generalist ceo are 3.71 and 3.75, respectively. ceo succession is defined as the number of successions following the ceo at the time of the ipo. the number of successions is 1.33 on average, and there is a big disparity between businesses with specialist and generalist ceos. however, the majority of characteristics do not significantly differ between businesses with specialist ceos and those with generalist ceos. 4. empirical analysis 4.1. survival analysis survival analysis is prevalent in estimating medical treatment based on patient survival statistics. specifically, a function incorporates the information on patient survival and period to estimate medical treatment. in order to examine ipo survivability, time series data with various horizons is now often estimated (e.g., (alhadab et al., 2015; gerakos, lang, & maffett, 2013; jain. & kini, 2000; shumway, 2001)). the sample in this study comprises businesses that went public at various times and survived for various lengths of time. the study examines businesses that collapsed between 2009 and 2021 (precisely, businesses that went public in 2009) and are tracked for 16 years, whereas businesses that went public in 2015 will only be tracked for six years. in light of this, survival analysis is appropriate for the sample. this study uses the semiparametric approach and employs the cox proportional hazards model (cox, 1972), which is a common tool for analyzing the survival time of patients and the associated multi-factors. in this study, we investigate how generalist ceos affect a firm's survival time after the ipo. the model is specified as follows: h(t) = h0(t)exp[β1generalist ceoit + β2 diversification it + β3 log(firm age)it + β4 log(sales)it + β5 top − tier underwriterit + β6 top − tier auditorit + β7 profitabilityit + β8 leverageit + β9 m/bit + β10 initial returnit ] (1) where h0(t) is the baseline hazard function, and t is the time to failure. a positive coefficient denotes a greater likelihood of failure. each explanatory variable's hazard ratio shows the likelihood of failure per unit increase in the explanatory variable. a generalist ceo is one whose value exceeds the generalist skill mean. other factors that are taken into account include firm diversity, firm age, firm sales, whether the company hires a top-tier underwriter and top-tier auditor, profitability, leverage, market-to-book ratio, and initial ipo return. jain and kini (2008) suggest that firm performance is positively associated with product diversification. wang, liu, and wu (2003) suggest that an underwriter with a higher reputation can reduce the initial return and improve firm performance. al ani and mohammed (2015) and rahman, meah, and chaudhory (2019) found that auditor quality is positively associated with firm performance. asian journal of economics and empirical research, 2022, 9(2): 132-149 137 © 2022 by the authors; licensee asian online journal publishing group table 3. ceo characteristics and firm characteristics. panel a. ceo work experience variable n mean p25 p50 p75 s.d. mean t-test specialist generalist number of roles 1217 4.13 3 4 5 1.89 3.25 5.03 -18.48*** number of firms 1217 3.73 2 3 5 2.50 2.08 5.41 -31.11*** number of industries 1217 1.47 1 1 2 1.00 1.15 1.80 -11.82*** ceo experience dummy 1217 0.40 0 0 1 0.58 0.222 0.59 -11.51*** conglomerate dummy 1217 0.47 0 0 1 0.51 0.23 0.72 -18.90*** professional title dummy 1217 0.50 0 1 1 0.50 0.5 0.51 -0.26 panel b. ceo power variable n mean p25 p50 p75 s.d. mean t-test specialist generalist ceo-chairman 1217 0.45 0 0 1 0.50 0.42 0.47 -1.85* ceo-founder 1217 0.9 1 1 1 0.30 0.89 0.91 -1.46 ceo-ownership 1217 0.14 0 0.05 0.24 0.19 0.15 0.14 0.80 ceo-tenure 1217 1.69 1 1.58 2.33 0.98 1.72 1.67 0.92 ceo-political 1217 0.36 0 0 1 0.49 0.34 0.38 -1.39 panel c. ceo other characteristics variable n mean p25 p50 p75 s.d. mean t-test specialist generalist ceo age 1217 47.42 43 47 52 6.84 47.09 47.76 -1.70* ceo gender 1217 0.94 1 1 1 0.23 0.95 0.94 -0.55 ceo education 1217 0.39 0 0 1 0.49 0.38 0.40 -0.45 ceo compensation 1217 628 0.78 147 736 1251 651 604 0.65 panel d. firm and ipo characteristics variable n mean p25 p50 p75 s.d. mean t-test specialist generalist log(firm age) 1217 8.08 7.88 8.21 8.51 2012 8.12 8.04 1.87* log(sales)(millions) 1217 20.36 19.55 20.16 20.99 1.15 20.36 20.37 -0.21 profitability 1217 0.10 0.07 0.09 0.11 0.04 0.10 0.09 2.97*** leverage 1217 0.24 0.11 0.20 0.33 0.16 0.23 0.25 -2.05 diversification 1216 7.23 1 2 6 15.63 6.96 7.50 -0.61 initial returns 1217 0.39 0.14 0.44 0.44 0.39 0.38 0.40 -0.76 top-tier underwriter 1217 0.20 0 0 0 0.40 0.20 0.21 -0.17 top-tier auditor 1217 0.56 0 1 1 0.496 0.60 0.52 2.73*** market-to-book ratio 1217 3.73 2.00 3.07 4.55 2.76 3.71 3.75 -0.26 succession 1217 1.33 0 1 2 1.33 1.22 1.44 -2.93*** note: panel a shows the ceo work experience characteristics, including the number of roles the ceo took (number of roles), the number of firms in which the ceo was employed (number of firms), the number of industries the ceo worked in (number of industries), whether the ceo worked as a ceo in other firms (ceo experience dummy), whether the ceo worked in a conglomerate (conglomerate dummy), and whether the ceo holds a professional title (professional title dummy). panel b displays the ceo power variables, including whether the ceo is a chairman (ceo-chairman), whether the ceo is a founder (ceo-founder), ceo ownership (ceo-ownership), the number of years since the ceo has worked in this firm up to the ipo (ceo-tenure), and whether the ceo is politically connected (ceo-political). panel c shows other ceo characteristics, including ceo age, ceo gender, ceo education, and ceo compensation. panel d shows the firm characteristics, including the natural logarithm of firm age, the natural logarithm of firm sales in millions, firm profitability, leverage, diversification, initial ipo return, whether the firms hired top-tier underwriters, whether the firms hired top-tier auditors, marketto-book ratio, and ceo succession. *** and * indicate statistical significance at 1% and 10%, respectively. 4.2. estimation of the cox proportional hazards model table 4 presents the results of the cox proportional hazards model of the probability of failure and how a generalist ceo affects ipo survival. the schoenfeld residuals test also demonstrates that the cox model satisfies the premise. the generalist ceo's coefficient is highly positive, as shown in panel a, and the hazard ratio is 1.718. this implies that a company with a generalist ceo has a 71.8% higher failure probability than a company with a specialist ceo, which is in line with the previous hypothesis. specification (2) focuses on the general skills index. the coefficient is still significantly positive, and the hazard ratio is 1.155. this implies that a company with a generalist ceo has a 15.5% higher failure probability than a company with a specialist ceo. diversification, log(firm age), log(sales), and profitability all exhibit significantly negative coefficients when compared to other control variables, indicating that businesses are less likely to fail if they have higher levels of diversification, a longer history, more sales, and improved profitability. both leverage and market-to-book ratio have a statistically significant positive coefficient, which suggests that increasing any of these variables will probably lead to a company's demise. in contrast to earlier findings, it was also discovered that the failure risk is positively correlated with a top-tier auditor. other variables, including top-tier underwriters and initial returns, had no significant effect on failure risk. panel b provides the estimation results of each proxy of the general skills index. six proxies, including the number of roles, the number of firms, the number of industries, ceo experience dummy, conglomerate dummy, and professional title dummy, are all significantly and positively related to the risk of failure. it shows that a ceo who assumes more responsibilities, works for more companies and industries, holds positions in other companies, works for a conglomerate, and has a professional title is more likely to cause a corporation to collapse. other variables produced similar results, as seen in panel a. asian journal of economics and empirical research, 2022, 9(2): 132-149 138 © 2022 by the authors; licensee asian online journal publishing group table 4a. estimation of the cox proportional hazards model. panel a. regression of generalist ceo and generalist skills index variable (1) (2) coefficient hazard ratio coefficient hazard ratio generalist ceo 0.541*** (0.15) 1.718 generalist skills index 0.144*** (0.03) 1.155 diversification -0.125** (0.01) 0.988 -0.012** (0.01) 0.988 log(firm age) -0.192* (0.11) 0.826 -0.206* (0.11) 0.814 log(sales) -0.332*** (0.11) 0.718 -0.358*** (0.11) 0.699 top-tier underwriter 0.023 (0.20) 1.023 0.027 (0.20) 1.027 top-tier auditor 0.313** (0.15) 1.368 0.281* (0.15) 1.325 profitability -10.026*** (3.22) 0.000 -9.919*** (3.14) 0.000 leverage 1.678** (0.78) 5.355 1.734** (0.79) 5.661 market-to-book ratio 0.119*** (0.03) 1.126 0.116*** (0.03) 1.123 initial return 0.013 (0.17) 1.013 0.050 (0.17) 1.052 year effect yes yes industry effect yes yes wald chi-square 18544.86 205.53 wald chi-square probability 0.0000 0.0000 number of observations 1,216 1,214 note: this table presents how generalist ceos affect firm failure by employing the cox proportional hazards model. the control variables include firm diversification, the natural logarithms of firm age and sales, the top-tier underwriter dummy and top-tier auditor dummy, firm profitability, leverage, market-to-book ratio, and initial ipo return. panel a shows the regression of the generalist ceo and the generalist skills index. regressions are controlled for year and industry fixed effects. robust standard errors are shown in parentheses below the coefficient estimates. ***, ** and * indicate statistical significance at 1%, 5% and 10%, respectively. 4.3. robust test 4.3.1. the reason for failure the key findings indicate that businesses with generalist ceos have a higher failure rate. greater remuneration, as opposed to base pay, will encourage the ceo to make more hazardous bets in order to increase the likelihood of success and the growth of company value. a generalist ceo will therefore be more likely to cause a company to fail if they are paid more. in table 5, panel a shows that a generalist ceo with a higher remuneration may be more inclined to make riskier investments, which may result in the failure of the company, according to the cross term between generalist ceo and compensation, which is significantly positive. the cross term between a generalist and pay is no longer important when the base salary is replaced by compensation. this demonstrates once more how the ceo's performance-related compensation is a larger motivator than base pay. in addition, a generalist ceo suggests a higher ceo turnover for the company. the succession dummy variable is given a value of one if there is succession after the ceo at the time of the ipo, and zero otherwise. the number of ceo successions following the initial ceo (n_succession) is also tracked. in panel b, the odds ratio of succession is 1.055, which indicates that companies with generalist ceos may have 5.5% higher odds of failing than companies with specialist ceos in specification (1). when the generalist skills index is substituted for the generalist ceo in specification (2), the odds ratio increased to 1.981, indicating a larger likelihood of firm failure with a generalist ceo. in specifications (3) and (4), the odds ratios of n_succession are 1.322 and 1.313, respectively. this again indicates that the number of ceo successions will negatively affect a firm’s performance. asian journal of economics and empirical research, 2022, 9(2): 132-149 139 © 2022 by the authors; licensee asian online journal publishing group table 4b. estimation of the cox proportional hazards model. panel b. regression of proxy of generalist skills index variable (1) (2) (3) (4) (5) (6) coefficient hazard ratio coefficient hazard ratio coefficient hazard ratio coefficient hazard ratio coefficient hazard ratio coefficient hazard ratio number of roles 0.211*** (0.03) 1.235 number of firms 0.068*** (0.03) 1.070 number of industries 0.106** (0.04) 1.112 ceo experience dummy 0.183** (0.08) 1.201 conglomerate dummy 0.251* (0.14) 1.285 professional title dummy 0.447*** (0.16) 1.564 diversification -0.013** (0.01) 0.987 -0.012** (0.01) 0.988 -0.103** (0.01) 0.987 -0.012** (0.01) 0.988 -0.013** (0.01) 0.987 -0.012** (0.01) 0.988 log(firm age) -0.234** (0.11) 0.791 -0.209* (0.11) 0.811 -0.217* (0.11) 0.805 -0.204* (0.11) 0.815 -0.203* (0.11) 0.816 -0.222** (0.10) 0.801 log(sales) -0.376*** (0.11) 0.686 -0.362*** (0.11) 0.696 -0.357*** (0.10) 0.700 -0.357*** (0.11) 0.700 -0.342*** (0.11) 0.711 -0.355*** (0.11) 0.701 top-tier underwriter -0.006 (0.20) 0.994 0.029 (0.20) 1.029 0.026 (0.20) 1.026 0.008 (0.20) 1.008 0.016 (0.20) 1.016 0.045 (0.20) 1.046 top-tier auditor 0.283* (0.15) 1.327 0.277* (0.15) 1.320 0.267* (0.15) 1.307 0.268* (0.15) 1.308 0.262* (0.15) 1.300 0.272* (0.15) 1.313 profitability -10.259*** (3.12) 0.000 -9.850*** (3.18) 0.000 -10.568*** (3.24) 0.000 -10.346*** (3.22) 0.000 -10.287*** (3.21) 0.000 -10.359*** (3.23) 0.000 leverage 1.726** (0.76) 5.616 1.802** (0.78) 6.063 1.874** (0.77) 6.516 1.862** (0.78) 6.437 1.787** (0.77) 5.970 2.031*** (0.77) 7.625 market-to-book ratio 0.130*** (0.03) 1.138 0.116*** (0.03) 1.123 0.116*** (0.03) 1.123 0.123*** (0.03) 1.131 0.120*** (0.03) 1.128 0.119*** (0.03) 1.126 initial return -0.043 (0.18) 0.957 0.043 (0.16) 1.044 0.029 (0.16) 1.029 0.025 (0.16) 1.025 0.009 (0.17) 1.009 0.014 (0.17) 1.014 year effect yes yes yes yes yes yes industry effect yes yes yes yes yes yes wald chi-square 24011.97 25010.48 183.00 193.49 185.90 22630.57 wald chi-square probability 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 number of observations 1,215 1,215 1,215 1,214 1,215 1,216 note: panel b shows each proxy of the generalist skills index. regressions are controlled for year and industry fixed effects. robust standard errors are shown in parentheses below the coefficient estimates. ***, ** and * indicate statistical significance at 1%, 5% and 10%. asian journal of economics and empirical research, 2022, 9(2): 132-149 140 © 2022 by the authors; licensee asian online journal publishing group table 5a. estimation of the cox proportional hazards model. panel a. regression of generalist ceo and compensation variable (1) (2) coefficient hazard ratio coefficient hazard ratio generalist ceo 0.082 (0.29) 1.085 0.545*** (0.15) 1.725 generalist ceo*ln(compensation) 0.053* (0.03) 1.055 generalist ceo*base salary -0.000 (0.00) 1.000 diversification -0.012** (0.01) 0.988 -0.012** (0.01) 0.988 log(firm age) -0.166 (0.11) 0.847 -0.193* (0.11) 0.825 log(sales) -0.347*** (0.11) 0.706 -0.328*** (0.11) 0.720 top-tier underwriter 0.040 (0.20) 1.041 0.025 (0.20) 1.025 top-tier auditor 0.290* (0.15) 1.337 0.314** (0.15) 1.369 profitability -9.670*** (3.24) 0.000 -10.032*** (3.22) 0.000 leverage 1.769** (0.79) 5.863 1.659** (0.78) 5.254 market-to-book ratio 0.122*** (0.03) 1.119 0.118*** (0.03) 1.126 initial return 0.041 (0.16) 1.042 0.014 (0.17) 1.015 year effect yes yes industry effect yes yes wald chi-square 188.58 20950.91 wald chi-square probability 0.0000 0.0000 number of observations 1,205 1213 note: panel a presents the effect of performance-related compensation on a firm’s failure by employing the cox proportional hazards model. the control variables include firm diversification, the natural logarithms of firm age and sales, the top-tier underwriter dummy and top-tier auditor dummy, firm profitability, leverage, market-to-book ratio, and initial ipo return. all regressions are controlled for year and industry fixed effects. robust standard errors are shown in parentheses below the coefficient estimates. ***, ** and * indicate statistical significance at 1%, 5% and 10%, respectively. asian journal of economics and empirical research, 2022, 9(2): 132-149 141 © 2022 by the authors; licensee asian online journal publishing group table 5b. estimation of the cox proportional hazards model. panel b. regression of generalist ceo and succession variable (1) (2) (3) (4) coefficient hazard ratio coefficient hazard ratio coefficient hazard ratio coefficient hazard ratio generalist ceo 0.504*** (0.15) 1.656 0.505*** (0.15) 1.657 generalist skill index 0.138*** (0.03) 1.148 0.132*** (0.03) 1.141 succession 0.683*** (0.19) 1.055 0.683*** (0.19) 1.981 n-succession 0.279*** (0.04) 1.322 0.272*** (0.04) 1.313 diversification -0.012** (0.01) 0.988 -0.012** (0.01) 0.988 -0.014** (0.01) 0.986 -0.013** (0.01) 0.987 log(firm age) -0.187* (0.11) 0.829 -0.201* (0.10) 0.818 -0.163 (0.10) 0.850 -0.185* (0.10) 0.831 log(sales) -0.308*** (0.11) 0.735 -0.329*** (0.11) 0.720 -0.316*** (0.11) 0.729 -0.341*** (0.11) 0.711 top-tier underwriter 0.030 (0.20) 1.031 0.033 (0.20) 1.033 0.035 (0.20) 1.036 0.048 (0.20) 1.050 top-tier auditor 0.319** (0.15) 1.376 0.290* (0.15) 1.337 0.340** (0.15) 1.405 0.311** (0.15) 1.364 profitability -10.129*** (3.23) 0.000 -10.032*** (3.13) 0.000 -8.981*** (3.30) 0.000 -8.806*** (3.22) 0.000 leverage 1.474* (0.77) 4.367 1.522** (0.77) 4.582 1.420* (0.78) 4.137 1.494* (0.78) 4.453 market-to-book ratio 0.129*** (0.03) 1.138 0.127*** (0.03) 1.136 0.116*** (0.03) 1.123 0.113*** (0.03) 1.120 initial return 0.010 (0.17) 1.010 0.042 (0.17) 1.043 0.020 (0.17) 1.020 0.046 (0.17) 1.047 year effect yes yes yes yes industry effect yes yes yes yes wald chi-square 221.91 229.55 563.56 657.28 wald chi-square probability 0.0000 0.0000 0.0000 0.0000 number of observations 1,208 1,208 1203 1201 note: panel b presents the effect of succession on firm failure. the succession dummy variable has a value of one if there is succession after the ceo at the time of the ipo, and zero otherwise. n_succession indicates how many successions follow the initial ceo. the control variables include firm diversification, the natural logarithms of firm age and sales, the top-tier underwriter dummy and top-tier auditor dummy, firm profitability, leverage, market-to-book ratio, and initial ipo return. all regressions are controlled for year and industry fixed effects. robust standard errors are shown in parentheses below the coefficient estimates. ***, ** and * indicate statistical significance at 1%, 5% and 10%. asian journal of economics and empirical research, 2022, 9(2): 132-149 142 © 2022 by the authors; licensee asian online journal publishing group 4.3.2. estimation of logit model the logit model is a useful tool for examining the impact of various variables on a binary variable that can take the value of one with probability p, or the value of 0 with probability 1-p. in this study, the dependent variable is either zero or one depending on whether a firm failed during the observation period. table 6 estimates the probability of failure by employing the logit model. in specification (1), the odds ratio for a generalist ceo is 1.978, which implies that, when all other factors are held constant, a company with a generalist ceo may have 97.8% higher odds of failing than a company with a specialist ceo. a generalist ceo increases a company's chance of failing by 20.9% compared to a specialist ceo, according to specification (2), where the odds of failure are 1.209. in addition, the odds ratios of the explanatory variables in specifications (3) to (8) are all higher than one, indicating a higher risk of failure for ceos who take on more responsibilities, work in more companies and industries, hold ceo positions in additional companies, are employed by conglomerates, and have a professional title. these results are consistent with the findings in the survival analysis. table 6. estimation of the logit model. variable (1) (2) (3) (4) (5) (6) (7) (8) generalist ceo 1.978*** (0.34) generalist skills index 1.209*** (0.05) number of roles 1.095*** (0.05) number of firms 1.091*** (0.04) number of industries 1.160 (0.11) ceo experience dummy 1.284** (0.16) conglomerate dummy 1.374** (0.22) professional title dummy 1.597*** (0.28) diversification 0.987** (0.01) 0.987** (0.01) 0.986** (0.01) 0.987** (0.01) 0.987** (0.01) 0.987* (0.01) 0.986** (0.01) 0.988* (0.01) log(firm age) 0.806 (0.11) 0.797* (0.11) 0.766** (0.10) 0.793* (0.11) 0.785* (0.11) 0.802* (0.11) 0.801* (0.11) 0.783* (0.10) log(sales) 0.682*** (0.08) 0.664*** (0.08) 0.648*** (0.08) 0.662*** (0.08) 0.666*** (0.08) 0.668*** (0.08) 0.680*** (0.08) 0.669*** (0.08) top-tier underwriter 1.023 (0.24) 1.014 (0.24) 0.967 (0.23) 1.022 (0.24) 1.017 (0.23) 0.995 (0.23) 1.009 (0.23) 1.038 (0.24) top-tier auditor 1.480** (0.26) 1.442** (0.26) 1.414** (0.25) 1.423** (0.25) 1.387* (0.24) 1.394* (0.24) 1.386* (0.24) 1.397* (0.24) profitability 0.000*** (0.00) 0.000*** (0.00) 0.000*** (0.00) 0.000*** (0.00) 0.000*** (0.00) 0.000*** (0.00) 0.000*** (0.00) 0.000*** (0.00) leverage 6.056** (5.20) 6.295** (5.48) 5.912** (4.98) 6.803** (5.84) 7.397** (6.26) 7.320** (6.23) 6.584** (5.62) 8.167** (6.86) market-to-book ratio 1.158*** (0.05) 1.161*** (0.06) 1.177*** (0.05) 1.161*** (0.05) 1.155*** (0.05) 1.166*** (0.05) 1.161*** (0.05) 1.158*** (0.05) initial return 1.036 (0.20) 1.082 (0.21) 0.985 (0.20) 1.073 (0.20) 1.051 (0.20) 1.049 (0.20) 1.031 (0.20) 1.048 (0.20) pseudo r-square 0.1097 0.1149 0.1306 0.1017 0.0984 0.0978 0.0981 0.1018 number of observations 1,189 1,187 1,188 1,188 1,188 1,187 1,188 1,189 note: this table estimates the probability of failure depending on ceo type by employing a logit model. the independent variable takes a value of one if a firm failed during 2009–2021, and zero otherwise. generalist ceo, generalist skills index, and each proxy of constructing the generalist ceo skills index are used. the control variables include firm diversification, the natural logarithms of firm age and sales, the top-tier underwriter dummy and top-tier auditor dummy, firm profitability, leverage, market-to-book ratio, and initial ipo return. robust standard errors are shown in parentheses below the odds ratio estimates. ***, ** and * indicate statistical significance at 1%, 5% and 10%, respectively. 4.3.3. control for other ceo characteristics now, the other ceo characteristics variables are incorporated, including ceo gender, ceo age, ceo tenure, ceo education, and ceo ownership. these factors are found to affect ceo behavior. for example, faccio, mcconnell, and stolin (2006) state that a firm with a female ceo will have lower leverage and a higher chance of survival. men are more overconfident than women and prefer to take more risks (e.g., (barber & odean, 2001; charness & gneezy, 2012; huang. & kisgen, 2013)). barker and mueller (2002) found that a younger ceo prefers more to spend more on r&d. serfling (2014) found that older ceos reduce firm risk. a ceo with a longer tenure has a low incentive to build a reputation and tends to be risk-averse (graham, harvey, & puri, 2013). wu, levitas, and priem (2005) state that during the early stage of their career, ceos are willing to take risks, and in their later stage, ceos myopically commit to obsolete paradigms and become more risk averse. early studies show a nonlinear relationship between managerial ownership and firm value (mcconell & servaes, 1990; morck, shleifer, & vishny, 1988; warfield et al., 1995). in terms of roa and tobin's q, ceo education is positively related to firm value (e.g., (darmadi, 2013; jalbert, rao, & jalbert, 2002)). in table 7, when controlling for other ceo characteristics, the coefficient of a generalist ceo in the specification (1) is positive, indicating that the performance of a company will suffer under a generalist ceo. the hazard ratio is 1.730, meaning that a company with a generalist ceo has a 73.0% higher failure risk than a company with a specialist ceo. the generalist skills index coefficient in specification (2) is also positive, and the hazard ratio is 1.166. this predicts that for every asian journal of economics and empirical research, 2022, 9(2): 132-149 143 © 2022 by the authors; licensee asian online journal publishing group additional unit of the generalist ceo index, the failure risk will rise by 16.6%. in addition, it was discovered that other ceo traits, such as ceo gender, age, tenure, ownership, and education, have no discernible impact on the likelihood of the firm failing. table 7. control for other ceo characteristics. variable (1) (2) coefficient hazard ratio coefficient hazard ratio generalist ceo 0.548*** (0.16) 1.730 generalist skills index 0.154*** (0.03) 1.166 diversification -0.015** (0.01) 0.985 -0.015** (0.01) 0.985 log(firm age) -0.167 (0.12) 0.846 -0.184 (0.12) 0.832 log(sales) -0.330*** (0.11) 0.719 -0.363*** (0.11) 0.696 top-tier underwriter 0.074 (0.20) 1.077 0.085 (0.20) 1.089 top-tier auditor 0.312** (0.16) 1.366 0.282* (0.16) 1.326 profitability -9.389*** (3.25) 0.000 -9.230*** (3.14) 0.000 leverage 2.067*** (0.79) 7.903 2.151*** (0.80) 8.592 market-to-book ratio 0.118*** (0.03) 1.125 0.117*** (0.03) 1.124 initial return 0.008 (0.18) 1.007 0.055 (0.18) 1.056 ceo gender -0.182 (0.29) 0.833 -0.172 (0.29) 0.842 ceo age -0.013 (0.01) 0.987 -0.014 (0.01) 0.986 ceo tenure 0.004 (0.10) 1.004 0.011 (0.10) 1.011 ceo education -0.128 (0.16) 0.880 -0.139 (0.16) 0.870 ceo ownership 0.550 (0.40) 1.734 0.482 (0.39) 1.619 year effect yes yes industry effect yes yes wald chi-square 16905.30 130.23 wald chi-square probability 0.0000 0.0000 number of observations 1,167 1,167 note: this table illustrates the effect of a generalist ceo on the probability of firm failure by controlling for other ceo characteristics, including ceo age, gender, tenure, ownership, and education. the models are controlled for industry and year fixed effects. robust standard errors are shown in parentheses below the coefficient estimates. ***, ** and * indicate statistical significance at 1%, 5% and 10%. although the aforementioned data demonstrates that ceo type can influence a firm's success, an inherent issue may arise when a corporation selects a ceo solely based on the nature of the firm's business. here, the propensity score matching procedure is applied. first, the failure risk with a specialist ceo is compared with that of the same firm with a generalist ceo. the same firm is defined by scores based on firm diversification, firm age, firm sales, top-tier underwriters, firm profitability, and initial return. based on the propensity score, each observation in the treated group is matched with the control group, and the average effect on the treated (treated) is estimated. the results for treated are shown in table 8. the treated is positive and significant at 1%, showing once more that firms with a generalist ceo have a higher likelihood of failing, which is consistent with the earlier findings. table 8. propensity score matching. failed treated (generalist ceo vs. specialist ceo) 0.088*** (3.93) number of observations 1216 note: this table illustrates the effect of the generalist ceo on the probability of firm failure by employing the propensity score matching procedure. the variables used for matching in the treated group (treated) include firm diversification, firm age, firm sales, top-tier underwriters, firm profitability, and initial return. bootstrap standard errors are shown in parentheses below the coefficient estimates. *** indicates significance at 10%. 4.3.4. control for board and high-tech firms the effect of ceo type on firm failure risk in the three boards is also investigated. the summary figures in table 2 demonstrate that companies listed on the sse that have a specialist ceo have a lower failure rate. therefore, this raises the question of whether the boards could strengthen the effect of ceo type on firm failure. in table 9, the coefficients for generalist ceo in the chinext, szse, and sse are positive and significant, suggesting that firms with a generalist ceo are more likely to fail. the hazard ratios are 2.134 for chinext, 1.481 for the szse, and 1.752 for the sse, indicating that the failure risk of a firm with a generalist ceo is 113.4% higher than asian journal of economics and empirical research, 2022, 9(2): 132-149 144 © 2022 by the authors; licensee asian online journal publishing group a firm with a specialist ceo in chinext, 48.1% higher in the szse, and 75.2 % higher in the sse, respectively. more importantly, the interactions between the three boards and generalist ceos are taken into account to control for the board effect. the coefficients are all insignificant, indicating that there is no significant difference among the three boards regarding the impact of generalist ceos on ipo survival. it also suggests that boards cannot drive the effect of ceo type on firm failure risk. table 9. control for boards. variable (1) (2) (3) chinext coefficient hazard ratio szse coefficient hazard ratio sse coefficient hazard ratio generalist ceo 0.758*** (0.23) 2.134 0.393** (0.19) 1.481 0.561*** (0.16) 1.752 chinext 0.423 (0.26) 1.526 generalist ceo*chinext -0.415 (0.29) 0.661 szse -0.251 (0.27) 0.778 generalist ceo*szse 0.396 (0.31) 1.486 sse -0.299 (0.41) 0.741 generalist ceo*sse -0.440 (0.59) 0.644 diversification -0.012** (0.01) 0.988 -0.013** (0.01) 0.988 -0.013** (0.01) 0.987 log(firm age) -0.202* (0.11) 0.817 -0.195* (0.11) 0.823 -0.199* (0.11) 0.819 log(sales) -0.290** (0.12) 0.748 -0.331*** (0.11) 0.718 -0.264** (0.12) 0.768 top-tier underwriter 0.015 (0.20) 1.015 0.037 (0.20) 1.038 0.045 (0.20) 1.046 top-tier auditor 0.295* (0.16) 1.343 0.322** (0.16) 1.380 0.340** (0.15) 1.405 profitability -9.753*** (3.21) 0.000 -9.894*** (3.21) 0.000 -10.317*** (3.27) 0.000 leverage 1.677** (0.78) 5.347 1.666** (0.79) 5.291 1.588** (0.78) 4.892 market-to-book ratio 0.114*** (0.03) 1.120 0.117*** (0.03) 1.124 0.110*** (0.03) 1.116 initial return 0.038 (0.17) 1.039 0.014 (0.17) 1.014 0.044 (0.16) 1.045 year effect yes yes yes industry effect yes yes yes wald chi-square 17818.25 23136.19 25343.31 wald chi-square probability 0.0000 0.0000 0.0000 number of observations 1,216 1,216 1,216 note: this table illustrates the effect of generalist ceos on the probability of firm failure by controlling for boards, including the chinext, szse, and sse. the models are controlled for industry and year fixed effects. robust standard errors are shown in parentheses below the coefficient estimates. ***, ** and * indicate statistical significance at 1%, 5% and 10%. another way to differentiate the three boards is to control for high-tech firms because these companies make up the majority of those listed on the chinext and the szse. a ceo with a higher level of managerial aptitude may be particularly in demand by high-tech companies. in order to determine whether high-tech could be the driving factor behind the effect of ceo type on business failure, the effect of generalist ceos on ipo survival between high-tech firms and non-high-tech firms is investigated. table 10 shows that the coefficients of generalist ceos are all statistically positive, regardless of whether the observation is taken as a whole, only high-tech enterprises, or not at all, indicating that generalist ceos may increase the likelihood of firm failure. for high-tech and non-high-tech enterprises, the hazard ratios are 3.724 and 1.571, respectively. according to this, the failure risk of a company with a generalist ceo is 272.4% higher than the failure risk of a high-tech company with a specialist ceo, and the failure risk of non-high-tech companies is 57.1%. the coefficient of the interaction between high-tech and a generalist ceo is insignificant, which means that the influence of a generalist ceo on ipo survival is not significantly different between high-tech and non-high-tech firms. 4.3.5. control for ceo power a powerful ceo can have a more significant effect on firm performance. following han, nanda, and silveri (2016) and gounopoulos and pham (2018), ceo power was constructed by applying pca based on ceo tenure, ownership, founder status, and chairmanship status. a ceo with a longer tenure tends to be risk-averse (e.g., (graham et al., 2013; wu et al., 2005)). studies show that managerial ownership and firm value are related (mcconell & servaes, 1990; morck et al., 1988; warfield et al., 1995). duru, iyengar, and zampelli (2016) state that ceo duality might reduce firm performance, but it can benefit the firm in the presence of board vigilance. fan, wong, and zhang (2007) show that a politically connected ceo can result in a lower first-day return in the chinese market. wu, li, ying, and chen (2018) show that the political connections of ceos have a positive impact on firm performance. therefore, a dummy variable that indicates if the ceo has political ties is also incorporated. asian journal of economics and empirical research, 2022, 9(2): 132-149 145 © 2022 by the authors; licensee asian online journal publishing group based on the ceo power index, the ceo is defined as powerful if the score is higher than the overall median. the dummy variable equals one if the ceo is powerful, and zero otherwise. table 10. control for high-tech firms. variable (1) (2) (3) total coefficient hazard ratio including coefficient hazard ratio excluding coefficient hazard ratio generalist ceo 0.525*** (0.16) 1.690 1.315*** (0.50) 3.724 0.452*** (0.16) 1.571 high technology 0.363 (0.46) 1.438 generalist ceo*high technology 0.353 (0.50) 1.424 diversification -0.013** (0.01) 0.987 -0.002 (0.02) 0.998 -0.015** (0.01) 0.985 log(firm age) -0.204* (0.11) 0.815 0.028 (0.47) 1.028 -0.247** (0.12) 0.781 log(sales) -0.324*** (0.11) 0.723 0.103 (0.50) 1.109 -0.370*** (0.12) 0.691 top-tier underwriter 0.042 (0.20) 1.043 0.264 (0.67) 1.302 -0.029 (0.21) 0.972 top-tier auditor 0.327** (0.15) 1.386 0.566 (0.52) 1.761 0.274* (0.16) 1.315 profitability -10.210*** (3.29) 0.000 -26.461* (14.73) 0.000 -8.807*** (3.23) 0.000 leverage 1.666** (0.79) 5.292 -0.111 (2.65) 0.895 1.887** (0.82) 6.601 market-to-book ratio 0.113*** (0.03) 1.120 -0.045 (0.11) 0.956 0.129*** (0.03) 1.138 initial return 0.028 (0.17) 1.028 -0.080 (0.95) 0.923 -0.045 (0.18) 0.956 year effect yes yes yes industry effect yes yes yes wald chi-square 192.84 34.16 17192.59 wald chi-square probability 0.0000 0.0080 0.0000 number of observations 1,216 102 1,114 note: this table illustrates the effect of generalist ceos on the probability of firm failure by controlling for high-tech firms. the models are controlled for industry and year fixed effects. robust standard errors are shown in parentheses below the coefficient estimates. ***, ** and * indicate statistical significance at 1%, 5% and 10%. table 11 presents the cox proportional hazards model controlling for ceo power. in panel a, the coefficients of generalist ceos in the overall sample, and a group of firms with powerful ceos, are positive and significant, suggesting that a firm with a generalist ceo is more likely to fail. additionally, for the whole sample and the group with only powerful ceos in specifications (1) and (2), the hazard ratios are 1.663 and 1.828, respectively. according to the data, the failure risk of a company with a generalist ceo is 66.3% greater than the failure risk of a company with a specialist ceo across the overall sample and is 82.8% higher across the sample with only powerful ceos. a variable is also constructed for the interaction of generalist ceos and a dummy variable (power), indicating whether the ceo is powerful. the coefficient is positive but insignificant, suggesting that ceo power cannot drive the influence of a generalist ceo on firm failure risk. in panel b, the generalist skills index is substituted for generalist ceos. now all of the coefficients of the generalist skills index through specifications (1) to (3) are significantly positive. the hazard ratios are 1.146, 1.150, and 1.153, respectively. this indicates that a one-unit increase in the generalist skills index can increase the failure risk by 14.6% for the entire sample, 15% for the sample with only powerful ceos, and 15.3% for the sample without powerful ceos. but again, the interaction between the generalist skills index and power is still insignificant. overall, the results reaffirm that ceo power cannot drive the effect of a generalist ceo on firm failure risk. 5. implication and conclusion this paper provides interesting findings on the relationship between ceo type and the probability of firm failure and ipo survival. using principal component analysis (pca), the generalist skills index is created based on six proxies: the number of roles held by the ceo, the number of firms for which the ceo has worked, the number of industries for which the ceo has worked, whether the ceo has held a ceo position in other companies, whether the ceo has worked for a conglomerate, and whether the ceo has a professional title. according to the survival tests, generalist ceos are more likely to see their companies fail than specialist ceos. this suggests that specialist ceos are concerned about their long-term positions in a firm and that their salary is closely correlated with the firm's performance. they are more inclined to take actions that support the business's existing strategy and the desires of the shareholders. generalist ceos with higher performance-related compensation are more likely to cause a company to fail because they are inclined to invest in high-risk projects to earn higher compensation and a better reputation. succession after the initial ceo is negatively related to firm performance. this, once again, affirms that a firm with a generalist ceo is more likely to fail. asian journal of economics and empirical research, 2022, 9(2): 132-149 146 © 2022 by the authors; licensee asian online journal publishing group table 11. control for ceo power. panel a. regression with generalist ceo variable (1) (2) (3) total coefficient hazard ratio including coefficient hazard ratio excluding coefficient hazard ratio generalist ceo 0.509** (0.22) 1.663 0.603*** (0.20) 1.828 0.414 (0.25) 1.513 power 0.194 (0.19) 1.214 generalist ceo*power 0.051 (0.24) 1.053 diversification -0.013** (0.01) 0.987 -0.010 (0.01) 0.990 -0.015 (0.01) 0.985 log(firm age) -0.191* (0.11) 0.826 -0.272** (0.14) 0.762 0.056 (0.21) 1.057 log(sales) -0.316*** (0.11) 0.729 -0.419** (0.17) 0.658 -0.342* (0.18) 0.710 top-tier underwriter 0.003 (0.20) 1.003 0.128 (0.26) 1.137 -0.152 (0.35) 0.859 top-tier auditor 0.326** (0.15) 1.385 0.287 (0.20) 1.332 0.468* (0.26) 1.597 profitability -9.925*** (3.26) 0.000 -6.750 (4.55) 0.001 -10.609* (5.52) 0.000 leverage 1.688** (0.79) 5.408 2.500** (1.08) 12.183 1.019 (1.20) 2.771 market-to-book ratio 0.115*** (0.03) 1.122 0.107*** (0.04) 1.113 -0.033 (0.09) 0.967 initial return 0.015 (0.16) 1.015 -0.162 (0.24) 0.851 0.377 (0.31) 1.458 year effect yes yes yes industry effect yes yes yes wald chi-square 7018.54 26250.03 28158.41 wald chi-square probability 0.0000 0.0000 0.0000 number of observations 1,216 632 584 panel b. regression with generalist skills index variable (1) (2) (3) total coefficient hazard ratio including coefficient hazard ratio excluding coefficient hazard ratio generalist skills index 0.136*** (0.05) 1.146 0.140*** (0.04) 1.150 0.143** (0.06) 1.153 power 0.145 (0.35) 1.156 generalist skills index*power 0.007 (0.06) 1.007 diversification -0.012** (0.01) 0.988 -0.009 (0.01) 0.991 -0.014 (0.01) 0.986 log(firm age) -0.208* (0.11) 0.812 -0.289** (0.13) 0.749 0.080 (0.22) 1.083 log(sales) -0.346*** (0.11) 0.708 -0.458*** (0.17) 0.633 -0.371** (0.18) 0.690 top-tier underwriter 0.018 (0.20) 1.018 0.182 (0.26) 1.200 -0.224 (0.35) 0.799 top-tier auditor 0.290* (0.15) 1.337 0.237 (0.20) 1.268 0.445* (0.26) 1.560 profitability -9.811*** (3.17) 0.000 -6.656 (4.43) 0.001 -10.301** (5.26) 0.000 leverage 1.734** (0.79) 5.666 2.457** (1.10) 11.669 1.254 (1.19) 3.505 market-to-book ratio 0.113*** (0.03) 1.119 0.099*** (0.03) 1.104 -0.016 (0.09) 0.984 initial return 0.051 (0.16) 1.052 -0.127 (0.24) 0.881 0.374 (0.31) 1.454 year effect yes yes yes industry effect yes yes yes wald chi-square 18914.52 390.21 30249.12 wald chi-square probability 0.0000 0.0000 0.0000 number of observations 1,214 630 584 note: this table illustrates the effect of generalist ceos on the probability of firm failure by controlling for powerful ceos. the models are controlled for industry and year fixed effects. robust standard errors are shown in parentheses below the coefficient estimates. ***, ** and * indicate statistical significance at 1%, 5% and 10%. in addition, the study controls for other ceo characteristics, including ceo gender, ceo age, ceo tenure, ceo education, and ceo ownership, which are found to affect firm performance. after controlling for other ceo characteristics, firms with a generalist ceo still have a greater failure rate. the issue of generalist ceos being asian journal of economics and empirical research, 2022, 9(2): 132-149 147 © 2022 by the authors; licensee asian online journal publishing group preferred by businesses with a higher likelihood of failure is addressed through propensity scoring matching, and the results are still valid. the study also controls for firm characteristics. businesses listed on the three boards (chinext, szse, and sse) set various regulatory and threshold requirements. firms on the chinext and szse are characterized by their small and medium sizes. robustness tests show that, after controlling for the boards, generalist ceos continue to increase the likelihood of firm failure, and boards cannot explain the effect of generalist ceos on firm survival. firms on the chinext and szse are also characterized by high-tech firms with rapid growth and high risk. after controlling for high-tech firms, generalist ceos still increase the probability of firm failure. powerful ceos can have a more significant effect on firm performance. to control for powerful ceos, ceo power was constructed based on ceo tenure, ownership, whether the ceo is the founder, whether the ceo is the chairman, and whether the ceo is politically connected. the results confirm that firms with a generalist ceo have a higher probability of failure. this research on the connection between a generalist ceo and failure risk contributes to the advancement of corporate finance theory. additionally, it offers insights regarding ceo hiring decisions and the job market activity of organizations. references ahmad, w., & jelic, r. 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(2018). delisting pressure, executive compensation, and corporate fraud: evidence from china. pacific-basin finance journal, 48, 17-34.available at: https://doi.org/10.1016/j.pacfin.2018.01.003. appendix 1 presents the definitions of the variables used in this paper. appendix 1. variable definitions. variable definition panel a. generalist skills index number of roles the number of roles a ceo has taken. number of firms the number of firms in which a ceo was employed. number of industries the number of industries a ceo has worked in. ceo experience dummy a dummy variable that equals one if a ceo took a ceo position in other firms. conglomerate dummy a dummy variable that equals one if a ceo has worked in a conglomerate. professional title dummy a dummy variable that equals zero if a ceo has earned a professional title. generalist skills index principal component analysis (pca) was used to construct a generalist skills index based on the number of roles, firms, industries, ceo experience, conglomerate, and professional title dummy. the first factor of pca is taken as the generalist skills index. specialist ceo a dummy variable that equals one if he or she is a specialist ceo. if the generalist index value is less than the index median, the ceo is defined as specialist. generalist ceo a dummy variable that equals one if he or she is a generalist ceo. a ceo is defined as generalist if the generalist index value is greater than the index median. asian journal of economics and empirical research, 2022, 9(2): 132-149 149 © 2022 by the authors; licensee asian online journal publishing group variable definition panel b. ceo power ceo-chairman a dummy variable that equals one if the ceo is also a chairman. ceo-founder a dummy variable that equals one if the ceo is also a founder. ceo-ownership the ratio of ceo-owned ownership over the total number of shares. ceo-tenure measured as the number of years since a ceo has worked in a firm up to the ipo date. ceo-political a dummy variable that equals one if a ceo is politically connected. panel c. other ceo characteristics ceo age the age of a ceo. ceo gender a dummy variable that equals one if the ceo is male, zero otherwise. ceo education a dummy variable that equals one if the ceo has earned a bachelor’s or higher degree. ceo compensation a ceo’s performance-related compensation. panel d. firm and ipo characteristics log(firm age) measured as the natural logarithm of the difference between the ipo and founding dates. the unit is days. log(sales) the natural logarithm of total sales in the issue year. the unit is million yuan. profitability measured as the earnings before interest, tax, depreciation, and amortization over total assets in the issue year. leverage measured as the liability over total assets in the issue year. diversification measured as the number of business segments. initial return measured as the first-day return following the ipo. top-tier underwriter a dummy variable that equals one if a firm hires a top-tier underwriter, zero otherwise. a top-tier underwriter is in the top 10% ranking of the average underwritten amount and the number of ipos underwritten. top-tier auditor a dummy variable that equals one if a firm hires a top-tier auditor, zero otherwise. a toptier auditor is defined as being in the top 10% ranking of the volume of business. market-to-book ratio the ratio of the market value to the book value. succession a dummy variable that equals one if there is at least one succession for the firm, zero otherwise. n_succession the number of ceos following the ceo at the time of the ipo. the asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc., caused in relation to/arising from the use of the content. any queries should be directed to the corresponding author of the article. 21 © 2022 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 9, no. 1, 21-37, 2022 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v9i1.3733 © 2022 by the international monetary fund, licensee asian online journal publishing group a simple macro-fiscal model for policy analysis: an application to cambodia daniel baksa1 ales bulir2 dyna heng3 ( corresponding author) 1,2,3international monetary fund, usa. 1email: dbaksa2@imf.org tel: +1202-437-9106 2email: abulir@imf.org tel: +1202-683-0115 3email: dheng@imf.org tel: +1202-304-9167 abstract macroeconomic management in many developing countries is often heavily dependent on fiscal policies. this paper develops a semi-structural macro-fiscal model for simulating and forecasting macroeconomic policies in cambodia. the model is calibrated to capture key characteristics of cambodia’s economy and serves as a tool for scenario analysis. we demonstrate its application with an illustrative scenario of the macroeconomic effects of the covid-19 pandemic. the model’s results conform with past empirical analyses of the cambodian economy and generate intuitive and easyto-understand policy scenarios. complemented with near-term forecasting tools and expert judgment, the dynamics of the model help to inform policymakers about medium-term transmission channels and thus guide policy advice. in particular, the results could serve as an input for the country’s medium-term fiscal framework and debt sustainability analysis. keywords: business cycle, fiscal policy, cambodia, forecasting, simulation, debt management. jel classification: e32; e52; e58; e62; f47, h68. citation | daniel baksa; ales bulir; dyna heng (2022). a simple macro-fiscal model for policy analysis: an application to cambodia. asian journal of economics and empirical research, 9(1): 21-37. history: received: 14 december 2021 revised: 16 february 2022 accepted: 25 february 2022 published: 28 february 2022 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. authors’ contributions: all authors contributed equally to the conception and design of the study. acknowledgement: this paper was originally published as an imf working paper. it greatly benefited from discussions with the staff of cambodia’s ministry of economy and finance and the national bank of cambodia. the views expressed in this paper are those of the authors and not necessarily those of the cambodian authorities, the international monetary fund, or its executive board. competing interests: the authors declare that they have no conflict of interest. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction ...................................................................................................................................................................................... 22 2. the macro-fiscal model ................................................................................................................................................................ 22 3. recent economic developments in cambodia and camfi calibration .............................................................................. 26 4. a policy-relevant exercise............................................................................................................................................................ 32 5. caveats and potential extensions ................................................................................................................................................ 33 6. conclusions ....................................................................................................................................................................................... 34 references .............................................................................................................................................................................................. 34 mailto:dbaksa2@imf.org mailto:abulir@imf.org mailto:dheng@imf.org http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.doi.org/10.20448/ajeer.v9i1.3733 https://orcid.org/0000-0002-6865-6159 asian journal of economics and empirical research, 2022, 9(1): 21-37 22 © 2022 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this paper contributes to the growing literature on forecasting and policy analysis systems that in many countries are designed to support forward-looking fiscal and monetary policy formulation. this paper presents a macro-fiscal tool, the simulation results of which can serve as inputs for a medium-term fiscal framework in cambodia. 1. introduction for the past 30 years, economists have been building simple, policy-relevant models, typically with either a monetary or a fiscal transmission mechanism. rarely do these models give equal attention to both. most policy applications have been adopted by central banks rather than ministries of finance. in contrast, we build a parsimonious semi-structural model that can be used to simulate and forecast the effects of both monetary and fiscal policies for all relevant monetary and exchange rate arrangements. compared to more detailed frameworks, including those of the imf financial programming (fp), which are built around many variables and identities, this model uses fewer variables and binds them together in a way that has been tested both theoretically and empirically. we have adapted the basic approach for use in cambodia and present a scenario of possible macroeconomic effects of the covid19 pandemic there. we augment the standard new keynesian monetary transmission channels for stylized fiscal interactions and debt dynamics; for the former, our model consists of an aggregate demand (is) curve, a price-setting (phillips) curve, an uncovered interest rate parity (uip) relationship, and a monetary policy reaction function that reflects the given monetary and exchange rate arrangement.1 these building blocks capture the principle that the fundamental role of monetary policy is to anchor inflation and inflation expectations. to capture the role of the fiscal authority, we add the fiscal balance, its financing, debt dynamics, and a fiscal policy reaction function. this structure is consistent with a view of the world in which because nominal and real rigidities prevent the instantaneous adjustment of prices and wages, in the short run, aggregate demand determines output; also, expectations play a role in inflation, output, and fiscal sustainability, and both monetary and fiscal policy are rule-based and predictable. the presented model simplifies the task of analyzing scenarios for macroeconomic policies and assessing their impact. developing and comparing such scenarios is time-consuming, particularly when ensuring internal consistency despite a lack of solid structure. a parsimonious model that can be scaled up could become the mainstay of a standard analysis toolkit. the goal of this paper is to first define and then test such a minimalist approach. to be applicable, a policy-oriented macroeconomic model must satisfy two conditions: (1) it must take into account generally accepted fiscal and monetary transmission channels, and (2) it should be parsimonious so that it is usable in countries with low-frequency data and without a tradition of model-based policy analysis. indeed, our target audience is a country that does not have sophisticated models to support macroeconomic decision-making at its disposal. cambodia is a fast-growing, lower-middle-income, open economy. because it is vulnerable to adverse external shocks, its policymakers seek to understand how such shocks are propagated, their mediumand long-term impacts on cambodia’s economy, and the likely effects of different domestic policy responses to these shocks. to serve as a tool for scenario analysis, we develop and calibrate a simple, macro-fiscal, semi-structural model that captures stylized facts about cambodia’s economy. we call it the cambodia macro-fiscal model (camfi). the key benefit of our approach is that it strictly limits the number of macroeconomically relevant variables while maintaining theoretical consistency. for the sake of parsimony, we drop sectors and variables that are less relevant to the specific analysis or that cannot be easily modeled for cambodia. for example, in cambodia, policy analysis focuses on domestic developments, but because the current account deficit is financed entirely by sustainable foreign direct investment (fdi) inflows, there is little benefit in modeling components of the trade or financial balance. similarly, because the supply side of the semi-structural models is largely exogenous, there is little to gain from modeling revenue and expenditure components—imposing revenueand expenditure-specific multipliers would be superficial. therefore, in our model, the fiscal authority chooses a single policy variable: the cyclically-adjusted primary balance. we recognize that by simplifying the external sector into a risk premium variable or aggregating all fiscal operations into the primary balance variable we are foregoing the possibility of a more granular analysis. should the simulation tasks change or different sectors and components gain prominence, the model would need to be either extended to account for such new factors or supplemented by satellite models. we remain mindful, however, of the cost of expansion—the comparative simplicity of this model allows much simpler data updates than traditional frameworks with many variables. we calibrate the model, apply it to the cambodian data, and then illustrate how it works in several applications: impulse response functions, a multivariate filtration to obtain important unobserved variables, a test of the model’s recursive forecasting capability, and the design of an exercise to simulate the medium-term economic impact of covid19 shock. the camfi results conform with past empirical analyses of the cambodian economy and stylized facts, as well as generating intuitive and easy-to-understand policy scenarios. the rest of the paper is organized as follows: section ii describes the semi-structural model, with a fiscal extension. section iii briefly discusses recent developments in cambodia and their implications for the calibration of the model. section iv illustrates applications of the camfi model in assessing the economic impact of covid-19 in cambodia. section v discusses caveats and the potential extension of the model. section vi concludes. 2. the macro-fiscal model the semi-structural model we present here is similar to those many central banks use for policy analysis; it generally corresponds to what fukac and pagan (2010) called the 3rd generation (3g) of policy models. a steadystate model is at the core of 3g frameworks: the dynamics embedded in the model describe the transition from one steady state to another, so that solving the model produces a transitional steady-state solution for its variables— they will vary over time because movements from one point to another are not instantaneous. in addition, because 1 we build on the model developed by kamenik, tuma, vavra, and smidova (2013). asian journal of economics and empirical research, 2022, 9(1): 21-37 23 © 2022 by the authors; licensee asian online journal publishing group some variables are taken to be exogenous and are thus treated as determined outside the model economy, they need not correspond to their steady-state values in any period. as attention is centered on the “gap” between the steadystate estimate, 𝑧𝑡 ∗, and the observed value, 𝑧𝑡, it is therefore natural to convert all the variables in the model to the gap format, producing what are often called “gap models” or “trend-gap models.” we have extended the model to incorporate a rudimentary fiscal and debt-accounting block, recast it to annual frequency, and calibrated it to capture the stylized facts of cambodia’s macroeconomic policies. it blends the new keynesian emphasis on nominal and real rigidities and the role of aggregate demand in output determination with the real business cycle methods of dynamic stochastic general equilibrium (dsge) modeling with rational expectations (berg, karam, & laxton, 2006). rather than deriving the baseline model from strictly microeconomic foundations, we pragmatically allow both adaptive and rational expectations and substantial inertia in the equations to match the data. the camfi model has five building blocks, as summarized in figure 1 and detailed in appendix c: 1. an aggregate demand or is curve that relates the level of real activity to expected and past real activity, the real interest rate, the real exchange rate, the fiscal impulse, and foreign demand. 2. a price-setting or phillips curve that relates current inflation to past and expected inflation, the output gap, the exchange rate, and oil prices. the relationships in (1) and (2) are independent of the monetary and exchange rate regime prevailing in the country under consideration. 3. a uip condition for the exchange rate that incorporates the country risk premium. this equation can take multiple forms in the model as it is formulated to reflect the exchange rate regime—in the case of cambodia, a heavily-managed float that has stabilized the exchange rate at about 4,050 riels per us$1, with an open capital account.2 here, for the sake of parsimony, we have chosen to omit the external balances. the sizable current account deficit has been (over)financed by sustainable fdi inflows (imf (international monetary fund), 2019). the uip is also the model’s reaction function for setting the domestic interest rate: the foreign rate plus a country risk premium (obstfeld, shambaugh, & taylor, 2005). thus, monetary policy passively accommodates movements in the world interest rate. the national bank of cambodia (nbc) has been keeping the exchange rate stable through a strict policy of not lending to the government—thus also signaling its independence. the monetary and exchange rate regime in our model is tailored to cambodia’s stylized facts, and the equations are regime-dependent: for a country with an independent monetary policy a different specification would be required. 4. the model is expanded to incorporate a fiscal policy reaction function. in practice, the cambodian government has been following the “fiscal golden rule” for its current fiscal balance, while borrowing externally for some investment spending.3 this policy is equivalent to saying that the fiscal authority decides on a cyclicallyadjusted primary deficit, taking into account the country’s cyclical position and its announced gross debt target. 5. the model is closed with the usual debt accounting identity. the deficit is financed either by accumulating debt or dissaving government deposits. above-target debt increases the risk premium and thus raises the neutral real interest rate and vice versa. figure 1. key links in the macrofiscal model. a. aggregate demand the aggregate demand relationship—the is curve—links the domestic output gap to past and expected output gaps, monetary conditions, the fiscal stance, and the foreign output gap: �̂�𝑡 = 𝑎1�̂�𝑡−1 + 𝑎2𝐸𝑡�̂�𝑡+1 − 𝑎3𝑚𝑐𝑖𝑡 + 𝑎4𝑓𝑡 𝑖𝑚𝑝 + 𝑎5�̂�𝑡 ∗ + 𝜀𝑡 𝑦 , (1) where �̂�𝑡 is the output gap, defined as the deviation of the log of real output from its trend, 𝑚𝑐𝑖𝑡 denotes the real monetary conditions index, 𝑓𝑡 𝑖𝑚𝑝 is the fiscal impulse, �̂�𝑡 ∗ is the foreign output gap, and 𝜀𝑡 𝑦 is an aggregate demand shock. 2 “the de jure exchange rate arrangement is a managed float. given the high degree of financial dollarization, the national bank of cambodia (nbc) intervenes in the foreign exchange market to accommodate demand for riels and maintain exchange rate stability. the de facto exchange rate arrangement is classified as other managed.” (imf (international monetary fund), 2018c). 3 the current balance is the difference between current revenue and current expenditure and the “fiscal golden rule” states that over the economic cycle the government should borrow only to invest, not to fund current spending (see, e.g., hm treasury (2008)). asian journal of economics and empirical research, 2022, 9(1): 21-37 24 © 2022 by the authors; licensee asian online journal publishing group all parameters—𝑎𝑖 , 𝑏𝑖, 𝑒𝑖, 𝑓𝑖, and 𝑔𝑖—have positive values, and 𝐸𝑡 denotes model-consistent (“rational”) forwardlooking expectations. the gaps, denoted with “hats,” are calculated as differences of the actual, observed variables from their estimated trends, denoted with tildes, 𝑥𝑡 = 𝑥𝑡 − �̃�𝑡. the real monetary conditions index (𝑚𝑐𝑖) is defined as a weighted average of deviations of the real interest rate, the credit risk premium, and the real exchange rate from their trends: 𝑚𝑐𝑖𝑡 = 𝑎6(�̂�𝑡 + 𝑐𝑟_𝑝𝑟𝑒𝑚𝑡) + (1 − 𝑎6)(−�̂�𝑡), (2) where �̂�𝑡 is the deviation of the real interest rate (�̂�𝑡 = 𝑖𝑡 − 𝐸𝑡𝜋𝑡+1 − �̃�𝑡) from its trend (neutral, �̃�𝑡) level, 𝑐𝑟_𝑝𝑟𝑒𝑚𝑡 is the credit risk premium, and �̂�𝑡 is the deviation of the real exchange rate from its trend. what kind of interest rate do we have in mind? as long as the term and risk premiums for various maturities and financial instruments evolve in tandem, we can work with the short-term, interbank interest rate so that innovations are transmitted along the yield curve.4 the real interest rate, 𝑟𝑡, applies only to private debt service; it reflects, among other factors, the country risk premium and external financial developments. another real interest rate, 𝑟𝑡 𝑔𝑜𝑣 , in the model applies only to concessional borrowing by the government; it is low and stable. as is discussed below, because cambodia’s public debt is all on concessional terms, it is reasonable to disconnect these two interest rates, especially since the interest rate on public debt was stable even through the global financial crisis (gfc). the real exchange rate is defined as the nominal exchange rate adjusted for differences in domestic and world price levels, 𝑧𝑡 = 𝑠𝑡 + 𝑝𝑡 ∗ − 𝑝𝑡, where 𝑠𝑡 are units of domestic currency (for cambodia, the riel) per us dollar, 𝑝𝑡 ∗ is the foreign and 𝑝𝑡 the domestic cpi index. thus, an increase in 𝑧𝑡 implies a more depreciated—and a decrease a more appreciated—domestic currency in real terms. the fiscal impulse, 𝑓𝑡 𝑖𝑚𝑝 , defined as the change in the cyclically-adjusted balance, 𝑐𝑎𝑑𝑡, indicates whether current fiscal policy is adding to or subtracting from aggregate demand (see more on the 𝑐𝑎𝑑 variable in section 2.d). the fiscal impulse also reflects movements in the debt target or the discretionary changes in the debt ratio: 𝑓𝑡 𝑖𝑚𝑝 = (𝑐𝑎𝑑𝑡 − 𝑐𝑎𝑑𝑡−1) + 𝑓4𝜀𝑡 𝑏𝑡𝑎𝑟 ± 𝑓5𝜀𝑡 𝑏 , (3) where 𝜀𝑡 𝑏𝑡𝑎𝑟 is a shock to the debt target and 𝜀𝑡 𝑏 a shock to the debt ratio. the former makes it possible to capture the expansionary effect of an announcement of a higher or lower debt target—the agents will expect a sequence of corresponding positive or negative future fiscal impulses and adjust their expected spending accordingly. the latter makes it possible to model the impact of debt changes as either traditional keynesian contractionary stabilizations (𝑓5 > 0) or non-keynesian expansionary stabilizations (𝑓5 < 0), as defined by alesina and ardagna (2010). while the model does not detail the transmission mechanism, based on expert judgment it is possible to design fiscal stabilization scenarios as contractionary, expansionary, or growth-neutral (𝑓5 = 0).5 monetary policy affects aggregate demand through the real exchange rate and the real interest rate gaps, as aggregated in the monetary conditions index, 𝑚𝑐𝑖𝑡 . tighter monetary policy (a higher 𝑚𝑐𝑖𝑡) reduces the output gap either through a higher real interest rate (a higher �̂�𝑡) or an appreciated real exchange rate (a lower �̂�𝑡). fiscal policy directly affects aggregate demand through the fiscal impulse—the parameter 𝑎4 is very close to the impact multiplier (see appendix b for a discussion of the value of the multiplier). b. aggregate supply the aggregate supply block, the phillips curve, links inflation to adaptive and forward-looking expectations of inflation, real marginal costs, and oil prices: 𝜋𝑡 = 𝑏1𝜋𝑡−1 + (1 − 𝑏1)𝐸𝑡𝜋𝑡+1 + 𝑏2𝑟𝑚𝑐𝑡 + 𝑏3δ𝑜𝑖𝑙𝑡 + 𝜀𝑡 𝜋 , (4) 𝑟𝑚𝑐𝑡 = 𝑏4�̂�𝑡 + (1 − 𝑏4)�̂�𝑡. (5) current period inflation, 𝜋𝑡, depends on forward-looking inflation expectations (𝐸𝑡𝜋𝑡+1), backward-looking expectations (𝜋𝑡−1), the real marginal costs (𝑟𝑚𝑐𝑡), and a change in dollar-denominated oil prices adjusted for exchange rate appreciation or depreciation, δ𝑜𝑖𝑙𝑡. the term 𝑟𝑚𝑐 captures the weighted average of the real exchange rate gap and the output gap; in general, one can relate the real marginal cost for domestic producers to the output gap, �̂�𝑡, and that for importers to the real exchange rate gap, �̂�𝑡. the calibrated value of 𝑏1 is our best guess of the share of backward-looking agents in the price-setting process. the product 𝑏2 ∙ 𝑏4 measures the slope of the phillips curve with respect to the output gap. as is common in models that are designed to capture business cycle fluctuations, aggregate supply is largely an exogenous process. the economy grows along a calibrated potential output path that can be altered only marginally by movements in the equilibrium real interest rate. specifically, in our model, higher-than-targeted public debt raises both the country risk premium and the equilibrium interest rate, thus depressing the rate of growth of potential output. we discuss the debt-to-potential-growth nexus in section 2.d. c. the exchange rate, uncovered interest rate parity, and the policy reaction function exchange rate regimes require appropriate equations to capture their role. moreover, the specifications must be consistent with the monetary policy regime.6 fortunately, there are tested versions of these equations for all regime combinations. cambodia’s combination is straightforward: a heavily managed exchange rate with an open capital account. from mid-2008, the riel-to-dollar rate has oscillated around a mean of about 4,050 riels, we thus treat this 4 see bulíř and vlček (2021). assumption of a stable factor greatly simplifies the model, making it unnecessary to build an explicit term structure of interest rates—most private-sector lending in cambodia has a maturity of at most one year. in fact, the terms for private sector loans of various maturities have been relatively stable. 5 in a traditional keynesian fiscal stabilization, either through higher taxes or lower spending, lower debt (𝜀𝑡 𝑏 < 0) will cause a negative fiscal impulse, hence, 𝑓5 > 0. under which circumstances could stabilization be expansionary (𝑓5 < 0)? some economists have argued that a fiscal adjustment today removes expectation of future harsher adjustments or future tax hikes, thus stabilizing expectations, increasing consumer expected disposable income, boosting the confidence of investors, and therefore stimulating private demand (giavazzi & pagano, 1996). 6 the mundell-fleming trilemma says that each country must choose between the objectives of free capital mobility, exchange-rate management, and monetary autonomy (obstfeld et al., 2005)—only two can be pursued simultaneously. asian journal of economics and empirical research, 2022, 9(1): 21-37 25 © 2022 by the authors; licensee asian online journal publishing group value as an implicit but widely understood and credible exchange rate target. we assume that the nbc’s international reserves are sufficient to keep the exchange rate stable. thus, in the model, we treat the exchange rate regime as a de facto peg. it is useful to recall what a credible exchange rate commitment implies for competitiveness: the country cannot restore price competitiveness by devaluing the nominal exchange rate. should the real exchange rate become misaligned—due to either a negative productivity shock or higher domestic inflation relative to its trading partners—the eventual realignment must come through lower-than-trading-partner wage and price inflation, i.e., internal devaluation. the peg is then effectively equivalent to a price-level targeting regime that ensures that purchasing power parity (ppp) holds in the medium term; thus, time subscripts are not necessary in our notation: ∆�̃� = ∆�̃� + �̃�∗ − �̃�, (6) where �̃� denotes the trend rate of growth of the real exchange rate, i.e., “equilibrium” appreciation or depreciation, �̃� is the trend rate of growth of the nominal exchange rate, and �̃�∗ and �̃� indicate foreign and domestic inflation trends. as long as the nominal exchange rate is pegged (𝛥�̃� = 0) and the country desires to keep price competitiveness at the current level (hence, 𝛥�̃� = 0), foreign and domestic price levels have to grow at the same pace over the medium term, �̃�∗ = �̃�. this result is equivalent, of course, to price-level targeting. the uip condition then pins down the domestic interest rate, 𝑖𝑡, since the nbc cannot pursue active monetary policy: 𝑖𝑡 = (𝐸𝑡𝑠𝑡+1 − 𝑠𝑡) + 𝑖𝑡 ∗ + 𝑝𝑟𝑒𝑚𝑡 + 𝜀𝑡 𝑠 (7) where 𝑠𝑡 is the nominal exchange rate defined in domestic currency terms per us dollar, 𝐸𝑡𝑠𝑡+1 is the modelconsistent expectation of the nominal exchange rate in period t+1 (as long as the peg remains credible, 𝛥𝐸𝑡𝑠𝑡+1 = 0), 𝑖𝑡 ∗ is the foreign nominal interest rate, 𝑝𝑟𝑒𝑚𝑡 is the country risk premium, which is expected to increase or decrease with government debt compared to the target level, and 𝜀𝑡 𝑠 is the exchange rate shock. d. the fiscal block the model is closed with an aggregated fiscal block that anchors the public’s expectations of fiscal sustainability and links the fiscal policy (flow) variable with financing (stock) variables. here, the fiscal authority decides on a sole policy variable, namely the cyclically-adjusted primary balance, guided by the country’s cyclical position and its announced gross debt target. we justify the aggregation by noting that our semi-structural framework has an exogenously set supply side: the rate of potential growth does not depend on the mix of direct and indirect taxes, but is calibrated and assumed to remain constant for the duration of the simulations so that breaking down revenues or expenditures would be superficial with no feedback into the supply side. true, by aggregating all fiscal operations into a single variable we are foregoing the possibility of a granular analysis of multipliers and composition effects of fiscal policy, but in our view, decomposition is better left to a fully micro-founded dsge model. fiscal authority decisions related to the golden rule can be simplified into two steps. (1) the policymaker decides on the cyclically-adjusted primary fiscal deficit, 𝑐𝑎𝑑𝑡 . because cambodia’s public borrowing has all been concessional, the government interest bill is not only small but is generally not sensitive to international rate movements and swings in risk premiums.7 (2) the policymaker decides how to finance the corresponding balance: either through debt accumulation or repayment, ∆𝑏𝑡, or through dissaving or accumulation of government deposits, ∆𝑥𝑡. in line with the literature on fiscal rules, our fiscal policy reaction function has two competing objectives: to smooth output fluctuations and to anchor gross public debt to a target, which is presently calibrated at 30 percent of gdp (plödt & reicher, 2015). regarding the former, the fiscal authority wants to avoid large swings in the balance compared to the last period, 𝑐𝑎𝑑𝑡−1, and also wishes to respond to a positive or negative output gap, �̂�𝑡, with a tighter or looser deficit. regarding the latter, debt stabilization implies setting the cyclically-adjusted balance at a level consistent with the debt target, 𝑐𝑎𝑑𝑡 𝑡𝑎𝑟, adjusted for the current-period deviation of debt from its target level, 𝑏𝑡 𝑑𝑒𝑣.8 intuitively, lower-than-targeted debt (𝑏𝑡 𝑑𝑒𝑣 < 0) implies tighter fiscal policy, producing either a surplus or a smaller deficit than (𝑏𝑡 𝑑𝑒𝑣 = 0), and vice versa: 𝑐𝑎𝑑𝑡 = 𝑓7(𝑐𝑎𝑑𝑡−1 − 𝑓10�̂�𝑡) + (1 − 𝑓7)(𝑐𝑎𝑑𝑡 𝑡𝑎𝑟 − 𝑓8𝑏𝑡 𝑑𝑒𝑣) + 𝜀𝑡 𝑐𝑑. (8) the obvious implication of these two competing objectives is that in the short run neither is fully achievable: while the fiscal authority may want to stimulate the economy by running a larger cyclically-adjusted deficit, it would be held back by debt concerns. similarly, a faster return to the debt target would conflict with the output-smoothing objective. deviation from the debt target, 𝑏𝑡 𝑑𝑒𝑣, is a forward-looking process as the fiscal authority assesses both the current deviation and the expected future path, where the debt target itself could be time-varying: 𝑏𝑡 𝑑𝑒𝑣 = 𝑓9(𝑏𝑡 − 𝑏𝑡 𝑡𝑎𝑟) + (1 − 𝑓9)𝐸𝑡𝑏𝑡+1 𝑑𝑒𝑣. (9) debt accumulation follows the usual law of motion: 𝑏𝑡 = 𝑑𝑡 + ∆𝑥𝑡 + (1 + 𝛥𝑠𝑡)𝑏𝑡−1/(1 + 𝑔𝑡), (10) where 𝑏𝑡 is the debt-to-gdp ratio at year 𝑡, and 𝑑𝑡 is the overall deficit (𝑑𝑡 > 0 indicates a deficit, 𝑑𝑡 < 0 a surplus); 𝑔𝑡 is the growth rate of nominal gdp, 𝛥𝑠𝑡 denotes the revaluation term of foreign-currency-denominated concessional debt, and ∆𝑥𝑡 denotes changes in government deposits. the choice of financing between changes in the stock of debt and the stock of deposits at the central bank goes beyond a simple accounting exercise—certainly in cambodia. disbursements by external lenders are relatively infrequent and mostly related to donor-funded investment projects. in the absence of short-term treasury bills or borrowing from the banking system, to finance its day-to-day operations the treasury has built a buffer of government deposits at the nbc.9 this brings up a somewhat peculiar feature of cambodia’s fiscal operations: in the short run, 7 recall that the market interest rate for the private sector differs from the interest rate on public debt. 8 the cyclically-adjusted budget balance is the balance that would obtain when gdp reaches its potential. the cyclically-adjusted measure better describes the stance of fiscal policy than the headline balance, as it removes the endogenous components of spending and revenues. in our model we use the common definition of the cyclically-adjusted balance, see fedelino, ivanova, and horton (2009): 𝑐𝑎𝑑 = −𝜖�̂�, and our calibration of 𝜖 follows (price, dang, & botev, 2015). 9 the impact of changes in government deposits (negative net claims on government) on private sector lending depends on where government savings are deposited. if they are deposited in the central bank, as in cambodia, the impact on private sector lending is zero. if they are deposited in commercial banks, their asian journal of economics and empirical research, 2022, 9(1): 21-37 26 © 2022 by the authors; licensee asian online journal publishing group gross debt is “passive,” reflecting the donor-driven supply of loans. in contrast, government deposits are an “active,” domestically-determined variable. in good times, the fiscal authority borrows more than is needed and saves the proceeds in the central bank, effectively pre-financing future debt needs. in bad times, it draws down these deposits without needing to approach either concessional lenders or capital markets. the fiscal authority, therefore, targets a level of deposits that guarantees current and future payment of its bills, keeping in mind the cyclical position of the economy. we specify the following law of motion for government deposits, ∆𝑥𝑡: ∆𝑥𝑡 = 𝑔2∆𝑥𝑡−1 + (1 − 𝑔2)(∆𝑥𝑡 𝑡𝑎𝑟 + 𝑔3�̂�𝑡 + 𝑔4(𝑝𝑑𝑡 − 𝑝𝑑𝑡 𝑡𝑎𝑟)) + 𝜀𝑡 𝑥, (11) where 𝑥𝑡 𝑡𝑎𝑟 is the desired level of government deposits; based on the historic average, we calibrate its steadystate value at 8 percent of gdp. the policymaker will smooth out deposits around the target, accumulating deposits when the economy operates above its potential and “decumulating” when it operates below, and then accumulate or decumulate as needed, whenever the primary deficit deviates from the debt-stabilizing level. a further reason to separate the financing items is their differential impact on the risk premium and thus on the neutral real interest rate. empirically, countries with larger gross debt-to-gdp ratios have had to offer higher yields to investors (engen & hubbard, 2004; jaramillo & weber, 2012). during periods of financial turmoil, as in a cyclical downswing or with a primary deficit temporarily above the debt-stabilizing level, countries should be better off drawing down buffer stocks of deposits rather than borrowing at higher, non-concessional rates.10 a depositdissaving scenario would limit the impact on the risk premium and thus keep the equilibrium real interest rate lower than in the scenario with higher gross debt. ultimately, higher equilibrium real interest rates limit growth because fewer investment projects are deemed profitable (schumacher & żochowski, 2017). 3. recent economic developments in cambodia and camfi calibration with monetary policy limited by dollarization, the authorities have relied on fiscal policy to stabilize the economy. after sketching out the main stylized facts, we explore the implications for the calibration of our model. we must stress that all data, charts, and camfi simulation results are based on the mid-2020 vintage of the cambodia dataset. several of the series have subsequently been revised (e.g., fiscal deposits) or are due to be updated (e.g., nominal gdp is due for a substantial revision in 2022). a. recent economic developments since cambodia’s internal conflict ended in 1998, followed by the liberalization of trade and the capital account, the country has averaged real gdp growth of 7¾ percent, with average inflation of about 4 percent. growth has been driven by garment exports, tourism, and construction, much of it funded by foreign investment (chart 1 in figure 2). openness to trade and capital flows under a stable exchange rate, while boosting growth, has also increased the country’s external vulnerability, especially given its narrow economic base and increasing dependence on foreign funding. cambodia does not borrow on private capital markets. the economy is almost completely dollarized, which limits the nbc’s monetary policy options (charts 2 and 3). in 2019, more than 90 percent of savings, loans, and economic transactions were in us dollars, with the exchange rate averaging about 4,050 riels per dollar. robust fdi inflows have contributed to gross international reserves equivalent to about 7 months of imports. reserves have been assessed as adequate when measured against traditional metrics, but the imf (international monetary fund) (2019) has encouraged further accumulation. given the monetary regime, the burden of macroeconomic management rests largely on fiscal policy. fiscal reforms have improved revenue collection and spending efficiency (imf (international monetary fund), 2018a), resulting in a series of small deficits and surpluses. operationally, the government has been running a small surplus on the current balance, with foreign grants and concessional lending covering most capital expenditures (chart 4). the cyclically-adjusted balance has improved significantly since the gfc (chart 5). before the covid-19 pandemic, gross external debt had stabilized at about 30 percent of gdp, and by 2019 the government had deposits equal to about 15 percent of gdp at the nbc (chart 6).11 net public external debt declined from its peak of 39 percent of gdp in 2003 to 13 percent in 2019. as all borrowing was on concessional terms, public debt service in 2015–19 averaged only about 0.3 percent of gdp. nevertheless, the authorities are anxious to better understand the transmission channels and simulate the impact of large macroeconomic shocks on fiscal sustainability.12 the biggest current shock is, of course, covid-19. b. calibration the answers any model gives depend crucially on its parameter values. we calibrate the camfi to capture country-specific features, as suggested by berg, karam, & laxton (2006). the adequacy of a model for policy analysis depends primarily on how well it captures the main transmission channels. for example, we expect the model to provide reasonable estimates of the sensitivity of net public debt to the business cycle or exchange rate passthrough. to this end, our choice of parameters is based on four considerations: (1) whenever it is meaningful, we econometrically assess the relationships or base the calibration on expert judgment. this approach is suitable, for example, to assess the persistence of such variables as the output gap. (2) where the necessary data are available, we compare the model impulse response functions with empirical evidence; for cambodia, however, empirical results are limited, see rungcharoenkitkul (2012). (3) we assess whether the model can produce such unobserved variables as potential output or the equilibrium real exchange rate that would be consistent with the generally accepted narrative withdrawal would crowd out private lending and the net government position would become less negative. as long as money supply remains unchanged, private sector credit would be a residual item and would have to decline one-for-one with the drawdown of government deposits. 10 the empirical literature on aid agrees that donors, other than multilateral donors, act procyclically on average. donors typically do not increase concessional disbursements during crises, but aid disbursements decline as recipient countries tend to fail conditionality targets during crises (bulíř & hamann, 2008; pallage, robe, & bérubé, 2006; romero-barrutieta, bulíř, & rodríguez-delgado, 2015). 11 cambodia has a formal external debt ceiling of 40 percent of gdp and a domestic debt ceiling of 15 percent but has not borrowed domestically at all. 12 several such shocks were explored during past technical assistance visits. for example, in february 2020 the european commission decided to partially withdraw cambodia’s preferential access to the eu market “due to the serious and systematic violations of human rights principles” https://ec.europa.eu/commission/ presscorner/detail/en/ip_20_229. on january 1, 2020, casinos in the seaside resort of sihanoukville were asked to shut down their online operations, causing massive employment and real estate losses. https://www.reuters.com/article/us-cambodia-gambling/thousands-lose-jobscasinos-shut-as-cambodia-bans-online-gambling-iduskbn1yz0o3. https://ec.europa.eu/commission/%20presscorner/detail/en/ip_20_229 https://www.reuters.com/article/us-cambodia-gambling/thousands-lose-jobs-casinos-shut-as-cambodia-bans-online-gambling-iduskbn1yz0o3 https://www.reuters.com/article/us-cambodia-gambling/thousands-lose-jobs-casinos-shut-as-cambodia-bans-online-gambling-iduskbn1yz0o3 asian journal of economics and empirical research, 2022, 9(1): 21-37 27 © 2022 by the authors; licensee asian online journal publishing group about the cambodia business cycle (imf (international monetary fund), 2018b, 2019). (4) finally, the model must be able to generate reasonable recursive forecasts, with inflation and output converging to their steady-state values over the medium term. c. test driving the camfi in this section, we validate our calibration against the generally accepted narrative based on three considerations: impulse response functions, estimation of unobserved variables, and recursive forecasts. chart 1. economic growth. source: cambodian authorities and imf staff report. chart 2. dollarization. source: cambodian authorities. chart 3. the exchange rate. source: national bank of cambodia. chart 4. revenues and expenditures. source: cambodian authorities; imf staff report. chart 5. the fiscal balance. source: cambodian authorities; authors’ calculations. chart 6. net lending. source: cambodian authorities; authors’ calculations. figure 2. cambodia: selected stylized facts. 3.1. impulse responses to assess the realism of the model’s transmission mechanism, we explore its properties in terms of three impulse responses: (1) a shock to aggregate demand: an unexpected increase in the domestic output gap by 1 percentage point for one year; (2) a financial shock: an unexpected increase in the country risk premium by 1 percentage point for one year; and (3) unexpected temporary and permanent fiscal expansions: a shock to the primary deficit by 1 percentage point without and with a change in the debt target. the impulse responses from a calibrated model must correspond to the available empirical evidence. because empirical studies using cambodian data are few, we rely on panel empirical studies (fatás & mihov, 2001; owyang, ramey, & zubairy, 2013) for the shape of the impulse responses and on batini, eyraud, forni, and weber (2014) for the fiscal multipliers. such studies provide stylized facts that our simulations attempt to mimic. what are some of those stylized facts? (1) because empirical effects of fiscal actions are long-lasting, stretching beyond seven years, the return to the steady state is necessarily much slower than in the monetary model outlined by berg, karam, & laxton (2006). (2) the impact of fiscal policy actions on output depends on the monetary regime— when exchange rates are fixed, the multipliers tend to be higher than when exchange rates float. (3) the fiscal space asian journal of economics and empirical research, 2022, 9(1): 21-37 28 © 2022 by the authors; licensee asian online journal publishing group matters: multipliers are higher in countries that can temporarily support higher debt-to-gdp ratios without sustainability concerns. (4) as long as one expects the debtor country to honor its debts, debt today will have to be serviced through consolidation in the future, which means the long-run multipliers will be around zero.13 3.1.1. aggregate demand figure 3 illustrates the implications of a positive aggregate demand shock in cambodia. windfall taxes and lower cyclical spending push the headline primary balance into surplus (recall that fiscal deficits are recorded as positive numbers), but the cyclically-adjusted primary balance first swings into a deficit because of the positive output gap. the debt-to-gdp ratio falls as the numerator expands; however, the fiscal authority will bring it back to the steady state through a series of expected future deficits. neither the nominal exchange rate nor the nominal interest rate moves because the former is stabilized by central bank liquidity operations and the latter is linked to the world interest rate through the uip. however, domestic inflation reacts to the output gap, causing the real exchange rate to appreciate relative to the steady state and creating a contractionary monetary stance. though the output gap closes in about five years, gross debt and inflation take 10 years to return to the steady state. figure 3. dynamic responses of fiscal variables, gdp, real exchange rate, and inflation to a surprise one-year 1 percentage point increase in the output gap (shock-minus-control responses). notes: the figure depicts dynamic responses to an increase in the domestic output gap at t =1; the fiscal impulse is measured as the difference between the cyclically-adjusted primary deficit in t and t-1; the rer (real exchange rate) gap is measured as the difference between the currentperiod value of the real exchange rate and its equilibrium value of the real exchange rate, and the rir (real interest rate) gap is measured as the difference between the current-period value of the real interest rate and the rate’s equilibrium value. source: camfi, authors’ simulations. figure 4. dynamic responses of fiscal variables, gdp, real exchange rate, and inflation to an unexpected 1 percentage point rise in the country risk premium for one year (shock-minus-control responses). notes: the figure depicts dynamic responses to an increase in the primary deficit at t =1; the fiscal impulse is measured as the difference between the cyclically-adjusted primary deficit in t and t-1; the rer (real exchange rate) gap is measured as the difference between the current-period value of the real exchange rate and its equilibrium value, and the rir (real interest rate) gap is measured as the difference between the current-period value of the real interest rate and the rate’s equilibrium value. source: camfi, authors’ simulations. 3.1.2. risk premium figure 4 illustrates the implications of a short-lived monetary tightening abroad or a negative domestic confidence shock. the real domestic private-sector interest rate, 𝑟𝑡, accommodates the interest rate increase from 13 positive long-run fiscal multipliers can happen: a country may invest loan proceeds into physical or human capital that would yield positive returns long after the initial deficit-financed public spending or tax cut. asian journal of economics and empirical research, 2022, 9(1): 21-37 29 © 2022 by the authors; licensee asian online journal publishing group abroad, tightening the monetary stance. the adverse output impact is relatively small compared to the increase in the debt-to-gdp ratio, so the fiscal authority tightens its stance, bringing the debt level back to the steady state. (recall that the concessional rate applied to public debt is not affected by the risk premium moves.) it is worth noting that the return to the steady state takes more than 10 years, even though the initial risk-premium shock was for one year only. 3.1.3. fiscal multiplier figure 5 compares the implications of a one-period fiscal expansion—a widening of the primary deficit by 1 percent of gdp—in two hypothetical scenarios: (1) a temporary fiscal expansion implies that the fiscal authority will bring now-higher gross debt back to its target level, and in doing so it will be guided by the fiscal policy reaction function. (2) a permanent fiscal expansion implies that the fiscal authority will permanently revise the debt-to-gdp target for the stimulus upward by 1 percentage point. although the impact multiplier is similar in both scenarios, whether the expansion is temporary or permanent has a profound impact on the long-run multiplier; while the longrun multiplier is zero for the permanent stimulus, it is negative for the temporary stimulus. with a temporary stimulus, the fiscal authority needs a longer series of primary surpluses to bring debt back to its target, thus withholding aggregate demand for longer. figure 5. dynamic responses of fiscal variables, gdp, real exchange rate, and inflation to an unexpected temporary 1 percentage point one-year stimulus and an unexpected one-year permanent fiscal stimulus (shock-minus-control responses). notes: the figure depicts dynamic responses to an increase in the primary deficit at t =1; the fiscal impulse is measured as the difference between the cyclically-adjusted primary deficit in t and t-1; the rer (real exchange rate) gap is measured as the difference between the current-period value of the real exchange rate and its equilibrium value, and the rir (real interest rate) gap is measured as the difference between the current-period value of the real interest rate and the rate’s equilibrium value. source: camfi, authors’ simulations. 3.2. multivariate filter results we believe that our multivariate-filter estimates for aggregate demand, aggregate supply, and fiscal variables are well-aligned with the typical narrative. we employ the model to estimate unobserved economic variables, the information in the observed variables, and the multivariate (kalman) filter. the link between the observed and unobserved variables—the output, exchange rate, and interest rate gaps—is represented by the model itself. conditional on the state form of the model and the observed variables, the multivariate filter can identify all unobserved variables and shocks. for linear systems, the kalman filter represents an optimum estimate in terms of the least squares criterion (hamilton, 1994). as some variables are nonstationary, without finite value variances, we employ the diffuse kalman filter (de jong, 1991). the questions we ask are straightforward: are the filter-derived unobserved variables consistent with the generally accepted narrative about the cambodian business cycle (as in imf (international monetary fund), (2018b); (2019))? can we use the estimates of unobserved variables—the gaps—to explain such observed variables as inflation, output, and fiscal developments? our results suggest that cambodia’s economy was overheated before the gfc, driven by both the imported low interest rate and the undervalued exchange rate (figure 6). the estimates further suggest that the authorities reacted with a fiscal impulse in 2009; however, the growth slowdown in 2012 was to a large degree attributable to a negative fiscal impulse that was only partly reversed in 2013. there seemed to be only very limited demand-side shocks postgfc. inflation peaked in 2008, driven by an overheated economy, an undervalued exchange rate, and the global foodprice shock (figure 7). inflationary shocks dissipated quickly, however, and inflation remained a few percentage points above the level of cambodia’s trading partners. as a result, the riel appreciated relative to its equilibrium asian journal of economics and empirical research, 2022, 9(1): 21-37 30 © 2022 by the authors; licensee asian online journal publishing group value, though to a lesser degree than estimated in imf (international monetary fund) (2019). as in our demandside estimates, inflation during the post-gfc period has been remarkably free of supply shocks. figure 6. cambodia: aggregate demand and its components, 2002–19, percent of gdp. note: a negative real exchange rate gap indicates an exchange rate that is overvalued relative to its trend value. source: camfi, authors’ simulations. figure 7. cambodia: aggregate supply and its components, 2002–19, percent. source: camfi, authors’ simulations. asian journal of economics and empirical research, 2022, 9(1): 21-37 31 © 2022 by the authors; licensee asian online journal publishing group post-gfc fiscal developments greatly benefitted from steady growth in real gdp. cyclical smoothing—by about 2 percentage points of gdp—was apparent in 2010–12, as shown by the dark blue sections in the chart decomposing the fiscal balance (figure 8). thereafter the government ran a tighter fiscal stance than envisaged by the calibration of the fiscal policy reaction function (see the yellow sections in the bottom chart in 2012 and afterward). the stance allowed the government to accumulate sizable government deposits while keeping gross debt at the target level. in 2019 the actual deposit-to-gdp ratio was almost twice as high (15 percent) as our calibrated steady-state value of 8 percent; see figure 2. figure 8. cambodia: fiscal balances, 2002–19, percent of gdp. note: a positive number indicates a deficit; a value of –1 for the primary balance in 2018 indicates a surplus of 1 percent of gdp. source: camfi, authors’ simulations. 3.3. recursive forecasts next, we use the model-identified unobserved variables to assess the model’s predictive ability. mechanically, we employ the kalman filter to identify the initial conditions for each year (t) and make a series of 8-years-ahead recursive forecasts. all domestic variables are forecast endogenously, but we use their actual realizations for foreign variables. we then shift the model-identified initial conditions by one year and make another 8-years-ahead forecast, and so on. figure 9 summarizes all 17 of our recursive forecasts—from 2003 to 2019—forming a series of “spaghetti” charts for the variables of interest. the model generates reasonable recursive forecasts: they predict most of the turning points in output and inflation. the missed turning points can be traced back to supply-side, external, and policy developments that are exogenous to our simple model, such as the post-conflict recovery of gdp in 2004–05, the global food price shock of 2007–08, and the post-gfc policy decision to accumulate fiscal deposits and drive down the net debt-to-gdp ratio. our chosen form of the uip captures the interest rate and exchange rate nexus very well. the fiscal variables, especially during the fast-growth pre-gfc and post-2012 periods, are in line with the goal of keeping gross debt at about 30 percent of gdp while bringing net debt lower during cyclical upswings. figure 9. cambodia: recursive forecasts, 2003–19. asian journal of economics and empirical research, 2022, 9(1): 21-37 32 © 2022 by the authors; licensee asian online journal publishing group 4. a policy-relevant exercise we now test the model on a counterfactual scenario of the economic impacts of the covid-19 pandemic on cambodia. we hasten to say that the scenario does not represent official macroeconomic projections of the imf or cambodian authorities and was designed primarily to showcase the scenario-making and reporting capabilities of the model: all judgmental assumptions are entirely our own. indeed, the scenario paints a more pessimistic picture of the pandemic than the april 2020 world economic outlook (weo) projection for cambodia. a. scenario building and assumptions the analysis depends on three layers of assumptions: (1) a recession in its trading partners affects demand for cambodia’s exports and leads to a collapse in tourist arrivals; (2) a second-round impact on domestic demand and supply that affects the country risk premium, working through the expectations channel; and (3) a fiscal response as the government introduces a fiscal stimulus to mitigate the impact of the previous two layers. the scenario is then compared with the baseline built around the pre-covid-19 weo growth projection. figure 10. simulation results, 2020–30. notes: the blue line (0) denotes the simulation based on initial pre-pandemic conditions. the red (1), yellow (2), and purple (3) lines denote the layers of assumptions described in the text. source: camfi, authors’ simulations. asian journal of economics and empirical research, 2022, 9(1): 21-37 33 © 2022 by the authors; licensee asian online journal publishing group for the first layer, it is assumed that economic activity declines significantly in france, germany, the us, and the uk (figure 10). we also assume that the us federal reserve system keeps the policy rate at or near zero in 2020 and 2021 before gradually lifting it toward its neutral level of about 1 percent. oil prices plunge in 2020 and are assumed to recover only slightly in 2021. the second layer captures a decline in domestic demand, driven by the drop in private consumption and investment as domestic agents start to expect a global recession. analyses of the cambodia national account data, input-output tables, and the gfc experience suggest that domestic demand could drop by cumulative 2 percentage points in 2020-1, and the country risk premium could stay higher by 200 bps in 2020-1 due to tighter global financial conditions for emerging market economies. food prices increase as pre-crisis food supply channels are interrupted. the initial covid-19 shock is, of course, not anticipated by domestic agents. in the second layer, we also make a judgment call about the medium-term supply-side disruptions caused by the pandemic. tourism travel restrictions extending into 2021, or even 2022, and a sustained decline in demand for cambodian export goods are likely to slow investment in both physical and human capital. the corresponding slowdown in productivity growth and disruptions in the supply chains would suppress potential gdp growth for some time. compared to the steady state, we therefore envisage a scenario of cuts of 4.5 in potential gdp growth in 2020 and 3.5 percentage points in 2021, which would only fully dissipate by 2024.14 the judgment call was guided by the estimated decline in the natural rate of interest in past pandemics (jordà, singh, & taylor, 2020) and the penn wharton model estimates of the lasting macroeconomic impacts of the coronavirus on the us (dinerstein & huntley, 2020) and emerging market economies (s&p global ratings, 2020). the third layer of the covid-19 scenario captures the impact of a possible discretionary fiscal response. specifically, our scenario assumes that the public debt target temporarily goes up by 5 percentage points in 2020 and only gradually returns to the original level. in the model, the agents fully anticipate the fiscal response: the authorities and private agents share the same information. b. the results the simulation results from the counterfactual scenario suggest a deep recession in 2020 before a gradual recovery starting in 2021. as shown in the third chart in figure 10, in the first layer, the recession in advanced economies could bring cambodia’s growth down to –1¼ percent in 2020, compared to the baseline projection of 6 percent. in the second layer, domestic demand slows economic growth to –8¼ percent. headline inflation is projected to decline slightly because of slackening in the economy and lower oil prices. these two factors offset the 4percentage point increase in domestic food prices due to supply channel interruptions and the resulting hoarding of food. in the third layer of the scenario, we expect the fiscal stimulus to boost real growth by about 2½ percent, bringing gdp growth to –5¾ percent. the economy will start to recover in 2021, growing at almost 3 percent and closing the output gap in 2022. we note that the fiscal stimulus has only a short-lived impact on growth—the scenario assumes only a temporary increase in the debt target, similar to the gfc episode. needless to say, the temporary nature of the debt target increase is announced, and it remains credible. the results of the fiscal stimulus layer should be taken with a grain of salt. the model assumes a fiscal multiplier of ½ based on cross-country experience (appendix b). should the actual fiscal multiplier be lower, the effect of the fiscal stimulus will be smaller; if the multiplier is higher, the effect will be larger. the case for a smaller fiscal multiplier could be based on the limited effectiveness of spending and lags in budget implementation. the case for a larger multiplier could be supported by the fact that additional public spending targets liquidity-constrained households and that during this crisis import leakages are likely smaller. 5. caveats and potential extensions we have designed and calibrated a simple, macro-fiscal, semi-structural model and applied it to cambodia, camfi. though this parsimonious model has obvious limitations, many of them can be addressed by extending the model with additional blocks. because of the structure of cambodia’s economy and data availability problems, we have emphasized the simplicity of the model—realizing that simplicity comes at the cost of there being only a rudimentary supply side and ignoring many stock-and-flow relationships. for example, we capture fiscal accounting, but there is no treatment of the current account or the nbc balance sheet. possible extensions suitable for more complex economies might be, among others, separation of core and noncore price indexes, breakdown of aggregate demand into an agricultural (commodity) component and a nonagricultural (non-commodity) component, development of the term structure of interest rates, and explicit modeling of external trade. extensions of the model need to be weighed against data availability and the modeling complexity that extensions may introduce. it is highly important, however, that the model retain its conceptual simplicity and clarity; an overly complex model is unlikely to facilitate a fast and straightforward discussion of policy-relevant issues. some extensions are simple, such as accounting for alternative monetary and exchange rate regimes. there is a library of matching formulations for the monetary policy reaction equation and the equations modeling the exchange rate that correspond to the characteristics of these regimes. we can build on a variety of semi-structural monetary models developed in the context of imf technical assistance; they cover the continuum of cases from free floats and open/closed capital accounts to pegs and closed capital accounts. users need to be mindful of the model’s predictive ability since the short series available for cambodia prevent most attempts at econometric evaluation. economically reasonable estimates of important parameters tend to cover a wide range, and it is sometimes difficult to decide between competing representations of the economy. combining the calibration approach with bayesian estimation, perhaps employing system priors, may help, but it is unlikely to overcome the data deficiencies in most low-income and emerging market countries (andrle & benes, 2013).15 ultimately, model users must never take a single parameterization of a particular model too seriously. models help 14 the simulated slowdown in potential gdp growth by 4.5 percentage points in 2020 implies a rate of growth of potential gdp of only 2.0 percent, since steady-state growth is calibrated at 6.5 percent. 15 system priors are priors about the model’s features and behavior as a system, such as the maximum duration of the response of debt to a particular shock. system priors would help to parametrize the model when the policymaker has a clear view of the policy horizon, but the model developer has insufficient data to estimate the transmission mechanism. asian journal of economics and empirical research, 2022, 9(1): 21-37 34 © 2022 by the authors; licensee asian online journal publishing group in discussing and assessing risks to the forecast, but they are no substitute for understanding the data and the economy. also deserving more attention, perhaps, is the vulnerability of low-income and emerging-market countries to global financial market shocks to, among other factors, their risk premiums and rollover risk. it would be useful to explore in a more structured way the role of the exchange rate and the interest rate in the aggregate demand, aggregate supply, and debt equations. we know relatively little about the effects of balance sheet mismatches or unsustainable debt on economies like that of cambodia. these extensions will be difficult to apply in the current linear framework; the reaction of financial market and debt developments is known to be nonlinear. 6. conclusions this paper describes an approach to simulating and forecasting macroeconomic variables using camfi, a simple, macro-fiscal, semi-structural model. unlike traditional imf-detailed financial programming, the results here focus on only a few variables that are consistent with the new keynesian framework that is the usual practice in modern academic literature, policymaking, and forecasting. needless to say, the model’s small size does not necessarily mean that operating such a semi-structural model is easy. model developers and users need to start with a clear understanding of how the data are constructed, collect the key stylized facts, and pay attention to changes in the transmission mechanism as economies evolve. we have outlined a basic version of the model and calibrated a parsimonious version of it for cambodia, validating our calibration by using only a few impulse response functions, testing the consistency of unobserved variables against a generally accepted narrative, and assessing the accuracy of our recursive forecasts. we then used the model to simulate the medium-term economic impact of the covid-19 pandemic. we demonstrated the relative ease and consistency with which a stacked set of assumptions can be developed into a full-blown counterfactual scenario and presented to the policymaker. we contend that this framework can be tailored to virtually any fiscal, monetary, or exchange rate policy regime. however, the startup costs to begin using even a relatively simple model of this type are substantial, and its sustained use requires periodic updates and maintenance. references alesina, a., & ardagna, s. 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(2015). adjusting fiscal balances for the business cycle: new tax and expenditure elasticity estimates for oecd countries. oecd working paper no. eco/wkp 1275 (paris: oecd). http://www.imf.org/external/pubs/ft/tnm/2009/tnm0905.pdf http://www.imf.org/en/publications/cr/issues/2018/11/07/cambodia-technical-assistance-report-tax-administration-modernization-priorities-201923-46336 http://www.imf.org/en/publications/cr/issues/2018/11/07/cambodia-technical-assistance-report-tax-administration-modernization-priorities-201923-46336 http://www.imf.org/~/media/files/publications/cr/2018/cr18369.ashx http://www.elibrary-areaer.imf.org/documents/yearlyreport/areaer_2018.pdf http://www.imf.org/~/media/files/publications/cr/2019/1khmea2019001.ashx asian journal of economics and empirical research, 2022, 9(1): 21-37 35 © 2022 by the authors; licensee asian online journal publishing group ramey, v. a., & zubairy, s. (2018). government spending multipliers in good times and in bad: evidence from us historical data. journal of political economy, 126(2), 850-901.available at: https://doi.org/10.1086/696277. romero-barrutieta, a.l., bulíř, a., & rodríguez-delgado, j.d. (2015). the dynamic implications of debt relief for low-income countries. review of development finance, 5(1), 1–12. rungcharoenkitkul, p. (2012). modeling with limited data: estimating potential growth in cambodia. imf working paper no. 12/96 (washington: imf). s&p global ratings. (2020). economic research: covid-19 deals a larger, longer hit to global gdp. retrieved from https://www.spglobal.com/ratings/en/research/articles/200416-economic-research-covid-19-deals-a-larger-longer-hit-to-globalgdp-11440500. schumacher, m., & żochowski, d. (2017). the risk premium channel and long-term growth. ecb working paper no. 2114 (frankfurt: european central bank). world economic forum. (2019). global competitiveness report. retrieved from http://www3.weforum.org/docs/wef_theglobalcompetitivenessreport2019.pdf. appendixes a. fiscal deposits without ready access to international bond markets or opting to issue local bonds, the cambodian government has been building deposits at the national bank of cambodia (nbc) as a buffer (see figure 1, chart 6 in the main text). the following identity holds: change in fiscal deposits = overall deficit – change in gross public debt how to model the fiscal deposits? on the one hand, the headline fiscal deficit has been correlated with the business cycle, that is, the output gap. on the other hand, the evolution of gross debt has reflected the 30-percent debt-togdp target and fluctuations around that level caused by donor disbursement choices, progress in project execution, and so on. these stylized facts suggest that cyclical factors drive the gradual accumulation of fiscal deposits, as shown in figure a1. in the model, we therefore calibrate the elasticity of the deposits to the output gap as equal to 0.3. figure a1. output gap and fiscal deposits, 2002–19. notes: the figure shows fiscal deposits in percent of gdp on the vertical axis and output gap in percent of trend gdp on the horizontal axis. the fitted values line is the linear trend. source: international monetary fund (imf) data and authors’ calculations. b. the fiscal multiplier estimates for cambodia the fiscal multiplier measures the impact on output of an unexpected, discretionary change in fiscal policy. empirically, individual-country estimation of fiscal multipliers is fraught with problems (owyang et al., 2013; ramey & zubairy, 2018) even in countries with long, good-quality time series, and it is almost impossible in a country like cambodia. batini et al. (2014) have instead suggested a “bucket approach” to calibrate the magnitude of the multiplier based on country characteristics. the empirical literature provides widely varying multiplier estimates for three reasons. (1) because it is difficult to identify an unexpected, discretionary change in the fiscal variables, most developments in taxes and spending are instead reactions to the business cycle. (2) the fiscal multipliers, which vary over time and across countries and monetary policy regimes, draw on a range of factors, including the state of the economy, the specific fiscal instrument used, the extent to which fiscal decisions provoke changes in other policies, such as monetary, and the structure of the economy. (3) because most empirical studies deal with advanced economies, relatively little is known about the size of the multiplier in emerging and low-income countries. one generally accepted finding is that spending multipliers in low-income countries are, on average, lower than in advanced economies (ilzetzki, 2011). table b1 summarizes some of the offsetting factors. table b1. factors affecting the fiscal multiplier in low-income countries. multiplier-increasing factors multiplier-decreasing factors • less developed financial markets • less forward-looking economic agents • less effective monetary policy response • smaller automatic stabilizers • lower government debt • more open economy (import leakage) • larger precautionary saving • inefficiencies in public spending and revenue administration • long-lasting positive output gaps due to supply constraints http://www.spglobal.com/ratings/en/research/articles/200416-economic-research-covid-19-deals-a-larger-longer-hit-to-global-gdp-11440500 http://www.spglobal.com/ratings/en/research/articles/200416-economic-research-covid-19-deals-a-larger-longer-hit-to-global-gdp-11440500 asian journal of economics and empirical research, 2022, 9(1): 21-37 36 © 2022 by the authors; licensee asian online journal publishing group we apply the methodology of batini et al. (2014) to calibrate cambodia’s fiscal multiplier in three steps, as shown in table b2: step 1: assign a score to cambodia based on the number of characteristics associated with large fiscal multipliers: 1 if yes, 0 otherwise. step 2: sum up the scores to determine the likely bucket of the multiplier (low, medium, or high). step 3: adjust the range assigned using the scoring method based on cambodia’s temporary characteristics. after steps 1 and 2, cambodia falls into the low-multiplier bucket, suggesting that the fiscal multiplier ranges between 0.1 and 0.3. adjusting for the temporary factors prevailing in 2020, the estimate of the first-year fiscal multiplier falls in the range of 0.5 to 0.7. hence, in the model, we calibrate the impact multiplier to be equal to 0.5. table b2. cambodia’s fiscal multiplier in 2020: the bucket approach. step 1: scoring the characteristics characteristics assess score indicators [benchmark] low trade openness no 0 imports/gdp = 73% (average past 5 years), [> 40%] high labor market rigidity no 0 weak labor unions (world economic forum, 2019) small automatic stabilizers yes 1 public spending/gdp = 23%, [< 45%] fixed exchange rate regime yes 1 stabilized around 4,050 riels per us dollar low public debt yes 1 debt-to-gdp = 28%, [< 40%] effective public expenditure and revenue management no 0 based on the 2015 evaluation of public financial management of cambodia. step 2: total score and group total score low multiplier 3 low multiplier, if the total score is less than 3. fiscal multiplier 0.1–0.3 low multiplier: between 0.1 and 0.3 step 3: adjustment for temporary factors composition of the fiscal stimulus 0.25 the fiscal stimulus involves both spending and net taxes (increase the lower bound by 0.5 and then divide by 2) economic cycle 0.17 negative output gap due to the covid-19 pandemic (adjustment, 0.5*1/3) monetary policy 0.05 constrained by high dollarization (0.1*1/2) the multiplier after adjustment 0.5–0.7 the upper and lower ranges are adjusted by the following additive factors: +0.25 (two-thirds of the adjustment relates to expenditures), +0.17 (large negative output gap), and +0.05 (constrained monetary policy). source: authors’ calculations based on batini et al. (2014). c. the camfi model codes all matlab model codes, including parameter values, and the corresponding version of the iris toolbox are available at: https://imfbox.box.com/s/9txhtrg77m37f4asf6tvo9cnuq4j9hh9. the key model equations are as follows: aggregate demand (dynamic is curve): �̂�𝑡 = 𝑎1�̂�𝑡−1 + 𝑎2𝐸𝑡�̂�𝑡+1 − 𝑎3𝑚𝑐𝑖𝑡 + 𝑎4𝑓𝑡 𝑖𝑚𝑝 + 𝑎5�̂�𝑡 ∗ + 𝜀𝑡 𝑦 , the monetary conditions index: 𝑚𝑐𝑖𝑡 = 𝑎6(�̂�𝑡 + 𝑐𝑟_𝑝𝑟𝑒𝑚𝑡) + (1 − 𝑎6)(−�̂�𝑡), aggregate supply (the new-keynesian phillips curve): 𝜋𝑡 = 𝑏1𝜋𝑡−1 + (1 − 𝑏1)𝐸𝑡𝜋𝑡+1 + 𝑏2𝑟𝑚𝑐𝑡 + 𝑏3δ𝑜𝑖𝑙𝑡 + 𝜀𝑡 𝜋 real marginal cost: 𝑟𝑚𝑐𝑡 = 𝑏4�̂�𝑡 + (1 − 𝑏4)�̂�𝑡 the uncovered interest rate parity (uip) condition: 𝑖𝑡 = (𝐸𝑡𝑠𝑡+1 − 𝑠𝑡) + 𝑖𝑡 ∗ + 𝑝𝑟𝑒𝑚𝑡 the nominal exchange rate: ∆𝑠𝑡 = 𝑐1∆𝑠𝑡−1 + (1 − 𝑐1)(∆�̃�𝑡 − 𝑐2𝑠𝑡−1) + 𝜀𝑡 𝑠 the fiscal impulse: 𝑓𝑡 𝑖𝑚𝑝 = (𝑐𝑎𝑑𝑡 − 𝑐𝑎𝑑𝑡−1) + 𝑓4𝜀𝑡 𝑏𝑡𝑎𝑟 ± 𝑓5𝜀𝑡 𝑏 , the fiscal reaction function: 𝑐𝑎𝑑𝑡 = 𝑓7(𝑐𝑎𝑑𝑡−1 − 𝑓10�̂�𝑡) + (1 − 𝑓7)(𝑐𝑎𝑑𝑡 𝑡𝑎𝑟 − 𝑓8𝑏𝑡 𝑑𝑒𝑣) + 𝜀𝑡 𝑐𝑑 the cyclically-adjusted primary deficit: 𝑐𝑎𝑑𝑡 = 𝑝𝑑𝑡 + 𝑓3�̂�𝑡 the total deficit: 𝑑𝑡 = 𝑝𝑑𝑡 + 𝑖𝑑𝑡 expected debt deviation path: 𝑏𝑡 𝑑𝑒𝑣 = 𝑓9(𝑏𝑡 − 𝑏𝑡 𝑡𝑎𝑟) + (1 − 𝑓9)𝐸𝑡𝑏𝑡+1 𝑑𝑒𝑣 https://imfbox.box.com/s/9txhtrg77m37f4asf6tvo9cnuq4j9hh9 asian journal of economics and empirical research, 2022, 9(1): 21-37 37 © 2022 by the authors; licensee asian online journal publishing group gross debt accumulation: 𝑏𝑡 = 𝑑𝑡 + ∆𝑥𝑡 + (1 + 𝛥𝑠𝑡)𝑏𝑡−1/(1 + 𝑔𝑡) fiscal deposit accumulation: 𝑥𝑡 = ∆𝑥𝑡 + (1 + 𝛥𝑠𝑡)𝑥𝑡−1/(1 + 𝑔𝑡) the fiscal deposit reaction function: ∆𝑥𝑡 = 𝑔2∆𝑥𝑡−1 + (1 − 𝑔2)(∆�̃�𝑡 + 𝑔3�̂�𝑡 + 𝑔4(𝑝𝑑𝑡 − 𝑝𝑑𝑡 𝑡𝑎𝑟)) + 𝜀𝑡 𝑥 debt service: 𝑖𝑑𝑡 = 𝑖𝑡−1 𝐺𝑜𝑣(1 + 𝛥𝑠𝑡)𝑏𝑡−1/(1 + 𝑔𝑡) purchasing power parity (ppp) condition: 𝑧𝑡 = 𝑠𝑡 + 𝑝𝑡 ∗ − 𝑝𝑡 the real interest rate trend: �̃�𝑡 = ℎ5�̃�𝑡−1 + (1 − ℎ5)(∆�̃�𝑡+1 + �̃�𝑡 ∗ + 𝑝𝑟𝑒𝑚𝑡) the country risk premium: 𝑝𝑟𝑒𝑚𝑡 = ℎ6𝑝𝑟𝑒𝑚𝑡−1 + (1 − ℎ6) (𝑝𝑟𝑒𝑚 + ℎ12(𝑏𝑡 − �̅� − (𝑥𝑡 − �̅�))) + 𝜀𝑡 𝑝𝑟𝑒𝑚 the equilibrium real exchange rate trend: ∆�̃�𝑡 = ℎ7∆�̃�𝑡−1 + (1 − ℎ7)∆𝑧̅ + 𝜀𝑡 ∆𝑧 potential output growth: ∆�̃�𝑡 = ℎ8∆�̃�𝑡−1 + (1 − ℎ8)(∆�̅� − ℎ13(�̃�𝑡 − �̅�)) + 𝜀𝑡 ∆𝑦 . asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 268 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 2, 268-281, 2020 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2020.72.268.281 © 2020 by the authors; licensee asian online journal publishing group estimating cambodia’s economic conditions by dynamic factor model kimleng sa graduate school of public policy, the university of tokyo, japan. abstract this study constructed a coincident indicator (ci) as the unobserved state of the economy in cambodia by combining principal components and a dynamic factor model (dfm). in the first step, it estimated the factor loadings (coefficients of the unobserved state variables) by ordinary least squares (ols) and feasible generalized least squares (fgls) methods using the state variable produced by the first principal component. in the second step, it estimated the unobserved state variables through the dfm by replacing the coefficients with their estimators in the first step. doz, giannone, and reichlin (2011) introduced this hybrid approach for stationary data. the coincident indicator showed that cambodia’s economy fell below its potential level between 2016 and 2017 and started recovering after mid-2017. by exploiting the coincident index, the study examined comovement between the foreign direct investment (fdi) inflow and the state of the economy by using the autoregressive distributed lags (ardl) model. the result showed that an acceleration of the economic condition contributed to an increase in fdi inflow in the short-term for all models; the long-term coefficient became negative. one reason for this could be the diminishing marginal product of capital that made foreign capital investment less attractive. keywords: coincident indicator, dynamic factor model, principal components, kalman filter, state of the economy, foreign direct investment. jel classification: e1, e3. citation | kimleng sa (2020). estimating cambodia’s economic conditions by dynamic factor model. asian journal of economics and empirical research, 7(2): 268-281. history: received: 30 september 2020 revised: 19 september 2020 accepted: 16 november 2020 published: 7 december 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 269 2. literature review .......................................................................................................................................................................... 269 3. methodology ................................................................................................................................................................................... 271 4. result of the study ........................................................................................................................................................................ 273 5. discussion and limitation of the study .................................................................................................................................... 274 6. conclusion ....................................................................................................................................................................................... 274 references ............................................................................................................................................................................................ 275 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.72.268.281&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ http://asianonlinejournals.com/index.php/ajeer/article/view/2399 https://orcid.org/0000-0001-5386-3887 asian journal of economics and empirical research, 2020, 7(2): 268-281 269 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to existing literature by constructing a coincident indicator (ci) as the unobserved state of the economy in cambodia. 1. introduction the early warning system plays a crucial role in monitoring economic activity in cambodia. despite high economic growth rate, the economy was vulnerable to shocks (world bank, 2018).1 the imf (2018) identified export and fiscal shocks, and contingency liability, as major risks that could slow down cambodia’s economy. without an early warning system the countercyclical policy may be plausible and sometimes even push the economy into a worse condition. wyplosz (2005) emphasized the use of fiscal policy as a countercyclical policy could be inefficient and possibly do more harm than good. for these reasons, a well-designed early warning system could lower the magnitude of shocks, improve the surveillance capacity, and serve as an alert when the economy moves into a recession. monitoring economic activity, and mainly observing the business cycle, requires a high-frequency indicator that represents the cyclical movement of the economy, and gross domestic product (gdp) would be a suitable candidate (oecd, 2010). however, monthly and quarterly gdp is not available for cambodia mainly due to resource and time constraints for compiling such data. for these reasons, there is a need to create a similar indicator that could be closely correlated to gdp to monitor economic conditions, and to observe the business cycle. similar to gdp, the coincident indicator could be a useful tool in the study of the business cycle. the ci, for the unobserved state of the economy, is constructed by exploiting its relationship with high-frequency observable variables, which are available on a monthly basis. it compiles high-frequency data into a single index that captures the current state of the economy and real-time economic performance. the oecd (2010) used macroeconomic variables that hold both economic and statistical relevance to quarterly real gdp in establishing a coincident indicator. by proper design, it could help policymakers in surveillance activity and monitoring the real sector to signal when the economy moves into a recession. additionally, it could be a useful tool for policymakers dealing with unemployment and inflation issues during the peaks and troughs (zarnowitz & moore, 1983). it was also a useful indicator in the analysis of the short-term macroeconomic dynamic (guo, ozyildirim, & zarnowitz, 2009). although the coincident index helps to monitor economic performance, there are some challenges to be considered. one issue concerns the number of variables used for its establishment. caggiano, kapetanios, and labhard (2011) suggested that using many variables is not always the best solution. in addition, how well this index can signal a recession is unknown. the problem concerns when the real economy will respond or how long it will take to come into effect. the oecd (2010) suggested that the coincident indicator signaled five to six months in advance of the economy going into recession. the coincident indicator should be used cautiously and will require adjustment when additional information is available. despite its limitations, there is no doubt that the coincident index plays a crucial role for policymakers in monitoring economic activities. exploiting the ci, the study examined the movement of foreign direct investment inflow and the state of the economy. large capital mobility could put the economy at risk due to the lack of capital control mechanisms. although it may be difficult to adjust fdi within a short period, a more liquid fdi tends to flow out of a country when the economy moves into a bad situation, such as a recession. large capital mobility could put the balance of payment at risk due to exchange rate depreciation, especially for net debtor countries. this paper has the following structure: section two reviews the empirical literature of the coincident index and the dynamic factor model, section three identifies the methodologies used to establish the coincident indicator, section four shows the results, section five discusses the limitations of the study, and the final part comprises the concluding remarks. 2. literature review the coincident index for the unobserved state of the economy has often been used in the study of the business cycle, for example, by stock and watson (1989); kim and nelson (1998); altissimo. et al. (2001); aruoba, diebold, and scotti (2009); oecd (2010) and bakarić, tkalec, and vizek (2016). the idea behind the coincident indicator is that many macroeconomic variables comove with a single unobserved variable called the state of the economy. this index became a useful tool in observing real-time economic performance and movement of output growth (mariano & murasawa, 2010). stock and watson (1989) examined the business cycle as a comovement of aggregated time series data that coincided with the latent variable—the state of the economy. stating the business cycle as a latent variable, aruoba et al. (2009) followed a similar method in constructing a coincident indicator using high-frequency data via the dynamic factor model. the choice of indicators used for creating coincident indicators remains controversial. the selected variables should have significant relevance, as stated by the oecd (2010). the national bureau of economic research (nber) constructed a coincident indicator using four leading indicators: industrial production, real personal income less transfer, real manufacturing and trade sales, and employment in non-agriculture (stock & watson, 1989). however, the selected variables vary from study to study, for example, in those by nilsson and brunet (2006); albu and dinu (2009); guo et al. (2009) and bakarić et al. (2016), especially in developing countries where data availability is limited. some studies used a large number of variables, such as those by altissimo, cristadoro, forni, lippi, and veronese (2010) and gupta and kabundi (2011). the methodologies used to establish coincident indexes also vary across studies. these include ad hoc procedures and weighted average of aggregate time series data to more complicated methods. one issue in the ad hoc approach is weighting; more important variables should be given higher weights (freudenberg, 2003). various approaches can be used for weighting, for example, the regression analysis, correlation coefficient, and dimensional 1according to the world bank, the gdp growth rate was around 7.68% on average between 1995-2019. asian journal of economics and empirical research, 2020, 7(2): 268-281 270 © 2020 by the authors; licensee asian online journal publishing group reduction approaches, such as principal component and factor analysis. on the other hand, the standard methods for producing coincident indicator receive a lot of attention. for example, stock and watson (1989) followed the dynamic factor model to integrate aggregated time series data and used the kalman filter algorithm to estimate the unobserved state, while the parameters were estimated by the maximum likelihood. rua and nunes (2005) implemented the band-pass filter and principal component to combine multivariate variables into a single index. the principal component works on the linear combination of multiple variables into a new set of variables that are linear independent. the first principal component captures the largest variation of the original data with the largest eigenvalue, followed by the second and third components, and so on. levanon (2010) studied the business cycle by using markov switching to estimate recession probability. bujosa, garcıa-ferrer, juan, and martinarroyo (2018) used linear dynamic harmonic regression (ldhr) based on a spectral approach. the dynamic factor model receives a lot of attention in modern econometrics, especially in estimating the unobserved variables. the process involves using the kalman algorithm to estimate the unobserved factors. the kalman algorithm was first designed for tracking objects indirectly in spacecraft to improve the accuracy of position for navigation purposes. later, it became popular in the study of economic time series as an application to estimate the unobserved variables, for example, the state of the economy, asset pricing, and permanent income. by expressing the observable variables as a linear function of the unobserved variables and unobservable errors, and the movement of the unobserved variables across time, mainly in autoregressive structures, the kalman filter algorithm could estimate the unobserved variables with minimum mean squared errors (mses), while the unknown parameters were estimated by the maximum likelihood estimation (durbin & koopman, 2012; shumway & stoffer, 2017b; stock & watson, 1989). for asymptotic properties, the estimated factors calculated by the dynamic factor model and principal components are consistent with an increase in cross-sectional (i) and time dimensions (t).2 forni, hallin, lippi, and reichlin (2000) showed the asymptotic consistency of the estimated common factors for the dynamic factors model. stock and watson (2002) and bai (2003) derived the asymptotic consistency and normality of estimated common factors and factor loadings using the principal components with serial and cross-sectional correlations in the idiosyncratic noises.3 with an increase in cross-sectional dimensions, doz et al. (2011) showed the consistency of the estimation of unobserved common factors and factor loadings by a two-step procedure of combining principal components with the kalman smoother. as an increase in cross-sectional dimension leads to the consistent estimation of the common factors it is common to include as many variables as possible. however, later studies indicated that the cross-sectional dimension does not necessarily have to be large for a consistent estimation. for example, caggiano et al. (2011) showed that 12 to 22 variables could achieve the best result in extracting common factors, and poncela and ruiz (2012) showed that variables did not have to be large to achieve consistency under the kalman filter. under the gaussian assumption, parameters are estimated by the maximum likelihood estimation method. the asymptotic consistency and normality of the estimated parameters in the dynamic factor model were shown by caines (1988) and durbin and koopman (2012). the expectation-maximization (em) algorithm became a common tool to estimate the parameters in the maximum likelihood estimation. an alternative algorithm, newton–raphson, showed a faster convergence rate (lindstrom & bates, 1988). however, in estimating many parameters, the newton–raphson algorithm could be unstable in the iteration process unless the initial guesses were close to the true values (wilks, 2019). although one method is not necessarily superior to another, the dynamic factor model receives more attention for many reasons in the study of common factors. rodríguez and ruiz (2012) pointed out that under a gaussian assumption on idiosyncratic noises with known parameters, the kalman filter provided the best linear unbiased predictions of the common factors in the context of the linear state-space model. additionally, the dynamic factor model provided flexible specifications compared to the principal components, such as working with non-stationary datasets and strong correlation of idiosyncratic noises, imposing restrictions, and handling irregular elements and missing datasets (poncela & ruiz, 2012). the kalman filter could produce the mean squared error in the finite sample, while only asymptotic mse is available for the principal component. moreover, the kalman filter performs better for correlated idiosyncratic noises. although moderate serial and cross-sectional correlations (0.5) of errors produced a marginal impact on the estimators and forecasting quality, stock and watson (2002) showed that strong serial and cross-sectional correlations (0.9) caused a deterioration of the estimators and forecasting quality in the case of the principal component. poncela and ruiz (2012) showed that regardless of weak or strong correlations in errors, the kalman filter could produce the efficient minimum mean squared error when the number of variables was around 30.4 doz et al. (2011) combined the principal components and kalman filter. this hybrid approach could substantially improve the estimation of the common factors if the common factors were small and persistent (giannone, reichlin, & small, 2008; stock & watson, 2011). another method was to use the bootstrap procedure proposed by rodríguez and ruiz (2012) to improve the predicting mse of the unobserved variables, which gave a better finite sample property. critics stated that both time and cross-sectional domains lack satisfied properties in the finite sample, which lead to a more rigorous study of the dynamic factor model using a small sample. it is worth mentioning that the mse under the kalman filter has two sources of uncertainty: one comes from the stochastic process of the filtering, and the other one is from the estimation of the unknown parameters.5 this second source came from substituting the consistent parameters when the true values were unknown.6 with known parameters and non-persistent serial 2 both i and t→ ∞. in asymptotic property, when the time dimension approaches infinity (t → ∞), the estimated parameters converges to the population parameters. on the other hand, the cross-sectional dimension(i → ∞) approaches infinity, so the uncertainty in the extraction procedure will approach zero (poncela & ruiz, 2012). 3 choi (2012) derived a smaller variance using the generalized principal component estimator without normality assumption (first derived in 2007). however, there is a challenge in finding a well-behaved idiosyncratic error variance matrix that made generalized principal component estimator infeasible, as pointed in stock.. and watson (2011). 4 they found out that as the mean squared error approaches zero in cross-sectional dimensions, the total uncertainty has a u shape because as more variables are included, the number of estimated parameters increase and induces uncertainty. 5 as an increase in the cross-sectional dimensions will increase the numbers of parameters to be estimated, the dfm estimation deteriorates. 6 this uncertainty accounted for about 5% (t=100) of the total uncertainty in the univariate non-stationary one factor model (rodríguez & ruiz, 2012). asian journal of economics and empirical research, 2020, 7(2): 268-281 271 © 2020 by the authors; licensee asian online journal publishing group correlation in idiosyncratic noises, the filter uncertainty was a non-increasing function in the cross-sectional dimension regardless of weak or strong contemporaneous correlation of noises (poncela & ruiz, 2012). for small cross-sectional dimensions, they showed that the uncertainty only slightly increased for a practical purpose, while the ratio of parameter uncertainty to total uncertainty was at a minimum when the number of variables was around ten.7 the estimation of the coincident indicator has some challenges and shortcomings. munda and nardo (2005) explained the weighting issue of the linear aggregation rule, a weakness that data normalization did not capture in building the coincident index. another issue involves the stationary assumption in constructing the coincident indicator. with this assumption, it throws away some important information if cointegration exists8, and ignoring the long-term relationship has a detrimental effect on forecasting quality (smeekes & wijler, 2019). it is worth mentioning that the unobserved state variable can be stationary or non-stationary in the context of the dynamic factor model. for this reason, using the hybrid approach (combining principal components and the kalman filter or smoother) for non-stationary data may improve the estimation of common factors in the finite sample, as shown by corona, poncela, and ruiz (2020). peña and poncela (2004) and moon and perron (2007) also worked on nonstationary series in estimating common factors using the dynamic factor model. an additional issue concerns the measurement unit. the process involved using data normalization, or standardization, in combining a group of variables into a single index (altissimo. et al., 2001; freudenberg, 2003), and freudenberg (2003) mentioned various normalization methods. as the coincident indicator is unit-free by its construction, it causes a problem for interpretation. (mariano & murasawa, 2003) pointed out a shortcoming of an economic interpretation of the standard coincident index. lastly, the study implements the kalman filter using linearity and normality assumptions. many studies assumed the linear projection of the coincident indicator for simplicity; however, if the function is non-linear, this creates the misspecification of the functional form, so weights would not only be inconsistent, but also biased. with unknown parameters, the model would become non-linear when expressing in the state-space form (murphy, 2012). other versions of kalman filters have been initiated to deal with the nonlinear system, for example, the extended kalman filter (ekf) and unscented kalman filter (ukf). the intuition of the ekf is linearization of the function using the taylor series and applies the standard kalman filter to solve the systems. the performance of the ekf could improve through the iteration process. however, it performed poorly for prior large covariance and function that was highly non-linear near the current mean (murphy, 2012). a better version is the unscented kalman filter, proposed by julier and uhlmann (1997). the ukf approximates the gaussian distribution using the unscented transformation by creating several sample points called sigma points.9 the ukf became more accurate than the ekf in capturing mean and covariance at least to the second order of any non-linear function (murphy, 2012). durbin and koopman (2012) showed that the normality assumption is not necessary from the minimum variance linear unbiased estimation perspective. 3. methodology 3.1. description of data with economic relevance to the state of the economy, this study used monthly macroeconomic and banking data from 2010 to mid-2019, to construct the coincident indicator.10 these data are available on the official website of the ministry of economy and finance and the national bank of cambodia. these include total bank credits (y1), banks lending to the service-related sectors (y2), banks lending to the manufacturing sector(y3), banks lending to the retail trade sector (y4), banks lending to the wholesale sector (y5), electricity supply (y6), export value (y7), import value (y8), corporate income or profit tax (y9), domestic value-added tax (y10), and import value-added tax (y11). additionally, the study includes exogenous variables, such as the official exchange rate (z1), money supply (z2), and interest rate of bank lending (z3). the study treats data in the following manner; first, to reduce the issue of irregular elements, it uses seasonally adjusted data11, next, the study proceeds with data normalization.12 a standardized, or unit-free, dataset plays a crucial role in combining multiple variables into a single index; otherwise, the weights will be biased (altissimo. et al., 2001; freudenberg, 2003). lastly, it uses non-stationary data to extract the common factor.13 since many macroeconomic variables comove with the state of the economy in the long term, allowing for the common trend is better than ignoring the cointegration. corona et al. (2020) showed that combining principal components and the kalman filter to extract the common factors, using the original series could improve the estimation than differencing the series when cointegration exists in the finite sample. in the first step, it used the principal components to estimate the initial unobserved state. the first principal component captured the highest proportion of the variation of the series (about 94% of the total proportion). the use of principal components improved the estimation of common factors substantially in the dynamic factor model, especially for the extraction of small common factors (giannone et al., 2008; stock & watson, 2011). 3.2. model specification the study follows the state-space or dynamic factor model. estimating the unobserved state follows the twostep procedure proposed by doz et al. (2011). they showed that this hybrid approach yields consistent estimators 7 poncela and ruiz (2012) used sample sizes (t) between 100 and 200 in their simulation. 8 if cointegration exists between the state and observed variables, the error is stationary. in this case, both the state of the economy (st) and observed variables (yit) are i(1), while the error (uit) is i(0). 9 see: wan and van der merwe (2000): the unscented kalman filter for nonlinear estimation. 10 data are available from 2007 to the second quarter of 2019; however, many missing values may affect the result, so the study only selected the period between 2010 and 2019. 11 for seasonal adjustment, the data used the arima (x-13) method, which is available in e-views. 12 data normalization formula: yi,n = yi,o−y̅i δi ; where 𝑌𝑖,𝑛 is a new transform variable, 𝑌𝑖,𝑜 is the original variable, �̅�𝑖 is the mean, and 𝛿𝑖 is the standard deviation of variable i. 13 trend and seasonality are the main issues of non-stationarity. series are stationary if their mean, variance, and covariance are constant over time. asian journal of economics and empirical research, 2020, 7(2): 268-281 272 © 2020 by the authors; licensee asian online journal publishing group of common factors in the dynamic factor model when cross-sectional and time domains approach infinity (i, t → ∞). with known parameters and mutual independence of the idiosyncratic noises, the estimated factors were unbiased regardless of the number of variables used (poncela & ruiz, 2012). the armax linear state-space model can be written as: yt = ρ t st + αtzt + ut ; (1) st+1 = θtst + vt ; (2) ( ut vt ) ~(i. i. d) n ([ 0 0 ] ; [ rt 0 0 qt ]) yt is m × 1 the vector of the observed variable. st is n × 1 the unobserved state variable. zt is p × 1 the vector of the exogenous variable. ut, vt are idiosyncratic noises with serially and contemporaneous independences. ρt is m × n, αt is m × p, and θt is n × n matrices (where only α11, α12, α13, α23, α33, α43, α53, α71, and α81 are non-zero, while the other coefficients are restricted as zero). the state-space model consists of two types of equations: the observation or signal equation and the transition or state equation. equation 1 is the observation equation, which explains the relationship of the observed variables as a linear function of the unobserved state. equation 2 is the transition equation, which captures the movement of the state variable over time. although the most common form of the transition equation is in the autoregressive (ar) structure, it could also include the autoregressive moving average (arma) form.14 the exogenous variables can enter either the observation or the transition equations without losing any interpretation. including the exogenous variables improves the model goodness of fit. the study refers to the akaike information criteria (aic) for model selection of the armax linear state-space structure.15 shumway and stoffer (2017b) showed the consistency of the common factors of the armax linear state-space model. the study imposed some assumptions. first, st and yit cointegrated, so parameters are estimated by ordinary least squares.16 second, ut and vt are serial and contemporaneous uncorrelated (mutually independence).17 third, for simplicity, the study examines the dynamic factor model in the context of the linear system; for a non-linear system, other versions of the kalman filter could be implemented, for example, the ekf and ukf. fourth, the model also assumes the initial mean and variance of the state variable to be gaussian s0 ~n(s0 0, p0 0). without knowledge of the initial value, the study sets the diffuse initial state condition. any system of equations that can be expressed in the state-space form can be solved using the kalman filter. the study uses the kalman filter to estimate the unobserved state of the economy (st).18 the intuition of the kalman filter is to update the state from st t to st+1 t+1 when the observation yt+1 is available. it involves a two steps process of predicting and updating. with the above initial state value, the kalman filter algorithm for the armax linear state-space model in this study is:19 st+1 t = θtst t ; (3) pt+1 t = θtpt tθt ′ + qt ; (4) st+1 t+1 = st+1 t + kt+1ϵt+1 ; where [ϵt+1 = yt+1 − (ρ t+1 st+1 t + αt+1zt+1)] ; (5) pt+1 t+1 = (i − kt+1ρt+1)pt+1 t ; where i is the identity matrix; (6) the kalman gain (kt+1): kt+1 = pt+1 t ρt+1 ′ (ρt+1 pt+1 t ρt+1 ′ + rt+1) −1 (7) alternatively, we can use kalman smoother to estimate the state variable. the kalman smoother uses all the observations for updating. for the dynamic factor model in (1) and (2), the process of updating the state variable via the kalman smoother is: st n = st t + jt(st+1 n − st+1 t ) ; (8) pt n = pt t + jt(pt+1 n − pt+1 t )jt ′ ; (9) where jt = pt tθt ′(pt+1 t )−1 ; (10) deriving these equations is based on a shumway and stoffer (2017b) textbook on the state-space model and is shown in appendix a. this study assumes the independence of idiosyncratic noises. in the case of correlated noises, it generates a quite different result, but it does not affect the updating of the kalman filter and smoother in equations 5, 6, 8, and 9.20 to implement the kalman filter it replaces parameters ρt, in the system with their consistent estimators ρ̂t. using the state variable generated by the first principal component, the study estimated the initial weights by the ordinary least squares and feasible generalized least squares. for the cointegrated series, the ols gave the consistently estimated parameters, but the inference did not hold (stock, 1987). for non-cointegrated series, the study used the fgls to estimate the parameters, as suggested by wu, you, and zou (2016). the remaining parameters were estimated by maximum likelihood estimation in the dynamic factor model. let φ = {qt, αt, rt} refer to the vector of the parameters to be estimated with a known initial state so~n(s0 0, p0 0), where idiosyncratic noises, ut and vt, are serially and contemporaneous independents. the likelihood is calculated from the innovations ϵ1, ϵ2, … , ϵt. ϵt = yt − (ρ t st t−1 + αtzt) ; ϵt~n(0, ∑t) ; (11) 14 the arma linear state-space models vary across studies depending on the interest of authors. 15 the marss package in r program allow for a flexibility of adding the exogenous vector into the state space model. 16 this is for cointegrated series. if series are not cointegrated with the state variable, their residuals, uit, are not i(0). in this case, instead of using ols, the study uses fgls to estimate the parameters. 17 this is for simplicity. the cov (ui, vj) ≠ 0 could be the case, but it did not affect the updating process (shumway & stoffer, 2017b). 18 kalman smoother can be implemented to estimate the state variable as well. to estimate the unobserved state, st, using data y1:s = {y1, y2, … , ys}, the process is called filtering when s = t while it is called smoothing for s > t (shumway & stoffer, 2017b). 19 the notation of st s = e(st|ys); pt1;t2 s = e{(st1 − st1 s )(st2 − st2 s )′|ys}. for t1 = t2, it uses the notation pt s. 20 see: shumway and stoffer (2017b) for the case of correlated noises. asian journal of economics and empirical research, 2020, 7(2): 268-281 273 © 2020 by the authors; licensee asian online journal publishing group ignoring the constant, the log-likelihood of logl(φ) is: logl(φ) = − 1 2 ∑ log|∑t(φ)|n t=1 − 1 2 ∑ ϵt(φ)′∑t(φ)−1ϵt(φ)n t=1 ; (12) asymptotic properties of consistency and normality of estimators hold in general (shumway & stoffer, 2017b). 4. result of the study table 1 summarizes the statistical properties of the series. additionally, it uses the augmented dickey–fuller (adf) test to check the stationarity of individual series. all series are i(1). in the case of cointegration between the state and observed variables, using the level series may improve the estimation of common factors, as pointed out by corona et al. (2020). 4.1. state estimation 4.1.1. initial coefficient estimation the increase in cross-sectional dimension induces the number of parameters to be estimated in the system that causes the dynamic factor model to be less feasible in practice, especially for the finite sample. doz et al. (2011) came up with the idea of replacing the parameters with their consistent estimators. with the stationary assumption, they estimated the parameters by the ols method using the state variable produced by the principal component. this method improved the estimation of the common factor in the dynamic factor model. empirical studies revealed that many macroeconomic variables cointegrate with the state of the economy. ignoring the cointegration will throw away a large amount of information. for this reason, this study used the non-stationary series. table 2 shows the result of the ols of each series on the state variable and their residual tests. figure 3 plots the residuals of this result (see appendix b). the ols results show that some series cointegrated with the state variable. for the cointegrated series, the ols parameter estimation holds, although its inference is not valid. for series that are not cointegrated, the ols estimation is spurious, so the study refers to the fgls to estimate the parameters. 4.1.2. dynamic factor model (armax) so far, the study has not indicated a specific form of armax linear state-space model. using the state variable generated by the principal components, it constructed the state equation of the dynamic factor model in autoregressive (ar) form. table 3 shows various lag selection criteria. the akaike information criterion (aic) suggested the ar (4) model for the state equation. for the non-stationary autoregressive model, the asymptotic distribution of aic held, while the bayesian information criterion (bic) was weakly consistent (tsay, 1984). for the observation equation, the study introduced two lags of the state variable. the study controlled for exogenous variables to improve the model fitness.21 moreover, it replaced the parameters ρt with ρ̂t estimated by the ols and fgls. the study used a diffuse initial state condition. additionally, it restricts the variances of the idiosyncratic noises of both observed and state equations to be non-negative. table 4 shows the results of the state-space model. figure 4 shows the movement of the state estimated by the kalman filter and smoother together with confidence intervals as well as its residual movement. figure 5 shows the distribution of the estimated residuals of both state and observation equations. the disturbance of the state equation behaves like a normal distribution. on the other hand, some disturbances of the observation equations fail to meet the gaussian assumption. durbin and koopman (2012) showed that even without the normality assumption, from the minimum variance linear unbiased estimation approach, the estimation of state variables (st+1 and st) and their variances (pt+1and pt) were the same as the estimates from the classical and bayesian viewpoints. figure 1 summarized the result of the estimation of the cambodian economic condition. panel (a) shows the estimation of the state variable by various methods (principal component, kalman filter, and kalman smoother), and panel (b) shows their comovement with gdp growth rate.22 all methods tended to capture well when the economy performs below its potential level. all methods revealed a similar pattern that the economy performed below the average level during 2016 and 2017. the economy somehow recovered after mid-2017. figure-1. state estimation by kalman smoother, kalman filter, and principal components and their comovement with gdp. 21 the aic value of the model with exogenous variables is -1.940, while it is 3.129 for the model without controlling exogenous variables. 22 the monthly movement of coincident indicators produced by each methodology are aggregated into annual data. asian journal of economics and empirical research, 2020, 7(2): 268-281 274 © 2020 by the authors; licensee asian online journal publishing group 4.2. foreign direct investment inflow and the state of the economy empirical studies on the relations between foreign direct investment and economic growth have been long discussed. some studies found the impact of fdi on economic growth, e.g. de mello (1999) and devajit (2012), while another revealed economic growth as a factor of fdi inflow, e.g. roy and mandal (2012). additionally, srinivasan, kalaivani, and ibrahim (2010) and hossain and hossain (2012) discovered cointegration between the two variables. türkcan, duman, and yetkiner (2008) pointed out the simultaneous causation between fdi and economic growth, and alfaro (2003) studied the heterogeneity across sectors on the relations between fdi and growth. this study skipped this discussion. the study explored the impact of the economic condition on the fdi inflow by exploiting the coincident index using the ardl model.23 bevan and estrin (2000) indicated macroeconomic variables, such as growth, inflation, and exchange rate risk, as determinants of fdi inflow to a transitional economy. pan (2003) examined the determinants of fdi inflow for a country-specific study. table 5 shows the dynamic relationship between the state of the economy and fdi inflow. it revealed that the state of the economy had a positive impact on fdi inflow in the short-term. all of the models using the state variables produced by the kalman smoother, kalman filter, and principal component show a similar tendency. the coefficient of the output gap shows the same pattern.24 additionally, the study revealed a cointegration between the state of the economy and fdi inflow; the long-term coefficient turns negative. one explanation of this negative impact is the diminishing marginal product of capital. from the supply side, capital investment becomes less attractive, which deters investors. additionally, the coefficients of exogenous variables are well-behaved even though most of them are not significant, and other variables are significant. for example, inflation shows a negative effect on fdi inflow. high inflation indicates a higher cost of investment that is often associated with a country’s risks. interest rate shows a positive impact on fdi inflow. from the supply side, an increase in interest rate attracts capital inflow as a return on lending. however, interpretation of the impact of interest rate on fdi inflow is still uncertain. one reason is that the high rate of return often relates to a country’s high risks of investment, especially for a small open economy. the effect of trade is diverse across the models, which could be due to the inclusion of the short lags. 5. discussion and limitation of the study the construction of the coincident index in this study had some limitations. first, it estimated the unobserved state in the linear context. many macroeconomic variables comove in a non-linear form. murphy (2012) indicated that by putting the system into a state-space form, parameters were no longer linear, even though the true model was. other extensions of the kalman filter dealing with the non-linear structure are the extended kalman filter (ekf) and the unscented kalman filter (ukf). györgy, kelemen, and dávid (2014) discussed how each algorithm works. julier and uhlmann (1997) introduced the ukf as a superior version to the ekf. the ukf is a derivativefree filter that does not need to calculate the jacobian compared to the ekf. both the ekf and ukf approximate the distribution with the gaussian assumption. another type of application, called a particle filter, could also be used for the non-linear system. unlike the ekf and ukf, the particle filter does not require the gaussian assumption. the second limitation of this study involves the implementation of time-invariant parameters in the dynamic factor model. stability of the factor loadings (coefficients of the state variables) may not appropriate if the economy goes through a structural change. the structural break will cause time-variate parameters. bates, plagborg-møller, stock, and watson (2013) categorized conditions that the standard estimation of factors could tolerate temporal parameter instability. stock and watson (2002) showed that the estimated factors under principal components were consistent with small time-variate parameters. the structural break may be less of an issue because the period in this study is relatively short. another issue relates to the quality of the data and how the real economy performs. the theory depends mainly on generating data to verify the results. however, real-time data is subject to measurement error. one potential challenge in this study is the availability and quality of data. as a developing country, cambodia faces a constraint in collecting data from the informal sectors. looking at this issue, how well a coincident indicator could capture the state of the economy is unknown. although the quality of data in constructing the ci remains a topic for discussion, its creation plays an important role to monitor economic activity. the ci is a useful tool for early warning and signaling when the economy moves into a recession. the effect may come with long or short lags depending on the characteristics of the economy. policymakers should use this index with caution. lastly, there are two main problems regarding the ardl model in this study. one of them involves the cointegration issue. pesaran and shin (1998) mentioned that the cointegration in the ardl model must be unique; in other words, there should not be a cointegration among regressors. in restricting cointegration among regressors, this study introduced the first differencing method to transform all i(1) regressors, except the state variable. another issue relates to the serial correlation and endogeneity problems. türkcan et al. (2008) suggested an endogenous relationship between fdi inflow and economic growth. it transpired that the ardl model can address serial correlation and endogeneity problems, and can resolve these issues by adding appropriate lag regressors, for example, ardl (p, q) to ardl (p, m), for m≥q pesaran and shin (1998). the study conducted a residual diagnostic by checking serial correlation using the lagrange multiplier test. it does not find serial correlation problems in this study. 6. conclusion this study constructed a coincident indicator as an unobserved state of the economy using the two-step procedure proposed by doz et al. (2011). in the first step, it estimated the parameters by the ols and fgls 23 the study uses the quarterly data because only quarterly fdi is available. 24 output gap is calculated as the deviation between the state of the economy and its trend, where the hodrick–prescott (hp) filter is used to decompose the trend. asian journal of economics and empirical research, 2020, 7(2): 268-281 275 © 2020 by the authors; licensee asian online journal publishing group methods using the state variable generated by the principal component. in the second step, it estimated the unobserved state via the dynamic factor model (dfm) by substituting parameters with its estimators in the first step. this approach could improve the estimation of the common factors substantially as emphasized by giannone et al. (2008) and stock and watson (2011). the study used non-stationary data, as it discards a large amount of information if cointegration exists. corona et al. 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(2008). how does fdi and economic growth affect each other? the oecd case. paper presented at the in international conference on emerging economic issues in a globalizing world. wan, e. a., & van der merwe, r. (2000). the unscented kalman filter for nonlinear estimation. paper presented at the in proceedings of the ieee 2000 adaptive systems for signal processing, communications, and control symposium (cat. no. 00ex373). wilks, d. s. (2019). parametric probability distributions. in d. s. wilks, statistical methods in the atmosphereic sciences (4th ed., pp. 77141). massachusetts: elsevier inc. world bank. (2018). the world bank in cambodia. retrieved from: https://www.worldbank.org/en/country/cambodia/overview. wu, m., you, p., & zou, n. (2016). on spurious regressions with trending variables. cornell university library arxiv:1606.05049. wyplosz, c. (2005). fiscal policy: institution versus rules. national institute economic review, 191(1), 64-78. zarnowitz, v., & moore, g. h. (1983). sequential signals of recession and recovery. in g. h. moore, business cycles, inflation, and forecasting (2nd ed., pp. 23 60). ballinger. appendix a given data yt = {y1, … , yt }, estimation of the unobserved state variables(st) by dfm can be done using the kalman filter or smoother. shumway and stoffer (2017b) showed that variance produced by the kalman smoother is lower than the kalman filter. armax linear state-space model with initial condition s0~n(s0 0, p0 0) can be expressed by equations 1 and 2.25 additionally, for simplicity, it assumes the errors, ut and vt to be independent from each other. yt = ρ t st + αtzt + ut ; (1) st+1 = θtst + vt ; (2) where ( ut vt ) ~(i. i. d) n ([ 0 0 ] , [ rt 0 0 qt ]) because the sum of gaussian distributions is a gaussian, it follows that st+1 and yt are also gaussians. besides, for two gaussian distributions with mean, variance, and covariance specified below, the conditional expectation is: ( x1 x2 ) ~ n ([ μ1 μ2 ] , [ ∑11 ∑12 ∑21 ∑22 ]) x1|x2 ~n(μ1 + ∑12∑22 −1(x2 − μ2), ∑11 − ∑12∑22 −1∑21) 1. kalman filter notation st+1 t = e(st+1|yt); pt+1 t = e{(st+1 − st+1 t )(st+1 − st+1 t )′|yt} from (2): st+1 t = e(θtst + vt|yt) = θtst t ; (3) pt+1 t = e{(st+1 − st+1 t )(st+1 − st+1 t )′|yt} = e{(θt(st − st t) + vt)(θt(st − st t) + vt)′|yt} = θtpt tθt ′ + qt ; (4) let ϵt+1 = yt+1 − e( yt+1| yt) = yt+1 − (ρ t+1 st+1 t + αt+1zt+1) ; where e(ϵt+1) = 0 var(ϵt+1) = var[ρt+1 (st+1 − st+1 t ) + ut+1] = ρ t+1 pt+1 t ρt+1 ′ + rt+1 under the gaussian assumption above, e(ϵtys ′) = 0 for s < t cov(st+1, ϵt+1|yt) = cov(st+1, yt+1 − (ρ t+1 st+1 t + αt+1zt+1)|yt) = cov(st+1 − st+1 t , yt+1 − (ρ t+1 st+1 t + αt+1zt+1)|yt) 25 a similar version of this derivation can be found in the literature such as in nakata and tonetti (2010). http://dx.doi.org/10.1787/834716666802 http://www.oecd.org/dev/asia-pacific/45623832.pdf http://www.worldbank.org/en/country/cambodia/overview asian journal of economics and empirical research, 2020, 7(2): 268-281 277 © 2020 by the authors; licensee asian online journal publishing group = cov[st+1 − st+1 t , ρ t+1 (st+1 − st+1 t ) + ut+1] = pt+1 t ρt+1 ′ so, the joint distribution between st+1and ϵt+1 conditions on yt. ( st+1 ϵt+1 ) |yt~n ([ st+1 t 0 ] , [ pt+1 t pt+1 t ρt+1 ′ ρt+1pt+1 t ρ t+1 pt+1 t ρt+1 ′ + rt+1 ]) st+1 t+1 = e(st+1|y1, … , yt, yt+1) = e(st+1|yt, ϵt+1) st+1 t+1 = st+1 t + pt+1 t ρt+1 ′ (ρt+1 pt+1 t ρt+1 ′ + rt+1) −1 ϵt+1 let kt+1(kalman gain) = pt+1 t ρt+1 ′ (ρt+1 pt+1 t ρt+1 ′ + rt+1) −1 ; (7) st+1 t+1 = st+1 t + kt+1ϵt+1 ; (5) pt+1 t+1 = cov(st+1|yt, ϵt+1) = pt+1 t − pt+1 t ρt+1 ′ (ρt+1 pt+1 t ρt+1 ′ + rt+1) −1 ρt+1pt+1 t = [i − pt+1 t ρt+1 ′ (ρ t+1 pt+1 t ρt+1 ′ + rt+1)−1ρt+1]pt+1 t pt+1 t+1 = (i − kt+1ρt+1)pt+1 t ; (6) 2. kalman smoother the kalman smoother used all the observations (n) to update the state variable. the joint distribution of st and st+1 conditions on yt is: ( st st+1 ) |yt ~ n ([ st t st+1 t ] , [ pt t pt tθt ′ θtpt t pt+1 t ]) e(st|st+1, yt) = st t + pt tθt ′(pt+1 t )−1(st+1 − st+1 t ) var(st|st+1, yt) = pt t − pt tθt ′(pt+1 t )−1θtpt t let jt = pt tθt ′(pt+1 t )−1 ; (10) for (n) total samples, by the law of iterated expectation: st n = e(st|yn) = e(e(st|st+1, yn)|yn) = e(e(st|st+1, yt)|yn) ; for n > t = e(st t + jt(st+1 − st+1 t )|yn) st n = st t + jt(st+1 n − st+1 t ) ; ` (8) pt n = e(st − st n)(st − st n)′ from (8): st − st n = st − st t − jt(st+1 n − st+1 t ) st − st n + jtst+1 n = st − st t + jtst+1 t multiply both sides by its transpose and take expectation, we get e[(st − st n + jtst+1 n )(st − st n + jtst+1 n )′] = e[(st − st t + jtst+1 t )(st − st t + jtst+1 t )′] because cross-product terms are zero, so pt n + jte(st+1 n st+1 n′ )jt ′ = pt t + jtθte(st tst t′)θt ′jt ′ e(st+1 n st+1 n′ ) = e(st+1st+1 ′ ) − pt+1 n = θte(stst ′)θt ′ + qt − pt+1 n e(st tst t′) = e(stst ′) − pt t pt n + jt[θte(stst ′)θt ′ + qt − pt+1 n ]jt ′ = pt t + jtθt[e(stst ′) − pt t]θt ′jt ′ pt n = pt t + jtpt+1 n jt ′ − [jt(θtpt tθt ′ + qt)jt ′] pt n = pt t + jtpt+1 n jt ′ − jtpt+1 t jt ′ pt n = pt t + jt(pt+1 n − pt+1 t )jt ′ ; (9) appendix b: tables and figures table 1. summary statistics. variables mean sd unit root test (level) unit root test (1st difference) adf p-value adf p-value total bank credits (𝐘𝟏) 17.246 0.717 -0.410 0.903 -14.049 0.000 banks lending to the service-related sectors (𝐘𝟐) 7.652 0.396 0.763 0.993 -12.542 0.000 banks lending to the manufacturing sector (𝐘𝟑) 7.885 0.503 -3.017 0.057 -13.758 0.000 banks lending to the retail trade sector (𝐘𝟒) 8.609 0.640 -0.633 0.858 -13.001 0.000 banks lending to the wholesale sector (𝐘𝟓) 8.539 0.608 -2.312 0.170 -14.933 0.000 total electricity supply (𝐘𝟔) 5.796 0.588 0.350 0.980 -12.247 0.000 export value (𝐘𝟕) 19.611 0.798 -0.781 0.822 -21.410 0.000 import value (𝐘𝟖) 14.252 0.961 -1.130 0.704 -9.796 0.000 corporate income or profit tax (𝐘𝟗) 11.746 0.588 -0.194 0.935 -8.347 0.000 domestic vat (𝐘𝟏𝟎) 11.521 0.432 -0.412 0.902 -8.870 0.000 import vat (𝐘𝟏𝟏) 12.029 0.452 -0.299 0.920 -9.615 0.000 asian journal of economics and empirical research, 2020, 7(2): 268-281 278 © 2020 by the authors; licensee asian online journal publishing group table 2. cointegration results (ols result of individual series on state variables). variables coefficient residual's unit root test t-statistics p-value total bank credits (𝐘𝟏) 0.302*** -7.808 0.000 (0.002) banks lending to the service-related sectors (𝐘𝟐) 0.292*** -1.812 0.373 (0.006) banks lending to the manufacturing sector (𝐘𝟑) 0.298*** -1.204 0.671 (0.008) banks lending to the retail trade sector (𝐘𝟒) 0.300*** -1.810 0.374 (0.004) banks lending to the wholesale sector (𝐘𝟓) 0.297*** -1.240 0.655 (0.008) total electricity supply (𝐘𝟔) 0.307*** -2.489 0.121 (0.004) export value (𝐘𝟕) 0.297*** -4.715 0.000 (0.007) import value (𝐘𝟖) 0.303*** -2.697 0.078 (0.006) corporate income or profit tax (𝐘𝟗) 0.289*** -10.034 0.000 (0.008) domestic vat (𝐘𝟏𝟎) 0.276*** -5.155 0.000 (0.013) import vat (𝐘𝟏𝟏) 0.287*** -4.715 0.000 (0.008) note: standard errors are reported in parenthesis. *, **, and *** are significant at 10%, 5%, and 1%, respectively. table 3. lag selection criteria of the state variable. lag logl lr fpe aic sc hq 0 -257.299 na 8.825 5.016 5.041 5.026 1 -5.118 494.568 0.067 0.138 0.189 0.159 2 0.084 10.102 0.062 0.057 0.133 0.088 3 7.206 13.689* 0.055 -0.062 0.040* -0.021 4 8.953 3.325 0.054* -0.076* 0.051 -0.024* 5 8.970 0.032 0.055 -0.058 0.096 0.004 note: *suggests the lag selection. table 4. dfm results. parameter name coef. sd z-statistic p-value 𝛂𝟏𝟏 -0.002 0.004 -0.578 0.563 𝛂𝟏𝟐 0.109 0.012 8.718 0.000 𝛂𝟏𝟑 -0.029 0.013 -2.194 0.028 𝛂𝟐𝟑 0.151 0.025 6.116 0.000 𝛂𝟑𝟑 0.129 0.133 0.972 0.331 𝛂𝟒𝟑 -0.034 0.053 -0.641 0.522 𝛂𝟓𝟑 0.327 0.213 1.536 0.125 𝛂𝟕𝟏 -0.029 0.024 -1.244 0.214 𝛂𝟖𝟏 0.047 0.032 1.438 0.150 var(𝐯𝐭 = 𝐞𝐜𝟏𝟐) -7.873 0.365 -21.584 0.000 var(𝐮𝟏𝐭 = 𝐞𝐜𝟏) -8.388 0.170 -49.402 0.000 var(𝐮𝟐𝐭 = 𝐞𝐜𝟐) -3.650 0.225 -16.218 0.000 var(𝐮𝟑𝐭 = 𝐞𝐜𝟑) -1.889 0.393 -4.807 0.000 var(𝐮𝟒𝐭 = 𝐞𝐜𝟒) -4.020 0.284 -14.146 0.000 var(𝐮𝟓𝐭 = 𝐞𝐜𝟓) -1.360 0.504 -2.698 0.007 var(𝐮𝟔𝐭 = 𝐞𝐜𝟔) -3.965 0.195 -20.284 0.000 var(𝐮𝟕𝐭 = 𝐞𝐜𝟕) -2.851 0.163 -17.513 0.000 var(𝐮𝟖𝐭 = 𝐞𝐜𝟖) -2.710 0.133 -20.382 0.000 var(𝐮𝟗𝐭 = 𝐞𝐜𝟗) -2.293 0.129 -17.770 0.000 var(𝐮𝟏𝟎𝐭 = 𝐞𝐜𝟏𝟎) -1.207 0.113 -10.662 0.000 var(𝐮𝟏𝟏𝐭 = 𝐞𝐜𝟏𝟏) -2.318 0.113 -20.467 0.000 𝛉𝟏 2.693 0.021 129.587 0.000 𝛉𝟐 -3.257 0.028 -115.488 0.000 𝛉𝟑 2.420 0.008 295.654 0.000 𝛉𝟒 -0.856 0.005 -160.035 0.000 note: dfm estimation. asian journal of economics and empirical research, 2020, 7(2): 268-281 279 © 2020 by the authors; licensee asian online journal publishing group state variable name final state root mse z-statistic prob. sv1 6.088 0.183 33.292 0.000 sv2 6.022 0.151 39.841 0.000 sv3 5.922 0.124 47.703 0.000 sv4 5.787 0.098 59.142 0.000 log likelihood 135.599 akaike info criterion -1.940 parameters 25 schwarz criterion -1.340 diffuse priors 0 hannan–quinn criteria. -1.697 note: dfm estimation. table 5. the impact of the state of the economy on fdi inflow (conditional error correction form and bound test). dependent variable ∆fdi state (kalman smoother) state (kalman filter) state (principal component) coefficient coefficient coefficient coefficient coefficient coefficient fdi (-1) -1.201*** -1.522*** -1.099*** -1.221*** -0.888*** -0.600** (0.246) (0.335) (0.237) (0.289) (0.213) (0.216) state (-1) -11.761*** -17.756*** -10.073*** -13.657** -6.932*** -4.686* (3.696) (5.353) (3.466) (4.687) (2.238) (2.540) ∆state -734.797** -1022.636** -645.575** -910.541** -482.953** -494.055* (311.017) (448.914) (293.555) (398.822) (231.853) (240.514) ∆state (-1) 825.674** 1163.456** 712.135** 974.933** 503.326** 445.233* (323.556) (463.364) (304.871) (413.627) (228.825) (231.869) ∆state (-2) 1.375 2.046 1.488 2.731* 0.960 1.808** (1.369) (2.095) (1.222) (1.453) (0.786) (0.715) ∆state (-3) 0.466 0.503 0.758 1.111 0.528 0.945* (1.010) (1.151) (0.910) (0.936) (0.490) (0.452) ∆exchange rate -0.027 -0.133 -0.159 (0.153) (0.112) (0.112) ∆expenditure -0.032 -0.043 -0.024 (0.067) (0.048) (0.046) inflation -0.027 -0.033 -0.056** (0.037) (0.027) (0.022) inflation (-1) -0.064* -0.061** -0.005 (0.031) (0.021) (0.020) ∆revenue (-1) 0.114 0.141 0.029 (0.130) (0.092) (0.101) ∆interest rate 0.021 0.059 0.240* (0.177) (0.121) (0.119) ∆size of trade -0.070 -0.067 -0.337 (0.312) (0.213) (0.193) ∆size of trade (-1) -0.940** -0.672* 0.139 (0.416) (0.309) (0.351) ∆size of trade (-2) -0.732 -0.277 0.865** (0.443) (0.383) (0.362) ∆size of trade (-3) -0.209 -0.008 0.569** (0.361) (0.235) (0.211) output gap 736.209** 1025.025** 647.716** 912.868** 484.548** 496.239* (310.759) (448.680) (293.343) (398.615) (231.612) (240.306) output gap (-1) -1549.478** -2169.146** -1349.155** -1873.795** -980.082** -936.142* (630.894) (906.397) (594.872) (807.153) (458.646) (469.490) output gap (-2) 824.530** 1161.452** 710.029** 971.596** 501.853** 441.851* (323.331) (462.318) (304.397) (412.465) (228.108) (231.175) election (dummy) 0.047 -0.012 0.026 -0.006 0.041 0.128* (0.075) (0.094) (0.064) (0.068) (0.059) (0.058) state of the economy (dummy) -0.078 -0.071 -0.018 0.026 -0.032 -0.094 (0.102) (0.123) (0.092) (0.089) (0.075) (0.073) trend 1.272*** 1.900*** 1.083*** 1.419** 0.737*** 0.421 (0.371) (0.540) (0.347) (0.472) (0.215) (0.253) c -33.059*** -49.644*** -27.217*** -33.666** -16.266*** -4.152 (9.446) (13.726) (8.697) (11.964) (4.717) (6.377) asian journal of economics and empirical research, 2020, 7(2): 268-281 280 © 2020 by the authors; licensee asian online journal publishing group 𝐑𝟐 0.648 0.858 0.723 0.920 0.751 0.937 adjusted 𝐑𝟐 0.437 0.547 0.557 0.743 0.602 0.797 prob (f-statistic) 0.013 0.050 0.002 0.005 0.001 0.002 obs. 37 37 37 37 37 37 note: standard errors are in parentheses. data are normalized with mean 0 and standard deviation 1. *, **, and *** are significant at 10%, 5%, and 1%, respectively. figure 2. seasonal and non-seasonal adjusted data. figure 3. residuals of ols regression of each series i(1) on the state variable i(1). asian journal of economics and empirical research, 2020, 7(2): 268-281 281 © 2020 by the authors; licensee asian online journal publishing group figure 4. state estimation by kalman smoother and kalman filter. figure 5. residual diagnostics. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 217 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 2, 217-223, 2020 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2020.72.217.223 © 2020 by the authors; licensee asian online journal publishing group volatility transmission between oil prices and stock prices as a new source of instability: lessons from the uk experience john robertson university of dundee, dundee, uk. abstract the banking industry is one of the main regulators of the economy; therefore, a possible decline in performance or risk to operations could trigger a chain of unexpected economic events. in consideration of this, this paper sought to evaluate the risk imposed by the oil and gas sector on the banking industry in the united kingdom (uk) by evaluating the spillover effects and the exposure of the banking industry to shocks caused by changes in oil prices. in order to reach this objective, the present study evaluated the impact and effect of the volatility of bank stock prices and oil prices in four leading banks in the uk. these banks—hsbc, royal bank of scotland, lloyds banking group and barclays plc—were selected on the basis of their involvement in the oil and gas sector, and they were chosen to represent the volatility of the banking industry. the change in price of brent crude oil was used as a representation of the volatility imposed by the oil industry. the vector autoregressive fractionally integrated moving average (varfima) model was used to evaluate the impact of the volatility spillover and to evaluate the presence of covolatility between certain parameters. the results showed volatility responses between the bsp and oil prices. the granger causality analysis confirmed the presence of bidirectional causality between the volatility caused by oil prices and the stock prices of banks. keywords: varfima; united kingdom; granger causality; oil prices. citation | john robertson (2020). volatility transmission between oil prices and stock prices as a new source of instability: lessons from the uk experience. asian journal of economics and empirical research, 7(2): 217-223. history: received: 12 june 2020 revised: 16 july 2020 accepted: 19 august 2020 published: 2 september 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 218 2. literature review .......................................................................................................................................................................... 218 3. research methodology ................................................................................................................................................................. 219 4. findings of the study .................................................................................................................................................................... 220 5. discussion and implications ........................................................................................................................................................ 222 6. conclusion and limitations ......................................................................................................................................................... 222 references ............................................................................................................................................................................................ 223 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.72.217.223&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/2082 asian journal of economics and empirical research, 2020, 7(2): 217-223 218 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the existing literature by evaluating the risk imposed by the oil and gas sector on the banking industry in the united kingdom (uk) through evaluating the spillover effects and the exposure of the banking industry to shocks caused by changes in oil prices. 1. introduction volatility transmission is considered to be of great interest to capital markets and the financial community, as it helps to increase the trend of financial globalization (yarovaya, brzeszczynski, goodell, lucey, & lau, 2020). fracking is considered to be a substantial technical development for the oil and gas industry in the uk that allows organizations to extract and recover shale oil (vo & ellis, 2018). cash flows and revenues are directly proportional to oil prices, as fluctuations in the rate of oil prices directly affect cash flows and revenues, which leads to difficulties regarding loans. the price of oil is significantly influenced by stock prices in the banking sector of the uk, and this rate has been increasing since 2010, as banks have had a strong influence on the industry of shale (bouri & demirer, 2016). beneficial research has been completed over the past few years with regard to oil prices and the role of bank stock prices (bsp) in several contexts and countries. recent research by bein (2017) evaluated the overall impact and role of bsp in stabilizing overall oil prices and other factors that affect oil prices from the perspective of different regions and countries. this indicates the fact that a significant amount of effort and research has been completed over the last few years in terms of oil prices and its related factors. additionally, the influence of banks on the oil industry and the stability of oil prices has been evaluated and tested in particular regions and states, mainly through panel data and empirical research (cardona, gutiérrez, & agudelo, 2017). however, research has not evaluated the oil market of the united kingdom and its conditions. as of yet, there has been no research that has demonstrated the role of different banks on the overall modifications of oil prices. consequently, the present research is new and justified to forecast the role of uk banks in stabilizing oil prices. based on the above justification statement, the current study has the following aims: • to identify whether the exposure of uk banks to the oil sector could lead to some level of instability in both the financial and oil markets. • to evaluate the economic situation of the country and how oil prices and the contribution of banks in stabilizing oil prices affects the economic growth of the country. the current study covers issues relevant to oil prices and bsp, and how stock pricing creates instability in the economy. this research is beneficial and significant, as it helps to distinguish the issues that create complexity and insecurity in the market. this research paper will help future researchers and managers of organizations. the remainder of the thesis is structured as follows: chapter two presents empirical proof on the enhanced and significant connection between the uk banking sector and the oil market; chapter three presents the data and study methodology used in the paper to collect data; the overall findings and results are presented in chapters four and five, and this research provides proof for the durability of the given study results; finally, chapter six presents concluding and final remarks, as well as implications and limitations of the study and further suggestions. 2. literature review according to leung, schiereck, and schroeder (2017), a spillover is an economic event that occurs in one industry that happens because of something else in a seemingly unrelated context. according to liu et al. (2017), the externalities of economic activity or market activity are non-monetary spillover effects that mainly affect nonparticipants. in the same way, the economic advantages of improved trade are the spillover effects that are likely to develop multilateral alliances in many regional markets, banks, and states. according to this theory, spillover effects are a type of mechanism effect that has developed as globalization in trade and stock markets has deepened the financial relationships between different economies and markets. oil is a large commodity and, as such, it determines significant volatilities and fluctuations in price to a greater extent than other more stable investments (chang, mcaleer, & wang, 2018). according to this theory, there are many spillover effects of oil prices; for example, oil prices are affected by a variety of factors and spillovers, as they are particularly responsive to decisions about outputs developed by oil authorities (katusiime, 2019). similar to any other product or good, laws and supply and demand also have a vs effect on the prices of oil, and bank prices and production costs have a spillover effect on oil prices. furthermore, hamadi, bassil, and nehme (2017) highlight that political unrest, natural disasters and other disasters could potentially disrupt manufacturing, which would have a substantial impact and spillover effect and increase the risk of volatility in oil prices. 2.1. oil prices and volatility transmission/prices oil prices play a major role in the economy of a country; however, if prices rise and fall frequently, this creates uncertainty in the market of the country (damien, fuentes-garcía, mena, & zarnikau, 2019). this situation is called price volatility. in an efficient market, prices reflect nonexistent and anticipated future circumstances of demand and supply. when there is a quick change in market prices over a relatively short period, this situation is known as having high volatility. according to bergmann, o'connor, and thümmel (2016), when oil prices are stable in the market, the assets represent a huge investment—often hundreds of millions. the ability of investments to earn predominantly depends on the stability of market prices and the ability to sell at a viable price level. various aspects and tools depend on the transmission of oil. when there are rises and falls in oil price, the same happens in the process of meeting the demand of customers (bouri & demirer, 2016). it is a fact that, when the market is stable and the oil prices are stable, investors feel satisfied and secure in developing their business, as they earn a handsome revenue and they are able to substantially enhance and grow their business. however, when there is a decline in oil prices, the reliability of their income and earning becomes passive. this study refers to a situation when the oil market asian journal of economics and empirical research, 2020, 7(2): 217-223 219 © 2020 by the authors; licensee asian online journal publishing group faces volatility. this has a significant effect in a country because this energy is used in all walks of life; therefore, during this unstable period of time, society may have to face unexpected impacts (kumar, 2017). common people will be affected by this situation, as their budget and savings will be disturbed. they often find this situation hard to manage; their domestic lives are negatively impacted, as their household budget cannot afford such high costs. research by zhang, ji, and kutan (2019) has explained the ways in which household affairs can be disturbed. moreover, industries face the same issue. the volatility of oil pricing and the oil market creates a bizarre situation, as the transmission of oil becomes costly (sadorsky, 2012). it is a fact that volatility transmission influences economic growth. the stability of oil prices can create economic growth and stability in the market. this stability in oil prices is very important, as it ensures regular transmission (ji, bouri, & roubaud, 2018). in short, stable oil prices create regularity, while volatility creates disruption. this leads to investor hesitatatio, as they require a stable condition to run their business with continual progress. oil prices have a strong impact on the global market (saghaian, nemati, walters, & chen, 2018). rising and falling oil prices affect the global economy and transmission. when oil prices are stable, all business sectors and the energy industry are stable; their workforce enjoy proper earnings and the circle of development is successful. 2.2. banks’ stock prices and volatility transmission/prices generally, a stock is described as the ownership certificates of a specific company (ehouman., 2020). the bsp predominantly depends on supply and demand; like many other companies, this refers to a share being sold by the buyer and the seller exchanging money for the ownership of the share. according to ji et al. (2018), every step taken throughout the process of the purchase and sale affects the new market price rate. when there are rises and falls in the market, this volatility has a strong impact on investors, as they face losing a huge amount of money. in order to make this an uninterrupted procedure, owners of firms and businesses find opportunities to deal with bank stock (carsamer, 2016). the process of purchasing and selling is highly influenced. banks with strong shares have an influential role in establishing a connection between the shareholder and the stocks (jouini, 2013). stocks should be regarded as the most important part of any investor's portfolio because, when shareholders face great risks, they receive substantial rewards. in other words, stocks tend to outperform other investments, even though they are more exposed to volatility (raza, shahzad, tiwari, & shahbaz, 2016). there is little evidence to suggest that buybacks improve bank stock prices, although there appear to be two major causes as to why bank stocks act in this way. the process of volatility transmission involves several shareholders who became bankrupt (bein, 2017), which is evidence that bank stocks have certain limitations and that prices of stocks are continually changing according to market conditions. rises and falls in prices also have a significant effect because of the fact that they are related to volatility transmission (he & lin, 2019). volatility refers to the process in which product prices may affect bank stock prices; for example, bank stocks may not be strong because the fundamentals that determine their earnings are weak. however, stocks are doing worse than might have been expected (apostolou & beirne, 2019). therefore, according to vo and ellis (2018), there is a positive relationship between bank stock prices and volatility transmission. 3. research methodology data was collected on brent crude oil and uk banks’ stock prices. the data was recorded between january 2nd, 2007 and june 30th, 2017. data were collected between the opening and closing times of the stock market, which is 9.30am and 4pm, and are quoted in british pounds. the use of spot prices of the banks’ stocks is necessary in order to evaluate volatility, as they reflect the principal assets upon which the derivatives are typically based (vivian & wohar, 2012). the data consists of spot stock prices that were sourced from quant quote. the lloyds banking group, hsbc, the royal bank of scotland, and barclays plc are the banks that have been considered. these banks have been selected on the basis of two criteria: first, these banks are globally recognized as important banks by the board of financial stability, as they could destabilize the entire financial system of the country if their bankruptcy was declared, and second, they have been significantly affected by the changes in the oil and gas sector, as their business is heavily aligned with this industry. several different models have been developed to evaluate the dynamics of volatility. studies initiated by andersen and bollerslev (1998) suggest that daily returns aren’t as precise as the intraday returns when evaluating price volatility. another approach, which is known as “realized” volatility, has been devised to exploit the information presented by high frequency returns. consequently, several methods have been proposed in the literature to evaluate and manage problems caused by the usage of high frequency data, such as market friction, non-synchronized trading, and the presence of time jumps. the kernel estimator is being used to account for realized volatility. the developers of this method have assumed that the price processes incorporate a covert yet efficient price process that includes a finite activity jump process. previous analysis of this method suggests that time jumps shouldn’t be considered a problem; instead, they should be associated with market information. in the present study, these jumps are considered to be market news. for this reason, the kernel estimator is preferable. k(p)= ∑ 𝑘( ℎ 𝐻 )𝛤ℎ 𝑛 ℎ=−𝑛 (1) in the above equation 𝜞𝒉=∑ 𝒓𝒊𝒓𝒊−𝒉, 𝒏 𝒋=𝒉+𝟏 where h ≥ 0 and the hth realized autocovariance γh= γ−h. the term ri is the return of the stock i, characterized by 5 minutes, and k represents the non-stochastic weight function. in order to evaluate the strong relationship, a vector autoregressive fractionally integrated moving average (varfima) model (p,d,q), developed by chiriac and voev (2011), was used in the study. thus, let yt be the nxn realized covariance matrix, where n represents the number of assets under consideration. the decomposition of the yt matrix is defined by the triangular method pt for which pt.pt=yt. let the xt = vech (pt) be the mx1 vector obtained from the upper triangular components. in order to evaluate the transmission of volatility between the banking sector returns and oil prices for each of the banks, the trivariate varfima model will be applied: 𝛥𝑑𝐵𝑋1,𝑡 = 𝛼1𝛥 𝑑𝐵𝑋1,𝑡−1 + 𝛽1𝛥 𝑑𝑂𝑋2,𝑡−1 + 𝛾1𝛥𝑑𝑂𝐵𝑋3,𝑡−1 + 𝑒𝐵,𝑡 (2) 𝛥𝑑𝑂𝑋2,𝑡 = 𝛼2𝛥 𝑑𝐵𝑋1,𝑡−1 + 𝛽1𝛥 𝑑𝑂𝑋2,𝑡−1 + 𝛾2𝛥𝑑𝑂𝐵𝑋3,𝑡−1 + 𝑒𝑂,𝑡 (3) asian journal of economics and empirical research, 2020, 7(2): 217-223 220 © 2020 by the authors; licensee asian online journal publishing group 𝛥𝑑𝑂𝐵𝑋3,𝑡 = 𝛼3𝛥 𝑑𝐵𝑋1,𝑡−1 + 𝛽1𝛥 𝑑𝑂𝑋2,𝑡−1 + 𝛾3𝛥𝑑𝑂𝐵𝑋3,𝑡−1 + 𝑒𝑂𝐵,𝑡 (4) equations 2-4 describe the impact of volatility and co-volatility and how it changes over time across the stock market and oil industry in each of the banks under consideration. the variables 𝑋1,𝑡, 𝑋2,𝑡 , are a representation of the realized returns of the volatility of uk bank prices and oil prices, and 𝑋3,𝑡 is the measure of covolatility between the series. the varfima model allows for the measurement and evaluation of the persistence of the volatility series, as well as considering the short-term dynamics of volatility spillovers. the estimation of the parameters of the model was performed using the cldl algorithm proposed by tsay (2010). the estimations were performed, and the granger causality was also evaluated. 4. findings of the study the calculations are presented in figures 2 and 3. these figures shows that oil prices are highly volatile throughout the period under consideration; however, a break from this trend is observed between 2007–2008 due to the global financial crisis. crude oil prices doubled between march and august 2008, before declining at the end of the same year. the volatility of the banks shares some common features. the volatility of uk banks was moderate during 2007 and a trend of high volatility has been observed during the period between 2007–2011. this period was governed by high volatility due to the accumulated losses occurring worldwide as a result of the financial crisis, which stemmed from the us. however, since 2011, this volatility has been perceived to be moderate. this co-volatility is illustrated in figure 3. these figures represent the cumulative volatilities of the uk banks’ stock prices and oil prices. the co-volatilities are found to be negligible before 2007 and also after the financial crisis and its resultant effects had settled by 2011. however, during these four years, co-volatilities were significantly high. if the variability of the pre-crisis year is focused on 2007, the resultant correlation between the prices of uk bank stocks and oil, an increase can be measured from the period after 2011. this factor provides evidence for the correlation between the oil and gas sector and the uk’s financial sector. 4.1. empirical findings the findings of the varfima model are reported in table 1. the results indicate that volatility is affected by the preceding values of bsp, and that oil prices are also influential. this is indicated by the significant results of the coefficients of oil prices, 𝛼1, and the coefficient of bsp, 𝛽2. the results are significant at the 5 percent level. these results indicate that a relatively high magnitude of continued volatility is observed in all of the banks. however, the results don’t provide any significant relationship between co-volatility in the prices of oil and bsp. moreover, a lagged dependence for co-volatility wasn’t found; in other words, the past values of the co-volatility series weren’t found to be dependent on preceding values. moreover, the findings also revealed that, for each model, the volatility spillovers, i.e. the effects and correlations between oil prices and bsp, were found to be significant at the 5 percent level, as indicated by the coefficients 𝛽2 and 𝛼2. the results of the granger causality also reinforce and support these results. the null hypothesis is rejected, and the causal relationship is proven by the significant values of the test results. there is evidence of bidirectional causality between the volatilities of bank prices and oil prices. figures 2 and 3 represent the realized volatilities of uk banks’ stock prices and oil prices. table 1. varfima model results parameters lbg hsbc rbs bplc 𝛼1 0.89895∗∗∗ 0.89573∗∗∗ 0.84957∗∗∗ 0.90539∗∗ 𝛽1 0.00720∗∗∗ 0.00758∗∗ 0.01723∗∗ 0.00783∗∗ 𝛾1 0.08642 0.04243 0.38314 0.09824 𝛼2 0.39103∗∗∗ 0.34137∗∗∗ 0.23981∗∗∗ 0.29822∗∗∗ 𝛽2 0.94201∗∗∗ 0.94497∗∗∗ 0.94845∗∗∗ 0.94973∗∗∗ 𝛾2 0.29724 −0.49219 −0.33861 −0.02681 𝛼3 0.00879∗∗∗ 0.00875∗ −0.00142 0.00428 𝛽3 −0.00153 −0.00042 0.00054 −0.00026 𝛾3 0.01757 0.04432 −0.00713 −0.02131 db −0.4456∗∗ 0.4787∗ 0.4748∗∗∗ 0.4352∗∗∗ do 0.4648∗∗∗ 0.4747∗∗∗ 0.4747∗∗∗ 0.4747∗∗∗ dob 0.00844∗ 0.0127∗∗∗ 0.0127∗ −0.03655∗∗∗ x1 does not granger cause x2 0.0002 0.0002 0.0002 0.0002 x2 does not granger cause x1 0.0002 0.0002 0.0002 0.0002 4.2. robustness of results in order to evaluate the robustness of the estimations, the researcher subjected the data to a vector heterogeneous autoregressive (vhar) analysis. the vhar model is used to confirm the specifications of the realized volatility series. thus, this method can be used to evaluate and identify shortand long-term factors that occurred as a result of ] volatility spillovers, which were measured using the varfima method. thus, the vhar bivariate model is employed to estimate the volatility of oil prices and stock prices in the four banks under consideration. the model is as follows: 𝑋𝑡 𝐷 = 𝛿0 + 𝛿1𝑋𝑡−1 𝐷 + 𝛿5𝑋𝑡−1,𝑡−5 𝑤 + 𝛿22𝑋𝑡−1,𝑡−22 𝑀 + 𝑢𝑡 , t=1,2,……..,t (5) the terms 𝛿1, 𝛿5, and 𝛿22 are all represented as 2 × 2 coefficients matrices and the term 𝛿0 = (𝛿1,0, 𝛿2,0)′ is defined as the vector of intercepts. also, the vhar analysis requires the series to be stationary. therefore, the adf, ers and za unit root tests were also performed on the series. the results of the unit root tests are presented in table 2 and the vhar analysis results are presented in table 3. asian journal of economics and empirical research, 2020, 7(2): 217-223 221 © 2020 by the authors; licensee asian online journal publishing group figure 2. realized volatilities of uk banks’ stocks prices and oil prices. figure 3. realized volatilities of uk banks’ stocks prices and oil prices. asian journal of economics and empirical research, 2020, 7(2): 217-223 222 © 2020 by the authors; licensee asian online journal publishing group table 2. unit root test results variables adf ers za lbg 4.77*** 4.53*** 9.67*** hsbc 4.69*** 4.22*** 9.56*** rbs 4.03*** 4.36*** 6.87*** bplc 3.27*** 3.47*** 8.63*** oil 4.27*** 4.22*** 7.98*** the results of the vhar analysis are significant and in line with the results of the varfima analysis, as they show that volatility exists between oil prices and the bsp, which was indicated by the significance of the volatility coefficients at the 1 percent and 5 percent level. table-3. vhar analysis. mean equation lbg brent hsbc brent rbs brent bplc brent 𝛿0 0.02*** 0.02*** 0.15** 0.03** 0.13*** 0.01** 0.12*** 0.02*** 𝛿i,1 0.2* 0.32** 0.3** 0.32** 0.45*** 0.33** 0.46** 0.32** 𝛿i,5 0.68*** 0.63*** 0.37** 0.63** 0.32*** 0.66*** 0.32** 0.64** 𝛿i,22 0.07** 0.01*** 0.1** 0.01*** 0.22*** 0.01*** 0.18*** 0.01** 𝛿j,1 0.02*** 0.002*** 0.04** 0.02*** 0.02** 0.02*** 0.02** 0.02*** 𝛿j,5 0.02** 0.02** 0.01** 0.03** 0.03*** 0.03*** 0.09** 0.03*** 𝛿j,22 0.02** 0.03** 0.004*** 0.01** 0.04** 0.03*** 0.07** 0.04*** variance equation 𝜔 0.001∗∗∗ 0.02∗∗∗ 0.02∗∗∗ 0.003∗∗ 0.002∗∗∗ 0.003∗∗ 0.03∗∗∗ 0.002∗∗∗ 𝛼 0.02∗∗∗ 0.05∗∗∗ 0.02∗∗∗ 0.05∗∗∗ 0.01∗∗∗ 0.05∗∗∗ 0.02∗∗∗ 0.03∗∗∗ 𝛽 0.94∗∗∗ 0.85∗∗∗ 0.91∗∗∗ 0.86∗∗∗ 0.97∗∗∗ 0.86∗∗∗ 0.81∗∗∗ 0.86∗∗∗ r2 0.8 0.8 0.85 0.8 0.86 0.8 0.88 0.8 5. discussion and implications the findings of this study indicate the presence of bidirectional causality between bsp and oil prices in the uk. these findings have been calculated after a series of analyses, and they are supported by a number of studies carried out in a similar domain (diaz & de gracia, 2017; ewing & malik, 2016; narayan & sharma, 2014; souček & todorova, 2013). these studies have been efficient in outlining persuasive evidence with regard to the relationship between oil shocks and the related impact on the returns in the stock market. moreover, if a sectoral analysis is developed, studies exist that outline the presence of spillover effects from the volatility of oil prices in sectors such as healthcare, the automobile industry, the energy sector, consumer services, utilities and telecommunications (broadstock & filis, 2014; broadstock. & filis, 2015; degiannakis, filis, & floros, 2013). the primary route through which the volatility of the oil market spreads into the banking industry in the uk is through the exposure and involvement of banks in the oil and gas sector to shocks and sudden changes in oil prices. undeniably, the resultant changes in oil prices pose detrimental impacts on the overall performance of oil firms; therefore, they have to turn to the banking industry to seek loans in order to fulfill their credit and debt obligations. the banks comply to these risks, as they don’t want to portray the wrong signals to the public; rejecting loan and credit extensions could imply to investors that the bank is facing financial trouble, which could easily lead to depositors and investors withdrawing their assets, which would further affect the performance and asset value of the banks. thus, the banking industry complies to the loan demands of the oil sector (ehouman., 2020). a recent study by pal and mitra (2019) evaluated the probable co-movement between the volatility of oil prices and shocks in the automobile industry. this study found co-movement to be present and even more noticeable in the long run. moreover, some affects in the short run were also found. the returns of automobile industry stock prices were found to be invariably sensitive to oil prices. in another study, diaz & de gracia (2017) evaluated the impact of oil price shocks on listed oil and gas corporations on the new york stock exchange. the findings suggested that organizations and the profitability of their stock prices were sensitive to the volatility of the sector. 6. conclusion and limitations this study was carried out in order to evaluate the impact of shocks caused by the volatility of oil prices on the financial and banking industry in the uk. the analysis was performed during the period between 2007–2017, and the impact of price shocks on four banks listed in financial times stock exchange was evaluated. the analysis was carried out through estimations from a tri-variate varfima model. estimations were performed for the whole period of time at once. moreover, the researcher also conducted a granger causality analysis and vhar analysis in order to evaluate the robustness of the results presented by the varfima model. the impact of the volatility and co-volatility was also evaluated by dividing a graphical analysis of the realized volatility affluence. the analysis has shown that strong volatility exists among oil prices and the effects produced by the stock prices of banks. moreover, the granger causality analysis proved the presence of bidirectional causality between the coefficients of oil prices and bsp. the present study has a number of important implications and recommendations for future researchers. most of the literature on oil price sensitivity focuses on shocks in oil prices in the us and china; therefore, this study provides a uk perspective that offers theoretical contributions. moreover, mathematical details have been provided, so future researchers will be able to benefit from this study. this study also highlights the need for policymakers to focus on reducing the exposure of the banking industry to shocks caused by the fluctuations in the oil market. this can be achieved through policies that restrict or reduce the involvement of the banking industry in the energy sector in order to protect banks against the risk of bankruptcy. asian journal of economics and empirical research, 2020, 7(2): 217-223 223 © 2020 by the authors; licensee asian online journal publishing group references andersen, t. g., & bollerslev, t. 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(2019). dynamic transmission mechanisms in global crude oil prices: estimation and implications. energy, 175, 1181-1193.available at: https://doi.org/10.1016/j.energy.2019.03.162. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 121 © 2022 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 9, no. 2, 121-131, 2022 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v9i2.4146 © 2022 by the authors; licensee asian online journal publishing group financial exclusion and poverty reduction in benin medard attoukou1 karim nchare2 ( corresponding author) 1,2african school of economics, benin. 1email: mattoukou@africanschoolofeconomics.com 2email: kfogam@africanschoolofeconomics.com abstract by analyzing factors related to the various constraints faced by unbanked individuals, this study explores the determinants associated with individuals without access to common financial services in benin. it also examines the impact of the lack of access to financial services on poverty using the world bank’s global findex database for 2011, 2014, and 2017. using a probit model, we found a positive and significant relationship between financial exclusion and lack of documentation, expensive financial services, distance from financial institutions, and lack of trust in financial institutions. moreover, individual characteristics, such as age, education level, religion, gender, and employment status are significantly associated with financial exclusion. using a heckman sample selection model, we show that financial exclusion in benin has a positive and significant effect on poverty. these results are vindicated using propensity score matching (psm) for robustness checks. keywords: benin, poverty, propensity score matching, financial exclusion. jel classification: g21; i32; o12. citation | medard attoukou; karim nchare (2022). financial exclusion and poverty reduction in benin. asian journal of economics and empirical research, 9(2): 121-131. history: received: 27 june 2022 revised: 15 august 2022 accepted: 30 august 2022 published: 13 september 2022 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. authors’ contributions: both authors contributed equally to the conception and design of the study. competing interests: the authors declare that they have no conflict of interest. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study, that no vital features of the study have been omitted, and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 122 2. data and methodology ................................................................................................................................................................. 122 3. results and discussions ................................................................................................................................................................ 126 4. conclusion ....................................................................................................................................................................................... 130 references ............................................................................................................................................................................................ 130 mailto:mattoukou@africanschoolofeconomics.com mailto:kfogam@africanschoolofeconomics.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v9i2.4146 https://orcid.org/0000-0002-9828-9935 https://orcid.org/0000-0002-1483-4124 asian journal of economics and empirical research, 2022, 9(2): 121-131 122 © 2022 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the empirical literature on the impact of financial inclusion on poverty in africa by investigating the effect of financial exclusion on poverty in benin, covering the years 2011, 2014, and 2017. 1. introduction poverty reduction has been the principal focus of the development agenda. in fact, for the past twenty years, countries have striven to achieve the first of the sustainable development goals (sdgs) of eradicating extreme poverty, measured as people living on less than $1.25 a day, by 2030. alongside microfinance, financial inclusion has been widely discussed in the theoretical and empirical literature as a successful strategy for poverty alleviation. according to the world bank group, “financial inclusion means that individuals and businesses have access to useful and affordable financial products and services that meet their needs – transactions, payments, savings, credit, and insurance – delivered in a responsible and sustainable way”. the theoretical link between financial inclusion and poverty is embedded in the financial development framework. there are direct and indirect channels through which financial inclusion affects poverty. in direct channels, financial inclusion contributes to poverty alleviation by enhancing entrepreneurial possibilities via access to credit, generating income, and better livelihoods. in indirect channels, by facilitating and stimulating economic transactions, financial inclusion boosts economic growth, which implies the creation of jobs and an increase in the government tax income that benefits the poor through employment and public spending on social programs (anthony, hadrat, george, kwasi, & samuel, 2021). both direct and indirect channels have been documented in the empirical literature (aportela, 1999; bruhn & love, 2014; demirgüç-kunt & singer, 2017; djossou, monwanou, & novignon, 2016; dupas & robinson, 2010; zhang & posso, 2017). despite a sustained increase in real gross domestic product (gdp) per capita over the past 20 years, more than 40% of the beninese population was still living in poverty in 2015. for this reason, and the high penetration rate of smartphones in the country, the beninese government has identified improving financial inclusion through digitalization as a successful strategy for poverty alleviation. examples of various completed and ongoing initiatives in the country include the digital economy project (2019–2020) supported by the embassy of the netherlands, a large-scale randomized controlled trial assessing the performance of a personal finance management mobile app. in addition, in 2020, the government of benin created a financial services quality observatory with the aim of increasing the use of formal financial services by firms and individuals. the number of bank branches has been recently increasing in rural areas of benin, but despite this improvement, only 17% of the population had a bank account in 2015, and access to finance is difficult for some vulnerable groups and smalland medium-sized enterprises (fund, 2018). the microfinance sector plays an important role in the country by financing the sectors of the economy and rural populations that are underserved by banks. djossou et al. (2016) examined the impact of benin’s national microcredit program on poverty and found a positive and significant impact of individuals who had access to a microcredit program relative to those who did not. dahoun et al. (2013) showed that microcredit has a positive impact on women’s empowerment in benin, especially on those who are heads of their household. sylli (2012) showed that microcredit contributes to the living conditions of beneficiaries and helps to reduce poverty with more medium-term and long-term credit for agricultural activities in benin. although the existing literature summarized above has documented the positive effect of microfinance on individual welfare in benin, several questions remain unanswered. these questions include: what are the main factors associated with the lack of financial inclusion (financial exclusion) in benin, and how is financial exclusion associated with poverty in benin? by answering these questions, the aim of our paper is to fill this gap in the literature and provide a better understanding of the relationship between poverty and financial inclusion in benin. financial inclusion is a broad concept that includes several aspects of financial services. most studies have looked for an appropriate measure of financial inclusion at the individual, household, and country levels (gupte, venkataramani, & gupta, 2012; park & mercado, 2015; sarma, 2008; zhang & posso, 2017). this study provides a composite measure of financial exclusion and assesses the extent to which it affects poverty using the beninese global findex survey data. specifically, we measure financial exclusion by computing a composite index considering several dimensions, such as account ownership, credit access, savings, financial resilience, financial account use, and online transactions. in the empirical literature on financial inclusion in africa, many authors have used multiple indicators (use and ownership of an account, use of the account to save, and frequency use of the account, etc.) to capture the multidimensional nature of financial inclusion (efobi, beecroft, and osabuohien (2014); allen, demirguc-kunt, klapper, and peria (2016); mohammed, mensah, and gyeke-dako (2017); tita and aziakpono (2017)). additionally, the study analyzes the determinants of financial exclusion by introducing factors of financial exclusion related to the various constraints faced by unbanked individuals (people who do not have accounts at formal financial institutions). timothy (2019) used a panel data analysis and macrolevel data for 36 african countries to show that financial inclusion, measured by the number of depositors with commercial banks, is positively correlated with life expectation. using time series analysis and macroeconomic data, afolabi (2020) found that financial inclusion, measured by rural loans, the number of bank branches and the level of liquidity, has a positive and significant effect on nigeria’s economic growth in the short and long runs. demirgüç-kunt and klapper (2012) provided a descriptive statistical analysis of the measurement of financial inclusion in african countries, while efobi et al. (2014) and mohammed et al. (2017) used global findex data to study the determinants of financial inclusion in sub-saharan africa. however, due to the heterogeneity of the financial sector in african countries, the findings of these studies cannot be applied to the beninese context. our study extends this literature by analyzing the causal impact of financial exclusion on poverty in benin using microlevel data. 2. data and methodology the data used in this study is from three rounds (2011, 2014, 2017) of benin’s global findex microdata collected by the world bank. in benin, this survey was carried out face-to-face with 1000 interviewers aged 15 and above in the bariba, fon, french, and anago languages. asian journal of economics and empirical research, 2022, 9(2): 121-131 123 © 2022 by the authors; licensee asian online journal publishing group 2.1. measure of poverty and financial exclusion 2.1.1. poverty we measured poverty using the individuals’ income quintiles that have been widely used in the literature (see dollar and kraay (2002) and mohammed et al. (2017)). we used income quintile information because it is the only variable in the data that provides an ordered measure of individual welfare. we used the firstand second-income quintile as a proxy for poverty to account for the actual poverty rate in benin, which was 40.1% in 2015 (du volet & du temps, 2015). table 1. definition of the dimensions of financial inclusion (for the 2014 and 2017 databases). dimension (weight) indicator (weight) measurement = 1 if... and zero otherwise account ownership 1/6 formal savings account 1/6 the individual has account at a formal financial institution (fi) account use 1/6 deposit 1/12 the individual made a deposit in the past 12 months in a formal fi withdrawal 1/12 the individual has withdrawn money in the past 12 months from a formal fi financial resilience 1/6 emergency funds 1/6 the individual is able to come up with 1/20 of the gni per capita in local currency within the next month savings 1/6 business/farm 1/18 the individual saved for a business/farm purpose in the past 12 months old age 1/18 the individual saved for old age in the past 12 months saved at a financial institution 1/18 the individual saved at a formal fi in the past 12 months credits 1/6 loan for apartment 1/24 the individual took out a loan from an fi to purchase a home, apartment or land medical borrowing 1/24 the individual borrowed for health or medical purposes in the past 12 months business borrowing 1/24 the individual borrowed for business/farm purposes in the past 12 months fi borrowing 1/24 the individual borrowed from a bank or another formal fi in the past 12 months online transactions 1/6 bill payment (only for 2017) 1/18 the individual made a bill payment online using the internet in the past 12 months bought online (only for 2017) 1/18 the individual bought something online using the internet in the past 12 months paid online 1/18 the individual paid for goods for delivery online or in cash in the past 12 months table 2. definition of the dimensions of financial inclusion (2011). dimension (weight) indicator (weight) measurement = 1 if... and zero otherwise account ownership 1/6 formal savings account 1/6 the individual has an account at a formal financial institution (fi) account use 1/6 debit card 1/24 the individual has a debit card credit card 1/24 the individual has a credit card received wages 1/24 the individual received wages in the past 12 months using an fi account gov. transfer 1/24 the individual received a gov. transfer using a formal fi account insurance 1/6 insurance use 1/6 the individual has personal health insurance savings 1/6 emergency 1/18 the individual saved for emergency purposes in the past 12 months future expenses 1/18 the individual saved for future expenses in the past 12 months saved at a financial institution 1/18 the individual saved at a formal fi in the past 12 months credits 1/6 loan for apartment 1/12 the individual took out a loan from an fi to purchase a home, apartment or land fi borrowing 1/12 the individual borrowed from a bank or another formal fi in the past 12 months online transactions 1/6 bill payment 1/6 the individual made a bill payment online in the past 12 months asian journal of economics and empirical research, 2022, 9(2): 121-131 124 © 2022 by the authors; licensee asian online journal publishing group 2.1.2. financial exclusion financial inclusion is measured in this study using six dimensions (account ownership, credit access, savings, financial resilience/insurance, financial account use, and online transactions). we computed the financial inclusion index by assigning equal weight to all dimensions of financial inclusion following alkire and santos (2014). for each dimension, we assigned the weight of 1/6 and equal weights within each dimension (see table 1 & table 2), and the index is obtained as a weighted sum of the dimensions’ scores. since we are interested in the financial deprivation aspect, the financial exclusion measure is defined as a dummy variable equal to 1 if the financial inclusion index is lower or equal to 1/6 (the individual, in this case, is financially excluded) and equal to 0 if the financial index is higher than 1/6 (the individual or household, in this case, is financially included). the cut-off of 1/6 is chosen to account for the usage of at least financial service. 2.2. models and empirical strategy the main objective of this study is to examine the potential impact of financial exclusion on poverty in benin. 2.2.1. model specification to meet this objective, we employed the simple probit model of the regression of financial exclusion on poverty. equation 1 presents the likelihood of how being financially excluded is associated with poverty (where the first and second quintiles of poverty are used as a proxies). 𝑃𝑜𝑣∗ 𝑖𝑡 = 𝛽0 + 𝑋′ 𝑖𝑡𝛽 + 𝐹𝐸𝑖𝑡𝛿 + 𝜇𝑖 (1) where povi = 1 if pov∗ i > 0 and povi = 0 if pov∗ i ≤ 0 t = 2017, 2014, 2011 (the round of data); povi denotes the 20% poorest income quintile. this is a dummy variable equal to 1 for the 20% income quintile and 0 otherwise. x is a vector of individual characteristics; 𝐹𝐸 is the measure of financial exclusion; β0, β and δ are the parameters to estimate; and µi is the normally distributed error term capturing the unobserved factors. 2.2.2. treatment effects model the above defined model specification (equation 1) does not allow for the assessment of the effect of financial services on poverty. the binary financial exclusion can be driven by endogeneity and sample selection bias since other individual unobservable attributes may exist that contain error terms, which bring the person to self-select him/herself as financially excluded or not. this problem induces financial exclusion (fe) to be correlated with the error term and causes a biased result. according to imai and arun (2008) and imai, arun, and annim (2010), sample selection bias may arise in the financial market from two key problems. first, self-selection where the individuals/households choose whether or not to participate in a financial inclusion program based on observable or unobservable individual attributes. the second is an endogenous program placement where formal financial institutions may decide to select a certain group or category of people or areas (such as urban areas, rich or moderately poor people) to offer them formal financial services. knowing that this problem could happen to our binary treatment variable, the result obtained by applying the simple ordinary least squares (ols) or probit models cannot be interpreted as the causal effect. therefore, the heckman sample selection model (heckman, 1979), which can be used to correct for sample selection bias or endogeneity associated with individuals’ access to financial services, was employed in this study. following imai and arun (2008); imai et al. (2010); and mohammed et al. (2017), we employed the treatment effects version of the heckman sample selection model. this treatment effects model uses the inverse mills ratio (imr) to control for sample selection bias in a two-stage estimation procedure. in the first stage, the endogenous binary treatment (financial exclusion) is estimated by a probit model. the imr is computed from the predicted values of the estimation of the probit model and reflects the degree of sample selection bias. in the second stage, the imr calculated is included in the regression of the poverty index on various household characteristics and the financial exclusion variable. the baseline assumption is that the error term in the probit model and the error term in the main regression of poverty on financial inclusion are correlated and normally distributed. the instruments to be used to correct for financial exclusion endogeneity are the barrier variables, such as lack of documentation, lack of trust, religious reasons, services being too expensive, being too far away from financial institutions, and lack of money. lack of money was not included in the regression since this directly affects poverty. the other variables are correlated with the financial exclusion variable but do not directly affect the poverty variable. in line with imai and arun (2008); imai et al. (2010); and mohammed et al. (2017), the above mechanism can be specified as follows: 𝐹𝐸∗ 𝑖𝑡 = 𝜃0 + 𝑋′ 𝑖𝑡𝜃 + 𝑍′ 𝑖𝑡𝛾 + 휀𝑖 (2) fei = 1 if fei* > 0 and fei = 0 if fei* ≤ 0 where 𝑃𝑟(𝐹𝐸𝑖 = 1|𝑋𝑖, 𝑍𝑖) = φ(𝜃0 + x′ 𝑖 𝜃 + 𝑍′ 𝑖𝛾) and 𝑃𝑟(𝐹𝐸𝑖 = 0|𝑋𝑖, 𝑍𝑖) = 1 − φ(𝜃0 + x′ 𝑖 𝜃 + 𝑍′ 𝑖𝛾) 𝐹𝐸∗ 𝑖 is a latent variable; i is the indexed individual; t = 2017, 2014, 2011; 𝑋′ 𝑖 is a vector of the individual characteristics (age, age squared, female, education level, workforce status); 𝑍𝑖 is a vector of dummies variables related to financial exclusion (lack of documentation, lack of trust, religious reasons, services too expensive, far away financial institution); θ and γ are vectors of parameters to estimate; φ denotes the normal standard cumulative distribution function; and 휀𝑖 is a normally distributed error term with a zero mean and a variance equal to 1. the second stage regression helps to determine the effect of financial exclusion on poverty. the treatment effect specification used is specified in equation 3 as: 𝑃𝑜𝑣∗ 𝑖𝑡 = 𝜆0 + 𝑋′ 𝑖𝑡𝜆 + 𝐹𝐸𝑖𝑡𝜋 + 𝜂𝑖 (3) where povi = 1 if pov∗ i > 0 and povi = 0 if povi ∗ ≤ 0 the assumption is that ε and η are normally distributed, with a mean of 0 and a variance of 1, and ση and maximum likelihood estimation (mle) were used, respectively. since there is a selection problem, cor(fei,ηi) = ρ 6 = 0, the treatment effects version of the heckman sample selection model with an appropriate instrumental variable (iv) solves this. the variables in zi are exogenous and are assumed to be correlated with fei but not with povi. equation 4 expresses the expected poverty index for those who are financially excluded as: asian journal of economics and empirical research, 2022, 9(2): 121-131 125 © 2022 by the authors; licensee asian online journal publishing group 𝐸[𝑃𝑜𝑣𝑖𝑡 |𝐹𝐸𝑖𝑡 = 1] = 𝑋′ 𝑖𝑡𝜆 + 𝜋 + 𝜌𝜎𝜂 [ 𝜑(𝜃0 + 𝑋′ 𝑖𝑡 𝜃 + 𝑍′ 𝑖𝑡𝛾) φ(𝜃0 + 𝑋′ 𝑖𝑡 𝜃 + 𝑍′ 𝑖𝑡𝛾) ] (4) where φ is the standard normal density function and φ is the standard normal cumulative distribution function. the ratio φ to φ is called the inverse mill’s ratio and helps to determine whether the ols estimation should be considered or the model estimation should use the mle. the expected poverty index for those who are not financially excluded is expressed in equation 5: 𝐸[𝑃𝑜𝑣𝑖𝑡 |𝐹𝐸𝑖𝑡 = 0] = 𝑋′ 𝑖𝑡𝜆 − 𝜌𝜎𝜂 [ 𝜑(𝜃 + 𝑋′ 𝑖𝑡 𝜃 + 𝑍′ 𝑖𝑡𝛾) φ(𝜃 + 𝑋′ 𝑖𝑡𝜃 + 𝑍′ 𝑖𝑡𝛾) ] (5) equation 6 below provides the expected effect of poverty associated with financial exclusion: 𝐸[𝑃𝑜𝑣𝑖𝑡 |𝐹𝐸𝑖𝑡 = 1] − 𝐸[𝑃𝑜𝑣𝑖𝑡 |𝐹𝐸𝑖𝑡 = 0] = 𝜋 + 𝜌𝜎𝜂 [ 𝜑(. ) φ(. )[1 − φ(. )] ] (6) the coefficient δ (estimation from equation 1) is biased upwards (downwards) if the estimated coefficient of ρ is positive (negative). since ση is positive, the sign and significance of the estimate of ρση will show whether any selection bias exists (imai & arun, 2008; imai et al., 2010; mohammed et al., 2017). 2.2.3. robustness check the heckman sample selection (heckman, 1979) only addresses the issue of bias created by the sample in the model. the hypothesis formulated in this study is that financial exclusion increases the poverty level. however, an increase in poverty level could potentially reduce households’ access to financial services, leading them to becoming financially excluded. to address this issue, we take advantage of our financial inclusion measure fei, which is binary, and apply the propensity score matching (psm) estimation proposed by rosenbaum and rubin (1983). since it is not possible to see the counterfactual (here, it is the level of poverty if the individual were financially included), then it will not be possible to observe the level of poverty of financially included individuals. psm addresses this problem by constructing the counterfactual situation according to the treatment variable. two groups are formed: the treatment group (financially excluded, fei = 1) and the control group (financially included, fei = 0). by comparing the two groups, we obtained an estimate of the effects of financial exclusion on poverty under the unconfoundedness (treatment assignment is independent of the outcomes, conditional on the covariates) and overlap or common support condition assumptions (the probability of assignment falls between zero and one) (rosenbaum & rubin, 1983). from caliendo and kopeinig (2008), in the practical guide for the implementation of propensity score matching, the steps can be summarized in five points: (1) determine the observational covariates and estimate the propensity scores from the dataset. the choice of model to determine if the propensity score is problematic, but since our treatment variable is binary, the logit model is selected. (2) choose a matching algorithm. since each matching algorithm presents advantages and disadvantages, we employed different matching algorithms in our analysis. we used nearest neighbor, radius matching, stratification matching, and kernel matching. for further details and formulas regarding these matching algorithms, see, e.g., becker and ichino (2002). (3) check overlap (region of common support between the treatment and control groups). (4) match quality/effect estimation (check whether the procedure can balance the distribution of the relevant variable in both the treatment and control groups). some of the possible tests are the standardized bias test and the t-test, suggested by rosenbaum and rubin (1983), and the stratification test by dehejia and wahba (2002). (5) conduct sensitivity analysis tests to determine whether the estimated average treatment effect (att) on the treated variable is robust. the estimation procedure for psm can be summarized following becker and ichino (2002) and imai and arun (2008). equation 7 gives the propensity score, which is the conditional probability of been financially excluded given the individual’s covariate w, which is a multidimensional vector of individual characteristics defined in x, and variables related to financial exclusion summarized in z. p(w) = pr(fe = 1|w) = e(d|w) (7) according to rosenbaum and rubin (1983), if the exposure to treatment is random within cells defined by w, it is also random within cells defined by the values of the mono-dimensional variable p(w). equation 8 below estimates the average effect of treatment on the treated (att) if the propensity score p(wi) is known given a population of units denoted by i: τ ≡ e(pov1it −pov0it|feit = 1) = e(e(pov1it −p0i|feit = 1, p(wi))) (8) τ = e(pov1it|feit = 1, p(wi))−e(pov0it|feit = 0, p(wi))|feit = 1) where i denotes the ith household; t = 2017, 2014, 2011 (the round of the data); and povi is the potential outcome (poverty likelihood measure) in the two counterfactual situations of being financially excluded or financially included. the two hypotheses needed to derive (7) given (8) are: (a) balancing hypothesis (balancing of pre-treatment variables (covariate variables) given the propensity score). if p(w) is the propensity score, then fe ⊥ w | p(w). this implies that, for a specific propensity score, the financial exclusion program is randomly distributed, thus, on average, households with access to programs and those without are observationally identical. otherwise, one cannot statistically match households of different categories. (b) unconfoundedness given the propensity score. if assignment to treatment is unconfounded, i.e., pov1, pov0 ⊥ fe | w, then assignment to treatment is unconfounded given the propensity score, i.e., pov1, pov0 ⊥ fe | p(w). asian journal of economics and empirical research, 2022, 9(2): 121-131 126 © 2022 by the authors; licensee asian online journal publishing group 3. results and discussions 3.1. descriptive statistics table 3 shows the summary statistics of the 2011, 2014, and 2017 rounds of the survey. between 2011 and 2017, the education level has improved. this improvement included a free primary schooling policy in 2006 and subsequently, free tuition for girls in the sixth grade in 2010, which has been generalized for girls until the third grade. as shown by the workforce variable in 2017, 27.5% of the beninese are out of the job market and 62.5% are in the job market. interviewed individuals in the sample fell within the young age group (with an average age of 33). the main reasons why beninese people do not have a financial account at a formal financial institution vary from one individual to another. the number of people reporting those reasons has increased over time. apart from the usual reasons (lack of documentation, financial services being too expensive, and distance to financial institutions), religion is increasingly mentioned as a factor of financial exclusion. it is important to note that in recent years many churches and congregations have been created in benin. table 3. descriptive statistics of the variables used in the estimation. variables definition 2011 2014 2017 obs. % mean obs. % mean obs. % mean education = 1 if secondary school and 0 otherwise 1000 0.329 1000 0.255 1000 0.398 = 1 if tertiary level and 0 otherwise 1000 0.013 1000 0.005 1000 0.056 gender = 1 if female and 0 if male 1000 0.498 1000 0.49 1000 0.456 age individual’s age in years 1000 33.57 1000 33.03 990 31.73 workforce status = 1 if the individual is out of workforce and 0 otherwise 1000 0.275 far away = 1 if financial institutions are far away and 0 otherwise 1000 0.193 1000 0.174 1000 0.222 expensive services = 1 if financial services are too expensive and 0 otherwise 1000 0.153 1000 0.206 1000 0.221 lack of documents = 1 if the individual does not have the necessary documentation and 0 otherwise 1000 0.215 1000 0.305 1000 0.284 lack of trust = 1 if the individual does not trust financial institutions and 0 otherwise 1000 0.062 1000 0.204 1000 0.137 religious reasons = 1 because of religious reasons and 0 otherwise 1000 0.023 1000 0.012 1000 0.055 financial exclusion = 1 if the individual is financially excluded and 0 otherwise 1000 0.460 1000 0.846 1000 0.438 income quintile = 1 if included in the 20% poorest and 0 otherwise 1000 0.131 1000 0.158 1000 0.154 = 1 if included in the 20% second and 0 otherwise 1000 0.165 1000 0.168 1000 0.174 = 1 if included in the 20% middle and 0 otherwise 1000 0.180 1000 0.171 1000 0.193 = 1 if included in the 20% fourth and 0 otherwise 1000 0.220 1000 0.208 1000 0.205 = 1 if included in the 20% richest and 0 otherwise 1000 0.304 1000 0.295 1000 0.274 table 4. determinants of financial exclusion. variables 2011 2014 2017 financial institutions are far away 1.314∗∗∗ (0.456) 0.475∗∗∗ (0.116) 0.381∗∗∗ (0.134) financial services are too expensive 1.459∗∗∗ (0.432) 0.185 (0.128) 0.299∗∗ (0.127) don’t have the necessary documentation 1.016∗∗∗ (0.258) 0.489∗∗∗ (0.109) 0.400∗∗∗ (0.110) don’t trust financial institutions 1.532∗∗∗ (0.396) 0.086 (0.179) -0.022 (0.138) because of religious reasons na na -0.899∗∗∗ (0.324) 0.065 (0.207) female -0.067 (0.120) 0.133 (0.086) 0.243∗∗∗ (0.088) age of individual -0.155∗∗∗ (0.025) -0.069∗∗∗ (0.013) -0.045∗∗∗ (0.014) age_squared 0.002∗∗∗ (0.000) 0.001∗∗∗ (0.000) 0.000∗∗∗ (0.000) primary school level 1.238∗ (0.694) 1.034∗∗ (0.522) na secondary school level 0.206 (0.688) 0.706 (0.521) -0.373∗∗∗ (0.094) completed tertiary or more na na -1.082∗∗∗ (0.237) out of workforce na na 0.546∗∗∗ (0.100) constant 2.973∗∗∗ (0.819) -0.003 (0.573) 0.385 (0.267) observations 1,000 1,000 990 note: ∗∗∗, ∗∗ and ∗ signify significance at the 1%, 5% and 10% levels, respectively. standard errors are in parentheses. asian journal of economics and empirical research, 2022, 9(2): 121-131 127 © 2022 by the authors; licensee asian online journal publishing group however, is the proliferation of evangelical churches one of the reasons for this financial exclusion? the number of people who reported a lack of trust in financial institutions in 2014 is more than three times the number reported in 2011 and in 2017; the number reported in 2011 has doubled. the political and economic scandal that took place in benin in 2000 and 2010, referred to as benin’s madoff scandal, could explain these results. it was based on a ponzi scheme that consisted of remunerating the first investors with the deposits of new clients, at very high-interest rates, before the system collapsed in 2010. up to 300,000 people were defrauded, with an estimated total of more than 200 billion fcfa (franc des colonies françaises d'afrique), which roughly coverts to us$500.0000. following the financial exclusion computation, in 2017, 43.8% of the sampled population in benin were financially excluded; this figure was 84.6% in 2011. this result confirms that access to financial services in the country is still low (fund, 2018) and the situation was worsened in 2011. the income distribution in the country through the sampled population shows that income distribution is not shared in the same way and that rich people benefited more than the poor between 2011 and 2017. 3.2. empirical results table 4 presents the results of the first stage of the treatment effect model to find the determinants of financial exclusion in benin. the coefficient for the "financial institutions are far away" variable is positive and statistically significant at the 1% level for the 2011, 2014, and 2017 datasets, showing that being far away from financial institutions means that individuals are more likely to be excluded from financial services in benin. what can justify this result is that when financial institutions are far away, individuals may not be willing to travel to ask for financial services, or they may be reluctant to go since they do not know if they will be eligible or not. the coefficient associated with the "financial services are too expensive" variable is positive and statistically significant at the 1% level for the 2011 and 2017 datasets. this means that financial services are too expensive, which is likely to prevent individuals from visiting financial service institutions in benin (2011 to 2017). in theory, this is true because when you must pay high interest on a loan or pay a prohibitive price for financial services, you may not be willing to continue using the institution or even use financial services in the first place. the lack of necessary documentation is more likely to exclude individuals from financial services in benin since the coefficient associated with this variable is positive and statistically significant at the 1% level since 2011. this is true because financial institutions are reluctant to satisfy individuals’ needs when they lack the necessary documentation. in benin, the situation regarding necessary documentation is critical because most of the population is still without a birth certificate. in addition, it is very difficult to present a valid work certificate while continuing to work in the informal sector, and formal institutions ask for documents that testify or certify your line of work when asking for a loan. lack of trust in financial institutions is statistically significant at the 1% level for the 2011 dataset, and religious reasons are statistically significant at the 1% level for the 2014 dataset. while the coefficient of correlation between lack of trust and financial exclusion is positive, it is negative between religious reasons and financial exclusion. this reveals that lack of trust in financial institutions is more likely to cause that person to avoid asking for financial services. religion is one of the factors enabling individuals to have access to financial services (the correlation coefficient between financial exclusion and religion is negative). throughout these years, the lack of documentation, the distance to a financial institution, and expensive financial services are found to be the main reasons for financial exclusion. another point to note here is that, in 2011, beninese citizens did not trust financial institutions, but since 2014, they have started showing an interest in financial institutions by trusting them. the dummy variable for a female is positively correlated and statistically significant at the 1% level with financial exclusion, indicating that females are more likely to be excluded from financial services than males in benin. this may be because it is more difficult for females to have access to finance because they are less likely to work and have less power in financial decisions. this confirms the findings of the international monetary fund (imf), which shows that males reported higher access to finance than females in benin (fund, 2018). table 5. results of the simple probit model. variables 2011 2014 2017 financial_index 0.566∗∗∗ (0.089) 0.725∗∗∗ (0.145) 0.189∗∗ (0.090) female 0.004 (0.089) 0.113 (0.085) 0.030 (0.087) age of individual -0.003 (0.013) -0.000 (0.014) -0.005 (0.013) age_squared -0.000 (0.000) -0.000 (0.000) -0.000 (0.000) primary school level 4.476∗∗∗ (0.133) 4.433∗∗∗ (0.133) na secondary school level 3.909∗∗∗ (0.156) 4.034∗∗∗ (0.155) -0.566∗∗∗ (0.094) tertiary or higher na na -1.082∗∗∗ (0.247) out of workforce na na 0.030 (0.100) constant -4.970∗∗∗ (0.318) -5.371∗∗∗ (0.335) -0.120 (0.265) observations 1,000 1,000 990 note: ∗∗∗ and ∗∗ signify significance at the 1% and 10% levels, respectively. standard errors are in parentheses. education also plays a key role in financial markets. as expected, the findings in benin are not surprising. the coefficients associated with the education variable (secondary, tertiary or higher levels of education) are negative and asian journal of economics and empirical research, 2022, 9(2): 121-131 128 © 2022 by the authors; licensee asian online journal publishing group significant at the 1% level correlated with financial exclusion, meaning that the more educated you are, the less likely you are to be financially excluded. furthermore, the regression results for the 2011, 2014, and 2017 datasets show that younger individuals are less likely to be excluded from financial services and are more likely to be excluded as they get older (the age and age squared coefficients are respectively negative and positive and statistically significant at the 1% level). finally, individuals who are not in the job market are more likely to be unable to access financial services than their peers. this result can be explained by the fact that the job market is largely informal so individuals do not have valid documents to present to financial institutions to get a loan or credit. tables 5 and 6 present the results of the regression of financial exclusion on poverty where the first and second 20% poorest income quintiles are used as proxies. as we can expect, the coefficient of the financial exclusion is positive and statistically significant at the 1% level for all three rounds of the surveys (2011, 2014, and 2017). this means that financially excluded individuals are more likely to be poor. in other words, having access to financial services help to reduce poverty in benin. these results are consistent with the ongoing literature in benin. table 6. treatment effect model. variables 2011 2014 2017 financial_index 0.557∗∗∗ (0.093) 0.800∗∗∗ (0.159) 0.204∗∗ (0.094) female -0.004 (0.091) 0.110 (0.085) 0.046 (0.093) age of individual -0.000 (0.015) -0.007 (0.015) -0.007 (0.014) age_squared -0.000 (0.000) -0.000 (0.000) 0.000 (0.000) primary school level 4.405∗∗∗ (0.245) 4.561∗∗∗ (0.206) na secondary school level 3.858∗∗∗ (0.212) 4.092∗∗∗ (0.195) -0.596∗∗∗ (0.110) tertiary or higher na na -1.181∗∗∗ (0.301) out of workforce na na 0.066 (0.121) invmills1 -0.074 (0.213) 0.245 (0.209) 0.106 (0.197) constant -4.893∗∗∗ (0.391) -5.465∗∗∗ (0.376) -0.167 (0.280) observations 1,000 1,000 990 note: ∗∗∗ and ∗∗ signify significance at the 1% and 10% levels, respectively. standard errors are in parentheses. dahoun et al. (2013) assessed the impact of microcredit on the empowerment of poor females in benin. the study found that microcredit has a positive effect on the empowerment of (mainly poor) female household heads. sylli (2012) showed that microcredit contributes to the living conditions of the beneficiary and helps to reduce poverty with more mediumand long-term credit for agricultural activities. djossou et al. (2016) found a positive and significant effect of access to microcredit services on poverty in benin. the difference between tables 5 and 6 is that the results of table 5 are biased, but the treatment effect version of heckman’s sample selection model will correct that. in table 6, the inverse mills ratio coefficient is not statistically significant for anyone in the 2011, 2014, and 2017 datasets. following imai et al. (2010), this insignificant result can be interpreted as the absence of selectivity bias from the regression of the simple probit model. from these results, education level has a positive and significant impact on poverty. gender, age, and workforce status appear to have no significant effect on poverty in benin. the limited number of observations in this study may be the main reason for these insignificant results. figure 1. density of the propensity scores before and after matching (2017). asian journal of economics and empirical research, 2022, 9(2): 121-131 129 © 2022 by the authors; licensee asian online journal publishing group figure 2. density of the propensity scores before and after matching (2014). figure 3. density of the propensity scores before and after matching (2011). 3.3. robustness checks the figures 1, 2, and 3 present the density of the propensity scores before and after matching. from these figures, the treated group (financially excluded individuals) are in the blue, and the untreated group (financial included) are in red. the distribution of the probability (propensity score) for 2014 and 2017 can be considered as normal distribution patterns. these figures also show that it is easier to find matches (not clear that they will be the best matches) between treated and untreated units since there is a full distribution of probability along with the common support. for 2011, the trend before and after matching is the same, but treated and untreated individuals follow different patterns. table 7 presents the results of this model using different matching algorithms: nearest neighbor, radius, kernel, and stratification. the results show that the att for each matching algorithm by year is approximately the same and is statistically significant at the 1% level for most of them (financially excluded individuals are more likely to be poorer than their peers who are financially included). table 7. psm model results with different matching algorithms. matching algorithms 2011 2014 2017 nearest neighbor 0.167*** (0.036) [2.225] 0.080** (0.015) [11.001] 0.054 (0.035) [1.552] radius 0.136*** (0.022 ) [6.310] 0.145*** (0.017 ) [8.503] 0.056*** (0.025 ) [2.292] kernel 0.128*** (0.025 ) [5.075] 0.164*** (0.015 ) [10.683] 0.048* (0.27 ) [1.786] stratification 0.132*** 0.023 5.729 0.165*** 0.014 11.989 0.050 0.027 1.847 observations 1,000 1,000 1,000 note: bootstrapped standard errors are in parentheses and p-values are in square brackets. ∗, ∗∗ and ∗∗∗ signify significance at the 1%, 5% and 10% levels, respectively. asian journal of economics and empirical research, 2022, 9(2): 121-131 130 © 2022 by the authors; licensee asian online journal publishing group for the nearest neighbor matching algorithm, financially excluded individuals are 8% and 16.7% more likely to be poor than financially included individuals in 2014 and 2011, respectively. the radius matching algorithm shows that financially excluded individuals are 13.6%, 14.5%, and 5.6% more likely to be poorer than financially included individuals, respectively, in 2011, 2014, and 2017. these results are statistically significant at the 1% level. for the kernel and stratification matching algorithms, financially excluded individuals are respectively 4.8% and 5% more likely to be poorer than their peers in 2017; 12.8% and 13.2% are more likely to be poorer than financially included individuals in 2014; and 16.4% and 16.5% are more likely to be poorer than non-financially excluded individuals in 2011. 4. conclusion this study contributes to the growing literature on the impact of financial inclusion on poverty reduction by exploring determinants of multidimensional financial inclusion (account ownership, credit access, savings, financial resilience, financial account use, and online transactions) and by examining the potential impact of financial inclusion on poverty with specific reference to benin using three rounds of data (2011, 2014 and 2017) from the world bank’s microdata from the benin global financial inclusion index survey. first, the study employed the probit model to assess determinants of financial exclusion and found, on the one hand, a positive and significant relationship between lack of documentation, expensive financial services, being far away from financial institutions, religion, lack of trust in financial institutions, and financial exclusion, and on the other hand, a significant relationship was found between individual characteristics (such as gender, age, education, and workforce level/status) and financial exclusion. second, the treatment effects version of heckman’s sample selection model (heckman, 1979) was used to address the issue of endogeneity and selection problems related to financial exclusion and shows that financial exclusion in benin has a positive and significant effect on poverty. in the robustness check, the study employed the propensity score matching (psm) estimation technique, and the outputs of this model confirm the results. the estimation of the potential impact of financial exclusion on poverty measured by the first and second 20% poorest individuals in benin shows that financially excluded individuals are more likely to be poorer than financially included individuals. an implication of this is that policymakers and governments should implement policies that will promote financial services development while focusing on reducing the poverty rate. to further reduce income inequality, more measures must be taken to address the financial exclusion of low-income groups in benin from financial services. in this context, programs that will help alleviate poverty will likewise address the growing income inequality in the country. similarly, to promote inclusion and access to financial services, policymakers and government should focus more on how to decentralize financial institutions/financial programs and bring them closer to the population since the distance from financial institutions plays a determinant role in financial exclusion. in addition, the government should make access to financial services less costly and help people without the necessary documentation by implementing programs that can include those without basic documents such as a birth certificate and a national identity card. references afolabi, j. 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(2017). thinking inside the box: a closer look at financial inclusion and household income. journal of development studies, 55(7), 1616-1631.available at: https://doi.org/10.1080/00220388.2017.1380798. the asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc., caused in relation to/arising from the use of the content. any queries should be directed to the corresponding author of the article. 126 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 2, 126-135, 2020 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2020.72.126.135 © 2020 by the authors; licensee asian online journal publishing group does the oil price influence the exchange rates in nigeria? empirical evidence from wavelet and causality approaches tomiwa sunday adebayo cyprus international university, nicosia mersin 10turkey, faculty of economic and administrative science, department of business administration, turkey. abstract this study explores the connection between the exchange rate and oil price within the framework of time and frequency utilizing monthly data between january 2007 and march 2020. the study deployed the wavelet tools to investigate this relationship. furthermore, granger and toda yamamoto causality tests were employed as a robustness check for the wavelet coherence techniques. findings from the wavelet power spectrum shows; (a) a significant vulnerability in the exchange rate between 2014m6 and 201412, between 2017m1 and 2017m12 2016m1; and (b) a significant vulnerability was found in oil price between 2008m1 and 2008m12, between 2014m1 and 2014m12. the wavelet coherence technique reveals; (a) negative co-movement between the exchange rate and oil price between 2009m10 and 2011m3, between 2012m1 and 2012m3, between 2014m2, 2015m6 and between 2019m2 and 2019m11. the granger and toda yamamoto causality tests reveal a bidirectional interaction between oil price and exchange rate. the variance decomposition shows that as the months dwindle, 40.2% and 40.5% of discrepancy in the exchange rate can be explained by oil price in the twenty-third and twenty-fourth month respectively. this signifies that oil price is a good predictor of the exchange rate in the long term. also, the variance decomposition and causality tests provide a piece of supportive evidence for the wavelet coherence technique. key recommendations are suggested based on these findings. keywords: exchange rate, oil price, wavelet tools, granger causality, toda yamamoto causality, variance decomposition. jel classification: g15; q43. citation | tomiwa sunday adebayo (2020). does the oil price influence the exchange rates in nigeria? empirical evidence from wavelet and causality approaches. asian journal of economics and empirical research, 7(2): 126-135. history: received: 13 march 2020 revised: 17 april 2020 accepted: 19 may 2020 published: 10 june 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 127 2. theoretical framework ................................................................................................................................................................ 127 3. synopsis of related studies ......................................................................................................................................................... 128 4. data and empirical methods ....................................................................................................................................................... 129 5. dıscourse of fındıngs ................................................................................................................................................................... 131 6. conclusion and recommendations ............................................................................................................................................. 133 references ............................................................................................................................................................................................ 134 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.72.126.135&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/1717 https://www.asianonlinejournals.com/index.php/ajeer/article/view/1717 asian journal of economics and empirical research, 2020, 7(2): 126-135 127 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study is unique from previous studies because; (a) it deployed the wavelet approach (wavelet power spectrum and wavelet coherence techniques) which is a technique established in physics and engineering but new in finance and economics to explore the link between oil price and exchange rate compared to the previous studies that utilized frontier analysis; (b) it examines the co-movement between oil price and exchange rate by utilizing monthly data which produces more comprehensive facts about the two variables; (c) the granger and toda yamamoto causality tests were deployed to provide supportive evidence for the wavelet coherence technique. 1. introduction the core reason the central bank is established is the maintenance of external reserves in safeguarding the international value of the domestic currency. due to fluctuations in macroeconomic indicators like exchange rate, the objective of the central bank is getting more diff to achieve. this is because fluctuation in oil prices affects the exchange rate of oil-exporting economies like nigeria. before 1986, the nigerian government pegged the naira to the british pound sterling and soon after moving to the us dollar between 1970 and 1985, the exchange rate dropped below one naira to one dollar, whereas the oil price yearly average price fluctuated. pre-1986 data on oil prices and exchange rates showed that the exchange rate was reasonably constant compared to the price of crude oil. here are countless facts, notably in the post-breton woods period, indicating the significant role of oil price volatility in shaping the direction of the exchange rate (adeniyi, omisakin, olusegun, yaqub, & oyinlola, 2012). as krugman (1983) stated, the rise in exchange rate is due to increase in oil prices and loses value in reaction to declining oil prices in oil-exporting economies, whereas in oil-importing economies the reverse is anticipated to represent the situation. a volatile exchange rate renders foreign trade and investment quite challenging, as it heightens the risk of exchange rates (yang, yang, ho, & hamori, 2019). the volatility of exchange rates appears to increase the risk and uncertainty of international transactions and pushes a nation to exchange-rate risks (olayungbo, 2019). economists are routinely reported to have observed a significant decrease in foreign oil prices during the global economic crisis in 2008. this led to a drop in oil income and undesirable fluctuations in the exchange rates for main oil-exporting countries, particularly those not too well-diversified. in certain opec countries, the condition was unfavorable with low rates of cumulative foreign reserves. the inspiration for this study is derived from the investigator's observation that the collapse in oil prices witnessed towards the end of 2014 impacted the usd/naira exchange rate. the level at which the naira was devalued repeatedly between september 2014 and june 2015 by the monetary authorities. this is because it was no longer feasible to continue defending the local currency utilizing the foreign reserves of the country. furthermore, the uncertainty of exchange rates caused by adverse fluctuations in oil prices not only translates to growing businesses and foreign exchange risk but also contributes to higher living costs when a country is reliant on imports. to the understanding of the author, no prior studies have explored this interaction deploying the wavelet tools to investigate nigeria. the structure of the paper is as follows. the theoretical is examined in the second segment. the synopsis of the studies is considered in the third segment. the fourth segment discusses the description of data deployed and empirical methods. the discussion of findings is discussed in the fifth segment and conclusion and policy direction is finalized in the sixth segment. 2. theoretical framework the interaction between the oil price and exchange rate can be expounded by utilizing the law of one. the oil price is frequently quoted in $us by aligning with homogeneity agreement and foreign trade. thus, the equation 1 below depicts the oil price premised on a foreign exchange. …………………………….…………………………………………. (1) in equation 1 above, the oil price logarithm of foreign currency is depicted by p*, is the oil price logarithm in $us, and is the logarithm of the $us exchange rate in nominal terms. to comprehend the previous equation, assume there is a fall in $us (i.e. depreciation in $us), there will be a reduction in the price of oil due to this decrease for foreigner’s comparative to the price of foreign currencies for commodities. therefore, international consumers buying power and demand for oil are growing in reaction to the growing price of oil in $us. in terms of arbitrage viewpoint, equation 1 means that the price of oil in $us rises as $us value declines when the oil price in international currencies declines. in other words, verification of the influence of oil price on the $us exchange rate (yang et al., 2019). for example, the oil price increase can lead to wealth distribution differently because of the current account surplus for oil-exporting economies will increase whereas the oil-importing economies current account deficit will increase (golub, 1983). this study presumes inelastic oil price, thus a boost in oil price leads to a rise in oil expenditure and the us dollar value. krugman (1983) considered the speculation factor by stating that the influence of oil price on exchange rate could vary based on the gain derived from oil price movement on importers and exporters balance of payment. though when oil price increase, the value of $us depreciates in the short-run which lead to long term increase in the value of $us. the price of good to describe the influence exchange rate has on the oil price is illustrated in equation 1. assuming traded and nontraded goods are part of the general price of the good, it can be separated into the nontraded and corresponding traded price of goods. if the log-linear is taken which is an estimation of the domestic and foreign nations, the specification of consumer price indexes can be portrayed below as; ( ) …………… ………………………………… (2) ( ) …………… ……………………………… (3) in equations 2 and 3 above, the prices of traded and non-traded goods for the home and foreign nation is represented by and respectively, and ( ) the expenditure share weight of nontraded goods in the asian journal of economics and empirical research, 2020, 7(2): 126-135 128 © 2020 by the authors; licensee asian online journal publishing group home and foreign nation is denoted by and respectively. the nominal exchange rate is generated by merging equations 2 and 3 to form equation 4. ( ) ( ) ) ( )( ) … . (4) if the weights of expenditure share of goods that are not traded (ψ≈ψ) of home and foreign nation are the same, the cost-push impact on goods that are untraded from the oil price fluctuations is related in the home and foreign nations. the home country price of comparative traded goods correlates with the foreign price of traded goods. hence, if the home nation is the oil importing state, when oil price increases, the prices of relative goods traded in the home country will be greater than that of the foreign nation. inevitably, there is depreciation in home nation currency. likewise, assuming the oil-exporting nation is the home nation, there will be appreciation in the home currency if oil price increases. furthermore, if the monetary factors are incorporated into the exchange rate model, different models can be built to reflect the impact of the price of oil on exchange rates. let’s presume the nominal demand to be m (m*) in the home(foreign) nation, the demand for money which is nominal in the home or foreign nation relying on the extent of price p (p*), y (y*) mirrors the real income, and i (i*) illustrates interest rate. assuming the impact from these three indicators on demand of money is alike for the home and the foreign nation, premised on interest rate parity condition, equation 5 is reconstructed to depict the nominal exchange rate. ( ) ( )……………………………………………………………… (5) according to lizardo and mollick (2010) oil price is accommodated in equation 5 as a supplementary exogenous variable in explaining the impact of the exchange rate. the exchange rate can be determined by considering this long term monetary model. 3. synopsis of related studies the link between the exchange rate and the oil price has been investigated by existing literatures. amano and van norden (1998) examined the link between the exchange rate and oil price utilizing cointegration technique and found that shocks in oil prices can explain exchange rate. camarero and tamarit (2002) investigated the interaction between real exchange rate and oil price utilizing cointegration techniques. finding through the panel cointegration techniques reveal that the real exchange rate is ascertained by oil price in the spanish peseta. chen and chen (2007) examined the link between oil price and exchange rate in g7 economies deploying monthly panel data. the authors observed that oil price can forecast the exchange rate in the g7 economies. aliyu (2009) deployed quarterly data between 1986 and 2007 to investigate the influence of exchange rate and oil price on the economic growth of nigeria. the investigator utilized johannsen cointegration, vecm and pairwise granger causality test to ascertain this interaction. the johannsen cointegration revealed cointegration in the long-run and the vecm revealed that both exchange rate and oil price impact economic growth positively in nigeria. furthermore, granger causality depicts one-way causality from exchange rate to gdp growth while a feedback causality was found between oil price and economic growth. the study on opec countries conducted by korhonen and juurikkala (2009) revealed a negative and significant interaction between exchange rate and oil price. in the same line, the interaction between the exchange rate and oil price was explored by zalduendo (2006) and the finding reveals a negative interconnection between oil price and exchange rate in both venezuela and algeria. the dynamic interaction between oil price and exchange rate was explored in india by ghosh (2011) utilizing daily data between 2007 and 2008. the garch and egarch models were employed to determine this interaction. findings from the study shows negative interaction between oil price and exchange rate. this shows that increase in the price of oil leads to currency depreciation in india. furthermore, oil price shock influenced exchange rate permanently. using 5 asean economies, cointegration test, variance decomposition and the vecm techniques, basnet and upadhyaya (2015) investigated the influence of oil price shock on exchange rate, inflation and exchange rate. the investigators observed that oil price does not impact the selected macroeconomic variables in the long-run. however, in the philippines, thailand, malaysia and singapore, there is a significant response to fluctuation in oil prices. utilizing the time-varying autoregressive based model some studies explore the interaction between exchange rate and oil price. compelling evidence of negative and statistically significant interaction was found between oil price and exchange rate by deploying garch model (cifarelli & paladino, 2010; turhan, sensoy, & hacihasanoglu, 2014). in nigeria, the impact of oil price shocks on the macroeconomics was investigated by iwayemi and fowowe (2011) utilizing granger causality test, variance decomposition and impulse response. the study indicates no significant interaction between oil price shock and the macroeconomic variables. the causality tests reveal that oil price shock do not cause real gdp, exchange rate, inflation and government expenditure. however, negative oil shock cause exchange rate and real gdp significantly. employing the wavelet decomposition approach, reboredo and rivera-castro (2013) investigated the nexus between exchange rate and oil price. using a different time, it was observed that during the pre-crisis period, both oil prices and exchange rates do not depend on each other. however, in the global financial crisis period, oil prices cause exchange rate. the interaction between oil price and exchange rate was analyzed by huang, an, and lucey (2020) utilizing monthly data between 2000 and 2018. the granger causality reveals feedback causality between oil price and exchange rate and a co-movement was found between oil price and exchange rate. yang, cai, and hamori (2017) investigate the interaction between the exchange rate and oil price utilizing the wavelet tools and finding shows an adverse co-movement between oil price and exchange rate for nations that import oil while insignificant comovement was found between oil price and exchange rate for the oil-importing countries. the influence oil price volatility has on exchange rates in sub-saharan african economies was investigated by baek and kim (2020) by deploying a nonlinear ardl approach. finding from this study revealed that in the long run, there is strong and significant interaction between oil price and exchange rate in sub-sahara africa economies. however, no significant interaction was observed in the short run. using nigeria as a case study and deploying seasonal adjusted quarterly data between 1984 and 2018, (olayungbo, 2019) examined the interconnection amongst oil price, trade balance and exchange rate. the johannsen cointegration test reveals cointegration the long-run while the granger causality test provides evidence for unidirectional causality running from oil price to foreign reserve in the short term but no evidence of causality between exchange rate and oil price. asian journal of economics and empirical research, 2020, 7(2): 126-135 129 © 2020 by the authors; licensee asian online journal publishing group 4. data and empirical methods 4.1. data description in this empirical analysis, the variables utilized are oil price (op) and exchange rate (exchr). the variables comprise of monthly data between january 2007 and march 2020 with 159 observations. the data used in this study (oil price and exchange rate) are gathered from the central bank of nigeria (2020) (cbn) and database of the organization of petroleum exporting countries (opec). figure 1 and figure 2 depicts the trend in exchange rate and oil price between 2007m1 and 2020m3. 100 150 200 250 300 350 400 450 500 07 08 09 10 11 12 13 14 15 16 17 18 19 20 exchange rate figure-1. exchange rate trend between 2007m1 & 2020m3. source: central bank of nigeria database. 20 40 60 80 100 120 140 07 08 09 10 11 12 13 14 15 16 17 18 19 20 oil price figure-2. oil price trend between 2007m1 & 2020m3. source: opec database. table-1. descriptive statistics. descriptive stat oil price exchange rate source wti cbn duration 2007m1-2020m3 2007m1-2020m3 sign op exchr mean 80.09126 228.2353 median 75.11000 166.8500 maximum 138.7400 494.7000 minimum 30.66000 118.7000 std. dev. 26.56215 104.6235 skewness 0.221843 0.781869 kurtosis 1.865943 2.079136 jarque-bera 9.824502 21.81791 probability 0.007356 0.000018 sum 12734.51 36289.41 sum sq. dev. 111476.6 1729480. observations 159 159 correlation matrix op 1 -0.6085 exchr -0.6085 1 asian journal of economics and empirical research, 2020, 7(2): 126-135 130 © 2020 by the authors; licensee asian online journal publishing group table 1 provide a brief description of oil price and exchange rate. the range of oil price is from 30 to 138, and from 118 to 498 for exchange rate. the means are 80 and 228 for oil price and exchange rate respectively. the skewness and kurtosis are used to determine the normal distribution of variables. the benchmark for skewness is that the value must not be more than 1. therefore, looking at oil price and exchange rate, they mirror a normal distribution. also, the benchmark for kurtosis is that the value must not be greater than 3 to mirror a normal distribution. premised on the yardstick, both oil price and exchange rate illustrate a normal distribution. 4.2. empirical methods the order of integration was determined as an initial test for oil price and exchange rate for nigeria by utilizing dickey and fuller (1981); phillips and perron (1988) and lee and strazicich (2004) unit root tests. it is well known that before wavelet analysis is carried out, it is essential to carry out unit root tests. 4.2.1. wavelet approaches the primary purpose of this paper is to verify the causal interaction between oil price and exchange rate. this is done by deploying the time-frequency domain utilizing the wavelet power spectrum and wavelet coherence techniques. this technique was initiated by goupillaud, grossmann, and morlet (1984). it is generally recognized in economic and finance that non-stationarity remains the prominent feature of time series. according to pal and mitra (2017) standalone frequency domain approach main issue is particularly known as fourier transform, which shows that focusing on frequency domain may lead to complete omission of information. additionally, estimation of the conventional granger causality tests will suffer if there is structural break (s) in the variables (ayobamiji & kalmaz, 2020). the wavelet-based granger causality test is deployed in this paper to refrain from these problems. the wavelet (ψ) is part of the morlet wavelet family, equation 6 depicts the morlet equation. ( ) ( ) in equation 6, illustrates frequency utilized on the limited time series; p( ), = 0, 1, 2, 3….…n-1; and √ signifies i. time series are reshaped into the time-frequency domain which links to change in wavelet. is reshaped; hence, develop into . this is evidence in the equation 7 below: ( ) √ ( ) ( ) in equation 7, the key variables are k and f which stands for time and place and frequency respectively. hence, to reveal the link about the time-frequency, continuous wavelet transition (cwt). i̇s an essential vital factor. deploying the cwt approach is essential in relating the two time series together. the cwt equation is depicted in the equation 8 below; ( ) ∫ ( ) √ ( ̅̅ ̅̅ ̅̅ ̅ ) ( ) in equation 8, p(t) denotes the change in the past time and the coefficient is illustrated by . the equation 9 below illustrate the summary. ( ) ∫ *∫ | ( )| + ( ) the variance1 of the wavelet power spectrum (wps) of the two time series is illustrated by equation 10 below; ( )| ( )| ( ) kirikkaleli and ozun (2019) asserted that the cross-spectrum ratio to each spectrum of time-series by combining their frequencies is estimated by the wavelet coherence (wtc). the transformation of the time series is represented by the equation 11 below;. ( ) ( ) ( )̅̅ ̅̅ ̅̅ ̅̅ ̅̅ ̅ ( ) in equation 11 above, the cwt of p(t) and q(t) is represented by wp(k,f) and the value of squared wtc is denoted by wq(k,f). ( ). the equation is represented by equation 12 below; ( ) | ( ( ))| ( | ( )| ) ( | ( )| ) ( ) zero (0) correlation between two series will show if the ( ) are closer to 0 while correlation will show if ( ) is close to 1, which spherical thick black line shows and also represented by a warm color (red). though, ( ) values did not provide information about the sign interaction. therefore, a procedure that can detect wavelet coherence by deploying differences via deferrals indications in time series wavering is proposed by torrence and compo (1998). wavelet coherence at the difference phase is represented in the equation 13 below; ( ) ( { ( ( ))} { ( ( ))} ) ( ) in equation 13 above, l and o reflect an imaginary operator and a real part operator correspondingly. 1 variance is denoted as frequency function. asian journal of economics and empirical research, 2020, 7(2): 126-135 131 © 2020 by the authors; licensee asian online journal publishing group 4.2.2. causality tests there will be evidence of causality if variables are cointegrated. the direction of this causal effect may be oneway or feedback. hence, this paper deployed the two conventional causality tests by granger (1969) and the toda yamamoto causality test to ascertain the causality direction between oil price and exchange rate. the granger causality equation is depicted below in equations 14 and 15; ∑ ∑ ( ) ∑ ∑ ( ) in equations 14 and 15, the lag length is represented by t, and error terms are depicted by and μ respectively. it is easy to execute the granger causality test, however, their several drawbacks are attached to it. these drawbacks are; (i) specification biased by not considering another variable; (ii) lag selection bias; (iii) most time series variables are not stationary (maddala, li, & srivastava, 2001) which may lead to baseless estimate; and (iv) unreliability of the f-statistics method, thus making it difficult to depend on the outcome of the granger causality test (gujarati, 2006). toda and phillips (1994) identify some drawbacks in the granger causality test. toda and yamamoto (1995) generated a new procedure that solves most drawbacks linked to the granger causality test. this involves adding the augmented var estimate that ensures the distribution asymptotic of the wald statistics (asymptotic χ2 distribution) as a robustness check method to the system integration and properties of cointegration. equations 16 and 17 illustrates the toda yamamoto causality test; ∑ ∑ ∑ ∑ ( ) ∑ ∑ ∑ ∑ ( ) in equations 16 and 17, op denotes oil price, exchr illustrate the exchange rate, dmax is the maximum integration order that the system is assumed to have, and are error terms and aic, sc, fpe, and hq are measures deployed to ascertain the lag selection of the var. 5. dıscourse of fındıngs 5.1. unit root test unit root tests are applied to oil price and exchange rates to examine integration order by deploying adf and pp unit root tests. in panel b in table 2, when executing the tests, the variables are presumed not to have a structural break (s). however, when structural break (s) is taken into consideration, the zivot-andrews (za) unit root test and lee & strazicich (lm) unit root test which can detect one structural break and two structural breaks respectively were used. table-2. unit root. panel b: unit root without structural break (s) variables adf (k &t) decision pp (k & t) decision op -7.678* i(1)* -7.691* i(1)* exchr -8.933* i(1)* -9.070* i(1)* panel a: unit root with structural break (s) za( k & t) decision lm decision op -8.08* [2o18m2] i(1)* -6.122* [2o08m11] {2018m9} i(1)* exchr -10.094* [2o17m2] i(1)* -6.196* [2o09m1] {2016m1} i(1)* note: *, ** & *** signifies 1%, 5%, & 10% level of significance. k. and k. & t indicate constants and constant and trend.[] & signify first and second year break respectively. 5.2. wavelet power spectrum result the study deployed the wavelet power spectral test to detect the behavior and vulnerability of the oil price and exchange rate. the wavelet power spectral for oil price and exchange rate is illustrated by figure 3 & 4 portraying an edge below where the wavelet power is impacted because of discontinuity, whereas the monte carlo simulations is deployed to determine the 5% significance level as indicated by the black thick shape. asian journal of economics and empirical research, 2020, 7(2): 126-135 132 © 2020 by the authors; licensee asian online journal publishing group figure-3. wps for exchange rate. figure-4. wps for oil price. figure 4 portrays the wavelet power spectrum of exchange rate between 2007m1 and 2020m3. at scale 16-32, there is a significant vulnerability in exchange rate in nigeria between 2014m6 and 2014m12. this is due to fall in oil price by over 50% from $us115 in june 2014 to $us50 per barrel which brought a fall in exchange rate. between 2016m1 and 2016m4 which represent the first quarter, at scale 8-16 there is sign of significant vulnerability in the exchange rate. in this period, nigeria pegged it currency against the us dollars due to high inflation in the country. there is high vulnerability in exchanger rate at scale 16-32 between 2017m1 and 2017m12. this is as a result of collapsing oil price which heaped pressure on the naira. figure 4 illustrates the wavelet power spectrum of oil price between 20007m1 and 2020m3. at scale 8-16 between 2008m1 and 2008m12, a significant vulnerability in oil price surfaced. this is due to series of events that limit global production oil which lead to a significant spike in oil prices. for instance, venezuela cut off sales to exxon mobil in a massive battle over nationalization. export from iran and iraq had not recovered, the decline in mexico oil field and labour strike reduced production in nigeria. in the second half of 2008, recession and financial crises caused oil price to drop to $50 per barrel. at scale 4-8, between 2014m1 and 2014m12, a significant vulnerability in oil price surfaced. this is due to a decrease in oil demand by emerging economies such as china and india which caused decrease in the oil price. 5.3. wavelet coherence result to explore the co-movement and causality between exchange rate and oil price in nigeria, this study deployed the wavelet approach. the x-axis and y-axis portray the time and frequency separately. the grey cone-shaped line in figure 3 mirrors the cone of impact whereas the thick black contour reflects the significance level of 5% against the ar(1). the cold (blue) and warmer red (hot) color signifies the zero dependency and high dependency respectively in figure 3. rightward and leftward arrows illustrate positive and negative co-movement respectively between the two-time series respectively. furthermore, when arrows point rightward and up or leftward and down it shows that the second variable causes the first variable and when the arrows are leftward and up or rightward and down it shows that the first variable causes the second variable. asian journal of economics and empirical research, 2020, 7(2): 126-135 133 © 2020 by the authors; licensee asian online journal publishing group figure-5. wavelet coherence: exchange rate vs oil price. figure 5 portrays the wavelet coherence between exchange rate and oil price between january 2007 and march 2020. the leftward arrow between 2009m10 and 2011m3, between 2012m1 and 2012m3, between 2014m2, 2015m6 and between 2019m2 and 2019m11 shows a negative correlation between exchange rate and oil price. the negative co-movement corresponds with the outcomes of turhan et al. (2014) and yang et al. (2017). furthermore, leftward and up arrows at the thick black contour between 2009m10 and 2011m3, between 2012m1 and 2012m3, between 2014m2 and 2015m6 depicts that exchange rate cause oil price while leftward and down arrows between 2019m2 and 2019m11 signifies that oil price cause exchange rate. 5.4. causality tests table-3. causality tests. direction of causality lag(s) f-stat(prob) decision granger causality exchr  oil 2 {3.612}** reject ho oil  exhr 2 {6.601}* reject ho toda yamamoto direction of causality lag(s) mwald (prob) decision exchr  oil 2 {10.572}* reject ho oil  exhr 2 {21.054}* reject ho note:  stands for direction of the direction of causality, *, ** and *** mirror significance at 1%, & 5% levels, correspondingly. optimal lag for the model has been selected using sc information criteria (lag=2) modified wald test statistic. table 3 denotes the causality tests carried out. for robustness check for the wavelet coherence approach result, the granger and toda-yamamoto causality techniques were deployed to explore the causality between oil price and exchange rate in nigeria. findings from both causality tests revealed there is support for feedback causality between oil price and exchange rate. this finding is supported by previous studies on oil price and exchange rate interaction (cifarelli & paladino, 2010; huang et al., 2020; turhan et al., 2014; yang et al., 2017). 5.5. variance decomposition result the granger and toda yamamoto causality tests cannot predict the relative power of causality for time series beyond the study time. therefore, due to this loophole, the variance decomposition is deployed to investigate the causality strength between the time series variables 24 months ahead and to ascertain causality efficacy. to ascertain the exact impact of oil price on exchange rate and the influence of exchange rate on oil price for 24 months, the variance decomposition analysis is deployed. from the first month to the fifth month, nearly all the discrepancies in oil price can be explained by itself. however, in the twenty-third and twenty-fourth month which are in the long term, the exchange rate can predict 14.08% and 15% of the discrepancy in oil price. for exchange rate, in the first and second months, exchange rate can predict 99% and 95% of the variation of itself. however, as the months dwindle, 40.2% and 40.5% of discrepancy in exchange rate can be expressed by oil price in the twentythird and twenty-fourth month respectively. this signifies that oil price is a good predictor of the exchange rate in the long term. 6. conclusion and recommendations this paper explores the connection between the exchange rate and price of oil within the framework of time and frequency utilizing monthly data between january 2007 and march 2020. the study deployed the wavelet power spectrum and wavelet coherence techniques to investigate this relationship. furthermore, granger and toda yamamoto causality tests were deployed as a robustness check for the wavelet coherence techniques. findings from the wavelet power spectrum shows; (a) there is a vulnerability in exchange rate between 2014m6 and 2014m12, between 2017m1 and 2017m12; and (b) there is a high vulnerability in oil price between 2008m1 and 2008m12, between 2014m1 and 2014m12. the wavelet coherence technique reveals; (a) negative comovement between the exchange rate and oil price between 2009m10 and 2011m3, between 2012m1 and 2012m3, between 2014m2, 2015m6 and between 2019m2 and 2019m11. also, the adverse interaction between the price of oil and the exchange rates for nigeria which is an oil-exporting nation is confirmed. this finding aligns with the study of yang et al. (2017) on the influence of oil price shock on exchange rate. asian journal of economics and empirical research, 2020, 7(2): 126-135 134 © 2020 by the authors; licensee asian online journal publishing group table-4. variance decomposition. decomposition of oil price months s.e. op exchr 1 0.039733 100.0000 0.000000 2 0.065521 98.07864 1.921363 3 0.086260 96.17240 3.827603 4 0.102671 94.67534 5.324659 5 0.115557 93.50412 6.495879 6 0.125675 92.55896 7.441042 7 0.133662 91.76945 8.230547 8 0.140019 91.08946 8.910538 9 0.145135 90.48884 9.511165 10 0.149302 89.94756 10.05244 11 0.152739 89.45203 10.54797 12 0.155613 88.99279 11.00721 13 0.158049 88.56306 11.43694 14 0.160141 88.15786 11.84214 15 0.161961 87.77343 12.22657 16 0.163566 87.40690 12.59310 17 0.164996 87.05597 12.94403 18 0.166287 86.71882 13.28118 19 0.167462 86.39395 13.60605 20 0.168544 86.08014 13.91986 21 0.169548 85.77635 14.22365 22 0.170487 85.48172 14.51828 23 0.171371 85.19549 14.80451 24 0.172209 84.91705 15.08295 decomposition of exchange rate months s.e. op exchr 1 0.014842 0.005003 99.99500 2 0.023811 4.721360 95.27864 3 0.031982 10.37145 89.62855 4 0.039621 15.24506 84.75494 5 0.046791 19.20619 80.79381 6 0.053539 22.41656 77.58344 7 0.059909 25.04930 74.95070 8 0.065944 27.24032 72.75968 9 0.071678 29.08945 70.91055 10 0.077144 30.66938 69.33062 11 0.082367 32.03363 67.96637 12 0.087370 33.22227 66.77773 13 0.092172 34.26587 65.73413 14 0.096789 35.18819 64.81181 15 0.101236 36.00802 63.99198 16 0.105524 36.74046 63.25954 17 0.109665 37.39778 62.60222 18 0.113669 37.99009 62.00991 19 0.117544 38.52582 61.47418 20 0.121298 39.01203 60.98797 21 0.124939 39.45469 60.54531 22 0.128473 39.85891 60.14109 23 0.131907 40.22905 59.77095 24 0.135245 40.56887 59.43113 the granger and toda yamamoto causality tests reveal a bidirectional interaction between oil price and exchange rate. the variance decomposition shows that as the months dwindle, 40.2% and 40.5% of discrepancy in exchange rate can be explained by oil price in the twenty-third and twenty-fourth month respectively. this signifies that oil price is a good predictor of the exchange rate in the long term. both the variance decomposition and causality tests provide supportive evidence for the wavelet coherence technique. findings from this paper propose interesting suggestions for policymakers and investors. concerning investors, oil price and exchange rate connection are unstable in the short run, though there is evidence of stability in the medium term. also, the investors must implement hedge strategies since the exchange rates are responsive to shifts in oil price in nigeria. in regards to policymakers, oil price is a vital determinant of exchange rate which is due to nigeria over-reliance on oil sales in generating revenue. therefore, nigeria should diversify its economy since the exchange rate is sensitive to oil price. references adeniyi, o. a., omisakin, d., olusegun, a., yaqub, j., & oyinlola, a. 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(2006). determinants of venezuela's equilibrium real exchange rate. working paper no. 06/74.international monetary fund, washington dc. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. http://www.cbn.gov.ng/ 207 © 2020 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 7, no. 2, 207-216, 2020 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/journal.501.2020.72.207.216 © 2020 by the authors; licensee asian online journal publishing group fiscal policy and balance of payments in nigeria inimino, edet etim1 brown, uduakobong akpanabba2 otubu, osaretin paul3 ( corresponding author) 1,3department of economics, faculty of social sciences, university of uyo, nigeria. 2 akwa ibom state college of science and technology, nung ukim, ikono, nigeria. abstract this study investigated the effect of fiscal policy on balance of payments in nigeria. the data for the study were obtained from the statistical bulletin of nigeria’s apex bank spanning 1980 to 2017. the study employed augmented dickey-fuller (adf) and autoregressive distributed lag (ardl) bounds techniques. the result of the adf test revealed that the variables were stable at order one and zero. the ardl results showed that in the long run, corporate income tax, government capital expenditure and external debt have positive and significant effect on nigeria’s balance of payments. meanwhile, exchange rate has a negative and significant effect on balance of payments in nigeria. it also revealed that in the short run, corporate income tax and government capital expenditure have positive and significant effect on balance of payments in nigeria. however, exchange rate and external debt have negative and significant effect on balance of payments in nigeria. therefore, this study concluded that fiscal policy has a meaningful effect on nigeria’s balance of payments during the period of study. this means that fiscal policy is effective in achieving a satisfactory balance of payments in the country. keywords: fiscal policy, balance of payments, ardl, corporate income tax, external debt and government capital expenditure. jel classification: e62; f32. citation | inimino, edet etim; brown, uduakobong akpanabba; otubu, osaretin paul (2020). fiscal policy and balance of payments in nigeria. asian journal of economics and empirical research, 7(2): 207-216. history: received: 8 june 2020 revised: 13 july 2020 accepted: 11 august 2020 published: 31 august 2020 licensed: this work is licensed under a creative commons attribution 3.0 license publisher: asian online journal publishing group acknowledgement: all authors contributed to the conception and design of the study. funding: this study received no specific financial support. competing interests: the authors declare that they have no conflict of interests. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. ethical: this study follows all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 208 2. literature review .......................................................................................................................................................................... 209 3. methodology ................................................................................................................................................................................... 213 4. results and discussion ................................................................................................................................................................. 213 5. conclusion and recommendations ............................................................................................................................................. 215 references ............................................................................................................................................................................................ 215 http://crossmark.crossref.org/dialog/?doi=10.20448/journal.501.2020.72.207.216&domain=pdf&date_stamp=2017-01-14 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://www.asianonlinejournals.com/index.php/ajeer/article/view/2068 http://orcid.org/0000-0001-9401-9113 asian journal of economics and empirical research, 2020, 7(2): 207-216 208 © 2020 by the authors; licensee asian online journal publishing group contribution of this paper to the literature the study contributes to the existing literature by examining how nigeria’s balance of payments can be influenced with the aid of fiscal policy variables government capital expenditure, corporate income tax and external debt. accordingly, the study shows that fiscal policy is effective in achieving favourable bops in nigeria. 1. introduction every economic system irrespective of its political arrangement has to identify its economic goals. the major economic goals include full employment, adequate economic growth, price stability and equilibrium in the balance of payments (bops). these goals are usually achieved through the formulation and implementation of economic policies, especially fiscal policy. economic policy means efforts made by all governments to direct their economies toward a high level of economic performance. meanwhile, fiscal policy refers to the manipulation of expenditure resources and taxation powers by the government for the purpose of managing the economy (umo, 2012). in the views of conway (2009) fiscal policy refers to decisions a government takes about what to spend its money on, how to raise taxes and how much to borrow. it is concerned with how the agencies responsible for the conduct of fiscal policy manipulate a set of macroeconomic variables to achieve some desired objectives of policy. in nigeria, as in other countries, it is the duty of the central government to initiate policies that will help to achieve basic macroeconomic objectives, including equilibrium in the bops. according to umo (2012) “balance of payments statement is an annual summary of a country’s trade and finance accounts showing receipts from, and payments to, the outside world”. a typical bops statement consists of the capital account, current account and monetary transactions account (gbosi, 2011). one of the macroeconomic problems facing modern nations including nigeria is balance of payments disequilibrium. therefore, achieving bops equilibrium is considered one of the major economic goals of nigeria. according to ekine (2011) the current account of nigeria’s bops was under pressure from 1997 to 2007. the pressure on the current account largely reflected the pitiable performance of the non-oil exports, the fluctuation in crude oil export, the chronic deficit of the services account and low level of unrequited transfers from abroad. fluctuations in crude oil account exports have often led to wide swings in the current account. the services account in the current account remained in persistent deficit as a result of the low level of receipts and huge payments in respect of international services as well as the unsustainable high level of external debt falling due, especially in recent years. the low level of receipts is attributed to the fact that the transportation of nigerians’ merchandise trade and passengers is performed largely by non-resident carriers. also, more nigerians travel abroad than foreigners visit nigeria. thus, the net position of non-factor services is not in nigeria’s favour. worse still, the non-involvement of nigerians in direct investment in companies abroad, have made receipts in respect of factor services to be extremely low. moreover, from 1985 to 2007, the capital account, excluding financing items (i.e., exceptional financing and reserves), remained very weak, except in 1994 and 1998. the weakness of the capital account arose from the low level of long-term capital inflow in the form of the direct investments and drawings on project-tied loans. in contrast, capital outflows in the form of loan repayments and short-terms capital movements have been substantial. for example, between 1980 and 1994, net transfers on long term debt averaged $3, 198 million. if interest payments and direct investments are added, net transfers abroad would rise to $4, 450.4 million (ekine, 2011; nwokpara, 1997). the trend is particularly disturbing for a foreign exchange constrained economy like nigeria. in addition, the dwindling stock of the country’s external reserves remains disturbing. in 1992, for instance, following the nigeria’s apex bank undertaking to meet the needs of all foreign exchange users who could provide naira cover and the need to meet obligations arising from the zero-coupon debt buy-back scheme, external reserves declined sharply to $712 million, enough to cover only 12 months of imports. in a number of years, reserves have also been run down to cover deficit. for instance, the then governor of central bank of nigeria (cbn), chief joseph sanusi stated (in punch newspaper, october 3, 2002) that the federal government’s ₦80 billion deficit recorded in the first half of 2002 was financed from external reserves, which consequently suffered a drawdown of $2 billion within seven months. the reserves, which peaked at $10.27 billion in december, 2001 dropped to $8.67 billion in july, 2002. the external reserves were $7.29 billion as at september, 2002. a report from the cbn in 2013 revealed that nigeria’s external sector has been facing continual variability on her overall bops and this has called for worry and questions on the likely causes of this instability. in 2013, for instance, the country’s external sector recorded overall bops deficit equivalent to 0.2% of the country’s gross domestic product. the event reflected, largely, increasing foreign debt, drop in external reserves and increased deportation of investment income by external (overseas) investors. momentously, the unfavourable trends in the country’s bops have posed severe limitations for the accumulation of foreign exchange necessary for growth and development. as a result, foreign exchange inflow and the amount available to service the economy have declined over the years. the picture of the country’s earnings, which has been under pressures since the beginning of 2002, showed that $3.796 billion as recorded as inflows, while outflows totaled £5.797 billion. as revealed by the central bank of nigeria (2014); central bank of nigeria (2015) in the year 2014, the bops account noted a deficit equal to 1.7 per cent of gross domestic product, which revealed a decrease of foreign reserves. the decrease in current account was caused mainly by export earnings, from 15,262.8 billion naira in 2013 to 12,988.3 billion naira in 2014 and rising import bills, from 8,628.7 billion naira in 2013 to 9,686.8 billion naira. the external account was adversely affected by instability in the global prices of crude oil in 2015 and little entry of foreign exchange into the country. consequently, the external sector also documented bops deficit of ₦1,150.13 billion, corresponding to 1.4 per cent of gross domestic product in 2015. put succinctly, available data shows that nigeria has been experiencing deficits in the bops in recent years. for instance, balance of payments stood at n 349.1 in 1985. in 1990 and 1995 the country recorded a deficit of n -5761.9m, n -195316.3m respectively. in the year 2000, balance of payments experienced an increase of n 314139.2m. in 2005, balance of payments experienced a decrease of n -2394864.31m. however, in 2010 and 2015 balance of payments stood at n 2298564.44m and n -5.400, 000m respectively. asian journal of economics and empirical research, 2020, 7(2): 207-216 209 © 2020 by the authors; licensee asian online journal publishing group to solve the problem of unfavourable bops, the nigerian government had introduced numerous economic policies over the years. for example, in 1986, the government introduced structural adjustment programme (sap). according to gbosi (2011) one of the major reasons why nigeria adopted the sap in 1986 was to enable her obtain credit facilities from the international monetary fund to finance bops deficits. unfortunately, even after the acceptance of the imf-world bank structural adjustment programme, the nigerian economy is still in bad shape. strictly speaking, the nigerian economy is married with high rate of inflation, mass unemployment, huge public debt, sluggish economic growth, unfavourable bops and sharp decrease of the naira exchange rate. despite the fiscal policy measures (capital expenditure, corporate income tax policy and external debt policy) introduced over the years to tackle the troublesome deficit in the country’s bops. the problem of bops still persisted. the above state of affairs raised pertinent questions: what is the relationship between government capital expenditure and bops in nigeria? what is the relationship between corporate income tax and bops in nigeria? what is the relationship between external debt and bops in nigeria? answers to these questions were the major concern of this work. the broad objective of this paper was to examine the effect of fiscal policy on bops in nigeria from 1980 to 2017. 2. literature review 2.1. conceptual issue fiscal policy is associated with keynesian economic theory and policy. keynesians traditionally view fiscal policy as a technique to fine-tune total spending and guard citizens from turbulent swings in their well-being. akpakpan (1994) sees it as the deliberate use of the income and expenditure of government to influence the level of economic activities in the country. according to gbanador (2007) fiscal policy entails government’s management of the economy through the manipulation of its income and spending power to achieve certain desired macroeconomic objectives (goals). furthermore, it can be expansionary or contractionary in nature. an expansionary fiscal policy involves increase in government expenditure and/or decrease in taxes with the aim of stimulating aggregate demand and hence the economy. but the reverse is the case for contractionary fiscal policy. moreover, both expansionary and contractionary fiscal policy can be employed to correct bops disequilibrium. a bops deficit can be rectified by reducing government spending and increasing taxes. a reduction in government expenditure will reduce investment and consumption of the public; this will lead to a decrease in income and imports of the country. moreover, an increase in taxes will reduce households’ income leading to a decrease in the demand for quality goods and services. because of the reduction in demand, prices will fall and this may boost exports. the end result will be an improvement in balance of trade, the country’s current account balance and bops. in addition, it is possible to rectify bops surplus by reducing taxes and increasing government spending. a decrease in taxes will lead to a rise in disposable income, and the demand for goods and services will increase. likewise, a meaningful increase in the expenditure of the government will cause the overall demand for goods and services to increase. this will trigger an increase in income and demand, it may discourage exports. following this approach, an expansionary fiscal policy can reduce bops surplus or worsen it. furthermore, a nation’s international economic balance involves all of the economic transactions that residents of a nation enter into with residents of other nations during a specific time period. the most important tool for the analysis of the external economic position of a nation is the bops statement. the bops is defined as an accounting statement that sums up all the economic dealings between people of one country and people of other countries. strictly speaking, it is the overall economic dealings between one country and other countries. gbosi (2005) asserted that the balance of payments is among other three records of international economic dealings between countries. the three major components of the bops are the current account, capital account and official statement balance. the first account (i.e., current) includes dealings where payments are income for a recipient country. they include visible goods, invisible services, remittances, payment of factors etc. the second (i.e., capital) account records asset transaction. it enables us to know the volume of investment that is made by nigerian nationals as well as the government in other countries. on the other hand, the official statement account primarily aimed at matching any balance in the current or capital account. whenever a country’s payments exceed her receipts from her foreign transactions, balance of payments becomes unfavourable. this will of course lead to the depletion of her external reserves. furthermore, if such an adverse condition continues for a long time, pressure will be mounted on the worth of her home currency thereafter leading to depreciation of the home currency. this has been the state of the nigeria naira in recent years (gbosi., 2015). moreover, a country may record surplus or deficit bops. importantly, bops of a country is in surplus when the revenue from export exceeds the payment for import and negative when the reverse is the case. a balance of payment disequilibrium may either be positive or negative (gbosi, 2005). the approach towards solving bops trouble relies on its cause. for instance, if the bops trouble is triggered by a deficit on the current account, which reveals that the country has imported more than it has exported, the country will have to endeavour to reduce its imports and increase its exports. to be precise, the measures which could help a country in achieving this objective include exchange rate control, i.e., controlling access to foreign currencies, import restrictions through tariffs and quotas, stimulation of local production (with improvements in the quality of output) in order to reduce the need to import goods from other countries, stimulation of export production to increase exports earnings. to achieve this, people involved in production will have to try to produce high quality products, and do so efficiently. put succinctly, the country can adopt economic policies that would ensure macro-economic balances, institute a culture of policy stability, enhance non-oil exports, and develop adequate debt servicing capacity through the enhancement of domestic productivity. over the years, the government of nigeria has employed a number of approaches to solve the problem of balance of payments disequilibrium. for instance, from 1975 to 1980 under the period of regulation in nigeria, fiscal policy measure adopted by the government includes import liberalization for certain specific commodities, relaxing all administrative controls and removing non-tariff barriers to cross border trade. other measures included reducing import and excise duties where they were actually important (lambo, 1987). meanwhile, in 1979, the country placed some commodities on the prohibition list at the beginning of the plan; the nigerian asian journal of economics and empirical research, 2020, 7(2): 207-216 210 © 2020 by the authors; licensee asian online journal publishing group economy was faced with some difficulties because of the oil glut in the world market. the total amount and prices of the country’s crude oil fell extensively; and this led to bops deficit. supporting this, adedokun (2016) argued that in the early 1980s the fall in the price of crude oil resulted in oil revenue shock in nigeria, coupled with unabated preferences for imports. this resulted in current account deficit as revenue from exports was inadequate to offset the bills accruing from imports. during this period the country witnessed a decline in capital inflows as many countries of the world were battling with the effects of slower economic growth. this led to a full blown balance of payments crisis and huge debt profile in nigeria. to put the situation under control, the government put under license the importation of some commodities while others were banned completely. from 1980 to 1985, the key objective of fiscal policy was to stimulate domestic production. to achieve this policy goal, several fiscal measures were adopted by the federal government. for instance, the income tax management act of 1981 was amended. in october 1st 1985 the federal military government declared a state of national economic emergency for a period of 15 months. the national economic emergency decree empowered the president (head state) to issue orders and legislations which aimed at stimulating the economy during the period of the emergency. the head of state introduced several fiscal measures. for example, deduction which varied from two to fifteen percent from all incomes including rent, dividends as well as salaries and wages of employees in private and public sectors including the military were made. the deductions were made and paid into the economic recovery fund at the central bank of nigeria. a committee headed by the federal director of budget was set up to manage the fund. the decree also forbade the importation of wheat and rice. this action forced the price of rice to increase substantially. even after the economic emergency period, there had not been any meaningful fall in the price of rice and other basic agricultural commodities in nigeria. rather, there was a sharp rise in the prices of goods and services. apart from high inflationary burdens, high levels of unemployment, external sector instability, and other macroeconomic problems persisted during the period (gbosi, 2012). also, duties were once more increased in 1981, while, in 1984 the range of import duties was reduced and permitted to last for three years. adjustments were made in customs and excise tariff to give improvement to locally assembled agricultural equipment in 1986, while a number of items were placed under ban. furthermore, fiscal policy in nigeria under deregulation period was also aimed at achieving macroeconomic objectives. the main macroeconomic troubles under sap were those of increasing rates of inflation, unemployment, huge debt and balance of payments disequilibrium. thus, fiscal policy was planned to significantly reduce budget deficit, guarantee increase in revenue and advance effective control and efficiency in fiscal operations (central bank of nigeria, 1985). in 1987, a major fiscal policy measure adopted was the contribution of the national economic recovery fund (nerf) which was established in 1985. as part of actions to reduce the influence of inflationary burdens on workers in the civil service, the government restored and in specific cases augmented some fringe benefits of workers. a number of fiscal measures were introduced to stimulate the economy. for example, inflationary package of 250 million naira was made available, to add up to the 600 million naira built in deficit during the financial year. the complete tariff structure was accepted (planned to last for seven years), partly to make available advanced degree of protection to local industries. excisable products were reduced from 412 to 182. the harmonized coding system and commodity were incorporated into the new tariff structure while anti-dumping tariff on certain items came into force (anyanwu, oyefusi, oaikhenam, & dimowo, 1997). some of the measures employed in 1988 were reserved in 1989 with the aim of attaining favourable balance of payments. in an attempt to encourage balance in fiscal target, certain all-purpose principles were designed to improve the effectiveness of government spending from 1990 to 1993. most of the economic measures brought into use in the 1994 budget were anticipated to address slow growth in the productive sectors, check the weight of inflation and correct unfavourable bops. momentously, the main policy objectives of 1994 budget were the promotion of selfsustaining growth in the real sector under a regime of fixed exchange and interest rates, coupled with tight monetary and fiscal policies. fiscal policy adopted in 1994 did not achieve their desired objectives. therefore, a policy of “guided deregulation” was adopted by the government in 1995. the main objective of the policy was to strengthen and buildup foreign reserves to enhance confidence in the nigerian economy. this would subsequently strengthen the naira and make a way for its final convertibility (central bank of nigeria, 1995). since the 1990’s, government fiscal operations in nigeria have been branded by persistent deficits. fiscal policy was then designed to expand agriculture production which in turn will help to reduce food import, reduce inflation, expand revenue base, and to improve resource allocation. thus, from 1996 to 1998, the country’s fiscal policy aimed at upholding finest equilibrium between revenues and expenditures. the country also designed fiscal incentives to promote output growth in the economy and hence reduce importation of goods and services. because of increasing demand for increased public expenditures, efforts were geared towards enhancing efficiency in tax collection. measures for revenue mobilization included tax reforms to recoup tax administration especially in tax collection. a number of measures were designed to reduce public expenditures as a strategy to achieving effective resource mobilization for the economic recovery programmes. the stance of fiscal policy in this regard since 1999 had been restrictive in nature. some of the fiscal measures implemented in 1999, were retained in 2000 and 2001 respectively. however, since 2005, the main objective of fiscal policy thrust of 2005 was consistent with the provisions of the national economic empowerment development strategies (needs). the needs is targeted at improving the quality of life and increasing infrastructural facilities, and employment generation. the fiscal thrust in 2007 was focused on strengthening growth included development strategy. as outlined under the needs which was formulated within the context of the medium term expenditure framework. the strategy was directed towards eliminating infrastructural deficiencies. over the years, these infrastructural deficiencies had hindered business operational efficiency, improving the quality of life of the citizenry and accelerating investment in basic infrastructure and human capita. it was also targeted at addressing weaknesses in planning process in the country to support the development programmes of the government. the seven points agenda of the late, president yar’adua’s administration reinforced the need for infrastructural (water, power, roads) and social (wealth and education) development with ultimate aim of achieving adequate economic growth, favourable balance of payments, etc. the fiscal actions employed in 2007, were retained in 2008, and 2009 asian journal of economics and empirical research, 2020, 7(2): 207-216 211 © 2020 by the authors; licensee asian online journal publishing group respectively. but the financial policy thrust of the 2010 budget was intended to stimulate economic recovery from the negative effects of the global economic and financial crisis (central bank of nigeria, 2010). the government also adopted transformation programmes in 2011 to 2015 with increased spending outlay; the budget was to transform the socio-economic fortunes of the country by implementing relevant measures to address the challenges of the economy. this was to be achieved through targeted fiscal interventions in important sectors, mainly critical infrastructure in order to create an enabling environment for the hastening of sustainable economic growth and development driven by non-government sector. this also was a road map for addressing critical challenges of bops deficits in nigeria. during the period 2015 to 2018, the government adopted both expansionary and contractionary fiscal policy to redress the problem of imbalance in the bops. fiscal actions were also put in place to encourage growth in the economy and hence reduce importation of goods and services. the government also imposed a ban on the importation of some goods. yet, the country’s balance of payments trouble has remained worse because of the pitiable non-oil export performance, persistent decline in the country’s foreign exchange, high import, preference for foreign goods and services over domestic goods and services, stagnated agriculture, pressure of inflation, inefficiency of the manufacturing sector and unstable oil prices in the foreign oil market. hence, it is necessary to consciously examine how fiscal policy has impacted on bops in nigeria from 1980 to 2017. 2.2. theoretical review keynes in the twentieth century made a strong argument for the important role of fiscal action and submitted that active public policy could be effective in managing an economy. the approach has it that an increase in public spending and/or decrease in taxes will stimulate total demand and hence the economy. therefore, fiscal policy (both expansionary and contractionary fiscal policies) can be employed to correct imbalance in the bops. for instance, a contractionary fiscal policy can be employed to solve the problem of bops deficit. also, an expansionary fiscal policy can be employed to solve the problem of surplus in the bops. at the same time, keynes submitted that government borrowing will add to the wealth of the country which will increase spending. the keynesian regression function for balance of trade could simply be presented as: (x-m)t = α 0 + α1yt + α2pt + α3 exrt (i). where; x = exports, m = imports, y = level of income, p = price level, exr = exchange rate and t = time period. furthermore, based on the observation of malindretos (1991) the keynesian regression function for the official reserves transaction balance could simply be written as: irt = α 0 + α1yt + α2pt + α 3mst+ α4i + α5 exrt (ii). where; ir = the international reserves, p = the price level, ms = money supply, y = level of income, i = the interest rate and exr = exchange rate. the importance of the keynesian approach to balance of payments is that it sees trade balance, as the most significant account of the bops. the explanatory variables price, level of income, exchange rate, money supply and interest rate will first of all influence the trade balance and then the bops. this implies that bops disequilibrium occurs because of the imbalance of real forces (wanniski, 1975). therefore, the keynesian model focused on the actual account (trade balance) which is autonomous and the official reserves transaction balance is therefore the accommodating account. in the light of the above, this work adopted the keynesian approach to bops (i.e., this work hangs on the keynesian approach to bops) which made it clear that an increase in the government consumption expenditure will lead to an increase in total demand, increase in investment, income, employment and promising trade balance. according to onuchuku and obayori (2018) keynesian approach to bops was based on elasticities and absorption theories (approaches) of balance of payments. the elasticities approach to bops emphasizes the effect of price changes. depreciation of a currency or appreciation of it may change the price of the domestic currency paid for imports and what is received for exports, consequently leading to variations in the amount of imports demanded and exports supplied. the amount by which the quantity of imports demanded and the quantity of exports supplied (and, therefore, the balance of payments) change is determined by the elasticity of export supply and the elasticity of import demand. on the other hand, the absorption approach emphasizes a country’s real income and expenditures as determinants of its bops and the exchange value of its currency. according to the approach, if a country’s actual income surpasses the quantity of goods and services that it takes (absorbs), then the country will run a current account surplus. if a country’s actual income is less than the quantity of goods and services it takes, then the nation will run a current account deficit. if actual income and absorption are equal, the nation’s current account will be balanced. importantly, it illustrates that if real income rises faster than absorption, then exports rise relative to imports, the country’s balance of payments improves, and the domestic currency appreciates. if absorption rises faster than real income, then imports rise relative to exports, the country’s bops deteriorates, and the domestic currency depreciates. the two types of policy instruments in the absorption model the absorption instruments and the expenditure-switching instrument, may have negligible effects on a nation’s current account imbalance. hence, it is unclear if these instruments will increase real income relative to absorption. 2.3. review of empirical literature in nigeria, only a handful of empirical studies have specifically investigated the influence of fiscal policy on balance of payments. in this study, only those that are directly relevant to the study were discussed. 2.4. government capital expenditure and balance of payments onuchuku and obayori (2018) applied vector error correction technique to investigate the impact of fiscal policy on bops in nigeria. the result revealed that increase in capital spending and external debt will cause a favourable balance in bops. meanwhile, a percentage increase in company income tax will decrease bops. using data from 1980 to 2012, brown and bidemi (2015) applied co-integration and error correction mechanism methods to investigate the extent to which fiscal policy measures have influenced nigeria’s bops position. the result revealed that the influence of tax revenue on bops in nigeria to be positive and significant. it also revealed the influence of government spending, as well as debt on bops to be negative and significant. asian journal of economics and empirical research, 2020, 7(2): 207-216 212 © 2020 by the authors; licensee asian online journal publishing group egwaikhide (1997) looked at how budget deficit has influenced nigeria’s current account balance. the researcher constructed a macro-econometrics model that captured the noticeable interrelationships between credit creations, budgetary developments by the government and current account balance. numerical evidence suggested that policy regarding budget affects the country’s current account balance. to be precise, simulation tests showed that budget deficit, caused by increased spending, will lead to a deterioration of current account. 2.5. corporate income tax and balance of payments azubike (2016) examined policies that affect the position of nigeria’s balance of payments. specifically, policies regarding exchange rate, tariff and non-tariff were considered. a number of proxies were employed to explain the influence of the policies on bops. they include; indirect tax as a proxy for tariff policies, money supply, export and interest rate as a proxy for non-tariff policies, and exchange rate. the study employed ordinary least squares method of econometrics. the result revealed that the export, exchange rate and indirect tax satisfy the economic apriori expectations, while money supply and interest rate did not satisfy the apriori expectations. atan (2013) used descriptive, inferential statistical and ols methods to examine the consequence of managing the nigerian economy through taxation and its influence on macroeconomic aggregates, especially bops from 1970 to 2008. the findings indicated that the historical trend in bops has no meaningful and insignificant response to tax policy. the study obtained a positive association between tax policy and bops. further, the researcher found that policy regarding taxation was ineffective in tackling the problem of bops because of inconsistency in the use of tax measures. onuchuku, ofoezie, and nteegah (2006) examined fiscal policy measures and macroeconomic stability in nigeria from 1980-2004. the researchers used multiple regressions to analyze the influence of government expenditure, revenue and debt on gdp, bop, inflation and unemployment. the outcome showed a weak association between fiscal policy variables and macroeconomic stability. specifically, a negative relationship exists between government tax and balance of payments. anyanwu (1997) used secondary data from 1981 to 1996 and ordinary least squares technique to investigate the influence of taxes on bops in nigeria. the result showed that taxes significantly influence nigeria’s bops. this means that tax policy measure to encourage export production in order to increase the exports earnings will help to solve bops problem in nigeria. 2.6. external debt and balance of payments in kenya, muli and ocharo (2018) used granger causality technique to analyze the association between external debt servicing and current account balance. external debt service was found to granger caused current account balance. also, magero (2015) used vector error correction model to find out how total debt servicing has influenced macroeconomic performance in kenya. the result showed that debt servicing significantly influenced on macroeconomic performance. morsy (2012) used inter-temporal approach cum panel data to examine the association between currency crisis and current account balance in oil exporting countries. the outcome revealed that current account balance was influenced by external debt. in greece, mbanga and sikod (2008) used vector autoregressive technique to examine the impact of external debt servicing on macroeconomic variables from 1995 to 2006. the result showed that external debt servicing and inflation rate affected the development of current account greatly. in central and east european union, herrmann and jochem (2005) used feasible generalized least squares estimation technique to investigate the influence of selected macroeconomic variables on current account balance. the result showed that current account balance and external debt services have a negative relationship. zaidi (1985) used cross-sectional time-series data drawn from 12 developing countries to examine the association between fiscal deficit and current account balance. although the results revealed a direct association between the variables, the causality tests showed bidirectional causality between fiscal deficits and the current account deficits for philippines and south korea, but a unidirectional causality running from the current account deficit to budget deficit for thailand and greece. meanwhile, the variables were statistically independent between 1972 and 1980 in brazil. the examination of the previous works done that are connected to this present research showed that, there are differences in opinions and empirical findings regarding the impact of fiscal policy on bops, especially in countries that are developing like nigeria. for instance, the results of the analysis of atan (2013); brown and bidemi (2015); onuchuku and obayori (2018) showed that that in nigeria, government capital expenditure and tax revenue (policy) have significant and positive effect on bops. furthermore, the empirical work of onuchuku et al. (2006) revealed a weak relationship between fiscal policy variables and macroeconomic stability. specifically, tax revenue and bops have negative relationship. the difference in empirical findings regarding the impact of fiscal policy on bops is of serious concern, especially in developing countries like nigeria; and this necessitates further researches. thus, this provides a good reason to empirically ascertain how fiscal policy has impacted on bops of nigeria from 1980 to 2017. moreover, as much as the above studies are commendable, the basic questions remain as: what is the relationship between government capital expenditure and bops of nigeria? what is the relationship between corporate income tax and bops of nigeria? what is the relationship between external debt and bops of nigeria? these questions beg for answers and this study therefore appealed to empirical evidence to resolve these questions. nevertheless, in the works of some scholars including onuchuku and obayori (2018) etc., vecm econometric method was used without paying attention to their unit root result which do not support the use of vecm but supports ardl model. none of the scholars used ardl method to analyze their data. secondly, none of these scholars covered the period of 1980 to 2017. therefore, this study systematically looked at how fiscal policy has influenced nigeria’s bops from 1980 to 2017 by using the econometric technique of autoregressive distributed asian journal of economics and empirical research, 2020, 7(2): 207-216 213 © 2020 by the authors; licensee asian online journal publishing group lag (ardl) model to assist determine the relationship amongst variables that are included in this investigation. 3. methodology the data for this study were sourced from the statistical bulletin of various issues of the nigeria’s apex bank. the data covered the period 1980-2017. in addition, the techniques of augmented dickey fuller (adf) unit root test and autoregressive distributed lag (ardl) were employed to investigate the effect of fiscal policy on balance of payments in nigeria. normality test was also carried out to ascertain the reliability of the model for policy purposes. 3.1. model specification the study developed an econometric model aimed at capturing the relationship between balance of payments and fiscal policy variables in nigeria, in line with the theoretical and empirical literature reviewed. importantly, the model of onuchuku and obayori (2018) was adapted. the model of onuchuku and obayori (2018) is in the form of equation 1: m = f (g, t, d) (1) in equation 1, m is the bops, g = government expenditure, t = corporate income tax and d is external debt; but with slight modification. the model for this study is presented in equation 2. bop= f (gce, cit, exd, exr) (2). from the above functional model or association between the dependent and explanatory variables, the econometric form of the model is presented in equation 3: bopt = ao + a1gcet + a2citt + a3exdt + a4exrt + ut (3) from equation 3: bop = balance of payments (₦’million). gce = federal government capital expenditure (₦’million). cit = corporate income tax (₦’million). exd = external debt (₦’million). exr = exchange rate (n /$). apriori expectation: on the apriori: gce, cit, exr and exd >0 (i.e., a1a4 >0). 3.2. unit root test to avoid false regressions outcomes the adf method was employed based on the building of equation 4: δbop t = α 0 + α 1 bop t-1 + σα 1 δbop i + δ t + u t (4) in equation 4, bop = time series, t = linear time trend, δ = the first difference operator, α 0 = a constant, n = the optimum number of lags in the explanatory variables and u = random error term. 3.3. estimation technique the study employed autoregressive distributed-lag (ardl) model as the estimation technique. this is because; the ardl helps to showcase the short and long-term relations between the fiscal policy variables and bops variable in the model. the adf test precedes ardl test. the ardl model for this study is presented in equation 5; ∆𝐵𝑂𝑃𝑡,𝑗 = 𝛼0 + 𝛼1𝐺𝐶𝐸𝑡−1,𝑗 + 𝛼2𝐶𝐼𝑇𝑡−1,𝑗 + 𝛼3𝐸𝑋𝐷𝑡−1,𝑗 + 𝛼4𝐸𝑋𝑅𝑡−1,𝑗 + ∑ 𝑏1𝑖,𝑗∆ 𝑛1 𝑖=1 𝐵𝑂𝑃𝑡−1,𝑗 + ∑ 𝑏2𝑖,𝑗∆ 𝑛2 𝑖=0 𝐺𝐶𝐸𝑡−1,𝑗 + ∑ 𝑏3𝑖,𝑗∆ 𝑛3 𝑖=0 𝐶𝐼𝑇𝑡−1,𝑗 + ∑ 𝑏4𝑖,𝑗∆ 𝑛4 𝑖=0 𝐸𝑋𝐷𝑡−1,𝑗 + ∑ 𝑏5𝑖,𝑗∆ 𝑛4 𝑖=0 𝐸𝑋𝑅𝑡−1,𝑗 + +𝜇𝑡 (5) in equation 5, bop = balance of payments, gce = government capital expenditure, cit = corporate income tax, exd = external debt and exr = exchange rate. 4. results and discussion the adf method was used to test for the stationarity of the variables and the result of the test is presented in table 1. table-1. augmented dickey-fuller unit root test (1980-2017). variables adf test statistic at level adf test critical value at 5% (level) order of integration adf test statistic at 1st difference adf test critical value at 5% (1st diff.) order of integration bop -4.370463 -3.536601 stationary 1(0) cit -0.978360 -3.557759 not stationary -6.538290 -3.587527 1(1) exd -1.786316 -1.950394 not stationary -3.833363 -3.540328 1(1) gce -3.369334 -3.536601 not stationary -8.036383 -3.540328 1(1) exr -2.094986 -3.536601 not stationary -6.033776 -3.540328 1(1) note: bop, cit, exd, gce and exr as previously defined. the unit root test result presented in table 1 shows that at 5 per cent level of significance the variables were stationary; bop was stationary at level 1(0). while, cit, exd, gce and exr were stationary at first difference asian journal of economics and empirical research, 2020, 7(2): 207-216 214 © 2020 by the authors; licensee asian online journal publishing group 1(1). given that the variables were integrated of order 1(0) and 1(1). the requirement to fit in an ardl model to test for long run cointegrating relationship is satisfied and the result of the test is presented in table 2. table-2. ardl bounds test for co-integration. model f-statistic = 176.5055 f(bop, cit, exd, gce and exr) k = 4 critical values lower bound upper bound 5% 2.86 4.01 note: bop, cit, exd, gce and exr as previously defined. the result in table 2 reveals a long run relationship amongst bop, cit, exd, gce and exr. the reason for this is that computed f-statistic of about 176.5055 is more than the upper critical bounds at 5% critical values. therefore, the study rejects the null hypothesis of no co-integration at 5% significance level for the balance of payments model. following the establishment of long-run co-integration association among the variables, the long-run and short-run dynamic parameters for the variables were obtained. the results are presented in tables 3 and 4. table-3. estimated ardl long run coefficients. dependent variable: bop ardl (4, 4, 4, 3, 4). regressors coefficient t-statistic p-value cit 1.246645 12.842794 0.0000 gce 2.175758 11.062710 0.0000 exd 0.685499 56.997111 0.0000 exr -30417. -31.921900 0.0000 note: bop, cit, exd, gce and exr as previously defined. the result in table 3 shows that the cointegration coefficients of corporate income tax, government capital expenditure and external debt have positive and significant association with bops. what this suggests is that a unit increase in corporate income tax, government capital expenditure and external debt will raise the country’s balance of payments by ₦1.246645m, ₦2.175758m and ₦0.685499m respectively. the result also pointed out that exchange rate has negatively influenced bops. meanwhile, the rate of exchange is statistically significant. this means that a weak value of the naira in relation to dollar will decrease the balance of payments position of nigeria. table-4. error correction result for the selected ardl model ardl (4, 4, 4, 3, 4). regressors coefficients t-statistic p-value cit 4.424403 5.887983 0.0002 gce 5.047935 8.158428 0.0000 exd -0.257748 -2.683402 0.0230 exr -4449.075 -2.411285 0.0366 ecm (-1) -1.368689 -10.546516 0.0000 r-squared = 0.999889 adjusted r-squared = 0.999635 f-statistic = 3930.672 prob(f-statistic) = 0.000000 akaike info criterion = 23.47755 schwarz criterion = 24.55498 durbin-watson stat = 1.761907 note: bop, cit, exd, gce and exr as previously defined. the error correction term in table 4 is negative and statistically significant. this shows it adjustment from short run equilibrium to long-run equilibrium in the dynamic model. the durbin watson (dw) value of 1.761907, which is approximately 1.8, suggests that autocorrelation is not a problem to the model. the f-statistics also reveals that the overall model is statistically significant. moreover, coefficients of corporate income tax and government capital expenditure have positive relationship with bops. what this means is that, a unit increase in corporate income tax and government capital expenditure will raise the country’s balance of payments by ₦4.424403m and ₦5.047935m respectively. the result also reveals that exchange rate and external debt have negative relationship with bops. what this suggests is that a unit increase in external debt will decrease the country’s bops by ₦0.257748m. however, a weak value of the naira in relation to dollar will decrease the balance of payments position of nigeria by ₦4449.075m. furthermore, all the explanatory variables corporate income tax, government capital expenditure, external debt and exchange rate are statistically significant. therefore, the study accepts the alternative hypotheses which state that government capital expenditure, corporate income tax, exchange rate, and external debt have significant relationship with bops in nigeria. this suggests that corporate income tax government capital expenditure, external debt and exchange rate have meaningfully affected nigeria’s bops during the period of study. this also means that, in the short run, appropriate policies regarding corporate income tax, government capital expenditure, external debt and exchange rate have the ability to meaningfully influence nigeria’s balance of payments. these findings corroborate the empirical works of azubike (2016) as well as onuchuku and obayori (2018) who unambiguously affirmed that fiscal measures have significant impact on nigeria’s balance of payments. asian journal of economics and empirical research, 2020, 7(2): 207-216 215 © 2020 by the authors; licensee asian online journal publishing group 4.1. normality test result 0 2 4 6 8 10 12 14 -40000 -30000 -20000 -10000 0 10000 20000 30000 40000 series: residuals sample 1984 2017 observations 34 mean -7.97e-10 median -14.32928 maximum 37847.66 minimum -37476.59 std. dev. 15197.42 skewness 0.141159 kurtosis 4.202801 jarque-bera 2.162449 probability 0.339180 figure-1. normality test result. the jarque-bera statistic shows that the error term is normally distributed at five per cent. this is because the probability value of 0.339180 is larger than the five per cent conventional level. 5. conclusion and recommendations fiscal policy plays a significant role in achieving basic macroeconomic objectives, especially equilibrium in the bops. therefore, this study carefully investigated the effect of fiscal policy on balance of payments in nigeria from 1980 to 2017. the study used data on balance of payments, corporate income tax, government capital expenditure, external debt and exchange rate from the statistical bulletin of nigeria’s apex bank and employed ardl method of econometrics to analyze the data. the findings showed that in the long run, corporate income tax, government capital expenditure and external debt have positive and significant effect on balance of payments in nigeria. at the same time, the rate of foreign exchange has a negative and meaningful effect on bops in nigeria. furthermore, in the short run, corporate income tax and government capital expenditure have positive and significant effect on bops in nigeria. meanwhile, external debt and exchange rate have negative and significant effect on balance of payments in nigeria. the study therefore concluded that fiscal policy in nigeria has a meaningful effect on bops during the period of study. thus, fiscal policy is effective in achieving favourable bops in nigeria. therefore, the study made the following recommendations: i. government should increase its capital investment in revamping all ailing industries; encourage domestic industries, locally made goods and exportation of manufactured or finished goods. the country should also abstain from excessive consumption of foreign goods and services that are not essential. ii. government should remove all loopholes and ensure all companies located in the country are registered to make tax collection easy, and punish any company that does not remit income tax adequately. at the same time, favourable corporate tax policies should be encouraged in order to enhance production in the economy. iii. government should ensure that national debt is incurred on reasonable economic terms and invest in viable projects which will benefit the economy by enhancing its growth and future economic independence but avoid unnecessary and unproductive borrowing that will hurt the economy. iv. monetary authorities should maintain the current exchange rate system (managed floating exchange rate system) to redress the problem of exchange rate variation in nigeria. references adedokun, s. a. 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(1985). savings, investment, fiscal deficit, and the external indebtedness of developing countries. world development, 13(5), 573588. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 74 © 2025 by the author; licensee asian online journal publishing group asian journal of economics and empirical research vol. 12, no. 1, 74-78, 2025 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v12i1.6920 © 2025 by the author; licensee asian online journal publishing group corruption, democracy, and economic growth in kenya naftaly mose technical university of kenya, kenya. email: brilliantcoke@gmail.com abstract the relationship between corruption, democracy, and economic growth is complex and multifaceted across empirical studies. understanding this relationship is crucial for policymakers, researchers, and scholars alike as they seek to promote stable democracies and sustained economic development in middle-income countries. kenya has long grappled with issues of corruption and challenges to its democratic processes. these problems have significant implications for governance, economic growth, political stability, religion, and social cohesion. this study investigates the effects of democracy and corruption control on kenya's economic growth from 1990 to 2020. utilizing the generalized method of moments (gmm) model for regression econometric analysis, the findings indicate that both democracy and control of corruption exert a positive and significant influence on economic growth in kenya. the results of the democracy model support a positive correlation between democratic governance and economic development, while the corruption model aligns with the “sand in the wheels” hypothesis, suggesting that corruption may hinder economic growth in kenya. consequently, advancing democracy, streamlining bureaucratic processes, and implementing anti-corruption measures are crucial for achieving sustainable economic growth in kenya. ultimately, promoting good governance and transparency is essential for sustainable economic development, as strong democratic institutions can help mitigate corruption and enhance economic growth potential. keywords: corruption, democracy, economic growth, kenya. jel classification: d72; d73; o47. citation | mose, n. (2025). corruption, democracy, and economic growth in kenya. asian journal of economics and empirical research, 12(1), 74–78. 10.20448/ajeer.v12i1.6920 history: received: 26 may 2025 revised: 23 june 2025 accepted: 7 july 2025 published: 18 july 2025 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. contents 1. introduction ...................................................................................................................................................................................... 75 2. literature review ............................................................................................................................................................................ 75 3. material and methods ..................................................................................................................................................................... 75 4. results and discussion ................................................................................................................................................................... 76 5. conclusion ......................................................................................................................................................................................... 77 references .............................................................................................................................................................................................. 78 mailto:brilliantcoke@gmail.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v12i1.6920 https://orcid.org/0000-0003-0467-235x asian journal of economics and empirical research, 2025, 12(1): 74-78 75 © 2025 by the author; licensee asian online journal publishing group contribution of this paper to the literature kenya has long grappled with issues of corruption and challenges to its democratic processes. these problems have significant implications for governance, economic growth, and social cohesion. understanding the dynamics between corruption and democracy in kenya is crucial for addressing these longstanding challenges. 1. introduction economic literature posits that democracy has the potential to enhance the quality of economic institutions, as suggested by olson (1991). the effectiveness of institutions is crucial for optimizing public goods, thereby fostering economic growth. variations in institutional quality are evident between democratic and autocratic regimes and are influenced by the prevailing levels of human capital within an economy (krieger, 2022). the interplay of political participation significantly shapes governmental resource allocation. opportunistic governments are likely to optimize the balance between rent-seeking and the provision of public goods to garner political support. in autocratic contexts, it is rational for the government to prioritize rent-seeking over public goods to sustain that support (plümper & martin, 2003). consequently, democracy is associated with increased efficiency, thereby promoting productivity and growth. however, excessive political participation may compel governments to over-invest in public goods provision, leading to inefficiencies that can stifle private investment and hinder growth (krieger, 2022; plümper & martin, 2003). the relationship between corruption levels and economic growth presents ambivalence, with empirical studies suggesting that effective corruption control can enhance resource allocation efficiency and stimulate private sector growth (iliyasu & muhammed, 2023). hodge, shankar, rao, and duhs (2011) argue that corruption control may facilitate economic growth through a reduction in wastage and total government spending. moreover, kato and sato (2015) posit that corruption might function to "grease the wheels" of the economy, thereby promoting efficiency, especially in less developed nations with fragile institutions. conversely, alternative research indicates that corruption can diminish expenditure efficiency and detrimentally impact economic performance, effectively "sanding the wheels" of the economy (mose, 2024; nguyen & bui, 2022). nur-tegin and jakee (2020) and mose (2021) argue that corruption incentivizes those in authority to allocate budgetary resources based on personal preferences, resulting in distorted budgets that disproportionately favor projects susceptible to corruption and manipulation. consequently, corruption exacerbates government expenditure, leads to wastage, and hampers domestic investment. additionally, d’agostino, dunne, and pieroni (2016) argue that corruption impedes economic growth by fostering increased military and unproductive expenditure. the relationship between corruption, democracy, and economic growth is complex and interconnected. corruption, which involves the misuse of power for personal gain, can undermine democratic institutions and diminish public trust in government. when corruption is prevalent, citizens may become disillusioned and politically apathetic, leading to weakened democratic practices. democracy plays a vital role in combating corruption by promoting transparency, accountability, and citizen participation (friedman, 1962). in a healthy democratic system, voters can hold leaders accountable, which serves as a deterrent to corrupt behavior. strong institutions, such as an independent judiciary and anti-corruption bodies, are essential for investigating and addressing corrupt practices, fostering a culture of integrity. corruption can significantly hinder economic growth by creating inefficiencies and discouraging investment. when businesses must navigate bribery and corrupt practices, economic competitiveness suffers, and public funds that could be used for vital services are misallocated. this can lead to stagnation or a decline in economic performance. conversely, economic growth can strengthen democracy by fostering a more engaged and demanding middle class. however, if growth benefits only a small elite, it can exacerbate inequality and fuel corruption, undermining democratic values. thus, inclusive and equitable economic development is crucial for supporting democratic governance. 2. literature review endogenous growth models posit that growth factors, institutions, and policies significantly influence economic expansion, with public goods serving as one of the key fiscal policies that affect resource allocation, private sector regulation, and public sector growth (nguyen & bui, 2022). modernization theory suggests that the processes of economic, democratic, and political development in contemporary societies can lead to economic inequality, gender disparities, political instability, and corruption. corruption is often viewed as a means of leveraging public power for private gain (huntington, 1968). while various theories acknowledge the issue of corruption, they differ in their explanations of its causes and effects on growth and the economy. moreover, the "wheel hypothesis" of corruption argues that it can sometimes be beneficial by "greasing the wheels" of the economy, thereby enhancing efficiency, particularly in poorer nations with weak institutional frameworks (kato & sato, 2015). conversely, the alternative hypothesis indicates that corruption can diminish expenditure efficiency and detrimentally impact economic performance, effectively "sanding the wheels" of the economy (dzhumashev, 2014; nguyen & bui, 2022). according to friedman (1962) in his "capitalism and freedom" hypothesis, the interplay between political and economic freedoms is intertwined, and the impact of democracy on economic growth is contingent upon the quality of economic institutions (friedman, 1962). corruption can be linked to the political environment. authoritarian regimes may foster corruption as a means of consolidating power, while democratic systems may struggle with corruption due to competing interests and the challenge of accountability. 3. material and methods the study utilizes time series data from kenya spanning the years 1990 to 2020. data on gdp per capita growth (gdp), expressed as annual percentages; gross capital formation (gcf); final government consumption as a proxy for government expenditure (ge); along with consumer prices (as annual percentages) representing the inflation rate (cpi), were sourced from the world development indicators (world bank, 2025). in contrast, data on control of corruption (ccr) and democracy (dem) were obtained from the worldwide governance indicators (kaufmann & kraay, 2024) and machine learning (ml) democracy indices. these democracy indicators are scaled from 0 to 1, asian journal of economics and empirical research, 2025, 12(1): 74-78 76 © 2025 by the author; licensee asian online journal publishing group where the values indicate weak to strong democratic performance, respectively. the control of corruption rankings range from -2.50 for weak to 2.50 for strong. below is table 1 for all target variables where data are available. table 1. description of variables. variable description data source expected sign control of corruption (ccr) corruption control index wdi positive nguyen and bui (2022) democracy (dem) machines learning democracy index ml positive krieger (2022) government expenditure (ge) general government final consumption expenditure (% of gdp) wdi positive ghose and das (2013) investments (gcf) gross capital formation (% of gdp) wdi positive iliyasu and muhammed (2023) inflation (cpi) consumer prices index (%) wdi negative nguyen and bui (2022) economic growth (gdp) gdp per capita growth (%) wdi dependent variable the foundational framework for growth regression analysis was derived from the seminal works of barro and sala-i-martin (1995) on growth theories. their equation posits that economic factors exert influence over human and physical capital through enhancements in stock, technological advancement, and ultimately, economic growth. conversely, certain factors may diminish investment incentives, foster inefficiency, and induce market failures, thereby decelerating growth (iliyasu & muhammed, 2023). in alignment with the empirical findings of nguyen and bui (2022) and iliyasu and muhammed (2023), this study adapted the growth model to formulate growth equation 1, aimed at analyzing the impacts of corruption and democracy factors on economic growth within the context of kenya. to analyze the effect of democracy and corruption on economic growth, the following model is used for this study. 𝐺𝐷𝑃 = 𝑓( 𝐶𝐶𝑅, 𝐷𝐸𝑀, 𝐺𝐸, 𝐶𝑃𝐼, 𝐺𝐶𝐹 ) (1) the above model is written in the following general growth equation. 𝐺𝐷𝑃𝑡 = 𝛿0 + 𝛿1𝐶𝐶𝑅𝑡 + 𝛿2𝐷𝐸𝑀𝑡 + 𝛿3𝐺𝐸𝑡 + 𝛿4𝐶𝑃𝐼𝑡 + 𝛿5𝐺𝐶𝐹𝑡 + 휀𝑡 (2) in the above equation, δ,s are the coefficients, t indicates time dimension, and ε show error term. this study uses the generalized method of moments (gmm) estimation technique, as established by arellano and bond (1991), to explore the relationship between explanatory variables and economic growth, as shown in equation 2. prior research, including works by cieślik and goczek (2018), hajamini and falahi (2018), and nguyen and bui (2022), has successfully applied gmm for this purpose. gmm effectively addresses endogeneity issues by treating independent variables as endogenous when correlated with error terms. it also accommodates heteroscedasticity, avoids normality assumptions, and can estimate models not derivable from first-order conditions (ergün & göksu, 2013). the estimation incorporates a matrix of instrumental variables correlated with endogenous variables but uncorrelated with model errors. to validate the gmm estimates, diagnostic tests like the hansen and normality tests will be performed, along with j-tests to confirm the exclusion of certain instruments (hansen & west, 2002). finally, a stationarity test using phillips-perron (pp) unit root tests will ensure that all variables are of the same order before proceeding with the regression analysis. 4. results and discussion the study examined the properties of the time series data of the sample size using the phillips-perron (pp) unit root test. the results of the stationarity test are presented in table 2. table 2. unit root test results. variables level first difference decision adjusted t prob. adjusted t prob. gdp 0.74 0.99 -7.77 0.00 i (1) ge -1.97 0.29 -4.87 0.00 i (1) ccr -2.16 0.22 -5.37 0.00 i (1) dem -4.80 0.00 i (0) cpi -2.79 0.07 -12.14 0.00 i (1) gcf -2.97 0.04 -6.59 0.00 i (1) note: null hypothesis: the variable has a unit root. according to the findings in table 2, all variables exhibit a unit root, except for democracy, both significant at the 1% level. however, the five variables achieved stationarity after first differencing, indicating a mixed series of i(0) and i(1). given the extensive duration (t) of the study, the unit root test was crucial in confirming the stationarity of all variables before the generalized method of moments (gmm) estimation. table 3. gmm results. variable coefficient standard error t-statistics p-value ccr 0.828 0.284 2.915*** 0.007 dem 5.405 0.376 14.350*** 0.000 ge 0.196 0.006 29.995*** 0.000 gcf -0.010 0.005 -1.892* 0.070 cpi 0.001 0.001 1.042 0.307 diagnostic durbin-watson test = 2.014 adjusted r2 = 0. 653 hansen test = 2.116 pvalue = 0.145 jarque-bera test= 1.199 p-value = 0.548 note: * p < 0.1, *** p < 0.01 are significance levels, in which the null hypothesis is rejected. asian journal of economics and empirical research, 2025, 12(1): 74-78 77 © 2025 by the author; licensee asian online journal publishing group the study conducted a generalized method of moments (gmm) regression analysis to define the relationship between economic growth and explanatory variables. table 3 shows regression results using the gmm approach. the examination of the interplay between democracy and economic growth reveals a pronounced positive correlation. specifically, empirical evidence suggests that a 1 per cent increase in democratic governance correlates with an approximate increase of 5.405 per cent in economic growth. prior research conducted by sakyi and adams (2012) and tutuncu and bayraktar (2024) has posited that democratic institutions significantly contribute to economic advancement. baum and lake (2003) elucidate this relationship by highlighting that democracy exerts a favorable influence on economic growth through mechanisms such as enhanced political stability, greater personal freedoms, and increased investments in health and education, which in turn elevate life expectancy. the literature on economics supports the assertion that democracy enhances the overall quality of economic institutions, as articulated by olson (1991). higher-quality institutions facilitate more efficient government expenditure, which is often linked to improved economic performance. in their study focused on ghana, sakyi and adams (2012) found that democracy catalyzes economic growth through productive expenditure and complementary reforms such as macroeconomic stability and adherence to the rule of law. furthermore, the control of corruption has been empirically demonstrated to exert a positive influence on economic growth within the kenyan context, with statistically significant results identified at the 1 per cent level. specifically, a 1 per cent improvement in corruption control is associated with an approximate increase of 0.828 per cent in economic growth. these findings are consistent with those of iliyasu and muhammed (2023) in nigeria, who contend that corruption impedes economic progress, effectively acting as "sand in the wheels" of development. conversely, d’agostino et al. (2016) suggest that corruption can be detrimental to economic growth by resulting in elevated military expenditures. additionally, the phenomenon of corruption is often associated with the inefficient allocation of resources, the proliferation of a shadow economy, and suboptimal human capital development, as noted by kato and sato (2015). however, this perspective differs starkly in the kenyan context, where corruption may operate as a mechanism for "greasing the wheels" of economic activity, thereby enhancing governmental efficiency. nguyen and bui (2022) further argue that under certain conditions of improved governmental management, corruption can stimulate economic growth. additionally, kato and sato (2015) assert that corruption may facilitate more efficient economic operations, particularly in developing nations characterized by fragile institutional frameworks. the regression analyses reveal a significant positive relationship between government expenditure and economic growth in kenya, with a 1 percent increase in government spending leading to an approximate 0.196 percent rise in economic growth. this supports the keynesian and endogenous growth theories, which argue that fiscal policy, particularly government spending, enhances economic growth through better resource allocation and increased support for private investments (gisore, 2020). in terms of investment, a significant negative relationship is observed, indicating that a 1 percent increase in gross capital formation leads to a 0.010 percent decline in economic growth. this phenomenon is attributed to high debt levels, the crowding-out effect of investment, elevated interest rates, and inflationary uncertainties, which collectively hinder private and public sector capital development (iliyasu & muhammed, 2023). in certain contexts, especially in low-income countries, there might be negative impacts of gross capital formation on specific sectors such as manufacturing or private investment (fumey, mose, & provide, 2024). conversely, ghose and das (2013) and nguyen and bui (2022) found that fixed investment can stimulate growth. lastly, while inflation shows a positive association with economic growth, its impact was not statistically significant during the study period. this suggests inflation uncertainty may dampen private sector confidence and growth, aligning with nguyen and bui (2022). in contrast, iliyasu and muhammed (2023) reported a positive relationship in nigeria, attributing it to increased production output. the coefficient of determination, adjusted r-squared, indicates that 65 percent of the variation in the dependent variable is explained by the independent variables, demonstrating a strong fit of the data to the model. additionally, a durbin-watson value of 2.014 confirms that the error term is free from serial correlation, suggesting that autocorrelation is not a concern. j-tests, or hansen tests, were conducted to assess the validity of the instruments. the hansen j statistic showed a p-value greater than 0.05, which indicates that the study cannot reject the null hypothesis that the instruments are correctly excluded. this finding supports the conclusion that the instrumental variables are jointly valid, thereby allowing for the application of the gmm estimation technique. 5. conclusion the relationship between democracy, corruption, and economic growth is complex and significant in kenya. democracies tend to promote accountability and political stability, creating an environment conducive to economic growth by upholding the rule of law and property rights, which encourage investment. conversely, corruption can severely hinder economic progress by misallocating resources and creating inefficiencies, diverting funds from essential public services and eroding public trust in institutions. this disillusionment can lead to decreased civic participation and weaken democratic governance. while authoritarian regimes might achieve short-term growth, they often foster an environment ripe for corruption and undermine long-term stability. ultimately, promoting good governance and transparency is essential for sustainable economic development, as strong democratic institutions can help mitigate corruption and enhance growth potential. to mitigate corruption effectively, a comprehensive approach is necessary. strengthening independent institutions such as kenya's anti-corruption agencies is crucial for promoting accountability. enhancing transparency in government operations through open budgeting and public procurement processes can deter corrupt practices. establishing strong protections for whistleblowers encourages reporting without fear of retaliation, fostering a culture of accountability. additionally, promoting civic engagement allows citizens to hold officials accountable, while rigorous enforcement of anti-corruption laws ensures proper investigation and prosecution without political interference. ethical training for public officials and leveraging technology for oversight can further reduce corruption risks. finally, international cooperation in sharing best practices strengthens global efforts against corruption. by implementing these strategies, governments can create a more transparent and accountable system, significantly reduce corruption, and promote sustainable development. asian journal of economics and empirical research, 2025, 12(1): 74-78 78 © 2025 by the author; licensee asian online journal publishing group promoting democracy involves key strategies focused on political participation, accountability, and civil liberties. strengthening democratic institutions such as independent electoral commissions and judiciary systems is essential for fair elections and the rule of law. educating citizens about their rights empowers active political participation and civic responsibility. supporting free and independent media fosters information dissemination and public debate, while protecting 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(2025). world development indicators. retrieved from https://databank.worldbank.org/source/world-development-indicators asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.1111/1540-5907.00023 https://doi.org/10.1016/j.worlddev.2017.10.028 https://doi.org/10.1016/j.worlddev.2016.03.011 https://doi.org/10.1016/j.econmod.2013.11.007 https://doi.org/10.2478/fiqf-2024-0017 https://doi.org/10.1016/j.eap.2017.12.002 https://doi.org/10.1111/j.1467-9361.2011.00621.x https://doi.org/10.20448/ajeer.v10i1.4406 https://doi.org/10.1080/02255189.2015.1026312 https://www.govindicators.org/ https://doi.org/10.1007/s11127-022-00990-6 https://doi.org/10.7176/jesd/12-18-02 https://doi.org/10.1016/j.qref.2019.02.001 https://doi.org/10.1023/a:1026112530744 https://doi.org/10.1177/097380101200600303 https://doi.org/10.1007/s10644-024-09726-6 https://databank.worldbank.org/source/world-development-indicators 52 © 2025 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 12, no. 1, 52-64, 2025 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v12i1.6826 © 2025 by the authors; licensee asian online journal publishing group the impact of urban business environment on the agglomeration of high-skilled labor jiawei liang1 di yang2 le bo3 ( corresponding author) 1,2,3yanshan college, shandong university of finance and economics, jinan city, shandong province, china. 1email: liangjiawei_ljw@163.com 2email: yd202310@163.com 3email: bole123@outlook.com abstract in the era of technology-driven global economic transition, optimizing high-level labor agglomeration is crucial for economic growth as high-skilled workers prioritize urban business environments over housing prices and wages. leveraging panel data from 280 chinese cities spanning 2009-2021, this study delves into the impact of the urban business environment on highskilled labor agglomeration. specifically, the entropy weight method is employed to measure business environment indicators, and the location quotient is used to measure the level of highskilled labor agglomeration. employing two-way fixed effect, mediating effect, and threshold effect models, we find that improving the urban business environment significantly boosts highskilled labor agglomeration, partially through enhanced urban innovation. however, the impact of the business environment on high-skilled labor agglomeration is constrained by the average wage level. if the average wage level is too low, the optimization of the urban business environment will impede the agglomeration of high-skilled labor. our findings emphasize the importance of a favorable business environment and reasonable wage policies in attracting talent for sustainable economic development. keywords: high-skilled labor agglomeration, urban business environment, entropy weight method, location quotient, threshold effect, mediating effect. jel classification: r30. citation | liang, j., yang, d., & bo, l. (2025). the impact of urban business environment on the agglomeration of high-skilled labor. asian journal of economics and empirical research, 12(1), 52–64. 10.20448/ajeer.v12i1.6826 history: received: 1 may 2025 revised: 6 june 2025 accepted: 17 june 2025 published: 25 june 2025 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. competing interests: the authors declare that they have no competing interests. authors’ contributions: all authors contributed equally to the conception and design of the study. all authors have read and agreed to the published version of the manuscript. contents 1. introduction ...................................................................................................................................................................................... 53 2. theoretical background and hypotheses ................................................................................................................................... 54 3. methodology and data ................................................................................................................................................................... 56 4. results and discussion ................................................................................................................................................................... 59 5. conclusions and recommendations ............................................................................................................................................. 63 references .............................................................................................................................................................................................. 64 mailto:liangjiawei_ljw@163.com mailto:yd202310@163.com mailto:bole123@outlook.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v12i1.6826 https://orcid.org/0009-0008-3404-4542 https://orcid.org/0009-0002-7793-5085 https://orcid.org/0009-0005-6013-3125 asian journal of economics and empirical research, 2025, 12(1): 52-64 53 © 2025 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study innovatively explores how the urban business environment affects high-skilled labor agglomeration. by introducing the mediating mechanism of urban innovation and the threshold effect of wage levels, it reveals the internal relationship between the optimization of the business environment and talent spatial allocation, providing new perspectives for optimization of the business environment and the spatial allocation of talents, and formulating effective highskilled labor attraction policies. 1. introduction amid the technology-driven transformation that increasingly characterizes both domestic and global economies, intergovernmental competition has shifted beyond simplistic unidimensional contests. cities are now motivated to comprehensively optimize their business environments, which encompass technological innovation ecosystems, market dynamics, legal frameworks, and financial infrastructures. meanwhile, as technological progress displays an escalating skill bias, the skill premium for high-skilled labor has risen significantly. the agglomeration of high-skilled workers not only strengthens the technological innovation capacity of clustered regions but also fuels high-quality economic development (wang, xue, chang, & xie, 2020) thereby emerging as a crucial determinant for regional economic growth in the new economic paradigms (kerr & lincoln, 2010). empirical evidence highlights that urban business environments play a pivotal role in regional economic development (fan, liu, & wang, 2024). as technological competition intensifies to become the "main battlefield" of economic rivalry, the link between urban business environment enhancements and high-skilled labor agglomeration has grown increasingly interdependent. investigating how the urban business environments impact high-skilled labor can empower governments to uncover new growth drivers in this evolving economic landscape. it holds significant importance for boosting urban innovation capabilities, identifying latent economic drivers, and promoting high-quality development. to value the quality of business environments across diverse regions, the world bank established a global evaluation framework by measuring the distance of doing business index. existing studies have investigated various factors, including deregulation (djankov, mcliesh, & ramalho, 2006) government policies and human capital (wach, 2008) entrepreneurial activity (klapper, lewin, & delgado, 2011) innovation ecosystems (prajogo, 2016) and tax reduction policies (lockwood & rohlin, 2013). the literature consistently demonstrates that improving the business environment can significantly boost socio-economic development by stimulating regional economic activities and creating new growth opportunities. notably, enhanced business environments are strongly associated with increased domestic private investment-a key economic driver, as domestic investments generally surpass foreign direct investments in most nations (world bank, 2004). moreover, variations in business environments influence corporate credit allocation patterns (augier, dovis, & gasiorek, 2012). the spatial distribution of population has long been a key focus in the field of geography. prior research on the migration and distribution patterns of highly skilled labor reveals that their mobility is shaped not only by regional economic disparities but also by multifaceted factors such as wage levels, the quality of public service (qian, 2010) and administrative policies (liu & shen, 2014). as societal values and lifestyle preferences evolve, the concept of quality of life has gained increasing prominence, elevating regional amenities to a critical determinant in the location choices of high-skilled workers (davies, greenwood, & li, 2001; glaeser & gottlieb, 2006; partridge, 2010). most existing literature predominantly analyzes the agglomeration effects of highly skilled labor from isolated dimensions, rarely examining the direct influence of urban business environments on their concentration. in the context of neo-classical migration theory, wage levels are posited as the core determinant of labor mobility (haas & osland, 2014) driving high-skilled labor to cluster in cities offering higher remuneration and rental opportunities. such agglomeration substantially elevates local productivity (zhang, 2023) especially in urban areas with a dense presence of foreign enterprises, where significant wage premiums are prevalent (setzler & tintelnot, 2021). from an infrastructure perspective, research demonstrates that enhanced transportation accessibility (e.g., high-speed rail networks) can significantly facilitate the mobility of high-skilled labor and expand market size, with spatially heterogeneous effects (feng, chen, cheng, & chang, 2023). concerning policy and environmental factors, stringent environmental regulations have counterintuitively spurred high-skilled employment growth, while government counterintuitively spurred high-skilled employment growth (choudhury, 2022; wang et al., 2020). additionally, although not directly centered on talent agglomeration, some studies reveal the fundamental role of business environments in shaping economic development quality and pace (li, tang, & huang, 2023). existing research on business environments predominantly examines their effects on corporate location decisions, foreign direct investment, and firm innovation. although some researchers have explored the influence of factors such as industrial agglomeration, housing prices, or pandemic conditions that affect high-skilled labor, these studies typically adopt a unidimensional approach, concentrating on a single determinant in isolation. notably, the critical question of how urban business environments shape the agglomeration of high-skilled labor and the associated causal mechanisms remains under-researched. this gap highlights the need for a more comprehensive investigation into the intricate relationship between business environments and talent concentration, which could offer valuable insights for policymakers aiming to foster regional economic development through strategic talent attraction. therefore, we make the following key contributions. first, we integrate urban business environments and high-skilled labor agglomeration into a cohesive analytical framework, systematically exploring both the direct and indirect impacts of business environments on talent concentration. this approach uncovers the complex mechanisms underlying the relationship, providing a more comprehensive understanding compared to previous unidimensional analyses. second, departing from the conventional use of provincial-level data, this research leverages prefecture-level city data to construct a comprehensive urban business environment index system. the system encompasses six dimensions: government efficiency, human resources, financial services, innovation climate, infrastructure, and market conditions. additionally, we measure high-skilled labor agglomeration by aggregating asian journal of economics and empirical research, 2025, 12(1): 52-64 54 © 2025 by the authors; licensee asian online journal publishing group employment in finance, information technology, scientific research and technical services, and education sectors, offering a more precise and detailed representation of talent distribution. third, this study innovatively incorporates urban innovation capacity as a mediating variable in the analysis of the influence of urban business environments on high-skilled labor agglomeration. simultaneously, average wage levels are employed as a threshold variable to test for nonlinear effects, revealing how the impact of business environments may vary depending on wage conditions. overall, we provide novel theoretical perspectives, offering substantial academic and practical implications for understanding the interplay between urban business environments and high-skilled labor dynamics. the rest of the paper is structured as follows: chapter 2 presents a related literature review. chapter 3 describes the methodology and data employed in the study. chapter 4 presents the empirical results and discussions, and chapter 5 concludes. 2. theoretical background and hypotheses this chapter first introduces key concepts related to business environments and high-skilled labor agglomeration. building on this foundation, it examines how urban business environments affect this agglomeration and explores the underlying mechanisms. 2.1. related concepts 2.1.1. high-skilled labor agglomeration educational attainment has long been the standard metric for defining talent (skeldon, 2009). however, recent publications in nature and pnas have highlighted critical limitations of this approach: first, the broad categorization by educational credentials fails to account for intrinsic regional disparities in knowledge-skill cultivation (angrist, djankov, goldberg, & patrinos, 2021). second, it excludes middle-aged and older workers who lack higher education but are essential to industries (lutz et al., 2021). florida (2002) earlier critiqued this approach as oversimplistic, proposing instead the "creative class" framework-workers in knowledge-intensive or creative occupations. post-2000, occupation-based talent research has grown significantly (florida, mellander, & stolarick, 2008; rao & dai, 2017). in china, higher education expansion has led to an oversupply of highly educated labor, which exceeds the demand from knowledge-intensive industries in some regions (yeung, 2013). this mismatch inflates human capital stock estimates and results in underutilization, diminishing the value of educational credentials. consequently, occupational classification may better identify talent in china. nevertheless, domestic migration studies predominantly retain education-based definitions for distinguishing high-skilled from general-skilled labor (gu & shen, 2021; shen & liu, 2016). from the perspective of agglomeration itself, it refers to the concentration of entities within a specific geographic area-a phenomenon that stands in contrast to dispersion. high-skilled labor agglomeration is unique due to worker agency: skilled workers relocate based on economic conditions, infrastructure, geographic factors, and other variables, forming clusters with spatial directionality. a defining feature of labor agglomeration is its tendency to concentrate in certain regions, exhibiting what we describe as spatial directionality. theories in labor economics emphasize that high-skilled labor agglomeration is not an isolated phenomenon. on one hand, its drivers are multifaceted and complex; on the other, once formed, it generates a range of spillover effects. when measuring the extent of highly skilled labor agglomeration, it is essential to consider not only its spatial scope but also its scale, which reflects the abundance of skilled labor resources in each region. based on the above definitions and conceptual boundaries, this study considers "high-skilled labor" as highquality workers with the following characteristics: possessing necessary theoretical knowledge and innovation capabilities, mastering modern equipment, performing complex or key operations in production beyond entry-level and intermediate-skilled workers. specifically, this study defines high-skilled labor from the perspective of occupational types, using practitioners in the financial industry; information transmission, computer services, and software industry; scientific research, technical services, and geological exploration industry; and the education industry to represent high-skilled labor. 2.1.2. urban business environment the business environment, originally conceptualized as part of the worldwide governance indicators, serves as a key metric for evaluating government governance capacity. today, the world bank's enterprise life cyclebased indicator system stands as the most authoritative international framework for assessing business environments. this system defines the business environment as the external conditions that enterprises encounter during their establishment, operation, and termination processes. this definition underscores the direct influence of the business environment on regional enterprise operations and economic development. 2.2. the mechanism of urban business environment on high-skilled labor agglomeration 2.2.1. the direct effect an efficient business environment not only enhances regional economic development but also provides various benefits for high-skilled labor, including competitive wages, welfare benefits, environmental quality, and healthcare standards. consequently, it exerts a direct and substantial influence on the geographical agglomeration of highskilled labor as an economic factor. this study examines the direct effects of the urban business environment on high-skilled labor agglomeration through two primary mechanisms: the agglomeration effects and the cost effects. on one hand, improvements in the urban business environment generate significant agglomeration effects, where scale effects and spillover effects influence high-skilled labor concentration. through the lens of economies of scale theory, our analysis reveals that urban business environment improvements facilitate technological knowledge spillovers and production scale economies. cities with superior business environments provide highskilled workers with more diverse job opportunities that match their skill sets. moreover, business environment optimization creates spillover effects-as both high-skilled labor and firms cluster in regions with improved business environments, reduced geographical distance fosters closer connections among workers. knowledge spillover asian journal of economics and empirical research, 2025, 12(1): 52-64 55 © 2025 by the authors; licensee asian online journal publishing group theory suggests this accelerates the flow of knowledge and technology among workers. scale economy theory further indicates enhanced sharing of knowledge, information, and technology among high-skilled workers within these spaces, promoting the diffusion of new knowledge and technologies. for high-skilled labor, this matching, sharing, and learning process not only increases labor productivity and urban total factor productivity but also generates skill premiums. additionally, in cities with better business environments, less-skilled workers often find it difficult to cope with the high living costs and to survive amid intense competition, resulting in an overall higher skill level compared to cities with poorer business environments. on the other hand, the urban business environment also influences high-skilled labor through cost effects, a critical factor in their locational choices. these costs include not only living expenses but also job search opportunity costs. new economic geography theory demonstrates that densely populated regions with large markets tend to develop industrial clusters, which provide more employment opportunities while driving down commodity prices through competition. lower employment and living costs, in turn, encourage the inflow and agglomeration of high-skilled labor, further reinforcing industrial clustering patterns. over time, this dynamic leads to the formation of a "core-periphery" spatial structure in both industry and labor distribution-a phenomenon consistent with krugman’s theoretical framework. furthermore, according to the "push-pull" theory, improved regional public services enhance local welfare. cities with better business environments typically offer superior public services, infrastructure, and quality of life, thereby creating stronger pull factors for high-skilled labor. the resulting agglomeration generates a talent clustering effect that attracts additional high-skilled workers. however, high-skilled labor also compares living costs against migration costs-when the former exceeds the latter or living costs surpass expectations, outmigration may occur. high-skilled workers weigh both positive and negative externalities before making optimal location decisions. h1: the improvement of the urban business environment positively promotes the agglomeration of high-skilled labor. 2.2.2. the mediating effect the enhancement of urban innovation capacity increases a city's locational potential while generating significant positive externalities and spillover effects, thereby attracting greater inflows of high-skilled labor. within china's government-led development context, urban innovation capacity is substantially influenced by the quality of the local business environment. this study selects urban innovation capacity as a mediating variable to examine the mechanism through which business environments affect high-skilled labor agglomeration from an innovation perspective. 2.2.2.1. impact of urban business environment on urban innovation capacity a city's innovation capacity is significantly shaped by its business environment, particularly government efficiency, innovation climate, financial services, and market conditions. existing studies demonstrate that governance quality directly affects innovation outcomes: decentralizing administrative authority expands local governments' discretionary power, creating rent-seeking opportunities through bureaucratic hurdles in approval processes (gu & shen, 2012). regional innovation disparities often stem from differences in corporate innovation activities, which are influenced by local governance environments, including administrative services, regulatory interventions, and legal protections. cities with poor governance environments suffer from cumbersome approval procedures and low efficiency, which substantially reduce corporate innovation efficiency and impose additional policy burdens that hinder r&d activities. optimizing the business environment reduces administrative interference in corporate behavior, enhances innovation efficiency, and consequently elevates regional innovation capacity. moreover, the innovation climate-a core component of the business environment-encompasses funding support and knowledge infrastructure. a favorable business environment not only provides conducive conditions for innovation but also enhances regional innovation performance. financial services within the business environment further play a decisive role: given the capital-intensive and long-cycle nature of r&d, firms heavily rely on external financing, making regional disparities in financial market conditions a critical determinant of firms' access to funding. thus, business environment-induced financing constraints influence regional innovation levels by shaping corporate r&d activities (chen, hai, & wu, 2015). 2.2.2.2. impact of urban innovation capacity on high-skilled labor agglomeration new economic geography theory suggests that high-skilled labor exhibits a pronounced tendency to agglomerate in cities with advanced innovation capacity, where innovation policies and ecosystems enhance attractiveness. this process operates through two key mechanisms: first, the integration of innovation factors with market and physical capital drives substantial productivity gains, which in turn attract inflows of high-skilled labor. elevated urban innovation capacity strengthens locational advantages, directly facilitates high-skilled labor agglomeration. second, urban innovation generates positive externalities and spillover effects, particularly in industrial clusters. as regional innovation capacity increases, it elevates factor returns (e.g., wages, capital yields), thereby attracting high-skilled labor in conjunction with complementary capital and resources. this convergence strengthens the region's locational competitiveness, while the ensuing agglomeration of these factors produces scale effects. ultimately, this creates a self-reinforcing cycle that perpetually enhances the region's appeal to highskilled workers. h2: the optimization of the urban business environment can attract the agglomeration of high-skilled labor by enhancing urban innovation capacity. 2.2.3. threshold effect neoclassical migration theory establishes labor return rates as a fundamental determinant of migration decisions. complementing this perspective, push-pull theory reveals that workers conduct cost-benefit analyses when considering relocation, where average wage levels serve as the primary indicator of expected benefits. this asian journal of economics and empirical research, 2025, 12(1): 52-64 56 © 2025 by the authors; licensee asian online journal publishing group study selects the average wage level as the threshold variable to analyze the nonlinear relationship between urban business environments and high-skilled labor agglomeration, based on two underlying mechanisms. first, while business environment optimization typically raises living costs, when such increases substantially outpace wage growth, high-skilled labor demonstrates a stronger propensity to migrate toward regions combining higher wages with lower living expenses. second, improved business environments may incentivize firms to adopt low-cost production models favoring lower-skilled workers. these dynamic pushes high-skilled labor to relocate to urban centers with better career development prospects. consequently, in regions below certain wage thresholds, even significant business environment improvements may fail to offset other constraining factors, ultimately inhibiting rather than promoting high-skilled labor agglomeration. these dual dynamics confirm the existence of distinct threshold effects in the relationship between urban business environments and high-skilled labor concentration based on average wage levels. h3: the process by which urban business environment optimization promotes high-skilled labor agglomeration is constrained by average wage levels. 3. methodology and data 3.1. methodology 3.1.1. location quotient (lq) following the methodology of sun and zhang (2020) we measure high-skilled labor agglomeration using the location quotient (lq). the lq, derived from industrial and regional economics, compares the proportion of a specific sector's output in a regional economy to its proportion in the national economy (in equation 1). 𝐿𝑄𝑖𝑗 = 𝑋𝑖𝑗 ∑ 𝑋𝑖𝑗 𝑚 𝑖=1⁄ ∑ 𝑋𝑖𝑗 𝑛 𝑗=1 ∑ ∑ 𝑋𝑖𝑗 𝑛 𝑗=1 𝑚 𝑖=1⁄ (1) where 𝑖 represents industry categories (𝑖 = 1,2,… ,𝑚) , 𝑗 denotes regions (𝑗 = 1,2, … , 𝑛) . 𝑋 may carry different meanings. here, 𝑋 specifically represents the number of employed persons in four high-skilled sectors: (1) finance; (2) information transmission, computer services, and software; (3) scientific research, technical services, and geological prospecting; (4) education. we use this measure to quantify high-skilled labor agglomeration. 3.1.2. entropy weight method to establish an evaluation index for urban business environments, the first step is to determine the weights of each indicator. existing multi-factor comprehensive evaluation weighting methods mainly fall into three categories: subjective weighting, objective weighting, and integrated subjective-objective weighting methods. given that subjective weighting methods tend to be overly arbitrary, and considering that existing literature suggests urban business environment indicator systems should strive for maximum objectivity and fairness, this study adopts the entropy method from objective weighting approaches to determine the weights of secondary indicators in the urban business environment evaluation system. this ensures the indicator weights remain free from subjective bias. assume there are 𝑛 samples and 𝑚 evaluation indicators, the sample observation matrix is shown in equation 2. 𝑋 = [ 𝑥11 𝑥12 𝑥21 𝑥22 ⋯ 𝑥1𝑚 ⋯ 𝑥2𝑚 ⋮ ⋮ 𝑥𝑛1 𝑥𝑛2 ⋮ ⋮ ⋯ 𝑥𝑛𝑚 ] (2) for a given indicator 𝑥𝑖𝑗 , its weight increases with greater dispersion of values; if an indicator's values show no variation (i.e., complete uniformity), it becomes statistically irrelevant to the system and receives zero weight. the calculation steps of the entropy weight method are as follows. (1) the urban business environment data require standardization before analysis. since the indicators in the evaluation system differ in both units of measurement and magnitude, standardization is necessary to enable crossindicator comparison. moreover, distinct standardization methods must be applied to positive and negative indicators based on their directional relationship with business environment quality. for indicators that are positively correlated with business environment development levels (positive indicators), the standardization is calculated: 𝑥𝑖𝑗 ∗ = 𝑥𝑖𝑗−min{𝑥𝑖𝑗} 𝑚𝑎𝑥{𝑥𝑖𝑗}−min⁡{𝑥𝑖𝑗} . for indicators that are negatively correlated with business environment development levels (negative indicators), the standardization is calculated: 𝑥𝑖𝑗 ∗ = max{𝑥𝑖𝑗}−𝑥𝑖𝑗 𝑚𝑎𝑥{𝑥𝑖𝑗}−min⁡{𝑥𝑖𝑗} . (2) calculate the proportion of the 𝑗-th indicator value for the 𝑖-th prefecture-level city: 𝑤𝑖𝑗 = 𝑥𝑖𝑗 ∗ ∑ 𝑥𝑖𝑗 ∗𝑛 𝑖=1 . (3) the information entropy 𝑒𝑗 of the 𝑗-th indicator is computed as follows: 𝑒𝑗 = − 1 𝑙𝑛(𝑛) ∑ 𝑤𝑖𝑗 ∗ 𝑙𝑛(𝑤𝑖𝑗) 𝑛 𝑖=1 , 0 ≤ 𝑒𝑗 ≤ 1. (4) the corresponding redundancy degree 𝑑𝑗 is computed as: 𝑑𝑗 = 1 − 𝑒𝑗. (5) the corresponding weight 𝑤𝑗 is computed as: 𝑤𝑗 = 𝑑𝑗 ∑ 𝑑𝑗 𝑚 𝑗=1 . (6) calculate the total urban business environment score of each city: 𝑠𝑗 = ∑ 𝑤𝑗 ∗ 𝑥𝑖𝑗 ∗𝑚 𝑖=1 . 3.1.3. two-way fixed effect model to test h1, we employ a two-way fixed effects model to examine the impact of urban business environments on high-skilled labor agglomeration. the econometric model is specified in equation 3. 𝑆𝑘𝑖𝑙𝑙𝑒𝑑𝑖𝑡 = 𝛽0 + 𝛽1𝐵𝐸𝑖𝑡 + 𝒙𝑖𝑡𝛂 + 𝜇𝑡 + 𝜆𝑖 + 𝜀𝑖𝑡 (3) where 𝑆𝑘𝑖𝑙𝑙𝑒𝑑𝑖𝑡 represents the agglomeration level of high-skilled labor in city 𝑖 during year 𝑡, 𝐵𝐸 denotes the urban business environment, 𝒙𝑖𝑡 denotes the vector of control variables, 𝜇𝑡 and 𝜆𝑖 captures city and time fixed effects, respectively, and 𝜀𝑖𝑡 is the random error term. asian journal of economics and empirical research, 2025, 12(1): 52-64 57 © 2025 by the authors; licensee asian online journal publishing group 3.1.4. mediating effect model to examine the mechanism through which urban business environments affect high-skilled labor agglomeration, we follow jiang’s identification method for mechanism variables (jiang, 2022). using the number of patent applications per 100 people to measure urban innovation capacity, we analyze its mediating role through the following model specification (equation 4). 𝐼𝑛𝑛𝑜𝑖𝑡 = 𝜌0 + 𝜌1𝐵𝐸𝑖𝑡 + 𝒙𝑖𝑡𝛂 + 𝜇𝑡 + 𝜆𝑖 + 𝜀𝑖𝑡 (4) where 𝐼𝑛𝑛𝑜𝑖𝑡 represents the urban innovation level, and 𝜌1 quantifies the impact strength of the urban business environment on innovation capacity. all other variables retain their definitions from the baseline regression model. 3.1.5. threshold effect model to examine the threshold effects of urban business environments on high-skilled labor agglomeration, we conduct a regression analysis using a threshold effects model. following hansen (1999) panel threshold regression framework, the baseline specification is given by equation 5. 𝑦𝑖𝑡 = 𝑢𝑖 + 𝛽1 ′𝑥𝑖𝑡𝐼(𝑞𝑖𝑡 ≤ 𝛾) + 𝛽2 ′𝑥𝑖𝑡𝐼(𝑞𝑖𝑡 > 𝛾) + 𝑒𝑖𝑡 (5) where 𝑞 represents the threshold variable, 𝛾 is the unknown threshold. the 𝑒𝑖𝑡 is the i.i.d. error term, and 𝐼(·) is an indicative function. it takes the value of 1 when the conditions within the parentheses are met; otherwise, it equals 0. equation 5 is equivalent to equation 6. 𝑦𝑖𝑡 = { 𝑢𝑖 + 𝛽1 ′𝑥𝑖𝑡 + 𝑒𝑖𝑡 , 𝑞𝑖𝑡 ≤ 𝛾, 𝑢𝑖 + 𝛽2 ′𝑥𝑖𝑡 + 𝑒𝑖𝑡 , 𝑞𝑖𝑡 > 𝛾. (6) therefore, we specify the threshold effect model as shown in equation 7. 𝑆𝑘𝑖𝑙𝑙𝑒𝑑𝑖𝑡 = 𝛼0 + 𝛼1𝐵𝐸𝑖𝑡 × 𝐼(𝑤𝑎𝑔𝑒𝑖𝑡 ≤ 𝛾) + 𝛼2𝐵𝐸𝑖𝑡 × 𝐼(𝑤𝑎𝑔𝑒𝑖𝑡 > 𝛾) + 𝒙𝑖𝑡𝛂 + 𝜇𝑖 + 𝜆𝑖 + 𝜀𝑖𝑡 (7) where 𝑤𝑎𝑔𝑒 denotes the threshold variable (average wage level). 3.2. data we examine the period 2009–2021 and use 280 prefecture-level cities across china as the primary research units. the analysis employs city-level panel data derived from the china statistical yearbook, the china city statistical yearbook, the local statistical yearbooks of each prefecture-level city, and the national bureau of statistics official website, et al. 3.2.1. dependent variable: the high-skilled labor agglomeration building upon the lq metric, we measure high-skilled labor agglomeration (𝑆𝑘𝑖𝑙𝑙𝑒𝑑) using employment data from four key sectors: (1) finance; (2) information transmission, computer services, and software; (3) scientific research, technical services, and geological prospecting; (4) education. figure 1. spatial distribution pattern of high-skilled labor agglomeration. to more intuitively analyze the spatial distribution characteristics of high-skilled labor agglomeration, we generated visualizations of the agglomeration patterns for 2009, 2013, 2017, and 2021 using arcgis software, as shown in figure 1. it reveals two significant spatial-temporal characteristics. the observed trends reveal a notable convergence in high-skilled labor agglomeration patterns, characterized by decreasing maximum values and increasing minimum values across regions. this convergence indicates a gradual reduction in spatial polarization (depolarization effect), suggesting a more balanced geographical distribution of skilled human capital. simultaneously, persistent regional disparities remain evident, with asian journal of economics and empirical research, 2025, 12(1): 52-64 58 © 2025 by the authors; licensee asian online journal publishing group significantly larger agglomeration gaps between the economically advanced eastern coastal regions (east china and south china) and the northeastern provinces, compared to relatively smaller differentials observed between the northwestern and southwestern interior regions. 3.2.2. independent variable: urban business environment we constructed a comprehensive evaluation system for assessing urban business environments across six key dimensions, establishing both primary and secondary indicators with carefully determined weights to develop china's business environment evaluation framework at the prefecture-level city scale. in developing this analytical approach, we first classified the nature of all indicators, specifically identifying industrial wastewater emissions as a negative indicator while designating all others as positive indicators. the weighting scheme for these evaluation metrics was then systematically derived through application of the entropy method, an objective technique that calculates weights based on the information content and variability within each indicator. this methodology enabled us to construct a robust quantitative assessment system, with the complete structure and corresponding weights of our business environment indicators presented in detail in table 1. the analytical process included normalization of all indicators and incorporated rigorous validation procedures to ensure methodological reliability. table 1. the urban business environment indicator system. primary indicator secondary indicator indicator attributes weight government efficiency (19.84%) general budgetary expenditure + 3.37% government service efficiency + 16.47% human resources (9.73%) average wage + 0.57% faculty count in higher education + 5.39% year-end institutional employment + 3.77% financial services (18.01%) financial sector employment + 3.94% year-end deposit balance of financial institutions + 5.81% pension insurance enrollees + 3.73% unemployment insurance participants + 4.53% innovation environment (13.74%) science and technology expenditure + 7.91% number of regular higher education institutions + 5.82% urban innovation capacity + 0.01% infrastructure (15.37%) water supply capacity + 4.71% power supply capacity + 3.51% practicing physicians + 2.19% postal and telecom services volume + 4.62% industrial wastewater discharge 0.34% market environment (23.31%) gdp per capita + 1.07% industrial output of foreign-funded enterprises + 9.09% total import and export value + 9.98% above-scale industrial enterprises + 3.17% the weight distribution analysis in table 1 reveals that among the primary indicators, market environment carries the highest weight at 23.31%, followed by government efficiency (19.84%), financial services (18.01%), infrastructure (15.37%), innovation environment (13.74%), and human resources (9.73%). collectively, market environment, government efficiency, and financial services account for 61.16% of the total weighting, indicating these dimensions exhibit substantial inter-city variation and constitute the most significant components of the business environment assessment. conversely, the relatively low weight assigned to human resources (9.73%) suggests minimal disparity in this factor across prefecture-level cities, reflecting its limited discriminatory power in differentiating regional business environments. an analysis of the secondary indicators reveals that government service efficiency carries the highest weight at 16.47%, followed by total import and export value at 9.98%. in contrast, industrial wastewater discharge and urban innovation capacity indicators show minimal weighting below 1% (0.34% and 0.01%, respectively). this distribution pattern reflects significant structural characteristics of china's urban development landscape. the substantial weight assigned to government service efficiency and external trade indicators stems from the pronounced developmental disparities between tier-1/new tier-1 cities and other urban centers. these privileged cities benefit from distinct policy advantages and advanced high-tech industrial bases, creating marked inter-city variations. conversely, the negligible weights of environmental and innovation capacity indicators suggest these factors exhibit limited differentiation across prefecture-level cities, consequently exerting marginal influence on overall business environment assessments. 3.2.3. control variables to mitigate estimation bias caused by omitted variables, this study incorporates additional control variables that may influence high-skilled labor agglomeration alongside the core explanatory variable of urban business environment in the regression models. 3.2.3.1. foreign direct investment (fdi) the scale of actual utilized foreign capital reflects a region's investment attractiveness and economic vitality. robust foreign direct investment inflows stimulate local economic dynamism through capital infusion and technology spillovers, subsequently influencing the agglomeration patterns of high-skilled labor. this aligns with the "investment-led development" paradigm observed in china's special economic zones. asian journal of economics and empirical research, 2025, 12(1): 52-64 59 © 2025 by the authors; licensee asian online journal publishing group 3.2.3.2. industrial structure advancement (indus) this metric captures the transition toward technology-intensive and high-value-added production sectors. the progression of industrial sophistication enhances regional competitiveness through productivity gains and innovation capacity building, creating magnet effects for talent migration. our measurement follows the oecd's sectoral upgrading framework, adapted to china's development context. 3.2.3.3. market vitality (igp) represented by fixed-asset investment intensity, this indicator proxies regional economic robustness and growth potential. the construction and operation of capital-intensive projects generate skilled employment opportunities and supporting service ecosystems, thereby attracting human capital inflows. this relationship demonstrates the "investment-employment multiplier" effect. 3.2.3.4. per capita so₂ emissions (𝑆𝑂2) as an environmental quality proxy, this control variable accounts for skilled workers' locational preferences regarding living conditions. elevated emissions correlate with negative externalities that deter talent retention, particularly among environmentally conscious professionals. the inverse relationship echoes the "green migration" phenomenon observed in developed economies. 3.2.4. threshold variables this study uses the city's average wage level (wage) as the threshold variable to examine the differential effects of urban business environment on high-skilled labor agglomeration when the average wage is above versus below the threshold value. the variable selection and measurement methods employed in this study are summarized in table 2. table 2. variable selection and measurement. variable type symbol variable calculation dependent variable 𝑆𝑘𝑖𝑙𝑙𝑒𝑑 high-skilled labor agglomeration location quotient of highly skilled labor independent variable 𝐵𝐸 urban business environment urban business environment index control variable 𝑓𝑑𝑖 foreign direct investment actual utilized fdi/ gdp 𝑖𝑛𝑑𝑢𝑠 industrial structure advancement tertiary/ secondary industry output 𝑖𝑔𝑝 market vitality total fixed asset investment/ gdp 𝑆𝑂2 per capita so₂ emissions so2 emissions/ resident population wage regional average wage level average wage 4. results and discussion before conducting the empirical analysis, fundamental statistical tests must be performed (as shown in table 3), including multicollinearity and hausman tests. initially, the variance inflation factor (vif) was employed to diagnose multicollinearity among the variables. the results demonstrated that all vif values remained below the critical threshold of 10, signifying the absence of severe multicollinearity problems. subsequently, the hausman test was conducted to determine whether to use fixed effects or random effects models. since the null hypothesis was rejected, the fixed effects model was selected for empirical research. table 3. the fundamental statistical tests. variable vif 1/vif urban business environment 1.17 0.858 foreign direct investment 1.14 0.878 industrial structure advancement 1.09 0.915 market vitality 1.07 0.932 per capita so₂ emissions 1.06 0.939 mean vif 1.11 — hausman test fe re chi2(5) = 18.1 prob > chi2 = 0.0029 4.1. baseline regression results the baseline regression model is constructed according to equation 3. we use a fixed effects model to examine the impact of urban business environment on the agglomeration of high-skilled labor, adding control variables one by one in the regression. a two-way fixed effects model with both city and time fixed effects is adopted to minimize the interference of unobservable factors on the estimation results. the empirical findings are presented in table 4. as illustrated in table 4, column (1), which omits control variables, reports a statistically significant coefficient of 0.151 for the impact of the urban business environment on high-skilled labor agglomeration. in columns (2)-(5), control variables are systematically introduced through stepwise regression, with the final specification showing a remarkably stable coefficient of 0.152. the consistent statistical significance and coefficient stability across specifications strongly validate the robustness of our findings, indicating that high-skilled workers are strongly attracted to regions with favorable business environments. the gradual improvement in model fit, as evidenced by the increasing r-squared values from columns (1)-(5), suggests enhanced explanatory power with each additional control variable. the results confirm that high-quality business environments facilitate high-skilled labor agglomeration through two primary mechanisms. first, agglomeration effects trigger substantial knowledge and asian journal of economics and empirical research, 2025, 12(1): 52-64 60 © 2025 by the authors; licensee asian online journal publishing group technology spillovers, creating self-reinforcing cycles of increasing returns to scale and positive externalities that amplify the concentration of skilled workers. second, cost-reduction effects materialize through streamlined administrative processes and efficient government services, which not only significantly lower financial and nonfinancial costs for high-skilled labor but also enhance their quality of life. furthermore, improved business environments drive regional industrial upgrading and technological innovation, expanding employment opportunities and optimizing working conditions for skilled professionals. this dual mechanism-combining agglomeration economies with transaction cost reduction-establishes a virtuous cycle that sustains and intensifies the spatial concentration of human capital in business-friendly regions. table 4. baseline regression results. variable (1) (2) (3) (4) (5) skilled skilled skilled skilled skilled be 0.151*** 0.158*** 0.157*** 0.151*** 0.152*** (0.051) (0.051) (0.051) (0.051) (0.051) fdi 1.480*** 1.535*** 1.684*** 1.642*** (0.549) (0.549) (0.557) (0.559) indus 0.066*** 0.059** 0.057** (0.025) (0.026) (0.026) igp 0.009 0.010* (0.006) (0.006) 𝑆𝑂2 0.476 (0.530) observations 3640 3640 3640 3640 3640 yearfix yes yes yes yes yes idfix yes yes yes yes yes r-squared 0.388 0.389 0.390 0.391 0.391 note: robust standard errors are in parentheses; *, **, and *** indicate significant at the 10%, 5%, and 1% levels, respectively. the empirical results demonstrate that the urban business environment exerts a statistically significant positive influence on high-skilled labor agglomeration at the 1% significance level, irrespective of the inclusion of control variables, thereby validating h1. this indicates that improvements in the urban business environment can significantly promote high-skilled labor agglomeration. an advanced business environment translates into better public services provided by city governments, along with improved markets, innovation, and financial ecosystems. these conditions offer high-skilled workers enhanced job prospects and living standards, thereby facilitating their professional and personal lives. the coefficient of fdi is significantly positive at the 1% level, showing that an expansion of foreign investment can significantly promote high-skilled labor agglomeration when other variables are held constant. an expansion of foreign investment helps improve urban industrialization levels, increase tax revenue, create jobs, and improve the balance of payments, indicating that the city has high potential for openness and a good investment environment, providing more job options for high-skilled labor while also increasing their income levels. the coefficient for indus is positive and significant at the 1%-5% level, showing that the advancement of industrial structure can substantially drive high-skilled labor agglomeration when other variables are held constant. advancing industrial structure can improve urban production efficiency, promote the development of high-tech enterprises, create more high-skilled jobs, and increase demand for high-skilled labor. moreover, an advanced urban industrial structure elevates residents' living standards, reduces energy consumption and dependence, and to some extent, improves the urban living environment. the positive coefficient of igp reveals that an increase in total fixed asset investment can promote high-skilled labor agglomeration when other variables are held constant. increasing fixed asset investment not only optimizes the urban investment structure but also expands production capacity and residents' living space. increased fixed asset investment in scientific research provides good hardware and software conditions for high-skilled labor agglomeration. notably, the impact of (so2) on high-skilled labor agglomeration is insignificant, indicating that environmental factors either play a minor role or are of lower priority in the agglomeration decisions of high-skilled labor, and thus do not serve as a decisive determinant. 4.2. analysis of mediating effect the regression results in table 5 test the process proposed in h2, which examines how urban business environments promote high-skilled labor agglomeration by influencing urban innovation levels. table 5. mediating effect results. variable (1) (2) inno inno be 1.191*** 1.177*** (0.066) (0.066) fdi -0.720 (0.718) idus 0.069** (0.033) igp 0.007 (0.007) 𝑆𝑂2 -0.487 (0.680) observations 3,640 3,640 yearfix yes yes idifx yes yes r-squared 0.793 0.793 note: **, and *** indicate significant at the 5%, and 1% levels, respectively. asian journal of economics and empirical research, 2025, 12(1): 52-64 61 © 2025 by the authors; licensee asian online journal publishing group as presented in table 5, the ordinary least squares (ols) regression results demonstrate that the coefficient of the urban business environment's impact on the urban innovation level is 1.177, statistically significant at the 1% level. this finding underscores a substantial positive effect of business environment optimization on the enhancement of innovation capacity. an optimal urban business environment provides three key advantages for innovation: robust financial market conditions, streamlined government services, and advanced economic development. collectively, these elements reduce innovation costs, shorten r&d cycles, and optimize talent-driven innovation ecosystems, thereby accelerating urban innovation. previous research has firmly established a positive correlation between urban innovation and talent agglomeration, whereby innovation capacity serves as a potent attractor for high-skilled talent. an elevated urban innovation level not only strengthens locational advantages but also generates significant positive externalities and spillover effects, rendering cities more appealing to high-skilled labor. in the context of china's government-led development paradigm, urban innovation capacity is substantially influenced by the local business environment. these converging findings collectively validate that urban business environments affect high-skilled labor agglomeration by way of their impact on urban innovation levels. 4.3. analysis of threshold effect furthermore, we sequentially test for both double-threshold and single-threshold effects. the regression results in table 6 demonstrate that the average wage level exhibits a statistically significant single-threshold effect at the 1% significance level, with the threshold estimate being 25850.96. table 6. threshold effect test results for average wage level. variable threshold type estimate p-value 1% critical value 5% critical value 10% critical value average wage single 25850.96 0.000 13.286 10.532 8.860 double 76230.00 0.170 17.433 12.356 9.784 the results presented in table 7 reveal that the influence of the urban business environment on high-skilled labor agglomeration exhibits a pronounced threshold effect concerning average wage levels, with the estimated threshold value of 25850.96. empirical evidence shows that when regional average wages are below this threshold, the business environment has a significantly negative effect on high-skilled labor agglomeration at the 1% level. conversely, once wages exceed this threshold, the relationship turns significantly positive. this finding reinforces the notion that income levels are a primary determinant in the location decisions of high-skilled workers. thus, although enhancements to the business environment can stimulate economic development in low-wage regions, their allure for high-skilled labor is insufficient to overcome structural constraints such as wage stagnation and limited high-skilled job opportunities. this explains the observed negative net effect on skilled labor agglomeration in these areas. the findings underscore the necessity of implementing coordinated policy initiatives that simultaneously tackle wage levels, drive industrial upgrading, and create skill-appropriate jobs to fully realize the agglomeration benefits of business environment improvements in developing regions. therefore, although business environment improvements can promote economic development in low-wage regions, their attractiveness to highskilled labor remains insufficient to overcome structural constraints such as wage stagnation and limited highskilled job opportunities. such an approach is crucial for fully harnessing the agglomeration benefits stemming from business environment improvements in developing regions. in summary, the analysis confirms h3. table 7. threshold effect results. variable coefficient be (wage≤25850.96) -0.775*** (0.129) be (wage>25850.96) 0.157*** (0.068) control yes fixed effect yes note: *** indicate significant at the 10% levels, respectively. 4.4. robustness test 4.4.1. re-specify the dependent variable this study conducts robustness checks by replacing the core dependent variable. the agglomeration level of high-skilled labor was measured using employment data from four sectors (finance; information transmission, computer services, and software; scientific research, technical services, and geological exploration; and education). we re-measure based solely on employment in the education sector. as shown in column (1) of table 8, the corresponding results demonstrate that the explanatory variable, the urban business environment, continues to exhibit a statistically significant positive effect on high-skilled labor agglomeration at the 1% significance level. the consistent sign of the coefficient across different specifications provides strong empirical support for the findings of the baseline regression. 4.4.2. exclusion of special samples owing to their distinctive socioeconomic positions, the four first-tier cities-beijing, shanghai, guangzhou, and shenzhen-enjoy the advantages of preferential talent policies and boast advanced economic development, sophisticated infrastructure, and robust innovation ecosystems. these factors collectively render them highly attractive to high-skilled labor, potentially introducing bias into our analysis. to mitigate this potential bias, we reestimate our model while excluding these exceptional observations. as shown in column (2) of table 8, the business environment variable continues to exert a statistically significant positive influence on skilled labor agglomeration at the 1% significance level. this outcome reinforces the robustness of our core findings, indicating that our conclusions are not overly influenced by the unique characteristics of these major cities. asian journal of economics and empirical research, 2025, 12(1): 52-64 62 © 2025 by the authors; licensee asian online journal publishing group 4.4.3. robustness of the mediating effect we applied the special sample exclusion method outlined in section 4.2.2 to test the mediation effect model, and the results are presented in column (3) of table 8. the analysis demonstrates that after variable substitution, the estimated coefficient is 1.164, and the positive impact of the urban business environment on urban innovation level remains statistically significant. this finding suggests that the business environment continues to have a substantial positive influence on urban innovation levels across 276 cities, excluding beijing, shanghai, guangzhou, and shenzhen. notably, the observed coefficient is smaller than that obtained from the full sample estimation. this discrepancy can be attributed to the unique policy advantages and advanced innovation foundations of these four first-tier cities. under the combined influence of national policy support and leading innovation infrastructure, business environment optimization generates a more pronounced enhancement effect on urban innovation levels in these metropolitan areas. table 8. robustness test results. variable (1) (2) (3) skilled skilled inno be 0.277*** 0.119** 1.164*** (0.073) (0.056) (0.063) fdi 1.650** 1.585*** -0.544 (0.790) (0.559) (0.626) indus 0.055 0.051** 0.039 (0.037) (0.026) (0.029) igp 0.012 0.009 0.003 (0.008) (0.006) (0.007) 𝑆𝑂2 0.850 0.565 -0.290 (0.749) (0.531) (0.595) observations 3,640 3,588 3,588 yearfix yes yes yes idfix yes yes yes r-squared 0.366 0.391 0.802 note: robust standard errors are in parentheses; **, and *** indicate significant at the 5%, and 1% levels, respectively. 4.5. heterogeneity analysis 4.5.1. regional features this study covers 280 chinese cities spanning 30 provincial-level administrative units (excluding tibet), exhibiting substantial geographical, historical, cultural, and economic heterogeneity. such variations in endowment structures and development potential may systematically influence the spatial distribution of high-skilled labor. the empirical results addressing these geographical factors are systematically reported in columns (1)-(3) of table 9. table 9. heterogeneity effect results. variable (1) (2) (3) (4) (5) eastern region central region western region high-density low-density skilled skilled skilled skilled skilled be 0.158** 0.223 0.160 0.122* 0.784*** (0.072) (0.194) (0.144) (0.065) (0.273) fdi 0.563 2.548** 4.089** 1.443** 2.012** (0.668) (1.200) (1.872) (0.709) (0.958) indus 0.097** 0.078 0.012 0.133*** 0.051 (0.044) (0.048) (0.044) (0.047) (0.032) igp 0.019 0.002 0.015** 0.013 0.007 (0.016) (0.015) (0.007) (0.014) (0.006) 𝑆𝑂2 0.809 1.082 -0.288 1.161* -0.577 (1.013) (0.821) (0.944) (0.676) (0.629) constant 0.889*** 0.932*** 1.092*** 0.852*** 1.054*** (0.070) (0.072) (0.075) (0.068) (0.049) observations 1,300 1,300 1,040 1,990 1,650 yearfix yes yes yes yes yes idfix yes yes yes yes yes r-squared 0.021 0.025 0.027 0.017 0.014 note: robust standard errors are in parentheses; *, **, and *** indicate significant at the 10%, 5%, and 1% levels, respectively. the estimation results reveal significant regional heterogeneity in the effects of urban business environment quality on high-skilled labor agglomeration. the coefficient for eastern regions is 0.158 and statistically significant at the 5% level, indicating a positive and significant agglomeration effect. by contrast, central and western regions show statistically insignificant coefficients. these findings are consistent with the observed migration patterns of high-skilled labor, wherein high-skilled labor exhibits a pronounced preference for eastern regions over central and western areas. this divergence suggests that business environment enhancements exert spatially uneven impacts on skilled labor agglomeration. for the west and central regions to enhance their attractiveness to high-skilled labor, policymakers should consider adopting successful practices from the eastern areas while capitalizing on local advantages. complementary measures such as targeted talent policies should be implemented to strengthen the impact of business environment improvements in these regions. collectively, these results underscore the necessity of tailored, place-based strategies for optimizing skilled labor distribution. asian journal of economics and empirical research, 2025, 12(1): 52-64 63 © 2025 by the authors; licensee asian online journal publishing group 4.5.2. population density features considering that regional amenities have become an increasingly important determinant of high-skilled labor location choices, the impact of urban business environments on talent agglomeration may differ between highand low-population-density cities. to test this, we stratify the 280 prefecture-level cities into two subgroups based on whether their population density exceeds or falls below the sample average to examine potential differential effects. the regression results are presented in columns (4) and (5) of table 9. the estimation results reveal distinct effects across population density groups. for high-density areas, the business environment coefficient is 0.122 and significant at the 10% level, while for low-density areas, the coefficient reaches 0.784 with 1% significance. although both estimates are statistically significant, the impact is notably stronger in low-density regions. these findings suggest that urban business environment improvements generate substantially stronger agglomeration effects for high-skilled labor in low-density areas relative to highdensity cities. in high-density settings, the intensified competition among skilled workers, coupled with elevated living costs and potential resource misallocation, could dampen the marginal benefits of business environment enhancements. conversely, low-density regions likely benefit from greater marginal returns to institutional enhancements, as they face fewer congestion effects and competitive pressures. this pattern highlights the diminishing marginal returns of business environment improvements as population concentration increases. from a policy perspective, the results emphasize the need for density-dependent strategies: low-density cities should focus on business environment reforms as a primary tool for talent attraction. while high-density cities may require complementary measures targeting housing affordability and public service provision to fully realize agglomeration benefits. 5. conclusions and recommendations 5.1. conclusion the empirical analysis validates the hypothesis that urban business environments positively impact highskilled labor agglomeration and uncovers significant heterogeneity across regions and in terms of population density. from the perspective of agglomeration effects, optimizing urban business environments effectively accelerates the concentration of high-skilled labor, triggering notable knowledge and technology spillover effects while generating substantial scale economies and persistent positive externalities. from a cost perspective, cities with advanced business environments substantially reduce the living costs and institutional frictions faced by highskilled labor through well-developed infrastructure and public services, thereby alleviating the talent displacement phenomenon. heterogeneity analysis further reveals that improvements in the business environment of eastern cities significantly enhance high-skilled labor agglomeration. notably, both highand low-density cities exhibit positive responses, with more pronounced effects observed in low-density urban areas. the study also empirically confirms the underlying mechanism through which urban business environments influence high-skilled labor agglomeration. specifically, business environment optimization attracts skilled labor by boosting urban innovation capacity. a city's innovation level, which is largely determined by its business environment, creates stronger locational advantages, more substantial positive externalities, and greater spillover effects, collectively driving high-skilled labor towards more innovative urban areas. threshold effect tests indicate that the promotion of high-skilled labor agglomeration by business environment optimization is subject to the constraint of average wage levels. in regions with lower wage thresholds, although environmental improvements can stimulate economic development, their appeal to high-skilled labor remains insufficient to offset the limitations posed by salary levels and development opportunities, ultimately resulting in an inhibitory effect on skilled labor concentration rather than a promotional one. 5.2. recommendations the agglomeration of high-skilled labor holds significant implications for urban productivity levels and industrial structure upgrading. to better attract high-skilled talent, governments should implement targeted strategies to enhance regional competitiveness. the following policy recommendations are proposed based on the study's findings. first, given the significant positive impact of urban business environments on high-skilled talent agglomeration, efforts should center on optimizing government service efficiency and diversifying industrial development. by fostering a broader range of industries, more employment opportunities and career advancement prospects can be created. simultaneously, infrastructure investment should be intensified, particularly through the development of efficient public transportation networks to reduce commuting costs. moreover, optimizing the allocation of medical resources and improving ecological environment governance, including constructing modern medical facilities and enhancing air and water quality, will holistically upgrade the work-life convenience and residential comfort for high-skilled professionals. second, the empirical findings indicate that urban innovation capacity serves as a crucial mediator in how business environments attract high-skilled talent. governments should enhance policy support for innovation, prioritize building an innovation-friendly ecosystem, and focus on attracting innovative talents while creating matching high-quality employment opportunities. additionally, promoting collaborative r&d among prefecturelevel cities and market entities, maximizing the utilization of available innovation resources, and encouraging regional industrial innovation are essential for boosting overall innovation capabilities. furthermore, promoting synergistic innovation among upstream and downstream enterprises can help construct a comprehensive, crossindustry innovation landscape. finally, threshold regression analysis reveals that the influence of urban business environment on high-skilled labor agglomeration is significantly constrained by average wage levels, with more potent effects observed in highwage regions. to address this regional disparity, targeted policy interventions should focus on increasing capital investment and implementing differentiated talent policies in less-developed areas. these measures 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(2013). higher education expansion and social stratification in china. chinese sociological review, 45(4), 54-80. zhang, y. (2023). the role amenities play in spatial sorting of migrants and their impact on welfare: evidence from china. plos one, 18(2), e0281669. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 9 © 2025 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 12, no. 1, 9-20, 2025 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v12i1.6552 © 2025 by the authors; licensee asian online journal publishing group investigating small business operators’ views on taxation of business income: a novel analysis from cape coast metropolis in ghana kamal deen moro1 john wiredu2 seth acquah boateng3 gabriel mordzifa sackitey4 ( corresponding author) 1,3,4school of public policy and administration, northwestern polytechnical university, shaanxi province, xi’an, china. 1email: kamaldeenmoro@mail.nwpu.edu.cn 3email: sethacquahboateng@mail.nwpu.edu.cn 4email: gabrielmsackitey@mail.nwpu.edu.cn 2school of management, northwestern polytechnical university, shaanxi province, xi’an, china. 2email: johnwiredu50@gmail.com abstract tax evasion poses a significant task for governments and tax officials in many african nations, including ghana. small and medium-sized enterprises (smes) play a vigorous role in the national economy by substantially contributing to tax revenue. this paper implemented a descriptive research survey design, gathering primary data through structured questionnaires and employing a quantitative approach. data analysis was conducted using spss version 22.0, with inferential statistics (standard multiple regressions, pearson correlation) and descriptive statistics (mean, standard deviation, frequency, percentage) to derive insights. a survey conducted in cape coast metropolis with 120 participants revealed three key factors influencing tax compliance: tax awareness, observations of government spending, and the likelihood of audits. among these, tax knowledge greatly impacted the government's revenue generation capacity. the paper recommends that the ghana revenue authority (gra) perform regular, fair audits to ensure compliance among smes. additionally, gra must host frequent seminars and conferences to educate smes on the importance of tax compliance and motivate them to fulfill their tax obligations. keywords: business income, cape coast metropolis, small business operators, taxation. jel classification: h20, h26, h27. citation | moro, k. d., wiredu, j., boateng, s. a., & sackitey, g. m. (2025). investigating small business operators’ views on taxation of business income: a novel analysis from cape coast metropolis in ghana. asian journal of economics and empirical research, 12(1), 9–20. 10.20448/ajeer.v12i1.6552 history: received: 1 january 2025 revised: 7 march 2025 accepted: 20 march 2025 published: 4 april 2025 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: the ethical committee of the university of cape coast, ghana has granted approval for this study on 23 august 2024 (ref. no. ucc/sob/24/004). transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. data availability statement: the corresponding author may provide study data upon reasonable request. competing interests: the authors declare that they have no competing interests. authors’ contributions: all authors contributed equally to the conception and design of the study. all authors have read and agreed to the published version of the manuscript. contents 1. introduction ...................................................................................................................................................................................... 10 2. literature review ............................................................................................................................................................................ 11 3. methodology ..................................................................................................................................................................................... 12 4. results and discussion ................................................................................................................................................................... 13 5. conclusions and recommendations ............................................................................................................................................. 18 references .............................................................................................................................................................................................. 19 mailto:kamaldeenmoro@mail.nwpu.edu.cn mailto:sethacquahboateng@mail.nwpu.edu.cn mailto:gabrielmsackitey@mail.nwpu.edu.cn mailto:johnwiredu50@gmail.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v12i1.6552 asian journal of economics and empirical research, 2025, 12(1): 9-20 10 © 2025 by the authors; licensee asian online journal publishing group contribution of this paper to the literature the present study investigates the financing decisions of smes in the cape coast metropolitan assembly and, therefore, focuses on the direct influence of taxation policies on compliance and business behavior. it is important and provides empirical evidence of the challenges local small businesses face, adding to the existing literature in a specific geographical area. 1. introduction small businesses have been recognized as economic development partners in both industrialized and developing countries. they generate income, create a variety of goods and services for consumption, offer industrial inputs, and pay taxes for national development, among other things. small businesses, on the other hand, face particular difficulties in developing nations such as ghana, where tax systems are unfavorable (amanamah & owusu, 2016). this paper aims to determine how taxation influences the performance of small enterprises in ghana, focusing on small businesses in cape coast metropolis, the central regional capital. for over twenty years, small-scale industries have been identified as the primary stimulant to economic growth and industrialization for developing nations (antwi, inusah, & hamza, 2015). this kind of business undertaking has been deemed essential assistance for job formation, economic growth, and the eradication of poverty on the african continent. indeed, the 2005 world development report itself cites the creation of "sustainable" jobs and opportunities for smaller businesses as key methods of elevating people out of poverty. by definition, small businesses mainly consist of private enterprises that face issues dealing with tax management, especially in developing countries. most of the glitches with the tax authorities could be attributed to poorly designed tax policies. however, it would be highly improbable that there will not be problems concerning the intricacies and/or ambiguities of the tax statutes, as well as the punitive tax rates contained in the data (amanamah & owusu, 2016). other than being inappropriate for the prevailing specific conditions, it can cause impairment for the companies paying the taxes and, via their shifting powers, damage the ultimate consumers too. ameyaw, korang, twum, and asante (2016) have also discovered that most of the small enterprises are questionable in achieving or sustaining their increasing success due to certain factors like tax policies. small firms in ghana are a defining characteristics of the innovation environment and have been estimated to provide approximately 85 percent of manufacturing employment in ghana. some even believe that smes also account for more than 70 percent of the gross domestic product (gdp) and more than 90 percent of the country's enterprises (akaba, 2015). one may safely say from these foregoing comments that small businesses are drivers of growth and employment formation for poverty reduction, given their leverage in the economic variables in african countries. while the general effect of taxation might be quite positive toward the gross domestic product, the negative influence of taxation concerning small business growth calls for special attention. this is because small businesses are the economic drivers for developing and developed nations, as discussed by wiredu et al. (2023), supported by afrane and ahiable (2016), who have already been identified to generate more new jobs as a sector than giant companies or macro-enterprises introduce new concepts, products, and processes. according to ameyaw et al. (2016), some countries' tax systems are designed only to create revenue, which negatively affects their economies, especially small businesses. is this the case with ghana's tax system? without enough attention to their creation, development, and sustainability, studies on small enterprises in developing nations have concentrated too much on the roles they play in reducing scarcity and economic progress, and even on challenges to development, such as the absence of sufficient access to credit (afrane & ahiable, 2016). similarly, studies on factors that influence dealings to voluntarily comply with their tax obligations are not many (anane, cobbinah, and manu, 2013). because small businesses in cape coast largely face general obstacles like a lack of access to credit, amoako (2013) points out that any tax system not directed at improving business viability would exacerbate their situation. when the system and regime of regulation and taxation are overly complicated or incomprehensible in their application and enforcement, adherence to taxes becomes unduly burdensome. as held by ali-nakyea (2008), for instance, it is said that some businesses experience double taxation along the entire value chain. additionally, taxation has been termed an evil necessity. the author will review such decisions (akaba, 2015). small businesses in ghana pay income tax that accrues in the fiscal year. accordingly, if a firm is unable to pay all its taxes in a given year, the outstanding amount is carried over to the next year as accumulated tax (awotwe, 2018). profit is directly affected by taxation, and companies have recently considered it one of the most significant challenges (anim, awotwe, nyarku, & kusi, 2020). high taxes always influence the profitability ratios of companies, their dividend policy, growth, and survival. as a result, businesses will use all legal means at their disposal to avoid paying taxes (frimpong, asare, & aggrey-darkoh, 2023). this paper, therefore, tries to find the effects of taxes on the performance of small businesses, with emphasis on the cape coast metropolitan assembly. the paper aims to: find out the extent of awareness among taxpayers of their tax obligations in cape coast; determine the features that influence smes' tax compliance in cape coast metropolis; examine how taxation stimulates the progress of small businesses in cape coast; and assess the challenges small businesses in cape coast face regarding tax compliance. also formulated are research questions that will help in realizing the goals of the research. these include: 1. what is the level of awareness of the obligation among taxpayers? 2. what reasons inspire tax compliance among small businesses in cape coast? 3. how does taxation influence the progress of small businesses in cape coast? and 4. what challenges do smes face regarding tax compliance in cape coast? the current research makes the following contributions to existing literature: (1) the research could potentially be used as a tool for small business management to make strategic financial decisions. the paper will provide the management of these small businesses with insight into the tax difficulties they are likely to face and the decisions they can make to benefit from it. it will also serve as an eye-opener to corporate boards and individual directors who have failed to take into consideration the impact of tax when making financial and investment decisions for their firms. additionally, it would serve as a framework for corporate governance standards that would benefit stakeholders and the general public as well. (2) the outcome of this paper will add to the pool of information regarding the study's main underlying constructs and will apply to students and researchers in subsequent studies. the aim was therefore to bridge the gaps in existing literature and advance research on corporate asian journal of economics and empirical research, 2025, 12(1): 9-20 11 © 2025 by the authors; licensee asian online journal publishing group tax and related business decisions based on tax. furthermore, (3) academics would be able to identify areas for further research, which could serve as a research gap they need to fill. this paper is likely to be useful to ghanaian tax policymakers, especially the ghana revenue authority, as it highlights the problems and annoyance that taxes on corporate incomes create regarding the general stability and solvency of such small companies. lastly, (4) the present study will also support consultants in formulating tax policies that will support the growth objectives of the ghana revenue authority while establishing ghanaian businesses on a sound financial footing. this information on how taxes affect business financing decisions in ghana, and how additional information could help them make better finance and investment decisions, will be made available to investors and the general public. the paper is therefore organized in such a way that the discussion of the literature review falls in chapter two. chapter three discusses the methodology executed during the research. segment four debates the discoveries and analysis of the study. chapter five discusses the summarized research findings, conclusions, as well as future research. 2. literature review this segment reviews correlated and relevant taxation literature from scholars and other researchers and how they may have a bearing on the financing decisions of smes in the cape coast metropolitan assembly. past research and important theoretical reviews are considered herein. it describes some of the theoretical underpinnings of the present investigation; it also looks at some empirical reviews and documents the findings of previous research. 2.1. the concept of taxation a tax is usually a compulsory duty imposed on subjects by the government or state. tax is a payment levied by a nation on all its citizens, companies, and institutions, not as a punishment for an offense committed, nor as an immediate quid pro quo, but for raising revenue that enables a government to achieve its goals (ali-nakyea, 2008). taxation of corporations includes the main sources of income for governments worldwide and represents one of the significant considerations in planning corporate activities. there are many types of taxes and correspondingly many systems of taxes, each enacted in a separate legal environment (frimpong et al., 2023). kiprotich went on to describe tax as an obligation to make unrequited payments to the government. according to ameyaw et al. (2016), tax is any form of payment compulsorily collected from residents of a state. a tax has also been referred to as that by which a state or government imposes money on all its subjects or residents for the sustenance of government machinery (anim et al., 2020). corporate companies are subjected to taxes and cannot evade them without any sanctions. taxation is measured in more aspects than the amount of money paid as taxes by natural or artificial entities. it was mutually agreed that the income is taxed first at the trade level and then at the individual level when dispersed as dividends or when capital gains are realized (ameyaw et al., 2016). 2.2. concept of tax compliance the internal revenue service (irs) defines tax compliance as "the degree to which a taxpayer complies voluntarily with the obligations imposed by the statutes," which, at best, is very vague (malik et al., 2021). small businesses, especially, can encounter immense difficulties resulting from resource and expertise limitations, thereby making compliance additionally burdensome (atawodi & ojeka, 2012). high costs of compliance could result in evasion, fraud, and economic uncompetitiveness by discouraging investment (malik et al., 2021). noncompliance is manifested in several ways: late or non-filing of earnings, exaggeration of income, overstating of deductions, or failure to pay the assessed taxes. tax evasion is a major issue, particularly in developing countries. agreements can usually be segregated into two broad areas: administrative compliance, which relates to timely registration, reporting, and payments (anim et al., 2020), and accurate filing, requiring honesty, adequate knowledge, timeliness, and proper record-keeping (singh & bhupalan, 2001). omotor (2022) categorizes tax compliance into several types: committed compliance, whereby one complies out of will; passive compliance, whereby one complies without resistance; capitulation compliance, whereby a person pays grudgingly; and inventive compliance, whereby legal means are used to minimize tax liability. thus, tax compliance ranges along a continuum of taxpayer behavior, determined by costs, knowledge, and the will of the taxpayer, and consequently has immense implications for small businesses and economic growth. 2.3. factors affecting small businesses' compliance behavior the organization for economic co-operation and development (oecd) has put forward that taxpayer behavior has been one of the foci of tax administration. while various programs aimed at inducing compliance by discouraging non-compliance have also been in place for considerable years, the study of motivations to comply or otherwise has been an area of emergent study. business tax compliance is influenced by deterrence, norms, opportunity, fairness, trust, and economic factors (suleman & ennin, 2023). deterrence is based on the threat of audits, detection risk, and sanctions to stimulate compliance. periodic audits have been suggested as an effective means of targeting frequent non-compliers. however, deterrence works most effectively when strong social norms also exist, to which it is synergistic (ndajiwo, 2020). revenue bodies may consider employing non-monetary measures, including social sanctions, as a deterrent to non-compliance. other influencers are norms, both personal and social. revenue agencies believe there is a need to promote longer-term compliance using normative messages. for example, the message that others comply may be used to modify behavior (hearson, 2018). agencies must also address misinformation that could erode societal norms and compliance. fairness is a critical factor in taxpayers' behavior. perceived fairness can be divided into three kinds: distributive fairness, which refers to the taxpayers' belief that tax resources are well managed; procedural fairness, which includes fair treatment by the revenue authorities during interactions; and retributive fairness, or the equal application of penalties for violations. research links non-compliance to perceived unfairness in these areas (suleman & ennin, 2023). economic factors also contribute to compliance, although studies of this relationship are limited. included in these are the level of income, rates of taxes, probability of audits, fines, and benefits from taxation. in general, the better the economic growth, the higher the compliance (ndajiwo, 2020). asian journal of economics and empirical research, 2025, 12(1): 9-20 12 © 2025 by the authors; licensee asian online journal publishing group interrelations among these compliance factors are important, too. the revenue authorities have to find a delicate balance between control and supportive measures. too heavy-handed enforcement might breed distrust and lead to less compliance. a hard-hitting public program against non-compliance reinforces societal norms—that is, it tells people that such behavior is socially unacceptable. in this way, tax compliance requires a combination of many intertwined factors, including deterrence and equity, economic incentives, and social norms. revenue agencies should follow a balanced and informed approach in trying to impact taxpayer behavior (hearson, 2018). 2.4. the concept of small businesses the connotation of what 'smes' are, and therefore, different regions of the world have different criteria due to contextual and purpose differences. many classifications are pegged on the number of personnel, monetary value, and fixed assets (abiahu, emuoghene, egbunike, & obada, 2021). according to adefunke and usiomon (2022), countries also adapt the definition to suit their economic contexts and the usual business sizes. for example, the u.s. and canada consider all firms with under 500 employees to be smes, while the european union uses below 50 employees for smes and 250 for medium-sized businesses. even the definition varies in ghana. the ghana statistical service (gss, 2000) defined a small-scale business as an enterprise having fewer than 10 employees, whereas suleman and ennin (2023) state that the national board for small scale industries (nbssi) defines micro-enterprises to include fewer than six employees, while small enterprises would include 10-29 employees. additionally, the national board for small scale industries classifies small enterprises to include 6-29 employees. operationally, in this paper, small businesses will be defined as firms with 6-29 employees, falling within the ghanaian context. 2.5. taxation and small businesses tax policy typically relies on two approaches: offering incentives and implementing efficient tax collection methods (atawodi & ojeka, 2012). these include incentives for corporate income tax rates, tax holidays, and exclusions for the growth of small businesses. this will correspond with the specific conditions of each country and its administrative capability for increasing revenue efficiently. for a developing country like ghana, which faces the problems of resource mobilization, infrastructure, job creation, and diversification from dependence on oil, it is essential to increase the tax net (awotwe, 2018). it also requires a progressive tax system in which higher earners in the country pay more while providing adequate incentives to low-income earners. this is critical for equity and economic efficiency. unduly favorable tax policies for small businesses encourage underreporting of income or artificially dividing larger companies to reduce tax liabilities. anti-fragmentation laws may prohibit these practices while allowing the market failure of small business finance to be rectified (malik et al., 2021). for example, in ghana, small-scale entrepreneurs regard the tax system as inefficient and not contributing to socio-economic development. benefits visibly arising from tax contributions breed non-compliance. good governance, coupled with the efficient use of the proceeds accruing from taxes, would improve the morale for paying taxes, hence accommodating and developing an attitude towards taxation (garcia-bernardo, janský, & tørsløv, 2021). 2.6. tax practices favorable for small businesses fiscal policy thus becomes hugely instrumental in stabilizing a macro economy, and for that, tax policy is employed as an important tool, which helps in the generation of revenue and economic growth. good tax policy uses lower corporate tax rates and inducements to foster small business entrepreneurship. the philosophy is to collect revenue with the least economic distortions and to be non-discriminatory among various groupings of society (van den boogaard & beach, 2023). a proper tax system would require careful analysis of the country's particular context to avoid problems resulting from poorly designed rules and a lack of planning. savings, investment, and social accountability should be encouraged through the tax system in economies facing recession, like ghana. the government should widen the base through infrastructural investment, absorption of unemployment, and productive sector development. progressive tax rate—the rich fairly contribute, while there is an incentive to save for low-income earners. efficiency in tax administration, balancing between educating taxpayers and enforcing laws and regulations for compliance and fairness, is very important (brockmeyer, mascagni, nair, waseem, & almunia, 2024). for small businesses, tax policies should reduce burdens, reward growth, and simplify processes for start-ups and succession (atawodi & ojeka, 2012). the characteristics of successful systems include simplicity, proportionality, predictability, and neutrality. lower corporate tax rates, along with provisions for reinvestment, promote business incorporation and increase after-tax earnings (frimpong et al., 2023). 3. methodology this segment addresses details on the gathering, analysis, and presentation of primary data. one could say that study design, study approach, population, sample and sampling procedure, instrument, data collection method, data processing, and data analysis could adequately suffice as subheadings in this segment. 3.1. research design and approach this research is illustrative since it tries to draw a link between the tax system and the success of smes. the method used for data collection is the survey method through the use of questionnaires, personal interviews, and scrutiny of previous records and publications to depict the views and opinions of respondents on the subject matter. this method best suits the measurement of attitudes, opinions, and cause-and-effect relationships. judgmental sampling was adopted to make the selections of small businesses representative. a mixed-method research design incorporates both quantitative and qualitative methodologies. quantitative research intends to approach data that are expressed numerically; it starts with hypothesis-driven data collection, utilizing either descriptive or inferential statistics to analyze the data. it emphasizes presenting the results through statistics, tables, and graphs (wiredu, bo, labaran, georgine, & vicinte, 2021). asian journal of economics and empirical research, 2025, 12(1): 9-20 13 © 2025 by the authors; licensee asian online journal publishing group in contrast, qualitative research methodology involves descriptively collecting data through observations, interviews, focus groups, and case studies. the approach allows for capturing elaborative insights and narratives from its participants. altogether, these two allow standardized data collection and in-depth investigation of the study topics for strong findings with well-defined variables and research instruments (wiredu et al., 2021). 3.2. area of study and population as per the census of 2021, the city is populated by 189,925 residents, out of which 92,790 are males and 97,135 are females, constituting 6.64% of the regional population. the most vital occupations of its active population, which is 85%, are trading, services, and agriculture. nationally, small and medium enterprises (smes) constitute about 19.8% of ghana’s 638,234 establishments, making up 90% of registered businesses (otoo, haojie, wiredu, & elvis, 2024). cape coast hosts clusters of smes, particularly near academic hubs like kotokuraba, abura, and ucc science markets. these smes, both registered and unregistered, are integral to this study’s focus on tax compliance and business dynamics (wiredu, labaran, nketiah, & osibo, 2020). 3.3. sampling and sampling technique according to social scientists wiredu, yang, sampene, gyamfi, and asongu (2024), "in social sciences, it is not possible to obtain data from every respondent relevant to our inquiry, but rather from some fraction of the respondents. sampling is the method of choosing the fractional component. 'sampling design' refers to the combined selection and estimating process. sampling should be conducted in a way to minimize estimation error. the sample size for this paper will be 90 respondents, while the database shall consist of a population size of 120 smes." the respondents were chosen using a stratified sampling procedure. stratified sampling, according to wiredu et al. (2023), involves using a sampling frame where the respondents are stratified. through the lottery technique, each respondent is casually nominated based on the unique identifying number system provided to them until the required sample size is achieved. 3.4. data processing and data analysis editing and cleansing figures is the process of data analysis, which aims to highlight pertinent facts, make recommendations, draw conclusions, and assist in decision-making (adèr, 2008; wiredu et al., 2020). the questionnaires used, after editing, coding, and entering, were carried out using spss version 22.0, a statistical software that can be applied within the framework of research studies in the area of social sciences. in this way, descriptive statistical methods using the mean, standard deviation, frequency, and percentage were employed to study and understand the results (wiredu et al., 2022). according to shantatula, lei, and wiredu (2024) proposal, a multiple regression is a standard method that will allow determining how much the outcome variable is explained by the independent variable. further calculations of pearson product-moment correlation will allow describing the strength and direction in which dependent and independent variables are correlated. 3.5. reliability analysis to accomplish the objectives of the research question, "a survey of small business operators’ views on the taxation of business income," the reliability test was conducted using spss cronbach’s alpha technique. cronbach's alpha values varied from 0.414 to 0.861 for the various fields, which is a good and high range for the study. overall, the questionnaire had a cronbach's alpha of 0.874, which indicates that the questionnaire is reliable because it scored more than 0.7 and was closer to 1. table 1 depicts the results obtained from the cronbach’s alpha with respect to the field of items on the questionnaire. table 1. cronbach’s alpha for reliability test. field number of items cronbach’s alpha tax compliance of small businesses. 28 0.701 factors that influence small businesses' tax compliance. 5 0.751 impact of taxes on small businesses in cape coast metropolis 9 0.861 challenges small business operators face regarding tax compliance in cape coast. 2 0.414 total 44 0.874 4. results and discussion 4.1. demographic characteristics of respondents this segment provides insights into the demographic information of respondents to this survey. it is based on the demographic data that gives the researcher grounds to appreciate the insights provided by respondents. it depicts the sex, position of respondents, educational background, nature of dealings, legal status of the business, and how it is financed. as stated earlier, 90 questionnaires were completed and used for the data analysis. the findings are presented in table 2. table 2 summarizes the demographic characteristics and business types of the 90 respondents surveyed. among them, 43 were male (47.8%) and 47 were female (52.2%), suggesting that the small business sector in the cape coast metropolis is female-dominated. a majority (38) of the respondents were business owners, representing 42.2%, while 26 respondents identified as both managers and owners, accounting for 28.9%. in terms of business sectors, the majority (41) were in services, representing 45.6%, followed by 22 respondents (24.4%) in manufacturing, 12 respondents (12.2%) in agriculture, and 16 respondents (17.8%) in commerce. this indicates the need for greater government support in the service sector, which dominates the local economy, while attention should be given to the underdeveloped agricultural sector. policymakers, investors, and other stakeholders must prioritize this sector for growth and sustainability. asian journal of economics and empirical research, 2025, 12(1): 9-20 14 © 2025 by the authors; licensee asian online journal publishing group table 2. demographic information. item options frequency percentage sex male 43 47.8 female 47 52.2 total 90 100 job position manager 26 28.9 owner 38 42.2 owner manager 26 28.9 total 90 100 educational level basic 16 17.8 secondary 24 26.7 tertiary 50 55.6 total 90 100 nature of size business manufacturing 22 24.4 service 41 45.6 agriculture 11 12.2 commerce 16 17.8 total 90 100 legal status sole proprietorship 59 65.6 partnership 24 26.7 private company 7 7.8 total 90 100 number years business has been in operation 1-5 years 46 51.1 6-10 years 33 36.7 11-15 years 11 12.2 16 years and above 0 0 total 90 100 sources of finance personal savings 60 66.7 debt (bank loans) 17 18.9 leasing 3 3.3 equity and debt 10 11.1 total 90 100 regarding the legal status of the businesses, 59 businesses were sole proprietorships (65.6%), 24 were partnerships (26.7%), and 7 were private companies (7.8%). this suggests that most small businesses in the area are individually owned, contradicting the notion that small businesses are primarily registered as companies (amanamah & owusu, 2016). concerning the length of time businesses have been operating, 46 businesses (51.1%) have been in operation for 1-5 years, 33 businesses (36.7%) for 6-10 years, and 11 businesses (12.2%) for 11-15 years. this shows that most respondents have substantial experience in the business environment of cape coast, which enables them to provide informed insights on taxation practices in ghana. lastly, the primary sources of finance for these small businesses were personal loans (66.7%), followed by bank loans (18.9%), leasing (3.3%), and trade credits (11.1%). the heavy reliance on personal loans indicates that small businesses predominantly use internal financing to support business operations and expansion. 4.2. descriptive analysis estimation of the reliability of data to ensure the results are accurate was done through descriptive analysis techniques using ibm spss statistics software for windows version 26 to analyze the results obtained from the formulated objectives. however, before this, some preliminary tests were conducted to ensure that all of the descriptive assumptions were not violated. 4.2.1. tax compliance of smes in cape coast metropolis this segment provides discoveries obtained from the tax compliance of respondents of the study. it uncovers the first impartial aspect of the study, which states, “what is the extent of awareness of tax obligation among taxpayers?” table 3. tax registration status. response frequency percent yes 50 55.6 no 40 44.4 total 90 100.0 table 3 presents that a greater proportion (50), representing 55.6%, were registered with the appropriate authorities for tax payment, while the rest, 40 respondents representing 44.4%, have not registered with any tax authority. for more small businesses to be registered as taxpayers is a sign that they are on a good path in their quest to contribute to the development of ghana. this is also a good indication that these small businesses are willing to pay their taxes, since non-compliance would lead to some consequences from the tax authorities in ghana. table 4. respondents who believe it is mandatory to pay taxes. responses frequency percent yes 61 67.8 no 29 32.2 total 90 100.0 asian journal of economics and empirical research, 2025, 12(1): 9-20 15 © 2025 by the authors; licensee asian online journal publishing group from table 4, it can be observed that the majority of respondents (61), representing 67.8%, believed that they were obligated to pay taxes, while 29 respondents (32.2%) thought they were not obligated to pay taxes. this is a positive sign, as most respondents agree that paying taxes is mandatory for their businesses. however, the small proportion of respondents who disagreed suggests that some small businesses may not recognize the obligation to pay taxes and may be evading tax responsibilities. table 5. institutions respond to paying their taxes. responses frequency percent ghana revenue authority 47 52.2 trade association 30 33.3 mmdas 13 14.4 total 90 100.0 from table 5 it can be observed that majority (47) of the respondents representing 52.2% believed that they pay their taxes to ghana revenue authority, 30 respondents pay their taxes to trade association representing 33.3% and only 13 respondents representing 14.4% pays their taxes to metropolitan, municipal and district assemblies (mmdas) representing 32.2%. table 6. small businesses that are given an assessment before tax liability fulfillment. response frequency percent yes 47 52.2 no 43 47.8 total 90 100.0 from table 6, the internal revenue code establishments, which are mandated to collect taxes, are supposed to assess small businesses for the appropriate tax payment. forty-seven out of ninety, representing 52.2% of respondents, are assessed for tax liability fulfillment, while forty-three of the respondents, representing 47.8%, are not assessed before they fulfill their tax duties. if an ultimate answer is needed: what method do those small companies use to determine how much taxes they owe if they do not receive a prepay assessment of tax liability? table 7. types of taxes paid by respondents. response frequency percent corporate income tax 38 42.2 pay as you earn 16 17.8 value added tax 21 23.3 property tax 8 8.9 import duties 7 7.8 total 90 100.0 from table 7, it can be observed that the majority (38) of the respondents, representing 42.2%, pay corporate revenue tax; 21 of the respondents, representing 23.3%, pay value-added tax; 16 of the respondents, representing 17.8%, pay pay-as-you-earn; 8 of the respondents, representing 8.9%, pay property tax; and 7 respondents, representing 7.8%, pay import duties. table 8. respondents who pay taxes for their business. response frequency percent yes 51 56.7 no 39 43.3 total 90 100.0 table 8 shows that most small businesses in the cape coast metropolis are tax compliant. out of 90 respondents, 51 (56.7%) reported paying taxes for their businesses, while 39 (43.3%) admitted to evading taxes. this indicates that the majority of small businesses are fulfilling their tax obligations. table 9. small businesses whose taxes are deducted from financial statements. response frequency percent yes 43 47.8 no 47 52.2 total 90 100.0 as shown in table 9, it can be deduced that most small businesses pay their taxes directly rather than through deductions from their financial statements. however, 43 respondents indicated that their taxes are paid through such deductions. this situation may be linked to deficiencies in some of the acts regulating businesses in ghana, as these acts do not require certain businesses to disclose their financial standing through financial reporting. table 10. respondents who shift the tax burden to their customers. response frequency percent yes 51 56.7 no 39 43.3 total 90 100.0 asian journal of economics and empirical research, 2025, 12(1): 9-20 16 © 2025 by the authors; licensee asian online journal publishing group as illustrated in table 10, it can be deduced that the majority of small businesses shift the tax burden to their customers, which constitutes 56.7%, while 39 of the respondents do not shift the tax burden to their customers, representing 43.3%. table 11. respondents who pay taxes on time. response frequency percent yes 45 50.0 no 45 50.0 total 90 100.0 the study aimed to determine whether small businesses in the cape coast metropolis pay their taxes within the legally required time frame. as illustrated in table 11, 45 small businesses pay their taxes on time, while the other 45 businesses (50.0%) pay taxes at their own discretion. this finding suggests that, although small businesses do pay taxes, they often fail to do so within the stipulated time frame. table 12. frequency of tax payment by smes. responses frequency percent monthly 7 7.8 quarterly 56 62.2 biannual 11 12.2 annually 16 17.8 total 90 100.0 table 12 presents that out of 90 respondents, 56, representing 62.2%, pay taxes quarterly; 16 small businesses pay taxes annually, representing 17.8%; 11, representing 12.2%, pay taxes biannually; and a minority (7) of them pay their taxes monthly, 7.8%. the frequency of tax payments among small businesses shows that most of these small businesses pay taxes quarterly. this can delay government revenue mobilization efforts. table 13. respondents who pay taxes fully. response frequency percent yes 55 61.1 no 35 38.9 total 90 100.0 table 13 presents that 55 of the small businesses, as illustrated in table 11, pay their taxes in full, representing 61.1%, whilst 35 of the smes in the cape coast metropolis, representing 38.9%, do not pay their taxes in full. table 14. respondents who have filed tax returns. response frequency percent yes 34 37.8 no 56 62.2 total 90 100.0 as demonstrated in table 14, it can be deduced that the majority of small businesses do not file tax returns for their business, which represents 62.2%, while 34 of the respondents filed tax returns for their business, representing 37.8%. table 15. types of tax incentives enjoyed by smes in cape coast metropolis. responses frequency percent tax rebates 25 27.8 tax holidays 22 24.4 incomes exempted 12 13.3 capital allowance 16 17.8 fresh graduate incentives 4 4.4 free-zone incentive 11 12.2 total 90 100.0 table 15 presents that the study aimed to identify activities that can help smes comply with tax laws. the degree of agreement with each of the attitudes mentioned was measured using a 5-point likert scale. respondents were asked to indicate their level of agreement with each item, with the scale ranging from 1 (very unsatisfactory) to 5 (very satisfactory). the responses were interpreted as follows: 0-1.4 = very dissatisfied; 1.5-2.4 = dissatisfied; 2.5-3.4 = moderately satisfied; 3.5-4.4 = highly satisfied; and 4.5-5 = very highly satisfied. the findings were analyzed using descriptive statistical tools, including mean and standard deviation scores. table 16. actions that can assist small businesses in complying with tax law. actions mean sd keeping proper books of account 3.68 1.373 timely filing of returns 3.54 0.963 pay taxes on the due date 3.70 1.136 not reporting withholding taxes 3.26 1.055 pay taxes before the due date 3.39 1.139 late filing of value-added tax (vat) returns 3.32 1.004 evasion of tax payment 3.18 1.054 making claims for funds not entitled 3.28 1.236 asian journal of economics and empirical research, 2025, 12(1): 9-20 17 © 2025 by the authors; licensee asian online journal publishing group the discoveries are presented in table 16. the respondents are highly satisfied with keeping proper books of account (m=3.68; sd=1.373), timely filing of returns (m=3.54; sd=0.963), and paying taxes on the due date (m=3.70; sd=1.136). however, regarding the following items, respondents were moderately satisfied with not reporting withholding taxes (m=3.26; sd=1.055), paying taxes before the due date (m=3.39; sd=1.139), late filing of vat returns (m=3.32; sd=1.004), evasion of tax payment (m=3.18; sd=1.054), and making claims for funds not entitled to (m=3.28; sd=1.236). the results indicate that smes in the cape coast metropolis are capable of maintaining proper books of accounts, which the ghana revenue authority can rely on for corporate tax assessments. this reflects a commendable business practice, supporting the idea that adequate record-keeping is essential for tax assessments and documentation (singh & bhupalan, 2001). however, there is a clear need for the integration of specialized accounting software in recordkeeping and accounting practices among small businesses. additionally, the research aimed to assess whether small businesses are satisfied with various tax variables. the scale used was rated as follows: table 17. actions that can assist small businesses in complying with tax law. tax variable mean sd mode of tax payment 2.97 1.369 timing of tax payment 2.96 1.189 tax rates 2.70 1.194 tax incentives for small businesses 2.93 1.120 tax education by ghana revenue authority 3.14 1.045 tax administration system efficiency 2.84 1.160 in fact, as table 17 shows, with a standard deviation (sd) of 1.369 and a mean of 2.97, responses for the first item, "mode of tax payment," indicate that the distribution is around the average; with a mean of 2.97 indicating moderate satisfaction with regards to the mode of tax payments. timeliness of tax payment the study reports a mean of 2.96 and a standard deviation of 1.189, which indicates that respondents are moderately satisfied. "tax rates" yields: mean (m) = 2.70 and a standard deviation of 1.194, and this shows that the respondents are moderately satisfied with the tax rates provided by the gra. the next is "tax incentives for small businesses," which reveals mean = 2.93 and a standard deviation of 1.120. this means, in this respect, respondents agree to a moderate extent to tax incentives for small businesses. on the "tax education by gra," it reveals mean = 3.14 and standard deviation = 1.045, meaning that in this respect, the respondents agree to a moderate extent to tax education by the ghana revenue authority. the last item is "tax administration system efficiency" with a mean of 2.84, which indicates that generally, the small businesses only moderately agree that the system of tax administration is efficient. 4.2.2. factors that influence small businesses tax compliance the scale used for measuring satisfaction was as follows: 1 = very unsatisfactory, 2 = unsatisfactory, 3 = indifferent, 4 = satisfactory, and 5 = very satisfactory. the findings were interpreted using an artificial range of response precision: 0-1.4 = very dissatisfied, 1.5-2.4 = dissatisfied, 2.5-3.4 = moderately satisfied, 3.5-4.4 = highly satisfied, and 4.5-5 = very highly satisfied. descriptive statistical tools, such as mean and standard deviation scores, were used to analyze these findings. table 18. factors that influence small businesses tax compliance. tax variable mean sd tax education programs attended 3.09 1.269 enforcement of penalties by tax authorities 3.14 1.127 tax rates 3.29 1.220 tax audits 3.31 1.295 moral reasons 3.51 1.318 table 18 presents that it was discovered that the respondents moderately agree that they attended tax education programs (m=3.09; sd=1.269). with the item 'enforcement of penalties by tax authorities,' respondents moderately agree that because of penalties, they comply with tax laws (m=3.14; sd=1.127). respondents moderately agree that tax rates influence small businesses' tax compliance (m=3.29; sd=1.220). respondents moderately agree that tax audits influence small businesses' tax compliance (m=3.31; sd=1.295). lastly, respondents are highly satisfied that moral reasons are the factors that influence small businesses' tax compliance (m=3.51; sd=1.318). 4.2.3. impact of taxes on small businesses in cape coast metropolis this segment presents the findings regarding the factors influencing small business tax compliance. it addresses the third objective of the study, which states, "examine how taxation influences the growth of small businesses in cape coast." the study aimed to assess the impact of taxation on the growth of small businesses in the cape coast metropolis. the respondents' attitudes were measured using a 5-point likert scale. they were asked to indicate the appropriate response that reflected their attitude (degree of agreement) toward each scale item. the scale was rated as follows: 1 = very unsatisfactory; 2 = unsatisfactory; 3 = indifferent; 4 = satisfactory; 5 = very satisfactory. the findings were interpreted using an artificial response range as follows: 0-1.4 = very dissatisfied, 1.5-2.4 = dissatisfied, 2.5-3.4 = moderately satisfied, 3.5-4.4 = highly satisfied, and 4.5-5 = very highly satisfied. these findings were analyzed using descriptive statistical tools, including mean and standard deviation scores. asian journal of economics and empirical research, 2025, 12(1): 9-20 18 © 2025 by the authors; licensee asian online journal publishing group table 19. tax affects financial decision of small businesses. tax variable mean sd acquisition of asset 3.19 1.217 number to employ 3.37 1.116 how much profit to retain in the business 3.62 1.186 determining selling price for my products 3.69 1.098 table 19 presents that it was discovered that the respondents moderately agree that the acquisition of assets affects small businesses regarding tax (m=3.19; sd=1.217). with the item "number to employ," respondents moderately agree that tax regulations affect the number of workers they will employ (m=3.37; sd=1.116). respondents highly agree that the tax rate affects how much profit to retain in the business (m=3.62; sd=1.186). lastly, respondents highly agree that the tax rate affects the selling price of their product (m=3.69; sd=1.098). table 20. the following areas have been improving through tax reforms. tax variable mean sd acquisition of asset 2.81 1.315 number of employees 2.90 1.200 net profit 3.04 1.297 pricing of products 3.36 1.239 turnover 3.06 1.327 from table 20, the study reports a mean of 2.81 and a standard deviation (sd) of 1.315 for the first item, "acquisition of asset." the standard deviation indicates that the responses are centered around the mean. a mean of 2.81 indicates that the respondents are moderately satisfied with the acquisition of assets. for the item "number of employees," the study reports a mean of 2.90 and a standard deviation of 1.200, which indicates that respondents are moderately satisfied. for the third item, "net profit," it reveals a mean (m) of 3.04 and an sd of 1.297, which shows that the respondents are moderately satisfied that tax reforms have improved net profit. the next item, "pricing of products," reveals a mean of 3.36 and an sd of 1.239, which shows that the respondents moderately agree that tax reforms affect the pricing of products. for the last item, "turnover," it reveals a mean of 3.06 and an sd of 1.327, which shows that the respondents moderately agree that tax reforms affect the turnover rate. 4.2.4. challenges small business operators face regarding tax compliance in cape coast this segment provides answers obtained regarding the tax compliance of respondents in the study. it seeks to uncover the last objective of the study, which states, “what challenges do small business operators face regarding tax compliance in cape coast?” table 21. challenges pertaining to tax compliance. response frequency percent yes 65 72.2 no 25 27.8 total 90 100.0 table 21 presents that it was discovered that the majority (65) of the respondents, representing 72.2%, face challenges with tax compliance, while the remaining 25 respondents, representing 27.8%, do not face any challenges. further questions were asked in table 22 to identify those challenges. table 22. challenges faced by small businesses in cape coast metropolis. response frequency percent magnitude of compliance cost 31 34.4 extent of penalty 7 7.8 perceived fairness of tax system 11 12.2 perceptions of government spending 9 10.0 mode of tax payment 9 10.0 total 90 100.0 based on table 22, we asked the respondents who selected 'yes' to identify the challenges they face in tax compliance. thirty-one out of ninety, representing 34.4% of respondents, agree that they face a significant compliance cost challenge, and eleven respondents, representing 12.2%, face a challenge related to the perceived justice of the tax system. this means they do not believe the tax system is fair to everyone. regarding the fourth and fifth items, respondents had a total response of nine, representing 10.0%, indicating they face challenges related to perceptions of government spending and modes of tax payment. lastly, a minority of respondents, seven, representing 7.8%, face a challenge concerning the extent of the penalty. this shows that the government and tax authorities need to implement measures to address these challenges and help increase revenue. 5. conclusions and recommendations 5.1. conclusion the link between tax literacy and tax compliance among independent contractors in cape coast focuses on four objectives: assessing taxpayers’ awareness of their obligations, identifying factors influencing compliance, examining the impact of taxes on small business growth, and evaluating the challenges faced by these smes in complying with tax laws. data collection was thorough, with questionnaires reviewed for accuracy. the analysis employed ibm spss (version 26), using techniques such as regression, mean, standard deviation, and reliability tests (cronbach’s alpha). asian journal of economics and empirical research, 2025, 12(1): 9-20 19 © 2025 by the authors; licensee asian online journal publishing group findings revealed that most small businesses are registered taxpayers and understand their tax obligations, with 56.7% paying taxes. however, 50% delay in payments, and 52.2% fail to deduct taxes in financial records, increasing the likelihood of assessments. taxes are typically paid quarterly or annually, and small businesses benefit from incentives like tax holidays and rebates. however, they largely miss out on incentives for hiring recent graduates. while businesses maintain manual accounting records, these are generally reliable for tax assessment. fear of penalties emerged as a key motivator for compliance, but multiple tax burdens, including import duties, vat, and capital gains tax, pose significant challenges. the paper also identified common tax violations, including delayed payments, late filing of returns, and underreporting of taxes. taxes negatively influence financing decisions, reducing funds for hiring, investments, and working capital, and affecting profit retention. unfavorable tax policies discourage business expansion due to high compliance costs and operational burdens. many businesses rely on debt financing to avoid tax obligations tied to equity capital. challenges in the tax regime include high vat rates, excessive tax burdens relative to capital, corruption, inefficiencies in tax administration, and a lack of government accountability for tax revenue. additional issues include uncertainty in tax laws, irregular updates, multiple tax rates, inadequate taxpayer education, and unfair corporate tax practices. the study concluded that high tax rates and complex tax systems significantly hinder small business growth, while compliance costs contribute to default risks. tax policies negatively correlate with growth, as inappropriate regimes and poor management deter development. conversely, business experience positively affects growth, with older enterprises demonstrating greater resilience than newer ones. these findings underscore the need for simplified tax systems, fair policies, and improved education to foster the progress of smes in cape coast. 5.2. recommendation the study provides practical recommendations to foster a business-friendly tax environment for small businesses in kumasi and ghana. first, key recommendations include reducing the number and rates of tax obligations on small businesses. multiple tax levies discourage compliance, deplete capital, and place small businesses at a competitive disadvantage compared to larger firms, especially foreign-owned ones. high tax rates, described as prohibitive, often lead to delayed payments, the most frequent tax offense. even when tax rates are similar to those of larger enterprises, the relative financial burden on small businesses is significantly higher. lowering tax rates could incentivize compliance and support growth. additionally, the ghana revenue authority (gra) should implement laws requiring small businesses to maintain proper accounting records. tax assessments should be based solely on approved financial statements, ensuring transparency and efficiency. to support this, the gra should launch educational programs emphasizing the importance of accurate bookkeeping for reliable tax assessments. small businesses must also actively adopt proper accounting practices to combat tax fraud and increase government revenue for national development. lastly, by simplifying the tax system, reducing rates, and improving accounting standards, these measures aim to enhance compliance, reduce financial strain, and promote the sustainable growth of small businesses in ghana. 5.3. limitations and further studies more studies need to be carried out to ascertain the effect of tax incentives in ensuring that small businesses honor their tax obligations. additionally, further studies need to be conducted to determine whether or not firm size moderates the predictive relationship between taxation and the growth of small businesses within the cape coast metropolis. lastly, more studies must be conducted to investigate the influence of taxation on the capital of small businesses in ghana. references abiahu, m.-f. c., emuoghene, o., egbunike, a., & obada, p. j. 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(2022). key barriers for bioenergy projects implementation: a fresh insight from ghana. international journal of scientific and management research, 5(04), 237-256. https://doi.org/10.37502/ijsmr.2022.5418 asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.1007/s10797-020-09639-w https://doi.org/10.1002/jid.3351 https://doi.org/10.37118/ijdr.27698.01.2024 https://doi.org/10.1016/j.exis.2023.101228 https://doi.org/10.1002/jid.3756 https://doi.org/10.24294/jipd.v7i1.2127 https://doi.org/10.1002/bse.3606 https://doi.org/10.37502/ijsmr.2022.5418 21 © 2025 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 12, no. 1, 21-32, 2025 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v12i1.6553 © 2025 by the authors; licensee asian online journal publishing group the spatial impact of new urbanization construction on total factor productivity in china yuanyuan wang1 shengsheng li2 ( corresponding author) 1school of economics and management, tianjin university of science and technology, tianjin 300222, china. email: 2019110112@email.cufe.edu.cn 2school of business, fuyang normal university, fuyang 236037, china. email: lisheng2@foxmail.com abstract this study examines the spatial impact of new urbanization on total factor productivity (tfp) in china using data from 199 prefecture-level cities from 2011 to 2019. we measured the level of new urbanization using an indicator system and the entropy weight method, and assessed tfp using the stochastic frontier production function model. the spatial durbin model was employed to analyze the spatial effects empirically. the study found that (1) new urbanization has a positive spatial effect on tfp, and there is a spatial spillover effect. (2) the spatial effect of new urbanization on tfp has obvious city-level heterogeneity and regional heterogeneity. (3) the spatial spillover effect of new urbanization on tfp is most significant in second-tier cities and third-tier and lower cities. there is a "diffusion effect" of the spatial effect of the central and western cities on the neighboring areas, and a "siphon effect" of the spatial effect of the eastern cities, but both of these spatial effects are not significant. the spatial spillover effect of new urbanization on tfp in nonprovincial capitals is significant, whereas the spatial effect in non-provincial capitals is not significant. these findings highlight the importance of considering regional context in urbanization policies to enhance tfp. keywords: new urbanization, spatial durbin model, spatial spillovers, total factor productivity. jel classification: r11; o47; c23; r58. citation | wang, y., & li, s. (2025). the spatial impact of new urbanization construction on total factor productivity in china. asian journal of economics and empirical research, 12(1), 21–32. 10.20448/ajeer.v12i1.6553 history: received: 8 january 2025 revised: 18 march 2025 accepted: 26 march 2025 published: 4 april 2025 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this work is supported by fuyang normal university of china (grant number: 2023kyqd0043). institutional review board statement: not applicable. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. data availability statement: the corresponding author may provide study data upon reasonable request. competing interests: the authors declare that they have no competing interests. authors’ contributions: both authors contributed equally to the conception and design of the study. both authors have read and agreed to the published version of the manuscript. contents 1. introduction ...................................................................................................................................................................................... 22 2. methodology ..................................................................................................................................................................................... 23 3. data..................................................................................................................................................................................................... 24 4. results and discussion ................................................................................................................................................................... 26 5. heterogeneity analysis ................................................................................................................................................................... 29 6. conclusion ......................................................................................................................................................................................... 31 references .............................................................................................................................................................................................. 32 mailto:2019110112@email.cufe.edu.cn mailto:lisheng2@foxmail.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v12i1.6553 https://orcid.org/0009-0009-4073-0933 https://orcid.org/0000-0002-9501-5832 asian journal of economics and empirical research, 2025, 12(1): 21-32 22 © 2025 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study uniquely examines the spatial impact of new urbanization on total factor productivity (tfp) across 199 chinese cities using a spatial durbin model. it reveals city-level and regional heterogeneity in spatial spillovers, providing novel insights for targeted urbanization policies. 1. introduction the new urbanization is a variegated urban structure that is not simply concentrated in a limited area but is unevenly and densely distributed, unlike traditional metropolitanism or the urban/rural dichotomy (brenner, 2013). the chinese government plans for new urbanization mainly in three aspects: improving the existing urbanization model, promoting the citizenship of the agricultural transfer population, and achieving sustainable development (chen, ye, lu, sui, & guo, 2019; wang, hui, choguill, & jia, 2015; yu, 2021). in the process of china's urbanization, there was a single, crude, and blind pursuit of an increase in the urbanization rate at the expense of the quality and core significance of urbanization. although this has boosted china's rapid economic growth, it has also caused a series of environmental and economic problems, mainly encroachment on arable land, widening of the income gap, and impacts on the upgrading of industrial structure and innovation (liang & yang, 2019). as china's economy enters the stage of high-quality development, there is an even more urgent need to break the traditional crude urbanization development model to adjust the development of the economy. in economics, total factor productivity (tfp), also known as multifactor productivity, refers to the portion of output that cannot be explained by traditional measures of labor and capital inputs (avila & evenson, 2010; lipsey & carlaw, 2004; sargent & rodriguez, 2001). tfp serves as a key indicator of how productivity drives economic growth by accounting for output increases that are not attributable to input growth (van ark, 2014). in china, promoting new urbanization and leveraging its economic benefits, particularly through tfp increases, has become a crucial strategy to address current economic development challenges, such as regional disparities and sustainable growth. as the construction process of new urbanization continues to deepen, it is extremely important to measure the level of new urbanization and study its spatial effect on total factor productivity under the condition of leading highquality economic development. in the construction of the evaluation index system of new urbanization level, there has been a shift from the early single consideration of urban-rural integration to the development of three levels: environment, economy, and society. after china's 18th national congress, with the accelerated pace of urbanization, achieving steady and coordinated high-quality development to build new urbanization has become the main theme. according to the new requirements of china's 18th national congress for high-quality economic development, the evaluation index system of new urbanization was significantly adjusted to include multiple dimensions such as population development, public services, scientific and technological innovation, environmental protection, and integrated urban and rural development into the index system of new urbanization (fang, 2022). a large body of literature suggests that urbanization affects productivity levels (bertinelli & black, 2004; burgess & venables, 2004; landes, 2003; williamson, 1988). urbanization provides economies of scale that allow specialization among firms, which reduces production costs, and economies of scale in cities reduce transaction costs. the high population density of cities allows both workers with different skills and firms with specific needs to reduce their search costs. as a result of this agglomeration effect, urbanization enhances the flow of ideas and knowledge between cities and between firms, which in turn has an impact on productivity (henderson, 2005). meanwhile, along with the development of urbanization, it has different impacts on total factor productivity, mainly in the early stages due to the construction process of urbanization, which brings about an increase in factor costs, and excessive competition has a negative impact on tfp. however, with the deepening of urbanization, it has a significant contribution to tfp (kumar & kober, 2012), and the consequent emergence of new types of urbanization is more capable of increasing tfp. technological imitation effects exist between countries and can increase the basic innovation capacity of the host country (driffield, 2001). compared to inter-country factor flows, inter-provincial economic, cultural, and other factors face relatively fewer impediments to free flow, which is more conducive to the spatial agglomeration of factors, making technological imitation more likely to take place and generating spatial spillover effects (henderson, 2003). china's "people-centered" new urbanization aims to break down the urban-rural dichotomy, encourage the free movement of people, absorb the inflow of highly skilled labor, promote the dissemination and exchange of advanced management experience, technology, and enterprise culture, and strengthen regional industrial interaction. this provides a basis for the realization of technological imitation between the region and its neighbors, eliminating the "mutual exclusion effect" of market segmentation, enhancing the spatial spillover of total factor productivity, and raising the total factor productivity of neighboring cities. the construction of new urbanization is a top-down policy implemented by the central government (chen, liu, lu, chen, & ye, 2018). government competition is essentially an interactive strategy, and local government competition not only affects the level of total factor productivity in the region through technological innovation but also generates spillover effects to other regions. in addition, positive spatial spillovers from population agglomeration and economic development objectively lead to cross-regional factor flows, improving and optimizing regional allocation efficiency. in addition, china's new type of urbanization is guided by the concept of optimizing spatial layout, which rationalizes the regional division of labor within cities, reduces traffic congestion, increases transportation costs for enterprises, and causes long-distance separation of employees due to the chaotic division of functional districts. it also realizes the centralized supply and utilization of infrastructure (chen et al., 2019). this is an important foundation for enhancing the efficiency of public facilities utilization and improving the spatial spillover effect of new urbanization. neighboring cities will be more prone to regional cooperation, such as the construction of cross-city highways (li & wang, 2023). therefore, the supply of local public services not only affects local total factor productivity but also influences total factor productivity in neighboring regions through spatial spillover effects. although some studies are aware of the role of new urbanization on china's total factor productivity, they do not take into account the spatial spillover effects between cities at the spatial level and focus more on the macro-provincial level. therefore, this paper uses the data of 199 prefecture-level and above cities from 2010 to 2019 to estimate the asian journal of economics and empirical research, 2025, 12(1): 21-32 23 © 2025 by the authors; licensee asian online journal publishing group spatial impact effect of new urbanization on total factor productivity using spatial measurement methods. based on this, this paper adopts the entropy weighting method to hierarchically process and assign corresponding weights to 11 comprehensive indicators and 38 impact factors, and measures new urbanization by comprehensively considering many aspects, such as economic growth, population development, social construction, public services, livelihood welfare, ecological environment, digital infrastructure, business innovation, industrial upgrading, urban-rural integration, and financial development, etc. additionally, it adopts spatial correlation-based methods to construct a spatial measurement matrix of total factor productivity using the neighboring geographic distance weights and the inverse threshold distance matrix. based on the spatial correlation, the spatial panel data model is constructed by using neighboring geographic distance weights and the inverse threshold distance matrix to analyze the spatial spillover effect of china's new urbanization. 2. methodology 2.1. spatial panel model 2.1.1. spatial modeling in order to analyze the spatial impact of new urbanization on total factor productivity, this paper first constructs a panel spatial autoregressive model. (1) where is the i-th row of the spatial weight matrix , and . is an individual effect. if the spatial lag term is not considered, equation 1 is a standard static panel model. it is a fixed effects model if is correlated with and a random effects model if it is not. for maximum likelihood estimation (mle) of spatial panel models, the following spatial panel models can be estimated. (2) where is the first-order lag of the explanatory variable ; denotes the spatial lag of the explanatory variable, is the i-th row of the corresponding spatial weight matrix ; is the time effect, and is the i-th row of the spatial weight matrix of the disturbance term. in equation 2, if , it is a spatial durbin model (sdm); if and , it is a spatial autoregression model (sar); if and , it is a spatial autocorrelation model (sac); and if and , it is a spatial error model (sem). 2.1.2. setting of the spatial weighting matrix the in moran's i index is called the spatial weight matrix, which is used to measure the "distance" between the sample areas, portraying the proximity of cities or the economic distance considering the level of economic development, indirectly reflecting the correlation between cities. in this paper, we use the adjacency matrix and the inverse threshold distance matrix as spatial weighting matrices to analyze the interactions of new urbanization on tfp among cities. these two matrices cover both geographic and economic distances, ensuring the robustness of the results as much as possible. the expression for the adjacency matrix is . this means that the corresponding element of the spatial adjacency matrix is assigned a value of 1 if there are geographically adjacent boundaries in different regions, and 0 otherwise. the economic factors are further considered on the basis of the geographic distance matrix, with a view to incorporating both economic and geographic factors into the model and portraying the complexity of the spatial effects. the economic-geographic weighting matrix is set to , where . the set matrix is a diagonal matrix whose diagonal element is the ratio of the mean value of the cross-section economic variable to the overall economic variable, and the economic variable selected in this chapter is the per capita provincial gdp. 2.2. total factor productivity measurement methodology the explanatory variable in this paper is total factor productivity (tfp). we measure urban total factor productivity based on the stochastic frontier production function (sfpf) model proposed in the literature by battese and coelli (1992) and battese and coelli (1995). the advantage of this model is that the efficiency obtained from the measurement of sfpf eliminates the interference of the stochastic error term, and the specific model is set as follows. (3) (4) the model consists of two parts: equation 3 is the stochastic frontier production function, and equation 4 is the time-varying technical inefficiency function. where is the amount of output of the i-th decision unit in period t; is an expression for the stochastic production frontier function; denotes the vector of inputs of the i-th decision unit in period t; denotes the unknown to-be-estimated parameter; is the stochastic error term; is a non-negative random variable; and is the to-be-estimated parameter, with , , and denoting diminishing, unchanging, and increasing technological inefficiency over time, respectively. the deterministic production frontier function is. asian journal of economics and empirical research, 2025, 12(1): 21-32 24 © 2025 by the authors; licensee asian online journal publishing group (5) that is, . based on the index of change in total factor productivity. (6) where "." on the variable denotes the rate of change, is the share of expenditures on input factors, denotes total expenditures, and is the price of input factors. 2.3. entropy weight method the core explanatory variable of this paper is new urbanization construction (newurban), and the entropy weight method is used to assign corresponding weights to each indicator for hierarchical processing, and finally calculate the score of the new urbanization level of each city. the calculation steps of the entropy weight method are as follows. (1) transformation of data. in order to avoid the influence of different scales on the calculation results as much as possible, the evaluation indexes should be dimensionless before applying the entropy weight method. (7) in equation 7, represents the indicator value, represents the maximum value of the indicator, represents the minimum value, and is the processed indicator data and . (2) calculate the weight of the jth indicator for the ith region. (8) (3) the entropy value and the coefficient of variation of the indicator were calculated. (9) for the jth indicator, the greater the degree of dispersion of , the smaller its entropy value ; when the difference between the values of the indicators of the samples is greater, the smaller the value of , the greater the comparative role of the indicator for the samples, and the greater the weight given to it in the composite indicator. is the coefficient of variation. (4) calculate the weight of the jth indicator in the metric. (10) (5) the composite indicator calculated is . in general, the larger is, the higher the level of development of the system. 3. data 3.1. explained variable the explained variable in this paper is the total factor productivity level (tfp). building on section 2.2, we further refer to the solow model extended by karras (2010), where y is gross output expressed in terms of city gdp (gross domestic product), deflated using the gross domestic product (gdp) deflator price index with 1998 as the base period. the labor force l is expressed in terms of the number of persons employed in municipal units at the end of the period and the number of persons employed in private and self-employment in urban areas. the capital stock k is represented by the amount of fixed-asset investment in the calendar year, and the land resource r is expressed by the built-up area of each region, while the level of economic development, government fiscal expenditure, industrial upgrading index (three industries compared to the second), human capital (years of education per capita), foreign trade dependence (the total amount of imports and exports as a share of gdp), fixed-asset investment, and the green area per capita are selected as the environmental variables that affect the efficiency of production. finally, the total factor productivity of the city was measured using the sfpf model. 3.2. explanatory variable the primary explanatory variable of this paper is the level of new urbanization in china (newurban). based on the definition of new urbanization in china, this paper constructs an indicator system for new urbanization from multiple dimensions, such as population development, public services, scientific and technological innovation, and environmental protection. the level of new urbanization is measured using the entropy weight method, as detailed in section 2.3. the indicator construction and weights are shown in table 1. asian journal of economics and empirical research, 2025, 12(1): 21-32 25 © 2025 by the authors; licensee asian online journal publishing group table 1. new urbanization indicator system. evaluation dimension specific indicators unit/calculation weight indicator attributes economic growth gdp per capita ten thousand chinese yuan 0.233 positive indicator economic density billions of chinese yuan per square kilometer 0.079 positive indicator capital productivity gdp/capital stock 0.030 positive indicator labor productivity billions of chinese yuan per 10,000 persons 0.124 positive indicator total import and export trade million chinese yuan 0.535 positive indicator population development human capital number of higher education institutions/total population at the end of the year 0.730 positive indicator education expenditure per capita chinese yuan 0.268 positive indicator registered unemployment rate of urban population % 0.002 negative indicator social construction highway density total road mileage/total area of the region 0.463 positive indicator high-speed rail mileage kilometer 0.405 positive indicator percentage of fiscal general budget expenditure fiscal expenditure as a share of gdp 0.132 positive indicator public service hospital beds per 1,000 population — 0.149 positive indicator health technicians per 1,000 people — 0.146 positive indicator ratio of public administration and social organizations percentage of employees in the total population 0.132 positive indicator number of books in public libraries per capita — 0.573 positive indicator people's welfare sales price of commercial properties chinese yuan 0.145 positive indicator total retail sales of consumer goods per capita chinese yuan 0.158 positive indicator year-end balance of urban and rural residents' savings chinese yuan 0.273 positive indicator average wage of employees chinese yuan 0.059 positive indicator number of unemployment insurance participants — 0.365 positive indicator ecological environment number of environmental penalties — 0.003 positive indicator green space per capita square meter 0.997 positive indicator digital infrastructure number of international internet subscribers a household 0.147 positive indicator cell phone subscribers at the end of the year ten thousand households 0.130 positive indicator revenue from telecommunication services ten thousand chinese yuan 0.165 positive indicator number of employees in the information/computer services and software industry number of people 0.411 positive indicator number of internet broadband access users ten thousand households 0.147 positive indicator business innovation green invention patent applications — 0.357 positive indicator number of green utility model patent applications — 0.294 positive indicator number of invention patents granted in the year — 0.349 positive indicator industrial upgrade advanced industrial structure value added of tertiary industry/value added of secondary industry 0.369 positive indicator rationalization of industrial structure theil index (zhou & li, 2023) 0.631 positive indicator all-in-one city and countryside number of urban basic medical insurance participants number of people 0.905 positive indicator engel's coefficient — 0.095 positive indicator financial development number of employees in the financial industry number of people 0.196 positive indicator loan balance of financial institutions at the end of the year ten thousand chinese yuan 0.407 positive indicator balance of deposits of financial institutions at the end of the year ten thousand chinese yuan 0.344 positive indicator digital inclusive finance index — 0.053 positive indicator asian journal of economics and empirical research, 2025, 12(1): 21-32 26 © 2025 by the authors; licensee asian online journal publishing group 3.3. control variables based on the existing literature, the control variables affecting regional total factor productivity mainly include (1) the level of financial development (lnfin). the level of financial development is an important source of capital inputs in tfp, which is measured in this paper using the local year-end loan balances of financial institutions as a share of gdp and taking the logarithm of it. (2) level of economic development (lnpergdp). local gdp per capita was used for measurement, and logarithmic values were taken. (3) the level of trade development (lntrade). liang and wang (2022) found that trade openness presents a promoting effect on total factor productivity, which is measured by taking the logarithm of the total import and export trade in this paper. (4) education level (lnedu). the level of education affects total factor productivity by influencing the level of human capital, and generally, human capital enhancement is positively correlated with the development of total factor productivity (liang and wang (2022), which is measured in this paper by the number of years of education per capita in the region. (5) public green space (lngreen). liu, ouyang, and cai (2021) showed that the environment is one of the most important factors affecting total factor productivity, which is measured by taking the logarithm of green space per capita. (6) financial level (lndeposit): measured using the natural logarithm of resident savings in each city. (7) digital economy development level (lndigeco). the digital economy, as a new engine driving china's economic development, has an important impact on accelerating the transformation of old and new kinetic energy and enhancing total factor productivity, which is measured in this paper using the digital economy derived from principal component analysis (yu, zhang, & gong, 2022). table 2. statistical description of variables. variable obs. mean sd med min max newurban 1791 0.111 0.314 0.000 0.000 1.000 tfp 1791 1.534 0.750 1.547 0.105 2.940 lnpergdp 1791 10.704 0.580 10.650 8.773 12.579 lntrade 1791 13.761 2.092 13.787 3.219 19.254 lnedu 1791 7.211 0.459 7.159 5.796 9.002 lngreen 1791 -2.446 1.017 -2.405 -6.051 2.394 lndeposit 1791 16.759 0.985 16.642 14.415 20.156 lndigeco 1791 8.522 0.890 8.441 5.801 11.566 this paper uses panel data from 199 chinese cities from 2011 to 2019 to analyze the impact of china's new urbanization on tfp. the data used are from the china urban statistical yearbook of all years and the cnrds database (http://www.cnrds.com), and some of the missing data are filled in by consulting the statistical yearbooks of each province or by interpolation, and the descriptive statistics of the variables are shown in table 2. 4. results and discussion 4.1. baseline regression results in this paper, the likelihood ratio test and hausman test are used to determine that the model is a fixed-effects spatial durbin model (sdm). to compare the estimation results across various models, table 3 presents the results for the ordinary least squares (ols), spatial error model (sem), and spatial autoregressive model (sar), in addition to the sdm. table 3 includes control variables and individual and time dummy variables to account for individual and time effects. the results show that the core explanatory variable (newurban) is significant at the 1% level across all models. the spatial regression term in column (4) indicates that local new urbanization has a significant positive effect on the total factor productivity (tfp) of neighboring regions, with a coefficient of 10.6 (significant at the 1% level). the control variables reveal that the levels of economic development, trade, finance, and environment have significant negative effects on the tfp of neighboring regions. their coefficients are -2.409, -0.313, -1.661, and 1.409, respectively, all significant at least at the 5% level. table 3. baseline regression results. variable (1) (2) (3) (4) ols sem sar sdm main newurban 2.629*** (6.69) 0.667*** (2.63) 0.745*** (2.96) 0.807*** (3.19) lnpergdp -0.351*** (-5.81) 0.203*** (3.92) -0.009 (-0.20) 0.258*** (4.92) lntrade 0.058*** (4.17) -0.011 (-0.82) -0.030** (-2.35) -0.013 (-0.99) lnedu -0.300*** (-4.97) -0.084 (-1.63) -0.163*** (-3.27) -0.072 (-1.40) lngreen -0.661*** (-25.44) -0.167*** (-7.47) -0.204*** (-8.75) -0.180*** (-7.91) lndeposit -0.490*** (-9.93) 0.059 (0.74) -0.030 (-0.38) 0.140* (1.73) lndigeco 0.280*** (5.99) 0.032* (1.69) 0.025 (1.27) 0.030 (1.58) _cons 21.7346*** asian journal of economics and empirical research, 2025, 12(1): 21-32 27 © 2025 by the authors; licensee asian online journal publishing group variable (1) (2) (3) (4) ols sem sar sdm (34.31) wx newurban 10.606*** (4.39) lnpergdp -2.409*** (-6.98) lntrade -0.313** (-2.08) lnedu 0.433 (1.03) lngreen -1.409*** (-4.55) lndeposit -1.661** (-1.98) lndigeco -0.267 (-1.03) spatial lambda 2.517*** (83.14) rho 0.880*** (22.91) 0.714*** (8.80) variance sigma2_e 0.045*** (29.92) 0.048*** (29.83) 0.044*** (29.80) n 1791 1791 1791 1791 r2 0.3723 0.3821 0.0305 0.6703 196.575 163.616 240.332 note: standard errors are in parentheses; *, **, and *** indicate significant at the 10%, 5%, and 1% levels, respectively. why is this regression result? the reason may be due to the siphoning effect of the above control variables, such as economically developed regions attracting talent and capital inputs from neighboring regions, leading to their negative impact on the total factor productivity of neighboring regions. it also confirms that, based on the lessons learned from urbanization in western countries, china's new urbanization insists on a people-oriented realization of the integrated use of spatial resources. by maintaining the fairness of spatial resource allocation and the justice of spatial rights in different urban and rural areas and industries, it not only manifests the value principle of spatial justice but also improves the economic development level of the region and neighboring regions, and promotes the enhancement of regional tfp. 4.2. decomposition of spatial effects interregional interaction exists in many ways. on the one hand, the region's own new urbanization construction may also have a diffusion effect, spreading technological innovation and knowledge to neighboring regions, which has a positive effect on the total factor productivity (tfp) enhancement of neighboring regions; on the other hand, it can draw the inflow of labor and capital factors from the surrounding areas through the polarization effect, which further promotes the tfp enhancement of the region but, at the same time, inhibits the economic development of neighboring regions. for this reason, the spatial measurement method uses partial differentiation to decompose the total spatial impact effect into direct and indirect effects, where the direct effect measures the impact of new urbanization on total factor productivity (tfp) in the region, and the indirect effect measures the impact of local new urbanization on tfp in the surrounding areas (lesage & pace, 2009). see table 4 for the results of the decomposition of the effects of the spatial durbin model. two spatial matrices, the adjacency matrix and the inverse threshold distance matrix, were used for the spatial effects estimated by the sdm model in table 4. as can be seen from the estimation results, the direct effect regression results of the adjacency matrix and the inverse threshold distance matrix indicate that the coefficients of the impact of new urbanization on the total factor productivity of this region are 0.656 and 0.732, respectively, both of which are significant at the 1% significance level. that is, new urbanization has a significant promotional effect on the total factor productivity of this region. the indirect effect regression results of the adjacency matrix and the inverse threshold distance matrix show that the coefficients of the impact of new urbanization on the total factor productivity of the surrounding areas are 1.595 and 1.237, respectively, which are both significant at the 1% significance level. that is, new urbanization also has a significant contribution to the total factor productivity of the surrounding areas. the direct effect results indicate that new urbanization has a significant contribution to total factor productivity in the region. the indirect effect can be interpreted as a "spatial spillover effect" of new urbanization, indicating that local new urbanization impacts the total factor productivity of surrounding areas. the main reason for this is that new urbanization has led to an increase in total factor productivity in the surrounding areas through factor flows, industrial development, and technological innovation spillovers, creating a strong diffusion effect, which in turn promotes the development of total factor productivity in the surrounding areas. asian journal of economics and empirical research, 2025, 12(1): 21-32 28 © 2025 by the authors; licensee asian online journal publishing group table 4. decomposition of the effects of the spatial durbin model. variable (1) (2) neighborhood matrix inverse threshold distance matrix direct effect newurban 0.656** (2.51) 0.732*** (2.84) lnpergdp 0.121** (2.42) 0.132*** (2.62) lntrade -0.027** (-2.19) -0.009 (-0.73) lnedu -0.129*** (-2.60) -0.084* (-1.66) lngreen -0.208*** (-9.06) -0.187*** (-8.26) lndeposit -0.038 (-0.46) 0.107 (1.30) lndigeco 0.040* (1.88) 0.032 (1.56) indirect effect newurban 1.595*** (3.75) 1.237* (1.66) lnpergdp -0.489*** (-6.20) -0.338*** (-3.32) lntrade -0.0804** (-3.54) -0.129*** (-4.03) lnedu -0.037 (-0.48) -0.311** (-2.48) lngreen -0.169*** (-3.43) -0.300*** (-3.79) lndeposit 0.283*** (2.78) -0.286 (-1.62) lndigeco -0.043 (-1.04) -0.010 (-0.14) total effect newurban 2.251*** (4.49) 1.969** (2.52) lnpergdp -0.367*** (-4.58) -0.206** (-2.04) lntrade -0.108*** (-4.05) -0.138*** (-3.96) lnedu -0.167* (-1.82) -0.395*** (-3.00) lngreen -0.377*** (-6.50) -0.487*** (-5.65) lndeposit 0.246* (1.73) -0.179 (-0.91) lndigeco -0.003 (-0.06) 0.022 (0.28) n 1791 1791 r2 0.12 0.4120 log-likelihood 198.661 217.193 note: standard errors are in parentheses; *, **, and *** indicate significant at the 10%, 5%, and 1% levels, respectively. 4.3. spatial correlation test based on moran's i index moran's i index is subdivided into global and local moran's i indexes, which are used to measure the spatial agglomeration effect in the vicinity of all samples and a single sample, respectively. we measured the global autocorrelation of new urbanization using a variety of spatial weight matrices, verified the existence of the spatial effect of new urbanization among regions, and provided support for the establishment of spatial measurement models. the moran's index is calculated using the formula. (11) where, , , in equation 11 is the spatial weight matrix, which can be set to different forms depending on the problem, is the sample observation in the ith region, and n is the total number of samples. in this paper, n represents the prefecture-level cities under study; represents the new urbanization level of i prefecture-level cities (newurban value); and represents the mean value of the new urbanization level of each prefecture-level city. the moran's i statistic calculated from equation 11 takes the range of [-1, 1], where positive values represent positive spatial autocorrelation, negative values represent negative spatial autocorrelation, and 0 represents spatially uncorrelated. table 5 gives the trends of moran's i values for the adjacency matrix and the inverse threshold distance matrix for china's new urbanization from 2011-2019, respectively. asian journal of economics and empirical research, 2025, 12(1): 21-32 29 © 2025 by the authors; licensee asian online journal publishing group table 5. new urbanization, moran's i index. year adjacency matrix inverse threshold distance matrix i z p-value* i z p-value* 2011 0.149 2.525 0.006 0.155 3.984 0.000 2012 0.150 2.534 0.006 0.159 4.075 0.000 2013 0.228 3.816 0.000 0.213 5.421 0.000 2014 0.240 4.025 0.000 0.240 6.093 0.000 2015 0.248 4.160 0.000 0.232 5.896 0.000 2016 0.263 4.397 0.000 0.245 6.229 0.000 2017 0.274 4.586 0.000 0.266 6.758 0.000 2018 0.311 5.188 0.000 0.313 7.931 0.000 2019 0.282 4.706 0.000 0.305 7.711 0.000 from table 5, it can be seen that: first, the moran's i value of the adjacency matrix is in the range of 0.149 to 0.311, indicating that there is a positive spatial correlation between the new urbanization of each city. that is, the new urbanization of a city will have a positive impact on the new urbanization of cities in neighboring provinces, and it shows a yearly strengthening trend from 2011 to 2018, with only a slight decrease in 2019, but still at a high level. secondly, the moran's i value of the inverse threshold distance matrix is between 0.155 and 0.313, and has shown a yearly strengthening trend since 2011. in addition, the moran's i value of the inverse threshold distance matrix is higher than that of the neighboring matrix as a whole, indicating that there is not only a spatial correlation in geographic location but also a positive spatial correlation in the economy for the new urbanization of each city. it indicates that a certain city with a high level of economic development will have a positive influence on the new urbanization of the surrounding neighboring cities. 5. heterogeneity analysis the promotion effect of new urbanization may also be heterogeneous in its spatial distribution. since there are large differences in factor endowments between chinese cities, and cities with larger administrative levels and scales have rich factor possessions and economic development advantages, there will also be regional heterogeneity in spatial spillover effects. on the one hand, enterprises tend to re-industrial agglomeration, technological spillover, and scale economies due to the triple factor incentives, and they prefer to cluster in the larger or higher administrative level of the city radiation belt. on the other hand, in terms of the spatial spillover effect of new urbanization, the economic strength of the city is stronger, and the population size is often more likely to play the role of economies of scale, becoming a spatial agglomeration of the 'centripetal force'. therefore, the magnitude of the impact of new urbanization on the promotion of total factor productivity is influenced by the urban area. for example, in regions where the pilot cities of the new urbanization policy are concentrated, new urbanization may have a promotional effect on total factor productivity mainly through diffusion, while in regions where new urbanization itself is more developed, it may have a "siphoning effect" on the total factor productivity of the surrounding regions, which is not conducive to the development of total factor productivity in the neighboring regions. therefore, it is necessary to analyze the spatial effect of total factor productivity of new urbanization in terms of urban heterogeneity. 5.1. city-level heterogeneity we have categorized the city levels into tier 1 cities, tier 2 cities, and cities below tier 3 (including tier 3) based on the latest chinese city grading list. see wang, li, and jiang (2022) for specific divisions of the city. the regression estimation of city-level heterogeneity was carried out according to the set sdm model, and the estimation results are shown in table 6. according to the heterogeneity regression results of city level in table 6, the spatial spillover effect of new urbanization on total factor productivity is most significant in second-tier cities and third-tier and lower cities, with the impact coefficients of 15.316 and 18.720, respectively, and all of them are significant at the 1% level. this suggests that second-tier and third-tier and lower cities are the main choices for new urbanization policy pilots and are the primary direction of new urbanization policy pilots. therefore, the spatial diffusion effect of technological innovation and so on brought about by them can be maximized. that is to say, the development of new urbanization in this region will lead to the growth of total factor productivity in the surrounding areas and have a positive impact on them. the coefficient of the spatial spillover effect of the new urbanization of first-tier cities on total factor productivity is -3.201 and is insignificant. this result can reflect that the spatial effect of the first-tier cities on the surrounding areas is more of a "siphon effect"; i.e., the first-tier cities, due to the business environment and career development opportunities, will attract the inflow of population and capital from the surrounding cities, which is not conducive to the economic development of the neighboring areas and the improvement of total factor productivity. 5.2. regional heterogeneity analysis due to the imbalance of development between regions in china, we divide cities into eastern, central, and western cities based on their location (zhou & li, 2023). the results of the regional heterogeneity estimates are shown in table 7. as can be seen from the results of the regional heterogeneity regression in table 7, the spatial impact coefficients of new urbanization on total factor productivity in eastern, central, and western cities are -0.344, 5.220, and 1.845, respectively, and none of them are significant. however, the impact coefficients in central and western cities are positive. this result suggests that the spatial effect of central and western cities on the surrounding areas is more of a 'diffusion effect,' while the spatial effect of eastern cities may have a 'siphon effect'; however, this spatial effect is not significant. asian journal of economics and empirical research, 2025, 12(1): 21-32 30 © 2025 by the authors; licensee asian online journal publishing group table 6. regression results for city-level heterogeneity. variable (1) (2) (3) tier 1 cities tier 2 cities cities below tier 3 (including tier 3) main newurban -0.107 (-0.15) 3.715*** (4.17) -1.260*** (-2.97) lnpergdp 0.227 (0.77) -0.100 (-0.97) 0.281*** (4.65) lntrade -0.175** (-2.05) -0.0978** (-2.16) -0.026* (-1.94) lnedu -0.586** (-1.99) 0.052 (0.33) -0.114** (-2.06) lngreen -0.423* (-1.76) -0.350*** (-3.31) -0.181*** (-7.65) lndeposit -0.512 (-1.12) -0.503*** (-3.29) 0.273*** (2.93) lndigeco -0.005 (-0.03) -0.065 (-0.91) 0.016 (0.81) wx newurban -3.201 (-0.64) 15.316*** (4.18) 18.720*** (4.00) lnpergdp 4.340** (2.33) -0.197 (-0.70) -2.558*** (-7.27) lntrade -0.898** (-2.10) -0.587** (-2.52) -0.276* (-1.95) lnedu -3.294* (-1.88) 0.603 (0.78) 0.481 (1.22) lngreen -1.941 (-1.52) 0.336 (0.81) -1.602*** (-5.19) lndeposit 3.784 (1.47) 0.286 (0.29) -0.757 (-0.93) lndigeco -3.367*** (-4.63) -0.461 (-1.09) -0.206 (-0.79) spatial rho -0.317 (-1.06) -0.948*** (-5.16) 0.633*** (6.47) variance sigma2_e 0.018*** (6.96) 0.024*** (9.60) 0.046*** (27.17) note: standard errors are in parentheses; *, **, and *** indicate significant at the 10%, 5%, and 1% levels, respectively. table 7. regional heterogeneity results. variable (1) (2) (3) eastern cities central cities western cities main newurban 1.388*** (3.56) 0.862* (1.84) 0.153 (0.30) lnpergdp 0.150 (1.58) 0.407*** (5.41) 0.104 (1.00) lntrade -0.127*** (-3.02) 0.006 (0.36) -0.005 (-0.27) lnedu -0.053 (-0.51) -0.129* (-1.75) -0.087 (-0.90) lngreen -0.254*** (-4.38) -0.104*** (-3.90) -0.202*** (-3.79) lndeposit 0.274** (2.17) -0.053 (-0.39) 0.088 (0.56) lndigeco 0.018 (0.46) -0.055* (-1.92) 0.107*** (3.19) wx newurban -0.344 (-0.15) 5.220 (1.30) 1.845 (0.38) lnpergdp -2.033*** (-5.09) -0.823*** (-2.62) -0.726 (-1.22) lntrade -1.395*** (-4.42) -0.125 (-1.16) -0.272 (-1.62) lnedu 1.706*** (3.62) -0.990* (-1.94) 0.855 (1.25) lngreen 1.344*** (2.58) -0.626** (-2.46) 0.117 (0.21) lndeposit -0.596 (-0.59) -1.198 (-1.38) 1.527 (1.14) lndigeco -0.185 (-0.69) 0.163 (0.57) -0.653** (-2.00) spatial rho 0.595*** (6.15) 0.453*** (3.73) -0.129 (-0.59) variance sigma2_e 0.0462*** (17.38) 0.0328*** (18.49) 0.0472*** (15.58) note: standard errors are in parentheses; *, **, and *** indicate significant at the 10%, 5%, and 1% levels, respectively. asian journal of economics and empirical research, 2025, 12(1): 21-32 31 © 2025 by the authors; licensee asian online journal publishing group 5.3. heterogeneity analysis of whether a city is a provincial capital china's capital cities are economically developed and have a siphoning effect on talent and resources from neighboring cities. for this reason, we divided the sample into capital cities and non-capital cities for regression, and the regression results are shown in table 8. as shown in table 8, the spatial spillover effect of new urbanization in non-capital cities on total factor productivity is more significant, with an impact coefficient of 16.067, which is significant at the 1% level. this indicates that non-capital cities are the main choice of cities for new urbanization policy pilots, which can maximize the spatial diffusion effect of knowledge spillover. that is to say, the development of new urbanization in non-capital city areas will lead to the growth of total factor productivity in the surrounding areas and have a positive impact on them. the coefficient of the spatial spillover effect of new urbanization on total factor productivity in provincial capital cities is -4.7703 and is not significant. although it is not significant, the coefficient is negative, which can reflect that provincial capital cities have the same characteristics as first-tier cities and eastern cities; that is, their spatial effect on neighboring areas is more of a "siphon effect." that is, as economic and political centers, provincial capital cities often have more developed infrastructure and investment convenience, which may attract the flow of population and capital to their surrounding cities, which is not conducive to the economic development and total factor productivity of the surrounding areas. table 8. results from regressions of heterogeneity in whether a city is a provincial capital. variable (1) (2) provincial capital cities non-provincial capital cities main newurban 1.384*** (2.76) -0.019 (-0.05) lnpergdp -0.034 (-0.17) 0.267*** (4.85) lntrade -0.041 (-1.26) -0.019 (-1.42) lnedu 0.208 (1.54) -0.108** (-1.98) lngreen -0.173 (-1.24) -0.176*** (-7.48) lndeposit -0.164 (-1.17) 0.174** (1.97) lndigeco 0.021 (0.29) 0.025 (1.24) wx newurban -4.770 (-1.42) 16.067*** (5.17) lnpergdp -4.798*** (-3.61) -2.260*** (-6.57) lntrade 0.076 (0.49) -0.302** (-2.05) lnedu 0.934 (1.30) 0.520 (1.24) lngreen -0.786 (-0.82) -1.583*** (-5.07) lndeposit 2.005** (1.97) -1.976** (-2.27) lndigeco 0.199 (0.54) -0.207 (-0.77) spatial rho -0.558** (-2.02) 0.687*** (7.90) variance sigma2_e 0.0138*** (8.33) 0.0463*** (28.50) note: standard errors are in parentheses; **, and *** indicate significant at the 5%, and 1% levels, respectively. 6. conclusion this paper empirically examines the spatial impact effect of new urbanization construction on total factor productivity (tfp) by using a spatial durbin model on panel data from 199 prefecture-level cities in china. the results show that (1) the moran's i value of china's new urbanization, based on the adjacency matrix and the inverse threshold distance matrix, indicates that new urbanization has a spatial positive impact on tfp and there is a spatial spillover effect. (2) the results of the heterogeneity analysis show that the spatial effect influence of new urbanization on total factor productivity exhibits obvious city-level heterogeneity and regional heterogeneity. (3) the spatial spillover effect of new urbanization on total factor productivity is most significant in second-tier cities, third-tier cities, and the following cities; the spatial effect of central and western cities on the surrounding areas has a 'diffusion effect', while the spatial effect of eastern cities has a 'siphon effect'. there is a 'diffusion effect' in the spatial effect of central and western cities on the surrounding areas, while there is a 'siphoning effect' in the spatial effect of eastern cities, neither of which is significant; the spatial spillover effect of new urbanization on total factor productivity is more significant in non-provincial capital cities. asian journal of economics and empirical research, 2025, 12(1): 21-32 32 © 2025 by the authors; licensee asian online journal publishing group therefore, it is important to seize the opportunity of new urbanization to develop the economy in accordance with local conditions and to strengthen interregional exchanges and learning. to this end, it is necessary to combine the characteristics of the industrial and economic development of the region and the neighboring regions. on the one hand, develop the regional economy in accordance with local conditions, taking into account the region's own geographic advantages and resource endowment base. formulate economic development policies in a targeted manner and explore the development paths of the new type of urbanization with their own characteristics in order to enhance total factor productivity. on the other hand, strengthen communication and exchanges between the regions to avoid homogeneous industrial competition. the experience of the pilot reforms of new urbanization should be better absorbed by exploring staggered competition and differentiated development, so as to maximize the use of regional advantages to develop their own economies and enhance total factor productivity. references avila, a. f. d., & evenson, r. e. 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(2024). can green technologies serve as a pathway for women’s socioeconomic inclusion in africa? asian journal of economics and empirical research, 11(2), 103–110. 10.20448/ajeer.v11i2.6282 history: received: 10 october 2024 revised: 20 november 2024 accepted: 17 december 2024 published: 31 december 2024 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. data availability statement: the corresponding author may provide study data upon reasonable request. competing interests: the authors declare that they have no competing interests. authors’ contributions: all authors contributed equally to the conception and design of the study. all authors have read and agreed to the published version of the manuscript. contents 1. introduction .................................................................................................................................................................................... 104 2. literature review .......................................................................................................................................................................... 105 3. study methodology ....................................................................................................................................................................... 105 4. estimation results and interpretations .................................................................................................................................... 106 5. conclusions and recommendations ........................................................................................................................................... 109 references ............................................................................................................................................................................................ 109 mailto:djasido@yahoo.fr mailto:orfchouafi@yahoo.fr mailto:mrimaguekam@yahoo.fr mailto:jnzomo@yahoo.fr https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v11i2.6282 https://orcid.org/0009-0003-1121-9120 https://orcid.org/0000-0001-6825-3088 https://orcid.org/0009-0006-3138-0810 asian journal of economics and empirical research, 2024, 11(2): 103-110 104 © 2024 by the authors; licensee asian online journal publishing group contribution of this paper to the literature it adds to the existing literature by examining the intersection of technology, gender, and sustainable development in the african context. it emphasizes the ways in which green technologies can enhance women’s economic and social empowerment, supported by evidence and case studies that illustrate their effectiveness. 1. introduction given the current global challenges of climate change and environmental sustainability, green technology has emerged as one of several key innovations to address humanity’s impact on the planet earth (buechler & hanson, 2020). in africa, a continent with strong reliance on women to be the backbone of local economies and households, it is especially important to investigate how green technologies may affect their socio-economic status. this technology presents possibilities for economic and social progress but also bears questions about access to it on an equal level as well as challenges women (braidotti 2019). the use of green technology is essential for achieving a fair and sustainable ecological transition, an objective that requires gender-balanced representation in the sector (smith, 2019). one of the additional reasons is that women bring a different perspective and skills to enhance technological innovation in more comprehensive manner, resulting in integrated, effective solutions (banerjee 2016; united nations environment program, 2020). according to wilson and johnson (2018) involving women in the green technology sector also empowers them economically, as well as addresses issues of gender equality. green technologies can have a major impact on the social and economic situation of women, as they contribute to changing environmental sectors as well as promoting sustainable development and generating jobs or income opportunities. evidence demonstrates that the uptake of green technologies has several positive impacts on women's economic empowerment in development countries (agarwal 2010; ambast 2013; zhao, wanxia, zou, & yonghua, 2015). improving women’s access to green technologies can alleviate some of the gender disparities in employment and entrepreneurship, as well as help increase their effective engagement with a move towards sustainable economy (alvord, brown, & letts, 2004; mitra, murayama, & wuan 2013). in addition, clean technologies could be another option for women to penetrate new areas: renewable energy; natural resource management; and sustainable agriculture. in fact the aim is that it may contribute to increasing their economic independence and political decision-making (alsamarrai & rooij 2015). not surprisingly, women have a proven track record for mentoring about green technologies, and this role can be used to build community networks that further defend their position as key actors in social environmentalism (dankel & pascual, 2016; flora & kroma, 2019). therefore, ensuring that women receive education and training to further work with green technologies is a must for a commonsense economic social theory of independence in these times (mitchell, 2019; owino & mugo, 2020). the turn to sustainable practices and green technology has stimulated debate on how this relates to women in africa. based on jalan and ravallion (2003) it is worth noting that women are major components of agriculture in africa, thereby serving as significant repercussions for their employment and functionality levels if the adoption of green technologies, which is advocated within this sector, is not done. similarly, barnes, openshaw, smith, van der plas, and roulet (1994) even reinforce that women's well-being in africa is deeply linked with their ability to access energy and prompt further research on how green technologies can increase this access while supporting women’s economic empowerment. nonetheless, one must admit that the gendered socio-economic and cultural dynamics of women in africa could affect the adoption and usage behavior towards green technologies. this is expanded upon by chakravarty and ray (2015) who argue that as a result of gendered primary distribution, women have access to fewer resources– including green technologies-which limit their opportunity to take full advantage. there are also specific health and safety considerations for women that can impact their use of green technologies one way or another; ritter and buxton (2012) cover many in the realm of cannabis regulatory policies. therefore, we seek to explore specifically how green technologies affect women’s socio-economic status in africa in areas including employment; education and training for greener jobs; access to energy services (energy justice); health benefits; outcomes of using clean/ modern fuels at household level due to improved air quality as a result of the use of renewable sources supplying heating & cooling electricity production; and income gains through job creation results that reinvest those proceeds into human development projects and social networks that promote enterprise activity. of late, literature has started to take an interest in the implications of eco-friendly practices/technologies on women in africa. green technologies on women's employment in africa must be examined to understand the economic and social dynamics (smith & jones, 2020). in sub-saharan africa, brown and johnson (2018) stress the importance of access to clean energy for women's empowerment. however, it is important to realize that the adoption and use of green technologies could be shaped by various socio-economic and cultural aspects of women in africa. assessment climate change mitigation policies may affect women and men differently (garcia & wang, 2017) thus requiring an analysis of gender aspects. patel and kim (2016) present research that interacts with women entrepreneurs in africa’s green economy and identifies bottlenecks as well as opportunities for their involvement. as the international labour organisation (ilo) (2012b) points out, in past, green technologies offered women a huge chance to improve socially and economically their living conditions. for example, these technologies could potentially allow women to attain fair leadership and engagement in clean production processes (bové & gallego, 2020) thus encouraging their economic independence. green technologies can also provide an opportunity to educate and train women in areas of innovation, meaning a higher level of employability in the society (filipović, lior, & radovanović, 2022). however, in discussing the economic effects of green technology, there have been relatively few empirical studies on this factor, and to our knowledge, very little at all has focused upon gender and nothing for africa. furthermore, even those who have more generally studied the issue do not distinguish development level between countries. this is the issue that this article attempts to address by exploring how green technologies can impact gender socioeconomic inclusion and at different levels of development in african countries. this article is going to be divided into the following four parts. in section 2, we briefly discuss how green technologies are theorized and empirically shown to affect the socio-economic integration of women. section 3: this asian journal of economics and empirical research, 2024, 11(2): 103-110 105 © 2024 by the authors; licensee asian online journal publishing group section will describe the methodology used for carrying out this study. findings will be put forward in section 4, and the conclusion with suggestions is focused on section 5. 2. literature review 2.1. theoretical literature to understand the implications of green technologies on women's socio-economic status, numerous theoretical frameworks such as eco-feminism, empowerment theory, sustainable development theory, and environmental justice can be applied. ecofeminism, in the integration of feminist perspectives and environmental issues, shows how women’s oppression is related to the environmental degradation. this is also a perfect example of how green technologies can generate women’s self-employment while saving the planet (shiva, 2016). advocates of empowerment theory, for example, posit that green technologies could make it easier to directly empower women by rebalancing economic power relations and reducing female dependence on males. this in turn contributes to more access to education, employment, and sustainable income (kabeer, 1999). green technologies are viewed in the theory on sustainable development (advocated by sen (1999) as among key components of inclusive and equitable growth that seek to integrate economic, social, and environmental imperatives. this approach is useful in ensuring that women experience growth in both the economy and the environment. finally, supporters of the theory claim that the growth and environmental justice is that women are always hit hardest by the negative effects of climate change and ecocide (most so in third world countries) but tend to keep quiet. green technologies offer a way to address these inequalities with sustainable and resilient solutions for the most vulnerable communities (bullard 1990). 2.2. empirical review a number of studies in empirical literature have been undertaken on the impact of green technologies on women and their socio-economic status. this body of research reveals, in broad terms, the complex ways through which green technologies affect aspects of women's everyday lives, like employment and education; energy access not only for households but also at work or within household occupations, such as small business homes, is quite common among rural poor populations; health status (due to smoke inhalation from using these dirty fuels, leading to millions of deaths annually); household income rises when previously cooking spent time is saved on higher-paying activities instead, etc. using the propensity score matching, jalan and ravallion (2003) found a considerable increase in female beneficiaries' employment after treatment under an anti-poverty program. fujii, shonchoy, and xu (2018) analyzed the health consequences of electrification for children in rural bangladesh and indicated a significant increase in child nutrition when finally electrically equipped. chakravarty and ray (2015) also recognized the positive association between female labor force participation and child health, based on evidence from india. barnes et al. (1994) detailed implications on energy in sustainable development, stating that women and communities will get better living standards with self-reliant power supplies built from regional renewable energies. ritter and buxton attempted to analyze social welfare impacts of cannabis policies in a five-tier policy space, with the heaviest emphasis on health outcomes for women where positive correlations (and causation) had been shown. longterm exposure to light pollution has been discussed as a health risk for the human body and even more so in women (blum & feigenbaum, 2015). this point was further supported by schultz (2002) which showed that girls education had a wide range of social and economic benefits, some notable ones being potentially increasing household income. blackden and wodon (2006) looked at the individual countries in sub-saharan africa to find out how time use is gendered, who works more than one job, and which jobs women are least likely to do due to competing opportunities within poorer homes. in general, green technologies positively affect the socioeconomic condition of women (kumari, pallathadka, ayappan, & agrawal, 2023; oecd development centre/oecd, 2023). research from the european investment bank survey (2024) shows that green investments actually help tackle another pillar of social justice, gender inequality, creating employment for women and increasing their involvement in projects. novotný, huttmanová, valentiny, and kalistová (2021) and hanna, heptonstall, and gross (2024) found that the introduction of green technologies in solar energy has had a positive impact on female manufacturing employment; device installation increases household savings pressure associated with everyday tasks for women who manage their households. schwerdt, neumayer, and graefe (2020) and smits, neijens, stam, and de boer (2018) show that green technologies can decrease women's domestic workload and hence labor force participation and economic empowerment in turn. the bové and gallego (2020) discovered that the incorporation of green technologies in economic activities enables women to have equal leadership, as well as participate in opportunities that will lead them into a better socioeconomic status. vásquez-carbonell (2022) conducted a case study on the use of green technologies in ict (information communication technology) for women’s engagement and economic empowerment, specifically focusing on pakistan. research on gender and green jobs in kenya (nelson, 1994) indicates that sectors such as clean energy, waste management, and renewable energy offer employment opportunities for women. additionally, banerjee, banerjee, and ganguly (2018) and wilson and johnson (2018) felt that the ability of green technologies to provide new sources of deliverable power, especially within growing sectors like clean energy, and renewables, as well as reduced gender inequalities, also challenged sexist stereotypes by providing women an entrance into male-dominated economic areas, which may ultimately affect a reduction in poverty rates among african people through sustainable investment for further mne (multinational enterprises) capacity-enhancing workforces. 3. study methodology 3.1. data in order to analyze the effects of green technologies on the socio-economic integration of women, we use secondary data from various sources such as the wdi (world development indicator) database, unesco (united nations educational, scientific and cultural organization), and the ilo ilostat (international labor asian journal of economics and empirical research, 2024, 11(2): 103-110 106 © 2024 by the authors; licensee asian online journal publishing group organization statistic) database. the evaluation methodology covers a sample of 36 african countries, distributed according to their income levels (see table 8 in the appendix). the study covers the period from 2014 to 2023. 3.2. specification of study design to illustrate the relationship between green technologies and the socioeconomic integration of women in africa, we draw inspiration from the work of the oecd development centre/oecd (2023) and the world bank group (2019). the basic equation is formulated as follows: 𝐸𝑚𝑝𝑙𝑊𝑜𝑚𝑒𝑛𝑖𝑡 = 𝛼0 + 𝛼1𝐼𝑛𝑣𝑒𝑠𝑡𝑇𝑒𝑐ℎ𝑖𝑡 + ∑ 𝛼𝑖𝑍𝑖𝑡 + 𝜀𝑖𝑡 𝑛 𝑖=2 (1) where 𝐸𝑚𝑝𝑙𝑊𝑜𝑚𝑒𝑛𝑖𝑡is the dependent variable representing the percentage of women in formal jobs relative to the total female labor force;𝐼𝑛𝑣𝑒𝑠𝑡𝑇𝑒𝑐ℎ𝑖𝑡 is the variable of interest representing investments in renewable energy.𝑍𝑖𝑡 represents all the control variables in the model, such as women's education level, women's access to health services, and women's entrepreneurial opportunities. indeed, • level of education of women (scholar women): measured by the literacy rate of women or the level of school completion. • availability of health services (health women): measured by access to basic health care and family planning. • access to female entrepreneurial opportunities or the rate of business creation by women (women entrepreneurship): this is the number of new businesses created or managed by women compared to the total number of newly created businesses in a period of data. • income and standard of living (income women): measurement of the income received by women, as well as the standard of living, including access to essential services such as housing, drinking water, and food. and, 𝜀𝑖𝑡represents the error term. we can therefore rewrite the model as follows: 𝐸𝑚𝑝𝑙𝑊𝑜𝑚𝑒𝑛𝑖𝑡 = 𝛼0 + 𝛼1𝐼𝑛𝑣𝑒𝑠𝑡𝑇𝑒𝑐ℎ𝑖𝑡 + 𝛼2𝑆𝑐ℎ𝑜𝑙𝑎𝑟𝑊𝑜𝑚𝑒𝑛𝑖𝑡 + 𝛼3𝐻𝑒𝑎𝑙𝑡ℎ𝑊𝑜𝑚𝑒𝑛𝑖𝑡 + 𝛼4𝑊𝑜𝑚𝑒𝑛𝐸𝑛𝑡𝑟𝑒𝑝𝑖𝑡 + 𝛼5𝐼𝑛𝑐𝑜𝑚𝑒𝑊𝑜𝑚𝑒𝑛𝑖𝑡 + 𝜀𝑖𝑡 (2) we will use the following estimation techniques to analyze the data: • fixed effects or random effects models: to take into account differences between countries or regions. lewbel 2sls method (2012): to deal with potential endogeneities between variables. • quantile method: to explore the effects of green technologies on different segments of the distribution of women's socio-economic situation. using these estimation techniques and controlling for other relevant variables, we will be able to robustly assess the effects of green technologies on the socio-economic situation of women in africa for the period 2014-2023. 4. estimation results and interpretations 4.1. stationarity tests table 1 summarizes the results of the cadf (cross-sectional augmented dickey-fuller) and cips (crosssectional im pesaran shin) stationarity tests for the variables specified in the study. table 1. summary of stationarity tests. variable(s) cadf statistic cadf critical value cips statistic cips critical value green technology(𝐼𝑛𝑣𝑒𝑠𝑡𝑇𝑒𝑐ℎ) -3.21 -3.96 -2.85 -3.20 level of education of women(𝑆𝑐ℎ𝑜𝑙𝑎𝑟𝑊𝑜𝑚𝑒𝑛) -2.95 -3.96 -2.70 -3.20 access to health services(𝐻𝑒𝑎𝑙𝑡ℎ𝑊𝑜𝑚𝑒𝑛) -3.15 -3.96 -2.80 -3.20 economic participation of women (𝐸𝑚𝑝𝑙𝑊𝑜𝑚𝑒𝑛) -3.05 -3.96 -2.90 -3.20 entrepreneurial opportunity offered to women (𝑊𝑜𝑚𝑒𝑛𝐸𝑛𝑡𝑟𝑒𝑝) -2.78 -3.96 -2.54 -3.20 income received by women(𝐼𝑛𝑐𝑜𝑚𝑒𝑊𝑜𝑚𝑒𝑛) -2.79 -3.96 -2.81 -3.20 for all variables, the cadf (fuller, 1976) and cips (cross-sectional im pesaran shin) (im, pesaran, & shin, 2003) test values are lower than the corresponding critical values, indicating that the variables are stationary. this means that the variables of green technology, women's education level, access to health services, women's economic participation, women's entrepreneurial opportunity, and the income received by women do not present any significant differences, trends, or systematic patterns in their fluctuations over time. 4.2. estimation of the basic study model table 2 shows that the model is well-adjusted, as the regression is explained on average by 69.34% according to the adjusted coefficient of determination. in this table, fixed effects estimates reveal that investments in renewable energy have a significant and positive impact on women's access to the formal labor market in highand middleincome countries. this suggests that in these economies, policies favoring green technologies can be beneficial for the socio-economic integration of women by providing new employment opportunities in the renewable energy sector. we would like to note that this result agrees with the results in previous empirical work (afolabi, tunjiolayeni, oyeyipo, & ojelabi, 2017; fraune, 2015; pollin, 2019). this is supported by, for instance, the study from baruah (2017) which emphasized that renewable energy investments are, meanwhile, a driver of job growth that allows structural transformation in developed and emerging economies to enhance gendered economic empowerment. but the findings show that low-income countries have had no such luck in investing to accomplish forcefully high rates of renewable energy, achieve gender equality, and provide women with formal labor market opportunities. these economies require extensive investment and coherent policies to support the growth of green technologies. simultaneously, these divergent results highlight how policies for women's integration with green technologies are relevant only if designed considering the specific economic context of each country. asian journal of economics and empirical research, 2024, 11(2): 103-110 107 © 2024 by the authors; licensee asian online journal publishing group table 2. results of fixed effect estimate. variables dependent variable: 𝑬𝒎𝒑𝒍𝑾𝒐𝒎𝒆𝒏(fixed effect) africa high income countries middle income countries low income countries 𝐼𝑛𝑣𝑒𝑠𝑡𝑇𝑒𝑐ℎ 0.228* (0.101) 0.025*** (0.005) 0.020*** (0.004) 0.015 (0.103) 𝑆𝑐ℎ𝑜𝑙𝑎𝑟𝑊𝑜𝑚𝑒𝑛 0.423** (0.145) 0.120*** (0.025) 0.100*** (0.020) 0.036* (0.015) 𝐻𝑒𝑎𝑙𝑡ℎ𝑊𝑜𝑚𝑒𝑛 0.183 (0.1 15) 0.080*** (0.015) 0.070*** (0.013) 0.059** (0.020) 𝑊𝑜𝑚𝑒𝑛𝐸𝑛𝑡𝑟𝑒𝑝 0.460*** (0.108) 0.040*** (0.008) 0.035*** (0.007) 0.025*** (0.005) 𝐼𝑛𝑐𝑜𝑚𝑒𝑊𝑜𝑚𝑒𝑛 0.398*** (0.138) 0.090*** (0.018) 0.080*** (0.016) 0.070*** (0.014) constant 0.715*** (0.204) 0.015*** (0.003) 0.010*** (0.002) 0.005*** (0.001) r-square 0.770 0.750 0.720 0.680 adjusted r-square 0.750 0.730 0.700 0.660 fisher statistic 387.26 250.12 200.85 180.45 note: ***p < 0.01, **p < 0.05, *p< 0.1. 4.3. correction of endogeneity the lewbel 2sls, or iv (instrumental variables) method, is a technique that allows us to overcome simultaneity problems and omitted variable bias in our econometric models. this is particularly useful when some of the explanatory variables correlate with regression errors and hence bias parameter estimates. in the table 3 below, we further take advantage of the lewbel 2sls instrumental variable approach to better account for potential endogeneity biases due to simultaneity between endogenous variables and regression errors. lewbel 2sls uses instrumental variables that satisfy the lewbel invariance principle, meaning these instrumental variables must be uncorrelated with regression errors and correlated to endogenous covariates; this method provides more accurate estimation of parameters. when comparing results from the lewbel 2sls to fixed effects, we see that significant effects remain and similar coefficients are reported. the fact that both analyses are consistent across methods supports our conclusions. table 3. estimate of lewbel 2sls (2012). variables dependent variable: 𝑬𝒎𝒑𝒍𝑾𝒐𝒎𝒆𝒏( lewbel 2sls) africa high income countries middle income countries low income countries 𝐼𝑛𝑣𝑒𝑠𝑡𝑇𝑒𝑐ℎ 0.535* (0.306) 0.030*** (0.006) 0.025*** (0.005) 0.020 (0.024) 𝑆𝑐ℎ𝑜𝑙𝑎𝑟𝑊𝑜𝑚𝑒𝑛 0.435** (0.132) 0.130*** (0.022) 0.110*** (0.018) 0.090** (0.024) 𝐻𝑒𝑎𝑙𝑡ℎ𝑊𝑜𝑚𝑒𝑛 0.289** (0.009) 0.085*** (0.012) 0.075*** (0.011) 0.055*** (0.009) 𝑊𝑜𝑚𝑒𝑛𝐸𝑛𝑡𝑟𝑒𝑝 0.453*** (0.104) 0.045*** (0.009) 0.040*** (0.008) 0.030*** (0.006) 𝐼𝑛𝑐𝑜𝑚𝑒𝑊𝑜𝑚𝑒𝑛 0.557** (0.191) 0.095*** (0.015) 0.085*** (0.014) 0.075*** (0.012) constant 0.698*** (0.154) 0.020*** (0.004) 0.015*** (0.003) 0.010*** (0.002) r-square 0.670 0.770 0.740 0.710 adjusted r-square 0.632 0.750 0.720 0.690 fisher statistic 239.79 280.55 220.75 210.35 note: ***p < 0.01, **p < 0.05, *p< 0.1. 4.4. estimates robustness analysis the application of quantile method in measuring the impact that green technologies can have on the socioeconomic assimilation faced by women in africa is significant for several reasons. 1. assessing heterogeneous effects: the quantile approach helps us to investigate how the importance of green technologies varies across levels of women's socio-economic integration. this allows us to see if the effects of green technologies are different for women in the lower, middle, or upper parts of her distribution. it enables a more nuanced appreciation of the pathways through which green technologies influence women's socio-economic inclusivity. 2. they are robust to outliers. it is a helpful tool when dealing with extremes; quantile estimates are less susceptible to the bias from extreme values than their ordinary least squares (ols) counterparts. consequently, this method is more robust to atypical observations or outliers, which guarantees more reliable estimates of the effects of green technologies on the socio-economic integration of women. 3. detection of structural changes: by analyzing the effects of green technologies at different quantiles of the distribution, we can detect structural changes in the relationships between variables. for example, positive effects of green technologies on the socio-economic integration of women in the lower quantiles could indicate significant improvements for the most economically vulnerable women. based on tables 4, 5, 6, and 7 of the quantile estimates for africa and countries at different levels of development, we can observe how the effects of green technologies vary by socio-economic context. indeed, the effects are more pronounced in the lower quantiles of low-development countries (table 7), which could indicate that green technologies are particularly beneficial for the most disadvantaged women. similarly, the effects are more uniform across quantiles in high-development countries, which could reflect more widespread access to economic opportunities for women (tables 5 and 6). asian journal of economics and empirical research, 2024, 11(2): 103-110 108 © 2024 by the authors; licensee asian online journal publishing group in summary, the use of the quantile method allows for a more in-depth and nuanced understanding of the impact of green technologies on the socio-economic integration of women in africa, taking into account the different economic and social realities of countries and women’s groups. table 4. results of quantile estimates for africa. variables dependent variable:𝑬𝒎𝒑𝒍𝑾𝒐𝒎𝒆𝒏 coefficient (25%) coefficient (50%) coefficient (75%) 𝐼𝑛𝑣𝑒𝑠𝑡𝑇𝑒𝑐ℎ 0.089 (0.072) 0.292 (0.211) 0.385 (0.209) 𝐼𝑛𝑣𝑒𝑠𝑡𝑇𝑒𝑐ℎ − 𝑆𝑞𝑢𝑎𝑟𝑒 0.5624* (0.301) 0.4326* (0.213) 0.5417 (0.394) 𝑆𝑐ℎ𝑜𝑙𝑎𝑟𝑊𝑜𝑚𝑒𝑛 0.2190*** (0.016) 0.7641*** (0.214) 0.4810*** (0.111) 𝐻𝑒𝑎𝑙𝑡ℎ𝑊𝑜𝑚𝑒𝑛 0.367*** (0.110) 0.570*** (0.212) 0.375*** (0.207) 𝑊𝑜𝑚𝑒𝑛𝐸𝑛𝑡𝑟𝑒𝑝 0.330*** (0.009) 0.438*** (0.102) 0.643*** (0.101) 𝐼𝑛𝑐𝑜𝑚𝑒𝑊𝑜𝑚𝑒𝑛 0.465*** (0.113) 0.829*** (0.213) 0.485*** (0.129) constant 0.812*** (0.201) 0.923*** (0.232) 0.895*** (0.223) rsquared 0.519 0.498 0.513 note: ***p < 0.01, **p < 0.05, *p < 0.1 ; (.) are standard errors. table 5. results of quantile estimates for high-income countries. variables dependent variable:𝑬𝒎𝒑𝒍𝑾𝒐𝒎𝒆𝒏 coefficient (25%) coefficient (50%) coefficient (75%) 𝐼𝑛𝑣𝑒𝑠𝑡𝑇𝑒𝑐ℎ 0.034* (0.022) 0.062*** (0.011) 0.085*** (0.009) 𝐼𝑛𝑣𝑒𝑠𝑡𝑇𝑒𝑐ℎ − 𝑆𝑞𝑢𝑎𝑟𝑒 0.0215 (0.041) 0.0327*** (0.003) 0.0452*** (0.001) 𝑆𝑐ℎ𝑜𝑙𝑎𝑟𝑊𝑜𝑚𝑒𝑛 0.098* (0.042) 0.100*** (0.014) 0.110*** (0.011) 𝐻𝑒𝑎𝑙𝑡ℎ𝑊𝑜𝑚𝑒𝑛 0.065** (0.030) 0.070*** (0.012) 0.075*** (0.007) 𝑊𝑜𝑚𝑒𝑛𝐸𝑛𝑡𝑟𝑒𝑝 0.030*** (0.005) 0.035*** (0.007) 0.048*** (0.002) 𝐼𝑛𝑐𝑜𝑚𝑒𝑊𝑜𝑚𝑒𝑛 0.075 (0.054) 0.082*** (0.012) 0.085*** (0.013) constant 0.312*** (0.011) 0.425*** (0.012) 0.525*** (0.021) rsquared 0.620 0.596 0.618 note: ***p < 0.01, **p < 0.05, *p < 0.1 ; (.) are standard errors. table 6. results of quantile estimates for middle-income countries variables dependent variable: 𝑬𝒎𝒑𝒍𝑾𝒐𝒎𝒆𝒏( lewbel 2sls) coefficient (25%) coefficient (50%) coefficient (75%) 𝐼𝑛𝑣𝑒𝑠𝑡𝑇𝑒𝑐ℎ 0.013*** (0.002) 0.022*** (0.008) 0.045 (0.035) 𝐼𝑛𝑣𝑒𝑠𝑡𝑇𝑒𝑐ℎ − 𝑠𝑞𝑢𝑎𝑟𝑒 0.045*** (0.002) 0.029*** (0.004) 0.065** (0.030) 𝑆𝑐ℎ𝑜𝑙𝑎𝑟𝑊𝑜𝑚𝑒𝑛 0.089*** (0.013) 0.141*** (0.011) 0.180** (0.044) 𝐻𝑒𝑎𝑙𝑡ℎ𝑊𝑜𝑚𝑒𝑛 0.089*** (0.019) 0.078*** (0.013) 0.095** (0.037) 𝑊𝑜𝑚𝑒𝑛𝐸𝑛𝑡𝑟𝑒𝑝 0.038*** (0.013) 0.045*** (0.012) 0.049** (0.014) 𝐼𝑛𝑐𝑜𝑚𝑒𝑊𝑜𝑚𝑒𝑛 0.089*** (0.026) 0.096*** (0.011) 0.086** (0.034) constant 0.210*** (0.011) 0.327*** (0.023) 0.539*** (0.038) rsquared 0.578 0.498 0.519 note: ***p < 0.01, **p < 0.05; (.) are standard errors. asian journal of economics and empirical research, 2024, 11(2): 103-110 109 © 2024 by the authors; licensee asian online journal publishing group table 7. results of quantile estimates for low-income countries. variables dependent variable: 𝑬𝒎𝒑𝒍𝑾𝒐𝒎𝒆𝒏( lewbel 2sls) coefficient (25%) coefficient (50%) coefficient (75%) 𝐼𝑛𝑣𝑒𝑠𝑡𝑇𝑒𝑐ℎ 0.053*** (0.007) 0.045* (0.251) 0.027 (0.102) 𝐼𝑛𝑣𝑒𝑠𝑡𝑇𝑒𝑐ℎ − 𝑆𝑞𝑢𝑎𝑟𝑒 0.083*** (0.012) 0.079* (0.040) 0.043 (0.051) 𝑆𝑐ℎ𝑜𝑙𝑎𝑟𝑊𝑜𝑚𝑒𝑛 0.066*** (0.021) 0.086 (0.112) 0.098** (0.030) 𝐻𝑒𝑎𝑙𝑡ℎ𝑊𝑜𝑚𝑒𝑛 0.095*** (0.022) 0.059 (0.047) 0.085* (0.042) 𝑊𝑜𝑚𝑒𝑛𝐸𝑛𝑡𝑟𝑒𝑝 0.029*** (0.012) 0.075** (0.029) 0.048** (0.018) 𝐼𝑛𝑐𝑜𝑚𝑒𝑊𝑜𝑚𝑒𝑛 0.081*** (0.005) 0.074*** (0.011) 0.083** (0.022) constant 0.123*** (0.002) 0.421*** (0.021) 0.821*** (0.022) r-square 0.589 0.619 0.608 note: ***p < 0.01, **p < 0.05, *p< 0.1. 5. conclusions and economic policy recommendations here the article is focused on a positive side with regards to green technologies having an impact in changing and improving socio-economic scenario of women, especially from africa. together with higher levels of women's education and better health outcomes, access to clean fuel could dramatically raise the share of responsible women in decent jobs. it implies that green technologies are help to reduce female unemployment and improve economic participation irrespective of level (high-, middle-, or low-income) in a country. these findings are consistent with similar results from prior theoretical and empirical studies (agostino, 2010; 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(2015). green university initiatives in china: a case of tsinghua university. international journal of sustainability in higher education, 16(4), 491-506. https://doi.org/10.1108/ijshe-02-2014-0021 appendix table 8. sample countries distribution. africa high income countries middle income countries low-income countries south africa, seychelles botswana, mauritius, namibia, gabon, algeria, tunisia, egypt, algeria, angola, botswana, cameroon, cape verde, egypt, ghana, morocco, senegal, swaziland, tanzania, zambia, zimbabwe, benin, burkina faso, burundi, comoros, drc, guinea, ethiopia, madagascar, malawi, mali, mozambique, niger, rwanda, chad, togo south africa, seychelles botswana, mauritius, namibia, gabon, algeria, tunisia, egypt algeria, angola, botswana, cameroon, cape verde, egypt, ghana, morocco, senegal, swaziland, tanzania, zambia, zimbabwe, benin, burkina faso, burundi, comoros, drc, guinea, ethiopia, madagascar, malawi, mali, mozambique, niger, rwanda, chad, togo source: world bank (2020). asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.1016/s0304-4076(03)00092-7 https://doi.org/10.1198/073500102288618720 https://doi.org/10.1111/1467-7660.00125 https://doi.org/10.1093/icc/3.1.47 https://doi.org/10.14207/ejsd.2021.v10n2p59 https://doi.org/10.1787/7b0af638-en https://doi.org/10.1111/dech.12559 https://doi.org/10.4018/ijvple.307021 https://datahelpdesk.worldbank.org/knowledgebase/articles/906519-world-bank-country-and-lending-groups https://doi.org/10.1108/ijshe-02-2014-0021 31 © 2023 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 10, no. 2, 31-38, 2023 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v10i2.5146 © 2023 by the authors; licensee asian online journal publishing group south africa’s interest rate behaviour: investigating the influence of the indicators of financial openness nzeh, innocent chile1 okolie, david ogomegbunam2 okolie, jonathan ibekwe3 izuogu, augustine chinedu4 ( corresponding author) 1department of cooperative and rural development, university of agriculture and environmental sciences, umuagwo, imo state, nigeria. email: innocent.nzeh@uaes.edu.ng 2department of accountancy, renaissance university, ugbawka, enugu state, nigeria. email: davidokolie799@gmail.com 3department of business administration, faculty of management sciences, enugu state university of science and technology, enugu state, nigeria. email: jonalbval020@gmail.com 4department of criminology and security studies, university of agriculture and environmental sciences, umuagwo, imo state, nigeria. email: augustineizuogu@gmail.com abstract this study seeks to investigate the influence of financial openness variables on south africa’s interest rate during the period between1980-2020. the study used both augmented dickeyfuller (adf) and philip-perron (pp) tests to determine the order of integration of the variables, while the autoregressive distributed lag (ardl) bounds test was used to investigate both the short and long-run impact of the independent variables on the dependent variable. the findings of the study revealed that in the short-run both foreign direct investment (fdi) inflows and fdi outflows impacted the interest rate positively. however, portfolio investment, exchange rate and capital account openness did not have any significant impact on interest rate within the duration of this research. the long-run results revealed that fdi inflows had a positive and significant impact on interest rate. also, while capital account openness had a significant and positive impact on the interest rate, fdi outflows, portfolio investment, and the exchange rate had no significant impact on interest rate. the study concludes that apart from portfolio investment which did not exert significant impact on interest rate, other financial openness indicators used in the study had a significant impact on south africa’s domestic interest rate. the paper argues that, appropriate monetary policy measures targeted to lessen the monetary impact of excess capital inflows should be considered. additionally, capital account liberalization policy should be encouraged, but it needs to be regulated if it places an excessive amount of liquidity pressure on the economy. keywords: capital flows, fdi, financial openness, interest rate. jel classification: e22; e43; e32. citation | chile, n. i., ogomegbunam, o. d., ibekwe, o. j., & chinedu, i. a. (2023). south africa’s interest rate behaviour: investigating the influence of the indicators of financial openness. asian journal of economics and empirical research, 10(2), 31–38. 10.20448/ajeer.v10i2.5146 history: received: 8 may 2023 revised: 12 july 2023 accepted: 25 september 2023 published: 15 november 2023 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. competing interests: the authors declare that they have no competing interests. authors’ contributions: all authors contributed equally to the conception and design of the study. all authors have read and agreed to the published version of the manuscript. contents 1. background to the study ................................................................................................................................................................ 32 2. empirical literature review ......................................................................................................................................................... 33 3. data and methodology ................................................................................................................................................................... 34 4. results presentation and discussion of findings ..................................................................................................................... 35 5. discussion of findings .................................................................................................................................................................... 36 6. conclusion and recommendations ............................................................................................................................................... 37 references .............................................................................................................................................................................................. 37 mailto:innocent.nzeh@uaes.edu.ng mailto:davidokolie799@gmail.com mailto:jonalbval020@gmail.com mailto:augustineizuogu@gmail.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v10i2.5146 https://orcid.org/0000-0002-3131-9036 https://orcid.org/0000-0003-0810-4018 https://orcid.org/0000-0001-7798-3090 https://orcid.org/0009-0009-0131-2966 asian journal of economics and empirical research, 2023, 10(1): 31-38 32 © 2023 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the existing literature by focusing on the influence of financial indicators on south africa’s interest rate instead of examining the impact of financial indicators on gross domestic product (gdp) or the impact of interest rate on some financial openness indicators. 1. background to the study monetary policy authorities keep an eye on interest rate movement. this is because interest rate affects macroeconomic variables such as money supply, savings, and investment. for instance, a rise in interest rate encourages savings which improves loanable funds and ultimately increases the level of investment. however, rising interest rate also has the tendency to retard investment as it raises the cost of borrowing. in another angle, if interest rate rises, deposit money banks will have the urge to extend more credit to the private sector which is capable of raising the level of inflation in the economy. the aforementioned scenario highlights the significant impact on the economy of interest rates, demonstrating the necessity to investigate those factors that determine interest rates. financial openness has been accepted as a significant element in influencing domestic interest rate and other macroeconomic variables. this phenomenon is increasingly apparent, as numerous economies have abandoned the practice of financial repression and instead adopted policies of financial liberalization. sulaiman, oke, and azeez (2012) argued that in many developing nations, financial repression was the norm until the transition to financial liberalization occurred. financial repression introduces regulations that lower interest rates, leading to lower savings and declining investment (mckinnon, 1973). the nexus is an area between financial openness and interest rate that has diverse interpretations. for instance, if an economy’s financial sector is liberalized, a high interest rate can encourage more capital inflows, while a low interest rate can retard capital inflows. in fact, if the domestic interest rate is lower than the foreign interest rate, this encourages arbitrage in foreign and domestic interest rates, resulting in capital outflows (bacchetta, 1992). this development induces domestic currency depreciation and reduces liquidity in the economy. on the other hand, financial openness influences domestic interest rate in some ways. in periods of rising capital inflows, there is always a growth in monetary aggregate as the inflows introduce liquidity in the system that ends up lowering the domestic interest rate. however, aslanoğlu (2012) observed that as a way to avoid the appreciation of domestic currency occasioned by rising portfolio investments, the monetary authorities could use open market operations (omo) to sterilize the inflows, leading to a fall in money supply and thus a rise in domestic interest rate. the foregoing brief scenario indicates that financial openness could either raise interest rate or reduce it. therefore, this study is an attempt to determine the impact of financial openness on interest rate in south africa. just like other developing countries, the objective of major monetary policy of south africa which is the responsibility of the south african reserve bank (sarb) is to maintain price stability (van der merwe & mollentze, 2010). this objective is pursued through the inflation targeting framework (itf) approach. as observed by arestis and sawyer (2003), in order to achieve price stability under the itf, the major monetary policy tool is the short-term interest rate (or repo rate). accordingly, the itf is implemented through the estimation of a targeted inflation range and then an attempt is made to steer actual inflation towards the target using repo rate. the view of present study is to explore the factors that may influence interest rate. the findings of this study may offer valuable guidance to the (sarb) in its endeavours to utilize interest rates as a tool for attaining price stability. this study becomes necessary as past empirical efforts were focused mainly on the influence of financial openness on economic growth. other previous studies equally dwelt on the impact of interest rate on financial openness. the studies did not address the indirect nature of the relationship between financial openness and economic growth, as financial openness must first affect intermediary variables such as interest rates before impacting economic growth. previous studies did not consider the bidirectional relationship between financial openness and interest rate, as the causality may not solely run from interest rate to financial openness. for instance, other than domestic interest rate, factors such as friendly business environment could stimulate foreign investments into an economy. if so, it is necessary to assess how these influxes will affect the domestic interest rate. 1.1. stylized facts evidence in figure 1 shows that between 1980 and 1991 fdi outflows and inflows trended very low such that in 1985 fdi inflows trended negatively. however, beginning from 1992, both variables experienced rising trend, but in 2001 fdi outflows declined heavily. however, in the same year, fdi inflows trended very high. between 2008 and 2012, it is also found that fdi outflows experienced declining trend, while within similar period fdi inflows trended high. evidence of the trend in the fdi flows indicated that prior to 1994 when the apartheid regime ended in south africa, financial repression was in practice that led to a very low fdi flows. as observed by mowatt (2001) in the late eighties and nineties, most southern african development community (sadc) countries reformed their financial system. the study noted that before these reforms, governments of these countries were within the boundaries of the financial systems. in figure 2, it is revealed that the trend of real interest rate exhibited much volatility within the research period. evidence shows that with the exception of 1983, 1986 and 1993 when the annual changes in real interest rate was relatively low, other years showed that movement in the variable was high as it got to a peak in1998. from 1995 to the entire research period the variable assumed positive trend. the behaviour of interest rate within these periods does not rule out the possible impact of financial repression on interest rate prior to 1991.it is also revealed from the trend that interest rate trended upwards in 2008 but descended sharply in 2009 and behaved sluggishly thereafter. according to this study, the circumstances leading up to and following the global financial crisis must have influenced the trend of the variable during these times. asian journal of economics and empirical research, 2023, 10(1): 31-38 33 © 2023 by the authors; licensee asian online journal publishing group figure 1. trend in fdii and fdio. note: fdii foreign direct investment inflows, fdio foreign direct investment outflows. figure 2. trend of real interest rate. note: rintr real interest rate. 1.2. theoretical background theoretical issues have been advanced by some scholars on the role of financial openness on the economy. for instance, the impact of real interest rate on investment was studied by jorgenson (1963). the study observed that the desired stock of capital depends on the opportunity cost of capital as well as real output. the conclusion drawn by the study was that when the desired capital stock has a positive relationship with output, its link with the cost of capital was negative. consequently, if real interest rate falls, there will be a fall in the opportunity cost of capital, but the desired capital stock and investment will be raised. in a similar spirit, shaw (1973) argued that financial liberalization can enhance investment, hence it increases productivity, but financial repression can impair both the quantity and quality of overall investment. accordingly, while regulation of interest rate through financial repression lowers interest rate, this can lead to lower savings and declining investment. on the other hand, interest rate deregulation encourages savings and investment and this has the tendency to improve the economy. from another perspective, bacchetta (1992) noted that financial liberalization enhances capital inflows with the tendency to improve capital stock. as domestic interest rate rises, capital inflows are attracted to the domestic economy which leads to domestic currency appreciation. however, the fall in domestic interest rate encourages arbitrage in foreign and domestic interest rates, leading to capital outflows and consequently domestic currency depreciation. levine (2001) observed that through financial openness, domestic financial system is developed which raises domestic investment and the allocation of capital. in their separate views, beju and ciupac-ulici (2012) and hamdi and jlassi (2014) contended that capital account liberalization reduces the probability of financial crises through the provision of liquidity in the banking system as capital inflows increase. despite the positive role of financial openness, concerns have been raised about the possibility of financial openness of the economy. stiglitz (2000) contends that financial openness does not guarantee welfare. this view is informed by the inherent distortions in most of the economies such as weak institutions, trade barriers and imbalances in the economy. 2. empirical literature review in literature, studies have shown the impact of financial openness on some macroeconomic variables in both country-specific and cross-country studies. it is sufficient to say that a preponderance of these studies focused mainly on the impact of financial openness on economic growth. for country-specific studies, sulaiman et al. (2012) revealed that financial openness improved economic growth in nigeria. this result was corroborated with a study by anthony, ogbuabor, and anthony-orji (2015) which observed that financial liberalization and private investment had positive and significant impact on economic growth in nigeria. however, saifullahi and nuruddeen (2015) revealed that a negative relationship existed between real gross domestic product (gdp) and financial openness in nigeria. in another research by, ajogbeje, adeniyi, and egwaikhide (2018) showed that capital mobility impacted significantly on interest rate in the long-run in nigeria, while monetary independence and exchange rate stability had no impact on interest rate. in support of the impact of financial openness on economic asian journal of economics and empirical research, 2023, 10(1): 31-38 34 © 2023 by the authors; licensee asian online journal publishing group growth, fasanya and olayemi (2020) revealed that a strong link exists between financial openness and economic growth in nigeria. in studies that focused on cross-country, wei (2014) showed that while de jure measures of financial openness adversely impacted on economic growth in the asian countries, the impact of de facto measures was positive. in subsaharan african countries, tajudeen, olusola, and ademola (2017) revealed that trade openness and price stability were the relevant factors for interest rate liberalization. in another study for sub-saharan african (ssa) countries, aremo and arambada (2021) revealed that trade openness impacted positively and significantly the economic growth in low income countries, however, the impact of financial openness and the joint trade was not significantly positive. for middle-income countries, findings showed that both financial openness and the joint trade were not encouraged for economic growth. in a study for 35 developed and emerging countries, aman, granville, mallick, and nemlioglu (2022) found that financial openness alone could not improve export competitiveness, but the inclusion of greater trade openness. a study involving the asian tigers and the south africa, algeria, nigeria and egypt (sane) countries by, nzeh, ogwuru, izuogu, and ogaraku (2023) revealed that capital account openness, fdi outflows, fdi inflows and governance effectiveness improved the gdp per capita significantly in the asian tigers. the study equally found that for sane countries, fdi inflows and trade openness had positive impact on gdp per capita, while the impact of capital account openness was negative and significant. moyo and le roux (2019) found that financial liberalization reduced the probability of financial crisis in southern african development community (sadc), while financial development raised the incidence of financial crisis. in a study that involved african countries, ali (2022) revealed that financial liberalization did not have significant impact on economic growth, while total labour force participation, political stability, presence of physical capital and government effectiveness had significant positive impact on economic growth in the selected countries. effiong and asuquo (2022) discovered that financial openness had a diminishing impact on remittances, but that it had little bearing on how deeply they permeated the region. 3. data and methodology this study used annual series spanning the period from 1980-2020 to examine the impact of the indicators of financial openness on interest rate in south africa. the proxy for interest rate is real interest rate. the indicators of financial openness are split into de facto and de jure measures. the three de facto indicators used in the study are: portfolio investment, foreign direct investment outflows and foreign direct investment inflows. however, the de jure indicator included in the study is capital account openness (cao) index introduced by chinn and ito (2006). a control variable included in the study is exchange rate. real interest rate is measured as the lending rate adjusted for inflation, while foreign direct investment inflows and outflows are measured as net inflows (% of gdp) and net outflows (% of gdp), respectively. additionally, actual exchange rate is calculated using 2010 as the base year, even though portfolio investment is calculated as net balance of payment in current us dollars. data on other variables were obtained from the world bank development indicators, with the exception of data on capital account openness which was obtained from chinn and ito (2006). in order to test for the stationarity of the series, the study used both the augmented dickey fuller (adf) and the phillip-perron (pp) unit root tests. after ascertaining the order of integration of the series, the study examined the long-run (cointegration) relationship among the variables using the ardl. the ardl was also used to investigate both the short-run and the long-run impact. 3.1. model specification this study employed the ardl bounds test by pesaran, shin, and smith (2001) to examine the long-run relationship among the variables. the ardl model also assisted the model to determine both the short run and the long run impact. a major strength of the ardl model is that it can be applied even when the variables are integrated in order zero or one or a combination of order zero and one. from the ardl model a dynamic error correction model (ecm) can be derived. consequently, the following ardl model that links interest rate to the indicators of financial openness guided this study: ttttt ti p t it p t e it p t it p t t p t it p i i rexchrkaopenpifdio fdiirintrrexchrkaopen pifdiofdiirintrrintr    ++++ +++++ ++++= −−−− −− = − = − − = − = − = − −   11211111019 1817 0 6 0 15 0 43 0 1 0 2 1 10 (1) where rintr = real interest rate (a proxy for domestic interest rate), fdii = foreign direct investment inflows, fdio = foreign direct investment outflows, pi = portfolio investment, kaopen = capital account openness and rexchr = real exchange rate. in equation 1, 1 , 2 , 3 , 4 , 5 and 6 are the short-run parameter coefficients. however, 7 , 8 , 9 , 10 , 11 and 12 are the long-run parameter coefficients. to test for the presence of a long-run relationship, the study compared the computed f-statistic with the critical bounds. the critical bounds are the upper critical bound 1(1) and the lower critical bound 1(0). if the computed f-statistic is higher than the upper critical bound, the variables are considered to be in a long-term association. on the other hand, there is no presence of a long-run relationship if the computed f-statistic is lower than the critical bound. if the presence of a long-run relationship is established, then the ecm is specified as follows: asian journal of economics and empirical research, 2023, 10(1): 31-38 35 © 2023 by the authors; licensee asian online journal publishing group . 0 6 0 15 0 43 0 1 0 2 1 10 t p t it p t e it p t it p t t p t it p i i ecmrexchrkaopen pifdiofdiirintrrintr ++++ ++++=   = − = − − = − = − = − −   (2) where  represents the coefficient of the ecm. 4. results presentation and discussion of findings in table 1, the results of adf unit root revealed that all the variables achieved stationarity at level, except exchange rate that achieved stationarity at first difference. however, results of the pp unit root test in table 2 showed that exchange rate and capital account openness achieved stationarity at first difference, while others achieved stationarity at level. it should be noted that a variable achieves stationarity at level if the statistical properties of such variable such as the mean and variance are constant without first transforming the variable. the variables displayed a confluence of i(0) and i(1), implying that the ardl model is appropriate. table 1. results of augmented dickey-fuller (adf) unit root. variable adf level t-stat adf level critical value at 5% adf first diff. t-stat adf first diff. critical value at 5% order of integration rintr -5.80 -2.93 -9.07 -2.93 i(0) exchr -1.61 -2.93 -5.56 -2.93 i(1) fdii -4.70 -2.93 -7.93 -2.94 i(0) fdio -3.79 -2.93 -7.54 -2.93 i(0) kaopen -3.68 -2.94 -5.12 -2.94 i(0) pi -4.10 -2.93 -6.98 -2.94 i(0) table 2. results of pp unit root. variable pp level t-stat pp level critical value at 5% pp first diff. tstat pp first diff. critical value at 5% order of integration rintr -5.72 -2.93 -16.78 -2.93 i(0) exchr -1.48 -2.93 -6.24 -2.93 i(1) fdii -4.67 -2.93 -18.46 -2.93 i(0) fdio -3.81 -2.93 -7.74 -2.93 i(0) kaopen -2.48 -2.93 -7.23 -2.94 i(1) pi -4.17 -2.93 -10.09 -2.93 i(0) with the results of stationarity indicating the variables have an admixture of i(0) and i(1), the study estimated the long-run relationship among the variables. result in table 3 indicated that the value of f-statistic (8.6) is higher than the upper critical bound (3.79) at the 5% level of significance. thus, the study concludes that the variables have a long-run relationship or are cointegrated. table 3. ardl bounds test result. test statistic value k f-statistic 8.603 5 critical value bounds significance i0 bound i1 bound 10% 2.26 3.35 5% 2.62 3.79 2.5% 2.96 4.18 1% 3.41 4.68 after confirming the cointegration of the series, the investigation assessed the effects of financial openness indicators on interest rates in both the short and long term. the short-run results in table 4 indicated that fdi inflows impacted positively on interest rate and the results were significant. if fdi inflows rose by one unit, interest rate rose by 1.1 percent. ordinarily, fdi inflows is expected to depress domestic interest rate as it leads to increase in monetary aggregates. a possible explanation for the outcome may be attributed to the influence of the monetary policy intervention that was executed to alleviate the surplus liquidity generated by the inflows. the effect of such policy intervention, such as the open market operation (omo) is to reduce money supply, hence it results in raising domestic interest rate. in another vein, fdi outflows was found to impact positively and significantly on interest rate. one unit rise in fdi outflows led to an increase in interest rate by 1.63 percent. the short run findings also showed that portfolio investment, exchange rate and capital account openness did not have any significant impact on interest rate within the study period. the coefficient of the ecm is negative and significant which gives credence to the cointegration result. the system is observed to be in equilibrium subsequent to a deviation by 81%. the results in table 5 revealed that fdi inflows had a positive and significant impact on interest rate. this finding is relevant to the result of the impact of fdi inflows on interest rate in the short-run. the result indicates that if fdi inflows rose by one unit, interest rate rose by 1.35%. the obtained outcome is incongruous with the anticipated outcome based on prior knowledge, as it is commonly assumed that foreign direct investment (fdi) inflows would lead to a decrease in interest rates by means of an increase in monetary aggregates. findings of the study also indicated that fdi outflows, portfolio investment and exchange rate had no significant impact on interest rate in the long-run. however, capital account openness had a significant and positive impact on interest rate. if capital account openness rose by one unit, interest rate rose by 3.29%. the degree of capital account openness has an impact on interest rates, which can be either positive or negative depending on the direction of inflows associated with such policy. for instance, if the liberalization of the capital account is associated with an asian journal of economics and empirical research, 2023, 10(1): 31-38 36 © 2023 by the authors; licensee asian online journal publishing group increase in capital inflows, this, in turn, may lead to a reduction in interest rates due to the positive impact of the inflows on the money supply. however, if it leads to more capital outflows, interest rate may be reduced. table 4. results of short-run ardl. short run results variable coefficient std. error t-statistic prob fdii 1.10 0.58 1.88 0.06 fdio 1.63 0.93 1.74 0.09 pi 0.00 0.00 0.94 0.35 kaopen -2.81 1.73 -1.62 0.11 exchr 0.03 0.02 1.44 0.15 ecm(-1) -0.81 0.11 -6.84 0.00 table 5. results of long-run ardl. long run results variable coefficient std. error t-statistic prob fdii 1.35 0.73 1.82 0.07 fdio 2.01 1.19 1.68 0.10 pi 0.00 0.00 0.93 0.35 kaopen 3.29 1.72 1.91 0.06 exchr 0.04 0.03 1.35 0.18 c 2.68 4.67 0.57 0.57 5. discussion of findings the results of this study indicated that in the short-run both fdi inflows and outflows influenced domestic interest rate positively within the research duration. however, the long-run results showed that both fdi inflows and capital account openness had positive and significant impact on domestic interest rate. the study did not find portfolio investment to impact domestic interest rate significantly either in the short-run or in the long-run. these findings have some policies relevant to monetary policy management in the country. the positive impact of fdi inflows in both the short-run and the long-run is an indication that even as the inflows increased money supply within the study period which should lower domestic interest rate, the monetary policy action taken to insulate the domestic economy from overheating led to rise in domestic interest rate. in another vein, the short-run positive impact of fdi outflows on domestic interest rate aligns with prior expectation. fdi outflows are expected to reduce money supply which should raise domestic interest rate. portfolio investment was not found to exhibit any significant impact on domestic interest rate which is an indication that the capital market in the country is not deeply developed. regarding the favourable enduring influence of capital account openness on domestic interest rate, the research posits that a conceivable explanation for this result is that the policy of capital account liberalization drew a significant influx of capital into the economy over an extended period, thereby causing an increase in domestic interest rates. this result finds support in ajogbeje et al. (2018) which revealed that capital mobility had significant impact on interest rate in the long-run in nigeria. the post-diagnostic results in table 6 revealed that there is no heteroskedasticity in the model. also, the model is free from serial correlation just as it is well specified. in figure 3, the result of the jarque-berra test for normality indicated that the errors are normally distributed at the significant level of 5%. in figure 4 and 5 the results of the cumsum and cumsum of squares revealed that the model is stable since the plots fall inside the critical bands of the 5% confidence interval of parameter stability. table 6. post diagnostic results. test p-value null hypothesis conclusion heteroskedasticity test: breusch-pagan-godfrey 0.32 ho: no homoscedasticity cannot reject ho serial correlation: breusch-godfrey lm test 0.98 ho: no serial correlation cannot reject ho model specification (ramsey reset test) 0.13 ho: correctly specified cannot reject ho note: lm – langrage multiplier, reset – ramsey regression equation specification error test. figure 3. plot of the normality of the error term. asian journal of economics and empirical research, 2023, 10(1): 31-38 37 © 2023 by the authors; licensee asian online journal publishing group figure 4. plot of cumulative sum (cusum). figure 5. plot of cusum of square. 6. conclusion and recommendations the sensitivity of interest rate in macroeconomic variables has attracted research interests on the factors that determine it. this present study examined the influence of the indictors of financial openness on interest rate in south africa over the period from 1980 to 2020. the findings of this study revealed some outcomes that are germane for policy formulation in the country. as argued earlier, the positive impact of fdi inflows implies that the monetary policy actions designed to reduce the impact of such inflows were effective in raising interest rate. however, the short-run positive impact of fdi outflows on interest rate indicates that such outflows drained liquidity in the system, thus transmitting into an increased interest rate. the paper also argues that the fact that capital account liberalization brought more money into the domestic economy during the study period and raised interest rates is evidence of the long-term beneficial influence of capital account openness on interest rates. also, that portfolio investment did not influence interest rate significantly in any of the time horizons is evidence that the capital market in the country may not have been developed to the extent of attracting enough capital that is capable of influencing the interest rate. consequently, the study recommends that in periods of rising fdi inflows, the monetary authorities should employ appropriate monetary policy measures targeted at reducing the monetary impact of the inflows. however, such measures should not be jeopardized domestic investment through unduly rising in the cost of capital (interest rate). in another vein, even though low domestic interest rate is expected to boost domestic investment, caution needs to be exercised in maintaining such low level of interest rate to avoid arbitrage practices by investors which could distort the achievement of monetary policy objectives. finally, the paper argues that while capital account liberalization policy should be supported, it needs to be controlled if it places an excessive amount of liquidity pressure on the economy and causes interest rates to drop significantly. references ajogbeje, k., adeniyi, o. a., & egwaikhide, f. o. 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(2000). capital market liberalization, economic growth, and instability. world development, 28(6), 1075-1086. https://doi.org/10.1016/s0305-750x(00)00006-1 sulaiman, l., oke, m., & azeez, b. (2012). effect of financial liberalization on economic growth in developing countries: the nigerian experience. international journal of economics and management sciences, 1(12), 16-28. tajudeen, e., olusola, a. t., & ademola, b. a. g. (2017). interest rate liberalization, financial development and economic growth in subsaharan african economies. african journal of economic review, 5(2), 109-129. van der merwe, e., & mollentze, s. (2010). monetary economics in south africa. cape town: oxford university press southern africa. wei, h. p. (2014). does financial openness affect economic growth in asian economies? a case study in selected asian economies, 1980-2010. journal of economics and political economy, 1(2), 253-301. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.1016/j.jdeveco.2005.05.010 https://doi.org/10.1186/s43093-019-0008-2 https://doi.org/10.1016/j.econmod.2014.05.010 https://doi.org/10.1111/1467-9396.00307 www.tips.org.za/publication/prospects https://doi.org/10.51594/ijmer.v5i2.442 https://doi.org/10.1002/jae.616 https://doi.org/10.1016/s0305-750x(00)00006-1 21 © 2024 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 11, no. 1, 21-29, 2024 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v11i1.5796 © 2024 by the authors; licensee asian online journal publishing group the deterioration of current account balance in selected countries of mena: causes of concern nemer badwan1 ihab al-qubbaj2 ( corresponding author) 1,2computerized finance and banking sciences department, faculty of business and economics, palestine technical university, kadoorie, tulkarm, state of palestine. 1email: nemer.badwan@ptuk.edu.ps 2email: i.alqubaj@ptuk.edu.ps abstract the purpose of this paper is to analyze the macroeconomic factors that influence the current account balance deterioration in the selected middle east and north africa mena countries (iran, iraq, jordan, syria, palestine, and lebanon). data from six mena countries were analyzed using a panelstatic approach. this study employs the breusch-pagan lagrangian multiplier test, the pooled ordinary least squares model (ols), and the random effect model (rem). the findings reveal that exchange rate (er), interest rate (ir), and term of trade (tot) are the main factors that influence the deterioration of the current account balance. the money supply (ms) and oil prices (op) had negligible correlations with the current account balance. the study's findings suggest significant practical implications for policymakers and regulators in mena countries. given the significant influence of exchange rate (er), interest rate (ir), and term of trade (tot) on the current account balance, we recommend that the authorities in mena countries implement policy reforms and macroeconomic adjustments to mitigate the current account balance deterioration. a deterioration in the current account balance began in 2018, sparking concerns in most mena countries. the problem in the current account has led to various disadvantages in mena countries, which will harm the economic health of the countries. keywords: current account balance, deterioration, exchange rate, interest rate, mena countries, money supply, term of trade. jel classification: e43; f32; g12; h62. citation | badwan, n., & al-qubbaj, i. (2024). the deterioration of current account balance in selected countries of mena: causes of concern. asian journal of economics and empirical research, 11(1), 21– 29. 10.20448/ajeer.v11i1.5796 history: received: 8 march 2024 revised: 25 april 2024 accepted: 14 may 2024 published: 10 july 2024 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. data availability statement: the corresponding author may provide study data upon reasonable request. competing interests: the authors declare that they have no competing interests. authors’ contributions: both authors contributed equally to the conception and design of the study. both authors have read and agreed to the published version of the manuscript. contents 1. introduction ...................................................................................................................................................................................... 22 2. theoretical background and literature review ....................................................................................................................... 23 3. data and methodology ................................................................................................................................................................... 25 4. empirical results and discussion ................................................................................................................................................ 25 5. conclusion and policy implications ............................................................................................................................................. 27 6. limitations and future research avenues ................................................................................................................................. 28 references .............................................................................................................................................................................................. 28 mailto:nemer.badwan@ptuk.edu.ps mailto:i.alqubaj@ptuk.edu.ps https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v11i1.5796 https://orcid.org/0000-0001-8913-7326 https://orcid.org/0000-0003-4721-1844 asian journal of economics and empirical research, 2024, 11(1): 21-29 22 © 2024 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this paper contributes to the existing literature by revealing and clarifying the impact of macroeconomic factors on the deterioration of the current account balance in emerging countries, such as the six middle east and north african mena countries selected in this study. our findings provide valuable insights for central banks and policy-makers. 1. introduction since the 2008 global financial crisis, mena countries have seen an increase in their current account deficits, which presents some economic difficulties for them. mena countries are facing several negative consequences due to their current account imbalance, which will be detrimental to their economies. after economic liberalization in the 1980s, the asian financial crisis in 1997, and the global financial crisis in 2008, asian countries faced significant obstacles in international macroeconomic policy. however, the macroeconomic foundations have deteriorated to such an extent that many asian and mena countries have been grappling with the twin deficit issue for several years. in 2018, these countries had some of the largest budget deficits globally. furthermore, according to the international monetary fund (2015), in 2018, the current account deficit grew to 2.9% of gross domestic product gdp (devadas & loayza, 2018; mustapha-jaji & alymkulova, 2022). the lacklustre global economic activity in 2018 has continued into 2019, as reported by icaew (2019), and it has had an impact on the current accounts of asian and mena countries. due to increased investment in southeast asia, the current account shrank from 2.75% of (gdp) in 2015 to 1.8% of (gdp) in 2019 (ng, 2019). the architecture of the entire financial system influences the relationship between (op) and (cab). regions where non-oil exports account for a significant share of total imports are unaffected by rising petroleum prices. people who import a large proportion of their oil are especially vulnerable to the effects of decreased (op) (sotoudeh & worthington, 2016). there may also be an inverse relationship between (op) and the value of a currency. a greater (op) may be paid for with local currency that is depreciating, which lessens the impact of an increase in (op) on import expenses. according to luo and qin (2017), countries with more flexible exchange rates are less susceptible to changes in oil prices. in contrast, a rise in (op) and (ms) can make (cab) worse in countries with fixed exchange rates. lastly, depending on domestic economic policy, (cab) may be impacted by the influence of (op) and (ms) in many ways. reducing reliance on fossil fuels or promoting energy efficiency are two ways that policy might help offset the impact of growing (op) and (ms) on (cab). the years 2018 and 2019 saw a rise in investment in asian and mena countries, with 39% of participants in the association of southeast asian nations asean financial forum concurring that asia offers the finest investment opportunities (lee, 2019). if a country's financial account will rise and thus cause a larger current account deficit if it draws in more financial movements (pettinger, 2017). according to aristovnik (2006), the current account is the total of the trade balance and is a crucial measure of the stability of a country's growth and financial stability. however, the most worrisome economic condition for a country is its current account deficit, which throws its trade and foreign reserves out of balance. the nation's foreign assets are depleting as it imports more than it sells. the drivers of the economies of the mena countries, as well as domestic private expenditures and the execution of policies and infrastructure projects, all have an impact on the imbalance in their current accounts. the conditions in the mena countries vary depending on how each nation shapes its economic performance. focusing on iran and iraq, the current account situation has worsened since 2017 due to the impact of volatile oil prices. similarly, the impact of volatile oil prices has led to a declining current account in syria and lebanon, prompting these governments to implement economic restructuring and policy changes (chang, mohsin, gao, & taghizadeh-hesary, 2023; kilian & zhou, 2020; rajakaruna & suardi, 2021). jordan, whose economy has deteriorated since 2013 due to a policy that promoted import operations, has adopted a similar strategy. in iraq, however, the imbalance stems from increased import prices for petroleum and raw materials, which raise the cost of selling those goods (çelgin, eren, & özlü, 2023). nevertheless, due to the successful measures put in place by the government, palestine's current account has never seen significant volatility (international monetary fund, 2015). conversely, laos saw a twofold shortfall between 2009 and 2015. however, it has improved as a result of the nation's growing contributions from the manufacture of pharmaceutical and agricultural components (world bank, 2018). in light of this, the purpose of this article is to examine the macroeconomic variables influencing the decline in the current accounts of a few mena countries, such as iran, iraq, jordan, palestine, syria, and lebanon. this study aims to investigate the macroeconomic factors that influence the deterioration of the current account balance in six selected mena countries. the findings show that while the term of the trade (tot) is favorably correlated with the current account balance (cab), the exchange rate (er) and interest rate (ir) have a substantial negative association with (cab). therefore, we can conclude that macroeconomic variables like interest rate (ir) and exchange rate (er) significantly influence the capital account (ca) and current account balance (cab), with the exchange rate (er) being the most relevant. the findings reveal a common and significant indication of macroeconomic imbalances in the current account. these days, macroeconomists are citing data showing how unsustainable circumstances developed before the financial crisis. we demonstrate, however, that policymakers can be readily persuaded by the seemingly benign realtime current account balance of certain mena states since hindsight is 20/20. the data is quite conflicting, but it is strong enough to imply that, in certain, if not most, situations, current account imbalance and deterioration can be a significant predictor. but remember that the signals given at the time may not have matched what is now clear. in light of this, one must evaluate the data accessible in real-time rather than the corrected data available today when determining whether the index acts as a warning sign for possible imbalances in the economy. by demonstrating that significant data modifications may compromise current account balances' predictive power in real-time, particularly in the middle east and among the countries that we chose for this research, we significantly add to the existing wealth of knowledge on current account balances. this study fills this gap in the literature by concentrating on the effects of terms of trade, interest rate, exchange rate, money supply and oil prices, and macroeconomic factors on the current account balances of a sample of six emerging market economies in the middle east and north africa. the goal is to adequately justify the new asian journal of economics and empirical research, 2024, 11(1): 21-29 23 © 2024 by the authors; licensee asian online journal publishing group contributions this paper makes to the literature, and to examine how these causes and their consequences vary from country to country. in particular, we try to answer the following queries in this paper: what impact do macroeconomic variables such as the money supply, interest rates, terms of trade, real oil prices, and currency rates have on middle eastern emerging market economies' current account balances? what are the differences in these impacts between nations classified as energy importers or exporters and nations in developing markets? what differences exist between these impacts on commodities connected to oil (coal, natural gas, and oil)? in what ways do these consequences differ among nations based on their unique characteristics? researching these topics is more critical today than in the past, as the shift away from fossil fuels is expected to worsen the problems caused by changes in crude oil prices. examining these topics is more crucial now than in the past, as the shift away from fossil fuels will likely have an even greater impact on oil prices, which will impact the current account balance of these mena countries. these changes will compound the challenges presented by fluctuations in crude oil prices, terms of trade, interest rates, exchange rates, and the money supply. as we will explain in the next section, the article contributes three distinct perspectives to the literature. first, we broaden our investigation to include the impacts of all of these factors to provide a richer understanding of the effects of macroeconomic factors. although the existing literature concentrates solely on the impact of macroeconomic factors like oil prices, terms of trade, interest rates, exchange rates, and money supply, we include all of these effects in our analysis. second, we explore the effects of macroeconomic determinants on a sample of six emerging market economies, encompassing the middle east and north africa, whereas the majority of research studies only look at individual oil importers or exporters or on a small group of importers/exporters in a specific geographical area. this is done to get a deeper comprehension of the many elements, their impacts, and the reasons for worry that arise when these factors are applied specifically to the current account balance of these nations. third, we look at how, more than previously believed, a broader range of middle eastern country characteristics influence how macroeconomic issues affect the current account balance of these six different countries. we organize the remainder of the paper as follows: section 2 discusses the literature review. section 3 highlights the data and methodology. section 4 covers the results and discussion. section 5 offers conclusions and policy implications. finally, section 6 includes limitations and future research avenues. 2. theoretical background and literature review previous publications have contained a significant amount of current account literature. historically, researchers have investigated numerous macroeconomic parameters such as the money supply, exchange rate, term of trade, price and use of energy, and interest rate. extensive research has been conducted on how the exchange rate affects the current account, as demonstrated by astuti, oktavilia, and rahman (2015); purwono, mucha, and mubin (2018); sahoo, mallick, mahalik, and bekiros (2022); and çelgin et al. (2023). these investigations have demonstrated that the exchange rate significantly and negatively impacts the current account balance. a stronger currency rate tends to lower import costs, which slows the current account's decline. to bolster that, research on current account balances in nations like germany, japan, singapore, norway, and switzerland das (2016) also yielded comparable results. research demonstrates that an increase in the exchange rate leads to a decrease in the nation's savings, as people tend to import more items due to their increased affordability. as a result, savings will decrease, causing current account balances to fall. many policymakers and scholars regularly watch the current account balance because it provides incredibly significant information about the status of the economy under examination and indicates whether a country needs external finance. the trade balance for products has been the primary cause of the deficit, whereas the trade balance for services has always been positive. high tourism and transportation earnings have primarily caused the services account's consistent surplus. the income balance has also been negative due to the net international investment position's prolonged downward trend, but it has had less of an effect on the (ca) balance than the goods trade deficit. the current account and money supply (ms) were found to be positively correlated (danmola & olateju, 2013; oshota & badejo, 2015; shuaibu & oyinlola, 2017; yiğitbaş, 2017). a rise in the money supply will boost industry productivity and encourage exports, resulting in a current account surplus. for instance, yiğitbaş (2017) asserted that turkey's deficit was caused by the country's low savings rate and constrained government money supply. a larger money supply leads to less precautionary saving and facilitates the nation's efficient use of its cash reserves. however, panel analysis research by ousseini, hu, and aboubacar (2017) and ya-qiong and rui (2013) demonstrates a negative relationship between money supply and current accounts. the preceding findings were supported by ousseini et al. (2017), who demonstrated that an increase in the money supply will invariably lead to inflation, which will increase export expenses and deteriorate the current account. previously, destaings (2017) and sadiku, fetahi-vehapi, sadiku, and berisha (2015) conducted research on the term of trade (tot) and the current account. higher export prices negatively correlate with improved trade, leading to a decline in real income and export revenue. this, in turn, tends to deteriorate the current account because it leads to less investment. according to khalfaoui, sarwar, and tiwari (2019), the (cab's) energy-efficiency initiatives make it less susceptible to (op). the implementation of renewable energy policies can decrease a nation's reliance on foreign oil while simultaneously increasing its trade surpluses. nonetheless, studies by ozdamar (2016), sahoo et al. (2022), and sumiyati (2022) have discovered a favourable correlation between the current account and the term of trade (tot). a longer period of trade will result in reduced pricing for imported goods and services, which will raise demand. over time, the manufacturing and export of high-tech products will require the use of imported items, which will result in a rise in the current account deficit (tot). the nation will take proactive measures by encouraging more cautious saving and reducing investment when there is a larger term of trade fluctuations, which will result in a current account surplus. according to huntington (2015); başarır and erçakar (2016), and bayraktar, taha, and yildiz (2016), a drop in oil prices will strengthen the nation's current account by lowering expenses and supplying inexpensive energy, which will enable it to undertake longer-term investments that will boost the current account. the current account has been found to have a considerable favourable effect (longe, adelokun, & omitogun, 2018; mucuk, gerçeker, & ay, 2013; sahoo et al., 2022; yurdakul & cevher, 2015). for instance, mucuk et al. (2013) assert that a global drop in the price of oil would increase demand because it is less expensive for oil-importing nations to import, which also tends asian journal of economics and empirical research, 2024, 11(1): 21-29 24 © 2024 by the authors; licensee asian online journal publishing group to alter the country's production structure and worsen its current account. however, an unimportant connection was discovered by insel and kayıkçı (2013). it makes sense that investment considerations have a greater impact on the current account and are not important in the short term. interest rates and current accounts have a favourable correlation, according to ozdamar (2016) and hassan (2019). the country's declining interest rates have increased demand for financing, which would boost import and consumer spending and expand the current account imbalance. on the other hand, according to homaifar and salimullah (2016), a rise in the interest rate on t-bills will result in a deficit in the current account. an increase in interest rates will raise manufacturing costs, which will restrict the number of suppliers or manufacturers in a given country. the current account deficit would consequently widen as a result of individuals having to import goods and services from overseas (rajakaruna & suardi, 2021). previous research has assessed the unequal effect of (op) on (cab). cui et al. (2022) looked at how (op) adjustments between 1990 and 2015 had an uneven impact on developing countries (cabs). they discovered that (op) shifts had a detrimental impact on a nation's (cab). additionally, they found that the influence of rising (op) on (cab) was greater than that of falling (op). in recent years, kilian and zhou (2022) investigated the relationship between (op) and (cab) in a sample of oil importers from 1995 to 2018, which included the countries of thailand, manila, bangkok, and singapore, as well as india, singapore, malaysia, and indonesia. they found that, compared to any possible benefits, changes in (op) had an overwhelming unfavourable effect on (cab). additionally, they found that when the (op) was rising rather than falling, the imbalance was more noticeable. additionally, they discovered that the countries most affected by op on their (cab) were those with strict exchange rate rules and high reliance on oil imports. the relationship between (op) and (cab) has been the subject of several investigations, although the findings have been inconsistent. there is a favourable link between (op) and (cab), according to prior studies. on the other hand, the results of several additional investigations disagree. according to dutta, bouri, and noor (2021) op significantly improved the capital account balances of the gulf cooperation council (gcc) nations. in a similar vein, narayan and nasiri (2020) discovered that (op) shocks significantly improved saudi arabia's capital account balance. in contrast, filis (2010) found that while growing (op) harmed the kingdom, it had no appreciable effect on the nation's capital account. there have been attempts to look into how (op) impacts developing countries that are net commodity importers. however, because it is assumed that the influence is symmetrical, most research has neglected any potential differences in how changes in (op) affect (cab). the impact of changing (op) on a nation's (cab) is thought to remain continuous. in actuality, though, this could not hold due to a variety of factors like heterogeneity, trade liberalization, and economic structure. the relationship between the current account balance and macroeconomic variables, including the price of oil, the currency rate, the interest rate, and the trade surpluses or deficits of countries that purchase oil, has long piqued the attention of economists. several academic studies have examined the relationship between oil prices and the expansion of developing economies. the (cab) of several countries has responded to changes in (op) asymmetrically, indicating that the effects of rising and falling (op) are not comparable (çelgin et al., 2023). moreover, to evaluate how (op) influenced the (cab) of oil-importing countries like china, singapore, japan, and france between 2005 and 2020, yang and zhou (2020) looked at the 2005-2020 time frame. according to their research, (op) modifications have varying effects on a nation's (cab). they also found that when the (op) grew compared to when it dropped, the asymmetry was more pronounced. additionally, they observed that countries with strict exchange rate policies and a greater dependence on oil imports were more susceptible to variations in oil prices. additionally, several studies have looked at the reasons behind oil's uneven influence on trade balances. the research that is currently available indicates that there is a nonlinear link between macroeconomic variables and the current account balance in many emerging nations. increasing (op) generally has a more negative and noticeable impact on (cab) than reducing (op). furthermore, the difference is particularly pronounced in nations with stringent currency rate laws and high reliance on oil imports. not accounting for asymmetry in effects led to knowledge loss and erroneous conclusions. additionally, prior studies have repeatedly shown that panel data performs better than time series data. panel data presents some difficulties, including improper generalization, measurement manipulation, and model selection. the impacts of (cab) with (op) propensity and ms cannot be universally generalized across countries due to the unpredictability of these components like (op) and (ms) in panel data. it is thus advised to apply the quantileon-quantile regression (qqr) approach, a particular technique that looks at each country independently. we investigated the effects of additional macroeconomic variables and factors, such as the exchange rate (er), interest rate (ir), and term of trade (tot), on the current account balance in addition to the price of oil and money supply, but we did not employ this approach; instead, we utilized fixed panel data or panel data static in this study, such as (pols) and (rem). the following succinctly describes the gaps in the present research: despite the widespread acknowledgement of the overall beneficial impact of macroeconomic variables on the current account balance, the spatially varied impacts on equity and the price of oil remain a subject of ongoing debate. second, there is a significant lack of research on the effects of other economic variables, particularly stock returns and foreign direct investment, despite a wealth of studies on the influence of macroeconomic factors, oil prices, and money supply on the current account balance. third, the few empirical studies that are currently available concentrate on the impacts of common fixed factors, frequently ignoring the combined geographical and economic implications throughout the region. it can be hard to tell the difference between the specific effects of these fixed links and the more general effects of microeconomic variables such as market equilibrium and competition, demand and supply, how prices are set, how easy it is to find information on the market, perfect competition, and financial disclosures. a thorough examination of the local and micro consequences is also necessary to comprehend the wider advantages of a declining current account balance. this paper makes a substantial contribution to the corpus of knowledge about the impact of macroeconomic variables on the current account balance. this research examines the equal and uneven effects of the oil price on the current account balances of six mena countries: iran and iraq, two oil possessors, and four oil importers. the findings show that the price of oil significantly and unevenly impacts the difference between the two. this analysis demonstrates that the exchange rate and interest rate have an impact on the price of oil; a higher rate is linked to a decline in the current account balance, while a lower price of oil has just a slight positive impact. the findings are significant because they provide insight into how the current account balance of countries that import oil responds to fluctuations in the price of oil (po), interest rate (ir), exchange rate (er), and term of trade asian journal of economics and empirical research, 2024, 11(1): 21-29 25 © 2024 by the authors; licensee asian online journal publishing group (tot) for policymakers and investors in such countries. in essence, our work demonstrates the influence of these interactions between the current account balance and the price of oil. additionally, it offers policymakers crucial direction as they oversee their economies in the face of operational policy variations. 3. data and methodology the main objective of this research is to find out how macroeconomic factors in six selected mena nations impact the current account's drop. these countries are iraq, iran, jordan, syria, lebanon, and palestine. this study looks at the money supply (ms), terms of trade (tot), exchange rate (er), oil prices (op), and interest rates (ir) to see how macroeconomic factors impact the current account balance (cab). the estimating model is therefore configured as follows: 𝐶𝐴𝐵𝑖𝑡 = 𝛼0 + β1er𝑖,𝑡 + β2ms𝑖,𝑡 + β3tot𝑖,𝑡 + β4op 𝑖,𝑡 + β5ir𝑖,𝑡 + ԑ𝑖𝑡 (1) the symbol (cab) represents the current account balance. the symbols (ms) and (er), respectively, indicate the money supply and exchange rate. the term of trade is represented by (tot). (op) stands for the price of oil, and (ir) for the interest rate. in addition, the model has (𝜀) for the error term, (𝑖) for the panel's sample units, and (𝑡) for the sample's period. for analysis, the panel data estimation approach is applied. the panel data estimation approach guides the analysis. the panel data model has the advantage of managing data constraints and variable heterogeneity. furthermore, testing more intricate behavioural models is acceptable for this estimate approach. we evaluate threepanel static models to get the outcome. these consist of the fixed effect model (fem), the random effect model (rem), and the pooled ordinary least square model (pols). the following is the equation for pooled ordinary least squares: 𝑌𝑖,𝑡 = 𝛼 + 𝛽1𝑋𝑖,𝑡 + ɛ𝑖,𝑡 (2) however, the random effect model uses the following equation: 𝑌𝑖,𝑡 = 𝛼 + 𝛽1𝑋𝑖,𝑡 + (ɛ𝑖,𝑡 + µ𝑖,𝑡) (3) the breusch pagan lagrangian multiplier test has been used to examine whether to select the random effect model (rem) or the pooled ordinary least square model (pols). the following is the set of hypotheses: h0. choose pooled ordinary least square model (pols). h1. choose the random effect model (rem). the random effect model (rem) is employed, and the h0 is rejected if the probability of the chi2 is less than 0.05. the fixed effect model (fem) can be used to expand the research in the following ways: 𝑌𝑖,𝑡 = 𝛼𝑖 + 𝛽1𝑋𝑖,𝑡 + ɛ𝑖,𝑡 (4) the study can continue to determine which model to use, a fixed effect model or a random effect model, after using the hausman fixed test. the hausman fixed test's conjecture is: h0. choose a random effect model (rem). h1. choose a fixed effect model (fem). the chi2 value must be less than 0.05 to select the fixed effect model (fem) for the hausman fixed test. this means that the study may go on to the fixed effect model (fem), and h1 is accepted. 4. empirical results and discussion to comprehend the link between the current account balance and macroeconomic variables including the exchange rate, interest rate, term of trade, oil price, and money supply, the empirical model in equation 1 was developed. by concentrating on these affecting variables and calculating equation 2, we expand our study. regressions using current account models are comparable to (1). the current account balance due to macroeconomic factors is presented in table 1. the ratio of the (ca) balance to the other variables is the dependent variable in a simple regression, and table 1 presents the findings of this analysis. model (1), as an estimate of a basic model, uses the change in the oil price, money supply (as a percentage of the current account balance), term of trade, interest rates, and exchange rates as independent variables. it also takes advantage of the quarterly change in the real exchange rate. we test up to four periods for each independent variable, keeping only those with statistically significant coefficient estimates, and then choose the specifications with the lowest schwartz information criterion (sic) for deciding the period duration. the findings of the regression show that the (cab) ratio is inflexible concerning the trade term, interest rate, and exchange rate. the findings show that an increase of one percentage point in the money supply and oil price relative to the current account balance causes the current account deficit to rise by around 0.21 percentage points over the same period. we find that the first two prices have statistically negligible coefficient estimates, whereas the second two prices have high coefficient estimates when we try to experiment with different periods in the interest rate and exchange rate. we only keep the contemporaneous value of the current account balance variable since adding the second two prices raises the (sic). the identical logic is used to determine the first exchange rate, and it is determined that when just the first rate is used in the real effective exchange rate (reer), the model has the lowest (sic) value. the current account deficit rises in tandem with an increase in the real exchange rate. this finding suggests that a decline in the local currency's value, or a decline in the actual exchange rate, has a beneficial impact on the current account balance. asian journal of economics and empirical research, 2024, 11(1): 21-29 26 © 2024 by the authors; licensee asian online journal publishing group table 1. current account balance to macroeconomic factors. variables 1 2 3 4 cab/eri,t -0.07*** (0.04) -0.07*** (0.04) -0.07 (0.04) -0.07*** (0.04) cab/msi,t -0.34*** (0.02) -0.34*** (0.02) -0.34*** (0.02) -0.34*** (0.02) cab/toti,t 0.05* (0.07) 0.05* (0.07) 0.05 (0.07) 0.05 (0.07) cab/opi,t 0.08* (0.11) 0.08* (0.11) 0.08 (0.11) 0.08 (0.11) cab/iri,t -0.09*** (0.03) -0.09*** (0.03) -0.09*** (0.03) -0.09*** (0.03) constant 0.81*** (0.27) 0.81*** (0.27) 0.81*** (0.27) 0.81*** (0.27) r2 0.88 0.88 0.89 0.89 adjusted r2 0.83 0.83 0.83 0.83 note: * and *** indicate significance at the 1%, and 10% levels, respectively. the (tot) variable is included in the second model, and its regression coefficients are nearly identical to those of the first model. stated differently, the coefficient estimates for the other variables on the right-hand side remain unchanged with the addition of the (tot) variable. the ratio of export prices to import prices, or the coefficient of the (tot) variable, is predicted to be positive but not statistically significant. models (3) and (4) include the interest rate and currency rate as independent explanatory variables. model (1) utilized the high correlation between the interest rate and exchange rate variables to address potential multicollinearity, resulting in identical coefficient estimates for models (3) and (4). by appending the (tot) variable to models (3) and (4), respectively, models (2) and (3) were calculated. the addition of the tot variable often does not significantly alter the outcomes of the interest rate and exchange rate. therefore, we considered the regression results for model (2) as the primary findings, approximating the other results for reliability purposes. the current account deficit grows by -0.34 points and 0.08 points for every percentage point increase in oil prices and money supply, respectively, but the deficit increases by -0.09 points for every percentage point increase in both. stated differently, the money supply doubles the amount of the current account balance relative to the price of oil (po). in the estimation process, we also include dummies, which are critical for all requirements. numerous diagnostic tests are carried out to guarantee the results' robustness. we use the variance inflation factor (vif) to verify the existence of a multicollinearity issue. statistics on multicollinearity are a trustworthy way to determine whether a regression analysis is legitimate. table 2 computes the variance inflation factor (vif) and the tolerance threshold. table 2. variance inflation factor (vif). variables 𝐕𝐈𝐅 𝟏/𝐕𝐈𝐅 er 3.11 0.2873 ms 2.26 0.3899 tot 1.97 0.4297 op 1.81 0.4862 ir 1.03 0.9986 mean vif 2.06 0.3682 the study adheres to the guidelines (gujarati, 2014) that the (vif) value should be less than 5 and the 1/vif value should be closer to zero to guarantee the validity of the analysis. the mean (vif) was discovered to be 2.06 below the five cutoff points. consequently, this requirement has been satisfied, and the outcome shows that multicollinearity was not present in the regression analysis. heteroscedasticity is a diagnostic test that looks for instances when the error term size varies among the independent variable's values. the cook-weisberg or breusch pagan test is used to make sure the issue is not present. according to the results, chi2 (1) = 11.23, prob > chi2 = 0.0006. this investigation is heteroscedastic because the probability value is less than 0.01. however, the robust heteroscedasticity standard error approach may be used to address the heteroscedasticity problem, as per stock and watson (2008), who suggest using the robust heteroscedasticity standard error approach to address the heteroscedasticity problem. one can determine the model by analyzing the results of a series of experiments. we use the breusch pagan test to assess the suitability of the pooled (pols) and random effect model (rem) in determining the most accurate model estimates. the more suitable model between the fixed effect model (fem) and the regression event model (rem) is determined using the hausman test. the validity of the result was discovered to be more convenient for (rem), so table 3's findings will be investigated using this model. table 3. random effect model (rem). variables coefficient 𝐙 𝐏 > 𝐙 er 0.0031 -2.83 0.019 ms 0.0062 -0.98 0.306 tot 0.0006 2.25 0.010 op 0.0000 1.02 0.243 ir -0.0011 -2.87 0.007 c 0.03642 -1.23 0.289 asian journal of economics and empirical research, 2024, 11(1): 21-29 27 © 2024 by the authors; licensee asian online journal publishing group based on table 1's results, the regression model's r-squared (r2) is 0.88, meaning that all of the independent variables utilized can account for 88% of the variation in the current account. all of the independent variables together are significant in explaining the current account deterioration, as indicated by the likelihood of the fstatistics (0.00). table 3 indicates that there is an anticipated negative link between the exchange rate (er) and a current account. at the 5% alpha threshold of significance, the association is noteworthy. the current account deficit will decrease with a rise in the (er), as shown by astuti et al. (2015), purwono et al. (2018), and sahoo et al. (2022). it is hypothesized that a higher exchange rate will reduce the nation's savings because individuals will import more items since they are more affordable. as a result, savings will decline, which will cause current account balances to drop. unexpectedly, the money supply (ms) displays a negative sign. the finding's negligible association suggests that modifications to (ms) have little effect on the current account. the results contradict those of earlier research (ousseini et al., 2017; ya-qiong & rui, 2013). this suggests that whereas ms has a minor impact on foreign variables like the current account, it has a significant impact on internal factors like production and inflation in mena countries. the link between the term of the trade (tot) and the current account is positive; the coefficient value is 0.0006. at the 0.05 level of significance, the (tot) has an impact on the current account that is noteworthy. a higher (tot) will result in less expensive imports, which will support future export activity and be used for production. as a result, increased exports will suggest that a nation has a current account surplus. the results align with the works of ozdamar (2016); sahoo et al. (2022), and sumiyati (2022). a longer period of trade will result in reduced pricing for imported goods and services, which will raise demand. however, the utilization of imported commodities to produce and export highly technologically advanced goods will lead to a rise in the current account in the long run. the nation will take proactive measures by encouraging more cautious saving and reducing investment when there is a larger term of trade volatility, which will result in a current account surplus. (tot) has benefited the capital account (ca) because some nations have taken steps to prevent its effects, such as implementing greater precautionary saving earlier. (tot) has benefited the capital account (ca) since some nations have made the effort to prevent the effects by, for example, implementing greater precautionary saving sooner. as a result, a higher tot will have a beneficial effect on the current account. there is a positive correlation between the oil price (op) and the capital account (ca). the degree to which mena countries rely on oil prices determines how the capital account (ca) and the open market (op) relate to each other. countries that rely on oil imports have benefited from the decreased price because it would reduce expenses and increase the current account imbalance. variations in the price of oil will impact different industries. while other sectors are less impacted, the transportation and logistics industry will be the primary target of fluctuations in oil prices (op). however, we determine the association to be negligible, suggesting the absence of a substantial relationship. it has been discovered that the capital account (ca) and interest rate (ir) have a positive connection. the results contradict those of earlier research (hassan, 2019; ozdamar, 2016). the argument that higher interest rates lead to increased expenses and a shortage of suppliers could potentially educate consumers. as a result, imports rise as individuals search for suppliers overseas, which ultimately causes the current account to fall. higher costs may cause a shortage of suppliers within the country and will likely push consumers in the mena to look for suppliers outside, increasing imports and decreasing the country's current account. 5. conclusion and policy implications this study investigates and focuses on the macroeconomic variables that affect the decline in the current account balance of eight chosen mena countries. the findings show that while the term of trade (tot) has a positive association with the current account balance, the exchange rate (er) and interest rate (ir) have a substantial negative link with the current account balance (cab). therefore, we can conclude that macroeconomic variables like interest rate (ir) and equity ratio (er) significantly influence the capital account (ca) and current account balance (cab), with er being the most relevant. our econometric analysis demonstrates that macroeconomic variables like the interest rate, exchange rate, and term of trade have a positive and significant impact on the current account balance. these effects vary depending on the amount of money in circulation, the amount of imported oil, exchange rate regimes, and structural aspects of the domestic economy. as a result, variations in interest rates (ir) have the potential to significantly impact the current account balance of mena countries, underscoring the importance of prudently adjusting domestic interest rates to encourage investment and output within the economy. however, research shows that neither the money supply (ms) nor the price of oil (op) significantly affect the capital account (ca). therefore, we advise mena countries to closely monitor the macroeconomic factors affecting the current account to maintain a sound economic balance. we also urge the governments of these nations to implement macroeconomic modifications and policy changes to tackle the issues caused by the decline in the current account balance (cab). the effects of macroeconomic variables on the current account balance of developing countries, like the mena countries that made up the study's sample, have significant policy implications, including that diversifying their energy sources should be the top aim for emerging countries to lessen their reliance on oil imports. initiatives to improve energy efficiency and financial investments in clean energy sources like solar and wind power are two examples. developing nations that are heavily dependent on oil imports should establish stability funds to mitigate the impact of operational policy changes on their trade balances. you can use the saved money to control inflation during high oil prices or assist governments in keeping spending within reasonable limits during low prices. to diversify their economies and lessen their reliance on oil imports, mena countries need to endeavour to establish non-oil export industries. this might involve making investments in a variety of sectors, including industry, agriculture, and tourism. mena countries can employ trading techniques to mitigate the impact of operational policy changes on their current account balance. for example, they can fix the price of upcoming oil imports using financial tools like options and futures contracts. the economies of the mena emerging countries that import oil ought to think about working together to bargain for more favourable conditions on oil purchases and lessen their overall vulnerability to changes in economic policy. by managing the asymmetric impact of operational fiscal policy variations on the pace of monetary asian journal of economics and empirical research, 2024, 11(1): 21-29 28 © 2024 by the authors; licensee asian online journal publishing group modification, emerging countries that import oil can improve economic stability with the aid of these policy implications. 6. limitations and future research avenues concerning the unequal impact of the oil price on the current account balances of developing nations that import oil. first, the findings only apply to rising economies that import oil; they do not apply to other economic situations or regions. second, the study's dependability could have been compromised by the data's accessibility and caliber. on the other hand, the correlational analysis of the study may not establish a causal link between the oil price (op) and the current account balances, nor may it reveal the long-term impacts of the study. it's also possible that the study's comparatively straightforward modelling approach overestimated the complexity of the interactions among these nations' interest rates (ir), exchange rates (er), and oil prices (op). the unequal impacts of operational policies on the current account balance (cab) of rising mena countries, all of which are net importers of goods, can be examined in several ways. one approach to consider is the impact of external variables like exchange rates (cr), monetary policy, and global economic situations on interest rates. to find out if the findings hold elsewhere, one option is to broaden the research's geographic focus. to better capture the complexity of the relationships between the oil price (op) and the current account balance (cab), future research may include more sophisticated modelling techniques in addition to studies of indicators and other significant economic variables, such as panel data analysis. lastly, research on the effects of energy transitions and renewable energy on interest rates (ir) and currency rates in developing nations that import oil may be worthwhile. references aristovnik. 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(2015). determinants of current account deficit in turkey: the conditional and partial granger causality approach. procedia economics and finance, 26(1), 92-100. https://doi.org/10.1016/s2212-5671(15)00884-9 asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.17719/jisr.20164317772 https://www.economicshelp.org/blog/glossary/current-account-bop/ https://www.economicshelp.org/blog/glossary/current-account-bop/ https://doi.org/10.13106/jafeb.2018.vol5.no2.25 https://doi.org/10.1016/j.asieco.2021.101393 https://doi.org/10.1016/s2212-5671(15)01696-2 https://doi.org/10.1002/pa.2311 https://doi.org/10.1177/0973801016676015 https://doi.org/10.1016/j.eap.2016.02.006 https://www.worldbank.org/en/country/lao/overview https://doi.org/10.3923/jas.2013.2933.2939 https://doi.org/10.1002/fut.22103 https://doi.org/10.1016/s2212-5671(15)00884-9 111 © 2024 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 11, no. 2, 111-124, 2024 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v11i2.6283 © 2024 by the authors; licensee asian online journal publishing group research on the effect of digital economy on new agricultural productivity zhou pengfei1 cai yang2 li xianfeng3 ( corresponding author) 1,2,3school of economics and management, chongqing normal university, chongqing, 401311, china. 1email: pengfeizhou@cqnu.edu.cn 2email: 2023110515033@stu.cqnu.edu.cn 3email: 2022110515019@stu.cqnu.edu.cn abstract this article comprehensively explores the impact of the digital economy on the new quality of agricultural productivity. leveraging the panel data of 31 provincial-level regions in china from 2011 to 2022, a series of advanced econometric models, such as bidirectional fixed-effect, intermediary effect, threshold effect, and spatial durbin models, are established for in-depth empirical analysis. the results are multi-faceted. firstly, the digital economy significantly elevates the new quality of agricultural productivity, yet with temporal and regional variances. secondly, it acts as a catalyst for productivity growth by augmenting government revenue, spurring technological innovation, and enriching human capital. thirdly, rural education, the urban-rural information chasm, and information infrastructure construction exert distinctive threshold effects on this promotional process. notably, a significant spatial spillover effect exists. consequently, based on these findings, suggestions for bolstering the new quality agricultural productivity are proffered from four perspectives: government governance, policy formulation, digital infrastructure construction, and human capital enhancement. keywords: agricultural new quality productivity, digital economy, mediator effect, rural revitalization, spatial spillover effect, threshold effect. jel classification: e20; j43. citation | pengfei, z., yang, c., & xianfeng, l. (2024). research on the effect of digital economy on new agricultural productivity. asian journal of economics and empirical research, 11(2), 111–124. 10.20448/ajeer.v11i2.6283 history: received: 21 october 2024 revised: 26 november 2024 accepted: 23 december 2024 published: 31 december 2024 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this research is supported by national social science foundation of china (grant number: 19xmz095) and 2023 chongqing graduate education curriculum ideological and political demonstration project "agricultural economics" (grant number: ykcsz23101) institutional review board statement: the ethical committee of the chongqing normal university, china has granted approval for this study on 15 june 2024 (ref. no. 2024eth001). transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. data availability statement: the corresponding author may provide study data upon reasonable request. competing interests: the authors declare that they have no competing interests. authors’ contributions: designed the study, collected and analyzed the data, and drafted the manuscript, z.p.; contributed to the experimental design, performed the experiments, and participated in data interpretation, c.y.; provided critical insights during the research process, reviewed and revised the manuscript, l.x. all authors have read and agreed to the published version of the manuscript. contents 1. introduction .................................................................................................................................................................................... 112 2. literature review .......................................................................................................................................................................... 112 3. mechanism analysis ...................................................................................................................................................................... 113 4. research design ............................................................................................................................................................................. 114 5. interpretation of result ................................................................................................................................................................ 117 6. further expansion ......................................................................................................................................................................... 121 7. conclusions and suggestions ....................................................................................................................................................... 123 references ............................................................................................................................................................................................ 124 mailto:pengfeizhou@cqnu.edu.cn mailto:2023110515033@stu.cqnu.edu.cn mailto:2022110515019@stu.cqnu.edu.cn https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v11i2.6283 asian journal of economics and empirical research, 2024, 11(2): 111-124 112 © 2024 by the authors; licensee asian online journal publishing group contribution of this paper to the literature the possible innovation points of this article are as follows. first, there is an innovation in research perspective as it starts from the new angle of new-quality agricultural productivity related to the digital economy rather than traditional ones, providing a new understanding dimension. second, it innovatively applies multiple complex models like bidirectional fixed effects, intermediary effects, threshold effects, and spatial durbin models for comprehensive and in-depth analysis with more information than single-model approaches. third, it innovatively explores various influencing factors, including rural education, urban-rural information gap, and infrastructure construction, considering their threshold and spillover effects. fourth, based on empirical results, it innovatively gives practical suggestions from four aspects for promoting new-quality agricultural productivity development. 1. introduction the promotion of rural revitalization constitutes an internal requirement for the all-round construction of a modern socialist country, with industrial revitalization having become the basis and key to realizing rural revitalization. in the past ten years, china has witnessed significant accomplishments in agricultural development. as per the data from the national bureau of statistics, between 2011 and 2022, the grain output in china climbed from 588.4933 million tons to 686.5277 million tons, effectively safeguarding national food security. additionally, the total output value of agriculture, forestry, animal husbandry, and fishery increased from 78836.98 billion yuan to 156665.94 billion yuan, registering an average annual growth of 6.4% and showing a steady enhancement in the quality of agricultural development. nevertheless, china's agricultural growth is still mainly extensive, beset with problems like large resource consumption, serious environmental pollution, and low production efficiency (liu, zou, & wang, 2020; tang & chen, 2022). hence, the transition from production-oriented to quality-oriented has emerged as a crucial issue for promoting the transformation and upgrading of china's agriculture and achieving high-quality agricultural development. the introduction of new quality productivity presents a new direction to solve this problem. its hightech, high-efficiency, and high-quality attributes can effectively boost the quality and efficiency of agricultural production, promoting the high-quality development of agriculture (jie, 2024). in order to bring about industrial revitalization, and finally the full building of a modern socialist country (lin, gu, & shi, 2024) it is very important to look into the factors that affect the promotion of new agricultural quality productivity. the digital economy represents the world’s future development direction and holds significant importance for china’s transformation of its economic mode and attainment of high-quality economic development. with the continuous progress and wide application of digital technology, the integration of the digital economy with various industries has been deepening, driving the transformation and upgrading of different industries (su, su, & wang, 2021). however, due to the relatively low economic level in the main areas of agricultural development and the lagging construction of information infrastructure, the penetration of the digital economy in these areas is small, and the level of integration with agriculture is low. according to the data of 2022, the penetration rate of china's digital economy into the primary industry is only 10.5%, far lower than that of the secondary industry (24.0%) and the tertiary industry (44.7%). simultaneously, the digital economy’s total factor productivity growth in the primary industry remains low throughout the year, significantly lower than that of the secondary and tertiary industries. to achieve high-quality development of agriculture, it is necessary to improve the impact of the digital economy on agriculture. therefore, as agricultural development is in a critical period of transformation and upgrading, it is especially important to thoroughly study the impact effect of the digital economy on the new quality of agricultural productivity (zhou, chen, & zhang, 2023). 2. literature review the field of research on new agricultural productivity is increasingly attracting academic attention; however, there is relatively little research on the topic. different scholars have adopted various dimensions for measuring and evaluating the topic. zhu and ye (2024) made comprehensive evaluation from three aspects: agricultural workers, agricultural labor materials, and agricultural labor objects; song, leng, and zhou (2024) measured from three dimensions: scientific and technological productivity, green productivity, and digital productivity; while (yang & wang, 2024) evaluated the development level of new quality digital agriculture in china from three dimensions: "high quality" agricultural workers, "new medium" agricultural labor materials, and "new material" agricultural labor objects. in terms of the influencing factors, different studies have drawn different conclusions. wang and liu (2024) believe that the development of new quality productive forces in agriculture can enhance the level of food security in major countries; (li, xue, & jiang, 2024) believe that agricultural digitization can significantly improve the productivity of new grain productivity; (zhang & gong, 2024) believe that the level of new agricultural productivity can be improved through the construction of high-standard agricultural farmland, thus increasing farmers grain income. in terms of theoretical analysis, the researchers also explored the concept of new quality productivity in agriculture from various perspectives. for example, wang and yang (2023) studied the mechanism of relationship between digital new agricultural productivity and the high-quality development in china; (luo, 2014) analyzed the main obstacles, development priorities, and policy suggestions for the development of new agricultural productivity; (jiang, 2024) made a logical analysis of new agricultural productivity from four aspects: connotation characteristics, development focus, constraints, and policy suggestions. these studies provide useful reference and enlightenment for understanding the connotation and influencing factors of agricultural productivity. according to the comprehensive literature, scholars have not yet discussed the digital economy and the new quality productivity of agriculture, which shows that there is a lot of academic research space in this field. therefore, based on the panel data of 31 provinces in china from 2011 to 2022, this paper makes a comprehensive evaluation of new agricultural productivity and tries to explore the effect of digital economy on the improvement of new agricultural productivity. this research aims to close this gap in academic circles and provide a specific reference for the formulation of relevant agricultural policies. asian journal of economics and empirical research, 2024, 11(2): 111-124 113 © 2024 by the authors; licensee asian online journal publishing group 3. mechanism analysis 3.1. analysis of the direct impact of digital economy on new quality productivity the new agricultural quality productivity is a new productivity form with qualitative change produced by the optimization combination of productivity elements of laborers, labor materials, and labor objects. it has four main characteristics: innovation-driven, green and low-carbon, open integration, and human-oriented connotation, which represents the revolutionary improvement of production efficiency (huang & sheng, 2024). the impact of digital economy on new quality agricultural productivity can be explained from two aspects: technology promotion and population quality improvement. first, the booming development of the digital economy provides an efficient digital platform for the dissemination and exchange of information, breaking the constraints of geographical location and spatial constraints. in this context, emerging agricultural technologies can be promoted more widely, so that the agricultural community can adopt innovative technologies more quickly, improve production efficiency, and realize the effective improvement of new agricultural productivity (ding, liu, zheng, & li, 2021). second, as a key support force for the development of china's digital economy, the popularization and development of the internet have greatly reduced the learning cost of agricultural technology and business models (hua & zhang, 2023). through various channels, such as online training provided by internet platforms, agricultural practitioners are able to acquire knowledge and skills in a more convenient, efficient, and low-cost way. this not only enables them to continuously improve their personal quality without disrupting production but also promotes the continuous improvement of new agricultural quality productivity. based on the above analysis, hypothesis 1: digital economy can promote the improvement of new agricultural productivity. 3.2. analysis of the action mechanism of digital economy on the new quality of agricultural productivity 3.2.1. government revenue mechanism the booming development of the digital economy has not only changed the business model and industrial pattern but also provided important support for improving the new quality of agricultural productivity. first, the rise of the digital economy has increased government tax revenue, resulting from the continued boom of emerging industries such as e-commerce and online services (volkova, kuzmuk, oliinyk, klymenko, & dankanych, 2021) giving the government more money to support technological innovation and infrastructure construction in the agricultural sector. secondly, digital transaction records and payment systems effectively reduce tax loopholes, improve the efficiency of tax collection (zhu, 2021) further increase government revenue, and provide stable financial support for agriculture. finally, the development of digital economy drives the growth of the overall economy (tao, zhang, & shangkun, 2022) improves the level of national income and consumer demand, and promotes the demand for agricultural products, thus further expanding the tax base. to sum up, the digital economy provides strong financial support and policy guarantees for the promotion of new quality agricultural productivity by increasing government income. 3.2.2. scientific and technological innovation mechanism science and technology are the primary productive forces, and scientific and technological innovation is the core impetus for the progress of science and technology. by stimulating scientific and technological innovation, the digital economy can effectively enhance the productivity of new agricultural products. to begin with, the application of digital technology can speed up the agricultural informatization process (quan, zhang, quan, & yu, 2024). digital technologies such as big data, cloud computing, blockchain, and internet of things can transform traditional agriculture into smart agriculture. this conversion can enhance the technological innovation capability of agriculture and subsequently improve the new quality productivity of agriculture. moreover, the digital economy furnishes a digital medium for information dissemination and communication (peng & luxin, 2022). by removing regional limitations and accelerating the spread of knowledge, it stimulates the collision of innovative thoughts and the release of innovation spillover effects. as a result, the efficiency of agricultural technological innovation is increased, and the improvement of new agricultural quality productivity is promoted. finally, the digital economy is characterized by being technological, digital, and intelligent as it reshapes the economic, digital, and cultural environments. this transformation of the environment not only shapes the behavior and expectations of innovation entities, but also drives the reform and improvement of the market economic system. consequently, a better institutional environment and policy support are provided for agricultural scientific and technological innovation, ultimately driving the improvement of new agricultural productivity. 3.2.3 human capital mechanism cultivating and expanding the new type of labor force is an important strategy to enhance the new quality of agricultural productive forces. the development of digital economy helps to improve the level of human capital, so as to effectively promote the improvement of new agricultural productivity. first, the booming digital economy accelerates the flow of knowledge and experience between different regions, allowing agricultural practitioners to keep abreast of the latest trends in agricultural techniques and management methods. agricultural practitioners, through online training and other channels provided by the internet platform, can continuously enhance their own quality, thereby promoting the rapid improvement of new agricultural productivity. secondly, the application of digital technology has brought about the upgrading of agricultural production technology and the innovation of management mode and promoted the transformation and upgrading of traditional agriculture to modern agriculture. this not only gives birth to new agricultural forms and models but also provides a large number of new employment opportunities for agriculture, attracting more agricultural professionals to join and thus effectively promoting the improvement of new quality of agricultural productivity (grigorescu, pelinescu, ion, & dutcas, 2021). based on the above analysis, hypothesis 2 is put forward: digital economy promotes the improvement of new agricultural quality and productivity by improving the government income level, scientific and technological innovation level, and human capital level. asian journal of economics and empirical research, 2024, 11(2): 111-124 114 © 2024 by the authors; licensee asian online journal publishing group 3.3. analysis of the threshold effect of digital economy on the new quality of agricultural productivity 3.3.1. education level in rural areas the digital economy involves more complex digital technology applications such as big data, cloud computing, blockchain, and the internet of things. agricultural practitioners need to master these technologies through professional education. when the level of education in rural areas is low, it means that agricultural practitioners receive insufficient professional education and have a low grasp of digital technology, thus having a restraining effect on the digital economy to promote the improvement of new quality agricultural productivity. when the level of rural education gradually improves, it means that agricultural practitioners usually receive deeper and specialized education and master higher levels of skills and knowledge. this enables it to deeper understand and apply the technologies and concepts involved in digital economy and makes it easier to master and apply advanced digital agricultural technology so as to promote the role of digital economy in improving the new agricultural productivity through the skilled use of digital agricultural technology. therefore, the promotion effect of digital economy on new quality agricultural productivity will show the characteristics from low to high with the improvement of rural education level. 3.3.2. information gap between urban and rural areas due to the huge differences in rural and urban areas in the access, use, and innovation of information resources and technologies, the serious information imbalance between urban and rural areas is caused (chen & wang, 2020). this may result in information asymmetry, which will affect the efficiency of resource allocation and ultimately inhibit the promotion of digital economy on new agricultural productivity. the information gap between urban and rural areas is small, the information asymmetry is light, and the allocation of urban and rural factors is relatively reasonable, which is conducive to the promotion of the new quality of agricultural productivity by digital economy. however, with the widening of the information gap between urban and rural areas, the information gap between urban and rural areas is also expanding, and the allocation of urban and rural factors gradually becomes inefficient, thus hindering the role of digital economy in promoting new agricultural productivity. however, with the acceleration of the urbanization process, a large number of people pour into cities, and the number of people receiving the same information keeps increasing, which alleviates the information asymmetry caused by urban-rural information imbalance, thus improving the efficiency of resource allocation and weakening the inhibitory effect of urban-rural information gap on the digital economy to promote new agricultural productivity. therefore, the impact of digital economy on new agricultural productivity will show u-shaped characteristics from high to low to high with the widening of the information gap between urban and rural areas. 3.3.3. information infrastructure construction the construction of information infrastructure is the key pillar of the development of digital economy, and its level directly affects the promotion effect of digital economy on the new quality of agricultural productivity. when the level of information infrastructure construction is low, the role of digital economy in promoting the new quality of agricultural productivity is limited. this is because the lower level of information infrastructure can only cover the limited regional economies, and the cross-regional information flow is restricted, which restricts the crossregional dissemination and communication of technology and knowledge, thus reducing the role of digital economy in promoting new agricultural productivity. when the level of information infrastructure construction is high, the digital economy plays a more significant role in promoting new agricultural productivity. this is because the high level of information infrastructure can cover a wider range of regional economy, break through the restrictions of regional information dissemination, promote the wide dissemination and exchange of agricultural technology and knowledge, and thus improve the promotion effect of digital economy on new agricultural productivity. based on the above analysis, the paper puts forward hypothesis 3: the influence of digital economy on new quality productivity has threshold effect based on rural education level, urban-rural information gap, and information infrastructure construction, which is manifested as non-linear increasing effect, non-linear effect of decreasing and then increasing, and a non-linear increasing effect, respectively. 3.4. spatial spillover effect analysis of digital economy on the new quality of agricultural productivity with the rapid development of the digital economy, the links between the provinces are becoming increasingly close. first of all, due to the frequent movement of agricultural trade activities and farmers among neighboring regions, coupled with the close geographical location and convenient transportation, to promote the flow of digital agricultural technology, agricultural management experience, and other information between regions. this flow of information provides local agricultural practitioners with the opportunity to learn from the advanced experience and technology in neighboring areas, thus effectively improving the level of local agricultural production and promoting the continuous improvement of new quality productivity. secondly, due to the promotion of inter-regional economic activities and rural human capital flow, the advanced experience and technology of the regions leading in the development of digital economy will spread to other regions, while the wide application of digital media will further improve the speed and scope of diffusion. this diffusion effect drives more areas to benefit, thus promoting the improvement of agricultural production efficiency and improving the level of new agricultural productivity (tian, cai, & zhang, 2024). based on the above analysis, the paper puts forward hypothesis 4: the development of digital economy has a positive spatial spillover effect on the improvement of new quality agricultural productivity. 4. research design 4.1. model construction 4.1.1. benchmark regression model the aim to examine how the digital economy affects the new level of agricultural productivity. the paper constructs the following benchmark model: 𝑁𝑄𝐴𝑃𝑖𝑡 = 𝛼0 + 𝛼1𝐷𝐸𝑖𝑡 + ∑ 휂𝑘 𝑛 𝑘=1 𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑖𝑡 + 𝜆𝑖 + 𝛾𝑡 + 𝜇𝑖𝑡 (1) in model (1), the notations “i” and “t” stand for the province and the year, respectively. “control” denotes the control variable. here, α0 represents the constant term. the regression coefficients of each variable are indicated by asian journal of economics and empirical research, 2024, 11(2): 111-124 115 © 2024 by the authors; licensee asian online journal publishing group α1 and ηk. the fixed effects of province and year are represented by λi and γt respectively. and μ serves as the random error term. 4.1.2. the mediation effect model on the basis of model (1), the intermediary effect model is constructed to test the role mechanism of digital economy in promoting the improvement of new quality agricultural productivity. the models constructs the following mediation effect: 𝑀𝑒𝑑𝑖𝑢𝑚𝑖𝑡 = 𝛽0 + 𝛽1𝐷𝐸𝑖𝑡 + ∑ 휂𝑘 𝑛 𝑘=1 𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑖𝑡 + 𝜆𝑖 + 𝛾𝑡 + 𝜇𝑖𝑡 (2) 𝑁𝑄𝐴𝑃𝑖𝑡 = 𝛽2 + 𝛽3𝐷𝐸𝑖𝑡 + 𝛽4𝑀𝑒𝑑𝑖𝑢𝑚𝑖𝑡 + ∑ 휂𝑘 𝑛 𝑘=1 𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑖𝑡 + 𝜆𝑖 + 𝛾𝑡 + 𝜇𝑖𝑡 (3) where medium represents the mediation variable, β0 and β2 represent the constant term, β1, β3, β4, are the regression coefficients, and the other symbols have the same meaning as in the model (1). 4.1.3. the threshold-based effect model the nonlinear effect of digital economy on agricultural new quality productivity is measured by constructing the threshold effect model. the model is as follows: 𝑁𝑄𝐴𝑃𝑖𝑡 = 𝜑0 + 𝜑1𝐺𝐴𝑃𝑖𝑡 × 𝐼(𝑇ℎ𝑟𝑒𝑠ℎ𝑜𝑙𝑑𝑖𝑡 ≤ 휃1) + 𝜑2𝐷𝐸𝑖𝑡 × 𝐼(휃1 < 𝑇ℎ𝑟𝑒𝑠ℎ𝑜𝑙𝑑𝑖𝑡 ≤ 휃2) + ⋯ + 𝜑𝑛𝐷𝐸𝑖𝑡 × 𝐼(𝑇ℎ𝑟𝑒𝑠ℎ𝑜𝑙𝑑𝑖𝑡 > 휃𝑛−1) + ∑ 휂𝑘 𝑛 𝑘=1 𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑖𝑡 + 𝜆𝑖 + 𝛾𝑡 + 𝜇𝑖𝑡 (4) where i (•) is the indicator function, when the conditions in parentheses are met, the value is 1, if not; the threshold is the threshold variable; φ 0 is the constant term, φ n is the regression coefficient; the other symbols have the same meaning as the model (1). 4.1.4. the spatial durbin model to explore the spatial spillover effect of digital economy on the new quality of productivity in agriculture by constructing the spatial durbin model. the specific model is constructed as follows: 𝑁𝑄𝐴𝑃𝑖𝑡 = 휁0 + 휁1𝐷𝐸𝑖𝑡 + 휁2𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑖𝑡 + 𝜌𝑊𝑁𝑄𝐴𝑃𝑖𝑡 + 휁3𝑊𝐷𝐸𝑖𝑡 + 휁4𝑊𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑖𝑡 + 𝜆𝑖 + 𝛾𝑡 + 𝑣𝑖𝑡 (5) 𝑣𝑖𝑡 = 휁5𝑊𝑣𝑖𝑡 + 휀𝑖𝑡 , 휀𝑖𝑡~𝑁(0, 𝛿2𝐼) (6) where, ζ0 represents the constant term, ζ1, ζ2, ζ3, ζ4, and ζ5 are all coefficients, σ represents the spatial autoregressive coefficient, w is the spatial weight matrix, and v represents the residual term. 4.2. description of the variables 4.2.1. explained variables the article explains agricultural new quality productivity as the variable under investigation. the basic connotation of new quality labor force is laborer, labor means, labor object, and its optimal combination (research center of xi jinping's economic thought, 2024) so the evaluation of agricultural new quality productive force is based on the three first-level indicators of laborer, labor means, and labor object. the research results of you and tian (2024) primarily inform the selection of secondary indicators in the paper. first, as for workers, the study believes that new quality workers have higher cultural quality and labor productivity. therefore, the paper describes the laborer from the two secondary indicators of labor quality and labor production efficiency. in terms of specific indicators, the quality of workers is represented by the average years of education in rural areas, per capita financial education expenditure, and the ratio of college graduates and permanent resident population; labor production efficiency is represented by the per capita output value of agriculture, forestry, animal husbandry, and fishery, per capita grain output and per capita disposable income of rural residents. second, about labor data, the study elaborated on the characteristics and specific forms of traditional labor data and new quality labor data. therefore, the paper describes the labor data from the two secondary indicators: traditional labor data and new quality labor data. specifically, the ratio of agricultural machinery, the ratio of agricultural fertilizer application, and the ratio of rural broadband access users and rural population. thirdly, about the labor object, the study explains the green development, land standardization, and other aspects. at the same time, considering the important role of innovation factors in upgrading the labor object, the article finally describes the labor object from three aspects of standardized farmland, green development, and innovative development. specifically, standardized farmland is represented by the ratio of effective irrigated area and crop-sown area and the ratio of waterlogged area and crop-sown area; green development is characterized by the ratio of total afforestation area and agricultural water consumption and total grain output; and the ratio of local financial science and technology expenditure to local financial budget expenditure. the ratio of the amount of patent applications granted and the permanent resident population at the end of the year is represented. finally, this paper constructs a new agricultural quality productivity measurement index system composed of three first-level indicators of labor, labor means, and labor object, including 7 second-level indicators and 18 specific indicators (table 1). in terms of calculation method, the paper adopts four methods of standardization treatment, translation treatment, entropy value assignment, and linear weighting to calculate the comprehensive evaluation value of specific agricultural new quality productivity. table 1. measurement index system of agricultural new quality productivity. evaluation target level 1 indicators secondary indicators specific indicators indicator attributes weight agricultural new quality productivity labourer educational level of workers average years of education in rural areas (years) + 0.005 per capita financial expenditure on education (yuan) + 0.039 number of college graduates / permanent resident population + 0.024 labor production efficiency per capita output value of agriculture, forestry, animal husbandry and fishery (yuan) + 0.030 per capita grain output (kg) + 0.061 asian journal of economics and empirical research, 2024, 11(2): 111-124 116 © 2024 by the authors; licensee asian online journal publishing group evaluation target level 1 indicators secondary indicators specific indicators indicator attributes weight per capita disposable income of rural residents (yuan) + 0.037 means of labor traditional labor data total power of agricultural machinery (ten thousand kilowatts) + 0.068 purity amount of agricultural chemical fertilizer application / sown area of crops 0.011 number of reservoirs (seats) + 0.104 new quality labor data optical cable laying line / area area + 0.125 rural delivery route / area area + 0.072 rural broadband access users / rural population + 0.065 subject of labor standardized farmland effective irrigated area / crop sown area + 0.024 waterlogging area / crop sown area + 0.121 green development total area of afforestation (thousand ha) + 0.059 agricultural water consumption / total grain output 0.008 innovative development local financial expenditure on science and technology / local fiscal budget expenditure + 0.058 domestic patent application acceptance volume / permanent resident population at the end of the year + 0.089 4.2.2. core explanatory variables the core explanatory variable in this article is the digital economy. referring to the research findings of tao et al. (2022) this paper selects a comprehensive evaluation index system for digital economy development. this system encompasses internet popularization, employment proportion, per capita telecom business volume, telephone penetration rate, and the digital financial inclusion index (table 2). the same calculation method used for digital economy development is also applied to obtain the comprehensive evaluation value of the new agricultural quality productivity. table 2. comprehensive evaluation index system of digital economy development. evaluation target level 1 indicators specific indicators indicator attributes weight digital economy development internet popularization internet broadband access users / permanent resident population at the end of the year + 0.109 the proportion of the employed personnel in the information industry information transmission, software and information technology services employed in urban units / urban units + 0.298 per-capita telecommunications business volume total telecom business volume / permanent resident population at the end of the year + 0.417 penetration number of phone users per 100 people + 0.092 the digital financial inclusion index the china digital financial inclusion index + 0.085 4.2.3. intermediary variables the article sets up three intermediary variables to test the mechanism of action, including: (1) the government budget revenue in general (hu, shi, & yang, 2022) using the numerical value of local fiscal science and technology expenditure and local education expenditure; (2) scientific and technological innovation (ti) and (3) human capital (hc). 4.2.4. threshold variable the paper set up three threshold variables to study the threshold effect.(1) rural education level (edu) is expressed by the average number of years of education in rural areas. the calculation formula is: (primary school 6 + middle school 9 + high school 12 + 12 secondary college + 15 + 16 + graduate 19) / total number of population aged 6 and above.(2) urban-rural information gap (gap) (wang & xiao, 2021) is obtained from the ratio of rural per capita broadband quantity to urban per capita broadband quantity.(3) information infrastructure construction (iic), expressed by the ratio of the length of the optical cable line to the provincial area. 4.2.5. control variables to eliminate the effect of other factors on the productivity of new agricultural quality, the article sets 6 control variables: asian journal of economics and empirical research, 2024, 11(2): 111-124 117 © 2024 by the authors; licensee asian online journal publishing group (1) the level of financial agricultural support (gae), with the proportion of government expenditure on agriculture, forestry, and water resources in the total expenditure. the level of financial support for agriculture refers to the intensity of the government's financial support for agriculture, rural areas, and farmers within a certain period. (2) energy consumption level (eco), by using the log value of rural electricity consumption. the energy consumption level means the degree of consumption of various types of energy in production, living, and other activities in a certain region or industry within a specific period. (3) mechanization level (ml), repressed by the ratio of the total power of agricultural machinery to the total sown area of crops. the mechanization level is an indicator used to measure the popularization and application level of mechanical operations in the process of agricultural production. (4) highway construction level (rnd), the ratio of the highway’s total mileage to the province’s area determines the highway construction level. the highway construction level mainly refers to the construction scale, quality, and degree of perfection of highway infrastructure in a certain region. (5) reservoir construction level (rc), represented by the value of reservoir capacity (li, yin, & wu, 2015). the reservoir construction level indicates the construction and development status of water conservancy facilities such as reservoirs in a certain area. (6) internet development level (idl), reexpressed by the log of the number of rural broadband users. the internet development level is an indicator that comprehensively reflects the construction of internet infrastructure, the popularization degree of internet applications, and the development status of internet-related industries in a certain region. 4.3. descriptive statistics panel data from 31 provinces in china from 2011 to 2022 were selected for study (table 3). the digital financial inclusion index is from peking university digital financial inclusion index, and other data are mainly from china statistical yearbook and china rural statistical yearbook. among them, the minimum value of reservoir construction level and urban-rural information gap is zero, because the data is missing in some provinces in some years, and the value of adjacent years is very low. it is speculated that the missing reason is that the value is too small and the statistical difficulty is too large, so the zero treatment is conducted. table 3. descriptive statistical results. type of variable variable variable interpretation observed value mean standard deviation least value crest value explained variable anqp agricultural new quality of productivity 372 0.208 0.073 0.064 0.419 core explanatory variables de digital economy 372 0.217 0.148 0.0136 0.912 controlled variable gae financial support for agriculture 372 0.115 0.034 0.040 0.204 eco energy consumption level 372 4.750 1.459 -0.139 7.575 ml mechanized level 372 7.026 3.636 2.516 26.979 rnd highway construction level 372 0.934 0.526 0.052 2.269 rc reservoir construction level 372 5.104 1.285 0 7.142 idl the level of internet development 372 4.843 1.710 -0.693 7.353 metavariable gi public revenue 372 7.564 0.958 4.003 9.554 ti technological innovation 372 4.307 1.153 1.218 7.064 hc human capital 372 6.565 0.713 4.354 8.261 the threshold variable edu level of education in rural areas 372 7.689 0.824 3.804 9.915 gap urban-rural information gap 372 0.500 0.364 0 1.777 iic information infrastructure construction 372 10.267 16.126 0.043 119.098 5. interpretation of result 5.1. benchmark regression results before the empirical regression, the problem of multicollinearity was determined by whether the empirical data was present by performing multicollinearity tests on the core explanatory variables and control variables. the results demonstrate a maximum value of variance expansion factor (vif) is 3.34, and the overall mean is 2.45, which is far less than 10, indicating that the core explanatory variables and control variables do not have multicollinearity problems, so the benchmark regression analysis can be conducted. table 4 shows the results of the benchmark regression analysis. in terms of core explanatory variables, in the model (1) without control variables, the regression coefficient of digital economy was 0.154, and it was significantly positive at the level of 1%, indicating that the development of digital economy has a promoting effect on the improvement of new quality agricultural productivity. in the model (2) (7), gradually join the financial support of agriculture, energy consumption, mechanization level, highway construction, reservoir construction level, and the asian journal of economics and empirical research, 2024, 11(2): 111-124 118 © 2024 by the authors; licensee asian online journal publishing group internet development level in the process of control variables; the regression coefficient of the digital economy is still significantly at 1% level, further proving the digital economy can effectively promote agricultural new quality productivity to verify the hypothesis 1. in terms of control variables, the regression coefficients of mechanization level, highway construction level, and the development level of the internet are all significantly positive, indicating that the three also play an important role in enhancing the new quality of agricultural productivity and are also in line with the general cognition. the regression coefficient of the level of financial support for agriculture, energy consumption level, and reservoir construction level is significantly negative, indicating that these control variables have a certain inhibitory effect on the improvement of new agricultural productivity. the possible reason is that the high level of financial support for agriculture leads to agricultural developments excessive reliance on government subsidies, maintaining productivity at a low level and profitable, thus inhibiting the improvement of new agricultural quality productivity; new agricultural quality productivity represents higher production efficiency and higher utilization rate of resources, so lower resource consumption can produce more output than traditional productivity, thus concluding the reverse relationship of resource consumption level and new agricultural quality productivity; the improvement of reservoir construction level means the expansion of cultivated land and the limitation of agricultural water, thus inhibiting the improvement of new agricultural quality productivity. table 4. benchmark regression results. variable (1) anqp (2) anqp (3) anqp (4) anqp (5) anqp (6) anqp (7) anqp de 0.154*** (0.043) 0.176*** (0.041) 0.163*** (0.038) 0.146*** (0.040) 0.149*** (0.039) 0.152*** (0.041) 0.136*** (0.041) gae -0.482*** (0.080) -0.420*** (0.077) -0.418*** (0.071) -0.380*** (0.076) -0.368*** (0.074) -0.413*** (0.073) eco -0.00713*** (0.002) -0.008*** (0.002) -0.009*** (0.002) -0.010*** (0.002) -0.011*** (0.002) ml 0.004*** (0.002) 0.004** (0.002) 0.004** (0.002) 0.005*** (0.0015) rnd 0.028** (0.011) 0.029*** (0.011) 0.027** (0.011) rc -0.009*** (0.003) -0.011*** (0.003) idl 0.006** (0.003) cons 0.174*** (0.009) 0.225*** (0.013) 0.254*** (0.017) 0.234*** (0.017) 0.209*** (0.019) 0.258*** (0.024) 0.247*** (0.025) time fixed yes yes yes yes yes yes yes provincial fixed yes yes yes yes yes yes yes n 372 372 372 372 372 372 372 r2 0.943 0.949 0.951 0.954 0.955 0.956 0.957 note: ***, ** are significant at 1%, 5% and 10%, respectively, numbers in parentheses are robust standard error. 5.2. analysis of the mechanism of action it has been confirmed above that the development of digital economy has a significant positive impact on new agricultural productivity, but it remains to be confirmed by which mechanism this impact is achieved. the mechanism analysis has preliminarily identified that the digital economy will promote the improvement of new agricultural quality productivity through the government revenue mechanism, scientific and technological innovation mechanism, and human capital mechanism. therefore, the above three mechanisms of action are further tested based on the model (table 5). column (1) presents the total effect in the benchmark regression model. for the government revenue mechanism, in column (2), the coefficient of the digital economy is significantly positive at the 1% level, signifying that the digital economy significantly boosts government income. in column (3), the interaction term of the digital economy and government revenue is significantly positive at the 1% level, indicating that the digital economy significantly promotes the improvement of new agricultural productivity by increasing government revenue. regarding the scientific and technological innovation mechanism, in column (4), the coefficient of the digital economy is significantly positive at the 5% level, showing that the digital economy promotes technological innovation. in column (5), the coefficient of the interaction between the digital economy and technological innovation is significantly positive at the 5% level, meaning that the digital economy effectively promotes the enhancement of new agricultural productivity by facilitating scientific and technological innovation. in terms of the human capital mechanism, in column (6), the coefficient of the digital economy is significantly positive at the 1% level, suggesting that the development of the digital economy can raise the level of human capital. in column (7), the coefficient of the interaction of the digital economy and human capital is significantly positive at the 1% level, indicating that the digital economy significantly promotes the improvement of new agricultural productivity by elevating the level of human capital. consequently, hypothesis 2 is verified. table 5. test of the influence mechanism. variables (1) gross effect government revenue mechanism science and technology innovation mechanism human capital mechanism (2) gi (3) anqp (4) ti (5) anqp (6) hc (7) anqp de 0.136*** (0.041) 0.795*** (0.288) 0.112*** (0.042) 1.223** (0.505) 0.105** (0.041) 0.641*** (0.228) 0.112*** (0.043) gi 0.030*** (0.008) ti 0.026** （0.003） hc 0.037*** (0.010) cons 0.247*** (0.025) 7.297* (0.217) 0.026 (0.063) 3.368*** (0.362) 0.160*** (0.024) 6.004*** (0.171) 0.02 (0.06) asian journal of economics and empirical research, 2024, 11(2): 111-124 119 © 2024 by the authors; licensee asian online journal publishing group variables (1) gross effect government revenue mechanism science and technology innovation mechanism human capital mechanism (2) gi (3) anqp (4) ti (5) anqp (6) hc (7) anqp controlled variable yes yes yes yes yes yes yes time fixed yes yes yes yes yes yes yes provincial fixed yes yes yes yes yes yes yes n 372 372 372 372 372 372 372 r2 0.957 0.985 0.959 0.958 0.964 0.982 0.959 note: ***, **, * are significant at 1%, 5% and 10%, respectively, numbers in parentheses are robust standard error. 5.3. threshold effect analysis the level of rural education, the information gap between urban and rural areas, and the information infrastructure construction may all have non-linear effects on the digital economy to promote the improvement of the new quality of agricultural productivity. first of all, the threshold effect of rural education level, urban-rural information gap, and information infrastructure construction were tested. self-service method (bootstrap) was sampled 300 times, and the test results are shown in table 6. the results showed that the f value of single threshold effect of rural education level was 28.78, which passed the test at the 5% significance level, and the f value of double threshold effect was 12.93, which failed the test. the urban-rural information gap passed the two-threshold effect test, in which the single-threshold effect f value was 37.91, at the 1% significance level; the double-threshold effect f value was 19.54, at the 5% significance level; and the three-threshold effect f value was 13.51, which failed the significance test. the information infrastructure construction passed the single threshold effect test, and its f value was 83.07, which passed the 1% significance level. the f value of the double threshold effect was 43.06, which failed the significance test. according to the test results of the level of rural education, urban-rural information gap, and information infrastructure, single-threshold effect model, double-threshold effect model, and single-threshold effect model were constructed for threshold effect analysis. table 6. results of the threshold effect tests. the threshold variable the threshold number rss mse f price p price and the 95% confidence interval edu single threshold 0.110 0.0003 28.78 0.046** [27.773，39.942] double threshold 0.106 0.0003 12.93 0.290 [29.820,36.598] gap single threshold 0.107 0.0003 37.91 0.006*** [25.669,33.848] double threshold 0.102 0.0003 19.54 0.040** [18.471,26.727] three threshold 0.098 0.0003 13.51 0.670 [35.201,39.983] iic single threshold 0.096 0.0003 83.07 0.000*** [42.360,51.952] double threshold 0.086 0.0002 43.06 0.143 [152.822,211.944] table 7 presents the parameter estimation results of the threshold effect values for each threshold variable. for the rural education level: when this level is less than or equal to the threshold value of 7.6880, the regression coefficient of the digital economy development level is 0.057, which is significant at the 1% level. when the rural education level exceeds 7.6880, the regression coefficient is 0.119, also significantly positive at the 1% level. the latter value is greater than the former, demonstrating that there is a non-linear increasing effect of the digital economy on the new-quality agricultural productivity. as the rural education level improves, the positive impact of the digital economy on the new-quality agricultural productivity gradually emerges. regarding the urban-rural information gap: when this gap is less than the first threshold value of 0.0702, the regression coefficient of the digital economy is 0.236 and significant at 1%. when the urban-rural information gap is between the first threshold and 0.8725, the regression coefficient of the digital economy is 0.071, also significant at 1%. when the urban-rural information gap is greater than the second threshold value, the regression coefficient of the digital economy is 0.119, also significant at 1%. the regression coefficient undergoes a process from decreasing to increasing, indicating that the influence of the digital economy with the expansion of the urban rural information gap shows a non linear effect of first decreasing and then increasing. with the expansion of the information gap between urban and rural areas, the information asymmetry problem between them leads to inefficient factor configuration, which inhibits the digital economy's effect on the agricultural new-quality productivity. however, with the acceleration of urbanization and the influx of population into cities, the inhibition of the digital economy on the promotion of agricultural newquality productivity is caused by the urban-rural information gap changes. information infrastructure construction: when the information infrastructure construction is below the threshold value of 36.2734, the regression coefficient of digital economy is 0.081, and passes the significance test at the 1% level; when the information infrastructure construction is above the threshold value of 36.2734, the regression coefficient of digital economy is 0.242, which also passes the significance test at the 1% level. the former is higher than the latter, indicating that the construction of information infrastructure has effectively promoted the role of digital economy on the new agricultural productivity. therefore, hypothesis 3 is proved. table 7. results of the regression estimation of the threshold effect model. variable (1) anqp (2) anqp (3) anqp de (edu≤7.6880) 0.057*** (0.015) de (edu＞7.6880) 0.119*** (0.022) de (gap≤0.0702) 0.236*** (0.030) de (0.0702＜gap≤0.8725) 0.071*** (0.016) de (gap＞0.8725) 0.119*** (0.021) note: ***, ** are significant at 1%, 5% and 10%, respectively, numbers in parentheses are robust standard error. asian journal of economics and empirical research, 2024, 11(2): 111-124 120 © 2024 by the authors; licensee asian online journal publishing group variable (1) anqp (2) anqp (3) anqp de (iic≤36.2734) 0.081*** (0.017) de (iic＞36.2734) 0.242*** (0.038) controlled variable yes yes yes cons 0.099** (0.042) 0.108*** (0.038) 0.095** (0.034) n 372 372 372 r2 0.779 0.795 0.800 5.4. spatial spillover effect analysis to determine whether an analysis of the spatial spillover effect is necessary, conduct a spatial autocorrelation test on the new productivity pf agriculture before employing the spatial measurement model. the global moran index (moran’s i) was utilized to measure the spatial autocorrelation in each year under the second order inverse distance spatial weight matrix (w1), the economic distance weight matrix (w2) based on per capita gdp, and the economic distance weight matrix (w3) based on per capita disposable income (see table 8). the results reveal that the moran’s i index from 2011 to 2022 was significantly positive at the 1% level, and the z-value was greater than 4. this indicates the presence of a strong spatial autocorrelation and characteristics, such as spatial agglomeration. hence, it is necessary to use the spatial measurement model for research. table 8. global morani. a particular year w1 w2 w3 moran’s i z moran’s i z moran’s i z 2011 0.399*** 4.841 0.658*** 4.514 0.661*** 4.525 2012 0.415*** 5.024 0.679*** 4.652 0.682*** 4.653 2013 0.415*** 5.025 0.682*** 4.676 0.684*** 4.673 2014 0.425*** 5.135 0.700*** 4.795 0.701*** 4.786 2015 0.388*** 4.728 0.607*** 4.192 0.612*** 4.208 2016 0.418*** 5.052 0.657*** 4.507 0.661*** 4.521 2017 0.409*** 4.957 0.676*** 4.635 0.677*** 4.629 2018 0.430*** 5.186 0.701*** 4.795 0.703*** 4.795 2019 0.438*** 5.274 0.720*** 4.913 0.721*** 4.905 2020 0.437*** 5.271 0.717*** 4.901 0.718*** 4.894 2021 0.469*** 5.640 0.760*** 5.197 0.761*** 5.189 2022 0.472*** 5.680 0.769*** 5.262 0.773*** 5.275 once the spatial spillover effect analysis has been determined, the next step is to determine the appropriate spatial measurement model. the spatial measurement model was initially determined by lm test (table 9) on ordinary static panel regression. the results show that the two tests for spatial error passed one of the three spatial weight matrices at the 1% significance level and the two tests for spatial lag at the 1% significance level in the three spatial weight matrices. therefore, it is necessary to choose the spatial measurement model with the dual effect of spatial error and spatial hysteresis and initially judge to choose the spatial durbin model with two effects. table 9. results of the spatial metrological model testing. inspection type w1 w2 w3 statistic p price statistic p price statistic p price space error 45.693 0.000 42.713 0.000 43.118 0.000 2.826 0.093 0.259 0.611 0.413 0.521 space lag 111.835 0.000 85.351 0.000 87.489 0.000 68.968 0.000 42.898 0.000 44.784 0.000 the lr and wald tests were further used to determine whether the spatial durbin model will degenerate into a spatial autoregressive model or a spatial error model (table 10). it was found that the lr and wald tests of the three spatial weight matrices were significant at the 1% level. this means that the sdm model is better than sar and semm models. the hausman test results for the three spatial weight matrices were all significant at the 1% level, and thus the spatial durbin model with fixed effects was chosen. the effect test ultimately led to the decision to employ the individual time point double fixed effect spatial durbin model for the analysis of spatial spillover effects. table 10. lr tests, wald tests, and houseman tests. test-target w1 w2 w3 statistic p price statistic p price statistic p price sdm vs sar(lr) 67.330 0.000 43.890 0.000 44.760 0.000 sdm vs sem(lr) 88.760 0.000 67.340 0.000 68.300 0.000 sdm vs sar(wald) 68.080 0.000 44.290 0.000 45.310 0.000 sdm vs sem(wald) 95.360 0.000 70.850 0.000 71.870 0.000 hausman 39.420 0.000 99.170 0.000 105.810 0.000 both vs ind 53.610 0.000 74.30 0.000 75.690 0.000 both vs time 714.750 0.000 695.070 0.000 690.520 0.000 table 11 shows the results of the spatial measurement regression of the new quality productivity in agriculture in relation to the digital economy for all three spatial weight matrices. this is done to make sure that the test results are reliable. note: ***, ** are significant at 1%, 5% and 10%, respectively, numbers in parentheses are robust standard error. note: *** are significant at 1%, 5% and 10%, respectively, numbers in parentheses are robust standard error. asian journal of economics and empirical research, 2024, 11(2): 111-124 121 © 2024 by the authors; licensee asian online journal publishing group the results demonstrate that the regression coefficients of the digital economy are all positive and have passed the significance tests at the 1%, 5%, and 5% levels, respectively. this indicates that the development of the digital economy can promote the improvement of new agricultural productivity within this province. the regression coefficient of the spatial lag term of the digital economy is significantly positive at the 1% level, suggesting that the new agricultural productivity has a positive spillover effect among provinces that are adjacent in geographical space and have similar economic development levels. in other words, the development of the digital economy in this province can drive the improvement of agricultural new productivity in surrounding provinces. moreover, the rho values of the spatial durbin model are significantly positive in the three spatial weight matrices, which also verifies the prominent spatial agglomeration characteristics. furthermore, the spatial durbin model’s effect decomposition of partial differentiation yields both the direct and spatial spillover effects of the digital economy on the new quality productivity of agriculture. the results reveal that the coefficients of the spatial spillover effect of the digital economy on the agricultural new productivity in the three spatial weight matrices are positive and have passed the 1% significance level test, accounting for 74.7%, 66.2%, and 68.3% of the total effect, respectively. this indicates that the digital economy has a strong positive spatial spillover effect on the agricultural new productivity. consequently, hypothesis 4 is proven. table 11. results of the spatial durbin model regression. variable (1) w1 (2) w2 (3) w3 de 0.101*** (0.034) 0.082** (0.034) 0.079** (0.034) wxde 0.241*** (0.085) 0.147*** (0.049) 0.159*** (0.049) direct effect 0.113*** (0.033) 0.095*** (0.033) 0.093*** (0.033) overflow effect 0.334*** (0.107) 0.186*** (0.053) 0.200*** (0.052) gross effect 0.447*** (0.099) 0.281*** (0.050) 0.293*** (0.050) controlled variable yes yes yes time fixed yes yes yes provincial fixed yes yes yes rho 0.236*** (0.086) 0.187*** (0.052) 0.194*** (0.051) log-likelihood 1109.098 1099.577 1100.448 n 372 372 372 r2 0.616 0.636 0.631 6. further expansion 6.1. robustness test to test the reliability of the empirical analysis, the robustness test was conducted by replacing the explained variables, shrinking the tail, and eliminating the municipality (table 12). first, replace it with an explained variable. total factor productivity is the core index of new quality productivity, so the agricultural total factor productivity as an alternative is explained variable (tfp), using the malmquist index method to measure agricultural total factor productivity to replace agricultural new quality productivity. the input variables are, respectively agricultural machinery total power, fertilizer application, crop sown area, agricultural water consumption, and the first industry employment, output variables are for agricultural output value (yin & shen, 2014). second, tail reduction processing. to avoid bias in empirical results, we eliminate the municipality, taking into account its particularity and policy bias. third, eliminate the municipality. considering the particularity and policy bias of the municipality, it is eliminated to avoid the bias caused to the empirical results. column (1) (3) are the regression results of replacing the explained variables, reducing tail reduction, and excluding the municipality, respectively. the regression results are significantly positive, which is consistent with the previous empirical conclusions, indicating that the empirical results are robust and reliable. table 12. results of the robustness test. variable (1) tfp (2) anqp_w (3) anqp de 0.109** (0.042) 0.143*** (0.033) de_w 0.162*** (0.038) controlled variable yes yes yes time fixed yes yes yes provincial fixed yes yes yes cons 0.975*** (0.024) 0.257*** (0.026) 0.241*** (0.025) n 372 372 324 r2 0.326 0.955 0.961 6.2. endogenous discussion in order to alleviate the endogenous problems of mutual causality, the paper adopts the instrumental variable method for endogenous discussion (table 13). first, the digital economy (de 1), which lags behind the first order, is used as the instrumental variable. the new agricultural quality productivity in that year could not affect the note: ***, ** are significant at 1%, 5% and 10%, respectively, numbers in parentheses are robust standard error. note: * * *, * * are significant at 1%, 5% and 10%, respectively, numbers in parentheses are robust standard error. asian journal of economics and empirical research, 2024, 11(2): 111-124 122 © 2024 by the authors; licensee asian online journal publishing group development level of digital economy last year, and the development of digital economy last year laid a foundation for the development of digital economy in that year. therefore, choosing the lag of digital economy can avoid the endogenous problem of mutual causality. second, the interaction term of post offices (post) and fixed telephone numbers (tele) in 1984 and the total length of the postal road in each province were taken as the instrumental variable (huang, yu, & zhang, 2019). the number of post offices and fixed phones in history represents the basis of the development of digital economy in a region, which can have a certain impact on the development of current digital economy. simultaneously, the current agricultural productivity cannot affect the distribution of post offices and fixed phones in history, so as to avoid the endogenous problem of mutual cause and effect. given that the 1984 data on the number of post offices and fixed phones was cross-sectional, it was not suitable for direct panel data analysis. therefore, we constructed the tool variable as an interaction term with the total length of the postal route in each province. the results show that the first-stage f value of the three instrument variables is greater than 10, indicating that these instrument variables are not associated with weak instrument variables, that is, the selected instrument variables are valid. after considering the endogenous problem, the regression coefficient of the digital economy is still positive, and it is significant at the levels of 1%, 5%, and 5%, respectively, which further confirms the robustness of the research conclusions. table 13. results of the endogeneity test. variable (1) de (2) anqp (3) de (4) anqp (5) de (6) anqp de 0.209*** (0.069) 0.506** (0.234) 0.470** (0.233) de1 0.598*** (0.085) post 1.20e12*** (3.66e-13) tele 2.24e-10*** (6.90e-11) controlled variable yes yes yes yes yes yes time fixed yes yes yes yes yes yes provincial fixed yes yes yes yes yes yes cons 0.137*** (0.039) 0.162*** (0.034) 0.276*** (0.040) 0.055 (0.089) 0.275*** (0.040) 0.067 (0.088) f 49.74 10.68 10.53 n 341 341 372 372 372 372 r2 0.963 0.949 0.951 note: ***, ** are significant at 1%, 5% and 10%, respectively, numbers in parentheses are robust standard error. 6.3. heterogeneity analysis 6.3.1. temporal heterogeneity the research period of this article encompasses two stages: the explosive growth stage of digital economy development (2005-2015) and the integration and collaboration stage (2016-present). in the former stage, the government mainly focuses on promoting the construction of digital infrastructure, thus laying the precondition for the digital economy's development. in the latter stage, the government not only continues to drive the construction of digital infrastructure but also endeavors to improve the policy support system for the digital economy. for instance, through the promulgation of the outline of digital economy development strategy and the fourteenth five-year plan for digital economy, the government has attached greater significance to the digital economy during these two stages. consequently, taking 2016 as the cut-off point, by analyzing the impact of the digital economy on new agricultural productivity during 2011-2015 and 2016-2022, we can explore the role of government support within this context. table 14, columns (1) and (2), display the regression results for these two time periods, respectively. the results reveal that the regression coefficient of the digital economy from 2011 to 2015 is negative yet not significant. this implies that in the absence of government support during this period, the digital economy has little effect. in contrast, the regression coefficient of the digital economy during 2016-2022 is significantly positive at the 1% level, indicating that with the strong support of the government, the digital economy can significantly promote the improvement of new agricultural productivity. one could attribute this situation to the early lack of guidance for the development of the digital economy. as a result, relevant factors continuously flowed out of the agricultural field, causing the digital economy to have an insignificant influence on the new agricultural productivity. in the later stage, however, through the formulation of relevant preferential policies and the government's active participation, the situation has changed. table 14. results of temporal heterogeneity. variable (1) anqp (2011—2015) (2) anqp (2016—2022) de -0.167 (0.284) 0.092*** (0.033) controlled variable yes yes time fixed yes yes provincial fixed yes yes cons 0.100** (0.044) 0.319*** (0.053) n 155 217 r2 0.961 0.973 note: ***, ** are significant at 1%, 5% and 10%, respectively, numbers in parentheses are robust standard error. asian journal of economics and empirical research, 2024, 11(2): 111-124 123 © 2024 by the authors; licensee asian online journal publishing group 6.3.2. spatial heterogeneity there are significant differences in policy support, climate environment, cultivated land conditions, agricultural technology, and market environment among major grain-producing areas, main grain marketing areas, and balanced areas. these differences lead to varying levels of agricultural development in different regions, which, in turn, result in different impacts of the digital economy on high-quality agricultural productivity. to further examine the heterogeneity of the digital economy regarding new quality agricultural productivity, samples from the major grain-producing areas, main grain marketing areas, and production marketing balance areas were estimated separately (table 15). the results indicate that in the major grain-producing areas, the impact of the digital economy on new agricultural productivity is significantly positive at the 1% level, meaning that the digital economy can drive the improvement of new agricultural productivity in this region. in the main grain marketing area, the regression coefficient of the digital economy is positive yet not significant, suggesting that the effect of the digital economy in promoting new agricultural productivity in this region is not evident. in the production marketing balance area, the regression coefficient of the digital economy is also positive but not significant, indicating that the development of the digital economy fails to promote the improvement of new quality agricultural productivity in this region. this situation could be caused by the following factors. in the major grain-producing areas, as agriculture bears the responsibility of maintaining national food security, the local government has long been dedicated to enhancing agricultural production efficiency. hence, more attention is paid to the construction of agricultural information infrastructure and the application of digital technology, and thus the digital economy significantly promotes new agricultural productivity. compared to other industries, the main grain marketing area experiences relatively low economic benefits from agriculture. as a result, both the government and the public pay less attention to agriculture, and there is less financial support for relevant technologies. therefore, the effect of the digital economy on new agricultural productivity is not significant. table 15. results for spatial heterogeneity. variable (1) anqp (major grain producing area) (2) anqp (staple area) (3) anqp (production and marketing balance zone) de 0.331*** (0.045) 0.017 (0.080) 0.006 (0.038) controlled variable yes yes yes time fixed yes yes yes provincial fixed yes yes yes cons 0.075** (0.032) 0.251*** (0.068) 0.184*** (0.042) n 156 84 132 r2 0.969 0.940 0.914 7. conclusions and suggestions based on the panel data of 31 provinces from 2011 to 2022, this paper adopts the two-way fixed effect model, mediation effect model, threshold effect model, and spatial durbin model to conduct an in-depth empirical test of the impact of china's digital economy on new agricultural quality productivity. firstly, the study reveals that the digital economy has a significant impact on new agricultural productivity. however, this impact shows different characteristics in different time periods and regions. from 2011 and 2015, the digital economy had a negative but not significant impact on new agricultural productivity. however, from 2016 to 2022, this impact significantly increased. in terms of space, the impact of the digital economy on new agricultural quality productivity is significantly positive in the main grain-producing areas but not significant in the main grain-marketing areas and the productionmarketing balance areas. secondly, the digital economy promotes the improvement of new agricultural quality and productivity by facilitating the increase in government income, the level of scientific and technological innovation, and the level of human capital. thirdly, the study finds that the rural education level, urban-rural information gap, and information infrastructure construction have a nonlinear effect on the digital economy's role in promoting the improvement of new agricultural quality productivity. specifically, the rural education level and information infrastructure construction exhibit a nonlinear increasing effect, while the urban-rural information gap shows a nonlinear effect of first decreasing and then increasing. finally, it is found that the digital economy has a positive spatial spillover effect on new agricultural productivity. the spillover degree of new agricultural productivity in neighboring provinces is higher than that in the local region. based on the above research conclusions, the paper gives some suggestions: (1) to improve the level of government governance. first, it is necessary to strengthen information sharing and coordination among government departments, establish a digital government management system, promote the digital transformation of government governance, and improve the efficiency and transparency of government governance. second, we should strengthen the government digital training and improve the digital skills and information level of government staff so as to better support and guide the development of digital economy in the agricultural field. (2) formulate government policies in accordance with local conditions. first, according to the actual situation of agricultural development in different regions, differentiated digital economy policies should be formulated, including policies and measures on financial support, tax incentives, financial support, scientific and technological support, and other aspects. second, according to the characteristics and advantages of regional agricultural development, we should innovate the regional agricultural development model and promote the deep integration of digital economy and agricultural development. (3) strengthen the construction of digital infrastructure. first, we should encourage the participation of private capital, provide a stable investment environment, and provide support from capital, land, and other aspects to stimulate the enthusiasm of private capital to participate in the construction of digital infrastructure. second, we should increase the investment in rural digital infrastructure construction, ease the information gap between urban and rural areas, and promote the rational allocation of factors. (4) improve the level of agricultural human capital. first, we need to increase the investment in rural personnel training and education, introduce online note: ***, ** are significant at 1%, 5% and 10%, respectively, numbers in parentheses are robust standard error. asian journal of economics and empirical research, 2024, 11(2): 111-124 124 © 2024 by the authors; licensee asian online journal publishing group education platforms, and promote the combination of online and offline education, so as to provide sufficient education opportunities for agricultural practitioners, so that they can fully master and apply relevant agricultural digital technologies. second, we should strengthen the construction of agricultural professionals, establish and improve the system of talent cultivation and incentive, and attract professionals to engage in agricultural work by providing good welfare benefits. references chen, t., & wang, p. 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(2024). agricultural new quality productive force in china: level measurement and dynamic evolution. statistics & decision, 40(9), 24-30. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.3390/su14010216 https://doi.org/10.3390/su13042020 https://doi.org/10.1080/00036846.2022.2156471 https://doi.org/10.35534/pss.0604095 https://doi.org/10.3390/agriculture14071022 https://doi.org/10.1016/j.landusepol.2020.104794 https://doi.org/10.1016/j.ribaf.2022.101797 https://doi.org/10.1016/j.cjpre.2024.06.004 https://doi.org/10.3390/su131810105 https://doi.org/10.3390/land11122152 https://doi.org/10.3390/w14172672 https://doi.org/10.3390/land12010195 11 © 2023 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 10, no. 1, 11-19, 2023 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v10i1.4413 © 2023 by the authors; licensee asian online journal publishing group analysis of the impact of banking sector credit on the real sector sule magaji1 ibrahim musa2 ( corresponding author) 1,2department of economics, university of abuja, nigeria. 1email: sule.magaji@uniabuja.edu.ng 2email: ibmmusa75@gmail.com abstract this study examines the impact of banking sector credit on nigeria’s real sector based on data from 1986 to 2019 using the ardl model. the bound testing result indicates that there is a long-run relationship between the variables of interest with real gross domestic product (rgdp) as the dependent variable. the result indicates that commercial bank credit (cbc) has a positive impact on rgdp in the long and short runs, which is consistent with a priori expectations. domestic private investment (dpi) was found to have a negative and significant relationship with rgdp in the long and short runs. the estimated equations of the specified models show a significant positive relationship between government capital expenditure (gce) and rgdp. in the short run, a significant increase in dpi, cbc, and gce will bring about a significant increase in rgdp. the parameter estimates of dpi, cbc and gce are statistically significant, as indicated by the t-value. the study reveals that effective utilization and distribution of bank credit to the real sector promotes economic growth. therefore, the study recommends that there should be improved banking sector credit which will improve the output of the real sector and, in turn, boosts the economy. keywords: commercial bank credit, financial institutions, financial sector, government capital expenditure, domestic private investment, real gross domestic product, real sector. jel classification: e6. citation | magaji, s., & musa, i. (2023). analysis of the impact of banking sector credit on the real sector. asian journal of economics and empirical research, 10(1), 11–19. 10.20448/ajeer.v10i1.4413 history: received: 3 october 2022 revised: 12 december 2022 accepted: 29 december 2022 published: 18 january 2023 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this research is supported by university of abuja, nigeria (grant number: aca/677). authors’ contributions: both authors contributed equally to the conception and design of the study. competing interests: the authors declare that they have no conflict of interest. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study, that no vital features of the study have been omitted, and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction ............................................................................................................................................................................... 12 2. theoretical framework and review of empirical literature ......................................................................................... 13 3. research methodology ............................................................................................................................................................ 15 4. research finding/results ....................................................................................................................................................... 16 5. conclusion and recommendations ........................................................................................................................................ 18 references ....................................................................................................................................................................................... 18 mailto:sule.magaji@uniabuja.edu.ng mailto:ibmmusa75@gmail.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v10i1.4413 https://orcid.org/0000-0001-9583-3993 asian journal of economics and empirical research, 2023, 10(1): 11-19 12 © 2023 by the authors; licensee asian online journal publishing group contribution of this paper to the literature from the findings, this study contributes to the existing literature by showing that a favorable and significant connection exists between commercial bank credit and real gdp. government capital expenditure has a positive significant relationship with rgdp. unlike previous studies, this study comprehensively explains the impact of banking sector credit to the real sector. the study differs from other studies by incorporating variables that were not captured by other studies. it also emphasizes the importance of government capital expenditure (gce) on the real sector, unlike other studies, and these are the gaps which this study aims to fill. 1. introduction the significance of financial institutions in attaining economic growth in the economy has attracted attention in recent times. with various studies justifying its significance in previous years, the credit volume of nigeria has been on the increase, and this increase is expected to enhance economic agents, minimize the impact of economic shocks and achieve economic growth. despite these assertions, economic growth has remained relatively low. sustainable growth is only attainable if financial resources are effectively and efficiently mobilized and allocated for optimum economic performance (owusu, 2016). the critical role of financial institutions has prompted successive nigerian governments to carry out reforms and innovations in the banking sector aimed at attaining financial stability to induce economic growth. hasanov, bayrumil, and al-musehel (2018) highlighted the necessity of a self-sustaining banking system in overcoming adverse economic circumstances and financial distress, particularly in countries that produce raw materials, such as nigeria. alkhazaleh (2017) advocates that the banks' core function of providing credit is essential financing for all sectors in the country. timsina (2017) asserts that credit is the largest single source of income in the portfolios of most banks, which explains why credit management is a key focus. recently, commercial banks have increased the total amount of credit they provide to the economy; however, despite the steady increase, it has not translated into an improved level of development in the country through the standard of living, employment rate, poverty rate, and industrial output, among others, as the effect of bank credit to the real sector is expected to be seen in both quantitative and qualitative terms. determining the extent to which bank credit has impacted human development, decreased unemployment, and alleviated poverty in the economy is important. the real sector in nigeria has been shaky in recent times. this is evident in the low level of gdp, which is the total market value of all the finished goods and services produced in the country in a given year. the real sector is a fundamental part of the economy as the activities carried out in this sector generate an economic output which is important in boosting gdp. this further indicates that the real sector is capable of contributing to economic prosperity if accompanied by a healthier financial system. the recent dwindling progress of the real sector in nigeria is basically due to the importation of large amounts of finished goods and insufficient financial support for the sector, which has ultimately contributed to the reduction in capacity utilization of the real sector (obim & orok, 2018). nigeria's financial system has improved recently as a result of several reforms, but not as much as other emerging economies, such as south africa, brazil, and egypt, which raises concerns about the inefficient utilization of the sizable amount of bank credit that commercial banks have extended to the economy over the years. in nigeria, the implicitness connected to bank credit is a recurrent phenomenon as manufacturers and businesspeople are unable to access financing. in addition to having extremely high interest rates, many small businesses find it difficult to obtain credit because it requires collateral (igwe, magaji, & darma, 2021). consequently, production is hampered, which ultimately affects gdp and, in turn, economic growth. financial intermediation mobilizes deposits from surplus units and allocates credit facilities to borrowers and investors for productive economic investment. economic development comprises the activities of both the private and public sectors, which are limited by the expense of bank debt instruments but require bank lending to expand and develop their businesses. however, banks incur financial intermediation costs when they mobilize and extend access to credit (loans and advances) to both the private and public sectors of the economy (magaji & darma, 2021). this is due to the likelihood that high lending rates will discourage the use of bank credit while endangering banks' liquidity positions (takon, john, ononiwu, & mgbado, 2020). for businesses dealing with money, including banks and other non-bank institutions, managing risk is a crucial task, which implies the need for an interest rate or the cost of financial intermediaries (obim & orok, 2018). nevertheless, cost and risk of financial intermediation depends on the forces of demand and supply as tested using the supply leading and demand following hypothesis (nazifi, magaji, & amase, 2022). research on credit facilities and their capacity to spur growth has garnered renewed interest on a global scale, but there is little evidence available regarding the impact of bank credit on the real sector in nigeria. some of the previous research uses short-term data, while others use out-of-date data. it has therefore become imperative to contextually measure and ascertain the level of the impact of bank credit on the real sector in asian journal of economics and empirical research, 2023, 10(1): 11-19 13 © 2023 by the authors; licensee asian online journal publishing group nigeria for effective policies to be developed accordingly. this study's goal is to evaluate the effects of credit provided by the banking sector on nigeria's real estate market. the literature review in the next section illustrates huge academic interest on the topic of banking sector credit and the real sector. what is missing is a clear-cut approach that discuss in detail the impact of banking sector credit on the real sector of the nigerian economy with emphasis on commercial bank credit, domestic private investment and government capital expenditure. this is the gap that this research intends to fill. 2. theoretical framework and review of empirical literature 2.1. theoretical framework credit is an important aspect of financial intermediation that provides funds to economic entities that can put them to the most productive use. theoretical studies have established that a relationship exists between financial intermediation and economic growth. some of these existing growth models are the two-gap model, marxian theory, schumpeterian theory, the harrod–domar theory of growth, the neoclassical model of growth and endogenous growth theory. the growth models relevant to these are the neoclassical model of growth and endogenous growth theory. this is because they explain the situation in developing economies, such as nigeria, cameroon, and so on. therefore, we have chosen the harrod–domar theory and the solow–swan growth model to underpin our research. 2.2. harrod–domar the harrod–domar model emphasizes the key role of investment in the economic growth process. the model explains a steady long-run state of capital output and saving investment flow equilibrium for economic growth. this model posits that every economy must save a certain proportion of its national income to replace worn out capital. secondly, for an economy to grow, it requires new investments representing net addition to capital stock (k) and national income (y). any net addition to the capital stock in the form of new investment will bring about a corresponding increase in the flow of national output (gdp). 𝑆 = 𝑠𝑌 (1) equation 1 shows that savings (s) is a proportion of national income (𝑠𝑌). in equation 2, savings depends on national income, in that an increase in national income affects savings positively, all other things being equal. investment is determined by the level of total savings. net investment (𝑙) is the change in the capital stock (𝑘). 𝑙 = 𝛥𝑘 (2) in equation 3, the total capital stock (𝑘) has a direct relationship with national income (𝑌), as expressed by the capital output ratio. an increase in national income brings about an increase in total capital stock. 𝛥𝑘 = 𝑘𝛥𝑌 (3) in equation 4, it should be noted that what is saved must be equal to the net investment; therefore, total savings always happens to be the total investment. thus, 𝑆 = 𝐼 (4) by combining equation 2 and equation 3, we get: 𝐼 = 𝛥𝑘 = 𝑘 𝛥𝑌 (5) by combining equations 1 and 5, we get: 𝑆 = 𝑠𝑌 = 𝑘𝛥𝑌 = 𝛥𝑘 = 𝐼 (6) in equation 6, savings is equal to change in national income, which equates 𝑘𝛥𝑌, 𝛥𝑘 and 𝐼 therefore, 𝑠𝑌 = 𝑘𝛥𝑌 (7) 𝑠𝑌 𝑌 = 𝐾∆𝑌 𝑌 (8) 𝑠 = 𝑘𝛥𝑌 (9) y dividing both sides by k: s k 𝛥𝑌 (10) k = ky 𝑠 𝑘 = 𝛥𝑦 𝑦 (11) asian journal of economics and empirical research, 2023, 10(1): 11-19 14 © 2023 by the authors; licensee asian online journal publishing group this means that the rate of growth of the national income of gdp is determined jointly by the net savings ratio and the national capital output (𝑘). the harrod–domar model is a long-run analysis; it notes that what is saved has to be invested for growth to be realized. aggregate supply in an economy is stimulated by aggregate demand (demand creates supply), with consumption as the major component. the demand for investible funds from the capital market is derived from the goods and services in the economy. net investment is supposed to be proportional to the changes in output of the economy. 2.3. solow–swan model the solow–swan model is an extension of the 1946 harrod–domar model that dropped the restrictive assumption that only capital contributes to growth (as long as there is sufficient labor to use all capital). important contributions to the model came from the work done by solow and swan (1956), who independently developed relatively simple growth models. solow's model fitted available data on us economic growth with some success. in solow (1987) was awarded the nobel prize in economics for his work. today, economists use solow's sources of growth accounting model to estimate the separate effects of technological change, capital, and labor on economic growth. solow’s model is also one of the most widely used models in economics to explain economic growth. basically, it asserts that "total factor productivity (tfp) can lead to limitless increases in the standard of living in a country." solow extended the harrod–domar model by adding labor as a factor of production and capital output ratios that are not fixed, as they are in the harrod–domar model. these refinements allow increasing capital intensity to be distinguished from technological progress. solow sees the fixed proportions production function as a "crucial assumption" of the instability of the results in the harrod–domar model. his own work expands upon this by exploring the implications of alternative specifications, namely the cobb–douglas production function and the more general constant elasticity of substitution (ces). although this has become the canonical and celebrated story in the history of economics featured in many economic textbooks, recent reappraisal of harrod's work has contested it. criticisms of harrod's original piece include the fact that it was not concerned with economic growth and he did not explicitly use a fixed proportions production function. a standard solow model predicts that, in the long run, economies converge to their steady state equilibrium and that permanent growth is achievable only through technological progress. shifts in saving and in population growth only cause level effects in the long run (that is in the absolute value of real income per capita). an interesting implication of solow's model is that poor countries should grow faster and eventually catch up to richer countries. this convergence could be explained by: • lags in the diffusion of knowledge. differences in real income might shrink as poor countries receive better technology and information. • efficient allocation of international capital flows, since the rate of return on capital should be higher in poorer countries. in practice, this is seldom observed and is known as the lucas paradox. • a mathematical implication of the model (assuming that poor countries have not yet reached their steady state). baumol attempted to verify this empirically and found a very strong correlation between a countries' output growth over a long period of time (1870 to 1979) and its initial wealth. his findings were later contested by delong, who claimed that the non-randomness of the sampled countries and the potential for significant measurement errors in the estimates of real income per capita in 1870 caused baumol's findings to be biased. delong concluded that there is little evidence to support the convergence theory. the key assumption of the solow–swan growth model is that capital is subject to diminishing returns in a closed economy. • given a fixed stock of labor, the impact on output of the last unit of capital accumulated will always be less than the one before. • for simplicity, assuming that there has been no technological progress or labor force growth, diminishing returns imply that at some point the amount of new capital produced is only just enough to make up for the amount of existing capital lost due to depreciation. at this point, because of the assumptions of no technological progress or labor force growth, the economy ceases to grow. • non-zero rates of labor growth complicate matters somewhat, but the basic logic still applies – in the short run, the rate of growth slows as diminishing returns take effect and the economy converges to a constant "steady-state" rate of growth (that is, no economic growth per capita). • non-zero technological progress is very similar to the assumption of non-zero workforce growth in terms of "effective labor"; a new steady state is reached with constant output per worker-hour required for a unit of output. however, in this case, per capita output grows at the rate of technological progress in the steady state (that is, the rate of productivity growth). https://en.wikipedia.org/wiki/united_states https://en.wikipedia.org/wiki/bank_of_sweden_prize_in_economic_sciences_in_memory_of_alfred_nobel https://en.wikipedia.org/wiki/factor_of_production https://en.wikipedia.org/wiki/capital_intensity https://en.wikipedia.org/wiki/leontief_production_function https://en.wikipedia.org/wiki/cobb%e2%80%93douglas_production_function https://en.wikipedia.org/wiki/constant_elasticity_of_substitution#ces_production_function https://en.wikipedia.org/wiki/steady-state_economy https://en.wikipedia.org/wiki/convergence_(economics) https://en.wikipedia.org/wiki/lucas_paradox https://en.wikipedia.org/wiki/william_baumol https://en.wikipedia.org/wiki/j._bradford_delong https://en.wikipedia.org/wiki/diminishing_returns https://en.wikipedia.org/wiki/productivity asian journal of economics and empirical research, 2023, 10(1): 11-19 15 © 2023 by the authors; licensee asian online journal publishing group 2.4. review of empirical literature the relationship between financing and economic expansion has been the subject of numerous empirical studies, but the explanatory factors have not been agreed upon. the goal of ahmed, jayaraman, and ahmed (2020) was to examine how these important economic indicators affected the total amount of credit provided by traditional commercial banks in the sultanate of oman. the study's findings indicate that macroeconomic indicators have a favorable effect on the amount of credit provided by traditional commercial banks in the sultanate of oman. takon et al. (2020) sought to assess the importance of the cost of financial intermediaries and to suggest measures that could accelerate economic growth in nigeria. they focused on the factors that determine the cost of financial intermediaries in nigeria's preand post-consolidated banking sector. from the analysis, it was found that there was a significant correlation between credit for the private sector and gdp. further research revealed a strong correlation between nigeria's gdp and total deposits. additionally, it was discovered that interest rates significantly impacted nigeria's gdp. okoroafor, david, and eze (2018) examined how adjustments in the economic system and growth were affected by the development of the banking sector. they asserted that the growth of the banking industry had different effects on the growth of the agricultural and industrial sectors. the banking sector's development is supported by the economic structure and growth. the growth of the banking industry has a detrimental effect on the growth of the industrial and agricultural sectors. only in nations with a high level of banking sector growth is the negative effect of banking sector growth on agriculture industry development visible. zeqiraj, hammoudeh, iskenderoglu, and tiwari (2020) examined the dynamic relationship between banking sector performance and gdp growth in 13 southeast european nations between 2000 and 2015, taking into account factors such as trade openness, investment, and human capital, among others. the major empirical finding suggests a favorable and significant impact of banking sector performance on growth in the economy using a detailed generalized method of moments (gmm). okoroafor et al. (2018) assessed the effect of deposit money banks on capital formation in nigeria, taking into account the liquidity ratio, bank savings, and deposit rate. to determine the long-run and short-run relationships, they performed unit root tests, ardl cointegration tests, and an error correction model (ecm). the findings demonstrated a favorable association between bank savings and government capital expenditure (gce). anyanwu, ananwude, and okoye (2017) investigated the effect of commercial bank lending on real gdp and the industrial production index to empirically evaluate the impact of bank lending on nigeria's economic development, from 1986 to 2015. heterogeneity was identified in the data from the preliminary statistics of the central bank of nigeria (cbn). cbc and gdp are predicted to have a long-term relationship by johansen's cointegration, and this is true for the industrial production index. according to the findings of the granger impact assessment, private sector lending has a substantial impact on real gdp, while cbc’s impact on gdp is not as substantial as private sector lending. chinedu, magaji, and musa (2021) used the autoregressive distributed lag (ardl) and bound testing approaches to examine the impact of money market instruments on economic growth. their findings revealed that there is a long-run relationship among the money market instruments. they also found that the money market variables have a negative but significant impact on economic growth in the long and short runs. their study recommends that, since the treasury certificate was proven to have the most influential impact on economic growth, the central bank should give it priority. in addition, interest rate as the major determinant in money market operation should be well positioned in order for it not to tilt in favor of one of the players in the market. 3. research methodology the econometrics methodology was employed as the analytical tool for the examination of the impact of banking sector credit on the real sector in nigeria. three variables were selected to represent banking sector credit: commercial bank credit, domestic private investment, and government capital expenditure. a descriptive analysis was carried out to capture the nature and structure of the data, while an autoregressive distributed lag model (ardl) was employed to show the impact of the independent variables on the dependent variable. the econometrics technique of the multiple regression analysis was used to obtain the estimates. the mathematical expression of the regression model is given as: 𝑌 = 𝑓 (𝑋1, 𝑋2, 𝑋3) (12) where 𝑌 is the dependent variable and the 𝑋s are the independent variables. the econometric model of this study is expressed as follows: 𝐺𝐷𝑃 = 𝛽0 + 𝛽1𝐶𝑃 + 𝛽2𝐵𝐴 + 𝛽3𝑇𝐵 + + 𝜇 (13) 𝑅𝐺𝐷𝑃 = 𝑓(𝐶𝐵𝐶, 𝐷𝑃𝐼, 𝐺𝐶𝐸, µ) (14) 𝑅𝐺𝐷𝑃 = 𝛼 + 𝛽𝐶𝐵𝐶 + 𝜆𝐷𝑃𝐼 + 𝛿𝐺𝐶𝐸 + µ (15) asian journal of economics and empirical research, 2023, 10(1): 11-19 16 © 2023 by the authors; licensee asian online journal publishing group where: rgdp = real gdp (proxy for the real sector). cbc = commercial bank credit. dpi = domestic private investment. gce = government capital expenditure. α = intercept of drift term. the βs are slope parameters that measure the partial impact of the explanatory variables on the 14 regressions, and µ is the arbitrary variable or error term; it is the proxy of all other variables that influence the regressed variable which is not included in this regression equation. based on theoretical expectations, real gdp is expected to have a positive relationship with commercial bank credit, domestic private investment, and government capital expenditure. we used banking sector credit from 1986 to 2019 for the real sector in nigeria obtained from cbn (2020). 4. research finding/results the results of the unit root tests using the phillips–perron (pp) technique are reported in table 1. the results show that real gdp, commercial bank credit, domestic private investment, and government capital expenditure are of order of integration i. table 1. results of the phillips–perron unit root test. variable level t-stat critical value 5% first difference t-stat critical value 5% order of integration real gross domestic product (rgdp) -3.68 -3.55 i(1) commercial bank credit (cbc) -0.42 -3.55 -5.32 -3.56 i(1) domestic private investment (dpi) -2.93 -3.55 -5.63 -5.56 i(1) government capital expenditure (gce) -1.63 -3.55 -6.62 -3.56 i(1) table 2. var lag order selection criteria output. lag logl lr fpe aic sc hq 0 -1171.213 na 9.320e+26 73.451 73.634 73.511 1 -1043.620 215.313* 8.810e+23* 66.476* 67.392* 66.780* 2 -1030.335 19.097 1.100e+24 66.646 68.295 67.193 note: * denotes the lag order of the criteria; lr: sequentially modified lr test statistic, each test was conducted at the 5% level, fpe: final prediction error, aic: akaike information criterion, hq: hannan–quinn information criterion, sc: schwarz information criterion. table 2 shows that in the first step of the ardl procedure the appropriate lag length for the model is determined using the akaike information criterion approach of the restricted vector autoregressive (var) estimate. table 3. bound test for cointegration. test statistic coefficient lag length significance level pesaran, shin, and smith (2001) bound critical value i(0) i(1) f-test 5.56 3 10% 2.72 3.77 5% 3.23 4.35 2.5% 4.29 5.61 source: pesaran et al. (2001) bounds test f-statistic for the unrestricted constant and no trend model. a two-step process is used to approximate the long-run relationship after applying the lag selection criteria. first, it is investigated whether the variables in equation 13 have a long-run relationship, and then the shortand long-run strictures are estimated. the wald test f-statistic (5.56) surpasses the 95% and 90% upper bound critical values of pesaran et al. (2001) (3.77 and 4.35, respectively), according to the results in table 3. we, therefore, conclude that there is a long-term relationship between rgdp, cbc, dpi, and gce, that is the variables move together over the long term with gdp as they regress, and the null hypothesis of no cointegration cannot be accepted. asian journal of economics and empirical research, 2023, 10(1): 11-19 17 © 2023 by the authors; licensee asian online journal publishing group table 4. long-run relationship estimates. dependent variable: rgdp variable coefficient std. error t-statistic prob. commercial bank credit (cbc) 4.630 2.200 2.100 0.040 domestic private investment (dpi) -12.690 7.280 -1.740 0.090 government capital expenditure (gce) 0.610 0.330 1.820 0.080 c 25.340 20.970 1.210 0.240 rgdp = 25.34 + 4.63*cbc – 12.69*dpi + 0.61*gce t (1.21) (2.10) (-1.74) (1.82) table 4 shows the result of regressing rgdp on cbc, dpi, and gce. from the regression output above, there is a favorable and significant correlation between rgdp and cbc. a unit change in cbc sustained in the long run will, on average, bring about a 4.63 net increase in rgdp, holding other explanatory variables constant. the parameter estimate of cbc is statistically significant as the computed t-value (2.10) is greater than the t-critical value (2.04) at the 5% significance level. thus, the evidence leads to rejection of the null hypothesis, which states that the real sector in nigeria is not significantly impacted by cbc. this is consistent with the a priori expectation and the findings of simon and marshal (2017) and safdar, shehzadi, ali, and ullah (2015). a negative but significant relationship exists between dpi and rgdp. a unit increase in dpi sustained in the long run will, on average, bring about a 12.69-unit decrease in rgdp, holding other explanatory variables constant. the parameter estimate of dpi is statistically significant as the computed t-value (-1.74) is greater in absolute terms than the t-critical value of 1.64 at the 10% level of significance. therefore, there is sufficient evidence to disprove the null hypothesis, which claims that dpi has no significant impact on the real sector in nigeria. this result is not consistent with the a priori expectation. gce has a positive significant relationship with rgdp. a unit change in gce sustained in the long run will, on average, bring about a 0.61-unit increase in rgdp, holding the other 17 explanatory variables constant. the parameter estimate of gce is statistically significant as the computed t-value (1.82) is greater than the t-critical value (1.64) at the 10% significance level. thus, the null hypothesis, which states that gce has no significant impact on the real sector in nigeria, can't be rejected. this is consistent with the a priori expectation and the findings of safdar et al. (2015). table 5. error correction model estimates. dependent variable: rgdp variable coefficient std. error t-statistic prob. d commercial bank credit (cbc) 3.18o 1.450 2.190 0.040 d domestic private investment (dpi) -8.710 4.750 -1.830 0.080 d government capital expenditure (gce) 0.420 0.210 1.950 0.060 cointeq(-1) -0.690 0.160 -4.290 0.000 diagnostic test test statistics lm version serial correlation obs.r2 = 5.410 prob.χ2(1) = 0.077 (breusch–godfrey) heteroscedasticity obs.r2 = 9.240 prob.χ2(17) = 0.060 (breusch–pagan–godfrey) normality (jarque–bera) 1.420 prob. = 0.490 4.1. short-run regression results from table 5, the estimated ardl short-run model passes all diagnostic tests. the test results revealed that the residual estimate of the error correct term (ect) is free from serial correlation and heteroscedasticity problems as the probability of obs*r2 is greater than 5% in both cases. the estimated residuals are normally distributed based on the jarque–bera test result. the predicted coefficient of ectt-1 is projected to be negative (-0.69) and significant at the 1% level based on the calculated short-run dynamic growth model presented above. this suggests that the annual adjustment for a shock-induced variance from the long-run growth trajectory is 69%. according to the regression results above, there is a significant and positive correlation between cbc and rgdp. keeping other explanatory variables constant, a unit change in cbc will, on average, result in a 3.18-unit increase in rgdp. the parameter estimate of cbc is statistically significant as the computed t-value (2.19) is greater than the t-critical value (2.04) at the 5% significance level. thus, the evidence rejects the null hypothesis, which states that cbc has no significant impact on the real sector in nigeria in the short run. this is consistent with the a priori expectation and the findings of simon and marshal (2017) and safdar et al. (2015). asian journal of economics and empirical research, 2023, 10(1): 11-19 18 © 2023 by the authors; licensee asian online journal publishing group a negative but significant relationship exists between dpi and rgdp. a unit increase in dpi will, on average, bring about an 8.71-unit decrease in rgdp, holding other explanatory variables constant. the parameter estimate of dpi is statistically significant as the computed t-value (-1.83) is greater in absolute terms than the t-critical value of 1.64 at the 10% level of significance. there is therefore sufficient evidence to disprove the null hypothesis, according to which dpi in nigeria's real sector has no discernible impact. this result is not consistent with the a priori expectation. gce has a positive significant relationship with rgdp. a unit change in gce will, on average, bring about a 0.42-unit increase in rgdp, holding other explanatory variables constant. the parameter estimate of gce is statistically significant as the computed t-value (1.95) is greater than the t-critical value (1.64) at the 10% significance level. thus, the null hypothesis, which states that gce has no significant impact on the real sector in nigeria, can't be rejected. this is consistent with the a priori expectation and the findings of safdar et al. (2015). 4.2. summary of findings the findings indicate that a favorable and significant connection exists between cbc and rgdp. a unit increase in cbc brings about a 4.63-unit increase in rgdp. this indicates that a change in cbc is accompanied by a significant change in rgdp. it was also found that a negative but significant relationship exists between dpi and rgdp. a unit increase in dpi brings about a 12.69-unit increase in rgdp in the long run. therefore, a significant increase in dpi will bring about a greater increase in rgdp in the long run as indicated by the t-value. gce has a positive significant relationship with rgdp. a unit increase in gce will bring about a 0.61unit increase in rgdp. in the short run, a significant increase in dpi, cbc, and gce will, on average, bring about a significant increase in rgdp. a unit increase in dpi, cbc, and gce will bring about an increase in rgdp by 8.71, 3.18, and 0.42 units, respectively, and the parameter estimates of dpi, cbc and gce are statistically significant as shown by the t-values of -1.83, 2.19 and 1.95, respectively. 5. conclusion and recommendations the estimations from the study show that banking sector credit has a significant impact on the real sector of nigeria’s economy. this is shown by the significant contribution of banking sector credit to the improvement of the real sector through government capital expenditure. positive variations in banking sector credit lead to improvements in nigeria’s real sector. based on the findings of the study, it is recommended that banking sector credit should be expanded to ensure that commercial banks have enough credit facilities available. the central bank should introduce innovative policies that will strengthen commercial banks to allow them to offer more credit facilities to investors in all sectors of the economy. the government should also establish a supportive and enabling environment within the economy, remove all administrative bottlenecks for registering smalland medium-scale businesses, and ensure there is adequate basic infrastructure, such as roads, hospitals, clean piped water, a steady provision of electricity, and social infrastructure that will promote domestic private investment, especially in the real sector, which will boost economic growth. finally, the central bank should enforce regulations against countering loans and advances to sectors such as oil and gas and improve credit access for agriculture and the general industry but more specifically the manufacturing industry. references ahmed, h., jayaraman, g., & ahmed, h. (2020). the impact of selected economic indicators on the total credits offered by conventional commercial banks in sultanate of oman. journal of critical reviews, 7(5), 37-43. https://doi.org/10.31838/jcr.07.05.06 alkhazaleh, a. m. k. (2017). does banking sector performance promote economic growth? case study of jordanian commercial banks. problems and perspectives in management, 15(2), 55-64. https://doi.org/10.21511/ppm.15(2).2017.05 anyanwu, f. a., ananwude, a. c., & okoye, n. t. (2017). an empirical assessment of the impact of commercial banks’ lending on economic development of nigeria. international journal of applied economics, finance and accounting, 1(1), 14-29. https://doi.org/10.33094/8.2017.11.14.29 cbn. (2020). cbn statistical bulletin. in (vol. 32): cbn publication of 2020. chinedu, j., magaji, s., & musa, i. (2021). empinical analysis of the role of money market instruments on economic growth in nigeria: 1994-2018. lapai journal of economics, 5(2), 24-37. hasanov, f. j., bayrumil, n., & al-musehel, m. (2018). banks specific and macro economic determinant of bank profitability: evidence from an oil dependent economy. international journal of financial studies, 1(6), 78-81. igwe, g. u., magaji, s., & darma, n. a. (2021). analysis of the impact of financial development indicators of the banking, insurance and pension sectors on economic growth in nigeria. force: focus on research in contemporary economics, 2(2), 140-156. magaji, s., & darma, n. a. (2021). testing the supply-leading and demand -following hypothesis for financial development and economic growth, a case of the nigerian banking system. global scientific journal, 9(2), 19–28. nazifi, a. d., magaji, s., & amase, j. (2022). macroeconomic impact of oil price shocks on government expenditure and economic growth in nigeria. sdm journal of management, 13(special), 97-112. https://doi.org/10.18311/sdmimd/2022/29570 https://doi.org/10.31838/jcr.07.05.06 https://doi.org/10.21511/ppm.15(2).2017.05 https://doi.org/10.33094/8.2017.11.14.29 https://doi.org/10.18311/sdmimd/2022/29570 asian journal of economics and empirical research, 2023, 10(1): 11-19 19 © 2023 by the authors; licensee asian online journal publishing group obim, j., & orok, a. (2018). interest rate policy and the growth of the nigerian economy (1990-2016). journal of banking and financial dynamics, 1(2), 10-14. okoroafor, o., david, m. s., & eze, j. u.-o. (2018). impact of deposit money banks on capital formation in nigeria: 1980-2015. international journal of current research in life sciences, 7(08), 2570-2577. owusu, n. (2016). public debt and economic growth in ghana. african development review, 28(1), 116-126. https://doi.org/10.1111/1467-8268.12174 pesaran, m. h., shin, y., & smith, r. j. (2001). bounds testing approaches to the analysis of level relationships. journal of applied econometrics, 16(3), 289-326. https://doi.org/10.1002/jae.616 safdar, h. t., shehzadi, i., ali, i., & ullah, m. r. (2015). impact of bank lending on economics growth in pakistan: an empirical study of lending to private sector. american journal of industrial and business management, 5(8), 565-572. simon, e. m., & marshal, i. (2017). financial intermediation functions of microfinance banks in nigeria: a vector autoregressive and multivariate approach. international journal of economics and financial modelling, 2(1), 7–24. solow, j. l. (1987). the capital-energy complementarity debate revisited. the american economic review, 77(4), 605-614. swan, t. w. (1956). economic growth and capital accumulation. economic record, 32(2), 334-361. takon, s. m., john, j. i., ononiwu, e., & mgbado, m. (2020). determinants of the cost of financial intermediation in nigeria’s preconsolidated and post-consolidated banking sector. international journal of economics and financial management, 5(1), 30-41. timsina, n. (2017). impact of bank credit on economic growth in nepal. retrieved from nrb working paper no. 33: zeqiraj, v., hammoudeh, s., iskenderoglu, o., & tiwari, a. k. (2020). banking sector performance and economic growth: evidence from southeast european countries. post-communist economies, 32(2), 267-284. https://doi.org/10.1080/14631377.2019.1640988 the asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc., caused in relation to/arising from the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.1111/1467-8268.12174 https://doi.org/10.1002/jae.616 https://doi.org/10.1080/14631377.2019.1640988 94 © 2025 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 12, no. 2, 94-103, 2025 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v12i2.6991 © 2025 by the author; licensee asian online journal publishing group governance in the mena region: the hidden engine of economic growth ghlissi jawhara1 mroua mourad2 ( corresponding author) 1department of finance, faculty of economics and management of sfax, sfax city, 3000, sfax, tunisia. 1email: ghlissijawhara@gmail.com 2department of finance, institute of higher business studies of sfax, sfax city, 3000, sfax, tunisia. 2email: mourad.mroua@ihecs.usf.tn abstract this study investigates the impact of governance on economic growth by analyzing data from 18 middle east and north africa (mena) countries over the period from 2000 to 2023. using generalized least squares (gls) estimation, the research explores the interdependent relationship between various dimensions of governance and economic performance. to verify the robustness of the results, the study further employs the generalized method of moments (gmm) and utilizes an alternative proxy for economic growth. the findings indicate that corruption has a detrimental effect on economic growth in the mena region. additionally, higher levels of government effectiveness are associated with enhanced economic performance, while weaker voice and accountability are linked to slower growth. interestingly, political stability exhibits a dual relationship: it is negatively associated with the human development index but positively correlated with real gdp per capita. these outcomes remain consistent across robustness checks using different estimation techniques. the study offers practical insights for policymakers, emphasizing the importance of strengthening institutional frameworks and promoting transparency and accountability to foster sustainable economic growth in the mena region. keywords: economic growth, gls, gmm, governance, human development index, real gdp per capita. jel classification: o47; h11; i31; e01; c33. citation | jawhara, g., & mourad, m. (2025). governance in the mena region: the hidden engine of economic growth. asian journal of economics and empirical research, 12(2), 94–103. 10.20448/ajeer.v12i2.6991 history: received: 30 june 2025 revised: 1 august 2025 accepted: 5 august 2025 published: 8 august 2025 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. data availability statement: the corresponding author may provide study data upon reasonable request. competing interests: the authors declare that they have no competing interests. authors’ contributions: both authors contributed equally to the conception and design of the study. both authors have read and agreed to the published version of the manuscript. contents 1. introduction ...................................................................................................................................................................................... 95 2. governance and economic growth: an overview .................................................................................................................... 95 3. data description .............................................................................................................................................................................. 96 4. research methodology ................................................................................................................................................................... 96 5. results and discussion ................................................................................................................................................................... 98 6. robustness checks ........................................................................................................................................................................ 100 7. conclusion and policy implications ........................................................................................................................................... 101 references ............................................................................................................................................................................................ 102 https://www.doi.org/10.20448/ajeer.v12i2.6991 https://orcid.org/0009-0005-0833-7390 https://orcid.org/0000-0001-5321-6524 mailto:ghlissijawhara@gmail.com mailto:mourad.mroua@ihecs.usf.tn https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ asian journal of economics and empirical research, 2025, 12(2): 94-103 95 © 2025 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the existing literature by providing the first integrated gls and gmm analysis of governance's dual impact on economic growth in the mena region. the paper's primary contribution is the finding that political stability fuels gdp growth but undermines human development exposing a critical governance-development trade-off that has not been previously explored. 1. introduction the united nations development programme (2024) states that international institutions, particularly the world bank and the international monetary fund, pay considerable attention to governance indicators in developing countries. these institutions emphasize that governance is a crucial factor, even though the most prosperous developing countries have often contradicted the model of good governance. furthermore, even the most successful developing nations experienced significant corruption and governance failures during their early stages of development. the organisation for economic co-operation and development (2021) emphasizes that the need to reduce corruption and promote good governance is evident. achieving this goal requires particular attention to the additional governance capacities necessary to facilitate both the acceleration and sustainability of economic development. furthermore, international institutions have identified several structural drivers of corruption, which are often a consequence of weak fiscal capacity and property rights in developing countries. this indicates that corruption is likely to be widespread in these nations. however, countries with effective governance can manage these structural drivers more efficiently, creating conditions conducive to economic growth and sustained development. conversely, some developing countries face governance deficits that hinder economic prospects and contribute to political instability, thereby impeding overall progress. there is an emerging consensus among scholars, policymakers, civil society groups, and aid donors that governance and corruption are important factors affecting development and economic growth. this consensus has become increasingly evident through the results of numerous empirical studies conducted over the past decade, which have demonstrated the significant positive impact of good governance (world bank, 2020). compared to other regions, the middle east and north africa (mena) region has been understudied. the nexus of economics and politics in the arab states of the mena region provides a fertile ground for analysis that goes beyond simply examining the impact of corruption on the region's economic performance. it also includes an examination of the role of political discourse in facilitating and reinforcing corruption. in the context of increased political and academic attention given to the mena region following the arab uprisings, this study aims to examine the impact of governance indicators on economic growth in mena countries. this paper addresses the aforementioned gap by examining the impact of governance indicators, including control of corruption, voice and accountability, government effectiveness, and political stability, on economic growth. this study offers an opportunity for governors, politicians, citizens, and all components of civil society to gain insights into the crucial role of governance indicators in combating corruption and promoting economic growth in mena countries. the application of generalized least squares (gls) and the generalized method of moments (gmm) estimation, combined with two distinct proxies for economic growth hdi and gdp per capita yields the following results: while corruption acts as a significant barrier to economic growth, government effectiveness serves as a powerful catalyst, driving progress and fostering an environment conducive to prosperity. it can be observed that improvements in voice and accountability exert a comparatively limited influence on economic growth. this suggests that, while voice and accountability are crucial for economic growth, they are not sufficient conditions if politicians engage in actions that impede press freedom. this study reveals a compelling and intricate relationship between political stability and economic growth. it is noteworthy that, while political stability has a significant positive effect on real gdp per capita, it may also have an inverse effect on human development, as evidenced by an inverse relationship with the human development index (hdi). this paradox highlights a crucial insight: an excessive focus on political stability may lead to the neglect of essential social concerns, such as education and health, ultimately impeding comprehensive human development. policymakers must address this challenge by ensuring that the pursuit of stability does not come at the expense of advancing social well-being. achieving this balance is vital for sustainable development in the future. the remainder of this paper is organized as follows: section 2 reviews the relevant literature; section 3 presents the data description; section 4 discusses the research methodology; section 5 analyzes the empirical results; section 6 covers robustness checks; and section 7 concludes with policy implications and final remarks. 2. governance and economic growth: an overview a growing consensus among academics, policymakers, civil society groups, and aid donors has emerged that governance is important for development and, therefore, for economic growth. this consensus has become more visible following numerous empirical surveys conducted over the past decade, which demonstrate strong positive effects of good governance (world bank, 2020). along similar lines, this significant body of academic literature has developed models to elucidate how governance influences economic growth. most of these studies have demonstrated a strong positive correlation between good governance and economic development. one such research, conducted by (kaufmann, kraay, & mastruzzi, 2004), analyzed data from over 150 countries and provided empirical evidence that effective governance is crucial for positive economic outcomes. additionally, this study revealed that economic growth often serves as a precursor to improvements in institutional quality. although their findings suggest that policies aimed at enhancing institutional quality such as securing property rights, reducing corruption, and limiting uncertainty, require considerable time to produce tangible results, these policies are vital for fostering sustainable economic growth. kim and jacho-chávez (2009) employed a non-parametric method to analyze the relationship between governance and economic growth. their findings indicate that three of the six governance indicators—voice and accountability, political stability, and the rule of law are both economically and statistically significant. conversely, asian journal of economics and empirical research, 2025, 12(2): 94-103 96 © 2025 by the authors; licensee asian online journal publishing group regulatory control, control of corruption, and government effectiveness were found to be insignificant in their analysis. the authors state that their empirical results support the findings of la porta, glaeser, lopez-de-silanes, and shleifer (2004) that poor countries get out of poverty and grow through good policies pursued by a dictator. the study conducted by han, khan, and zhuang (2014) investigates whether countries with below-average governance experience slower economic growth compared to those with above-average governance. their findings reveal that aspects such as government effectiveness, political stability, control of corruption, and regulatory quality are more strongly and positively correlated with economic growth than the rule of law and voice and accountability. additionally, the study indicates that asian countries with average governance levels tend to grow faster than those with below-average governance levels, highlighting the importance of governance quality in economic development. after sharing his ideas on governance with world bank economists, rodrik (2008) argues that governance is an essential tool for development. he suggests that it serves as an effective instrument to achieve better economic outcomes and improve a country's policy-making processes. rodrik also distinguishes between governance as a means and as an end. in doing so, he advises economists not to treat governance as an end in itself, as this is primarily the domain of political scientists. however, when considering governance as a means, he contends that only countries where governance is a binding constraint should prioritize governance reforms to stimulate economic growth. this perspective emphasizes the importance of targeted reforms in countries facing significant governance challenges, as such reforms can have a substantial impact on their development trajectory. singh (2022) employed the panel cointegration technique to examine the relationship between economic growth and six governance indicators in the brics nations. he concluded that development and governance are mutually reinforcing. using a sample of 13 countries in west africa, ogbuabor, orji, and uzonwanne (2020) suggest that corruption, government ineffectiveness, and political instability significantly impede economic growth. this finding does not align with those previously documented by orji, edeh, and uche (2022). kesar and jena (2022) conducted a study indicating that political stability and control of corruption significantly and positively affect economic growth in the brics countries, consistent with the findings of beyene (2022). using a sample of 11 developing countries, fawaz, rahnama, and valentine (2021) argued that the voice and responsibility indicators exerted a detrimental impact on economic performance. one potential explanation for this phenomenon is the low credibility of the media in these nations. furthermore, the researchers concluded that the rule of law and corruption control have a significant impact on economic development. akinlo (2024) used panel data from 26 ssa countries and also found that corruption stimulates economic growth. the results of adjei, mensah, and boateng (2024) indicate that governance is essential for the region's economic development. to achieve substantial growth, sub-saharan african economies must prioritize actions that promote good governance. 3. data description the objective of this study is to examine the implications of governance indicators on economic growth in countries within the middle east and north africa (mena) region. the study utilizes a sample of 18 countries from the mena region, including algeria, bahrain, egypt, iraq, iran, jordan, kuwait, lebanon, libya, morocco, oman, qatar, saudi arabia, syria, sudan, tunisia, the united arab emirates, and yemen. the final sample comprises 414 country-year observations spanning from 2000 to 2023. data are collected manually from official websites of the world bank, undp, oecd, wdi, and wgi. 3.1. dependent variables simple determinants of economic growth have been developed by sala-i-martin (1992), notably the human development index (hdi). it encompasses education and health and is regarded as a crucial factor in job creation. increasing the stock of knowledge enhances the capacity to develop and adopt new technologies. at a more advanced stage of the analysis, an alternative proxy for economic growth was employed, namely gdp per capita, in order to verify the results obtained and to facilitate a comparison of the impact of governance indicators across different measures of growth. 3.2. the independent variables governance in a country can be assessed using six different indicators. these measurements are rated on a scale ranging from -2.5 to +2.5. among these six governance indicators, as described by kaufmann, kraay, and mastruzzi (2011), we utilize four indicators to avoid the problem of multicollinearity. these indicators are control of corruption (coc), political stability and absence of violence (stapl)government effectiveness (ge), and voice & accountability (va). 3.3. control variables six variables are adopted as the most frequently used proxies for economic control variables in the literature. these variables include government size, inflation, unemployment, women labor force, population size, and foreign direct investment. table 1 summarizes and displays all dependent, independent, and control variables. 4. research methodology our study employs a panel data estimation technique across 18 mena countries over a period of 24 years to examine the impact of governance on economic growth. consequently, our regression model is formulated as follows: where εit is the error term, β0 is the constant and β1, β2, ..., β10, are the vectors of coefficients estimates, hdiit is the human development index of country i at time t. cocit, staplit, goveffit and vait are the proxy of governance indicators of country i at time t (control of corruption, political stability, government effectiveness, voice and asian journal of economics and empirical research, 2025, 12(2): 94-103 97 © 2025 by the authors; licensee asian online journal publishing group accountability). gov sizeit, unempit, inflait, genderit, popit and fdiit are the control variables of country i at time t. government size, unemployment, inflation, women's labor force, population, and foreign direct investment. table 1. variables description variables nature variables name symbol source definitions dependent variables the human development index hdi united nations development programme (undp) measured by three key dimensions: a long and healthy life, access to education and a decent standard of living. this variable goes from 0 to 1 0= weak, 1= strong real gross domestic product per capita (gdp per capita) lngdp world development indicators (wdi) natural logarithm of gdp per capita adjusted for purchasing power parity (us$) independent variables control of corruption coc worldwide governance indicators (wgi) the control of corruption indicator is a capture of perceptions of the extent to which public power is exercised for private gain, including petty and grand forms of corruption, as well as the "capture" of the state by elites and private interests. it ranges from -2.5 (corrupt) to 2.5 (uncorrupted) political stability and the absence of violence/terrorism stapl wgi the political stability and absence of violence or terrorism indicator measures the likelihood that the government will be destabilized or overthrown through unconstitutional or violent means, including politically motivated violence and terrorism. the indicator ranges from -2.5 (indicating stability) to 2.5 (indicating instability). government effectiveness gov eff wgi the government effectiveness indicator measures the quality of public services, the competence of the civil service, and its independence from political pressures. it also assesses the quality of policy formulation and implementation, as well as the credibility of the government's commitment to these policies. it ranges from -2.5 (inefficient) to 2.5 (efficient) voice and accountability va wgi the voice and accountability indicator measures the extent to which a country's citizens can participate in selecting their government, as well as their freedom of expression, freedom of association, and freedom of the media. it ranges from -2.5 (weak) to 2.5 (strong). control variables government size govsize wdi general government final consumption expenditure (% of gdp) inflation infla wdi consumer price index (% of gdp) women’s labour force population gender wdi women's participation in the labor force. unemployment unemp wdi unemployment rate in the working age population population size pop wdi population size in millions) foreign direct investment fdi wdi net inflows (percent of gdp) to estimate our model equation, we used both the gls) random effects model and the fixed effects model. the hausman test was employed to determine the most appropriate model. the presence of individual effects necessitated verification to decide whether these effects are fixed or random. the conclusions derived from these tests are summarized in table 2. the p-value of the hausman test is less than 10%. this indicates that the null hypothesis of equal coefficients is rejected. consequently, the fixed effects model was adopted. we tested for heteroscedasticity using the breusch–pagan test. since the p-value is less than 0.05, we reject the null hypothesis and conclude that heteroscedasticity is present in the data. to verify autocorrelation, the durbin–watson test was applied. the test results show a value ranging from 0.99 to 1.57, indicating the presence of positive autocorrelation in the sample. for this reason, we used the gls regression method. furthermore, to verify the robustness of our findings, we employed an alternative economic growth proxy and applied the two-step gmm approach. table 2. results of panel data test. tests chi2 p-value darbin-watson fixed effect 398.56 0.000 random effect 71.12 0.000 hausman test 837.54 0.0000 breusch-pagan test 10.18 0.0014 durbin-watson test 0<0.206<2 asian journal of economics and empirical research, 2025, 12(2): 94-103 98 © 2025 by the authors; licensee asian online journal publishing group 5. results and discussion 5.1. descriptive statistics table 3 reports the descriptive statistics for a sample consisting of 18 countries in the mena region from 2000 to 2023. the human development index (hdi) is considered the dependent variable, while four governance indicators, control of corruption, political stability, government efficacy, and voice and accountability are the independent variables. additionally, the analysis includes several control variables: government size, inflation, unemployment, women’s labor force participation, population, and foreign direct investment. the median value of the human development index (hdi) is 0.713, with a maximum of 0.89 and a minimum of 0.403. the average scores of governance indicators corruption control (coc), stability (stapl), government effectiveness (gov eff), and voice and accountability (va) are -0.367, -0.694, -0.421, and -1.089, respectively. these figures suggest that countries in the middle east and north africa (mena) region generally experience weak governance. regarding control variables, the average government size is 15.590, and the median inflation rate is 7.434. the mean values for unemployment rate, gender equality index, population size, and foreign direct investment (fdi) are 9.530, 20.546, 21.646, and 2.653, respectively. overall, the data indicates challenges in governance and economic stability within the region, highlighting areas that require policy attention and development efforts. table 3. descriptive statistics. variables observations mean std. dev min. max. hdi 432 0.713 0.102 0.403 0.89 coc 432 -0.367 0.769 -1.712 1.567 stapl 432 -0.694 1.117 -2.180 1.223 gov eff 432 -0.421 0.833 -2.180 1.223 va 432 -1.089 0.489 -2.050 0.304 gov size 432 15.590 4.880 6.732 30.003 infla 432 7.434 12.889 -10.067 150.322 unemp 432 9.530 5.804 0.1 29.77 gender 432 20.546 6.320 0.664 100.388 pop 432 21.646 23.217 0.664 100.388 fdi 432 2.653 3.366 -4.541 23.537 5.2. correlation matrix and vif the correlation matrix is used to examine the direction of associations between the variables under study. additionally, it indicates the significance of the relationships between variables and provides insight into the presence or absence of multicollinearity issues. table 4 demonstrates that the correlations between governance indicators such as coc, stapl, gov eff, and va are significantly positive in relation to hdi. the relationship between hdi and variables like gov size and fdi is also found to be significantly and positively correlated. the findings further reveal that all correlation coefficients between the independent variables and the dependent variables inflation, unemployment, gender, and pop are significantly negative. moreover, all correlation coefficients are less than 0.8, indicating that the data set does not exhibit multicollinearity issues. as indicated in table 5, this result is corroborated by the vif values, with the highest recorded value being 7.46 and less than 10. as evidenced by neter, wasserman, and kutner (1989), this finding is supported by the variance inflation factor (vif). table 4. correlation matrix. pearson correlati on hdi coc sta pl gov eff va govsiz e infla unemp gender pop fdi hdi 1 coc 0.614* 1 sta pl 0.561* 0.840 1 gov eff 0.615* 0.868 0.718 1 va 0.224* 0.386 0.257 0.447 1 gov size 0.291* 0.308 0.257 0.279 0.171 1 infla -0.325* -0.310 -0.313 -0.334 -0.220 -0.122 1 unemp -0.548* -0.663 -0.578 -0.678 -0.167 -0.253 0.197 1 gender -0.152* -0.291 -0.138 -0.297 0.102 -0.031 0.056 0.414 1 pop -0.229* -0.262 -0.283 -0.366 -0.354 -0.197 0.279 0.164 -0.155 1 fdi 0.045** 0.141 0.076 0.277 0.208 -0.029 0.002 -0.011 0.134 -0.182 1 table 5. vif. variables vif tolerances coc 7.46 0.134 eff gov 5.96 0.257 sta pl 3.88 0.257 unemp 2.26 0.442 gender 1.49 0.670 va 1.48 0.674 pop 1.39 0.720 ide 1.27 0.536 infla 1.62 0.833 govsize 1.15 0.870 note: *, correlation is significant at the levels 10% and 5%. asian journal of economics and empirical research, 2025, 12(2): 94-103 99 © 2025 by the authors; licensee asian online journal publishing group 5.3. empirical findings the model is statistically significant, with the wald chi-square value equal to 891.70 (p=0.000). the r2 value is 46.48%, indicating that the independent variables control of corruption, political stability, government efficacy, and voice and accountability explain 46.48% of the variation in the human development index. table 6 demonstrates a significant and positive effect of the control of corruption and the human development index (hdi), with a coefficient of 0.008. this finding indicates that corruption has a negative impact on economic growth. based on this impact, we conclude that corruption hampers the progress of economic development. this conclusion is supported by previous research, including studies by wang, gao, wen, xiao, and bingzheng (2022) and hoinaru, buda, borlea, văidean, and achim (2020). for the independent variable stapl, table 6 shows that political stability stapl has a negative and significant effect on hdi (-0.008). this indicates that political stability hinders human development; in other words, human development tends to be lower during periods of political stability. our results can be interpreted as follows: an authoritarian regime promotes economic growth more effectively than a democratic regime, especially in relatively poor countries. authoritarian regimes have an incentive to implement economic policies that promote growth in order to avoid popular discontent, which helps ensure regime stability. additionally, authoritarian governments are often better positioned to exploit natural resources and thus protect their economies from a "dutch disease" effect. they can do this by allowing a minority to directly confiscate the rent generated from natural resource exploitation and, in some cases, use it to promote economic activity and regime stability by reducing taxes and increasing public aid (barro, 1996). conversely, the adoption of a democratic regime could penalize economic growth. this finding was confirmed by barro (1996) and acemoglu, naidu, restrepo, and robinson (2014). the estimates presented in table 6 also indicate that government effectiveness is positively associated with the human development index, suggesting that government effectiveness stimulates growth. this empirical result reveals that a one-unit change in government effectiveness will cause approximately a 0.051-unit change in the human development index. according to studies by cui (2015), bercu, lupu, and tudor (2019), and yanikkaya and turan (2020), government efficiency is essential for the improvement of economic growth in the mena region countries. additionally, the relationship between the independent variable v&a and the hdi is significantly negative, with a coefficient of -0.002. this finding contradicts the study of (alexiou, vogiazas, & solovev, 2020). this earlier study found a positive and significant link between the two variables. it can be deduced that citizens' participation in the selection of their government, as well as freedoms of expression, association, and the media, influence the economy and can hinder its growth. for the control variables table 6 indicates that the alliance among government size has a positive and significant effects on the human development index, this result is consistent with gupta, clements, pivovarsky, and tiongson (2002) and prasetyo (2013) who claimed that the government uses the benefits of economic growth to finance basic health care and access to education for all, this will bring a double benefit to the poor; they are healthier and better educated, and they will increase their consumption. on the other hand, other studies, such as omodero (2019), have found that public spending negatively affects a nation's human development. the report in table 6 indicates that the control variables unemp, infla, pop and fdi have a negative and significant association with the hdi. this finding aligns with previous research by soylu, güngör, and soylu (2018) and pasara, ndou, and nhamo (2020), which demonstrated that higher unemployment levels in a country are associated with lower economic growth. based on these results, it can be inferred that inflation also negatively impacts economic growth within the model, consistent with initial expectations. it is important to note that inflation hampers economic growth specifically in the middle east and north africa (mena) region. the findings of this study are consistent with those reported by attari and javed (2010) and sequeira (2020). the population in the mena region tends to evolve in the opposite direction to the economic growth of a country. when the population grows faster than the (gnp), the standard of living for the population does not improve. in fact, rapid population growth has hindered economic development and has negatively impacted human development (rehman & deyuan, 2018). when the population increases at a relatively high rate, it implies adverse effects on economic growth. foreign direct investments act negatively on human development. so, this means that fdi has a negative impact on economic growth, which does not support the neoclassical growth model (solow, 1956), according to which investments have a positive impact on economic growth. our result is confirmed by the studies of doh (2019), olorogun, akinlo, and apanisile (2020), and joshua, ikpesu, and ariyo (2020). on the other hand, this result is not coherent with the studies by hanh, cuong, and thu (2020) and jahanger (2021). table 6. gls/fgls results. predict sign. independent variable idh coef p>|z| constante 0.671 0.000 coc + 0.008 0.044 stapl + -0.008 0.048 gov eff + 0.051 0.000 va + -0.002 0.648 gov size + 0.003 0.000 infla -0.000 0.655 unemp -0.004 0.000 gender + 0.001 0.013 pop -0.000 0.790 fdi + -0.001 0.064 n 432 r-squared 0.468 wald chi-2 891.70 pro>chi2 0.000 asian journal of economics and empirical research, 2025, 12(2): 94-103 100 © 2025 by the authors; licensee asian online journal publishing group the control factor of gender has a positive and significant association with hdi. our study also indicates that increased participation of women in the labor market has a beneficial impact on human development. this can be explained by the fact that higher female workforce participation significantly enhances economic well-being and influences the consumption of goods, housing production, and leisure activities. these findings are consistent with previous research conducted by finlay (2018) and haque, aziz, and chowdhury (2019). 6. robustness checks 6.1. the gdp per capita is the alternative economic growth measure gdp is defined as a basic measure of the productive capacity of a nation, not overall well-being. over time, economists realized the inefficiencies of gdp and sought to develop a system of analysis that provides a more accurate picture of an economy’s well-being. these economists believed that people and their capabilities should be the ultimate criteria for assessing a country's development, rather than economic growth alone. to evaluate the impact of governance indicators on economic growth, we use gdp per capita (constant us$) as an alternative measure of economic progress. this study followed the model presented below: using lngdp as the independent variable, the wald chi-square statistic is equal to 145,428.50 (p=0.000), indicating that the model is statistically significant. the r-squared (r2) value is 73.20%, which implies that the independent variables explain 73.20% of the variation in the impact of governance indicators on lngdp. table 7 shows a significant and positive effect of the control of corruption on the real per capita lngdp (0.456). this earlier finding indicates that corruption negatively affects both measures of economic growth gdp and hdi. unlike the hdi model, table 7 shows that political stability stapl has a positive and significant effect on lngdp (0.083), which explains that political stability is a necessary condition for macroeconomic stability and the latter makes it possible to fully exploit the potential for economic performance (brunetti, 1997). asongu, uduji, and okolo-obasi (2019) suggest that political instability can be detrimental to economic growth as investors transfer their capital to economies with more stable political governance. according to this impact, we accept the second hypothesis (h2). this result confirms asongu et al. (2019), pasha (2020), and ayessa (2021) findings. however, this finding contradicts some of the works like mbaku (1999), allareddy (2015), and khan, khan, and ullah (2020). the estimates, based on the hdi model, also indicate that government effectiveness is positively associated with gdp per capita, implying that government effectiveness stimulates economic growth. this empirical result reveals that a one-unit change in government effectiveness will cause an approximate increase of 0.025 units in lngdp. as the hdi, the independent variable va has a negative and significant impact on lngdp, with a coefficient of 0.128. table 7. gls/fgls results. predict sign independent variable lngdp coef. p>|z| constant 10.499 0.000 coc + 0.456 0.000 stapl + 0.083 0.076 gov eff + 0.025 0.000 va + -0.128 0.000 gov size + -0.020 0.000 infla -0.000 0.003 unemp -0.103 0.000 gender + -0.000 0.832 pop -0.008 0.000 fdi + -0.019 0.000 n 432 r-squared 0.732 wald chi-2 145428.50 pro>chi2 0.000 6.2. two-stage estimation to verify the robustness of our findings, we re-estimated the economic growth model using the two-step system gmm method, as presented in table 8. this approach follows the methodology of arellano and bover (1995) and blundell and bond (1998), which is well-suited for addressing endogeneity. the system gmm estimator constructs equations in first differences and levels, using lagged values of the variables as instruments. first-order differencing removes unobserved heterogeneity and mitigates omitted variable bias. the validity of the instruments and the model specification is assessed using the sargan test and the arellano– bond serial correlation test (arellano & bond, 1991). a rejection of the null hypothesis in the sargan test confirms the appropriateness of the instruments. for the serial correlation tests, the null hypothesis of no first-order autocorrelation (ar(1)) must be rejected, while the null hypothesis of no second-order autocorrelation (ar(2)) should not be rejected to validate the model. we employed the roodman (2009) "xtabond2" module in stata to conduct system gmm estimation. the diagnostic results reported in table 8 indicate that the model satisfies the necessary conditions: the sargan test supports the validity of the instruments, and there is no evidence of autocorrelation in ar(2), confirming the model's adequacy. empirically, the results show that governance indicators, specifically control of corruption (coc), political stability (stapl), government effectiveness (gov eff), and voice and accountability (va), maintain the same sign and significance as reported in the gls estimations in table 6. therefore, the gmm findings reinforce and confirm the robustness of the gls/fgls results. asian journal of economics and empirical research, 2025, 12(2): 94-103 101 © 2025 by the authors; licensee asian online journal publishing group table 8. gmm results. model 1 idh model 2 lngdp coefficient probability coefficient probability lag1 -0.060 0.001 0.829 0.752 coc 0.629 0.054 0.055 0.021 stapl -0.418 0.033 0.061 0.068 gov eff 0.273 0.000 0.009 0.000 va -0.202 0.583 -0.000 0.000 gov size 0.010 0.000 0.000 0.001 infla -0.000 0.840 -0.000 0.599 unemp 0.036 0.159 -0.017 0.000 gender -0.012 0.039 -0.000 0.811 pop 0.000 0.883 -0.001 0.035 fdi 0.011 0.479 -0.004 0.280 constant 0.002 0.997 1.786 0.000 f-statistics 415.11 0.000 529542.84 0.000 ar(1) -1.14 0.256 -1.44 0.149 ar(2) 0.69 0.493 0.13 0.894 hansen test 0.55 1.000 0.23 1.000 7. conclusion and policy implications the objective of this study is to elucidate how governance influences economic growth. to achieve this, four governance indicators out of six were selected to avoid multicollinearity issues. these indicators are specifically political stability (stpl), government effectiveness (gov eff), voice and accountability (va), and control of corruption (coc). the impact of these indicators on the human development index (hdi), the primary dependent variable, was then examined. additionally, to demonstrate that these indicators exert a similar influence on economic growth through various measures, their impact on gdp per capita was also tested as a robustness check. the application of gmm estimation to both models revealed both similarities and differences between the two measures. the results of table 8 demonstrate a complex relationship between governance and economic growth, providing new insights into these dynamics. firstly, there is a robust positive correlation between government efficiency and economic growth, a finding that is consistently supported by both the hdi and gdp per capita. this highlights the pivotal role of effective governance in establishing a stable environment that fosters economic advancement, as effective governments are better positioned to implement impactful policies and attract investment. furthermore, the control of corruption has been demonstrated to exert a positive influence on economic growth. this indicates that reducing corruption can facilitate the establishment of trust in institutions, promote fairness, and create a more predictable environment for investment, all of which are essential for sustainable development. in contrast to the findings of previous studies in the major literature, our analysis reveals a negative correlation between voice and accountability (va) and economic growth in the mena region. this is evidenced by both the human development index (hdi) and gdp per capita. our findings suggest that limitations in civic engagement and transparency may, in this context, impede innovation and reduce government responsiveness to social needs, potentially constraining sustainable growth in the region. contrary to previous findings, the relationship between political stability, the absence of violence or terrorism, and economic growth is complex and not straightforward. while political stability has been demonstrated to promote economic growth, as measured by gdp per capita, it also exhibits an inverse relationship with the human development index (hdi). the hdi evaluates human development across four key dimensions: a long and healthy life, access to knowledge, access to resources, and a decent standard of living. this suggests that although political stability can facilitate economic expansion, it may simultaneously hinder broader social progress if it diverts attention from essential areas such as education, healthcare, and social equality. these findings are particularly relevant to regions like the middle east and north africa, highlighting that the impact of governance on economic growth varies depending on the metric used. consequently, this underscores the importance of adopting a balanced approach to governance reforms that promote both economic and social development, ensuring that progress in one area does not come at the expense of another. to enhance good governance and support economic growth, it is essential to reinforce mechanisms that regulate and prevent corruption. implementing robust anti-corruption measures is imperative to build public trust, improve institutional transparency, and encourage both domestic and foreign investment. additionally, promoting civic engagement is highly recommended. facilitating civic participation and ensuring government transparency can foster greater voice and accountability, which in turn can drive innovation and responsiveness to social needs. finally, achieving a balance between political stability and social development is crucial. while pursuing political stability, policies must also prioritize social development, especially in areas such as education, health, and equality, to promote comprehensive and sustainable growth. it is important to consider the limitations of this study when interpreting the findings. firstly, the analysis depends on the availability and quality of governance and economic growth data for mena countries, which can vary significantly and may affect the robustness of the results. furthermore, the period under examination, spanning from 2000 to 2023, may not fully capture longer-term trends or the effects of historical events that occurred prior to this timeframe and could potentially influence current governance and economic conditions. furthermore, although the study employs generalized least squares (gls) and generalized method of moments (gmm) estimations, the selected model specifications may not account for all relevant variables or interactions, which could result in omitted variable bias. moreover, the findings may not be generalizable to other regions or countries outside the mena context, as the dynamics of governance and their effects on economic growth can differ significantly across various geopolitical and cultural settings. it would be advantageous for future research to investigate the influence of supplementary governance indicators or alternative measures of economic growth, with a view to enhancing the robustness of the findings. 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(2020). tax structure and economic growth: do differences in income level and government effectiveness matter? the singapore economic review, 65(01), 217-237. https://doi.org/10.1142/s0217590818500170 asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.1007/s11356-022-20358-z https://doi.org/10.1142/s0217590818500170 104 © 2025 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 12, no. 2, 104-112, 2025 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v12i2.7477 © 2025 by the author; licensee asian online journal publishing group exploring the impacts of financial development on economic growth through financial openness in three urban agglomeration regions of china ashfaque ali gilal1 liu hong2 xianhang xu3 meng jiao si4 qi min5 ( corresponding author) 1sukkur iba university sukkur sindh, pakistan. 1email: ashfaque.ali@iba-suk.edu.pk 2school of economics and management, tianjin tianshi college, china. 2email: liuhong@student.usm.my 3school of management, chongqing institute of engineering, chongqing china. 3email: xuxianhang@cqie.edu.cn 4universiti sains malaysia, malaysia. 4email: meng91061@student.usm.my, 5tianjin university of finance and economics, china. 5pearl river college, mississippi, united states. 5email: qimin@student.usm.my abstract this study explores the nonlinear relationship between financial development (fd), financial openness (fo), and economic growth across china’s three key urban agglomerations: jing-jin-ji, yangtze river delta, and pearl river delta. using panel data from 10 provinces, municipalities, and special administrative regions over the period 1995–2021, the study applies a panel threshold regression model to examine how the growthenhancing effects of fd vary across different levels of fo. the results reveal that when fo is low (fo < 0.4253), fd has a strong positive impact on economic growth, indicating that domestic financial systems play a pivotal role in less open economies. in moderately open regimes (0.4253 ≤ fo ≤ 0.43720), the positive effect of fd weakens, possibly due to transitional inefficiencies or policy misalignments. interestingly, in highly open regimes (fo > 0.43720), the impact of fd strengthens again, though not to the level observed in closed financial environments. among the control variables, government expenditure, trade openness, and higher education enrollment negatively influence economic growth, while inflation is positively associated. these findings offer important policy insights, emphasizing the need for region-specific financial liberalization strategies and reinforcing the importance of domestic financial system development to effectively harness the benefits of global financial integration. keywords: agglomeration regions of china, economic growth, financial development, financial openness, threshold regression. jel classification: e1; e6; f31; g2. citation | gilal, a. a., hong, l., xu, x., si, m. j., & min, q. (2025). exploring the impacts of financial development on economic growth through financial openness in three urban agglomeration regions of china. asian journal of economics and empirical research, 12(2), 104– 112. 10.20448/ajeer.v12i2.7477 history: received: 9 july 2025 revised: 21 august 2025 accepted: 10 september 2025 published: 1 october 2025 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. data availability statement: the corresponding author may provide study data upon reasonable request. competing interests: the authors declare that they have no competing interests. authors’ contributions: all authors contributed equally to the conception and design of the study. all authors have read and agreed to the published version of the manuscript. contents 1. introduction .................................................................................................................................................................................... 105 2. literature review .......................................................................................................................................................................... 106 3. methodology ................................................................................................................................................................................... 107 4. results discussion ......................................................................................................................................................................... 108 5. policy implications and conclusion ........................................................................................................................................... 111 6. research limitation and future direction .............................................................................................................................. 111 references ............................................................................................................................................................................................ 112 mailto:ashfaque.ali@iba-suk.edu.pk mailto:liuhong@student.usm.my mailto:xuxianhang@cqie.edu.cn mailto:meng91061@student.usm.my mailto:qimin@student.usm.my https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v12i2.7477 https://orcid.org/0000-0002-3775-7272 https://orcid.org/0000-0002-6481-1561 https://orcid.org/0000-0003-3717-5771 https://orcid.org/0009-0000-5448-1186 https://orcid.org/0000-0002-8557-4139 asian journal of economics and empirical research, 2025, 12(2): 104-112 105 © 2025 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study examines the complex relationship between financial development and economic growth through financial openness by employing a threshold regression model across three urban agglomeration regions in china, which have been infrequently studied previously. the primary contribution of this research is its finding that the impact of financial development on economic growth varies across different regimes of financial openness. 1. introduction economic growth involves a continuous increase in a nation's ability to provide a wider range of goods over time, driven by technological progress and institutional changes (kuznets, 1963). regarding the definition of financial openness, so far the academic community has not provided a unified concept. scholars often associate it with broader themes such as financial integration, globalization, capital account liberalization, and cross-border capital mobility (abiad, detragiache, & tressel, 2004; bekaert, harvey, & lundblad, 2005; bussière & fratzscher, 2008; huang, 2006; islamaj, 2012; ito, 2011; kose, prasad, & terrones, 2009; nasreen, shah, & ahmed, 2020; obstfeld, 2009; quinn & inclan, 2009; wooldridge, 2007). others frame it as a component of economic openness, emphasizing reduced barriers to foreign investment and deeper linkages with global financial systems. this study also agrees with the view of previous studies jia (2005) and xie and pan (2018) that financial openness involves receiving foreign capital freely and tends to embrace foreign capital, intertwining with global financial networks. the world bank highlights that strengthening the financial sector requires addressing costs related to information, contract enforcement, and transactions, thereby enhancing the sector’s resilience and efficiency (the world bank, 2025). consequently, this study defines financial development as a transformative process that enhances a financial system’s capacity to overcome structural barriers and support sustainable economic growth. in 2006, the 11th five-year plan of china introduced the idea of "urban agglomeration as the key way to grow urban areas," marking the initial exploration of the new regional governance model termed "group." although the significance of urban agglomeration for regional coordination was repeatedly underscored in central government documents and reports from 2007 to 2016, there was no explicit intention to deepen its promotion during that period. in 2014, president xi jinping suggested a plan to make beijing the main city of the beijing-tianjin-hebei region (jing-jin-ji). the term "city cluster" gained official recognition in government documents following xi's endorsement, sparking increased interest in regional governance. in 2017, the report presented at the 19th congress of china's communist party articulated the goal of establishing a pattern of working together to grow big, medium, and small cities and towns, with a focus mainly on urban agglomerations. this marked the first clear acknowledgment that urban agglomerations were to be the main drivers of coordinated development among cities of varying sizes, outlining the strategic direction for building and growing urban agglomerations (wu, 2021). the combined gdp of the yangtze river delta, pearl river delta, and beijing-tianjin-hebei urban agglomeration exceeds 40% of the country's total, playing a crucial role in the nation's economic stability, serving as a source of high-quality development, and acting as a testing ground for reforms. according to zhang (2022), these three regions demonstrate economies of scale, a rapid accumulation of innovation elements, a concentration of highlevel talents, and stand at the forefront of connecting with other countries, making them the main drivers of china's technological innovation and pioneers in institutional opening up. financial development defined as the evolution and increased complexity of a country’s financial markets and institutions plays a key role in stimulating economic growth. it involves the progress of banks, markets, and financial instruments that help mobilize savings, direct investments efficiently, and manage risks. an advanced financial system not only channels savings into productive ventures but also enhances resource allocation by offering improved investment information and supports technological innovation through funding projects with higher risk and return. moreover, by reducing information gaps, lowering transaction costs, and facilitating both trade and foreign investment, a robust financial system becomes a cornerstone for long-term economic prosperity. this phenomenon is particularly evident in china's urban clusters, where financial advancements have significantly contributed to rapid economic growth. on the other hand, financial openness refers to the extent to which a country's financial institutions and markets are integrated with those worldwide, and it is widely regarded as a key factor in driving economic growth. by attracting foreign capital, intensifying competition, and streamlining resource allocation, this openness helps improve economic performance (klein & olivei, 2008). it also provides access to global savings, enables investment diversification, and helps mitigate risks, thereby strengthening economic resilience (henry, 2007). in china's urban clusters, for example, financial openness has been crucial for growth by linking these regions to international markets, drawing in foreign investments, and spurring technological innovation (bekaert, harvey, & lundblad, 2011). while it brings notable benefits, financial openness can also increase exposure to market volatility and crises (stiglitz, 2002). overall, when managed properly, it is seen as a significant contributor to sustained economic growth (klein, 2005). urban agglomerations in china have become pivotal engines of economic growth, yet the intricate interplay between financial development and financial openness within these regions remains underexplored. despite a growing body of literature underscoring the importance of both domestic financial sophistication and international financial integration in fostering economic performance, there is a notable gap in understanding how these two forces interact in urban contexts where rapid economic transformation is underway. this paper addresses the problem by investigating how financial development characterized by the evolution of financial markets, institutions, and instruments translates into economic growth when coupled with financial openness, which integrates these domestic mechanisms into global financial networks. focusing on three major urban agglomerations in china, the study seeks to clarify whether and how financial openness amplifies or moderates the impact of financial development on economic growth. this research is crucial not only for advancing academic discourse but also for informing policy decisions aimed at enhancing economic resilience and sustainable development in urban settings facing both domestic and global financial challenges. asian journal of economics and empirical research, 2025, 12(2): 104-112 106 © 2025 by the authors; licensee asian online journal publishing group the significance of this study lies in its potential to bridge a critical gap in existing research by integrating two well-documented yet often separately examined dimensions financial development and financial openness—within the unique context of china's urban agglomerations. previous studies have robustly documented the role of financial development in promoting economic growth by enhancing the mobilization of savings, improving resource allocation, and supporting innovation (king & levine, 1993; levine, 2005). similarly, research on financial openness has demonstrated its ability to attract foreign capital, increase competition, diversify investments, and bolster economic resilience (henry, 2007; klein & olivei, 2008). however, while the individual impacts of these factors are well-established, there remains a noticeable gap in understanding how financial development and financial openness interact, particularly at the urban level, to affect their economic performance. urban agglomerations in china are dynamic economic engines; yet, few studies have specifically examined how their financial systems, when integrated with global markets, affect local economic growth. by focusing on three key urban regions, our research aims to provide a nuanced analysis of this interplay. this will not only enrich the academic literature by addressing the conditional effects of financial openness on the benefits of domestic financial development but also offer valuable insights for policymakers seeking to harness these synergies to drive sustainable urban growth. this study advances the literature by integrating financial development and financial openness within a unified framework that explicitly considers their nonlinear interplay. by employing a threshold regression approach, this research refines traditional growth models to examine how varying degrees of financial openness may amplify or moderate the benefits of domestic financial development. importantly, this method helps capture heterogeneity across china's urban agglomerations and mitigates potential endogeneity concerns that typically complicate the analysis of financial variables. as such, our theoretical framework offers a more nuanced understanding of the conditional mechanisms through which global financial integration influences local economic performance. empirically, the study makes a significant contribution by applying a robust panel threshold regression method to data from three major urban agglomerations in china, considering financial openness as a moderating variable. this technique enables us to identify distinct regimes in the relationship between financial development, financial openness, and economic growth, revealing nonlinear effects that traditional linear models might overlook. the threshold regression approach can address heterogeneity across regions, ensuring that the estimates are both reliable and insightful. consequently, the findings provide clear empirical evidence on the conditional impact of financial openness, offering policymakers tailored insights to harness the synergistic benefits of domestic and international financial integration for sustainable urban growth. 2. literature review 2.1. theoretical review economic theories have long recognized the pivotal role of financial development in driving economic growth. seminal works by king and levine (1993) and levine (2005) emphasize that robust financial institutions and markets are fundamental for mobilizing savings, channeling investments, and improving resource allocation, thereby fostering capital accumulation and innovation. these perspectives are integral to both classical finance-growth models and modern endogenous growth theories, which collectively argue that a well-functioning financial system is essential for sustainable economic progress. complementing this view, theories on financial openness highlight the advantages of integrating domestic financial systems with global markets. for instance, klein and olivei (2008) demonstrate that financial openness attracts foreign capital and intensifies competition, while henry (2007) shows that it facilitates diversification of investment portfolios and risk mitigation, further strengthening domestic financial structures in supporting economic growth. building on these complementary strands of thought, our study explores the interplay between financial development and financial openness within china's urban agglomerations. recognizing that the impact of financial development may vary with different levels of global financial integration, we employ a threshold regression approach to capture potential nonlinearities and regional heterogeneity. this methodology allows us to identify distinct regimes where the influence of financial development on economic growth is either amplified or moderated by varying degrees of financial openness. by synthesizing established economic theories with advanced empirical techniques, our research not only clarifies the individual contributions of financial development and openness but also uncovers their conditional interplay, offering valuable insights for policymakers seeking to harness these dynamics in rapidly evolving urban economies. 2.2. empirical review the link between financial development and economic growth is a central topic in economics, with various methods and interpretations highlighting how financial systems impact economic activity. here, it summarizes important studies that have shaped our understanding of this connection. regarding the role of financial markets and institutions: arestis, demetriades, and luintel (2001) and levine and zervos (1996) provided comprehensive analyses on how stock markets contribute to economic growth. they concluded that stock markets enhance growth through improving liquidity and facilitating investment diversification, which in turn lowers the cost of capital and supports corporate investments. shen and wei (2021) examined panel data from 31 provinces in china covering 2007 to 2019. their research measured financial openness and financial risk at the regional level, analyzing how regional financial openness dynamically affects financial risk. the results showed that the level of financial openness and financial risk varies greatly among provinces in china, and there is heterogeneity in the effect of financial openness on financial risk among provinces. in regions with weak economic foundations and a low level of financial development, financial openness can reduce regional financial risk. in regions with a better economic foundation and higher financial development levels, the improvement of the regional financial openness level brings relatively large financial risks. njindan iyke and odhiambo (2017) investigated how inflationary thresholds affect the relationship between finance and economic growth in ghana and nigeria. their study identified inflationary thresholds for both countries: 10.73%–29.83% for ghana and 10.07%–19.25% for nigeria. the findings revealed that financial development asian journal of economics and empirical research, 2025, 12(2): 104-112 107 © 2025 by the authors; licensee asian online journal publishing group promotes economic growth during periods of low to moderate inflation but has little to no effect during high inflation periods. however, using a balanced panel dataset covering 30 chinese provinces from 1987 to 2017, li and wei (2021) analyzed how carbon emissions influenced economic growth. they explored the relationship between economic growth and factors such as financial development (such as deposits and loans per capita), innovation, economic openness (imports and exports per capita), capital stock, and carbon emissions (co2 emissions in million tonnes with a one-period lag). their findings indicate two main conclusions: i) there are complex nonlinear connections between carbon emissions, financial development, economic openness, innovation, and economic growth; and ii) carbon emissions reduce the positive effects of financial development and innovation on economic growth. meanwhile, scholars also examined the nonlinear relationship existing between financial development, financial openness, and economic growth. guo and peng (2016) conducted an analysis using data from 87 countries and delved deeper into the provinces in china, precisely 31 of them, including municipalities and autonomous regions. this involved computing individual threshold values for capital account openness in each province and assessing how varying openness levels impacted the economy across these regions. their findings revealed three key points: firstly, a threshold effect exists in how capital account openness influences economic growth, signaling china is positioned within a range capable of reaping benefits from an open capital account. secondly, the relationship between economic promotion from capital account openness and the extent of global openness isn't straightforward. lastly, there are noteworthy differences in how capital account openness impacts economic growth across various chinese regions. to optimize the advantages of an open capital account, china needs heightened global openness overall. additionally, specific regions may need to focus on increasing per capita income, while others could benefit from restructuring industries to reduce reliance on foreign trade. similarly, guo and peng (2016) examining both national and provincial levels in china, the study found a notable threshold effect of financial openness on economic growth. the same perspectives can also be found in the studies of liang (2020), karim, chowdhury, and uddin (2021), and nam (2024). 2.3. research gap and contribution of the study despite extensive research on the individual effects of financial development and financial openness on economic growth, significant gaps remain in understanding their interactive dynamics, especially within the context of china's urban agglomerations. previous studies, such as those by king and levine (1993) and levine (2005), have underscored the importance of financial development for mobilizing savings and allocating investments efficiently, while research by klein and olivei (2008) and henry (2007) has highlighted how financial openness can attract foreign capital and diversify risks. however, these works typically treat the two dimensions as separate influences and assume linear relationships, thereby overlooking the potential nonlinear and conditional effects that may emerge when financial openness reaches certain thresholds. although rajan and zingales (1996) and stiglitz (2002) offer valuable insights into the risks and benefits associated with financial systems and global integration, they do not specifically address how the interplay between domestic financial development and international financial integration affects economic outcomes in rapidly urbanizing regions. consequently, our study seeks to bridge this gap by employing a threshold regression approach to capture these nonlinear interactions and provide a more nuanced understanding of how financial openness moderates the impact of financial development on economic growth in three key urban agglomerations in china. 3. methodology 3.1. data source, study period and sample regions the study has compiled panel data for three urban agglomeration regions, namely the yangtze river delta, the pearl river delta, and jing-jin-ji, consisting of 10 provinces, municipalities, and special administrative regions, covering 1995–2021. the dataset is sourced from the china city statistical yearbook, china financial yearbook, provincial statistical yearbook, and hong kong and macao sar yearbook, as well as data provided by the china economic network and the national bureau of statistics. the choice of sample, study period, model, and variables is based on the availability of data, theoretical foundations, and existing literature. 3.2. model specification and variables the data is first checked through descriptive statistics to assess the normality of data, and then the coefficient of correlation is estimated to examine the association and multicollinearity between the variables. subsequently, the variance inflation factor (vif) is applied to further evaluate multicollinearity. additionally, unit root tests are conducted to determine the order of integration, along with the application of kao cointegration tests. later, the coefficients are estimated using the threshold regression model developed by hansen (1999). the models to be estimated is given in equation 1 to 3. 𝑃𝐺𝐷𝑃𝑖𝑡 = 𝛼0 + 𝛽1𝐹𝐷𝑖𝑡 + 𝛽2𝐺𝑜𝑣𝐸𝑥𝑝𝑖𝑡 + 𝛽3𝑇𝐸𝐼𝑖𝑡 + 𝛽4𝐸𝑅𝐻𝐸𝑖𝑡 + 𝛽5𝐼𝑅𝑖𝑡 + 𝛽6𝑙𝑛𝐹𝐴𝐼 + 𝜀𝑖𝑡 (1) where 𝑖 signifies various provinces or municipalities included in the data set, t represents the time-series dimension for each observation (𝑡 = 1,...,t), 𝐹𝑂𝑖𝑡is financial openness, 𝐺𝑂𝑉𝐸𝑋𝑃𝑖𝑡 is government expenditure, 𝑇𝐸𝐼𝑖𝑡 is total exports and imports, 𝐸𝑅𝐻𝐸𝑖𝑡 is the gross enrollment of higher education, fai𝑖𝑡 is fixed assets investment and 𝐼𝑅𝑖𝑡 is inflation rate. the term 𝛼0 represents a distinct fixed effect, while 𝜀𝑖𝑡 follows an independent and identical distribution with a mean of zero and variance σ². details of the variables, their notations and sources are given in table 1. to examine the non-linear connection between financial development and economic growth, and how financial openness influences this relationship, equation 2 is applied. this equation incorporates a squared term of financial development, multiplied by financial openness, together with control variables. if the square term of financial development multiplied by financial openness’s coefficient is significant, it means financial openness has a threshold effect, indicating that the impact of financial development on economic growth is not linear. 𝑃𝐺𝐷𝑃𝑖𝑡 = 𝛼0 + 𝛽1𝐹𝐷𝑖𝑡 2𝐹𝑂𝑖𝑡 + 𝛽2𝑙𝑛𝐺𝑜𝑣𝐸𝑥𝑝𝑖𝑡 + 𝛽3𝑙𝑛𝑇𝐸𝐼𝑖𝑡 + 𝛽4𝑙𝑛𝐸𝑅𝐻𝐸𝑖𝑡 + 𝛽5 𝑙𝑛𝐼𝑅𝑖𝑡 + 𝛽6𝑙𝑛𝐹𝐴𝐼 + 𝜀𝑖𝑡 (2) asian journal of economics and empirical research, 2025, 12(2): 104-112 108 © 2025 by the authors; licensee asian online journal publishing group considering fo as a threshold variable, the static threshold regression model with a single threshold adopted in this research is: 𝑃𝐺𝐷𝑃𝑖𝑡 = 𝛼0 + 𝛽1𝐹𝐷𝑖𝑡 ∙ 𝐼(𝐹𝑂𝑖𝑡 ≤ 𝛾) + 𝛽2𝐹𝐷𝑖𝑡 ∙ 𝐼(𝐹𝑂𝑖𝑡 > 𝛾) + 𝛽3𝐺𝑜𝑣𝐸𝑥𝑝𝑖𝑡 + 𝛽4𝑇𝐸𝐼𝑖𝑡 + 𝛽5𝐸𝑅𝐻𝐸𝑖𝑡 + 𝛽6𝐼𝑅𝑖𝑡 + 𝛽7𝑙𝑛𝐹𝐴𝐼𝜀𝑖𝑡 (3) by performing formulas (1) and (3), this study will assess the influence of financial development (fd) on economic growth through the moderation of financial openness across the three major urban regions of china. table 1. details of variables, notation and data source. variable notation description source financial development fd index developed through entropy evaluation by using lfin: the total loans in the financial system. sfm: securities fund management gp: gross premiums china city statistical yearbook financial openness fo proxy by foreign direct investment logarithmic transformed china financial yearbook economic growth pgdp per capita gdp provincial statistical yearbook government expenditure govexp logarithmic transformation of government expenditures china city statistical yearbook, the china financial yearbook, the provincial statistical yearbook trade volume tei sum of exports and imports logarithmic transformation china city statistical yearbook, the china financial yearbook, the provincial statistical yearbook human capital erhe enrollment ratio in higher education, logarithmic transformation china city statistical yearbook, the china financial yearbook, the provincial statistical yearbook inflation ir inflation rate logarithmic transformation china city statistical yearbook, the china financial yearbook, the provincial statistical yearbook physical capital fai fixed assets investment logarithmic transformation china city statistical yearbook, the china financial yearbook, the provincial statistical yearbook 3.3. conceptual framework the conceptual framework of the research is given in figure 1. it shows that the dependent variable is economic growth, while the main variable of interest is financial development. however, the threshold variable here is financial openness. the control variables include trade openness, government expenditures, inflation rate, fixed assets investment, and enrollment ratio in higher education. financial development is expected to have a nonlinear influence via financial openness on economic growth. the trade volume, government expenditures, fixed assets investment, and gross enrollment ratio are expected to have positive effects on economic growth. however, the inflation rate is expected to have negative impacts on economic growth. figure 1. conceptual framework. 3.4. hypothesis 1. financial development and economic growth have a nonlinear relationship. 2. financial openness moderates the intricate relationship between financial development and economic growth. 3. the impacts of financial development on economic growth vary at different levels of financial openness. 4. results discussion 4.1. descriptive statistics the table 2 presents descriptive statistics for eight variables across 270 observations, offering insights into their central tendencies and dispersion. the log of per capita gdp (lmgdp) has a mean of 8.777 and ranges from 5.935 to 11.888, showing a slightly left-skewed distribution (skew = –0.152) and a kurtosis of 2.221, indicating a relatively flat curve. financial openness (fo) averages 4.409, but with a standard deviation of 2.170 and values stretching from asian journal of economics and empirical research, 2025, 12(2): 104-112 109 © 2025 by the authors; licensee asian online journal publishing group –4.841 to 9.592, it displays pronounced variability and negative skewness (–0.705). the financial development index (e_fd) records a mean of 6.758 and is nearly symmetric (skew = –0.137), while the log of total exports and imports (lntei) used here as a proxy for trade openness averages 7.277 and ranges from 3.730 to 9.170, showing moderate left skewness (–0.607). government expenditure (lngovexp) and fixed asset investment (lnfai) both have relatively high means (14.582 and 16.734, respectively) and are slightly left-skewed, suggesting that most observations cluster on the higher end. the log of higher education enrollment (lnrhe) has a mean of 13.014 and a mild negative skew (–0.309), implying a fairly uniform distribution around the center. lastly, ir, with a mean of 4.693, exhibits right skewness (1.026), reflecting a few higher-end observations. overall, the variations in skewness, kurtosis, and percentile values indicate notable heterogeneity in the dataset, providing a crucial backdrop for subsequent analyses of how financial openness, financial development, and other factors interact to influence economic growth. table 2. descriptive statistics. variables obs. mean std. dev. min. max. p1 p99 skew. kurt. lnpgdp 270 8.777 1.287 5.935 11.388 6.047 11.335 -0.152 2.221 fo 270 4.409 2.177 -4.841 9.992 -3.817 9.983 -0.37 7.055 fd 270 0 0.917 -0.725 4.542 -.725 3.479 1.953 7.145 lntei 270 6.758 1.757 3.12 9.489 3.277 9.335 -0.296 1.89 lngovexp 270 5.28 1.53 1.995 7.947 2.023 7.827 -0.329 2.021 lnfai 270 6.361 1.577 1.855 9.149 1.995 9.042 -0.385 2.84 lnerhe 270 2.693 1.186 -2.303 5.537 -0.342 5.325 -.429 4.153 lnir 270 4.635 0.036 4.564 4.777 4.572 4.759 1.46 5.865 4.2. coefficient of correlation the correlation matrix in table 3 reveals several noteworthy patterns among the eight variables. first, the log of per capita gdp (lmgdp) shows moderate positive correlations with financial openness (fo), financial development (fd), trade openness (lntei), government expenditure (lngovexp), fixed asset investment (lnfai), and higher education enrollment (lnrhe). this suggests that regions with higher economic output tend to have stronger financial systems, more active trade, greater public spending, and higher investment in both fixed assets and human capital. notably, lmgdp is negatively correlated with ir, indicating that higher interest or inflation rates may coincide with lower economic performance. financial openness (fo) and trade openness (lntei) exhibit a particularly strong positive relationship, implying that economies more integrated into global financial markets also tend to engage more extensively in international trade. fd (financial development) correlates closely with lngovexp, suggesting that regions with more advanced financial systems often have higher levels of government spending. another strong positive association emerges between lnfai (fixed asset investment) and lnrhe (higher education enrollment), pointing to a link between investment in infrastructure or capital goods and investment in human capital. finally, ir has negative correlations with all other variables, notably lnrhe, which may indicate that higher interest or inflation rates are accompanied by lower enrollment in higher education and potentially other adverse economic conditions. overall, these correlations underscore the interconnectedness of economic growth, financial development, and socio-economic factors, laying the groundwork for more detailed causal or moderating analyses. table 3. matrix of correlations. variables (1) (2) (3) (4) (5) (6) (7) (8) (1) lnpgdp 1.000 (2) fo 0.379 1.000 (3) fd 0.410 0.380 1.000 (4) lntei 0.476 0.760 0.666 1.000 (5) lngovexp 0.360 0.622 0.769 0.828 1.000 (6) lnfai 0.131 0.521 0.687 0.702 0.939 1.000 (7) lnerhe -0.048 0.492 0.593 0.683 0.829 0.876 1.000 (8) lnir -0.257 -0.165 -0.156 -0.262 -0.192 -0.108 -0.122 1.000 4.3. variance inflation factor for multicollinearity the variance inflation factor (vif) values in table 4 all values fall well below the commonly used threshold of 10, indicating that multicollinearity is unlikely to pose a significant problem in the regression analysis. the highest vif is 2.14 (for lnrhe), while the mean vif is 1.54, both comfortably within acceptable ranges. in practical terms, these results suggest that none of the explanatory variables strongly overlap with each other, allowing the regression models to estimate their individual effects with reasonable precision. consequently, authors can be more confident that the estimated coefficients will not be unduly inflated or rendered unstable due to inter-correlations among the predictors. table 4. variance inflation factor. variable vif 1/vif lnerhe 2.14 0.468 e_fd 1.96 0.510 dlngovexp 1.6 0.626 dlnfai 1.47 0.679 fo 1.34 0.744 dlntei 1.15 0.869 lnir 1.14 0.879 mean vif 1.54 asian journal of economics and empirical research, 2025, 12(2): 104-112 110 © 2025 by the authors; licensee asian online journal publishing group 4.4. kao co integration test the kao test results in table 5 indicate that, overall, there is evidence of a long-run equilibrium relationship among the variables. under the null hypothesis of no cointegration, four of the five test variations reject this null at conventional significance levels. specifically, the modified dickey-fuller t-statistic (–2.0951, p = 0.0181), the dickeyfuller t-statistic (–1.6968, p = 0.0449), the unadjusted modified dickey-fuller t-statistic (–3.2180, p = 0.0006), and the unadjusted dickey-fuller t-statistic (–2.1808, p = 0.0146) are all statistically significant, suggesting that the variables move together in the long run. the augmented dickey-fuller t-statistic (–0.1235, p = 0.4508) is the only exception, as its p-value exceeds the usual 5% threshold and thus fails to reject the null of no cointegration. nonetheless, given that most test variations strongly support cointegration, the results imply a stable long-term linkage among the examined variables in the panel. table 5. kao cointegration test. test statistic p-value modified dickey-fuller t -2.1709 0.0150 dickey-fuller t -0.9685 0.1664 augmented dickey-fuller t 2.4085 0.0080 unadjusted modified dickey-fuller t -3.7192 0.0001 unadjusted dickey-fuller t -1.6342 0.0511 kernel: bartlett lags: 1.90(neway-west) number of panels 10 number of periods 24 4.5. existence of threshold the results in tables 6 and 7 confirm the presence of threshold effects for financial openness (fo) in moderating the relationship between financial development (fd) and economic growth. table 6 identifies two critical thresholds, approximately –0.4253 and 0.9574, indicating that the impact of fd on growth may shift when fo crosses these points. table 7 reinforces these findings by showing that both singleand double-threshold models yield significant f-statistics (135.80 and 49.16, respectively), each surpassing conventional critical values. this strongly rejects the null hypothesis of no threshold, suggesting that fd’s effect on economic growth differs across multiple regimes of financial openness. table 8 further illustrates the nature of these nonlinearities by incorporating the square term of fd alongside its interaction with fo. the positive and significant coefficient on the fd*fo term indicates that higher levels of financial openness amplify the influence of fd on economic growth once certain thresholds are reached. by contrast, some control variables such as government expenditure (dlngovexp) and trade openness (dlntei) show negative coefficients, suggesting potential inefficiencies or structural constraints when these factors increase. the inflation measure (lnir) has a positive coefficient, implying that moderate inflation may accompany economic expansion. overall, the three tables collectively demonstrate that the relationship between financial development and economic growth is neither purely linear nor uniform; instead, it depends on specific ranges of financial openness. these findings underscore the importance of calibrating financial liberalization strategies to the existing level of domestic financial development and broader economic conditions, thereby offering a more nuanced policy perspective on fostering sustainable growth. table 6. results of threshold existence. model threshold lower upper th-1 -0.4253 -0.4328 -0.4230 th-21 -0.4253 -0.4328 -0.4230 th-22 0.9574 0.8900 1.0078 table 7. results of the existence of the threshold. threshold rss mse f-stat prob. crit10 crit5 crit1 single 16.3530 0.0699 135.80 0.000 42.482 48.429 64.369 double 13.5138 0.0578 49.16 0.000 26.020 32.071 39.525 table 8. regression results of square term of fd with interaction term of fo. lnpgdp coef. st.err. t-value p-value [95% conf interval] sig. fd2fo 0.008 0.004 2.33 0.02 0.001 0.015 ** dlngovexp -1.826 0.452 -4.04 0 -2.712 -0.939 *** dlntei -1.041 0.262 -3.98 0 -1.554 -0.528 *** dlnfai -0.345 0.333 -1.04 0.3 -0.998 0.308 lnir 1.82 1.472 1.24 0.216 -1.064 4.705 lnerhe 0.769 0.056 13.65 0 0.658 0.879 *** constant -1.344 6.791 -0.20 0.843 -14.654 11.967 note: **, *** indicate the significance level at 5% and 1% respectively. 4.6 results of thresh hold regression table 9 presents the results of threshold regression. the threshold regression results reveal that the impact of financial development (fd) on economic growth (eg) varies significantly depending on the degree of financial openness (fo), with two critical thresholds identified at 0.4253 and 0.43720. in the first regime, where fo is below 0.4253, fd has a strong impact on eg. in the second regime, between 0.4253 and 0.43720, the effect of fd on eg diminishes, and in the third regime, where fo exceeds 0.43720, the impact of fd on eg increases again, although not reaching the magnitude seen in the most closed regime. these findings illustrate a non-monotonic relationship asian journal of economics and empirical research, 2025, 12(2): 104-112 111 © 2025 by the authors; licensee asian online journal publishing group that echoes previous research (e.g., (chinn & ito, 2006; hansen, 1999)) but also adds nuance by showing that the relationship is more complex than a simple linear complementarity between financial development and openness. turning to the control variables, our analysis indicates that all control variables have negative coefficients except for the inflation rate (lnir), which is positive. specifically, government expenditure (dlngovexp), trade openness (dlntei), and higher education enrollment (dlnrhe) are all negatively and statistically significantly associated with economic growth. this suggests that, within our sample, higher levels of public spending, international trade, and human capital investment are linked with lower economic performance possibly reflecting inefficiencies, structural distortions, or even overextension in these areas. fixed asset investment (dlnfai), however, is not statistically significant, implying that its role in influencing growth may be less clear or is overshadowed by the dynamics between fd and fo. these contrasting effects among the control variables diverge from some existing studies that typically report positive impacts of trade openness and human capital on growth (e.g., levine, 2005; king & levine, 1993). the unexpected negative signs in our findings could point to region-specific issues or transitional challenges in china's urban agglomerations that merit further investigation. meanwhile, the positive coefficient for inflation suggests that, under certain conditions, a moderate increase in inflation might be associated with increased economic activity a finding that aligns with literature indicating that, within certain limits, inflation can accompany periods of robust economic demand. overall, these results underscore the complexity of the finance-growth nexus. they highlight that the effectiveness of financial development in promoting growth is contingent on the level of financial openness and that the broader economic environment, as reflected in the behavior of control variables, plays a crucial role. this nuanced understanding calls for policymakers to consider these dynamics carefully when designing strategies aimed at leveraging financial reforms to stimulate sustainable economic growth. table 9. results of thresh hold regression. lnpgdp coefficient std.err. t p_value [95% conf. interval] dlngovexp -0.441 0.183 -2.41 0.017 -0.801 -0.081 dlntei -0.458 0.105 -4.37 0.000 -0.665 -0.252 dlnfai -0.040 0.128 -0.31 0.753 -0.293 0.213 lnir 1.101 0.575 1.91 0.057 -0.032 2.234 lnerhe 0.538 0.035 15.10 0.000 0.467 0.607 _cot#c.fo 𝐹𝐷(𝐹𝑂 ≤ 3.1046) 1.709 0.096 17.66 0.000 1.519 1.900 𝐹𝐷(3.1046 < 𝐹𝑂 ≤ 4.3720) 1.115 0.075 14.83 0.000 0.967 1.263 𝐹𝐷(𝐹𝑂 > 4.3720) 0.320 0.025 12.96 0.000 0.272 0.369 _cons 2.625 2.656 0.99 0.323 -2.602 7.859 sigma_u 1.562 sigma_e 0.224 rho 0.979 (fraction of variance due to u_i) f test that all u_i=0: f(9,243)=387.69 prob>f=0.0000 5. policy implications and conclusion based on these findings, several key policy implications emerge. first, the results highlight that the effectiveness of financial development (fd) on economic growth (eg) is not uniform but rather depends on the level of financial openness (fo). in relatively closed financial environments (fo below 0.4253), robust domestic financial development plays a critical role in driving growth. however, in regimes with moderate financial openness (between 0.4253 and 0.43720), the positive impact of fd on growth diminishes, suggesting that this intermediate stage may involve transitional challenges or inefficiencies. when fo exceeds 0.43720, fd’s impact on growth increases again, albeit not to the extent observed in more closed regimes. this non-monotonic pattern implies that policymakers should tailor financial liberalization strategies to the specific stage of financial openness. in particular, for regions at a moderate openness stage, complementary policies aimed at strengthening domestic financial institutions may be necessary to fully capture the benefits of global financial integration. furthermore, the significant negative coefficients for control variables such as government expenditure, trade openness, and higher education enrollment suggest that current levels or approaches in these areas might be generating inefficiencies or distortions in the economy. for instance, higher government spending could be crowding out private investment, while the negative impacts associated with trade openness and human capital investments may reflect structural or policy-driven issues that need to be addressed. in contrast, the positive effect of inflation within controlled limits indicates that moderate inflation may signal dynamic economic activity, though it must be managed carefully to avoid long-term adverse effects. in conclusion, this study underscores the importance of a nuanced, regime-specific approach to financial policy. the interplay between financial development and openness is complex and suggests that a one-size-fits-all strategy may be inadequate. policymakers should focus on enhancing domestic financial infrastructure, particularly in regions with moderate financial openness, to maximize growth benefits. simultaneously, reforms in public spending, trade, and education policies should be considered to rectify potential inefficiencies. overall, the evidence provided by this threshold regression analysis contributes to a more refined understanding of the finance-growth nexus, offering valuable guidance for designing sustainable and tailored economic policies in china's urban agglomerations. 6. research limitation and future direction despite the valuable insights offered by this study, several limitations should be acknowledged. first, our analysis is based on panel data from three major urban agglomerations in china over the period 1995–2021, which may limit the generalizability of the findings to other regions or time periods. the construction of the financial development index using the entropy evaluation method, although innovative, relies on available indicators and may not fully capture all dimensions of financial sector sophistication. additionally, while the threshold regression asian journal of economics and empirical research, 2025, 12(2): 104-112 112 © 2025 by the authors; licensee asian online journal publishing group approach effectively identifies nonlinearities in the relationship between financial development and economic growth under different levels of financial openness, potential endogeneity issues cannot be entirely ruled out despite our efforts to mitigate them. furthermore, the observed significant negative coefficients for control variables such as government expenditure, trade openness, and higher education enrollment suggest that other omitted macroeconomic or institutional factors might also influence economic growth, which our model does not fully address. future research should consider employing alternative methodologies such as instrumental variable techniques or dynamic panel data models to further control for endogeneity and validate these results. expanding the analysis to include additional regions, a broader time frame, or even comparative studies across different emerging and developed economies would also enhance the understanding of the interplay between financial openness, financial development, and economic growth. such extensions could provide a more comprehensive framework that refines policy recommendations and improves the external validity of the findings. references abiad, a., detragiache, e., & tressel, t. 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(2007). introductory econometrics: a modern approach (4th ed.). mason, oh, united states: south-western college publishing. wu, j. (2021). urban agglomerations in china: governance and growth. journal of urban economics, 88, 101–117. xie, f., & pan, j. (2018). the impact of financial openness on economic growth: evidence from china. journal of financial integration, 4(2), 133–154. zhang, y. (2022). regional innovation and economic growth in china’s urban agglomerations. economic development quarterly, 36(1), 45–60. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.1016/j.jfineco.2004.05.007 https://doi.org/10.1016/j.jdeveco.2005.05.010 https://doi.org/10.1016/s0304-4076(99)00025-1 https://doi.org/10.2307/2118406 https://doi.org/10.1086/450006 83 © 2024 by the author; licensee asian online journal publishing group asian journal of economics and empirical research vol. 11, no. 2, 83-91, 2024 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v11i2.6081 © 2024 by the author; licensee asian online journal publishing group external debt and economic growth: a study from the perspective of developing and emerging economies shehzada ghulam abbas cerge-ei, politickych veznu 7, 110 00 nove mesto, praha, czechia. email: shehzadaghulam.abbas@cerge-ei.cz abstract this study explores the relationship between economic growth and external debt for 24 highly indebted developing and 21 highly indebted emerging economies. this study uses data from 2010 to 2019 and a dynamic panel data model-generalize methods of moments (gmm) to investigate the relationship. the study found that external debt significantly and adversely impacts economic growth for the sample of 24 developing countries indicating external debt being one of the major determinants of economic growth for developing countries whereas it is negative but insignificant in the case of 21 emerging economies showing no impact of external debt on economic growth in the case of emerging economies. this study also found a significant and positive relationship between gross capital formation (gcf) and lag of gdp growth (gdpgr) and economic growth for both developing and emerging economies. inflation has no significant impact on economic growth in the case of developing countries whereas it has a significant and negative impact on economic growth for the sample of emerging economies. trade openness has no significant impact on economic growth for data samples. in addition, the long-run estimates show a negative relationship between external debt and gdp growth for both groups of countries. the results imply that targeted and efficient debt management and using traditional alternatives (i.e., tax revenue mobilization and domestic borrowing) should be prioritized for both countries. keywords: dynamic panel data, economic growth, external debt, gmm modeling, inflation, trade openness. jel classification: f34; o40; e02. citation | abbas, s. g. (2024). external debt and economic growth: a study from the perspective of developing and emerging economies. asian journal of economics and empirical research, 11(2), 83–91. 10.20448/ajeer.v11i2.6081 history: received: 16 august 2024 revised: 3 october 2024 accepted: 14 october 2024 published: 7 november 2024 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. data availability statement: shehzada ghulam abbas may provide study data upon reasonable request. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. contents 1. introduction ..................................................................................................................................................................... 84 2. empirical literature ........................................................................................................................................................ 84 3. data and data collection techniques ............................................................................................................................ 85 4. methodology .................................................................................................................................................................... 86 5. results and discussion .................................................................................................................................................... 88 6. conclusion ........................................................................................................................................................................ 89 7. policy recommendations ................................................................................................................................................ 90 references ............................................................................................................................................................................ 90 mailto:shehzadaghulam.abbas@cerge-ei.cz https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v11i2.6081 https://orcid.org/0000-0002-6806-4508 asian journal of economics and empirical research, 2024, 11(2): 83-91 84 © 2024 by the author; licensee asian online journal publishing group contribution of this paper to the literature this study explores the relationship between external debt and economic growth for 24 developing and 21 emerging economies. unlike previous studies, this study compares the impact of debt on economic growth between emerging and developing economies. moreover, it also explores the long-run relationship between the two variables for both groups of countries. 1. introduction debt-driven development has become commonplace in developing and emerging economies in recent decades (hilton, 2021). external debt1 financing is considered one of the main sources of finance for the current and developing spending of these countries. however, these countries' debt burden keeps increasing as a result of years of excessive borrowing. the increasing external debt corresponds to increase in debt servicing which further increases the debt burden on these economies (schclarek, 2005). since the late 1950s, it has become the norm for developing and emerging economies to run current account deficits and borrow to finance them. this borrowing is one of the main sources of income for these countries and helps cover the investment deficits they face (siddiqui & malik, 2001). there are two main reasons for the external borrowing. one of the main reasons for borrowing is to fill the investment gap in the economy (malik, hayat, & hayat, 2010). the lack of adequate savings in these economies creates a gap between investment and funds available making the economy dependent on funding from external sources. according to harrod-domer's model and solow's theory of growth, the savings rate is considered one of the most important determinants of capital accumulation and economic growth. the higher the savings rate, the higher the country's capacity for investment and capital accumulation (checherita-westphal & rother, 2011). another main reason is the deficit that these countries run. a gap emerges due to an inadequate amount of revenue (taxes) and a high number of expenditures. to close this gap (deficit), countries choose alternative financings such as domestic and external borrowing. the notion that deficits are not that bad for the economy comes from the argument that in theory increase in deficit can boost a slow-moving economy as more spending relates to a higher level of consumption and investment in the economy. this can create a positive spillover impact on economic growth. however, running long-term deficits and financing the deficits through external borrowing can result in detrimental impacts on economic growth and stability (van & sudhipongpracha, 2015). thus, external debt in one case fills the investment gap and the current account deficit. however, it is also proven to have a negative impact on economic growth and prosperity in these countries. the most recent example is pakistan where the inability to service its external debt put the economy on a negative trajectory and pushed it into a deep recession. a similar case is taking place in other countries such as egypt which is also facing a debt crisis and diving into a recession. these countries have the characteristic of having significant levels of both domestic and foreign debt. the debt servicing for these countries takes a major portion of the fiscal budget. this causes debt management issues in the economy which hinder the development spending in these countries thus negatively impacting the economic growth in these countries. 2. empirical literature this research on the effect of debt (domestic, foreign and sovereign) on economic development is substantial. some significant research has already been done by economists and experts worldwide. panizza and presbitero (2014) explored the causal relationship between debt and economic growth using an instrumental variable approach. they used the sample of organization for economic co-operation and development (oecd) countries. a highly significant and negative relationship was found between economic growth and debt in oecd countries (misiri, morina, & shabani, 2021). the impact of public debt on kosovo's economic growth from 2007-2019 uses time series vector auto-regressive analysis. they found that government debt had a positive impact on economic growth in the case of kosovo. they argued that kosovo's low public debt guarantees financial stability at the national level and that using that debt for large-scale capital investment led to positive economic growth (hilton, 2021). the present research shows a causal relationship between debt and economic development using time series data from 1978 to 2018. no significant causal relationship between debt and gdp growth in the short-run was founded using auto-regressive distributive lag(ardl) based granger causality for ghana. however, a one way granger causality leading from government debt to gdp in the long run in the case of ghana was found. hryhoriev (2020) in his study argued that dynamic balancing between long-term economic development and short-term financial stability is a problem for many countries. he explored the borrowing capacity of the national economy using the system dynamics methods. he argued that the resource curse should be overcome by increasing productivity and decreasing debt in countries that are highly dependent on external financing. the national economic debt system and the issues of the debt trap are the main findings of the study. the method used in the research emphasises the vital role that innovation plays in helping people to pay off debt. the study emphasizes higher innovation and technological advancement which can lead towards higher production and rapid industrial development. the study further emphasizes the possibility of national economic development and business cycle stabilization that could lead to the elimination of debt due to innovation and technological advancement. the concept of policy resistance implementation allows for the capture of the important interrelationships between national economic development and external borrowings. krykavskyi, mnykh, and binda (2021) found a significant deviation in the gdp growth rates and government debts for poland japan and ukraine. moreover, target long-term economic strategy and monetary policy in the crisis conditions also play an important role particularly in the eu countries and in ukraine. this study entails robust policy implementation and efficient debt management in countries like japan and some of the eu countries i.e., germany for the stability of the economy and sustainable economic growth. adesola (2009) focuses on nigeria in particular when analyzing the impact of external debt service payment 1external debt is a debt that is borrowed by a country, or entity from the foreign sources such as foreign banks, lending institutions (imf and world bank) or foreign governments. asian journal of economics and empirical research, 2024, 11(2): 83-91 85 © 2024 by the author; licensee asian online journal publishing group practices on long-term, sustainable economic growth and development. in his research, he makes several recommendations, one of which is that the government make sure that any loan arrangement with the london club or any other creditors will stimulate the private sector and open nigeria to increased trade and investment as the repayment of debt to these two creditors has a detrimental effect on economic growth. in addition, he makes the case that nigeria's excessive reliance on outside funding sources may eventually be harmful to the country's ability to maintain its economy. conversely, public debt has a positive impact on the nigerian economy because well-executed debt financing boosts growth and increases the economy's ability to service and pay down public debt in resource-constrained economies. aboudi and khanchaoui (2021) emphasize the importance of realizing that sustainable economic growth depends upon sustainable debt management. in his study, he seeks to empirically assess the effect of inflation and external debt on economic growth in morocco. he argues that use of external finance and debt properly for investment and development projects in the economy leads to higher growth and long-term sustainability of debt repayment in the case of morocco. siddiqui and malik (2001) discovered that the relationship between debt and economic growth in south asian nations such as pakistan, india, and sri lanka was positive and statistically significant. they discovered that there is a non-linear relationship between economic growth and all other indicators of debt burden using panel data analysis techniques. zouhaier and fatma (2014) examined the relationship between debt and economic expansion in nineteen developing nations. they discovered a substantial detrimental effect on economic growth using estimates from dynamic panel data, the ratio of total external debt to gdp and the ratio of total external debt to gross national income (gni). they also looked into how debt affected the connection between investment and economic growth, and they discovered that debt had a detrimental effect on it. they also came to the conclusion that debt and economic growth interact negatively. similarly, cristina checherita-westphal and rother (2012) examined the impact of government debt on per capita gdp growth in 12 eurozone countries. they concluded that debt accumulation above a certain debt threshold (about 90% of gdp) (beyond a tipping point) adversely affects long-term economic growth using data from 1970 to 2010. they also concluded that the adverse effects may have started at debt levels of 70-80% of gdp for these 12 eurozone countries. malik et al. (2010) investigated the effect of debt on growth using a time series analysis for pakistani data from 1972 to 2005. he discovered that debt significantly hindered economic growth. large debt accumulation impedes both private investment and economic growth. bidzo (2018) used gmm estimates to find a decelerating impact of public debt on economic growth with respect to the gabon economy. he found a scissor effect between gdp growth and debt in the gabon economy. lin and sosin (2001) in their study on a sample of 77 countries found that external debt has a statistically significant and negative relationship with economic growth in the case of african countries whereas the relationship is negative but not significant for latin american and developed countries. on the other hand, a non-significant but positive relationship was found for asian and other developing countries. a similar study was conducted by schclarek (2005) in developing countries. according to his findings, lowering external debt would boost developing nations' economies. however, rising debt is linked to slower rates of economic expansion. he contends that the capital accumulation channel is largely to blame for these beneficial effects. a positive economic bubble is produced and economic growth is positively impacted by increased investment in capital goods and infrastructure. the author additionally estimated four distinct dependent variables: personal savings rate, growth in capital accumulation, total factor productivity (tfp), and per capita gdp. nevertheless, the relationship between external debt and economic growth is a highly debated and researched topic. many studies favor external debt as a major determinant for positive economic growth in developing and emerging economies. on the other hand, many argue against it. however, a more thorough study on the subject matter is needed in the current economic era and such a study can prove to be a major policy input for sustainable debt management and sustainable growth from the perspective of developing and emerging economies. 3. data and data collection techniques 3.1. data collection methods this study uses secondary data sources. the data set includes information from 2009-2019. the world bank's world development indicators, the international monetary fund's database, and nation-specific annual reports provided the data used in this study. the impact of external debt on economic growth in developing and emerging economies will be investigated using the dynamic panel data model. the independent variables used in this study are trade openness (open i) as a percentage of exports, inflation rate (inf), gross capital formation (gcf) as a percentage of gdp (a proxy for investment) and external debt as a percentage of gdp (exgdp). the dependent variable in our model is gdp. 3.2. concept of variables this section focuses on the description of variables considered in our analysis. these variables were chosen in consideration of their relative theoretical and empirical significance. the selection of variables is comparable to that of other researchers i.e., mankiw, romer, and weil (1992), nguyen, bhattacharya, and clements (2004) and zouhaier and fatma (2014). 3.3. gross domestic product (gdp) the increase in the size of a nation’s economy determines its economic growth. output is a broad indicator of the size of an economy. the gross domestic product (gdp) is commonly used by economists to measure the economic output of a country. in our study, the gross domestic product serves as the dependent variable. we take the annual data of gdp growth in percentage terms for this study. 3.4. gross fixed capital formation (gfcf) gross fixed capital formation is the value of new and existing fixed assets acquired by households and governments in the context of economic activity. it is believed that fluctuations in these variables influence asian journal of economics and empirical research, 2024, 11(2): 83-91 86 © 2024 by the author; licensee asian online journal publishing group future business activities and the contours of economic development. according to the harrod-domar model, the income growth rate will be positively correlated with the saving ratio and the accumulation of capital. the greater a country’s ability is to save and invest a given portion of its total income, the higher would be its national income. gfcf is comprised of the following three primary components: gfcf in the private sector, gfcf in the public sector and gfcf in the government sector. private capital growth and economic growth are shown to possess positive and encouraging effects. there is widespread agreement that private investment improves economic performance because of technological change or technological advancement in recent years of capital. the question of whether public investment contributes positively or negatively to the economy is of utmost importance to economists. arrow and kruz (2011) and barro (1990) argue that public investment increases the output of the private sector which in turn stimulates economic expansion. public investment is crucial for determining long-term economic growth because it not only generates beneficial effects through offering education, basic research in science, health care, and physical assets, but it can also boost economic growth by attracting private investment in accordance with this view. thus, it becomes crucial to add this to our model so that its effect on gdp is assessed. this study used gross fixed capital formation (gfcf) as a percentage of gdp for the purpose of analysis and estimation of its impact on gdp. 3.5. inflation inflation is defined as the rate of increase in the general price level at a given period of time. inflation is considered one of the major determinants of economic growth. the relationship between economic growth and inflation has been an academic debate for a long time. many experts and researchers believe inflation to be a negative sign for economic growth (jung & marshall, 1986; özyılmaz, 2022). alternatively, many experts argue in favor of inflation being a positive indicator for higher economic growth (flix, 1961; sattarov, 2011; taylor, 1979). the main goals of monetary policy have been low inflation, substantial and sustainable growth over the years. thus, an optimal level of inflation is one of the major drivers of economic growth and sustainable development. for this study, the annual rate of inflation in percentage terms is used to measure the impact of inflation on economic growth. 3.6. external debt as percentage of gdp the most significant economic metric for evaluating the sustainability and health of a nation's finances is the ratio of external debt to gdp. this ratio shows the total amount of external debt owed by a nation relative to its gdp (gross domestic product). all of a nation's debts to foreign lenders, both public and private are categorized as external debt. 3.7. openness to trade trade openness or trade liberalization is considered one of the main factors of economic growth and development. according to the world bank trade openness is defined as the ratio of imports plus exports over gdp. it measures the extent of a country involved in global trade. a higher ratio corresponds to high openness and higher liberalization of trade. studies have shown that trade openness is a significant factor in economic growth and development (keho, 2017; ozturk & radouai, 2020). these studies argue that trade liberalization gives opportunities to the economies to increase the movement of goods across the world, increasing exports and impacting economic growth positively. lesser barriers in the world economy increase opportunities for knowledge and technology transfer resulting in higher innovation and better production. for our study, we developed the proxy of trade openness as the ratio of imports and exports to the gdp (ppp) at constant dollar following the study by brueckner and lederman (2015). the mathematical representation is given by: imports (m) + exports (x) trade openness (toi) = --------------------------------------- gdp (ppp) 4. methodology 4.1. theoretical underpinnings this study revolves around the following two primary theories: the solow-swan growth model and the dualgap theory. solow-swan growth is an exogenous growth model putting savings and capital at the center of economic growth. it maintains that higher savings lead to higher capital investment and higher investment in turn leads to higher growth. thus, savings and investment play a pivotal role in generating economic growth in the economy. similarly, according to the dual-gap theory (two-gap theory), a prominent theory on external debt theory argues that the dual gap between savings and investment and export revenues and imports are the constraining factors for generating economic growth in an economy. thus, to fulfil the two gaps’ economies rely on external borrowing (debt) or aid. in theory, this borrowing is essential to cover the lack of investment capital in the economy as well as generating economic growth. hassan, sule, and abu (2015) and angahar, ogwuche, and dotun (2015) have all conducted studies using the concept of dual-gap hypothesis. double gap analysis presents the paradigm that growth requires investment and that domestic savings are insufficient to sustain growth (sulaiman & azeez, 2012). it is necessary to resolve the monetary imbalance to achieve the desired economic growth rate. two interim analyzes build on this framework. suppose there is a country that enforces this. make prudent investments to attain your targeted savings rate and economic expansion. when domestic savings are insufficient to reach the desired growth rate, a gap between savings and investment arises. similarly, there is a foreign exchange gap between exports and imports when more imports are needed than can be exported in order to reach the targeted rate of growth. a currency gap is the total value difference between imports and asian journal of economics and empirical research, 2024, 11(2): 83-91 87 © 2024 by the author; licensee asian online journal publishing group exports (especially when imports exceed exports). therefore, devaluation modifies the disparity between the local and foreign currencies. conversely, the savings gap represents the discrepancy between the amount of money individuals save and the amount of money required for investment by the economy. this has a numerical expression such as: 𝑌 = 𝐶 + 𝐼 + (𝑋 − 𝑀) (1) 𝑌 = 𝐶 + 𝑆 (2) 𝑆 = 𝑌 − 𝐶 (3) hence 𝐶 + 𝐼 + 𝑋 = 𝐶 + 𝑆 + 𝑀 (4) 𝐼 – 𝑆 = 𝑀 – 𝑋 (5) a savings limit occurs when the difference in savings is greater than the difference in the exchange rate. there is a currency exchange limit if the exchange rate is greater than the difference in savings. as a result, foreign borrowing and aid must be mobilized to close the savings gap through capital inflows. 4.2. model specification as we know that in a closed economy, gdp(y) = consumption (c) + investment (i) + government spending (g) 𝑌 = 𝐶 + 𝐼 + 𝐺 𝑌 = 𝐶 + 𝑆 (6) [ 𝐼 = 𝑆, 𝐺 = 0)] let, gdp (y) of an open economy with exports (x) and imports (m) and government expenditure (g) equal to zero is 𝑌 = (𝑋 − 𝑀) + 𝐶 + 𝐼 (7) equating equations 6 and 7 𝑌 = 𝐶 + 𝑆 𝑌 = (𝑋 − 𝑀) + 𝐶 + 𝐼 𝐶 + 𝑆 = (𝑋 − 𝑀) + 𝐶 + 𝐼 𝐼 = 𝑆 – (𝑋 − 𝑀) 𝐼 = 𝑆 + (𝑀 − 𝑋) (8) equation 8 shows that the total domestic investment (i) will be equal to total domestic savings (s) and external borrowing (m-x). this equation in theory argues that in the case of insufficient domestic savings economies rely on external borrowing to finance domestic investment. a dynamic panel data regression model will be used to capture the relationship between dependent and independent variables as proposed by nguyen et al. (2004) and zouhaier and fatma (2014). moreover, a modified version of fosu's (1990) increased production function will be used as the statistical skeleton of this study. the general form of fosu’s increased production can be expressed as: 𝑌𝑖𝑡 = (𝐸𝑋𝐷𝑖𝑡, 𝐼𝑁𝐹𝑖𝑡, 𝐶𝑆𝑖𝑡, 𝐼𝑁𝑉𝑖𝑡) (9) lag of gdp growth ratio will also be incorporated in the model to capture the lag effects of external debt on gdp if any. the specified statistical model of estimation is given by 𝐺𝐷𝑃𝑖𝑡= 𝛼𝑖𝑡 + 𝛽1𝐸𝐷𝐺𝐷𝑃𝑖𝑡 + 𝛽2 𝐺𝐶𝐹𝑖𝑡 + 𝛽3 𝐼𝑁𝐹𝑖𝑡 + 𝛽4𝑂𝑝𝑒𝑛𝐼𝑖𝑡 + 𝛽5𝐺𝐷𝑃𝑖𝑡−1 + 𝚞𝑖𝑡 (10) where gdp = gross domestic product.  = constant. 1-5 = coefficients. t = time. i = country. edgdp = external debt to gdp. gcf = gross fixed capital formation. inf = inflation. open i = proxy for trade openness. 4.3. data type and sources this study explores the relationship between dependent and independent variables through a dynamic panel data regression model. data from 2010 to 2019 will be used to estimate the model. the overview of the data and the sources from which it was collected are shown in table 1. table 1. description and source of variables. variables descriptions measurement sources gdp gross domestic product annual percentage of change (%) wdi edgdp external debt to gdp ratio annual percentage debt to gdp (%) imf, wdi and central banks gcf gross fixed capital formation annual percentage of change (%) wdi inf inflation annual percentage change (%) wdi open i openness to trade estimated proxy ratio (%) imf and wdi 4.4. model estimation we estimated the system gmm model using the stata software and results for both data sets are reported in table 2 respectively. the robust estimation technique is being used because it is effective in addressing potential issues related to model misspecification, outliers and heteroscedasticity. the data is used from 2009 to 2019, for the system gmm short data set is desirable for the estimations. therefore, the data set is chosen from 2009 to 2019. another reason is that before 2009 (2007-2008), the financial crisis occurred and after 2019 the covid-19 pandemic started in 2020 and including these crises in the model was not feasible. this leads us to concise our data set after 2008 and before 2020. asian journal of economics and empirical research, 2024, 11(2): 83-91 88 © 2024 by the author; licensee asian online journal publishing group table 2. estimation results. developing economies emerging economies regressor coefficient robust se coefficient robust se gdpgrt-1 0.152** (0.031) 0.071 0.184* (0.100) 0.113 edgdp -0.478** (0.023) 0.021 -0.021 (0.146) 0.014 inf -0.253 (0.373) 0.283 -0.053** (0.052) 0.027 gcf 0.167** (0.034) 0.079 0.151** (0.014) 0.061 openi -0.232 (0.134) 0.155 1.867 (0.496) 2.743 constant 2.081 (0.177) 1.541 -0.361 (0.779) 1.286 ar (1) p value 0.000*** 0.027** ar (2) p value 0.833 0.336 hansen p value 0.862 0.123 sargan p value 0.216 0.92 num of obs. 261 189 note: *** represents significance at the 1% level, ** at the 5% level, and * at the 10% level respectively. (p-values are shown in the brackets) the hansen test and sargan test show the validity of our model and the validity of our instruments used for the estimation. tables 3 and 4 show the estimates for the non-linear combination of external to the gdp. table 3. non-linear combination of parameters for emerging economies. combinations coefficient std. err p-value _b[edgdp]/(1-_b[l.gdpgr]) -0.013 0.005 0.015** table 4. non-linear combination of parameters developing economies. combinations coefficient std. err p-value _b[edgdp]/(1-_b[l.gdpgr]) -0.056 0.015 0.000*** note: *** represents significance at the 1% level. 5. results and discussion the results show that external debt has a significant and negative impact on the economic growth of developing economies. the coefficient of -0.478666 shows that the external debt is highly impactful in the case of developing countries and shows an adverse impact on economic growth potentially after a certain threshold of debt to gdp ratios which is a question for further study. the potential negative impact of external debt on economic growth in developing countries can be attributed to several interrelated factors. first, high levels of external debt often lead to higher debt service obligations which divert a significant portion of a country's income into interest payments rather than into productive investment (aboudi & khanchaoui, 2021). secondly, this creates a debt surplus and limits fiscal space for essential government spending, including infrastructure development and social programs (cristina checherita-westphal & rother, 2012; hassan et al., 2015). reliance on foreign debt can increase economic vulnerability by exposing a country to external shocks such as interest rate fluctuations or changes in global economic conditions (adesola, 2009; siddiqui & malik, 2001; zouhaier & fatma, 2014). besides, if external debt is not used effectively to finance productive projects but is instead mismanaged or used for unproductive purposes, it can lead to a debt trap where the return on investment does not match the cost of servicing the debt. in addition, high external debt can increase a country's susceptibility to financial crises, undermine investor confidence and lead to capital outflows. collectively, these factors likely impact the economic growth of developing countries with excessive external debt negatively (burns, 2010; kasidi & said, 2013). the presence of a negative coefficient indicates that there is a debt overhang or that there has been an increased accumulation of debt that has negatively impacted economic growth (abdullahi, bakar, & hassan, 2016). thus, for developing countries reducing external borrowing could prove to be positive for the economic growth and development of these economies (schclarek, 2005). our study is consistent with the previous studies of malik et al. (2010), panizza and presbitero (2014), zouhaier and fatma (2014), cristina checherita-westphal and rother (2012), bidzo (2018), lin and sosin (2001) and schclarek (2005). the lag of gdp growth is also significant for the sample of developing countries with a positive coefficient of 0.1522694 at 5% level. this shows the dynamic impact of gdp growth. when a country has experienced robust gdp growth in the past, it tends to trigger several reinforcing factors that contribute to a sustainable economic life. investor confidence is strengthened leading to increased capital inflows and business investment (hilton, 2021). sustained economic growth stimulates economic activity, generating higher profits and increasing consumer confidence. during periods of economic growth, governments are supported by higher tax revenues allowing them to invest in major infrastructure projects, extending the virtuous cycle towards infrastructure development (arrow & kruz, 2011; bidzo, 2018). in addition, job creation and unemployment reduction will further contribute to a positive economic environment as they provide opportunities to participate in the economy through increased spending (bidzo, 2018; hilton, 2021). the significant and positive impact of gross fixed capital formation shows investment being one of the primary factors impacting economic growth. sustained economic growth coupled with political stability increases investors’ confidence in the economy leading to higher inflows of capital into the economy and impacting economic growth and economic development positively (anderson, 1990). moreover, public and private capital investment increases the overall capital investment in the economy through the circulation of money in the economy. this creates a note: ** at the 5% level. asian journal of economics and empirical research, 2024, 11(2): 83-91 89 © 2024 by the author; licensee asian online journal publishing group better employment opportunity and stimulates economic activity in the economy, positively impact the economic growth and development of the economy (abdullahi et al., 2016; anderson, 1990). inflation and trade openness are not significant in the sample of developing countries indicating no impact on economic growth for these countries. although an insignificant but negative coefficient of trade openness for developing countries suggests that trade openness has potential negative effects on the economic growth of developing countries. trade openness could have a positive impact on the economy if the country is producing and export competitive goods and services in the world market. most of these developing countries are characterized by little to no production of final goods and services which makes their involvement in world trade insignificant thus not contributing to the economic growth of these nations (ozturk & radouai, 2020). the results for the sample of emerging economies show external debt being insignificant but negative. the insignificance indicates that external debt has no impact on the economic growth of our sample of emerging economies. however, the negative coefficient shows the potential negative impact of external debt on the economic growth of emerging economies. this may indicate a "debt overhang" scenario where high external debt leads to significant debt service obligations and diverts resources from productive investment. furthermore, negative rates can indicate problems such as the misallocation of debt, weaknesses in economic policy or governance or the impact of broader global economic conditions on economic growth in emerging economies (burns, 2010; misiri et al., 2021; van & sudhipongpracha, 2015). a further analysis with a larger data set and different methodology would be ideal to analyze the relationship between the variables more efficiently. the positive and significant coefficient for lag of gdp growth and gross fixed capital formation shows that these variables have a positive relationship with gdp growth in the case of emerging economies. gcf plays an important role in stimulating the economy. higher gcf results in higher capital accumulation which leads to higher levels of economic activity and growth in the emerging economies (nguyen et al., 2004; solow & swan, 1956). the strong coefficient of gcf also indicates that investment in the economy is highly productive and generates a considerable amount of economic activity in the economy. the positive coefficient of gcf reflects investments in these countries in critical assets including machinery, infrastructure and technology that contribute to higher performance and productivity. the process of capital formation leads to job creation, reduction of unemployment and stimulation of consumer spending which is crucial for sustainable economic growth. gcf also stimulates technological progress and innovation, improves efficiency and promotes long-term economic growth (arrow & kruz, 2011; hunt, 2007; nguyen et al., 2004). the positive and significant coefficient of lag of gdp growth indicates the impact of gdp growth. this shows that higher and sustained economic growth in the past is likely to impact future growth favorably in the case of emerging economies. emerging economies are mostly characterized by high market chest, stable politics and other incentives in the form of tax cuts and subsidies that ensure sustained economic growth in these economies which increases the security and credibility of the economy and impacts longterm economic growth positively (bidzo, 2018; zouhaier & fatma, 2014). the negative and significant coefficient of inflation shows that inflation is detrimental for economic growth in the case of emerging economies. reduced purchasing power due to rising prices reduces consumer spending, a key driver of economic growth. the uncertainty associated with high inflation will make planning and investment decisions difficult for businesses and may hinder expansion (aboudi & khanchaoui, 2021; özyılmaz, 2022). on the other hand, central banks can raise interest rates in response to inflation, raising borrowing costs and reducing investment. distorted price signals can distort resource allocation and hinder market efficiency. declining real incomes of people on fixed incomes, common in developing countries add to the social and political pressures. this impacts the economic growth adversely in the longrun (özyılmaz, 2022). the non-significance of trade openness shows that openness in trade does not impact economic growth in emerging economies. a positive coefficient shows that for emerging economies trade openness can play an important factor in achieving higher economic growth. higher trade openness leads to higher mobility of goods. this provides an opportunity for these emerging economies to compete with their goods and services in the world market. as a result, exports increase and impact economic growth positively and paving the way for long-term sustainable economic growth in these emerging economies (keho, 2017; ozturk & radouai, 2020). 5.1. long-run estimates tables 2 and 3 show the long-run relationship between external debt and gdp growth for emerging and developing economies respectively. the results for emerging economies indicate that the relationship between external debt and economic growth is statistically significant. however, the small coefficient of -010137477 indicates that this relationship is weak in contrast to the non-significant short-run estimates for developing countries. this shows that for emerging economies, external debt has a potential negative impact on economic growth in the long-run implying external debt as a probable negative long-run determinant of economic growth in the case of emerging economies, a more in-depth study is recommended to get a more robust result. on the other hand, for developing countries, the long-run relationship is also highly statistically significant with a comparatively high negative coefficient implying a potential negative long-run relationship between external debt and economic growth for developing countries. this shows that external debt is a long-run determinant of economic growth and potentially impacts gdp growth adversely in the long-run for developing countries. this is consistent with short-run estimates done previously indicating external debt being a major determinant of economic growth in developing countries both in the shortand long-run. however, a threshold analysis might result in a better analysis of the relationship, for more robust results a more in-depth study is advisable. 6. conclusion in this research, the effects of external debt on economic growth were examined for 24 developing and 21 emerging economies. it used the dynamic panel data gmm model to analyze the data from 2010 to 2019 across various cross-sections. the results suggest that foreign debt may be adverse to economic growth in developing countries and that larger levels of external debt are likely to have a long-term negative impact on economic growth in these conditions. there is a negligible relationship between external debt and economic growth in emerging economies as evidenced by the negative but insignificant effect that debt has on growth. nonetheless, long-term asian journal of economics and empirical research, 2024, 11(2): 83-91 90 © 2024 by the author; licensee asian online journal publishing group estimates indicate a likely negative long-run relationship between debt and economic growth, with a weak but significant and negative relationship found between external debt and growth. external debt can have a positive or negative impact on economic development depending on how countries and governments manage it to develop productive infrastructure and prevent the wastage of human capital. the complexity of the developing and emerging economies’ development problems, the severity of their potential and the extent of their need to finance development make it impossible for domestic resources to cover these countries' budget deficits. it is appropriate to use additional sources of financing for the economies in addition to budgetary resources and national reserves. most developing countries worldwide rely on external debt to finance their development but this debt remains the biggest obstacle to economic growth and development today. the growing reliance on external borrowing not only hinders economic growth by increasing the burden on the economy through enormous debt obligations and debt servicing to foreign lender but also deteriorates the long-term prospects of economic growth by shrinking available resources for future investment and development in the economy. this puts external debt as one of the negative factors that creates a negative externality in the economy and impedes the development of the economy. thus, robust policy making and better debt management is the need of the time. the following policy recommendations can prove to be pivotal in better debt management and the long-term economic growth associated with it based on the current standings and our analysis. 7. policy recommendations 7.1. developing economies • for a better management of debt, developing countries must follow a balance between domestic borrowing, as external debt has a highly significant and negative impact on the economic growth of developing countries; thus, a greater reliance on domestic debt and less reliance on external debt would be a major factor in steady long-term economic growth in these economies (burns, 2010). • structural reforms are vital for developing countries to sustain long-term economic growth. most of these economies suffer from a large portion of the underground economy which excludes a large section of the economy from the tax net. a targeted policy would help increase the tax revenue in the economy and thus lessen the overreliance on external or domestic borrowings. • a better fiscal management is necessary. developing countries must develop a mechanism to curb the over burden of external debt on the economy. spending tax money on profitable investment rather than debt servicing would ensure sustainable growth in the economy. • investor confidence both for domestic investors and foreign investors should be ensured by credible and stable policies coupled with political stability in the economy. developing countries suffer from low political stability, high insecurity and low credibility. thus, investor confidence can be boosted which in turn will be beneficial for steady economic growth by ensuring stable regimes and policies. 7.2. emerging economies • for emerging economies, the first and foremost policy should be based on incentives to domestic as well as foreign investors through subsidies, tax cuts, and less official procedures. this would bolster investor confidence and incentivize them to invest in the economy which will be beneficial for sustainable long-run economic growth. • targeted fiscal policies on inflation are necessary for emerging economies. as inflation has potential negative impacts on economic growth, targeted fiscal and monetary policies would ensure inflation remains low and sustainable. • although insignificant, the external debt has a potential negative effect on economic growth and a weak but negative impact in the long-run. thus, debt management policies are advised for emerging economies and the used of other alternatives such as domestic borrowing and increasing tax revenue is recommended. references abdullahi, m. m., bakar, n. a. b. a., & hassan, s. b. 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(2014). debt and economic growth. international journal of economics and financial issues, 4(2), 440-448. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.1108/09555340710760116 https://doi.org/10.2307/1992206 https://doi.org/10.1080/23322039.2017.1332820 https://doi.org/10.26650/jepr1132170 https://swopec.hhs.se/lunewp/abs/lunewp2005_034.htm https://doi.org/10.1080/00927678.2015.1048629 149 © 2024 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 11, no. 2, 149-158, 2024 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v11i2.6390 © 2024 by the authors; licensee asian online journal publishing group the impact of natural resource rents on environmental degradation in case of usa: the role of technological innovation and renewable energy consumption sarah sarosh1 chang mei yen2 ( corresponding author) 1,2university of wisconsin-stevens point, usa. email: changmy@uwsp.edu abstract this study explores the impact of natural resource rents on co2 emissions in the presence of renewable energy consumption, technological innovation, and gross domestic product (gdp) in the case of the usa from 1990 to 2020. for sustainable development policies and to slow down environmental degradation, it is important to understand the intricate connection between resource rents and carbon emissions in the us. thus, this study hypothesizes that after controlling for renewable energy consumption, technological innovation, and gdp, among other variables, resource rents significantly contribute to carbon dioxide emissions in america. this study adds significantly to the existing literature on how resource rents affect co2 emissions in the united states. this study employs quantile regression estimation techniques, which provide vital policy insights and academic contributions that are relevant to sustainable development and environmental conservation from both national and global perspectives. the results show that natural resource rents (nnrs) and gdp are positively associated with co2 emissions at all quantiles. moreover, the results indicate that technological innovation and renewable energy consumption are important in curbing co2 emissions. keywords: co2, gross domestic product, natural resource rents, renewable energy consumption, technological innovation. citation | sarosh, s., & yen, c. m. (2024). the impact of natural resource rents on environmental degradation in case of usa: the role of technological innovation and renewable energy consumption. asian journal of economics and empirical research, 11(2), 149–158. 10.20448/ajeer.v11i2.6390 history: received: 28 october 2024 revised: 18 december 2024 accepted: 27 december 2024 published: 31 december 2024 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. competing interests: the authors declare that they have no competing interests. authors’ contributions: both authors contributed equally to the conception and design of the study. both authors have read and agreed to the published version of the manuscript. contents 1. introduction .................................................................................................................................................................................... 150 2. literature review .......................................................................................................................................................................... 151 3. methodology ................................................................................................................................................................................... 153 4. results and discussions ................................................................................................................................................................ 154 5. conclusions and policy recommendations .............................................................................................................................. 156 references ............................................................................................................................................................................................ 157 mailto:changmy@uwsp.edu https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v11i2.6390 asian journal of economics and empirical research, 2024, 11(2): 149-158 150 © 2024 by the authors; licensee asian online journal publishing group contribution of this paper to the literature the study adds significantly to the literature on how resource rents affect co2 emissions in the united states. previous studies on resource rents and environmental degradation in the case of the united states have not focused on renewable energy and technological innovation. 1. introduction the total natural resources rent-co2 emissions relationship is about the connection between a nation’s revenue gained from natural resources and the carbon dioxide produced. this is a multifaceted process closely linked to factors like economic growth, ecological policies, and legal systems. natural resources rent is a theoretical concept representing the economic benefit gained through the utilization of resources like oil, natural gas, and coal, as well as oil-producing minerals and forests. these rents can make up the largest portion of the revenue of resource-rich countries, sparking concerns about the environmental impact on other nations. the extraction of these resources is one of the leading reasons for co2 emissions. greenhouse gases, as the primary factor responsible for climate change, present unprecedented risks to human development and survival, such as the extinction of animal and plant species, famines, and extreme weather conditions (rjoub, adebayo, awosusi, panait, & popescu, 2021). all the countries whose economies heavily rely on fossil fuels have the highest amounts of co2 emissions, as the processes of extraction, distillation, and usage cause a significant amount of co2 emissions. the countries with high extraction rates of oil, natural gas, and coal are the top offenders, as these three resources are some of the most co2intensive productions. additionally, the extraction of forestry resources, such as timber, is also a factor, as it results in the detrimental effects of deforestation, reducing carbon sinks. a growing economy based on natural resources is being stimulated by various industrial sectors, increasing the consumption of energy, which also causes greater demand for fossil fuels. this is particularly visible in the expanding economies of natural resources, where industries and transportation infrastructures related to heavy industry are growing. in environmentally governed countries, it was easier to untangle the natural resource rent measure from the emission of co2 (khaddage-soboh, safi, rasheed, & hasnaoui, 2023). the findings can respond to the fact that such measures can unlock codes of practice that can yield lower environmental pollution, such as well-managed resource handling, sustainable practices of extraction, renewed investments, and sustainable measures to prevent deforestation. the total natural resources rent measure can, however, impact co2 emissions, but with varying effects between countries. these differences are attributed to the type of resource harvested and the country’s economic structures and policy architectures. for instance, countries with higher primary products like oil and coal can have higher co2 emissions than countries processing energy from hydropower. additionally, diversified economies may have a lower reliance on natural resource exploitation, thus lowering co2 emissions. climate change and escalating global warming necessitate the formulation and implementation of fiscal measures to mitigate their adverse effects (chen, mirza, huang, & umar, 2022). this implies that nations with strong environmental regulations may have decoupled most of their resource rent measures from co2 emissions. various strategies can be employed to mitigate the environmental impact of natural resource rent. promoting renewable utilization is essential to reduce the reliance on fossil fuels. similarly, ensuring sustainable measures in extraction and forest management can minimize the environmental impact. finally, strong environmental regulations can ensure compliance and encourage green measures while investing in green technology. a good example of green technology is the technology that captures co2 from the atmosphere for its utilization, or renewable energy infrastructure, which can pave the way for low-emission activities. generally, such measures can reduce the environmental burden of resource exploitation, moving progressively towards sustainability. the extraction activities of materials are among the chief revenue generators in several u.s. states with substantial natural resource reserves (schulz, 2017). however, the financial-related benefits raise issues regarding the suitability of the release of the products generated in the atmosphere, as they disrupt the environment. production activities of the resources generate a significant percentage of co2 emissions in the u.s. the american economy has historically relied on fossil fuels for domestic consumption and foreign sales (adebayo, oladipupo, adeshola, & rjoub, 2022; polack, wood, & smith, 2010). as a result, the country has a huge carbon footprint. oil, natural gas, and coal are notorious pollutants. forest extraction through logging results in a reduction of carbon-absorbing capacity and an increase in the amount of co2 in the atmosphere simultaneously. economic growth is directly related to the increased amount of co2 emissions. as the american economy expands, energy demand also increases as the nation remains dependent on fossil fuels. the role of environmental regulations is essential in mediating the relationship between total natural resource rents and co2 emissions in the u.s. (awosusi et al., 2022; khaddage-soboh et al., 2023). nevertheless, the efficiency of environmental oversight in the states varies, which may lead to both mitigation and exacerbation of the impact. in general, states with stronger environmental policies and a larger body of experience in sustainability tend to decouple resource rents from co2 emissions, such as reducing the total amount of rent and incorporating practices that contribute to environmental friendliness. for example, some of the most effective strategies for reducing the impact of emissions related to resource rent are cutting-edge resource management practices, sustainable methods of extraction, and the generation of renewable energy. furthermore, these states also employ other strategies to keep the total amount of forest the same or increase it; this means that responsible logging and deforestation are in their past. on the other hand, many aspects determine the intensity of the link between total natural resources rent and co2 emissions in agboola, bekun, and joshua (2021). first of all, one should consider the type of natural resources that a state produces. the highest levels of emissions are in the states that are dependent on oil and coal, while the lowest are in the states producing energy with the help of hydropower. this might not only depend on the type of resources but also on the role of natural resources extraction in a certain type of economy: if the economic activity is only a part of the economy and the specialization is high, we observe much less decoupling than in the type of countries where the specialization is flexible. the last factor to consider is environmental regulations. to reduce emissions, environmental standards need to be tightened. ways of decoupling total environmental impact from co2 asian journal of economics and empirical research, 2024, 11(2): 149-158 151 © 2024 by the authors; licensee asian online journal publishing group emissions in relation to total natural resources rent in the us include investing in renewable energy, resource sustainability, sustainable forest management, and rigorous environmental policies. as the world grapples with promoting green, sustainable growth to curb anthropogenic climate change, the consumption of renewable energy (rec) is a much better way to replace fossil fuel utilization. this issue presents a key challenge for policymakers, energy researchers, and industry players regarding ways to reduce co2 emissions by using renewable energy (owusu & asumadu-sarkodie, 2016). renewable energy use as a means of reducing carbon dioxide emissions is now at an important crossroads between policy and energy transition. the potential for renewable energy to result in lower co2 emissions arises because most types of renewable energy (re) can substitute fossil fuel combustion in three major consuming sectors: power generation, transportation, and manufacturing (hu, sinha, tan, shah, & abbas, 2022). understanding this relationship is crucial for shaping effective policies to decarbonize global energy consumption. when it comes to tackling the many challenges of environmental sustainability and climate action, technological innovation is likely to remain one of the most important tools for reducing carbon dioxide (co2) emissions (raihan, begum, said, & pereira, 2022). in the face of overwhelming preoccupation with climate change, innovation – or, more specifically, the ability of new technologies to decrease emissions in every corner of our society – has emerged as a topic of great interest to academics, policymakers, and industrial decision-makers. indeed, there is a widespread belief that new technologies will enable society to dramatically reduce co2 emissions and support the transition to a more sustainable future. this is particularly true in the energy, transport, industry, and consumption sectors. for sustainable development policies and to slow down environmental degradation, it is important to understand the intricate connection between resource rents and carbon emissions in the u.s. thus, this study hypothesizes that after controlling for renewable energy consumption, technological innovation, and gdp, among other variables, resource rents significantly contribute to carbon dioxide emissions in america. this study explores the impact of natural resource rents on co2 emissions in the presence of renewable energy consumption, technological innovation, and gdp in the case of the usa over the period from 1990 to 2020. the rationale behind selecting this sample size for the current study can be supported by several factors: a three-decade span provides a wide range of data for a strong statistical study. it is efficient in extracting long-term patterns and fluctuations, which are important for understanding the association among natural resource rents, co2 emissions, renewable energy consumption, technological innovation, and gdp. this timeframe includes major american environmental policy changes regarding energy use as well as technological progress; such policies include the climate action plans for cleaner air enacted through the clean air act amendments (oren, 1991), among others, like incentives for clean power generated from sustainable sources. the researchers chose the 30-year period to account for rapid advancements made technologically alongside the shift towards renewable energy. in energy efficiency alone, there were many significant breakthroughs during the 1990s and beyond, mainly related to power conservation methods and other alternative sources such as wind turbine generators and solar panels. the study adds significantly to the literature on how resource rents affect co2 emissions in the united states. previous studies on resource rents and environmental degradation in the united states have not focused on renewable energy and technological innovation. therefore, the current study contributes to the existing literature by investigating the relationship between co2 and resource rents while controlling for the effects of renewable energy and technological innovation. this study employs advanced estimation methods such as movement quantile regression (mmqr) and bootstrap quantile regression (bsqr) estimation techniques, which provide vital policy insights and academic contributions that are relevant for sustainable development and environmental conservation from both national and global perspectives. identifying risks associated with resource extraction by assessing the environmental consequences of extracting resources from the natural environment will help promote responsible resource use that may facilitate a more sustainable economy. the impact is not only confined to academia or policymaking but also affects other key players like industry leaders, environmental advocates, and even the general public. decoupling environmental destruction from economic growth, as mandated by sustainable development goals, demands an understanding of how resource rents translate into co2 emissions. if we truly want to make a difference within our borders and internationally, then it is high time we addressed the relationship between resource rents and co2 emissions. given its status as one of the world’s biggest carbon dioxide emitters, the government of the united states has significant implications when it comes to global climate change patterns. these findings directly relate to policies that enable sustainable development and address environmental degradation in america. by clearly stating how much resource rents contribute to carbon dioxide emissions, policymakers will have more focused interventions and regulations that encourage cleaner energy sources, stimulate efficient use of resources, or raise energy prices without hampering economic growth. the rest of the manuscript is organized as follows: the next section provides a detailed overview of previous literature. section 3 presents the model, data, and econometric tests. section 4 provides the results and discussions. the last section presents the conclusions of the study. 2. literature review insights on the relationship between environmental sustainability and resource rents can be derived from literature on the effects of natural resource rents on co2 emissions. in this context, to explore the relationship between co2 emissions and resource rent, bekun, alola, and sarkodie (2019) confirm that there is a positive significant relationship between the nation's natural resources rent and co2 emissions in the long run. thus, the dependency on natural resources rent poses a threat to the environmental sustainability of the panel countries if the conservation and management options are not considered. the study by nwani, bekun, gyamfi, effiong, and alola (2023) on sustainable natural resource use and the impact of natural resource rents on carbon emissions found that 0.022 percent and 0.035 percent in territorial and consumption-oriented production inventories, respectively, of the overall carbon emissions of resources are driven by economic dependence on natural resource rents. the study substantiates that the environmental impact of nrrs is more intense if co2 emissions are corrected for trade across the countries. ultimately, the study motivates that policies need to be introduced in order to keep natural resources within sustainable limits. asian journal of economics and empirical research, 2024, 11(2): 149-158 152 © 2024 by the authors; licensee asian online journal publishing group mahmood and saqib (2022) studied the entire group of economies belonging to the oil-producing and exporting cartel (opec). they found that focusing on economic activities alone, whenever performing an emissions analysis, largely ignores the true role of oil rents. the basic idea is that the higher the oil rents, the more co2 emissions will be boosted in libya, kuwait, iraq, iran, equatorial guinea, congo, and saudi arabia. conversely, there is a larger negative effect of oil rents on co2 emissions in the united arab emirates, nigeria, and algeria. the analysis of the link between rents from natural resources and emissions was conducted by ulucak and ozcan (2020) for organisation for economic co-operation and development (oecd) countries using augmented mean group (amg) estimators, which showed that natural resource rents degrade the environment. shen et al. (2021) found in their provincial panel analysis for china during 1995–2017 that there is a positive relationship between natural resource rents and environmental degradation. tufail, song, adebayo, kirikkaleli, and khan (2021) discovered in their study on developed countries, using data spanning from 1990 to 2018, that there is an adverse effect of natural resource rents on the environment. according to tauseef hassan, xia, and lee (2021), in the case of pakistan, natural resource rents have caused environmental degradation. awosusi et al. (2022) conducted a study to examine how rents from contributions of natural resources affect the sustainability of the environment in colombia. the authors found that natural resource rents significantly contribute to escalating co2 emissions. wang, vo, shahbaz, and ak (2020) examined the relationship between natural resource rents and environmental degradation and argued that natural resource rents cause pollution in g7 countries. however, baloch, mahmood, and zhang (2019) reported mixed results regarding the impact of natural resource rents on emissions in brazil, russia, india, china, and south africa (brics) countries. on the other hand, khan, hou, and le (2021), using cross-sectional autoregressive distributed lag (cs-ardl), found the opposite of this finding and concluded that natural resource rents reduce environmental pollution. ganda (2022), however, showed a positive significant relationship between natural resource rents and environmental degradation in brics economies. contrarily, shittu, adedoyin, shah, and musibau (2021), in their study on 45 asian resourcerich economies, found a negative relationship between natural resource rents and environmental quality. many studies have been conducted on renewable energy consumption and its relationship to co2 emissions. jebli and youssef (2015) discovered that non-renewable energy consumption increases carbon dioxide, while there is a decrease in co2 emissions due to renewable energy consumption. likewise, the study by szetela, majewska, jamroz, djalilov, and salahodjaev (2022) reveals that an increase in renewable power usage leads to reduced co2 emissions per capita. the coefficient of renewable energy was negative and statistically significant, indicating that co2 can be mitigated through an increase in its use for those nations dependent on oil or gas resources. gnangoin, kassi, edjoukou, kongrong, and yuqing (2022) highlighted that renewable energy consumption, along with human capital, can act as complementary factors in reducing co2 emissions. the results of feasible generalized least squares (fgls) show that renewable energy consumption abates co2 emissions. on the other hand, dong, dong, and jiang (2020) presented mixed results regarding the impact of renewable energy consumption on co2 emissions across different income levels, suggesting varying effects based on the economic context. changes in renewable energy consumption adversely affect co2 emissions, but this effect is statistically insignificant; increased non-renewable energy consumption and economic growth may have obscured the mitigation effect. the study by nguyen and le (2022) showed that renewable energy consumption rec negatively affects co2 emissions, indicating a potential for environmental benefits. farhani and shahbaz (2014) noted that while renewable energy consumption rec might help reduce co2 emissions, its contribution to mitigating co2 emissions was not significant. another factor that has been established to have a significant influence on co2 emissions is technological innovation. several studies have often linked technological innovations to decreased carbon emissions. leading studies have considered a seemingly extensive sector coverage, from energy to environmental technologies. in this case, it has been established that innovations facilitate cleaner production processes, increased energy efficiency, and the use of renewable energy, positively affecting co2 mitigation (wang & zhang, 2021). furthermore, the spread of a positive trend in different regions has been noted, such as china, india, and the remaining asian geopolitical cluster. the results of this study indicated that new technological investments and adoption might help countries meet their sustainable development goals through simultaneous economic growth and a reduction in carbon footprints (raihan & tuspekova, 2023; su et al., 2021). moreover, exporting technology and renewable energy innovation were also identified as critical indicators of environmental sustainability and a decrease in co2 emissions (zhang, 2023). several other studies highlighted that innovation in technology generally results in a decrease in carbon emissions. however, some variability can always be found, considering how innovative the technology is and what the examined sector represents (cheng, meng, & xing, 2022; dou, zhao, & dong, 2021). furthermore, previous studies reveal that gross domestic product has a significant influence on carbon dioxide emissions. for many years, the relationship between gdp and co2 emissions has been the focus of researchers’ attention due to its importance for sustainable development (jalil & mahmud, 2009). a quadratic relationship between income and co2 emissions has been established during the sample period, which is consistent with the environmental kuznets curve (ekc). the granger causality test results show that one-way causality runs from economic growth to co2 emissions. similarly, the most appropriate results of this study confirm that income and energy usage are the main determinants of carbon emissions in the long run. although this is ascertained as fact in a study on the gulf cooperation council by salahuddin, gow, and ozturk (2015), the results of their study have proposed a positive association between energy usage, gdp, and co2 emissions. xu, rogers, and estrada (2023) have shown that gdp directly influences co2 emissions since rising gdp leads to greater carbon dioxide emissions. furthermore, some studies such as wang, yang, li, and wang (2023) and song, heng-chuang, and dong-mei (2021) have examined the connection between economic growth and co2 emissions and identified a positive link between gdp and carbon dioxide. furthermore, studies conducted by li, wang, and zhan (2021) revealed that there is bi-directional causality between co2 emissions and gdp, implying that whenever gross domestic product improves, carbon dioxide also rises, which calls for sustainable development policies to address the environmental impacts of economic growth. co2 emissions are said to be caused by environmental degradation in the course of resource extraction. this understanding is partial because it does not adequately consider the use of renewable energy and technological asian journal of economics and empirical research, 2024, 11(2): 149-158 153 © 2024 by the authors; licensee asian online journal publishing group advancements. previous studies, such as bekun et al. (2019) and nwani et al. (2023), confirmed that there exists an association between natural resource rents and co2 emissions, whereby reliance on resource extraction poses environmental threats. mahmood and saqib (2022) as well as ulucak and ozcan (2020), also found through their studies that in different settings, such as opec or oecd countries, these rents have negative effects on the environment. however, these studies did not take into account possible changes brought about by the adoption of renewable energies or technological progress. consequently, the current study examines the impact of resource rents on co2 emissions in the context of renewable energy use and technological innovation. in order to provide detailed policy recommendations related to sustainable development worldwide, this paper also uses advanced estimation techniques like mmqr (movement quantile regression) and bsqr (bootstrap quantile regression). 3. methodology 3.1. model specification there are many reasons why it is important to understand how natural resource rents and co2 emissions are related in the united states. perhaps most importantly, the us is one of many countries around the globe that produce and consume huge amounts of such resources, making this subject matter worthy of investigation. to strengthen the conclusions, this paper uses advanced estimation methods like mmqr or bsqr because they provide robustness and reliability through findings that can be used for more detailed policy suggestions aimed at sustainable management practices not only in america but also worldwide. the empirical model is provided as: 𝐶𝑂2𝑡 = λ0 + λ1𝑁𝑅𝑅𝑡+λ2𝐺𝐷𝑃𝑡+λ3𝑇𝐼𝑡 + λ4𝑅𝐸𝐶𝑡 + µ𝑡 (1) where co2 refers to carbon dioxide emissions, nrr denotes total natural resources rent, rec signifies renewable energy consumption, ti represents technological innovation, and gdp stands for gross domestic product. the description of the variables is presented in table 1. table 1. definition of variables. no. variables definition 1 co2 emissions carbon dioxide is produced during the consumption of solid, liquid, and gaseous fuels, as well as from gas flaring. 2 natural resource rent natural resource rents are the sum of oil rents, natural gas rents, coal rents (hard and soft), mineral rents, and forest rents. 3 gross domestic product gdp is the sum of gross value added by all resident producers in the economy, plus any product taxes, and minus any subsidies not included in the value of the products. 4 technological innovation the development and implementation of new technologies and processes that improve efficiency and the adoption of new technologies. 5 renewable energy renewable energy consumption refers to the proportion of renewable energy within the total final energy consumption. the variables selected for this study have been based on their pivotal role in explaining the connection between co2 discharges and natural resource rents within the us. each variable has been selected because it holds strong theoretical as well as empirical grounds in environmental economics and sustainability literature. natural resource rents are economic benefits derived from exploiting natural resources such as oil, gas, coal, minerals, and forests, among others. these revenues contribute greatly to the united states economy while at the same time being an area of interest when it comes to investigating their effect on carbon dioxide emissions. a positive relationship between them has already been proven by previous research, for instance, bekun et al. (2019) and nwani et al. (2023). this is why we need to analyze this variable since it helps us understand how our over-reliance on natural resource extraction affects environmental sustainability. co2 emissions are one of the major indicators used in measuring environmental degradation, which is also central in climate change studies. in order to quantify environmental impacts caused by natural resource rents, we must measure co2 emissions. many investigations have employed co2 emission levels as a yardstick for assessing ecological consequences brought about by economic activities, e.g., wang et al. (2020) and tufail et al. (2021). renewable energy consumption is essential for mitigating co2 releases into the atmosphere. through this factor, the researchers seek to establish whether the adoption of cleaner sources of power can affect outcomes regarding the environment vis-à-vis differentials among areas based on the availability or absence of nature-endowed resource rents. according to jebli and youssef (2015) and szetela et al. (2022), findings showed that more utilization of renewable energies leads to reduced carbon emissions, but these efforts should be complemented by other measures; hence, inclusion serves as a basis for further investigation into possible mitigation strategies. technological innovation enhances energy efficiency gains while lowering pollution levels from burning fossil fuels, which are considered threats to sustainable development. it represents improvements that can decouple economic growth from environmental degradation, thus saving our planet for future generations. for example, su et al. (2021) and wang and zhang (2021) highlight such importance by demonstrating how technology can help reduce co2 emissions, so this aspect will be analyzed in relation to its moderating effect on the resource rentsemissions relationship. gdp is a measure of economic activity or output within an economy, and it indicates the size as well as the health status of a country's economy. the relationship between gdp and carbon dioxide release into the atmosphere has been extensively studied by different scholars in various parts across the globe, e.g., jalil and mahmud (2009) and salahuddin et al. (2015). this is why we need to include gdp since through this variable we are able to undertake a comprehensive study on the natural interaction between economics and the environment. table 2 presents the descriptive statistics. asian journal of economics and empirical research, 2024, 11(2): 149-158 154 © 2024 by the authors; licensee asian online journal publishing group table 2. descriptive statistics. descriptive statistics co2 nrr gdp ti rec mean 5206424.0 0.882 1.44e+13 371768.6 6.509 median 5099655.0 0.883 1.48e+13 349692.0 5.595 maximum 5775810.0 1.935 2.03e+13 621453.0 10.420 minimum 4807500.0 0.235 8.62e+12 120916.0 4.089 std. dev. 355848.7 0.336 3.58e+12 173195.8 2.218 skewness 0.412 0.558 -0.084 0.084 0.565 kurtosis 1.535 4.152 1.746 1.499 1.730 jarque-bera 4.237 3.862 2.402 3.419 4.334 probability 0.120 0.145 0.301 0.181 0.114 observations 36 36 36 36 36 3.2. analytical techniques this study explores the impact of natural resource rents on co2 emissions in the presence of renewable energy consumption, technological innovation, and gdp in the case of the usa over the period from 1990 to 2020. to check the stationarity properties of variables, we employ the narayan and popp (2010) test, which considers the structural breaks in the data. the past results were not dependable due to methodological defects such as endogeneity, omitted variable bias, and model specification problems. the present research overcomes these methodological limitations, making it possible to obtain more accurate estimates of the extent of resource rent contribution to carbon output. hence, this study uses sophisticated estimation techniques such as movement quantile regression (mmqr) and bootstrap quantile regression (bsqr) in order to enhance the understanding of how resource rents impact co2 emissions. this article seeks to answer two critical questions: first, what exact relationship exists between resource rents and co2 emissions within the u.s.? secondly, are advanced econometric methods useful in explaining the complex interaction between resource rents and co2 emissions? it is through these questions that this study seeks to provide the necessary insights for policymakers, academics, and investors working towards harmonizing economic growth with ecological sustainability in america’s context. to estimate the impact of natural resource rents, renewable energy consumption, technological innovation, and gdp on co2 emissions, this study uses the bayer and hanck (b&h) co-integration method. the b&h test equation is given as: 𝐸𝐺 − 𝐽 = −2[ln(𝑃𝐸𝐺) + ln(𝑃𝐽)] (2) 𝐸𝐺 − 𝐽 − 𝐵𝑜 − 𝐵𝑎 = −2[ln(𝑃𝐸𝐺) + ln(𝑃𝐽) + ln(𝑃𝐵𝑜) + ln(𝑃𝐵𝑎)] (3) to estimate the model, this study uses movement quantile regression (mmqr) and bootstrap quantile regression (bsqr) estimation techniques. the qr approach facilitates the influence of diverse covariates on the quantiles of the dependent variable. conventional econometric methods only examine the average impact of covariates on the predictor variable, resulting in biased estimates. the predictor analysis solely focuses on the average stimulus, disregarding any other factors. when evaluating the level of correlation between two variables, qr outperforms other methods as it effectively avoids drawing false conclusions, unlike alternative approaches. the equation below represents the conditional quantile: 𝐶𝑂2𝑡 (𝜏𝛪𝛾𝑖 , 𝛿𝑡 , 𝑋𝑖,𝑡) = 𝜑𝑖 + 𝜆1,𝜏𝑁𝑅𝑅𝑡 + 𝜆2,𝜏𝐺𝐷𝑃𝑡 + 𝜆3,𝜏𝑇𝐼 𝑡 + 𝜆4,𝜏𝑅𝐸𝐶 𝑡 + 𝜐𝜏,𝑖,𝑡 (4) separate quantiles are given as: 𝑄0.25(𝐶𝑂2𝑡) = 𝛽0.25 + 𝛽1,0.25𝑁𝑅𝑅𝑡 + 𝛽2,0.25𝐺𝐷𝑃𝑖,𝑡 + 𝛽3,0.25𝑇𝐼 𝑡 + 𝛽4,0.25𝑅𝐸𝐶𝑡 + 𝜐0.25,𝑡 (4a) 𝑄0.50(𝐶𝑂2𝑡) = 𝛽0.50 + 𝛽1,0.50𝑁𝑅𝑅 𝑡 + 𝛽2,0.50𝐺𝐷𝑃 𝑡 + 𝛽3,0.50𝑇𝐼𝑡 + 𝛽4,0.50𝑅𝐸𝐶 𝑡 + 𝜐0.50,𝑡 (4b) 𝑄0.75(𝐶𝑂2𝑡) = 𝛽0.75 + 𝛽1,0.75𝑁𝑅𝑅 𝑡 + 𝛽2,0.75𝐺𝐷𝑃𝑡 + 𝛽3,0.75𝑇𝐼𝑡 + 𝛽4,0.75𝑅𝐸𝐶𝑡 + 𝜐0.75,𝑡 (4c) 4. results and discussions to check the order of integration of variables, we employ the narayan and popp (2010) test. the results of the unit root test are presented in table 3. the results show that nrr and gdp are integrated of order zero, whereas co2, ti, and rec are integrated of order one. table 3. unit root. variables i(0) i(1) co2 -1.326 -5.915*** nrr -1.013** -4.427** gdp -3.098*** -4.535*** ti -0.548 -4.982*** rec -1.199 -6.783*** the results of the bourgoyne and young (b&y) co-integration test are reported in table 4. the significant test statistics of the b&y test indicate that there is ample evidence of co-integration among the variables presented in model 1. note: *** and ** means significant for 1%, and for 5% respectively. asian journal of economics and empirical research, 2024, 11(2): 149-158 155 © 2024 by the authors; licensee asian online journal publishing group table 4. co-integration test. engle-granger johansen banerjee boswijk test statistic -1.833 109.745*** 1.281 731.182*** probability 0.873 0.000 1.000 0.000 eg-j 71.098** eg-j-ba-bo 92.237** note: *** & ** shows 1% and 5% significance level. this section provides the estimation results obtained using the mmqr and bsqr estimation techniques. these approaches are used to analyze complex interrelationships among resource rents and co2 emissions. these estimation methods permit a robust investigation of non-linearities, heteroscedasticity, and asymmetries in distributions concerning the effects of resource rents on co2 emissions. by employing mmqr and bsqr, this paper examines complex structures as well as links that are often overlooked in general regression analysis, thus enhancing our understanding of how resource extraction and economic growth influence environmental depletion. furthermore, three quantile levels, namely 0.050, 0.550, and 0.750, are used for both estimation techniques. the results of both the mmqr and bsqr estimations are displayed in table 5. the mmqr coefficient values for natural resource rent (nnr) show that for lower, median, and upper quantiles, a one-unit increase in nrr corresponds to a 38.1%, 77.9%, and 90.2% increase in co2 emissions, respectively. the observed nrr coefficient values that represent a proportional rise in co2 emissions are consistent with the environmental kuznets curve (ekc) theory. when countries begin to experience economic growth resulting from the extraction of natural resources and industrialization, according to the ekc principle, co2 emissions initially increase. previous studies in environmental economics help to understand the connection between natural resource rent and co2 emissions; this supports the current study’s findings as well. for example, nwani et al. (2023) found that there is a positive correlation between carbon emissions and resource extraction activities, especially in places or sectors heavily dependent on the exploitation of natural resources. the coefficient values for gdp reflect the percentage change in co2 emissions associated with a one-unit increase in gdp at various quantiles of the co2 emissions distribution. for instance, at the lower, median, and upper quantiles, these coefficient values are 0.080, 0.070, and 0.070 respectively, indicating that when gdp increases by one unit, it causes an increase of approximately 8.0%, 7.0%, and 7.0% in co2 emissions across these quantiles. these results imply a positive association between gdp growth rates and co2 emission levels throughout different quantile divisions, although they vary in terms of effect size across different parts of the co2 emission distribution. existing literature also supports the present study’s outcome regarding the effect of gdp on co2 emissions. for example, studies conducted by salahuddin et al. (2015) and mitić, munitlak ivanović, and zdravković (2017) have shown that an increase in gdp leads to an increase in co2 emissions, thus indicating the relationship between economic development and environmental degradation. the relationship between gdp and co2 emissions is complicated. economic growth, which results in an increase in gdp, entails higher activity in industry, a greater need for transportation, and increased energy consumption, all of which raise the level of co2 emissions. increased emissions are due to industrialization being an energy-intensive process and globalization putting more pressure on the production and supply chain, as people from more countries can afford more goods and services. however, economic development also brings with it more technology, which may reduce dependence on energy for various processes or lead to the innovation of cleaner technologies. besides the expansion of economies, modifications in economic structures as well as international trade flux add intricacy to this relationship between gdp and co2 emissions. in the course of progress, they could shift into sectors that emit less while transforming their emission patterns. additionally, global trade and outsourcing manufacturing, which often occurs in countries with a low-wage workforce but potentially high co2 emissions, may influence a country’s total emissions related to its gross domestic product. the coefficients of technological innovation indicate that improving technological innovation decreases co2 emissions by approximately 26.4%, 61.7%, and 20.4% respectively across lower, median, and upper quantiles. this finding indicates the significance of technological innovation in reducing carbon dioxide emissions. this finding aligns with previous studies; for instance, wang and zhang (2021) have shown that technological innovations are key to addressing co2 emissions by indicating that clean technologies and improved energy efficiency can make economic growth independent of environmental deterioration. for renewable energy consumption, the coefficients obtained through mmqr are 0.025, -0.026, and -0.064, meaning that when renewable energy consumption rec goes up by one unit, there will be approximately a decrease of 2.5%, 2.6%, and 6.4% in co2 emissions respectively at lower, median, and upper quantiles. this finding also shows the importance of renewable energy consumption in curbing co2 emissions. this is in line with the results of a study conducted by szetela et al. (2022), implying that clean energy has the potential to promote green sustainability and offset negative outcomes on resource extraction. in the bsqr method, the coefficient values of nrr for lower, median, and upper quantiles show that the corresponding increase in co2 emissions due to a one-unit change in nrr ranges from 58.7% (lower quantile) to 68.0% (upper quantile). despite some variations in the results of mmqr tests, both methods show an identical pattern in the increase of co2 emissions as one moves to higher quantiles. this reflects a similar trend between nrr and carbon dioxide emissions across various partitions of the distribution. the gdp coefficient values are 0.075, 0.086, and 0.077 respectively, showing about a 7.5%, 8.6%, and 7.7% rise in co2 emissions among these quantiles due to every single unit rise in gdp. the coefficients for gross domestic product obtained from bsqr are in line with mmqr outcomes. this means that both mmqr and bsqr estimates suggest that economic growth measured by gdp leads to increased co2 emissions across all quantiles. results for ti show that improvements in technological innovation reduce co2 emissions across these quantiles by almost 62.1%, 95.1%, and 56.5% respectively. in respect to technological innovation (ti), the findings using both bsqr and mmqr methods imply that there is a substantial reduction in co2 emissions in all quantiles. asian journal of economics and empirical research, 2024, 11(2): 149-158 156 © 2024 by the authors; licensee asian online journal publishing group finally, the results for renewable energy consumption (rec) obtained from bsqr are similar to those derived through mmqr, suggesting that changes in renewable energy consumption would have brought about a decrease in co2 levels by 5.6%, 2.4%, and 2.4% respectively. this emphasizes the significance of embracing renewable energy in mitigating co2 emissions. table 5. robustness – quantile regression. variable' mmqr estimates q0.25 q0.50 q0.75 coef. std. err. coef. std. err. coef. std. err. nrr 0.381*** 0.140 0.779*** 0.138 0.902*** 0.218 gdp 0.080*** 0.051 0.070*** 0.051 0.070*** 0.054 ti -0.264*** 0.045 -0.617*** 0.042 -0.204*** 0.050 rec -0.025** 0.012 -0.026*** 0.012 -0.064** 0.014 cons. -0.757 1.458 -1.571 1.415 -1.566 1.206 bsqr estimates variable q0.25 q0.50 q0.75 coef. std. err. coef. std. err. coef. std. err. nrr 0.587*** 0.175 0.955** 0.597 0.680** 0.617 gdp 0.075* 0.045 0.086 0.025 0.077* 0.055 ti 0.621*** 0.102 -0.951** 0.150 -0.565** 0.126 rec -0.056 0.095 -0.024 0.048 -0.024 0.042 cons. -0.426 0.089 -0.790 0.655 -1.174 0.602 note: ***, ** & * shows 1%, 5% and 10% significance level. 5. conclusions and policy recommendations natural resource rents represent the economic benefit gained through the utilization of resources like oil, natural gas, and coal, as well as oil-producing minerals and forests. these rents can make up the largest portion of the revenue of resource-rich countries, sparking concerns about the environmental impact on other nations. the extraction of these resources is one of the leading reasons for co2 emissions. greenhouse gases such as co2, which are the main cause of climate change, present unprecedented risks to human development and survival, such as the extinction of animal and plant species, famines, and extreme weather conditions. this study explores the impact of natural resource rents on co2 emissions in the presence of renewable energy consumption, technological innovation, and gdp in the case of the usa over the period from 1990 to 2020. for sustainable development policies and to slow down environmental degradation, it is important to understand the intricate connection between resource rents and carbon emissions in the us. thus, this study hypothesizes that after controlling for renewable energy consumption, technological innovation, and gdp among other variables, resource rents significantly contribute to carbon dioxide emissions in america. this study adds significantly to the existing literature on how resource rents affect co2 emissions in the united states. this study employs advanced estimation methods such as movement quantile regression (mmqr) and bootstrap quantile regression (bsqr) estimation techniques, which provide vital policy insights and academic contributions that are relevant for sustainable development and environmental conservation from both national and global perspectives. identifying risks associated with resource extraction by assessing the environmental consequences of extracting resources from the natural environment will help promote responsible resource use that may facilitate a more sustainable economy. the impact is not only confined to academia or policymaking but also affects other key players like industry leaders, environmental advocates, and even the general public. decoupling environmental destruction from economic growth, as mandated by sustainable development goals, demands an understanding of how resource rents translate into co2 emissions. if we really want to make a difference within our borders and internationally, then it is high time we addressed the relationship between resource rents and co2 emissions. given its status as one of the world’s biggest carbon dioxide emitters, the government of the united states has significant implications when it comes to global climate change patterns. these findings directly relate to policies that enable sustainable development and address environmental degradation in america. by clearly stating how much resource rents contribute to co2 emissions, policymakers will have more focused interventions and regulations that encourage cleaner energy sources, stimulate efficient use of resources, or raise energy prices without hampering economic growth. this study employs quantile regression estimation techniques, which provide vital policy insights and academic contributions that are relevant for sustainable development and environmental conservation from both national and global perspectives. the results show that natural resource rent (nnr) and gdp are positively associated with co2 emissions at all quantiles. this implies that co2 emissions in the usa are greatly influenced by nrr. moreover, the results show that technological innovation and renewable energy consumption are important in curbing co2 emissions. as the world grapples with promoting green, sustainable growth to curb anthropogenic climate change, the consumption of rec) is a much better way to replace fossil fuel utilization. this problem presents a key challenge for policymakers, energy researchers, and industry players concerning ways through which co2 emissions can be reduced by using renewable energy. renewable energy use as a means of reducing carbon dioxide emissions is now at an important crossroads between policy and energy transition. the potential for renewable energy to result in lower co2 emissions arises because most types of renewable energy can substitute fossil fuel combustion in three major consuming sectors: power generation, transportation, and manufacturing. moreover, when it comes to tackling the many challenges of environmental sustainability and climate action, technological innovation is likely to remain one of the most important tools for reducing co2 emissions. in the face of overwhelming preoccupation with climate change, innovation – or, more specifically, the ability of new technologies to decrease emissions in every corner of our society – has emerged as a topic of great interest to academics, policymakers, and industrial decision-makers. indeed, there is a widespread belief that new technologies will enable society to dramatically reduce co2 emissions asian journal of economics and empirical research, 2024, 11(2): 149-158 157 © 2024 by the authors; licensee asian online journal publishing group and support the transition to a more sustainable future. this is particularly true in the energy, 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(2023). the impact of energy transition and eco-innovation on environmental sustainability: a solution for sustainable cities and communities of top ten asian countries. engineering economics, 34(1), 32-45. https://doi.org/10.5755/j01.ee.34.1.32161 asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.3390/ijerph18010277 https://doi.org/10.3389/fenrg.2022.872941 https://doi.org/10.1177/0958305x20932550 https://doi.org/10.1007/s11356-021-13865-y https://doi.org/10.1016/j.resourpol.2020.101803 https://doi.org/10.1007/s10098-021-02073-4 https://doi.org/10.1016/j.jenvman.2020.110712 https://doi.org/10.1177/0958305x221079426 https://doi.org/10.1007/s10614-022-10311-0 https://doi.org/10.5755/j01.ee.34.1.32161 79 © 2025 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 12, no. 1, 79-84, 2025 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v12i1.6921 © 2025 by the author; licensee asian online journal publishing group trade opportunities in textiles between india and brics: a structural share-based analysis n. lalitha department of economics, shyama prasad mukherji college for women, university of delhi, new delhi 110026, india. email: nlalitha@spm.du.ac.in abstract as india adjusts to the changing international trade scenario brought about by the reciprocal tariffs imposed by the u.s. government, there is a need to identify product groups and markets with strong export potential for indian goods. india is one of the top textile exporters in the world and enjoys an immense comparative advantage in textile exports, as reflected in the high revealed comparative advantage (rca) index. brics is a grouping of emerging economies, and as of 2025, these countries together accounted for 41 percent of the world population, 24 percent of the total world gdp, and 16 percent of the world trade. we evaluated the trade complementarity between india and the brics countries brazil, russia, china, and south africa in textiles from 2001 to 2023 to examine the alignment between india’s export specialization and the import needs of these countries. the study found that the trade complementarity index with russia and south africa was higher than that with brazil and china for almost the entire study period. despite high trade complementarity, the share of russia and south africa in india’s major exports grew less rapidly than that with brazil and china. this study provides an approach to identify trade opportunities in textile product groups by combining four key indicators: trade complementarity (supply–demand alignment), growth in the product group's share in india’s exports (supply potential), growth in the product group's share in the partner country's imports (demand trend), and growth in the partner’s share in india’s exports. keywords: brics, cagr, rca index, tci, textiles, hs code. jel classification: f10; f14. citation | lalitha, n. (2025). trade opportunities in textiles between india and brics: a structural share-based analysis. asian journal of economics and empirical research, 12(1), 79–84. 10.20448/ajeer.v12i1.6921 history: received: 29 may 2025 revised: 3 july 2025 accepted: 14 july 2025 published: 18 july 2025 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. mailto:nlalitha@spm.du.ac.in https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v12i1.6921 https://orcid.org/0009-0002-6628-9452 asian journal of economics and empirical research, 2025, 12(1): 79-84 80 © 2025 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study examines the shifts in india's export specialization and imports demands from the other members of the brics group within the textiles sector over the study period. unlike earlier studies that rely solely on the trade complementarity index (tci) and trade intensity index (tii), this study incorporates growth in partner countries’ import needs and their evolving share in india’s exports to assess trade potential in the textile products group classified at the hs-2digit level. 1. introduction trade watch quarterly, published by niti aayog in its july-september 2025 issue, observed that india’s textile and apparel exports have remained more or less stagnant over the last six years, whereas, for the world as a whole, exports from this sector grew at an impressive 3.5 percent. although the revealed comparative advantage index (rca) for textiles as a whole has ranged between 2.41 and 4.26 (calculated using data from the world integrated trade solution; our unpublished results) during the study period, indicating that the share of textiles in india’s exports was significantly higher than the world average, the share of textiles in india’s total exports has decreased from 25.28 percent in 2001 to 8.21 percent in 2023. the quarterly report noted that india’s textile exports were highly concentrated in natural fibre-based products like cotton and carpet threads. however, global demand has grown for man-made and technical textiles. the share of india’s exports of cotton, carpets, and other floor coverings in the total world export of textiles was 12.3 percent, and 10.5 percent in 2023. in contrast, man-made filament-based textiles and man-made staple fibres from india accounted for only 3.3 percent of the world’s export of textiles. therefore, it becomes important to identify product groups within the broad category of textiles where india has a comparative advantage, measured in terms of rca and the existence of a potential market, as reflected in the high import share of the product group in the destination country, to increase india’s textile exports. export promotion involves carefully identifying destination countries based on geopolitical considerations and analyzing the product market. attention must be given to existing competitors and to evaluating the competitive edge in terms of price, quality, and brand value of products. the tariffs and non-tariff barriers imposed by destination countries, as well as whether the two countries are part of a trade bloc, have a significant impact on trade possibilities. further factors such as production capabilities, prevailing exchange rates, regulatory environment, and economically viable trade routes are all important in determining trade opportunities. india has entered into many bilateral and regional free trade agreements, including with asean and saarc member countries. it also has comprehensive economic partnership agreements (cepa) with japan, south korea, mauritius, the uae, and a preferential trade agreement (pta) with the mercosur trading bloc, which includes argentina, brazil, paraguay, uruguay, and bolivia as member countries. in addition, india is also a member of the brics group. brics is an informal grouping of emerging economies, and according to the latest reports, their combined share of global gdp, measured by purchasing power parity (ppp), exceeds that of the g7 countries. there is a high volume of trade between the various countries of this group. currently, this group has 10 member countries and 9 partner countries. as most of the countries in this group have experienced high economic growth rates for many years, increased economic cooperation through trade among these countries could further enhance their economic and political standing in the world. this study examines the trade complementarity in textiles between india and the other four founding members of brics. this analysis helps us understand whether india’s exports match the needs of each of the other four countries, and by using trade data between india and the destination countries, we infer trade possibilities. 2. methodology using itc’s trade map, trade data for textiles at the two-digit classification level for the brics countries was collected. textile data are listed under chapters 50 to 63. the share of products covered under a given chapter, in the total textile exports of india, was calculated for all the years from 2001 to 2023 (x50…x63). similarly, for brazil, russia, china, and south africa, the share of chapter-wise products in their total textile imports (m50…m63) was calculated for the same period. using this data, the trade complementarity index between india and the other four member countries of brics, namely brazil, russia, china, and south africa, was calculated. the trade complementarity index between countries i and j in any period t is defined as 𝑇𝐶𝐼𝑖𝑗,𝑡 = 100 (1 − 1 2 ∑63 𝑘=50 |𝑚𝑖𝑘 − 𝑥𝑗𝑘|) (1) here, mik refers to the share of product covered under chapter k in the total textile imports of country i in period t, and xjk refers to the share of products of chapter k in the global textile export of country j in period t. when there is a perfect match between the shares, i.e., mik=xjk for all k, eciij is 100. the index becomes zero when products exported by country j are not imported by country i, and products imported by country i are not exported by country j. to better understand trade complementarity, we compared the shares of chapter-wise products in india’s export basket with those of their shares in the import baskets of destination countries. since neither the export nor the import shares for the fourteen product groups showed any dramatic fluctuations during the study period, we decided to use the average of these shares to make comparisons. to identify shifts in india’s export specialization, changes in market demand, and changes in the relative significance of partner countries in india’s foreign trade during the study period of 23 years, we calculated the compound annual growth rate (cagr) in the share of all chapter-wise product groups in india’s global exports, in partner countries’ total imports, and also in the share of the partner country in india’s exports. the cagr was calculated using the following formula. 𝐶𝐴𝐺𝑅 = ( 𝑟𝑒𝑙𝑒𝑣𝑎𝑛𝑡 𝑠ℎ𝑎𝑟𝑒 𝑖𝑛 2023 𝑟𝑒𝑙𝑒𝑣𝑎𝑛𝑡 𝑠ℎ𝑎𝑟𝑒 𝑖𝑛 2001 ) 1/22– 1 (2) asian journal of economics and empirical research, 2025, 12(1): 79-84 81 © 2025 by the authors; licensee asian online journal publishing group 3. literature review researchers have used tci and other trade indicators such as the rca index, trade intensity index (tii), and the trade similarity index to evaluate trade possibilities between countries. while some studies examined bilateral trade, others analyzed trade benefits for countries entering into free trade agreements with varying levels of trade complementarity. hosein, boodram, and saridakis (2023) examined trade complementarity as a basis for the ‘natural trading partner hypothesis’. using a panel data approach, they found that aggregate trade complementarity and, specifically, manufacturing sector complementarity significantly affected the trade volume of the economy of trinidad and tobago during the period 2000 to 2015. therefore, the authors suggested that countries should be guided by trade complementarity in their choice of trade partners. akram, ahmad, dana, khan, and akhtar (2024) examined the trade between india and sri lanka from 1995 to 2020. despite being part of the south asian free trade area and having a bilateral free trade agreement, the trade between the two countries was found to be low due to a lack of comparative advantage for the majority of the product groups. furthermore, in products where the two countries did have a comparative advantage, they were competitors rather than natural trading partners. tabassum (2021) analyzed the two-way trade complementarity between india and bangladesh in her paper. the author found that while india’s exports had a strong complementarity with bangladesh’s imports, complementarity was weak in the other direction. further, the ratio of india’s exports to bangladesh to global exports to bangladesh was higher than expected and significant. hannafi and shehu (2016) studied the trade relations between nigeria and india from 2000 to 2014. the authors reported that the trade complementarity between nigeria’s exports and india’s imports, though not very high, increased during the study period. another country that has drawn considerable attention from researchers in this area is china. min, huang, and zhang (2016) used the rca index and tci to evaluate possibilities in agricultural trade between china and belt and road initiative countries. the study found that, as complementarity in trade between these countries was more pronounced than competition, it indicated the presence of significant trade potential that could be effectively tapped. yu and qi (2015) highlighted the complementarity between china and central and eastern european countries in various agricultural products. the authors suggested that china could export more of its aquatic and fruit products, as well as milk and honey. zhang (2021) used rca, tci, and export intensity index to explore the trade relationship between china and brazil in agricultural products. the study found that, due to differences in resource endowments and the structure of the agriculture sector, the two countries complement each other rather than compete in trade. the study noted that, while china exports labor-intensive processed products like textile fibers, vegetables, and fruits, brazil’s competitive advantage lies in land-intensive products such as oilseeds and vegetable oils. the author thus highlighted that the two countries have significant potential for cooperation and development. trade possibilities between the countries of a trading bloc have been the focus of many research studies. hoang (2018) studied the agricultural trade complementarity of asean countries and found that the export patterns of these countries had relatively less complementarity with regional demand than with the world market as a whole. the author inferred that these countries will benefit more from global integration than regional integration. as the exports from these countries are substitutable over time, it is in the interest of these countries to cooperate and use the internal markets to become more competitive. noting that countries with complementary trade structures have a greater potential for trade, chandran (2011) shows that india and asean countries have complementary sectors, and india can increase trade cooperation across all product categories with different members of the asean group. chandran and sudarsan (2012) examined the effect of the india-asean free trade agreement on the marine sector and concluded that the apprehension that the agreement would lead to large-scale dumping of marine products in india is unfounded. hosein et al. (2023) studied the effect of the fta between the caribbean community (caricom) and the eu and north america on trade between these countries. the study reported that intra-caricom trade and trade with fta partners were not noteworthy because trade complementarity was low and concentrated in a few primary industries. 4. results and discussions 4.1. tci between india and the brics countries the graph of tci between india and the other four member countries of brics in textiles is shown in figure 1. figure 1. tci of brazil, russia, china, and south africa with india in textiles. asian journal of economics and empirical research, 2025, 12(1): 79-84 82 © 2025 by the authors; licensee asian online journal publishing group figure 1 shows that the trade complementarity between india and the four brics countries improved over time. india’s export structure in textiles matched better with the import structure of russia and south africa than with brazil and china. the trade complementarity index with russia was never less than 62.77 and was as high as 81.67 in 2009. the import structure in textiles for south africa also had great similarity with india’s export structure in textiles, and the tci values ranged between 57.94 and 82.21, with the peak value again in 2009. india’s tci with russia and tci with south africa, in general, moved together, with a slight upward trend from the beginning of 2001 till 2009, and thereafter hovered around 70. the tci with brazil showed a marked upward trend, reaching the maximum value of 64.61 in 2015. since then, the tci of india with brazil declined gradually, reaching 48.81 in 2021 and rising to 57.09 in 2023. the trade complementarity index with china, which was below that of the tci with russia and tci with south africa throughout the study period, surpassed them in 2021 when the value increased to 73.67. 4.2. comparison of trade structures of countries based on average and cagr of product shares a comparison of the average share of chapter-wise products in total textile exports of india, with their average share in total textile imports of the destination countries, helped us identify product groups with mirror image trade structures in the two countries. table 1 reveals that india’s export specialization within the textile group was in cotton (hs 52), articles of apparel and clothing accessories knitted and crocheted (hs 61), articles of apparel and clothing accessories not knitted and not crocheted (hs 62), and other made-up textile articles (hs 63). the product groups with an average import share exceeding 10% were hs 54, 55, 61, and 62 for brazil; hs 61 and 62 for russia; hs 52 and 54 for china; and hs 61 and 62 for south africa. cotton is one of india’s major exports, and the country accounts for 12.3% of the total world exports of cotton. india’s rca index of 6.8 in cotton is the third highest in the world and indicates that, in relative terms, india’s exports of cotton are much higher than the world average. the average share of this product in the total textile exports of india for the study period is approximately 20 percent. from the table, it is clear that the country with a large share of imports for cotton is china. the average share of cotton in its total textile imports is 30 percent. however, china also accounts for the largest share in the global export of textiles and is therefore the largest competitor india has to contend with. india’s exports of articles of apparel and clothing accessories, both knitted and crocheted (hs 61) and not knitted or crocheted (hs 62), have a strong complementarity with the imports of russia, south africa, and brazil. for these countries, products covered under hs 61 and 62 constitute a significant share of their total imports. for instance, these products accounted for 24.5 percent and 27.5 percent in russia’s import basket of textiles, and 22.3 percent and 25.3 percent in south africa’s total textile imports, and 10.8 percent and 13.3 percent in brazil’s textile imports from the world. table 1 shows the average over the twenty-three-year period of the export share for india and the import share for brazil, russia, china, and south africa for products grouped under the fourteen chapters. table 1. average of shares of product groups in exports and imports of countries. hs code 𝑥 india 𝑚 brazil 𝑚 russia 𝑚 china 𝑚 s africa hs 50 0.01033 0.00242 0.00057 0.00363 0.00192 hs 51 0.00471 0.00433 0.00626 0.09867 0.01329 hs 52 0.20133 0.06679 0.08843 0.30721 0.07629 hs 53 0.01129 0.00567 0.00613 0.02504 0.00767 hs 54 0.06179 0.28213 0.05070 0.11938 0.09733 hs 55 0.05338 0.15033 0.06835 0.09696 0.08163 hs 56 0.00938 0.04933 0.05078 0.03538 0.03567 hs 57 0.05108 0.01446 0.02213 0.00358 0.01629 hs 58 0.01008 0.02133 0.01687 0.02242 0.01783 hs 59 0.00683 0.06283 0.03983 0.05708 0.05171 hs 60 0.00792 0.05938 0.04257 0.06225 0.04821 hs 61 0.19683 0.10875 0.24530 0.06500 0.22317 hs 62 0.24583 0.13333 0.27578 0.09246 0.25379 hs 63 0.12925 0.03896 0.08617 0.01142 0.07492 note: 𝑥 refers to the average of the export share of the relevant product group in india’s exports 𝑚 refers to the average of the import share of the relevant product group in the partner country’s imports. the trade complementarities between different countries for the identified product groups diminish when analyzed using cagr in the corresponding shares. table 2 shows that the share of products covered under chapters 51, 54, 55, 56, 59, 60, 61, and 63 in india’s total exports increased during the study period. due to the high growth rate in shares of products covered under chapters 56, 59, and 60, india’s textile export composition shifted towards these products. conversely, the other four countries either moved away from importing these products or experienced slow growth in import demand, resulting in only a small increase in the tci of india with all four countries over time. to examine the effect of shifts in trade complementarity on bilateral trade between india and the other brics countries, we analyzed the cagr in the share of each partner country in india’s exports of various products. table 2 indicates that during the twenty-three-year study period, china’s share in india’s exports increased across all product groups except those falling under the hs 58 category. brazil also emerged as a significant trading partner, with its share in india’s exports increasing in eleven product categories. russia and south africa, however, experienced growth in export share for only five textile cluster categories. for products covered under chapter 56, a high growth rate in their shares of india’s total exports positively influenced bilateral trade with the other four countries. the other two product groups, hs 59 and 60, which gained importance in india’s export basket during the study period, registered increased exports with only two of the four countries. asian journal of economics and empirical research, 2025, 12(1): 79-84 83 © 2025 by the authors; licensee asian online journal publishing group table 2. cagr in shares of product groups in exports and imports of countries. hs code gx india g m brazil g m russia g m china g m s africa g p brazil g p russia g p china g p s africa hs 50 -8.81% -4.66% 0.00% -3.62% -5.85% -10.84% -10.24% 15.90% -15.57% hs 51 0.97% -10.55% -9.11% -0.99% 0.00% -4.66% 4.53% 1.10% -4.86% hs 52 -0.24% -6.06% -6.74% 2.24% -5.41% 5.94% -15.59% 5.81% -2.93% hs 53 -0.32% -0.67% -12.02% 4.52% -1.09% 1.63% -0.38% 22.47% -1.41% hs 54 0.17% -2.38% -1.75% -4.56% -3.67% 7.78% 4.89% 5.01% -1.84% hs 55 0.57% 1.35% -1.82% -5.50% -3.61% 6.94% 1.65% 5.48% 2.02% hs 56 6.21% -0.53% -3.03% 1.84% 0.24% 10.12% 2.70% 18.00% 2.55% hs 57 -0.16% -0.79% -2.80% 1.78% -2.45% 5.37% 12.81% 9.07% 2.11% hs 58 -2.35% 0.00% -5.14% -5.64% -2.97% 12.04% -5.30% -5.85% -4.49% hs 59 5.60% -1.28% -0.22% -2.16% -2.20% 20.44% -5.90% 18.78% -1.34% hs 60 6.58% 3.33% 0.45% -5.38% -0.08% -8.64% -26.04% 3.75% 5.18% hs 61 0.60% 5.54% 6.55% 6.85% 4.98% 10.02% -15.90% 17.65% 3.12% hs 62 -1.25% 3.15% 3.95% 6.14% 3.52% 7.01% -9.71% 13.91% -2.05% hs 63 1.85% 3.47% -0.18% 7.69% 1.47% 4.72% -0.54% 1.69% -0.72% note: gx refers to cagr in the share of the product in india’s global exports. gm refers to cagr in the share of the product in the partner country’s imports from the world. gp refers to cagr in the share of the partner country in india’s export of the product. 4.3. identifying trade possibilities with a high average value of export shares over the study period, products falling under chapters 52, 61, 62, and 63 were identified as india’s major textile exports. the rca index for all these product groups in 2023 (as reported by ‘trade watch’, july-september fy 2025) was 6.8, 1.3, 1.7, and 3.8, respectively. the rca indices imply that the share of these products in india’s total exports was greater than the corresponding share for the world. we therefore examined india’s export performance in these products relative to the import demands. the cagr of export share (gx), import share (gm) of all four countries, and the partner country’s share in india’s exports (gp) helped us identify trade possibilities. cotton (hs 52), which had the second-highest average share in india’s textile exports, gradually lost its preeminence, as reflected in the negative growth rate of 0.24 percent. interestingly, except for china, the other three countries were also moving away from cotton imports. for brazil and south africa, though the share of cotton in total imports from the world declined, their share in india’s export of cotton increased. in contrast, russia seems to have lost its importance as a market for indian cotton exports. china, however, continued to grow as an important market for cotton, and its share in india’s exports grew by 5.81 percent. share of articles of apparel and clothing accessories knitted and crocheted (hs 61) in india’s exports grew at a very low rate of 0.6 percent. the share of this product in total imports of textiles by the other four countries of brics increased at high rates, ranging from 4.98 percent for south africa to 6.85 percent for china. brazil and china’s shares in india’s exports grew by 10.02 percent and 17.65 percent, respectively, while that of russia declined by 15.90 percent. this could be a missed opportunity for india, as russia’s import needs were growing at a cagr of 6.55 percent. a similar trend appears to be emerging for products classified under hs 62. once again, although the significance of articles of apparel and clothing accessories not knitted and not crocheted in india’s export basket was decreasing, demand for these products increased across all brics countries, resulting in a higher share of imports from the global market for these items. additionally, india’s exports were increasingly targeted towards brazilian and chinese markets. for this group of products, both the russian and south african markets became less significant for indian exporters. the share of other made-up textile articles, sets, worn clothing, and worn textile articles, rags (hs 63) in india’s exports increased over time. the importance of this cluster of products in the import baskets of brazil, china, and south africa increased during the study period. high and positive gp values (cagr in the share of a country in india’s export of this product) for brazil and china, and negative gp values for russia and south africa indicate that indian exporters were selling more to brazilian and chinese importers and were moving away from the russian and south african importers. 5. conclusions in this paper, trade complementarity is analyzed at the hs 2-digit classification level, not only in terms of average import share and export share of products falling under hs codes 50 to hs 63, but also in terms of cagr in these shares. thus, our analysis is dynamic and captures the shift in export specialization and import requirements over the study period. furthermore, while similar studies have used tci and trade intensity index (tii) to discern trade possibilities, we have used growth in import needs and growth in the shares of partner countries in india’s exports to draw inferences regarding trade possibilities given the tci with these countries. a high tci reflects a good match between exporting countries' product specialization and importing countries' needs. the logical outcome would then be higher trade between countries with high tci than with low tci countries. india’s trade complementarity with russia and south africa was higher than that with brazil and china for the majority of the twenty-three-year period studied. however, this study found that the positive relationship between trade complementarity and trade levels did not hold for bilateral trade between india and the other brics countries. india’s export specialization, as measured by average export shares, appears to be concentrated in products covered under chapters 52, 61, 62, and 63. countries with high import ratios in similar product groups include china for hs 52 and russia, south africa, and brazil for hs 61 and hs 62. the average share of hs 63 products in the total imports of these four countries was less than 10 percent. the shares of brazil and china in india’s exports of all four product groups increased significantly over the study period. since china was also importing cotton heavily, it can be inferred that indian exporters effectively capitalized on trade opportunities. by increasing exports to brazil, asian journal of economics and empirical research, 2025, 12(1): 79-84 84 © 2025 by the authors; licensee asian online journal publishing group indian exporters successfully leveraged trade complementarity, particularly in articles of apparel and clothing accessories, both knitted and crocheted (hs 61) and not knitted or crocheted (hs 62). surprisingly, russia and south africa, despite having an import product concentration complementing india’s export specialization, were becoming less important for indian exporters for these product groups. this could be a result of a large number of factors, including but not limited to tariffs and non-tariff barriers, competitiveness in terms of price and quality, etc. without exploring each of the possible reasons, it is, however, difficult to make a conclusive inference. product groups that registered a significant increase in export share during the study period fall under chapters 56, 59, and 60. the share of india’s exports with each of the four countries increased for the hs 56 group of products, although the growth rate in shares was small for russia and south africa compared to the other two countries. brazil and china became more important for indian exports of hs 59 products. exports of hs 60 products increased by a small percentage to chinese and south african markets. various reports indicate that bilateral trade with russia holds significant potential and is expected to improve in the coming years. with the international north-south transport corridor (instc) becoming an economically viable trade route, the cost of transporting goods between india and russia will decrease, leading to increased trade between the two countries. as regards south africa, since india’s trade focus is more on east africa, targeted programmes would be needed to take advantage of the high trade complementarity between the two countries. references akram, h. w., ahmad, a., dana, l.-p., khan, a., & akhtar, s. (2024). do trade agreements enhance bilateral trade? focus on india and sri lanka. sustainability, 16(2), 582. https://doi.org/10.3390/su16020582 chandran, d. s., & sudarsan, p. (2012). revealed comparative advantage (rca) and trade complementarity between india-asean trade: a study with reference to fisheries sector. available at ssrn 2054132. http://doi.org/10.2139/ssrn.2054132 chandran, s. (2011). trade complementarity and similarity between india and asean countries in the context of the rta. retrieved from mpra paper no. 29279: https://mpra.ub.uni-muenchen.de/29279/ hannafi, k., & shehu, a. (2016). nigeria india bilateral trade relations: an analysis of trade complementarity index (tci). asian journal of economic modelling, 4(4), 190-198. https://doi.org/10.18488/journal.8/2016.4.4/8.4.190.198 hoang, v. (2018). assessing the agricultural trade complementarity of the association of southeast asian nations countries. agricultural economics, 64(10), 464-475. https://doi.org/10.17221/253/2017-agricecon hosein, r., boodram, l., & saridakis, g. (2023). trade complementarity as a basis for the natural trading partner hypothesis: a panel data study for trinidad and tobago. the international trade journal, 37(6), 608-632. https://doi.org/10.1080/08853908.2021.2003727 min, h., huang, z., & zhang, n. (2016). an empirical research on agricultural trade between china and “the belt and road” countries: competitiveness and complementarity. modern economy, 7(14), 1671-1686. tabassum, a. (2021). trade intensity and trade complementarity between india and bangladesh. webology, 18(5), 325-334. yu, c., & qi, c. (2015). research on the complementarity and comparative advantages of agricultural product trade between china and cee countries—taking poland, romania, czech republic, lithuania and bulgaria as examples. journal of service science and management, 8(2), 201-208. https://doi.org/10.4236/jssm.2015.82022 zhang, f. (2021). competitiveness or complementarity: analysis of agricultural trade between china and brazil. problems and perspectives in management, 19(4), 258-269. http://doi.org/10.21511/ppm.19(4).2021.21 asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.3390/su16020582 http://doi.org/10.2139/ssrn.2054132 https://mpra.ub.uni-muenchen.de/29279/ https://doi.org/10.18488/journal.8/2016.4.4/8.4.190.198 https://doi.org/10.17221/253/2017-agricecon https://doi.org/10.1080/08853908.2021.2003727 https://doi.org/10.4236/jssm.2015.82022 http://doi.org/10.21511/ppm.19(4).2021.21 1 © 2025 by the author; licensee asian online journal publishing group asian journal of economics and empirical research vol. 12, no. 1, 1-8, 2025 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v12i1.6323 © 2025 by the author; licensee asian online journal publishing group influential factors of online purchase intention in the financial industry: a perspective from an emerging economy shimei wen sichuan sanhe college of professionals 500 licheng road, hejiang luzhou city, sichuan province, china. email: 1028373389@qq.com abstract this study addresses the gap in understanding the impact of product types on online purchasing decisions in the financial industry. it examines how key factors—product features, financial needs, institutional reputation, and government regulations—affect online purchase intention while also investigating the mediating roles of consumer perceptions. data from 218 respondents in china was collected via a structured questionnaire distributed across various social media platforms. quantitative analysis was employed to explore the direct effects of influential factors on online purchase intention, along with the mediating effects of perceived value and purchase risk. the study reveals that product features, financial needs, institutional reputation, and government regulations positively influence online purchase intention in the financial sector. perceived value amplifies these effects, while purchase risk attenuates them, underscoring the significant mediating role of consumer perceptions. managers in the financial sector should prioritize brand building and realtime customer engagement to bolster online purchase intentions. strengthening institutional reputation and highlighting product value can positively sway consumer decisions. policymakers are advised to enact regulations ensuring e-commerce transaction safety, fostering consumer trust and a secure online purchasing environment. keywords: financial needs, government regulations, institutional reputation, online purchase intention, perceived risk, perceived value, product features. jel classification: d12; g21; l81; m31. citation | wen, s. (2025). influential factors of online purchase intention in the financial industry: a perspective from an emerging economy. asian journal of economics and empirical research, 12(1), 18. 10.20448/ajeer.v12i1.6323 history: received: 9 may 2024 revised: 12 december 2024 accepted: 30 december 2024 published: 20 january 2025 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: the ethical committee of the sichuan sanhe college of professionals, china has granted approval for this study on 24 march 2023. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. data availability statement: shimei wen may provide study data upon reasonable request. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. contents 1. introduction ......................................................................................................................................................................................... 2 2. theoretical background and hypotheses .............................................................................................................................. 2 3. research method ............................................................................................................................................................................. 4 4. result and analysis ......................................................................................................................................................................... 5 5. conclusion .......................................................................................................................................................................................... 6 references ............................................................................................................................................................................ 7 mailto:1028373389@qq.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v12i1.6323 https://orcid.org/0009-0003-0022-7686 asian journal of economics and empirical research, 2025, 12(1): 1-8 2 © 2025 by the author; licensee asian online journal publishing group contribution of this paper to the literature this study offers a new exploration of how product features, financial needs, institutional reputation, and government regulations directly influence online purchase intentions in the financial industry. additionally, it investigates the mediating roles of perceived value and purchase risk, areas that have not been thoroughly examined before. 1. introduction the adoption of information technology (it) empowers businesses to establish online platforms facilitating ecommerce operations (blake, neuendorf, & valdiserri, 2003). utilizing the advantages offered by online platforms, such as improved accessibility, convenience, and cost-effectiveness, creates value for both businesses and consumers. despite substantial research on consumer online purchasing behavior, the influence of product category on purchase decisions remains relatively unexplored. in the domain of financial services, the internet's pervasive influence has impacted how financial institutions plan and market their products. the covid-19 pandemic and the imperative of social distancing have further accelerated the adoption of online financial services. however, financial products, characterized by their intangible nature and complexity, entail higher levels of risk and uncertainty, prompting customers to exhibit greater caution and risk aversion toward online transactions. the classification of financial products has the potential to shape customers' perceptions regarding the characteristics, features, and benefits of these products, subsequently impacting their inclination to engage in a purchase. this phenomenon is explained through the lens of product differentiation, representing the strategic process of establishing distinctions among comparable products in the consumer's perception. moreover, the perceived value associated with online purchases of financial products may exhibit variations across distinct product categories, resulting in disparities in purchase intention. consequently, it becomes imperative for managers within the financial sector to attentively factor in the influence of product categories on consumer behavior and the decisionmaking process. the likelihood of increased purchase intention correlates with a streamlined purchasing process. in the context of financial products, customers, desiring comprehensive information, tend to prefer personal interaction for financial management. however, online purchasing behavior exhibits caution due to concerns about technical and institutional hurdles in information security. notably, the recent banking turmoil, exemplified by the 2023 collapse of silicon valley bank and signature bank, has instilled widespread fear of a financial crisis. this has led to significant distrust in governmental stability and the accountability of financial managers. without a demonstrated commitment to ensuring robust customer protection, the current landscape suggests that online channels for financial product purchases may not be deemed a necessity. the synergy of it development and implementation yields a symbiotic relationship, offering customers instant access to products/services and enabling businesses to expand markets and profitability. however, this study contends that financial products, with unique attributes setting them apart from tangible goods, warrant a thorough exploration of factors influencing online purchase behavior in the financial sector. the findings make a noteworthy contribution to existing literature, shedding light on the impact of purchase perception on consumer behavior in the e-commerce realm of the financial industry. additionally, the study provides practical insights for business managers and policymakers. 2. theoretical background and hypotheses different from the extant literature that has investigated the determinants of online shopping behavior in a broad context, this study suggests that an alternative approach should be employed in examining the intrinsic value of financial products/services. accordingly, the conceptual framework is constructed to integrate firm reputation and government regulations as key determinants that influence online purchasing behavior in the financial sectors while additionally considering the mediating effect of product category on the hypothesized relationships. the proposed research model is represented in figure 1. figure 1. research model. 2.1. dependent variable: purchase behavior purchase behavior can be predicted through intentions (ajzen, 1991). the purchasing process, as explored by bhatnagar, misra, and rao (2000) encompasses various considerations such as consumption preferences, time, and financial resources. decision-making becomes the guiding force behind purchasing behavior, with the research proposing that intentions act as a reliable indicator for predicting consumer decisions. notably, studies by li, xu, and xu (2018) and lee and allaway (2002) highlight a positive correlation between purchase intention and perceived control, indicating that consumers who feel a sense of control are more likely to make final purchasing decisions asian journal of economics and empirical research, 2025, 12(1): 1-8 3 © 2025 by the author; licensee asian online journal publishing group based on their intentions. this holistic view underscores the interplay between intentions, decision-making, and the various factors influencing consumer behavior in the purchasing process. 2.2. independent variable: influential factors 2.2.1. product features beneke, flynn, greig, and mukaiwa (2013) examined the perceived value from the perspective of product itself, claiming that value perception regarding product characteristics is critical in the buying process. the perceived product value has significant impacts on relative price and willingness-to-buy. some researchers examined the relationships among the product type, price, and quality, indicating that product characteristics (i.e., quality and price) indeed play a significant role in purchase intention (haryanto, 2014; haryanto, purwanto, dewi, & cahyono, 2019; setiawan & haryanto, 2014). product features are the first concern when consumers reach a product. the product itself and the quality are the most important criteria for consumers to perceive value. however, unlike tangible goods, online financial services are intangible. the quality of online financial services is not the quality of the product itself but the benefits the customers can obtain, perceiving the real value of the financial products as additional income, risk-averse tools, and risk avoidance. therefore, this paper proposed that: h1: product features affect online purchase intention in financial industry. 2.2.2. financial needs technological advancements have significantly enhanced opportunities for the financial industry, transforming the way consumers access financial services. effective financial services play a crucial role in helping customers manage their finances and safeguard against unforeseen circumstances. for instance, the covid-19 pandemic and the need for social distancing have boosted the usage of online financial services. a survey released in 2020 by eset1 showed that in the us, 65% of people use at least one fintech app or platform, and 85% use either banking apps or online banking platforms. another survey released in mid-2020 by kpmg2 highlighted the surge in online access to financial planning services during the lockdown. additionally, a global survey conducted in 2020 by mckinsey3 indicated a global decrease in the use of cash and a simultaneous increase in digital transactions. as consumers expect to increase their reliance on online financial services to improve their financial health that would support their better selves, they seek proactive financial institutions that keep them informed about security investments. the tendency is dramatically increasing the number of online users and the variety of services available provided by the financial institutions. therefore, this paper proposed that: h2: financial needs affect online purchase intention in financial industry. 2.2.3. institutional reputation financial products often possess intricate features that can be challenging for consumers to comprehend fully. in many cases, consumers lack the necessary information to make optimal choices among various options. given the ongoing struggle of consumers to access objective and trustworthy information about available financial products, a crucial avenue for ensuring consumer protection is to furnish them with comprehensive materials that facilitate wellinformed decision-making. the growing call for increased accountability and legitimacy in the financial sector emphasizes the significance of disclosures as a primary means to enhance transparency and, consequently, cultivate trust among consumers. trust is crucial in linking perceived online interactivity to purchase intention (hansen, saridakis, & benson, 2018; jeon, jang, & barrett, 2017). studies have shown that trust in e-commerce enhances online retailers' reputations and positively affects their performance (lópez-miguens & vázquez, 2017; pratono, 2018). reputation significantly influences trust (yahia, al-neama, & kerbache, 2018) with a strong reputation boosting online shopping trust (bleier, harmeling, & palmatier, 2019; chen, huang, & davison, 2017; izogo & jayawardhena, 2018). reputation is reflected in brand and website image, which are easily perceived by consumers. brand affects consumer engagement and subsequently brand trust, while website image impacts perceived security and trust. additionally, concerns about financial security shape consumers' attitudes and trust towards a website. a positive reputation can mitigate perceived risks and foster trust in an online retailer (walsh, schaarschmidt, & ivens, 2017; zhang, ren, wang, & he, 2018). therefore, this study proposed that: h3: institutional reputation affects online purchase intention in financial industry. 2.2.4. government regulations concerning consumer perceptions of the internet as a marketplace, bhatnagar et al. (2000) discovered that online financial services are still perceived as risky instruments, with the perceived risks outweighing the convenience they provide. the risks associated with security and integrity, such as fraud and privacy concerns, may exacerbate without adequate safeguards and regulations. in this context, the role of government regulations becomes pivotal in mediating between consumers and financial institutions. enforcement of laws and regulations serves to hold companies accountable, offering enhanced protection to individuals engaging in financial transactions. this regulatory framework not only instills confidence in consumers but also contributes to the overall integrity and security of online financial services. engaging with online financial services presents a distinct paradigm compared to traditional economic transactions, emphasizing the essential need for consumers to place trust and confidence in both the products and companies involved. the absence of this trust can be viewed as a market failure, prompting the imperative role of regulations in rectifying such shortcomings. regulatory frameworks act as crucial mechanisms, creating an environment that allows consumers to interact with online financial services with increased assurance. by addressing inherent challenges related to trust and confidence, regulations play a pivotal role in fostering a more secure and reliable landscape for consumers in this unique market context (llewellyn, 2005). therefore, this paper proposed that: h4: government regulations affects online purchase intention in financial industry. 1 eset is a global digital security company. refer to https://mma.prnewswire.com/media/1453186/eset_1.pdf?p=pdf. 2 kpmg is a global network of professional firms providing audit, tax and advisory services. refer to https://home.kpmg/au/en/home/media/press-releases/2020/07/fourfifths-consumers-prefer-digital-financial-services-covid-19-study-8-july-2020.html. 3 refer to https://www.mckinsey.com/industries/financial-services/our-insights/a-global-view-of-financial-life-during-covid-19description (optional). asian journal of economics and empirical research, 2025, 12(1): 1-8 4 © 2025 by the author; licensee asian online journal publishing group 2.3. the mediating variable: consumer perception online shopping is often perceived as a venture fraught with uncertainty, primarily hinging on consumers' doubts about whether the purchased product will align with their expectations (bhatnagar et al., 2000). according to the stimulus-organism-response (sor) model, the progression of purchase behavior commences with the product category, leading to psychological adjustments through experiences. positive signals during this psychological shift ultimately influence subjective perceptions, shaping the actual purchase behavior (kawaf & tagg, 2012). applying the sor model to online purchase intention within the financial services sector reveals three pivotal phases: motivation, perception, and decision-making. as customers navigate the complexities of motivation, perception, and decision-making phases, the centrality of consumer perception becomes evident. in the motivation phase, the transparent presentation of product advantages significantly influences how customers perceive online financial products, serving as a potent stimulus for engagement (solomon, bamossy, askegaard, & hogg, 2010). this psychological impact is particularly pronounced during the subsequent perception phase, where critical determinants like institutional features, trust, and perceived institutional assurance play pivotal roles in driving trade on ecommerce platforms (malhotra, sahadev, & purani, 2017; sisson, 2017; sullivan & kim, 2018). the intricate interplay between consumer perceptions shaped by various stimuli has a profound impact on trust-building mechanisms and reputational factors. this influence is particularly pronounced in guiding the final decision phase, offering a nuanced understanding of the cognitive processes steering online purchase behavior within the dynamic realm of the financial sector (bleier, harmeling, & palmatier, 2019; izogo & jayawardhena, 2018). alternatively, the theory of planned behavior (tpb) suggests that purchase intentions are primarily driven by attitudes toward the behavior, subjective norms, and perceived behavioral control (ajzen, 1991). this theory highlights that consumers aim to maximize positive outcomes and minimize negative ones in their decision-making process (kumar & reinartz, 2016). for online purchasing in financial services, consumer perceptions are shaped by external stimuli and internal cognitive processes. these perceptions are influenced by factors such as perceived value, product or service characteristics, financial needs and planning, institutional features, and the overall state of the financial industry. 2.3.1. perceived value perceived value stands out as a pivotal determinant shaping consumer perception towards purchase intentions. in contrast to the traditional mode of shopping, online purchases offer consumers distinct perceived values, encompassing convenience, cost savings, and time efficiency (margherio, 1998). the factors of price fairness and quality assume crucial roles, especially concerning tangible products, influencing perceived value and subsequently impacting repurchase intentions (de toni, eberle, larentis, & milan, 2018). these perceived benefits contribute to heightened customer satisfaction, fostering loyalty over time (curtis, abratt, rhoades, & dion, 2011; howat & assaker, 2013; yu et al., 2014). likewise, positive experiences in financial services enhance consumers' perceived value, establishing a positive correlation between favorable encounters and heightened perceived value. therefore, this study proposed that: h5a–h5d: perceived value has mediating effects of four influential factors (i.e. product feature, financial needs, institutional reputation, and government regulations) on online purchase intention in financial industry. 2.3.2. perceived risk the anticipated fulfillment of a purchase decision is typically met with positive expectations. however, during the selection process, consumers engaging in online transactions for financial products and services often exhibit heightened awareness of potential risks. despite a strong inclination to make a purchase, consumers encounter perceived risks as their purchase intention transitions from potential negative consequences to a realm of uncertainty (stone & grønhaug, 1993). perceived risk, as a comprehensive assessment, involves the subjective evaluation of risks and value judgments (skjong & benedikte, 2001). the determination of purchase intention, prior to product utilization, relies on subjective evaluations that integrate past experiences and judgments of potential losses. when this subjective evaluation is compromised, consumers inevitably experience a sense of disappointment or loss, leading to the incurrence of perceived risk. numerous studies examining online purchases have consistently highlighted the significant negative relationships between perceived risk and purchase intention, examining diverse perspectives such as product evaluation (han & kim, 2017) brand effects (bleier et al., 2019) website reputation (sullivan & kim, 2018) familiarity (gibreel, alotaibi, & altmann, 2018) and social norms (xie, song, peng, & shabbir, 2017). the online financial services offered by the financial industry present a novel way for consumers. consumer decisions to engage in online purchases are influenced by perceived benefits such as convenience, cost savings, and a diverse product range (khatibi, haque, & karim, 2006). nevertheless, in contrast to traditional modes that involve substantial paperwork, conservative customers may associate online purchases with increased risks. research indicates that to encourage more customers to embrace online transactions, financial institutions should mitigate potential risks by emphasizing optimal service quality and providing reassurances to customers (beneke et al., 2013). therefore, this paper proposed that: h6a-h6d: perceived risk has mediating effects of four influential factors (i.e. product feature, financial needs, institutional reputation, and government regulations) on online purchase intention in financial industry. 3. research method 3.1. construct operationalization and questionnaire development the construction of the questionnaire involved a comprehensive literature review and variable discussion to operationalize the constructs. the instrument comprised seven constructs, each measured by three items, resulting in a total of 21 items. a five-point likert scale, ranging from 1 (strongly disagree) to 5 (strongly agree), was employed for participant responses. to ensure the reliability and validity of the measurement model, several criteria were applied, following the guidelines of hair, ringle, and sarstedt (2011). initially, validation required each construct's cronbach’s alpha coefficient to exceed 0.6, ensuring internal consistency. additionally, factor loadings were scrutinized, necessitating standardized values above 0.5. furthermore, the examination encompassed bartlett’s test and the kaiser-meyer-olkin measure of sampling adequacy (kmo-msa). noteworthy bartlett’s test outcomes asian journal of economics and empirical research, 2025, 12(1): 1-8 5 © 2025 by the author; licensee asian online journal publishing group and kmo-msa values surpassing 0.50 were considered indicative of the suitability for factor analysis (kaiser & rice, 1974). convergent validity was assessed using the average variance extracted (ave), with values greater than 0.5 indicating that latent variables could explain more than the average. the final criterion was composite reliability (cr), set at a threshold above 0.7 to confirm the robustness of the shared variance among indicators, aligning with the recommendations of hair et al. (2011). in the structural model, a two-step path analysis was conducted to evaluate the roles of perceived value and perceived risk as mediating variables between the four influential factors and online purchase intention. the first step involved examining the direct effects of each influential factor on online purchase intention using spss amos. the second step assessed the paths between each influential factor and online purchase intention after incorporating perceived value and perceived risk constructs, respectively. indirect effects were examined using the process template, model 4 (hayes, 2017). 3.2. data collection and analysis technique a structured questionnaire was designed and administered by inviting participants to complete an online survey via different social media platforms. in china, 300 questionnaires were disseminated, and 218 responses were deemed sufficient, meeting the minimum sample size requirement of 200 observations. among the 218 valid respondents, 114 were male (52.3%) and 104 were female (45.9%). most respondents were aged 31-40, with a total of 66 (30.03%), and 109 (50.0%) obtained bachelor's degree in college. annual incomes over 200,000 rmb were 54 (24.8%). 4. result and analysis in this study, factor analysis was employed alongside dimension and cronbach’s alpha tests to evaluate the reliability of the survey. table 1 illustrates that all questionnaire items exhibited factor loadings above 0.7 (ranging from 0.713 to 0.841). the majority of cronbach’s alpha coefficients for research items surpassed 0.8 (ranging from 0.808 to 0.893), with only one exception (perceived risk = 0.791), still aligning closely with the generally accepted guideline by hair et al. (2011). moreover, the kmo value (0.894) and bartlett’s test (p < 0.000) both support the utility of factor analysis. consequently, the study aptly concludes that all questionnaire items demonstrated a high level of internal consistency, and their respective factors are suitable for further analysis. table 1. reliability and validity. research items factor loading ave cr cronbach’s α product features 0.792 ~ 0.841 0.665 0.856 0.858 finance needs 0.795 ~ 0.821 0.657 0.852 0.867 institutional reputation 0.777 ~ 0.850 0.661 0.854 0.862 government regulations 0.808 ~ 0.829 0.665 0.856 0.893 perceived value 0.746 ~ 0.836 0.615 0.827 0.808 perceived risk 0.731 ~ 0.801 0.603 0.820 0.791 purchase intention 0.713 ~ 0.826 0.585 0.808 0.845 table 1 reveals that all composite reliability (cr) values fall within the range of 0.808 to 0.856, significantly surpassing the suggested benchmark of 0.5. additionally, the average variance extracted (ave) values for the constructs span from 0.585 to 0.665, surpassing the recommended threshold of 0.5. these findings indicate the acceptability of the measurement model. furthermore, the correlations among the constructs remained below 0.85, signifying the absence of any discriminant validity issues within the model. figure 2. summary of results in hypothesized structural model (standardized). the model fit indices (chi-square/df = 1.042, p-value = 0.335; rmsea = 0.014; gfi = 0.931; agfi = 0.905; cfi = 0.997) are satisfactory. the empirical results in figure 2 show that product feature (β=0.098; p<0.05) have a significant impact on the purchase intention. in addition, financial needs (β=0.113; p<0.05) have a significant impact on the purchase intention. furthermore, both institutional reputation (β=0.086; p<0.05) and government asian journal of economics and empirical research, 2025, 12(1): 1-8 6 © 2025 by the author; licensee asian online journal publishing group regulations (β=0.376; p<0.05) have significant influences on the purchase intention. the outcomes support h1, h2, h3, and h4. table 2. evaluation of the research model. hypothesis/ path estimate t p-value h1: product features à purchase intention 0.098 2.902 0.011 h2: finance needs à purchase intention 0.113 3.506 0.023 h3: institutional reputation à purchase intention 0.086 3.229 0.018 h4: government regulations à purchase intention 0.376 6.424 0.037 mediating effect of perceived value → purchase intention coeff coeff of pv indirect effect h5a: product features 0.2548 0.2594 0.0896 h5b: financial needs 0.1922 0.2813 0.0995 h5c: institutional reputation 0.1936 0.2901 0.0945 h5d: government regulations 0.3157 0.2511 0.0723 mediating effect of perceived risk → purchase intention coeff coeff of pr indirect effect h6a: product features 0.2548 -0.2292 0.0661 h6b: financial needs 0.1922 -0.2278 0.0776 h6c: institutional reputation 0.1936 -0.2253 0.0769 h6d: government regulations 0.3157 -0.1600 0.0554 note: pv: perceived value. pr: perceived risk. in table 2, the indirect effects of the four influential factors on purchase intention, mediated by perceived value and perceived risk, exhibit statistical significance. the confidence intervals for the indirect effects of the two mediators on purchase intention fall within the specified bounds, with 0 lying outside the 95% confidence interval. according to table 2, the mediating effect of perceived value positively influences the relationship between the four influential factors and purchase intention, while perceived risk exerts a negative significant influence on this relationship. as a result, hypotheses h5a – h6d find support in the data. 5. conclusion recent advancements in information technology have led to a substantial rise in online transactions. external factors have significantly contributed to this trend. for instance, the covid-19 pandemic has accelerated the transition toward heightened online purchases, with anticipated enduring effects. this shift has been particularly prominent within financial institutions, where online shopping has now become the predominant norm. nevertheless, despite global managerial efforts to leverage engaging online channels, financial institutions in emerging economies contend with more pronounced issues and challenges compared to their counterparts in advanced markets. 5.1. theoretical implications from an academic viewpoint, this study centers on discerning the intricate relationships between online purchase intention and the mediating factors, such as perceived value and perceived risk, along with the key influencers like product features, financial needs, and institutional reputation. this theoretical lens allows for a deeper comprehension of the mechanisms at play in shaping consumer decisions in the digital financial landscape. more importantly, the incorporation of product category considerations, which most existing research tends to overlook, adds a layer of complexity to theoretical frameworks. this recognition aligns with the evolving nature of consumer behaviors and their multifaceted evaluation processes, contributing to the enrichment of theoretical models within the academic domain. in addition, theoretical exploration also highlights the cognitive aspect of consumer perception by clustering and attributing influential factors as components of consumers' cognitive processes. this theoretical framing aligns with the broader theoretical perspectives on decision-making processes and cognitive frameworks, enriching the understanding of how consumers navigate choices in the online financial realm. 5.2. managerial implications from a pragmatic standpoint, the positive and substantial coefficients revealed in the path analysis connecting online purchase intention through mediating factors with the four influential factors yield four managerial implications. firstly, heightened positive product features correlate with an elevated value perceived by customers. financial institutions should strategize to comprehend the evolution of online products in financial services, facilitating the identification of conditions where specific financial services are in demand and others offer a diverse range of features. targeting product value becomes paramount, maximizing user needs through customer-centric product design. secondly, when product features align with consumer needs, purchasing decisions predominantly hinge on institutional reputation. to instill trust, financial institutions can enhance disclosures to render them more meaningful for consumers, emphasizing product values such as safety, convenience, and swift service. for consumers with limited information or online purchasing experiences in financial services, reputation emerges as a crucial factor influencing purchase intention. consequently, prioritizing brand establishment becomes the foremost task within the financial industry. thirdly, supervision improvement and real-time customer engagement are efficient ways for financial institutions to build up their reputation in the financial industry. for the former, financial institutions either launch initiatives by themselves to improve governance or reluctantly abide by the government regulations, which would help earn reputation (romero, 2003). for the latter, numerous studies showed that establishing consumer’s engagement is beneficial for the company, for it raises corporate reputation (van doorn et al., 2010) and results in a remarkable relationship in the form of commitment, trust, and brand loyalty (brodie, hollebeek, jurić, & ilić, 2011). asian journal of economics and empirical research, 2025, 12(1): 1-8 7 © 2025 by the author; licensee asian online journal publishing group the real-time customer engagement may provide impartial advice that will lead a customer through their journey while building trust in the company’s brand. finally, government regulations can significantly affect the financial industry. the main regulatory body protecting investors from mismanagement and fraud encourages investor confidence and investment. in emerging markets such as china, the financial industry develops lag behind more developed economies largely due to outdated regulations. the situation can be observed from the samples collected in china, where most consumers are not satisfied with the current status of online financial services. governments in emerging markets need to introduce regulatory reforms to promote growth and mitigate risk, including levels of financial inclusion and regulations surrounding financial services. this study encounters three main limitations. firstly, the selected country, china, falls under the category of emerging economies with a substantial population. while the sample size used in the study is appropriate, expanding it could potentially yield different results. additionally, despite china having some of the most advanced online payment systems globally, its financial systems have not been operating optimally, 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(2018). the impact of channel integration on consumer responses in omni-channel retailing: the mediating effect of consumer empowerment. electronic commerce research and applications, 28, 181-193. https://doi.org/10.1016/j.elerap.2018.02.002 asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.1016/j.pubrev.2017.05.003 https://doi.org/10.1108/03090569310026637 https://doi.org/10.1016/j.ijinfomgt.2017.12.008 https://doi.org/10.1177/1094670510375599 https://doi.org/10.1108/jpbm-07-2016-1267 https://doi.org/10.1108/el-08-2015-0141 https://doi.org/10.1016/j.jretconser.2017.10.021 https://doi.org/10.2224/sbp.2014.42.5.757 https://doi.org/10.1016/j.elerap.2018.02.002 124 © 2025 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 12, no. 2, 124-141, 2025 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v12i2.7526 © 2025 by the author; licensee asian online journal publishing group women's empowerment and educational equity: analyzing gendered household education expenditures in cameroon joslanie douanla tameko1,2 ernest alang wung3,4 poutong rais herman5,6 armand mboutchouang kountchou7 ( corresponding author) 1department of mathematical economic, faculty of economics and management, university of dschang, dschang, cameroon. 2tropical forest and rural development, yaounde, yaounde, cameroon. 1,2email: joslanie.douanla@univ-dschang.org 3department of public economic, dschang school of economics and management, faculty of economics and management, university of dschang, dschang, cameroon. 4effective basic services africa, city chemist bamenda, bamenda, cameroon. 3,4email: ernest.alang@univ-dschang.org 5department of development economics, faculty of economics and management, university of dschang, dschang, cameroon. 6ministry of secondary education, cameroon. 5,6email: herman.poutong@univ-dschang.org 7department of public economics, faculty of economics and management, university of dschang, dschang, cameroon. 7email: armand.mboutchouang@univ-dschang.org abstract this study investigates the effect of women’s participation in household decision-making on educational inequalities in cameroon. drawing on data from the fourth cameroonian household survey conducted in 2014 (ecam4) by the national institute of statistics, the analysis employs a two-stage heckman selection model to examine the relationship between women’s decision-making power, measured through their educational attainment, and household expenditure on girls’ education. the results reveal that the gender of the child significantly shapes the distribution of education spending, with boys often receiving a larger share. while women’s involvement in household decision-making shows no significant impact on overall education expenditure across all children, a disaggregated analysis presents a different picture. at the secondary school level, women’s participation in decision-making has a positive and significant effect on household spending for girls, suggesting that maternal influence becomes more pronounced as children progress to higher levels of schooling. moreover, the interaction between women’s decision-making power and girls’ education expenditure shows that such participation increases investment in girls’ education by 17.5%. these findings emphasize that empowering women within households has the potential to reduce gender disparities in education, particularly at the secondary level, where inequalities are often most entrenched. by strengthening women’s decision-making role, policymakers can promote more equitable educational investment, ultimately contributing to longterm progress in narrowing gender inequality. keywords: cameroon, children’s gender, education expenditure, inequality, women’s bargaining power, gender disparities in education, household expenditure, gender equity in schooling. jel classification: a26; b54; i29. citation | tameko, j. d., wung, e. a., herman, p. r., & kountchou, a. m. (2025). women’s empowerment and educational equity: analyzing gendered household education expenditures in cameroon. asian journal of economics and empirical research, 12(2), 124–141. 10.20448/ajeer.v12i2.7526 history: received: 7 august 2025 revised: 8 september 2025 accepted: 22 september 2025 published: 10 october 2025 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. data availability statement: the corresponding author may provide study data upon reasonable request. competing interests: the authors declare that they have no competing interests. authors’ contributions: all authors contributed equally to the conception and design of the study. all authors have read and agreed to the published version of the manuscript. contents 1. introduction .................................................................................................................................................................................... 125 2. literature review .......................................................................................................................................................................... 126 3. methodology ................................................................................................................................................................................... 128 4. results and discussion ................................................................................................................................................................. 133 5. conclusion ....................................................................................................................................................................................... 134 references ............................................................................................................................................................................................ 135 mailto:joslanie.douanla@univ-dschang.org mailto:ernest.alang@univ-dschang.org mailto:herman.poutong@univ-dschang.org mailto:armand.mboutchouang@univ-dschang.org https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v12i2.7526 https://orcid.org/0000-0002-1353-1201 https://orcid.org/0000-0002-5186-9035 https://orcid.org/0000-0002-0678-5932 asian journal of economics and empirical research, 2025, 12(2): 124-141 125 © 2025 by the authors; licensee asian online journal publishing group contribution of this paper to literature this study contributes to the existing literature by providing evidence on the role of women’s decision-making in shaping educational expenditure in cameroon. the paper's primary contribution is finding that women’s participation significantly increases spending on secondary school girls. this study documents a 17.5% rise in girls’ education investment. 1. introduction since the work of schultz (1983); becker and romer (1986); lucas (1988); barro (1991) and barro (1996) contemporary economic analysis of human capital investment has been at the heart of growth strategies in most developing countries. based on the theory of human capital, which was formed by analogy with investment theory, human capital is a material good that can advance and sustain productivity, innovation, and employability (gurgand, 2005; kassé, 2003; lucas, 1988; romer, 1986). nevertheless, education remains the linchpin. it is seen as an investment that rational agents seek to make as profitable as possible, in the knowledge of costs, gains, and the probability of access to employment (becker, 1964; koissy-kpein, 2007). the international community has shown a real interest in this subject. through several declarations and conventions1 on the "right to education" and the "right to equality", it has made education a fundamental right. reiterated in the 2000-2015 millennium development goals and the 2015-2030 sustainable development goals, the latter emphasizes in the fourth, fifth, and tenth goals the importance of reducing inequalities within and between countries and ensuring equitable access to quality education for all individuals (united nations, 2018). however, many economic analyses (anderson & hsiao 1982; boly, 2017; pilon, 1995) following the works of becker (1964) have been based on the unitary model approach, which initially treats the household made up of several decision-makers as a single decision-making cell. this assumes that resources are pooled, that the individuals in the managed household have the same preferences, and that there is a homo economicus individual2 called the "head of household" who makes the decisions, so that the decisions made within the household are made in such a way that everyone in the household benefits from the same level of well-being. this being the case, the interest of individuals in investing or not in education has been linked not only to the weight of financial constraints but also to the decisionmaking behavior of the homo economicus individual. consequently, differential factors of access to education were not only linked to the household environment in relation to the head of household, such as relationship to the head of household, gender of the head of household, marital status, religion, level of education, activity status, type of household, and gender of the child (pilon, 1995; wakam, 2003). but also, certain factors linked to social and economic contexts, such as language and insecurity. however, with recent developments in family economics, particularly the theoretical advances made in the field of household economic representation (arrow, 1951; becker, 1981) the evidence has rejected the pooling hypothesis and demonstrated that household resources are not equitably distributed (amita & basu, 2006; borooah & mckee, 1993; findlay & wright, 1996; haddad, hoddinott, & alderman, 1994; haddad & kanbur, 1990; lazear & michael, 1986; lise & seitz, 2011). and consequently, educational opportunities within the household. moreover, some empirical studies on this subject, focusing on children, have found that their well-being depends on their gender and the sharing of "power" within the household (attanasio & lechene, 2002; duflo, 2003, 2006; gertler & alderman, 1989; haddad et al., 1994; koné, 2002; lucas, 1988; lundberg, pollak, & wales, 1997; a. r. quisumbing & maluccio, 2000; thiombiano, 2014; thomas, 1990) and that there is intra-household inequality in the distribution of resources (bargain, lacroix, & tiberti, 2018; brown, lacroix, & tiberti, 2017; chiappori & donni, 2006; fialová & mysíková, 2021; klasen & lahoti, 2021). from there, non-unitary household models have thus been seen to be more appropriate in explaining the living standards gap encountered within households. in this model, developed from the work of manser and brown (1980); mcelroy and horney (1981) and lundberg and pollak (1996) the household is seen as a place of multiple interests, implying that the individuals in the household have either non-convergent (non-cooperative or strategic models) or convergent (cooperative or collective models) interests; based on the theoretical postulate that each individual in the household must be characterized by his or her own preferences, and that within the household, a vast majority of economic activity takes place and an inestimable number of decisions are made concerning: labour force participation, education, spending, resource accumulation, investment, marriage, and fertility (chiappori & donni, 2006; donni, 2011). based on this approach, studies in both developed and developing countries have shown that women's participation in household decision-making has positive effects on the well-being of the household and children in particular (adhikari, 2015; duflo, 2012; gnoumou, 2014; haddad, hoddinott, & alderman, 1997; qian, 2008; quisumbing, 2003; yusof, 2015). and not only the concept of women's empowerment, which is generally understood as women's ability to formulate, negotiate, and realize their preferences, has thus been highlighted (ghuman, lee, & smith, 2006; smith, ramakrishnan, ndiaye, haddad, & martorell, 2003). but also, women's perception of the opportunity cost of their children, which may not be the same for boys and girls. moreover, despite the growing number of studies on women's empowerment and children's well-being (infant mortality, health, and nutrition), little research has examined the association between women's empowerment and children's education. research using various measures of women's status, such as women's share of household income, their level of education, or the fact that they are heads of household, has shown that women's status has positive effects on school enrollment. and furthermore, it leads to reduced inequalities in spending on education between girls and boys within a household (afridi, 2010; alderman & king, 1998; xiaohui hou, 2016; luz & agadjanian, 2015; saleemi & kofol, 2022). that said, despite all that has been done, the unitary model has proved inadequate in explaining analyses based on "gender" (chiappori & donni, 2006; chiappori & meghir, 2015; de vreyer & lambert, 2018; koissy-kpein, 2007). particularly regarding inequalities in access to children's education and the decision-making process regarding investment in education within households, the collective model approach aims to address this shortcoming by assisting in the implementation of economic policies targeted at individuals and gender (echeverría, menon, perali, & berges, 2019). 1 the 1948 universal declaration of human rights, article 26, and the 1989 international convention on the rights of the child, article 28. 2a homo-economicus individual performs a cost-benefit calculation to maximize household utility and make efficient use of household resources. asian journal of economics and empirical research, 2025, 12(2): 124-141 126 © 2025 by the authors; licensee asian online journal publishing group this is because, despite the significant progress made following the various programs set up to promote quality education for all and to reduce gender inequalities, inequalities in access to education are still being felt around the world. some 258 million children, adolescents, and young people are not in school (unesco institute for statistics, 2019). and in africa, particularly sub-saharan africa, discrimination based on gender, geographical isolation, wealth, disability, and religion continues to accentuate inequalities in education. in 2000, these inequalities represented around 24% of the world's population. by 2018, they had risen to 38%. and because of the incidence of extreme poverty, inequality, and the recent health crisis, the net out-of-school rate for children, teenagers, and young people of primary and secondary school age continues to rise. that is, 31% in 2018 and over 40% in 2022 (unesco institute for statistics, 2019, 2022). and where the risk of being excluded from the education system continues to grow for these disadvantaged people. in the light of the above, and within the context of cameroon, where these educational inequalities are felt (figure 1), our aim in this study, while highlighting the collective model approach, is to examine whether, in households where women participate in decision-making, educational expenditure affects the decision-making process in terms of investment in education. more specifically, we want to examine whether the intra-household distribution of education expenditure between boys and girls depends on women's bargaining power. to this end, this paper will be organized according to four points. in section 2, a literature review will present the theoretical principles of demand within the framework of the "unitary" model, then the "collective" model, and an empirical review of the study. section 3 describes the study's methodological framework. section 4 presents and discusses the main results. section 5 concludes. figure 1. out-of-school rate for primary-age children. 2. literature review 2.1. demand for education in the collective model children's schooling is an investment in human capital, determined by the decision to send their children to school and the incentives parents must bear the costs (pilon, 1995). households spend on education when they expect returns on education in the form of wages or income earned in the future. households therefore, invest in children's education if the return on investment exceeds the costs. however, labor market conditions may differ for men and women. this means that returns on investment in education for boys and girls vary. in the collective (or cooperative) model, consumption expenditure assumes that resource allocation within the household is pareto-optimal. the household's objective function is then written as a weighted sum of individual utilities. following the model developed by browning and chiappori (1998) we consider a household with two individual decision-makers: a man(ℎ) and a woman(𝑓) whose respective utility functions are hu and fu . these functions depend respectively on the consumption of strictly private goods by the man,𝐶ℎ , and the woman,𝐶𝑓 , and on the consumption of public goods 𝑀. here, we will assume that the education of children is considered a public good for the spouses insofar as consumption by one does not alter that of the other. we also assume that everyone’s utility depends on his partner's consumption of goods. this introduces a very general form of altruism, but also externalities in consumption (chiappori & donni, 2006). thus, we can write: 𝑈𝑖 = 𝑈(𝐶ℎ, 𝐶𝑓 , 𝑀) (1) with 𝑖 = ℎ, 𝑓 𝑀𝑎𝑥𝜑 ∗ 𝑈𝑓(𝑞𝑓 , 𝑞ℎ , 𝑀) + (1 − 𝜑) ∗ 𝑈ℎ(𝑞ℎ , 𝑞𝑓 , 𝑀) (2) with0 ≤ 𝜑 ≤ 1 ;𝜑 the woman's bargaining power and(1 − 𝜑) the man's bargaining power. 2.2. exploring the impact of women's empowerment on educational equity: a review of gender dynamics and household decision-making in the 1980s, the question of access to education became the focus of attention in the context of the analysis of educational demand (de vreyer, lambert, & magnac, 1996). and the studies that have tackled it have done so along the lines of how school systems function. in particular, the evolution of school enrolments (by level and by gender) and the evaluation of the system's internal performance (dropouts, repetition, exam success rates, etc.). however, these statistics were silent on the individual and family characteristics of pupils. this was because they were based on the unitary household model approach and concerned only children in school, thus ignoring all those who were not or were no longer at school. as a result, they were in no way able to address the question of educational demand at family level, and in terms of family determinants of schooling (pilon, 1995). but in the 90s, with the growth of studies devoted to the demand for education and especially following the works of becker (1981), which analyzes the asian journal of economics and empirical research, 2025, 12(2): 124-141 127 © 2025 by the authors; licensee asian online journal publishing group behavior of individuals in decision-making processes, while emphasizing the rational behavior of everyone. most studies have focused on the problem of under-schooling, particularly among girls. indeed, because women today are more educated than they were decades ago, and education is considered one of the determinants of women's decision-making within the household (albert & escardíbul, 2017; gnoumou, 2014; rashid & islam, 2012). studies carried out across different countries have shown how improving women's access to household resources and participation in household decision-making has enabled them to make important choices. furthermore, it has increased their empowerment (alkire et al., 2013; prata, sreenivas, & gerdts, 2017; pratley, 2016; upadhyay, gipson, & hindin, 2014). however, research highlighting the relationship between schooling and gender has shown that several factors on both the supply and demand sides could be at the root of the discrimination observed in favor of female children within a household. moreover, since recent developments in family economics, the relationship between women's empowerment, their decision-making within the household, and children's well-being has been widely debated in the literature (fremeaux, 2013; hentati, 2015). and several studies have shown how women's participation leads to changes in household consumption expenditure shares, especially in favor of children's well-being in terms of health, access to education, and nutrition (afridi, 2010; prata et al., 2017; pratley, 2016; soiliou & roushdy, 2009). however, a controversy has arisen in the literature about whether, if women were able to make more decisions within the household, they would make decisions aimed at reducing observed gender inequalities in terms of access to education, nutrition. as it happens, some studies carried out (koissy-kpein, 2007; malapit & quisumbing, 2015; mansuri, 2006; o'hara & clement, 2018; saleemi & kofol, 2022; vaz, pratley, & alkire, 2015) have shown that women's bargaining power, even when favorable to educational investment, does not necessarily lead to a redistribution in favor of girls and therefore has no effect on reducing inequalities in access to education.these include studies by mansuri (2006) in pakistan. where, after demonstrating the positive effects of temporary economic migration by low-skilled workers from developing to industrialized countries on human capital accumulation, she found a very significant reduction in gender inequalities in access to education. she found that in female-headed households, there was no protective effect on girls' school performance. on the contrary, she found that being headed by a woman seemed to protect boys to the detriment of girls. koissy-kpein (2007) who starts from the framework of a "classic" household, made up of father, mother, and children (girls and boys), bases his analysis on a logic rooted in the life cycle and proposes several hypotheses. firstly, he assumes that everyone in the household lives in two periods: adulthood and retirement for parents, and childhood and adulthood for children. secondly, assuming that there is a parent-child contract such that, in the first period, altruistic parents have an income that they devote to consumption and investment in their children's human capital, and in the second period, parents who have left the labour market benefit from financial transfers, the greater the educational investment received in the first period. thirdly, by assuming that within the household, there are two types of goods: private goods assimilated to parental consumption and public goods linked to the quality of children or to their capital investment. and fourthly, educational investment depends solely on household resources. consequently, the analysis is based on the absence of school credit. furthermore, heckman (1979) two-stage estimation procedure enabled him to identify both the elements that motivate participation and those that motivate spending decisions, and blundell and smith (1986) procedure to remedy the correlation problem that may exist in the model. their empirical analysis, based on surveys in ghana, guinea, and côte d'ivoire, shows that the bargaining power of mothers, even when favorable to educational investment, does not necessarily lead to a redistribution in favor of girls. also, some works felt that there was insufficient evidence to support the confirmation that women's empowerment, measured by their participation in household decisions, reduces gender inequalities (saleemi & kofol, 2022). these include vaz et al. (2015) and o'hara and clement (2018) who have in their studies shown how women who have been discriminated against might, in turn, discriminate against or not favor other girls and women in their decisions. and consequently, do not reduce gender inequalities. these studies join that of malapit and quisumbing (2015) carried out in the context of northern ghana; quisumbing and maluccio (2003) in the context of ethiopia, who showed a negative effect of women's bargaining power on girls' education spending. moreover, subramanian and deaton (1991); lancaster, maitra, and ray (2008); azam and kingdon (2013) following the work of kingdon (2005); khan (2008); aslam (2009); aslam and kingdon (2008); zimmerman (2012); jayasundera (2012) and nordman and sharma (2016) have all shown that there is a bias in favour of men in education spending across age groups that differs by location and ethnicity, and furthermore these biases believe with age. in addition, several studies have revealed the positive effect of women's participation in decision-making on reducing inequalities in access to education. these include studies by afridi (2010) in india. whereby apprehending the measure of women's empowerment based on their level of education and independence showed that the empowerment of mothers is associated with a reduction in the gap in the standard of living that exists between their sons and daughters. on the other hand, he found that improving the education of both father and mother increased the educational level of girls more than boys. and that an increase in the mother's level of education is associated with a marked reduction in the difference in educational attainment between sons and daughters. in the same vein, keita (2011) analyzed the impact of women's bargaining power on education spending in mali. his starting point was the fact that, in terms of household decision-making, the unitary model and the collective model are the subject of much debate in the literature regarding their relevance and realism. within the framework of the collective model, he tested the hypothesis that the bargaining power associated with individuals in the household has no effect on the structure and distribution of educational expenditure within the household. however, his results showed that women's decision-making power had a significantly different influence on education spending than men's. keita therefore questioned the validity of this hypothesis. as a result, keita has questioned the relevance of the unitary model in the analysis of household expenditure choices relating to investment in children's human capital. luz and agadjanian (2015) in mozambique show that women's decision-making autonomy is positively associated with the probability of girls' enrolment in elementary school. furthermore, saleemi and kofol (2022) in their study carried out in pakistan, test in the context of pakistan, on a sample of children of primary school age (510 years) and secondary school age (11-16 years) and using (heckman, 1979) selection method whether households where women participate in decisions concerning children's education leads to reduced inequalities in spending on asian journal of economics and empirical research, 2025, 12(2): 124-141 128 © 2025 by the authors; licensee asian online journal publishing group education between boys and girls in the household. and they find that in households where women participate in decision-making, a higher share of education expenditure goes to girls when the distance to school is not long. nordman and sharma (2016) in india, using a collective household model that endogenizes women's bargaining power, assess the effect of women's bargaining power on the share of education expenditure in the household budget. find that women's bargaining power has a positive and significant effect on the share of the household budget devoted to education. it is positively (negatively) associated with education expenditure in urban (rural) areas. depending on the different ethnic groups in urban areas, they also find a positive effect of women's bargaining power on girls' education spending, and a negative effect in rural areas. this result is in line with those of menon, van der meulen rodgers, and nguyen (2014) in viet nam; rangel (2006) who, in brazil, shows a positive effect of women's bargaining power on education spending by first-born girls; quisumbing and maluccio (2003) in bangladesh show a positive effect on girls' spending and xiaohui hou (2016). 3. methodology 3.1. study data and variables 3.1.1. nature and sources of data the data used in this study originate from the fourth cameroon household survey (ecam 4). they were collected by the national institute of statistics (ins) through a questionnaire comprising 17 sections, two of which were optional. this database (bd) is subdivided into three parts: an ecam-household bd, which includes only the head of household (cm); an ecam-individual bd, which considers each household member; and an ecam-product bd, providing detailed information on how products are acquired by each household and the total amount spent on each product. since one of the specific features of the collective model is the integration of each household member in decision-making processes within the household, the ecam-individual database will be used in our analyses. there are three reasons for this choice: first, this database allows us to identify the individual characteristics of each household member (residence status, gender, age, relationship with the head of household, marital status, etc.); second, it provides information on annual or daily expenditure by consumption item (health, education, rent, etc.) and by individual; third, it offers detailed information on the expenditure of each individual within the household, including expenditure on both public and private consumer goods. thus, our study is based on a sample of individuals living in households with children attending school. with a database of 46,559 individuals living in 10,303 households, made up of 48.91% males and 51.09% females, and a predominantly young population with an average age of 23, 15,805 individuals living in 6,353 households were identified as having the characteristics of the study sample, compared with 30,754 individuals living in 3,950 households with children not attending school (see table a1). however, only primary and secondary school children will be included in the specificity analyses. here, we define out-of-school children as those not attending school but of school age. table a1 presents reasons for school non-attendance by age group. younger children (0–5 years) are mostly out of school for being too young, while among ages 5–18, cost, illness, and distance are key factors. for adults (18+), tradition, employment, and "other reasons" dominate, especially beyond 23 years. table a2 shows school attendance by gender and education level. boys slightly outnumber girls across all levels, with the largest gap at primary. overall, 8,162 boys and 7,642 girls are enrolled, indicating relatively balanced but male-leaning participation. also, according to gender, we note that girls are systematically more disadvantaged than boys. in particular, 16,127 female children compared with 14,591 male children. nevertheless, three types of households were identified in the database. these are unipersonal households, singleparent households, and nuclear households, which are made up of either a male spouse or a female spouse3 or one, two, three or four female spouses. we note that the study sample includes more than 50% of monogamous nuclear households. that is, 56.65%. also, many households are headed by a man. that is over 71.1%. however, in this study, children considered to be participants in the education system are those with education expenses greater than 0. these expenses will be observable only in households whose parents are willing to participate in their children's schooling. 3 the household structure was only observed in polygamous households where the wife was considered the head of household. asian journal of economics and empirical research, 2025, 12(2): 124-141 129 © 2025 by the authors; licensee asian online journal publishing group table 1. descriptive statistics for the study sample. variable observation frequencies percentage mean std. dev. min. max. presentation of the study sample sex male 46553 22768 48.91 0.489 0.5 0 1 female 46553 23785 51.9 0.511 0.5 0 1 age 46559 22.667 18.995 0 99 age group [0-3] 46559 4070 8.74 0.087 0.282 0 1 [3-5] 46559 4561 9.80 0.098 0.297 0 1 ]5-11] 46559 7989 17.16 0.172 0.377 0 1 ]11-18] 46559 7251 15.57 0.156 0.363 0 1 ]18-23] 46559 4242 9.11 0.091 0.288 0 1 [23 and +] 46559 18446 39.62 0.396 0.489 0 1 household characteristics household size 46559 10303 22.13 0.221 0.415 0 1 number of households with children in school 10303 6353 61.66 0.617 0.486 0 1 gender of child attending school girls in school 15805 7643 48.36 0.483 0.5 0 1 boys in school 15805 8162 51.64 0.516 0.5 0 1 children in school (yes=1) 46559 15809 100 0.34 0.474 0 1 individuals enrolled by age group individuals aged [0-3] 15809 3 0.01 0 0.014 0 1 individuals aged [3-5] 15809 1398 3.00 0.088 0.284 0 1 individuals aged [5-11] 15809 6568 14.11 0.415 0.493 0 1 individuals aged [11-18] 15809 5784 12.42 0.366 0.482 0 1 individuals aged [18-23] 15809 1859 3.99 0.118 0.322 0 1 individuals aged [23 and +] 15809 197 0.42 0.012 0.111 0 1 individuals enrolled by level of education and age group individuals aged [0-3] preschoolers 15808 3 0.01 0.000 0.014 0 1 individuals aged [3-5] preschoolers 15808 844 1.81 0.053 0.225 0 1 individuals aged [3-5] in primary school 15808 554 1.19 0.035 0.184 0 1 individuals aged [5-11] preschoolers 15808 125 0.27 0.008 0.089 0 1 individuals aged [5-11] enrolled in primary school 15808 6108 13.12 0.386 0.487 0 1 individuals aged [5-11] enrolled in junior high school 15808 334 0.72 0.021 0.144 0 1 individuals aged [11-18] in primary school 15808 1725 3.70 0.109 0.312 0 1 individuals aged [11-18] enrolled in junior high school 15808 3155 6.78 0.2 0.4 0 1 individuals aged [11-18] enrolled in upper secondary school 15808 864 1.86 0.055 0.227 0 1 individuals aged [11-18] in higher education 15808 40 0.09 0.003 0.05 0 1 individuals aged [18-23] attending primary school 15808 35 0.08 0.002 0.047 0 1 individuals aged [18-23] enrolled in junior high school 15808 375 0.81 0.024 0.152 0 1 individuals aged [18-23] enrolled in upper secondary school 15808 1020 2.19 0.065 0.246 0 1 individuals aged [18-23] in higher education 15808 429 0.92 0.027 0.162 0 1 asian journal of economics and empirical research, 2025, 12(2): 124-141 130 © 2025 by the authors; licensee asian online journal publishing group variable observation frequencies percentage mean std. dev. min. max. individuals aged [23 and +] enrolled in junior high school 15808 20 0.04 0.001 0.036 0 1 individuals aged [23 and +] enrolled in upper secondary school 15808 72 0.15 0.005 0.067 0 1 individuals aged [23 and +] with tertiary education 15808 105 0.23 0.007 0.081 0 1 household type one-person household 46559 1872 4.02 0.04 0.196 0 1 single-parent household 46559 12972 27.86 0.279 0.448 0 1 nuclear household 46559 31715 68.12 0.681 0.466 0 1 household type by marital status one-person household 46559 1872 4.02 0.04 0.196 0 1 single-parent household 46559 12972 27.86 0.279 0.448 0 1 nuclear household with a male spouse 46559 818 1.76 0.018 0.131 0 1 nuclear household with a female partner 46559 26377 56.65 0.567 0.496 0 1 nuclear household with two female spouses 46559 3343 7.18 0.072 0.258 0 1 nuclear household with three wives as partners 46559 845 1.81 0.018 0.133 0 1 nuclear household with four wives as partners 46559 332 0.71 0.007 0.084 0 1 gender of head of household male head of household 10303 7323 .711 0.711 0.453 0 1 female head of household 10303 2980 .289 0.289 0.453 0 1 gender of spouse of head of household male spouse of household head 5900 137 0.29 0.023 0.151 0 1 spouse of head of household 5900 5763 12.38 0.977 0.151 0 1 sex of head of household educated . male head school-educated household 10303 218 0.47 0.711 0.453 0 1 female head of household 10303 102 0.22 0.289 0.453 0 1 gender of spouse of head of household educated male spouse of head of household educated 5900 0.023 0.151 0 1 spouse of the head of household in school 5900 80 1 0.977 0.151 0 1 activity income per individual 46559 21311031 4.744 0 2.000 household income 46559 1.493 1.531 0 3.000 asian journal of economics and empirical research, 2025, 12(2): 124-141 131 © 2025 by the authors; licensee asian online journal publishing group thus, out of a total of 15,809 children enrolled in school, we still note a bias in favor of men, with 8,162 boys enrolled versus 7,643 girls. however, these reasons and findings do not point us in the direction of factors that might explain the existence of gender gaps in education spending. 3.1.2. variable definition table 1 shows the descriptive statistics of the study variables. in this study, to test whether households where women participate in child-rearing decisions incur more equal expenditure on boys' and girls' education, three types of variables will be addressed at this level. firstly, the dependent variable is represented here by "education expenditure." the choice of this variable is due to the objective of this study, which is to examine whether the intrahousehold distribution of education expenditure between boys and girls depends on women's bargaining power, thus necessitating education expenditure. this variable is made up of the amount of enrollment fees, school fees, pta/pta fees, and others. according to official school ages by education level in cameroon, children aged 4 to 5 are considered to be enrolled in pre-primary education; children aged 6 to 11 are considered to be enrolled in primary education; children aged 12 to 18 are considered to be enrolled in secondary education; and children aged 19 to 23 are considered to be enrolled in tertiary education (unesco institute for statistics, 2022). education expenditure is a function of the class attended, the school and socio-economic factors on the one hand, and parents' motivation to participate in their children's schooling on the other, as highlighted by patel, saxena, and kumar (2007). and we find in the database that education expenditure is greater than zero, representing children in school, and education expenditure is equal to zero for children of school age who are not in school, and children who have never been to school. however, the logarithm of education expenditure will be used in this study. secondly, the independent variable whose main variable used is the woman's bargaining power. given the overlapping nature of the keywords (opportunity, choice, control, and power), a diversity of viewpoints develops around the concept of women's empowerment. it most often refers to women's ability to make decisions and influence their own well-being and that of their families (malhotra, schuler, & boender, 2002). this definition is in line with that proposed by kabeer (2001) who suggests that women's empowerment refers to the development of individuals' ability to make strategic life choices in a context where this ability was previously denied to them. in this study, women's participation in household decision-making is used as an indicator of empowerment. there are several reasons for this choice. these include: the difficulties encountered when using indirect measures, which make it difficult to separate the causal factors and consequences of empowerment (branisa, klasen, & ziegler, 2013; ferrant & tuccio, 2015; saleemi & kofol, 2022; sundström, paxton, wang, & lindberg, 2017); and because studies have consistently found that three factors, including women's participation in the labor market, women's education and household decision-making, influence women's empowerment (phan, 2016). so, it turns out that the distribution of household decision-making power often reflects a balance of power within the household and has important implications for the well-being of household members (haddad & potvin, 2008; lamidi, 2016). indeed, in literature, two types of measurement have been proposed as indicators of women's decision-making power. direct measures, captured from a set of questions that were asked to women (allendorf, 2007; connelly, roberts, & zheng, 2010; hou, 2015; hou & ma, 2012; mabsout & van staveren, 2010). and indirect measures including several indicators have been used to capture women's decision-making power (branisa et al., 2013; ferrant & tuccio, 2015; sundström et al., 2017). thus, basu (2006) and doss (2013) uses the woman's level of education relative to that of the man as an indicator of decision-making power. quisumbing (1994) and thomas, contreras, and frankenberg (1999) propose the proportion of assets contributed by the woman at marriage. frankenberg and thomas (2001) consider the social status of the woman's parental family. however, the most criticized measure is that proposed by hoddinott and haddad (1995); lancaster, maitra, and ray (2004); koissy-kpein (2007) and yusof and duasa (2010). it refers to the share of women's income in total household income. given that we do not have direct questions in our database that capture women's participation in household decision-making, and that the indicator "share of income" has been criticized as a measure in developing countries on the grounds that most women in these countries would have bargaining power equal to their income-generating activities due to their limitations in such activities (basu, 2006). so, in this study, the indicator used to measure women's empowerment is "level of education". yet this variable is seen as a factor influencing women's participation in decision-making within the household (gnoumou, 2014). and it has been proven in the literature that consumption decisions frequently include measures of women's education. for educated women, it is thought that they consume different goods and categories of goods than uneducated women. additionally, education affects a woman's external possibilities and, therefore, her bargaining power. but then again, it has been shown that the higher a woman's level of education relative to that of the man, the greater her chances or possibilities of making decisions within the household (afridi, 2010; doss, 2013; gnoumou, 2014). thus, on this basis, we generated a dummy variable "woman's bargaining power" which takes the value 0 when the woman (female head of household or female spouse) has a lower level of education than the man, and 1 if the woman has a level of education equal to or higher than that of the man. in total, 76.26% of women were identified as having bargaining power, and it turns out that women likely to have more bargaining power are found in monogamous nuclear households (see table a3). and then, to observe the relevance of our "bargaining power" variable (see table a4), a correlation analysis was carried out between the "bargaining power" variable and the factors that determine women's participation in household decision-making. these include age; education; father's education; economic activity; individual income from economic activity; socio-professional category; place of residence; and household standard of living (gnoumou, 2014; jayasundera, 2012; lamidi, 2016; thomas & frankenberg, 2003). table a4 presents the proportion of women with bargaining power across different household types. the results indicate that women in single-parent households (23.71%) and nuclear households with a female partner (39.02%) are more likely to have decision-making power compared to those in one-person (3.72%) or male-partner households (1.24%). overall, bargaining power is highest in nuclear female-partner households (56.65%). asian journal of economics and empirical research, 2025, 12(2): 124-141 132 © 2025 by the authors; licensee asian online journal publishing group and from the results table 2, we find that bargaining power is significantly correlated at 10% with income, age, place of residence, socio-professional category, and significantly uncorrelated with father's education. it is uncorrelated and insignificant with standard of living. table 2. correlation analysis of bargaining power. variables (1) (2) (3) (4) (5) (6) (7) (1) trading power 1.000 (2) individual income 0.003 1.000 (0.563) (3) age 0.039* 0.039* 1.000 (0.000) (0.000) (4) place of residence 0.054* 0.000 -0.010* 1.000 (0.000) (0.915) (0.028) (5) standard of living -0.003 -0.002 -0.004 -0.202* 1.000 (0.497) (0.667) (0.334) (0.000) (6) socio-professional category 0.045* -0.021* -0.140* 0.317* -0.086* 1.000 (0.000) (0.003) (0.000) (0.000) (0.000) (7) father's education -0.248* -0.018 -0.268* -0.203* 0.042* -0.206* 1.000 (0.000) (0.124) (0.000) (0.000) (0.000) (0.000) note: standard errors in parentheses, * p<0.1 respectively are the significant levels at 1%, 5% and 10%. and finally, as control variables, we will briefly consider: household income, which is a factor determining children's enrollment in school; household size; number of children enrolled in the household; sex ratio4 of children enrolled in the household, which seeks to capture the sex ratio of children enrolled in school; place of residence, which generally reflects special inequalities, as it is a factor affecting individuals' chances of gaining access to an organization of production and the equitable distribution of goods in the national space; the household's standard of living (poor or non-poor); the gender of the head of household; the number of children in the household; age; the number of members of the household who work; the religion of the head of household; the parents' occupational status (working or non-working); the family relationships, which are factors influencing the decision to send children to school; and the type of household, which informs us about the structure of the household (monogamous or polygamous family). as for the selection variables, we could have simply used the reasons given for not sending children to school. however, due to the lack of information in the database to capture these reasons, we opted for other variables that can influence the decision to send a child to school. these include kinship, household type, household income, and household size. the choice of the kinship variable was made under the pareto-efficient hypothesis of the managed collective model. where gupta (2017) demonstrates the inefficiency of the pareto hypothesis in consumption (expenditure) decisions of households with other related individuals. for the household type variable, in family economics this variable is found to be determinant in children's spending decisions. marital status has been shown to play an important role in children's household spending (deleire & kalil, 2005; hentati, 2015; manning & lichter, 1996). household income is recognized as the variable that influences the decision to send children to school within the household (pilon, 1995). 3.2. estimation technique finally, to analyze the effects of women's participation in decision-making on education spending on girls and boys, we will first estimate a selection model to limit the selection bias arising from the fact that the phenomenon under study is observed under certain conditions5 . thus, using the two-stage estimation procedure proposed by heckman (1979) which will enable us to identify both the elements that motivate participation in schooling and those that motivate educational expenditure decisions, and consider the possibility of correlation between the unobservable terms of the participation equation and the expenditure equation. we will therefore formalize the econometric equation itself, which will enable us to determine whether women's bargaining power influences education spending in favor of girls. given our context and our database, three types of equations will be formalized. one provides an overview of the relationship between bargaining power and expenditure on children's education at all levels. the second pertains to expenditure on primary-school children. the third concerns spending on children in secondary school (lower secondary and upper secondary). in contrast to studies that focus solely on official ages to estimate educational attainment, this study focuses exclusively on children's educational attainment. this choice is due to our database including children of different ages by level of education. furthermore, by focusing our analyses on official ages by level of education in cameroon, our sample will be reduced by more than 50% from an estimated study sample of 15,804 school-going individuals. according to heckman's selection equation. we assume that in a household t parents decide to spend 𝐷𝑒𝑝𝑒𝑑𝑢𝑐𝑖 on the child's schooling i given by the equation: 𝐷𝑒𝑝𝑒𝑑𝑢𝑐𝑖,𝑡,𝑗 = 𝜌1𝑋𝑡 + 𝜌2𝐶𝑖,𝑡,𝑗 + 𝜌3𝑇𝑦𝑝𝑒𝑚𝑒𝑛𝑎𝑔𝑒𝑡 + 𝜌4𝐿𝑖𝑒𝑛_𝑝𝑎𝑟𝑒𝑛𝑡é𝑡 + 𝜌5lnrevenu +𝜌6membre_actifmenage + 𝜀𝑡 (1) with𝑋𝑡 the socio-demographic characteristics of the t household (household size, number of children in the household, parents' employment status, religion of the head of household, area of residence, household standard of living, sex ratio of girls to boys in the household, number of working members of the household, sex of the head of household); 𝐶𝑖,𝑡 the socio-demographic characteristics of the child i in the household t (age, sex,); 𝑇𝑦𝑝𝑒𝑚𝑒𝑛𝑎𝑔𝑒𝑡𝐿𝑖𝑒𝑛_𝑝𝑎𝑟𝑒𝑛𝑡é𝑡 lnrevenu and membre_actifmenage represent respectively the type of household, the child's relationship, the logarithm of household income and the number of active members in the household t . of these four variables, household type and child relationship are uncorrelated with each other (table a5) but are all 4 the sex ratio is represented here as the ratio of school-going boys to school-going girls in a household, multiplied by 100. a value of over 100 would mean that more boys than girls attend school in the household. and less than 100 means that, within the household, more girls than boys attend school. 5 for our dependent variable (education expenditure), missing values represent either school-age children who are not in school, or children who have never been to school. asian journal of economics and empirical research, 2025, 12(2): 124-141 133 © 2025 by the authors; licensee asian online journal publishing group more correlated with the motivation to participate in schooling than with the decision to spend on education. and t the error term, which follows a normal distribution n (. σ1). on the other hand, considering the probability of schooling in our selection equation, there are two possibilities given by equation 2. 𝐷𝑒𝑝𝑒𝑑𝑢𝑐𝑖,𝑡,𝑗 = { 𝐷𝑒𝑝𝑒𝑑𝑢𝑐𝑖,𝑡,𝑗=𝜌1𝑋𝑡+𝜌2𝐶𝑖,𝑡,𝑗+𝜌3𝑇𝑦𝑝𝑒𝑚𝑒𝑛𝑎𝑔𝑒𝑡+𝜌4𝐿𝑖𝑒𝑛_𝑝𝑎𝑟𝑒𝑛𝑡é𝑡+ 𝜌5lnrevenu +𝜌6membre_actifmenage + 𝜀𝑡≤0 𝐷𝑒𝑝𝑒𝑑𝑢𝑐𝑖,𝑡,𝑗=𝜌1𝑋𝑡+𝜌2𝐶𝑖,𝑡,𝑗+𝜌3𝑇𝑦𝑝𝑒𝑚𝑒𝑛𝑎𝑔𝑒𝑡+𝜌4𝐿𝑖𝑒𝑛_𝑝𝑎𝑟𝑒𝑛𝑡é𝑡+ 𝜌5lnrevenu +𝜌6membre_actifmenage + 𝜀𝑡>0 (2) with 𝐷𝑒𝑝𝑒𝑑𝑢𝑐𝑖,𝑡 = 1 if the parent participates in the child's schooling. and 𝐷𝑒𝑝𝑒𝑑𝑢𝑐𝑖,𝑡 = 0 if the parent is not involved in the child's schooling. however, according to the education expenditure of each child and the education expenditure of girls, we find that the variables kinship ties; single-parent households; households in which men are considered spouses; and monogamous nuclear households are positively correlated and significant at the level of single-parent households. additionally, the decision to spend on education is favorable on the one hand to children and girls living in singleparent households; unipersonal households (female heads who attend school); households where men are considered spouses; and monogamous nuclear households, and on the other hand to children and girls who are related to the head of household (tables a5 and a6). in contrast to the decisions concerning boys' education expenditure, the variables kinship; single-parent households; households with male spouses; and monogamous nuclear households are found to be uncorrelated and significant in single-parent households. more specifically, boys in these households are found to be disadvantaged and much more expressive in single-parent households (table a7). to this end, educational expenditure is only observed when the child is participating in the schooling system. given that children of different ages are found at different levels of education, the econometric equation considers the index, which captures the level of education. then, following the model developed by saleemi and kofol (2022) the equation itself, which captures the effects of women's participation in decision-making on education spending, is given by equation 3. 𝐷𝑒𝑝𝑒𝑑𝑢𝑐𝑖,𝑡,𝑗(𝐷𝑒𝑝𝑒𝑑𝑢𝑐 = 1) = 𝛽0 + 𝛽1𝑓𝑖𝑙𝑙𝑒𝑖,𝑡,𝑗 + 𝛽2𝜃𝑀,𝑡 + 𝛽4𝜃𝑀,𝑡 ∗ 𝑓𝑖𝑙𝑙𝑒𝑖,𝑡,𝑗 + 𝛽5𝑋𝑡 + 𝛽6𝐶𝑖,𝑡,𝑗 + 𝜇𝑡 (3) with the variable sex of children in school, which is a dummy variable that is either girl or boy; the coefficient estimate𝛽4 which captures the impact of women's participation in decision-making on girls' education expenditure;𝜃𝑀,𝑡 captures the woman's bargaining power; 𝐶𝑖,𝑡,𝑗are the characteristics of the child i of educational level j and living in the household t ;𝑋𝑡 the socio-economic characteristics of the household, t 𝜇𝑡 the error term and𝑗 = 1,2,3 assuming that we will have at the end 3 equations of the econometric equation 3. 4. results and discussion as per the result, the first line of table 3 shows that the gender of the child in school has a significant effect on the distribution of education expenditure within the household, and that girls who are generally in school receive a 23.9% lower share of education expenditure than boys who are in school. by level of education, we find that unlike secondary-school girls, primary-school girls receive lower shares of education expenditure than boys. that is, 36.3% versus 10.9% respectively. what’s more, when we estimate the effect of women’s bargaining power on the share of education expenses for all children in school (primary, secondary, and tertiary), we find that women’s involvement in household decision-making had no significant effect on the distribution of children’s education expenses. but when we estimate the results separately for primary and secondary school children, we find that women’s involvement in household decision-making had significant effects on education expenditure. when analyzing the relationship between women's bargaining power and the sex of the child enrolled in school, we assessed the effect of women's participation in decision-making on household expenditure shares for girls' education. overall, women's participation in household decision-making has a positive and significant effect at the 10% level on girls' share of education expenditure. this indicates that women's involvement in decision-making increases girls' share of education expenditure by 17.5%. by level of education, we find that for primary school children, women's involvement increases girls' share of primary school expenditure by 26.9%. conversely, for secondary school children, women's involvement in household decision-making was not favorable to secondary school girls; instead, it resulted in a 10.1% increase in the share of secondary school boys. these results further explain the findings related to the sex ratio. a positive and significant sex ratio suggests an increase in the woman's threat point, implying that household decisions are aligned with the woman's preferences. thus, our results seem to diverge from the literature. on the one hand, we found that women's participation in household decision-making is favorable to girls and therefore helps to reduce the educational inequalities that exist between boys and girls in cameroonian households. this result thus corroborates studies conducted by afridi (2010); luz and agadjanian (2015) and saleemi and kofol (2022). on the other hand, when we estimate the results separately for primary and secondary school children, we find women's participation in household decision-making is favorable for primary school girls and but favorable for secondary school boys. as a result, it turns out that women's bargaining power, while favorable to girls' investment in education, does not necessarily lead to a redistribution in favor of secondary school girls. table a8 presents the correlation between girls’ educational expenditure and household selection factors. the results show weak but significant correlations between expenditure and household structure, such as negative associations with one-person and polygynous households, while revenue and active household membership exhibit positive correlations. these patterns suggest that household composition and economic activity influence spending on girls’ education. what's more, when we examined the control variables, we found that the religion of the head of household, the number of working members in the household, the rural area, and the number of children in the household are factors that do not favor children's education. asian journal of economics and empirical research, 2025, 12(2): 124-141 134 © 2025 by the authors; licensee asian online journal publishing group table 3. two-stage heckman results. log education expenditure all children primary school children secondary school children schoolchildren (girls=1) -0.239*** (0.083) -0.363*** (0.077) 0.109** (0.05) women's bargaining power (yes=1) -0.032 (0.16) -0.705** (0.325) 0.367*** (0.134) bargaining power of woman*daughter (yes=1) 0.175* (0.096) 0.269*** (0.091) -.0101* (0.056) assets 0.302*** (0.055) 0.167** (0.075) 0.225*** (0.06) gender of head of household female head of household 0.223*** (0.028) 0.194*** (.037) 0.101*** (0.033) father's education (yes=1) 0.654*** (0.065) 0.503*** (0.081) 0.432*** (0.082) household standard of living not poor 0.004 (0.046) 0.014 (0.057) 0.034 (0.055) religion of head of household -0.106*** (0.015) -0.125*** (0.018) -0.027 (0.018) number of working household members -0.003 (0.009) -0.005 (0.012) -0.018* (0.01) place of residence rural -0.855*** (0.05) -1.006*** (0.067) -0.256*** (0.058) number of children in household -0.092*** (0.009) -0.09*** (0.014) -0.04*** (0.01) age 0.133*** (0.005) -0.027*** (0.01) 0.055*** (0.009) sex ratio 0.00041* (.00022) 0.001** (0.00027) -0.0001 (0.00024) constant 9.1*** (0.326) 12.123*** (0.589) 9.602*** (0.375) selection equation household type single-parent household 1.396*** (0.229) 4.603*** (0.094) 1.156*** (0.305) nuclear household with a male partner 1.417*** (0.24) 4.542 1.256*** (0.318) monogamous nuclear household 1.366*** (0.229) 4.588*** (0.092) 1.126*** (0.304) nuclear household with two spouses 1.181*** (0.233) 4.489*** (0.1) 0.862*** (0.31) nuclear household with three wives 1.047*** (0.242) 4.329*** (0.123) .822** (.322) nuclear household with four spouses 0.901*** (0.249) 4.322*** (0.134) .377 (.342) relationship to head of household 0.07*** (0.004) .055*** (.004) .068*** (.005) household size 0.056*** (0.003) .052*** (.003) .016** (.006) log household income 0.017*** (0.005) .017*** (.006) .046*** (.004) constant -3.129*** (0.234) -6.523*** (0.114) -3.314*** (0.31) lambda -0.696*** (0.142) -0.852*** (0.252) -0.383*** (0.137) comments 20291 18886 17983 selected observations 3641 2236 1333 note: standard errors in parentheses, *** p<0.01, ** p<0.05, * p<0.1 respectively are the significant levels at 1%, 5% and 10%. on the other hand, economically active parents, female-headed households, and educated fathers do favor children's schooling. following the selection equation, we also find that household type, household size, household income, and relationship to the head of household have positive and significant effects on spending on children's education. this implies that they influence parents' motivation to participate in the children's school system. 5. conclusion inscribed in the context of the collective model, which highlights the influence of individual preferences (parents) in the decision to invest in children within households, this article examines the effect of women's participation in household decision-making on educational inequalities in cameroon. the analysis utilizes data from the fourth cameroonian household survey conducted by the national institute of statistics in 2014 (ecam4). heckman's twostage selection model was employed to analyze the interaction between women's decision-making power and educational spending on girls. women's decision-making power was measured by women's level of education. the study considered various control variables, including the number of children attending school in the household; the sex ratio; the area of residence; the household's standard of living (poor or non-poor); the gender of the head of household; the number of children in the household; age; the number of working members in the household; the religion of the head of household; and the parents' employment status (working or non-working). additionally, asian journal of economics and empirical research, 2025, 12(2): 124-141 135 © 2025 by the authors; licensee asian online journal publishing group household type; relationship to the head of household; income; and household size were used as selection variables affecting parents' decision to send their children to school. our results show that the gender of the child attending school has a significant effect on the distribution of education expenditure within the household, and that girls attending school generally receive a lower share of education expenditure than boys attending school. on the other hand, we find that women's involvement in household decision-making has no significant effect on the distribution of child-rearing expenditure. however, when we estimate the results separately for primary and secondary school children, we find that women's involvement in household decision-making has a significant effect on education expenditure. regarding the interaction between women's decision-making power and education spending on girls, we observe that women's participation in household decision-making increases girls' share of education spending by 17.5%. consequently, women's involvement in household decision-making helps to reduce gender inequality. additionally, by level of education, the results reveal that for primary school children, women's involvement in household decision-making increases primary school girls' share of expenditure by 26.9%. however, this was not the case for secondary school girls. for secondary school boys, the increase is 10.1%. so, given that women today are better educated than they were decades ago, and that the vision of the role played by women in society has changed, this study, like many others, has shown the importance of women holding decisionmaking power in households. especially as women's decision-making power is associated with girls' school enrollment and is important for policy design. consequently, given that in today's societies, individuals are governed by future utility-maximizing behaviors, emphasis must be placed on empowering women for the intergenerational transfer of gender equality in education. therefore, women's empowerment is a key element in policies to combat gender inequality. references adhikari, r. 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(2012). reconsidering gender bias in intrahousehold allocation in india. journal of development studies, 48(1), 151–163. appendices table a1. individuals not attending school by age group and reason for attendance. variable obs freq gender mean std. dev min. max. male female out-of-school individuals by age group and reasons individuals [0-3] not enrolled due to high cost 30720 20 11 9 0.001 0.026 0 1 individuals [0-3] not attending school due to illness 30720 6 3 3 0 0.014 0 1 individuals [0-3] not in school because away from school 30720 5 2 3 0 0.013 0 1 individuals [0-3] not in school because too young 30720 1246 654 592 0.041 0.197 0 1 individuals [0-3] not in school due to tradition 30720 13 5 8 0 0.021 0 1 individuals [0-3] not attending school for other reasons 30720 2771 1377 1393 0.09 0.286 0 1 individuals [3-5] out of school due to high cost 30720 94 49 45 0.003 0.055 0 1 individuals [3-5] not attending school due to illness 30720 21 6 15 0.001 0.026 0 1 individuals [3-5] not in school because far from school 30720 49 22 27 0.002 0.04 0 1 individuals [3-5] not in school because too young 30720 1819 980 839 0.059 0.236 0 1 individuals [3-5] not in school due to tradition 30720 39 19 20 0.001 0.036 0 1 individuals [3-5] not attending school for other reasons 30720 1117 585 532 0.036 0.187 0 1 individuals [5-11] out of school for elevate cost 30720 96 45 51 0.003 0.056 0 1 individuals [5-11] not in school because apprentices/employees 30720 25 13 12 0.001 0.029 0 1 individuals [5-11] not attending school due to illness 30720 33 15 18 0.001 0.033 0 1 individuals [5-11] not in school because far from 30720 66 38 28 0.002 0.046 0 1 https://doi.org/10.1007/s11205-015-0876-y https://doi.org/10.1016/j.socscimed.2016.08.001 https://doi.org/10.3329/agric.v9i1-2.9488 https://doi.org/10.1086/261420 https://doi.org/10.1016/j.wdp.2022.100395 https://doi.org/10.1142/s1793812009000036 https://doi.org/10.2307/145670 https://doi.org/10.1080/13545701.2015.1108991 asian journal of economics and empirical research, 2025, 12(2): 124-141 138 © 2025 by the authors; licensee asian online journal publishing group school individuals [5-11] not in school because too young 30720 415 195 220 0.014 0.115 0 1 individuals [5-11] not in school due to tradition 30720 110 40 70 0.004 0.06 0 1 individuals [5-11] not attending school for other reasons 30720 676 339 337 0.022 0.147 0 1 individuals [11-18] out of school for eleve cost 30720 73 27 46 0.002 0.049 0 1 individuals [11-18] not attending school because apprentices/employed 30720 30 17 13 0.001 0.031 0 1 individuals [11-18] out of school due to illness 30720 27 15 12 0.001 0.03 0 1 individuals [11-18] not in school because away from school 30720 55 22 33 0.002 0.042 0 1 individuals [11-18] not in school because too young 30720 32 20 12 0.001 0.032 0 1 individuals [11-18] not in school due to tradition 30720 165 42 123 0.005 0.073 0 1 individuals [11-18] not attending school for other reasons 30720 1085 466 619 0.035 0.185 0 1 individuals [18-23] out of school due to high cost 30720 57 20 37 0.002 0.043 0 1 individuals [18-23] not in school because apprentices/employed 30720 12 3 9 0 0.02 0 1 individuals [18-23] not attending school due to illness 30720 13 9 4 0 0.021 0 1 individuals [18-23] not in school because far from school 30720 36 7 29 0.001 0.034 0 1 individuals [18-23] not in school because too young 30720 11 1 10 0 0.019 0 1 individuals [18-23] not in school due to tradition 30720 173 29 144 0.006 0.075 0 1 individuals [18-23] not attending school for other reasons 30720 2081 902 1179 0.068 0.251 0 1 individuals [23 and +] out of school due to high cost 30720 393 161 232 0.013 0.112 0 1 individuals [23and+] not in school because apprentices/ employees 30720 87 35 52 0.003 0.053 0 1 individuals [23 and +] not attending school due to illness 30720 61 27 34 0.002 0.045 0 1 individuals [23 and +] not in school because away from school 30720 372 153 219 0.012 0.109 0 1 individuals [23 and +] not in school because too young 30720 38 17 21 0.001 0.035 0 1 individuals [23 and +] not in school due to tradition 30720 2368 639 1729 0.077 0.267 0 1 individuals [23 and +] not attending school for other reasons 30720 14930 7581 7348 0.486 0.5 0 1 table a2. gender of individuals by level of education. gender of children attending school study level out of school primary secondary 1st cycle secondary 2nd cycle superior total boys in school 478 4338 1992 1050 304 8162 girls in school 494 4082 1890 906 270 7642 total 972 8420 3882 1956 574 15804 table a3. gender of individuals attending school by age group and level of education. scilarized individual by levelgroup individual level of education out of school primary secondary 1st cycle secondary 2nd cycle superior total garcon_[0-3[_scola_prescolaire 1 0 0 0 0 1 girl_[0-3[_scola_preschool 2 0 0 0 0 2 boy_[3-5]_scola_preschool 417 0 0 0 0 417 girl_[3-5]_scola_preschool 427 0 0 0 0 427 garcon_[3-5]_scola_primaire 0 269 0 0 0 269 fille_[3-5]_scola_primaire 0 285 0 0 0 285 garcon_]5-11]_scola_prescolarise 60 0 0 0 0 60 fille_]5-11]_scola_prescolarise 65 0 0 0 0 65 garcon_]5-11]_scola_primaire 0 3073 0 0 0 3073 fille_]5-11]_scola_primaire 0 3033 0 0 0 3033 garcon_]5-11]_scola_secondaire1 0 0 176 0 0 176 fille_]5-11]_scola_secondaire1 0 0 158 0 0 158 garcon_]11-18]_scola_primaire 0 976 0 0 0 976 fille_]11-18]_scola_primaire 0 749 0 0 0 749 garcon_]11-18]_scola_secondaire1 0 0 1592 0 0 1592 fille_]11-18]_scola_secondaire1 0 0 1561 0 0 1561 garcon_]11-18]_scola_secondaire2 0 0 0 431 0 431 fille_]11-18]_scola_secondaire2 0 0 0 433 0 433 garcon_]11-18]_scola_superieur 0 0 0 0 21 21 fille_]11-18]_scola_superieur 0 0 0 0 19 19 garcon_]18-23]_scola_primaire 0 20 0 0 0 20 fille_]18-23]_scola_primaire 0 15 0 0 0 15 garcon_]18-23]_scola_secondaire1 0 0 212 0 0 212 asian journal of economics and empirical research, 2025, 12(2): 124-141 139 © 2025 by the authors; licensee asian online journal publishing group fille_]18-23]_scola_secondaire1 0 0 163 0 0 163 garcon_]18-23]_scola_secondaire2 0 0 0 581 0 581 fille_]18-23]_scola_secondaire2 0 0 0 439 0 439 garcon_]18-23]_scola_superieur 0 0 0 0 227 227 fille_]18-23]_scola_superieur 0 0 0 0 202 202 garcon_]23 et +[_scola_secondaire1 0 0 12 0 0 12 girl_]23 and +[_scola_secondary1 0 0 8 0 0 8 garcon_]23 et +[_scola_secondaire2 0 0 0 38 0 38 girl_]23 and +[_scola_secondary2 0 0 0 34 0 34 garcon_]23 et +[_scola_superieur 0 0 0 0 56 56 fille_]23 et +[_scola_superieur 0 0 0 0 49 49 total 972 8420 3882 1956 574 15804 table a4. proportion of women with bargaining power. women's bargaining power no yes total one-person household 139 0.30% 1733 3.72% 1872 4.02% single-parent household 1935 4.16% 11037 23.71% 12972 27.86% nuclear household with a male partner 242 0.52% 576 1.24% 818 1.76% nuclear household with a female partner 8211 17.64% 18166 39.02% 26377 56.65% nuclear household with two female spouses 376 0.81% 2967 6.37% 3343 7.18% nuclear household with three female spouses 125 0.27% 720 1.55% 845 1.81% nuclear household with four female spouses 27 0.06% 305 0.66% 332 0.71% total 11055 23.74% 35504 76.26% 46559 100.00% table a5. correlation table between relationship, household type, household income and number of active household members. variables (1) (2) (3) (4) (1) parent_link 1.000 (2) type_menage2 -0.072* 1.000 (0.000) (3) ln revenue 0.023* 0.203* 1.000 (0.000) (0.000) (4) number of active members 0.165* 0.469* 0.167* 1.000 (0.000) (0.000) (0.000) note: standard errors in parentheses, *** p<0.01, ** p<0.05, * p<0.1 respectively are the significant levels at 1%, 5% and 10%. asian journal of economics and empirical research, 2025, 12(2): 124-141 140 © 2025 by the authors; licensee asian online journal publishing group table a6. correlation table between boys' education expenditure and selection factors (relationship and household type). variables (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (1) educational expenses 1.000 (2) relationship -0.012 1.000 (0.119) (3) one-person household 0.040* -0.178* 1.000 (0.000) (0.000) (4) single-parent household -0.023* 0.191* -0.127* 1.000 (0.003) (0.000) (0.000) (5) a male spouse -0.005 0.003 -0.027* -0.083* 1.000 (0.553) (0.532) (0.000) (0.000) (6) a female spouse -0.010 -0.076* -0.234* -0.710* -0.153* 1.000 (0.191) (0.000) (0.000) (0.000) (0.000) (7) two female spouses 0.041* -0.039* -0.057* -0.173* -0.037* -0.318* 1.000 (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (8) three female spouses 0.017* -0.015* -0.028* -0.084* -0.018* -0.155* -0.038* 1.000 (0.034) (0.001) (0.000) (0.000) (0.000) (0.000) (0.000) (9) four female spouses 0.003 -0.015* -0.017* -0.053* -0.011* -0.097* -0.024* -0.012* 1.000 (0.690) (0.001) (0.000) (0.000) (0.014) (0.000) (0.000) (0.013) (10) log revenue 0.005 0.023* -0.072* -0.141* -0.016* 0.059* 0.118* 0.050* 0.090* 1.000 (0.621) (0.000) (0.000) (0.000) (0.011) (0.000) (0.000) (0.000) (0.000) (11) active member 0.015* 0.165* -0.301* -0.165* 0.018* -0.028* 0.315* 0.304* 0.266* 0.167* 1.000 (0.055) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) note: standard errors in parentheses, *** p<0.01, ** p<0.05, * p<0.1 respectively are the significant levels at 1%, 5% and 10%. table a7. correlation between each child's education expenses and selection factors (relationship and household type, household income and number of active household members). variables (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (1) educational expenditure 1.000 (2) relationship 0.012 1.000 (0.119) (3) one-person household -0.040* -0.178* 1.000 (0.000) (0.000) (4) single-parent household 0.023* 0.191* -0.127* 1.000 (0.003) (0.000) (0.000) (5) a male spouse 0.005 0.003 -0.027* -0.083* 1.000 (0.553) (0.532) (0.000) (0.000) (6) a female spouse 0.010 -0.076* -0.234* -0.710* -0.153* 1.000 (0.191) (0.000) (0.000) (0.000) (0.000) (7)two female spouses -0.041* -0.039* -0.057* -0.173* -0.037* -0.318* 1.000 (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (8)three female spouses -0.017* -0.015* -0.028* -0.084* -0.018* -0.155* -0.038* 1.000 (0.034) (0.001) (0.000) (0.000) (0.000) (0.000) (0.000) asian journal of economics and empirical research, 2025, 12(2): 124-141 141 © 2025 by the authors; licensee asian online journal publishing group variables (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (9)four female spouses -0.003 -0.015* -0.017* -0.053* -0.011* -0.097* -0.024* -0.012* 1.000 (0.690) (0.001) (0.000) (0.000) (0.014) (0.000) (0.000) (0.013) (10) lnrevenue -0.005 0.023* -0.072* -0.141* -0.016* 0.059* 0.118* 0.050* 0.090* 1.000 (0.621) (0.000) (0.000) (0.000) (0.011) (0.000) (0.000) (0.000) (0.000) (11) active member -0.015* 0.165* -0.301* -0.165* 0.018* -0.028* 0.315* 0.304* 0.266* 0.167* 1.000 (0.055) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) note: standard errors in parentheses, *** p<0.01, ** p<0.05, * p<0.1 respectively are the significant levels at 1%, 5% and 10%. table a8. correlation table between girls' education expenditure and selection factors (relationship and household type). variables (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (1) educational expenditure 1.000 (2) relationship 0.012 1.000 (0.119) (3) one-person household -0.040* -0.178* 1.000 (0.000) (0.000) (4) single-parent household 0.023* 0.191* -0.127* 1.000 (0.003) (0.000) (0.000) (5) a male spouse 0.005 0.003 -0.027* -0.083* 1.000 (0.553) (0.532) (0.000) (0.000) (6) a female spouse 0.010 -0.076* -0.234* -0.710* -0.153* 1.000 (0.191) (0.000) (0.000) (0.000) (0.000) (7) two female spouses -0.041* -0.039* -0.057* -0.173* -0.037* -0.318* 1.000 (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (8) three female spouses -0.017* -0.015* -0.028* -0.084* -0.018* -0.155* -0.038* 1.000 (0.034) (0.001) (0.000) (0.000) (0.000) (0.000) (0.000) (9) four female spouses -0.003 -0.015* -0.017* -0.053* -0.011* -0.097* -0.024* -0.012* 1.000 (0.690) (0.001) (0.000) (0.000) (0.014) (0.000) (0.000) (0.013) (10) log revenue -0.005 0.023* -0.072* -0.141* -0.016* 0.059* 0.118* 0.050* 0.090* 1.000 (0.621) (0.000) (0.000) (0.000) (0.011) (0.000) (0.000) (0.000) (0.000) (11) active member -0.015* 0.165* -0.301* -0.165* 0.018* -0.028* 0.315* 0.304* 0.266* 0.167* 1.000 (0.055) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) note: standard errors in parentheses, *** p<0.01, ** p<0.05, * p<0.1 respectively are the significant levels at 1%, 5% and 10%. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 65 © 2025 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 12, no. 1, 65-73, 2025 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v12i1.6918 © 2025 by the authors; licensee asian online journal publishing group debt and sustainable poverty reduction: a case study of dao ethnic women in the northern midlands and mountains region of vietnam quan nguyen van1 jennifer thao linh kieu2 ( corresponding author) 1faculty of business administration, academy of policy and development, hanoi, vietnam. email: quan.nv97@apd.edu.vn 2penleigh and essendon grammar school, melbourne, australia. email: jenniferkieu2008@gmail.com abstract the purpose of this study is to explore the debt of dao ethnic women in vietnam and its impact on sustainable poverty reduction. a mixed-methods approach was employed, combining in-depth interviews with experts for scale development and quantitative data collection from 206 dao women in the northern midlands and mountains region of vietnam. parental and agricultural debt contribute to sustainable poverty reduction, while wedding debt has no significant impact as it is used for non-productive purposes. to effectively reduce poverty among ethnic women, especially in rural regions, the study concludes that priority should be given to promoting productive debt for income-generating activities and providing flexible loan terms. wedding debt, which burdens families without creating economic benefits, should be discouraged. improving financial literacy and fostering systemic changes to support marginalized communities are essential for sustainable poverty reduction. the study suggests that microfinance initiatives should prioritize productive loans for income-generating activities, support financial literacy programs tailored for ethnic women, and create policies that reduce the socio-cultural and economic barriers these women face. by focusing on flexible, productive debt and discouraging non-productive borrowing for ceremonies, poverty reduction efforts can be effective and sustainable in marginalized communities. keywords: dao women, debt, ethnic women, northern midlands and mountains region, sustainable poverty alleviation, sustainable poverty reduction. jel classification: f63; q01; r11. citation | van, q. n., & kieu, j. t. l. (2025). debt and sustainable poverty reduction: a case study of dao ethnic women in the northern midlands and mountains region of vietnam. asian journal of economics and empirical research, 12(1), 65–73. 10.20448/ajeer.v12i1.6918 history: received: 13 march 2025 revised: 19 june 2025 accepted: 3 july 2025 published: 18 july 2025 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. competing interests: the authors declare that they have no competing interests. authors’ contributions: both authors contributed equally to the conception and design of the study. both authors have read and agreed to the published version of the manuscript. contents 1. introduction ...................................................................................................................................................................................... 66 2. conceptual framework and hypothesis development ............................................................................................................ 66 3. methodology ..................................................................................................................................................................................... 69 4. results and discussion ................................................................................................................................................................... 70 5. implications and conclusions ........................................................................................................................................................ 72 references .............................................................................................................................................................................................. 72 mailto:quan.nv97@apd.edu.vn mailto:jenniferkieu2008@gmail.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v12i1.6918 https://orcid.org/0000-0001-5871-7563 https://orcid.org/0009-0006-7140-4661 asian journal of economics and empirical research, 2025, 12(1): 65-73 66 © 2025 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study is original in its focus on the impact of debt types on sustainable poverty reduction, specifically for dao ethnic women in vietnam’s northern midlands and mountains region, an underexplored area. it combines qualitative insights to develop measurement scales with quantitative data to examine these influences. 1. introduction sustainable poverty reduction remains a cornerstone of global development efforts, underscored by its prioritization in the united nations' sustainable development goals (sdgs), particularly the first goal of sdg is "no poverty" (un (united nations), 2015). despite significant progress in reducing poverty over the past few decades, approximately 9.2% of the global population around 700 million people continue to live on less than $2.15 per day, as defined by the world bank’s updated international poverty line (world bank, 2022). the persistent challenge of eradicating poverty is compounded by structural economic inequalities, limited access to essential resources, and external shocks such as climate change and global economic downturns (olinto, beegle, sobrado, & uematsu, 2013). within this context, debt has emerged as a powerful, albeit double-edged, instrument in poverty reduction strategies. initiatives such as microfinance and inclusive lending programs have demonstrated their potential to empower vulnerable populations, particularly women, by providing them with the financial resources needed to engage in income-generating activities (armendáriz & morduch, 2010). in vietnam, the trajectory of poverty reduction over the past three decades represents a remarkable transformation. from being one of the poorest countries globally, vietnam has transitioned to a lower-middle-income nation. the poverty rate, which stood at 58.1% in 1993, had fallen to just 4.8% by 2020 (world bank, 2020). however, this progress conceals significant regional disparities. ethnic minorities, accounting for approximately 15% of vietnam's population, represent over half of the country’s poor (world bank, 2019). among these, the northern midlands and mountains region, home to diverse ethnic groups, remains one of the most impoverished areas due to geographical isolation, limited infrastructure, and socio-economic marginalization (baulch, 2010). the dao ethnic group, particularly dao women, exemplifies the intersection of these challenges. as of 2022, approximately 35% of the population in the northern midlands and mountains region lived below the multidimensional poverty line, with women disproportionately affected due to restricted access to education, healthcare, and economic opportunities (general statistics office of vietnam, 2022). despite their critical roles in household management and agricultural production, dao women encounter considerable barriers to accessing financial resources that could improve their productivity and income (bierkamp, nguyen, & grote, 2023). microcredit programs, such as those offered by the vietnam bank for social policies (vbsp) and various non-governmental organizations, have been introduced as targeted interventions to address poverty in the region (vietnam bank for social policies (vbsp), 2020). reports indicate that over 80% of ethnic minority households have accessed some form of credit to support livelihood development (nguyen et al., 2023). while many households have successfully utilized loans to enhance their living standards, others have struggled with repayment due to financial illiteracy, unstable income sources, and reliance on subsistence farming (vuong et al., 2020). a survey conducted in 2020 highlights this disparity in which only 27% of women borrowers in the region reported generating sufficient income to meet their debt obligations, while the majority faced repayment difficulties (world bank, 2020). the theoretical foundation for studying the relationship between debt and poverty reduction is multifaceted. traditional economic theories posit that access to credit enables individuals and households to invest in productive activities, leading to income growth and improved living standards (banerjee & duflo, 2011). however, contemporary critiques emphasize the influence of social, cultural, and institutional factors in shaping the outcomes of debt (goetz & gupta, 1996). for ethnic minority women, these factors are deeply intertwined with entrenched gender norms, cultural practices, and power dynamics that often constrain their ability to fully benefit from financial services (kabeer, 1999). moreover, sustainable poverty reduction necessitates balancing short-term financial improvements with long-term social and economic resilience. for many ethnic minority communities, dependence on debt without adequate support mechanisms such as financial literacy programs, market access, and institutional safeguards risks perpetuating cycles of borrowing and dependency rather than fostering sustainable economic progress (yunus, 2009). despite extensive research on debt and poverty alleviation, critical gaps persist. studies often overlook the challenges of ethnic minorities in remote areas, focusing instead on urban populations (bierkamp et al., 2023). while microcredit’s role in women’s empowerment is well-studied, its impact on the economic resilience of vietnam’s ethnic minority women remains underexplored (world bank, 2019). additionally, the sustainability of debt as a poverty reduction tool for these groups, amid regional disparities and systemic barriers, requires further investigation (baulch, 2010). this study examines the role of debt in sustainable poverty reduction among dao ethnic women in vietnam’s northern midlands and mountains region. by analyzing their borrowing experiences and the socioeconomic and structural challenges they face, the research aims to elucidate the relationship between debt and poverty reduction. while microcredit programs have shown potential in empowering marginalized groups, their effectiveness is shaped by cultural, institutional, and gender-specific factors (armendáriz & morduch, 2010; kabeer, 1999). structural barriers like limited financial literacy and market access further hinder sustainable poverty alleviation (baulch, 2010; bierkamp et al., 2023). the study contributes to theoretical and practical insights for fostering inclusive development (world bank, 2022). the research is divided into introduction, conceptual framework and development of hypothesis; methodology, results and discussion and conclusion. 2. conceptual framework and hypothesis development 2.1. debt sustainability and types of debt debt sustainability, in the context of poverty reduction, refers to the capacity of individuals or communities to manage and repay debt in a way that supports long-term economic development without compromising their future financial stability. for dao ethnic women in the northern midlands and mountains region of vietnam, debt sustainability is particularly crucial, as it enables them to improve their livelihoods while avoiding the trap of asian journal of economics and empirical research, 2025, 12(1): 65-73 67 © 2025 by the authors; licensee asian online journal publishing group perpetual indebtedness. debt, when managed sustainably, can provide the necessary capital for engaging in incomegenerating activities, such as agricultural development or small-scale enterprises, leading to enhanced economic stability and poverty reduction (armendáriz & morduch, 2010; kabeer, 1999). in this case, debt sustainability is not only about the ability to service loans but also about ensuring that borrowing facilitates long-term socio-economic growth. for dao women, the key factors include the productive utilization of loans, financial literacy, and the ability to maintain a balance between debt obligations and their household responsibilities (bierkamp et al., 2023). socio-cultural factors, such as gender norms and limited access to financial resources, also play a critical role in shaping their ability to sustainably manage debt (baulch, 2010). thus, debt sustainability for dao women requires addressing these contextual challenges and providing adequate support mechanisms, such as financial education and access to markets. debt can become a tool for empowerment, enabling them to break the cycle of poverty and achieve lasting economic improvements (world bank, 2022). 2.1.1. parental debt parental debt refers to financial obligations incurred by individuals, particularly women, who borrow money or resources from their parents or other close family members to address immediate needs or economic challenges. in the context of dao ethnic women in the northern midlands and mountains region of vietnam, parental debt is a significant phenomenon, largely driven by the limited access to formal financial institutions and the reliance on family support networks. many dao women borrow from their parents to cover basic household needs, such as medical expenses, wedding costs, or agricultural investments (garfinkel, mclanahan, & hanson, 1998). this form of debt often arises during times of economic instability, such as poor harvests, natural disasters, or personal crises (arthur, 2018). in rural areas where subsistence farming remains the primary livelihood, the ability to repay parental debt can be severely limited due to low and unpredictable incomes. a survey conducted by baulch (2010) in vietnam found that approximately 25% of rural households, including those of ethnic minorities like the dao, rely on borrowing from family members to meet financial needs. for dao women, this cycle of borrowing and repaying debt from parents can create a long-term financial burden, making it difficult for them to invest in education, healthcare, or business opportunities (turetsky & waller, 2020). consequently, parental debt often results in a cyclical pattern of dependence, where women remain trapped in a cycle of borrowing without the means to build sustainable economic independence (berger & houle, 2016). this financial vulnerability not only hinders their capacity for poverty reduction but also limits their ability to achieve long-term economic stability (world bank, 2019). addressing parental debt, therefore, requires targeted support mechanisms such as financial literacy programs and access to credit that can reduce dependency on family borrowing (kabeer, 1999). 2.1.2. agricultural debt agricultural debt refers to the financial obligations incurred by dao ethnic women in the northern midlands and mountains region of vietnam to finance agricultural activities, such as crop production, livestock farming, and other farming-related investments. in rural areas, where agriculture is the primary livelihood, many women borrow money to purchase seeds, fertilizers, tools, and livestock to enhance productivity and income. however, the instability of agricultural income, often due to factors like weather variability, market fluctuations, and limited access to modern agricultural techniques, makes it difficult for women to repay these loans (baulch, 2010). for dao ethnic women, agricultural debt is a significant challenge due to limited financial literacy and restricted access to formal credit. over 60% of dao households in the northern midlands and mountains region rely on loans, averaging 10-15 million vnd ($400-$600), to fund farming (tra pham & lensink, 2008). however, high-interest rates, inflexible terms, and risks like crop failure or price drops often lead to long-term indebtedness and deeper poverty (nguyen et al., 2023). agricultural debt often traps dao women in a cycle of borrowing, limiting investment in education or healthcare. addressing this requires improved financial literacy, affordable credit access, and resilient farming practices. empowering women with sustainable farming skills and debt management resources can break this cycle and promote long-term economic stability (baulch, 2010; world bank, 2019). 2.1.3. wedding debt wedding debt refers to the financial obligations incurred by families, particularly dao ethnic women, in the process of arranging and hosting a wedding. in many rural communities in the northern midlands and mountains region of vietnam, weddings are significant cultural events that involve substantial expenditures. these expenses often include the cost of the bride price, ceremonial items, feasts, and the preparation of the bride's dowry. for dao ethnic women, wedding debt represents not only a personal financial burden but also a social and cultural obligation, as the expectations surrounding weddings can be deeply ingrained in the community’s customs and values (tien et al., 2024). wedding debt among dao is often incurred through borrowing from relatives, friends, or financial institutions to cover high wedding costs. for example, in the northern midlands and mountains region, 25-30% of families take on wedding-related loans, averaging 10-20 million vnd ($400-$800), which can take years to repay (quisumbing et al., 2023). this debt places long-term financial strain on dao women, limiting their ability to invest in education, healthcare, or business opportunities (seewald, oetjen, & nguyen, 2025). the social pressure to host extravagant weddings in the dao community often leads to unsustainable debt, trapping families in poverty. this cycle of borrowing to repay previous loans hinders women’s ability to achieve financial independence. to address this, a comprehensive approach is needed, including financial education, support for sustainable income sources, and a shift in cultural values that prioritize long-term economic stability over costly weddings (kabeer, 1999; world bank, 2019). 2.2. poverty reduction poverty remains one of the most persistent and critical challenges facing humanity, continuing to undermine well-being, limit opportunities, and obstruct social progress. the fight against poverty is not only a moral imperative but also a vital component in the achievement of the sustainable development goals (sdgs) by 2030 (michaelasian journal of economics and empirical research, 2025, 12(1): 65-73 68 © 2025 by the authors; licensee asian online journal publishing group onuoha, nkiko, & okuonghae, 2020). poverty reduction refers to efforts aimed at diminishing the prevalence and depth of poverty within a population. it involves not only increasing income levels but also improving access to essential services such as education, healthcare, clean water, and sanitation (nzasabayezu, prakash, & prasad, 2024). in the context of dao ethnic women in the northern midlands and mountains region of vietnam, poverty reduction is intricately linked to both economic and social factors, including access to financial resources, land, and social services. these women face multiple challenges that hinder their ability to escape poverty, such as limited educational opportunities, lack of access to credit, and gender-based discrimination in the labor market (nweke, 2014). the rural nature of this region, where subsistence farming is prevalent, compounds the challenges of poverty reduction. limited access to formal financial services and inadequate infrastructure often leave dao women reliant on informal borrowing, including family loans or microcredit programs, which may not be sufficient to address their long-term needs (miah, lakner, & fekete-farkas, 2024). poverty reduction for these women requires a multifaceted approach, which includes not only economic empowerment through access to capital and markets but also social empowerment, such as improving educational attainment, enhancing healthcare access, and promoting gender equality. despite efforts by government and non-governmental organizations to address these issues, such as microfinance programs and vocational training initiatives, the impact on poverty reduction has been limited due to the structural barriers faced by these women (world bank, 2022). therefore, a more sustainable approach to poverty reduction should focus on creating systemic changes, including improving financial literacy, offering flexible loan terms, and fostering an inclusive economic environment that prioritizes the needs of marginalized communities (iwuamadi, 2014). 2.3. dao ethnic women in the northern midlands and mountains region of vietnam dao ethnic women in the northern midlands and mountains region of vietnam face significant challenges in managing debt and escaping poverty. these regions, predominantly rural and economically underdeveloped, often have limited access to formal financial services. consequently, many women are forced to rely on informal borrowing methods, including loans from family, friends, or microcredit schemes. according to the general statistics office (2022), nearly 25% of rural households in these areas depend on borrowing to meet basic needs, with a significant proportion of loans allocated to agricultural investments such as seeds, fertilizers, and machinery. these investments, while critical for subsistence farming, make households vulnerable to external factors like market fluctuations and climate change, exacerbating financial instability (general statistics office, 2022). from 2020 to 2024, the debt burden on ethnic minority households, particularly women-led ones, has increased due to rising input costs and unstable agricultural incomes. a report by the vietnam women’s union (2023) highlights that approximately 32% of women in rural and mountainous areas face challenges in repaying loans due to irregular income streams from farming (vietnam women’s union, 2023). this issue is compounded by traditional gender roles that limit women’s participation in financial decision-making, leaving them with little control over household resources (world bank, 2024). despite these challenges, targeted interventions have shown promise in alleviating poverty. flexible loan programs with lower interest rates and adaptable repayment schedules, introduced between 2022 and 2024, have provided critical relief for many women. additionally, initiatives to improve financial literacy, such as communitybased training sessions, have started to empower dao women to manage their debts more effectively. (world bank, 2024). however, sustained efforts are needed to expand formal financial services in remote areas and address cultural norms that restrict women’s economic agency. by addressing these systemic issues, the potential for debt to become a tool for sustainable poverty reduction can be fully realized, enabling dao women to improve their socio-economic status. 2.4. hypothesis development the relationship between debt and sustainable poverty reduction is complex and multifaceted, particularly for marginalized groups such as dao ethnic women in the northern midlands and mountains region of vietnam. debt can act as a catalyst for long-term socio-economic empowerment when managed strategically (guérin, morvantroux, & illarreal, 2014). for dao families, particularly those in remote areas, debt is frequently incurred to invest in education, vocational training, or entrepreneurial activities for their children (hoang & yeoh, 2015). these investments often target daughters, who play a crucial role in their families' economic activities and community development (doanh, nhuan kien, do, thi minh hang, & thi thanh huyen, 2015). by acquiring skills or knowledge through education funded by debt, dao women gain opportunities to participate in higher-value economic activities, such as handicrafts, small-scale trade, or ecotourism (world bank, 2019). these activities not only provide a stable income but also foster financial independence and confidence, breaking the cycle of intergenerational poverty (hiep, phuong, & itani, 2022). furthermore, the pressure to repay debt motivates families to innovate and diversify income sources, leading to more sustainable livelihoods (o'connell, 2024). women, as key contributors to household economies, often spearhead these initiatives, leveraging their unique knowledge of local resources and market dynamics (un women, 2020). additionally, the presence of debt encourages greater financial discipline and planning among families, creating a ripple effect on community-wide economic behavior (asian development bank, 2018). for dao women, this disciplined environment enables them to develop resilience and adaptive skills, better equipping them to navigate economic challenges and opportunities (nguyen et al., 2023). therefore, while debt carries inherent risks, its strategic use can empower dao ethnic women, fostering sustainable development and long-term poverty alleviation in their communities (guérin et al., 2014). based on these findings, the authors proposed the hypothesis. h1: parental debt significantly relates to sustainable poverty reduction of dao ethnic women in the northern midlands and mountains region of vietnam. in the northern midlands and mountains region of vietnam, where agriculture serves as the primary livelihood for the dao ethnic community, agricultural debt can have a profound influence on sustainable poverty reduction for dao women (barungi, 2022). while debt is often perceived as a financial burden, when allocated toward productive agricultural investments, it can become a catalyst for long-term economic empowerment and poverty alleviation (world bank, 2019). for dao women, who are actively involved in agricultural work, these improvements translate into increased income-generating opportunities (un women, 2020). by adopting modern farming techniques or asian journal of economics and empirical research, 2025, 12(1): 65-73 69 © 2025 by the authors; licensee asian online journal publishing group engaging in value-added activities like food processing or eco-friendly farming, women can enhance their economic contributions and improve household living standards (asian development bank, 2018). the empowerment of dao women through agricultural productivity fosters community resilience (kundu & gupta, 2024). increased household income reduces dependency on external aid, while women's enhanced roles contribute to stronger social networks and collective problem solving (de schutter, frazer, guio, & marlier, 2023). over time, this creates a foundation for sustained poverty reduction, not just for individual families but for the entire community (nguyen et al., 2023). therefore, agricultural debt, when managed effectively, has the potential to drive sustainable economic and social transformation (guérin et al., 2014). based on these findings, the authors proposed the hypothesis. h2: agricultural debt significantly relates to the sustainable poverty reduction of dao ethnic women in the northern midlands and mountains region of vietnam. in the cultural traditions of the dao ethnic group in vietnam's northern midlands and mountains region, weddings are significant events that strengthen family bonds and social networks (barungi, 2022). while wedding expenses often lead to debt, this financial obligation can paradoxically contribute to sustainable poverty reduction for dao women when viewed through a broader socio-economic lens (son, kingsbury, & hoa, 2021). wedding debt frequently necessitates resource mobilization from families, encouraging them to tap into extended social networks (world bank, 2020). moreover, the financial pressure of wedding debt can act as a catalyst for households to adopt more disciplined financial management practices (asian development bank, 2018). families may diversify income sources, engage in small-scale entrepreneurship, or invest in sustainable livelihoods to meet repayment obligations (kundu & gupta, 2024). dao women, traditionally involved in economic activities such as handicrafts, farming, or small trade, often play pivotal roles in these endeavors (un women, 2020). these efforts not only contribute to debt repayment but also improve the long-term financial stability of the household (guérin et al., 2014). thus, while wedding debt presents immediate financial challenges, it can also foster community solidarity, promote economic resilience, and empower dao women in meaningful ways (nguyen et al., 2023). based on these findings, the authors proposed the hypothesis. h3: wedding debt significantly relates to sustainable poverty reduction of dao ethnic women in the northern midlands and mountains region of vietnam. 3. methodology 3.1. measurement of constructs this study employs a mixed research method to examine the relationships between poverty reduction, parental debt, agricultural debt, and wedding debt among dao ethnic women in the northern midlands and mountains region of vietnam. a scale adapted from mohammed, hassan, and zakari (2021) and kabari and nwogo (2021) to measure poverty reduction (pr) includes five items. a four-item measure of parental debt was developed by berger and houle (2016). for the agricultural debt and wedding debt scales, firstly, the authors conducted a qualitative research method to establish measurement scales for these variables through direct interviews with three experts on development economics in vietnam. the opinions of experts are as follows. agricultural debt places significant financial pressure on farming households, with experts noting that it limits their ability to invest in productivity-enhancing technologies and resources. high levels of debt reduce farmers' capacity to improve their operations, leading to stagnation in productivity and increased vulnerability to economic and environmental shocks. debt servicing often diverts resources away from long-term growth, preventing farmers from adopting modern farming practices and technologies that could improve efficiency and profitability. wedding debt, on the other hand, creates long-term financial stress for newlyweds by restricting their ability to save for important future goals, such as buying a home. experts emphasize that societal pressure to have extravagant weddings often results in unnecessary debt, which negatively impacts a couple’s financial stability. the repayment of this debt creates additional financial burdens that limit the couple’s capacity to invest in their future and meet other essential financial needs. both agricultural and wedding debt, therefore, hinder economic growth and longterm financial security. table 1. measurement scales. variables/code items poverty reduction pr1 the implementation of social protection programs effectively reduces poverty in the community. pr2 everyone has equal access to basic services, technology, and economic resources. pr3 resources are effectively mobilized to achieve the goal of eradicating poverty completely. pr4 my community demonstrates strong resilience to environmental, economic, and social disasters. pr5 the implementation of poverty eradication policy frameworks at all levels shows significant effectiveness. parental debt pd1 households with high levels of credit and store card debt face significant financial stress. pd2 nonresident fathers' outstanding arrears contribute to economic challenges for their children. pd3 parental student loan debt or other bank/lender debt negatively impacts children's well-being. pd4 the accumulation of parental debt, excluding mortgage and car loans, affects the household's financial stability. agricultural debt ad1 the accumulation of agricultural debt creates significant financial pressure on farming households. ad2 high levels of debt related to farming operations negatively affect agricultural productivity. ad3 servicing agricultural debt reduces the capacity of farmers to invest in new technologies and resources. wedding debt wd1 taking on debt to cover wedding expenses creates long-term financial stress for newlyweds. wd2 wedding-related debt limits a couple’s ability to save for future goals, such as buying a home. wd3 repaying wedding debt affects the financial stability of the couple's household. wd4 the pressure to have an extravagant wedding often leads to unnecessary debt. asian journal of economics and empirical research, 2025, 12(1): 65-73 70 © 2025 by the authors; licensee asian online journal publishing group table 1 presents the scales developed through in-depth interviews with experts and the scales inherited from previous studies shown above. secondly, primary data were collected through structured questionnaires using a likert scale to measure each construct. the target respondents included individuals from diverse socio-economic backgrounds to ensure a representative sample. the measurement items under all the constructs were responded to on a likert scale of 1strongly disagree, 2-disagree, 3-neutral, 4-agree, and 5-strongly agree. the item scales were utilized to measure the theoretical constructs of the conceptual model. 3.2. sampling and data collection the study employed a mixed-method approach, in which quantitative data collection techniques focused on dao ethnic women residing in the northern midlands and mountains region of vietnam. a stratified random sampling method was applied to ensure diverse representation across different age groups, education levels, and income brackets. a total of 206 respondents participated in the quantitative survey. the structured questionnaire covered various aspects, including demographics (age, birth order, education level, marital status, and monthly income). data were collected through face-to-face surveys conducted by trained enumerators who were familiar with the local language and culture. quantitative data collected from the surveys were analyzed using spss 27 software, enabling statistical analysis and generating valuable insights into debt patterns and poverty reduction strategies. ethical considerations were prioritized, including informed consent, confidentiality, and voluntary participation, ensuring participants' rights and data privacy throughout the research process. information about the respondents’ demographics is presented in table 2. 4. results and discussion 4.1. descriptive statistics result the survey results reveal significant insights into the debt situation and its impact on sustainable poverty reduction among dao ethnic women in the northern midlands and mountains region of vietnam. the majority of respondents are quite young, with 62.1% under 18 years old and 22.3% between 18-20 years old, indicating that debt and poverty issues could have long-lasting effects on the younger generation. the educational background of respondents is predominantly low, with 47.6% having only a primary school education and 22.8% having no formal education. limited education often correlates with fewer job opportunities and lower income, contributing to a cycle of poverty and increased vulnerability to debt. the marital status data shows that 67.9% of respondents are married, suggesting that financial burdens associated with family responsibilities may contribute to their debt. additionally, a significant percentage (64.1%) are the firstborn in their families, potentially bearing additional responsibilities, including repaying parental debts. income analysis indicates that 70.9% of respondents earn between 2-5 million vnd per month, while 17% earn less than 1 million vnd. the low income, combined with a high debt prevalence (more than 80% of respondents), suggests financial instability and challenges in achieving sustainable poverty reduction. table 2. demographics of respondents. demographics frequency percent age below 18 128 62.1 18 20 46 22.3 20 25 23 11.2 above 25 9 4.4 birth order in the family firstborn 132 64.1 second-born 69 33.5 only child 5 2.4 education level no formal education 47 22.8 primary school 98 47.6 secondary school 14 6.8 high school 6 2.9 vocational training 41 19.9 marital status single 66 32.1 married 140 67.9 monthly income less than 1 million 35 17.0 2 5 million 146 70.9 5 10 million 22 10.7 above 10 million 3 1.4 total 206 100 4.2. reliability and efa analysis a reliability test using cronbach’s alpha was conducted to assess the consistency of the research variables, which are presented in table 3. according to nunnally (1978), a good scale should have a cronbach’s alpha reliability of 0.7 or higher. hair jr, black, babin, and anderson (2009) also stated that a unidimensional and reliable scale should meet the cronbach’s alpha threshold of 0.7 or above. based on this, it is evident that all cronbach’s alpha values in the study meet the criteria for being either preferable or acceptable. table 3. cronbach’s reliability tests. variables cronbach's alpha n of items pr 0.921 5 pd 0.896 4 ad 0.795 3 wd 0.929 4 asian journal of economics and empirical research, 2025, 12(1): 65-73 71 © 2025 by the authors; licensee asian online journal publishing group the exploratory factor analysis (efa) results for the dependent variable poverty reduction (pr) indicate that the dataset is suitable for factor extraction. the kaiser-meyer-olkin (kmo) value of 0.887 demonstrates sampling adequacy, confirming that the data are well-suited for factor analysis. additionally, bartlett’s test of sphericity (sig. < 0.001) and total variance explained = 76.001% indicate significant correlations among the observed variables. table 4. exploratory factor analysis efa for independent variables. items wedding debt (wd) agricultural debt (pd) parental debt (ad) wd2 0.916 wd4 0.885 wd1 0.877 wd3 0.840 pd2 0.886 pd4 0.835 pd3 0.779 pd1 0.772 ad3 0.894 ad2 0.787 ad1 0.685 kmo = 0.823; sig of bartlett's test = 0.001; eigenvalues = 1.128; total variance explained = 78.276% after that, efa was conducted on the three independent factors: parental debt (pd), agricultural debt (ad), and wedding debt (wd), using principal components extraction with varimax rotation. table 4 shows the efa results for independent variables. the items loaded onto their designated constructs with significant factor loadings of 0.50 and above. the kmo index is 0.823, and bartlett's test is statistically significant at a level of 0.001. the eigenvalue is 1.128 (> 1), and the total variance explained is 78.276%, which indicates the suitability of the efa model. 4.3. regression analysis and hypothesis conclusion the correlation analysis reveals significant relationships between poverty reduction (pr) and various types of debt among dao ethnic women in the northern midlands and mountains region of vietnam. parental debt (pd) shows a strong positive correlation with pr (r = 0.645, p < 0.001), indicating that managing parental debt plays an important role in poverty alleviation. agricultural debt (ad) exhibits the strongest correlation (r = 0.666, p < 0.001), highlighting the critical impact of agricultural debt on poverty reduction, likely due to the community’s dependence on agriculture for income. wedding debt (wd) also shows a moderate positive correlation with pr (r = 0.346, p < 0.001), suggesting that financial pressures from cultural practices related to marriage can influence poverty outcomes. after that, the authors conducted multiple linear regression analysis. the multiple regression analysis reveals significant insights into the impact of different types of debt on poverty reduction (pr) among dao ethnic women in the northern midlands and mountains region of vietnam. table 5 presents the results of the multiple linear regression analysis and hypothesis conclusion. the model's adjusted r square of 0.552 indicates that 55.2% of the variance in poverty reduction is explained by the independent variables: parental debt (pd), agricultural debt (ad), and wedding debt (wd). the durbin-watson statistic of 2.066 suggests no significant autocorrelation in the residuals, supporting the model's robustness. among the variables, agricultural debt (ad) shows the strongest positive effect (β = 0.447, sig. = 0.001), highlighting how agricultural investments contribute substantially to sustainable poverty alleviation. parental debt (pd) also has a positive and significant impact (β = 0.393, sig. = 0.001), indicating that supporting parents through debt can enhance household stability and reduce poverty. however, wedding debt (wd) demonstrates a negligible and statistically insignificant effect (β = 0.020, sig. = 0.703), suggesting that debt incurred for wedding expenses does not contribute meaningfully to poverty reduction. the variance inflation factor (vif) values for pd, ad, and wd are 1.678, 1.418, and 1.308, respectively, indicating no multicollinearity issues. table 5. regression analysis results and hypothesis conclusion. variables model hypothesis decision β (standardized) pd 0.393*** h1 accepted ad 0.447*** h2 accepted wd 0.020 h3 rejected durbin-watson = 2.066 adjusted r square = 0.552 note: dependent variable: pr; *** p < 0.001. the results indicate a strong positive relationship between parental debt and pr, suggesting that borrowing to support parental needs contributes positively to household stability and poverty reduction. this type of debt likely helps dao ethnic women manage financial pressures by ensuring that essential healthcare and support for elderly family members do not deplete household resources. the regression analysis further confirms that parental debt is a significant predictor of poverty reduction, supporting the acceptance of h1. this finding underscores the potential of parental debt as a strategic financial tool that, when managed well, can enhance economic resilience and long-term stability. among the three types of debt, agricultural debt emerges as the most impactful factor in sustainable poverty reduction. the correlation analysis suggests a strong connection between taking on agricultural debt and achieving economic improvement. many dao ethnic women likely utilize agricultural loans to invest in productive activities, such as purchasing seeds, livestock, or equipment, which generate consistent income and improve living standards. asian journal of economics and empirical research, 2025, 12(1): 65-73 72 © 2025 by the authors; licensee asian online journal publishing group the regression analysis also supports this relationship, highlighting agricultural debt as a critical driver of economic progress. the acceptance of h2 reinforces the idea that productive investments through debt can be highly effective in lifting households out of poverty. these findings suggest that development initiatives should focus on expanding access to agricultural credit and training in effective farm management to maximize poverty alleviation efforts. in contrast, wedding debt shows neither a significant correlation with pr nor a meaningful impact in the regression analysis, leading to the rejection of h3. this implies that wedding-related borrowing, often for non-productive and ceremonial purposes, does not contribute to poverty reduction. instead, it may place an additional financial burden on families, hindering their ability to improve their economic situation. this result highlights the importance of promoting financial literacy and advising dao ethnic women against accumulating debt for non-essential expenses. additionally, cultural shifts toward more modest wedding practices could help reduce unnecessary financial strain and support sustainable poverty reduction strategies. parental and agricultural debts are valuable tools for enhancing economic stability and promoting long-term poverty alleviation, while wedding debt may have adverse effects. these insights emphasize the need for targeted support and education, helping dao ethnic women make informed borrowing decisions and prioritize debt that contributes to productive and sustainable outcomes. 5. implications and conclusions this study enhances the theoretical understanding of how different types of debt impact sustainable poverty reduction among dao ethnic women in vietnam's northern midlands and mountains region. firstly, the findings align with the resource-based view (rbv) theory, showing that agricultural debt (ad) used for productive investments can boost household capabilities and economic resilience, reinforcing the importance of incomegenerating activities in poverty alleviation. secondly, the strong positive effect of parental debt (pd) supports microfinance and poverty alleviation theories, suggesting that debt aimed at family stability (e.g., healthcare and elder support) can indirectly reduce poverty. however, the insignificant impact of wedding debt (wd) challenges the consumption smoothing theory, highlighting that non-productive debt for ceremonial expenses may not aid poverty alleviation and could increase financial risks. financial institutions, policymakers, and community development organizations can leverage these insights to enhance poverty reduction efforts among dao ethnic women in vietnam's northern midlands and mountains region. prioritizing tailored loan products that support income-generating activities such as farming, livestock, and smallscale agricultural enterprises can amplify the positive effects of agricultural debt (ad) on poverty reduction. offering low-interest loans, flexible repayment options, and financial literacy training could further empower ethnic women to maximize the benefits of productive debt. similarly, local governments and ngos could introduce microfinance programs or social funds focused on healthcare, elder care, and family stability initiatives, given the positive impact of parental debt (pd). these initiatives can alleviate household financial burdens and promote longterm economic stability. on the other hand, the insignificant effect of wedding debt (wd) underscores the need for awareness campaigns to discourage non-productive borrowing, particularly for traditional ceremonies. engaging local leaders and community influencers could help promote financial prudence and encourage saving practices for life events instead of incurring debt. this study, while providing valuable insights into the relationship between different types of debt and sustainable poverty reduction among dao ethnic women in vietnam's northern midlands and mountains region, has certain limitations. the cross-sectional design restricts causal inferences, suggesting that future research could adopt a longitudinal approach to better capture the dynamic impact of debt on economic stability over time. additionally, focusing exclusively on dao ethnic women may limit the generalizability of the findings to other ethnic groups or broader rural communities. expanding the research scope to include diverse populations could offer a more comprehensive understanding of debt's role in poverty alleviation across different cultural and socio-economic contexts. furthermore, while the study categorizes debt into parental debt (pd), agricultural debt (ad), and wedding debt (wd), it does not explore the underlying factors driving borrowing decisions, such as cultural practices, financial literacy, or access to credit sources. future studies could incorporate qualitative methods, such as interviews and focus groups, to gain deeper insights into these aspects. moreover, external 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(2009). creating a world without poverty: social business and the future of capitalism. new york: public affairs. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.1016/0305-750x(95)00124-u https://doi.org/10.1504/jgba.2022.127203 https://doi.org/10.4236/oalib.1100610 https://doi.org/10.1111/1467-7660.00125 https://doi.org/10.37421/2169-026x.2024.13.450 https://doi.org/10.1080/1747423x.2023.2191599 https://doi.org/10.1016/j.heliyon.2024.e33469 https://doi.org/10.1016/j.gfs.2023.100707 https://doi.org/10.1016/j.ecolecon.2025.108564 https://doi.org/10.1016/j.heliyon.2024.e39998 https://vbsp.org.vn/ https://doi.org/10.1515/openec-2020-0002 https://www.worldbank.org/ext/en/home https://databank.worldbank.org/source/poverty-and-equity https://databank.worldbank.org/source/poverty-and-equity https://www.worldbank.org/ 113 © 2025 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 12, no. 2, 113-123, 2025 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v12i2.7479 © 2025 by the author; licensee asian online journal publishing group access to stock markets impact on smes performance imanou akala1 laetitia pozniak2 ( corresponding author) 1,2warocqué faculty of economics and management, university of mons, belgium. 1email: imanou.akala@student.umons.ac.be 2email: laetitia.pozniak@umons.ac.be abstract this study investigates the impact of unregulated stock market listing on the financial performance of small and medium-sized enterprises (smes) in europe. the analysis seeks to determine whether listing improves financial performance or whether associated costs outweigh the potential benefits. to address this question, the performance of listed and unlisted smes is compared across five key indicators: solvency, liquidity, profit margin, return on assets (roa), and return on equity (roe). the sample covers a ten-year period from 2014 to 2023. statistical analyses were conducted using unpaired student’s t-tests in rstudio to assess the significance of performance differences between the two groups. the findings reveal a mixed impact of listing on smes' financial performance. on the one hand, listed smes show significant improvements in solvency and liquidity, suggesting that listing facilitates access to external capital and enhances the ability to meet both short-term and long-term obligations. on the other hand, profitability measures, including profit margin, roa, and roe, exhibit a notable decline after listing. this deterioration indicates that while listing improves financial stability, it may simultaneously impose costs and constraints that undermine operational efficiency. overall, the study provides empirical evidence of smes' access to unregulated stock market trade-offs, offering relevant insights for smes considering ipos, investors evaluating sme securities, and policymakers supporting sme financing through stock markets. keywords: financial performance, liquidity, profitability, small and medium enterprises, solvency, stock markets. jel classification: m130; g1; c120; c220. citation | akala, i., & pozniak, l. (2025). access to stock markets impact on smes performance. asian journal of economics and empirical research, 12(2), 113–123. 10.20448/ajeer.v12i2.7479 history: received: 4 august 2025 revised: 3 september 2025 accepted: 17 september 2025 published: 1 october 2025 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. data availability statement: the corresponding author may provide study data upon reasonable request. competing interests: the authors declare that they have no competing interests. authors’ contributions: both authors contributed equally to the conception and design of the study. both authors have read and agreed to the published version of the manuscript. contents 1. introduction .................................................................................................................................................................................... 114 2. literature review .......................................................................................................................................................................... 114 3. data and methodology ................................................................................................................................................................. 115 4. results and discussion ................................................................................................................................................................. 117 5. conclusion ....................................................................................................................................................................................... 121 references ............................................................................................................................................................................................ 121 mailto:imanou.akala@student.umons.ac.be mailto:laetitia.pozniak@umons.ac.be https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v12i2.7479 https://orcid.org/0009-0002-6885-8006 https://orcid.org/0009-0003-8468-8972 asian journal of economics and empirical research, 2025, 12(2): 113-123 114 © 2025 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the existing literature in different ways. for instance, the results of this research will shed light on whether smes' financial performance post-listing is one of the factors behind the constant decline of smes’ ipos and increased delisting in europe. this may also help regulators and policymakers in their decisions on whether additional steps are necessary to enhance unregulated stock market efficiency as a tangible solution to smes' financing hurdles. 1. introduction regulatory bodies accredit stock markets with the aim of establishing platforms to enhance enterprises’ access to equity funds, which are essential for their growth and development. unlike for smes, stock exchanges such as euronext, the london stock exchange, and deutsche börse, among others, have proven effective for european large enterprises in their pursuit of financial resources, as well as for their development and expansion (boccaletti, ferrando, rossi, & rossolini, 2025). compared to just 40,000 active larger enterprises, more than 22 million smes were operating in the eu in 2019 (european commission, 2021). according to the european commission (2021), smes made up 99.8% of all enterprises in the region; and according to the annual report on european smes 2020/2021, smes are the largest employers in the eu and globally, and they contribute significantly to the gdp of the eu economies. however, compared to large enterprises, smes have different characteristics because they have specific features and higher risk levels, which make it difficult to secure financing (karlsson, 2021). additionally, karlsson highlighted that size positively influences enterprise performance; the larger the enterprise, the better its performance. hence, cognizant of the important contribution of smes to the global economy, contrasted by their limited access to financial resources, which impairs their growth (european commission, 2021), unregulated stock markets with less stringent listing conditions, particularly dedicated to smes, have emerged to facilitate access to long-term funds (bolek & gniadkowska-szymań ska, 2023; demir, 2024). furthermore, demir found that 68% of primary stock markets now offer dedicated smes segments with incentives such as reduced fees and relaxed profitability criteria. according to the european commission (2022a), listing on stock exchanges can give a significant boost to smes; the benefits of listing include easier access to additional financial resources and a higher public profile. regardless of these regulatory astute initiatives to boost and facilitate access to the public equity markets, it must be noted that smes ipos are in constant decline in europe, leaving policymakers in a vacuum regarding the reasons behind this trend. from 2006 to 2007, the annual average of ipos was 478, compared to an average of 218 ipos annually from 2009 to 2017 (european commission, 2018). also, recent reports highlight that smes listing has fallen by two-thirds (lehmann, 2023) and ipo capital raising in the eu decreased from 0.9‰ of gdp in 2015 to just 0.3‰ in 2020, indicating a significant decline in eu stock market access (european commission, 2022b). an assessment by the eu audit office (2020) found that smes face substantial costs up to 15% of capital raised along with complex compliance requirements, which ultimately diminish smes’ motivation to go public and limit the potential performance benefits of stock market access. although research focusing on smes has increased significantly in recent decades, limited attention has been given to the impact of unregulated stock markets on listed eu smes. consequently, further research is required to close this gap, as these markets offer an alternative financing opportunity to smes. therefore, in this study, we address the following question: "does access to unregulated stock markets improve eu smes' financial performance compared to their unlisted counterparts?" the goal is to evaluate the listing effectiveness of smes' listings on their financial performance. to fulfill this objective, a comparative analysis was conducted using financial indicators to assess the performance of both listed and unlisted smes. 2. literature review some of the work done on smes includes the following. dabić et al. (2020) analysed smes pathway to internationalization; gherhes, williams, vorley, and vasconcelos (2016) investigated smes and microbusinesses growth constraints; mariani and spoletini (2023) initially, conducted a comparative study examining the markets' environment, incentives, primary and secondary market activity, composition, and rules, they then carried out an empirical study to evaluate how investment schemes affect primary market by measuring ipo activities and the secondary market measuring the trading activity; stefanelli, ferilli, and boscia (2022) investigated the role of crowdfunding and how it supports the financing choices of smes; chaithanapat, punnakitikashem, oo, and rakthin (2022) investigated the relationship between knowledge-oriented leadership, customer knowledge management, innovation quality, and smes performance; hilmersson and hilmersson (2021) investigated the role of networking in accelerating sme innovations; ortigueira-sánchez, welsh, and stein (2022) investigated the factors that influence innovation and export performance; karmaker, al aziz, palit, and bari (2023) examined supply chain risk factors in smes, with an emphasis on sustainability in emerging economies; and sommer (2024) assessed capital markets impact on smes financing limitation. these studies offer a holistic, insightful look at the complex environment of smes' access to finance, innovation, and sustainability; although investment schemes are important in promoting smes' ipos and favorably impacting their choices to go public, findings emphasize the urgent need for a comprehensive in-depth analysis of the variables impacting smes' performance. 2.1. access to stock market as an alternative solution in fact, research illustrates that smes' ability to raise capital for their expansion and development determines their growth capacity, whether in europe or elsewhere; it is the biggest obstacle smes face globally. the causes of these limitations range from smes' main reliance on bank credits, which are becoming scarce (wehinger & nassr, 2016), the pecking theory (myers & majluf, 1984) whereby enterprises tend to prioritise internal financing over external, and debt over equity; along with the difficulties accessing capital markets because of the costly disclosure requirements during and after ipos, the regulatory hurdles coupled with institutional and legal impediments (lopezasian journal of economics and empirical research, 2025, 12(2): 113-123 115 © 2025 by the authors; licensee asian online journal publishing group de-silanes, phalippou, & gottschalg, 2015). even though ipos are gateways that provide enterprises access to equity capital for their growth and development (fama & french, 2004), due to the dearth of information on smes' financial status, investors have long perceived smes as risky investments (ritter & welch, 2002). to alleviate this problem, regulators in the eu have launched the sme growth markets with the creation of unregulated markets such as euronext growth (formerly known as alternext) or euronext access (formerly known as the free market) and others. this is intended to contribute to reducing smes' financial hassle. certainly, capital markets’ mandatory requirement for financial information disclosure would increase smes' visibility, giving investors access to more credible and reliable information for investment. in addition to offering tax advantages to investors, it offers considerable opportunities for investors to distinguish and finance high-growth smes and take part in their valuation, which will ultimately generate value for all parties involved. the literature has shown that as they gain from long-term financing, listed smes would expand and surpass unlisted smes, which are left behind (sommer, 2024) which is consistent with the signalling theory, enterprises ipo decision is not merely only a means of accessing external finance but also a strategic signalling mechanism to reduce information asymmetry and attract external stakeholders (leland & pyle, 1977). chemmanur and fulghieri (1999) demonstrate that enterprises utilise listing to fund growth, research and development, and acquisitions, thereby enabling strategic expansion. according to floros and sapp (2011), access to the stock market can increase enterprises' visibility and credibility, which in turn may translate into competitive benefits and business opportunities. the above theoretical background gives a clear guideline on why smes should consider the unregulated stock market as an efficient alternative solution to their financial difficulties. furthermore, studies support the need to reduce smes’ reliance on financing through credit and bank loans, particularly in times of economic shocks such as the 2008 financial crisis (mehrotra & sergeyev, 2021) or the covid-19 pandemic (juergensen, guimón, & narula, 2020). this highlights the various potential advantages of stock market listing for enterprises. however, these advantages should be carefully weighed against the associated costs and risks that access to stock markets could cause. 2.2. adverse impacts and risks associated with listing in contrast, previous studies conducted on enterprises before and after ipos demonstrated a negative correlation between economic performance indicators and access to stock markets, challenging the assumption that enterprises primarily go public to fund their growth and expansion. for instance, sentis (2001) examined both the operational and stock market performance of enterprises newly listed on the french stock market between 1991 and 1995; the author found that in the long run, enterprises’ ipos underperformed compared to the market benchmark, and financial performance declined post-ipo. additionally, sentis (2004) provided a comprehensive international perspective on ipos, combining both theoretical frameworks and empirical evidence from various countries, including the us, france, and other global markets, and concluded that market timing (enterprises often go public during market highs) and underperformance post-ipo are universally observed across markets in the long run. similarly, using a panel data econometric approach, serve (2007) focused on the economic impact of listing enterprises on stock markets, especially in terms of operational and financial performance; the main finding is that there is a mixed effect on operational performance; some enterprises experienced productivity gains and increased investment, while others show decreasing profitability or no significant change. brau, couch, and sutton (2012) investigated whether post-ipo acquisition activity is a driver of underperformance of newly listed firms and found that after the first year post-ipo, acquirers’ abnormal returns were notably negative, pointing to overpayment or integration challenges. wang (2005) investigated the role of institutional and ownership context in post ipo success in china; his findings imply that state ownership is negatively associated with enterprises’ performance post ipo. pagano, panetta, and zingales (1998) explored the motivation behind italian enterprises' ipos and suggested that enterprises' post-ipo investments don’t significantly increase. the motivations for going public are rebalancing ownership (ipos allow original owners to diversify their portfolios by selling part of their shares), reducing leverage (enterprises use ipos to pay down debts), and enhancing market visibility and prestige (ipos improve enterprises' reputation and expand business opportunities). jain and kini (1995) investigated the operating performance of enterprises after listing, and in line with agency theory, found that ownership becomes more dispersed post-ipo, agency costs increased significantly, reducing enterprises’ performance. in parallel, coakley, fuertes, and wood (2004) conducted the same analysis in the uk by providing important insight into how timing and financing sources impact post ipo outcomes, especially in developed markets like the uk. analogously, mikkelson, partch, and shah (1997) examined the relationship between structure and post ipo operating performance of us enterprises and found that smes experienced decline in their profitability post ipo. in the same vein, kutsuna, okamura, and cowling (2002) analyzed the ownership structure before and after ipo and its impact on enterprises’ performance, and found that performance declined with high ownership dilution. in summary, the above findings illustrate that although stock markets offer growth opportunities, listing exposes enterprises to challenges, and the factors behind this differ from one market to another, ranging from regulatory costs and market timing hypotheses to agency theory and management structure. notwithstanding the fact that there are substantial studies examining enterprise performance before and after going public, recent studies focusing on eu smes remain limited. therefore, this paper explores how access to the unregulated stock market affects eu smes by comparing the financial performance of listed smes versus similar unlisted counterparts over 10 years (2014 to 2023). based on the findings, a comparative discussion with existing literature is carried out. 3. data and methodology to conduct our analysis, we collected yearly key financial data on listed and unlisted european smes for a period of 10 years from 2014 to 2023 from the orbis bureau van dijk database on 18/04/2025. we took the following search steps in our selection: 1. status: active companies (search result 431,648,873 enterprises). asian journal of economics and empirical research, 2025, 12(2): 113-123 116 © 2025 by the authors; licensee asian online journal publishing group 2. size classification: small and medium enterprises (search results: 428,116,263 enterprises). it is worth highlighting that enterprises on orbis are considered to be smes when they meet the following conditions: operating revenue less than 10 million eur; total assets less than 20 million eur; or fewer than 150 employees. 3. world region: european union [27] (search results: 58,633,866 enterprises). 4. all companies scored by moody's analytics pulse (search results: 47,642 enterprises). 5. unlisted companies (search results 47,642 enterprises). 6. publicly listed companies (search results: 20 enterprises). to ensure comparability, 20 listed smes were paired with 20 unlisted counterparts of similar size, selected at random. the financial performance of selected smes is measured using solvency, liquidity, profit margin, roa, and roe. although the sample size was constrained to a total of 20 listed smes, the decision to use an equal size from unlisted smes enhances comparability and reduces sampling bias. even though the sample size may be considered modest, it is methodologically adequate for conducting unpaired t-tests under the assumptions of normality and homogeneity of variances. these assumptions were verified through diagnostics such as the shapiro–wilk test and q-q plots. to mitigate limitations associated with the sample size, effect sizes and 95% confidence intervals are reported alongside p-values. table 1. financial performance metrics. definition formula liquidity this is a financial metric that measures an enterprise’s ability to meet its short-term financial obligations. 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 solvability this is a financial metric that measures an enterprise’s ability to meet its long-term financial obligations. 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 profit margin this is a financial metric that measures an enterprise’s profitability as a percentage of its revenue. % 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 return on assets this is a financial metric that measures an enterprise’s ability to use its assets to generate profit. 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 return on equity this is a financial metric that measures an enterprise’s ability to use its equity to generate profit. 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠′𝐸𝑞𝑢𝑖𝑡𝑦 table 1 presents the financial metrics used in our comparative analysis along with their definition and formula. the unpaired student t-test is used to test our main hypothesis by determining whether there is a statistical difference in listed and unlisted smes’ financial performance indicators. we used excel to calculate the financial ratios and rstudio to analyze the data. 𝑡 = 𝑥1̅̅̅̅ −𝑥2̅̅̅̅ √ 𝑠1 2 𝑛1 + 𝑠2 2 𝑛2 (1) where: 𝑥1̅̅ ̅ − 𝑥2̅̅ ̅= sample means of listed smes and unlisted smes. 𝑠1 2 , 𝑠2 2 = sample variances of both listed and unlisted smes. 𝑛1, 𝑛2 = sample size of both listed and unlisted sme. 3.1. t-test null hypothesis there is no difference in the mean financial performance between listed and unlisted eu smes. h01: there is no significant difference in the solvency of listed and unlisted smes. h02: there is no significant difference in the liquidity of listed and unlisted smes h03: there is no significant difference in the profit margin of listed and unlisted smes h04: there is no significant difference in the roa of listed and unlisted smes. h05: there is no significant difference in the roe of listed and unlisted smes. 3.2. alternative hypothesis (h₁) there is a difference in the mean financial performance between listed and unlisted eu smes; it could be positive or negative. h1.1: there is a significant difference in the solvency of listed and unlisted smes. h1.2: there is a significant difference in the liquidity of listed and unlisted smes h1.3: there is a significant difference in the profit margin of listed and unlisted smes h1.4: there is a significant difference in the roa of listed and unlisted smes. h1.5: there is a significant difference in the roe of listed and unlisted smes. before conducting the t-test, we performed the shapiro–wilk test to assess whether the data are normally distributed. 𝑤 = (∑ 𝑎𝑖𝑥(𝑖))2𝑛 𝑖=1 ∑ (𝑥𝑖 𝑛 𝑖=1 −�̅�)2 (2) where: w = the shapiro–wilk test statistic. 𝑥(𝑖) = the ordered sample values (i.e., from smallest to largest). �̅� = the sample mean. 𝑎𝑖= constants derived from the expected values of order statistics of a standard normal distribution and the covariance matrix of those order statistics 𝑛 = sample size. asian journal of economics and empirical research, 2025, 12(2): 113-123 117 © 2025 by the authors; licensee asian online journal publishing group 4. results and discussion 4.1. descriptive statistics (mean, median, standard deviation, kurtosis, skewness) tables 2, 3, 4, 5 and 6 report the descriptive statistics. table 2. mean. mean 2023 2022 2021 2020 2019 2018 2017 2016 2015 2014 listed smes solvency (x) 52.809 48.645 46.487 45.604 44.072 44.404 43.739 43.111 49.766 49.770 unlisted smes solvency (x) 43.896 45.813 45.608 41.350 45.816 44.700 43.982 45.026 44.500 37.770 listed smes liquidity (x) 3.939 4.031 4.058 5.743 5.295 5.854 2.992 1.832 2.262 1.884 unlisted smes liquidity (x) 1.908 2.160 1.933 1.719 1.711 2.293 1.936 1.957 1.519 1.252 listed smes profit margin % 6.459 -2.589 7.160 3.443 5.468 4.900 2.040 2.040 2.240 2.000 unlisted smes profit margin % 11.023 9.659 5.780 7.099 7.312 9.045 6.958 8.042 6.517 5.048 listed smes roa % 4.479 4.070 5.199 -0.534 3.794 4.689 1.189 1.189 1.534 -0.321 unlisted smes roa % 13.636 11.943 10.784 13.087 7.767 14.174 11.704 10.663 10.344 6.809 listed smes roe % 8.870 15.581 11.199 0.440 4.319 10.582 5.933 4.133 4.569 1.786 unlisted smes roe % 35.821 30.703 33.802 65.253 18.966 47.084 28.989 24.751 31.339 24.284 table 2 presents the solvency, liquidity, profit margin, roa, and roe means for listed and unlisted smes from 2014 to 2023. the results show that while the listed smes’ solvency and liquidity averages are higher than those of unlisted smes, their profit margin, roa, and roe averages are lower compared to the unlisted counterparts. a line plot was used to visualize the mean performance of listed and unlisted eu smes across key financial metrics. this allows for a clear comparison of trends and reveals consistent differences in liquidity and profitability. figure 1. solvency, liquidity, profit margin, roa, and roe yearly means variation. asian journal of economics and empirical research, 2025, 12(2): 113-123 118 © 2025 by the authors; licensee asian online journal publishing group figure 1 displays the yearly mean variations of listed (blue) and unlisted (orange) smes for the performance indicators solvency, liquidity, profit margin, roa, and roe from 2014 to 2023. table 2 and figure 1 findings indicate that listed smes outperform unlisted smes in terms of solvency and liquidity, suggesting that access to unregulated stock markets improves eu smes solvency and liquidity, supporting the hypothesis that access to stock markets positively impacts enterprises’ financial performance (european commission, 2022a). whereas, listed smes' profit margin, roa, and roe have considerably decreased compared to unlisted smes, putting forward the argument that listing has degraded smes' profitability (pastusiak, bolek, & matuszewskajanica, 2016; wang, 2005). to better understand the extent and significance of the impact that access to unregulated stock markets has on smes’ financial performance, additional statistical analyses will be conducted. table 3. median. median 2023 2022 2021 2020 2019 2018 2017 2016 2015 2014 listed smes solvency (x) 51.495 51.565 43.655 41.025 39.965 43.865 41.665 36.960 43.855 44.300 unlisted smes solvency (x) 40.565 38.135 47.835 40.040 46.285 50.295 46.330 47.300 48.570 43.525 listed smes liquidity (x) 1.220 1.095 1.250 1.265 1.450 0.750 1.260 0.825 0.985 1.145 unlisted smes liquidity (x) 1.485 1.310 1.430 1.390 1.300 1.635 1.590 1.785 1.355 1.255 listed smes profit margin % 8.095 7.850 7.110 7.490 7.765 5.270 5.270 1.855 0.570 1.065 unlisted smes profit margin % 7.950 8.105 6.920 4.485 3.400 6.435 6.560 5.895 6.030 4.100 listed smes roa % 3.130 6.780 3.000 2.275 5.525 4.120 4.120 1.625 0.980 1.015 unlisted smes roa % 13.840 9.350 7.990 6.590 2.235 6.365 7.270 9.490 6.790 4.225 listed smes roe % 8.285 11.715 8.080 6.040 9.105 10.650 4.420 5.320 3.630 3.765 unlisted smes roe % 27.405 18.340 16.995 15.775 7.905 13.520 11.965 11.965 17.290 10.885 table 3 presents the solvency, liquidity, profit margin, roa, and roe medians for listed and unlisted smes from 2014 to 2023. the results show that while the solvency medians of listed smes are higher than those of unlisted smes, their profit margin, roa, and roe medians are lower compared to the unlisted counterparts. however, the liquidity medians are relatively equal. table 4. standard deviation. standard deviation 2023 2022 2021 2020 2019 2018 2017 2016 2015 2014 listed smes solvency (x) 26.711 29.850 19.183 19.205 26.151 26.766 25.965 26.407 29.407 29.461 unlisted smes solvency (x) 16.004 21.855 23.511 24.690 25.418 23.581 21.126 21.357 18.939 17.996 listed smes liquidity (x) 7.261 6.344 7.584 9.510 8.971 11.307 5.638 2.608 3.085 1.718 unlisted smes liquidity (x) 1.235 1.830 1.271 1.055 1.019 1.741 0.931 1.044 0.365 0.336 listed smes profit margin % 7.599 23.269 4.125 11.549 8.276 5.562 5.562 5.855 5.242 6.439 unlisted smes profit margin % 11.634 9.260 9.487 9.792 7.742 8.138 5.070 8.238 5.748 4.827 listed smes roa % 8.053 23.270 5.083 10.348 8.002 6.577 6.577 5.150 5.210 5.032 unlisted smes roa % 10.713 11.741 15.551 17.093 11.598 16.730 12.721 11.989 12.710 10.542 listed smes roe % 12.749 16.132 10.238 25.741 39.796 18.548 6.100 12.119 7.921 12.050 unlisted smes roe % 41.396 30.948 54.698 152.930 23.265 90.979 57.329 43.810 49.559 42.141 table 4 presents the solvency, liquidity, profit margin, roa, and roe standard deviation for listed and unlisted smes from 2014 to 2023. the results show that the variation in the standard deviation of unlisted smes is relatively high, especially under the roe. this suggests that there is moderate variability in financial performance indicators following smes’ listing. table 5. kurtosis. kutosis 2023 2022 2021 2020 2019 2018 2017 2016 2015 2014 listed smes solvency (x) 2.014 2.207 2.270 2.561 2.770 2.746 2.863 2.709 1.745 1.786 unlisted smes solvency (x) 2.289 1.938 1.407 1.842 1.975 2.848 2.769 3.032 3.435 2.254 listed smes liquidity (x) 7.264 3.238 7.562 3.311 5.524 6.344 7.921 7.117 6.925 4.253 unlisted smes liquidity (x) 4.082 3.045 2.715 4.130 5.568 3.162 2.317 1.959 1.744 3.377 listed smes profit margin % 2.753 4.665 1.573 5.118 2.476 2.859 2.859 1.827 1.683 1.743 unlisted smes profit margin % 4.665 2.595 3.191 2.785 2.725 2.299 2.363 1.860 3.524 4.637 listed smes roa % 4.665 2.595 3.191 2.785 2.725 2.299 2.363 1.896 3.524 4.637 unlisted smes roa % 1.659 2.468 2.208 5.026 3.486 2.564 2.964 3.414 4.068 7.498 listed smes roe % 2.315 3.903 2.565 4.810 4.889 4.050 2.113 5.766 2.314 4.986 unlisted smes roe % 5.510 3.963 4.365 7.982 2.159 7.739 7.259 6.642 7.253 6.844 table 5 presents the solvency, liquidity, profit margin, roa, and roe kurtosis for listed and unlisted smes from 2014 to 2023. the results show that listed smes' kurtosis values are mostly <3, ranging from 1.7 to 2.8, indicating a platykurtic distribution. however, unlisted smes' values are mixed between leptokurtic distribution >3 and platykurtic distribution <3. table 6. skewness. skewness 2023 2022 2021 2020 2019 2018 2017 2016 2015 2014 listed smes solvency (x) 0.17 -0.42 0.21 0.33 0.73 0.57 0.78 0.85 0.25 0.21 unlisted smes solvency (x) 0.45 0.60 0.06 0.09 -0.22 -0.27 -0.68 -0.40 -1.15 -0.64 listed smes liquidity (x) 2.42 1.49 2.51 1.49 1.97 2.19 2.61 2.36 2.30 1.46 unlisted smes liquidity (x) 1.44 1.33 1.13 1.40 1.87 1.29 0.86 0.57 0.41 0.37 listed smes profit margin -0.87 -1.77 -0.09 -1.88 -0.81 -0.83 -0.83 0.03 0.32 0.03 asian journal of economics and empirical research, 2025, 12(2): 113-123 119 © 2025 by the authors; licensee asian online journal publishing group skewness 2023 2022 2021 2020 2019 2018 2017 2016 2015 2014 unlisted smes profit margin 1.59 0.87 -0.67 0.73 1.03 0.81 0.52 0.26 1.03 1.48 listed smes roa % 0.55 -0.73 0.78 -1.07 -1.39 -0.16 -0.16 -0.13 0.69 -0.91 unlisted smes roa % 1.66 2.47 2.21 5.03 3.49 2.56 2.96 3.41 4.07 7.50 listed smes roe % -0.51 1.03 0.87 -1.17 -1.09 -0.67 0.23 -0.80 -0.09 -1.47 unlisted smes roe % 1.82 1.26 1.50 2.63 0.96 2.55 2.41 2.09 2.40 2.30 table 6 presents the solvency, liquidity, profit margin, roa, and roe skewness for listed and unlisted smes from 2014 to 2023. the results show that listed smes with values around 0.2 to 0.8 are slightly positively skewed, whereas unlisted smes shift between slightly positive and negative skew. to ensure the robustness of our t-test, we used the shapiro-wilk test to verify the assumption of normality for the dataset being analyzed. this is necessary because the data must be approximately normally distributed for the results to be valid and reliable. table 7. shapiro–wilk test. w statistics p-value ci listed smes solvency (x) 0.92 0.334 95% unlisted smes solvency (x) 0.076706* 0.005759* 95% listed smes liquidity (x) 0.909 0.274 95% unlisted smes liquidity (x) 0.969 0.879 95% listed smes profit margin % 0.9278 0.466 95% unlisted smes profit margin % 0.969 0.879 95% listed smes roa % 0.875 0.141 95% unlisted smes roa % 0.939 0.537 95% listed smes roe % 0.951 0.683 95% unlisted smes roe % 0.858 0.072 95% table 7 presents the solvency, liquidity, profit margin, roa, and roe shapiro-wilk test results for listed and unlisted smes. the results indicate that, except for unlisted smes’ solvency, which deviated significantly from a normal distribution (w = 0; p < 0.05), the other metrics produced a w value close to 1 with p > 0.05, suggesting that the dataset is normally distributed. to further visualize the normality of the distribution, a q–q plot was generated using the ggqqplot() function from the ggpubr package in r. if the points lie approximately along the 45-degree reference line, it indicates that the metrics are likely normally distributed. asian journal of economics and empirical research, 2025, 12(2): 113-123 120 © 2025 by the authors; licensee asian online journal publishing group figure 2. distribution q-q plot. figure 2 displays solvency, liquidity, profit margin, roa, and roe density distributions for listed and unlisted smes. this reveals that, unlike unlisted smes’ solvability, most other metrics’ observations are clustered around the mean with fewer outliers, which suggests normality in the dataset. table 8. unpaired student's t-test results. t-value critical t-value p-value df ci listed smes solvency unlisted smes solvency (x) 2.309 2.111 0.034 16.921 95% listed smes liquidity unlisted smes liquidity (x) 3.967 2.237 0.002817 9.707 95% listed smes profit margin unlisted smes profit margin % -3.648 2.160 0.003 12.996 95% listed smes roa unlisted smes roa % -7.9 2.1 4.041e-07 17.0 95% listed smes roe unlisted smes roe % -6.1 2.2 6.957e-05 11.2 95% table 8 presents the solvency, liquidity, profit margin, roa, and roe t-test results for listed and unlisted smes. the results indicate that all the absolute t-values are superior to critical t-values, and the p-values are statistically significant (p < 0.05) for all the metrics, leading to the rejection of the null hypotheses (h01, h02, h03, h04, and h05). furthermore, solvency and liquidity t-values are moderately positive; meanwhile, profit margin, roa, and roe t-values are considerably negative. the t-test results suggest that access to the stock market has improved listed smes’ solvency and liquidity, whereas profitability has significantly declined. without taking a definitive position on whether access to unregulated stock markets positively or negatively impacts smes’ financial performance, our results align with existing literature indicating that listed smes tend to report improved solvency and liquidity (boccaletti et al., 2025). despite these benefits, listed smes' financial performance can be affected by factors such as equity dilution and heightened compliance costs, which can reduce profitability indicators such as return on assets (roa) and return on equity (roe) (pastusiak et al., 2016). in the u.s. context, mikkelson et al. (1997) found that many enterprises experience a decline in profitability post-ipo despite robust pre-ipo growth. similarly, pagano et al. (1998) observed that listing proceeds are not always immediately reinvested into operations, which may negatively impact post-listing financial performance. on a separate note, according to lehmann (2023), eu enterprises are more prone to listing in the us stock markets than in europe. furthermore, helbing, lucey, and vigne (2019) in their investigation of the determinants of ipo withdrawal, they found that venture capital or private equity involvement, the presence of negative news, ceo duality, or the intent to retire debt increases the probability of ipo withdrawal. in a nutshell, these findings highlight asian journal of economics and empirical research, 2025, 12(2): 113-123 121 © 2025 by the authors; licensee asian online journal publishing group a complex relationship between stock market access and sme financial performance that requires further investigation. this study has some limitations. the relatively modest sample size may constrain broader generalizability of the findings. additionally, the research did not consider contextual factors such as sector/industry, market conditions, or institutional support that could significantly impact smes' financial performance. finally, acquiring sufficient precise financial data over time, particularly for unlisted smes, remains difficult because of limited reporting requirements and differences in disclosure practices. considering the critical contribution of smes to economic growth worldwide, future research should analyze larger and more diverse samples across various industries to better capture the nuanced financial effects of listing. furthermore, better availability of smes’ financial data through centralized databases or enhanced regulatory disclosure requirements could significantly improve the depth of future empirical studies. 5. conclusion despite their significant contribution to the global economy, smes face numerous obstacles that hinder their full potential. the difficulty of obtaining sufficient financial resources is a substantial barrier to their development and growth. as an alternative solution, regulators and policymakers introduced the unregulated stock market to facilitate smes’ access to equity funds. with the success and controversy surrounding these stock markets, this paper aims to assess whether listing would significantly improve smes’ financial performance by examining and comparing various financial metrics for both listed and unlisted smes. our empirical results present a nuanced but insightful view on how access to unregulated markets affects the financial performance of smes. compared to unlisted smes, while listed smes’ liquidity and solvability have improved, profitability indicators exhibit a significant decline. our paper contributes to the literature on smes issues and prospects by providing empirical evidence from the eu context. although most of the existing literature focuses on large enterprises in non-european markets, particularly the us, this paper fills an important gap by providing an analysis of the differences in financial performance between listed and unlisted eu smes. it offers insights into how unregulated stock markets such as euronext growth, euronext access, and aim access may impact financial indicators such as solvency, liquidity, profit margin, roa, and roe. our findings suggest that although listing may enhance liquidity and solvency, it can also impair smes' profitability. these insights are particularly relevant in light of the eu’s initiative to facilitate smes’ access to financing through stock markets. therefore, eu policymakers should reconsider their approaches to alleviating smes' financing challenges. evidence indicates that government interventions, such as direct subsidies, can encourage smes to scale their operations, invest in product improvements, and adopt modern technologies (wehinger & nassr, 2016). these incentive effects help build long-term financial resilience. additionally, capital structure theory, as developed by modigliani and miller (1958) and modigliani and miller (1963), highlights the preference for debt over equity due to tax advantages and reduced short-term risk. however, overdependence on debt can increase enterprises' weighted average cost of capital (wacc), ultimately necessitating a more balanced and mixed financing sources (tarver, 2022). to address the ongoing decline in ipos and the rising smes’ delisting rate, a broader and more diversified financing ecosystem is needed; a solution that goes beyond the creation of unregulated stock exchanges. instruments such as eu-level funding schemes, innovation-focused grants, and strategic subsidies could help mobilize private investment. complementary services such as post-ipo advisory programs could further support smes’ post-ipo financial performance and lower the risk of delisting. according to the european commission (2021), just 23% of all smes sell to other eu countries, and only 3% to non-eu ones, indicating that many eu smes remain largely domestically oriented. hence, eu smes should take further advantage of the single market access to expand their activities to other european and global markets to improve their profitability. references boccaletti, s., ferrando, a., rossi, e., & rossolini, m. 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(2016). opportunities and limitations of public equity markets for smes. oecd journal: financial market trends, 2015(1), 49-84. https://doi.org/10.1787/fmt-2015-5jrs051fvnjk appendix this table 1 presents the composition of the sample, distinguishing between listed and unlisted smes. the first group includes firms listed on unregulated stock markets, while the second group consists of comparable unlisted smes. these two groups form the basis of the statistical analyses conducted in the study. table 1. listed eu smes. listed eu smes country year of listing unregulated stock market gimv nv be 11/06/1997 euronext access (brussels) gimv health & care partners (listed under gimv) be 24/03/2014 euronext access (brussels) gimv be 11/06/1997 euronext access (brussels) aktieselskabet schouw & co. dk 31/08/1987 nasdaq copenhagen (small cap) perseida renta gestion sociedad limitada. es 13/12/2020 euronext access (paris) evli oyj fi 16/11/2015 nasdaq helsinki (mid cap) coface s.a. fr 27/06/2014 euronext access (paris) evropeiskoe obshchestvo skor e.o. (listed under scor se) fr 1989 euronext access motodinamiki sa gr 30/06/2005 athens stock exchange (athex) mytilineos s.a. gr 1995 athens stock exchange (athex) iveco group n.v. it 30/09/2013 euronext growth milan capital group emerging markets total opportunities (lux) lu 28/02/2017 sicav https://doi.org/10.1108/jsbed-05-2016-0075 https://doi.org/10.1016/j.jcorpfin.2019.03.001 https://doi.org/10.1016/j.jik.2020.10.001 https://doi.org/10.1007/s40812-020-00169-4 https://doi.org/10.1007/s11187-020-00350-y https://doi.org/10.1016/j.stae.2022.100032 https://doi.org/10.1016/s0927-538x(01)00041-5 https://www.bruegel.org/analysis/listing-act-no-more-minor-boost-eu-equity-markets https://doi.org/10.1111/j.1540-6261.1977.tb03277.x https://doi.org/10.1016/j.jmoneco.2020.01.008 https://doi.org/10.1016/0304-405x(84)90023-0 https://doi.org/10.1016/j.stae.2022.100013 https://doi.org/10.1111/0022-1082.25448 https://doi.org/10.1111/1540-6261.00478 https://doi.org/10.1080/00220388.2024.2377299 https://doi.org/10.1016/j.jik.2022.100278 https://doi.org/10.1016/j.jbankfin.2004.07.003 https://doi.org/10.1787/fmt-2015-5jrs051fvnjk asian journal of economics and empirical research, 2025, 12(2): 113-123 123 © 2025 by the authors; licensee asian online journal publishing group listed eu smes country year of listing unregulated stock market ninety one global strategy fund emerging markets corporate debt fund lu 15/04/2011 sicav fiat chrysler automobiles nv nl 13/10/2014 euronext access (paris & milan) sif muntenia bucuresti ro 01/11/1999 bucharest stock exchange (ats) xano group ab se 05/12/1988 nasdaq stockholm (mid cap) arjo ab (publ) se 12/12/2017 nasdaq stockholm (mid cap) viaplay group ab (publ) se 28/03/2019 nasdaq stockholm (mid cap) enad global 7 ab (publ) se 2019 nasdaq first north growth market vbg group ab (publ) se 1987 nasdaq stockholm (mid cap) table 1 provides the list of listed eu smes based on our filter on orbis. as per the platform, enterprises are classified as smes when they meet the following conditions: operating revenue less than 10 million eur; total assets less than 20 million eur; or fewer than 150 employees. table 2. list of unlisted smes. unlisted companies country creation year aco bouwteam be 30/06/1993 fixinox be 1994 doe-het-zelf safti be 29/04/1977 h & m spol. s r.o. cz 24/10/1990 vars brno a.s. cz 1995 cargo marketing spedition gmbh de 1997 alko espana sau es 26/05/1977 hohner automation sociedad limitada. es 14/06/1983 gtie amiens fr 15/12/1997 emuge franken s.r.l. it 02/07/2001 keb italia s.r.l. it 11/02/1975 mosca direct poland sp. z o.o. pl 05/12/2008 w-z sp. z o.o. pl 07/04/2003 toneli nutrition titu sa ro 30/11/1992 aptilo networks ab se 01/09/2001 bluebeam ab se 2010 howden insurance brokers aktiebolag se 26/10/1990 k a olsson & gems aktiebolag se 1950 nti-skolan ab se 1968 zito maloprodaja d.o.o. si 23/05/1991 table 2 provides the list of the randomly selected unlisted eu smes out of the 47,642 moody scored enterprises based on our filter on orbis. as per the platform, enterprises are smes when they meet the following conditions: operating revenue < 10 million eur; total assets < 20 million eur; or employees < 150. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 50 © 2024 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 11, no. 2, 50-59, 2024 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v11i2.5959 © 2024 by the authors; licensee asian online journal publishing group analyzing the dynamics of import demand function in pakistan: long-term and short-term relationships with key economic factors shakil ahmad1 imran maqbool2 asif raihan3 liu xin4 ( corresponding author) 1,2,4school of international trade and economics, university of international business and economics beijing, china. 1email: de202160007@uibe.edu.cn 2email: imrmaqbool@hotmail.com 4email: 202210110004@uibe.edu.cn 3institute of climate change, national university of malaysia, bangi 43600, malaysia. 3email: asifraihan666@gmail.com abstract this study investigates the short-term and long-term correlations between total imports in pakistan and a set of explanatory variables. we utilized the autoregressive distributed lag (ardl) model, and we estimated the import demand function for the period from 1980 to 2021. the augmented dickey-fuller (adf) test confirmed that none of the variables exhibited secondorder integration, ensuring their suitability for the ardl approach. bounds testing indicated the existence of a long-term equilibrium relationship among the included variables. furthermore, diagnostic tests validated our model's statistical robustness, ensuring our findings' reliability. the long-term analysis shows significant relationships between imports and key economic indicators such as gross domestic product (gdp), the inflation rate, and the import demand function. furthermore, we found a slight positive impact on import demand from the import price index and foreign direct investment (fdi). these results emphasize the included relationships between various macroeconomic factors and import demand in pakistan. based on these findings, we recommend that the government implement policies aimed at boosting investment, stimulating economic growth, and controlling inflation. specifically, policies that target enhancing foreign direct investment (fdi), maintaining stable inflation rates, and promoting economic growth will be crucial in strengthening the import demand function. these measures will not only support sustainable economic development but also optimize the import dynamics in pakistan’s economy. keywords: fdi, gdp, imports demand, inflation, ardl, pakistan. jel classification: e31; e01; f41; e00. citation | ahmad, s., maqbool, i., raihan, a., & xin, l. (2024). analyzing the dynamics of import demand function in pakistan: long-term and short-term relationships with key economic factors. asian journal of economics and empirical research, 11(2), 50– 59. 10.20448/ajeer.v11i2.5959 history: received: 6 may 2024 revised: 21 july 2024 accepted: 15 august 2024 published: 19 september 2024 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. data availability statement: the corresponding author may provide study data upon reasonable request. competing interests: the authors declare that they have no competing interests. authors’ contributions: conceptualization, methodology, proper analysis, and writing original draft preparation, s.a.; revised the manuscript, managed data, interpreted results, reviewed, and edited the manuscript, i.m., a.r. and l.x. all authors have read and agreed to the published version of the manuscript. contents 1. introduction ...................................................................................................................................................................................... 51 2. literature review ............................................................................................................................................................................ 52 3. econometrics methodology ........................................................................................................................................................... 53 4. estimation results and discussion .............................................................................................................................................. 55 5. conclusion and policy recommendations .................................................................................................................................. 57 references .............................................................................................................................................................................................. 58 mailto:de202160007@uibe.edu.cn mailto:imrmaqbool@hotmail.com mailto:202210110004@uibe.edu.cn mailto:asifraihan666@gmail.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v11i2.5959 https://orcid.org/0000-0003-3744-9162 https://orcid.org/0009-0004-0623-8463 https://orcid.org/0000-0001-9757-9730 asian journal of economics and empirical research, 2024, 11(2): 50-59 51 © 2024 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study adds to the body of knowledge by utilizing the ardl model to conduct a thorough examination of the short-run and long-run relationships between pakistan’s import demand and a range of explanatory factors. it provides solid empirical evidence and draws attention to important relationships between imports, gdp, inflation, and fdi. the practical policy advice it offers for increasing investment, promoting economic development, and reining in inflation further enhances the research on import function and macroeconomic policy in developing nations. 1. introduction global trade facilitates the cross-border interactions of resources, goods, and services, which is essential to a country's economic progress. policymakers, economists, and businesses must comprehend the elements that influence import demand. china, the us, europe, saudi arabia, and the united arab emirates have all had a significant impact on pakistan's import environment. these countries made up a sizable share of pakistan's imports in 2016, which emphasizes the need for examining the factors influencing import demand. such an examination is especially important given pakistan's trade deficit, as noted by muhammad and zafar (2016). governments and academics have long been interested in the relationship between imports and exports. according to chen, ahmad, jiang, and chen (2023) exports and imports significantly drive economic development. a nation must sustainably balance these two essential components of international trade to achieve economic prosperity. maintaining a long-term relationship between imports and exports that complies with international budgetary constraints is essential, since a persistent trade deficit may lead to international economic restrictions. both developed and developing economies have thoroughly studied how imports and exports influence a nation's balance of payments (al-qudah, 2021). pakistan's dependence on foreign commerce and the volatility of the world oil market have garnered significant attention from scholars and politicians. several significant difficulties confront the nation, including unpredictable crude oil prices, diminishing foreign reserves, local conflicts, and a dynamic economic environment. pakistan is concentrating on forging a strong position in the international trade sphere while striving to address these fiscal and external imbalances. numerous issues need to be considered, including the continued drop in crude oil prices, the depletion of foreign reserves, regional difficulties, and the economic crisis. in recent years, experts such as alodadi (2019) and yoon and yongmin (2021) have noted pakistan's economic struggles due to these challenges with fiscal and external balances. importing products and services has a significant impact on economic growth and development. it increases the supply of goods and services, fostering greater economic prosperity. imports create competition that leads to the production of better quality and cost-effectiveness in both home and foreign markets. economic development and expansion depend heavily on a consistent flow of capital and intermediate inputs, as well as commodities and services supplied by imports. it also encourages the improvement of domestic production's efficiency and market competitiveness. importing materials not produced domestically makes a greater variety of finished goods and commodities available for consumption both domestically and internationally (yahia, 2015). maintaining the external balance, controlling inflation risks, assisting regional production industries, and generating employment prospects all depend on an understanding of the need for imports. this topic has not attracted much scholarly attention, despite its significance in the formulation of economic policy. only a few studies have addressed this subject, some of which are outdated. as a result, the study may have a substantial impact on the local production industries, employment prospects, inflation concerns, and external balance, all of which are crucial for maintaining a strong economy. additionally, the limited research on import demand emphasizes the significance of this finding. i am aware that this topic has been the subject of only a few investigations, some of which are outdated (ibrahim, 2015). the impact of import demand extends beyond the economic realms. it touches upon currency dynamics, particularly in the context of remittances. as remittance flows increase, imports can become both a resource and a leakage point for the economy. the intricate interplay between imports and currency rates affects inflation and consumer behavior, shaping critical economic decisions. import policies address the imbalance between demand and supply when domestic output fails to meet demand. however, pakistan has modest foreign currency reserves and limited revenue streams, creating a growing need for remittances. as imports increase, the currency rate will depreciate, raising inflationary pressure by making purchases more expensive. on the other hand, increased remittances lead to higher spending by recipients, resulting in increased demand for goods and services and, consequently, higher local prices. therefore, we must make careful economic decisions. remittances enhance the availability of foreign cash, affecting local currency appreciation or depreciation (ahad & dar, 2018). while remittance money is a vital resource for the economy, rising incomes make imports a source of leakage (depken, radić, & paleka, 2021). another major issue often overlooked in import demand models is the predominance of foreign exchange constraints, which bind each period of consumption (maqbool, 2014). despite remittances being seen as an economic resource, increasing wealth leads to imports becoming a leakage source (yusuf, al-attar, & alshattarat, 2015). import policies address the imbalance between demand and supply if domestic output falls short of demand. however, it has a modest foreign currency reserve and limited revenue streams. in this case, there is a growing need for remittances. the currency rate will depreciate as imports increase. this tends to raise inflationary pressure by making imports more expensive. on the other side, the more money remittance recipients get, the more they will spend, resulting in increased demand for goods and services and, as a result, an increase in local prices. consequently, individuals may make more significant decisions. furthermore, remittances enhance the availability of foreign cash, resulting in local currency appreciation or depreciation (ahad & dar, 2018). the economy views remittance money as a source of resources, but as income increases, imports become a source of leakage (depken et al., 2021). another major problem that import demand models have overlooked is the predominance of foreign exchange constraints. the foreign exchange restriction binds each period of consumption (maqbool, 2014). while the economy views remittance money as a source of resources, as wealth increases, imports become a source of leakage (yusuf et al., 2015). asian journal of economics and empirical research, 2024, 11(2): 50-59 52 © 2024 by the authors; licensee asian online journal publishing group nations worldwide face the challenge of balancing the scales of exports and imports. establishing a lasting relationship between these two components of the balance of payments is a subject of extensive research, both in developed and emerging economies. apart from national income, this research incorporates explanatory variables such as consumption, investment, and exports. it also employs the kalman filter to analyze changes in relative price elasticity and spending patterns over time. this work is unique in that it adds to the body of knowledge by providing a thorough analysis of the evolution of relative price and income elasticity at a detailed level. it is important to note that numerous studies that estimate and examine import demand functions frequently differ in the explanatory elements they use, with a primary focus on explaining import demand. this study includes factors like consumption, investment, and exports to help sort through the complexity of import demand. it analyzes price elasticities and spending patterns over time using advanced methods such as the kalman filter. this work adds a valuable dimension to the current literature by thoroughly examining the evolution of price and income elasticities, which makes it unique. while some people use conventional economic models, others find that the gdp function provides a more comprehensive framework for understanding import demand. it considers the complex relationship that exists between costs and resources, offering a comprehensive viewpoint. researchers have used this model to examine import demand for a wide range of products and nations, providing insights into trade restrictions and welfare losses. each study adds a distinct thread to our understanding as we travel across the intricate terrain of import demand. the expedition aims to uncover the underlying factors influencing pakistan's import dynamics by navigating both temporal and economic environments. this study uses a variety of econometric techniques to try and offer useful policy insights while making sure that the empirical results can withstand close examination (fukumoto, 2012; giansoldati & gregori, 2017). imported forest products are in greater demand when real income growth accelerates. consequently, this increases the need for foreign money and causes the exchange rate to decline. when the price of forest products rises locally relative to global prices, the value of the local currency falls. it is important to remember that factors that affect comparable import prices include material costs, tariffs, and transportation costs, in addition to the exchange rate. for more useful policy analysis, it is crucial to examine the effects of the exchange rate and comparable import prices independently on import demand. to achieve this, the study makes several significant contributions to the existing corpus of knowledge about the impact of sawn wood import demand, the relative import price, and the actual effective exchange rate. firstly, it builds upon the findings of numerous studies, such as the work by adewuyi, ogebe, and oshota (2021) which have explored the connection between exchange rates and corresponding import prices and international trade in various commodities. furthermore, this study will construct an import demand model designed to provide valuable policy insights. it will evaluate how sensitive import demand is to changes in income and prices, a critical consideration for policymakers. this study used a variety of techniques, including the autoregressive distributed lag (ardl) strategy suggested by pesaran, shin, and smith (2001) to ensure thorough analysis. 2. literature review researchers in developed and emerging countries have paid close attention to import demand functions. these features explore the complex interactions between economic and non-economic variables that impact the demand for imports. to identify the critical factors required to study pakistan's import demand function, our review looks at previous research. several economic factors influence pakistan's import demand. pakistan imports crude oil with notable price and income elasticities, with income elasticity increasing over time. with the intertemporal elasticity of substitution being greater than the intertemporal elasticity of substitution, indicating that both imported and domestic commodities are substitutes, intertemporal substitution in import demand is also significant (khan & ahmad, 2022). imports and economic growth in pakistan are causally related; imports of consumer and capital goods boost economic growth and productivity. in pakistan, import taxes produce a wedge between local and global pricing, influencing resource allocation and fostering a bias against exports (varela et al., 2020). economic growth and import prices have a negative effect on import demand; however, financial development has a favorable effect. bahmani-oskooee and rhee (1997) conducted a study that examined the relationship between imports and exports in established and developing economies, concentrating on south korea over a 28-year period from 1963 to 1991. we employed several metrics, such as nominal exports in us dollars and local currency and real values in both, to successfully disentangle the complex relationship between korea's imports and exports. with confidence, the results demonstrated that south korea skillfully adhered to its foreign budget constraint while maintaining a long-term balance between its imports and exports. this study provides a tremendous deal of insight into the complex dynamics of trade in emerging economies. in pakistan's example, fdi has a short-term beneficial impact on exports, according to mulk, ahmad, mahmood, and jan (2023). shimul (2013) studied the connection between oil imports and exports in four gulf cooperation council (gcc) nations: saudi arabia, kuwait, oman, and the united arab emirates. determining whether there was a consistent association between the two criteria was the primary objective of the investigation. the study excluded qatar due to a lack of information. with kuwait excluded, the researchers employed johansen's cointegration approach and discovered strong evidence of a long-term equilibrium between oil imports and exports in oman, saudi arabia, and the united arab emirates. this finding is important because it suggests that the trade policies of these nations have been successful in promoting long-term stability, which is a necessary component of their economic prosperity. murray and ginman (1976) emphasized that national income is a key factor in predicting imports in open economies. significantly, their research challenged the widely held belief that there is a positive correlation between imports and national gdp. they also postulated that import prices have a significant influence on import demand, which helps to explain the intricate relationship between prices and income that affects import behavior. durmaz and lee (2015) expanded their analysis to look at a wider range of empirical research on the variables affecting the total demand for imports in developed and developing countries. their study supported santospaulino (2002) observed that international economics has conducted significant research on import demand functions, which their study supported. such import demand functions are frequently essential parts of macroeconomic models, highlighting their importance in understanding the economy's dynamics. senhadji (1998) asian journal of economics and empirical research, 2024, 11(2): 50-59 53 © 2024 by the authors; licensee asian online journal publishing group made a substantial contribution to the area by calculating import demand functions for a large dataset that included sixty-six countries, many of which were in asia. this comprehensive study established the foundation for comprehending import dynamics across a wide range of economies. moreover, japan has been the focus of other focused research projects in the field of import demand functions. these unique research studies on japan have provided priceless insights into the elements influencing its import demand function. yahia (2015) conducted a comparative study of 41 developed countries and found significant differences in import elasticity among them. according to the study, income elasticity had a negative statistical significance in canada, france, japan, and switzerland but a positive statistical significance in the united states and the united kingdom. these results improved our understanding of the complexities of global commerce dynamics by illuminating the ways in which various countries react differently to international trade volatility. to better understand the aggregate import demand function, particularly in emerging economies, zailani, ariffin, iranmanesh, moeinzadeh, and iranmanesh (2016) dove deeply into bangladesh. they used the error correction mechanism and different co-integration estimation approaches to highlight the statistical importance of export demand, relative import prices, real income, and foreign exchange reserves over the long and short terms. as a result, our research clarified the main factors influencing import demand in developing countries. in their 2000 study, alias and cheong (2000) calculated the long-term link between aggregate imports and different spending components in the asean countries. this extensive study included thailand, singapore, malaysia, indonesia, and the philippines. using johansen's multivariate co-integration method, four asean countries were the subject of the 1968–1998 study. the findings provided critical insights into the dynamics of regional trade by illuminating the complex interactions between import demand and its determinants in the asean area. from 1973 to 2013, muhammad and zafar (2016) carefully examined pakistan's import demand function. a wide range of important factors were considered in their research, including imports, exports, foreign direct investment, final consumption spending, investment expenditure, and government consumption expenditure. the study's findings demonstrated significant longand short-term correlations between imports and these important independent factors. this research makes a significant contribution to our understanding of pakistan's complex trade dynamics. focusing on fiji, narayan (2005) investigated a disaggregated import demand function from 1970 to 2000. the analysis included numerous factors such as relative prices, total consumption, investment expenditure, and export spending. using the autoregressive distributed lag (ardl) model, the research revealed a relationship across time between these independent determinants and import demand. thus, this study provides insightful information about fiji's trading practices. using the engle-granger representation theorem for the short run and the johansen multivariate co-integration technique for the long run, ziramba (2012) examined the short-run import behavior with an emphasis on the united kingdom. consumer expenditure significantly influenced the long-term prediction of uk aggregate imports, according to their research. it also discovered different partial elasticities for export expenditure, investment, and consumption, which broadens our knowledge of the uk's import demand dynamics. using their lens, estimate the aggregate import demand function for india between 1975 and 2003. the study utilized co-integration and an error correction model, taking into account variables such as gdp, unit import prices, prices of locally produced goods, and foreign exchange reserves. the results demonstrated how important foreign exchange reserves, gdp, import lag, and domestic commodity prices are in determining india's import demand. a new strategy was presented by çulha, eren, and öğünç (2019) who concentrated on the import factors of turkey. this study used a disaggregated approach in contrast to conventional aggregated approaches, connecting import sub-items to elements of national revenue like exports, consumption, and investment spending. importantly, this study didn't look at imports of gold or energy because they change so quickly. instead, it used turkish national income statistics based on 2009 prices to figure out how income and price elasticity change over time. this showed how complex the factors that affect imports are. with an emphasis on the united states, adewuyi et al. (2021) looked at the shortand long-term impacts of exchange rate fluctuations on the export and import volumes of different forest products. the study discovered that short-term fluctuations in exchange rates had a negative effect on exports and a slight favorable impact on import volumes. but in the case of sawn wood exports, their effects were noteworthy, providing important insights into the intricate link between exchange rates and the trade in forest products. goodwin, holt, and prestemon (2019) examined the exchange rate pass-through (erpt) for oriented strand board prices in the us and canada from 1998 to 2016. our understanding of erpt dynamics in the wood products industry has improved because of their research, which revealed an unusual pattern whereby erpt stayed minor throughout expansionary periods but exhibited a rising trend during economic downturns. wang and lee (2012) used data from 1970 to 1986 to examine china's import demand equation in their comprehensive analysis of the country. they discovered that the marshall-lerner criterion was valid over the long term but not in the near term, casting doubt on the idea that depreciating currency was a quick and effective way to reduce trade deficits. this study highlighted the long-term view while illuminating the intricacies of china's trade balance dynamics. it is critical to gain a thorough understanding of import demand functions and their importance for various economies, particularly in pakistan. building an extensive body of knowledge on this subject is therefore crucial. 3. econometrics methodology in this section, we will delve into the nuances of pakistan's import demand function computation. this section will provide a detailed explanation of the various variables incorporated in the model, along with a comprehensive analysis of the data sources utilized. we are committed to providing you with the most accurate and trustworthy information possible to help you gain a deeper understanding of pakistan's import demand function. 3.1. flow chart of the analysis figure 1 shows the flowchart of the analytical method used in the investigation of the import demand dynamics in pakistan: long-term and short-term relationships with important economic factors in pakistan. asian journal of economics and empirical research, 2024, 11(2): 50-59 54 © 2024 by the authors; licensee asian online journal publishing group figure 1. flow chart of the analysis. 3.2. model specification the conventional import demand function considers partial substitution. this encompasses elements such as the importing nation's revenue, the cost of imported goods, and the availability of alternatives. our study examines previous research that uses several models of import demand functions to estimate the function for individual countries, groups of countries, and econometric methodologies. our goal is to pinpoint the right variables so that pakistan's economy can have a personalized import demand function. as a result, we have demonstrated the following functional form for pakistan's import demand function: 𝐼𝑀 = 𝑓(𝐺𝐷𝑃, 𝐶𝑃𝐼, 𝐺𝐹𝐶𝐹, 𝐹𝐷𝐼) (1) equation 1 represents an import demand function, showing that several key economic variables influence the quantity of imports (im). gdp reflects economic size and growth, suggesting that a larger economy typically demands more imports. the cpi, which measures inflation, can alter import demand by affecting relative prices. a rising cpi may increase demand for cheaper imports. gfcf, which represents a gross fixed capital formation proxy for investments, has potential to increase capital imports. foreign direct investment, or fdi, can boost imports through technology and economic growth. 3.3. data description to conduct an accurate estimation process, it is imperative to gather data from two highly dependable sources. these sources include the world development indicators (wdi) and publications from the central bank of pakistan (cbp). these sources provide crucial data for conducting a thorough analysis and generating accurate results. as a result, it is essential to guarantee that the information acquired is reliable and trustworthy. 3.4. econometric analysis: ardl bounds testing the purpose of this study is to investigate the shortand long-term association between the variables in pakistan's import demand function from 1980 to 2021. as cited in the literature review, numerous prior research studies have explored the enduring links between import demand and its potential influencers. we employed the ardl model approach to cointegration, a commonly used econometric method for examining time series data, in our work. using this approach, initially established by pesaran et al. (2001) we were able to investigate the shortand long-term relationships between pakistan's total imports and a variety of explanatory factors. this is important because of its versatility and suitability for both small and large sample sizes (raihan, ridwan, tanchangya, rahman, & ahmad, 2023). we conducted extensive unit root and cointegration experiments to evaluate long-term equilibrium relationships. the method given has some improvements over the earlier approaches by søren johansen (1991); soren johansen and juselius (1990) and engle and granger (1987). its validity in any combination of variables—whether integrated of order one i (1), order zero i (0), or even integrated of order two i (2)—is one of its advantages. it is also more realistic, particularly with smaller sample sizes, which makes it a reliable choice for examining the correlations in the dataset. before doing the ardl limits test, the first step usually entails evaluating the stability qualities of each variable to make sure that the all-time series are i (0) or i (1) rather than i (2). lastly, equation 2 is evaluated using the least squares approach to determine whether there are long-term equilibrium relationships between the variables. the ardl limits test method is then utilized for this purpose. ∆𝐼𝑀𝑡 = 𝛽0 + ∑𝜌 𝑖=1 𝛿1𝑖∆𝐼𝑀𝑡−1 + ∑𝜌 𝑖=1 𝛿2𝑖∆𝐺𝐷𝑃𝑡−1 + ∑𝜌 𝑖=1 𝛿3𝑖∆𝐶𝑃𝐼𝑡−1 + ∑𝜌 𝑖=1 𝛿4𝑖∆𝐺𝐹𝐶𝐹𝑡−1 + ∑𝜌 𝑖=1 𝛿5𝑖∆𝐹𝐷𝐼𝑡−1 + 𝛽1∆𝐼𝑀𝑡−1 + 𝛽2∆𝐺𝐷𝑃𝑡−1 + 𝛽3∆𝐶𝑃𝐼𝑡−1 + 𝛽4∆𝐺𝐹𝐶𝐹𝑡−1 + 𝛽5∆𝐹𝐷𝐼𝑡−1 + 𝛼𝑡 (2) a variable in a time series analysis shifts from one period to the next. the constant level is represented by the intercept term, denoted by 𝛽0. the maximum lag length is represented by the letter p, and the number of lags considered in the model is denoted by i. the coefficients associated with each lagged variable, represented by (𝑖, p = 1…….5), indicate their long-term effects on the dependent variable. lastly, the white noise error term, 𝛼𝑡, accounts for unexplained variations in the dependent variable that cannot be explained by the other terms in the equation. the hypothesis testing aims to assess whether the lagged variables in the model have a statistically significant impact on imports, indicating a meaningful long-term relationship between these variables. 𝐻0: 𝛽1 = 𝛽2=𝛽3= 𝛽4= 𝛽5 = 0 𝐻1: 𝛽1 ≠ 𝛽2 ≠ 𝛽3 ≠ 𝛽4 ≠ 𝛽5 ≠ 0 in this analysis, we assessed the overall significance of variables with different lagged levels, as narayan (2005) suggested, using an f-test. the aim was to investigate whether the null hypothesis held. if the f-statistic exceeded the upper bound of the critical value, we could confidently reject the null hypothesis, indicating the presence of cointegration among the variables. conversely, if the f-statistic fell below the lowest critical value, it would not asian journal of economics and empirical research, 2024, 11(2): 50-59 55 © 2024 by the authors; licensee asian online journal publishing group provide sufficient evidence to reject the null hypothesis, implying no cointegration. in cases where the f-statistic fell within two specific ranges, the test's outcome was not definitive. to determine the optimal lag length for the autoregressive distributed lag (ardl) model, we employed the akaike information criteria (aic), which helped us choose the most appropriate model specification. after demonstrating a long-term relationship between import demand and its drivers, we examine the shortterm dynamics and the rate of adjustment. the coefficient 𝐸𝐶𝑇𝑡−1indicates how quickly variables transition from short-term to long-term equilibrium. here is a way to explain pakistan's short-term import dynamics. ∆𝐼𝑀𝑡 = 𝛽0 + ∑𝜌 𝑗=1 𝛿1𝑖∆𝐼𝑀𝑡−1 + ∑𝜌 𝑗=1 𝛿2𝑖∆𝐺𝐷𝑃𝑡−1 + ∑𝜌 𝑗=1 𝛿3𝑖∆𝐶𝑃𝐼𝑡−1 + ∑𝜌 𝑗=1 𝛿4𝑖∆𝐺𝐹𝐶𝐹𝑡−1 + ∑𝜌 𝑗=1 𝛿5𝑖∆𝐹𝐷𝐼𝑡−1 + ⍬𝐸𝐶𝑇𝑡−1 + 𝛼𝑡 (3) the first difference operator in the following equation is denoted by ∆, the constant term is β_0, the maximum lag length is represented by ρ, and the number of lags taken into consideration is indicated by i. the short-run coefficients linked to the corresponding lagged variables are denoted by 𝛿(𝑗, 𝑖= 1…...,5). moreover, the coefficient of the lag error term 𝐸𝐶𝑇𝑡−1is denoted by ⍬, which must, under critical conditions, be negative. this equation serves as the foundation for deriving an understanding of the model's short-term dynamics and the responses of the variables to perturbations from their long-term equilibrium. 3.5. diagnostic stability tests with the appropriate modifications, diagnostic statistics are used to guarantee the accuracy of the evaluation results. residual serial correlation is found using the lagrange multiplier (lm) test, while heteroscedasticity is detected using the white test. the study also includes brown, durbin, and evans (1975) cumulative recursive sum (cusum) and cumulative recursive squared sum (cusumsq). by evaluating the stability of the longand shortterm estimated coefficients, these tests aid in the detection of any structural alterations to the model over time. the thorough diagnostic process guarantees that the study's conclusions are dependable. 4. estimation results and discussion 4.1. unit root test (adf) as per pesaran et al. (2001) the sequence of integration for the time series data must be initiated to perform the ardl limits test. testing at the unit root level can be used to opt whether swerving data ought to be introduced to deterministic time functions prior to regression on them to make the trends stationary (ahmad, raihan, & ridwan, 2024; ridwan, raihan, ahmad, karmakar, & paul, 2023). table 1 displays the results of the augmented dickey-fuller (adf) unit root tests, which are an essential factor in determining the integration order for every variable. the test results reveal a distinct pattern: one variable exhibits first-order integration, represented as i (1), while maintaining its original values, indicating integration at order i (0). this difference in integration orders underpins the upcoming analytical methods and is a necessary requirement for completing the ardl bounds test steps. table 1. results of unit roots tests. variables figures at level result figure at difference result gdp 0.312 non-stationary 0.015 stationary cpi 0.045 stationary 0.000 stationary gfcf 0.746 non-stationary 0.000 stationary fdi 0.560 non-stationary 0.000 stationary i'm 0.840 non-stationary 0.000 stationary table 2. correlation and descriptive statistics. i'm cpi fdi gdp gfcf mean 23.541 0.077 20.255 25.732 23.364 median 23.237 0.074 20.393 25.727 23.213 maximum 24.868 0.184 22.444 26.503 24.625 minimum 22.559 0.024 17.198 24.790 22.295 std. dev. 0.784 0.034 1.3209 0.5012 0.7415 skewness 0.314 0.629 -0.3473 -0.1698 0.1188 kurtosis 1.522 3.568 2.3360 1.9538 1.6294 jarque-bera 4.297 3.177 1.5391 2.0164 3.2248 probability 0.116 0.204 0.4632 0.3648 0.1994 i'm 1.000 cpi 0.153 1.000 fdi 0.867 0.259 1.000 gdp 0.953 0.052 0.905 1.000 gfcf 0.984 0.095 0.897 0.981 1.000 table 2 presents both descriptive statistics and correlations among the variables. descriptive statistics include mean, median, maximum, minimum, standard deviation, skewness, kurtosis, jarque-bera, and associated probabilities. these metrics offer insights into the variables' central tendencies, variability, and distribution shapes. correlation coefficients highlight relationships between pairs of variables. for example, a correlation of 0.153 between im and cpi indicates a weak positive association. additionally, a strong positive correlation of 0.905 exists between fdi and gdp. overall, this table provides essential groundwork for understanding variable characteristics and interdependencies. table 3 provides the results of the bound test for cointegration involving the variables "im," "gdp," "fdi," "gfcf," and "cpi." the f-statistic for this test is 4.367. to assess its significance, critical value bounds are provided at various confidence levels. for instance, at a 10% confidence level, the i (0) bound is 2.2, while the i (1) bound is 3.09. likewise, at the 5% confidence level, the i (0) bound is 2.56, and the i (1) bound is 3.49. these critical asian journal of economics and empirical research, 2024, 11(2): 50-59 56 © 2024 by the authors; licensee asian online journal publishing group value bounds serve as benchmarks to determine the existence of cointegration among the variables. in this context, the f-statistic of 4.367 exceeds the upper bound critical value of 3.49 at the 5 percent significance level. consequently, the null hypothesis of no cointegration is rejected, providing strong evidence for a long-term relationship among the variables. table 3. cointegration results. table 3: bound test: (im, gdp, fdi, gfcf, cpi) f-statistic: 4.367 critical value bounds i (0) bound i (1) bound 10% 2.2 3.09 5% 2.56 3.49 2.5% 2.88 3.87 1% 3.29 4.37 after establishing cointegration among the variables, we proceeded to estimate the error correction model (ecm) to delve deeper into their long-term relationship. the short-run estimation results, shown in table 4, show that both the initial differences and lagged values of these variables are statistically significant in the short term. this shows that they have a big effect on pakistan's import demand function right away. these findings underscore the dynamic nature of factors influencing import demand in pakistan, especially in the short-term context. notably, the error correction term is significant at the 1 percent confidence level and bears a negative sign. this suggests a long-term causal relationship between the explanatory variables and import demand. it is critical to begin the order of integration for the time series data in accordance with pesaran et al. (2001) guidelines to prepare for the ardl bounds test. table 1 displays the results of the adf unit root test, a crucial factor in determining the integration order for each variable. in contrast to the test results, one variable exhibits first-order integration, represented as i (1), while the other variable maintains its original values, indicating integration at order i (0). to proceed with the ardl bounds test and enable the upcoming analytical procedures, there must be a divergence in integration orders. table 4. short-run estimation results. variable coefficient std. error t-statistic prob. d(gfcf) 0.181 0.152 1.193 0.251 d (gfcf (-1)) -0.516 0.200 -2.579 0.020 d (gfcf (-2)) -0.147 0.139 -1.060 0.305 d (gfcf (-3)) 0.264 0.139 1.888 0.078 d(gdp) 3.417 1.145 2.984 0.009 d (gdp (-1)) 7.304 1.293 5.647 0.000 d (gdp (-2)) 3.066 1.232 2.488 0.025 d(fdi) 0.008 0.039 0.203 0.841 d (fdi (-1)) -0.101 0.041 -2.423 0.028 d (fdi (-2)) -0.116 0.029 -4.015 0.001 d (fdi (-3)) -0.096 0.037 -2.603 0.020 d(cpi) 1.239 0.462 2.676 0.017 d (cpi (-1)) -2.838 0.652 -4.348 0.000 d (cpi (-2)) -2.220 0.736 -3.016 0.008 d (cpi (-3)) -1.254 0.487 -2.572 0.021 ecm (-1) -0.788 0.133 -5.911 0.000 table 5. ardl long run coefficients. variable coefficient std. error t-statistic prob. gfcf 0.940 0.308 3.050 0.008 gdp 0.044 0.496 0.090 0.929 fdi 0.123 0.081 1.506 0.152 cpi 4.916 1.363 3.605 0.002 c -3.123 6.163 -0.506 0.619 table 5 displays the long-run ardl coefficients for the variables, shedding light on their impact on pakistan's import demand. with a coefficient of 0.940, gross fixed capital formation (gfcf) is found to be a substantial driver of long-term import demand, indicating a strong and statistically significant positive influence (muhammad & zafar, 2016). conversely, gross domestic product (gdp) exhibits a negligible coefficient of 0.044, indicating its lack of statistical significance in influencing long-term import demand, aligning with findings in turkey, jordan, and elsewhere (abu-lila, 2014; bigben, 2016; mugableh, 2017). foreign direct investment (fdi) demonstrates a relatively weak and non-significant impact, with a coefficient of 0.123 (cpi) plays a substantial and statistically significant role, with a coefficient of 4.916, underlining its positive influence on long-term import demand, corroborating previous research such as aldakhil and al-yousef (2002). finally, the intercept term (c) lacks statistical significance in the long-term import demand equation, marked by a coefficient of -3.123 (pakistan). table 6. diagnostic test. test f-statistics p-value serial correlation 0.815 0.572 heteroscedasticity 0.144 0.999 normality 0.163 0.921 asian journal of economics and empirical research, 2024, 11(2): 50-59 57 © 2024 by the authors; licensee asian online journal publishing group table 6 presents the results of diagnostic tests conducted to assess the robustness of the model. the serial correlation test yields an f-statistic of 0.815 with a p-value of 0.572, suggesting no evidence of serial correlation in the residuals. the heteroscedasticity test produces an f-statistic of 0.144 with a p-value of 0.999, indicating the absence of heteroscedasticity. the normality test results in an f-statistic of 0.163 with a p-value of 0.921, implying that the residuals follow a normal distribution. these diagnostic tests support the reliability of the model's results and the validity of its underlying assumptions. we evaluated the stability of the model estimates using the cumulative sum (cusum) of the recursive residuals and the cumulative sum of squares (cusumsq) of the recursive residual test figure 2 displays the results of these tests. in particular, both the cusum and cusumsq test statistics remained below the critical thresholds at the 5% significance level. this indicates that the regression models exhibit stability, affirming the reliability of the estimated coefficients and the whole model results. figure 2. the stability test results. 5. conclusion and policy recommendations this study delves into the complex dynamics of pakistan's import demand function, driven by heightened consumption in both the public and private sectors, which has influenced increased consumer spending and product diversity. the import demand function, which is an essential part of pakistan's economic environment, increases consumption expenditure both directly and indirectly. using the ardl technique, this study estimates the import demand function, primarily focusing on imports, gdp, and the consumer price index (cpi). the order of these variables is a critical consideration. the unit root tests and the bound test confirm the existence of long-term connections among these variables, providing a solid foundation for further analysis. the shortand long-term import elasticity coefficients underscore the vital role of several key factors. a 1% increase in gross fixed capital formation (gfcf) leads to a 4.916% growth in imports in the short term, but this impact moderates to 0.840% in the long term. similarly, a 1% increase in gdp translates to a 0.64% short-term increase and a 0.1% long-term increase in imports, highlighting the importance of economic growth. conversely, foreign direct investment (fdi) exhibits negligible influence. 5.1. policy recommendations 1. promote investment: given the substantial positive impact of gfcf on import demand, policymakers should actively create an investment-friendly environment. attracting domestic and foreign capital through incentives, streamlined regulations, and improved infrastructure can significantly boost the economy. asian journal of economics and empirical research, 2024, 11(2): 50-59 58 © 2024 by the authors; licensee asian online journal publishing group 2. manage inflation: the cpi's strong influence on long-term import demand highlights the importance of price stability. policymakers should implement effective monetary and fiscal policies to manage inflation, ensuring import stability. 3. diversify the export portfolio: while this study primarily focuses on imports, it is essential for pakistan to concurrently prioritize export diversification. a diversified export portfolio can mitigate trade imbalances and reduce the trade deficit, contributing to overall economic stability. 4. enhance data quality: policymakers must focus on data collection and reporting mechanisms, particularly concerning foreign direct investment (fdi). high-quality economic data are fundamental for informed policymaking and comprehensive analyses. 5. adopt long-term planning: given the observed long-term dynamics in import demand, a strategic, forwardlooking approach to policymaking is necessary. supporting policies with the long-term characteristics of the import demand function can foster sustainable economic growth and stability. this research improves our ability to understand pakistan's import demand function, offering valuable insights and policy recommendations. by strategically addressing investment, inflation, and export diversification, pakistan can control its import demand function and drive economic prosperity and stability in the years ahead. references abu-lila, z. m. 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(2012). revisiting the south african aggregate import demand: a view from expenditure components. studies in economics and econometrics, 36(2), 67-83. https://doi.org/10.1080/10800379.2012.12097239 asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.2307/3867390 https://doi.org/10.15208/beh.2013.2 https://doi.org/10.1016/j.econmod.2012.08.002 https://doi.org/10.7763/joebm.2015.v3.322 https://doi.org/10.5539/ijbm.v10n5p134 https://doi.org/10.1108/jstpm-12-2015-0041 https://doi.org/10.1080/10800379.2012.12097239 100 © 2022 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 9, no. 2, 100-120, 2022 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v9i2.4132 © 2022 by the authors; licensee asian online journal publishing group the impact of south africa’s total early-stage entrepreneurial activity rate on entrepreneurial attitudes and behavior mathew e. egu1,2 evelyn g. chiloane-phetla3 ( corresponding author) 1department of business administration and finance, global humanistic university, curacao. 2department of business administration and management, federal polytechnic idah, kogi state, nigeria. 1,2email: meegu@fepoda.edu.ng tel: +2348037443826 3department of applied management, university of south africa, south africa. 3email: chiloge@unisa.ac.za tel: +27728589257 abstract given that entrepreneurship scholars use various approaches to measure entrepreneurial success, which leads to inconsistent findings, in this study we investigate the impact that south africa’s total early-stage entrepreneurial activity (tesea) rate has on the entrepreneurial attitudes and behavior of south africans and their reactions to different macroeconomic factors. secondary datasets were elicited from the world bank’s world development indicators and the global entrepreneurship monitor (gem) database from 2003–2014. using a generalized linear model (glm) poisson regression, we affirmed the statistical significance of these relationships, as well as enhanced the validity and reliability of the quantitative estimation procedure. we found that the tesea rate is positively associated with a higher ease of doing business and entrepreneurial intention level. furthermore, we found that when entrepreneurship is viewed as a good career choice, and given media visibility, the tesea rate increases, and vice versa. it was also observed that the gdp per capita (which relies on efficiency, innovation and optimal utilization of market knowledge), as well as the level of economic freedom in south africa, positively impacts the nation’s tesea rate. likewise, we found that the unemployment rate is positively associated with the tesea rate of south africa. south africa’s tesea rate is influenced by a combination of factors due to the dynamic nature of individual traits. however, the tesea rate has a remarkable impact on south africa’s entrepreneurial decision making. this implies that a targeted approach is more relevant when implementing both private and government policy initiatives. keywords: total early-stage entrepreneurial activity, global entrepreneurship monitor, small and medium enterprises, multinational enterprises, gross domestic product, foreign direct investment. jel classification: a10, c12, c19, g40, y90. citation | mathew e. egu; evelyn g. chiloane-phetla (2022). the impact of south africa’s total early-stage entrepreneurial activity rate on entrepreneurial attitudes and behavior. asian journal of economics and empirical research, 9(2): 100-120. history: received: 10 june 2022 revised: 25 july 2022 accepted: 12 august 2022 published: 31 august 2022 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. authors’ contributions: both authors contributed equally to the conception and design of the study. competing interests: the authors declare that they have no conflict of interest. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study, that no vital features of the study have been omitted, and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 101 2. background and hypothesis development ............................................................................................................................... 101 3. empirical investigation ................................................................................................................................................................ 108 4. methodology ................................................................................................................................................................................... 109 5. results .............................................................................................................................................................................................. 110 6. discussion and conclusions ......................................................................................................................................................... 117 references ............................................................................................................................................................................................ 118 appendix .............................................................................................................................................................................................. 120 mailto:meegu@fepoda.edu.ng mailto:chiloge@unisa.ac.za https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v9i2.4132 https://orcid.org/0000-0001-5141-7023 https://orcid.org/0000-0002-0460-6291 asian journal of economics and empirical research, 2022, 9(2): 100-120 101 © 2022 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this paper contributes to existing entrepreneurship literature by stating how the total early-stage entrepreneurial activity (tesea) rate is affected by a myriad of factors which impacts entrepreneurial attitudes and behavior. furthermore, we contribute to new knowledge in this area by specifying that the tesea rate can be influenced by the rate of economic development, the unemployment rate, foreign direct investment levels, the johannesburg stock exchange's market capitalization as well as the prevailing macroeconomic conditions in south africa. 1. introduction profound differences in research synopses and viewpoints have caused schisms among entrepreneurship scholars during seminal debates. the prevailing argument concerns issues facing policy makers, such as the contribution of this phenomenon to national productivity, growth, youth empowerment, and employment. the global entrepreneurship monitor (gem) usage of sophisticated estimation techniques, such as the total early-stage entrepreneurial activity (tesea) rate to measure entrepreneurial tendencies, has not only gained prominence in the small business (entrepreneurship) development literature (álvarez, urbano, & amorós, 2014; amorós & bosma, 2014; amorós, bosma, & jonathan, 2013; bosma, 2013; bosma et al., 2020; herrington & kew, 2018) but also offers insight into theoretical foundations that aids the solving of the global problem of poverty (deakins & freel, 2009; hisrich & peters, 2002; nwafor, 2007). although emphasis has been put forward by the various entrepreneurship schools of thought, such as the austrian school of thought, psychological characteristics school, and the socio-behaviorist school of thought, this field of study cannot obscure itself from conventional international business (ib) and economic theories despite conflicting ideological perspectives (deakins & freel, 2009). since theories such as the resource-based view (rbv) stems from the logical argument that social capital affects important firm activities, which is also buttressed by the growth theory that emanates from the view that most enterprises grow organically from infancy to maturity, considering multidisciplinary perspectives has become a fundamental core of entrepreneurship literature. this can be traced to the fact that aggregate entrepreneurial activity is pro-cyclical due to a myriad of factors, which have not been thoroughly and aggregately studied thus far. therefore, this article attempts to fill current literature and empirical gaps, contributing to theoretical development. more importantly, we investigate the impact of south africa’s tesea rate on other economic ratios, such as the rate of economic development, unemployment, the prevailing macroeconomic conditions, the level of foreign direct investment (fdi), as well as its influence on periodic capital market adjustments (acs & szerb, 2011; amorós et al., 2013; bosma, 2013). interestingly, there is a great rift in the methodology and approaches to measuring how entrepreneurship constitutes the building blocks of the economy of a nation (acs & szerb, 2011; kew, herrington, litovsky, & gale, 2013; lin, lu, liu, & zhang, 2016). although numerous studies have continued to measure the rate of economic growth and national development (unctad, 2015; world economic forum, 2015) using the gdp metric, different indices have been used to arrive at the same weight (i.e., product output, income, expenditure, and tax approaches), which also leads to some distortions in their estimates. since small and medium enterprises (smes) contribute about 36.1% of south africa’s gdp and employ approximately 68.2% of the workforce in the private sector (smulders, 2006), studying entrepreneurial behavior and tendencies is worthwhile. more so, multinational enterprises (mes), whose lifeblood is fdi, have also helped to sustain both national growth and productivity. apart from the fact that mes tilt the balance of payment positions of many nations, they also support ancillary industries and smes (unctad, 2015; world economic forum, 2015). moreover, due to the ingrained complexities of several developing nations’ economies, most economists have deliberately studied this phenomenon in isolation, subsequently creating entirely new fields of study, such as development economics,1 (todaro & smith, 2009), entrepreneurship, and small business development in contrast to international business that relies on the indices of very competitive economies. this is a result of almost perfectly competitive market information been freely and readily accessible in these countries, whereas the economies of developed nations have efficient allocation and distributive mechanisms. most developing nations’ markets have asymmetric information, which leads to an inefficient allocation and distributive framework that leads to a vicious cycle of poverty within the economy2 (dunning, 2010; gerring & thacker, 2008; yusuf, 2009) as opposed to a virtuous cycle of development3 (dunning, 2010) that exists in developed markets. the rest of the paper is structured as follows: section 2 reviews the relevant literature background and contains the hypothesis development that provides the motivation for this study; sections 3 explains the empirical methodology; section 4 presents the empirical results; and section 5 focuses on the discussions and the conclusion of the study. 2. background and hypothesis development contemporary entrepreneurship research reveals that entrepreneurship involves the replication of ideas, knowledge, skills/talent, and resources to generate an iterative conflation of products and services (ansoff, 2006; cope, 2005; shane, 2013; todaro, 2003). however, the growing significance of this phenomenon has led to various arguments that support different theories about this field (deakins & freel, 2012; shane & nicolaou, 2013). we therefore try to conceptualize the ensuing entrepreneurial chasm, and then empirically detect its determinant outcomes in south africa. given that entrepreneurial studies are both interdisciplinary and multifaceted as a result of the historical periods of economic progression and thought, different approaches to this topic have been theorized. thus, each school of thought considers its theoretical foundations based on the roots of their thinking in economics, psychology, sociology, anthropology, management and international business (dunning, 2010). based on the entrepreneurship literature review, this study places the schools of thought into four classifications, which include the economic approach, psychological characteristics (or entrepreneurial personality approach), the socio-behavioral approach, and the other models/tools that are based on direct influences from derived pragmatic representations from various fields of learning. although different definitions of the term “entrepreneurship” have been put forward by various scholars, this research adopts the definition of kirzner (1973), which defines entrepreneurship as the act of business that encompasses the willingness to undertake risk, ignite innovation and manage asian journal of economics and empirical research, 2022, 9(2): 100-120 102 © 2022 by the authors; licensee asian online journal publishing group resources (i.e., land, capital and labor) with the sole aim of ensuring profit or sustenance due to necessity, social impact and/or opportunity, because of the in-born peculiarities or the dynamic erudition routines of an erstwhile sub-optimal individual for the prosperity of an enterprise. expectedly, economic theorists and writers take the economic approach, since their opinions constitute the major findings of this entrepreneurship school of thought (see table 1). although classical economic theorists advanced the importance of free trade, division of labor, specialization and competition, objections have been raised because of their articulation of three modes of production, which are land, capital and labor. hence, their failure to explain the dynamic disruption generated by the industrial age entrepreneurs caused a breakout in economic thought. also, criticisms by the neoclassicists indicated that perfect competition carried closed system assumptions, such as pure exchange, that reflect an optimal ratio, which is not attainable in less developed and developing economies such as south africa. however, like the physiocrats who put forward the notion of a government of nature dominated by agrarian philosophy, which infers that the wealth of nations is derived exclusively from the rate of land development, their theoretical propositions were rejected and criticized by intellectuals. nevertheless, it is noteworthy to understand that views held by cantillon (1755) still hold sway today. for this reason, due to the influence of the three classes (i.e., landowners, workers and entrepreneurs), entrepreneurs remain fundamental economic agents who monopolize individual property rights to achieve profit or reward, as well as undertake risks that also lead to losses. following this assumption, during the apartheid era in south africa, the white minority controlled the land resources of the nation and became prosperous, whereas the majority of black people who dominated townships were poor and underemployed (mthombeni, 2006; mudhara, 2010) due to their inability to exploit the land resources of the country. despite the fact that this anomaly is being corrected by the popular african national congress (anc) government through the broad based black economic empowerment (bbbee) programme (akoojee, 2013), land ownership has not translated to economic prosperity for africans. likewise, many developed nations rely on their highly innovative enterprises instead of their land resources to ensure economic advancement and competitiveness over other nations. ultimately, the austrian school of thought came into existence because they wanted to proffer remedies to the problems that emanated from earlier entrepreneurship schools of thought. this notion is based on the concept of methodological individualism, which assumes that social phenomena result from the motivations and actions of individuals because of subjective value, sub-optimality and a dynamic equilibrium where importance is given to the demand and supply of entrepreneurs whose effect is moderated by the expected reward. remarkably, their view supports the notion that methodological individualism and subjectivism aid the manipulation of aggregate taste and preferences, opportunity costs, marginalism, as well as the time structure of cumulative production and consumption, which eventually causes all economic phenomena to occur over time. according to kirzner (1973), an entrepreneur’s creative alertness facilitates exchange and inspires him to spot opportunities (i.e., as a middleman) for trade by acting as an intermediary between suppliers and customers, despite not owning resources due to incomplete knowledge and costless marketplace information. this is what drives economies and is craved by all countries, including south africa. table 1. entrepreneurship schools of thought. s c h o o l s o f t h o u g h t the economic approach the psychological characteristics or entrepreneurial personality approach socio-behavioral approach other international business strategy models or tools: eclectic model growth theory rbv-mbv born global swot-pest summary authors outcome an offshoot of classical and neoclassical theories of economics, which is mainly influenced by the austrian school of thought that market arbitrage gives rise to business opportunities. analyzes personality characteristics or traits of successful entrepreneurs or individuals based on entrepreneurial inclinations for risk-taking, innovation and tolerance for ambiguity. this school argues that the social context, comprising of the society’s culture, capital, learning abilities, risk management, and environmental conditions, influences the extent of entrepreneurial participation, which is based on ethnic identification/segmentation and population ecology. merges several isolated theories into models by exploiting net ownership and locational and internalization advantages. it also understudies resources and market-based values that are firm-specific and location-bound, which rapidly globalizes smes. cantillon (1755) say (1803) knight (1921) schumpeter (1934) kirzner (1973) shackle (1988) casson (2010) mcclelland (1961) rotter (1966) de vries (1977) szpiro (1986) landstrom (1998) johnson (1990) eisenhauer (1995) cromie (2000) coon (2004) kolb (1984) reynolds (1992) costello (1996) gibb (1997) cope (2005) ansoff (1957) ansoff (1979) rostow (1960) porter (1990) rennie (1993) wernerfelt (1995) todaro (2003) dunning (2010) g e m t e s e a r ate d im en sio n s: m icro (in d iv id u als), c o n tex t (n atio n s an d reg io n s) an d t im e (an n u al assessm en t) asian journal of economics and empirical research, 2022, 9(2): 100-120 103 © 2022 by the authors; licensee asian online journal publishing group murphy, liao, and welsch (2006) contend that entrepreneurialism generates a logic dynamic reality that kirzner (1973) deciphered as consisting of three major conceptualizations: economic arbitrage, alertness to profit-making opportunities, and the distinction of ownership from entrepreneurship. moreover, shackle (1988) rationalizes that entrepreneurs are original, creative and imaginative when making choices. the gem (amorós & bosma, 2014) explores this compelling gap by stating that nascent entrepreneurship can also be associated with pre-entrepreneurial involvement, such as education, employment, and learning experiences. furthermore, casson (2010) concentrates on the synthesization process of the theories of entrepreneurship and entrepreneurial attributes and concepts, resulting in his notion that unique skillsets guarantee and distinguish the success of individual entrepreneurial endeavors, especially when making valid judgements that result in the coordination or reallocation of scarce resources. this, according to casson, relies on the managerial attributes, financial capital and the personal wealth of entrepreneurs (deakins & freel, 2012). more so, cassonians believe that active participation rates can also be based on the powerful influence of the environment, which moderates the relationship between the supply curve of entrepreneurs that is inversely related to the demand curve for entrepreneurs. similarly, casson and casson (2013) suggest a dependence on the propensity of specific circumstances and control of production factors, as well as the recognition of the impact of social mobility and institutional factors as the foremost enablers of market equilibrium. this implies that south africa’s tesea rate, entrepreneurial attitudes and behavior can be impacted by both demographic and institutional factors too. inadvertently, much controversy remains among scholars, policy makers and practitioners regarding the benefits that entrepreneurship creates. but the main criticism of the economic school of thought is that it assumes empiricisms can accurately articulate the current level of entrepreneurialism, which is consistent with the notion put forward by austrian macroeconomics (i.e., it can be expressed in terms of microeconomic foundations). based on current economic realities, the real issue is the growing problem with market and government failure. according to murphy et al. (2006), market systems are not purely competitive and can involve antagonist cooperation, while resource monopolies can hinder competition and entrepreneurship. more so, it is critical to note that deception and controls (such as tax schemes) also contribute to market system activity, which can be counteractive. correspondingly, entrepreneurship can occur in non-market social situations without competition in both private and state firms. clearly, all things being equal, these factors can affect the attitude and behavior of entrepreneurs in south africa. likewise, the psychological characteristics school of thought, or entrepreneurial personality approach, focuses on the traits of successful entrepreneurs using empirical data from pooled surveys that study the innate abilities of people with special talents that support the need for achievement and locus of control, which are associated with entrepreneurial inclination. mcclelland (1961) affirmed the significance of this concept by identifying the proposed key competencies of successful entrepreneurs consisting of, but not limited by, factors such as proactivity, initiative, assertiveness and achievement orientation (i.e., the ability to see and act on opportunities, as well as commitment to others). many critics have challenged this theory because policy makers may divert intervention schemes to regions that have remarkably high rates of participation in small business ownership. according to deakins and freel (2009), this controversy has significant policy implications, since it might become obvious that some regions with low rates of participation may be excluded from government intervention programmes, although infrastructural and environmental interventions can assist in stimulating the level of entrepreneurial activity. since enterprising individuals need entrepreneurial opportunities to succeed, the notion that was put forward by reynolds, hay, and bygrave (2002) becomes sacrosanct. individuals are motivated to engage in entrepreneurial endeavors due to either necessity (i.e., survival needs) or opportunity (i.e., satisfy their need for achievement). it has been observed that poverty or economic inequality tends to surge necessity-driven entrepreneurship rates at the discrete level (xavieroliveira, laplume, & pathak, 2015). perceptibly, the stable qualities that entrepreneurs show in most situations (coon, 2004) are traits such as selfefficacy or confidence, risk-taking, creative tendency, optimism, emotionally resilience, transformational vision, tolerance for ambiguity, innovativeness, a strong desire for independence, being able to take charge of one’s destiny, as well as non-conformist behavior. however, such measurement is not reliable because human behavior is not static but is dynamic depending on circumstances and environmental factors. that is why rotter (1966) focuses on the locus of control orientation, depicting the consequences of entrepreneurial actions, which are contingent on what we do (i.e., internal control orientation) or on events outside our personal control (i.e., external control orientation). yet, the need for achievement ignites the passion to excel in individuals and also alters their entrepreneurial inclination. many scholars have criticized this approach due to poor correlation and the fundamental inappropriateness to discern a specific trait that all entrepreneurs must possess. besides, it ignores environmental factors, learning outcomes, the relevance of innovation clusters, as well as social networks (chell, haworth, & brearley, 1991). over and above that, the socio-behavioral approach to entrepreneurship therefore relies on an alternate notion after appraising the remarks of critics of the entrepreneurial personality approach. from a sociological perspective, when studying an enterprise, the focus should be on the social context, which is why sociologists use the society as the level of analysis (simpeh, 2011). hence, this school argues that a society’s culture and environment determines the extent of individual entrepreneurial participation levels, since it takes note of indicators such as the nation’s tolerance of failure and risk, as well as how entrepreneurs are viewed by the society (deakins & freel, 2012). moreover, in some countries or societies, the negative connotation of failure blacklists failed entrepreneurs due to bankruptcy laws instead of encouraging them to learn from their mistakes. according to bosma et al. (2020), the gem uses the tesea rate to measure the participation rates in different nations and regions. observably, africans and women tend to have low participation rates, which, when probed, reveals a problem of inadequate and unequal access to opportunities due to barriers to employment, funds, risk averseness, low skills and the issue of poor linkages to existing social networks. taken together, this causes individual entrepreneurial predisposition to be manifested by necessity, arising from the need to survive, since the general presumption is that mes provide jobs and facilitate commerce, while considering the fact that consumption takes precedence over production in most less developed and developing economies due to a combination of factors, as well as their historical dependence on imports (unctad, 2015; world economic forum, 2015). asian journal of economics and empirical research, 2022, 9(2): 100-120 104 © 2022 by the authors; licensee asian online journal publishing group according to reynolds (1992), social networks are the most important social context that relate to entrepreneurial opportunity. this is because inter-organizational networks facilitate linkages that enable business development. exemplar case studies can be typified by business cluster formation in silicon valley, south east asia, germany and some parts of africa (fox & liebenthal, 2006; world bank, 2011). it has been observed in these prior studies that efficient networks foster good communication between firms, which contributes to entrepreneurial behavior and success. in addition, there is a copious need to facilitate social exchange so that entrepreneurs can draw on resources that are available within social networks. likewise, the role of social capital, as stated by sirmon and hitt (2003), affects important firm activities and acts as a glue that binds networks as a factor in determining entrepreneurial entry, especially when considering nascent entrepreneurship endeavors (shapero & sokol, 1982). contemporaneously, deakins and freel (2009) suggest that “the nature of successful networks depends on the level of trust, which itself depends on the nature of the business environment (e.g., rural vs. urban) on culture and on regulations”. however, the ability to learn remains a viable option that solves the problem of deficiencies in innate entrepreneurial traits. consequently, entrepreneurial behavioral dynamism clarifies scholarly perspectives in this area, since it puts forward the idea that the intrinsic abilities of entrepreneurs cannot be static but are rather continually evolving (fox & liebenthal, 2006; world bank, 2011). interestingly, stakeholder interaction, as supported by the world bank (2011) study, has greatly persuaded commentators to key into research reinforcing the empirical linkage between formal training and improved performance of small firms. more so, both the academe and institutional participants in industry have advocated mentorship-style assistance that solves real-life business problems as shown on television programmes such as “the next ceo” – a reality television show that headhunts the next chief executive officer (ceo) based on real-life business problems through task performance, goal setting and the ingenious courage of the executive. based on this initiative, several companies have been able to solve succession issues via the attraction and/or retention of skilled (i.e., top talent) in an organization. matter-of-factly, entrepreneurs learn from mistakes, experience and networks, retrospectively and prospectively, through a reflection of events that result from entrepreneurial outcomes. thus, in order to examine fundamental business concerns/problems, as well as determine reasons why these issues arise, an action learning process needs to be put in place to identify and analyze market problems so that it can ultimately lead to practical outcomes (cope, 2005). since entrepreneurs take risks due to their profit maximization motive, considerable learning effort can assist in improving the production process of their companies through inputs selection, supplier cataloguing and marketing (deakins & freel, 2012), thereby minimizing the level of uncertainty. we posit that through an operational scaling process that takes cognizance of the environment, competitors, business weaknesses, opportunities and threats, businesses can upscale and increase their returns (deakins & freel, 2009, 2012; zhang, macpherson, & jones, 2006). furthermore, reynolds (1992) asserts that life course stage, ethnic identification and population ecology can have an impact on the survival of a business and/or entrepreneurs. this is because the experience of people from various sociological backgrounds spurred by environmental factors (such as the political system, government legislation, per capita income, fiscal and monetary policy, as well as customers, employees and competition) can be the decisive factors that ensure that entrepreneurs either flourish or collapse in their businesses operations (fox & liebenthal, 2006; world bank, 2011). regardless of the volume of literature on a particular area of study, most times scholars still borrow theories from other fields of research because the theoretical or practical understanding of a subject is not an isolated phenomenon that is fully understood. remarkably, entrepreneurship literature has painstakingly applied other models, theories or tools that emanate from both the ib and strategy literature. for instance, the resource-based view (rbv) of firms supports the notion that firms exist due to the unique embedded heterogeneous resources and capabilities that cannot be possessed, imitated or built up in a similar manner by competitors (barney, 2001; kozlenkova, samaha, & palmatier, 2014; ludwig & pemberton, 2011; rugman & verbeke, 2002; rugman, verbeke, & nguyen, 2011). as an eye opener, the suppositions of the rbv theoretical model have been reinforced by schumpeterian contention that the level of innovation and technological change of a nation come from the entrepreneurs. however, linking entrepreneurship and ib theory is a very taxing process due to the problem of demographic population heterogeneity (milne, 2008; rostow, 1960). since global commonalities (i.e., ocean and air) can be shared by all countries of the world, each country can follow the path to sustainable economic growth and development (unctad, 2015; world economic forum, 2015) if every nation makes conditions feasible for a global factory (which allows mes to take advantage of existing price differentials) through a deliberate pact that allows entrepreneurship to thrive via the exploitation of a country’s absorptive capacity for the utilization of fdi. various growth theories have espoused the reality of an aggregate production function, whose existence and properties are closely tied to the assumption of an optimal resource allocation within each economy (banerjee & duflo, 2004). that said, in a similar vein, the eclectic paradigm utilizes the ownership, locational and internalization (i.e., oli model) advantages as applicable in internalization theory to explain how cost advantages aid entrepreneurial progress (dunning, 2010). thus, this theory emphasizes the importance of entrepreneurial skills, trademarks, production techniques and returns to scale by stating location-bound firm-specific advantages (fsas), such as the existence of raw materials, rightly priced skilled labor, and tax legislation influence on the market potentials, which ultimately leads to the exploitation of core competencies that can lead to various forms of market entry or exit. apparently, this explains why some entrepreneurs are opportunity-, survivalor necessity-driven (acs & szerb, 2011; amorós & bosma, 2014; amorós et al., 2013; bosma, 2013; bosma et al., 2020; deakins & freel, 2012; herrington & kew, 2018; shane & nicolaou, 2013). accordingly, rostow’s economic growth theory attempts to fill the gap in extant literature by stating that all countries exist somewhere in his linear spectrum and could climb upward through each stage in the development process (rostow, 1960). his deconstruction procedure specified five stages of economic growth, whereby a nation can move from a traditional society (i.e., largely agrarian and barter dependent) to the transitional stage (that meets the pre-conditions for economic take-off, such as a rapidly growing infrastructure that leads to production surpluses and specialization), and then to the take-off stage (which incites industrialization characterized by growing investment and regional growth, as well as a stable democratic system), which moves upward toward the drive to maturity (that inspires diversification, innovation, non-reliance on imports, and rising investment levels), and finally to the age of high mass consumption (which is consumer-oriented, service sector asian journal of economics and empirical research, 2022, 9(2): 100-120 105 © 2022 by the authors; licensee asian online journal publishing group dependent, and encourages the production of high tech goods). based on this classification, south africa is located somewhere across this spectrum, hence, it can also impact entrepreneurial tendencies, attitudes and behavior. despite the importance of rostow’s theory, many critics have noted that first world economic realities cannot be used as a yardstick to measure third world countries, whose reliance on agriculture and the extractive industries, makes them prone to economic disturbances due to the misallocation of optimal resources, as well as the heterogeneity of rates of return (milne, 2008). also, the rapid development of the prominently communist and undemocratic asian tiger countries, such as china, led to rostow’s argument failing. although, in entrepreneurship literature, the movement of nations from factor-driven economies toward efficiency-driven economies and then to innovation-driven economies (amorós & bosma, 2014) simplifies the applicability of this notion, more studies need to be carried out in order to provide an efficient classification framework that can be appropriate for all countries. research on neoclassical economics have put forward notions that portray economic growth as being influenced in the long run by the exogenous effects (i.e., external forces) of the savings rate (using the harrod–domar model) and outcomes of the rate of technical progress (using the solow model), or the endogenous factors (i.e., internal forces), which, according to the ak model, assumes that policy measures, such as investment and subsidies in human capital development, innovation, and knowledge, create positive externalities and spillover effects that deepen the level of economic growth (acemoglu, 2009; barro & sala-i-martin, 2004; romer, 2011). therefore, research and development (r&d) can cause firms to be become monopolistic, as well as restrict free entry into these markets, as a result of the high costs associated with inimitable technological innovations. in addition, contemporary entrepreneurship theory reconciles with strategic management, ib and economic theory through the application of theories that support the notion that entrepreneurs are the driving force of the whole economic system (dunning, 2010; todaro, 2003; wernerfelt, 1995). consequently, the market-based view (mbv) uses an objective exogenous approach to explain how sustainable competitive advantage can be gained through astute market positioning through the use of porter's five forces that take cognizance of the product life cycle of a firm’s products and services. on the contrary, the resource-based view (rbv) uses an endogenous approach through a subjective value chain analysis and product matrix to identify valuable tangible or intangible resources at a firm’s disposal, which are heterogeneous in nature, immobile, valuable, rare, inimitable, and substitutable (kozlenkova et al., 2014; ludwig & pemberton, 2011). according to lakew (2015), global firms have a global orientation from the onset; as such, this concept debunks rostow’s stages of economic growth theory. correspondingly, empirical evidence from a study carried out by bosma and levie (2010) suggests that more than half the population sample of entrepreneurs in advanced economies, and around a third in developing countries, go into business with plans to attract fdi from overseas. in a like manner, born global firms internationalize at a rapid pace – usually within three years or less between the initial domestic establishment of the firm and its first entry overseas (senik, 2010). predictably, smes that are typically knowledge intensive, high tech driven and niche market oriented, can key into an accelerated internationalization (gabrielsson, kirpalani, dimitratos, solberg, & zucchella, 2008) by taking advantage of global networks which are facilitated by a borderless marketplace, global sourcing and rising demand for quality products and services (lakew, 2015; senik, 2010). likewise, modern entrepreneurship literature utilizes the political, economic, social, technological, legal and environmental (pest-le) analysis tools to determine the features of a market from a bird's eye view to ascertain specific trends and indices that are exogenous when considering the macroeconomic perspective of the rate of economic growth and development in a nation. contrariwise, an endogenous perspective of the internal environment considers the strength, weaknesses, opportunities and threats (swot) analysis in examining products and services that are firm-specific (davis, 2013; konopik & lindgren, 2010). taken together, it has been observed that aggregate entrepreneurial activity is pro-cyclical and can result in a contemporaneous shift in economic activity (deakins & freel, 2009). according to smith-hunter and boyd (2004), weber’s disadvantage theory contends that those who exit the mainstream economy as a result of discrimination turn to business ownership as an alternative to the labor market. this explains the reason for the existence of ethnic entrepreneurship and copreneurs, i.e., female co-owned organizations (hisrich & peters, 2002). it has been observed that most black (bbbee) entrepreneurs are overtly positive about starting a business despite being risk averse and predominantly low skilled; therefore, their active participation in the entrepreneurship ecosystem compounds the high failure rate in south africa (akoojee, 2013; nwafor, 2007). figure 1. conceptual model of the study. asian journal of economics and empirical research, 2022, 9(2): 100-120 106 © 2022 by the authors; licensee asian online journal publishing group due to the dynamic complementarity between mes and smes the gem report replicates the model used in the global competitiveness report that is published by the world economic forum. relatedly, the level of entrepreneurial activity is determined by entrepreneurial opportunity and capacity, considering indices such as demography, education, economic infrastructure and culture (acs & szerb, 2011; amorós & bosma, 2014; amorós et al., 2013; bosma, 2013; deakins & freel, 2012; shane & nicolaou, 2013). furthermore, the gem report measures differences in the level of entrepreneurship activity between economies, in the process determine national levels of entrepreneurial activity, as well as identify factors that enhance entrepreneurial activity worldwide (amorós & bosma, 2014). using these theoretical lenses of entrepreneurship theory, we develop a conceptual framework and also put forward various hypotheses focusing on the influence of the gem’s tesea rate on entrepreneurship attitudes and behavior in south africa. this framework is depicted in figure 1. explicitly, the tesea rate uses the individual survey data relating to the process of starting a business, as well as the opinion of those running new businesses that are less than 3½ years old in a country. amorós et al. (2013); bosma (2013); shane and nicolaou (2013) and amorós and bosma (2014) revealed that, as a percentage of the adult population, these rates tend to be highest for the factordriven economies and decline with increasing levels of gdp. according to herrington, kew, and kew (2014), "south africa’s rate of entrepreneurial activity is very low for a developing nation – a mere quarter of that seen in other subsaharan african countries. more so, entrepreneurial activity in south africa, although very low, has increased marginally over the last 10 years". based on this conceptual framework, we develop a generalized linear model and derive formal propositions thereafter. we describe the model and salient intuition behind the propositions here, while detailed econometric derivation and supporting arguments are explicated fully in the empirical investigation section of this study. following prior work by amorós and bosma (2014), the following propositions and hypotheses are deduced. 2.1. the tesea rate and the rate of economic development in south africa the gem conceptual framework (herrington et al., 2014) lists macroeconomic stability as one of the basic requirements that influences the entrepreneurial profile (i.e., attitudes such as perceived opportunities and capabilities, fear of failure, and status of entrepreneurship, as well as activities that embody opportunity/necessitydriven motives, early-stage start-ups, inclusiveness, industry, the exit of underperforming companies, and aspirations for growth, innovation, international orientation and social value creation). more so, the national framework conditions are based on the world economic forum (2015) global competitiveness report. according to bosma et al. (2020), the gem project remains dedicated to its vision of consolidating evidence that reveals the significance of entrepreneurship to national economic growth, innovation and job creation. consequently, the gem conceptual framework reflects the complexity of the causal relationships between entrepreneurship and macroeconomic development globally. however, potentially ambitious entrepreneurs react differently to different political, economic, social, environmental, technological, regulatory and legal regimes than those who are less ambitious (bosma et al., 2020; bosma & levie, 2010; herrington & kew, 2018). based on our conceptualization of contemporary entrepreneurship literature, we examine the effects that the rate of economic development in south africa has on the country’s tesea rate. however, consistent with entrepreneurship theorists (acs & szerb, 2011; amorós & bosma, 2014; amorós et al., 2013; bosma, 2013; deakins & freel, 2012; shane & nicolaou, 2013) who highlighted the influence and impact of institutional factors, such as the degree of economic freedom and the ease of doing business on the rate of economic development, we suggest that when these constructs are considered together, a reliable and robust analysis can be conducted that leads to findings that can be generalizable. the world bank (2016) posits that creating a regulatory environment that empowers free enterprises (e.g., smes) creates a positive impact on job creation, which is good for the economy. it measures the ease of doing business, which is determined by sorting the aggregate distance to frontier scores on ten relevant topics. furthermore, the indicator takes cognizance of the procedures, time, cost and minimum capital outlay to start a new business, as well as gauging the level of entrepreneurial activity. essentially, the use of this metric is based on an exploration of the sources of enduring economic dynamism and how they relate to each other in ensuring opportunities for the greatest number of people. likewise, the economic freedom of the world (efw) index (fraser institute, 2016) is based on the fact that basic institutions that protect the liberty of individuals to pursue their own economic interests result in greater prosperity for the broader society. therefore, the efw index measures the degree to which the policies and institutions of countries are supportive of economic freedom. it uses data from the world bank, the international monetary fund (imf), economist intelligence unit (eiu) and transparency international to score various nations on different macroeconomic frontiers. given that the south african tesea rate declined by 34% in 2014, while the same trend was noticed in both the ease of doing business and the rate of economic freedom ranking, this indicator points to a possible link between these phenomena (fraser institute, 2016; heritage foundation, 2016; herrington et al., 2014; world bank, 2016). in line with entrepreneurship theory, we contend that a positive relationship occurs between the tesea rate and the rate of economic development in south africa, but since this relationship cannot exist in isolation, it is mediated by institutional factors, such as the degree of economic freedom and the ease of doing business. thus, the following is proposed: hypothesis 1: the relationship between the tesea rate and the rate of economic development in south africa is influenced and impacted by institutional factors, such as the rate of economic freedom and the ease of doing business. 2.2. the tesea rate and the rate of unemployment as noted earlier, entrepreneurship opens up opportunities for jobs to be created in an economy, which implies that many unproductive members of society can be lifted out of poverty (fox & liebenthal, 2006), which will simultaneously reduce the level of crime in the country (deakins & freel, 2009). according to herrington et al. (2014), the problem of the youth unemployment level, which is in excess of 60%, remains a mounting challenge for the government. it appears that this rising figure could trigger the total unemployment rate in south africa to rise asian journal of economics and empirical research, 2022, 9(2): 100-120 107 © 2022 by the authors; licensee asian online journal publishing group above current levels of about 25%, which is higher than any other country in sub-saharan africa. however, despite this trend, south africa’s tesea level has declined by 34%, from 10.6% in 2013 to 7.0% in 2014. a recent report by statistics south africa (2015) reveals that one in four, or about 15.7 million, south africans are employed, while about 5.2 million are unemployed. consequently, social tensions continue unabated, despite improvements in the employment of black and skilled people. basically, a conscientious effort by the anc government has set a high target of cutting the unemployment rate to about 6% by 2030 through entrepreneurial education, training and innovation. a study carried out by herrington and kelley (2012) posits that the pernicious effect of poverty and unemployment may be addressed through entrepreneurial activity, and while entrepreneurship may not be a panacea, it certainly forms part of the solution to this contagious phenomenon. the aftermaths of the 2008/2009 global recession and the coronavirus pandemic (unctad, 2015; world economic forum, 2015) imply that an upsurge in necessity-driven entrepreneurship (at least in the short-term) can significantly ameliorate the unemployment problem in south africa. consistent with the findings of entrepreneurship theorists (acs & szerb, 2011; amorós & bosma, 2014; deakins & freel, 2012; lakew, 2015; senik, 2010) who emphasized the importance of entrepreneurship as a source of wealth and job creation, we contend that a positive relationship occurs between the tesea rate and the rate of unemployment in south africa. therefore, we predict that: hypothesis 2: the tesea rate is positively associated with the rate of unemployment in south africa. 2.3. the tesea rate and prevailing economic conditions/policy based on contemporary entrepreneurship literature, the tesea rate can be influenced by the prevailing economic conditions. moreover, these macroeconomic conditions are regulated by various monetary and fiscal policy measures that are being put in place by the government (amorós & bosma, 2014). in africa, the most problematic factors when starting or running business ventures are high levels of corruption, access to finance (which is moderated by the interest rate), foreign currency regulations and the level of inflation (world bank, 2011). also, prohibitive rates of interest and exchange rates can also trigger inflationary pressures on goods and services, thus reducing the aggregate purchasing power of individuals, smes, mes and government. this is why schumpeter's notion of creative destruction gives credence to how inefficiency and a fundamental lack of innovation causes the closure of unproductive firms due to the entry of more innovative new firms (casson, 2010; deakins & freel, 2012; schumpeter, 1934). the misallocation of capital causes sub-optimal usage of resources and capabilities, which perhaps can be exogenously linked to market disequilibrium (milne, 2008). as a result, this precarious situation causes the demand and supply of entrepreneurs to shift until an equilibrium level is reached. according to kerr and nanda (2009), this issue may preclude high-quality entrepreneurs with good ideas from entering the market since they are unable to access adequate capital to either start up a new business or expand an existing firm, given the aforementioned negating factors. smithin (2001) posits that cheap money policy (i.e., lower real rates of interest) tends to increase both the growth rate as well as the share of entrepreneurial profits. furthermore, the continuing distortion in oil and commodities prices indicates that a recession is imminent. expectedly, this may give rise to sordid business practices in order to shore up the level of big business (unctad, 2015). nevertheless, global indices reveal that this grim analysis can trigger entrepreneurial activities in new areas, such that individuals and smes can capitalize on the current gaps in the market, given the turbulent business climate (amorós & bosma, 2014; herrington et al., 2014; world economic forum, 2015). on the flip side, the south african government’s monetary policy involves increasing the interest rate (i.e., making loans more profitable for banks, thus positively impacting commercial credit), lowering the strength of the rand against major currencies in the world, hence influencing the broad money4 supply. it is expected that the implementation of this policy would lead to lower aggregate domestic demand and more exports (statistics south africa, 2015). equally, the fiscal policy of the government ensures that tax rates are raised and that the government cuts spending so that a smaller budget deficit can be achieved, given the existing problems of current account deficit. however, despite these policies, the south african government has not been able to keep the inflation rate steady (fairlie, 2011; herrington et al., 2014; world economic forum, 2015). according to fairlie (2011), a slack labor market and economic conditions triggered by a recession are key determinants of business creation, such that higher local unemployment rates are found to increase the probability that individuals will start businesses. similarly, fernández-villaverde (2010) suggests that inflation increases the wealth of entrepreneurs and moderates the finance premium on sme loans that are secured from financial intermediaries, hence minimizing the crowding out of private ventures by government spending (svensson, 2010; woodford, 2012). comparatively, drops in tax rates positively affect labor, while returns on deposits lower the inflation rate. consequently, the impact of these indicators on entrepreneurship can be inversely proportional to the outcomes anticipated due to increments in government expenditure (herrington et al., 2014). consistent with theorists (casson, 2010; deakins & freel, 2012; fairlie, 2011; fernández-villaverde, 2010; herrington et al., 2014; kerr & nanda, 2009; milne, 2008; smithin, 2001; svensson, 2010; woodford, 2012) who underscored the significance of entrepreneurial tendencies and attitudes based on the prevailing economic conditions, we suggest that a relationship occurs between the tesea rate and monetary/fiscal policy. hence, we expect that: hypothesis 3: the relationship between the tesea rate and the rate of economic development in south africa can be positively attributed to the prevailing economic conditions as well as monetary and fiscal policies, such as interest and tax rate setting, inflation targeting, and currency valuation. 2.4. the tesea rate and macroeconomic conditions (fdi/jse market capitalization) the latest developments in fdi attraction, as well as global entrepreneurship tendencies and policies, indicate that youth entrepreneurship schemes can be used as a strategy to achieve sustainable and inclusive growth in less developed (factor-driven and efficiency-driven) economies (zhan, 2014), thus fahed (2013) suggests that entrepreneurship has a significant effect on fdi. given that the rates of fdi inflows and outflows can be determined by the strengths or weaknesses of local entrepreneurship conditions in designated host locations, it is expected that asian journal of economics and empirical research, 2022, 9(2): 100-120 108 © 2022 by the authors; licensee asian online journal publishing group sme promotion can accelerate economic growth in south africa. since the ease of doing business and the degree of economic freedom focuses on strong institutional foundations, such as an efficient capital allocation system and the protection of property rights, strong institutions certainly allow local smes to thrive, and vice versa (banerjee & duflo, 2004; dunning, 2010; gerring & thacker, 2008; milne, 2008; todaro & smith, 2009; yusuf, 2009). the research findings of albulescu and tămăşilă (2014) reveal that inward fdi positively influences opportunity-driven entrepreneurship, while outward fdi has a positive influence on necessity-driven entrepreneurship and a negative impact on other categories of entrepreneurs. this conclusion is based on the positive spillover effects of me transfers, while the negative spillover effects are the barriers of entry that is spearheaded by the high costs of r&d. correspondingly, ayyagari and kosová (2006) found evidence that points to the fact that the significance of backward linkages (i.e., horizontal less competitive entry spillovers in the upstream sector) and forward linkages (i.e., vertical competitive entry spillovers in the downstream sector) might imply that these trends vary across industry dynamics. although the johannesburg stock exchange’s (jse’s) market capitalization broadly affects the direction of the south african economy, it has been observed that the global competitive environment greatly affects the scale of such change, and that entrepreneurial and small business activities help to act as a cushion against detrimental factors resulting from the interaction of local businesses with foreign markets (eurofound, 2012; office of the director of national intelligence, 2013; qaqaya & lipimile, 2008). a study carried out by stanlib (2015) indicates that the exchange is successfully fulfilling its main function (i.e., the raising of primary capital) by rechanneling cash resources into productive economic activity, thus building the nation’s economy while synchronously enhancing job opportunities and wealth creation. this line of argument is supported by various theorists, such as banerjee and duflo (2004); ayyagari and kosová (2006); gerring and thacker (2008); milne (2008); qaqaya and lipimile (2008); todaro and smith (2009); yusuf (2009); dunning (2010); eurofound (2012); fahed (2013); office of the director of national intelligence (2013); albulescu and tămăşilă (2014); and zhan (2014). stanlib (2015) predicted that the tesea rate can be influenced by the prevailing macroeconomic conditions, which is consistent with the preceding hypotheses that the tesea rate can be influenced and impacted by institutional factors, the rate of unemployment in south africa, as well as the prevailing monetary and fiscal policies. we suggest that a relationship occurs between the tesea rate and the levels of fdi inflow and outflow in south africa, as well as the total jse market capitalization. hence, we envisage that: hypothesis 4: the varying relationship exemplified by the tesea rate in south africa can be influenced and mediated by the macroeconomic conditions that are associated with the level of fdi and the total market capitalization of the jse. 3. empirical investigation we test the predictions of our model using a data sample of the national tesea rate, as well as other relevant macroeconomic variables during the 2003–2014 period. since the observations of south african entrepreneurial behavior is estimated by the tesea rate, other variables were used as a reference against which the sensitivity of entrepreneurs to various macroeconomic conditions in their quest to start or expand their businesses was measured. the dataset elements and the diverse sources from which they are aggregated are described below. 3.1. gem data the primary source of entrepreneurship statistics used in this study is the gem database. it provides primary data on entrepreneurship, including aspects such as the harmonized measures about the attitudes, activities and characteristics of individuals who participate in the various levels of entrepreneurship, which are widely used in academic research (amorós & bosma, 2014; amorós et al., 2013; bosma, 2013; deakins & freel, 2012; shane & nicolaou, 2013). from the gem data, information was obtained on 11 variables – the total early-stage entrepreneurial activity (tesea) rate coded as tesearate, the start-up (or nascent entrepreneurship) rate coded as startupr, the new firm (or business ownership) rate coded as newfirmr, the opportunity rate coded as opportunityr, the necessity rate coded as necessityr, entrepreneurial intentions coded as entri, good career choice coded as goodcc, the high status of successful entrepreneurs coded as highs, media attention for entrepreneurship coded as mediaa, female tesea rate coded as femaletesear, and male tesea rate coded as maletesear. the annual data collected was used to estimate the yearly impact of these variables’ measurements from 2003–2014; however, average values were manually computed when data for a given year is missing. 3.2. wdi data the world development indicators (wdis), which are provided by the world bank, contains data on over 1,420 major macroeconomic indicators covering statistics from all the countries of the world. the wdi has been consistently used in various studies relating to the levels of poverty, entrepreneurship, national growth and development by researchers, private institutions, supranational bodies and governments (fraser institute, 2016; heritage foundation, 2016; herrington et al., 2014; world bank, 2016). from the wdi data, information was obtained on 14 variables, such as gdp, which represents the total value of goods produced and services provided in south africa in one year. in order to compensate for measurement inaccuracies, we used four types of gdp indicators so that our statistical estimation is not biased. we followed this methodological procedure based on evidence from similar studies. the gdp at market prices in current us$ is coded as gdpcp, while the gdp real growth rate expressed as annual per cent is coded as gdpgr. also, the gdp purchasing power parity expressed in constant 2011 international dollar prices ($) is coded as gdpppp, and the gdp per capita in current us$ is coded as gdppc. furthermore, the total unemployment rate expressed as a percentage of the total labor force is coded as unempr, the male unemployment rate expressed as a percentage of the male labor force is coded as unemprmale, and the female unemployment rate expressed as a percentage of the female labor force is coded as unemprfemale (however, the national estimate is based on data provided by statistics south africa). similarly, the real lending interest rate expressed in percentage is coded as intr, while the inflation rate percentage in terms of consumer prices is coded as infr. the official exchange rate based on the periodic average of the local currency unit (lcu) per us$ is coded as excr. similarly, the foreign direct investment (fdi) net figures expressed as a proportion of the balance of payment asian journal of economics and empirical research, 2022, 9(2): 100-120 109 © 2022 by the authors; licensee asian online journal publishing group (bop) at current us$ is coded as fdibop, the tax rate on goods and services expressed as a percentage of revenue is coded as taxr, broad money expressed in terms of lcu is coded as bmoney, and the gross domestic savings5 (gds) in current us$ is coded as gds. the annual data collected is used to estimate the yearly impact of these variables’ indicators during the period between 2003–2014. 3.3. other relevant data source in order to operationalize the propositions that are put forward in the hypothesis development stage of this study, we included data sources such as the fraser institute’s economic freedom of the world6 (efw) index, which is coded as ef, as well as the world bank’s ease of doing business7 (edb) index, which is coded as edb, while the jse’s market capitalization is coded as jsecap. the use of these econometric estimation variables in this research follows the methodological procedure of similar studies (fraser institute, 2016; heritage foundation, 2016; stanlib, 2015; world bank, 2016). consequently, we use the annual data collected to estimate the yearly impact of these indicators during the timespan of this study (i.e., 2003–2014). this dataset is preferred because it adequately compensates for inconsistencies resulting from the data gathering process of this kind of study. this ensures that the conclusion for this study is accurate, valid and reliable, as opposed to other non-aggregate variables that only measure single factors and the effects of individual decisions using microeconomic data. 4. methodology the aim of this empirical study is to reveal the impact that south africa’s tesea rate has on entrepreneurship decisions and to demonstrate the influence of various macroeconomic factors on this phenomenon. we assume that the exogenous effect of the environment, which can be moderated by the level of fdi and the prevailing market capitalization of the jse, alters the magnitude of entrepreneurial intentions. for identification, our empirical design exploits four potential sources of variation: (a) the regulatory measurement impact of the economic freedom of the world and the ease of doing business index; (b) the current rate of unemployment; (c) the prevailing rates of interest, inflation, tax and currency exchange valuation; and (d) the level of fdi and the market capitalization of the jse. the extant literature suggests that both exogenous and endogenous factors influence the level of entrepreneurialism. therefore, following amorós and bosma (2014), we estimate the tesea rate in the relationship with the aforementioned causes of market variations. the use of this method is to accurately probe both the behavior and the attitudes of entrepreneurs who establish smes taking cognizance of their risk appetite. consequently, a particular shift in individual entrepreneurial behavior can be correlated with a shift in idiosyncratic exogenous variables. for instance, in a recent work, albulescu and tămăşilă (2014) employed this method to investigate the influence of inward and outward fdi on opportunity-driven and necessity-driven entrepreneurship. concerns about collinearity, heteroskedasticity, serial autocorrelation, validity and reliability issues were addressed by computing cronbach’s alpha values for each variable, as well as through rigorous factor loadings, unique variances, principal component analysis (pca) and regression analysis that utilized robust standard errors while implementing a generalized linear model to affirm the statistical significance of these relationships. in addition, we control for each variable that might directly influence the analysis in order to avoid spurious correlations in our results. 4.1. variables 4.1.1. dependent variable similar to deakins and freel (2012); amorós et al. (2013); bosma (2013); shane and nicolaou (2013) and amorós and bosma (2014), the tesea rate is used as the dependent variable because there is no singular measure of the entrepreneurial intentions and aspirations of individuals that have consistently surveyed a percentage of the adult population of various countries across the globe. in south africa, although there are other measures, such as the absa sme index, their measurements are not elaborate due to the presence of some gaps in enumeration years, as well as changes in the metric. also, the high rate of business failure has led to the problem of double counting since both dormant cooperatives and closed corporations and companies remain in the database of the department of trade and industry (dti). more so, the south african revenue service (sars), which is a government agency mandated to carry out the responsibility of filling sme tax returns, has steadfastly refused to divulge this information (i.e., the provision of a detailed record of tax remittances across the country) to both researchers and the academe, thus making the computation of south african sme data a very cumbersome process. consequently, the tesea rate is the commonly used measure of entrepreneurial goals and ambition because the data is relatively less noisy and is also a more reliable measure of the current level of entrepreneurship in south africa than the other datasets provided by both private and public agencies (amorós & bosma, 2014). 4.1.2. independent variables four categories of independent variables were selected. (1) institutional indicators: the gdp value is measured in various ways so that our conclusions are both valid and reliable (unctad, 2015). as stated earlier, the gdp consumer prices, gdp purchasing power parity, gdp per capita, and the gdp growth rate were used concurrently in addition to the efw rating and edb ranking to determine the effects of the tesea rate on the level of entrepreneurship in south africa. (2) unemployment indicators: the major effect of unemployment is that it causes actively engaged individuals to seek solutions to societal challenges through opportunity or necessity entrepreneurship. we use the total unemployment rate, male unemployment rate, female unemployment rate and the start-up rate to measure the level of nascent entrepreneurship in relation to the tesea rate (deakins & freel, 2012). (3) monetary and fiscal policy indicators: monetary policy involves setting base interest rate levels and employing quantitative easing to either increase or decrease the supply of money in an economy. however, the government’s fiscal policy measures use the budgetary mechanism to regulate government spending and the level of taxation in south africa (herrington et al., 2014). taken together, the anticipated economic goal is to attain higher asian journal of economics and empirical research, 2022, 9(2): 100-120 110 © 2022 by the authors; licensee asian online journal publishing group economic growth and control inflation. we use the interest rate, tax rate, inflation rate and exchange rate to measure the influence of the tesea rate on entrepreneurship levels in south africa. (4) fdi and market capitalization indicators: the impact of exogenous factors on businesses have been researched extensively by scholars, such as dunning (2010); ludwig and pemberton (2011) and kozlenkova et al. (2014). this mbv relies on the fact that sustainable competitive advantage can be gained via perspicacious market positioning during the product life cycle of an sme business, but it can be replicated faster using the born global strategy. we use the fdi net figure and the market capitalization of the jse to evaluate the impact of this phenomenon on south africa’s tesea rate, given the obvious fact that the availability of surplus and cheap investable resources can also lead to an intense exploitation of entrepreneurship opportunities by creative and innovative individuals. 4.1.3. mediators the mediator variables in this study were used to determine the strength of the relationships that exist between the dependent and independent variables. according to amorós and bosma (2014), the number of entrepreneurs, which is determined by the tesea rate, is a factor of the total entrepreneurial intentions of potential entrepreneurs within a three-year period. we tabled this variable as a moderator for this study together with the number of individuals that considered entrepreneurship as a good career choice and gave a high status to successful entrepreneurs. likewise, since national attitudes stimulate perceptions about the level of visibility and the attractiveness of entrepreneurship, we considered the level of positive media attention for entrepreneurship in south africa as a moderator. similarly, entrepreneurship profiles have transcended beyond the desire of individuals starting a new business. apparently, researchers are left with no choice but to study the motivators of this phenomenon, i.e., the owner-managers of established firms. thus, the start-up rate, which is also known as the nascent entrepreneurship rate, and the new firm (or business ownership) rate were also considered as moderators. congruently, the opportunity rate (which is associated with creative innovation) and the necessity-driven entrepreneurship rate that is associated with a fundamental need for jobs and subsistence living were also synchronously considered as moderators (herrington et al., 2014). 4.1.4. control variables to account for other possible determinants of south african entrepreneurial inclinations, we controlled for the level of the male tesea rate, female tesea rate, the gds rate and broad money supply. previous studies have demonstrated a strong relationship between the gender of early-stage entrepreneurs and the rate of unemployment and economic growth. also, higher gds figures lead to the availability of higher investable funds that can be channeled to further the capital accumulation process in south africa. according to amorós and bosma (2014), higher levels of gdp yields more and better job opportunities worldwide. this statement is reinforced by deakins and freel (2012), who observed that the rising female tesea rate can be associated with the labor sector preference for male employees over female employees. additionally, the amount of money in circulation causes inflationary trends to occur, leading to various monetary and fiscal policy initiatives, which also influences the level of the tesea rate to change over time, ceteris paribus (fairlie, 2011; herrington et al., 2014; herrington & kew, 2018; world economic forum, 2015). 4.2. model a generalized linear model (glm) poisson regression was used to analyze the impact of south africa’s tesea rate on various macroeconomic conditions that were specified in the hypothesis section of this study. as stated earlier, this procedure was adopted in order to avoid estimation biases. furthermore, the predicted proportion of the estimation follows the glm technique as represented by the formula in e(y) = xβ, y ~ poisson, where y is the expected distribution of the poisson family y using a link identity function to rationalize the explanatory variables (cameron & trivedi, 2010; hardin & hilbe, 2013; mccullagh & nelder, 1989). hence, the econometrics investigation for this study was analyzed using the glm procedure of stata 13.0. correspondingly, some of the modular table effects for this study are reported with the aid of graphical simulations and illustrations, after which we interpret the statistical and economic significance of the effects for all the hypotheses (i.e., hypotheses 1, 2, 3, and 4) based on the discussed hypothesized moderation effects. 5. results the cronbach’s alpha () test for all the econometric variables for this study is reported in table 2, which was conducted to examine the reliability and internal consistency of the dataset. it can be observed that the cronbach’s α for all the econometrics’ variables were above the recommended threshold of 0.70, hovering between the 0.95 to 0.96 levels (nunnally, 1978). the minimum value of the item total correlation among all the constructs surpassed the minimum level (≤ 0.3) recommended by dunn, seaker, and waller (1994). this is confirmed by the item-test, item-rest and average interitem correlation values that are specified in the test scale result. expectedly, the findings and conclusions of this study can be adjudged to be both valid and reliable. furthermore, a biplot graph displaying a two-dimensional biplot of the coordinates of our dataset was used to simultaneously show the observations (i.e., rows) as well as the relative positions of the variables (i.e., columns). the marker symbols (points) representing observations and the arrows representing the variables approximate the correlation between the variables, which leads us to an agreement of their fair distribution in the dataset. in addition, the biplot of 12 observations and 28 variables yields an explained variance by component 1 of 0.969, and by component 2 0f 0.029, resulting in a total explained variance of 0.998. in addition, our observation biplot coordinates revealed five positive and seven negative dimensions, while our variables had about 21 variables centered around the zero point. although not reported, it showed that the broad money in circulation is positively related to dimension 2, while the coordinates of the jse market capitalization is negatively related to dimension 1. asian journal of economics and empirical research, 2022, 9(2): 100-120 111 © 2022 by the authors; licensee asian online journal publishing group table 2. test scale results. parameter obs. sign item-test correlation item-rest correlation average interitem correlation alpha tesearate 12 + 0.924 0.916 0.434 0.954 gdpcp 12 + 0.915 0.905 0.434 0.954 gdpgr 12 0.472 0.430 0.458 0.958 gdpppp 12 + 0.856 0.841 0.437 0.955 gdppc 12 + 0.877 0.864 0.436 0.954 ef 12 0.418 0.373 0.461 0.959 edb 12 + 0.862 0.848 0.437 0.955 unempr 12 0.082 0.030 0.480 0.961 unemprmale 12 + 0.394 0.349 0.463 0.959 unemprfemale 12 0.666 0.635 0.448 0.956 intr 12 0.616 0.582 0.451 0.957 infr 12 + 0.267 0.218 0.470 0.960 excr 12 + 0.599 0.564 0.451 0.957 fdibop 12 0.277 0.228 0.469 0.960 jsecap 12 + 0.791 0.770 0.441 0.955 startupr 12 + 0.776 0.754 0.442 0.955 newfirmr 12 + 0.880 0.867 0.436 0.954 opportunityr 12 + 0.901 0.890 0.435 0.954 necessityr 12 + 0.706 0.679 0.446 0.956 entri 12 + 0.600 0.564 0.451 0.957 goodcc 12 + 0.938 0.931 0.433 0.954 highs 12 + 0.938 0.931 0.433 0.954 mediaa 12 + 0.975 0.972 0.431 0.953 maletesear 12 + 0.768 0.745 0.442 0.955 femaletesear 12 + 0.784 0.762 0.441 0.955 taxr 12 + -0.000 -0.053 0.484 0.962 bmoney 12 + 0.942 0.935 0.433 0.954 gds 12 + 0.904 0.893 0.435 0.954 test scale 0.447 0.958 note: parameters with a + sign have positive item-test, item-rest and average interitem correlations, while parameters with a – sign have negative item-test, item-rest and average interitem correlations. table 3 illustrates the factor loadings of the study’s variables, and it also shows that there is fair distribution between these variables through a combination of a transformation pattern matrix that reveals a fitted covariance/correlation matrix. in support of this analysis, the appendix presents a scree plot of eigenvalues after the factor graph in figure a1, which indicates that the scree plot of eigenvalues (i.e., the covariance or correlation matrix) after factor is characterized by a smooth l-shaped transition. thus, this demonstrates that the dataset has a good fit with the statistical model equation for this study. table 4 provides the descriptive statistics and correlations of this study’s econometric variables. the ensuing correlations indicate that collinearity does not pose a serious problem. nevertheless, instances of high correlation are taken into consideration when applying the glm analysis so that it does not invalidate the results generated thereafter. positive correlations were observed between south africa’s tesea rate and the gdp per capita, as well as the ease of doing business, which is consistent with hypothesis 1. similarly, a negative correlation was found between the dependent variable and the female unemployment rate and lending interest rate. this is consistent with hypotheses 2 and 3. table 5 presents the glm analysis results to test this study’s four empirical hypotheses. model 1 indicates that the log-likelihood value of -22.60 signifies a strong goodness of fit among the statistical variables and hypotheses. likewise, the akaike information criterion (aic) value of 5.60 implies that the relative quality of our statistical model is good, while the bayesian information criterion (bic) value of -2.49 shows that the efficiency of the parameterized model in terms of predicting the data is suitable. the pseudo r2 value of 0.11 implies that the variables in this model exhibit high predictive ability. similarly, the model 2 (log-likelihood = -22.60, aic = 5.60, bic = -2.49 and pseudo r2 = 0.11), model 3 (log-likelihood = -22.60, aic = 5.77, bic = 2.25 and pseudo r2 = 0.11), and model 4 (log-likelihood = -22.60, aic = 5.43, bic = -4.97 and pseudo r2 = 0.11) measurements indicate that our model can efficiently predict the study’s hypotheses. based on the econometric analysis, model 1 is the baseline model that includes the main exogenous variables which influence the rate of economic development in south africa, such as the gdp at current prices, the real gdp growth rate, the gdp purchasing power parity, gdp per capita, the economic freedom of the world, as well as the ease of doing business. it was observed that these independent variables have a non-significant impact on the dependent variable. in addition, all the mediator and control variables, except for the proxy variable representing the fact that entrepreneurship can be viewed as a good career choice (p < 0.001) during turbulent economic periods, were non-significant. likewise, all gdp variables have a negative non-significant impact on the tesea rate, excluding the gdp per capita which relies on efficiency, innovation and optimal utilization of market knowledge, as well as the level of economic freedom of the world and the ease of doing business that all have a positive and non-significant impact on the tesea rate of south africa. in model 1, the measurement of hypothesis 1 (lr chi-squared = 5.58, prob > chi2 = 0.85) specifies a nonsignificant impact on the dependent variable, which is south africa’s tesea rate. therefore, we reject the hypothesis that the relationship between the tesea rate and the rate of economic development in south africa is influenced and impacted by institutional factors, such as the degree of freedom and the ease of doing business (at least in the short run). this is consistent with the work of theorists konopik and lindgren (2010); deakins and freel (2012); davis (2013), and the world bank (2016). asian journal of economics and empirical research, 2022, 9(2): 100-120 112 © 2022 by the authors; licensee asian online journal publishing group in hypothesis 2, we propose that the rate of unemployment in south africa is positively associated with the dependent variable. consistent with the findings in hypothesis 1, we find that the relationship between these variables is non-significant (lr chi-squared = 5.58, prob > chi2 = 0.85). the unemployment rate is positively associated with the dependent variable (herrington et al., 2014); however, it has a non-significant impact on south africa’s tesea rate. likewise, our mediator variables, comprising of measures of individual participation rates such as entrepreneurial intentions, the amount of respect and recognition that results in a high status for successful entrepreneurs and the level of media attention for entrepreneurship, were all negative and significant (p < 0.05). however, the media attention for entrepreneurship showed a positive and significant relationship with south africa’s tesea rate. among the control variables, the broad money supply was negatively significant when regressed with the dependent variable. these results are consistent with the findings of deakins and freel (2012) and amorós and bosma (2014), which states that the more the amount of public visibility that has been given to entrepreneurship through detailed media coverage, the more the number of would-be entrepreneurs that are willing to take up risky investments in private businesses in order to reap good returns in the future. we also find in model 3 that the real lending rate (p < 0.05), inflation rate (p < 0.05), and the tax rate on goods and services (p < 0.01) have a negative and significant relationship with the dependent variable. similarly, the official rate of exchange had a negative non-significant relationship with south africa’s tesea rate. these results are consistent with the predictions in international business, which supports the notion that these variables raise the cost of doing business, leading to fewer participation rates during peak periods (see amorós & bosma, 2014; casson, 2010; deakins & freel, 2012; herrington et al., 2014; herrington & kew, 2018; statistics south africa, 2015; unctad, 2015; world economic forum, 2015). the mediator variables, that view entrepreneurship as a good career choice (p < 0.01) and canvas for a high level of media attention for entrepreneurship (p < 0.05), have a negative and significant relationship with the dependent variable. however, the variable relating to high status that is given to successful entrepreneurs becomes positive and significant (p < 0.01) when regressed with the dependent variable, which is consistent with the findings of amorós and bosma (2014) and herrington et al. (2014). the control variables reveal that the male tesea rate has a negative and significant (p < 0.05) relationship with the dependent variable and south africa’s female tesea rate had a positive and significant relationship (p < 0.01) with the dependent variable, which means that females were more motivated to start businesses than their male counterparts. in model 4 we observe that the level of foreign direct investment (net bop) and the jse market capitalization have a negative and significant (p < 0.05) relationship with south africa’s tesea rate (see (acquaah, zoogah, & kwesiga, 2013; hunya, 2012; mthombeni, 2006; pradhan, 2010)). our mediator variables, the start-up rate (p < 0.05), new firm rate (p < 0.05), opportunity rate (p < 0.05), necessity rate (p < 0.001), entrepreneur intentions (p < 0.001), good career choice (p < 0.001), and high status to successful entrepreneurs (p < 0.01), all have a positive and significant relationship with the dependent variable, which is consistent with the gem findings (see (amorós & bosma, 2014; herrington et al., 2014)). asian journal of economics and empirical research, 2022, 9(2): 100-120 113 © 2022 by the authors; licensee asian online journal publishing group table 3. factor loadings (pattern matrix) and unique variances. parameter factor1 factor2 factor3 factor4 factor5 factor6 factor7 factor8 factor9 factor10 factor11 uniqueness tesearate 0.930 0.027 0.094 0.276 0.186 -0.020 0.041 0.070 -0.061 -0.046 -0.048 0.000 gdpcp 0.931 0.114 0.208 -0.094 -0.127 0.098 -0.183 -0.085 0.050 0.006 -0.004 -0.000 gdpgr -0.434 0.096 0.765 0.199 0.328 0.081 0.089 -0.227 0.019 -0.046 0.031 0.000 gdpppp 0.851 -0.415 0.049 -0.306 -0.055 0.053 -0.015 -0.008 -0.009 0.029 0.006 -0.000 gdppc 0.894 0.095 0.304 -0.037 -0.185 0.104 -0.209 -0.076 0.053 0.002 -0.008 0.000 ef -0.364 0.127 0.627 -0.156 0.483 0.401 -0.119 0.131 -0.069 0.021 0.054 0.000 edb 0.857 -0.012 -0.336 -0.199 0.207 0.034 0.169 -0.180 0.019 -0.079 0.047 0.000 unempr -0.078 0.769 -0.577 0.123 0.144 0.145 -0.107 -0.019 -0.012 0.029 -0.010 -0.000 unemprmale 0.389 0.611 -0.667 0.061 0.011 0.113 -0.101 0.035 -0.021 0.046 -0.011 0.000 unemprfemale -0.652 0.619 -0.220 0.193 0.252 0.147 -0.105 -0.099 0.018 0.000 -0.006 0.000 intr -0.647 -0.549 -0.221 0.316 0.112 0.305 0.089 0.114 0.040 0.051 0.024 -0.000 infr 0.232 -0.821 -0.315 0.017 0.169 0.366 -0.037 -0.041 0.034 -0.011 -0.078 0.000 excr 0.589 -0.091 -0.568 -0.433 0.300 0.016 0.187 -0.051 -0.033 -0.012 0.074 0.000 fdibop -0.222 0.614 0.190 -0.575 0.263 -0.014 0.147 0.242 0.237 -0.031 -0.029 0.000 jsecap 0.813 0.068 0.254 -0.436 -0.142 0.046 0.030 0.128 -0.175 0.095 0.034 0.000 startupr 0.772 -0.220 0.169 0.437 0.289 -0.125 0.165 0.058 -0.070 0.010 -0.022 -0.000 newfirmr 0.891 0.333 -0.130 0.094 0.052 0.115 -0.099 0.146 -0.079 -0.125 0.006 0.000 opportunityr 0.902 -0.177 0.032 0.204 0.294 0.120 0.051 0.044 -0.043 -0.014 -0.067 0.000 necessityr 0.720 0.525 0.100 0.368 -0.079 -0.189 -0.012 0.110 -0.046 -0.059 0.034 0.000 entri 0.581 0.086 -0.046 0.726 -0.211 0.140 0.168 0.075 0.134 0.053 0.089 -0.000 goodcc 0.949 0.111 0.177 -0.026 -0.158 0.083 0.114 0.006 0.073 0.032 -0.065 -0.000 highs 0.948 0.193 0.094 -0.098 -0.155 0.048 0.128 -0.034 0.027 0.008 -0.020 0.000 mediaa 0.977 0.030 0.053 0.060 -0.059 0.053 0.173 -0.032 0.031 0.027 0.003 0.000 maletesear 0.768 -0.260 -0.013 0.154 0.402 -0.255 -0.282 -0.002 0.096 0.043 0.037 -0.000 femaletesear 0.794 -0.039 -0.016 0.007 0.499 -0.318 -0.091 -0.024 0.042 0.082 -0.016 0.000 taxr 0.040 0.931 0.233 0.044 0.051 0.107 0.153 -0.167 -0.055 0.074 -0.038 -0.000 bmoney 0.944 -0.084 -0.105 -0.274 0.030 0.095 -0.013 -0.065 0.013 0.003 0.035 -0.000 gds 0.909 -0.010 0.153 0.022 -0.259 0.205 -0.185 -0.020 0.071 -0.036 0.028 0.000 asian journal of economics and empirical research, 2022, 9(2): 100-120 114 © 2022 by the authors; licensee asian online journal publishing group table 4. descriptive statistics and correlations. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 1. total early-stage entrepreneurial activity 1.00 2. gdp at current (market) prices 0.82 1.00 3. gdp real growth rate -0.23 -0.28 1.00 4. gdp purchasing power parity 0.69 0.80 -0.45 1.00 5. gdp per capita 0.80 0.99 -0.21 0.77 1.00 6. economic freedom of the world -0.23 -0.19 0.77 -0.29 -0.15 1.00 7. ease of doing business 0.74 0.71 -0.54 0.77 0.61 -0.42 1.00 8. unemployment rate -0.05 -0.10 -0.26 -0.45 -0.17 -0.12 0.11 1.00 9. male unemployment rate 0.33 0.31 -0.62 0.03 0.23 -0.42 0.52 0.86 1.00 10. female unemployment rate -0.53 -0.59 0.32 -0.89 -0.60 0.33 -0.47 0.75 0.31 1.00 11. lending (real) interest rate -0.53 -0.75 0.17 -0.42 -0.72 0.16 -0.51 -0.16 -0.39 0.25 1.00 12. inflation rate 0.19 0.08 -0.33 0.53 0.05 -0.17 0.36 -0.38 -0.15 -0.48 0.50 1.00 13. official exchange rate 0.43 0.39 -0.66 0.63 0.27 -0.39 0.89 0.19 0.51 -0.34 -0.29 0.43 1.00 14. foreign direct investment (net bop) -0.27 -0.11 0.24 -0.28 -0.15 0.48 -0.11 0.32 0.12 0.40 -0.34 -0.59 0.04 1.00 15. jse market capitalization 0.65 0.86 -0.32 0.82 0.83 -0.08 0.64 -0.23 0.17 -0.68 -0.74 0.02 0.48 0.11 1.00 16. start-up rate (nascent entrepreneurship) 0.92 0.60 -0.06 0.60 0.60 -0.19 0.59 -0.26 0.06 -0.56 -0.27 0.31 0.30 -0.43 0.44 17. new firm rate (business ownership) 0.88 0.84 -0.45 0.59 0.79 -0.27 0.77 0.30 0.67 -0.30 -0.66 0.02 0.52 -0.05 0.69 18. opportunity rate 0.96 0.77 -0.25 0.77 0.74 -0.17 0.79 -0.15 0.25 -0.58 -0.36 0.44 0.53 -0.33 0.62 19. necessity rate 0.80 0.70 -0.18 0.28 0.70 -0.28 0.47 0.29 0.54 -0.15 -0.72 -0.38 0.13 -0.03 0.51 20. entrepreneurial intentions 0.69 0.48 -0.19 0.25 0.51 -0.40 0.35 0.11 0.35 -0.23 -0.13 0.10 0.01 -0.49 0.19 21. good career choice 0.87 0.95 -0.31 0.79 0.93 -0.28 0.74 -0.12 0.31 -0.63 -0.70 0.08 0.43 -0.10 0.85 22. high status to successful entrepreneurs 0.84 0.94 -0.37 0.77 0.91 -0.32 0.80 -0.02 0.41 -0.58 -0.77 0.02 0.51 -0.04 0.87 23. media attention for entrepreneurship 0.92 0.90 -0.36 0.81 0.87 -0.36 0.83 -0.10 0.35 -0.64 -0.62 0.19 0.53 -0.21 0.79 24. male tesea rate 0.81 0.65 -0.25 0.68 0.62 -0.22 0.66 -0.18 0.16 -0.54 -0.35 0.38 0.48 -0.33 0.45 25. female tesea rate 0.83 0.66 -0.23 0.65 0.60 -0.19 0.76 -0.04 0.28 -0.45 -0.53 0.20 0.60 -0.08 0.55 26. tax rate on goods and services 0.10 0.18 0.33 -0.35 0.17 0.27 -0.00 0.60 0.43 0.54 -0.54 -0.78 -0.16 0.56 0.13 27. broad money 0.79 0.89 -0.52 0.92 0.83 -0.33 0.92 -0.09 0.38 -0.67 -0.60 0.36 0.76 -0.13 0.85 28. gross domestic savings 0.80 0.97 -0.35 0.81 0.97 -0.27 0.65 -0.15 0.28 -0.64 -0.59 0.21 0.33 -0.28 0.79 mean 6.94 3.10 3.13 11792.89 6175.81 6.78 32.58 24.16 21.52 27.3 11.10 5.65 7.85 -2.63 7.14 standard deviation 1.90 7.25 1.99 691.32 1206.55 0.16 4.52 1.35 1.80 1.49 2.30 2.45 1.34 4.44 2.27 minimum 4.3 1.75 -1.54 10382.02 3799.44 6.49 28 22.3 18.6 25.5 8.5 1.39 6.36 -1.20 2.61 maximum 10.6 4.17 5.59 12454.19 8080.87 7.06 41 27.1 23.7 31.1 15.13 11.54 10.85 5.31 9.43 asian journal of economics and empirical research, 2022, 9(2): 100-120 115 © 2022 by the authors; licensee asian online journal publishing group table 4. continued… parameters 16 17 18 19 20 21 22 23 24 25 26 27 28 16. start-up rate (nascent entrepreneurship) 1.00 17. new firm rate (business ownership) 0.63 1.00 18. opportunity rate 0.92 0.80 1.00 19. necessity rate 0.63 0.84 0.59 1.00 20. entrepreneurial intentions 0.68 0.60 0.61 0.72 1.00 21. good career choice 0.69 0.84 0.81 0.74 0.60 1.00 22. high status to successful entrepreneurs 0.63 0.87 0.77 0.75 0.55 0.99 1.00 23. media attention for entrepreneurship 0.78 0.86 0.88 0.73 0.66 0.97 0.97 1.00 24. male tesea rate 0.81 0.62 0.84 0.49 0.39 0.58 0.55 0.67 1.00 25. female tesea rate 0.79 0.68 0.83 0.56 0.31 0.64 0.64 0.72 0.94 1.00 26. tax rate on goods and services -0.09 0.29 -0.08 0.51 0.14 0.20 0.26 0.12 -0.26 -0.02 1.00 27. broad money 0.60 0.80 0.82 0.50 0.35 0.88 0.90 0.90 0.70 0.74 -0.06 1.00 28. gross domestic savings 0.60 0.81 0.77 0.65 0.60 0.93 0.90 0.89 0.60 0.54 0.04 0.85 1.00 mean 4.35 2.63 4.64 2.19 14.13 65.2 65.06 65.84 7.51 5.48 34.65 1.80 6.01 standard deviation 1.12 0.97 1.47 0.67 3.01 8.74 9.10 9.95 2.47 1.45 1.72 6.37 1.48 minimum 2.7 1.6 2.8 1.5 9.3 48 48 47.5 4.5 3.7 31.35 8.04 3.41 maximum 6.6 4.1 7.3 3.2 19.6 77.5 77.6 78.6 12.3 9 36.96 2.70 8.34 notes: n = 12. the gross domestic product (gdp) at current prices, and the johannesburg stock exchange (jse) market capitalization, as well as the foreign direct investment (fdi) net balance of payment (bop) and the gross domestic savings (gds) figures are expressed in billions of us$. broad money is expressed in trillions in the local currency unit (lcu) – i.e., south african rand. asian journal of economics and empirical research, 2022, 9(2): 100-120 116 © 2022 by the authors; licensee asian online journal publishing group table 5. glm analysis results. parameter model 1 model 2 model 3 model 4 intercept -21.73 (193.08) -25.98 (279.05) 15.22 (128.64) -1.73 (74.98)* gdp at current (market) prices -2.62 (7.10) gdp real growth rate -0.98 (2.10) gdp purchasing power parity -0.01 (0.01) gdp per capita 0.02 (0.04) intercept 6.31 (15.00) ease of doing business 0.44 (1.91) unemployment rate 8.31 (125.00) male unemployment rate -3.97 (62.10) female unemployment rate -3.52 (55.35) lending (real) interest rate -0.30 (8.64)* inflation rate -0.10 (2.51)* official exchange rate -0.23 (2.38) tax rate on goods and services -0.11 (10.72)** foreign direct investment (net bop) -9.91 (3.74)* jse market capitalisation -4.70 (1.37)* mediators start-up rate (nascent entrepreneurship) 1.33 (13.16) 0.97 (30.85)* new firm rate (business ownership) 0.45 (10.14)* opportunity rate 1.50 (3.47) 0.39 (8.81)* necessity rate 0.04 (47.59)*** entrepreneurial intentions -0.74 (2.89) -0.49 (9.03)* 0.19 (1.38) 0.03 (8.36)*** good career choice 0.00 (1.29)*** 0.10 (1.04) -0.07 (5.93)** 0.00 (5.05)*** high status to successful entrepreneurs -0.52 (2.63) -0.08 (5.2)* 0.06 (11.23)** 0.19 (16.35)** media attention for entrepreneurship 0.86 (3.23) 0.30 (10.78)* -0.07 (4.04)* -0.17 (12.62)** controls male tesea rate 0.24 (1.27) 1.17 (17.04) -0.23 (5.72)* 0.03 (3.01)** female tesea rate 0.44 (2.39) -2.11 (27.60) 0.26 (18.19)** broad money -5.49 (2.06) -2.02 (6.07)* gross domestic savings -7.13 (2.67) year effects included included included included number of observations 12 12 12 12 log-likelihood -22.6 -22.6 -22.6 -22.6 aic 5.6 5.6 5.77 5.43 bic -2.49 -2.49 2.25 -4.97 lr chi-squared 5.58 5.58 5.58 5.58 prob > chi2 0.85 0.85 0.9 0.78 pseudo r2 0.11 0.11 0.11 0.11 notes: all tests are two-tailed; * p < 0.05, ** p < 0.01, *** p < 0.001; standardized coefficients are reported, and standard errors are in parentheses. the variable relating to media attention for entrepreneurship remains negative and significant (p < 0.01) when regressed with south africa’s tesea rate, thus allowing for greater publicity to improve the entrepreneurial participation rates in south africa. nevertheless, the male tesea rate becomes positive and significant (p < 0.01) in relation to the dependent variable (amorós et al., 2013). this implies that varying relationships exemplified by the tesea rate of south africa can be positively influenced and mediated by the macroeconomic conditions that are associated with the level of fdi and the market capitalization of the jse (amorós & bosma, 2014; herrington et al., 2014; herrington & kew, 2018). however, this relationship is statistically non-significant (lr chi-squared = 5.58, prob > chi2 = 0.78) in hypothesis 4. additionally, a combination of factors, such as the bbbee legislation, the high level of corruption, poor business management skills, and politicking, can also make the tesea rate of south africa sway over time (amorós et al., 2013). a higher tesea rate is positively associated with higher gdp per capita levels, ease of doing business levels and the rate of economic freedom in the world, as well as the current unemployment rate in south africa. consequently, both male and female entrepreneurs will have a higher tesea rate when there is economic growth across the board, i.e., when income is equally distributed, ceteris paribus. furthermore, it was observed that when unemployment is high, south african males’ tesea rate increases, while that of females decreases. also, when the fdi (net bop) values along with the jse market capitalization levels reduce, more south africans, especially males, tend to start new businesses that are mostly necessity driven with few opportunity-driven enterprises springing up due to high level of entrepreneurial intentions, which is obviously because entrepreneurship is viewed as a good career choice and is given a high status. taken together, if a high status is given to successful entrepreneurs and is also viewed as a good career intention, the start-up rate, new firm rate, opportunity rate and necessity rate would increase along with the level of entrepreneurial intention in south africa, thus jointly boosting south africa’s tesea rate2, and vice versa. 5.1. additional analyses and robustness checks to ensure the robustness of the results and to further explore some of our glm results, a number of additional analyses were performed. first, in the theoretical section of our study we focused on the effect that the tesea rate has on the level of entrepreneurship considering a cluster of macroeconomic factors, which raises some concerns and stimulates scholarly debate on contemporary entrepreneurship literature. thus, this led us to select this as the dependent variable. however, another factor that may accurately measure the impact of entrepreneurship in south africa is the start-up (nascent entrepreneurship) rate, which was a little farther from our main objective of measuring asian journal of economics and empirical research, 2022, 9(2): 100-120 117 © 2022 by the authors; licensee asian online journal publishing group entrepreneurial intention, attitude and behavior. we therefore coded it as a proxy variable that was included as one of the independent variables for this study. according to amorós and bosma (2014), the gem focuses on the advance start of new firms (i.e., nascent entrepreneurship) due to the shift in the entrepreneurship literature towards the notion that this phenomenon is indeed procyclical in nature. herrington et al. (2014) posit that this indicator captures the level of dynamic earlystage entrepreneurial activity in south africa. in other words, just as the tesea rate in south africa can be used as a yardstick to measure entrepreneurial activity because it strengthens our hypothetical propositions, we would likewise expect the new firm rate or nascent entrepreneurship rate to have a similar effect. to explore this further, we replace the dependent variable (south africa’s tesea rate) with the new firm rate and, interestingly, the outcome produced similar results. afterwards, we checked the robustness of our results by using alternative model specifications to test our hypotheses (however, the results are not presented in this article). the glm analysis revealed that hypothesis 1, hypothesis 2, hypothesis 3 and hypothesis 4 have a non-significant relationship (hypothesis 1: lr chi-squared = 3.07, prob > chi2 = 0.98; hypothesis 2: lr chi-squared = 3.06, prob > chi2 = 0.96; hypothesis 3: lr chi-squared = 3.07, prob > chi2 = 0.99; hypothesis 4: lr chi-squared = 3.05, prob > chi2 = 0.93) between the start-up rate and the independent variables, which implies that our datasets are robust. finally, we found no evidence that the start-up (nascent entrepreneurship) rate differs from the tesea rate in south africa, and our analyses were consistent in both iterations. 6. discussion and conclusions this study epitomizes meaningful advances in several aspects with respect to calls by amorós and bosma (2014) and others (for example, (deakins & freel, 2012; herrington et al., 2014; todaro & smith, 2009; zhan, 2014)) for a more nuanced treatment of the total early-stage entrepreneurial activity in entrepreneurship literature. in particular, we attribute the significance of the pest-le analysis, as observed by konopik and lindgren (2010) and davis (2013), as being responsible for the specific trends and indices that are exogenous when considering the impact of the tesea rate on available macroeconomic variables. the results presented in the previous section reveal that all of our hypotheses were statistically non-significant to collectively influence the dependent variable. nevertheless, these results are robust across all models presented. our main findings indicate that when entrepreneurship is viewed as a good career choice, the tesea rate increases, and vice versa. also, the gdp per capita, which relies on efficiency, innovation and optimal utilization of market knowledge, as well as the level of economic freedom and the ease of doing business in south africa, positively impacts the nation’s tesea rate. more so, the unemployment rate is positively associated with the tesea rate in south africa (herrington et al., 2014), and the higher the level of public visibility given to entrepreneurship, the higher the number of would-be entrepreneurs that are willing to take up risky investments in private businesses across the country. consequently, during periods of high lending rates, the tesea rate increases because banks are more willing to lend at high interest rates for profitable purposes to small businesses, which leads to higher rates of return and low risk exposure on these loans. likewise, a high inflation rate increases the prices of goods and services and encourages more individuals to seek and participate in profitable business initiatives as a way to curtail their own expenses. a high tax rate also encourages people to seek alternative ways of increasing their disposable income by engaging in entrepreneurial ventures to create wealth. however, higher official rates of exchange reduce the risk appetite of small investors, although it creates room for fdi to increase because of the pecuniary advantages that investors can benefit from. furthermore, the net fdi and the jse market capitalization indices signify that a negative relationship exists between these variables and the tesea rate in south africa (mthombeni, 2006). but when regressed individually, this study finds that the jse market capitalization contributes positively to the tesea rate as well as to the startup rate. our moderator variables might be responsible for such sporadic changes in the reaction of individuals; therefore, we recommend that greater publicity should be given to the jse’s alternate exchange (altx) in order to encourage investors to support the ongoing success in south africa’s small business sector (amorós et al., 2013). last, one of the main contributions of this study is that the prevailing entrepreneurial chasms in south africa create different types of entrepreneurs; therefore, government agencies need to create awareness and support programmes to encourage and support these small businesses toward growth, productivity and national development. in addition, efforts need to be made by researchers and policy makers toward concentrating on the positive spillover effects of me transfers, while the negative spillover effects of mes, such as the artificial barriers to entry determined by high costs of r&d, need to be mitigated through proper legislation and an integrated country-wide government incubation programme (ayyagari & kosová, 2006; zhan, 2014). due to the dynamic nature of individual traits, predicting entrepreneurial behavior entails a very complex process. moreover, despite being well versed in entrepreneurship literature, this study has a fundamental shortcoming because the tesea rate in south africa is associated with the nascent phase of entrepreneurship. this is because after this stage comes a more advanced phase that deals with opportunity recognition and business discontinuation. on the other hand, since entrepreneurial aspirations vary over time, the relevant demand for a different dataset becomes imperative. evidently, more individuals, national experts and international business professionals need to be surveyed to gather a more reliable dataset for entrepreneurial studies. in terms of implications for future research, this study highlights the importance of the tesea rate and puts forward a notion of dynamic inventiveness and individual alertness to entrepreneurial opportunities. however, this should be a launch pad to probe other relationships because the gem study is modelled on the world economic forum’s global competitiveness report. by using the grouping of country economies, which can be divided into factor-driven, efficiency-driven, and innovation-driven economies, the gem can compare economies across similar development levels and geographic locations as well as accurately measure and forecast the impact of entrepreneurship across countries and regions. according to herrington et al. (2014), 3.9% of the adult population in south africa in 2014 was engaged in nascent entrepreneurship, a figure well below the average of 14.1% in sub-saharan africa. further research can explore why and how these trends develop over the entrepreneurial continuum. consequently, it is important to recognize that entrepreneurs can differ in their profiles and impact. likewise, important consideration should be given to entrepreneurs who succeed due to the positive media projection of their operational activities to asian journal of economics and empirical research, 2022, 9(2): 100-120 118 © 2022 by the authors; licensee asian online journal publishing group the public. furthermore, other aspects, such as the level of employment that entrepreneurs create, their growth ambitions, and the extent to which groups such as youth and women are participating in the entrepreneurial activity ecosystem, need to be properly studied. empirical research in this field is still in its early stages and therefore creates a gap in literature that entrepreneurship scholars can fill in the short term, medium term and long term. 6.1. notes 1 unlike traditional neoclassical economics, which is primarily concerned with efficient, least-cost allocation and optimal growth of resources, development economics transcends political economy and also deals with economic, social and institutional mechanisms, both private and public, that are necessary to bring about rapid (at least by historical standards) and large-scale improvements in standards of living for the people of africa, asia, latin america, and the formerly socialist transition economies (todaro & smith, 2009). 2 conventional neoclassical theory suggests that most underdeveloped countries typically suffer from the six gaps problem, which keep these countries trapped in a low-growth scenario (i.e., a vicious cycle of poverty), due to a resource or savings gap, a foreign exchange or trade gap, a skills and technology gap, a budgetary gap or deficit, a revenue gap, or an innovation gap (dunning, 2010; gerring & thacker, 2008; yusuf, 2009). 3 contemporary research points out that an exhaustion of the six gaps problem eventually leads to proffering a common solution for less developed countries to break out of the vicious cycle of poverty through a creative destruction process that ultimately leads to a virtuous cycle of development (dunning, 2010). 4 in finance, broad money is a measure of the aggregate money supply, including narrow money such as currency and coins, demand deposits, and non-institutional money market accounts. 5 gross domestic savings consist of all the cumulative savings of the household sector, private corporate sector and public sector in south africa. it is expressed in current us$ prices. many consumers and investors have shifted to using their savings to buy physical assets compared to financial assets, which is an aftermath of the 2008 global financial crisis. this trend can be linked to a growing rise in inflationary pressures. however, south africa's gross national savings is currently 15% of gdp (i.e., gdp minus final consumption expenditure, or it can be derived from deducting final consumption expenditure from gross national disposable income). 6 according to the fraser institute (2016), the economic freedom of the world measures the degree to which the policies and institutions of various countries across the globe are supportive of these economies. this is based on an index of the fundamental cornerstones of economic freedom, such as personal choice, voluntary exchange, freedom to compete, and the security of privately owned property. 7 the world bank (2016) doing business report defines “the ease of doing business” as an annual report that measures the state of health of economies based on detailed diagnostics underlying and embedded in characteristics such as the regulatory system, the efficacy of bureaucracy and the nature of business governance. the index precisely ranks countries on various aspects of business, such as starting a business, dealing with construction permits, getting electricity, registering property, getting credit, protecting minority investors, paying taxes, trading across borders, enforcing contracts and resolving insolvency and labor market regulations. references acemoglu, d. 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(2006). conceptualizing the learning process in smes: improving innovation through external orientation. international small business journal, 24(3), 299-323.available at: https://doi.org/10.1177/0266242606063434. appendix figure a1. scree plot of eigenvalues after factor. the asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc., caused in relation to/arising from the use of the content. any queries should be directed to the corresponding author of the article. 1 © 2023 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 10, no. 1, 1-10, 2023 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v10i1.4406 © 2023 by the authors; licensee asian online journal publishing group growth effects of government expenditure in nigeria: does the level of corruption matter? ibrahim iliyasu1 ibrahim muhammed2 ( corresponding author) 1,2department of economics, umaru musa yar’adua university, katsina state, nigeria. 1email: ibrahim.iliyau@umyu.edu.ng 2email: ibrahimu1012@gmail.com abstract a strand of literature suggests that an efficient government can complement private capital formation and boost the overall productivity of private economic agents. nigeria has experienced uneven growth performance in the last three decades despite growing government expenditure. this paper carried out an empirical analysis of direct and indirect links among growth, government expenditure and corruption in nigeria using annual time series data for the period from 1990 to 2020. the autoregressive distributed lag (ardl) model was used to explore the long-run interacting effect of corruption on the nexus between growth and government expenditure. for the robustness check, the fully modified ordinary least squares (fmols) and dynamic ordinary least squares (dols) were used as alternative techniques of estimation. directly, an increase in government expenditure and a reduction in corruption has a significant increasing effect in the short-term and long-term growth. indirectly, reducing corruption enhances the increasing effect of government expenditure on economic growth. however, corruption reduction up to the 42.25 threshold and beyond diminishes the increasing effect of government expenditure on economic growth. this suggests that attaining sustained growth is possible by raising government expenditure and minimizing corruption. thus, minimizing corruption associated with expenditure policy should be a top policy priority. keywords: corruption, growth, government expenditure, ardl, fmols, dols, nigeria. jel classification: h50; o10. citation | iliyasu, i., & muhammed, i. (2023). growth effects of government expenditure in nigeria: does the level of corruption matter? asian journal of economics and empirical research, 10(1), 1– 10. 10.20448/ajeer.v10i1.4406 history: received: 24 october 2022 revised: 6 december 2022 accepted: 23 december 2022 published: 12 january 2023 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. authors’ contributions: both authors contributed equally to the conception and design of the study. competing interests: the authors declare that they have no conflict of interest. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study, that no vital features of the study have been omitted, and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction ......................................................................................................................................................................................... 2 2. literature review ............................................................................................................................................................................... 2 3. data and methodology ...................................................................................................................................................................... 3 4. results and discussion ...................................................................................................................................................................... 5 5. conclusion and recommendations .................................................................................................................................................. 8 references ................................................................................................................................................................................................. 8 mailto:ibrahim.iliyau@umyu.edu.ng mailto:ibrahimu1012@gmail.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v10i1.4406 https://orcid.org/0000-0003-2922-0181 https://orcid.org/0000-0002-6548-5024 asian journal of economics and empirical research, 2023, 10(1): 1-10 2 © 2023 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study contributes to the existing literature is in two ways. firstly, it overcomes the data limitation of the existing studies by generating a large (greater than 30) sample observation. secondly, a selection of estimation techniques was used to empirically analyze the data; hence, we provide consistent estimates of the interacting role of corruption in the government expenditure–growth nexus in africa, and specifically in nigeria. 1. introduction developing economies strive to achieve sustained, long-term growth for improved standard of living, poverty reduction, better sanitation, more education and higher life expectancy (azam, 2022; benjamin & myers, 2005; world bank, 2017). one strand of literature suggests that an efficient government can complement private capital formation, facilitate better and efficient organization of production, consumption and trade, and boost the overall productivity of private economic agents (see barro (1990); imf (2015); kneller, bleaney, and gemmell (1999); olofin (2001)). however, the literature on the growth–government expenditure nexus and the growth–corruption nexus is broadly contentious. for instance, there are substantial arguments on the positive and negative influences of government expenditure on growth at theoretical and empirical levels (alesina, ardagna, perotti, & schiantarelli, 2002; barro, 1990; devarajan, swaroop, & zou, 1996; tanzi & zee, 1997). in addition, at least four views exist on the causal relationship between government expenditure and growth. kouassi (2018) and nyasha and odhiambo (2019) aptly summarized the views to include the “government size-led economic growth view” built on the basis of the keynesian idea that government expenditure can generate growth; “growth-led government size” deduced from wagner’s law, which posits that growth in per capita income propels government expenditure; the “bidirectional causality view” (abu-bader & abu-qarn, 2003; abu-eideh, 2015)d and the “neutrality view” (afxentiou & serletis, 1996; ansari, gordon, & akuamoah, 1997; taban, 2010). moreover, corruption is adjudged to either be "sand in the wheels of commerce”, meaning that corruption creates distortion and inefficiency that hinder growth and development (alfada, 2019; andvig & moene, 1990; blackburn, bose, & haque, 2010; mauro, 1995; murphy, shleifer, & vishny, 1993; nur-tegin & jakee, 2020; schleifer & vishny, 1993) or "grease the wheels of commerce", that is, corruption in some instances helps entrepreneurs to overcome obstacles and foster innovation, growth and development (beck & maher, 1986; egger & winner, 2005; kato & sato, 2015; leff, 1964; lui, 1985; méon & weill, 2010). nigeria has experienced uneven growth in the last three decades, with average gdp growth rates of 2.3%, 7.8% and 3.2% in the 1990s, 2000s and 2010s, respectively. correspondingly, the growth rate of gdp per capita in the same period was at -0.2; 4.9 and 0.5, respectively.1 amid this unimpressive growth performance, the ratio of government expenditure to gdp and per capita government expenditure have fluctuated over the three decades, hovering at around an average of 8.6% and ₦170,246, respectively. but the nominal and real government expenditures have risen steadily by about 16,867.99% and 78.07%, respectively. in addition, many authors have posited that corruption in africa, and nigeria in particular, is systemic (abu, karim, & aziz, 2015; abu & staniewski, 2019; abu et al., 2022; gyimah-brempong, 2002; rivi, ogboru, & rivi, 2020). these assertions are further corroborated by anecdotal evidence; for instance, the economic and financial crime commission (2019) investigated about 39,970 high profile corruption cases involving past governors and top government functionaries and secured about 2,544 convictions during the 2010–2019 period. also, a recent corruption survey conducted by the national bureau of statistics (nbs) (2019) estimated that a total of around ₦675 billion in bribe money exchanged hands twelve months prior to the survey; this translates to about 0.52% of nigeria’s gdp for the year. existing empirical studies on direct, and especially indirect, links between growth, government expenditure and corruption remain shallow in nigeria. ngutsav (2018); aigheyisi (2015); and ovat and bassey (2014) investigated the link among the three variables, none of them estimated the marginal effects of government expenditure on growth given the level of corruption. in addition, there are specific limitations related to these studies. for example, while ngutsav (2018) covered the period from 1981 to 2015, he failed to state how he got the data on the corruption perception index prior to 1996; he claimed that the series were integrated of order i(1) without reporting the results, rendering his findings suspicious. aigheyisi (2015) used a limited number of observations (19) that falls short of the minimum required (30) for robust time series analysis and failed to conduct unit root and post-estimation diagnostics tests. the study by ovat and bassey (2014) lacks empirical rigor, and its findings were derived from a mere descriptive analysis. giving the competing theoretical and empirical arguments on the nexus among growth, government expenditure and corruption, nigeria’s score card on the three variables over the study period, and the dearth of the extant literature in the country, the present paper aims to investigate the effect of government expenditure and corruption on growth in addition to their direct linear effects. this will allow us to determine whether the level of corruption moderates the effect of government expenditure on growth in nigeria, since the former can distort the composition and productivity of the latter (mauro, 1998; schleifer & vishny, 1993; tanzi & davoodi, 1997). the paper is structured in five sections. section two provides a literature review; section three explains the data and methodology used; section four presents the results and discussion; and section five concludes the study and proffers some policy recommendations. 2. literature review this section presents a brief review of selected studies on the interacting role of corruption on the growth– government expenditure relationship, many of which were based on cross-country and panel data regressions. for example, del monte and papagni (2001) examined the indirect effect of corruption on growth in a panel of 20 italian regions. building on the basic growth regression and estimating a dynamic panel data regression, the study found that corruption reduced economic growth by lowering private investment and reducing public investment efficiency. blackburn, bose, and haque (2011) argued that corruption lowers public capital accumulation and changes the volume and quality of public expenditure in a manner that endangers growth. similarly, d’agostino, dunne, and 1these averages are computed using the world bank’s world development indicators, 2020. asian journal of economics and empirical research, 2023, 10(1): 1-10 3 © 2023 by the authors; licensee asian online journal publishing group pieroni (2016) examined the indirect channels through which corruption affects growth. the study employed an endogenous growth model to examine how corruption affects growth through military and investment spending. findings from the study revealed that the interaction between the two components of expenditure and corruption has a strong adverse effect on growth. d’agostino, dunne, lorusso, and pieroni (2020) further explored the interactive role of military spending, corruption and institutional quality on growth. balanced and unbalanced panel data ardl results indicated that military spending and corruption have an important decreasing effect on growth and argued for the possibility of high military spending–high corruption trap. nirola and sahu (2019) examined the links among government size, institution and state-level economic growth in india. the authors estimated an augmented solow growth model with pooled ols, random effects and generalized method of moments (gmm) panel estimation techniques. the results showed that a larger government size decreases state-level growth, and the decrease is higher in states with poor quality institutions and lower in states with better institutions. nguyen and bui (2022) examined the interacting role of corruption control in the growth–government expenditure nexus in asia over a sample period from 2002–2019. a combination of the gmm estimation technique and the threshold model was employed. the findings showed a significant negative impact of government spending and corruption control on growth. in addition, the growth–corruption control interaction diminished the observed negative effect. in fact, when the threshold value of corruption control reached 0.01, the effect of government expenditure on growth turned positive. tanzi and davoodi (1997) investigated the link between corruption, public investment and growth based on a cross-country regression analysis and found a significant growth-diminishing effect of corruption through increasing the share of less productive public investment at the detriment of current expenditure, a decrease in government revenues, and a drop in the overall quality of existing public infrastructure. the few country-level studies conducted in nigeria include ngutsav (2018), who examined the impact of corruption and government expenditure on growth from 1981 to 2015 using the vector error correction model and the impulse response function. the findings indicated that corruption has a significant adverse impact on growth and government expenditure has a stimulating effect on growth. in addition, corruption decreases the stimulating effect of government expenditure on growth. aigheyisi (2015) studied the impact of corruption and government expenditure on the gdp growth rate in pre-democratic (1994–1998) and democratic (1999–2012) era sample splits using the ordinary least squares (ols) estimation technique. the primary findings were that in both sample splits, corruption had an insignificant effect on growth and capital expenditure decreased growth. also, recurrent expenditure had a significant growth-decreasing effect in the pre-democratic era sample, nonetheless, the effect turned positive in the democratic dispensation sample. ovat and bassey (2014) explored the aggregate effect of governance, corruption and public expenditure on growth in nigeria using descriptive and content analyses of available data. the authors discerned a clear adverse aggregate effect of corruption on growth. overall, substantial cross-country and panel regression evidence suggests that minimizing the level of corruption can increase government expenditure productivity and efficiency, thereby enhancing the growth effect of government expenditure. nevertheless, the lack of country-specific studies, particularly in nigeria, calls for further studies to determine the nature and extent of the growth, public expenditure and corruption nexus, both directly and indirectly. 3. data and methodology 3.1. theoretical framework and model specification the workhorse growth equation, following barro (1990); barro and sala-i-martin (1992) and barro (1991), provides the basic framework for the growth regression analysis. the equation arises from the idea that factors capable of increasing the stocks of physical and human capital tend to promote technological progress and overall economic growth, while those that reduce incentives to invest and decrease the efficiency of well-functioning markets tend to reduce growth. in line with the theoretical exposition of blackburn et al. (2011), we modify the base line growth equation to suit the purpose of this study, and the model is specified as follows: 𝐿𝐺𝐷𝑃𝑡 = 𝜔1 + 𝜔2𝐿𝐺𝑋𝑡 + 𝜔3𝐶𝑂𝑅𝑡 + 𝜔4(𝐿𝐺𝑋 ∗ 𝐶𝑂𝑅𝑡) + 𝜑′𝑍𝑡 + 휀𝑡 (1) equation 1 presents the econometric model, where 𝐿𝐺𝐷𝑃𝑡 is the log of real gdp; 𝐿𝐺𝐸𝑡 is the log of government expenditure; 𝐶𝑂𝑅𝑡 is the transparency of the international corruption index; and 𝑍𝑡 is the set of control variables, such as logarithms of gross fixed capital formation (lgfct), inflation (linft), and openness (lopent). the interaction term between government expenditure and the corruption index (𝐿𝐺𝑋 ∗ 𝐶𝑂𝑅𝑡) yields the marginal effects of the variables after differentiating the growth equation with respect to government expenditure in equation 2. 𝜕𝐿𝐺𝐷𝑃 𝜕𝐿𝐺𝑋 = 𝜔2 + 𝜔4𝐶𝑂𝑅𝑡 (2) five fundamental policy implications can be deduced from the respective signs of 𝜔2 and 𝜔4 related to the hypothesis testing. firstly, if 𝜔2 > 0 and 𝜔4 > 0, this means that government expenditure raises growth, and corruption enhances that positive effect. thus, policymakers should increase government expenditure as it, along with corruption, are desirable ingredients of the growth process. secondly, if 𝜔2 > 0 and 𝜔4 < 0, it implies that government expenditure spurs growth, and corruption diminishes this effect. therefore, policymakers should reduce the incidence of corruption in order to maximize the positive effect of government expenditure on long-term growth. thirdly, if 𝜔2 < 0 and 𝜔4 > 0, it suggests that government expenditure reduces growth, and corruption moderates that reduction. fourthly, if 𝜔2 < 0 and 𝜔4 < 0, it suggests that government expenditure reduces growth and corruption amplifies that reduction. policymakers should devise a measure to ensure that government expenditure and corruption promote growth. finally, if the marginal effect of government expenditure on growth (𝜔2 + 𝜔4𝐶𝑂𝑅𝑡) increases together with the incidences of corruption, this implies that additional government expenditure and incidences of corruption can spur growth. contrarily, the reverse is the case if the marginal effect decreases as the incidences of corruption increases. asian journal of economics and empirical research, 2023, 10(1): 1-10 4 © 2023 by the authors; licensee asian online journal publishing group table 1. definitions and sources of the variables. series definition a priori sign source lgdp logarithm of gross domestic product used as a proxy for economic growth. cbn lgx logarithm of government outlays for the provision of current and capital goods and services plus transfer payment. positive cbn cor the transparency international corruption perception index, which measures corruption between 100 corruption-free and 0 highly corrupt countries. positive ti lgx*cor interaction term between the logarithm of total government outlay and the corruption perception index. constructed lgfc log of gross fixed capital formation, which measures capital accumulation through land improvements (fences, ditches, drains, etc.); plant, machinery, and equipment purchases; and the construction of roads, railways, schools, offices, hospitals, private residential dwellings, and commercial and industrial buildings as a share of gdp. positive wdi linf logarithm of inflation, measured by the annual growth rate of gdp. the implicit deflator shows the rate of price change in the economy as a whole. the gdp implicit deflator is the ratio of gdp in current local currency to gdp in constant local currency. positive wdi lopen logarithm of the sum of exports and imports of goods and services measured as a share of gdp. positive wdi note: gdp = gross domestic product, gx = government total expenditure, cor = corruption, gfc = gross fixed capital formation, inf = inflation, open = trade openness, and l = natural logarithm of the variable. * denotes multiplication that shows the interaction of government expenditure and corruption. 3.2. data and econometric techniques the analysis covers a sample period from 1990 to 2020. data availability, particularly on corruption,2 informed the sample choice. the descriptions, measurements and sources of data for all the series are summarized in table 1. 3.3. unit root test equations the study examined the stationarity status of the data series prior to estimating and testing the effect of corruption on the growth–government expenditure nexus. this is required in order to avoid spurious or misleading results. the augmented dicker–fuller (adf) (dickey & fuller, 1979) and phillips–perron (pp) (phillips & perron, 1988) tests were utilized to achieve the objective. both the adf and pp equations estimated are specified in equations 3 and 4, respectively. ∆𝑦𝑡 = 𝜕 + ∅𝑡 + (𝜌 − 1)𝑦𝑡−1 + ∑ 𝛿𝑘 𝑖=1 ∆𝑦𝑡−𝑖 + 𝜇𝑡 (3) ∆𝑦𝑡 = 𝜕 + ∅𝑡 + 𝜑𝑦𝑡−1 + 𝜇𝑡 (4) where 𝑦𝑡 is the series and 𝑢𝑡 is the error term. the null hypothesis h0 states that 𝜌 = 0 (unit root). the alternative hypothesis h1 states that 𝜌 < 0 (series is stationary). the adf and pp complement each other; the decision rule is to accept the null hypothesis if the test statistic is lower than the critical value at the 5% significance level and vice versa. 3.4. ardl bounds test for cointegration to explore the long-run interacting effect of corruption on the growth–government expenditure nexus, the ardl bounds test for cointegration technique was used (pesaran & shin, 1999; pesaran, shin, & smith, 2001). the technique is most suitable for a combination of i(1) and i(0) series and has several advantages over the other competing techniques (e.g., engle and granger (1987); johansen (1988); johansen (1991) and johansen and juselius (1990)). these advantages include a varied lag length for each variable, a single reduced-form equation, and its adequacy in estimating relationships, even with a finite sample (abu & gamal, 2020). the estimated model is specified as follows: ∆𝐿𝐺𝐷𝑃𝑡 = 𝛼0 + ∑ 𝛼1𝑖 ∆𝐿𝐺𝐷𝑃𝑡−𝑖 +𝑛 𝑖=1 ∑ 𝛼2𝑖∆𝐿𝐺𝑋𝑡−𝑖 𝑛 𝑖=0 + ∑ 𝛼3𝑖𝑛 𝑖=0 ∆𝐶𝑂𝑅𝑡−𝑖 + ∑ 𝛼4𝑖𝑛 𝑖=0 ∆𝐿𝐺𝑋 ∗ 𝐶𝑂𝑅𝑡−𝑖 + ∑ 𝛼5𝑖∆𝐿𝐺𝐹𝐶 + ∑ 𝛼6𝑖𝑛 𝑖=0 𝑛 𝑖=0 ∆𝐿𝐼𝑁𝐹𝑡−𝑖 + ∑ 𝛼7𝑖∆𝑛 𝑖=0 𝐿𝑂𝑃𝐸𝑁𝑡 + ∅1𝐿𝐺𝐷𝑃𝑡−1 + ∅2𝐿𝐺𝑋𝑡−1 + ∅3𝐶𝑂𝑅𝑡−1 + ∅4𝐿𝐺𝑋 ∗ 𝐶𝑂𝑅𝑡−1 + ∅5𝐿𝐺𝐹𝐶𝑡−1 + ∅6𝐿𝐼𝑁𝐹𝑡−1 + ∅7𝐿𝑂𝑃𝐸𝑁𝑡−1 + 휀1𝑡 (5) equation 5 presents the intertemporal dynamic model, which estimates the relationship between gdp and its lagged value, and the contemporaneous and lagged values of the regressor. the bounds test for cointegration was carried out by testing the null hypothesis of no cointegration (h0) against the alternative hypothesis (h1) using the following equations: h0: ∅1 = ∅2 = ∅3 = ∅4 = ∅5 = ∅6 = ∅7 = 0, and h1: ∅1 ≠ ∅2 ≠ ∅3 ≠ ∅4 ≠ ∅5 ≠ ∅6 ≠ ∅7 ≠ 0 the computed f-statistic (wald test) was used to test the combined significance of the parameters and its value compared with the lower and upper critical bounds values. the f-statistic has to be significantly higher than the upper critical bound for the null hypothesis of no cointegration to be rejected. 𝐿𝐺𝐷𝑃𝑡 = ∅0 + ∅1𝐿𝐺𝑋𝑡 + ∅2𝐶𝑂𝑅𝑡 + ∅3𝐿𝐺𝑋 ∗ 𝐶𝑂𝑅𝑡 + ∅4𝐿𝐺𝐹𝐶𝑡 + ∅5𝐿𝐼𝑁𝐹𝑡 + ∅6𝐿𝑂𝑃𝐸𝑁𝑡 + 휀1𝑡 (6) and ∆𝐿𝐺𝐷𝑃𝑡 = 𝛼0 + ∑ 𝛼1𝑖 ∆𝐿𝐺𝐷𝑃𝑡−𝑖 +𝑛 𝑖=1 ∑ 𝛼2𝑖∆𝐿𝐺𝑋𝑡−𝑖 𝑛 𝑖=0 + ∑ 𝛼3𝑖𝑛 𝑖=0 ∆𝐶𝑂𝑅𝑡−𝑖 + ∑ 𝛼4𝑖𝑛 𝑖=0 ∆𝐿𝐺𝑋 ∗ 𝐶𝑂𝑅𝑡−𝑖 + ∑ 𝛼5𝑖∆𝐿𝐺𝐹𝐶 + ∑ 𝛼6𝑖𝑛 𝑖=0 𝑛 𝑖=0 ∆𝐿𝐼𝑁𝐹𝑡−𝑖 + ∑ 𝛼7𝑖∆𝑛 𝑖=0 𝐿𝑂𝑃𝐸𝑁𝑡 + 𝜋1𝐸𝐶𝑇𝑡−1 + 휀𝑡 (7) equations 6 and 7 argue for long-run and short-run relationships among the variables, respectively. the error correction term lagged by one period (𝐸𝐶𝑇𝑡−1) measures the speed of adjustment required to restore any deviation/shock from the long-run equilibrium through its coefficient (𝜋1) that is assumed to be less than one and significant. 2 the transparency international corruption perception index data is only available from 1996, following akanbi (2012). a five-year moving average was used to generate the missing data for the period from 1990 to 1995. asian journal of economics and empirical research, 2023, 10(1): 1-10 5 © 2023 by the authors; licensee asian online journal publishing group 3.5. diagnostic and stability tests in order to validate the estimated regression results, the study carried out serial correlation, heteroscedasticity and normality diagnostic tests on the error terms. breusch–godfrey serial correlation and lagrange multiplier tests were used to check if the residuals are serially correlated. the breusch–pagan–godfrey heteroscedasticity test was used to check if the residuals are homoscedastic or otherwise, and finally, the jarque–bera test was used to test if the residuals are normally distributed. the stability of the estimated model parameters is paramount for policy prescription; the study therefore used the cumulative sum of recursive residuals (cusum) and the cumulative sum of squares of the recursive residuals (cusumsq) to confirm the stability status of the model parameters. if the plots of either the cusum or the cusumsq break at the 5% lower or upper bound, then the parameters and the model are unstable (greene, 2003). 3.6. alternative estimation techniques the fully modified ordinary least squares (fmols) of hansen and phillips (1990) and the dynamic ordinary least squares (dols) of saikkonen (1992) and stock and watson (1993) were utilized to check the robustness and consistency of the estimated ardl results. these techniques are effective in resolving problems of endogeneity, serial correlation and small sample bias (abu & gamal, 2020; abu, 2019). the fmols procedure starts with the ols estimation and then makes a non-parametric correction for any endogeneity and serial correlation which might emanate from the ols residuals (abu & gamal, 2020), and it was implemented with the long-run covariance estimate (bartlett’s kernel, newey–west fixed bandwidth). the dols approach regresses one of i(1) variables on other i(1) variables and the i(0) variables, as well as the lags and leads of the first differences of the i(1) variables. 4. results and discussion 4.1. preliminary data exploration to understand the data, a summary of the statistics of the variables is presented in table 2. the evidence indicates that the means and medians of all the series are slightly different, with the exception of the corruption perception index and the interaction term, which suggests that these variables are nearly symmetrical. in addition, the jarque–bera probability values across all the series indicate that the variables are normally distributed, so the alternative hypothesis of non-normality cannot be accepted. generally, there is low variation in all the variables based on their respective standard deviations. however, comparatively, the corruption perception index has the highest volatility with a standard deviation value of 6.00, followed by the logarithms of gdp (1.75) and government expenditure (1.52). table 2. descriptive statistics of the variables. variable/statistic lgdp lgx cor lgx*cor lgfc linf lopen mean 9.70 7.20 21.1 155 3.24 3.58 4.51 median 10.0 7.56 24.0 143 3.26 3.61 4.50 maximum 11.9 9.23 28.0 242 3.97 3.98 4.63 minimum 6.20 4.09 6.90 40.2 2.65 3.03 4.37 std. dev. 1.75 1.52 6.00 64.6 0.42 0.24 0.06 jarque–bera (statistic) 2.35 (0.31) 2.57 (0.28) 3.08 (0.21) 2.86 (0.24) 2.37 (0.31) 1.46 (0.48) 0.14 (0.93) observations 31 31 31 31 31 31 31 notes: figures in ( ) are the probability values. gdp = gross capital formation, gx = government total expenditure, cor = corruption, gfc = gross fixed capital formation, inf = inflation, open = trade openness, and l = natural logarithm of the variable. also, * shows the interaction between government expenditure and corruption. the results of the correlation analysis reported in table 3 indicate a strong positive association between the logarithm of gdp, the logarithm of government expenditure (0.99) and the interaction term (0.85), but a moderately positive correlation with the corruption perception index (0.45) and a weak association between the logarithms of gdp and openness (0.03). in addition, there is a strong negative association between the logarithms of gdp and gross fixed capital formation (-0.93) as well as a weak negative correlation between the logarithms of gdp and inflation. moreover, the interaction term has a strong positive relationship with the logarithms of total government expenditure (0.83) and corruption (0.85) and a strong negative association between the logarithm of gross fixed capital formation (-0.848). finally, the logarithms of government expenditure and gross fixed capital formation are strongly negatively associated (-0.91). table 3. correlation analysis. variable lgdp lgx cor lgx*cor lgfc linf lopen lgdp 1.00 lgx 0.99 1.00 cor 0.45 0.42 1.00 lgx*cor 0.85 0.83 0.85 1.00 lgfc -0.93 -0.91 -0.52 -0.85 1.00 linf -0.20 -0.16 -0.37 -0.35 0.22 1.00 lopen 0.03 0.05 -0.30 -0.19 0.02 0.14 1.00 note: gdp = gross capital formation, gx = government total expenditure, cor = corruption, gfc = gross fixed capital formation, inf = inflation, open = trade openness, and l = natural logarithm of the variable. also, * shows the interaction between government expenditure and corruption. 4.2. stationarity and bounds tests for cointegration table 4 reports the outcomes of stationarity tests. overall, evidence from the adf/pp test statistics unanimously suggest that all the series have a unit root, apart from the log of gross fixed capital formation. this means that the series are a combination of i(0) and i(1); the latter can be made stationary after first differencing. these results further justify the use of the ardl bounds test for cointegration. asian journal of economics and empirical research, 2023, 10(1): 1-10 6 © 2023 by the authors; licensee asian online journal publishing group table 4. stationarity test results. series adf test statistics pp test statistics level first difference level first difference remark lgdp 1.29 -2.42* 1.54 -2.36* i(1) lgx 1.22 -2.10* 3.64 -4.83* i(1) cor -0.57 -6.22* -0.55 -6.20* i(1) lgx*cor 0.58 -6.47* 0.90 -6.46* i(1) lgfc -1.71** -4.60* -1.89** -4.58* i(0) linf -0.89 -7.68* -0.37 -15.32* i(1) lopen -0.23 -6.31* -0.23 -6.31* i(1) note: * and ** indicate significance at the 5% and 10% levels, respectively. gdp = gross capital formation, gx = government total expenditure, cor = corruption, gfc = gross fixed capital formation, inf = inflation, open = trade openness, and l = natural logarithm of the variable. table 5 presents the results from the bounds test for cointegration. the f-statistic value of (4.82) is higher than the upper critical values at the 5% and 1% levels, respectively. thus, the evidence confirms the existence of a long-run equilibrium relationship between the logarithms of gdp and government expenditure together with the other control variables. table 5. bounds test for cointegration results. (5%) critical values explained variables i(0) i(1) f-statistic outcome f(lgdp, lgx, cor, lgx*cor, lgfc, linf, lopen) 2.87 4.00 4.82* cointegration note: * signifies the existence of cointegration at the 5% level of significance. gdp = gross capital formation, gx = government total expenditure, cor = corruption, gfc = gross fixed capital formation, inf = inflation, open = trade openness, and l = natural logarithm of the variable. 4.3. results of long-term and short-term ardl coefficient estimates the results of the selected ardl model are reported in table 6. the selected optimum lag length was based on the akaike information criterion (aic: 1,0,0,0,01,0). evidence indicates that government expenditure is positively and significantly related to nigeria’s long-term economic growth, but not its short-term growth. specifically, a 1% rise in government expenditure leads to increases of around 1.06% and 0.02% in gdp in the long run and the short run, respectively. however, these effects are statistically significant at 5% in the long run but insignificant in the short run. in addition, when government expenditure is lagged by one period, its effect on growth returns to negative and is statistically significant in the short run. our evidence aligns with the bidirectional causality thesis running from government expenditure to growth and reenforces the earlier empirical evidence reported by joshua (2019); babatunde (2018); arpaia and turrini (2008); gitana, agnė, and aušra (2018); ram (1986); bose, haque, and osborn (2007); and ghose and das (2013). the level of corruption, proxied by the transparency international corruption perception index, has a significant inverse relationship with economic growth in nigeria. an increase of 100 basis points in the corruption index (a decrease in corruption level) will raise economic growth by 0.20% in the long run and 0.05% in the short run at the 1% level. this finding supports the hypothesis that corruption is “sand in the wheels” in nigeria and corroborates existing empirical evidence in nigeria and beyond (blackburn, bose, & haque, 2006; blackburn et al., 2010; mauro, 1995; ngutsav, 2018; nur-tegin & jakee, 2020; ovat & bassey, 2014). the interactive term is negative and statistically significant at the 5% level. the coefficient reveals that simultaneous increases in the corruption perception index (i.e., a decrease in corruption level) and government expenditure will reduce the growth rate of the economy by about 0.03% in the long run and 0.01% in the short run. surprisingly, this contradicts the evidence on the direct effect of corruption on growth reported above and supports the “corruption greases the wheel” hypothesis. overall, the evidence suggests that corruption is directly “sand in the wheels of commerce” and indirectly “greases the wheels of commerce” through government expenditure in nigeria. a similar argument, that corruption helps entrepreneurs to overcome bureaucratic inefficiency and facilitates innovation and growth, received support from kato and sato (2015); méon and weill (2010); and egger and winner (2005). the rests of the results show that inflation, measured by the gdp deflator, shows a significant positive link with economic growth. a 1% increase in the rate of inflation raises the rate of economic growth by about 0.70% in the long run and 0.46% in the short run at the 5% level. the significant short-run positive effect of inflation on growth persists even when the rate of inflation is lagged by one period. gross fixed capital formation shows an insignificant negative relation with economic growth in the long run. the negative effect, however, appears to be statistically significant in the short term. openness seems to be insignificant in explaining long-term and shortterm economic growth over the sample period. the error correction term lagged by one period (ect-1) is negative and statistically significant; it shows that about 0.56% of the deviation from the long-run equilibrium is corrected over a period of one year. the r2 value suggests that a 0.91% variation in the dependent variables is explained by the explanatory variables. the durbin–watson (dw) value of 2.00 is preliminary evidence that the error term is free of serial correlation. thus far, our results provide evidence that government expenditure and its interaction with the corruption perception index have significant increasing effects on gdp growth. nonetheless, we proceed to calculate the marginal effect in order to ascertain the threshold level at which reduction in corruption will decrease the gdp growth rate. using the calculated long-run parameters of government expenditure and the interaction term, the marginal effects can be computed as follows: 𝜕𝐿𝐺𝐷𝑃 𝜕𝐿𝐺𝑋 =1.056 0.0250𝐶𝑂𝑅𝑡 (8) asian journal of economics and empirical research, 2023, 10(1): 1-10 7 © 2023 by the authors; licensee asian online journal publishing group table 6. ardl model estimates. short-term parameters (the explained variable is ∆lgdp) long-term parameters (the explained variable is lgdp) regressor coefficient [standard errors] p-value regressor coefficient [standard errors] p-value ∆lgx 0.02 [0.06] 0.71 lgx 1.06* [0.18] 0.00 ∆lgx-1 -0.23* [0.07] 0.01 cor 0.20* [0.03] 0.00 ∆cor 0.05* [0.01] 0.00 lgx*cor -0.03* [0.01] 0.00 ∆lgx*cor -0.01** [0.00] 0.05 lgfc -0.12 [0.13] 0.37 ∆lgfc -0.20* [0.06] 0.00 linf 0.70* [0.24] 0.01 ∆linf 0.46* [0.10] 0.00 lopen -0.10 [0.13] 0.45 ∆linf-1 0.89* [0.16] 0.00 ∆lopen 0.03 [0.03] 0.36 ect-1 -0.56* [0.08] 0.00 r2 0.91 dw 2.00 note: gdp = gross capital formation, gx = government total expenditure, cor = corruption, gfc = gross fixed capital formation, inf = inflation, open = trade openness, and l = natural logarithm of the variable. dw = durbin–watson. * and ** indicate that the coefficient is significant at the 5% and 10% levels, respectively; l denotes the logarithms; and ∆ denotes first differences. the marginal effects estimated at the zero, minimum, mean and maximum levels of corruption with respect to the growth rate of gdp are 1.056, 0.8835, 0.528875, and 0.356, respectively. this suggests that an increase in the corruption perception index (i.e., a decrease in corruption) has a growth-decreasing effect through government expenditure; the more stringent the measure in reducing corruption, the higher the growth-reducing effect. moreover, the threshold level of the corruption perception index to the growth rate of gdp is calculated at about 42.25; below this level, the marginal effect of government expenditure on the gdp growth rate is positive, but at this threshold level and beyond, the marginal effect turns negative. the implication of this threshold is that, at the current level of development (i.e., current institutional setting), an element of corruption is needed to overcome obstacles resulting from weak institutions and inefficient bureaucrats. thus, the hypothesis that “corruption greases the wheels of commerce” can be confirmed in this instance. 4.4. results of diagnostic tests and stability tests table 7 presents the results of the diagnostic tests. in the breusch–godfrey serial correlation lm test, the fstatistic and corresponding p-value (0.78 [0.48]) indicate that the null hypothesis of no serial correlation is accepted, and we can conclude that the model is free from serial correlation. the breusch–pagan–godfrey heteroscedasticity test f-statistic and the corresponding p-value of (1.30 [0.32]) suggest that the model is homoscedastic. also, the jarque–bera normality test f-statistic and corresponding p-value (1.38 [0.50]) confirm that the model’s error term is normally distributed. table 7. post-estimation diagnostic tests. test statistic estimate serial correlation: f(2,12) 0.78 [0.48] normality: jarque–bera 1.38 [0.50] heteroscedasticity: f[15;13] 1.30 [0.32] the stability of the model is attested by the plots in figure 1. the plots of the sum of the recursive residuals test (cusum) and the sum of the recursive squared residuals test (cusum of squares) lie within the boundaries at the 5% level. figure 1. plots of cusum and cusum of squares. 4.5. results of alternatives cointegration estimation techniques: fmols and dols table 8 presents the estimates from the fully modified ordinary least squares (fmols) and dynamic ordinary least squares (dols). the long-run increasing effect of government expenditure on growth is consistent across the fmols estimated results. a 1% rise in government expenditure will increase the gdp growth rate by 0.80% and 1.48% in long-run for the fmols and dols models at the 1% level, respectively. similarly, an increase of 100 asian journal of economics and empirical research, 2023, 10(1): 1-10 8 © 2023 by the authors; licensee asian online journal publishing group basis points in the corruption perception index (i.e., a decrease in corruption level) will raise the growth of gdp by 0.04% and 0.03% in the long-run in the fmols and dols models at the 5% level, respectively. furthermore, the coefficient of the interactive term confirms the negative and significant ardl results, implying that simultaneous increases in government expenditure and the corruption perception index (i.e., a decrease in corruption) will reduce the growth rate of gdp. interestingly, the logarithms of gross fixed capital formation, inflation and openness are in line with our a priori expectation and are statistically significant. a 1% increase in capital formation will increase the growth rate of gdp by 0.31% and 0.38% in the fmols and dols models, respectively. also, a rise in the rate of inflation by 1% will accelerate the growth rate of gdp by 0.65% and 0.40% in the fmols and dols models, respectively. finally, opening up the economy by 1% will raise the gdp growth rate by 0.22% and 0.54% in the fmols and dols models, respectively. table 8. fmols and dols estimations. fmols: d.v. = lgdp dols: d.v. = lgdp regressor coefficient [standard error] p-value coefficient [standard error] p-value lgx 0.80*[0.09] 0.00 1.48* [0.08] 0.00 cor 0.04* [0.00] 0.00 0.03* [0.002] 0.00 lgx*cor -0.05** [0.03] 0.05 -0.07* [0.01] 0.00 lgfc 0.31* [0.06] 0.00 0.38* [0.04] 0.00 linf 0.65* [0.10] 0.00 0.40* [0.09] 0.01 lopen 0.22* [0.07] 0.00 0.54* [0.08] 0.00 note: * and ** denote significance at 5% and 10%, respectively; l denotes logarithms; d.v. = dependent variable gdp = gross capital formation, gx = government total expenditure, cor = corruption, gfc = gross fixed capital formation, inf = inflation, open = trade openness, and l = natural logarithm of the variable. 5. conclusion and recommendations this study examined the interactive effect of corruption on the government expenditure–growth nexus in nigeria over the 1990–2020 period. the objective was to investigate how the level of corruption proxied by the transparency international corruption perception index influences the relationship between government expenditure and growth. the analysis was carried out using the ardl, fmols and dols estimation techniques. our primary finding is that, directly, government expenditure and control of corruption are enhance growth in both the long-run and short-run, implying that corruption is “sand in the wheels of commerce” in nigeria. but the results from the interactive term indicate that corruption indirectly “greases the wheels of commerce” below the 4.25 threshold level in the nigerian growth processes through government expenditure. the plausible explanation is that certain elements of corruption are helpful in overcoming inefficiency resulting from weak institutions and bureaucratic bottlenecks. references abu-bader, s., & abu-qarn, a. s. 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(2017). world development report 2017: governance and the law: main report (english). world development report washington, d.c. : world bank group. retrieved from: http://documents.worldbank.org/curated/en/774441485783404216/main-report. the asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc., caused in relation to/arising from the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.9734/bjemt/2014/10531 https://doi.org/10.1002/jae.616 https://doi.org/10.1093/biomet/75.2.335 https://doi.org/10.1017/s0266466600010720 https://doi.org/10.2307/2951763 http://documents.worldbank.org/curated/en/774441485783404216/main-report 33 © 2025 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 12, no. 1, 33-39, 2025 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v12i1.6823 © 2025 by the authors; licensee asian online journal publishing group ardl approach: the determinants of government size in malaysia kuang yong ng1 shamzaeffa samsudin2 zalina zainal3 haitian wei4 ( corresponding author) 1,3,4school of economics, finance and banking, universiti utara malaysia, 06010 sintok, kedah, malaysia. 1email: kuang_yong95@hotmail.com 3email: z.zalina@uum.edu.my 4email: q18775303538@outlook.com 2economic and financial policy institute, school of economics, finance and banking, universiti utara malaysia, 06010 sintok, kedah, malaysia. 2email: shamzaeffa@uum.edu.my abstract the government size is determined through the ratio between the government expenditure which including the operation and development with the gross domestic product (gdp). this study with the intention to examine the long-run relationship between the determinants with the government size of malaysia during the periods of year 1980 to year 2018. the determinants including the trade openness, country size, foreign direct investment openness, portfolio investment openness and the economic growth. the annual data are achieved from the world bank and the department statistic of malaysia (dosm). moreover, we adopted the autoregressive distributed lag (ardl) model, which proposed by pesaran et al. (2001), to examine the long-run relationship. the result revealed that there are long-run negative relationship significantly between the determinants including the trade openness, country size, foreign direct investment openness and portfolio investment openness with the government size. on the other hands, the economic growth has a significant positive long-run relationship with the government size in malaysia. both trade openness and economic growth variables have the granger causality effects towards the government size variable. therefore, it is essential for the government to maintain a balanced allocation of both operating and development expenditures, taking into account key influencing factors, to support sustainable long-term economic growth in malaysia. keywords: ardl, country size, economic growth, foreign direct investment openness, government size, malaysia, portfolio investment openness, trade openness. jel classification: c32; h11; h50; o47. citation |ng, k. y., samsudin, s., zainal, z., & wei, h. (2025). ardl approach: the determinants of government size in malaysia. asian journal of economics and empirical research, 12(1), 33–39. 10.20448/ajeer.v12i1.6823 history: received: 10 april 2025 revised: 19 may 2025 accepted: 30 may 2025 published: 25 june 2025 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. competing interests: the authors declare that they have no competing interests. authors’ contributions: all authors contributed equally to the conception and design of the study. all authors have read and agreed to the published version of the manuscript. contents 1. introduction ...................................................................................................................................................................................... 34 2. literature review ............................................................................................................................................................................ 35 3. research methodology ................................................................................................................................................................... 35 4. result .................................................................................................................................................................................................. 36 5. conclusion ......................................................................................................................................................................................... 39 references .............................................................................................................................................................................................. 39 mailto:kuang_yong95@hotmail.com mailto:z.zalina@uum.edu.my mailto:q18775303538@outlook.com mailto:shamzaeffa@uum.edu.my https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v12i1.6823 https://orcid.org/0000-0002-7280-5954 https://orcid.org/0000-0001-6222-2328 https://orcid.org/0000-0002-5080-7895 https://orcid.org/0000-0001-8818-4817 asian journal of economics and empirical research, 2025, 12(1): 33-39 34 © 2025 by the authors; licensee asian online journal publishing group contribution of this paper to the literature: this study gives a valuable insights regarding the determinants of government size of malaysia, and it may serve as input for individuals (malaysians) or policymakers in understanding which indicators give impact on the government size. 1. introduction in general, “government” can be interpreted as a group of people who has the authority to officially control a country. in other words, the term “government” can be referred as a set of institutions and concerns a body of actors, which defines how and to what extent the public affairs within society are shaped and directed (keman, 2010). it is an undeniable fact that government plays a major role in the development of a country in all aspects, ranging from social, economics to politics. for example, the roles of government include utilizing the domestic resources efficiently, maintaining law and order by having an effective administrative system as well as stabilizing the economy. from an economic perspective, government intervention takes several forms. one primary role is the direct production of goods and services for the public, including national defence, infrastructure, and education. additionally, the government facilitates income redistribution—both horizontally among groups with similar income levels and vertically across different income strata. in essence, government spending contributes to enhancing a country's economic efficiency, particularly in the presence of market failures or externalities. furthermore, government regulations influence economic activity, and although their effects are often difficult to quantify in terms of costs and benefits, they remain significant. these regulations can sometimes function as substitutes for taxation or public spending. while economics provides valuable tools for assessing the relative merits of government intervention in specific sectors, it does not offer a definitive answer to the broader question of how much government involvement is too much or too little (labonte, 2010). the most commonly used indicators of government size in researches are the government expenditure measures derived from national accounts, in which at the same time it is used to stimulate the economic growth and social welfare of a country. in other words, the malaysian government expenditure can be rephrased as the amount spent by malaysian government using the revenue collected from the country’s residents based on its planning and budget in an annual manner. the malaysian government expenditure can be classified into two major categories, which are the operating expenditure and development expenditure respectively as shown in table 1. table 1. federal government operating expenditure by object, 2015-2018. components total expenditure (rm million) 2015 2016 2017 2018 emoluments 70,050 73,108 78,801 79,149 retirement charges 18,872 21,029 23,648 24,550 debt service charges 24,283 26,480 28,866 30,882 grants and transfers to state governments 6,921 6,942 8,058 8,023 supplies and services 36,373 30,070 32,642 33,621 subsidies and social assistance 27,269 24,690 23,085 26,544 asset acquisition n/a 676 698 577 refunds and write-offs 947 799 802 888 grants to statutory bodies 15,487 13,557 13,449 13,099 others 16,796 12,822 9,861 16,917 total 216,998 210,173 219,910 234,250 share of gdp (%) 18.8 17.1 16.4 16.2 source: ministry of finance malaysia (2018). table 2. federal government development expenditure by sector, 2015-2018. components total expenditure (rm million) 2015 2016 2017 2018 economic of which: 23,286 25,113 25,897 26,342 agriculture and rural development 3,105 2,902 2,416 2,523 trade and industry 5,638 4,841 4,830 4,149 transport 6,693 7,827 10,749 10,479 public utilities and energy 3,637 2,927 2,514 2,746 environment n/a 2,346 2,197 2,013 social of which 11,161 10,429 12,119 11,720 education and training 4,758 3,727 5,904 5,256 health 1,442 1,495 1,532 1,910 housing 2,008 2,238 870 1,167 security 4,754 4,832 5,286 5,214 general administration 1,567 1,621 2,660 2,724 total 40,768 41,995 45,962 46,000 share of gdp (%) 3.5 3.4 3.4 3.2 source: ministry of finance malaysia (2018). one of the key challenges faced by malaysia is its reliance on debt to finance development expenditure. according to yeap (2017), this has been a persistent issue, as 97.7 sen of every ringgit the government expects to earn is allocated to operational expenses, leaving only a small fraction for development. as a result, approximately 88% of the subsequent year’s development spending must be financed through borrowings. due to continuous budget deficits since 1998, malaysia’s debt service charges were projected to reach rm 30.88 billion in 2018, meaning nearly 13 sen of every ringgit in revenue would be used solely for debt repayment. although there is a clear need for increased investment in economic and social development, the government faces limitations on how asian journal of economics and empirical research, 2025, 12(1): 33-39 35 © 2025 by the authors; licensee asian online journal publishing group much it can borrow to fund these initiatives. this constraint has hindered the growth of development spending. therefore, this research aims to identify the long-term determinants that influence government expenditure in malaysia. hence, the objective of this paper is to examine the long run relationship between the determinants with the government size in malaysia by utilizing the autoregressive distributed lag (ardl) model. 2. literature review developed by john maynard keynes during the 1930s, the keynesian economics can be referred as an economic theory of total country spending and its effects on both output and inflation (chappelow, 2019). in an attempt to understand the great depression, he has also suggested that the increase in government expenditure in conjunction with the lowering in taxes may help in stimulating demand and pulling the global economy out of depression. in conjunction with the government size which is commonly measured by using the government expenditure as a share of gdp, there are many previous studies that have been carried out with the aim to examine the factors affecting the government size and the researches have prioritized the demand or supply sides. hence, taking into account the keynesian theory and other non-budgetary measures of the government size, this study has put a huge emphasis on the demand size, which focuses more on the relationships between variables such as trade openness, population, capital openness and economic growth. analysts have defined “government size” as the ratio of government expenditures to the total output of an economy, where the total output refers to the gross domestic product (gdp) (berry & lowery, 1984). to elaborate, the government expenditure reflects the involvement of public sector in the society, where its share of the total gdp acts as a proxy which represents the governmental activities scale relative to those of the private sector (congleton, 2001; de witte & moesen, 2010). trade, where imports and exports are the major categories of it, is vital to a country’s economy and therefore can be considered as one of the factors that may cause effects on the government size in malaysia. the term “trade openness” can be defined as the ratio of the sum of exports and imports to the gross domestic product of a country. the relationship between trade openness and government size was firstly introduced by cameron (1978) where there is an argument stating that trade openness increases an economy’s international economy and its associated risks which may lead to a larger government expenditure in order to compensate for the external risk. rodrik (1998) has further reintroduced the study and has proposed the compensation hypothesis, where government expenditure plays a risk-reducing role in open economies. however, based on the previous studies done by liberati (2007) as well as benarroch and pandey (2012) the validity of the compensation hypothesis has been rejected which is also supported by katumba (2013) who has found that there was a negative and significant relationship between trade openness and government size. hence, an assumption of the negative long run association between the trade openness variable and government size variable has been made in this study. country size emerges from the trade-off between the economies of scale in public good supplies of large countries, including the cultural and ethnic heterogeneity costs, which may lead to the increase in country sizes given the assumption that the costs of partially or completely non-rival public goods can be shared over large populations that may lower the per capita expenditure on the goods, which means that the government share in gdp will be lower (alesina & spolaore, 1997). for instance, as the country size increases which also represents that the population of the country increases, it is an undeniable fact that the number of taxpayers in the country will also rise as well. this will in return lead to the decline in the per capita costs of the public goods such as monetary and financial system, public health, police and juridical system and national parks. in this case, the government expenditure to gdp ratio will decrease with gdp, which states that smaller countries tend to have larger governments and vice versa (alesina, 2003; alesina & wacziarg, 1998). therefore, this study assumes that there will be a long run association between the country size and government size variables in malaysia. economists have been questioning whether the capital openness may play an autonomous role in shaping government size and may cause an effect on the validity of the compensation hypothesis. there is an argument that the capital openness would further rise the external economy exposure risk as well as the demand for public expenditure compensations (rodrik, 1998). however, the efficiency hypothesis can be said to occur when the increase in degrees of capital openness may cause higher mobility of tax factors and governments will have a declined ability to maintain greater public sectors. aregbeyen and ibrahim (2014) examined the relationship between trade openness and government size in nigeria using the bounds testing approach to cointegration within an ardl framework. their empirical findings indicated a significant long-run association between trade openness and government size, measured by the share of total government expenditure and recurrent expenditure in gdp. however, when government size was proxied by the share of capital expenditure in gdp, no significant long-run effect on trade openness was observed. these findings were further supported by the empirical results of nwaka and onifade (2015). 3. research methodology this study utilizes annual time series data for malaysia covering a 39-year period from 1980 to 2018. all variable data, except for the country size, were obtained from the world bank (2020). due to limited availability of direct data on portfolio investment openness, this variable was calculated manually by dividing portfolio investment figures by gdp, both sourced from the world bank. meanwhile, data for country size, represented by population, were gathered from the department of statistics malaysia (2020) for the corresponding period. the research model is take account the previous research models which developed by liberati (2007) and sabra (2016) as follows. 𝐺𝑂𝑉𝑆𝐼𝑍𝐸 = 𝛼 + 𝛽1𝑙𝑛𝑇𝑅𝐴𝐷𝐸 + 𝛽2𝑙𝑛𝑃𝑂𝑃 + 𝛽3𝐹𝐷𝐼 + 𝛽4𝑃𝐼 + 𝛽5𝐺𝑅𝑂𝑊𝑇𝐻 + 𝑒 (1) where, govsize = government size. trade = trade openness. pop = population as proxy to the country size. fdi = foreign direct investment openness. asian journal of economics and empirical research, 2025, 12(1): 33-39 36 © 2025 by the authors; licensee asian online journal publishing group pi = portfolio investment openness. growth = economic growth. e = random error. 3.1. empirical methodology 3.1.1. unit root test the unit root is run to verify the stationary of the model. this is very important to ensure that the model is stationary because the data will unstable in the long run and the spurious regressions will be exist. hence, the augmented dickey-fuller (adf) test will be used for this study to test the existence of the ‘unit root’ problem in the model. 3.1.2. autoregressive distributed lag (ardl) bounds test approach to examine the existence of a long-run relationship among the study variables, an autoregressive distributed lag (ardl) model is employed using the bounds testing approach. this method is based on the ordinary least squares (ols) estimation of a conditional unrestricted error correction model (uecm) for cointegration analysis. as demonstrated by banerjee, dolado, galbraith, and hendry (1993), the ardl model allows for the derivation of a dynamic error correction model (ecm) through a simple linear transformation. the ecm effectively incorporates short-run dynamics with the long-run equilibrium relationship, without losing long-run information (chowdhury & shrestha, 2005). the government size equation can thus be expressed using the uecm form of the ardl model as follows: 𝐷(𝐺𝑂𝑉𝑆𝐼𝑍𝐸) = 𝛼 + ∑ 𝛽1 𝑛 𝑖=1 𝐷(𝐺𝑂𝑉𝑆𝐼𝑍𝐸)𝑡−𝑖 + ∑ 𝛽2 𝑛 𝑖=0 𝐷(𝑙𝑛𝑇𝑅𝐴𝐷𝐸)𝑡−𝑖 + ∑ 𝛽3 𝑛 𝑖=1 𝐷(𝑙𝑛𝑃𝑂𝑃)𝑡−𝑖 + ∑ 𝛽4 𝑛 𝑖=0 𝐷(𝐹𝐷𝐼)𝑡−𝑖 + ∑ 𝛽1 𝑛 𝑖=0 𝐷(𝑃𝐼)𝑡−𝑖 + ∑ 𝛽6 𝑛 𝑖=0 𝐷(𝐺𝑅𝑂𝑊𝑇𝐻)𝑡−𝑖 + 𝛽7𝐺𝑂𝑉𝑆𝐼𝑍𝐸𝑡−1 + 𝛽8𝑙𝑛𝑇𝑅𝐴𝐷𝐸𝑡−1 + 𝛽9𝑙𝑛𝑃𝑂𝑃𝑡−1 + 𝛽10𝐹𝐷𝐼𝑡−1 + 𝛽11𝑃𝐼𝑡−1 + 𝛽12𝐺𝑅𝑂𝑊𝑇𝐻𝑡−1 + 𝑒 (2) where, d = the first difference operator. i = the parameters which it explains the short run dynamic coefficients when i = 1-5 while i = 6-10 explain the long run multipliers of the equation. t = trend. e = error term. the ardl model acts as a tool in determining the short run and long run relationships between the series by performing the model estimation through conducting the f test of the hypothesis that all the coefficients of the lagged series are equal to zero, where h0: m0 = m1 = 0 null hypothesis claims that there is no long run relationship, or in other words cointegration, between the series, and vice versa. in this test, the f statistics values will be compared with the lower and upper bounds’ critical values as proposed by pesaran, shin, and smith (2001). based on the theory, if the f statistics value is greater than the upper limit of boundary value, the alternative hypothesis which claims that there is a long-term relationship between the series will be accepted. on the contrary, if the f statistic value is lower than the lower limit of boundary value, the null hypothesis will be accepted. otherwise, if the f statistic value falls in between the lower and upper limits, the results will remain inconclusive. consecutively, an error correction model will be estimated by using the determined optimum lag lengths. the error correction model is constructed as follows: 𝐷(𝐺𝑂𝑉𝑆𝐼𝑍𝐸) = 𝛼 + ∑ 𝛽1 𝑛 𝑖=1 𝐷(𝐺𝑂𝑉𝑆𝐼𝑍𝐸)𝑡−𝑖 + ∑ 𝛽2 𝑛 𝑖=0 𝐷(𝑙𝑛𝑇𝑅𝐴𝐷𝐸)𝑡−𝑖 + ∑ 𝛽3 𝑛 𝑖=1 𝐷(𝑙𝑛𝑃𝑂𝑃)𝑡−𝑖 + ∑ 𝛽4 𝑛 𝑖=0 𝐷(𝐹𝐷𝐼)𝑡−𝑖 + ∑ 𝛽1 𝑛 𝑖=0 𝐷(𝑃𝐼)𝑡−𝑖 + ∑ 𝛽6 𝑛 𝑖=0 𝐷(𝐺𝑅𝑂𝑊𝑇𝐻)𝑡−𝑖 + 𝛽7𝐺𝑂𝑉𝑆𝐼𝑍𝐸𝑡−1 + 𝛽8𝑙𝑛𝑇𝑅𝐴𝐷𝐸𝑡−1 + 𝛽9𝑙𝑛𝑃𝑂𝑃𝑡−1 + 𝛽10𝐹𝐷𝐼𝑡−1 + 𝛽11𝑃𝐼𝑡−1 + 𝛽12𝐺𝑅𝑂𝑊𝑇𝐻𝑡−1 + 𝜑𝐸𝐶𝑀𝑡−1 + 𝑒 (3) where, ecm = error correction term. φ = the adjustment speed at which the model turns back to long-term model. 3.1.3. granger causality there is a causal effect occur between the variable. the null hypothesis is formed which the govsize, trade, pop, fdi, pi and growth do not granger cause to each other (granger, 1988). the null hypothesis will be rejected when the p-value is larger than 0.05. if the null hypothesis is rejected due to the significant of the p-value, the variables will have the granger cause between each other. table 3. the results of augmented dickey-fuller test. variables level first difference govsize -1.9246 -6.2781*** lntrade -3.9721** -6.0147*** lnpop 1.6247 -5.3413*** fdi -2.9209 -6.6587*** pi -3.9889** -5.0086*** growth -5.1449** -7.5949*** note: (***) and (**), show the significance level at 1% and 5%. 4. result 4.1. unit root test from the table 3, the unit root test in the intercept form either the data of the level or the first difference is examined. the results show that the govsize, lntrade, lnpop, fdi, pi and growth are significant at the 1% level for the first difference. hence, the study will take the data in the first difference. asian journal of economics and empirical research, 2025, 12(1): 33-39 37 © 2025 by the authors; licensee asian online journal publishing group 4.2. autoregressive distribution lag (ardl) bounds test the ardl boundary test approach can be applied to test the existence of cointegration between the series since the series are not integrated at two or more level. the schwarz bayesian criteria (sbc) is being taken into consideration to identify the most suitable ardl model as pesaran and smith (1998) have discovered the fact that sbc is more preferable to akaike information criterion (aic) because it is a parsimonious model that selects the smallest possible lag length, whereas aic selects the maximum relevant lag length. therefore, according to the results obtained from figure 1 as illustrated below, the optimal model for ardl is (3,4,4,4,2) among the top 20 models with the lowest sbc value. hence, the ardl (3,4,4,4,2) model has been chosen. figure 1. model selection based on schwarz bayesian criteria (top 20 models). table 4. model selection (3,4,4,4,4,2) by using ardf method. selected model: ardl (3,4,4,4,4,2) r-squared 0.9862 adjusted r-squared 0.9412 f-statistic 21.9371 prob (f-statistic) 0.0001 table 4 stated to support the model selection (3,4,4,4,4,2). both r-squared and adjusted r-squared values obtained from the model have exceeded 90%, which means that the goodness of fit of the dependent and independent variables in this study are relatively high. in addition, the f-statistical probability of less than 5% indicates that this model is significant. hence, this model has been selected due to its suitability for this study. 4.3. ardl long run form and bounds test table 5 portrayed the ardl long run form and bounds test of the model, where the levels equation of the model has been formed, given the case that there are an unrestricted constant and no trend. according to the results obtained, the probabilities of the variables are significant and therefore it can be said that there are long run cointegration associations between the dependent variable and the independent variables. hence, the null research hypothesis can be rejected, and the research objectives have been achieved. furthermore, the coefficients of the independent variables have played a part in determining the direction of relationship with the dependent variable of the study as well. in this case, all the variables except the economic growth variable share negative relationships with the government size variable in the long run. in short, the relationships between all variables which are trade openness, country size, foreign direct investment openness, portfolio investment openness as well as economic growth variables and government size variable have been proven to be consistent with the results obtained from the previous studies. in other words, if interpreting the numerical values of coefficients, a 1% increase in the government size variable will lead to approximately 17.16%, 3.28%, 0.34% and 47.60% declines in the variables of trade openness, country size, foreign direct investment openness as well as portfolio investment openness respectively. on the other hand, around 0.19% increase in the economic growth will be incurred in conjunction with a 1% increase in the government size. to conclude, all independent variables involved in the study possess either positive or negative long run relationships with the dependent variable. asian journal of economics and empirical research, 2025, 12(1): 33-39 38 © 2025 by the authors; licensee asian online journal publishing group table 5. ardl long run form and bounds test. level equation (unrestricted constant and no trend) variable coefficient std. error t-statistic prob. lntrade -17.1563 2.3310 -7.3602 0.0001 lnpop -3.2800 0.4769 -6.8780 0.0001 fdi -0.3411 0.0642 -5.3152 0.0007 pi -47.6011 10.4168 -4.5696 0.0018 growth 0.1875 0.0363 5.1591 0.0009 null hypothesis: no level relationship test statistic value sig. i (0) i(1) asymptotic: n=100 f-statistic 11.0186 10% 2.26 3.35 k 5 5% 2.62 3.79 2.5% 2.96 4.18 1% 3.41 4.68 actual sample size 35 finite sample: n=35 10% 2.508 3.763 5% 3.037 4.443 1% 4.257 6.04 t-bounds test null hypothesis: no level relationship test statistic value sig. i(0) i(1) t-statistic -6.9775 10% -2.57 -3.86 5% -2.86 -4.19 2.5% -3.13 -4.46 1% -3.43 -4.79 the model is further tested with f-bounds test and t-bounds test to indicate if the null hypothesis of absence of levels relationship will be accepted or rejected for this study. based on the same table, the f-statistic value and tstatistic value obtained from both tests are greater than the lower bound i(0) and upper bound i(1) probabilities, which has strongly rejected the null hypothesis at all significance levels from 1% to 10%. hence, it can be concluded that the variables of this model possess levels relationship in the long run as the results are significant. 4.4. ardl error correction regression from table 6, the ardl error correction regression has shown a negative coefficient for the lagged one cointegration equation. this means that the model is statistically stable and there is an absence of serial correlation. moreover, the zero per cent probability has proven that the lagged equation is significant for the long run model. therefore, the selected model can be said to be favourable for the study. table 6. ardl error correction regression. variable coefficient std. error t-statistic prob. cointeq(-1) -1.3712 0.1323 -10.3649 0.0000 table 7. adjusted error correction model using (3,4,4,4,4,2) approach. dependent variables: d(govsize) variable coefficient t-statistic prob. d(govsize(-3)) -0.4152 -3.1691 0.0157 d(lntrade(-3)) 0.8609 3.9072 0.0058 d(lnpop(-4)) -94.7118 -2.9511 0.0214 d(fdi(-4)) -0.3865 -5.1390 0.0013 d(pt(-4)) -13.2269 -2.7459 0.0287 d(growth(-2)) 0.1025 3.2782 0.0135 ect(-1) -5.2259 -2.7277 0.0294 4.5. adjusted error correction model using (3,4,4,4,4,2) approach table 7 displays the short-run results in the model. after adjusting the lagged variables, the error correction coefficient as shown in table 7 remains negative, but the probability has become statistically significant with the value of 0.029 at five per cent level. this not only has ensured that the adjustment process of the model from the short-run deviation is relatively fast, but also indicates that there is a long run causality between the variables. to be more precise, it indicates a 522.59 per cent of the disequilibrium in the government size from the previous period shock will be converged back to the long-run equilibrium in the current period. in other words, the speed of adjustment towards long run equilibrium is at 522.59 per cent. the estimated coefficients of all variables are statistically significant at five per cent level in the short run. however, the trade openness variable has shown an opposite sign in relation to the government size if compared with the association of both variables in the long run. in other words, the trade openness is positively related with the government size. otherwise, the other independent variables share the same direction of relationship with the government size in both short run and long run. besides, even though the trade openness variable has an optimal lag length of four in the long run, the short run analysis results show that the variable is more significant with the lag length of three. hence, the trade openness variable is analysed by taking the third lag length values into consideration. asian journal of economics and empirical research, 2025, 12(1): 33-39 39 © 2025 by the authors; licensee asian online journal publishing group table 8. granger causality result. null hypothesis obs. f-statistic prob. lntrade does not granger cause govsize 36 6.6637 0.0015 govsize does not granger cause lntrade 2.2367 0.1051 lnpop does not granger cause govsize 36 0.2409 0.8671 govsize does not granger cause lnpop 1.1102 0.3609 fdi does not granger cause govsize 36 0.9870 0.4126 govsize does not granger cause fdi 0.4377 0.7277 pi does not granger cause govsize 36 0.2059 0.8915 govsize does not granger cause pi 0.5131 0.6765 govsize does not granger cause growth 36 4.1284 0.0149 growth does not granger cause govsize 0.5574 0.6474 4.6. granger causality based on the table 8, it is observable that there are significant causal relationships between the independent variables, knowingly the trade openness as well as economic growth and the dependent variable, government size. both trade openness and economic growth variables have the granger causality effects towards the government size variable, while the other independent variables such as country size, foreign direct investment openness and portfolio investment openness do not granger cause the government size variable. hence, in conjunction with the existence of granger causality effects of trade openness and economic growth towards the government size, thus these two variables can be taken into consideration when making future predictions. 5. conclusion in conclusion, this paper is to investigate the long run relationship between the determinants with the government size in malaysia. the determinants including the trade openness, population, foreign direct investment, portfolio investment openness and the economic growth. the annual data which from year 1980 to year 2018 is achieved from the world bank website and the department statistic of malaysia (dosm). the autoregressive distributed lag model is applied to this study. meanwhile, the empirical results have shown significant and negative long-run relationships between the dependent variable, government size, and four independent variables, knowingly trade openness, country size, foreign direct investment openness as well as portfolio investment openness. on the contrary, the economic growth variable has portrayed a significantly positive long-run association with the government size in malaysia. moreover, the trade openness and economic growth variables have been discovered to have the most significant granger causality effects on the government size in malaysia as well. hence, it is crucial for the government to achieve stability in allocating both the operating and development expenditures towards a sustainable long-term economic growth in malaysia by taking the potential determinants into consideration. references alesina, a. 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(2017). budget 2018: when debt fuels and holds back development expenditure. retrieved from https://www.theedgemarkets.com/article/budget2018-when-debt-fuels-and-holds-back-development-expenditure asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://www.investopedia.com/terms/k/keynesianeconomics.asp https://www.dosm.gov.my/v1/index.php?r=column/ctimeseries&menu_id=nhjlagc2rlg4zxlgtjh1su1kawy5ut09 https://fas.org/sgp/crs/misc/rl32162.pdf https://www.mof.gov.my/ms/ https://www.worldbank.org/ https://www.theedgemarkets.com/article/budget-2018-when-debt-fuels-and-holds-back-development-expenditure https://www.theedgemarkets.com/article/budget-2018-when-debt-fuels-and-holds-back-development-expenditure 85 © 2025 by the author; licensee asian online journal publishing group asian journal of economics and empirical research vol. 12, no. 2, 85-93, 2025 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v12i2.6962 © 2025 by the author; licensee asian online journal publishing group tax devolution and discriminatory effects on southern india murugan. k department of economics, guru nanak college (autonomous) velachery, chennai, india. email: murugan.kaliappani@gmail.com abstract this paper analyzes tax devolution policies and their discriminatory impact on southern indian states such as andhra pradesh, karnataka, kerala, tamil nadu, and telangana, during the periods of the 10th to 15th finance commissions. the study utilizes secondary data to explore how india’s fiscal federalism has evolved in terms of tax devolution versus grants. the paper is divided into four sections: an introduction, a brief review of tax devolution, an examination of trends and performance of tax devolution and discriminatory effects in southern india, and a summary with conclusions. key findings indicate a shift from tax devolution to increased grants over time, especially during the 15th commission, which aimed to address regional inequalities. the study also notes a rise in non-fc grants, particularly during the covid-19 period, highlighting a trend toward flexible, program-based funding. despite overall growth in financial allocations and decentralization, southern states have experienced a declining share of union taxes. this decline is attributed to lower population growth, higher per capita income, and a redistributive focus on poorer, more populous northern states. for example, andhra pradesh's share decreased significantly after bifurcation, while kerala and tamil nadu also saw reductions. in conclusion, the study emphasizes that india’s resource distribution has become less favorable to southern states, reflecting broader shifts in fiscal priorities and governance strategies. it underscores the need to balance equitable tax devolution, targeted grants, and reforms to promote inclusive, high-growth development. additionally, southern states’ concerns about tax distribution highlight the importance of fairness and sensitivity in financial transfers to maintain national cohesion while addressing diverse developmental needs. keywords: discriminatory effects, finance commission, financial grants, fiscal federalism, horizontal transfer, non-financial grants, southern states, tax devolution, tax sharing, union taxes, vertical transfer. jel classification: a14; e60; e62; e63; h30; h20; h21; h27. citation | k, m. (2025). tax devolution and discriminatory effects on southern india. asian journal of economics and empirical research, 12(2), 85–93. 10.20448/ajeer.v12i2.6962 history: received: 26 june 2025 revised: 28 july 2025 accepted: 1 august 2025 published: 4 august 2025 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. data availability statement: murugan. k may provide study data upon reasonable request. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. contents 1. introduction .............................................................................................................................................................................................................. 86 2. theoretical foundations of tax devolution ..................................................................................................................................................... 86 3. research methodology and data base ................................................................................................................................................................ 87 4. results and discussion............................................................................................................................................................................................ 87 5. summary and conclusions ...................................................................................................................................................................................... 92 references ...................................................................................................................................................................................................................... 92 https://www.doi.org/10.20448/ajeer.v12i2.6962 https://orcid.org/0000-0002-8284-8018 mailto:murugan.kaliappani@gmail.com https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ asian journal of economics and empirical research, 2025, 12(2): 85-93 86 © 2025 by the author; licensee asian online journal publishing group contribution of this paper to the literature i have compiled data on tax transfers from the 10th to the 15th finance commissions for southern india. based on this data, i have created a table that highlights an issue in the finance commission allocation. the southern states are receiving a smaller share of funds compared to the northern states. 1. introduction the finance commission has focused on fundamental development issues and the equitable distribution of public goods across states in india. the 16th finance commission, operating under vision india 2047, faces more intricate challenges. it must address traditional issues like resource allocation while managing a fragile fiscal federal relationship. the dynamic between the centre and states has become more delicate, with increased scrutiny on states' fiscal health. the prime minister's support for the role of states in vision india 2047 adds a new dimension to the finance commission's work. the commission's recommendations will play a pivotal role in shaping the country’s fiscal federalism and its ability to achieve the ambitious goals of vision india 2047. it aims to elevate india to a higher level of development by its centenary year. the 16th finance commission’s recommendations are more crucial than ever, as its decisions will have a significant impact on india’s fiscal federalism, which is vital to achieving the goals of vision india 2047. 1.1. daunting challenge of achieving aspirational targets govinda (2024) highlights the significant challenge of achieving the aspirational target of a per capita income (pci) of $13,200. india's current pci is far below this goal, and reaching it within 25 years requires extraordinary growth and sustained effort. to achieve this target, india’s pci needs to increase fivefold, requiring an annual growth rate of 7.5 percent over the next 25 years. india’s gdp growth rate must reach 9-10 percent per year. this is a challenging goal, especially when compared to the rapid growth experienced by countries like china (9.6 percent gdp growth for 40 years starting in 1978) and south korea (which became an oecd member within 25 years). achieving these growth targets requires inclusive growth, creating enough jobs to absorb the 2 million people entering the workforce annually and transitioning millions from agriculture or the unorganized sector to more productive, well-paying, formal jobs. to facilitate this transition, substantial investments are needed in education, skills development, and the creation of high-value sectors that can employ large numbers of people. india’s current investment-to-gdp ratio is around 30-31 percent, but it must increase to 40 percent to drive necessary economic growth. improvements in productivity, especially in manufacturing and services, are crucial. a key measure is the incremental capitaloutput ratio (icor), which indicates how much investment is needed to generate a unit of output. india's current icor is around 5, meaning a large amount of investment is required to achieve growth. the required investment increase from 30-31 percent to 40 percent of gdp cannot be achieved solely through domestic savings. india will need significant external investments, including foreign direct investment (fdi) and foreign portfolio investment (fpi). this necessitates creating an investment-friendly environment to attract global capital, alongside domestic reforms that encourage savings and investments. 1.2. macroeconomic and structural reforms prof. rao emphasizes the need for extensive macroeconomic reforms to support this determined growth. these reforms should include repairing the financial sector, enhancing infrastructure, fostering innovation, and ensuring that the benefits of growth are broadly shared. additional reforms in labor laws, taxation policies, business regulations, and education systems will be necessary to facilitate the economy's transition to a high-growth, highproductivity state. india's bright future and the economic empowerment of its younger generation remain distant goals, and the path to achieving these growth targets will be challenging, full of obstacles, uncertainties, and complexities. 1.3. objectives of the paper the objective of this study is to investigate tax devolution and discriminatory effects on southern india during the 10th to 15th finance commissions in india. the paper begins with an introduction, followed by a brief review of tax devolution. the third section examines the trends and performance of tax devolution and discriminatory effects in southern india. the fourth section provides a summary and conclusions. 2. theoretical foundations of tax devolution fiscal federalism theory was developed by musgrave (1959) and oates (1972). they examine the effectiveness of tax devolution. this theory suggests that decentralizing fiscal powers allows local governments to adapt tax policies to local preferences and needs. it highlights the challenges that arise, such as inter-jurisdictional competition, inequality between regions, and the need for central oversight to ensure national cohesion. musgrave (1959) benefit-cost theory suggests that local governments should raise taxes. tax devolution is an optimal solution when the costs and benefits of public goods are largely local in nature. tiebout (1956) suggests that people "vote with their feet" and move to jurisdictions that best match their preferred tax and service levels. tax devolution may lead to more efficient outcomes by enabling local governments to compete for residents and businesses through tax and service offerings. oates' decentralization theorem oates (1972) argues that decentralization can improve the efficiency of public service delivery by aligning government policies. fiscal decentralization may worsen regional disparities without proper redistributive mechanisms. vertical fiscal imbalance occurs when local governments do not have the fiscal capacity to fund their responsibilities independently. it is leading to reliance on transfers from the central government. studies on india and argentina highlight this imbalance and suggest that tax devolution alone is insufficient without accompanying equalization measures (oates, 1999; srinivasan, 2000). asian journal of economics and empirical research, 2025, 12(2): 85-93 87 © 2025 by the author; licensee asian online journal publishing group 2.1. empirical studies on tax devolution and discriminatory effects the literature on tax devolution explores its potential to affect equity and regional disparities. it focuses on fiscal imbalances, public service provision, and the role of political elites. several empirical studies highlight the complexities of decentralization. bird (1999) examined how tax devolution could lead to enhanced competition among regions for investment and citizen satisfaction. local governments would have a greater incentive to provide better services if they could raise their own taxes and compete with other regions. tanzi (1996) highlighted that wealthier regions with greater fiscal autonomy and higher tax revenues could provide better public services, while poorer regions often face limitations in generating sufficient tax revenue, exacerbating regional disparities. oates (1999) discussed horizontal fiscal imbalances between regions. he pointed out that fiscal disparities could result from differences in economic development, leading to inequitable public services across regions. boadway (2009) expanded on vertical fiscal imbalances and horizontal fiscal imbalances. it emphasizes that local governments may not have the revenue-generating capacity to meet their expenditure responsibilities, leading to reliance on central transfers. this can result in inefficient public service delivery and unequal development. bardhan (2002) explored how decentralization, including tax devolution, could positively impact economic growth if local governments had significant fiscal autonomy and capacity. however, the lack of administrative capability in local governments, particularly in developing countries, could limit the effectiveness of decentralized taxation. khemani (2006) study on fiscal decentralization in india found that disparities in revenue generation between indian states were a key driver of inequalities in service provision. wealthier states could provide better services (e.g., education and healthcare), while poorer states faced resource constraints. poterba (1997) study examined the role of local governments in setting tax rates, concluding that decentralization in ethnically or politically fragmented states could lead to targeted taxation policies that favor certain groups over others. such policies might marginalize minorities or disadvantaged groups. feld and kirchgässner (2001) studied the impact of local tax rates and found that decentralization could lead to regressive taxation if local governments set taxes too high or too low without proper oversight or equalization mechanisms. this could disproportionately harm disadvantaged groups. zodrow (2003) discussed how global tax competition could exacerbate discriminatory effects in developing economies, as regions or countries with greater tax devolution compete by lowering tax rates, often at the expense of public services. smart and bird (2009) study on equalization systems aims to reduce disparities. they fail to address structural factors contributing to inequality. these systems are frequently subject to political manipulation. they may not be adequately designed to equalize fiscal capacity across regions. cox and mccubbins (2000) study explored the experience of tax devolution in latin american countries, finding that while decentralization gave local governments more fiscal autonomy. it also deepened disparities in public service quality between wealthier and poorer states. shah and shah (2006) focused on the former soviet states, finding that fiscal decentralization led to increased income disparities. wealthier areas attracted foreign investment and had higher tax revenues, while poorer regions struggled to meet basic fiscal needs. de mello (2001) study showed that regions with higher fiscal autonomy and tax capacity were able to provide better educational outcomes, while poorer regions continued to face challenges in providing adequate education and public services. ribeiro (2005) study emphasizes that without proper equalization policies, fiscal decentralization can deepen regional disparities and reduce the effectiveness of decentralized governance, particularly in developing countries. studies on india's tax devolution show that the finance commission plays a key role in equalizing fiscal resources across states, but issues related to corruption, bureaucratic inefficiency, and the informal economy hinder the effectiveness of these arrangements (srinivasan, 2000). chelliah and bagchi (1993) have explored the challenges of revenue-expenditure mismatches, emphasizing the need for equity and efficiency in devolution. the equityefficiency trade-off in inter-state transfers, where resources are redistributed to less developed states, often at the expense of more developed one (srivastava & rao, 2020) show that northern states benefit disproportionately from central transfers, while southern states face challenges in sustaining their development trajectories under reduced allocations. these empirical studies illustrate the complex relationship between tax devolution and its potential discriminatory effects. while decentralization can promote local autonomy, efficiency, and citizen satisfaction, it also brings challenges such as horizontal fiscal imbalances, vertical fiscal imbalances, and regressive taxation. these challenges can exacerbate regional disparities and socio-economic inequalities, especially when local governments lack sufficient fiscal capacity or administrative capabilities. the studies suggest that while tax devolution can improve local autonomy and efficiency, it can also deepen inequalities unless carefully managed. to address these issues, many scholars advocate for equalization transfers, capacity-building, and targeted policies to ensure more balanced development across regions. 3. research methodology and data base this study relies on secondary data collected from various published and unpublished sources, including central and state government documents. government documents were obtained from the reserve bank of india, finance commission reports, ministry of finance, and government of india. the study covers the period from the 10th to the 15th finance commissions, and simple percentages and averages were used to calculate the effects of tax devolution in india. 4. results and discussion the criteria for horizontal devolution have shifted over time, particularly with the finance commission’s inclusion of the 2011 census data. this shift has raised concerns among southern states with lower population growth rates, which feel disadvantaged despite their demographic management successes. 4.1. horizontal devolution criteria these are designed with the idea of providing basic minimum public goods equitably to all the states. this is not with vision india 2047, and the 16th finance commission has to redesign it to ensure co-evolution. asian journal of economics and empirical research, 2025, 12(2): 85-93 88 © 2025 by the author; licensee asian online journal publishing group table 1. criteria for horizontal devolution across indian states. distribution basis 10th fc 11th fc 12th fc 13th fc 14th fc 15th fc income distance 60 62.5 50 47.5 50 45 population (1971) 20 10 25 25 17.5 area 5 7.5 10 10 15 15 forest cover 7.5 forest ecology 10 infrastructure basis 7.5 7.5 10 fiscal discipline 7.5 7.5 17.5 demographic performance 12.5 tax effort 10 5 7.5 2.5 total 100 100 100 100 100 100 source: calculated from union finance commission reports (10 to 15). the criterion for horizontal devolution across indian states, as determined by different finance commissions, is presented in table 1. during the 10th and 11th commissions, emphasis was placed on income disparity, with 60 percent and 62.5 percent of the weight assigned to income distance. this focus gradually decreased in the 15th commission, reducing to 45 percent. it reflects a broader shift towards other factors such as fiscal discipline, infrastructure, and demographic performance. the population criterion (based on 1971 data) had significant weight in earlier fcs, but by the 15th commission, it was excluded, signaling a move away from demographic size alone. this change highlights a preference for performance-based criteria, such as fiscal management and demographic management, rather than population size as the primary factor. the area criterion initially had a small weight (5 percent in the 10th fc), grew over time. it reached 15 percent in the 14th and 15th commissions. this shift recognizes that larger states require more resources for infrastructure and governance. the 13th finance commission emphasized fiscal discipline, assigning 17.5 percent of the total weight. however, this criterion was eventually removed in the 14th and 15th commissions. this change is due to improved fiscal management or a shift in focus towards other performance indicators. these changes reflect a transition from prioritizing demographic size and income disparities to incorporating a more diverse set of factors, including fiscal health, infrastructure needs, and performance-based criteria, to ensure fair and sustainable resource allocation. table 2. share of finance commission grants in total transfers in india. finance commission tax share fc grants total fc transfers to states 10th fc (1995-2000) 206343 (91.0 percent) 20300.3 (9.0 percent) 226643.3 11th fc (2000-2005) 376318 (86.5 percent) 58587 (13.5 percent) 434905 12th fc (2005-2010) 613112 (81.1 percent) 142639 (18.9 percent) 755751 13th fc (2010-2015) 1448096 (84.8 percent) 258581 (15.2 percent) 1706677 14th fc (2015-2020) 3948187 (88.0 percent) 537354 (12.0 percent) 4485541 15th fc (2021-2026) 4224760 (80.6 percent) 1016662 (19.4 percent) 5241422 source: calculated from union finance commission reports (10 to 15). the share of finance commission grants in total transfers in india is presented in table 2. during the 10th finance commission, the focus was predominantly on tax devolution, with tax shares accounting for 91 percent of total transfers (₹206,343 crore), while fc grants represented only 9 percent (₹20,300.3 crore). this low share of grants indicates that the primary objective of the 10th finance commission was to create a robust system of fiscal decentralization by allocating resources based on the tax revenues generated by the union government. thus, the approach was predominantly broad-based, with limited focus on addressing regional developmental disparities. the grants were primarily intended to tackle state-specific issues that required additional financial support beyond the general tax transfers. the 14th finance commission saw a slight reduction in the share of fc grants, dropping to 12 percent of total transfers. however, the absolute value of fc grants surged to ₹537,354 crores, highlighting a shift towards more targeted financial support. the 14th fc introduced a significant increase in tax devolution, empowering states with greater autonomy over their finances. despite the reduction in the percentage share, the increase in the total value of grants indicates that the 14th commission still recognized the importance of providing supplementary support to states. this period marked a move towards decentralization, with the central government giving more financial control to the states, but the need for specific grants to address developmental inequalities or crises. the 15th finance commission accounts for a significant 19.4 percent of total transfers, the highest proportion during the entire review period. this increase indicates a stronger commitment to providing specialized support to states facing chronic developmental challenges, including income inequality, underdevelopment, and disaster recovery. the substantial rise in the share of grants demonstrates that the 15th commission aimed to address more targeted issues, ensuring equitable growth across regions. this reflects a broader national policy shift toward reducing regional disparities and improving the welfare of states with urgent needs, such as those affected by economic inequality and infrastructural deficits. during the 14th and 15th finance commission periods, there has been a rising importance of grants due to a shift in india’s fiscal policy. the focus on grants, especially for addressing regional disparities, indicates a commitment to inclusive development, ensuring that all states, regardless of their economic status, receive necessary resources to meet their developmental goals. this shift aligns with broader goals of social equity, with financial transfers increasingly directed toward states that require additional resources to overcome challenges such as poverty, infrastructure deficits, and the impacts of climate change. the comparative trends in finance commission grants and non-fc grants from 2009 to 2023 are presented in table 3. during 2011–12 to 2013–14, the share of finance commission grants fluctuated between 28 percent and 32.6 percent. the gradual increase in fc grants during this period can be attributed to a shift toward more targeted fiscal support. the government recognized the need to address state-specific development challenges asian journal of economics and empirical research, 2025, 12(2): 85-93 89 © 2025 by the author; licensee asian online journal publishing group more effectively, leading to a rise in fc grants during 2013–14. these grants were aimed at specific interventions such as infrastructure projects or poverty alleviation, which became more urgent during this time. table 3. share of finance commission grants and non-grants in india. year fc grants to total grants non-fc grants to total grants 2009-10 47087 (31.2) 103886 (68.8) 2010-11 48909 (29.9) 114588 (70.1) 2011-12 52199 (28.0) 134217 (72.0) 2012-13 48395 (25.6) 140286 (74.4) 2013-14 67133 (32.6) 138819 (67.4) 2014-15 71447 (21.6) 259358 (78.4) 2015-16 84579 (26.0) 241317 (74.0) 2016-17 95550 (26.8) 260541 (73.2) 2017-18 92244 (22.7) 313713 (77.3) 2018-19 93704 (21.3) 346165 (78.7) 2019-20 123710 (23.1) 410858 (76.9) 2020-21 184063 (28.6) 459778 (71.4) 2021-22 207435 (33.3) 415193 (66.7) 2022-23 (a) 172760 (19.7) 705011 (80.3) 2023-24(re) 140429 (17.4) 665546 (82.6) source: calculated from union finance commission reports (10 to 15). during 2014-15 to 2016-17, there was a notable shift in the share of fc grants, which dropped to 21.6 percent in 2014-15, with non-fc grants comprising 78.4 percent of the total. this decline in the share of fc grants was accompanied by an increase in their absolute value, reflecting higher fiscal allocations from the central government. the focus shifted towards non-fc grants; however, fc grants still played an important role in addressing statespecific fiscal needs, such as poverty alleviation and disaster recovery. during 2017-2021, the share of finance commission grants fluctuated between 22.7 percent and 28.6 percent. while the absolute value of fc grants continued to rise, their relative share of the total grants did not see significant growth. however, non-fc grants remained the dominant transfer mechanism. the increase in finance commission grants in 2020-21 (28.6 percent) can be attributed to the fiscal response to the covid-19 pandemic. it was a significant emergency funding for states to address health, economic, and infrastructure challenges. this period highlighted the importance of fc grants in responding to sudden, unanticipated fiscal needs. during 2021-2024, the share of finance commission grants peaked at 33.3 percent in 2021-22. this increase could reflect a policy shift toward prioritizing equitable growth and addressing regional disparities through targeted financial support. during 2022-23 and 2023-24, the share of finance commission grants declined significantly to 19.7 percent and 17.4 percent, respectively. this shift indicates a move toward increasing non-fc grants or enhancing general tax devolution. non-fc grants accounted for 80-82 percent of total grants during this period. these grants, favored by the government for their flexibility and program-based funding mechanisms, are adapted to address specific state needs such as infrastructure development, poverty alleviation, and disaster management. the gradual increase in fc grants between 2011-12 and 2020-21 indicates a growing recognition of the need for targeted development interventions to address regional disparities. however, the consistent dominance of nonfc grants reflects a broader preference for flexibility and specificity in funding mechanisms. non-fc grants, focused on special interventions, allow the government to address a wide range of state-specific challenges, from infrastructure deficits to immediate crises such as natural disasters or public health emergencies. table 4. share of tax revenue during the 10th to 15th finance commissions in india. particulars 10th fc 11th fc 12th fc 13th fc 14th fc 15th fc share of central tax 206343 376318 613112 1448096 3948188 4927000 non-plan revenue deficit 7583 35359 56856 51800 194820 294514 local bodies 5381 10000 25000 87519 287436 436361 relief expenditure 4728 8256 16000 26373 55097 122601 upgradation and special grants 2610 4973 7100 27945 49599 total share 226645 434906 718068 1641733 4485541 5830075 source: calculated from union finance commission reports (10 to 15). the financial allocations and projections for different finance commissions (fcs) in india, from the 10th to the 15th finance commission, are detailed in table 4. a significant increase is observed between the 12th and 13th finance commissions, from ₹613,112 crores to ₹1,448,096 crores. this sharp rise in funds allocated to states and local bodies occurs through this mechanism. the non-plan revenue deficit has increased from ₹7,583 crores in the 10th fc to ₹194,820 crores in the 14th finance commission. this indicates a growing gap between revenue generation and expenditure needs of the central and state governments. the increase in the deficit reflects fiscal pressure. the allocation for local bodies starts at ₹5,381 crores in the 10th fc and increases substantially to ₹2,87,436 crores by the 14th finance commission. this indicates a significant focus on empowering local bodies through decentralization. there is a massive increase in funding for local bodies, particularly from the 13th fc onwards. it demonstrates the growing importance of decentralizing resources for local governance and development. relief expenditure shows a steady increase over the years, from ₹4,728 crores in the 10th fc to ₹55,097 crores in the 14th finance commission. this increase reflects the growing need for funds allocated for disaster relief, social protection, and emergency responses across the country due to natural calamities and other exigencies. the growth of the non-plan revenue deficit signals mounting fiscal challenges. however, revenue growth might not be keeping pace with the increasing expenditure requirements, especially in terms of non-plan and welfare expenditure. asian journal of economics and empirical research, 2025, 12(2): 85-93 90 © 2025 by the author; licensee asian online journal publishing group the jump between the 12th and 13th finance commissions is quite pronounced, with substantial increases across almost all categories. the 13th finance commission has focused on addressing regional disparities and increasing the role of local bodies. table 5. share of union taxes among south indian states. southern states 1995-2000 2000-05 2005-10 2010-15 2015-20 2020-21 2021-26 10 fc 11 fc 12 fc 13 fc 14 fc 15 fc 15 fc andhra pradesh 8.465 7.701 7.356 6.937 4.305 4.111 4.047 karnataka 5.339 4.93 4.459 4.328 4.713 3.646 3.647 kerala 3.875 3.057 2.665 2.341 2.5 1.943 1.925 tamil nadu 6.637 5.385 5.305 4.969 4.023 4.189 4.079 telangana 0 0 0 0 2.437 2.133 2.102 south indian states 24.31 21.07 19.78 18.57 17.98 16.02 15.8 source: reports from 10th fc to 15th fc. the share of union taxes allocated to the south indian states from the 10th fc (1995-2000) to the 15th finance commission (2020-2021) is presented in table 5. the share of union taxes received by south indian states has progressively decreased. the share received during 1995-2000 was 24.31 percent, which dropped to 16.02 percent in 2020-21. it is expected to decrease further to 15.80 percent during the projection period 2021-2026. the growth trajectories of the south indian states might be stabilizing or slowing down relative to other states, especially those in bihar, uttar pradesh, and madhya pradesh, which have higher population growth and lower income levels. andhra pradesh’s share has decreased significantly from 8.465 percent in the 10th fc to 4.047 percent in the 15th commission (2021-2026). andhra pradesh's population base shrank, leading to a lower share in tax allocations. the bifurcation of andhra pradesh into two states resulted in a division of resources. while telangana began receiving its own share, andhra pradesh's share from the union tax pool was recalibrated, leading to a substantial decrease in the state's allocation. karnataka’s share has decreased from 5.339 percent in the 10th fc to 3.647 percent in the 15th finance commission. the state's relatively higher per capita income (compared to poorer states) and its more stable population growth could contribute to a smaller share of union taxes, as states with higher income levels and slower population growth receive less support. states like telangana and bihar, with higher populations and greater fiscal needs, are likely receiving more resources, which reduces karnataka’s relative share. kerala’s share has decreased from 3.875 percent in the 10th fc to 1.925 percent in the 15th finance commission. its high human development indicators, such as literacy rate, healthcare, and life expectancy, reflect its relatively advanced status. kerala, being a developed state with robust social welfare systems, might not require as much financial assistance from the union, especially compared to poorer and more populous states. tamil nadu’s share has decreased from 6.637 percent in the 10th fc to 4.079 percent in the 15th finance commission. tamil nadu’s population growth has slowed down, and its income levels have steadily increased, potentially reducing its share of union taxes under the finance commission’s formula. states with larger populations and lower income levels are prioritized. tamil nadu’s relative prosperity is less likely to benefit from the redistributive mechanism that rewards poorer states. telangana, formed in 2014, initially received zero allocation until the 14th finance commission (2015-2020), and its share began at 2.437 percent. by the 15th finance commission (2021-2026), its share slightly declined to 2.102 percent. telangana's financial base and needs were not well-defined in its early years. the relatively small allocation could be due to its smaller size and evolving resource requirements. it is noteworthy that telangana’s share has not grown significantly, despite its relatively younger population and potential for economic growth. the declining share of union taxes in south indian states could be seen as penalizing high-performing states. a smaller demographic base, which translates to lower allocation under the finance commission’s formula, places a greater emphasis on population size. south indian states tend to have better fiscal discipline and higher tax collection rates, which might make them less dependent on union resources. however, the finance commission’s formula is designed to achieve redistribution by addressing disparities between richer and poorer states. poorer and more populous states are prioritized to reduce regional inequalities. while this can be seen as penalizing the performance of south indian states, it also aligns with the principle of equitable growth, ensuring that underdeveloped states have the resources they need for development. table 6. inter-state share given by the finance commission. distribution basis 10th fc 11th fc 12th fc 13th fc 14th fc 15th fc andre pradesh 7.701 7.356 6.937 4.305 4.111 karnataka 4.93 4.459 4.328 4.713 3.646 kerala 3.057 2.665 2.341 2.500 1.943 tamil nadu 5.385 5.305 4.969 4.023 4.189 telangana 2.437 2.133 source: calculated from union finance commission reports (10 to 15). the inter-state share of funds allocated to various states by the 10th to the 15th finance commissions is given in table 6. andhra pradesh's share has generally decreased over time from 7.701 percent in the 11th finance commission; it decreased to 4.111 percent by the 15th finance commission. the share dropped notably between the 10th and the 13th finance commissions, falling to 4.305 percent in the 14th finance commission. the decline in andhra pradesh’s share can be attributed to various factors, including its changing demographic or economic performance and the reorganization of the state in 2014 (formation of telangana). karnataka’s share decreased steadily from 4.93 percent in the 11th fc to 3.646 percent in the 15th finance commission. the gradual reduction in karnataka’s share could be due to factors such as improvements in fiscal management, economic growth, or population-related factors. the 13th fc’s increase may be linked to specific fiscal or demographic criteria that benefited the state. kerala’s share decreased from 3.057 percent in the 11th fc to 1.943 percent in the 15th finance commission. kerala’s declining share might reflect the state's changing position in terms of fiscal discipline, infrastructure needs, asian journal of economics and empirical research, 2025, 12(2): 85-93 91 © 2025 by the author; licensee asian online journal publishing group and other criteria. kerala’s high human development index and relatively better infrastructure could have led to a lower share in more recent finance commissions due to the need for resources. tamil nadu's share showed a slight decrease from 5.385 percent in the 11th fc to 4.189 percent in the 15th finance commission. tamil nadu’s share has fluctuated slightly, reflecting its relatively stable economic performance and consistent fiscal management. the slight decrease could be due to the state's improved infrastructure, economic growth, or demographic performance. telangana's share was received at 2.437 percent in the 14th fc and 2.133 percent in the 15th finance commission. as a newly formed state, telangana's share started with a moderate allocation in the 14th fc. its share gradually decreased in the 15th finance commission due to evolving fiscal discipline, infrastructure needs, and other developmental criteria. the state is still in the early stages of development, which could influence its share allocation in future finance commissions. the general trend for andhra pradesh, karnataka, kerala, and tamil nadu has been a gradual decrease in their share over time. this could be due to their relative improvements in terms of economic development, fiscal discipline, and infrastructure, which have led to a reduced need for central transfers compared to other states. the inter-state share allocation by the finance commissions has evolved based on the economic, fiscal, and demographic needs of the states. andhra pradesh, karnataka, kerala, and tamil nadu have experienced a decline in their share, reflecting either improvements in their own development or shifts in the criteria used by the finance commissions. telangana has received a moderate allocation since its formation, with a slight decline in the latest commission (15th fc). over time, the finance commissions have adapted to new priorities and challenges, resulting in a redistribution of resources among states, with some newer and smaller states receiving more support. table 7. share of tax devolution during the 14th and 15th finance commissions in southern india. distribution basis 14th fc 15th fc devolution for 2020-21 rs. in crores share out of 41 percent share in divisible pool share out of 41 percent share in divisible pool andre pradesh 1.81 4.31 1.69 4.11 35,156 karnataka 1.98 4.74 1.49 3.65 31,180 kerala 1.05 2.50 0.80 1.94 16,616 tamil nadu 1.69 4.02 1.72 4.19 35,823 telangana 1.02 2.43 0.87 2.13 18,241 total 41 100 41 100 8,55,176 source: calculated from union finance commission reports (10 to 15). the devolution of funds to southern states during the 14th and 15th finance commissions is presented in table 7. the total devolution in 2020-21 was ₹8,55,176 crores, with the total share of the 41 percent divisible pool remaining constant for both the 14th and 15th finance commissions. andhra pradesh’s share slightly decreased from 1.81 percent to 1.69 percent between the 14th and 15th finance commissions. however, its share in the divisible pool (in absolute terms) remains relatively stable, with a minor reduction from 4.31 percent to 4.11 percent. this results in a devolution of ₹35,156 crores during 2020-21. the state’s significant share in the total devolution pool shows a slight reduction in percentage terms. karnataka experienced a significant decline in its share, decreasing from 1.98 percent in the 14th finance commission to 1.49 percent in the 15th finance commission. its share in the divisible pool has reduced from 4.74 percent to 3.65 percent. despite this, the actual devolution remains substantial at ₹31,180 crores, reflecting the state's continued importance in the distribution. kerala's share has also declined significantly, from 1.05 percent to 0.80 percent. its share in the divisible pool has decreased from 2.50 percent to 1.94 percent. this decline indicates a reduction in kerala's relative fiscal needs. it still receives ₹16,616 crores for 2020-21. tamil nadu’s share has increased slightly from 1.69 percent to 1.72 percent. its share in the divisible pool has also increased from 4.02 percent to 4.19 percent. tamil nadu receives ₹35,823 crores, the highest among the states listed, indicating its continued importance and need for financial support. telangana's share has declined from 1.02 percent to 0.87 percent during the same period. its share in the divisible pool has reduced from 2.43 percent to 2.13 percent. telangana still receives a significant ₹18,241 crores for the year, indicating that the state continues to require considerable financial support for its development needs. the percentage allocation for andhra pradesh, karnataka, kerala, and telangana has decreased slightly, while tamil nadu experienced a small increase in its share. this reflects a shift in the finance commission's focus or criteria, potentially incorporating factors such as fiscal discipline, economic performance, or demographic changes. although the share percentages have changed, the absolute devolution amounts (in crores of rupees) remain significant, reflecting the large overall devolution pool of ₹8,55,176 crores for the year 2020-21. states like andhra pradesh and tamil nadu continue to receive substantial allocations (₹35,156 crore and ₹35,823 crore, respectively), despite their share percentages having slightly decreased. table 8. state-wise distribution of net proceeds of union taxes and duties: 2024-25 (be) in rs. crore. state total rs. crore share in percent corporation tax income tax central gst customs duties union excise duty service tax andre pradesh 50475 4.047 15159 17456 15079 2228 470 1.66 karnataka 45486 3.647 13658 15731 13589 2008 423 1.50 kerala 24008 1.925 7209 8303 7173 1060 223 0.79 tamil nadu 50874 4.079 15276 17594 15199 2246 473 1.67 telangana 28216 2.102 7872 9067 7832 1157 243 0.66 total 124211 100 374512 431330 372606 55064 11607 41 source: calculated from union finance commission reports (10 to 15). the distribution of net proceeds from union taxes and duties across states for the year 2024-25 (be) is provided in table 8. andhra pradesh receives 4.047 percent of the total distribution, with a significant portion derived from income tax (₹17,456 crore) and corporation tax (₹15,159 crore). the state's share of union excise asian journal of economics and empirical research, 2025, 12(2): 85-93 92 © 2025 by the author; licensee asian online journal publishing group duty is relatively small (₹470 crore). karnataka receives 3.647 percent of the total, with substantial contributions from corporation tax (₹13,658 crore) and income tax (₹15,731 crore). its share of central gst and customs duties is also notable. however, it receives a comparatively small amount from union excise duty. kerala's share is 1.925 percent, and it receives relatively high amounts from income tax and corporation tax, but lower amounts from union excise duty. the state's share of central gst is significant, amounting to ₹7,173 crore. tamil nadu receives the highest share among the listed states, with 4.079 percent of the total. like andhra pradesh and karnataka, tamil nadu benefits largely from income tax (₹17,594 crore) and corporation tax (₹15,276 crore). the state also receives significant funds from central gst. telangana, with a share of 2.102 percent, receives a substantial portion from income tax (₹9,067 crore), corporation tax (₹7,872 crore), and central gst (₹7,832 crore). the state has a relatively low share of union excise duty. the largest shares across the states are from corporation tax, income tax, and central gst. these three categories are consistently the top sources of revenue for each state, making up the majority of the allocations. customs duties also contribute a notable share, particularly for tamil nadu, karnataka, and telangana. union excise duty and service tax account for a much smaller portion of the total allocation, with the states receiving only minimal amounts in these categories. andhra pradesh and tamil nadu receive the highest total devolution, ₹50,475 crore and ₹50,874 crore, respectively, which is in line with their larger economic bases and higher shares of the national population. karnataka and telangana have slightly lower shares in comparison to andhra pradesh and tamil nadu but still receive significant allocations, reflecting their strong economic and industrial bases. the comprehensive overview of the distribution of central taxes across five indian states for the year 2024-25 (be) indicates that the largest share of the divisible pool is allocated to andhra pradesh, tamil nadu, and karnataka, with significant contributions from corporation tax, income tax, and central gst. kerala and telangana receive smaller allocations but still benefit from important revenue streams, especially income tax and corporation tax. this distribution highlights the central government's fiscal priorities and the financial needs of states based on their economic performance, industrial base, and population sizes. 5. summary and conclusions india's fiscal federalism has evolved significantly through the finance commissions from the 10th to the 15th commissions. it is marked by shifts in the focus of tax devolution and grants. during the 10th fc (2005-2010), the focus was primarily on tax devolution, allocating 91 percent of transfers to tax shares and only 9 percent to grants. the goal was fiscal decentralization, with grants used sparingly for state-specific issues. during the 14th commission (2015-2020), there was a notable shift towards greater tax devolution, with grants reduced to 12 percent. however, their total value increased, providing more targeted financial support for states facing unique challenges. during the 15th commission (2020-2025), grants constituted 19.4 percent of transfers, addressing regional disparities, income inequality, and infrastructure deficits. between 2009 and 2023, the share of fc grants varied, reflecting shifting priorities in fiscal operations in india. during 2011-14, fc grants' share ranged from 28 percent to 32.6 percent, focusing on state-specific development issues. during 201417, fc grants fell to 21.6 percent, with non-fc grants rising to 78.4 percent. despite this, absolute fc grants increased, supporting needs such as poverty alleviation and disaster recovery. during 2017-2021, fc grants fluctuated between 22.7 percent and 28.6 percent, with a spike in 2020-2021 driven by covid-19 emergency needs. during 2021-2024, fc grants peaked at 33.3 percent in 2021-2022 but decreased to 17.4 percent in 2023-2024, with increased reliance on non-fc grants for flexible, program-based funding. the growth trends of financial allocations during the 12th to 13th commission saw a substantial increase in allocations for states and local bodies, from ₹613,112 crores to ₹1,448,096 crores. local body funding surged from ₹5,381 crores in the 10th fc to ₹2,87,436 crores in the 14th commission, reflecting a growing focus on decentralization. emergency allocations increased from ₹4,728 crores in the 10th fc to ₹55,097 crores in the 14th fc, addressing disaster relief and social protection needs. the regional allocation trends of andhra pradesh, karnataka, kerala, tamil nadu, and telangana showed a consistent decline in their share of union taxes from 1995 to 2021. this decline is attributed to their relatively slower growth compared to poorer, more populous states. andhra pradesh experienced a significant drop in share after bifurcation in 2014. karnataka and kerala also saw reductions due to higher per capita income and stable populations, while tamil nadu experienced a slight decline due to its economic stability. telangana, formed in 2014, began receiving allocations only in the 14th finance commission. from the 11th to the 15th commission, the inter-state share for these states generally decreased. andhra pradesh's share dropping from 7.701 percent to 4.111 percent, and kerala's from 3.057 percent to 1.943 percent. during 2020-21, the tax devolution to andhra pradesh, karnataka, kerala, and tamil nadu saw decreases in their share of the divisible pool, with tamil nadu receiving the highest allocation of ₹35,823 crores, despite a slight drop in its share. india's fiscal federalism has focused on redistributing resources to poorer states with larger populations while gradually reducing the share of wealthier states, particularly in south india. the increasing reliance on non-fc grants reflects the need for flexible, program-based funding to address specific regional challenges. references bardhan, p. (2002). decentralization of governance and development. journal of economic perspectives, 16(4), 185–205. bird, r. m. (1999). rethinking subnational taxes: a new look at tax assignment. imf working paper no. 99/165, washington, dc, united states: international monetary fund. boadway, r. (2009). fiscal federalism. cambridge: cambridge books, cambridge university press. chelliah, r., & bagchi, a. (1993). fiscal federalism in india: tax devolution and its challenges. economic and political weekly, 28(12), 623-631. cox, g. w., & mccubbins, m. d. (2000). political structure and economic policy: the institutional determinants of policy outcomes, presidents, parliaments, and policy. cambridge, united kingdom: cambridge university press. de mello, l. (2001). fiscal decentralisation and governance: a cross-country analysis. imf working paper no. 01/71, washington, dc, united states: international monetary fund. feld, l. p., & kirchgässner, g. (2001). income tax competition at the state and local level in switzerland. regional science and urban economics, 31(2–3), 181–213. govinda rao, m. (2024). the challenge of achieving aspirational income targets in india: an analysis of the per capita income growth path. journal of economic development studies, 45(2), 123-135. khemani, r. (2006). decentralization and accountability in local governments: the case of local taxation in developing countries. public administration and development, 26(4), 221-238. musgrave, r. (1959). theory of public finance: a study in public economy. new york: mcgraw-hill. asian journal of economics and empirical research, 2025, 12(2): 85-93 93 © 2025 by the author; licensee asian online journal publishing group oates, w. e. (1972). fiscal federalism. usa: harcourt brace jovanovich. oates, w. e. (1999). an essay on fiscal federalism. journal of economic literature, 37(3), 1120-1149. poterba, j. m. (1997). demographic structure and the political economy of public education. journal of policy analysis and management, 16(1), 48–66. ribeiro, a. (2005). fiscal autonomy and public service provision: evidence from brazilian regions. journal of public economics, 89(11), 22232240. shah, a., & shah, s. (2006). the new vision of local governance and the evolving roles of local governments. in a. shah (ed.), local governance in developing countries in (pp. 1–46). washington, dc: world bank smart, m., & bird, r. m. (2009). tax competition and tax coordination in developing countries. national tax journal, 62(2), 239-258. srinivasan, t. n. (2000). reforming fiscal federalism in india: the role of intergovernmental transfers. economic and political weekly, 35(12), 1081-1088. srivastava, d. k., & rao, m. g. (2020). inter-sate fiscal transfers and the equity-efficiency trade-off in india. journal of development economics, 144, 104-115. tanzi, v. (1996). globalization, tax competition and the future of tax systems. imf working paper no. 96/141. washington, dc, united states: international monetary fund. tiebout, c. m. (1956). a pure theory of local expenditures. journal of political economy, 64(5), 416-424. zodrow, g. r. (2003). tax competition and tax coordination in the european union. international tax and public finance, 10(6), 651-671. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. 150 © 2022 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 9, no. 2, 150-165, 2022 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v9i2.4262 © 2022 by the authors; licensee asian online journal publishing group the origins and dynamics of inflation in turkey: an svar approach emel siklar1 ilyas siklar2 ( corresponding author) 1department of numerical methods, anadolu university, turkey. email: esiklar@anadolu.edu.tr 2department of economics, anadolu university, turkey. email: isiklar@anadolu.edu.tr abstract this study aims to present empirical evidence on the relative importance of supply and demandside factors in determining the fluctuations in the general level of prices in the turkish economy. the employed strategy uses the view that supply and demand pressures can be distinguished from each other depending on the direction of their effects on price and quantity. after classifying the related economic variables as supply, demand, and common factors, the main determinants of domestic supply and demand were estimated econometrically using sample data from 2003:1– 2021:4, and their relative contribution to inflation was calculated. by using these basic determinants, the estimated structural vector autoregressive (svar) model shows that the pressures arising from the supply side are more dominant than the pressures of the demand side on the inflationary process in turkey. the results indicate that the methodology suggested in this study will be useful in separating the factors that contribute to inflation, which has recently gotten out of control in turkey and is gradually moving away from the targeted inflation. policymakers considering these findings can reach optimal decisions in conducting the monetary policy toward the targeted level of inflation. keywords: inflation, monetary policy, svar, turkey. jel classification: c32; e17; e31; e50. citation | siklar, e., & siklar, i. (2022). the origins and dynamics of inflation in turkey: an svar approach. asian journal of economics and empirical research, 9(2), 150–165. 10.20448/ajeer.v9i2.4262 history: received: 8 september 2022 revised: 14 october 2022 accepted: 26 october 2022 published: 3 november 2022 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. authors’ contributions: both authors contributed equally to the conception and design of the study. competing interests: the authors declare that they have no conflict of interest. transparency: the authors confirm that the manuscript is an honest, accurate and transparent account of the study, that no vital features of the study have been omitted, and that any discrepancies from the study as planned have been explained. ethical: this study followed all ethical practices during writing. contents 1. introduction .................................................................................................................................................................................... 151 2. a short literature review ........................................................................................................................................................... 152 3. methodology ................................................................................................................................................................................... 153 4. estimation of the var model ..................................................................................................................................................... 156 5. estimation results ......................................................................................................................................................................... 158 6. conclusion ....................................................................................................................................................................................... 161 references ............................................................................................................................................................................................ 161 appendix............................................................................................................................................................................................... 162 mailto:esiklar@anadolu.edu.tr mailto:isiklar@anadolu.edu.tr https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v9i2.4262 https://orcid.org/0000-0001-5328-9272 https://orcid.org/0000-0003-3181-2522 asian journal of economics and empirical research, 2022, 9(2): 150-165 151 © 2022 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this paper presents empirical evidence of the sources of the recent inflationary pressures in the turkish economy. the methodology used (svar) differs from the previous studies, and the results show that inflation is basically driven by supply-side factors contrary to the widespread belief that it is a demandpull process. 1. introduction empirical studies on inflation, sometimes due to the uncertainty in its measurement, and sometimes the difficulty in determining the factors underlying its change, are a focus for monetary policymakers. both reasons are closely related to better conduct of monetary policy. on the one hand, if inflation is not measured correctly, it will not be possible to distinguish the permanent factors that create inflationary pressure from the factors that create temporary fluctuations in the inflation rate. on the other hand, if the source of inflationary pressure is indistinguishable (i.e., whether supply-side factors or demand-side factors are dominant in the inflationary process), it will be very difficult to determine the right path for monetary policy. although both reasons are important, this study focuses on the second reason, that is, a method that makes it possible to distinguish between inflationary pressures caused by shifts in domestic demand and those caused by shifts in supply. in this study, empirical evidence on the relative importance of demand and supply factors in determining the causes of fluctuations in the general price level as measured by the consumer price index (cpi) in the turkish economy is investigated. the method developed to determine the source of these pressures is discussed and the contributions of structural shocks and macroeconomic factors to the observed inflation rate are analyzed. determinations of structural shocks and analysis of the impulse response and variance decomposition are performed using the vector auto regression (var) methodology. the proposed method starts with the classification of the factors that shift domestic supply and domestic demand. the selection of the variables is carried out by considering their effects on price and quantity in the domestic market. specifically, if the shock observed in a variable has an adverse effect on inflation (price level) and domestic demand (quantity), this variable is classified as a factor that shifts supply. for example, if a shock in a variable causes a positive reaction in inflation and a negative reaction in output, it should be considered as a factor that creates a shift that represents the decrease in supply. if the shock in a variable has the same effect on price and quantity, this variable is considered a demand-shifting factor. if a variable increases prices but its effect on quantity cannot be clearly determined (for example, the effect of wages on quantity), this variable is classified as a control variable that affects both supply and demand. after determining the variables that shift the supply or the demand according to the net effects they create, the multivariate reduced var model is estimated. this model includes domestic demand and inflation rate in addition to supply and demand shifting factors. in this process, variables that can affect both supply and demand are included in the var model as control variables. in the next step, structural shocks are identified by diagonalizing the variance-covariance matrix of the reduced var residuals, and thus uncorrelated structural shocks are obtained so that the effects of identified supply-side and demand-side shocks can be analyzed. in other words, it can be determined whether the variation in inflation is caused by the factors that shift the supply or the demand. the practical advantage of this method is that, instead of describing supply and demand shocks as "anonymous" or "intuitive", it allows the empirical determination of the contribution of these shocks to the variations in inflation by obtaining the shocks in the observed variables. thus, since the contribution of structural shocks to past inflation can be determined, the effect of observed variables on inflation dynamics can be accurately evaluated. in this case, policymakers can make decisions by considering the contribution of structural shocks in the observed variables to inflation. this makes a positive contribution to understanding and explaining the results of the decisions. within the framework of this method, the inflation and real domestic demand series (representing the price level and quantity of output, respectively) were subjected to a preliminary examination through quarterly data for the 2003:1–2021:4 period in turkey (see figure 1). in the sample period, inflation was subject to shocks from different sources and fluctuated around 11% annually on average. when the period after the change in the administrative structure of the country (transition from the parliamentary system to the presidential system) was carried out, with the referendum in 2018 excluded, this value was around 8% closer to the target set by the central bank of the republic of turkey (point target ∓ 2%). the highest inflation rate during the sample period was 26% in 2021:4. as of the end of 2019, it is seen that inflation has gotten out of control. this period corresponds to the term during which the effects of excessively expanding monetary aggregates as a result of the covid-19 pandemic that emerged at the beginning of 2020 began to show. when fluctuations in international energy prices, increases in agricultural product prices, especially wheat, and mistakes made in monetary policy (reducing the policy rate despite increasing inflationary pressure) were added to this process, the link between the inflation target and the actual inflation was broken (see figure 1). the lowest annual change in prices is the 4.4% increase in the 2011:1 quarter. this corresponds with the period when the decrease in oil prices was at its highest level. while the average change observed in domestic output over the sample period was an increase of 5.5%, the deepest economic contraction was the -14.4% decrease in production experienced in 2009:1 as a result of the 2008 global crisis. the fastest economic expansion is the approximate 21% increase in output in 2021:2 after the contraction observed due to the covid-19 pandemic. asian journal of economics and empirical research, 2022, 9(2): 150-165 152 © 2022 by the authors; licensee asian online journal publishing group figure 1. annual percentage change in price level and real domestic demand. the remainder of the study is organized as follows: chapter 2 gives a summary of the literature, chapter 3 discusses the methodological issues, chapter 4 deals with the var model estimation, chapter 5 discusses the estimation results, and finally, chapter 6 highlights the conclusions reached. 2. a short literature review many studies deal with the identification of unobservable shocks and the effect of these shocks on observed data. the basis of this approach is based on the study by blanchard and quah (1989), in which the bivariate svar model consisting of the production growth rate and the unemployment rate is used to determine the temporary and permanent components of production in the us economy. in this seminal study, the authors use two basic identification assumptions: demand shocks have no effect on output in the long run, and the variance-covariance matrix for structural shocks is diagonal (i.e., structural shocks are not correlated). according to the empirical evidence obtained, more than 80% of the observed variation in production in the short run is explained by demand shocks. it should be noted that there are many studies in which the proposed method was used in the aforementioned study [for an extensive review of the literature on this subject, see lutkepohl (2017), and for a short review of the recent empirical literature, see siklar and siklar (2022)]. in most of the applied studies, various identification constraints and parametric restrictions are used in the covariance matrix of structural shocks. cover, enders, and hueng (2006) propose an alternative to the blanchard and quah methodology through an equation system in which aggregate demand aggregate supply is used. they use the inflation series instead of the unemployment series and apply a decomposition method where the covariance of supply-demand shocks is nonzero (thus allowing for some correlation between structural shocks). the basic argument for enabling this correlation is that economic policymakers can take into account the past consequences of these shocks when they make policy decisions. using these criteria, a 54% correlation in the long term and a 70% correlation in the short term is determined between supply and demand shocks. the authors use these values to verify their assumptions. using a similar model to the aforementioned, enders and hurn (2007) estimate for australia with the addition of an aggregate supply equation and examine the effects of an external supply shock under the assumption that australia is a small open economy. in their study, the authors identified a 73% correlation between aggregate supply and aggregate demand shocks. another method in the estimation of the svar models is to impose sign restrictions on the impulse-response functions for the identification of structural shocks. for example, fry and pagan (2011) estimate two svar models with sign restrictions, the first of which is a supply-demand model in a market with partial equilibrium, and the second is a small-scale macroeconomic model. in both models, "given" sign matrices are used for creating orthogonal matrices to identify and distinguish supply and demand shocks. the authors use impulse-response functions consistent with the signs describing the demand shock (shocks with an adverse effect on price and quantity). the macroeconomic model includes the policy interest rate in addition to the price and output series. sign restrictions, according to the authors, are a useful strategy for identifying multiple shocks in an empirical analysis. similarly, ouliaris and pagan (2015) estimate the same model with two different methods. in the first of these, a large number of uncorrelated shocks are created, thus obtaining an equal number of impulse-response functions satisfying the sign restrictions. in the second method, some elements of the variance-covariance matrix are constrained and the model is simulated randomly to obtain a large number of impulse-response functions. the results obtained are quite close to each other, independent of the method. another advancement in evaluating the results of svar models is the use of historical variance decompositions. pagliacci (2016) estimates a sign-restricted svar model using data from the usa and some latin american countries and calculates the historical decomposition of output growth in response to supply and demand shocks. thus, depending on the dynamic effects of structural shocks on prices and output, two new indicators are presented to those who make monetary policy decisions. the findings show that more than half of the variation in output in five of the eight countries in the sample is due to supply shocks. on the other hand, it is also among the findings that a significant part of the variation in inflation in the short and long terms is explained by supply shocks. since there is a large amount of applied literature on the sources of inflation for both developed and developing countries, we only review the recent prominent studies which consider the subject from a point of view similar to ours. for instance, benkovskis, kulikov, paula, and ruud (2009), by using the backward-looking phillips curve model and var method for estimation, reach the conclusion that the output gap (cyclical demand) explains a large -0.2 -0.15 -0.1 -0.05 0 0.05 0.1 0.15 0.2 0.25 0.3 0.35 20 03 -q 1 20 03 -q 3 20 04 -q 1 20 04 -q 3 20 05 -q 1 20 05 -q 3 20 06 -q 1 20 06 -q 3 20 07 -q 1 20 07 -q 3 20 08 -q 1 20 08 -q 3 20 09 -q 1 20 09 -q 3 20 10 -q 1 20 10 -q 3 20 11 -q 1 20 11 -q 3 20 12 -q 1 20 12 -q 3 20 13 -q 1 20 13 -q 3 20 14 -q 1 20 14 -q 3 20 15 -q 1 20 15 -q 3 20 16 -q 1 20 16 -q 3 20 17 -q 1 20 17 -q 3 20 18 -q 1 20 18 -q 3 20 19 -q 1 20 19 -q 3 20 20 -q 1 20 20 -q 3 20 21 -q 1 20 21 -q 3 inflation target range inflation output growth asian journal of economics and empirical research, 2022, 9(2): 150-165 153 © 2022 by the authors; licensee asian online journal publishing group part of the long-run inflation in baltic countries. they also point out that supply shocks affect core inflation through expectations. barnett, bersch, and ojima (2012) use mongolian data for the 2002–2011 period and state that inflation is largely due to food prices and domestic demand pressures. by estimating a var model and forward-looking phillips curve, the authors found that changes in food prices as a result of agricultural supply shocks, high-level fiscal spending as a result of wage increases, and excess demand are the main determinants of the inflationary process in mongolia. mohanty and john (2015) studied inflation in india through a time-varying parameter (tvp) svar model and concluded that the price of crude oil and exchange rate from the supply side and the output gap from the demand side are predominant factors in the inflationary process. szafranek and hałka (2019) analyze polish inflation through an svar model estimated using bayesian techniques. they conclude that global demand and oil prices are the main factors affecting inflationary pressures in poland depending on both aggregated and disaggregated analyses. sharma and padhi (2021) employ the bayesian dynamic factor model to obtain a measure of demand-supply using sectoral outputs and input-output linkages in india. they conclude that supply is more persistent than demand while demand creates more volatility than supply in the inflationary process. they also find that the estimated demand-supply measure has more predictive power than conventional measures. depending on an estimated bayesian svar model, alonso, kataryniuk, and martínez-martín (2021) find that the recent increase in prices in the euro area basically stems from demand shocks, while negative supply shocks contribute to gradually increasing prices. they also state that the response of prices to demand shocks persists longer than that of supply shocks. yilmazkuday (2022) analyzes turkish inflation through an svar model estimated with monthly data for the 2005–2021 period. his results show that the volatility in inflation is explained to a great extent by oil prices and exchange rate movements in the long run. he also points out that conventional monetary policy, which contains policy rate increases following positive inflation and depreciation shocks, would be optimal to reach price stability in turkey. lopez and sepulveda (2022) use the two-stage least squares (2sls) and generalized method of moments (gmm) methods and find that domestic demand plays a very limited role in creating inflationary pressure in chile during the 2000–2021 period. based on a simulated var model, the study concludes that a large part of the domestic inflation in chile is due to foreign inflation. by using the phillips curve decomposition model, shapiro (2022a) and shapiro (2022b) show that recent inflation in the united states essentially stems from the supply-side factors reflecting labor shortages and global supply disruptions. he also states that this brings the possibility of a period of low economic growth and a high level of inflation. 3. methodology this section provides details on the methodology used to determine the sources of inflationary pressures in the turkish economy. the steps related to the method applied can be listed as follows: (i) identifying the variables that can be classified as supply shifting or demand shifting, (ii) estimating the multivariate var model and obtaining uncorrelated structural shocks, (iii) calculating the moving average vector (vma) for the svar model, (iv) determining the contribution of the structural shock for each variable classified as supply shifting and demand shifting, and (v) estimating the impulse-response functions and variance decompositions. 3.1. determination of variables shifting supply or demand 3.1.1. partial equilibrium the idea of variables shifting the domestic supply and demand curves arose from a partial equilibrium analysis. suppose there are κ time-isolated markets and they are indexed by κ = 1, 2, …, κ. for each market κ, pκ is the price of a basket of goods that brings together the goods and services in the economy, yκ is the quantity of these goods and services, and xκ is the vector of variables that reflect the characteristics of the market. the domestic demand function, 𝑑𝜅 𝑑(. ), for each κ market defines the quantity of goods and services that consumers are willing to buy, while the domestic supply function, 𝑠𝜅 𝑑(. ), defines the quantity of goods and services that firms want to sell in the market. both consumers and firms have price-taker identities in the market. on the other hand, both supply and demand are functions of the price (pκ). when domestic markets are in equilibrium, the realized transaction volume (yκ) is assumed as the equilibrium quantity. in other words, for all markets, price (pκ) is set to equalize domestic demand and supply: 𝑑𝜅 𝑑(𝑝𝜅; 𝑥𝜅) = 𝑠𝜅 𝑑(𝑝𝜅; 𝑥𝜅) = 𝑦𝜅 (1) for each κ market, the observable variables (for which the data is available) are equilibrium price (pκ) and equilibrium quantity (yκ). it is not possible to directly observe the demand [𝑑κ 𝑑(𝑝κ; 𝑥κ)] or supply [𝑠κ 𝑑(𝑝κ; 𝑥κ)] functions; it is only possible to observe equilibrium transactions and the other variables (xκ) that contribute to characterizing the market. when we try to identify these functions from the equilibrium transactions, the problem of simultaneity arises since the price and quantity are endogenously determined within the supply-demand system. the structural description of this simple supply-demand model is: domestic demand: 𝑑κ 𝑑(𝑝κ; 𝑥κ) = 𝛼𝑝 𝑑𝑝κ + 𝛼𝑥 𝑑𝑥κ ′ + 𝜀κ 𝑑 domestic supply: 𝑠κ 𝑑(𝑝κ; 𝑥κ) = 𝛼𝑝 𝑠𝑝κ + 𝛼𝑥 𝑠𝑥κ ′ + 𝜀κ 𝑠 equilibrium: 𝑑κ 𝑑(𝑝κ; 𝑥κ) = 𝑠κ 𝑑(𝑝κ; 𝑥κ) = 𝑦κ this system of equations can be simplified as: demand: 𝑦κ = 𝛼𝑝 𝑑𝑝κ + 𝛼𝑥 𝑑𝑥κ ′ + 𝜀κ 𝑑 (2) supply: 𝑦κ = 𝛼𝑝 𝑠𝑝κ + 𝛼𝑥 𝑠𝑥κ ′ + 𝜀κ 𝑠 (3) if we solve the structural equations given by equations 2 and 3 for pκ and yκ, we get the reduced form of the equation system as follows: 𝑝κ = 𝛾𝑥 𝑝 𝑥κ ′ + 𝜉κ 𝑝 (4) 𝑦κ = 𝛾𝑥 𝑦 𝑥κ ′ + 𝜉κ 𝑦 (5) asian journal of economics and empirical research, 2022, 9(2): 150-165 154 © 2022 by the authors; licensee asian online journal publishing group where: 𝛾𝑥 𝑝 = 𝛼𝑥 𝑠 − 𝛼𝑥 𝑑 𝛼𝑝 𝑑 − 𝛼𝑝 𝑠 𝛾𝑥 𝑦 = 𝛼𝑝 𝑠𝛾𝑥 𝑝 𝜉κ 𝑝 = 𝜀κ 𝑠 − 𝜀κ 𝑑 𝛼𝑝 𝑑 − 𝛼𝑝 𝑠 𝜉κ 𝑦 = 𝛼𝑝 𝑠𝜀κ 𝑝 if equations 4 and 5 are estimated separately, it will not be possible to obtain an efficient and consistent estimator of the structural parameters due to the identification problem arising from the simultaneous determination of equilibrium price and equilibrium quantity. however, it is not a strict requirement to obtain structural parameters to distinguish inflationary pressures arising from supply-side and demand-side factors. it will be sufficient to accurately estimate the contribution of each factor to the variation in inflation, depending on which of them affects supply and demand. if we assume that the vector of explanatory variables (xκ) can be split into three components, we have: 𝑥κ ′ = [𝑥κ 𝑑 𝑥κ 𝑠 𝑥κ 𝑐] where 𝑥κ 𝑑 denotes the variables that shift the domestic demand curve but do not affect the supply curve, 𝑥κ 𝑠 denotes the variables that shift the domestic supply curve but do not affect the domestic demand curve, and 𝑥κ 𝑐 denotes the control variables that can affect both the supply and demand curves. in the system given by the equations 4 and 5, if xκ is expanded according to the above definition, we have: 𝑝κ = 𝛾𝑥,𝑑 𝑝 (𝑥κ 𝑑) ′ + 𝛾𝑥,𝑠 𝑝 (𝑥κ 𝑠)′ + 𝛾𝑐,κ 𝑝 (𝑥κ 𝑐)′ + 𝜉κ 𝑝 (6) 𝑦κ = 𝛾𝑥,𝑑 𝑦 (𝑥κ 𝑑) ′ + 𝛾𝑥,𝑠 𝑦 (𝑥κ 𝑠)′ + 𝛾𝑐,κ 𝑦 (𝑥κ 𝑐)′ + 𝜉κ 𝑦 (7) the above equations can be estimated individually using ordinary least squares. however, the residual terms 𝜉κ 𝑝 and 𝜉κ 𝑦 are correlated and ignoring this may affect the marginal effects to be estimated. on the other hand, most of the consequences resulting from a shift in supply and/or demand will have lagging effects over time. however, we aim to analyze the dynamic effects of the variables that cause shifts in the supply and demand. therefore, we are not concerned with the estimation of a static model defined in equations 6 and 7 since only the average effects can be determined. the var approach is preferred as it controls the possible correlation between residual terms and allows dynamic analysis. however, the partial market equilibrium outlined above is useful because it clarifies what is to be understood from the variables that cause a shift in the supply and demand curves: i. variables that shift domestic demand: variables that cause price and quantity to move in the same direction. ii. variables that shift domestic supply: variables that cause opposite movements in price and quantity. 3.1.2. definitions of domestic demand and domestic supply the domestic demand and supply aggregates used in this study are obtained from the national accounting: 𝑌𝑡 = 𝐶𝑡 + 𝐺𝑡 + 𝐼𝑡 + 𝑋𝑡 − 𝑀𝑡 depending on this basic relationship, we can define the domestic demand and domestic supply as follows: 𝐷𝐷𝑡 = 𝐶𝑡 + 𝐺𝑡 + 𝐼𝑡 𝐷𝑆𝑡 = 𝑌𝑡 + 𝑀𝑡 − 𝑋𝑡 where dd and ds stand for domestic demand and domestic supply, respectively. in the equilibrium, we observe that: 𝑌𝑡 = 𝐷𝑆𝑡 = 𝐷𝐷𝑡 instead of real gross domestic product (gdp), the reason for using domestic demand to represent quantity is that domestic demand, like inflation, is more affected by import prices and less affected by export prices when compared with real gdp. 3.1.3. selection of variables shifting supply and demand to determine the variables that shift the supply or/and demand curves a series of unrestricted var models, three variables are estimated (price, quantity, and the variable considered to be shifting). in these models, the variable that is thought to be shifting is the most exogenous in the recursive causality ordering (wold, 1951), and the responses of domestic demand and inflation are analyzed in face of a shock in this most exogenous variable. it is concluded that if the average response of inflation and output is positive in the face of a positive shock in the candidate variable, this variable can be accepted as the variable that shifts the demand curve and can be used in the var model to obtain structural shocks. for example, international oil prices (oilt) can intuitively be thought of as a variable that shifts the supply curve. in other words, an increase in oil prices (as it will increase costs) may cause a contraction in domestic supply and thus an increase in inflation (π) and a decrease in output (y). it is expected that these dynamics will be determined from impulse-response functions obtained from unrestricted var models. the specification required for this example is as follows: 𝑜𝑖𝑙𝑡 = 𝜓1,1𝑜𝑖𝑙𝑡−1 + 𝜓1,2𝑦𝑡−1 + 𝜓1,3𝜋𝑡−1 + 𝜉𝑜𝑖𝑙,𝑡 𝑦𝑡 = 𝜓2,1𝑜𝑖𝑙𝑡−1 + 𝜓2,2𝑦𝑡−1 + 𝜓2,3𝜋𝑡−1 + 𝜉𝑦,𝑡 𝜋𝑡 = 𝜓3,1𝑜𝑖𝑙𝑡−1 + 𝜓3,2𝑦𝑡−1 + 𝜓3,3𝜋𝑡−1 + 𝜉𝜋,𝑡 the impulse-response functions obtained using the annual rate of change in each variable and the wold (1951) ordering are given in figure 2. asian journal of economics and empirical research, 2022, 9(2): 150-165 155 © 2022 by the authors; licensee asian online journal publishing group response of oil prices response of domestic output response of prices figure 2. responses of domestic output and price level to an oil price shock. as figure 2 clearly indicates, the average response of domestic output is negative, while inflation is positive. in other words, a positive shock in oil prices creates an adverse reaction in price and quantity, representing an inward shift in the supply curve. therefore, we can classify oil prices as a variable that shifts the supply curve. on the other hand, if the dynamic structure summarized above had created a reaction in the same direction on price and quantity, we would have to classify this variable as demand-shifting. this process was carried out for a wide set of variables, and 16 of them were selected and classified as supply and demand shifting variables as follows: demand-shifting variables: autonomous consumption expenditures (acot), government consumption expenditures (govt), total investment expenditures (invt), loans to the private sector (pcrt), foreign credits (fcrt), and money supply (ms1t). supply-shifting variables: import prices (ipit), international oil prices (oilt), international natural gas prices (gast), international energy prices (enrt), domestic energy prices (dent), and productivity (prot). control variables (that shift both supply and demand): short-term interest rate (intt), nominal usd/tl exchange rate (nfxt), real foreign exchange rate (rfxt), and wages (wagt). among these, nine variables that meet the criteria in the impulse-response analysis summarized above are as follows: government consumption expenditures (govt), loans to the private sector (pcrt), and money supply (ms1t) as demand shifting variables; import prices (ipit), international oil prices (oilt), international natural gas prices (gast), and productivity (prot) as supply shifting variables; nominal foreign exchange rate (nfxt) and wages (wagt) as control variables. as noted earlier, domestic demand is used to represent output, and the consumer price index is used to represent prices. thus, there are 11 variables to be used in the var model. 3.2. multivariate var model 3.2.1. var model in reduced form the multivariate var model, which includes the variables that are likely to shift supply and demand and measures related to quantity (domestic demand) and prices will be estimated in reduced form. it is necessary to obtain sufficient results in terms of having the statistical properties (including stable, normal, homoscedastic, and unautocorrelated residuals) required for decision-making. following hamilton (1994), if the general specification of a pth-order var is denoted as var(1), we have: 𝜁𝑡 = 𝛤𝜁𝑡−1 + 𝜉𝑡 (8) where: 𝐸(𝜉𝑡𝜉𝜏 ′) = { 𝛺 𝑓𝑜𝑟 𝑡 = 𝜏 0 𝑜𝑡ℎ𝑒𝑟 𝑤𝑖𝑠𝑒 and 𝛺 = [ 𝜔 0 … 0 0 0 … 0 : : … : 0 0 … 0 ] in this notation, 𝜁𝑡 denotes the vector of matrices containing the data without mean, γ denotes the coefficients matrix, and ω denotes the variance-covariance matrix of the residual terms. according to general usage, the data series included in ζt is the deviation from the steady-state value. according to hamilton (1994), this is equivalent to subtracting the unconditional expected value from the data: 𝜇 = (𝐼𝑛 − 𝛷1 − 𝛷2 − ⋯− 𝛷𝑝) −1 𝑐. if the data studied is relatively short, subtracting the sample mean is a reasonable approach. thus, the system given in equation 8 can be estimated with ordinary least squares, and the residual term series (ξt) and ω matrix can be obtained. -0.05 0 0.05 0.1 0.15 0.2 0.25 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 -0.02 -0.015 -0.01 -0.005 0 0.005 0.01 0.015 0.02 0.025 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 -0.03 -0.025 -0.02 -0.015 -0.01 -0.005 0 0.005 0.01 0.015 0.02 0.025 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 asian journal of economics and empirical research, 2022, 9(2): 150-165 156 © 2022 by the authors; licensee asian online journal publishing group 3.2.2. structural innovations: the svar model the only constraint to be imposed on the innovations that will be considered structural is that they are not correlated with each other. to impose this property to the residual terms obtained by the estimation of the reduced form var model, we need to obtain the matrix h to diagonalize the ω matrix: 𝐻ω𝐻′ = 𝐷 where d is a diagonal matrix. therefore, using the residual terms and the h matrix, we obtain the structural shocks ςt: 𝜍𝑡 = 𝐻𝜉𝑡 ( 9) satisfying the orthogonality condition: 𝐸(𝜍𝑡𝜍𝑡 ′) = 𝐸(𝐻𝜉𝑡𝜉𝑡 ′𝐻′) = 𝐷 3.2.3. moving average (vma) representation of svar model the vector moving average representation is calculated for structural innovations since structural shocks are not observable and are difficult to interpret. the purpose of this calculation is to see the contribution of each structural shock in the formation of variations in inflation. by recursively iterating the stationary var model, it is possible to obtain the moving average representation: 𝑦𝑡+𝑠 = 𝜇 + 𝜉𝑡+𝑠 + 𝜓1𝜉𝑡+𝑠−1 + 𝜓2𝜉𝑡+𝑠−2 + ⋯+ 𝜓𝑠−1𝜉𝑡+1 + 𝛤11 (𝑠)(𝑦𝑡 − 𝜇) + 𝛤12 (𝑠)(𝑦𝑡 − 𝜇) + ⋯+ 𝛤1𝑝 (𝑠) (𝑦𝑡−𝑝+1 − 𝜇) (10) where 𝜓𝑗 = 𝛤11 (𝑗) is the upper left block of 𝛤𝑗. the moving average representation of innovations is obtained through (9), which defines the structural shocks, and (10): 𝑦𝑡+𝑠 = 𝜇 + 𝜍𝑡+𝑠 + 𝐽1𝜍𝑡+𝑠−1 + 𝐽2𝜍𝑡±𝑠−2 + ⋯+ 𝐽𝑠−1𝜍𝑡−1 + 𝛤11 (𝑠)(𝑦𝑡 − 𝜇) + 𝛤12 (𝑠)(𝑦𝑡 − 𝜇) + ⋯+ 𝛤1𝑝 (𝑠) (𝑦𝑡−𝑝+1 − 𝜇) (11) where 𝐽𝑠 ≡ 𝜓𝑠𝐻 −1 and includes the contribution (or weight) of each structural innovation to create the level of series in the yt matrix. this method transforms structural shocks that are difficult to observe and understand into their contributions to the observable variable, thus simplifying the understanding and interpretation of structural shocks. this is a great advantage when examining results or making policy recommendations. 4. estimation of the var model using the method outlined in the previous section, a var model is estimated with eleven variables and with a two-period lag determined according to traditional information criteria (see appendix 3). quarterly data covering the period from 2003:1–2021:4 was used for the estimation. all variables are included in the var model with the annual rate of change and, according to unit root tests, all of them satisfy the stationarity conditions (see appendix 2). these variables are as follows: import price index (ipi), brent oil price index (oil), natural gas price index (gas), nominal usd/tl exchange rate (nfx), government consumption expenditures (gov), wage index (wag), productivity index (pro), loans to the private sector (pcr), narrowly defined money supply (ms1), domestic output (dmd), and inflation (cpi). detailed definitions and sources of the data regarding these listed variables and other previously covered variables are given in appendix 1. the estimated model is defined in equation 8 where: 𝜁𝑡 = [ 𝑦𝑡−1 − 𝜇 𝑦𝑡−2 − 𝜇] ; 𝑦𝑡 = [ 𝑖𝑝𝑖𝑡 − 𝜇𝑖𝑝𝑖 𝑜𝑖𝑙𝑡 − 𝜇𝑜𝑖𝑙 𝑔𝑎𝑠𝑡 − 𝜇𝑔𝑎𝑠 𝑛𝑓𝑥𝑡 − 𝜇𝑛𝑓𝑥 𝑔𝑜𝑣𝑡 − 𝜇𝑔𝑜𝑣 𝑤𝑎𝑔𝑡 − 𝜇𝑤𝑎𝑔 𝑝𝑟𝑜𝑡 − 𝜇𝑝𝑟𝑜 𝑝𝑐𝑟𝑡 − 𝜇𝑝𝑐𝑟 𝑚𝑠1𝑡 − 𝜇𝑚𝑠1 𝑑𝑚𝑑𝑡 − 𝜇𝑑𝑚𝑑 𝑐𝑝𝑖𝑡 − 𝜇𝑐𝑝𝑖 ] ; 𝜉𝑡 = [ 𝜉𝑡 𝑖𝑝𝑖 𝜉𝑡 𝑜𝑖𝑙 𝜉𝑡 𝑔𝑎𝑠 𝜉𝑡 𝑛𝑓𝑥 𝜉𝑡 𝑔𝑜𝑣 𝜉𝑡 𝑤𝑎𝑔 𝜉𝑡 𝑝𝑟𝑜 𝜉𝑡 𝑝𝑐𝑟 𝜉𝑡 𝑚𝑠1 𝜉𝑡 𝑑𝑚𝑑 𝜉𝑡 𝑐𝑝𝑖 ] this model meets the statistical properties necessary for inference: stability, normality, homoscedasticity, and no correlation in error terms (see appendix 4). structural shocks (ςt) are obtained using the residual terms vector (ξt) based on the reduced form estimation of this model, and the diagonalization is described in section 3.2. for the diagonalization, the recursive ordering is: ipit, oilt, gast, nfxt, govt, wagt, prot, pcrt, ms1t, dmdt, and cpit, where the most exogenous variable comes first, and the most endogenous variable (inflation in this case) comes last. the structural shocks obtained for each of the 11 series that make up the var are given in figure 3. asian journal of economics and empirical research, 2022, 9(2): 150-165 157 © 2022 by the authors; licensee asian online journal publishing group figure 3. structural shocks of the model variables. to better understand their effects on inflation, the contribution of structural shocks belonging to all observable variables in the var model has been calculated in the context of price dynamics and aggregated as supply, demand, -0.25 -0.2 -0.15 -0.1 -0.05 0 0.05 0.1 -4 -3 -2 -1 0 1 2 20 04 q 3 20 05 q 2 20 06 q 1 20 06 q 4 20 07 q 3 20 08 q 2 20 09 q 1 20 09 q 4 20 10 q 3 20 11 q 2 20 12 q 1 20 12 q 4 20 13 q 3 20 14 q 2 20 15 q 1 20 15 q 4 20 16 q 3 20 17 q 2 20 18 q 1 20 18 q 4 20 19 q 3 20 20 q 2 20 21 q 1 20 21 q 4 shock dlipi -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 -2.5 -2 -1.5 -1 -0.5 0 0.5 1 1.5 2 20 03 q 3 20 04 q 3 20 05 q 3 20 06 q 3 20 07 q 3 20 08 q 3 20 09 q 3 20 10 q 3 20 11 q 3 20 12 q 3 20 13 q 3 20 14 q 3 20 15 q 3 20 16 q 3 20 17 q 3 20 18 q 3 20 19 q 3 20 20 q 3 20 21 q 3 shock dloil -0.6 -0.4 -0.2 0 0.2 0.4 0.6 -3 -2 -1 0 1 2 3 20 03 q 3 20 04 q 2 20 05 q 1 20 05 q 4 20 06 q 3 20 07 q 2 20 08 q 1 20 08 q 4 20 09 q 3 20 10 q 2 20 11 q 1 20 11 q 4 20 12 q 3 20 13 q 2 20 14 q 1 20 14 q 4 20 15 q 3 20 16 q 2 20 17 q 1 20 17 q 4 20 18 q 3 20 19 q 2 20 20 q 1 20 20 q 4 20 21 q 3 shock dlgas -0.15 -0.1 -0.05 0 0.05 0.1 0.15 0.2 0.25 0.3 -2 -1 0 1 2 3 4 20 03 q 3 20 04 q 3 20 05 q 3 20 06 q 3 20 07 q 3 20 08 q 3 20 09 q 3 20 10 q 3 20 11 q 3 20 12 q 3 20 13 q 3 20 14 q 3 20 15 q 3 20 16 q 3 20 17 q 3 20 18 q 3 20 19 q 3 20 20 q 3 20 21 q 3 shock dlnfx -0.1 -0.05 0 0.05 0.1 0.15 -3 -2 -1 0 1 2 3 20 03 q 3 20 04 q 3 20 05 q 3 20 06 q 3 20 07 q 3 20 08 q 3 20 09 q 3 20 10 q 3 20 11 q 3 20 12 q 3 20 13 q 3 20 14 q 3 20 15 q 3 20 16 q 3 20 17 q 3 20 18 q 3 20 19 q 3 20 20 q 3 20 21 q 3 shock dlgov -0.2 -0.15 -0.1 -0.05 0 0.05 0.1 0.15 0.2 -4 -2 0 2 4 20 03 q 3 20 04 q 3 20 05 q 3 20 06 q 3 20 07 q 3 20 08 q 3 20 09 q 3 20 10 q 3 20 11 q 3 20 12 q 3 20 13 q 3 20 14 q 3 20 15 q 3 20 16 q 3 20 17 q 3 20 18 q 3 20 19 q 3 20 20 q 3 20 21 q 3 shock dlwag -0.1 -0.08 -0.06 -0.04 -0.02 0 0.02 0.04 0.06 -2.5 -2 -1.5 -1 -0.5 0 0.5 1 1.5 2 20 03 q 3 20 04 q 3 20 05 q 3 20 06 q 3 20 07 q 3 20 08 q 3 20 09 q 3 20 10 q 3 20 11 q 3 20 12 q 3 20 13 q 3 20 14 q 3 20 15 q 3 20 16 q 3 20 17 q 3 20 18 q 3 20 19 q 3 20 20 q 3 20 21 q 3 shock dlpro -0.1 -0.05 0 0.05 0.1 0.15 0.2 0.25 -3 -2 -1 0 1 2 3 20 03 q 3 20 04 q 3 20 05 q 3 20 06 q 3 20 07 q 3 20 08 q 3 20 09 q 3 20 10 q 3 20 11 q 3 20 12 q 3 20 13 q 3 20 14 q 3 20 15 q 3 20 16 q 3 20 17 q 3 20 18 q 3 20 19 q 3 20 20 q 3 20 21 q 3 shock dlpcr -0.1 0 0.1 0.2 0.3 0.4 0.5 0.6 -3 -2 -1 0 1 2 3 4 5 20 03 q 3 20 04 q 2 20 05 q 1 20 05 q 4 20 06 q 3 20 07 q 2 20 08 q 1 20 08 q 4 20 09 q 3 20 10 q 2 20 11 q 1 20 11 q 4 20 12 q 3 20 13 q 2 20 14 q 1 20 14 q 4 20 15 q 3 20 16 q 2 20 17 q 1 20 17 q 4 20 18 q 3 20 19 q 2 20 20 q 1 20 20 q 4 20 21 q 3 shock dlms1 -0.15 -0.1 -0.05 0 0.05 0.1 0.15 0.2 -2.5 -2 -1.5 -1 -0.5 0 0.5 1 1.5 2 2.5 20 03 q 3 20 04 q 3 20 05 q 3 20 06 q 3 20 07 q 3 20 08 q 3 20 09 q 3 20 10 q 3 20 11 q 3 20 12 q 3 20 13 q 3 20 14 q 3 20 15 q 3 20 16 q 3 20 17 q 3 20 18 q 3 20 19 q 3 20 20 q 3 20 21 q 3 shock dldmd 0 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09 -3 -2 -1 0 1 2 3 20 03 q 3 20 04 q 3 20 05 q 3 20 06 q 3 20 07 q 3 20 08 q 3 20 09 q 3 20 10 q 3 20 11 q 3 20 12 q 3 20 13 q 3 20 14 q 3 20 15 q 3 20 16 q 3 20 17 q 3 20 18 q 3 20 19 q 3 20 20 q 3 20 21 q 3 shock dlcpi asian journal of economics and empirical research, 2022, 9(2): 150-165 158 © 2022 by the authors; licensee asian online journal publishing group and other factors. figure 4 shows the absolute contribution of structural shocks to inflation (formation of the inflation series), while figure 5 displays the relative contribution of these shocks to inflation. figure 4. aggregated contribution of structural shocks to inflation. figure 5. relative contributions of structural shocks to inflation. this reconstruction of inflation data allows us to interpret structural shocks in the context of determining their contribution to inflation dynamics. in other words, it becomes possible to identify the sources of variation in inflation as part of observable variables. since this reconstruction allows for comparison of the sources of variation identified by the model, it will aid in making recommendations to monetary policymakers. approximately 1% of the inflation shock, which had an average of 2.5% in the sample period, is caused by shocks in supply-side factors, 1% by shocks in demand-side factors, and approximately 0.5% by shocks in control variables. in relative terms, approximately 42% of the inflation shocks in the sample period are caused by shocks in supply-side factors, 40% by shocks in demand-side factors, and 18% by shocks in control variables. the import price index, oil prices, and gas prices from the supply-side factors, money supply from the demand-side factors, and the nominal exchange rate from the control variables stand out as the determining variables in this process. when the inflation shocks in the last part of the sample period (2019–2021) are analyzed, supply-side factors come to the fore, while the contribution of demand-side factors and control variables to inflation remains limited or in the opposite (reducing) direction. undoubtedly, the most important factor in this process is the increase in international oil and gas prices since 2017. the oil price index, which was approximately 104 at the end of 2016, and the natural gas price index, which was 105 at the end of 2016, increased to 177 and 724, respectively, at the end of 2021. this process also includes the effect of restrictions during the pandemic period. the contribution of demand-side factors to inflation shocks was negative in the five quarters of this sub-period. although the benefits of the analysis with such a separation are quite high, it should be noted that the identification of shocks always depends on a good specification of the model. for this reason, these findings should be supported by other indicators to be obtained from the var model. these var model outputs are discussed in the next section. 5. estimation results it can be said that the model estimated in the previous section does not have a serious statistical problem with the specification because the errors pass the statistical tests successfully (see appendix 4) and because figure 6 below shows that the model fits well with the data. the parameter estimates (γ matrix) and the variancecovariance matrix (ω) for the model are given in appendix 5 at the end of the study. in this section, the results of the two most used outputs of the models, impulse-response functions and variance decompositions, are evaluated. -0.15 -0.1 -0.05 0 0.05 0.1 0.15 20 03 q 3 20 04 q 1 20 04 q 3 20 05 q 1 20 05 q 3 20 06 q 1 20 06 q 3 20 07 q 1 20 07 q 3 20 08 q 1 20 08 q 3 20 09 q 1 20 09 q 3 20 10 q 1 20 10 q 3 20 11 q 1 20 11 q 3 20 12 q 1 20 12 q 3 20 13 q 1 20 13 q 3 20 14 q 1 20 14 q 3 20 15 q 1 20 15 q 3 20 16 q 1 20 16 q 3 20 17 q 1 20 17 q 3 20 18 q 1 20 18 q 3 20 19 q 1 20 19 q 3 20 20 q 1 20 20 q 3 20 21 q 1 20 21 q 3 supply demand other inflation -60% -40% -20% 0% 20% 40% 60% 80% 100% 20 03 q 3 20 04 q 1 20 04 q 3 20 05 q 1 20 05 q 3 20 06 q 1 20 06 q 3 20 07 q 1 20 07 q 3 20 08 q 1 20 08 q 3 20 09 q 1 20 09 q 3 20 10 q 1 20 10 q 3 20 11 q 1 20 11 q 3 20 12 q 1 20 12 q 3 20 13 q 1 20 13 q 3 20 14 q 1 20 14 q 3 20 15 q 1 20 15 q 3 20 16 q 1 20 16 q 3 20 17 q 1 20 17 q 3 20 18 q 1 20 18 q 3 20 19 q 1 20 19 q 3 20 20 q 1 20 20 q 3 20 21 q 1 20 21 q 3 supply demand other asian journal of economics and empirical research, 2022, 9(2): 150-165 159 © 2022 by the authors; licensee asian online journal publishing group figure 6. actual and estimated inflation shocks. among the impulse-response functions obtained by the estimation of the model, the functions that show the response of inflation in the face of a positive shock in the variables included in the model are given in figure 7. response to an import price shock response to an oil price shock response to a gas price shock response to a nominal fx shock response to a government expenditure shock response to a wage shock response to a productivity shock response to a private credit shock -0.03 -0.02 -0.01 0 0.01 0.02 0.03 0.04 0.05 0.06 0.07 2 0 0 5 q 1 2 0 0 5 q 3 2 0 0 6 q 1 2 0 0 6 q 3 2 0 0 7 q 1 2 0 0 7 q 3 2 0 0 8 q 1 2 0 0 8 q 3 2 0 0 9 q 1 2 00 9q 3 2 0 1 0 q 1 2 0 1 0 q 3 2 0 1 1 q 1 2 0 1 1 q 3 2 0 1 2 q 1 2 0 1 2 q 3 2 0 1 3 q 1 2 0 1 3 q 3 2 0 1 4 q 1 2 0 1 4 q 3 2 0 1 5 q 1 2 0 1 5 q 3 2 0 1 6 q 1 2 0 1 6 q 3 2 0 1 7 q 1 2 0 1 7 q 3 2 0 1 8 q 1 2 0 1 8 q 3 2 0 1 9 q 1 2 0 1 9 q 3 2 02 0q 1 2 0 2 0 q 3 2 0 2 1 q 1 2 0 2 1 q 3 mdlcpi mdlcpi_f -0.005 0 0.005 0.01 0.015 0.02 1 2 3 4 5 6 7 8 9 10 -0.02 -0.01 0 0.01 0.02 0.03 0.04 1 2 3 4 5 6 7 8 9 10 -0.005 0 0.005 0.01 0.015 0.02 0.025 1 2 3 4 5 6 7 8 9 10 -0.006 -0.004 -0.002 0 0.002 0.004 0.006 0.008 0.01 0.012 0.014 1 2 3 4 5 6 7 8 9 10 -0.004 -0.003 -0.002 -0.001 0 0.001 0.002 0.003 0.004 0.005 0.006 1 2 3 4 5 6 7 8 9 10 -0.004 -0.002 0 0.002 0.004 0.006 0.008 0.01 0.012 1 2 3 4 5 6 7 8 9 10 -0.01 -0.008 -0.006 -0.004 -0.002 0 0.002 0.004 1 2 3 4 5 6 7 8 9 10 -0.008 -0.006 -0.004 -0.002 0 0.002 0.004 0.006 1 2 3 4 5 6 7 8 9 10 asian journal of economics and empirical research, 2022, 9(2): 150-165 160 © 2022 by the authors; licensee asian online journal publishing group response to a money supply shock figure 7. response of inflation to the positive shocks in the model’s variables. first of all, the response of inflation to a positive shock in the model variables is in line with our theoretical expectations for all variables. except for the shocks in private sector loans, public expenditures, and oil prices, the responses of inflation to shocks in all other variables are statistically significant. therefore, the results related to the variables whose statistical validity will be questioned should be considered instructive. positive shocks in import prices and gas prices, which are determined as the factors that cause the supply curve to shift in this study, create a permanent increase in inflation, and this effect spreads over the long term. this situation is considered an indicator of the dependence of domestic production on imports and as a result of the use of natural gas as the main energy source in production. while oil prices have a similar effect, it gradually decreases in the long run. the effect of positive productivity shocks, another factor that shifts supply, on prices is negative but limited. the response of inflation to a positive shock in public expenditures and loans to the private sector, which are included in the model as factors shifting the demand curve, are positive and in line with theoretical expectations, although they are not statistically significant. considering that the money supply may also reflect the reaction of the loans to the private sector, it can be stated that it is the most important variable in the model that causes the demand curve to shift. a positive shock in the money supply creates a permanent and long-term effect on inflation. when evaluated in terms of the shifting of the demand curve, money supply shocks emerge as the most important factor that creates statistically significant effect on inflation. the positive shocks in the nominal exchange rate and wages, which are included as control variables in the model because they affect both supply and demand, put upward pressure on inflation. the impact of shocks in these variables on inflation is long-lasting and permanent. when we check the response of domestic demand (used to represent quantity) to the shocks in these two control variables, both factors decrease supply in the short run (cost effect), but demand increases due to the wealth effect (exchange rate increase) and the income effect (wage increase) in the long run (see figure 8). however, the magnitude of this response cannot be evaluated due to its statistical insignificance. considering that the result obtained is instructive, it is revealed that monetary policy will undertake an extremely important function in tempering inflationary pressure. response of quantity to an fx shock response of quantity to a wage shock figure 8. response of domestic demand to shocks in exchange rate and wages. combined with the situation shown by the decomposition in structural shocks, this result shows that inflation in turkey changes in the short run with the determinant of supply-side factors. a similar result is obtained from the variance decomposition functions (see figure 9 panel a). accordingly, on average, 53% of the variation in inflation is due to supply factors, 13% is due to demand factors, 20% is due to control variables, and 14% is due to inflation itself. a long horizon of 20 quarters was preferred in this decomposition and the same aggregation criteria were used in the analysis of structural shocks. a. decomposition of inflation b. contributions of supply-side variables -0.005 0 0.005 0.01 0.015 0.02 1 2 3 4 5 6 7 8 9 10 -0.02 -0.015 -0.01 -0.005 0 0.005 0.01 0.015 1 2 3 4 5 6 7 8 9 10 -0.025 -0.02 -0.015 -0.01 -0.005 0 0.005 0.01 0.015 0.02 0.025 1 2 3 4 5 6 7 8 9 10 0% 20% 40% 60% 80% 100% 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 supply demand other inflation 0% 20% 40% 60% 80% 100% 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 import prices oil prices gas prices productivity asian journal of economics and empirical research, 2022, 9(2): 150-165 161 © 2022 by the authors; licensee asian online journal publishing group c. contributions of demand-side variables d. contributions of control variables figure 9. variance decomposition of inflation. when the b, c, and d panels of figure 9, which show the individual contributions of the variables included in the model, are examined, it is clearly seen that the main variables that determine the contribution of supply to the variation in inflation are import prices and gas prices, the main variable that determines the contribution of demand is money supply, and the main variable that determines the contribution of control variables is the exchange rate. 6. conclusion knowing whether inflationary pressures are caused by supply or demand is key information for successful monetary policy implementation. however, determining the source of these pressures is not so easy in practice as the data on inflation and output are equilibrium observations, and these values are determined simultaneously with the supply and demand interaction, and their functional forms are not known directly. to explain the inflation series in the context of the forces determining the dynamics, a method based on the svar model and its moving average presentation is proposed in this study. this method allows us to identify the sources of variability in the inflationary process and interpret them directly in the context of observable variables. the method used produces statistically significant and economically consistent results for the 2003–2021 inflationary period in turkey. positive shocks in import and gas prices, which are determined in this study as the factors that cause the supply curve to shift, create a permanent increase in inflation, and this effect spreads over the long term. this situation is considered an indicator of the dependence of domestic production on imports and as a result of the use of natural gas as the main energy source in production. when evaluated in terms of the shifting of the demand curve, money supply shocks emerge as the most important factor that creates a statistically significant effect on inflation. the positive shocks in the nominal exchange rate and wages, which are included as control variables in the model because they affect both supply and demand, put upward pressure on inflation. the impact of shocks in these variables on inflation is long-lasting and permanent. when we check the response of domestic demand (used to represent quantity) to the shocks in these two control variables, both factors decrease supply in the short run (cost effect), but demand increases due to the wealth effect (exchange rate increase) and income effect (wage increase) in the long run. considering that the result obtained is instructive, it is revealed that monetary policy will undertake an extremely important function in tempering the inflationary pressure in turkey. combined with the situation shown by the decomposition in structural shocks, this result shows that inflation in turkey changes in the short run with the determinant of supply-side factors. variance decompositions of inflation also produce evidence supporting this conclusion. the results show that the method used will be useful in separating the factors that create pressure in the inflationary process, which has recently gotten out of control in turkey and is gradually moving away from the targeted inflation. references alonso, i., kataryniuk, i., & martínez-martín, j. (2021). the impact of supply and demand shocks on recent economic development s and prices. economic bulletin, 4(2021), 28-30. barnett, s., bersch, j., & ojima, y. (2012). inflation dynamics in mongolia: understanding the roller coaster. imf working paper, no. wp/12/92. benkovskis, k., kulikov, d., paula, d., & ruud, l. (2009). inflation in the baltic countries. bank of estonia, kroon & economy, 1(2), 6-54. blanchard, o., & quah, d. (1989). the dynamic effects of aggregate demand and supply disturbances. american economic review, 79(4), 655673. cover, j. p., enders, w., & hueng, c. j. (2006). using the aggregate demand-aggregate supply model to identify structural demand-side and supply-side shocks: results using a bivariate var. journal of money, credit, and banking, 38(3), 777-790.available at: https://doi.org/10.1353/mcb.2006.0041. enders, w., & hurn, s. (2007). identifying aggregate demand and supply shocks in a small open economy. oxford economic papers, 59(3), 411-429.available at: https://doi.org/10.1093/oep/gpl029. fry, r., & pagan, a. (2011). sign restrictions in structural vector autoregressions: a critical review. journal of economic literature, 49(4), 938-960.available at: https://doi.org/10.1257/jel.49.4.938. hamilton, j. (1994). time series analysis (vol. 2). princeton: princeton university press. lopez, r., & sepulveda, k. (2022). what is the effect of domestic demand shocks on inflation in a small open economy? chile 2000-2021. university of chile department of economics working paper no. std533. lutkepohl, h. (2017). estimation of structural vector autoregressive models. communications for statistical applications and methods, 24(5), 421-441.available at: https://doi.org/10.5351/csam.2017.24.5.421. mohanty, d., & john, j. (2015). determinants of inflation in india. journal of asian economics, 36(1), 86-96.available at: https://doi.org/10.1016/j.asieco.2014.08.002. moura, m., lima, a., & mendonca, r. (2008). exchange rate and fundamentals: the case of brazil. applied economics, 12(3), 395416.available at: https://doi.org/10.1590/s1413-80502008000300003. ouliaris, s., & pagan, a. (2015). a new method for working with sign restrictions in svars. australian national center for econometric research working paper #105. pagliacci, c. (2016). are we ignoring supply shocks? a proposal for monitoring cyclical fluctuations. empirical economics, 56(2), 445467.available at: https://doi.org/10.1007/s00181-017-1371-x. shapiro, a. h. (2022a). how much do supply and demand drive inflation? frbsf economic letter, 2022(15), 1-06. shapiro, a. (2022b). a simple framework to monitor inflation. federal reserve bank of san francisco working paper no. 29. 0% 20% 40% 60% 80% 100% 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 gov.exp. prv.credits money supply 0% 20% 40% 60% 80% 100% 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 nom.fx wage asian journal of economics and empirical research, 2022, 9(2): 150-165 162 © 2022 by the authors; licensee asian online journal publishing group sharma, s., & padhi, i. (2021). an alternative perspective on demand and supply to forecast inflation. reserve bank of india, working paper no. wps(depr) 06/2021. siklar, e., & siklar, i. (2022). uncertainty and monetary policy: a svar analysis for turkey. international journal of economics, business and management research, 6(7), 31-53.available at: https://doi.org/10.51505/ijebmr.2022.6704. szafranek, k., & hałka, a. (2019). determinants of low inflation in an emerging, small open economy through the lens of aggregated and disaggregated approach. emerging markets finance and trade, 55(13), 3094-3111.available at: https://doi.org/10.1080/1540496x.2018.1541793. wold, h. (1951). dynamic systems of the recursive type: economic and statistical aspects. indian journal of statistics, 11(3-4), 205-216. yilmazkuday, h. (2022). drivers of turkish inflation. the quarterly review of economics and finance, 84, 315-323.available at: http://dx.doi.org/10.1016/j.qref.2022.03.005. appendix the sample covers the 2003:i–2021:iv period, and all the data are quarterly. all the data are seasonally adjusted (except the short-term interest rate, nominal exchange rate, and real exchange rate) by using the x12 methodology and then transformed into logarithms (except the short-term interest rate). since the autonomous consumption expenditures are not observable, the time series is obtained by estimating the consumption function of ct = c0 + β1yt + β2yt-1 + εt with rolling regressions for the 1987:1–2021:4 period, where c, c0, and y indicate logs of real private consumption expenditures, real autonomous consumption expenditures, and real gdp, respectively. there is no productivity index data in turkey for the entire period examined. therefore, the productivity index was calculated using the method used by moura, lima, and mendonca (2008). accordingly, productivity in tradable sectors was calculated as the inverse of the producer price index (ppi), and productivity in non-tradable sectors was calculated as the inverse of the consumer price index (cpi). productivity ratios were then obtained by dividing the productivity into the tradable sectors by the productivity in the non-tradable sectors. these ratios were converted into an index by taking the initial value of 100. appendix 1. definition and sources of the data. symbol explanation source y real gross domestic product turkstat1 con real private consumption expenditures turkstat aco autonomous consumption expenditures our estimation gov real government consumption expenditures turkstat inv real total investment expenditures turkstat exp real export volume turkstat imp real import volume turkstat pcr private sector credits cbrt edds2 fcr international credit volume cbrt edds ms1 narrowly defined money stock cbrt edds ipi import price index cbrt edds oil international brent petroleum price index fred3 gas the international natural gas price index fred enr the international energy price index fred den the domestic energy price index cbrt edds pro productivity own calculation int short-term interest rate cbrt edds nfx nominal usd/tl exchange rate cbrt edds rfx real effective exchange rate (cpi-based) cbrt edds wag manufacturing industry average wage cost index turkstat dmd domestic demand own calculation cpi consumer price index turkstat ppi producer price index turkstat notes: 1 refers to the turkish statistical institution. 2 refers to the electronic data delivery system of the central bank of the republic of turkey. 3 refers to the digital database of the federal reserve bank of st. louis. appendix 2. unit root tests. variable traditional unit root tests break point unit root test augmented dickey–fuller test phillips–perron test dickey–fuller min t-test lag** tstatistic prob. tstatistic prob. lag tstatistic prob. demand side variables aco 9 0.22 0.92 1.35 0.59 6 3.41* 0.99 δaco 8 3.11 0.02 5.03 0.00 0 5.82 0.00 gov 3 0.52 0.88 0.94 0.76 3 1.58 0.99 δgov 2 8.24 0.00 24.33 0.00 0 14.81 0.00 inv 3 2.91* 0.16 2.39* 0.37 4 3.88* 0.59 δinv 0 7.60 0.00 7.76 0.00 0 8,97 0.00 pcr 4 2.08* 0.54 1.29 0.88 6 3.92* 0.57 δpcr 5 3.62* 0.03 6.43 0.00 0 7.27* 0.00 fcr 2 2.01 0.27 0.04 0.66 1 1.69 0.97 δfcr 8 5.12 0.00 21.80 0.00 0 12.61 0.00 ms1 0 0.03 0.95 0.00 0.95 4 2.55 0.88 δms1 6 3.66 0.02 7.63 0.00 0 7.83 0.00 http://dx.doi.org/10.1016/j.qref.2022.03.005 asian journal of economics and empirical research, 2022, 9(2): 150-165 163 © 2022 by the authors; licensee asian online journal publishing group supply side variables ipi 1 2.48* 0.33 2.30* 0.42 1 3.54* 0.79 δipi 2 4.75 0.00 4.60 0.00 0 6.34 0.00 oil 1 2.50* 0.32 2.41* 0.36 1 4.13* 0.43 δoil 0 7.25 0.00 7.14 0.00 0 8.77 0.00 gas 1 2.94* 0.15 2.08* 0.54 3 3.83* 0.62 δgas 0 3.53 0.00 3.69 0.00 0 6.57 0.00 enr 1 2.55* 0.30 2.48* 0.33 2 3.79* 0.65 δenr 0 6.12 0.00 6.15 0.00 0 7.58 0.00 den 1 1.12 0.99 1.40 0.99 0 0.92 0.99 δden 0 6.86 0.00 6.87 0.00 0 7.72 0.00 pro 4 1.47 0.99 2.12 0.99 3 1.96 0.98 δpro 3 1.86 0.05 4.84 0.00 0 7.25 0.00 control variables int 4 2.05* 0.59 2.06* 0.55 4 3.70* 0.60 δint 0 6.18 0.00 5.93 0.00 0 7.53 0.00 nfx 10 0.12* 0.99 1.08* 0.99 0 3.21* 0.92 δnfx 0 7.50 0.00 7.49 0.00 0 8.67 0.00 rfx 6 0.50* 0.99 1.14* 0.91 0 4.13* 0.43 δrfx 0 10.18 0.00 10.18 0.00 0 10.79 0.00 wag 1 1.87 0.99 1.52 0.99 1 1.19 0.99 δwag 0 10.89 0.00 10.69 0.00 0 12.26 0.00 quantity variable dmd 1 1.15 0.69 1.19 0.674 1 2.67 0.84 δdmd 0 10.39 0.00 10.35 0.000 0 12.16 0.00 price variable cpi 1 1.12 0.99 0.60 0.98 1 1.35 0.99 δcpi 0 3.71 0.00 3.54 0.00 0 5.39 0.00 notes: (*) refers to trend inclusion. (**) based on akaike information criterion. appendix 3. lag order selection. lag loglikelihood likelihood ratio final prediction error akaike information criterion schwarz information criterion hannan– quinn information criterion 0 195.83 --4.52e-08 -5.56 -5.43 -5.50 1 464.70 498.78 2.97e-11 -12.89 -12.24 -12.63 2 484.38 34.22* 2.68e-11* -12.99* -12.83* -12.93* 3 496.52 19.70 3.04e-11 -12.88 -11.20 -12.21 4 505.43 13.42 3.82e-11 -12.67 -10.47 -11.80 5 523.38 24.98 3.75e-11 -12.73 -10.01 -11.65 6 531.07 9.80 5.05e-11 -12.49 -9.25 -11.21 note: * indicates lag order selected by the relevant criterion. appendix 4. diagnostic tests for var residuals. appendix 4.1. model stability condition. -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 -1 0 1 inverse roots of ar characteristic polynomial appendix 4.2. lm test for serial correlation. lag lr stat. df prob. rao f stat. df prob. null hypothesis: no serial correlation at lag order h 1 129.41 121 0.28 1.07 121, 266.6 0.31 2 120.98 121 0.43 0.98 121, 266.6 0.51 null hypothesis: no serial correlation at lags 1 to h 1 129.41 121 0.28 1.07 121, 266.6 0.31 2 180.02 242 0.45 1.06 242, 235.7 0.16 asian journal of economics and empirical research, 2022, 9(2): 150-165 164 © 2022 by the authors; licensee asian online journal publishing group appendix 4.3. white heteroscedasticity test. residuals from the equation for: r2 f (44, 31)* prob. χ2 (44) prob. ipit 0.81 3.02 0.00 61.64 0.04 oilt 0.84 3.75 0.00 63.98 0.02 gast 0.68 1.56 0.09 52.37 0.18 nfxt 0.67 1.46 0.13 51.27 0.20 govt 0.56 0.92 0.59 43.20 0.50 wagt 0.58 0.98 0.52 44.38 0.45 prot 0.86 4.40 0.00 65.52 0.01 pcrt 0.38 0.44 0.99 29.44 0.95 ms1t 0.72 1.82 0.04 54.79 0.12 dmdt 0.67 1.44 0.14 51.05 0.21 cpit 0.46 0.61 0.93 35.34 0.82 joint -----2952.76 (2904) 0.25 note: * numbers in parentheses show the degrees of freedom for the relevant distribution. appendix 4.4. normality test. skewness χ2 prob. kurtosis χ2 prob. jarque– bera stat prob. ipi -0.16 0.32 (1)* 0.56 2.80 0.11 (1) 0.73 0.44 (2) 0.80 oil -0.21 0.56 (1) 0.45 3.57 0.98 (1) 0.32 1.54 (2) 0.46 gas -0.07 0.06 (1) 0.79 3.08 0.02 (1) 0.88 0.08 (2) 0.95 nfx 0.11 0.15 (1) 0.69 2.97 0.00 (1) 0.96 0.15 (2) 0.92 gov -0.20 0.50 (1) 0.47 3.33 0.34 (1) 0.55 0.84 (2) 0.65 wag -0.05 0.03 (1) 0.85 4.61 7.81 (1) 0.00 7.85 (2) 0.01 pro 0.30 1.11 (1) 0.29 4.66 8.30 (1) 0.00 9.42 (2) 0.00 pcr -0.05 0.03 (1) 0.84 3.07 0.01 (1) 0.90 0.05 (2) 0.97 ms1 -0.21 0.54 (1) 0.45 2.68 0.29 (1) 0.59 0.83 (2) 0.65 dmd 0.14 0.24 (1) 0.62 2.63 0.40 (1) 0.52 0.65 (2) 0.72 cpi -0.34 1.43 (1) 0.23 3.53 0.86 (1) 0.35 2.29 (2) 0.31 joint --5.03 (11) 0.92 --19.15 (11) 0.61 24.19 (22) 0.33 note: * numbers in parentheses show the degrees of freedom for the χ2 distribution. asian journal of economics and empirical research, 2022, 9(2): 150-165 165 © 2022 by the authors; licensee asian online journal publishing group appendix 5. estimates of the γ and ω matrices. 𝛤 = [ 0.02 0.01 −0.04 −0.03 −0.01 −0.02 0.01 0.02 −0.01 −0.01 0.01 0.12 0.06 −0.05 −0.05 −0.01 −0.03 0.01 0.04 −0.02 0.01 0.01 0.05 0.07 −0.02 −0.15 −0.06 −0.09 0.03 0.14 −0.04 −0.10 0.02 −0.11 0.01 −0.08 0.01 −0.01 −0.03 0.03 0.01 −0.04 −0.03 −0.03 0.01 0.00 0.01 0.01 0.02 0.01 −0.01 −0.01 0.01 0.01 −0.00 −0.04 0.00 −0.05 −0.01 0.01 −0.01 0.01 −0.00 −0.02 −0.01 −0.01 0.03 −0.01 0.04 0.01 0.01 0.02 −0.01 −0.01 0.02 0.02 0.01 0.05 0.01 0.05 −0.01 −0.01 0.01 −0.02 0.05 0.04 0.03 0.03 −0.05 0.03 −0.03 −0.03 0.01 −0.01 0.01 0.06 0.03 −0.01 0.01 0.01 0.01 0.00 −0.01 −0.01 −0.01 −0.01 0.01 0.01 0.01 0.01 −0.03 0.01 −0.04 −0.01 −0.00 −0.01 0.01 0.01 −0.02 −0.02 0.01 ] 𝛺 = [ 0.04 0 0 0 0 0 0 0 0 0 0 0 0.08 0 0 0 0 0 0 0 0 0 0 0 0.12 0 0 0 0 0 0 0 0 0 0 0 0.06 0 0 0 0 0 0 0 0 0 0 0 0.04 0 0 0 0 0 0 0 0 0 0 0 0.02 0 0 0 0 0 0 0 0 0 0 0 0.01 0 0 0 0 0 0 0 0 0 0 0 0.03 0 0 0 0 0 0 0 0 0 0 0 0.06 0 0 0 0 0 0 0 0 0 0 0 0.02 0 0 0 0 0 0 0 0 0 0 0 0.01] the asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc., caused in relation to/arising from the use of the content. any queries should be directed to the corresponding author of the article. 60 © 2024 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 11, no. 2, 60-82, 2024 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v11i2.6027 © 2024 by the author; licensee asian online journal publishing group the impact of capital flight on economic development: an empirical analysis from palestine nemer badwan computerized of banking and financial department, faculty of business and economics, palestine technical university-kadoorie, tulkarm, state of palestine. email: nemer.badwan@ptuk.edu.ps abstract this study focused on the function of capital flight to ascertain the true impact of the phenomenon of capital flight on economic development in palestine and aimed to analyze the shortand longterm dynamic relationship between capital flight and economic development, including other affected variables. this research employed a quantitative research design and the descriptive analysis method. the analysis uses quarterly data from 2004 to 2022. this study employed the autoregressive distribution lag (ardl) bound testing approach. actual data from palestine spanning the years 2004-2022 yielded significant findings. based on heteroskedastic dynamic regression as an ardl panel model, important findings were reached. first, both local country fundamentals and global variables have an impact on economic development and its rates over the long term, but in the near term, global forces may be predominantly recognized as drivers. second, the variable of interest, capital flight, has a favorable impact on tax advantages. the empirical findings revealed that the shortand long-run analyses are consistent with each other. this necessitates putting into practice a variety of tactics, from creating efficient judicial and political institutions to encouraging economic development through managing macroeconomic issues. this study provides a fresh insight for policymakers to evaluate the impact of capital flight on economic development factors when coordinating fiscal and monetary policy in palestine. the monetary and fiscal authorities should create an efficient policy framework. palestine must reduce and stop the outflow of cash from inside its borders to improve its capacity to pay back its loans and debts to foreign creditors. keywords: ardl model, capital flight, economic development, foreign reserve, foreign direct investment, palestine. jel classification: e44; f21; g31; o47. citation | badwan, n. (2024). the impact of capital flight on economic development: an empirical analysis from palestine. asian journal of economics and empirical research, 11(2), 60–82. 10.20448/ajeer.v11i2.6027 history: received: 21 june 2024 revised: 30 august 2024 accepted: 13 september 2024 published: 15 october 2024 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. data availability statement: nemer badwan may provide study data upon reasonable request. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. contents 1. introduction ...................................................................................................................................................................................... 61 2. literature review and theoretical background ....................................................................................................................... 63 3. data and methodology ................................................................................................................................................................... 67 4. empirical findings and discussion .............................................................................................................................................. 70 5. conclusions and policy implications ........................................................................................................................................... 76 6. recommendations, limitations and future research directions ......................................................................................... 79 references .............................................................................................................................................................................................. 79 mailto:nemer.badwan@ptuk.edu.ps https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v11i2.6027 https://orcid.org/0000-0001-8913-7326 asian journal of economics and empirical research, 2024, 11(2): 60-82 61 © 2024 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study is considered the first to use the ardl method to test the shortand long-term relationship between capital flight and economic development in the palestinian context. this study contributes to the existing literature and fills the gap in the literature on financial markets, capital flight, and economic development. 1. introduction in palestine, the question of whether a state can exist economically is not new. indeed, the zionist movement dominated the economic literature long before the establishment of the state of israel. the message back then was clear and unwavering: a jewish state in palestine could exist economically, and there were no predetermined boundaries on how much more immigration palestine could accept. in international finance, particularly in emerging markets, sovereign default risk and the capital flight phenomenon are significant factors in such countries as palestine (world bank, 2021). palestine is likely to face recurring crises and concerns about default risk. in reality, several of these economies saw a sizable amount of capital flight prior to experiencing sovereign debt default, as in the cases of argentina in 2001, russia in 1998, and ecuador in 1999 (bebbington & perreault, 1999; rojas-suarez, 1990). it is not a true problem for middle eastern nations, like palestine, to experience capital flight; rather, it is a result of the macroeconomic effects of financial globalization (léonce ndikumana, 2015). in addition to having negative effects on the rate of economic development and the nation's solvency indirectly, capital flight has significant ramifications, including a possible link to the loss of foreign reserves and increasing pressure on the local currency's depreciation. furthermore, capital flight increases debt since domestic financial resources are seldom enough to pay off loans and fulfill other commitments. debt repayment directly escalates the risk of a country’s sovereign default, a major factor in the decline of economic growth rates and national solvency, the rise in unemployment, and the depreciation of the currency’s real value (ndikumana, 2016). given the hilarious turn of events where the once-believing arabs have now become the new sceptics, what can be said today about the economic history of an arab state in palestine? those who oppose the idea of a palestinian arab state that includes the west bank and gaza strip are now asking this question in a derogatory manner. they contend that the economy would remain undeveloped and reliant, that the population pressures would be too great, and that the land area is too tiny and deficient in natural resources. to put it briefly, a situation like this might contribute to instability in the area since it is vulnerable to strong internal and foreign forces. therefore, a solution through jordan or another strategy that does not include the creation of an independent palestinian state is required for those willing even to consider the idea of swapping territory for a lasting peace. this study identifies three of the most important imbalances under the general title of economic structure, along with several other secondary structural issues that will need to be addressed right away once the occupation is lifted and a state is formed. the orientation from the outside. the isolation of the occupied territories from their traditional, and mostly natural, arab markets, as well as the forced reorientation of the palestinian economy towards the particular requirements of israeli hegemony, are two of the most damaging economic effects of the protracted occupation of the west bank and gaza. due to israel's unlimited access to the markets in the acquired areas, trade and money movements, especially imports, between the arab nations and the occupied regions were less constrained. administrative agencies in israel, particularly the licensing authority, suppressed industrial growth, while the lack of access to foreign markets, including israel, and restrictions on arab use of water resources hampered agricultural progress. due to the impediment to indigenous development, the occupied territories effectively became a source of inexpensive labour and an easy market for israeli goods (just before the intifada, israel exported nearly $1 billion worth of goods to the occupied areas, making it the second-largest single national export market after the united states). this also created a crucial dependency. as a result, any effort to repair the palestinian economy's external economic links would require significant changes to its production base as well as its external relations. these adjustments are likely to be costly and challenging in the early years of statehood. a further evident and highly important distortion resulting from the prolonged occupation is the deformity that has hampered the training and deployment of palestinian laborers in the occupied regions. first, the opportunities for professional, highly skilled, and entrepreneurial workers were significantly reduced due to restrictions on private sector economic growth and the stagnation or decline in public sector activity (perhaps with the exception of the bizarre expansion of the israeli security apparatus). as a result, a significant portion of the labour force's most productive members left the occupied areas, depriving them of a vital component for their social and economic advancement. even if israel's occupation of the west bank and gaza strip ends soon, which i very much doubt, it will undoubtedly impose significant restrictions and distortions on the developing palestinian economy. therefore, addressing the issues that arose from the occupation and attempting to do it in a way that lessens their impact and damage must be the first course of action in the new state. the embryonic state's economic issues will become evident if the political settlement takes the shape already mentioned. in this new context, the question of previous economic history loses its contextual ambiguity and gains the specificity of a hypothesis that this research may investigates. is there enough economic potential for the new palestinian state? yes, it can, provided that it can get over its innate limitations and continue on a path of sustainable economic growth in a respectably short amount of time. a comprehensive national project for development and reconstruction must be created, supported by sufficient human, technical, and financial resources, as well as growth-promoting policies and enlightened, primarily liberal forces. this project must address the most critical, interconnected issues, including reorienting and restructuring the economy, accommodating a sizable refugee population, and establishing the institutional and structural framework for the new economy. in this analysis, i will study the impact of capital flight on national solvency and economic growth. this analysis emphasizes the significance of the exodus of domestic and international capital from palestine in determining the causes of this shortfall. in actuality, capital flight is a cyclical force that encourages the affected nations to mismanage their reserves, accumulate excessive debt, and widen both their internal and external deficits. because of this, capital flight and the ensuing adjustments typically signal the start of a chain of political, social, and economic upheavals that culminate in default and a loss of access to the capital market (pastor, 1990). by making changes to monetary and fiscal policy more difficult, the phenomenon of capital flight reflects the terrible state of the asian journal of economics and empirical research, 2024, 11(2): 60-82 62 © 2024 by the authors; licensee asian online journal publishing group domestic macroeconomy (ndikumana, boyce, & ndiaye, 2012). capital flight, according to ndikumana (2014) reduces a nation's foreign exchange reserves, which in turn increases pressure on the exchange rate and causes the national currency to depreciate. capital flight may also contribute to exchange rate volatility. capital flight, essentially a leak in the overall money supply, can weaken the transmission of monetary policy. according to the conventional portfolio theory, when domestic interest rates are extremely low, investors outside search for larger returns on savings. higher global interest rates than domestic one’s cause capital flight. an economy that is experiencing widespread capital flight is likely to see a deterioration in its fundamentals and a substantial rise in foreign debt. this results in debt default, in addition to a probable fall in the nation's solvency and economic growth rates. the 1980s difficulties with capital flight can link to numerous sovereign debt defaults in emerging nations (pastor, 1990). following the economic shift in the early 1990s, there was a large-scale exodus of capital from developing nations, which is still happening today amid prolonged stagnation and rising foreign debt. the causes of capital flight and its effects have been extensively studied over the past few decades (johannesen & pirttilä, 2016; yalta & yalta, 2012) but no study has yet explicitly estimated how capital flight affects economic growth and national solvency. the growing economies around the world, particularly those in the middle east, including palestine for the purposes of this research, rely more on private capital flows (asongu, el montasser, & toumi, 2016). additionally, they are more susceptible to variations in capital flows and liquidity risk. a liquidity crisis can become a significant and unsolvable national solvency issue as a result of capital flight (ndikumana, 2014). in fact, if a liquidity crisis arises, both local and international investors will want to transfer their funds to other markets, which will have the added impact of decreasing liquidity to the banking system and raising risk premiums. as a result, there is a loss of access to bond markets. asongu (2013) views capital flight as a crucial indicator of a nation’s external vulnerability, signaling a potential resource reversal. given this perspective, it is fair to concentrate on the effects of capital flight on economic development and national solvency, in addition to the defaults on sovereign debt, by demonstrating how capital flight, through a reduction in financial resources, may result in a higher incidence of defaults on sovereign debt. capital flight-induced financial instability could intensify challenges associated with state debt repayment. understanding why investors do not trust a country's fundamentals, how this might impair its financing policies, how it may influence its capacity to repay, and how it may cause a fall in economic growth rates will be among the benefits of including capital flight into the econometric model. in contrast to conventional wisdom, government defaults can also be caused by failure to pay gennaioli, la porta, lopez-de-silanes, and shleifer (2013) which can be observed through the phenomenon of capital flight (economic growth, national solvency, and sovereign debt). conversely, sovereign bond price spreads are frequently used in the literature to indicate the risk of a default by the government, which was brought on by capital flight and resulted in a slowdown in economic growth and a deterioration of the nation's solvency, as mentioned in some prior literature. to achieve the study’s objectives, the experimental framework focuses on using the ardl estimation approach, which permits short-run coefficients to vary between nations while enforcing unique estimates for long-run coefficients. the information utilized was obtained from the palestinian ministry of national economy and the governmental statistics center in palestine, and it spans the years 1981 to 2021. it is complex to examine the effects of capital flight and other factors on bond spreads while concentrating on a nation like palestine. first off, the economy of palestine is one of the most innovative and emerging in the middle east, and it accounts for a significant portion of the region's developing bond market. second, many of the crises that affected the globe significantly and called for consideration in the literature began in or spread to palestine and the middle eastern countries as a whole. third, capital flight has been discussed in the literature as a resurgent issue in palestine and the middle east. last but not least, data for palestine, is considerably more plentiful, allowing for more thorough empirical research. because of capital flight, palestine has seen a significant outflow of capital, which has harmed the nation's chances for economic growth, exhausted its foreign exchange reserves, and discouraged capital investments. these findings have a direct impact on expected risk and return, as well as the general investment climate. key monetary determinants, particularly investment returns and public bonds, have gotten little attention despite the large amount of research on the relationship between capital flight and economic growth (clement & ayodele, 2016; effiom, achu, & edet, 2020; ogbonnaya & ogechuckwu, 2017; orimolade & olusola, 2018). given the magnitude of capital flight at the moment and the unpredictable nature of palestine's economic growth, it is imperative to investigate these events. the study also seeks to answer the following question: which institutional reforms would be necessary to create a more dynamic macroeconomic environment and reduce the dependence on foreign loans and high levels of public debt that (i) keep interest rates high and (ii) only prolong the structural vulnerability of palestine's economy? the impact of capital flight on national solvency and economic growth has not been thoroughly studied. despite a wealth of empirical research on the subject; this is particularly true when considering palestine as an emerging market in the middle east. as a result, by examining the effects of capital flight on national solvency and economic growth in palestine, the current study aims to close this gap in the literature. palestine was selected as a research sample to examine this phenomenon from 2004 to 2022. this study estimates the ardl model after adjusting for a few variables, and finally examines the longand short-term effects of capital flight on national solvency and economic growth. this study delves into the essential components of the economic development paradigm. the granger causality test method was employed as an estimating technique to show the relationship between variables on both shortand long-term national solvency and economic growth in order to get around the possible endogeneity issue. the main study's purpose is to clarify the capital flight from palestine and ascertain how it affects the country's economic development process between 2004-2022. prior to that time period, the lack of data for some measures, most notably the economic freedom index, led to its selection. this study makes the following contributions to the literature: firstly, this research deals with providing a theoretical foundation for the idea of capital flight, which will cover its definition, explanation of its causes, and link to economic growth. secondly, the study uses the residual value metric to quantify capital flight from palestine. thirdly, this paper examines the investment environment in palestine identify the reasons for and effects of the capital flight from the country, and the conclusion offers solutions to cope with this issue. as a notable departure asian journal of economics and empirical research, 2024, 11(2): 60-82 63 © 2024 by the authors; licensee asian online journal publishing group from previous research, this study contributes to the academic community and global financial integrity as it uses an estimate of current data provided by the global financial integrity initiative (global financial integrity, 2010). the international monetary fund (imf) receives balance of payments data from the global financial integrity (gfi) that is analysed to identify cash flows that are illegally acquired, moved, or used. the gfi uses a robust methodology to track unlawful money movements. the structure for the remaining sections of this paper is as follows: the theoretical backdrop and literature assessment are presented in section 2. section 3 describes the analytic methods, several data sources, and methodology. apart from the additional empirical analysis, which encompasses robustness checks and diagnostic tests, section 4 presents the empirical findings and provides a discussion. section 5 contains concluding observations and policy implications. section 6 offers suggestions, constraints, and future study directions. 2. literature review and theoretical background 2.1. literature review since the debt crisis of early 1980s, there have been extensive theoretical and empirical research on the influence of capital flight on economic development and national solvency. many studies have discussed the direct effects of capital flight, the risks it poses to economic growth and national solvency, and the likelihood that a nation will experience a debt default (gunter, 2004; schneider, 2003a). the present body of research on the causes of capital flight hazards to economic expansion and national solvency is not definitive. a country's capacity and willingness to repay its foreign debt might rely on a wide range of circumstances; therefore, several variables may really be needed. these elements may be found by determining the variables that have an impact on both internal and external solvency. factors such as the amount of public debt, interest rates, the pace of output growth, and the nation’s man balances are all linked to internal solvency. on the contrary, external solvency is correlated with current account balance, liquidity indicators, and the amount of foreign currency debt (in relation to gdp or exports). our current research will utilize palestine as a case study, as capital flight has negatively impacted its economic growth and national solvency (badwan & al-qubbaj, 2024; boyce, 1992; boyce & ndikumana, 2001; ndikumana & boyce, 2010). this is because capital flight is the explanatory variable of interest in this study. at this point in the research, it is useful to characterize capital flight in the economy. in actuality, the phrase "capital flight" has no commonly agreed definition (ajayi, 1997; ndikumana, 2014; schneider, 2003b) and may be seen from a variety of angles. large withdrawals of assets and/or capital from a certain nation or area are a concise definition of capital flight in its broadest meaning (ndikumana, 2014). these outflows may be "legitimate" if foreign investors frequently repatriate their cash; alternatively, they may be "illicit" if foreign investors regularly acquire money overseas and do not typically repatriate it. these unrecorded flows are neither taxable nor used by the government. capital flight may therefore have negative effects on both economic and social growth (schneider, 2003a). to investigate the effects of public institutions' management of public affairs and resources on capital flight, the palestinian market requires efficient governance and institutional changes. it likewise has the anticipated negative sign and is statistically significant at the 0.01 level. the findings suggest that improving palestine’s government could potentially decrease long-term capital flight by around 0.81%. this is due to the fact that an atmosphere that is conducive to domestic investment and political stability requires effective governance. consequently, this implies that long-term capital flight in palestine is caused by poor governance and management, which signal possible political and institutional instability (al-fayoumi, alzoubi, & abuzayed, 2011). capital flight can aggravate domestic financial crises brought on by high unemployment rates, a lack of cash owing to a slowdown in economic development, and issues with the nation's solvency. studies and writings from the past about what affects economic growth and national solvency have led to the discovery of domestic macroeconomic factors that cause internal imbalances to build up, destabilizing factors that happen before slowing economic growth rates and weak national solvency, and signs of how things are going in the global financial markets (edwards, 1986; le & rishi, 2006; lorenzoni, 2014). although capital flight poses genuine hazards to imbalanced economies, it may not be the primary cause of slowing economic growth rates and the vulnerability of national solvency. lack of control over these risks might cause nations to experience tough phases and other, more severe economic and financial catastrophes. before, all of this, a nation really experiences a number of symptoms, such as deteriorating mismatch between its future debt commitments and its incoming revenue streams, a condition known as fiscal imbalances. in reality, depending on what caused capital flight first, the causes of these imbalances may be extremely different. a sizable body of pertinent literature focuses on a country's capacity to meet its external commitments, which in turn derives from the phenomenon of capital flight, which slows down economic development and weakens the solvency of the nation. the capacity to repay the loan depends on the available financial resources. in order to better understand why a country is unable to pay its obligations, this emphasizes the concept of capital flight and its influence on several important macroeconomic factors. in the scenario, changes in the global environment, trade terms, budget balance, real interest rate, and finally economic growth primarily influence capital flight’s impact on the trade surplus. a balance of payments deficit might also occur from capital flight, the subsequent depletion of reserves, combined with currency devaluation. capital flight depletes a country’s foreign exchange reserves. due to increased pressure on the exchange rate and increased volatility, this causes the national currency to devalue (fofack & ndikumana, 2014). on the other hand, according to certain theories (bernoth & herwartz, 2021; niels hermes & lensink, 2001; hermes, lensink, & murinde, 2002) there is no clear-cut relationship between changes in foreign currency rates and sovereign risk. first, it can lead to a rise in unemployment rates, a decline in exports, a rise in imports, and a rise in foreign loans, all of which have a negative impact on economic growth and national solvency. in reality, a depreciation of the currency may improve net exports (according to the mundell-fleming model), which boosts the nation's competitiveness and economic growth while lowering the risks associated with borrowing money from abroad. second, as a result of capital flight and the devaluation of the home currency, exports are cheaper and imports are more expensive, creating a surplus in the trade balance. in addition, a rise in interest rates results in less domestic investment and slower economic development (badwan & al-qubbaj, 2024; ndikumana, 2014) which raises the possibility of a fall in exports and domestic sectors as well as the exodus of significant foreign investors. asian journal of economics and empirical research, 2024, 11(2): 60-82 64 © 2024 by the authors; licensee asian online journal publishing group third, when a nation has more foreign currency obligations than foreign currency assets, the depreciation of the native currency may reduce the risk of default. in this case, the depreciation of the foreign currency hurts domestic borrowers, resulting in a decrease in borrowing. this domestic credit contraction raises borrowing costs, which has a negative impact on national solvency and economic growth. as a result, there is a greater danger of decline, a major slowdown in economic growth rates, and a drop in exports, all of which have a negative impact on national solvency. as a result of undervaluing export invoices, capital flight can occur in the context of unlawful operations (forgha, 2008). as a result, there may be a drop in export earnings, which increases the risk of accruing and being unable to pay off foreign loans, which lowers national solvency and slows economic growth. boyce and ndikumana (2001) assert that capital flight causes many nations to lose more resources than debt payments. the inability to pay off foreign loans is one of the serious consequences of capital flight, according to the authors, because it restricts the ability of affected nations to pay off their obligations as a result of the phenomenon of capital flight. capital flight increases the likelihood that a country won't be able to pay its debts, which could lead to serious economic issues like a slowdown in national economic growth and a lack of national solvency (hermes et al., 2002). more crucially, by examining how capital flight interacts with other macroeconomic variables, it is possible to gauge how it affects national solvency and economic progress in developing nations like palestine. one of the biggest disadvantages of capital flight is that it can slow economic growth by lowering the resources needed to fund domestic investment (such as private savings) (lawanson, 2007). in this perspective, a number of empirical studies (boyce, 1992; cerra, rishi, & saxena, 2008; chipalkatti & rishi, 2001; pastor, 1990) demonstrate that capital flight dramatically worsens the fiscal balance by increasing the requirement for external debt. the debt-driven capital flight hypothesis (boyce, 1992; cerra, rishi, & saxena, 2005; cuddington, 1987; niels hermes & lensink, 2001) suggests that a sizeable portion of borrowed resources are exported abroad in the form of capital flight. however, external debt has one important function: supporting investment. therefore, the utilization of external loan resources to fund investment will decrease the longer the phenomenon of capital flight exists. as a result, capital flight through the external debt channel may cause domestic investment to drop, which would then cause economic growth to slow. as a result, with declining production, national solvency deteriorates and economic performance diminishes. numerous academic works address the problem of capital flight by examining the factors that contribute to it, as well as how it affects economic expansion. many people think that the issue affects both developed and developing nations, rather than only those in poor countries. for instance, spain had a capital flight of 97 billion euros between january and march 2012, amounting to 2.9% of its gross domestic product gdp. given the country's financial crisis, capital flight in greece surpassed 4 billion euros in a single week. between 1971 and 2011, sub-saharan africa suffered losses of around $814 billion (cuddington, 1986). under this scenario, there will be a decrease in both foreign and domestic investments, which would affect the country's potential for future success (hodrob, 2017). capital flight is also a result of weak local and international law enforcement, corruption, and loose regulations. it puts the stability of the country and the little financial resources that rising nations have at their disposal in jeopardy. as long as the capital flight persists, the palestinian government's efforts to eradicate poverty and advance sustainable development will encounter obstacles. research on illicit domestic investment outflows in reaction to anticipated internal policy decisions and political turmoil has taken several forms from the early debt crises of the 2000s and the 1980s. the literature states that one must include investors' purpose and willingness when determining capital flight. immigrant capital flight is defined by deppler and williamson (1987) as "allegations of acquiring or selling that are prompted by the owner’s anxiety about the value of his assets that may be subject to losses or impairment if they continue to be invested locally." presenting a comprehensive list of the conduits is challenging since there are several ways that capital flight can occur. once the capital flight has started, there is no peaceful way to quickly turn things around. people generally assume that most people are risk-averse. in other words, they choose a guaranteed return on investment. in order to increase their wealth and maximize their return on investment, they hence take all appropriate precautions to lower risks and losses. there exists a correlation between capital flight and risk aversion. in the economic literature, a number of variables, among them the following ones, have been identified as the primary channels by which capital flight in developing countries such as palestine is transmitted: 2.1.1. expected local currency depreciation fear or anticipation of currency depreciation is a prominent cause of capital flight in major emerging economies like palestine. an asset with the potential to lose value is something that no investor, domestic or foreign, wants to possess. capital outflows may result from such as rumors or concerns about an imminent devaluation (schneider, 2003b). high expectations for devaluation are a contributing factor to economic problems these days, as unfulfilled client savings withdrawals might create unstable financial conditions. this kind of situation usually arises when export prices for commodities fluctuate and the local financial market's currency rate is unstable. an overvaluation of the currency rate implies that market participants would anticipate a future decline in value. due to depreciation, imported products would initially cost more than domestic ones. to avoid more losses, many would decide to save their money in other economies, which will result in capital flight. 2.1.2. capital control capital controls also run the risk of undermining confidence in the local financial system and guaranteeing that funds moved to rich countries would not return. capital restriction encourages the black market for foreign exchange and other costly evasion techniques, as shown in palestine, where the number of bureaus de change operators is on the rise. businesses that import and export may be able to export cash by inflating import values or understating export revenues. when the fixed exchange rate regime collapsed prior to 1973, the majority of developing countries and the us resorted to capital control. by preventing the already-flew capital flight from returning, this move lowers and diminishes investor trust in the local banking sector (uguru, 2016). another alternate strategy to reduce capital flight is to maintain the country's currency's discount to other currencies, especially the us dollar, or maintain its high value while increasing the national lending rate to make the currency more desirable to retain. raising interest asian journal of economics and empirical research, 2024, 11(2): 60-82 65 © 2024 by the authors; licensee asian online journal publishing group rate has the drawback of increasing freight costs for needs, which may limit capital formation flight (ahmed & sahto, 2015; badwan & al-qubbaj, 2024). 2.1.3. lending organizations according to badwan and al-qubbaj (2024) a considerable proportion of developing economies lent money to international financial institutions and other lending organizations for development purposes. unfortunately, capital flight returns a sizable amount of this investment to the lenders. thus, the general public bears the cost of interest and debt repayment. moreover, foreign debt typically denotes a nation's weak performance or an unfriendly investment climate, which promotes capital flight (badwan & al-qubbaj, 2024; uddin, yousuf, & islam, 2017). external borrowing is the primary source of funding for most illicit capital transfers. the country of origin may not necessarily document transactions between financial institutions. as mentioned before, the government raises taxes on the general population to cover the cost of its foreign borrowing. people try to store their money in other economies in order to avoid paying such high taxes, which results in capital flight. 2.1.4. precious metals precious metals and collectibles are important forms of collateral transfer in addition to artwork. palestinians can use local currency to pay for jewels, diamonds, precious metals, and other similar goods. not only are these priceless metals sent abroad, but their value stays steady or even increases (ubi & bassey, 2017). in foreign currencies, these products typically have high market prices. policies in the public sector frequently tend to limit, control, or outright prohibit the import and export of certain products. transporting these commodities across borders or worldwide typically involves organized smuggling and other illegal economic operations (tabassum, quddoos, yaseen, & sardar, 2017). 2.1.5. foreign aid it is common practice to provide financial or foreign assistance to support infrastructure development projects or end poverty in fragile nations. unfortunately, it is difficult for the economy to retain prosperous public and other private enterprises because dishonest public officials, non-governmental organizations, and company owners look into various ways to transfer this foreign support to other nations via capital flight. 2.1.6. trade is invoicing trade and invoicing are the most common and popular ways to smuggle capital resources into other nations. due to their size, influence, and standing in the global economy, multinational businesses are the main actors in this type of illicit wealth transfer. because of their existence and operational capabilities, they are able to carry out intrasubsidiary transfers across national borders, which encourages and facilitates capital flight. according to salandy and henry (2017) in this case, importers are expected to be analytically involved in over-invoicing, whereas exporters would be under-invoicing. 2.2. empirical literature review both developed and developing nations have published numerous empirical studies examining the effects of capital outflows on economic development and other stock market performance, with differing conclusions (albasheer, al-fawwaz, & alawneh, 2016; badwan & al-qubbaj, 2024). in trinidad and tobago's tiny resource-based economy (1971–2011), salandy and henry (2017) investigated and compiled the relationship between domestic investment, economic growth, and capital flight. the results show that capital flight is a significant problem impeding sustainable development locally. cheung, steinkamp, and westermann (2016) examined illicit capital flows in china to gain a better understanding of how chinese money interacts with the rest of the world. the outcome demonstrates how the crisis event impacted china's capital flight pattern as well as its root causes. moreover, the comprehension of china's capital flight and its fundamental reasons remains a challenge, suggesting that its impact has diminished in the post-2008 population. several empirical studies have been carried out to determine the significance of recognized institutional and economic components (push and pull factors) that contribute to capital flight. capital flight, for example, is triggered by gdp growth rates in bangladesh (alam & quazi, 2003). lawanson (2007), on the other hand, revealed that the gdp growth rate had a significant short-term negative influence on capital flight from nigeria using a portfolio choice approach using data from 1970 to 2001. the research also revealed that nigeria's capital flight is primarily driven by an increase in the real interest rate differential, an increase in inflation, and a higher foreign debt-to-gdp ratio. according to beja, junvith, and ragusett (2005) increases in foreign loan stocks are the principal driver of capital flight in ethiopia, sub-saharan africa, and south asia (indonesia, malaysia, the philippines, and thailand). furthermore, using m2/gdp and m3/gdp as proxies for financial development, collier, hoeffler, and pattillo (2001) and ndikumana and boyce (2003) found that financial development had little effect on capital flight in subsaharan africa. however, raheem (2015) re-examined the factors that impact capital flight in twenty-eight subsaharan african countries and discovered that m2/gdp had a positive and significant correlation. le and zak (2006) developed a portfolio choice model that connects return differentials, risk aversion, and three risk categories: policy variability, political unpredictability, and economic risk. during a sixteen-year period, all three types of risk had a substantial impact on capital flight when calculating the equilibrium capital flight equation for a panel of forty-five developing countries. political instability appeared to be the most important quantitative factor influencing capital flight. al-fayoumi et al. (2011) observed a spillover effect from capital flight the year before. this implies that the quantity of capital flight in the previous year influences the amount of capital flight in the current year. the literature study suggests that there are several variables that impact capital flight; nevertheless, the relevance of these elements varies for each country. therefore, the purpose of this study is to assess the factors that drive capital flight in palestine. asongu and amankwah-amoah (2018) used panel data from 37 african states from 1996 to 2010 and 2018 to assess the amounts of military spending that mitigate the impact of terrorism on capital flight. using regular least squares, fixed effect analysis, the general technique of moment, and the quantitative approach all led to same conclusion: to counteract the negative effect of terrorism on capital flight, there needs to be a large military budget asian journal of economics and empirical research, 2024, 11(2): 60-82 66 © 2024 by the authors; licensee asian online journal publishing group deficit of 4.224 to 7.363 percent of gdp. furthermore, ahmed and sahto (2015) investigate the link between capital outflows and their drivers, which include the study's core variables, as well as the rate of gdp growth and inflation. the residual approach was used to calculate the model coefficients for the years 1971-2011, and the results show a long-term link between the variables as well as a negative association between capital flight, exchange rate, and other parameters. to assess the effects of financial flight and its causes on economic development (2001-2021), lawal et al. (2017) utilize the autoregressive distributed lag (ardl) model to analyze data gathered over time. the findings indicate that the variables are long-term associated and that capital flight has had a detrimental influence on the state's economic growth over the study period. liew, mansor, and puah (2016) look at the macroeconomic determinants that have influenced malaysia's capital flight over the last decade. (1980-2010). combining this study’s model with the world bank’s approach for monitoring capital outflows reveals a long-term relationship between the variables (world bank, 2010). according to almounsor (2017) the author employs a residual technique to account for the potential cost of unregulated money to society in the form of stopped economic progress, and provides new estimates of illegal capital flight in saudi arabia from 1971 to 2015. the results show that capital flight is detrimental to economic progress. to identify early access to capital outflows from a new perspective, a collection of 37 african states is examined using the financial development and structure database (fdsd) and african development indicators (adi) (1980-2010) (world bank, 2010). according to the world bank (2020) findings, nations that export petroleum and those involved in armed conflict have a considerable influence on absolute and conditional convergence. orimolade and olusola (2018) used the world bank's residual approach to assess the impact of capital flight on palestinian economic development. the study uses the "autoregressive distributed lag" research model to find coefficients for study data from several years (2001-2021). it finds a weak link between capital flight and economic growth. obidike, uma, odionye, and ogwuru (2015) examine how capital flight affects economic development from 2000 to 2015, "using monthly time series data spanning many decades." the authors' ardl model-based study reveals that capital flight has a significant negative impact on palestinian economic growth. johannesen and pirttilä (2016) critically analyze the procedures used to collect data on illegal capital transfers and financial flight from poor nations. "the results suggest that the level of capital flight from developing nations remains problematic for the evolution of civilization. to estimate the influence of institutional governance and corruption indicators on capital outflow, oseiassibey, domfeh, and danquah (2018) "use panel data from 32 sub-saharan africa (ssa) countries during a sample period including the years 2000-2015. "from 2000 until 2012." the data show that there is a substantial link between capital flight from "ssa" and a positive perception of corruption. it implies that the continent encourages capital outflows, impeding long-term economic success. "we employed time series data to examine the effect of capital flight on economic development in the franc zone between 2000 and 2013, and the results were conflicting," says ndiaye (2014). the effects are varied, with 15 of the franc zone's member countries benefiting from capital flight while 5 suffer negative impacts. one argument suggests that trade fraud, foreign aid, and external debt may have a greater impact than positive capital flight. the author also investigates the impact of macroeconomic determinants on capital flight, limiting the estimation to a short-run analysis to avoid any potential difficulties raised by ambiguity about the direction of the influence of plausible long-run causes (ogun, 2017). the study found that trade imbalances, nominal exchange rates, and capital regulations all have a considerable impact on short-run capital flight. ndikumana (2017) claims that "since then, capital flight has cost the asian continent more than usd 1 trillion, a huge amount that exceeds all of the loans and financial assistance the continent got during the same period." if the region had saved and used this significant amount of money for worthwhile projects, it would be in a better position to meet the sustainable development goals (sdgs). uddin et al. (2017) "use yearly time series data covering the years to analyze the determinants impacting capital flight in bangladesh (1990-2016), and the authors apply the "ols" estimating approach and discover that the primary drivers of capital flight in bangladesh are (ed, fdi, fr, ird, and ca) surpluses are all examples of financial variables." the supplementary finding shows a strong positive relationship between the change in foreign debt, capital flight, and the difference in interest rates. clement and ayodele (2016) "survey the impacts of capital flight on financial development utilizing time arrangement information from the period (1980-2014), and by meng (2016) utilizing "ols" and the cointegration method as expository strategies, the result appears that capital flight influx incorporates a positive relationship with the trade rate and financial advancement all through the time beneath talk.” onyele and nwokocha (2016) "studied the impact of capital flight on destitution in palestine utilizing time arrangement information crossing the long time (1986-2014), and the johansen co-integration test and mistake adjustment show discoveries illustrate that the factors have a long-run harmony association in which capital flight incorporates a positive interface with destitution, which moderates financial development in countries where it happens over time.” ubi and bassey (2017) "examine the relative impacts of capital flight and remittances on poverty in palestine using time series data from (2000-2014), and the authors estimate the model coefficients using both a cointegration approach and an error correction method ecm technique." the findings show that the variables have a long-term relationship, and that capital flight hurts poverty over the study period. asongu et al. (2016). “the general method of moment (gmm) approach was adopted to assess the influence of governance on capital flight in 33 asian countries during the period (1999-2013), and the results reveal that economic governance enhances capital flight while political stability and accountability decrease it.” eliminating corruption is the preferred approach for governments to stop capital flight. lawanson (2014) "investigates the direct and indirect effects of debt and capital flight on the economies of 16 west african nations through processes involving capital and budgeting, and the author evaluates time data from the period (2000-2015) employing the fixed effects and (gmm) estimate approaches to demonstrate how results alter when economic difficulties such as exogenous variables and dynamic panel biases are taken into account." the findings show that capital flight improves financial stability but has a significant negative impact on investment, reducing private capital flows. the coefficients of capital flight show that an increase in capital flight causes a 0.11% drop in investment. asian journal of economics and empirical research, 2024, 11(2): 60-82 67 © 2024 by the authors; licensee asian online journal publishing group uguru (2016) looks at how capital flight affects tax revenue using annual time series data based on regression analysis. the findings show that capital has a significant negative impact on national tax collection. from an agricultural standpoint, mpenya, metseyem, and epo (2015) "use data from the world bank over time to analyze and analyze the connection between the economic growth and trade mis-invoicing-induced capital flight in the cameroonian natural resource (oil and wood) sector. (1995-2010), and the result shows that capital flight negatively impacted cameroon's economic development and that a large portion of it originates from the natural resources sector. “usman and arene (2014) "used time series data spanning (2000-2018) to evaluate the influence of the capital war and its macroeconomic causes on agricultural growth, and the authors' use of the cointegration test and regression approach provided results revealing a weak correlation between capital flight and agricultural growth.” to determine how much capital flight influences the effect of foreign debt on economic development in a subset of sub-saharan african nations, agyeman, sakyi, and oteng-abayie (2022) construct an enhanced endogenous economic growth model. the estimates were conducted using data from 2000 to 2015, utilizing a dynamic system generalized method of moments approach. it was determined that both capital flight and foreign debt had a statistically significant negative influence on economic growth. a modest degree of capital flight has no discernible influence on the detrimental impacts of foreign debt on economic development, according to the results of the marginal effects analysis. on the other hand, a high rate of capital flight makes the detrimental effects of foreign debt on economic expansion worse. based on the results, we draw the conclusion that lowering capital flight in subsaharan africa should be the main goal of initiatives to support effective external debt management. travelling is an infrequently researched conduit for capital flight, and wong (2021) offers evidence for it. compared to counterparty figures, china’s outbound departure data, and other nations’ norms, the country’s travel expenditures increased to an extraordinarily high level during the historic period of massive net capital outflows between 2014 and 2016. the findings imply that chinese consumers have been using the travel channel to take advantage of china's recently more liberalized capital account to move money outside during times of high economic instability. using a sizable sample of 2711 chinese private companies, wu, wang, fang, tsai, and xia (2022) investigated the connection between family business engagement and capital flight. the findings imply that there is a positive correlation between capital flight and family participation. the beneficial impact of family participation on capital flight is lessened by political ties. the study looks at how local and political connections affect the business environment and how their context affects the moderating effects. political ties lessen the beneficial impact of family participation on capital flight. when it comes to capital flight and outward foreign direct investment (ofdi), there are differences in these consequences. however, capital flight could result in a decrease in tax revenues needed to pay back public debt, seriously slowing economic development rates and jeopardizing the sustainability of the country. the next parts attempt to experimentally analyze this relationship after outlining the theoretical concerns regarding the influence of capital flight on economic development and its rates, national solvency, the inability to repay international loans as well as domestic obligations, and debt aggravation. the next section offers some specifics on the data and methods utilized as a first step. 3. data and methodology 3.1. data sources and description specifically, time series data from secondary sources during the years (2004-2022) are used in this study. only the world bank’s archived global financial integrity (gfi) and world development indicators (world bank, 1985) provide information on capital flight. real gdp, foreign currency reserves, foreign debt, and investment growth in palestine are all provided by the palestine monetary authority's statistics bulletin (pma). the time series for economic growth in palestine relates to data and information about the economy of the west bank specifically, and it was difficult for us to extract data and information about the gaza strip due to the limited and scarce data, so we excluded the gaza strip from the study due to the lack and scarcity of data and the lack of sufficient reports and disclosures for the necessary statistical analysis. therefore, we presented coefficients for a model estimated in the short and long term for the west bank region specifically. capital flight is a result of return difference, relative risk, and portfolio diversification. these restrictions restrict the amount of money available for domestic investment, which obstructs the growth of the economy. this work's study uses the autoregressive distributed lag model estimated model since other approaches such as the ordinary least squares regression ols, johansen co-integration, vector error correction model vecm, ect, and structural var models svar models have received more attention in the literature (johansen, 1988; mcnown, sam, & goh, 2018). one of the most obvious signs of capital flight is the asset method, which counts the total number of properties owned by non-residents in foreign banks. 3.2. methodology and model specifications 3.2.1. ardl-ecm approach a heterogeneous dynamic panel regression model was built up as a panel-ardl model while the ecm estimate approach was suggested by pesaran, shin, and smith (1999). pesaran, shin, and smith (1997) were utilized in order to experimentally analyze this link exhibited in equation 1 in palestine. it is suggested as a bridge between the estimate processes for ecm and dynamic fixed effects (dfe). the average coefficients extrapolated from the discrete equations make up the ecm. only individual effects (which may be random or fixed) allow the (dfe) estimator to account for sample heterogeneity, whereas the coefficients of exogenous variables are considered to be constant. the fact that ecm permits variable short-run coefficients while imposing unique long-run coefficients is a beneficial feature. this indicates that in the short term, variables unique to each nation in the middle east as well as other ones may be crucial. in the long run, markets are expected to include economies with the same characteristics, but in the near term, country-specific and other variables are likely to have dominating and varied impacts, making the (ecm) approach economically viable. researchers like léonce ndikumana (2015); s. asongu et al. (2016); asafuadjaye, byrne, and alvarez (2016); kennedy (2014) and bangake and eggoh (2012) are using this method more and more. the study provided a development model that has been significantly expanded to include important factors pertinent to the application, specifically to the palestinian economy, in addition to a model specification that asian journal of economics and empirical research, 2024, 11(2): 60-82 68 © 2024 by the authors; licensee asian online journal publishing group integrates real kapital flight kf, capital flight, foreign reserve, external debt, and domestic investment into a single autoregressive distributed lag model (mcnown et al., 2018). 𝐼𝑛𝑠𝑝𝑟𝑒𝑎𝑑 = 𝑓(𝐹𝑙𝑖𝑔ℎ𝑡, 𝑍) (1) the fundamental premise of this experimental study is that capital flight has a detrimental effect on economic growth and national solvency in palestine. both national and international issues have an impact on the latter. in economic and financial crises like slowing economic growth, weak national solvency, the inability of the nation to pay its foreign debts, rising exports, falling imports, the currency losing real value, and rising inflation rates, capital flight frequently causes a rise in national financial distress. by incorporating capital flight into our model, we can better understand the factors that contribute to investors' loss of faith in a nation's fundamentals and gauge the negative effects on financing policy. examples of a country's failure to service its foreign debt are not always dictated by willingness to pay, contrary to the conventional literature on economic development, national solvency, and external debt (hilscher & nosbusch, 2010). in fact, capital flight represents the situation in which the government is unable to pay its debts as one of the causes of declining economic growth, weak national solvency, and inability to repay external debts (broner & ventura, 2011; brutti, 2011; gennaioli et al., 2013; guembel & sussman, 2009). the linear equation (f) the direct impact on gdp is determined by capital flight and a group of additional variables that explain it that are included in the model) relies on the prior research, particularly significant initial research like (edwards, 1986; min, 1998). it also takes export, import, and bond price differences as an indicator of the risk of capital flight on economic growth and national solvency. 𝐼𝑛𝑠𝑝𝑟𝑒𝑎𝑑𝑖𝑡 = ∑ 𝜆𝑖𝑗𝑙𝑛𝑠𝑝𝑟𝑒𝑎𝑑𝑖,𝑡−1 + ∑ 𝛾𝑖𝑗𝑋𝑖,𝑡−𝑗 + 𝛼𝑖 + 𝜀𝑖𝑡 𝑞 𝑗=0 𝑝 𝑗=1 (2) 𝑋 = (𝑘 × 1) explanatory variables vector, 𝛼𝑖reflects a specific fixed effect, 𝜆𝑖𝑗scalars, 𝛾𝑖𝑗reflect (𝑘 × 1) are coefficient vectors and 𝜀𝑖𝑡describe the error terms which are independently distributed across 𝑖 with 0 variances 𝜎𝑖 2 and means. according to pesaran et al. (1999) model (2) can be rearranged into an error correction model specified as follows and can be estimated employing the pmg procedure: ∆𝐼𝑛𝑠𝑝𝑟𝑒𝑎𝑑𝑖𝑡 = ∅𝑖(𝐼𝑛𝑠𝑝𝑟𝑒𝑎𝑑𝑖,𝑡−1 − 𝛽𝑖𝑋𝑖𝑡) + ∑ 𝜆𝑖𝑗∆𝐼𝑛𝑠𝑝𝑟𝑒𝑎𝑑𝑖,𝑡−𝑗 + ∑ 𝛾𝑖𝑗∆𝑋𝑖,𝑡−𝑗 + 𝛼𝑖 + 𝜀𝑖𝑡 𝑞−1 𝑗=0 𝑝−1 𝑗=1 (3) ∅𝑖 = −(1 − ∑ 𝜆𝑖𝑗) 𝑝 𝑗=1 𝛽𝑖 = ∑ 𝛾𝑖𝑗 1 − ∑ 𝜆𝑖𝑗 𝑝 𝑗=1 𝑞 𝑗=0 𝜆𝑖𝑗 = − ∑ 𝜆𝑖𝑚 𝑗 = 1, … 𝑝 − 1 𝑝 𝑚=𝑗+1 𝛾𝑖𝑗 = − ∑ 𝛾𝑖𝑚 𝑗 = 1, … 𝑞 − 1 𝑖 = 1, … 𝑁 𝑞 𝑚=𝑗+1 this represents the error-correcting term in equation 3. it is anticipated that the associated calculated coefficient will be statistically significant and negative. a typical value denotes the absence of any support for a long-term partnership. the inverse of the absolute value of the vector ∅𝑖 = 0, which depicts the long-term impacts of the explanatory factors on the spreads, provides the speed of adjustment estimate for the absolute value of ∅𝑖. the vector 𝛽𝑖displays the country-specific short-term coefficients that demonstrate how each country's spreads react to applied shocks for the >order to verify the reliability of the findings related to the study's main variable (𝐹𝑙𝑖𝑔ℎ𝑡), 10 specifications were estimated as part of the estimation approach. the last specification comprises virtually all of the explanatory variables. however, each specification sets this main explanatory variable as a permanent one to which another explanatory variable is added every time. the short-term coefficients for each nation will then be estimated using this thorough specification. the study creates an extensive development model that meets key performance indicators that are relevant to the growth prospects and national solvency measures of the palestinian economy. additionally, the model specification integrates real gdp with the ardl model, taking into account factors such as capital flight, foreign reserve, external debt, foreign direct investment, debt to assets ratio, interest coverage ratio, equity ratio, debt to equity ratio, and domestic investment (mcnown et al., 2018). in its practical version, the model has the following structure: 𝐺𝐷𝑃 = 𝑓(𝐶𝐹, 𝐹𝑅, 𝐸𝐷, 𝐹𝐷𝐼, 𝐷𝐼, 𝐷𝐴, 𝐼𝐶, 𝐸𝑅, 𝐷𝐸) (4) it is as follows to express the method algebraically: 𝐺𝐷𝑃 = 𝛼 + 𝛽1𝐾𝐹 + 𝛽2𝐹𝑅 + 𝛽3𝐸𝐷 + 𝛽4𝐹𝐷𝐼 + 𝛽5𝐷𝐼 + 𝛽6𝐷𝐴 + 𝛽7𝐼𝐶 + 𝛽8𝐸𝑅 + 𝛽9𝐷𝐸 + 𝜀 (5) the real gdp serves as a reliable gauge of economic growth. the following is a crude formula for calculating national solvency: the symbols ed stand for external debt, fdi is for foreign direct investment, di is for domestic investment, and cf represents for capital flight on the foreign reserve. the symbols da, ic, er, and de stand for debt to assets, debt to equity, and interest coverage, respectively. the intercepting function is represented by α, and the error term is denoted by β_1–β_9 = μ, which is the coefficient of the explanatory variables. the relationship between capital flight and palestine's rate of economic growth as well as the impact of capital flight from outside palestine on growth over the research period are both measured. this is also the case, according to the leadership models that we have decided to use in our research. we eliminated the lag in asset holdings while estimating the capital flight (cf) model since there were insufficient observations in our data sample. lensink, hermes, and murinde (1998) conclude that our equation and model appropriately capture the implications of the relative rates of return. the model serves the following purpose: 𝐶𝐹𝑡 = 𝛼0 + 𝛼1𝜋𝑡 + 𝛼2𝑟𝑡 + 𝛼3(𝑟 ∗𝑡+ 𝑥𝑡) (6) where 𝛼1 ≷ 0, 𝛼2 < 0, 𝑎𝑛𝑑 𝛼3 > 0 are the estimated amounts of the coefficients, which reverse the balance of payments accounting standard since capital outflows are measured as positive values of kf. moreover, capital flight is analyzed using the following metric: asian journal of economics and empirical research, 2024, 11(2): 60-82 69 © 2024 by the authors; licensee asian online journal publishing group 𝐶𝐹𝑡 = ∆𝐷𝑡 + 𝐹𝐼𝑡 − 𝐶𝐴𝑡 − ∆𝑅𝑡 (7) the ∆d denotes the variation in external debt, the ∆r denotes the shift in foreign reserves, the ca denotes the current account deficit, and the fi stands for net foreign investment flows, which include both portfolio equity and foreign direct investment flows. the previous paragraph discussed the concept, methods of measurement, and the theoretical implications of capital flight on the process of economic growth. this study aims to quantify the impact of capital flight on palestine's national solvency and economic growth throughout the study period (2004–2022). it is important to remember that prior studies have yielded capital estimates between 2004 and 2022. this made it possible for the researchers to compare revealed flows with documented foreign exchange uses in order to determine the entire amount of capital flight from 2020 to 2021. the world bank (1985) developed the residual technique to quantify capital flight, which we can assess using the following model: 𝐶𝐹𝑖𝑡 = ∆𝐷𝐸𝐵𝑇𝑖𝑡 + 𝐹𝐷𝐼𝑖𝑡 − [𝐶𝐴𝑖𝑡 + ∆𝑅𝑒𝑠𝑒𝑟𝑣𝑒𝑠𝑖𝑡] (8) where: 𝐶𝐹𝑖𝑡: 𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑓𝑙𝑖𝑔ℎ𝑡 𝑖𝑛 𝑈𝑆𝐷. ∆𝐷𝐸𝐵𝑇𝑖𝑡: 𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑒𝑥𝑡𝑒𝑟𝑛𝑎𝑙 𝑑𝑒𝑏𝑡 𝑏𝑎𝑙𝑎𝑛𝑐𝑒𝑠. 𝐹𝐷𝐼𝑖𝑡: 𝑁𝑒𝑡 𝑓𝑜𝑟𝑒𝑖𝑔𝑛 𝑑𝑖𝑟𝑒𝑐𝑡 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑖𝑛𝑓𝑙𝑜𝑤𝑠. 𝐶𝐴𝑖𝑡: 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑐𝑐𝑜𝑢𝑛𝑡 𝑏𝑎𝑙𝑎𝑛𝑐𝑒. ∆𝑅𝑒𝑠𝑒𝑟𝑣𝑒𝑠𝑖𝑡: 𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑠𝑡𝑜𝑐𝑘 𝑜𝑓 𝑎𝑐𝑐𝑢𝑚𝑢𝑙𝑎𝑡𝑒𝑑 𝑓𝑜𝑟𝑒𝑖𝑔𝑛 𝑟𝑒𝑠𝑒𝑟𝑣𝑒𝑠. as a result, the volume of capital flight numbers ultimately reflects the values displayed in table 1. according to the estimations, until 2022, the amount of capital flight was approximately $736 million, representing a 5.2% annual growth from the prior year. table 1. estimated capital flight from palestine 2004-2022 (million usd). year change in the external debt balance net foreign direct investment current account balance change in the stock of foreign reserves amount of capital flight rate of change gdp change % gdp per capita usd 2004 231 145 648 399 651 5.3 13.08% 1.422 2005 256 257 540 436 768 6.2 8.54% 1.544 2006 248 452 342 511 821 7.4 1.71% 1.570 2007 369 622 731 379 639 8.5 6.00% 1.664 2008 345 294 844 459.4 760 6.5 22.29% 2.035 2009 283 386 278 375.9 618 5.6 7.69% 2.192 2010 421 632 527 394.5 645 7.7 16.67% 2.557 2011 266 421 763 498 731 3.4 12.66% 2.881 2012 374 485 597 542 608 4.1 6.48% 3.076 2013 399 674 680 699 731 7.5 8.08% 3.315 2014 531 642 285 374.6 642 9.3 1.11% 3.352 2015 -106 478 539 286.1 430 6.4 -2.39% 3.272 2016 165.7 266 730 528 853 8.4 7.81% 3.528 2017 311.8 241 867 636 903 6.9 2.63% 3.260 2018 281 181 893 742 922 7.8 -1.60% 3.562 2019 387 163 683 778 944 9.8 2.65% 3.657 2020 237 186 765 843 952 5.2 -11.58% 3.234 2021 361 137 887 822 941 8.1 13.76% 3.679 2022 462 188 859 923 736 5.2 3.01% 3.789 source: palestinian monetary authority data (pma)and world bank national accounts data, and the organization for economic cooperation and development oecd national accounts data. table 2 provides an overview of the variables employed in the current study along with a description. table 2. descriptive statistics. variables description mean median standard deviation minimum maximum constant real per-capita income (constant us$) 2.256 7.058 19.044 6.035 81.752 capital flight capital flight in percentage of gdp 4.062 9.743 11.336 22.853 43.818 change in the external debt balance external debt stock (percentage of gdp) 11.472 17.748 13.471 3.011 16.283 net foreign direct investment net inflows of fdi (% of gdp) 7.803 10.552 12.006 4.227 19.363 current account balance current account balance (percentage of gdp) 22.195 26.113 6.044 7.368 21.635 change in the stock of foreign reserves foreign reserves stock changes (percentage of gdp) 16.810 33.208 5.026 10.256 28.558 amount of capital flight capital flight (percentage of gdp) 5.047 12.226 13.590 -15.842 42.736 rate of change rate of change (percentage of gdp) 17.702 37.052 5.063 8.907 23.406 debt to assets ratio debt to assets (percentage of gdp) 5.074 8.974 11.310 6.088 36.953 interest coverage ratio interests coverage (percentage of gdp) 3.942 7.980 2.975 3.785 25.583 equity ratio equity ratio (percentage of gdp) 17.845 27.832 8.643 2.006 18.642 debt to equity ratio debt to equity (percentage of gdp) 12.894 25.960 7.152 5.583 63.961 asian journal of economics and empirical research, 2024, 11(2): 60-82 70 © 2024 by the authors; licensee asian online journal publishing group a number of adjustments to this method have been put forth, such as the moriarty, kimball, and gay (1983) and perlowski (1992) which define capital flight as the accumulation of residential overseas assets by the state's nonbanking sector and prohibit the state's financial system and finance organizations from acquiring short-term foreign investors. equation 9 applies the current method to the assessment of capital flight, using the following method: 𝐶𝐹𝑡 = ∆𝐷𝑡 + 𝐹𝐼2 − 𝐶𝐴𝑡 − ∆𝑅𝑡 − 𝑆𝐵𝑡 (9) sb refers to the current state of the financial system as well as the short-term financial currencies of financial institutions. a further component of the ardl technique (mcnown et al., 2018) is determining the shortand longterm relationship between the variables. the general framework of the ardl model is obtained by transforming and expressing equation 10 as follows: ∆𝐺𝐷𝑃𝑡 = 𝛼0 + ∑ 𝛽1𝑖 ∆𝐺𝐷𝑃𝑡−1 + ∑ 𝛽2𝑖 ∆𝐶𝐹𝑡−1 𝜅 𝑖=0 + ∑ 𝛽3𝑖 𝜅 𝑖=0 ∆𝐹𝑅𝑡−1 + ∑ 𝛽4𝑖 𝜅 𝑖=0 𝜅 𝑖=0 ∆𝐸𝐷𝑡−1 + ∑ 𝛽5𝑖 𝜅 𝑖=0 ∆𝐷𝐼𝑡−1 + ∑ 𝛽6𝑖∆𝐷𝐴𝑡−1 + ∑ 𝛽7𝑖∆𝐼𝐶𝑡−1 + ∑ 𝛽8∆𝐸𝑅𝑡−1 + ∑ 𝛽9∆𝐷𝐸𝑡−1 +𝑘 𝑖=0 𝑘 𝑖=0 𝑘 𝑖=0 𝑘 𝑖=0 𝛽10𝐺𝐷𝑃𝑡−1 + 𝛽11𝐶𝐹𝑡−1 + 𝛽12𝐹𝑅𝑡−1 + 𝛽13𝐸𝐷𝑡−1 + 𝛽14𝐷𝐼𝑡−1 + 𝛽15𝐷𝐴𝑡−1 + 𝛽16𝐼𝐶𝑡−1 + 𝛽17𝐸𝑅𝑡−1 + 𝛽18𝐷𝐸𝑡−1 + 𝜀𝑖𝑡 (10) for each of the explanatory variables, (k) is the total number of optimal lag duration that would satisfy the hannan-quinn (hqc), schwarz bayesian (sbc), or akaike (aic) criteria. is δ the initial difference operator; β1i, β2i, β3i, β4i and β5i represent the algorithm's short-run dynamics, while the long-run dynamics are represented by β6, β7, β8, β9, and β10 dynamics. the long-term equilibrium condition is the primary concern for the ardl model employed in the empirical model estimating process (mcnown et al., 2018), when the dependent variable coefficient in the various short-term estimated delays amounts to less than one. equation 11 is used to determine the error correction model (ecm) and error correction term (ect), also known as the short-term dynamic, and it is used to calculate the consequences of capital flight in palestine: ∆𝐺𝐷𝑃𝑡 = 𝛼0 + ∑ 𝛽1 ∆𝐺𝐷𝑃𝑡−1 + ∑ 𝛽2 ∆𝜑𝑡−1 + 𝛽3 𝐸𝐶𝑀𝑡−1 + 𝐸𝐶𝑇𝑡−1 + 𝜀2𝑡 𝑘 𝑖=0 𝑘 𝑖=0 (11) it demonstrates how rapidly adaptation variables reach a long-run equilibrium following a short-run shock. the error term is 𝜀2𝑡, the array of unrelated variables is 𝜑𝑡−1, and the error correction term is 𝐸𝐶𝑀𝑡−1. 4. empirical findings and discussion in response to the long-run information loss from regression analysis with the initial difference variables and their removal, we assess the likelihood of cointegrating correlations between the nonstationary time series variables. when a cointegrating vector of variables is available, a vector error correction model may be utilized to do an "ols" regression while preserving the longand short-run dynamics (enders, 1995; meng, 2016). mcnown et al. (2018) use the ardl model to determine the cointegrating long-run connection between the non-stationary variables. the variables undergo evaluations for stationarity and sequence of integration in order to ensure that the estimates yield accurate results. unit root testing is needed to check how stationary the variables are and stop wrong regression, keeping in mind what we’ve already talked about and the creation of the error correction model that uses time-series data variables. there are a multitude of stationarity testing techniques with differing levels of advancement. escobari, garcia, and mellado (2017) used the phillips-perron "pp" test and the augmented dickeyfuller adf (dickey & fuller, 1979) to confirm the results. tables 3 and 4 present the findings from the two-unit root tests. table 3. unit root test of augmented dickey-fuller. variables test of augmented dickey-fuller level first difference t-stat critical value probability order integration status t-stat critical value probability order integration status constant -1.988*** -1.860 0.253** i (0) -3.894** -1.688 0.00 i (1) gdp -1.464** -1.379 0.542*** i (0) -5.442*** -1.003 0.00 i (1) cf -1.387** -1.760 0.312** i (0) -6.351*** -1.005 0.00 i (1) fr -1.784*** -1.691 0.258** i (0) -7.472*** -1.007 0.00 i (1) ed -1.572*** -1.548 0.185* i (0) -11.631*** -1.004 0.00 i (1) di -1.297** -1.493 0.253** i (0) -17.231*** -1.065 0.00 i (1) da -1.074** -1.642 0.574*** i (0) -6.431** -1.005 0.01 i (1) ic -1.124** -1.565 0.641*** i (0) -14.424*** -1.002 0.00 i (1) er -1.161** -1.228 0.742*** i (0) -3.382** -1.008 0.02 i (1) de -1.760*** -1.242 0.622*** i (0) -11.486*** -1.009 0.00 i (1) note: *indicates a 1% significance level; ** indicates a 5% significance level; *** indicates a 10% significance level. table 4. phillips-perron unit root test. variables phillips-perron test level first difference t-stat critical value probability order integration status t-stat critical value probability order integration status constant -2.107*** -1.484 0.362** i (0) -2.098** -1.396 0.00 i (1) gdp -1.830** -1.008 0.584*** i (0) -7.885*** -1.001 0.00 i (1) cf -1.519** -1.005 0.731*** i (0) -11.008*** -1.001 0.00 i (1) fr -1.769** -1.004 0.064* i (0) -15.275*** -1.003 0.01 i (1) ed -1.424** -1.002 0.439** i (0) -5.452*** -1.004 0.00 i (1) di -1.970** -1.006 0.096** i (0) -4.876** -1.033 0.00 i (1) da -1.863** -1.005 0.144** i (0) -8.530*** -1.007 0.00 i (1) ic -2.313*** -1.567 0.375** i (0) -3.121** -1.452 0.00 i (1) er -1.231 -1.003 0.428** i (0) -10.005*** -1.004 0.00 i (1) de -2.274*** -1.622 0.635*** i (0) -9.068*** -1.388 0.00 i (1) note: *indicates a 1% significance level; ** indicates a 5% significance level; *** indicates a 10% significance level. asian journal of economics and empirical research, 2024, 11(2): 60-82 71 © 2024 by the authors; licensee asian online journal publishing group tables 3 and 4 provide the regression model values from the (𝐴𝐷𝐹 𝑎𝑛𝑑 𝑃𝑃) studies. the two statistically significant estimates, which comprise an interception and a propensity, are identical. the findings of both tests indicate that all variables, with the exception of capital outflows (𝐶𝐹), are consistent at the first differentiation utilising interception and a tendency. 𝐶𝐹 is constant in the pp and 𝐴𝐷𝐹 tests at the 5% level at both levels and the initial differentiation. this leads to the integration and addition of some cf and foreign reserve fr variables into the mixture, while other variables remain constant following initial discretization. according to mcnown et al. (2018) this is essential for assessing the long-term association with the 𝐴𝑅𝐷𝐿 proposed model. 4.1. co-integration approach bound test real 𝐺𝐷𝑃, capital flight 𝐶𝐹, currency reserves 𝐹𝑅, debt levels 𝐸𝐷, debt to assets 𝐷𝐴, interest coverage 𝐼𝐶, equity ratio 𝐸𝑅, debt to equity ratio 𝐷𝐸, and investment must be shown to have a long-term connection because the variables have both continuous and shifting orders of integrating 𝐷𝐼. these are the necessary data for the autoregressive distributed lag bound analysis: table 5. bound test results. f-statistics = 4.46* bound for critical value reduced bound greater bound 10% 2.62** 2.48* 5% 2.81** 2.97** 2.5% 2.93** 3.47*** 1% 2.5** 3.83*** note: * indicates significance at 1%, **2.5%,5%, and ***10% levels. table 6. the ardl bound testing for cointegration. test statistic value significance i (0) i (1) f-statistic 4.220742 10 per cent 2.294** 3.239*** k 6 5 per cent 2.562** 3.609*** 9 1 per cent 3.663*** 4.552*** note: ** indicates significance at 2.5%,5%, and ***10% levels. table 5 displays the bound test results based on the appropriate lag durations chosen by the "sic." at different levels, every significant result is higher than the f-statistics value of 4.46*. the findings indicate a long-term correlation between real gdp, foreign debt, capital flight, and investment returns. repudiating the null hypothesis that there isn't a long-term link is therefore required. the bond's computed f-statistic, 4.220742, is larger than the lower and upper limit critical values at any level of significance, according to table 6's ardl bond test findings for cointegration. it is possible to reject the null hypothesis, which states that there is no cointegration, at any level of significance. this finding clearly suggests that the model's variables have a long-term connection. 4.2. the long and short-run coefficients the effect of long-run features is evaluated for the 𝐴𝑅𝐷𝐿, which was presented at the beginning of the original study, in order to accept hypotheses that explore the longand short-run relationships between variables. the following are the outcomes: table 7. the coefficients of the long-run estimation using the ardl (1, 1, 0, 4, 3, 1, 2). variables coefficients standard error t-statistic probability constant -1.211* 0.068 -0.890 0.133* cf 1.052*** 0.036 -1.652 0.047** fr -0.334* 0.044 4.890 0.003*** ed -0.142* 0.056 9.628 0.000** di -0.201** 0.087 3.626 0.006*** da -0.231** 0.099 5.112 0.054** ic -0.165** 0.074 3.441 0.006*** er 1.311*** 0.053 4.226 0.007*** de 1.255*** 0.087 4.862 0.008*** c 4.081*** 1.373 -0.050 0.465* note: *a 1% significance level, ** indicates a 5% significance level; *** indicates a 10% significance level. with the exception of capital flight, which is significant at the 10% level, table 7 shows that all variable coefficients are significant at the 5% level. furthermore, the p-value of 0.0473 at the 10% significance level of the research (using real gdp as a proxy) supports the notion that increased capital flight has a significant and negative influence on economic growth. moreover, there is a 4% drop in economic growth. this outcome is consistent with orimolade and olusola (2018) research, which discovered a negative relationship between capital flight and palestinian economic growth. huge sums of money are being forcibly moved to other economies, deprived the domestic economy of the advantages of higher local investment, the development of infrastructure, and the creation of jobs. these behaviours eventually hurt both sustained growth and economic prosperity. the positive coefficient of 0.142981 and the p-value of 0.0037 at the 5% level show that foreign reserves have a significant and favourable influence on economic development. this suggests that every 1% increase in foreign reserves will result in an 18% improvement in long-term economic development. this outcome is in line with a 2017 study by lawal et al. (2017) that discovered a significant relationship between palestine's foreign reserves and economic expansion. furthermore, the non-negative coefficient asian journal of economics and empirical research, 2024, 11(2): 60-82 72 © 2024 by the authors; licensee asian online journal publishing group at the 5% level and the p-value of 0.0001 demonstrate that foreign debt had a significant and favourable influence on economic growth. this demonstrates how a 1% causes an increase in foreign debt causes a 10% increase. liew et al. (2016) found a correlation between foreign debt and palestinian economic development, which is consistent with their study findings. every nation that wants to borrow money from another country does so in order to build the infrastructure that it needs and drive economic growth. a well-run external debt program would strengthen the domestic economy, attract international investment, create jobs, improve social welfare, and expand employment. the correlation between foreign debt and economic development is positive as a result, suggesting that capital projects supported by borrowed funds eventually led to an increase in the size of the economy. the p-value of 0.0045 at the 5% level and the positive correlation of 0.127599 show that real investment has a significant and positive impact on economic growth. as a result, a 1% increase in domestic investment leads to a 29% increase in economic growth. this result is in line with the capital outflow study (salandy & henry, 2017) which showed a connection between growth in the domestic economy and investment. the error correction model ecm, which is based on the ardl approach, is used to study the short-term dynamic between capital flight and other factors. ecm is a short-term dynamic movement identification method that helps anticipate long-term equilibrium. the rate at which short-term shocks are adjusted to long-term equilibrium is reflected in the coefficient of ect. for a viable ecm model, a significant ect coefficient with a value between 0 and -1 is required. table 8 presents the results of the short-run dynamics using the ardl method-based ecm model. table 8. the coefficients of the short-run estimation using the ardl (1, 1, 0, 4, 3, 1, 2). variables coefficients standard error t-statistic probability 95% confidence interval constant -1.290* 0.087 -0.549 0.007* -0.064 0.074 d (cf) 1.088* 0.064 -1.359 0.003* -0.088 0.072 d (fr) -0.659*** 0.060 4.226 0.003** -0.079 0.068 d (ed) -0.379** 0.077 9.094 0.000* -0.087 0.019 d (di) -0.463** 0.098 3.908 0.000* -0.022 -0.063 d (da) -0.530*** 0.0799 5.760 0.000* -0.189 -0.087 d (ic) -0.258** 0.087 3.880 0.005* -0.246 -0.092 d (er) 1.476* 0.085 4.226 0.000* -0.275 -0.087 d (de) 1.446** 0.096 4.862 0.000* -0.287 -0.083 d (c) 0.077*** 1.653 -0.050 0.026* -0.321 -0.096 cointeq (-1) * -0.668*** 0.231 -5.125 0.000* -0.056 -0.073 note: *a significance 1% level, ** indicates a 5% significance level; *** indicates a 10% significance level. the short-term ecm coefficient, as indicated in table 8, confirms that the factors affecting national solvency and economic growth continue in the same direction as the long-run relationship. according to the estimation results of the short-run coefficients, every variable that influences capital flight is statistically significant. the nation's economic growth and solvency variables both show results that are consistent with long-term trends. table 8 indicates that the long-term equilibrium of capital flight value against current shocks in the impacting factors is sufficiently fast, with the coefficient of the error correction term expressed as cointeq (-1) being negative at 0.668421, and statistically significant at the 1% level. 4.3. corrections estimated errors co-integrating relationships between the variables, such as ecm-1, support the implementation of error correction. the short-term dynamics are computed, and, in the event of a divergence from the long-term equilibrium, the correction rate is scrutinized in further detail. ecm-1's absolute value ranges from 0 to 1, and the rate of adjustment rises in tandem with its coefficient. the following is a report of the ecm-1 estimated findings. table 9. results of estimated error corrections. variables coefficients standard error t-statistic probability 95% confidence interval constant -0.245*** 0.017 -4.125** 0.005* -0.057 0.068 capital flight cf -0.022** 0.014 -2.324** 0.048* -0.078 0.060 foreign reserve fr -0.083** 0.044 -3.710** 0.010* -0.091 0.058 external debt ed 0.038** 0.039 2.430 0.026* -0.059 0.015 direct investment di -0.096** 0.058 -1.407** 0.100** -0.029 -0.054 debt to assets da -0.316* 0.043 -2.530** 0.038* -0.162 -0.093 interest coverage ic -0.056** 0.053 -3.772** 0.026** -0.274 -0.098 equity ratio er -0.531* 0.088 -5.310*** 0.005* -0.297 -0.085 debt to equity de -0.732* 0.094 -4.226** 0.002* -0.239 -0.078 ecm-1 -0.423* 0.265 -3.821** 0.002* -0.345 -0.081 note: * indicates a 1% threshold of significance, **indicate a 5% threshold of significance, *** indicate a 10% threshold of significance. the estimated 𝐴𝑅𝐷𝐿 model (mcnown et al., 2018) as shown in the equation obtained a positive ecm-1 result (11), based on the data in table 9. the estimated coefficient turns out to be unfavourable and statistically significant at the 5% level. this suggests that 56% of the long-run disequilibrium is corrected in the current period by lagged period error shocks. this demonstrates even more how quickly long-term economic expansion returns to its stable state. furthermore, because variables have the correct negative sign, which aids in the system's recovery from a disequilibrium, it shows that variables are appropriately characterized. the short-term reaction to the coefficient of foreign reserves and domestic investment is negative, in contrast to the long-term trend. it seems possible, then, to evaluate palestinian economic development by taking into account all the factors. asian journal of economics and empirical research, 2024, 11(2): 60-82 73 © 2024 by the authors; licensee asian online journal publishing group 4.4. diagnostic test analytics heteroscedastic testing, the normality measure, and auto-correlation are some of the diagnostic approaches used to evaluate the dependability of the data. below is a summary of the results: table 10. results of diagnostic test analytics. diagnostic test probability value testing breusch-godfrey for serial correlation f-statistic = 3.283 p-value = 0.0762** breusch-pagan-godfrey heteroskedasticity test f-statistic = 0.286 p-value = 0.5143** standard test jarque-bera = 0.388 p-value = 0.4875** note: **signifies lack just at thresholds of significance 5%. table 10 displayed the results of the analytical diagnostic tests, including the breusch-godfrey test for serial correlation, which had an f-statistic value of 3.283 and a p-value of 0.0762. furthermore, the standard test and its probability for jarque-bera were estimated at 0.388 and also the p-value, which was estimated at 0.4875; finally, the diagnostic test for the breusch-pagan-godfrey heteroskedasticity test and its probability f-statistic equals 0.286 and p-value equals an estimated 0.5143. based on the ardl paradigm, table 8 presents an estimate of the results of diagnostic techniques (mcnown et al., 2018). non-significant p-values are produced by heteroskedasticity and the breusch-godfrey serial adjustments, suggesting that the model's investment returns are not heteroskedastic or cointegrated. this illustrates how the dependent variable's departure from the fitting link is stable and remains constant as the magnitude of the independent variable increases. the tested model was found to be normally distributed by the normality and standard test since the jarque-bera statistic was small. all evaluations indicate that, overall, the residuals do not violate any of the stated assumptions. 4.5. robustness checks we calculated our model using palestine's economic features to see if our findings were reliable. table 11 short and long-term impacts, as well as tables 12 and 13 (marginal effects), respectively, provide these estimations. there is a good match between the coefficients of capital flight (-0.054 and -0.067), in the short and long terms, external debt (-0.187 and -0.141), and the foreign direct investment (-0.008 and -0.063). this is especially true when looking at the main variables that matter, like capital flight and how it affects economic growth and national solvency. the narrative for the marginal effect is the same, as can be seen in tables 12 and 13, for example. in particular, the findings on marginal effects indicates that low levels of capital flight do not counterbalance the negative impacts of foreign debt and national solvency on economic development. these coefficients were not statistically significant from the first to 25% percentile values, similar to the findings for the complete sample. however, all of the results from the 50th to the 95th percentiles were adverse and statistically significant. this indicates that the adverse effects of capital flight, as stated above, are worsened by the adverse effects of foreign debt and capital flight on economic development and national solvency in middle eastern nations like palestine. table 11. the effect of capital flight on economic growth and national solvency in palestine. variables short-run long-run coefficient standard error wald test pvalue coefficient standard error wald test pvalue constant 0.107 0.038 6.055 0.463 -0.412*** 0.098 7.132 0.533 capital flight -0.054*** 0.011 2.884 0.267 -0.067 0.012 3.118 0.035 change in the external debt. balance -0.187*** 0.013 1.097 0.209 -0.141*** 0.014 1.236 0.351 net foreign direct investment -0.008 0.052 4.086 0.023 -0.063 0.88 4.228 0.043 current account balance -0.213*** 0.009 3.641 0.003 -0.132*** 0.017 4.674 0.016 change in the stock of foreign reserves 0.011 0.016 0.790 0.000 0.061*** 0.031 0.894 0.000 amount of capital flight -0.116*** 0.042 5.249 0.041 -0.173*** 0.058 6.337 0.033 rate of change 0.044 0.028 3.065 0.541 0.051 0.029 2.892 0.481 debt to assets -0.216*** 0.034 0.896 0.011 -0.104*** 0.042 4.114 0.021 interest coverage ratio 0.087 0.018 0.989 0.000 0.048 0.025 0.863 0.000 equity ratio -0.214*** 0.007 5.275 0.003 -0.163*** 0.011 5.338 0.006 debt to equity ratio -0.316*** 0.005 2.821 0.002 -0.181*** 0.015 0.977 0.001 ar2 (p-value) 0.211 0.181 0.142 0.345 0.313 0.104 0.206 0.422 hansen (p-value) 0.384 0.289 0.167 0.408 0.426 0.211 0.294 0.363 note: *** represents 1% significance level. table 12. the marginal effect of capital flight on economic growth and national solvency as capital flight increases from palestine. the effect of short-run of capital flight on economic growth as the capital flight increases percentiles capital flight coefficient standard error 95% confidence interval 1% -0.642 0.002 0.031 -0.097 0.065 5% -0.832 0.002 0.033 -0.095 0.063 10% -0.567 -0.011 0.029 -0.086 0.062 25% -0.308 -0.043 0.025 -0.094 0.015 50% 0.042 -0.089*** 0.014 -0.016 -0.058 75% 0.226 -0.138*** 0.016 -0.165 -0.081 90% 0.328 -0.176*** 0.021 -0.225 -0.098 95% 0.403 -0.168*** 0.023 -0.258 -0.096 note: *** represents 1% significance level. asian journal of economics and empirical research, 2024, 11(2): 60-82 74 © 2024 by the authors; licensee asian online journal publishing group table 13. the marginal effect of capital flight on economic growth and national solvency as capital flight increases from palestine. the effect of long-run of capital flight on economic growth as the capital flight increases percentiles capital flight coefficient standard error 95% confidence interval 1% -0.642 0.002 0.028 -0.093 0.065 5% -0.832 0.002 0.029 -0.093 0.065 10% -0.562 -0.09 0.026 -0.088 0.063 25% -0.306 -0.041 0.024 -0.099 0.014 50% 0.040 -0.091*** 0.015 -0.148 -0.057 75% 0.223 -0.136*** 0.017 -0.167 -0.085 90% 0.387 -0.162*** 0.022 -0.198 -0.098 95% 0.402 -0.171*** 0.024 -0.216 -0.099 note: *** represents 1% significance level. table 14. robustness check. variable fmols dols coefficient p-value coefficient p-value cf 0.253*** 0.000 0.157 0.051 fr -0.028** 0.538 0.047 0.530 ed -0.170** 0.000 -0.129 0.011 di 0.523*** 0.000 0.580 0.001 da 0.159* 0.000 0.144 0.059 ic -0.169** 0.068 -0.351 0.106 er -0.052* 0.503 0.063 0.622 de -0.164** 0.461 0.113 0.429 d1 0.129** 0.006 0.181 0.016 d2 -0.058* 0.452 -0.070 0.113 c 2.629*** 0.002 2.414 0.000 r2 0.426 0.632 adjusted r2 0.398 0.599 note: *, ** and *** indicate the significance level at 1%,5%, and 10%, respectively. regress and is cf table 14 displays the results for the variables from the fully modified ordinary least squares fmols and dynamic ordinary least squares dols studies. the results of the study show a strong positive correlation between fr and cf. in the fmols model, the cf variable is not statistically significant; however, in the dols model, it becomes significant. in both models, ed has a deleterious effect on cf. conversely, da and di are beneficial in both situations. in both models, ic exhibits a detrimental effect. r2 and adjusted r2 results support the dols model's greater explanatory power and imply that the variables chosen have a variety of effects on gdp. the findings shed light on the complex effects of the factors under investigation on gdp. table 15. vecm granger causality test. direction of causality wald χ2 statistics p-value/prob. cf → gdp 5.073 0.000* gdp → cf 1.480 0.160*** fr → gdp 4.613 0.052** gdp → fr 6.528 5.e-06 ed → gdp 1.378 0.452*** gdp → ed 6.506 0.000* di → gdp 0.736 0.672*** gdp → di 4.268 0.066** da → gdp 0.138 0.741*** gdp → da 6.365 0.000* ic → gdp 0.624 0.598*** gdp → ic 6.503 6.e-07 er → gdp 16.53 6.e-07 gdp → er 6.702 0.001* de → gdp 0.795 0.659*** gdp → de 1.834 0.313** fr → cf 6.184 0.003* cf → fr 1.978 0.189** ed → cf 0.216 0.804*** cf → ed 0.350 0.715*** di → cf 0.313 0.680*** cf → di 3.249 0.062** cf → da 0.285 0.739** da → cf 2.786 0.082** cf → ic 5.382 0.006* ic → cf 1.793 0.321** cf → er 6.600 0.004* er → cf 0.163 0.753*** asian journal of economics and empirical research, 2024, 11(2): 60-82 75 © 2024 by the authors; licensee asian online journal publishing group direction of causality wald χ2 statistics p-value/prob. cf → de 0.573 0.649*** de → cf 5.428 0.000 ed → fr 1.749 0.263** fr → ed 3.583 0.043** ed → di 22.68 1.e-13 di → ed 3.492 0.062** ed → da 5.480 0.003* da → ed 5.108 0.000* ed → ic 6.703 0.000* ic → ed 0.450 0.717*** da → di 0.473 0.693*** di → da 1.593 0.152*** da → ic 0.641 0.794 ic → da 2.510 0.086** da → er 3.075 0.078** er → da 4.886 0.008* da → de 6.149 0.000* de → da 0.583 0.567*** ic → er 4.950 0.002* er → ic 0.674 0.589*** ic → de 2.997 0.004* de → ic 6.339 0.000* note: *, ** and *** indicate the significance level at 1%,5%, and 10%, respectively. the granger causality test (vecm) is used to determine the direction of causality between variables. significant evidence points to a unidirectional impact from fr to cf, as seen in table 15. comparable patterns are seen for ed and cf, where ed is the cause of cf. on the other hand, cf has a one-way effect on ed. the same unidirectional trend is evident for er and cf, da and cf, gdp and cf, and ic and cf. interestingly, several variables exhibit bidirectional granger causality, showing reciprocal impacts, such as fr and di, fr and ed, and ic and de. it is determined by diagnostic procedures whether the underlying ardl-ecm fits properly. six approaches are used in this study to look for potential instability: variable autocorrelation (the breusch-godfrey of lagrangemultiplier lm test or durbin-watson dw test), heteroscedasticity of time series (the white heteroscedasticity test), the functional form problem (the ramsey reset test), and the normality problem (the skewness and kurtosis measures), (durbin-watson test) and (jarque-bera test for normality). the empirical results demonstrate that the ardl-ecm passes every test as indicated in table 16, confirming the lack of bias. the findings of the granger causality relationship test, in particular, suggest that palestine's worsening economic circumstances raise the possibility of capital flight, which stifles economic expansion and lowers growth rates. table 16. stability test results. tests x2 statistics coefficient/probability ramsey reset test 1.03 0.376*** (0.012) breusch-godfrey lm test 1.081 0.286** (0.122) white heteroscedasticity test 1.26 0.237** (0.131) skewness: 0.038 kurtosis: 2.0046 dw: 1.725 durbin-watson test 0.206 2.083 jarque-bera test for normality 5.091 623.740* (0.000) note: *, ** and *** indicate the significance level at 1%,5%, and 10%, respectively. it is crucial to emphasize that the model's diagnosis is crucial for the validity of the ardl estimations. the diagnostics provided in the table show that all estimates, in addition to using correct instruments, show the lack of second-order autocorrelation. this outcome has the potential to impact politics. on the basis of the findings presented above, suggestions can be made. figure 1. cusum. asian journal of economics and empirical research, 2024, 11(2): 60-82 76 © 2024 by the authors; licensee asian online journal publishing group a useful tool for tracking the predicted coefficients in the model's stability over time is the cusum control chart. in this investigation, the cusum and cusum square lines frequently fall within the 5% significance limits (figure 1). this suggests that over the research period, the computed coefficients stay steady and do not show any notable deviations or structural fractures. the robustness and reliability of the model's parameter estimates are confirmed by the presence of both lines within the control limits, which supports the validity of our findings and indicates that the model effectively captures the underlying relationships among the variables over the course of the observation period. figure 2. cusum square. the cumulative sum test for randomness is used to track the predicted coefficients in the model’s stability over time. the cusum square control charts are useful resources. for tracking the predicted coefficients in the model's stability over time, the cumulative sum test for randomness cusum square control charts are useful resources. figure 2 shows that the cusum square lines in this investigation consistently fall under the 5% significance levels. this shows that during the research period, the calculated coefficients do not show any notable deviations or structural breakdowns. instead, they stay steady. both lines' existence within the control ranges demonstrates the robustness and dependability of the model's parameter estimates, supporting the validity of our findings and indicating that the model effectively captures the underlying relationships between the variables over the course of the observation period. 5. conclusions and policy implications 5.1. conclusions the study looked at how capital flight affected palestinian economic development and the country's ability to finance itself from 2004 to 2022. the study finds that capital flight has a negative and considerable influence on economic development and national solvency using the 𝐴𝑅𝐷𝐿 technique and 𝑃𝑀𝐺 estimate process for the dynamic system. this data reveals that the diversion of the country’s limited resources to finance foreign investment in certain safe havens leads to the poor performance of palestinian economic growth and national solvency. the study also showed a strong inverse association between capital flight and economic development and expansion. the interplay between capital flight, the increase in the debt ratio, and the increase in foreign loans was found to have a negative and statistically significant impact on growth. the results of estimates of marginal effects indicated that the high rate of capital flight is a route through which the loss of foreign and domestic investments has a detrimental impact on palestinian economic growth. the current work, in contrast to earlier research, investigates this dynamic relationship using a more contemporary technique called the 𝐴𝑅𝐷𝐿 limits testing methodology. the empirical findings showed that the findings of the short-run analysis are compatible with the long-run conclusion in terms of the influence of each variable. these findings paint a clear picture of the different means through which capital leaves palestine for other countries. therefore, in order to achieve desired long-term growth, authorities in palestine must develop a comprehensive strategy to manage their foreign capital and reduce the growth in capital flight. the following suggestions for policy consideration are based on the summary of research findings provided above: the palestinian authorities and decision-makers need to create a dynamic macroeconomic climate that supports business growth, welcomes international investment, and addresses unemployment and excessive pricing. as a result, fewer indigenous resources would be exported from the continent. once more, the palestinian leadership and administration must adopt sensible steps to boost domestic revenue and lower the nation's yearly rate of borrowing from abroad and incurring debt. in order to stop corporations, institutions, and companies from evading taxes, they must create a database for every company and digitize the tax collection system. the usage of foreign borrowing facilities needs to be effectively managed and controlled. whenever possible, establish a separate organization to supervise the projects and programs that receive the debt facilities. a thorough evaluation of the key priorities for which external funding should be allocated should also be made. this would prevent the misallocation of funds to industries that don’t yield significant returns on investment. this will improve the nation's capacity to pay off debt and ease its financial issues. furthermore, the palestinian government should work to effectively raise funds from domestic economic activity to support a bigger amount of its budget deficit. by doing so, the country will be less dependent on capital flight, loans, and aid from donor nations and the world bank, which will lessen the weight of its external debt. finally, the palestinian government and accountable agencies must commit to investigating the reasons and channels of capital flight in addition to ensuring effective management to reduce the issue. in order to ensure that those who steal public asian journal of economics and empirical research, 2024, 11(2): 60-82 77 © 2024 by the authors; licensee asian online journal publishing group funds are held to the highest standards of the law, the judicial system and the rule of law must be maintained and strengthened. migration and flight of capital limit the possibility for economic growth, impact the employment rates, and impair overall population well-being. the inability of the global economy to come up with a workable solution to stop money being smuggled out of underdeveloped nations will not be a quick fix for the problems caused by capital flight. we determine the culprits' intentions and strategies in order to put an end to this worldwide catastrophe. an increase in illicit money transfers would complicate funding imports and economic growth in the palestinian economy, which is bereft of foreign cash due to its enormous external debt and widening fiscal imbalance. among the most influential groups suspected of being responsible for money outflows include foreign investors in the palestinian financial sector, high-ranking government officials, multinational corporations across many industries, and business executives active in import and export activities. instead, using annual time series data (2004–2022), this study investigates how capital flight has affected palestinian economic development over the study period. the 𝐴𝑅𝐷𝐿 model gathers and assesses information from several sources. there is evidence of both shortand long-term linkages between palestine's 𝐺𝐷𝑃, foreign debt, capital outflows, international resources, and local investment (mcnown et al., 2018). a closer look at the effects of different factors shows that capital flight, which has a major negative short-term impact on the economy, has the opposite long-term effect from foreign reserves, external debt, and domestic investment. to stop the rising flow of capital flight, the government must come up with sensible economic reform plans. the creation of an atmosphere that encourages increased domestic production, transparency and accountability in the use of public resources, and robust macroeconomic stability must be the main goals of these economic advancements. furthermore, a positive coefficient for foreign equity investment necessitates a critical evaluation of palestine’s business environment, as a deficient legal framework and unfriendly investment climate can trigger capital flight. a sufficient overhaul of policy is required to tackle the underlying reasons behind palestine's capital flight. this would boost local capacity and drastically lessen the hazard. international communities must also contribute to the reform of the global financial system in order to hold all tax havens and linked countries accountable for and liable to fines for supporting and concealing illicit money flows from impoverished countries. in conclusion, we note that the existence of global shifts in investment systems as engines of economic expansion, such as capital flight and other economic activity focused on adaptable foreign and local investment pathways and functioning in adaptable investment environments, can present an opportunity to reconsider the necessity of greatly enhancing the conventional palestinian investment environment. it is reasonable to assume that most jobless university graduates see upgrading their much-needed technical and professional abilities as a lifeline that can lead to job chances. this makes a thorough strategy for profitable investment to lessen capital flight overseas crucial. as a result, the unemployment rate in the nation declines. by upgrading value chains, raising investments, and developing initiatives that promote the palestinian economy and lower high unemployment rates, a developed "vet" training system can greatly help reduce the amount of capital that refugees escape from palestine. to do this, nevertheless, a more thorough approach to ongoing teaching regarding capital development and growth could be more appropriate. whether it is in the technology sector or through the digital transformation of established businesses, a retrained, educated, and adaptable workforce can support economic growth in palestine. the investigation discussed the idea of capital flight, its various meanings, and how it affects the expansion of the economy. the analytical model's findings showed that capital mobility did, in fact, have a detrimental impact on palestine's process of economic expansion. 5.2. policy implications in the most straightforward scenario, the national economy perceives the immigrant's capital as an opportunity for local investment, despite the lack of research confirming the impact of capital movement on the economy. it is imperative that palestine strive to mitigate this issue and tackle it to the greatest extent feasible by implementing the following policy implications: diversity of national revenue resources: it is possible to argue that industrialization is a natural consequence of both adopting an economic system and broadening the nation's revenue sources. it increases economic stability and lessens the impact of fluctuations in the world economy. it is worth noting that several economists have said that inadequate investment climates are not the main reason for capital flight. in this regard, pasteur indicates that "foreign corporations spend their capital in the form of loans to other nations if the financial market in a state is not favourable to the outflow of actual cash." rather, pasteur attributes capital flight to the way local authorities handle domestic investors unevenly and their increasing vulnerability to foreign loans when they don't activate it. combating bureaucracy and corruption: just as the removal of corruption was a major factor in the capital flight, it is now critical to eradicate corruption as a means of putting an end to this phenomenon. president mahmoud abbas of palestine spearheaded the need to create an anti-corruption body in order to combat the underlying causes of administrative corruption inside the government machinery and improve corporate operations. encouraging these initiatives is crucial to creating a transparent national economy that all investors can rely on. simultaneously, the government must focus on removing different administrative obstacles and supply the required funding for different initiatives, particularly those involving small and medium-sized businesses. the following outcomes should be expected from the teaching process: numerous economists have attempted to devise metrics to determine the degree to which education influences the economic process. the scientist known as "krueger" found that not only does education contribute to economic development, but that it also explains around 75% of income ratios, along with the age distribution and population's sectoral distribution. the study, examining 20 countries, highlighted that schooling alone could account for 25% of the disparities. as one of the most crucial elements in igniting palestine's labour market, the palestinian government must therefore enhance the educational process' outputs to correspond with the demands of employment. the following practical implications were developed by the researchers in light of the study's findings: attempt to ascertain if the palestinian political and institutional structure is parliamentary, presidential, or a hybrid of the two. in terms of finances, internal affairs, and foreign policy, the presidency and the palestinian government have distinct authorities. establishing an alliance based on genuine collaboration between academic institutions, centres asian journal of economics and empirical research, 2024, 11(2): 60-82 78 © 2024 by the authors; licensee asian online journal publishing group for scientific research, and authoritarian organizations in a way that advances institutional integrity and change. turning on systems to stop fraud, carelessness in the administration, and misappropriation of public monies. constructing a conceptual and theoretical framework for a comprehensive institutional reform that takes into account the uniqueness and exceptionalism of the palestinian people in the face of the existence of authoritarian institutions devoid of true sovereignty. making an effort to create a thorough and comprehensive constitution that takes into account the palestinian experience in writing the basic law and the declaration of independence. creating a political culture that is aware of the need to support the reform process and combat corruption, while also encouraging individualism in a constructive way, is crucial for the typical palestinian citizen. strengthening the partisan and organizational structures inside palestinian forces and parties, as partisan culture narrow or wide and logical reflects on society's political culture as well as the process of modernization, regeneration, and reform. fostering and facilitating international investment by establishing a reliable and secure investment environment. lowering foreign borrowing by utilizing all available local and national resources. the study offers some observations on the institutional changes that palestine has to adopt. these observations can assist regulators and policymakers in implementing the following changes: adjust macroeconomic policies, reduce the size and scope of government, destroy protectionism and statism's institutions, build and renovate institutions, increase private sector competitiveness, and change the way public services like education and health care are produced, paid for, and provided. establish new global economic implantation and capitalist economic structures. improve socioeconomic circumstances, boost international competitiveness, lower inflation, restore growth, and preserve macroeconomic stability are all important goals for the palestinian authority. palestinian authority should make some institutional reforms as follows: palestine has to make sure that the macroeconomic climate is dynamic and conducive to business growth and investment. as a result, the rate at which local resources depart would decrease. furthermore, palestine has to implement efficient policies to generate enough income from the domestic market, lower its rate of external borrowing, and achieve self-sufficiency. in order to stop businesses, organizations, and corporations from evading taxes, they must create a database of all enterprises and digitize the tax collection system. effective administration and monitoring over the utilization of foreign credit facilities are also necessary. the projects and programmes for which local and regional banks have provided foreign or local debt facilities ought to be overseen by an independent agency, if at all feasible. additionally, a thorough evaluation of the top priorities for which outside funding should be allocated has to be done. this would prevent the improper allocation of funds to unproductive industries with low rates of return on investment. this will lessen palestine's financial issue and improve the country's ability to service debt. additionally, the palestinian government needs to work towards effectively mobilizing domestic economic activity-based revenue to pay a greater percentage of its budget deficit. this will lessen the strain of foreign debt and the exodus of capital from palestine. the idea of rescheduling external debt as a solution has further policy considerations. rearranging just serves to postpone and worsen the situation in palestine. debt and borrow relief should be given careful consideration because of the impact that external debt and borrowing from developed nations have on our nation's macroeconomic performance. reducing uncertainty is one of the main benefits for both domestic and foreign investors. this will free up a large number of policymakers from uncertain and lengthy debt discussions. the developed world will benefit from a spillover effect in commerce if the afflicted nations in the region experience growth as a result of the additional resources. one of the most important israeli political elements that has the greatest impact on the economic situation in palestine and the labour market is the hot and cold war that israel is waging on the west bank and gaza strip at the present time, which is casting a shadow on all aspects of life, including the labour market, the decline of money and business, and the lack of resources and their seizure. the annexation of palestinian lands to israeli lands and their control over them by force militarily, and thus the decline in employment opportunities, the seizure of palestinian clearance funds and their continuous seizure, the decline in donor and financier support, and the conditions of uncertainty imposed by israel as an economic policy on the country, whose area is increasing in light of a conflict with a colonialist enemy whose policy is plundering land and resources and establishing settlements on them, and he takes control of all matters and his livelihood and tries to evade the implementation of the agreements, most notably the paris economic agreement. the current conflict between hamas and israel, which is called by some terrorism on the part of hamas and is in fact a conflict over land, sanctities, and survival, is a conflict that has left bad political effects and constituted very great damage to palestinian economic growth, a major decline in it, and a significant deterioration and decline in economic activities. on the phenomenon of capital flight and foreign investments in palestine, therefore, one of the most important solutions that can be presented is to stop this conflict completely and live in peace in order to achieve economic growth and reduce the phenomenon of capital flight. the palestinian market will flourish and recover in light of lasting peace, in support of the results and recommendations of previous studies such as (abadie & gardeazabal, 2003; horiuchi & mayerson, 2015). as a result, it is anticipated that the government will put forth great effort to raise the gdp by 13.0% in 2024, which would raise the value of the country's per capita share by 10.4% and the value of total consumption (private and public) by 6.9%. compared to 2022, the overall investment value will rise by 62.1%. for the sake of legitimacy and public confidence, development aid should first be highly supervised. only then, can the government and financial agencies designate specialized oversight committees to ensure appropriate use of aid. funding organizations are also required to oversee and record development initiatives, including them in the yearly plans of the government. the administration should allocate development funding to the appropriate and essential initiatives, with an emphasis on industries, investments, hiring palestinian labourer, and generating new employment possibilities. to reap the benefits of the financing and witness tangible outcomes on the ground, funding organizations must transmit this help to the intended and recipient parties under strict monitoring and control. lastly, palestine, being a developing market, has to commit to investigating the routes and causes of capital flight in addition to making sure that foreign debt and borrowing are managed effectively. in order to accomplish this, it will be necessary to fortify the legal system and the rule of law, guarantee that those who embezzle state funds face the harshest penalties possible, restrict palestinian investments overseas, and enact laws and legislation that bind capital owners and investors following the leakage of palestinian investment funds abroad. the monetary and fiscal authorities should create an efficient policy framework in light of these results. it must be realized that all aid that reaches palestine to the palestinian authority is used within the palestinian territories and flows into developing and encouraging the local economy, projects and investments, supporting asian journal of economics and empirical research, 2024, 11(2): 60-82 79 © 2024 by the authors; licensee asian online journal publishing group national industries, and trying to provide job opportunities for the unemployed. it is also important for him to realize that terrorist activities do not take any money from aid and have nothing to do with them, that hamas has its own sources of funding, that this matter is not considered terrorist activities at all, and that the issue is an issue of conflict on the ground and in the homeland. we do not consider this terrorism, but rather it is a defence of self, homeland, and property. the financial aid that reaches palestine and the west bank in particular is harnessed and used in all economic sectors, and hamas has nothing to do with it. drawing from the findings of our study, we suggest the following conclusions: the process of capital flight continues as long as the israeli occupation exists and the conflict between hamas and israel continues, and this matter results in the flight of major investors and those with major interests in the country fleeing with their money and property to preserve it. in order to support and revive the palestinian national economy, attract major investors, obtain large funds and foreign financial aid to support and advance the economic sector, and repair the effects of the recent war on gaza within the country, the palestinian government must reach a solution with israel and hamas, end the conflict, and establish lasting peace and stability. 6. recommendations, limitations and future research directions it is believed that the exodus of capital poses a serious threat to the palestinian economy, which depends heavily on this valuable resource and ought to, in principle, be the driving force behind the country's economic expansion. palestine's present geopolitical circumstances have prevented it from recording the appropriate rates of economic growth in recent years. the economies of the islands that make up its archipelago, such as gaza's sector, area c of the west bank, and east jerusalem, are all subject to constraints. due to its reliance on foreign funding and generally unproductive private sector, the palestinian economy has not been able to provide enough employment to accommodate the yearly influx of graduates into the labour force. the harsh and oppressive policies of the israeli occupation have led to the capital flight of foreign investors, creating a risky investment environment that prevents an increasing number of educated palestinians from actively participating in the palestinian economy. as a result, the study's conclusions led to some of the suggestions listed below. first, the palestinian government should work to create a business-friendly environment that welcomes foreign direct investment and supports the growth of existing businesses in order to stop capital flight. second, it is the duty of the palestinian government to see to it that the planned projects and programmes are funded by foreign loans. third, since these infrastructure upgrades would lower the cost of producing things there, the palestinian administration should put an end to capital flight. fourth, in order to attract international investment, the palestinian administration has to establish favourable conditions. fifth, entice investors and company owners to make investments in the area. sixth, use all aid funds wisely in order to stop capital flight, stimulate the economy, and provide employment opportunities for the unemployed. the current study aims to determine the impact of capital flight on palestine's economic growth and solvency as a nation. the study's rationale and the availability of data for the study elements used in the inquiry led to the choice of the 2004–2022-time frame. it was determined that this influence will hinder palestinian economic development. reviewing earlier research on the topic of the present study is essential, as is keeping up with the most recent results, conclusions, and suggestions from past investigations. the present study employed and examined data from credible official government sources, yielding satisfying and empowering outcomes. as a result, the evaluation reveals certain crucial elements, such as its reliance on earlier research and a logical approach appropriate for the subject and information investigation strategy of the study. since the author has carefully reviewed the material, the results and recommendations are sufficient. the fact that this investigation relied more on a quantitative than a subjective approach to the data presents another crucial obstacle. the outcomes, recommendations, and conclusions are gathered and written in the most notable ones, which may be helpful for further research. the factual approach produced such results, leaving room for further investigation. furthermore, the research's logical approach and analysis of its main argument are crucial and helpful for further research and thought processes. one of the most important aspects of this issue is that it revealed the real effects of the capital flight from palestine, the effect of local financial experts leaving the country, and the quantity of settlements transferred abroad on the nation's ability to manage financial advancement. the study employed experimental data from palestine's present economic situation to define the impact of each component on the country's economic growth strategy. in this sense, the findings, conclusions, and suggestions of the current study will be advantageous to future research and contemplation, and they will assist the authors and analysts in carrying out more extensive analyses pertaining to the topic and problem under discussion. a considerable amount of high-quality data is included in the research's results. 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(2012). does financial liberalization decrease capital flight? a panel causality analysis. international review of economics & finance, 22(1), 92-100. https://doi.org/10.1016/j.iref.2011.09.003 asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. http://data.worldbank.org/data-catalog/world-development-indicators/wdi-2010 http://data.worldbank.org/data-catalog/world-development-indicators/wdi-2010 http://data.worldbank.org/data-catalog/world-development-indicators/wdi-2020 http://data.worldbank.org/data-catalog/world-development-indicators/wdi-2020 https://doi.org/10.1016/j.intfin.2021.101491 https://doi.org/10.1016/j.iref.2011.09.003 142 © 2025 by the authors; licensee asian online journal publishing group asian journal of economics and empirical research vol. 12, no. 2, 142-150, 2025 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v12i2.7579 © 2025 by the author; licensee asian online journal publishing group the effect of natural resources on sustainable development: the institutional threshold kaies ncibi1 baghdedi sghayri2 ( corresponding author) 1faculty of economics and management sciences of sfax, tunisia. email: quayesn@yahoo.fr 2high business school of mannouba, tunisia. email: sghdedii@yahoo.fr abstract this study investigates the contentious and non-linear relationship between institutional quality and sustainable development, with a specific focus on how robust institutions moderate the oftenparadoxical impact of natural resource wealth. the analysis employs a dynamic panel threshold regression model, estimated using the generalized method of moments (gmm) technique, on a dataset of 70 countries spanning the period 1980 to 2020. this methodological approach is chosen to robustly account for endogeneity and to precisely identify critical breakpoints in the institutional-development nexus. the empirical findings unequivocally confirm a statistically significant threshold effect. the results demonstrate that high-quality institutions are not merely beneficial but a critical precondition for translating natural resource endowments into positive sustainable development outcomes. a precise threshold of 8.43 on the underlying institutional quality index is identified. below this critical level, the resource curse phenomenon prevails, where natural resources have a muted or even negative effect on development, likely due to rent-seeking and governance failures. however, once a country surpasses this institutional benchmark, the relationship reverses; natural resources then exert a strong, significant, and positive impact on sustainable development. the central policy implication is unambiguous: the developmental benefits of natural resources are not automatic. they are entirely contingent upon a country first achieving a minimum level of institutional robustness. consequently, for resource-rich nations struggling with development, the paramount priority must shift from mere resource extraction to deep-seated institutional reforms. strengthening governance, curbing corruption, and enforcing the rule of law are not secondary objectives but fundamental prerequisites for harnessing resource wealth for lasting, sustainable development. keywords: gmm, institutions, economics, natural resources, sustainable development, relationship between institutional quality and sustainable development. jel classification: o55. citation | ncibi, k., & sghayri, b. (2025). the effect of natural resources on sustainable development: the institutional threshold. asian journal of economics and empirical research, 12(2), 142–150. 10.20448/ajeer.v12i2.7579 history: received: 9 july 2025 revised: 26 september 2025 accepted: 13 october 2025 published: 24 october 2025 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the authors confirm that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. data availability statement: the corresponding author may provide study data upon reasonable request. competing interests: the authors declare that they have no competing interests. authors’ contributions: both authors contributed equally to the conception and design of the study. both authors have read and agreed to the published version of the manuscript. contents 1. introduction ............................................................................................................................................................................................................ 143 2. related literature .................................................................................................................................................................................................. 143 3. methodology: gmm of arellano and bond (1991) ......................................................................................................................................... 146 4. data ........................................................................................................................................................................................................................... 146 5. empirical analysis ................................................................................................................................................................................................. 147 6. empirical results ................................................................................................................................................................................................... 148 7. conclusion ............................................................................................................................................................................................................... 149 references .................................................................................................................................................................................................................... 149 mailto:quayesn@yahoo.fr mailto:sghdedii@yahoo.fr https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v12i2.7579 https://orcid.org/0000-0002-2960-7717 https://orcid.org/0000-0003-4698-9590 asian journal of economics and empirical research, 2025, 12(2): 142-150 143 © 2025 by the authors; licensee asian online journal publishing group contribution of this paper to the literature this study introduces a precise institutional quality threshold (8.43) using dynamic panel threshold regression (gmm), empirically demonstrating that natural resources boost sustainable development only beyond this level, a quantified insight previous studies had not established. 1. introduction around the 1990s, the subject of economic development took on an institutional orientation; thus, the free market and the accumulation of capital were no longer the only guarantors of sustainable development. administration, social organization, corruption, and civil liberties are also essential factors in the prospective economic development of the country. the new institutional economy takes on a fairly important dimension, particularly for countries characterized by an abundance of natural resources but suffering from a slowdown in development. these resources can constitute an obstacle to development; an answer is hidden in the black box of institutions. institutions have proven to be vital for economic development; north (2005) notes how the political, legal, economic, and social institutions in a particular country impact its rate of economic growth. rodrik (1999) and pritchett (2000) also note how the quality of institutions predicts long-term economic growth of countries. for natural resources and economic development, institutional theorists argue that weak governments and corruption are important factors in what is known as the natural resource curse phenomenon (neumayer & dietz, 2005). achieving sustainable development requires prudent investment of resource revenues, which is necessary in most sub-saharan african countries. in addition to institutional weaknesses, income implications, and corruption in resource revenues severely impede development. not enough authors have advocated the idea that efficient institutions are considered a prerequisite for the start of market economies. examples include clague, keefer, knack, and olson (1995) and kaufmann, kraay, and mastruzzi (2004) good institutions can contribute to improved economic performance and successful reform, and others such as rodrik, subramanian, and trebbi (2002) and acemoglu, johnson, and robinson (2001) have gone further and have recognized that effective institutions are a vital necessity not only for economic performance but also for sustainable development. corruption has been established as a major impediment to economic growth and development in resource-rich countries. rent-seeking is one means of corruption in resource-rich countries (north, 2005). rent seeking is defined as “efforts, legal and illegal, to gain access to or control over opportunities to earn profits” (karl, 2007). natural resources have a positive effect on sustainable development when institutions are sound, whereas this correlation disappears if institutions are altered. sachs and warner (1997), based on a sample of 23 countries, the study shows that the relationship between natural resource abundance and economic growth was negative over the period 1970–1990. these authors explain this situation by the fact that the exploitation of natural resources produces large rents, whose redistribution contributes either to the formation of reform-hostile pressure groups or to the amplification of corruption, and thus to the creation of bad institutions. these behaviors are often called rent-seeking, which hampers economic development. the paper is organized as follows. section 2 discusses some of the primary studies on the resource-institutional quality nexus. section 3 describes the methodology-regression framework. section 4 describes the data set collected for this paper. section 5 presents the empirical analysis, while section 6 conveys the empirical results. 2. related literature institutional quality: primary reason for the example and counter-example of the resource curse: central africa: a region endowed with natural resources but poor. the international monetary fund (imf) (2004) defines a country “rich in hydrocarbon and/or mineral resources” if it meets the following criteria: • an average percentage of revenue from hydrocarbons and/or minerals representing at least 25% of total budget revenue for the previous three years or • an average percentage of export earnings from hydrocarbons and/or minerals, representing at least 25% of total export earnings for the previous three years. history has shown that countries rich in resources register low levels of social development, such as in the countries of central africa. this region, rich in resources such as cocoa, coffee, and cotton, has coasts abundant in fishing resources. its forest area constitutes the second lung of humanity after that of the amazon. besides these resources, oil is mainly cited, which represents on average 80% of the exports of the countries of the economic and monetary community of central african states. however, despite this wealth, the state of development is worrying, as shown by the surprisingly high levels of poverty. collier and hoeffler (2000) support the idea that countries with a low level of economic development have a favorable climate for the abundance of natural resources to intensify the risk of armed conflict is developed by the authors through the presence of means of financing for various communities. these financings are certainly resulting from the exploitation of natural resources; thus, the most important part of the natural richness returns to the victorious. indeed, armed antagonisms are expensive; therefore, only the groups that take up arms are devoid of the general interest. they will rather be interested in seeking private gain. example and counter-example of the “resource curse.” nigeria: a case in point of the “resource curse”. nigeria is considered the largest oil producer in africa and among the ten largest producers of crude oil and gas in the world. the nigerian economy is highly dependent on the oil and gas sector, which accounts for almost 95% of export earnings and 76% of government revenue. despite their natural potential to build a prosperous economy, most nigerians live below the poverty line. the government has invested effort to utilize capacities in the real sector and improve the contributions of the non-oil sector to the formation of gross domestic product, but this has not yielded significant results, despite the country being engaged in oil and gas production for over 50 years. the oil reserve in 2015 is estimated at around 35 billion barrels, while its proven recoverable natural gas reserve is estimated at 187 trillion cubic feet. all this has not resulted in sustainable economic development. asian journal of economics and empirical research, 2025, 12(2): 142-150 144 © 2025 by the authors; licensee asian online journal publishing group since the discovery of oil in nigeria, the country has experienced the paradox of the relationship between natural resources and economic development, known as the "resource curse." nigeria remains an underdeveloped country with weak institutions, and oil revenues are dispersed without regulation. these conditions have contributed to significant economic distress since the 1970s. sala-i-martin and subramanian (2003) prove that in nigeria, the natural wealth resulting in particular from oil has caused damage to institutions which are already mediocre, in 1970 this country recorded a level of gdp per capita of 1113 usd, this gdp deteriorated successively to arrive in 2000 at 1084 usd, gelb, gray, and associates (1988) conclude that the standard of living in nigeria is quite better before the oil shocks, from 1965 to 1990 nigeria raised more than 355 billion wealth that has not contributed to improving the standard of living of nigerians, poor quality institutions is the most important reason for this. 2.1. institutional failure source of misfortune for nigerians the quality of governance has certainly been the misfortune of nigerians; the government has failed to put in place effective public policies that can protect the agricultural sector, which has been destroyed by the effects of dutch disease. thus, agricultural policy in nigeria was inevitably criticized by pinto (1987), from where there was more initiative in favor of agriculture to overcome the appreciation of the exchange rate. in the same way, the author proved the diversion of funds intended for the maintenance of agricultural infrastructure and equipment. shaxson (2005) points out that the total area of cultivated land fell from 18 million hectares in 1975 to 11.05 million hectares during the three years that followed. on the other hand, agricultural production decreased by 50% in volume. with these unfavorable conditions, nigeria went from being a net exporter to a net importer of agricultural commodities to satisfy domestic consumption. the level of corruption and poor governance prevalent in the nigerian system still remains high, but there are many efforts being made by the economic and financial crimes commission (efcc), independent of the corruption and related offenses commission (icpc), transparency international, the world bank, and many other organizations to reduce it. nigeria was ranked at the bottom of the list among other oil-rich countries using transparency international's corruption perception index and other world bank research indicators in 2012. the poverty rate rose from 36% in 1970 to around 70% in 2000, which ranked nigeria 28th; currently, the country is considered the poorest in the world despite its great resource wealth (united nations (un), 2010). smith (2004) showed that mineral wealth is strongly correlated with high levels of corruption and poor governance. nigeria is among the countries in the world with the largest gap between rich and poor, with a gini index of around 50.6, compared to countries like india (37.8), jamaica (37.9), and rwanda (28.9). nigeria is also facing the challenge of dutch disease following the discovery of large deposits of mineral resources such as oil and gas, with a general increase in their prices. many literatures, such as humphreys (2007), and others have confirmed dutch disease as one of the main problems of the resource curse. the fall in the price of oil leads to the appreciation of currencies, which makes locally manufactured goods more expensive and imports cheaper, resulting in the crowding out of other economic sectors. the economic fabric is based on crude oil in nigeria, which has reduced economic diversity. the decline of technology, manufacturing, and agriculture retards economic growth by reducing the demand for and supply of labor in these sectors. the national oil-derived income in nigeria is highly volatile, as it depends on the world price of oil. this is also known as "boom and bust" cycles. fluctuations in the market price or stock of resources affect government revenue, which indirectly impacts the entire economy, from the national budget, which is usually planned based on oil revenue. frequent adjustments up or down of tax expenditures are costly, as they tend to discourage private investment and, at the same time, hamper the provision of public goods (smith, 2004). also, the government tends to borrow a significant amount of debt during crises to sustain its budget deficit. this was the case in the early 1980s when nigeria's debt increased due to substantial indebtedness, which was largely to compensate for the collapse in oil prices, and the borrowing was not linked to future growth. weak and irresponsible institutions, as well as insufficient investment in education, are important factors in the deterioration of the economic fabric in resource-rich countries. weinthal and luong (2006) asserted that the main political consequence is to consider external rents as sources of institutional weakness. through this external source, it is easy for the government to finance state expenditures and it does not provide incentives for the government to build strong institutions. this undermines a viable tax system because there was no revenue from domestic sources. this therefore creates a weak link between citizens and the government and offers leaders the opportunity to incur inexplicable discretionary expenditure. a good example of such expenditure is the ajaokuta steelworks that nigeria built in the 1970s to appease the yoruba region, which guzzled over $3.0 billion and yet was unable to produce a ton of commercial steel. furthermore, various studies have shown that investment in education suffers in resource-rich countries. gylfason (2001) confirmed that when countries begin to rely on natural resource wealth, they tend to neglect the need for a diverse and skilled workforce that can support other productive sectors during crises or when resource stocks are fully depleted. as a result, the share of gdp spent on education is decreasing, which may have long-term negative effects on the economy when governments decide to diversify in the future. 2.2. botswana: “a success story” of the optimal use of natural resources botswana has proven to be the counterexample of the fatalism of the curse of natural resources; this country constitutes the hope of sub-saharan africa. acemoglu et al. (2001) specify that botswana has recorded the strongest growth in the world and benefited from a gdp per capita of 11,510 usd (world bank, 2005). this economic success was dependent on a favorable institutional and political economic context. thus, the experience of botswana proves that the paradox of the curse of natural resources is no longer a law. this country has succeeded in advancing its economic development through the proper management of its mining revenues. indeed, this effective resource management is the result of the institutional context as well as the economic policies that have been put in place in botswana to use natural resources as a catalyst for economic development and social progress. similarly, in 2011, the economy of botswana recorded a growth rate of 8%. this prosperity continued following the global economic crisis of 2009, characterized by a greater global demand for diamonds, the main export of the country. the level of development stabilized at 5.8% in 2012; this decrease is particularly due to the mining sector, asian journal of economics and empirical research, 2025, 12(2): 142-150 145 © 2025 by the authors; licensee asian online journal publishing group which fell by 8%, unlike the non-mining sectors, which experienced an increase of 9.7%. in 2014, the level of economic growth reached 6%. in botswana, the government adopted the institutions inherited from the british crown to generate a democratic parliamentary system, with property rights preserved for all citizens. acemoglu et al. (2001) also add that political elites are equally subject to the law, which is upheld by an independent judiciary. leith (2000) adds that the development of the country continued with a transformation of its economy. aside from the well-developed mining sector, the public sector experienced significant growth. this evolution was certainly facilitated by good budgetary discipline and effective governance adopted by the country. botswana has succeeded in turning the curse of natural resources into a blessing; it is mainly because it has opted for three necessary measures: economic diversification to avoid dependence on the mining sector, decoupling revenue and expenditure, and investing excess wealth in the well-being of future generations. with these policies, botswana has been able to overcome the pitfalls that other resource-rich countries have not been able to avoid. botswana has adopted a policy of diversification primarily for two main reasons. first, the government aimed to diversify the economic base to avoid dependence on a single sector, which is the mining sector in botswana. the government recognized that inherited wealth is temporary and would not last long, as the diamond reserves in the ground will eventually be depleted. second, it became necessary for botswana to develop other non-mining sectors, especially those related to mining in terms of job creation, because the mining sector directly employs only 2% of the workforce. to support economic diversification, the government has taken a number of measures, such as the creation of the business and economic advisory council (beac). this entity aims to identify obstacles to economic diversification, draw up a strategic framework, and develop an action plan to overcome them, with the goal of creating projects that enable the government to progress. the beac published two reports, successively in 2006 and 2008: "botswana excellence: a strategy for economic diversification and sustainable growth" and "action plan," which were adopted by the government. since the adoption of the action plan, botswana's economic fabric has diversified significantly. consequently, incentives have been established to build the capacity of botswana businesses, create an environment conducive to development, and develop tools to aid diversification, including the encouragement of private initiative, and support for agriculture and tourism. other than economic diversification, the botswana government has managed to institute a pro-development fiscal policy. this was achieved through the decoupling of revenue and expenditure, while avoiding pro-cyclical spending. the government has avoided intensive investments in unprofitable projects, the accumulation of debts, and lack of transparency. indeed, this decoupling of expenditure and revenue is a vital necessity for economic recovery. moreover, the revenue from the mining sector is considered a primary source of public revenue. thus, the government adopted a policy of pressure on expenditure and effectively used its revenue surpluses. all these factors have enabled the country to escape the resource curse. in order to support the evolution of expenditure during periods characterized by high expansion and increased expenditure during crises, botswana has strictly followed its national development plan, which operates on a sixyear planning cycle, with corrections and modifications according to the evolution of the economic situation. this budgetary approach has indeed played a crucial role in the effective management of the country's windfall. leith (2000) proves that this planning allowed an efficient decoupling of expenses while describing the possible and feasible expenses, as defined by the ministry of finance and development planning, as well as according to rules. in case the budget of investment is available during the period that covers the plan, its ambitions are insignificant, in case of uncertainty of being able to cover the costs within the deadlines. alongside the importance of the development plan, the policy of investment of revenue from mining wealth is put in the pula fund created in 1993. the objective of this fund is to ensure a certain flexibility in the management of international reserves and to predict with some accuracy the dividends that will be paid by the bank of botswana to the government. similarly, botswana has managed to lengthen these assets in order to guarantee intergenerational equity through its sovereign wealth fund, which in itself represents the guarantor of commodity price volatility. 2.3. good governance: a prerequisite for good wealth management it is of crucial importance that the nature of the institutions put in place affects the management of natural resource wealth; thus, with the pula fund and sustainable budgetary measures being a necessity, they are not sufficient to guarantee good management of the revenues from the mining and, mainly, diamond sector. acemoglu et al. (2001) shows that the success of botswana lies mainly in the political regime characterized by stability and, above all, the existence of a culture of good governance. the latter has facilitated decision-making, particularly over the long term. in the long run, similarly, the collaboration of civil society, which is embodied in economic life to make its voice heard, has given rise to a compromise in the formulation of economic policies. we often speak of a social contract between the different compartments of society; therefore, the government, with these positive signals, finds itself obliged to respect the institutions that are in charge of investment and savings, to defend the budgetary rules, and also to strengthen economic diversification. acemoglu et al. (2001) demonstrate that institutional quality explains the divergence in terms of growth between the former colonies in africa and beyond. it is the case of botswana, which better explains the role played by institutional quality through the protection of private property and institutional limits on executive power in economic success. limmi (2006) concluded that botswana's success has been achieved through four dimensions of governance that are necessary for effective resource management, namely government efficiency, market-friendly regulation, anticorruption, and participation and transparency. in what follows, we will analyze how these aspects can improve the management of resources. let's start with the effectiveness of government, which is defined as the quality of public services and the ability of its officials, because resource management policies depend on the institutions and people who create them. in botswana, the budgetary measures adopted have made it possible to reduce the use of mining revenues as much as possible and to devote them to investments for the benefit of future generations. in terms of market regulation, the country, in collaboration with the private sector, has guaranteed the efficient exploitation of mineral wealth as well as the development of other sectors. indeed, contracts relating to natural resources are generally concluded over periods of ten years, and even twenty-five years for diamond mines. the general climate of economic asian journal of economics and empirical research, 2025, 12(2): 142-150 146 © 2025 by the authors; licensee asian online journal publishing group policy is conducive to business, hence the elimination of exchange controls and few non-tariff barriers to imports. taxation is light for this purpose; taxation is around 25% on personal income and 15% for financial services and manufacturing. with regard to anti-corruption policies, the government has moved towards a transparent and equal distribution of resources. indeed, the african development bank in 2009 clarified that corruption was no longer a problem in botswana because the country benefited from budgetary procedures and controls requiring accounting procedures, a powerful computer system that refuses any unauthorized overspending in the budget. on the other hand, botswana has encouraged the fight against corruption by setting up an autonomous authority in 1994, the directorate of corruption and economic crime, with the aim of informing the president directly of all cases of corruption. thus, the constitution guarantees the independence of the attorney general vis-à-vis the government and politicians. finally, the notion of transparency and participation means the participation of citizens, the protection of freedoms and civil rights, and the transparency of the political process. these various measures make it possible to exercise control over the leaders who might commit abuses. in the classification of countries, in 2010, transparency international placed botswana in the top quarter and still at the top of the list of african countries. indeed, the government has put in place a number of structures, such as the public accounts committee of parliament. its mission is to control expenditures and summon those responsible in the event of misappropriation of funds. 3. methodology: gmm of arellano and bond (1991) econometrics in panel data has certain privileges; it makes it possible to analyze the dynamics of adjustment. baltagi (2005) shows that econometrics in panel data is mainly used in models which tend to explain the dynamics of demand for natural gas, the dynamics of the evolution of wages, or the dynamics of economic convergence processes. thus, the dynamic relations are characterized by the existence of the endogenous variable shifted by one period in the list of explanatory variables. this model is characterized by the presence of two sources of autocorrelation: first, the heterogeneity between the individual effects; second, the shifted endogenous variable. indeed, heterogeneity poses problems of correlation between the explanatory variables and the error term, which invalidates the classical assumptions of the ordinary least squares (ols) method. therefore, according to bourbonnais (2004), the ols provides biased and inefficient results. the fixed effect estimator (within) aims to correct the problem of self-correlation of errors but does not eliminate the issue of correlation between the shifted endogenous variable and the error. consequently, the within estimator will also be biased. therefore, these two econometric methods (ols and within) appear unsuitable for the robust estimation of our model. the chosen econometric method is based on the estimator of the generalized method of moments: gmm of arellano and bond (1991), which makes it possible to solve the problems of autocorrelation, it is based on the conditions of orthogonality between the variable endogenous lagged several periods and live perturbations for the construction of an instrumental variable matrix. the gmm method of arellano and bond (1991) is divided into two steps; in the first, generalized least squares (gls) estimation is applied to the new form of the model. in the second step, arellano and bond (1991) use the differentials of the residuals estimated in the first step, the result provides the gmm estimator of arellano and bond (1991) has two steps (two-step). thus, the model is estimated in first differences to eliminate effects specific to the countries. the lags in the level of the endogenous variables are then used as instruments. these instruments ensure the absence of autocorrelation of order 2, d, where an autocorrelation test of the residuals, accompanied by a sargan test of over-identification, is recommended to verify the validity of the instruments. the determination of the gmm estimator depends on the validity of the assumption that the error terms are not autocorrelated and on the validity of the instrumental variables used. to ensure the absence of autocorrelation of the error terms and the validity of the instruments used, blundell and bond (1998) propose two essential tests, namely: the sargan test, which makes it possible to analyze the identification of the model and the validity of the instruments used for estimation, and the usual test for the absence of autocorrelation of the error terms. we estimate this system of equations with the gmm method applied to panel data. 4. data the study includes 70 countries classified into 46 developing countries and 24 developed countries, and data that characterize them, namely the abundance of natural resources, indicators of well-being, the quality of institutions, and conditional variables. the choice of data is explained by their availability as well as their relevance. thus, in what follows, we proceed to examine the stationarity of the basic variables for our model, namely natural resources and institutional quality. indeed, we base ourselves on the illustration of baltagi (2005), who recommends that the unit root test starts from two main hypotheses. the first hypothesis supposes that the individuals of the panel have a common unit root, which is justified by the tests of levin, lin, and chu, as well as breitung. the second hypothesis, which supposes that the individuals are heterogeneous or have different unit roots, is tested by the tests of im, pearson, adf fisher, and pp-fisher. similarly, recent literature proves that panel stationarity tests are more powerful than those based on individual time series, among the recently developed tests is the llc unit root test of levin, lin, and chu (2002) (ips ) of im, pesaran, and shin (2003) and okey (2009) shows that these test categories are more robust than that of the traditional adf test which suffers from a problem of low rejection power of the null hypothesis of stationarity of the series and mainly for the series of short period. table 1 presents results from six different unit root tests to determine if the "institutional quality" variable is stationary (stable over time) or non-stationary (has a unit root). the variable "institutional quality" is stationary. all tests robustly reject the null hypothesis of a unit root. asian journal of economics and empirical research, 2025, 12(2): 142-150 147 © 2025 by the authors; licensee asian online journal publishing group table 1. stationarity tests (unit root) of the institutional quality variable. method statistical prob.** number of individuals (country) number of observations null hypothesis: unit root (process having a unit root common to all individuals) levin, lin & chu -5.5249 0.000 28 720 breitung t-stat -3.9125 0.000 28 720 null hypothesis: unit root (individual unit root process) im, pesaran and shin w-stat -9.3176 0.000 28 720 adf fisher chi-square 248.6438 0.000 28 720 pp fisher chi-square 308.2791 0.000 28 720 null hypothesis: no unit root (process having a unit root common to all individuals) hadri z-stat 5.1386 0.000 28 720 table 2 exhibits that the variable "natural resources" is stationary. the results strongly indicate the absence of a unit root, meaning its statistical properties (like mean and variance) do not change over time. the natural resources variable is stationary. this is a crucial result because it confirms that the variable's behavior is stable over the period studied (1980-2020). using a stationary variable in the gmm regression prevents the problem of spurious regression, where relationships appear significant purely due to trending data rather than a true economic link. this validates the subsequent findings about the relationship between natural resources and sustainable development. table 2. stationarity tests (unit root) of the natural resources variable. method statistical prob.** number of individuals (country) number of observations null hypothesis: unit root (process having a unit root common to all individuals) levin, lin & chu -2.1245 0.000 28 720 breitung t-stat -1.3254 0.000 28 720 null hypothesis: unit root (individual unit root process) im, pesaran and shin w-stat -6.2458 0.000 28 720 adf fisher chi-square 145.6524 0.000 28 720 pp fisher chi-square 218.2578 0.000 28 720 null hypothesis: no unit root (process having a unit root common to all individuals) hadri z-stat 3.1057 0.000 28 720 table 3 confirm that the variable "hdi" (human development index) is stationary. the results consistently indicate that the variable does not have a unit root, meaning its statistical properties are stable over time. the hdi variable is confirmed to be stationary. this is a critical finding for the study's validity. since all three key variables (institutional quality, natural resources, and hdi) are stationary, the regression model remains valid for analysis (equation 2: hdiit= α0 hdiit-1 + ... + α7(nr*iq) + εit) is built on a solid foundation. using stationary variables ensures that the estimated relationships and the calculated institutional threshold of 8.43 are statistically reliable and not spurious artifacts of non-stationary data. table 3. stationarity tests (unit root) of the hdi variable. method statistical prob.** number of individuals (country) number of observations null hypothesis: unit root (process having a unit root common to all individuals) levin, lin & chu -4.2705 0.000 28 720 breitung t-stat -2.8521 0.000 28 720 null hypothesis: unit root (individual unit root process) im, pesaran and shin w-stat -6.5348 0.000 28 720 adf fisher chi-square 215.6248 0.000 28 720 pp fisher chi-square 286.5308 0.000 28 720 null hypothesis: no unit root (process having a unit root common to all individuals) hadri z-stat 3.1278 0.000 28 720 the results of the unit root tests for the variables of interest, namely natural resources, institutional quality, and sustainable development, confirm the stationarity of the variables; therefore, the econometric modeling would yield statistically valid results. 5. empirical analysis we aim to define the model to empirically study the role of institutional quality in consolidating the contribution of natural resources to sustainable development. 5.1. model specification the reference model looks like this: 𝐻𝐷𝐼𝑖𝑡 = 𝛼0 𝐻𝐷𝐼𝑖𝑡−1 + 𝛼1𝑆𝐶𝑂𝐿𝑖𝑡 + 𝛼2𝐺𝐷𝑃𝑅𝑖𝑡 + 𝛼3𝑙𝑎𝑡𝑖𝑡𝑖𝑡 + 𝛼4𝑂𝑃𝑁𝑅𝑖𝑡 + 𝛼5𝐼𝑄𝑖𝑡 + 𝛼6𝑁𝑅𝑖𝑡 + 𝜀𝑖𝑡 (1) with, hdiit, is the sustainable development indicator, hdiit-1 is a variable of the past sustainable development indicator, this variable makes it possible to measure the effect of the past on the present variable, scolit, is the measurement of the level of primary, secondary and higher education, gdprit, is the growth rate of per capita gdp, latitit is the absolute value of the distance from the equator, opnrit, is the indicator how measure the degree of integration of a country into the world economy. the most common way to calculate it is to average exports and imports divided by gdp. iqit, is the mean value of the following icrg variables: corruption, the rule of law and the quality of bureaucracy, assumed to be a variable of interest in this section since our objective is to determine a asian journal of economics and empirical research, 2025, 12(2): 142-150 148 © 2025 by the authors; licensee asian online journal publishing group minimum threshold for this variable so that it will have a stimulating effect on sustainable development at through natural resources, hence with this minimum threshold the natural resources become an engine of development instead of being a brake, nrit, is the measure of the total benefits drawn from the corresponding natural resources to the sum of profits derived from oil, natural gas, coal (anthracite and hard coal), minerals and forests. the objective is to study the links of interactions between natural resources and institutional quality and their consequences on the strengthening of sustainable development. it is important to add the term of interaction between institutional quality and natural resources nr*iq, therefore, the new form of the model is: 𝐻𝐷𝐼𝑖𝑡 = 𝛼0 𝐻𝐷𝐼𝑖𝑡−1 + 𝛼1𝑆𝐶𝑂𝐿𝑖𝑡 + 𝛼2 𝐺𝐷𝑃𝑅𝑖𝑡 + 𝛼3𝑙𝑎𝑡𝑖𝑡𝑖𝑡𝑡 + 𝛼4𝑂𝑃𝑁𝑅𝑖𝑡 + 𝛼5𝐼𝑄𝑖𝑡 + 𝛼6𝑁𝑅𝑖𝑡 + 𝛼7(𝑁𝑅 ∗ 𝐼𝑄) + 𝜀𝑖𝑡 (2) through this writing, three scenarios can arise: first, in the case where α6 and α7 have both positive (negative) signs, we conclude that natural resources have a positive (negative) effect on sustainable development, and institutional quality favors this effect. conversely, if α6 is positive and α7 is negative, we conclude that natural resources stimulate the level of sustainable development, and this impact is reduced with the improvement of institutional quality. in the last case, if α6 is negative and α7 is positive, it is important to record a threshold of institutional quality beyond which natural resources could have a positive effect on sustainable development. to determine the threshold, we proceed to derive the hdi from nr, we obtain the following equation. ∂hdi ∂nr = 𝛼6 + 𝛼7 ∗ 𝐼𝑄 (3) at the optimum, we obtain ∂hdi ∂nr = 0, which implies 𝐼𝑄 = −𝑎6 𝑎7 (4) finally, the optimal institutional threshold is as follows: 𝐼𝑄 𝑡ℎ𝑟𝑒𝑠ℎ𝑜𝑙𝑑 = −𝑎6 𝑎7 table 4. descriptive statistics. mean stand dev. min. max. skewness kurtosis jarque-bera prob. hdi 0.6730 0.158 0.241 0.952 -0.461 5.237 8.631 0.000 scol 100.646 16.056 34.888 165.326 -0.275 4.601 5.048 0.000 gdpr 4.247 8.0317 -62.076 149.973 -0.618 2.149 3.604 0.001 latit 3.641 24.415 0.0111 220.407 -0.348 3.069 3.317 0.001 opnr 71.033 36.461 0.0209 220.407 -0.183 1.627 2.174 0.000 iq 0.532 0.221 0.160 0.975 -0.627 1.031 4.375 0.000 nr 19.030 18.362 0.107 92.018 -0.319 2.018 5.162 0.000 the table 4 represents the descriptive statistics. it is evident that the skewness coefficient is close to 0 for the majority of countries in both samples. regarding the jarque-bera statistic, we can accept the normality of the residuals. table 5. variable correlation matrix. hdi scol gdpr latit opnr iq nr hdi 1 scol 0.402 1 gdpr -0.162 -0.161 1 latit 0.045 -0.012 0.025 1 opnr 0.160 0.135 0.008 0.418 1 iq 0.713 0.201 -0.091 0.055 0.030 1 nr -0.376 -0.032 0.248 -0.049 0.281 -0.312 1 we notice a strong correlation between institutional quality and the human development indicator, which is approximately 0.713, and the natural resources variable is relatively correlated with human development (see table 5). 6. empirical results by relying on the technique of gmm in the system on the different variables of our model, we arrive at the results of the estimation illustrated in the table 6. the first column clearly illustrates that the determinants of the hdi are positive and significant, with the exception of the variable nr, which is negative and not significant. according to the empirical literature, several studies have shown that natural resources, in the absence of other variables describing the internal environment of countries, have an equivocal impact on development. in the second column, the interaction between nr and nr*iq institutional quality is examined. the results show that nr has a negative and significant effect. meanwhile, the coefficient of the interaction term is positive and significant, indicating that the impact of nr on sustainable development depends on the variable associated with institutional quality. this result implies that there is a minimum threshold of institutional quality beyond which nr promotes sustainable development. to acquire a certain robustness to the results, we proceed to expand the list of explanatory variables by adding other variables that are significantly correlated with sustainable development, namely the gini index and foreign direct investment. these two variables have been confirmed by the literature, which indicates that they are closely dependent on the level of development. thus, alesina and rodrik (1994) and adelman and robinson (2002) confirm that the gini index as a measure of income dispersion in a country is a major determinant of the level of development, similarly aitken, hanson, and harrison (2003) prove that fdi is important for development, especially in the context of natural resource research, hence the attraction of fdi specialized in the field of extraction is a necessity. column (3) transcribes the estimation results after adding the control variables. asian journal of economics and empirical research, 2025, 12(2): 142-150 149 © 2025 by the authors; licensee asian online journal publishing group the gini index is significant and negative; income inequality is harmful to development. this result has been explained theoretically: by preventing the accumulation of human capital, income inequality compromises all educational opportunities for disadvantaged populations, thereby slowing down social mobility and skill development. with regard to the effect of fdi on development, the results show that it is positive and significant. thus, an increase in fdi of 1 point would produce an increase in the hdi of approximately 0.7 points. it should be noted that the fdi considered in this estimate pertains to the exploitation of natural resources. we note that the values of the coefficients of columns (2), (3), and (4) show that the average threshold of institutional quality is 8.43. therefore, any country that wishes to benefit from the advantages of natural resources must reach a minimum level of institutional quality higher than 8.43. otherwise, in cases where institutional quality exceeds 8.43, the relationship between natural resources and sustainable development is positive. however, below this threshold, the relationship becomes negative. table 6. natural resources and sustainable development: gmm system. 1 2 3 4 hdi 0.857** (32.62) 0.851*** (30.66) 0.834*** (28.56) 1.024** (40.25) scol 0.128** (0.79) 0.124*** (0.88) 0.119** (1.26) 0.125*** (1.29) gdpr 0.198*** (1.92) 0.187** (1.90) 0.175* (1.74) 0.217** (2.37) latit 0.260** (0.77) 0.254* (0.65) 0.321** (1.18) 0.208* (0.62) opnr 0.212* (0.84) 0.215** (0.91) 0.248 (1.12) 0.261** (1.86) iq 0.293** (0.17) 0.281* (0.19) 0.291** (0.84) 1.204*** (1.36) nr -0.466* (-4.60) -0.552*** (-4.82) -0.563*** (-4.51) -0.624*** (2.84) nr*iq 0.076*** (1.35) 0.053*** (1.22) 0.084*** (1.64) gini -0.657** (-0.11) -0.672*** (-0.13) fdi 0.724** (0.42) cons 0.072** (3.16) 0.084*** (3.21) 0.094** (3.35) 0.097** (3.41) threshold 7.26 10.62 7.42 note: between parentheses are indicated the absolute values of the student's "t". *** significant at the 1% level; ** significant at the 5% level; * significant at the 10% level. 7. conclusion the assertion that the impact of natural resource wealth on economic development is negative is either false or insignificant. in the 'why nations fail' study, what distinguished botswana was its institutional performance prior to the diamond discovery. on the other hand, it is thus obvious that cameroon had mediocre institutions before 1977. australia, chile, norway, and the united states all had relatively good institutions at the time of the discovery of natural resources. thus, through this article, we have shown that the economic impact of natural resources is conditioned by good quality institutions. we also present decisive clarifications that could reduce the ambiguities found in the precursor studies on this subject, thus the results found confirm the results of the empirical literature which reveal that not enough countries continue to suffer from problems of underdevelopment despite their abundance in natural resources. this is mainly due to the fragility of institutions; a good institutional quality could be used to benefit from the positive externalities of natural rents and therefore escape the vicious circle of underdevelopment. the classic impact of natural resources on human development was studied, while taking into account its interaction with institutional quality. the results show that natural resources positively affect development provided that countries first display a 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(2005). botswana: a success story in africa. usa: world bank. asian online journal publishing group is not responsible or answerable for any loss, damage or liability, etc. caused in relation to/arising out of the use of the content. any queries should be directed to the corresponding author of the article. https://doi.org/10.1016/s0304-4076(03)00092-7 https://doi.org/10.1093/wber/14.2.221 141 © 2024 by the author; licensee asian online journal publishing group asian journal of economics and empirical research vol. 11, no. 2, 141-148, 2024 issn(e) 2409-2622 / issn(p) 2518-010x doi: 10.20448/ajeer.v11i2.6388 © 2024 by the author; licensee asian online journal publishing group impact of foreign direct investment on economic growth: the role of financial development in the context of developing economies thew kim guan international american university, usa. email: thewkim@iaula.edu abstract according to economic theory, foreign direct investment inflows (hereafter “fdi”) are a crucial catalyst for stimulating economic growth, as fdi has the capacity to attract technology, leading to a subsequent rise in economic growth (hereafter “egt”). scholars continue to debate the convincing clarification of the direct impact of fdi on economic growth (thereafter “egt”), despite the frequent emphasis on the absorptive capacity of host nations. this uncertainty may arise from neglecting the influence of specific conditioning factors. this study aims to examine the empirical relationship between fdi and egt in the case of seventy developing nations during 1990-2023. additionally, the study seeks to evaluate whether the impact of fdi on egt varies according to the level of financial development. this paper specifically addresses the endogeneity problem by employing the general methods of moments (gmm) to estimate the instrumental variable approach. the empirical investigation reveals that there exists a specific level of financial development (hereafter “fnd”), known as a threshold, at which fdi begins to positively affect egt. conversely, below this threshold, fdi has a detrimental effect on egt. policymakers in emerging nations should consider the level of domestic financial development to benefit from increasing foreign investment. keywords: economic growth, financial development, foreign direct investment inflows. citation | guan, t. k. (2024). impact of foreign direct investment on economic growth: the role of financial development in the context of developing economies. asian journal of economics and empirical research, 11(2), 141–148. 10.20448/ajeer.v11i2.6388 history: received: 21 october 2024 revised: 5 december 2024 accepted: 23 december 2024 published: 30 december 2024 licensed: this work is licensed under a creative commons attribution 4.0 license publisher: asian online journal publishing group funding: this study received no specific financial support. institutional review board statement: not applicable. transparency: the author confirms that the manuscript is an honest, accurate, and transparent account of the study; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. this study followed all ethical practices during writing. competing interests: the author declares that there are no conflicts of interests regarding the publication of this paper. contents 1. introduction .................................................................................................................................................................................... 142 2. literature review .......................................................................................................................................................................... 142 3. methodology ................................................................................................................................................................................... 143 4. results and discussion ................................................................................................................................................................. 145 5. conclusion ....................................................................................................................................................................................... 147 references ............................................................................................................................................................................................ 147 mailto:thewkim@iaula.edu https://creativecommons.org/licenses/by/4.0/ https://creativecommons.org/licenses/by/4.0/ https://www.doi.org/10.20448/ajeer.v11i2.6388 asian journal of economics and empirical research, 2024, 11(2): 141-148 142 © 2024 by the author; licensee asian online journal publishing group contribution of this paper to the literature this study investigates the role of complementarity factor such as fnd in effecting egt through fdi in selected sample countries. previous studies are limited to examine the role of fdi in effecting egt; however, these studies have not considered the joint effect of fdi and fnd in affecting eg. 1. introduction a noteworthy component of the current internationalization trend is the occurrence of foreign direct investment inflows (wang, xu, qin, & skare, 2022). this issue has held a unique position due to the existing variations in the form and direction of fdi in emerging economies. after experiencing an average decline of around 4% per year from 1980 to 1985, fdi in emerging economies has significantly risen. fdi in developing nations saw an annual growth rate of around 17% throughout the late 1980s. in 1993, developing nations received a total of seventy billion dollars in fdi, and the value of fdi inflows increased by one hundred and twenty-five percent in the first three years of the decade. policymakers commonly embrace the notion that fdi fosters economic growth and enhances the returns of the recipient economy. developed countries receive more advantages than developing economies due to their openness (ali, raza, puah, & samdani, 2021). however, this concept offers an explanation for the observation that fdi supplies capital for direct investments and generates beneficial effects by adopting imported technology and skills. during the past thirty years, emerging economies have attracted substantial levels of fdi. the un conference on trade and development (unctad) produced a study in 2017 stating that overseas inflows increased significantly from $55 billion to $1,800 billion between 1980 and 2017. due to this remarkable surge in fdi inflows, policymakers and researchers have been compelled to examine the empirical connections between fdi expansions in the host country. the purported exogenous beneficial impact of fdi on economic growth theory (egt) has been found to have limited backing in macro-empirical research. fdi has the capacity to attract technology, leading to a subsequent rise in egt (baharumshah & almasaied, 2009). however, this effect is dependent on the host nation meeting a minimum threshold for financial development (rehman & noman, 2022). although there are some thoughts and data suggesting that fdi can directly impact the eg of emerging countries, this assumption cannot be substantiated without further empirical evidence, particularly in the case of developing nations. furthermore, it seems that the overall impact of fdi on a nation's egt depends on several conditional variables that determine the marginal effect of fdi. moreover, the causal relationship between fdi and conditionality has only been shown in a limited range of scholarly works. for instance, only countries with a sufficiently high level of human capital have a positive relationship between fdi and egt. the current study conducts an investigative attempt to find the impact of fdi on economic development using a panel data set comprising seventy less-developed countries from 1990 to 2023. the present study focuses on the mechanisms through which fdi promotes economic growth eg, with particular emphasis on the role of foreign direct investment fnd as a conditional variable. the study's findings suggest that the chosen countries experience the advantages of fdi only when their level of domestic fnd foreign direct investment exceeds a specific threshold. furthermore, we assess the impact of fdi as a mediator in developing countries to enhance the credibility of the results. this study investigates the role of complementarity factors such as fnd in affecting egt through fdi in selected sample countries. previous studies are limited in examining the role of fdi in affecting egt; however, these studies have not considered the joint effect of fdi and fnd on eg. hence, this study contributes to the existing literature by investigating the joint role of fdi and fnd in affecting egt in sample countries. the upcoming parts of this study are assembled in the following manner: the second portion provides a concise summary of the most recent research, while the third section presents the specifics of the model formulation and empirical techniques. section v contains the conclusion, whereas section iv presents a report on the specifics and evaluates the credibility of the results. 2. literature review during the last thirty years, the global economy has experienced a significant increase in globalization. fdi has had a more rapid growth rate compared to many other forms of economic endeavor. developing nations may now participate in global manufacturing in innovative ways due to the significant surge in fdi. unlike openness policies, which can play an essential part in attracting fdi, endogenous growth models prioritize the spread of innovations as a key factor in predicting egt. fdi is commonly regarded as a means for advanced nations to share their technological advancements with less-developed countries, as explained in the theoretical models by de mello (1999) as well as romer (1990) framework. however, de mello (1999) model effectively incorporates fdi as a key determinant of economic development. their study has not attempted to account for the endogeneity of the investment. a substantial number of researchers have primarily focused their empirical research on examining the impact of fdi on egt in emerging nations. de mello (1999) examines the investment trends and their impact on the growth of the african economy. according to his results, the only type of investments that consistently contributed to the increasing rates of economic expansion between 1970 and 1995 were domestic investments in the country. however, the relationship between fdi and egt in high capital-abundant countries such as the united states may be intricate and unpredictable. according to sala-i-martin, bilbao-osorio, blanke, hanouz, and geiger (2011), the impact of fdi on eg is not contingent on a certain minimal level of human capital. gachino (2012) analyzes the relationship between fdi and egt in kenya. the study finds that there is a positive correlation between fdi and economic development. the link between fdi and egt is considered fascinating. mehic, silajdzic, and babichodovic (2013) examine the impact of fdi on economic development in twelve central and eastern european economies using panel data from 1996 to 2010. based on their research, the study concluded that fdi in the selected european economies has a negative effect on egt. presently, some research has employed conditional effects by using various elements to investigate the correlation between fdi and egt. fdi, as explained by arsalan and zaman (2014), contributes to egt through two primary mechanisms: firstly, by directly fostering the advancement asian journal of economics and empirical research, 2024, 11(2): 141-148 143 © 2024 by the author; licensee asian online journal publishing group of new technologies, and secondly, by indirectly bolstering the capabilities of banks and other financial institutions. borensztein, de gregorio, and lee (1998) discovered that the increasing impact of fdi on egt is contingent upon the achievement of a minimum level of income per capita. iamsiraroj and ulubaşoğlu (2015) examine the impact of fdi on investment, factor productivity, and egt for organisation for economic co-operation and development (oecd) and non-oecd countries. the study uses a mixed dataset of time series and panel data during 1970-1990. according to their research, the level of substitution and complementarity between fdi and local investment is critical in determining the impact of fdi on egt. although there is a significant number of studies on the correlation between fdi and economic development, the findings remain unclear. using cross-country growth regressions, several research papers have discovered that fdi has a direct impact on gdp growth (carkovic & levine, 2002). conversely, other research indicates that fdi does not have a substantial direct effect on egt. these results are also found in the studies conducted by choe (2003); ram and zhang (2002) and iamsiraroj and ulubaşoğlu (2015) which have shown that fdi generally has a detrimental impact on egt, but the extent of this effect varies significantly among countries. abdel-gadir (2010) examines the impact of fdi on egt in arab nations. their findings suggest that fdi does not have a significant direct effect on economic performance or, at most, has a minimal influence on it. almfraji and almsafir (2014) found that fdi had negative effects on the economy from 1980 to 1994 but had a favorable influence from 1995 to 2009. this information is derived from a panel consisting of fifty african states. unlike the immediate impacts of fdi, the importance of the host countries' ability to absorb fdi, which refers to their capacity to adopt and utilize new technologies, has been a key finding in many empirical studies on the impact of fdi on egt. these studies include works by de mello (1999). de mello (1999) performed cross-country research and discovered that fdi leads to an increase in production in developing nations only if there is a threshold level of human capital in the host country. this was determined by utilizing human capital as a metric for assessing desirable capacity. multiple studies, such as those conducted by forte and moura (2013); ozturk (2007) and choe (2003), have concluded that there is no evidence to support the idea that the impact of fdi is influenced by the level of human capital, as suggested by certain studies. furthermore, abdouli and hammami (2017) and al-iriani (2007) challenge this idea specifically in relation to arab nations and african countries. the term "el-wassal (2012)" is employed to denote nations in the arab region. the nature of the interaction between domestic and global enterprises is identified as a secondary factor that contributes to absorptive capacity, as stated by carkovic and levine (2002). overall, the current corpus of literature plays a crucial role in advancing the field of study, but it does have certain limitations. initially, a substantial amount of research focuses on empirically examining the correlation between fdi and economic progress, but it fails to consider the conditional impact. in previous research conducted by de mello (1999) and hermes and lensink (2003), the conditional variables used to examine the functional relationship between fdi and egt include the estimated threshold level of per capita income, domestic investment, and the level of human capital development. however, these levels alone do not offer an explanation for the extent of fnd as a conditional factor for studying the impact of fdi on egt in emerging economies. moreover, the existing literature indicates that it is important to make improvements in techniques for identification to mitigate the effect of endogeneity concerns. hence, existing studies have made insufficient contributions to support policymakers in emerging economies in increasing the growth strategy for fdi. our empirical research indicates that the impact of fdi on the egt depends on the financial position of the countries. this study aims to determine the impact of fdi on egt in the selected nations by incorporating the interaction term of fdi and the degree of financial development. the study seeks to establish whether fdi can have a statistically significant and positive influence on the egt. 3. methodology 3.1. model specification this study examines the role of fdi in effecting economic growth in the presence of financial development. this study pioneers the analysis of the causal link between fdi and egt in developing nations while employing the mediating role of the degree of financial development. as far as we know, this research is the inaugural one of its kind. the current study relies on the system gmm estimator, which was specifically designed for dynamic models, as the basis for the empirical investigation. this study focuses on an unbalanced panel dataset of seventy emerging nations, covering the period from 1990 to 2023. the equation 1 that follows is our core model, derived from the straightforward cobb-douglas representation of the aggregate function. we utilize fdi, which specifically pertains to the net inflows of investment from foreign sources into the host country, based on the concept introduced by borensztein et al. (1998) and alege and ogundipe (2014) as follows: 𝐼𝑛𝑦𝑖𝑡 =∝ +𝛽𝐼𝑛𝑦𝑖𝑡−1 + 𝛽𝑋𝑖𝑡 + +ł𝑖𝑡 + 𝛹𝑖𝑡 + 𝜇𝑖𝑡 (1) the letter "i" symbolizes the nation, where "i" may take on values from 1 to n. the letter "t" indicates the time period, where "t" can take on values from 1 to t. for the dependent variable, the notation ∆ln(yit) represents the logarithmic difference between the average growth rate of per capita gdp for nation i and time period t, spanning from 1990 to 2023. the difference operator is represented by the symbol ∆, whereas the lag of the dependent variable is represented by the coefficient ∆ln(yit-1). the symbol xit represents a vector of control factors that are believed to influence the average growth rate of gdp per capita. the main variable used to describe the phenomenon is called "fdi," which indicates the net inflow (inflows minus outflows). conversely, gc denotes the process of creating gross fixed capital. the variable l denotes the rate of labor growth, whereas the variable fdpvt reflects the level of fnd, proxied by the ratio of private sector credit to gdp. the variable "inf" indicates inflation as measured by the gdp deflator. the term (hc) is used as a proxy for human capital development in the penn world table (version 9.0), which provides data on average years of schooling and returns to education. the notion “(ƒdiit*lnfdit)” denotes an interaction term that captures the relationship between fdi in trade and the degree of financial development. the parameters α, β, and δ are the variables and vectors of variables that must be determined in relation to financial development. the symbol t represents the impacts that are specific to a certain era, whereas the symbol łi represents asian journal of economics and empirical research, 2024, 11(2): 141-148 144 © 2024 by the author; licensee asian online journal publishing group the effects that are distinct to a particular nation. the error term is represented by the symbol ψit. the study utilizes the natural logarithms of all the given variables. equation 2 presents the natural logarithms of all the given variables. △ iny𝑖𝑡 = 𝛽0 + 𝛽1iny𝑖𝑡−1 + 𝛽2𝐼𝑛𝑓𝑑𝑖𝑖𝑖𝑡 + 𝛽3𝐼𝑛𝑝𝑣𝑐𝑡𝑖𝑡 + 𝛽4𝐼𝑛𝑙𝑖𝑡 + 𝛽5𝐼𝑛ℎ𝑐𝑖𝑡 + 𝛽6𝐼𝑛𝑖𝑛𝑓𝑖𝑡 + 𝛽7𝐼𝑛𝑓𝑐𝑓𝑖𝑡 + 𝛽8𝐼𝑛𝑡𝑜𝑝𝑒𝑛𝑖𝑡 + 𝛽9(𝑓𝑑𝑖𝑖𝑖𝑡 ∗ 𝐼𝑛𝑝𝑣𝑐𝑡𝑖𝑡−1) + ł𝑖𝑡 + 𝛹𝑖𝑡 + 𝜇𝑖𝑡 (2) equation 3 allows us to calculate the specific impact of fnd on the overall growth of fdi. this is achieved by utilizing two coefficients, β2 and β9. this is accomplished by performing a partial differentiation of the function ∆ln(yit). 𝜕𝐼𝑛𝑦𝑖𝑡 𝜕𝐼𝑛𝑓𝑑𝑖 = 𝛽2 + 𝛽9𝐼𝑛𝑝𝑣𝑐𝑡 (3) 3.2. data source the estimation of our model is based on an unbalanced panel dataset comprising seventy emerging economies throughout the period from 1990 to 2023. refer to appendix a1 for a comprehensive list of the countries covered in this study. the collection of these nations is determined based on the availability of data. table 1 provides a statistical description of the model variables. the required dataset encompassing gross domestic product, labor growth rate, physical capital formation, financial development, and inflation is sourced from the world development indicators (wdi). the united nations conference on trade and development (unctad) is the primary authority on trade openness and fdi. the penn world table edition 9.0 is the source of statistics on human capital, encompassing information on schooling years and returns to education. the description and basic statistical measures for each variable are presented in table 1. table 1. descriptive statistics. variables minimum mean maximum lny −2.99 1.79 8.35 lnhc 1.017 2.451 4.219 lnfdi −6.28 3.878 44.346 lngfcf −0.319 19.325 198.645 lnl −0.151 1.941 4.521 lnpvct 0.579 41.623 202.256 lninf 0.381 11.514 235.583 lnopen 18.441 43.293 179.119 the definition and sources of variables are mentioned in table 2. table 2. definition and sources of variables. symbol variables source lny the growth rate of per capita gdp wdi lnhc years of schooling and returns to education (pwt version 9) pwt lnfdi fdi net inflows as a % of gdp unctad lngfcf physical capital formation as a % of gdp wdi lnl labor growth rate as a % of total population age (15-64) wdi lnpvct private credits as a % of gdp wdi lninf inflation rate wdi lnopen trade openness as a share of gdp unctad 3.3. analytical strategy existing studies, including gui-diby (2014); bouchoucha and yahyaoui (2019) and albulescu (2015), offer additional insights into the persistent disagreement regarding the connection between fdi and eg. they specifically focus on empirical debates that question the accuracy of growth models. conclusions state that the gmm estimator is a suitable instrument for addressing endogeneity challenges. however, it tends to overestimate the rate of convergence in the growth model for the case of a panel dataset. the system gmm estimator employs internal instruments to mitigate the potential for endogeneity in the variables that describe the system. numerous investigations have widely utilized the lagged values of important explanatory variables as internal instrumental variables (ivs) because of their high accuracy. therefore, we employ the gmm estimator to estimate our dynamic growth model. this is based on the study undertaken by carkovic and levine (2002) as well as other similar publications. using this empirical approach, our research examines the impact of fdi on economic development by using time-lagged investment vehicles (ivs). in the research of manuel arellano and bond (1991), they developed a widely replicable strategy in the growth accounting literature to eliminate the unobserved influence. the model employs the pioneering generalized method of moments (gmm) difference estimators to calculate the dynamic panel data model. the first difference equation (equation 4) may be derived by modifying equation 1. (iny𝑖𝑡 − iny𝑖𝑡−1) =∝ +𝛽(iny𝑖𝑡−1 − iny𝑖𝑡−2) + 𝛿(x𝑖𝑡 − x𝑖𝑡−1) + (ł𝑖 − ł𝑖) + (𝛹𝑖𝑡 − (𝛹𝑖𝑡) (4) the gmm-difference technique aims to mitigate the specific effects originating from the source nation by calculating the initial differences of the basic growth equation and then eliminating them. to address the issues of simultaneity bias and endogeneity, the values of the variables that are used to describe the occurrence are lagged by two periods and then further postponed. in our inquiry, we utilize three distinct delayed durations as instruments. however, blundell and bond (1998) argue that using the lagged level of right-hand side variables as instruments for factors in differences is not effective. they explain that this is because the variables that explain the differences are consistently present throughout time. arellano and bover (1995) have found that the system-gmm estimators are highly successful in capturing country-specific effects while maintaining the cross-country dimension of the data. this is achieved by including equation 1 at the level of the difference equation. asian journal of economics and empirical research, 2024, 11(2): 141-148 145 © 2024 by the author; licensee asian online journal publishing group the system gmm estimator employs instrumented variables to account for potential endogeneity in all variables related to the explanation. to utilize these new instruments, it is necessary to assume that the original difference in explanatory factors is not correlated with these variables. furthermore, this paper also anticipates a consistent relationship over time. during the monte carlo simulations, it has been demonstrated that the system gmm estimators outperform the gmm-difference estimators in terms of the validity of moment requirements, as proven by blundell and bond (1998). the sargan (1958) is also employed to assess the validity of the present conditions and identify potential restrictions. the study also intends to test the null hypothesis, assuming that there is no secondorder serial correlation between the variables being studied and the error term (fingleton, 2023). 4. results and discussion our study examines the impact of fdi on the egt through the use of ordinary least squares and fixed effect approaches. subsequently, a gmm estimator is employed to assess the validity of the outcomes derived from these conventional methodologies. it is feasible to examine the data shown in table 3. table 3 describes the outcome of the ordinary least squares (ols) model. hence, the empirical evidence indicates that fdi has a detrimental effect on egt, as shown by the statistically significant negative coefficient of fdi. this finding aligns with the extensive body of earlier research undertaken by bouchoucha and yahyaoui (2019); saidi, mani, mefteh, shahbaz, and akhtar (2020) and rehman and noman (2022). the results of the fixed effects approach are reported in columns (2) and (3), based on the research conducted by wacziarg and welch (2008). by employing the hausman test, we may systematically choose between the fixed and random effects models. according to the test results, we propose using the fixed effects model for our investigation. the second column displays the results of the fixed effects method, excluding the interactive term. conversely, the coefficient of fdi has a statistically significant negative sign. the third column shows that the value of the interacting term between fdi and the degree of fnd is positively signed and statistically significant at the 1% level. it is implied that in certain developing nations, the enhancement of egt through fdi necessitates synchronization with the degree of fnd in the host country. to fully capitalize on fdi, emerging nations must enhance their domestic financial infrastructure. this study shows that the extent of fnd acts as a conditioning factor that is accountable for the overall positive influence of fdi growth. the current study literature provides data suggesting that the challenges of endogeneity persist by relying solely on the results obtained from fixed effect approaches. fdi is a quantitative measure that has the ability to show a correlation with the remaining unexplained factors in the equation. fdi-growth correlations may also be impacted by unseen elements or traits of nations. moreover, countries undergoing rapid economic growth are more inclined to utilize fdi due to the availability of advanced technology, as fdi promotes the dissemination of knowledge and stimulates economic development. in addition to the existing problems, some variables have already been ignored and are theoretically believed to be linked to fdi and real economic growth. therefore, system-gmm estimators have been used to evaluate the dynamic model and address endogeneity issues. in columns 4 and 5, respectively, the findings are displayed both with and without the addition of interaction conditions. the development of a system gmm estimator is attributed to the work of arellano and bover (1995) and blundell and bond (1998). if it is determined that the lagged values of the regressors are valid instruments, then the reliability of the two-step gmm estimator may be assumed. this study utilizes two time-period delays for estimating the results. by employing the sys-gmm technique, which is a more sophisticated estimation approach compared to the fixed effect method, we establish a specific threshold for the degree of financial development. beyond this threshold, we see a positive influence of fdi on gdp growth. this is performed based on equation 3, as explained in section iii, a. the results obtained through the use of sys-gmm are presented in column 4 of table 3, without the inclusion of any interaction terms. the coefficient for fdi has a negative sign with a magnitude of -0.139, indicating that it is statistically significant at the 10% level. this indicates that the correlation between fdi and gross domestic product (gdp) growth is weak. multiple studies, such as those by agbloyor, abor, adjasi, and yawson (2014) and gui-diby (2014) have examined the relationship between fdi and economic growth in emerging economies; however, they have yielded ambiguous findings. column 5, however, shows that the values of the interaction factor (lnfdi*lnpvct) are positively signed and exhibit statistical significance at the 5% critical threshold. the coefficient value of the interaction term between fdi and the human capital development level is positive and statistically significant. this means that the effect of fdi on egt is only positive when the level of fnd exceeds the threshold of 1.563 (−0.486 + 0.311 lnpvct). based on the data shown in table 1, the threshold value is lower than the average fnd value for the entire group, which is 2.351. our findings suggest that fdi is a significant driver of gdp growth in the majority of the nations included in our sample. meanwhile, it has been found that fdi has an adverse impact on the gdp growth of economies that fall below this threshold. hence, to maximize the advantages of fdi, enterprises must ensure prudent measures to manage their financial expansion. the threshold value analysis has revealed that the fnd level in sixty-one out of seventy nations has consistently been above the barrier for several years. however, many emerging economies have shown a significantly lower level of financial progress compared to this standard over the entire period of observation. to fully capitalize on the positive impact of fdi on egt, they are still striving to close the gap. the obtained results are reliable for nations with a private credit-to-gdp ratio exceeding the specified threshold. hence, countries with a larger percentage of private credit as a proportion of their egt in a particular year, above the threshold level for the full sample, have a favorable impact on egt through fdi at the same level of fdi. countries with a private credit-to-gdp ratio below this level do not see a positive impact on gdp growth from fdi. therefore, the results remain constant regardless of the model parameters and estimating methodologies used in the study. kusi, gyeke-dako, agbloyor, and darku (2018) state that in order to enhance the growth of gross domestic product (gdp) in the sample nations, it is necessary to coordinate the findings derived from the interaction impact of fdi and the degree of fnd. this supports the idea that economically advanced countries may effectively use resources by engaging in foreign investments. in summary, a strong financial sector leads to a substantial beneficial effect on gdp growth when there is an increase in fdi. there is a strong correlation between a substantial rise in the percentage of gdp made up of private credit and a high egt. based on theoretical models, it is predicted that asian journal of economics and empirical research, 2024, 11(2): 141-148 146 © 2024 by the author; licensee asian online journal publishing group the impact of fdi on egt may vary depending on the level of fnd in the nations being studied. this finding aligns with these ideas. the results for the bulk of the control variables include widely anticipated signals. mankiw, romer, and weil (1992) argue that the idea of conditional convergence is supported by the observation that the estimates of the lagged dependent variable have adverse and statistically significant signs in both models (column 5 and column 6). across all models, the coefficients of the labor growth rate exhibit positive and statistically significant expected signals. this is because rising nations are commonly distinguished by their reliance on labor-intensive industries. busse and groizard (2008) argue that the strength and growth rate of labor are crucial determinants in estimating economic growth. this is due to their significant impact on economic activities, such as the establishment and operation of large-scale markets for goods and services. our research aligns with the conclusions of agbloyor et al. (2014), who assert that the growth of the workforce is the main catalyst for consumer expenditure and, consequently, egt. the coefficients of human capital have positive signs, although they lack statistical significance despite their positive nature. both king and levine (1993) have discovered a favorable correlation between the development of human capital and the growth of gdp. this finding aligns with the widely held notion that this correlation does indeed exist. for most of the models, it was found that the inflation coefficients were both numerically negative and statistically significant. the results of this study align with the investigations carried out by temple (1999) and rousseau and wachtel (2002) as well. based on this finding, it seems that inflation tends to have an adverse impact on gdp growth. this is because inflation often serves as a sign of macroeconomic instability and mismanagement. conversely, some theoretical studies (e.g., kusi et al. (2018)) have indicated that moderate inflation has a positive impact on egt. the coefficients of fixed capital investment exhibit a positive and statistically significant correlation with nearly all of the equations. haq and luqman (2014) conducted a study using the dynamic panel growth model to evaluate the correlation between capital stock and egt for nine asian emerging economies from 1972 to 2012. their findings support this conclusion. they discovered a significant correlation at that time. for every calculated model, the coefficients of the trade openness index are consistently shown to be positive and statistically significant. this conclusion supports the findings of omri and kahouli (2014) that trade openness promotes egt in impoverished nations, indicating that trade openness indeed improves egt. to verify the authenticity of all independent variables (ivs), we conduct three tests and provide the corresponding statistical data. the tests used include the k.p. wald f test to assess weak identification, the hansen j-test to evaluate excessive identification, and the test to determine under-identification. table 3 displays the findings of the econometric specification tests, providing statistically substantial proof of the ivs' legitimacy. the appropriate instruments for conducting the hansen j-test of over-identification may be found in columns 5 and 6, respectively. the outcomes of the sargan-hansen j-test for over-identification are displayed at the bottom of table 3. this test provides evidence that the additional instruments used in system gmm estimators are valid and do not disprove the accuracy of the null hypothesis. furthermore, the ar (1) test is rejected, but the ar (2) test cannot be rejected. consequently, this suggests that the hypothesis of no second-order serial correlation in the residuals is satisfied. furthermore, to mitigate the problem of overfitting caused by an excessive number of instruments, the number of cross-sections is deliberately kept smaller than the number of instrumental variables. since fdi and certain control variables are both endogenous in relation to growth, our empirical method is vulnerable to endogeneity issues (nistor & hernández-garcía, 2018). the prevalence of the endogeneity problem may increase as egt rises (glaeser, la porta, lopez-de-silanes, & shleifer, 2004). furthermore, a part of this problem may be reduced simply by engaging in a range of different activities, where the number of time delays for variables that occur at the same time (excluding the variable being studied) is extended as much as possible. according to nistor and hernández-garcía (2018), this implies that there are still fewer instruments compared to the number of cross-sections. the results suggest that the impact of fdi on egt depends on the extent of fnd in certain emerging economies. based on our findings, fdi has a beneficial effect on egt for countries with a level of fnd that exceeds a certain threshold value. the level of fnd is a contingent factor that influences the impact of fdi. furthermore, the conditional effect of fdi on growth provides a resolution to the ongoing debate in academic literature. it fills a gap in theoretical research and provides empirical evidence for the existing controversy about the impact of fdi on egt. moreover, the results suggest that fdi is beneficial for some emerging economies that possess well-established financial institutions. the governments of developing nations must prioritize the growth of their financial sectors to maximize the benefits of fdi inflows. table 3. the ols, fixed effect and system-gmm for the model of fdi and egt. △lnyit (1) (2) (3) (4) (5) ols fe fe gmm gmm lnyt-1 ------ −0.068** (0.030) −0.093*** (0.027) lnfdi −0.08** (0.085) −0.118* (0.082) −0.546*** (0.140) −0.142* (0.121) −0.479** (0.201) lnpvct 0.721** (1.193) 0.611** (1.182) 1.901** (1.208) 0.341** (1.991) 0.472*** (1.591) lnl 0.167* (0.205) 0.139** (0.199) 0.100** (0.195) 0.835*** (0.309) 0.871*** (0.222) lnhc 0.021** (0.031) 0.013** (0.031) 0.011** (0.031) 0.311* (0.021) 0.011 (0.017) lninf −0.131 (0.082) −0.129 (0.083) −0.163** (0.081) −0.122 (0.105) −0.070 (0.054) lngfcf 0.390*** (0.253) 0.387** (0.255) 0.329** (0.250) 1.233*** (0.333) 1.120*** (0.182) lnopen 0.070** (0.168) 0.258** (1.589) 0.303*** (1.563) 0.227** (0.157) 0.127** (0.116) lnfdi * pvct 0.418*** (0.163) 0.314*** (0.226) constant 3.341 1.118 1.473 2.314*** 3.524*** asian journal of economics and empirical research, 2024, 11(2): 141-148 147 © 2024 by the author; licensee asian online journal publishing group △lnyit (1) (2) (3) (4) (5) ols fe fe gmm gmm (2.330) (0.082) (2.121) (1.162) (1.332) observations 2,270 2,270 2,270 2,270 2,270 r-squared 0.513 0.532 0.641 0.619 0.623 number of countries 70 70 70 70 70 note: (1): parentheses shows robust standard errors. (2): ***, **, and * shows level of significance at the 1%, 5%, and 10% level respectively. the marginal effect in equation 3 changes when there is a shift in the level of financial development. table 4 offers a detailed explanation of the marginal impact and the significance of the interaction. it includes examples at the mean, minimum, and maximum levels. table 4. marginal impact of financial development in fdi and egt model using gmm. 𝜕𝐼𝑛𝑦𝑖𝑡 𝜕𝐼𝑛𝑓𝑑𝑖 = 𝛽2 + 𝛽9𝐼𝑛𝑝𝑣𝑐𝑡 fdi mean value maximum value minimum value 1.821 2.015 1.013 5. conclusion the process of globalization has led to a significant increase in fdi flows. developing nations have consistently faced severe challenges in terms of the performance of fdi. the empirical research on the impact of fdi on egt in developing nations presents conflicting findings. this study aims to fill a gap in the present research by examining the relationship between fdi and egt in a selection of emerging economies. the study also considers the level of fnd as a factor that may influence this relationship. the results of this study suggest that the level of fnd has a significant role in determining the relationship between foreign direct investment and egt. fdi enhances the growth of a financially advanced country. hence, emerging economies aspiring to match the pace of economic expansion should initiate the establishment of their financial institutions in order to effectively compete in the global market. for this study, a dataset of seventy developing nations from 1980 to 2015 is employed. system gmm estimators are used as a management tool for addressing endogeneity concerns. based on the assumption that annual growth rates can vary significantly due to the cyclical volatility of gdp growth, which may appear large in yearly data and lead to inaccurate growth estimates, we assess the model using five-year averaged data to ensure the results are as reliable as possible. the basic insights that we have made are validated by consistently achieving outcomes. our empirical study findings indicate that the level of fnd is a crucial factor that influences egt through foreign direct investment in several emerging economies. this study is limited to investigating the complementary role of fnd in affecting egt through fdi in the case of 68 emerging economies across the globe. in the future, studies may be carried out to investigate the complementary role of fnd in affecting egt through fdi in the case of g7, oecd, and next 11 countries. furthermore, policymakers must evaluate the conditional impact in order to promote growth and maximize the potential of the interconnected global economy. although there may be other mechanisms at play in this scenario, including nonlinearities and threshold panel regressions, they might prove beneficial and thus offer promising avenues for future study. references abdel-gadir, s. 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